A Guide to Working Capital Loans for Your Business

 

Introduction

If you are a business owner, you know the value of capital to keep the show going. But there comes a lean phase like an off-season when production costs outweigh the revenues or you need to use your savings for expanding the business. These kind of situations leave you with no cash cushion. In such situations, there is a need for short-term capital to maintain stable operations, which can be easily met through a Working Capital Loan. Let us learn more about this financial product.    

What is Working Capital?

Well, a company has to pay for everyday expenses like rent for the office space, purchasing inventory and equipment, paying for taxes, licenses and repair works, payment to suppliers and salary to staff among other things. The company pays for all this from the revenue generated by the sale of goods and services. So, when you subtract the current liabilities i.e. the payments owed to others from current assets i.e. cash on hand and accounts receivables, what you get is working capital. This difference, if positive, is the capital the owner uses both for running the day-to-day business without a glitch or uses it for the growth of the company.   

Why you would need a Working Capital Loan?

Let us take the example of Mr. Prashant Dhar, who runs a photography studio. Now during the wedding season, he and his employees are extremely busy and most employees work overtime. Now imagine, one of the cameras broke at an event and he quickly needs to buy another to cover another wedding in a couple of days. But the problem is that the payment for the assignment will come a week later. To afford another camera that can cost over a lakh, Mr. Dhar needs a little financial help until his payments are cleared. Similarly, in his business, during the off-season, he gets only handful of assignments but he still needs to pay the rent, electricity bills, salaries, etc. even when revenues are an all-time low. In these temporary moments of cash crunch, a Working Capital Loan comes handy. These short-term loans are generally not ideal for long-term investments or heavy purchases but to finance the short-term operational needs of a company. 

Types of Working Capital Loan

  • Secured:
    Generally, a secured loan is one that involves collateral to reduce the risk of the lender. In working capital loan, invoice factoring and merchant cash advance are secured type of loans because repayment is guaranteed. In these types of loans, you can obtain funds based on accounts receivable and future sales respectively. Here, the lender charges a percentage of the sales in lieu of capital lent in advance.

  • Unsecured:
    These loans have no collateral involved and they have small repayment window of 6-18 months with slightly steeper interest rates keeping the lender’s risk factor in the equation.

  • Working Capital Demand Loan: 

It is similar to a business line of credit where you can withdraw funds any time, up to the credit limit set by the lender and you repay only what you withdraw, with interest. It allows flexible financing to business houses to manage their everyday requirements.

The Pros of a Working Capital Loan

  1. Meet Short Term Requirements: 

Working capital loans are usually required to meet urgent short-term requirements and thus, they are quickly disbursed in a hassle-free manner. They also offer flexible repayment tenures to help the borrower plan payments comfortably.

  1. Maintain Cash Flow: 

A healthy cash flow helps the business stay stable. These loans provide companies the financial strength during any urgent or unexpected needs.

  1. Facility for Line of Credit: 

This benefit that enables the owner to withdraw the amount according to their needs and pay the interest on the amount withdrawn reduces his/her tension regarding rising interest amount. Also, this financial security helps the owner in conducting his day-to-day affairs without stress.  

  1. Ownership is Preserved: 

When you opt to take financial help from investors, you have to part away some of your ownership rights that can hurt you if payments get delayed. In such a case, you can opt for working capital loans that don’t put your proprietorship at stake.

How to Qualify for a Working Capital Loan?

  • The applicant should be running the business for at least 3 years in public, private or proprietorship sector. 

  • The business must prove its profitability as per industry norms. A decent credit score helps in getting better terms from the lender.

  • For the documentation and verification process, the applicant needs to submit audited financial statements of the last three years like balance sheets and IT returns along with business plans and future projections. The applicant also needs to provide details about the profiles and KYC of Directors and Partners in the company, the registration certificates, and other licenses.

Conclusion

A business owner can opt for working capital loans to finance the everyday operations of the business when cash reserves go down as he/she awaits payment from clients. These loans are quickly financed and come with flexible repayment and interest rates. One must collaborate with the right lender that has the experience in funding small-term requirements.