Working Capital Loans: Important Aspects You Must Know
The primary goal of running a business is making profits, but the underlying motive from the get-go is to never run into cash flow scarcity.
But, as your company evolves and grows, shortages in working capital can become a recurring problem. And it’s in these stages of scaling that companies, especially small and medium ones, struggle predominantly.
To that end, a working capital loan can alleviate the financial distress caused by cash flow deficits and allow your business to never lose the positive momentum. However, it’s essential to know the dynamics of this financing option in order to manage working capital more deftly.
Working Capital Loan: Meaning
It’s a short-term financing facility that allows companies to fund their day-to-day operations. A working capital loan is ideal for resolving cash flow problems instantly, without any hassle. Several financial institutions in India, like banks and NBFCs, offer these loans.
However, characteristically, this credit option differs from a traditional business loan provided by such financiers.
Take a look at their differences and how each of them are ideal for different use-cases.
Basis Of Difference
Term Business Loan
Working Capital Loan
|Tenure||Financial institutions usually provide such loans for a repayment period of up to 5 years.||It involves a shorter payment term, typically, 3 to 6 months.|
|Purpose||Companies avail a term loan to undertake major expenses in a business that will have a long-term bearing.||It’s usually borrowed to meet the operating expenditures of a business, like payment to suppliers.|
|Eligibility||Financiers usually require businesses to satisfy stringent criteria to be eligible for a term loan.||The eligibility criteria for a working capital loan are less rigid and are easier to qualify.|
Working Capital Loan: Types
As the name suggests, this loan type is specifically customised to provide financial assistance to companies, to buy new equipment or machinery. Such a loan usually entails an end-use restriction, meaning you cannot utilise the quantum for anything other than purchasing equipment.
Numerous enterprises use the bill discounting service to finance their various working capital needs. With this facility, you can release the amount blocked up in unsettled invoices ahead of their maturity dates.
To avail this working capital loan, you need to submit the unpaid bills with a financier. You can then borrow a considerably high sum as cash advance, depending on the value of your unpaid invoices. Usually, leading lenders discount somewhere around 10% and provide the rest as a loan.
It’s a line of credit extended by banks to various businesses. You can avail this facility if you are on good terms with your bank. An overdraft facility allows you to draw cash from your account even when its balance reaches zero but is capped at a predetermined limit. You can thus address your working capital concerns easily, with such a line of credit. However, the interest rate for this credit facility tends to be significantly higher than the rest.
Loan Against FD
It’s a secured loan option that requires you to collateralise your FD account. The quantum you can borrow as a working capital loan is usually a percentage of the outstanding FD balance. Also, interest rates on such a loan are usually a tad higher than the FD rates.
Working Capital Loan: Eligibility Criteria And Documents Required
The eligibility criteria for a working capital loan depend on the type you’re availing and also on the financial institution. Usually, the parameters based on which a financier extends a working capital loan are –
- Business vintage
- Annual turnover
- Credit rating
- Credibility of owners/directors
To give you a rough idea, a financier would usually be lenient to provide you with a working capital loan, if your company holds a robust credit rating, and there’s at least 10 – 12 months of business vintage.
The documents you need to submit to avail this loan facility are:
- MOA and AOA
- Previous year’s IT returns
- Certificate of incorporation and registration
- Business ID proof
- Audited financial statements
- KYC details of owners/directors
You may need to furnish additional documents for verification. Hence, it is important to keep all relevant papers handy. With such information in tow, you can easily apply for a working capital loan which suits your financial requirements.
Cash flow scarcity is a commonplace occurrence in any growing business, and a working capital loan is an ideal device to allay such monetary crunch. Working capital requirements will naturally vary across companies, and by gathering information about its features and different types, you can use this credit facility optimally.