What Is a Working Capital Loan?

For many people, starting a business is liberating. They start their business with a passion and put their blood and sweat into its operations. It is not easy to start and run a business. A budding business faces many challenges. Some struggle with their production, some struggle in the administrative field, and some businesses struggle in sales.

However, almost all business owners will agree that the most common and gruelling challenge is in the financial sector. Many businesses shut shop because they do not have enough working capital to run their business till they break even.

Here, business working capital loans can be of great help. These are essentially loans offered by banks for the sole purpose of running your business. They are different from regular loans and offer some benefits for the business owner.

If you want to know more about working capital loans for small businesses, keep reading this article. It will explain the working capital loan’s meaning and also list a few benefits of this type of business loan.

What is a Working Capital Loan?

Before we understand the meaning of a working capital loan, we need to know what working capital is.
 

Working capital is an important business metric. A company requires adequate liquidity to sustain its day-to-day activities. Working capital is your excess fund after paying your current liabilities. Subtract the liabilities from your current asset, and the remaining funds are considered working capital.
 

Current assets are inventory, cash, and accounts receivable, while current liabilities include accounts payable, wages, procurement expenses, and debt liability.
 

To illustrate, suppose you are running an SME business, and your current account holds ₹10 lakhs. Every month, your business requires ₹6 lakhs to pay wages and procure raw materials. So to calculate your working capital, you have to minus the expenditures (₹6 lakhs) from your available funds. According to that formula, ₹14 lakhs is your working capital.
 

There are two types of working capital: positive and negative working capital.

Positive working capital is when you have funds, as the example shows. On the other hand, negative working capital is when you lack funds to run your daily operations.

When businesses struggle with negative working capital, they take working capital loans. As stated above, a working capital loan is availed by businesses to carry out their daily business activities. A working capital loan makes the daily operations smooth for a business and is usually not used to fund long-term assets or investments.

Types of Working Capital Loans

Generally, banks offer the following types of working capital loans:
 

• Term Loan: In a working capital term loan, the loan amount and the interest need to be repaid within a decided period of time.
• Packing Credit: It is given to exporters to meet the financial need for procuring, processing, and packaging goods before shipping.
• Bank Guarantee: The bank guarantees on behalf of the loan applicant, ensuring that if the loan applicant (who is also the business owner) fails to make payment, the bank will step in.
• Accounts Receivable Loans: This type of loan is given on sales orders of a reputable company.
• Overdraft Facility or Cash Credit: In this type of loan, you only pay the interest on the withdrawn amount and not the entire loan principal.
• Letter of Credit: It is given to the seller, ensuring payment on behalf of the buyer (loan applicant) within a stipulated period.

Features of Working Capital Loans

• Working Capital Loan Amount: There is no capping on the loan amount, but it will depend on the business requirements like cash liabilities, short-term overheads, business experience, expertise and tenure. The working capital loans can be tailored to meet particular short-term goals of the business.
  
  
• Rate of Interest: Like any other loan, the interest rate depends on the lending banks, and it is curated as per the borrower’s needs.
  
  
• Collateral: Businesses may need to pledge collateral depending on their status. The banks may only offer a secured loan if a business is fairly new with very little experience. If your business is reliable and has been in the market for a significant time to gain some reputation, banks may offer you an unsecured loan.
  
  
• Loan payback tenure: The loan repayment period can be tailored considering the business’s cash flow generation. However, it can not be extended indefinitely.
  
  

In addition to all the above-mentioned features, banks charge a processing fee for working capital loans.

Eligibility for Working Capital Loans

To apply for a working capital loan, the borrower must be above 21 years and below the age of 65 years.
 

Entrepreneurs, private or public companies, partnership firms, sole proprietors, MSMEs, and self-employed professionals are eligible for working capital loans.

Working Capital Loans Benefits

There are many advantages of working capital loans:
 

• The business can borrow for a shorter repayment tenure.
• The banks may offer a line of credit facility.
• Working capital loans help deal with short-term financial challenges.
• Small businesses can get a secured loan against collateral through these small business capital loans.
• You can have access to working capital in the lean period when the sales are down.
• A working capital loan from a bank is better than investments from venture capitalists, where the business owner loses some ownership of the business.

Conclusion

The business world is full of ups and downs, and financial hardships are very common at all levels of business. A working capital loan can help a business stay buoyant until the tough times pass. Also, because of these uncertainties, it is important that a business owner gets SME insurance to safeguard his business, his employees, and himself from financial uncertainties.