What is Working Capital Loan
Working Capital Loan is a type of funding or credit required by several startups, enterprises or companies to manage their day-to-day business operations and to manage business cash flow. Working capital loans are short-term loans to fulfill instant business requirements and can not be used to buy long-term assets or for investment purposes.
Also Read: How to Apply for a Business Loan
The banking sector in the country is quite competent in providing different types of loans to its customers for their various financial needs. Considering their needs, working capital loans were introduced to fulfill the financial requirements of companies, business owners, for MSME, for startup and self-employed professionals.
|Working Capital Loan Interest Rate – Features|
|Interest Rate||Depends on applicant’s profile & varies from bank to bank|
|Age Criteria||Min. 18 years & Max. 65 years (At time of loan maturity)|
|Loan Amount||Depends on business requirements|
|Repayment Tenure||12 month – 84 months|
|Processing Fee||Up to 3% of the loan amount|
|Loan offered to||Entrepreneurs, Pvt. & Public Ltd. Companies, Partnership Firms, Sole Proprietorship, MSMEs & Self-employed Professionals|
|Interest Rate Type||Floating Rate of Interest – Mostly|
|Business Tenure||Min. 3 years in business with profit|
Note: The mentioned interest rates, fees and charges are subject to change and depend on the sole discretion of the bank and RBI. GST and service tax shall be levied extra on the mentioned charges.
Working capital loans are availed majorly by companies doing businesses related to manufacturing, providing services, retailing, stocking, distribution, restaurants, supermarkets, multi-brand outlets, departmental stores, etc.
Working capital loans are used to cover accounts, payables, wages, and other similar needs. Companies and businesses that witness high seasonality and fluctuating sales cycles usually rely on working capital loans to help with periods of reduced or lean business activity. In the case of loss or stagnation in business, these loans become a necessity for some companies and businesses.
Working capital loans are largely offered to MSMEs and are not for large corporate companies. The loan is intended only for Micro, Small, and Medium Enterprises for meeting their daily operational needs and ensuring they have funds for the daily operational expenditure. The majority of the working capital loans are unsecured.
Working Capital Loan Eligibility Criteria
If you are running a SME and are looking to apply for a working capital loan in India, you need to represent a business that has been in activity for a number of years or your business should have a certain annual turnover (Defined by the bank or NBFC). However, these requirements depend on the type of business you own.
Working Capital Loans are largely offered to MSMEs, Sole Proprietorship Firms, Partnerships and Private and Public Limited Companies.
- PAN Card
- Passport Sized Photographs
- Identity, Address and Income Proofs
- Last 3 years’ ITR and Income statement
- CMA (Credit Monitoring Arrangement) report, if business turnover exceeds ₹ 5 cr
- Last 2 years’ audit report financials
- Partnership deed
- Certificate of registration
- Certificate of incorporation
- Name of all the present directories on company letterhead
- Memorandum of Association (MoA) and Articles of Association (AoA)
Loan statement with sanction letters in the last one year (of other banks as well)
Different Types of WORKING CAPITAL Loans
There are varieties of working capital finances available in the Indian financing market. Working capital management outlines a major part of the daily activities of an entrepreneur. Therefore, they have been divided into different types so that one can avail it according to their needs. Here are the 10 different types of working capital loan:
1. Trade Credit
This is a type of loan which is provided by a present or potential supplier of the business. Creditworthiness plays a significant role for this type of loan. Trade credit is offered to businesses based on their creditworthiness, which is revealed by its liquidity situation, profit records and payment records. As with other funding programs, trade credit also comes with some specific requirements and costs. The supplier will also thoroughly evaluate your business credit history before offering you funds.
2. Cash Credit
These are the most significant and most widely used type of working capital finance used by SMEs. This type of cash facility is provided by commercial banks. The borrower is approved for a specific maximum limit – an amount of funds that you can use for meeting various business needs and specifically for making business payments. One of the biggest advantages of availing this loan is that cash credit works like a credit card in that the borrower pays interest only on the amount used.
3. Short-term loans
Unlike a overdraft facility, a short-term loan comes with a fixed interest rate and payment period. It is not a line of credit but a full-fledged loan. It is critical to pay back the loan with interest on time. The tenure is set by the lender institution or bank. Among the entire range of working capital loans available to a business owner, this one loan type is well suited to meet sudden and unexpected expenses. Usually, it is a secured loan. However, if your business has good credit history and healthy relationship with the lender, then the lender can allow you to get a short-term loan without any collateral.
4. Bank Overdraft
Bank Overdraft is also called Cash Credit. This facility is availed by most of the businesses wherein; the purchaser avails a specific amount for utilizing it to pay for operating payments. The rates of interest and line of credit depend on a firm’s relationship with the lending authority.
Moreover, the businesses have to pay the interest only on the amount which is utilized by it, instead of the whole amount. It is the most cost-efficient solution as the borrower keeps on depositing the amount as and when he employs it, to save the interest cost.
Also Read: How to Apply for Overdraft Facility
5. Accounts Receivable Financing
Accounts receivable financing is also a type of working capital loans for the businesses which need financing for a sales order received by it and needs to make payments for providing the deliverables. Accounts receivable financing is only for the sales orders which are confirmed but, the firm is unable to gather the required fund to pay for it. However, businesses must have an excellent record of credit for borrowing this loan.
