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Working Capital Loan vs Term Loan - What is the Difference?
Editorial Team - Nov 22 - 9 min. read
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Term loans and working capital loans are two popular funding options available for businesses in India. Want to know how they are different from each other? Keep reading!
Financial crunches are common in all types of businesses regardless of their size and industry. Fortunately, there are plenty of loan options available that allow businesses to finance their requirements and keep their business operations running smoothly.
Term loans and working capital loans are the most common corporate loan options in the country. While they are used for the same purpose, they differ in terms of benefits and certain features such as interest rates, repayment schedules, collateral requirements, and so on.
In this blog, we will outline the key difference between term loan and working capital loan to help you identify the right type of loan for your requirements.
Read on!
Working Capital Meaning - What is a Working Capital Loan?
Working capital refers to the capital or funds required for running daily business operations.
A Working Capital Loan or WCL is a loan designed for businesses to provide them with enough funds or capital to cover their regular business expenses. In simple terms, it helps companies to meet their financial commitment in the face of financial crunch.
As compared to other long-term loans, working capital loans are used for immediate access to desired funds for the short term. Further, it should be noted that working capital loans can not be used for making new investments, expanding business, or starting a new project. These are only intended to cover regular business expenses.
Term Loan Meaning- What is a Term Loan?
A term loan, as the name suggests, is a loan that comes with a fixed term that ranges from one year to ten years, depending on the loan amount. This loan is required by the businesses to make large investments and expand their operations. These usually involve a higher loan amount as compared to the working capital loans.
Working Capital Loan Vs Term Loan: Quick Comparison
Features |
Working Capital Loan |
Term Loan |
Purpose |
To meet short-term capital requirements of businesses. |
To finance significant investments, purchases, and business expansion. |
Term |
Short-term |
Long-term |
Loan Amount |
Usually a small loan amount. |
Loan amount is high. |
Collateral |
May or may not require collateral. |
Require collateral in most cases. |
Procedure |
Easy and non-complicated procedure. |
Involves a lot of paperwork and takes time for approval. |
Repayment |
Limited number of instalments for repayment. |
Can be repaid in multiple instalments over a longer period. |
Difference Between Term Loan and Working Capital Loan
The above table showcases the differences between both loan types in brief. Let’s now take a look at the detailed differences between a working capital loan and a term loan:
Purpose
Term loans are used for larger investments such as starting new projects, purchasing real estate, financing new machinery or equipment, and so on.
On the other hand, working capital loans are used for financing day-to-day business operations in case of financial emergencies. These include paying rent, paying salaries to employees, buying raw materials, and so on.
Duration
Term loans have a longer tenure that usually ranges between 1-10 years.
On the other hand, the duration for working capital loans is shorter and ranges between a few days to a couple of months.
Ease of Getting a Loan
Getting a working capital loan is fairly easy and less time-consuming. Moreover, it doesn’t involve a lot of paperwork.
On the contrary, getting a term loan is comparatively time-consuming and involves a lot of paperwork and legal formalities.
Loan Repayment
A working capital loan has a shorter repayment period. Borrowers can pay it in full or in instalments whenever the lender asks.
On the other hand, term loans have a fixed but longer repayment period. Borrowers can repay the long-term loans in multiple instalments spread over a longer tenure.
Collateral
Term loans essentially require collateral, such as any investment or property, to sanction the requested amount.
On the other side, working capital loans can be secured or unsecured. Simply put, they may or may not ask borrowers for collateral depending on the requested amount.
Loan Amount
The loan amount in the case of term loans is higher as compared to working capital loans. The reason is very obvious: term loans are designed for significant projects and investments.
Interest Rate
The interest rate is another major difference between term loans and working capital loans. Since term loans come with longer tenure, they carry comparatively lower interest rates than working capital loans.
Further, WCLs are used for immediate financing for the short term and hence carry a higher interest rate.
Creditworthiness
Although the creditworthiness of borrowers is checked in both types of loans, it is more emphasised for term loans.
In the case of working capital loans, lenders may be a bit lenient.
Final Thoughts
Understanding the main differences between working capital loans and term loans is important for all types of businesses.
This is especially true for SMEs (Small and Medium Enterprises) as they require external financing more than others. As we have discussed, term loans are suitable for long-term investments, while working capital loans are ideal for managing daily business operations.
Regardless of the choice of loan, SMEs should also consider getting SME insurance to protect their valuable assets and ensure a timely loan repayment even in a financial situation.
We hope this guide on “working capital loan vs term loan” assists you in making the right decision.
