Hema is the owner of a small manufacturing unit. She was using her current month’s income to fund the next month’s payment. While this can appear to be a good practice, this is not. One of her consumer delayed the payments by a week. Hema was planning to pay her workers with that money. Luckily, her sister, who worked in the banking industry, advised her to apply for a working capital loan. Numerous businesses, like Hema’s, could face such a financial situation and would urgently need liquidity.

Here are six things to know about working capital loans

  • What Is Working Capital

Working capital is the money required to manage the day-to-day operations of your company. Every business needs certain amount of cash to meet the routine payments. For example, you need money to pay for raw materials needed for production, wages, and any other unforeseen costs.

To have adequate working capital, you should be able to effectively manage the money that you owe to your creditors and what your customers owe you. Despite all this, the company may not have the required cash to manage daily operational expenses. Lenders offer working capital loans to business owners based on factors such as type of business, loan amount and debt history.

  • Tenure Of Working Capital Loan

Working capital loans typically come with a short tenure. It is generally around twelve months or lesser. This is because the main purpose of a working capital loan is to efficiently fill the gaps in the short-term cash flows of the company. This has dual benefits for a company:

  1. It can effectively fulfil its financial needs
  2. It can stay out of unnecessary credit traps

Also Read : Working Capital: Its Role In A Business Success

Thus, a Small and Medium Enterprise (SME) can form a good relationship with the creditor and avail funds regularly.

  • Collateral

Some lenders offer unsecured working capital loans. However, this is not a very common situation. Generally, only the companies that have high credit rating are eligible for such loans. Companies with little or no credit history will have to barter collateral to secure the loan.

You can use assets such as vehicles, equipment and stock as collateral based on your loan details. In some cases, you may be required to use your residential or commercial property as security.

  • Additional Benefits

Everyone likes to get that little ‘something extra’ in a deal. A working capital loan does offer certain additional benefits to the borrower. For example, you can avail other benefits such as cash credit loan, bank guarantees and overdraft facility through a working capital loan. Most lenders offer the above facilities so that the business can meet its everyday requirements.

  • Eligibility Criteria

Working capital loans are not handed out to any business. To be eligible for the loan, your company should have conducted business for a minimum number of years. The other criterion is that your company should have a certain annual turnover. These requirements depend on the type of business you own. Hence, the requirements for a sole proprietorship can be different from that of a partnership or a private limited company. Ensure that you go through the eligibility criteria of the lender before you apply for the loan.

  • Things You Should Be Aware of

While the basic criteria remain the same, different lenders have different parameters when they offer the loan. So, it is important that you have all the necessary documents ready to avoid any surprises. Some lenders may require you to sign a personal guarantee to secure the loan. Be careful when you commit to such loans because any missed payments may directly reflect on your personal credit score. Now, this comes as a double shock as it not only hurts your business prospects but also your personal credit opportunities.

To sum it up

As indicated by the above points, working capital loans can be crucial for a business to run smoothly. So, if you are a small business owner, ensure that you are aware of the different aspects of a working capital loan before you approach a funding institution.

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