The article takes the readers through in understanding the advantages and disadvantages of taking a working capital loan for a business. It spells out the impact of taking such loans while explaining how the loan amount gets reflected on the balance sheet due to high-interest rates.
Definition of Working Business Loans
Before understanding the meaning of working capital loans, let us first understand the meaning of working capital. Working capital is the amount of money required for carrying out the day-to-day operations of any business. Without smooth flow of working capital, a company may not be able to function smoothly and efficiently. A company can take a working capital loan to ensure interrupted operational performance.
I think you have got an idea of a working capital loan, isn’t it? A working capital loan is a type of loan taken to carry out the everyday operations of a business smoothly and effectively. A working capital loan is not for funding the expansion of your business or for buying assets for your business. It is a loan needed to fulfil the financial obligations in the short run and the operational needs.
The short-term liabilities may include payment of employee wages, buying raw materials, and management of inventory. Some businesses are unable to generate revenue or sales all over the year; hence, these businesses may require working capital loans to continue operations.
This is usually seen in the case of businesses that have a seasonal demand or have cyclical business profits. There are still others that may require working capital loans, particularly during the festive months or during a business lag, for that matter of fact.
Working capital loans may be secured, or they may be unsecured, based on the amount of loan required and the business’s financial condition. In the case of a secured working capital loan, you will have to keep collateral for availing of the loan. On the other hand, in the case of an unsecured working capital loan, a business does not have to keep collateral to avail of the loan. It should be noted that the working capital of a business reflects the financial condition and the liquidity position of the business.
This type of loan is applicable for small as well as medium enterprises. The tenure of working capital loans usually ranges from 6 months to 48 months. However, the loan tenure may vary from one bank to the other.
The interest rate charged on working capital loans may also differ from one bank to the other. The amount of loan offered also varies from bank to bank as per the guidelines laid down by the Reserve Bank of India (RBI). In this regard, let me tell you that the turnover of your business is an important element that is considered when finalising the loan amount.
Some of the types of working capital loans offered by banks include Cash Credit or Overdraft Facility, Term Loan, Packing Credit, Bank Guarantee, Accounts Receivable Loan, Letter of Credit, and Post Shipment Finance.
Features of Working Business Loans
You must have clearly understood the meaning of working capital loans, isn’t it? Now let us discuss some features of working capital loans.
- Amount of loan: The amount of loan offered through a working capital loan is based on the business needs, the experience of the business, and tenure.
- Interest rate: The interest rate on working capital loans differs between banks. However, it is curated according to the needs of the borrower.
- Collaterals: Working capital loans may be secured or unsecured. Examples of collaterals for working capital loans include property, gold, securities, investments, and the business. The bank you wish to avail of the working capital loan will curate the loan based on your collateral capability. In the case of unsecured working capital loans, lenders will check your financial statements, credit score, and tax returns.
- Repayment schedule: The repayment schedule of a working capital loan is designed to match the business’s cash flow.
- Age factor: To apply for a working capital loan, the borrower should be more than 21 years old and below 65 years of age.
- Working capital loan processing fee: Banks charge a processing fee when a borrower applies for a working capital loan. The amount of this fee varies from bank to bank.
- Loan Eligibility: An entrepreneur, a private company or a public company, a partnership firm, MSME, a sole proprietor, a self-employed professional or a non-professional can apply for working capital loans.
Advantages of Working Business Loans
There are many advantages of working capital loans. One of the most significant advantages of working capital loans is that you can easily avail yourself of this loan. It also allows the business owners to cover the gaps that may arise in working capital expenses hassle-free and efficient. Also working capital loan is a type of debt financing, and it does not need any equity transaction. This implies that the business owner has complete control over his company even if the need for funding is dire.
In addition, as already mentioned, some working capital loans are unsecured, and, in such cases, there is no need for the company to keep any collateral for securing the loan. However, unsecured working capital loans are primarily given to business owners or companies having high credit ratings.
Disadvantages of Working Business Loans
One of the most significant disadvantages of working capital loans is that these loans usually have higher rates of interest to compensate for factors related to the risk of taking such huge amounts on loan. Also, these loans are generally attached to the business owner’s credit, and hence, any missed payments or defaults could have an adverse impact on his credit score.
By now, I think everyone has an idea about working capital loans, the features of such loans, and the advantages and disadvantages of working capital loans. So, what are you still waiting for? If you are a business owner and you are finding it challenging to fund the day-to-day operations of your business, just visit your nearest bank today and enquire about working capital loans.
The article talks about the need to take a working capital loan in any business and how such an activity can get reflected on the balance sheet. Since such loans are available at high-interest rates, it is logical for the business owner to focus on the amount of loan being applied for in relation to the specific business requirements.
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