OD vs Term Loan
Overdraft vs Term Loan — The Working Capital Decision That Affects Every MSME
OD for revolving working capital swings. Term loan for one-time capex. Get this wrong and you either over-pay interest or under-fund operations.
The fundamental difference
Term loan
Lump-sum disbursement today, fixed EMI over fixed tenure. Interest charged on full amount from day 1. Best for one-time spends.
Overdraft (OD)
Approved limit you can draw and repay any time. Interest charged only on utilised amount, only for days used. Best for working capital swings.
Cash credit (CC)
Similar to OD but specifically for inventory/receivables financing. Drawing power = eligible receivables/inventory × lender's percentage.
Bill discounting
Specific form of working capital — lender discounts your accepted invoices, gives you cash upfront, recovers from your buyer on due date.
When to use which — by use case
- Buy machinery → term loan (one-time spend, long-life asset)
- Pay vendors during a 60-day receivables cycle → OD/CC (revolving)
- Festival season inventory build-up → OD/CC (peak need, then repay)
- Office renovation → term loan (one-time spend)
- Bridge a 30-day GST refund delay → OD (short-term, repay on refund)
- Expand to a new city → term loan for capex + OD for working capital
- Replace an old expensive loan → term loan (refinance)
- Bid for a large tender requiring bank guarantee → CC against margin
Cost comparison
₹20 L for 12 months — OD vs term loan cost
- Always need ₹20 L for 12 months → term loan cheaper (interest from day 1 either way)
- Need ₹20 L for 6 months, ₹0 for 6 months → OD much cheaper (interest only when used)
- Need ₹10 L average with ₹20 L peak → OD cheaper (interest on ₹10 L average)
- Need ₹20 L peak, ₹5 L trough → OD cheaper, but commitment fee may apply on unused
- Mixed use (some capex + some working capital) → term loan for capex + OD for working capital
FAQ
Common questions
Can I have both an OD and a term loan from the same lender?+
Yes — and it's often the optimal structure for MSMEs. A term loan for capex (machinery, expansion) plus an OD or CC for working capital. The lender sees both facilities, can underwrite them together, and may offer better combined terms than two separate lenders.
Is OD interest calculated daily?+
Yes — OD interest is charged on the daily utilised balance, typically debited monthly. This makes OD significantly cheaper than a term loan if your utilisation is irregular. The trade-off: most ODs have a 12-month renewable tenure, vs a term loan's fixed multi-year tenure.
What's the difference between OD and Cash Credit (CC)?+
OD is a generic overdraft against your banking relationship or collateral. CC is specifically for working capital against inventory and receivables — the lender sets a 'drawing power' based on your eligible current assets. CC tends to be cheaper (lower rate) but requires monthly stock/receivable statements. OD is simpler but often at a higher rate.
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