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Important aspects you should know about working capital loans


working capital

Important aspects you should know about working capital loans

Any business needs to make profits to sustain itself, and shortage of working capital can become a challenge as the business grows.

It is in such times that a working capital loan for MSMEs can alleviate the financial distress caused by cash flow deficits. However, the dynamics of this financing option needs to be understood to utilise the loan efficiently.

Working capital financing is a short-term loan option offered by various financial institutions in India, and it enables businesses to fund their day-to-day operations. It is most suited for resolving cash flow problems instantly, without any hassle.

However, this credit facility characteristically differs from a traditional business loan provided by such financiers.

Unlike a term loan which has a tenure up to five years and is availed by companies for meeting major expenses which have a long-term bearing, working capital financing usually is offered for a shorter term of up to 6 months, for meeting operating expenses of a business. Further, eligibility criteria for long term loans are more stringent than for working capital loans.
There are different types of working capital financing offered such as equipment loans, bill discounting, overdraft, and loan against fixed deposits (FDs).

Equipment loans

are given to companies, to acquire new equipment or machinery, with a condition that the loan is to be used only for purchasing the equipment.

Bill discounting service

is used by many enterprises to finance their various working capital needs. This helps to release the amount blocked up in unsettled invoices ahead of their maturity dates.

An overdraft

is line of credit extended by banks to companies based on their good relationship with the banks. This enables the business to draw cash from the account even when its balance reaches zero but is capped at a predetermined limit. However, the interest rate for this credit facility tends to be significantly higher.

Loans against FDs

can be availed by offering the FD as a collateral and the amount borrowed as a working capital loan is usually a percentage of the outstanding FD balance. Interest rates on such loans are little higher than the FD rates.

Parameters usually evaluated by a lender before extending a working capital loan for MSMEs are period for which the business has been in existence, annual turnover, credit rating, reliability of owners / directors and the business clientele. The eligibility criteria for working capital financing also depend on the type of the loan and also on the financial institution.

The documents you need to submit to avail this loan facility are:

• Memorandum of Association and Articles of Association
• IT returns for previous year
• Certificate of incorporation and registration
• Business ID proof
• Audited financial statements
• KYC details of owners/directors

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