A working capital loan is a debt instrument that meets the short-term financing needs of a company to continue its activities. This type of financing is common among small and medium-sized businesses where current assets do not match current liabilities or, in simple terms, “a business cannot afford to make ends meet”.
Most working capital financing is granted for a loan term of six to 12 months and charges between 11 and 16% interest, depending on a number of factors.
Working capital financing becomes relevant when a company’s current liabilities outweigh current assets. Under these circumstances, a business has little or no choice but to apply for a loan. Unfortunately, most business loans have a fixed term, which is recorded as “long-term liabilities” on a company’s balance sheet. This type of loan doesn’t really make sense for a business that doesn’t want to be burdened with long-term debt or pay off the loan within the next five to ten years.
Here’s how working capital financing works.
Benefits of Working Capital Financing
At its most basic, working capital financing is intended to fund existing orders when a business receives a promissory note from a customer for a specific number of goods to be delivered. It is also more rarely used to fund accounts payable when there are outstanding bills to pay. This ensures that the borrower does not owe more than he can reasonably repay.
Unlike most business finance or loans that finance a number of business activities, working capital loans are specifically taken out and repaid in a short period of time, eliminating the risk of bad debts.
Other benefits of working capital financing include:
1. Guaranteed Zero
Working capital loans do not require collateral. For most businesses with a good credit rating, getting a loan is a quick and easy process. Businesses do not need to worry about pledging their assets or inventory as collateral to secure the loan. However, not being responsible and making payments on time can lead to a lower credit score and even legal action from the lender.
2. Fast Approvals
One of the benefits of working capital financing is that a business with a good credit rating can obtain financing quickly. Banks and other financial institutions understand the importance of quick funding for a business to meet its immediate cash flow needs. Some reports also describe how easily and quickly companies can get an injection of working capital and restart their operations.
3. Flexible repayment options
For seasonal businesses, working capital financing offers greater flexibility and variable repayment terms to businesses. Businesses that experience high spikes during the year can opt for a working capital loan to balance their cash flow and maintain a steady flow of reserves when needed. It also gives them a cash cushion in the form of excess capital in case of an emergency. This gives a business much-needed leverage and confidence to take on additional risk.
Types of Working Capital Loans
There are different types of working capital loans. Each has its advantages and disadvantages. Choosing the right zero down cash requirement of an individual borrower.
Short term loan
This type of financing generally has a fixed term, between 6 and 12 months and a fixed interest rate. A borrower with a good credit rating can easily obtain this type of loan with minimal documentation, no collateral, and minimal verification. This type of loan is ideal for a company that urgently needs cash and has a good credit rating.
overdraft
This type of working capital financing is offered by a bank to its business customers. Whenever a customer’s account does not have sufficient funds to cover expenses, the bank allows an overdraft to meet cash requirements.
For example, a customer presents a check for INR 20,000 to a supplier for payment for purchased raw materials. Unfortunately, the customer only has INR 18,000 in his account. The bank will honor this check and book INR 2,000 as bank overdraft after consultation with the client. Interest rates on bank overdrafts are generally fixed and higher than loans.
Accounts Receivable (AR) Loans
The AR loan is a popular source of financing for a business that only covers the cost of orders placed. An AR loan is usually easy to obtain, especially when the borrower has purchase orders to fulfill. Lenders will typically require a Promise to Pay (PTP) note to indicate that the borrower will actually repay the principal amount with interest, after receiving payment for their orders.
There are a number of other working capital financing options available to businesses. The three mentioned above are the most popular forms of credit.
How do I apply for a working capital loan?
Applying for a line of credit is not a very difficult process, especially if you meet certain criteria that lenders deem appropriate.
Types of businesses that can benefit from working capital financing:
- Individual business
- Limited Liability Companies
- Limited Liability Companies
Also, lenders will generally prefer that your business has been in business for a certain number of years and has a certain minimum annual turnover. Keep in mind that this requirement differs from lender to lender and the type of business you work for.
Here are the standard documents you need to submit for a working capital loan:
- Standard Know Your Customer (KYC) documents including proof of identity, age and address. Some commonly accepted IDs are PAN card, Aadhaar card, driver’s license, passport, voter card, deed, etc.
- Business incorporation certificates including registration documents, Goods and Services Tax (GST) registration, partnership deed, rental agreement, company PAN card, etc.
- Bank statement for the last six months of the company’s current account.
- Computer declarations for the current year or the previous year.
- Details of outstanding debts, if any.
- Purchase orders showing the number of goods ordered and the capital required to purchase them.
Where to apply for a working capital loan?
Financing for working capital can be obtained from several sources.
1. Online banking aggregators
There are a number of banking aggregators available online that can help you with much needed funding. Some unique technology platforms offer a number of financing options from different banks, lending institutions, and non-bank financial companies (NBFCs) with varying interest rates and terms.
The application process on these platforms is relatively smooth and simple. Remember to have all the documents (mentioned above) ready before starting the application process. This will save you considerable hassle down the road.
2. Banking institutions
Banks are another excellent source of working capital financing. Most major Indian banks such as State Bank of India, PNB, ICICI Bank, IndusInd Bank and others offer working capital loans at competitive rates. You can either visit their website online and check eligibility for a working capital loan, or visit a branch and speak to a finance officer who will walk you through the process.
Pro Tip: Things will be much easier if you are already a bank customer. The bank won’t have to go into various details about your credit history, as most of the information will be easily accessible.
3. Online lending platforms
There are a number of technology platforms from other lenders that offer a number of advantages. These platforms offer unique benefits and provide instant funding if you meet their credit terms. You can download their app on Android or IOS and search for the latest live offers or promotions that could make you borrow cheaper in the long run.
Conclusion
Working capital financing helps maintain a positive cash flow for businesses. If your business is in dire need of cash, you may want to consider an appropriate working capital financing method to start your business. Negative cash flow can set alarm bells ringing for your business growth.
