Guide to Understanding Working Capital Loans

Working capital is the difference between a company’s current assets and current liabilities. In simple terms, it is the liquid cash at the disposal of a company to cover immediate expenses. Short-term expenses like operating expenses, inventory, and payments on short-term debt are covered by a company’s working capital. It helps a company run smoothly and handle its financial responsibilities within the coming year without any issues. 

A number of businesses have seasonality that requires a loan for new inventories. Small business financing such as working capital loans helps businesses with irregular revenue to run their operations. 

What Is a Working Capital Loan?

A working capital loan is short-term financial aid a company avails of to cover operating expenses. The short-term operational needs include costs like rent, debt payments, payroll, etc. A working capital loan comes in handy for businesses to cover these costs effectively.

Why Should You Take a Working Capital Loan?

As working capital is derived by subtracting current liabilities from current assets, it can be positive or negative. A positive figure suggests that a company is stable and can operate during a lean season without any issues. However, businesses that have high seasonality suffer from unstable working capital. Financial institutions provide SMEs and businesses with working capital finance at affordable interest rates to help them function during the lean season. 

A working capital loan is not a need-specific loan, meaning it can be used for any purpose by the business to cover its expenses. The affordable interest rates for these commercial loans make it useful for businesses to use them for relocation, expansion or to introduce new products.  Businesses take working capital loans to plug the gaps in working capital expenditures. However, not all businesses need these loans for the same reason and a well-timed loan can help you cover a number of costs. Here are some circumstances when you should consider taking a working capital loan.

Maintain Cash Flow

Every business has its share of highs and lows that can affect the revenue it earns. This is especially true for businesses that cater to a seasonal market. In lean periods, the revenue may be low and insufficient to cover the everyday expenses and this is where a working capital loan can help businesses.
In India, where there are numerous small businesses running on seasonality, business loans at affordable interest rates help keep a business afloat irrespective of revenue earned. Continued cash flow from working capital loans can enable a company to gain financial strength to cover any urgent need or unforeseen capital crunch. 

Meet Short-Term Requirements

Working capital loans have a flexible repayment tenure that help a business manage its finances better and meet any short-term operational cost with ease. It can help a business to prepare to meet any sudden or unexpected cash requirements in their day-to-day operations. 

Improve Credit Score

Paying your debts on time improves your credit score and thus, helps you acquire loans easily in the future. A good credit score is important for small businesses in order to get finance in India. 

Preserves Ownership

Unlike equity shares or venture capital where you cannot take any decision on your own, a working capital loan is simply a loan that you can repay while maintaining complete ownership of the business. If you decide to go public and allow other people to have ownership in your business, it will dilute your decision-making powers, which is not the case with a working capital loan.

Purchase Inventory

If you have a seasonal business, you may need extra capital to purchase inventory or cover increased operational costs during the peak season as this is the time for maximum sales. An easy and flexible working capital loan can help you cover all such costs and help your business make the most of these busy months. This makes it ideal for businesses to enhance their cash flow to purchase the increased amount of inventory required.

What Are the Most Common Types of Working Capital Loans in India?

The most common types of working capital loans in India are -

• Overdraft facility: A common short-term line of credit is the overdraft facility offered by various financial institutions. Businesses avail of the overdraft facility when their current account balance turns negative. Though there is no balance in the current account, financial institutions provide overdraft facilities 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.

• 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 a 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 a loan account for your working capital in India. 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.

What are the Eligibility Criteria to Get a Working Capital Loan?

Working Capital Loan eligibility involves experience, profitability, credit history, and certain business structures.

• Following are the eligibility criteria to get a Working Capital Loan from Hero FinCorp:
• Public, Private, Partnership, Trust, Society or Individual Doctor
• 5 years of experience and a minimum of 3 years in the current business
• Business profitability as per industry norms
• Satisfactory credit & financial history

What are the Documents Required to Get a Working Capital Loan?

Let Hero FinCorp be your financial partner - we make the loan application process a breeze. Just provide the required documents for the working capital loan and we'll take care of the rest! Documents required by Hero FinCorp to get a working capital loan:

• Last 3 years' audited financial statements and projections
• Profiles and KYC of Directors/ Partners/ Proprietor
• Company constitution documents and registration certificates

How to Calculate Interest on Working Capital Loan?

Calculating interest on a working capital loan means considering the loan amount, interest rate, and loan term. To calculate the interest amount, the periodic interest rate is multiplied by the outstanding balance of the loan. This ensures accurate calculations and you can fully understand the terms of the loan agreement.

Factors Affecting Working Capital Interest Rates

Working capital interest rates vary depending on the following factors:

1. Creditworthiness: A strong credit score and a good repayment history get you better interest rates on working capital loans.
2. Market conditions: Rates fluctuate based on prevailing market conditions, such as changes in the overall economy or shifts in the financial industry.
3. Chosen loan amount and duration: Based on how much you borrow and when you repay, you may have higher or lower interest rates.

Overall, the interest rate on a working capital loan is influenced by a range of factors, and being careful helps when seeking financing.

How Can a Working Capital Loan Work for Your Business?

A working capital for business purposes is necessary and a loan meets all your short-term requirements and with flexible repayment tenures, the applicant can choose the repayment size comfortably. It helps maintain healthy cash flow by taking care of urgent or unexpected needs. With the facility of a line of credit, you can withdraw the amount that you want and pay the interest only on the amount withdrawn and thus, reducing the pressure of rising interest amount. It does not demand any equity transaction and therefore, does not put your proprietorship at stake. These loans, if repaid timely, will help build your credit score as well.

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.

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 make 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.

How to Qualify for a Working Capital Loan?

• The applicant should be running the business for at least 3 years in the 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 licences.

Where to Apply for a Working Capital Loan?

We, at Hero FinCorp, understand your financial needs and have years of experience in helping businesses like Meera’s fashion enterprise meet financial requirements and see them grow at a great pace. Our eligibility criteria are quite simple. If you have been running the business for at least 3 years in the public, private, or proprietorship sector and can prove your profitability as per industry norms, you can apply for working capital finance with us. Your credit score will help you in getting better terms.

Our documentation and verification process is also fast and smooth for business loans making it easier for you to get the working capital. You need to submit audited financial statements of the last three years like balance sheets and IT returns along with business plans and future projections. Also, keep details about the profiles and KYC of directors, partners, and shareholders in the company, the registration certificates, and other licences, ready as they might be checked if needed.

Conclusion

When you start taking money out of your emergency funds, it means the company does not have enough working capital and it is becoming a challenge to meet operational costs. This can hamper the growth of the company. However, these cash crunch situations can be easily managed with Working Capital Loans. They keep the business afloat during lean phases and are quite easy to avail if you have the right credentials. We, at Hero FinCorp, offer prompt customer services along with customised plans that will suit your financial needs. 

FAQs

1. What are the tenures offered for a working capital loan?

Tenures for working capital loans vary by lender but typically range from 6 months to 5 years.

2. What are the charges for a working capital loan?

Charges for a working capital loan may include interest rates, processing fees, and prepayment penalties, among others.

3. Who requires an unsecured small business loan?

Small businesses with limited collateral or a short operating history often require unsecured loans.

4. Difference between a term loan and a working capital loan?

Term loans are typically used for long-term investments while working capital loans are meant to cover short-term operational expenses.

5. What is the requirement to qualify for the SME working capital loan?

Requirements for SME working capital loans vary by lender but may include a strong credit score, positive cash flow, and a solid business plan.