Working Capital Loans: Meaning And Types

What is a working capital loan? 

A working capital loan is a money borrowed from financial institutions for a firm or company’s day to day operations. They are not long-term assets or investments, but rather short-term easy money for operational needs. The working capital loan includes rent, debt payments and periodic payrolls of a company. Companies which have cyclic sales mostly rely on such short-term loans. In simple words, a working capital loan is a debt used by a company for its daily needs. 

Elements of working capital loans 

The working capital uses the current ratio of a firm. This ratio measures the ability to balance potential liabilities using current assets. There are three main key factors or components of a working capital loan. These include: 

1. Accounts receivables 
2. Inventory 
3. Account payable

Advantages of working capital loans

While applying for a loan, it is essential to carefully examine all possible advantages provided to us. This can help us understand our maximum profit in any given scenario. Mentioned below are some common advantages we get by investing in working capital loans: 

1) Easy and fast access to money

Capital loans are ideal solutions when facing a financial crisis. Handling a business is not easy and the probability to hit a financial wall is also very high. Working capital loans are productive options for young businesses who need fast money. This has proved to be more helpful than personal loans. 

2) Quick repayment 

Working capital loan deals with small and quick transactions. There is no lump sum amount to repay. This makes the entire repayment process stress-free. The default risk for such loans is small. In personal loans, it takes years of debt to repay loans. However, that is not the case here. The loans are small and repayable. 

3) No collateral is needed 

The concern for collateral is one of the main reasons why people do not like to apply for loans. One can remain assured that no collateral is asked for a working capital loan. Only in rare cases when you have a bad credit score or a history of debt, this is only when financial institutions might demand collateral. These regulations differ in different credit unions of various financial institutions. 

4) Ownership of a company 

Ownership of a company is especially relevant when borrowing equities from different investors. You will not only receive cash but also a part-ownership of a firm while borrowing equities from investors. If you stay committed to your repayment plans then full ownership of firms is also provided.

Types of working capital loans

Working capital loans are provided by various financial institutions and have various types. Given below are some commonly known types of working capital loans: 

1) Short-term Loans 

The loans that come with an interest rate on a fixed period of payment are called short-term loans. This is a secured type of loan. In short-term loans, financial institutions check your credit history and its credibility. This is an easy way to secure a loan without collateral. 

2) Bank Overdraft Facility 

A bank overdraft facility is commonly known as a credit line. It is one of the most flexible types of working capital loans. In this type of loan, the borrowers have to be cautious of not exceeding their loaned amount. Interest is charged upon the withdrawn amount instead of the approved amount. This is advantageous to saving interest. 

3) Trade Credit 

In a trade credit account, a bulk is ordered with potential or present suppliers. This is one of the only types that approve large amounts of money. To approve such loans, credit history and profit sheets are carefully studied. As the amount provided is large, the debtor has to prove his/her creditworthiness. The business needs to maintain its credibility to get approved for trade credits. The benchmarks vary in different loan providers and so keeping maximum safety credit is advised. 

4) Amount Receivables 

While applying for aworking capital loan, a firm can use its sales orders or amount receivables. If a firm lacks funds to distribute its orders, then this is an ideal solution to apply for a loan. However, a debtor has to keep in mind that their firm has a reputable sales history or else the loan cannot be approved. Financial setbacks are considered following sales history. Nominal credit scores also need to be maintained. 

5) Equity Funding 

Equity funding from investors is one of the most common and resourceful types of working loans. These loans are ideal for young start-ups with no credit history. It can be sourced through home equity loans, friends and family. These investments are productive and practical. Long-term security measures with part-ownership of firms are also allotted. 

6) Letter of credit

In this loan, a lender can sell his letter of credit to the buyer. The buyer further sends this credit letter to the potential seller. Then an agreed order is settled which is sent to the seller by the lender. The seller bears the cost of all the orders. At the stipulated time, the bank collects money from the buyer. The regulations for selling and/or buying may be different in various financial institutes. 

7) Bank Guarantee 

A Bank guarantee is a non-funding working capital loan. It is given to potential buyers or sellers to balance out any possible breach-agreement risks. The breach can range from payment to promise of services. The bank asks for security charges on commission. This can only be acquired by the holder on non-performance by the other party. Such loans are risky as they are non-funding ones. They completely work on written agreements and their breach.

8) Factor invoice 

In such a type of arrangement, a firm sells potential account payables to a third party. The selling price is lower than the original value of the accounts. Here, the third party is the factoring service. The third-party continues to finance bills and amounts from debtors. This is a convenient set up for businesses with poor credit histories. The third-party buyers usually only consider success rates. Regulations may differ in every financial institution. 

Working capital loan is agreat alternative which provide the maximum amount of profit at nominal repayment rates. Indeed a great opportunity for entrepreneurs!