A working capital finance is a type of lending product that provides the short-term capital a firm needs to keep running. Small and medium-sized businesses frequently use this sort of financing when their present assets don’t cover their current liabilities, or, to put it simply, when they “cannot make ends meet.”
The majority of working capital finance is provided for a loan term of six to twelve months with interest rates ranging from 11 to 16 percent, depending on a variety of variables.
When current liabilities exceed current assets, working capital financing becomes essential. A company in this situation essentially has no choice but to submit a loan application. Unfortunately, the majority of business loans have a fixed period and are recorded on a company’s balance sheet as “long-term liabilities.” For a business that doesn’t want to be tied down by long-term obligations or pay back the loan over the following five to ten years, this form of loan doesn’t really make sense.
Benefits of working capital finance
Working capital financing is fundamentally intended to finance ongoing orders when a business receives a promissory note from a customer for a specified quantity of items to be delivered. In cases where there are overdue invoices that need to be paid, it is also less frequently utilized to fund accounts payable. This guarantees that the borrower won’t be required to pay back more than they can afford.
Working capital loans are obtained expressly and repaid in a short period of time, as opposed to most business funding or loans that finance a range of business activities, eliminating concerns about bad debt.
Other advantages of working capital finance comprise:
Zero collateral
Loans for working capital don’t require any security. A loan is typically easy to obtain for businesses with strong credit scores. Businesses don’t have to worry about putting up their goods or assets as security for the loan, but failing to be accountable and make payments on time may result in the lender taking legal action, a decrease in your credit score, or both.
Fast approval
Working capital financing has the benefit of allowing businesses with good credit to obtain borrowing quickly. The importance of swift financing for a firm to meet its urgent cash flow requirements is recognized by banks and other financial institutions. There are reports that show how quickly and easily businesses can reactivate their operations with a working capital infusion.
Flexible repayment options
Working capital finance offers firms more flexibility and a range of payback periods for seasonal businesses. A working capital loan can help businesses with high annual peak cash flow manage their cash flow and keep a consistent source of reserves for when they are needed. Additionally, it provides them with a reserve of money in the form of surplus capital in case of an emergency. This provides a company with the much-needed leverage and assurance to take on more risk.
Types of working capital loans
The types of loans for working capital are numerous. Each has unique advantages and disadvantages. The best option depends on how much money the borrower needs specifically.
Short term loans
Typically, this sort of financing has a fixed tenure of six to twelve months together with a fixed interest rate. This kind of loan can be easily obtained by a borrower with good credit with little to no paperwork, no collateral, and little verification. This kind of loan is excellent for a business with strong credit that needs money immediately.
Bank Overdraft
A bank provides this kind of working capital lending to its commercial clients. The bank permits an overdraft whenever a customer’s account does not have enough money to cover expenses. This helps the customer meet cash flow needs.
Account receivable loans
For a corporation that simply covers the cost of placed orders, the AR loan is a well-liked source of funding. In general, getting an AR loan is simple, especially if the borrower has purchase orders that must be completed. To prove that the borrower will truly repay the principal amount plus interest after getting paid for their orders, lenders typically require a promise to pay (PTP) note.
There are numerous other ways for firms to finance their working capital. The three most common types of credit are those stated above.
How to apply for working capital loans?
If you satisfy certain requirements that lenders deem appropriate, applying for a line of credit is not a particularly challenging process.
Types of businesses eligible for working capital financing
- Sole Proprietorship
- Limited Liability Partnerships
- Private Limited Companies
Lenders also favor businesses that have been in existence for a while and generate a specific minimum amount of revenue each year. Remember that these criteria vary depending on the sort of business you are in and the lender.
Documents required
- KYC documents that include, ID proof, address proof, etc.
- Business incorporation certificates, such as registration documents, GST registration, partnership deeds, leasing agreements, company PAN cards, and more.
- Current account bank statement for the past six months for the company.
- IT returns for the most recent or previous year.
- information about any outstanding debts.
- Purchase orders that specify the number of items bought and the funding needed to make the purchase.
Conclusion
Financing for working capital aids in maintaining positive cash flows for firms. If your company is in dire need of money, you might want to think about an appropriate working capital finance strategy to get it off the ground. Being cash flow negative can be a red flag for your company’s expansion.