Every company, whether big or small, needs funds at one point of time or another to cover the expenses of their daily business operations. Although the banking sector in the country is quite competent in providing different types of loans to its customers for their various needs, they cannot provide loans for the small operational needs of a business every time. Therefore, they came up with an innovative idea of providing working capital loans to its customers.
Working capital loan is the money available to operate the immediate and short-term needs of your company. Sometimes, when companies do not have enough cash or assets liquidity to finance the short-term operational requirements, they can rely on working capital loans. They are simple corporate debt borrowings that are used by a company to finance its daily operational needs.
The main purpose of a working capital loan is to finance the day-to-day operations of a company. These expenses, however, do not include the cost to buy long-term assets or investments. Rather, the loan is used to cover accounts, payable, wages, and other similar needs. Companies that have high seasonality and fluctuating sales cycles usually rely on working capital loans to help with periods of reduced or lean business activity.
Many companies do not have stable revenue throughout the year. The profit and loss of such companies keep fluctuating. If the company acquires reasonable profit, there is no need for a working capital loan. But in the case of loss or stagnation, a working capital loan becomes almost compulsory. Manufacturing companies usually have periodic sales cycles that correspond with the needs of retailers. Most retailers sell the most products during the fourth quarter of the year – during the holiday season. Hence, the income of such companies is not consistent.
Increased production activity is mainly done to supply retailers with the proper quantity of goods. Manufacturers typically conduct most of their production activity during the summer months, getting inventories ready for the fourth quarter push. Then, at the end of the year arrives, retailers reduce manufacturing purchases as they focus on selling off their inventory and prefer to avoid having too many leftovers, thereby reducing sales for the manufacturing business.
Manufacturing companies with this type of instability and seasonality often require a working capital loan to pay wages and maintain other operating expenses during those periods of the year when they are not witnessing any reasonable sales. Although the company is not making adequate profits, they still have to pay its permanent workers, maintain machinery, pay utility bills, etc. Funds are required at every step of the way at various points of the year. This is where a working capital loan can fill the gap in funding. The loan is usually repaid at the time that the company hits its busy season and no longer needs the financing.
Working capital loans are not meant for large corporate companies. The loan is intended only for micro, small, and medium enterprises for meeting their working capital needs and ensuring they have funds for the daily operational expenditure of the company. The majority of the working capital loans are unsecured. However, the loans with higher risks need some guarantee. The usual duration of a working capital loan offered by banks in India varies from 6 to 12 months whereas the interest rate ranges from anywhere between 11% and 16% depending on the lender, be it a non-banking financial institution or a bank.
Working capital loans are a great way for businesses to generate capital and to start becoming laser-focused on business growth. To get anywhere in the world of business, it is extremely important to have capital on hand to cover small business needs such as marketing costs, payroll, and any other financial expenses that occur within the daily operations of your business. As the company starts to grow, they also begin to tie up a lot of cash in the day to day operations of the business that has nothing to do with its profits or losses. A common example is funds stuck in some part of the supply chain. Working capital loans can alleviate the paucity of liquid funds. This type of cash consumption can also be termed as called working capital.