Business

Why is Working Capital Loan the Best Funding Option

Businesses can earn you huge profits. But it cannot be established without capital. The requirement of raw materials and further processing requires a lot of initial investment that can be converted to a huge profit later. A working capital loan would help in the financial management and maintenance of such businesses.

Micro Small and Medium Enterprises (MSMEs), start-ups, etc. could be benefitted by a working capital loan and ensure smooth functioning of the business. One should not hesitate to take the easily maintained working capital loan to grab new opportunities and for the well-functioning of the business.

What Funding Options are available to Firms and MSMEs

Running an enterprise is a demanding job where even a million-dollar idea needs a lot of initial investment to bloom the business. Be it setting up the firm, infrastructure, services, wage of employees, purchase, transportation, or anything else. One needs to cater to all such things to run a successful business.

There are many options to gather financial support for the enterprise. Check out the list below for the most widely availed funding methods.

Term loans (long and medium):

These are provided by banks, Non-Banking Financial Company (NBFC), Securities and Futures Commission (SFC), Security Industry Development Corporation (SIDC), Small Industries Development Bank of India (SIDBI), etc. The loan is granted for the purchase of and construction, buying machines, and equipment.

  • Short term loan:

NBFCs and Commercial & Cooperative Banks provide this. The loan is sanctioned for the purchase of raw materials and consumables, paying wages, or urgent manufacturing or administrative expenses.

  • Working capital loan:

It is provided by all banks and NBFCs to take care of the financial needs of ongoing business. This loan is easy to maintain and depending upon the borrower’s credit history; it could be availed without any collateral.

  • Bridge loan:

As per the name, this type of loan acts aa a bridge between two tasks. It is provided to meet the immediate cash requirements until some other obligations are met.

Loan refinancing: In this, a borrower takes money to repay other pending loans. It is generally borrowed at a lower interest than the previous loans.

Out of these available funding options, a working capital loan would serve as the running business’s blood and bone. Other loan options are good to give a kick to start the business, building, constructing, and establishing a business empire. But a working capital will ensure smooth functioning while supporting new opportunities for a running firm/enterprise.

What is a Working Capital Loan?

A working loan is a sum borrowed by firms or companies to cover up the ongoing business expenses for a shorter period of time.

Let’s understand this with the following illustration.

Ram owned a small business of surgical masks production. Due to the spread of infectious diseases, the requirement of masks suddenly soars. Ram received a huge order of surgical masks from a renowned facility dedicated to the diseases.

Now Ram requires to purchase additional raw materials for the production, and he is also in need of extra labor to deliver the order within the stipulated time. Although he was paid some advance by the medical facility, it was insufficient to bear the increased production cost. To bear that additional cost, he needs to borrow money for the time being. After successful delivery and receiving the entire amount from the facility, he would be able to return the borrowed amount from the total profit.

The money borrowed for such purpose is what is defined as the working capital loan.

A working capital loan could either be secured or unsecured.

As per the definition, a working capital loan is the best option to borrow to fuel the needs of an ongoing work.

Types of Working Capital Loan

 A working capital loan is categorised into following

  • Short term loans:

Fixed secure loan is a type of secure loan that comes with a fixed period and interest rate. This was can be granted without bail depending upon the credit history of the firm.

  • Bank overdraft:

This one is a flexible option of working capital loan. Once the lender aporoves a loan amount, the borrower has the flexibility to use the sum required from that fixed approved budget. The interest rate would be charged only on the amount used and not on the entire approved capital.

  • Trade credit:

It is a B2B (business to business) type of capital loan. In such cases the supplier can be termed as the loan provider. The borrower can purchase the raw materials but need not pay for that right away but after a defined interval.

  • Account Receivables:

In this the borrower would pay for the purchase of service/goods after a fixed period of time. To understand this in a layman’s term, consider your internet service provider. You have purchased and consumed the internet service and pay the bill at the end of the month.

  • Equity funding:

This one is a good option for new firms that do not have an established credit history or fresh start ups. The working loan is granted by family, friends, etc.

  • Factoring invoices:

The other terms used for factoring invoices are debt factoring or asset-based lending. Businesses sell their invoices to a third party on a discounted rate, either a bank or finance providers, to enhance cash flow. The third party is known as the factoring company.

  • Letter of credit:

A letter of credit is an acknowledgement from the bank to the seller to take care of the expenses of the buyer for a stipulated period for which the buyer is unable to pay.

  • Bank Guarantee:

A person/business can take up a bank guarantee to purchase materials and services or can draw a loan if so required.

Why Working Capital Loan is a Good Option

 Working capital loans were introduced to boost the MSMEs.  Because of the following features of working capital loan, it could be the best option for a firm to maintain cash flow and grow.

  • Interest rates at which the working capital loan is granted varies as per the bank and also according to the applicant’s credit history.
  • Minimum age to apply is 18 years while the maximum age upon loan maturity should be 65 years.
  • Repayment period could vary between 12 months to 84 months. But it depends upon the conditions set by the lender
  • No collateral is required to avail working capital loan. It is generally given based upon the credit history of the business.
  • Entrepreneurs, self-employed, MSMEs etc are eligible for the working capital loan.

Find the brief features of a working capital loan in the table below.

Loan amount Rs. 50, 000 to Rs. 2 crore
Processing Rates Vary between 1% to 2% depending upon credit history
Loan tenure Lies between 12 month to 84 months
Payment mode Bi monthly and weekly
Age limit 18 years to 65 years
Turnover of firm/company More than Rs. 90,000 for a period of at least 3 months

How Working Capital Loan Helps in Growth of Business

A working capital loan boosts and help in growth of a business. As the name suggests capital is granted for proper working or functioning of the firm.

One could be in need of applying for working capital loan for the following reasons

  • To manage profit fluctuations during off season.
  • To meet up the demands of a bulk order.
  • To boost regular and stable cash flow.
  • To be ready and well equipped for new business opportunities.
  • It also acts as a cash cushion.

Above mentioned reasons arevapt enough in themselves for the continuous running and growth of the firm.

One could always check if a working capital loan is required or not as per the following rule.

Current assets – business liabilities= positive

If this positive value is large enough to cover daily expenses smoothly then one need not apply for a working capital loan.

But if the value is too high, one need to ensure if the firm is investing enough in new opportunities and growth of the enterprise.

Documents Required

 The following documents would be required to apply for the working capital loan depending upon the lender, type of working capital loan acquired, and the purpose.

  • PAN card of the applicant
  • Identity and address proof of applicant
  • Income proof
  • Income tax return (ITR) and income statement of last 3 years.
  • Financial audit report of last 2 years.
  • Registration and incorporation certificate.
  • List of current directories on the company’s letterhead.
  • Memorandum and articles of association i.e. MoA and AoA.
  • Loan statements with loan sanction letter of last one year if loan taken from other banks as well.

A working capital is easy to avail, have not very high interest rates, is taken for short periods and would be helpful to boost individual businessmen and MSMEs.

Though other loan options are necessary to construct a new enterprise but to keep the business running and growing, working capital loan is an ideal solution.

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