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SMALL BUSINESS LOAN VS WORKING CAPITAL LOAN WHICH ONE SHOULD I PICK

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Posted on
Jun 16, 2019

Well, there are two options for every business person to pick from when they apply for a business loan. However, most of you have confusion to choose between these two namely the small business loan and working capital loan. Therefore, to select a suitable kind of business loan first you must understand the difference between working capital loans and business term loans. Once you know what they are, then it becomes easy to choose the best one for making your business vision come true. Take a look at the details given below to decide on the small business loan or working capital loan for your business.

WORKING CAPITAL LOANS

Let us begin with the working capital loan and see what it is, where it can be used and how to use it effectively. The amount required to cover the everyday operational charges for running the business is called a working capital or operational cost. Loan applied for that purpose is called working capital loan. These types of loans help business owners to focus more on the growth of the firm or to generate capital etc.  In India fetching loan for working capital has become accepted among all the business owners to tackle their daily financial needs. The amount raised in this type of loan is typically used in payment of salaries/wages or operational expenses etc.

This type of loan is relevant for both medium and small businesses for their work capital needs as well as daily operations expenditure. Most of them are unsecured but still, a loan that is required for running a high-risk business needs security. The average duration for these loans is not more than 12 months. It typically ranges between 6 and 12 months with an. interest rate ranging between the lender between 11% and 16%. It varies based on risk, duration, security, and other factors. Personally one needs to check with the lender before moving forward. 

When working capital loans are small-term loans, then the period to repay will not be more than 4 months. These loans are customized as per the requirements of the business. Thus the loan amount is based upon the business running cost. 

A businessman can avail this type of loan multiple times since the only criteria are timely repayment. 

THE WORKING CAPITAL LOAN CAN BE OBTAINED UNDER THE FOLLOWING BUSINESS SITUATIONS 

  • Fluctuating seasonal sales – Drive sales during the festive season is the topmost reason business people apply for this loan. Thereby business owners can pay for the expenses when the sales shrink after the season. It is likelihood that business takes out working capital loans prior to a demanding season due to allocating capital anywhere else.
  • Liquidity crunch – In the event when business lack funding and there is a liquidity crunch, then working capital loans can be useful. This helps businesses to have liquid cash when a firm is in an emergency.
  • Fluctuating cash flow – Some kind of business takes time to collect a payment, thus cash flow gets affected. Working capital loans help to boost cash flow so that businesses can have money when needed.
  • Not to miss any new opportunity – A business can lose its profit when they don’t win a new project and this is primarily due to deficient capital. Working capital loans can help the businessman to grab these opportunities and expand their business.

Thus if a businessman is running a regular business and generally faces any risk and challenge, that negatively affect the business revenue then businessman should adopt for a working capital loan. This type of loan can help to absorb the below and provide sufficient cash to the business. It will help the businessman to cover daily activities as well as help in supplying for future operations. 

This will help businesses to complete huge orders by managing the manufacturing expenditure as well as product shipping. It will help the business person to carry out their business till payment is received against the products.

BEST TAKE AWAY FROM WORKING CAPITAL LOAN IN SUMMARY 

It is based upon outstanding invoices and existing orders. Thus you cannot borrow the excess amount that you may not pay promptly, this eliminates the problems associated with small business loans.

As a general suggestion, a businessman should avoid taking loans as long as possible. But keeping in mind about the benefits offered by working capital loan, you can always dream high and fulfill your wish with enough funding.

  1. Collateral-free loan – Maintain a credit history and that is the mantra to stand eligible for a collateral-free working capital loan. The businessman doesn’t require giving any assets for an unsecured loan but the repayment of these loans is very important as the lender will follow you and take actions if found defaulting. 
  2. Quick and flexible – One of the advantages of working capital loans in India is that the entitled organizations can get short term loans that consist of inventory loss or credits in a shorter duration. This type of loan can be very flexible in terms of amount and can vary in the rates and repaying conditions. 
  3. Spend money as per your need – Usually, working capital loans come with minimal to nil restrictions. The lender is concerned only about how the business owner utilizes the amount for expansion of the business.

CHOOSE AMONG THE WORKING CAPITAL LOAN TYPE

While getting the information about working capital; you should also look at different types of working capital which can suit your requirement.

  • Trade Credit – It is provided by the present or the potential supplier of the firm. The supplier will confirm the credit history of the business before lending.
  • Bank Overdraft Facility – BOF – The relationship between the firm and the lender will determine the interest rate as well as the maximum LOC (line of credit) that a firm can obtain. One advantage of the bank’s overdraft facility is that it only charges interest on the overdrawn sum but the interest rates are set above the rate of the bank.
  • Account receivable (AR) loan – It is based upon the sales order value that is confirmed for any business. Sale order funding business requirement can be fulfilled by applying for this loan. However, the firm must meet the credit history to avail this type of loan.
  • Advances and factoring – Factoring working capital loan functions in an identical way as the AR loans with the only difference is the amount is based upon the future credit card receipt. This loan type is suitable for firms accepting credit cards as a payment method.
  • Short-term loan – It comes up with a fixed rate of interest and the maximum time frame is one year. Good relation maintained with the lender allows getting this loan collateral-free.
  • Investor funding or personal resource sharing – New business without a credit history can opt for this loan. Equity funding id obtained from personal resources.

Key facts you should know about working capital

  • The interest rates are usually ranging between 12% and 16% but can differ from bank to bank.
  • The usual time frame for the working capital is one year and has a flexible collateral option.

ELIGIBILITY 

The firm planning to apply for working capital should have their presence for a few years at least and must have a particular annual turnover. Nevertheless the requirement depends upon the business type as well.

Sole proprietorship, Partnership, and Public and Private Limited Firms can apply for this loan and they need to submit required documents. 

SMALL BUSINESS LOANS

Having seen in detail about working capital loan, let us now introduce you to small business loans in few words and you will be able to make a call between the two types of the loan based on the situation.

  • A small business loan is taken for long-term, repayment period ranges between 1 and 5 years. 
  • Used for investing in expanding the business, purchase of machinery, plant, etc.
  • Another crucial variation between working capital loan and a small business loan is that the former is secured and the latter is unsecured loan. 

We would not want to beat around the bush and requesting you to know more about small business loan here

Feel free to talk to us and we will guide you to apply for the best loan providing you with the right features.