These loans are quite similar to accounts receivable financing. However, there is one difference between the two that the amount of the loans is based on future credit receipts. It is a process of arranging some chosen accounts payable and selling them to the party who provides funding to the business. The accounts payables are sold at a decreased amount than their actual value. The “factor party” here also collects the amount from the debtors of the company whom it is financing. This loan is either with recourse or without it. In the case of recourse, the risks are borne by the firm if debtors don’t pay the amount. Whereas, the risk is taken by the factor party if it is without recourse.
One of the most common operations of a business is – generating bills on sales. The statements are the proof or a verified document which are produced in front of debtors by a firm, to get the required money the debtors owe them. Banks provide this facility to these firms by offering them an amount after adding a discount on the amount of that bill on the bank interest rates. The remaining amount would be paid back to the seller. As the bill matures, the bank would collect that discounted money from the debtor.
8. Bank Guarantee
Bank guarantee refers to the financing responsibilities of a bank which are not based on money or any types of funds. A firm can acquire it for decreasing the number of risks that can arise due to any third party. The risks can either be about the non-payment on the part of the third party or receiving any services. However, this guarantee can only be bought by a seller when there is a non-performance of any of these tasks. A minimal commission is charged by the bank in addition to some collateral.
Letter of Credit is another type of working capital finance similar to Bank Guarantee, acquired by a borrower. The difference in both forms of loans is that; in Letter of Credit, as and when the opposite party delivers according to the defined terms the bank will pay for it. Hence, a borrower would purchase a Letter of Credit which would be sent to the seller with some terms and conditions written on it. As the seller performs the services according to the agreement, he would get the money by the bank and the purchaser would pay his dues to the bank.
10. Equity Finance
This type of working capital loan is typically borrowed from a business’s investments like investors, friends and family or home equities. This is an excellent option for the businesses who are just initiating their operations. Moreover, it can be the most realistic solution for paying off bills and raising capital as initially, a company won’t be having a credit record.
Benefits of Working Capital Loan
1. Short-tenured Loan
The repayment period of Working Capital Loan is as low as 9-12 months making it a loan of relatively shorter duration. Borrower does not have to plan for long-term EMIs if availing this loan. Working capital loans to new businesses is offered in form of short-term loan.
2. Handle Financial Difficulties
Even if your business is flourishing and has lots of fixed assets, it is not entirely unthinkable to find your business landing in a financial crisis at times. In situations like this, nothing can be better than a working capital loan. Under the best of circumstances, poor working capital leads to financial pressure on a company, increased borrowing, and late payments to creditors – all of which result in a lower credit rating. A lower credit rating means banks charge a higher interest rate for any money borrowed. Applying and using a working capital loan when you need it most will keep you in your business when shortages occur.
3. No Collateral Required
Unlike most other unsecured business (or even personal) loans, no security or collateral is required to avail a working capital loan from a bank or Non-banking Financial Company (NBFC). If you have a good credit history, then you may become eligible for unsecured working capital loans. The bank will check and verify your credit history and if satisfied, will give you the loan with a fixed tenure to pay it back.
Also Read: How to Get Collateral Free Business Loans?
4. Helps in Lean Periods
If you are running a seasonal business which witnessed high sales during a particular season only, you probably face risks and challenges that create problems in your annual revenues, then you should go for a working capital loan. These loans can help you to overcome the blows otherwise created by the lack of adequate spending potential.
5. Spend at Your Discretion
Working capital loans come with no riders or restrictions on how the funds are used. However, they do instruct you to use the money for valid needs only. This is to ensure that your business does not start to depend solely on credit to manage expenses. Even so, you can use the money for all your business requirements and nobody can question this.
Working Capital Formula
How to calculate Working Capital?
The formula to calculate working capital is simply a subtraction of an enterprise’s current liabilities from the company’s presently owned total assets.
Current Liabilities (-) Total Assets = Working Capital
Current Assets of a Company
Cash: Rs. 20,00,000
Account Receivable: Rs. 15,00,000
Inventories: Rs. 45,00,000
Total: Rs. 80,00,000
Current Liability of a Company
Accounts Payable: Rs. 25,00,000
Short Term Borrowing: RS. 5,00,000
Accrued Liabilities: Rs. 10,00,000
Total: Rs. 40,00,000
Working Capital: Current Assets (-) Current Liability
Rs. 80,00,000 – Rs. 40,00,000 = Rs. 40,00,000 (Working Capital)
Read Also: Mudra Loan
Difference between Term Loan and Working Capital Loan
Being a type of business loan, both these terms may seem bit similar; yet there are some significant differences to know before finalizing a loan for your business.
|Term Loan||Working Capital Loan|
|Types: Short-Term, Long-Term, Intermediate Term||Type: Business Credit, Letter/Line of Credit, Factoring, Account Receivables, etc.|
|Used for business expansion purposes, buying equipment/machinery, purchasing raw materials, paying rent and salaries, etc.||Used for maintaining business cash flow and meeting day-to-day business requirements.|
|Lower Interest Rate||Higher Interest Rate|
|Higher Loan Amount||Lesser Loan Amount|
|Higher Repayment Tenure||Shorter repayment Tenure|
|Collateral is required being a secured loan||No Collateral required|
|Detailed paperwork required||Lesser paperwork required|
|Increased chances of improving credit score||Lesser chances of improving credit score|
|Numerous EMIs to be paid||Limited EMIs, as loan amount is not high|
Working capital loan is basically the funding available to manage the day-today and short-term needs of your company or business. These loans are also used to enhance the business cash flow of enterprises. Sometimes, when companies do not have enough cash or assets liquidity to finance the short-term operational requirements, they may rely on working capital loans. They are simple corporate debt borrowings that are used by companies to finance their daily operational needs.