Working Capital Funding Guide – Forbes Advisor INDIA
A working capital loan is a debt instrument that meets the short-term financing needs of a business to continue its operations. This type of financing is common among small and medium-sized businesses where current assets do not match current liabilities or, put simply, “a business cannot afford to make ends meet.”
Most working capital financings are given for a loan term of six to 12 months and charge interest between 11 and 16%, depending on a number of factors.
Funding working capital becomes relevant when a company’s current liabilities exceed current assets. Under these circumstances, a business has little or no choice but to apply for a loan. Unfortunately, most business loans have a fixed term, which is recorded as a “long-term liability” on a company’s balance sheet. This type of loan doesn’t really make sense for a business that doesn’t want to be burdened with long-term debt or pay off the loan over the next five to ten years.
Here’s how working capital financing works.
Benefits of working capital financing
Basically, working capital funding is intended to fund existing orders when a business receives a promissory note from a customer for a specific number of goods to be delivered. It is also more rarely used to fund accounts payable when there are unpaid bills to pay. This ensures that the borrower does not owe more than they can reasonably repay.
Unlike most business finance or loans which fund a number of business activities, working capital loans are specifically taken out and repaid within a short period of time, thus eliminating bad debt problems.
Here are some other benefits of working capital financing:
1. No warranty
Working capital loans do not require any collateral. For most businesses with good credit, getting a loan is quick and easy. Businesses don’t have to worry about putting their assets or inventory as collateral to secure the loan. However, not being responsible and making payments on time can lead to a lower credit rating and even legal action from the lender.
2. Prompt approvals
One of the advantages of working capital financing is that a business with a good credit rating can obtain financing quickly. Banks and other financial institutions understand the importance of quick financing for a business to meet its immediate cash flow needs. Some reports also describe how easily and quickly businesses can get a working capital injection and get their operations back on track.
3. Flexible repayment options
For seasonal businesses, working capital financing offers businesses greater flexibility and variable repayment terms. Businesses that experience high peaks during the year can opt for a working capital loan to balance their cash flow and maintain a constant flow of reserves when needed. It also gives them a cash cushion in the form of excess capital in an emergency. This gives a business the leverage and confidence it so badly needs to take on additional risk.
Types of working capital loans
There are several types of working capital loans. Each has its advantages and disadvantages. Choosing the right zero corresponds to the liquidity need of an individual borrower.
Short term loan
This type of financing generally has a fixed term, between six and 12 months and a fixed interest rate. A borrower with a good credit rating can easily get this type of loan with minimal documentation, no collateral, and minimal verification. This type of loan is ideal for a business that is in dire need of cash and has a good credit rating.
This type of working capital financing is offered by a bank to its corporate clients. Whenever a customer’s account does not have sufficient funds to cover expenses, the bank allows an overdraft to meet cash demands.
For example, a customer presents a check for INR 20,000 to a supplier for payment for raw materials purchased. Unfortunately, the customer only has 18,000 INR in their account. The bank will honor this check and will count 2000 INR as a bank overdraft after consultation with the customer. Interest rates on bank overdrafts are generally fixed and charged more than on loans.
Loans to receive (AR)
AR Loan is a popular source of financing for a business that only covers the cost of orders placed. An AR loan is generally easy to obtain, especially when the borrower has purchase orders that need to be fulfilled. Lenders will generally need a Promise to Payment Note (PTP) to indicate that the borrower will actually repay the principal amount with interest, after receipt of payment for their orders.
There are a number of other working capital financing options available to businesses. The three mentioned above are the most popular 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:
- Individual company
- Limited liability companies
- Limited liability companies
Additionally, lenders will generally prefer that your business has been in business for a number of years and has a certain minimum annual turnover. Keep in mind that this requirement differs from lender to lender and the type of business you are in.
Here are the standard documents you must submit for a working capital loan:
- Standard Know Your Customer (KYC) documents that include proof of identity, age and address. Some commonly accepted identity documents are PAN card, Aadhaar card, driver’s license, passport, voter card, residence certificate, etc.
- Certificates of business incorporation, including registration documents, Goods and Services Tax (GST) registration, partnership deed, rental agreement, company PAN card, etc.
- Bank statement for the last six months of the company’s current account.
- IT returns for the current year or the previous year.
- Details of unpaid debts if applicable.
- Purchase orders that indicate the number of goods ordered and the capital required for their purchase.
Where to apply for a working capital loan?
Funding for working capital can be obtained through a number of sources.
1. Online banking aggregators
There are a number of bank aggregators available online that can help you with the much-needed financing. Some unique technology platforms offer a number of financing options from different banks, lending institutions, and non-bank financial corporations (NBFCs) with varying interest rates and terms.
The application process on these platforms is relatively smooth and straightforward. Remember to have all the documents (mentioned above) ready before you start the application process. This will save you considerable hassle on the road.
2. Banking institutions
Banks are another great source of working capital financing. Most major Indian banks such as State Bank of India, PNB, ICICI Bank, IndusInd Bank and others offer working capital loans at competitive rates. You can either visit their website online and check eligibility for a working capital loan, or visit a branch and speak with a finance manager who will walk you through the process.
Pro tip: Things will be much easier if you are already a customer of the bank. The bank will not have to go into various details about your credit history, as most of the information will be readily available.
3. Online lender platforms
There are a number of technology platforms from other lenders that offer a number of benefits. These platforms offer unique advantages and provide instant financing if you adhere to their credit provisions. You can download their app on Android or IOS and search for the latest offers or promotions live that might get you to borrow cheaper in the long run.
Funding working capital helps keep business cash flow positive. If your business is in dire need of cash, you may want to consider a suitable working capital financing method to start your business. Negative cash flow can sound the alarm bells for growing your business.