Guide

Guide To Working Capital Financing – Forbes Advisor INDIA

A working capital loan is a debt instrument that meets the requirements of short-term financing for a company to continue its operations. This type of financing is common among small and medium businesses where the current assets do not match the current liabilities or according to the layman’s terms, “the company does not have the means to cover its expenses”.

Most working capital financing is granted for a loan period of six to 12 months and charges between 11 and 16%, depending on a number of factors.

Working capital financing becomes relevant when a company’s current liabilities exceed its current assets. Under these circumstances, the company has little or no choice but to apply for a loan. Unfortunately, most business loans have a fixed term, which is counted as “long-term liabilities” on a company’s balance sheet. This type of loan really doesn’t make sense for a company that doesn’t want to take on the burden of long-term commitments or repay the loan for the next five to ten years.

Here’s how working capital financing works.

Benefits of working capital financing

In essence, working capital financing aims to finance existing orders as the company receives a promissory note from the customer for a specified number of goods to be delivered. It is also uncommon to use it to fund accounts payable as there are outstanding bills to be paid. This ensures that the borrower does not owe more than he can repay.

Unlike most business finance or loans that finance a number of businesses, working capital loans are specifically taken and repaid in a short period of time, eliminating bad debt concerns.

Some of the other benefits of working capital financing include:

1. Zero guarantees

Working capital loans require zero collateral. For most businesses with a good credit score, getting a loan is a quick and easy process. Businesses don’t need to bother putting up their assets or inventory as collateral to secure the loan. However, failure to take responsibility and make payments on time can lead to lower credit score and even legal action on the part of the lender.

2. Quick approvals

One of the advantages of working capital financing is that a company with a good credit score can obtain financing in a quick time. Banks and other financial institutions understand the importance of fast financing for businesses to meet immediate cash flow requirements. There are reports that also demonstrate the simplicity and speed with which companies can obtain an infusion of working capital and revive their operations.

3. Flexible Payment Options

For seasonal businesses, working capital financing offers greater flexibility and different repayment terms for businesses. Businesses that experience a high peak during the year can opt for a working capital loan to balance their cash flow and maintain a steady flow of reserves during times of need. It also gives them a cash cushion in the form of surplus capital in case of emergency. This gives the company much-needed leverage and confidence to take on additional risks.

Types of working capital loans

There are a number of different types of working capital loans. Each one has its own advantages and disadvantages. Choosing the correct zeros is due to the individual borrower’s need for liquidity.

short term loans

This type of financing generally has a fixed term of six to 12 months and at a fixed interest rate. A borrower with a good credit score can easily get this type of loan with minimal documentation, no collateral, and minimal verification. This type of loan is great for a company that is in dire need of liquidity and has a good credit score.

Overdraft

The bank offers this type of working capital financing to its business clients. When the customer’s account has insufficient funds to cover the expenses, the bank allows overdrafts to meet the cash flow requirement.

For example, a customer presents a check of INR 20,000 to the supplier to pay for the raw materials purchased. Unfortunately, the customer has only INR 18,000 in his account. The bank will honor this check and calculate INR 2,000 as overdraft from the bank after consulting the customer. Overdraft interest rates are generally fixed and charge higher fees when compared to loans.

Accounts Receivable Loans (AR)

An AR loan is a popular source of financing for a business that only covers the cost of applications made. It is generally easy to obtain an AR loan, especially when the borrower has purchase orders that must be fulfilled. Lenders will generally need a Payment Pledge (PTP) to indicate that the borrower will actually repay the principal amount with interest, after receiving payment against their application.

There are a number of other working capital financing options available to businesses. The three above are the most common forms of credit.

How to apply for a working capital loan?

Applying for a line of credit is not a very difficult process, especially if you meet certain criteria that lenders deem appropriate.

Types of businesses that can benefit from working capital financing:

  • Sole Proprietorship
  • Limited Liability Partnerships
  • Private limited companies

In addition, lenders will generally prefer that your business has been in operation for a number of years and has a certain minimum annual turnover. Keep in mind that this requirement varies from one lender to another and the type of business you work in.

Here are the standard documents that you need to submit for a working capital loan:

  • Standard Know Your Customer (KYC) documents that include proof of identity, age, and address. Some of the generally accepted forms of identification are PAN Card, Aadhaar Card, Driver’s License, Passport, Voter ID, House Deed, etc.
  • Business incorporation certificates, including registration documents, Goods and Services Tax (GST) registration, partnership deed, lease agreement, company PAN card, and more.
  • Bank account statement for the last six months of the company’s current account.
  • IT revenue for the current year or last year.
  • Details of outstanding debts, if any.
  • Purchase orders indicating the number of goods required and the capital required to purchase them.

Where do I apply for a working capital loan?

Working capital financing can be obtained through a number of sources.

1. Online bank aggregators

There are a number of online banking aggregators available that can help you with much needed financing. Some of the unique technology platforms offer a number of financing options from various banks, lending institutions and non-bank financial companies (NBFCs) at varying interest rates and terms.

The application process on these platforms is relatively smooth and straightforward. Just remember to have all the documents (mentioned above) ready before you begin the application process. This will save you a lot of trouble down the road.

2. Banking institutions

Banks are another great source of working capital financing. Most of the major banks in India like State Bank of India, PNB, ICICI Bank, IndusInd Bank etc. offer working capital loans at competitive rates. You can either visit their online website and check your eligibility for a working capital loan, or you can visit a branch and speak to a financial executive who will take you through the whole process.

Pro tip: Things will be a lot easier if you are an existing customer of the bank. The bank will not have to go into various details about your credit history because most of the information will be readily available to them.

3. Online lender platforms

There are a number of tech platforms for other lenders that offer a number of benefits. These platforms offer unique benefits and provide instant financing if you meet their credit conditions. You can download their app on Android or IOS and search for the latest offers or live promotions that may make it cheaper to borrow in the long run.

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Working capital financing helps keep businesses’ cash flow positive. If your business is in dire need of cash, you may want to consider a suitable working capital financing method for starting and running your business. Negative cash flow can be an alarm clock for your business growth.

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