Most business owners ask a bank for "a loan". The bank's first question back is: a loan for what? Machinery, a factory shed, stock for the festive season and a gap between paying suppliers and collecting from customers are four different needs, and banks fund them with different facilities.
Pick the wrong one and the costs show up later. Funding a machine out of cash credit squeezes the money you need for stock. Funding stock with a fixed-EMI term loan means paying interest on money that sits idle in slow months.
This guide covers the four facilities MSMEs, traders and manufacturers use most: term loans, cash credit (CC), overdraft (OD) and working capital demand loans (WCDL). If you are a contractor, our separate guide on working capital for contractors covers bank guarantees, retention money and bill discounting.
What is a term loan, and when should you use one?
A term loan is a fixed amount, disbursed in one go or in stages, and repaid in instalments over an agreed period. It is meant for assets that earn over several years:
- plant and machinery, equipment and vehicles
- a factory, warehouse or office (construction or purchase)
- expansion or modernisation projects
- in some cases, the long-term part of your working capital (often called the "margin money")
Interest is charged on the outstanding principal. It falls as you repay, and you repay through EMIs or structured instalments, sometimes after an initial moratorium while a project is being built. Security is usually the asset being financed (hypothecation of machinery, mortgage of the building) plus collateral where the lender asks for it.
Lenders size a term loan mainly on future cash flows: can the business service the instalments out of profits? Larger loans usually need a project report. Our guide on project reports and what lenders want explains what goes into one.
What is cash credit, and how is drawing power calculated?
RBI defines cash credit as a facility where a customer is allowed an advance up to the credit limit against the security of hypothecated (or pledged) goods, book debts and similar current assets. It is a running account: you draw and repay as often as you like. The outstanding is repayable on demand, which is why banks review the limit every year.
You pay interest only on what you actually use. Most banks work it out on the daily outstanding balance and debit it monthly. An unused limit costs no interest, though banks may levy commitment or other charges under their own policies.
Drawing power, step by step
The sanctioned limit is the ceiling. What you can actually draw on a given day is your drawing power (DP). RBI says DP is fixed periodically from the value of your eligible current assets. In practice:
- Take the value of stock (raw material, work in progress, finished goods) from your latest stock statement.
- Deduct unpaid stock, meaning goods bought on credit that your suppliers are still owed for, since the bank won't fund stock you haven't paid for.
- Apply the stock margin in your sanction letter.
- Add eligible book debts (receivables). Debts older than the age limit in your sanction are usually excluded. Then apply the book-debt margin.
- Your DP is the total, capped at the sanctioned limit.
An illustration (figures and margins are examples only; your sanction letter governs):
| Item | Amount |
|---|---|
| Stock as per statement | ₹60 lakh |
| Less: unpaid creditors for goods | –₹10 lakh |
| Paid stock | ₹50 lakh |
| Less: 25% margin | –₹12.5 lakh |
| Stock available for DP | ₹37.5 lakh |
| Eligible book debts | ₹20 lakh |
| Less: 40% margin | –₹8 lakh |
| Book debts available for DP | ₹12 lakh |
| Drawing power | ₹49.5 lakh |
With a sanctioned limit of ₹60 lakh, you could draw only ₹49.5 lakh that month. Margins differ from bank to bank. HDFC Bank, for example, says it funds dealers against stocks and book debts with a minimum 25% margin.
Stock statements: the paperwork that keeps your account regular
Under RBI's asset-classification directions, drawing power has to be based on a current stock statement. If the statement the bank relies on is more than three months old, the outstanding is treated as irregular. Most sanction letters ask for monthly statements. Larger limits often also need periodic stock audits.
Two more RBI rules matter for every CC or OD account:
- "Out of order" for 90 days. If the balance stays above the limit or drawing power for 90 days in a row, gets no credits for 90 days, or the credits don't cover the interest debited over the previous 90 days, the account is out of order. An account that stays out of order can be classified as a non-performing asset (NPA).
- Annual review. Regular and ad hoc limits have to be reviewed. If a limit isn't reviewed or renewed within 180 days from the due date, the account can be classified as an NPA. So send your audited financials, stock details and projections on time each year.
What is an overdraft, and how is it different from cash credit?
An overdraft (OD) lets you withdraw more than the balance in your current account, up to an agreed limit. The difference from cash credit is what backs it:
- Cash credit rests on your current assets (stock and receivables), so drawing power moves with them.
- Overdraft usually rests on other security: a fixed deposit, property (a common route for business owners), securities, or for strong borrowers no specific security at all. There is typically no monthly drawing-power calculation tied to stock.
Interest works the same way as CC: on the amount used. ODs suit service businesses and professionals with few inventories, and short, irregular gaps. Exact product terms vary by bank. If you plan to back an OD with property, our comparison of loan against property and lease rental discounting is a useful next read.
What is a working capital demand loan (WCDL)?
