A working capital loan is a perfect business funding option for when your business experiences a cash constraint. Business loans are not just to fund long-term investments but also to help meet your recurring expense requirements.
What is a Working Capital Loan?
A working capital loan is the perfect loan product to help you pay recurring expenses like rent, wages, and EMIs on time. This type of loan is great to keep your operations running smoothly in periods when your cash inflow is low.
Types of Working Capital Loan
Working capital loans can be of an unsecured and secured nature, meaning you may or may not need to provide security for them. There are four main types:
1. Bank Overdraft/Credit line:
An overdraft facility is a revolving line of credit, where the lender provides you with an approved limit in your bank account. Based on your needs, you can borrow money up to the sanctioned limit, and interest is charged only on the amount you use. This is the ideal solution for your working capital needs as it gives you access to a large sum of money without paying interest on the entire amount in case your revenues come through. Higher limits may require security.
2. Loan on Accounts Receivables
A lender may offer you a loan on accounts receivable as a working capital loan option if you have trusted customers who have a history of paying their dues on time. This is a form of a secured business loan, where the lender requires you to pledge your invoices in exchange for immediate funds. It is ideal for short-term credit needs and usually ends on the date the invoices are due.
This type of working capital loan is similar to invoicing as factoring advances are also sanctioned against accounts receivables. The difference here is you sell your invoices to the lender in exchange for money, and the lender will recover dues from your debtors themselves. Lenders will usually pay you about 70% of the money in advance, and the remaining amount is held for any unforeseen charges.
4. Supplier Invoice Financing
This type of working capital is an optimization tool for both buyers and suppliers. It is a way for the supplier to get advance cash, stabilizing their cash flows, and is based on the credit rating of both companies in the supply chain.
In this loan type, you get an advance payment on your invoice from a lender after the buyer approves the invoice. Then when the invoice is due, the buyer will directly make the payment to the lender.
If you do not have enough collateral to offer lenders, you can apply for an unsecured business loan instead.
Advantages of Working Capital Loans
- Streamline your cash flows during a lean business phase with immediate funds.
- Meet your financial obligations like wages, rent, supplier payments, etc., on time and maintain your credit score.
- Avoid situations where you may need to sell assets to meet your operational expenses or dilute your business ownership to meet your funding needs.
- Depending on your credit history and the loan amount you require, you may not need to provide the lender with any collateral to get this type of business funding.
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