Bank Overdraft and Cash Credit: Treatment as Current Liabilities
Both bank overdraft and cash credit are short-term financing options provided by banks to businesses and individuals. However, there is a fundamental difference in their nature that impacts their treatment as current liabilities.
What is a Bank Overdraft?
A bank overdraft occurs when an account holder withdraws more funds than they have available in their account. This essentially means they are borrowing money from the bank, and the amount borrowed is treated as a current liability in the balance sheet. The overdraft limit is typically set by the bank, and interest is charged on the outstanding amount.
What is a Cash Credit?
Cash credit is a type of loan facility provided by banks, where the borrower is allowed to withdraw a specific amount of money within a certain period. The borrower has the flexibility to draw down the credit line as needed and repay it in installments. This also constitutes a current liability as the outstanding amount is a short-term debt.
Why are they considered current liabilities?
Both bank overdraft and cash credit are considered current liabilities due to their short-term nature. The repayment period for these facilities is typically within a year, making them fall under the definition of short-term debts. Current liabilities are typically settled within a year and reflect the company's immediate financial obligations.
Key Differences:
While both are considered current liabilities, there are key differences between bank overdraft and cash credit:
- Purpose: Bank overdraft is used to cover temporary cash shortfalls, while cash credit is used for various business needs like working capital or inventory financing.
- Interest rate: Bank overdraft generally carries a higher interest rate than cash credit.
- Repayment: Bank overdraft is typically repaid on demand, while cash credit is repaid in installments over a fixed period.
Accounting Treatment:
- Balance Sheet: Both bank overdraft and cash credit are recorded as current liabilities in the balance sheet.
- Profit and Loss Account: Interest paid on both facilities is recorded as an expense in the profit and loss account.
Conclusion:
Bank overdraft and cash credit, despite their differing nature, are both considered current liabilities due to their short-term nature. Understanding the key differences between the two helps businesses make informed decisions on which financing option best suits their needs.