Three products, one confusion — and it's costing SMEs money
Walk into any bank or speak to any lending platform about working capital, and you'll hear three terms thrown around almost interchangeably — overdraft, term loan, and cash credit. Most business owners nod along as if they understand the difference. Many don't. And using the wrong one for your business need is one of the most common — and most expensive — financing mistakes SMEs make.
These are not the same product. They work differently, cost differently, and suit different business situations. Here's a clear, plain-language breakdown of all three — so you can walk into any lender conversation knowing exactly what you need and why.
Option 1 — Term loan
A term loan is the most straightforward of the three. You borrow a fixed amount, receive it in one lump sum, and repay it in fixed monthly instalments — EMIs — over a defined period. The interest rate can be fixed or floating, and the repayment schedule is set from day one.
Think of it like a purchase on EMI. You know exactly what you owe, exactly what you'll pay each month, and exactly when you'll be debt-free.
Best suited for:
- A specific, one-time investment — buying equipment, expanding a facility, renovating a space
- Situations where you need a defined amount and have a clear repayment plan
- Businesses that want predictability — same EMI every month, no surprises
- Long-term financing needs — tenures typically range from 1 to 7 years
The limitation: A term loan is inflexible. Once disbursed, the money is yours — but you're paying interest on the full amount whether you've deployed all of it or not. And if your needs change, you can't redraw funds you've already repaid.
Option 2 — Overdraft
An overdraft facility is a pre-approved credit limit linked to your current account. You can draw from it whenever you need — up to the sanctioned limit — and repay it as funds come in. Interest is charged only on the amount you actually use, for the number of days you use it.
Think of it like a financial buffer. The limit is always there. You dip into it when needed and top it back up when your cash flow improves.
Best suited for:
- Managing day-to-day cash flow gaps — salary dates, supplier payments, tax dues
- Seasonal businesses where revenue fluctuates significantly month to month
- Businesses with unpredictable or lumpy cash flows
- Situations where you want flexibility — draw only what you need, repay when you can
The limitation: Overdraft interest rates are typically higher than term loan rates. And because there's no fixed repayment schedule, some business owners fall into the trap of treating it as permanent debt rather than a short-term bridge — which gets expensive quickly.
Option 3 — Cash credit
Cash credit is structurally very similar to an overdraft — it's a revolving credit facility with a limit that you can draw from and repay repeatedly. The key difference is that cash credit is typically secured against current assets — your stock, debtors, or receivables — whereas an overdraft may be secured against fixed assets or offered on an unsecured basis.
Cash credit is the most common working capital facility for trading and manufacturing businesses in India, where stock and receivables form the bulk of business assets.
Best suited for:
- Trading businesses with large inventory holdings
- Manufacturers who need to fund raw material purchases before they convert to finished goods and revenue
- Businesses whose working capital needs fluctuate with their stock levels
- Borrowers who have significant current assets to offer as security
The limitation: Because cash credit is tied to current assets, lenders periodically reassess the drawing limit based on stock statements and debtor reports — which adds an ongoing administrative requirement. Drawing limits can also be reduced if stock levels fall.
How all three compare side by side
| Factor | Term loan | Overdraft | Cash credit |
|---|---|---|---|
| How funds are received | Lump sum, one time | Draw as needed, up to limit | Draw as needed, up to limit |
| Repayment structure | Fixed EMIs every month | Flexible — repay when cash available | Flexible — repay when cash available |
| Interest charged on | Full loan amount | Amount used, days used | Amount used, days used |
| Security required | May be secured or unsecured | Fixed assets or unsecured | Current assets — stock, debtors |
| Tenure | Fixed — 1 to 7 years typically | Renewed annually | Renewed annually |
| Interest rate | Lower — more structured risk | Slightly higher | Similar to overdraft |
| Best for | Specific investments | Cash flow management | Stock and trade financing |
| Flexibility | Low — fixed terms | High — draw and repay freely | High — but tied to asset levels |
The most common mistake — using a term loan for working capital
This is the single biggest mismatch we see SME owners make. They take a term loan to manage working capital needs — because it's familiar and straightforward — and end up paying interest on a large lump sum they don't need all at once, with fixed monthly outflows that don't match their variable cash flow.
Working capital is by nature revolving. Money comes in, money goes out, and the gap shifts every month. A revolving facility — overdraft or cash credit — is built for exactly this pattern. A term loan is not.
Conversely, taking an overdraft to fund a long-term asset purchase is equally problematic. You end up repeatedly renewing a short-term facility to fund something that should have been structured as a long-term repayment — and paying more in interest along the way.
The second most common mistake — not knowing which one you qualify for
Overdraft and cash credit facilities are typically harder to access than term loans for newer or smaller businesses. They require a banking relationship, a track record, and often security. Many SMEs default to term loans not because they're the best fit — but because they don't know whether they qualify for a revolving facility, or because no one has offered them one.
This is where working with the right platform makes a real difference. Rather than applying to one lender and getting whatever they offer, a platform that matches you across multiple lenders can surface options you didn't know were available — including revolving facilities that might suit your business better than a standard term loan.
How to decide which one is right for your business
Ask yourself these three questions:
1. Is this a one-time need or an ongoing one? If you need a specific amount for a specific purpose — buy equipment, fund expansion, make a one-time purchase — a term loan is the right fit. If your need is ongoing and variable — managing day-to-day cash flow, funding stock, bridging payment gaps — a revolving facility is better.
2. How predictable is your monthly cash flow? If your revenue is steady and predictable, fixed EMIs on a term loan are manageable. If cash flow is lumpy or seasonal, the flexibility of an overdraft or cash credit is more valuable.
3. What assets do you have to offer? If you have significant stock or receivables, cash credit against those assets may give you better rates and higher limits. If your assets are primarily fixed — property, equipment — an overdraft against those may work. If you have limited assets, an unsecured term loan or overdraft is the path to explore.
The right product changes everything
The difference between the right working capital facility and the wrong one isn't just about interest rates. It's about whether the product fits how your business actually operates — how cash flows in and out, how predictable your revenues are, and what you actually need the money for.
Getting this right from the start saves you money, reduces financial stress, and gives your business the kind of flexible, well-structured financing that supports growth rather than creating a fixed monthly burden.
Platforms like Finseich help SME owners navigate exactly these decisions — matching your business profile and need to the right product and the right lender, so you're not choosing blindly between options you only half understand.
Know what you need — before you walk in the door
The next time a lender asks what kind of facility you're looking for, you'll have a clear answer. And that clarity — knowing the difference between a term loan, an overdraft, and cash credit — puts you in a far stronger position to get the right product at the right terms.
Because the best loan for your business is the one that fits how your business actually works. Find the right working capital facility for your business on Finseich →