Small and Medium Enterprises (SME) and Micro, Small and Medium Enterprises (MSME) are very significant in India as they give employment and aiding the evolution and development of the country’s economy. All businesses need a good pouring of working capital for the fluid operations of its daily activities. Many companies require working capital loans at regular intervals. For example, the manufacturing industry is bereft of a regular income for the entire year; they are confronted with money paucity due to cyclical sales which hinge on the needs of the retailers. When sales are not up to the mark, manufacturers require working capital finance to meet the short-term functional expenditures. These costs could be rent and payroll to tax and debt payments.
Types Of Working Capital Loans
The 4 major working capital financing options are term loans, business credit cards, trade credit, and invoice financing.
Term Loan: Generally availed for one to ten years. This kind of loan is utilized to finance big investments, such as business expansion, acquiring equipment or tools etc.
Business Credit Cards: Commercial banks provide business credit cards with a whole set of features and benefits. This credit card makes working capital financing accessible. Companies are provided certain restrictions on spending on the cards and have to pay interest just on the amount spent.
Trade Credit: A convenient alternative of short-term working capital financing and the least costly one. It happens to be a business-to-business (B2B) agreement where the buyer get supplies from the supplier sans paying upfront; the supplier is paid back at a later date (ranging from 30 to 90 days) after the buyer has manufactured and sold the goods. Also, the buyer is supposed to pay interest for this kind of credit.
Invoice Financing: This kind of financing permits businesses to take money against customers’ unpaid invoices to bridge fiscal liquidity gaps when customers pay after a long time for goods and services. The lenders take a cut from the invoice as service fees.
Ways to Apply For Working Capital Finance?
Companies have to be in operations for a year at least to become suitable for working capital loans. Banks and non-banking financial institutions can verify the borrower’s credit history, credit rating, trading history, financial muscles, assets, liabilities, income, and profitability while going through the loan application. So, business owners should assess their loan suitability prior to applying for working capital finance.
Documents Needed to Get Working Capital Financing
- Identity, income, and address proofs
- PAN card
- Passport-size photographs
- Partnership deed
- Certificate of registration and certificate of incorporation
- Income statement and Income Tax Returns (ITR) of the last 3 years
- Financial audit reports of the last 2 years
- Memorandum of Association (MoA) and Articles of Association (AOA)
- Credit Monitoring Arrangement (CMA) report, if needed
- Last one year’s loan statement with sanction letters especially the ones from other credit institutions
- Company letterhead having names of all current directors
Merits and Demerits of Working Capital Loans
| Merits | Demerits |
| Businessmen get convenient and fast access to working capital finance to meet their companies’ short-term activities financing requirements. | At times linked to a business owner’s personal credit, so, if there is a delay in payments or missed payments, his or her personal credit score gets negatively impacted. |
| If it is an unsecured working capital loan, a company gets to secure the loan devoid of any collateral. | Only companies having a high credit rating are suitable for unsecured business loans. The ones having an uncharitable credit rating must furnish asset(s) as collateral to avail working capital finance. |
| This permits business owners to have control over their companies even if they badly require funding. | To offset credit risks, the borrowers are levied high-interest rates which can be a bit disadvantageous for business owners; as the debt burden swells, the prospects of defaulting on payments go up. |
Last but not the least
Despite certain disadvantages, working capital loans are a viable alternative for businesses in financial distress. Companies having good credit rating need not furnish any collateral to avail working capital financing. Similarly, short-term loan borrowers need not be anxious regarding long-term EMIs. Companies into seasonal operations can meet their daily functional expenses during unstable phases with working capital finance. Also, working capital financing can be utilized not just for daily functional requirements, but also for parking money in future business operations. Though there aren’t any limits on funds utilization, it’s better to utilize the same simply for legal business requirements.