MSMEs are the backbone of any economy. They are the primary source of employment and they contribute significantly to the overall economic growth. MSMEs contribute to 40-50% of India’s GDP and employ over 90% of its workforce. However, MSMEs face many challenges in their operations due to lack of working capital. Working Capital Loan for MSMEs is designed to help provide timely working capital support for MSMEs.
What is Working Capital Loan?
A working capital loan is a loan obtained to cover a business’ regular operating expenses. These loans are meant to provide the working capital necessary to meet a company’s immediate operating demands; they are not utilised to purchase long-term assets or investments. These expenses may include things like rent, payroll, and debt repayment. Working capital loans are thus merely corporate debt borrowings that a business uses to fund its ongoing operations.
Simply explained, a working capital loan is obtained to pay for a business’s operating costs. A business may use this form of loan when it lacks the cash flow to meet immediate demands. If you want to apply for this loan, the loan amount, repayment period, and interest rate might vary from bank to bank. However, you may get a fixed-interest loan for a minimum of Rs. 50,000 for terms up to 7 years. The money obtained through this loan may be put to a variety of uses, including:
- Payment of debt
- Purchasing supplies and raw materials
- Paying payments to employees
- Keeping expenses in check
- Paying vendors
A working capital loan cannot be used to make investments or to buy long-term assets, nevertheless.
Understanding Working Capital Loan
Business groups take out working capital loans to pay for their regular, daily operations. These loans are often obtained to pay expenses like employee salary or accounts payable. Loans for working capital are typically obtained by businesses with severe sales cycles that need money during slow periods of company activity. Loans for working capital may be unsecured or secured.
Working capital loans should not be used to buy assets or make long-term investments. These are typically employed for tasks like paying off debts, clearing up payroll, etc. These loans are designed to enable firms to go on with everyday operations even if they lack the necessary operational expenditures.
The loans are a technique to “buy time” so that you may continue with your regular business activities while you search for potential sources of income.
Working capital limitations can be distributed in a variety of ways, including:
Working of a Working Capital Loan
A business may occasionally lack the resources to cover its ongoing costs. A decline in business activity, changes in sales cycles, or irregular cash flow might all be to blame for this. An organization may think about taking out a working capital loan to manage current assets and obligations.
Currently, this sort of loan comes in a variety of forms:
- Term loan
- Bank promise
- Bill reduction
- Word of credit (LC)
- Available credit
- Credit/overdraft for cash
- Credit for packing
- After-shipment financing
A corporation can choose any of these variations to satisfy its goals, depending on its own business needs.
Types of Working Capital Loans
There are many working capital loan options available to you:
Overdraft or credit line at a bank
The lender has given its prior approval for the withdrawal cap on this loan. Despite the fact that the sanctioned limit may be larger, the interest is only applied to the amount you withdraw. For instance, if your approved withdrawal limit is Rs. 1 lakh and you only take out Rs. 20,000, the interest would be applied on the latter amount. It’s crucial to have a solid relationship with the lender in order to obtain this sort of loan.
The majority of the time, investors who could be intrigued by your company plan can assist you to get funding. Your friends or relatives may be the investors. You can apply for equity finance if your business is just getting started or if your credit is less than stellar.
These are short term loans with a set interest rate that must be paid on the loan amount. One of the most popular financing programmes for small businesses is this one.
Loan secured by receivables
This form of financing is available if you have a stable and trustworthy client base. Since there is always a chance that invoice payments may not be made on time, the majority of lenders avoid making this sort of credit.
Cash advances or factoring
Instead of proven sales, the loan is offered here on prospective credit card receipts. Only if the firm accepts credit cards as a form of payment is this sort of loan practical.
Current or new suppliers may provide this kind of credit. The loan is only provided, though, if there are large orders submitted. You should be aware that there are several severe requirements to meet in order to qualify for this loan.
Advantages of Working Capital Loans
A working capital loan provides a number of advantages that will be helpful to you if you need to manage your company’s current needs.
- Unsecured loans: You are not obliged to pledge any kind of asset as security when applying for a working capital loan. Additionally, a sizable loan sum of up to Rs. 30 lakh might be approved for you. Currently, the grant amount varies from bank to bank and is also based on other qualifying requirements.
- Speedy application and approval procedure: The simple application and approval process for a working capital loan is one of its main advantages. To start the application process, you only need to provide some basic information and send a few pieces of supporting evidence. Additionally, the absence of collateral expedites the approval procedure. You may anticipate that the sanctioned amount will be disbursed shortly once your loan has been granted.
- No interference: Because this is a brief loan, you are not obligated to provide your lender with any information on your spending. Due to the lack of ownership on their part or any share exchange, the lender is similarly uninvolved in your company’s affairs. You just need to worry about making your equal monthly instalments and paying off any outstanding debt before the due date.
- Flexible withdrawals: When it comes to acquiring new materials or controlling overhead expenditures, some organisations don’t have a formal budget or financial strategy. A working capital loan might help in this situation since it gives you the freedom to spend money however you see fit as per your discretion.
- You are not necessary to provide a thorough budget of the costs your business will incur to obtain the loan. In truth, flexible working capital loans are also provided by several banks. In this case, you only borrow what you need and pay interest on that sum. Without worrying about the pre-payment fees, you may pay your debts when you have the money.
- Offers for pre-approved loans: You may also be able to acquire pre-approved loans through some institutions. The application and approval processes are now much simpler thanks to these incentives. You might be required to provide your contact information on the bank’s website in order to take advantage of this promotion. If you are qualified for the loan, the approval and disbursal processes should be completed quickly.
Disadvantages of working capital loans
- Some loans for working capital are unsecured. A business is not obliged to put up any collateral to secure the loan if this is the case.
- An unsecured loan is only available to firms or business owners with excellent credit, though. Small to no credit businesses must securitize the loan.
- A working capital loan that is collateralized by assets may have disadvantages in the loan application procedure. However, this kind of working capital loan may also have additional disadvantages. In order to cover the lending institution’s risk, interest rates are high.
- Furthermore, company owners’ personal credit is frequently a factor in working capital loans, so any missing payments or defaults might lower their credit score.
Eligibility for getting a working capital loan
- The requirements change depending on the lender. However, there are certain prerequisites that must be met in order to be qualified for a working capital loan.
- The candidate must be at least 25 years old.
- A minimum 3-year vintage for business
- The most recent information on income tax returns
- No company should be put on a blacklist.
- Your company’s location shouldn’t be on a list of undesirable locations.
- NGOs, trusts and small enterprises are not eligible.
- Additionally, you could be requested more information to confirm your business.