A WCDL is a short-term loan carved out of your working capital limit, for a fixed amount and fixed tenor (often days or months), repaid in one go or in instalments. Because it is a loan rather than a running account, its interest can be lower than CC for money you know you'll need for a set period, such as a seasonal stock build-up.
For large borrowers it isn't optional. Under RBI's loan system for delivery of bank credit, now part of the Credit Risk Management Directions, 2025, a borrower with aggregate fund-based working capital limits of ₹150 crore or more from the banking system must keep at least 60% of the sanctioned fund-based working capital limit as a "loan component". Only the rest can be drawn as cash credit or overdraft. The loan component has a minimum tenor of seven days, and export credit and inland bill limits are excluded when the split is worked out. Smaller borrowers can still ask for a WCDL; whether to offer one is up to the bank.
Primary vs collateral security: what's the difference?
- Primary security is the asset created from the loan itself: the machine bought with a term loan, or the stock and receivables funded by cash credit (by hypothecation: the bank holds a charge while you keep possession).
- Collateral security is extra: property, deposits or guarantees offered on top, to cover the bank if the primary security falls short.
For micro and small enterprises, RBI rules and CGTMSE help here. Banks should not take collateral for MSE loans up to ₹20 lakh (from April 2026), and CGTMSE can guarantee collateral-free credit. Our contractors' guide covers these MSME benefits in more detail.
How much working capital will a bank give?
For micro and small enterprises with fund-based limits up to ₹5 crore, RBI's MSME FAQs say working capital should be assessed at a minimum of 20% of projected annual turnover. Above that, banks use their own Board-approved methods, typically based on your operating cycle: how long stock sits, how long customers take to pay, and how much credit your suppliers give you.
Which bank can keep your current, OD and CC accounts?
In August 2020 RBI restricted which banks could open current accounts for borrowers who had cash credit or overdraft facilities elsewhere, to stop funds being routed away from lending banks. Those rules were later relaxed, and from 1 April 2026 a new framework applies:
- Cash credit accounts: no restriction. A bank may provide CC as per the customer's needs.
- Banking-system exposure below ₹10 crore: any bank may keep your current account or OD account.
- Exposure of ₹10 crore or more: a bank can keep your current or OD account if it has at least a 10% share of the banking system's total (or fund-based) exposure to you. If no bank, or only one bank, qualifies, the two banks with the largest exposure can. Other banks may keep only collection accounts, which must pass funds on to your designated account within two working days.
If your borrowing is crossing ₹10 crore, plan your account structure before it does. Otherwise a bank may have to ask you to convert or close an account.
Interest rates, resets and switching lenders
We don't quote rates, because they depend on your rating, security and the lender. Two RBI rules apply across the board:
- Floating-rate loans to MSMEs must be linked to an external benchmark (such as the repo rate), and the rate must be reset at least once every three months.
- Pre-payment charges: for floating-rate business loans to individuals and micro and small enterprises sanctioned or renewed from 1 January 2026, commercial banks cannot levy pre-payment charges. For CC and OD, no charge applies if you tell the bank in advance that you won't renew and close the facility on the due date.
Term loan vs cash credit vs overdraft vs WCDL: comparison
| Term loan | Cash credit | Overdraft | WCDL | |
|---|---|---|---|---|
| Best for | Machinery, buildings, expansion | Stock and receivables | Short, irregular gaps | Known, time-bound needs |
| How you draw | Lump sum or stages | Running account, up to drawing power | Running account, up to limit | Fixed amount, fixed tenor |
| Interest on | Outstanding principal | Amount used | Amount used | Full loan amount for tenor |
| Repayment | Instalments | Repayable on demand; reviewed yearly | Repayable on demand or at expiry | Bullet or instalments at maturity |
| Primary security | Asset financed | Hypothecated stock and book debts | FD, property or other security | Same as working capital limit |
| Key paperwork | Project report, financials | Monthly stock statements, annual review | Periodic review | Part of working capital review |
Which should you choose?
- A trader or distributor whose stock turns over every month: cash credit, perhaps topped up with a WCDL before peak season. Dealers of large brands may also qualify for dealer and distributor finance.
- A manufacturer buying a new machine: a term loan for the machine, plus cash credit enhanced to fund the extra raw material and receivables the machine will create.
- A service business with a property but little stock: an overdraft against property or deposits.
- An exporter or importer: packing credit, bill discounting and letters of credit. See our guide to trade finance for MSMEs.
The most common mistake we see is funding long-term assets out of short-term limits. It eats your drawing power and can push the account out of order. Lenders spot it quickly too. Mismatched facilities are one of the reasons covered in why loan applications get rejected.
How Biz Corp Solutions helps
We help MSMEs, traders and manufacturers work out the right mix of term loan, cash credit, overdraft and WCDL for their business cycle. We prepare the financials, projections and stock data lenders expect, and approach suitable banks, NBFCs and financial institutions across Maharashtra, Gujarat and Karnataka. Sanction, limits and terms are always the lender's decision. Explore our inventory funding and project funding services.