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Working Capital Loan

A company might be faced with shortage of funds to meet their day-to-day expenses. Essentially, when they are in need of a short-term loan, banks and NBFCs are prepared to fund them with a Working Capital Loan. These loans are short-term loans required to meet some daily expenses like wages, utilities, rent, etc.

Working capital loan is most suitable for small and medium enterprises (SME) who are unable to generate a sustained or stable income throughout the year and need liquidity to meet their daily business needs. Certain businesses that can be termed seasonal, which earn a huge part of their income only during peak seasons are an example for businesses requiring this type of loan.

Working capital loans are a great way for the business to tackle unexpected expenses without hampering its growth. It has become quite popular among Indian businessmen, where festival-sales is a big thing. They obtain this short-term loan to meet their business needs during off-season and repay the loan with their peak-season sales. These loans are unsecured loans, unless the loan amount is huge. The loan tenure usually ranges between 6-12 months.

Working Capital Loan
Working Capital Loan

When should you consider a Working Capital Loan?

Working capital loans are small-term loans, predominantly availed to meet day to day business needs. Following are some of the reasons to be considered to avail one:

  • Off-season sale impact :

    As discussed before, off-season sales decline is one of the major reasons directing business owners to seek a working capital loan. This loan amount is utilized for expenses like salaries, utilities, rent and petty cash

  • Cash flow :

    This loan can be used to introduce some additional cash flow into the business, which could be used for raw material purchase, transport expenses and other smaller expenditure.

  • Delivery-Payment Gap :

    There arises certain times in business, when the buyer requests additional time to make payment. During such period, this loan provides financial support to the seller

  • Utilize business opportunities :

    When a new business opportunity presents itself, lack of funds shouldn’t hamper its progress. Working capital loan provides you with the necessary funds to capitalize on such opportunities.

What are the advantages of a Working Capital Loan?

A working capital loan is offered on existing orders or pending invoices which assures the banker/lender of the repayment, thus reducing the stress for both the parties involved. There are a few other advantages of this type of loan.

  • No collateral/security :

    A good credit history with the lender/bank will assure that the loan is offered for no collateral. In some cases where the loan amount is pretty high, the lender might require documents relating to pending invoices or orders or other substantial collateral

  • Quick and hassle-free processing :

    Since this loan is usually sought out by existing customers, the loan processing is pretty quick. There are lenders who process these loans within 24 hours

  • No restriction on spending :

    There is no restriction set by the lender on how the loan amount is spent, as long as it is for business improvement

Types of Working Capital Loans

Before applying for a working capital loan, it is wise to understand the types of credit one can avail through this loan

  • Cash Credit/Bank Overdraft :

    This is the most common form of working capital aid. It is a cash/credit facility extended by the lender to the applicant’s account. It is much preferred since the interest is charged only on the amount that is used and not on the total approved amount. This encourages the borrower to remit amounts back into the account to effectively reduce the interest burden.

  • Trade Credit :

    This facility is extended by a present or potential supplier of a business. It is offered upon thorough evaluation of your business credit history, which is presented through profit books, liquidity statement and payment records.

  • Purchase or Discounting of Bills :

    This is another common form of availing working capital by small business owners. They sell their pending bills to the lender for a discount and applicable interest rates to obtain immediate cash. This method infuses liquidity into the business for lesser interest rates.

  • Short-term loans :

    Short-term loans are essentially term loans, for a shorter period of up to 12 months. They are offered with a fixed interest rate and is primarily based on the credit relationship with the applicant.

  • Invoice Factoring :

    It is similar to discounting of bill, however here the factor takes on the responsibility of getting the payment from the customer directly. They also take credit control of the business and processing of invoice payments.

Working Capital Loan Eligibility :

Age Eligibility – You should be between 25-65 years, though the age limit may vary depending on the lender

Age of Business – Your business should be at least 3 years old

Ownership type – Working capital loan can be availed by

  • Sole Proprietorships
  • Partnership firms
  • Private and Public Limited Companies
  • Self-employed professionals, viz; Allopathic doctors, Chartered Accountants, Company Secretaries and architects with an established business practice

Interest rates – The rates are similar to business loans. The prevailing rate is between 12%-18%

Tenure of the loan – These are short-term loans and hence extend up to 12 months. However, the tenure could vary based on the credit type and the discretion of the bank

Documents – The following documents are generally required by the lender. Additional documents as requested by the lender needs to be submitted

  • KYC Documents
  • Passport size photographs
  • Business Proof: Certificate of Incorporation, Memorandum of Association, Articles of Association, etc;
  • Financial audit documents
  • Income tax documents
  • Bank statements

Pros and Cons of a Working Capital Loan

A working capital loan is the simplest way to infuse liquidity in to the business. It helps in maintaining the stability of the business and increase its functional efficiency during lean times. These loans are a great help in eliminating small hiccups in the business process, which do not need a huge long-term loan. These are short-term loans with flexible repayment option, which will help in maintaining a healthy credit rating for the business.

However, the interest rates on this loan is high due to the high risk factors involved. It is important to maintain accurate accounts of the business transactions to avoid over-borrowing. Also, repayment terms are to be adhered to very strictly. Any missed payments will have a great effect on the credit rating of the business.

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