Working capital is the financial metric representing operating liquidity required by business, organization, entity etc. to meet their daily expenditures. All the businesses regardless of their structure or size need working capital because maximum of their transactions generally take place through credit. Credit period can range anywhere between a few days and several weeks. As an outcome, businesses may not have adequate liquidity for their short-term obligations. Here is where different types of working capital loans come in to play to meet their monetary mismatches.
Check out 4 common types of working capital loan options for businesses:
- Cash credit
Cash credit is a massively used working capital credit option. This facility is available in lieu of pledge of raw materials, stock in trade, work in progress, fixed deposits, properties, finished goods or against the receivables from debtors or against shares etc. Separate cash credit accounts are required to be opened to avail this option. While the account holder of such accounts can withdraw over their balance amount, these withdrawals of over and above the balance is allowed just up to a predetermined limit. Note that interest is charged not on the sanctioned limit but on the limit used.
- Overdraft facility
Overdraft facility is provided to current account holders for cash withdrawal of a certain amount more than the available balance in their account. Such facility is usually provided to the current account holders with sizable deposits sharing a long-term consumer relationship. Overdraft limits are determined based on the security or collateral provided. Interest component is charged on the drawn amount until their final repayment.
- Bill discounting
Bill discounting refers to a fund-based option where the bank purchases a bill/invoice by the seller or supplier and pays to the borrower immediately after deducting a specific amount from the bill amount submitted as discount or commission. Bank shows the bill to the purchaser on or after the due date to directly collect the bill amount. In the event of any payment delay, banks may charge a pre-defined interest from the suppliers.
In such working capital funding, bill discounting is looked upon as an important financing tool that permits businesses to meet the gap in fund realization from sale date to due date of receiving payments. It assists in freeing up the cash for working capital and various other needs. Distributors, wholesalers, manufacturing firms, and businesses engaged in engineering, construction, logistics, and transport are few of the common users of this facility.
- Bank guaranteeBank guarantee refers to an undertaking from a bank assuring the vendors of repayment if the purchaser fails to repay. For example, if ‘Company N’ wants to make huge purchases from an extremely established ‘organization O’. If Company O is unsure regarding the repayment capacity of Company N, it would want the company to avail a bank guarantee. To avail a bank guarantee, Company N will approach a lender for bank guarantee. Note that it is issued in lieu of a commission and collateral. If Company N is not able to repay Company O by the due date, then the latter can notify the former’s lender to claim the amount mentioned in the bank
guarantee. Thus, this option allows businesses to conduct purchases, which otherwise was impossible for them to avail.
Every business needs a loan, may it be for running operations or for expansion purposes. Working capital loan is one of the common loans availed by businesses for meeting their short- term needs. However, for meeting their mid or long-term needs, businesses can consider
opting for term loans. Owing to their long-term nature, they have a longer repayment tenure of up to 30 years. Term loan interest rate is also lower than working capital loans.