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11 Aug

Guide To Understanding Working Capital Loans

  • By Editorial Team


Capital is the life blood of business and similarly working capital is the backbone, both of them are extremely critical to ensure smooth and successful business operations. Working capital is that component of capital which is available for daily operations and everyday expenses. On a balance sheet, it is calculated by subtracting the current liabilities from as current assets.

A lack of sufficient working capital makes it difficult for businesses to operate smoothly, it might even result in delayed order fulfilment or refusal to accept new orders due to lack or raw materials, etc.

Power, textile, sugar, infrastructure, aviation, gems/ jewellery and real estate are a few sectors which highly working capital intensive. Working Capital is essential to grow and expand your business, therefore one must ensure that adequate working capital is made available after considering the nature of business, industry standards, expected future trends, governmental policy and more.

Components of a Working Capital

There are three main components of working capital:

  1. Accounts receivable is revenue that is due to the business and is expected to be received by a given date. Analysts usually use a sales outstanding to assess a company's handling of accounts receivable, which reveals details pertaining to the collections cycle of the company.

  2. Accounts Payable mean outstanding dues. These are the payments which a company has to make to its vendors, distributors or suppliers. Most companies usually wait for as long as reasonably possible before releasing these payments, the tendency is to elongate the repayment cycle. It always helps if the collection cycle is shorter than the payment cycle, allowing for prudent cash management without affecting the business operations.

  3. Inventory Cost means the cost of holding goods in stock, usually expressed in percentage of the inventory value, it includes capital, warehousing, depreciation, insurance, taxation, obsolescence, and shrinkage costs.

What are Working Capital loan?

Working capital loans are usually taken to finance day-to-day operations or short term activities of a business such as, accounts payable, wages, marketing activities, inventory purchase, etc.

There most common types of working capital loans are:

  1. Bank Overdraft Facility

  2. Short-Term Loans

  3. Equity Funding

  4. Accounts Receivable Loans

  5. Factoring or Advances

  6. Trade Creditor

The interest rates charged are different for each loan type and they even vary among different NBFCs/ Financial Institutions. Such loans normally carry a tenure of around 3 years with an LTV or Loan-To-Value ratio of up to 90% against the security or collateral being pledged for obtaining the loan.

Eligibility Criteria for Working Capital Loan

These loans can be taken by all entity types, such as sole proprietorship, partnership, privately owned or publicly traded company, with a minimum business vintage of three years, and reasonable cash flow which should adequately cover the EMI obligation of the loan amount being considered.

Documentation requirements are similar to any other loan which is taken for business or commercial purposes, such as, last three years audited financials and projections; profiles and KYC or directors and partners and company constitution/ registration certificates. To know more about loan eligibility and documentation related aspects, click here.

Advantages of Working Capital Loan

There are several advantages of availing a working capital loan, a few of them are:

  1. Autonomy

NBFCs or other lenders do not have any kind of restrictions on where the money can or cannot be used, thus granting complete liberty to business owners on how they see fit to make the loan work for them. It can help take balanced business decisions.

  1. Flexibility

These loans can be taken against almost all asset types, such as real estate, machinery, bills receivable, lease rentals, etc.

  1. Quick Availability

Working capital loans are quick to get as opposed to a business or personal loan. The paperwork is incredibly easy and quick to put together. Usually, a working capital loan is approved within a week of applying, ensuring easy access that helps take immediate business decisions.

  1. Multiple Tenure Options

These loans can be taken for a few months to a few years, they help in bringing in much needed liquidity into businesses on a short to medium term basis.

The recent changes in indirect taxation has made working capital management slightly complicated. The Goods & Services Tax (GST), which was rolled out on July 1, 2017, has changed the working capital management process for almost every industry. GST has impacted the businesses in multiple ways, such as:

  1. Tax payment schedule

Under GST, tax is levied upon the transfer of stock, so businesses can't claim their tax credits until the shipped goods are sold. This can sometimes take months, during which the paid tax money won't reach the business. This has resulted in a lag between paying and realizing payment, thereby affecting working capital requirements.

  1. Moving products

Companies having multi location/ multi state presence have to register for each state that they operate in. GST has simplified most processes but this is one sphere where it is similar to some of the state-wise elements of the previous tax regime.

  1. Opening of input tax credits

Input tax credits are newly levied on businesses as a part of 'Furtherance of Business' instead of only on taxable output. This makes it easier for businesses to seek extra lines of credit, thus increasing temporary cash flows.

  1. Imports

Imports will be costlier, which will result in giving a boost to domestic manufacturers and service providers.

Working capital as mentioned earlier is critical for any business and a working capital loan can help expand your business, introduce new products and serve your customers in a better fashion. Easy repayment plans help to ensure that business owners do not have to part with equity and spend long periods repaying the loan. A well-structured working capital loan can help work wonders for your business.

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Did You Know

Borrower Incentive Programs

Borrower Incentive Programs are often offered by financial institutions to reward and encourage borrowers who keep making repayments on time. Incentives are often calculated on a monthly basis, and paid out to the borrower once a year.

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