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A Guide to Understand A Working Capital Loans

A Guide to Understand A Working Capital Loans

A Capital is the life blood of business, and similarly, working capital is the backbone. Both of them are incredibly critical to ensure smooth and successful business operations. Working capital is that component of capital that is available for daily operations and everyday expenses. On a balance sheet, it is calculated by subtracting the current liabilities from current assets.

When it comes to a lack of sufficient working capital, it makes it even more difficult for businesses to operate smoothly. It might result in delayed order fulfilment or refusal to accept new orders due to a lack of raw materials.

Power, textile, sugar, infrastructure, aviation, gems/ jewellery and real estate are a few sectors that are high working capital intensive. In a Working Capital, it is also essential to grow and expand your business. Therefore you must also ensure that adequate working capital is made available after considering the nature of business, industry standards, expected future trends, governmental policy and more.

Components of a Working Capital:

There are three main components of working capital:

When it comes to accounts receivable, it is revenue that is due to the business and is expected to be received by a given date. However, analysts usually use a sales outstanding to assess a company’s handling of accounts receivable, which also reveals details pertaining to the collections cycle of the company.

When it comes to accounts payable, it means outstanding dues. These are also the payments that a company has to make to its vendors, distributors or suppliers. The majority of the companies usually wait for as long as reasonably possible before releasing these payments. The tendency is to elongate the repayment cycle. However, it always helps if the collection cycle is shorter than the payment cycle, allowing for prudent cash management without affecting the business operations.

The inventory Cost means that the cost of holding goods in stock, usually expressed in percentage of the inventory value, includes capital, warehousing, depreciation, insurance, taxation, obsolescence, and shrinkage costs.

What is a Working Capital loan?

When it comes to a working capital loan, they are usually taken to finance day-to-day operations or short term activities of a business such as accounts payable, wages, marketing activities, inventory purchase, etc.

There most common types of working capital loan are:

  1. Bank Overdraft Facility
  2. Short-Term Loans
  3. Equity Funding
  4. Accounts Receivable Loans
  5. Factoring or Advances
  6. Trade Creditor

The charged rate of interest is different for each loan type, and they even vary among different NBFCs or any financial institutions. However, such loans can generally carry a tenure of around 3 years with an LTV or Loan-To-Value ratio of up to 90% against the security or collateral being pledged for obtaining the loan.

Eligibility Criteria for Working Capital Loan:

These loans can be taken quickly by all entity types, such as sole proprietorship, partnership, privately owned or publicly traded company, with a minimum business vintage of three years, and with the help of reasonable cash flow, which should adequately cover the EMI obligation of the loan amount being considered.

The documentation requirements are similar to any other loan taken for business or commercial purposes. These include the last three years audited financials and projections, profiles and KYC or directors and partners and company constitution/ registration certificates. 

Advantages of Working Capital Loan:

There are several advantages of availing of a working capital loan. A few of them are:

Autonomy: When it comes to NBFCs or other lenders, they do not have any restrictions on where the money can or cannot be used. Thus, granting complete liberty to business owners how they see fit to make the loan work for them. It can also help make balanced business decisions.

Flexibility: These loans can also be taken against almost all asset types, such as real estate, machinery, bills receivable, lease rentals, etc.

Quick Availability: When it comes to a Working capital loan, they are quick to get instead of a business or personal loan. The paperwork is also straightforward, and the granting is quick to put together. Usually, a working capital loan is approved within a week of applying, ensuring easy access that helps to make immediate business decisions.

Multiple Tenure Options: These are loans that can be taken for a few months to a few years. It will help you in bringing much-needed liquidity into businesses on a short to medium-term basis.

The recent changes that have been made in indirect taxation have made working capital management slightly complicated. The Goods & Services Tax (GST), rolled out on July 1, 2017, has changed almost every industry’s working capital management process. GST has also impacted the businesses in multiple ways, such as:

Tax payment schedule: Under the GST, tax is levied upon stock transfer, so the businesses can’t claim their tax credits until the shipped goods are sold. This can also sometimes take months, during which the paid tax money won’t reach the business. However, it has resulted in a lag between paying and realizing the payment, thereby affecting working capital requirements.

Moving products: The companies with multi-location or multi-state presence have to register for each state they operate in. However, GST has also simplified most processes, but this is one sphere where it is similar to some of the state-wise elements of the previous tax regime.

Opening of input tax credits: The input tax credits are also newly levied on businesses as a part of ‘Furtherance of Business’ instead of only on taxable output. This also makes it easier for businesses to seek extra lines of credit, thus increasing temporary cash flows.

Imports: The imports will be more costly, resulting in a boost to domestic manufacturers and service providers.

The working capital, as mentioned earlier, is critical for any business. A working capital loan will be able to help you expand your business, introduce new products, and serve your customers in a better fashion. With the help of easy repayment plans, it will ensure that business owners do not have to part with equity and spend extended periods repaying the loan. However, a well-structured working capital loan can help work wonders for your business.

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