A working capital loan is the amount of money borrowed from the banks to cover day-to-day operations and regular expenses. When a firm doesn’t have enough funds to manage their daily expenses such as clearing up wages, account payable etc, they generally opt for a working capital loan.
Here are a few advantages of taking a working capital loan:
1. No collateral required: If you have a good credit score, then you may become eligible for an unsecured working capital loan. This means that you do not need to secure any collateral or security in order to avail the loan.
2. Speed and flexibility: One of the biggest advantages of a working capital loan is that it gets quickly disbursed. These loans are generally flexible with varying repayment terms and interest rates that help the firm in smoothing out their cash flows.
3. Maintains cash flow: Irrespective of your requirement and monthly revenue, working capital financing helps maintain good cash flow for your business. This means that your business gains stability and financial strength for urgent or unexpected needs.
4. Provides a line of credit facility: These type of loans allow you to withdraw the amount according to your needs via a credit line. On a monthly basis, you only have to pay the interest in the form of EMIs and the principal amount has to be repaid only at the end of your tenor.
Types of working capital loans:
Before opting for a working capital loan, you should also take a look at its types and choose the one meeting all your requirements:
1. Short-term loans:
A short-term loan comes with a fixed interest rate for a maximum term of 12 months. The business’s good credit history and relationship with the lender can allow you to get a short-term loan without securing any collateral.
2. Bank overdraft facility:
The availability and terms of this type of loan are wholly dependent on your enterprise’s relationship with the lender. The advantage of this facility is that you need to pay interest only on the amount withdrawn. For this type of loan, the rates of interest are usually one or two percent above the prime interest rate levied by the lender.
3. Account Receivable Loans:
Being the most popular of working capital loans, account receivable loans are most sought out by SMEs. This type of finance is the best choice for businesses requiring equity to meet expenditures such as fulfilling a sales contract.
Eligibility and documents:
To be eligible for a working capital loan, your business must fall under one of the following categories:
• Limited or private limited company
• Partnership or proprietorship firm
• Self-employed professional
• Self-employed non-professionals
The following documents are required to avail a working capital loan:
• Signed Application form
• PAN Card
• Proof of ID, in the form of, a copy of Aadhar Card, Passport, Voter ID, driving license
• Proof of address, in the form of, a copy of Aadhar Card, Passport, Voter ID, driving license
• Bank statement of last 6 months
• Latest ITR with the computation of income, balance sheet, and profit and loss account for the last 2 years.
• Proof of business continuation (ITR/Trade License/Establishment/Sales Tax Certificate)
Difference between a working capital loan and a business loan:
Working capital loans are not meant for long-term investments or assets purchases. For such purposes, you have the option to avail a business loan. However, the approval process of a business loan may take a longer time as compared to a working capital loan. Also, in many cases, a business loan must be used specifically for the purpose stated in the application. For example, if the funds were requested to purchase inventory, then that’s what must be done. Deviating from the plan isn’t allowed, even if the business owner has a better or more profitable use of the funds. But, that is not the case with a working capital loan. Business owners can use the funds for any purpose they wish. There is no requirement whatsoever to get approval, or even disclose how the funds are being used. Lastly, a working capital is generally provided for a shorter tenure of up to 1 year, whereas a business loan can be taken for up to 5 years.
Conclusion: Both business loans and working capital loans help to fulfill different requirements of your business. Based on your requirement and eligibility, you can choose any one of them to ensure financial stability and growth of your business.