Fundamental Things To Know About Working Capital Loans

Working capital is essential for every business. It covers the operating costs that are essential to keep an organization running smoothly and efficiently. Operating costs include all expenses associated with the day-to-day maintenance and administration of a business. Expenses such as rent, machinery and inventory purchases, and salaries of employees, all come under its ambit.

Every now and then, businesses go through a lean phase and require funds to sustain their daily operations. This is especially true in the light of the pandemic. This is when working capital loans (secured or unsecured) can step in to take care of their short-term needs.

So, read on to know more about their types and benefits.

What are the most common types of working capital loans in India?
In India the most common types of working capital loans are -
 

• Overdraft facility: A common short-term line of credit is the overdraft facility offered by various financial institutions. Businesses avail the overdraft facility when their current account balance turns negative.Though there is no balance in the current account, financial institutions provide overdraft facility to businesses as per the limit set on the customer’s account. The interest is levied on the amount withdrawn. Some financial institutions also charge an overdraft facility fee.

 
Meanwhile, if the borrower takes an overdraft facility from his or her own account, then it generally comes under the purview of unsecured debt. And because it is unsecured, there is no requirement for collateral or guarantee. However, if the overdraft facility is availed against an asset, FDs, insurance policies etc., it becomes a secured debt. Therefore, the overdraft amount and the interest rate charged will vary, depending on the collateral.
 
Also Read: Working Capital Loans: What, How, and Where?
 

• Short-term loans: As the name suggests, short-term loans for working capital are generally for a shorter period, usually for one to two years, and accompanied by fixed interest rates. The short-term loans are a secured form of debt, and hence,you need to provide collateral. However, depending on the credit history, repayment history and the working relationship with the lenders, borrowers can avail short-term loans without providing any collateral.

 

• Trade creditor: When a supplier offers goods and services to its clients on credit, it is known as trade credit. The supplier usually offers trade credit when a client takes bulk orders from them. However, before securing trade credit, the supplier checks the client’s credit history, balance sheet and working rapport. This facility is typically for the short term, until the invoice is settled. The period varies from one industry to another, and generally ranges from 30 days to three months. Since the credit is given against the invoice, no interest rate is charged.

 

• Equity funding: The money raised through selling a part of the ownership business is commonly termed as equity financing. The funding obtained by offering stake in the company to investors, or through Initial public offering, venture capitalists, or angel investors, comes under this category.  

 

• Account receivable loan: One of the most flexible and quickest modes to tide over short-term financial needs is an accounts receivable loan. Accounts receivable allows businesses to raise money from their outstanding invoices. Hence, under this financing option, the loan is secured based on a stream of future receivables.

 
Also Read: A Guide to Working Capital Loans for Your Business

What are the advantages of working capital loan?
The biggest advantage of working capital loan is that you get instant access to cash. You do not need to go through any lengthy application process that traditional loans often entail. Besides, most working capital loans assist in bridging the gap in capital without giving away the control of the company. In addition, it is generally flexible with varying working capital loan interest rates and repayment terms. This can help organizations to make their cash flow smooth.

What are the documents required for availing working capital loan?
The documents you need to submit for a working capital loan will depend on the type of short-term loan. Financial institutions, in general, require a borrower to fill the basic loan application form and provide account statement of the last six months.

Also Read:Guide to Understanding Working Capital Loans

To conclude
Working capital loans are your best bet to maintain consistent cash flows during uncertain times. With these, businesses can function efficiently and tackle emergencies in the short run, without dipping into their savings.