Working Capital Loan is a loan availed by a small business to finance their daily operational expenditure. Such loans provide a short-term cash infusion and generate revenues from the conduct of business operations. These loans help meet expenditure like labor wages, inventory purchase, payment to suppliers and other routine expenses.
Fintech lenders extend unsecured working capital loans without collateral cover. The duration generally ranges between 6-12 months.
The following are the types of Working Capital Loans commonly raised in India for funds requirement:
1) Trade Creditor Loan
Trade creditor working capital loan is offered by a current or prospective supplier. The vendor will conduct a thorough check of the credit history of the small business, before extending this small business loans.
2)Overdraft Facility
This is extended by the lender and the business rapport with the financial institution determines the interest rate and the amount range of credit facility.
A big advantage of an OD is that one needs to pay interest only upon the overdrawn amount and not the eligible amount. However, the rates are generally set above the prime rate of the financial institution.
3) Account Receivable Loan
The account receivable loans are based on the confirmed sales order value of a business. It is ideal for a business that requires funding towards fulfilling a sales order. However, the prerequisites to avail this small business loan are having a good business track record and a good credit rating.
4) Factoring or Advances facility
The Factoring working capital loan functions in a similar way to the accounts receivable loans. However, in the case of factoring, the loan value is dependent upon future credit card payments. This loan is suite to business units that accept credit cards as a payment mode.
5) Short-term loan
A short-term working capital loan is charged at a fixed interest rate for a maximum tenure of 12 months. Fintech lenders allow a credit with zero collateral cover.
Broadly a working capital loan is taken to meet the shortfall in operational expenses so that business operations can continue. The following are the specific situations when working capital infusion from a fintech lender comes in handy:
1) Seasonal nature of sales
In case fluctuation in sales or seasonal nature of the business, a working capital loan helps meet everyday expenses during a lean period. It may also happen that a business allocates working capital into a more profitable avenue before the start of the business season. There are several small businesses which operate on a cyclical revenue model and cater exclusively to the retail requirements. Examples include agro-commodities or jewelers which post high sales during marriage season. The retailers, in turn, sell most of the goods during the peak festive season.
The business units conduct the production during the off-season to meet the consumption demand during the peak season.
Hence when the peak season arrives, the purchases towards manufacturing get reduced as the focus is purely on sales of inventory. Hence a working capital loan is availed in the off-season to meet the expenses of the wages and other overhead expenses. The business loan is then repaid off in the busy season,
2) Cash Buffer
The working capital loan can help augment the cash pool in case of inadequate cash reserves. There is additional capital available to meet any emergency.
3) Prolonged cash cycle
Some business units take a longer period of time to convert inventory to finished products and final realization of sales proceeds. The working capital loan can help fulfill any short-term cash needs.
4) Seizing an investment opportunity
Funds constraint should not be a reason to forego a big contract. A working capital loan can aid in the bulk purchase of raw material to fulfill a big order. The working capital finance can result in huge profits in the long run.
Hence a working capital loan is especially suited to those in a cyclical business or those with a long cash cycle. Sufficient cash flow is the secret to the success of a small business. It will carry the business through until the payment from the debtors is obtained.
Negative cash flow over a medium to long term can result in a shutdown of the small business, which has limited cash buffer. This is where a working capital loan can step in and save the day. The working capital loan ensures smooth conduct of business operations, efficiently and effectively. This helps protect the liquidity and credibility of the business unit.
