Businesses require working capital to fund various day-to-day expenses and continue functioning efficiently. Some businesses may endure seasonal sales followed by periods of low revenue. Funding operational costs during these times becomes a challenge without cash inflow. In such instances, you may be tempted to use your business credit card to pay for employee salaries or purchase raw materials. However, opting for a working capital loan is a better alternative, especially for bridging sustained revenue gaps, since these easily available loans come with flexible repayment windows, pocket-friendly interest rates, and much higher loan amounts.
What is a Working Capital Loan?
A working capital loan is a type of finance option that helps businesses fund their everyday operations. Entrepreneurs can use the loan amount to meet short-term obligations like cover employee salaries, accounts payable, and inventory management, but not asset purchase or business expansion. In other words, working capital loans help businesses secure adequate funds during low sales or revenue periods to continue smooth operations.
Working capital loans can be secured or unsecured. Tenures for such loans vary from one lender to the next but typically fall within 6-48 months. Similarly, the applicable interest rate, processing charges, and loan amount details vary depending on the selected lender. Most lenders usually have a simple eligibility checklist for such loans and a digital application process ensuring easy access to business credit.
Working capital loans help firms fund their operational expenses efficiently. These working capital loans may have different tenures as per the lender policy and applicant’s requirements. These are repaid over several months or even years and would typically be arranged on flexible repayment terms that align with the cash flow cycle of the business. The underlying logic behind these loans is to fund short term obligations to ensure that business’ operations are not disturbed and can function smoothly. This also comes in handy in case of unexpected expenses or liabilities.
What is a Business Credit Card?
A business credit card is a type of credit card that’s designed specifically for business-related expenses. Such cards are available to both small and medium-sized enterprises, as well as large corporations. Functioning like regular credit cards, business credit cards sanction a line of credit to a company to meet its working capital requirements. These credit cards help separate business expenses from personal ones and maintain a streamlined expense ledger.
Business credit cards also pack business-specific features and rewards. Some of the most notable perks include cashbacks on business expenses, increased cash withdrawal limits, vendor-wise expense tracking, and employee spending limit caps. These features and perks help incentivise the use of business credit cards to improve a company’s working capital ratio.
Also, unlike personal credit cards, with business credit cards like capital credit cards, the liability is not attached to a person but to the business entity.
In both forms of credit, i.e working capital loan or a business credit card, there is usually a dedicated helpline number or customer care for any issues you may face. You can dial business loan customer care number to resolve issues or get answers to questions (if any). Helpline numbers can be found easily over the internet or in the documents, for credit cards, it can be found at the back of the card.
Advantages of Working Capital Loans Over Business Credit Card
Opting for a working capital loan is a prudent choice to maintain an optimal working capital turnover ratio. Here’s why choosing a working capital loan over a business credit card is better:
1. Lower Interest Rates
Interest rates for business credit cards can be quite high, ranging up to 40% p.a. Moreover, while business credit cards offer a 20 to 50-day interest-free period, this is temporary. Once the interest-free period ends, high interest charges are added to your outstanding dues. Working capital loans, on the other hand, offer credit at a much lower interest rate. While interest rates for working capital loans vary from one lender to the next, they remain pocket-friendly, making these loans cheaper business credit lines. Also, depending upon the venue where you want to use the business credit card like a capital card, vendors may charge a surcharge of up to 2% of the transaction value as convenience fee. Whereas there’s no such convenience fees attached to line of credit, you simply withdraw whatever amount you require!
2. Higher Loan Amount
Working capital loans can easily finance both small and large fund requirements. You can easily secure up to Rs. 2 Crore by meeting simple eligibility criteria. With a working capital loan, you can choose the loan size to suit your business needs. On the other hand, business credit cards have lower monthly limits on the funds you can borrow in a billing cycle, restricting your access to finance. Moreover, cash withdrawals using business credit cards also attract a 1%-7% fee, over and above your monthly interest rate. Upon calculation, all the convenience fee and surcharge really adds up and for sizable expenses, these amounts can be really high!
3. Flexible Repayment Options
The ideal credit line for your business should offer both the required loan amount and convenient repayment options. Business credit cards do not offer long and flexible repayment options. They have a fixed billing cycle, after which dues need to be cleared. However, certain types of working capital loans allow you to customise repayment durations to suit your business needs. Lending institutions can match loan payments with the business’s cash flow to avoid extra pressure during low sales periods. This flexibility is best demonstrated with the overdraft working capital loans that allow fund withdrawals as and when needed and charge interest only on the withdrawn sum. Moreover, some loans may allow you to repay the interest component of the loan during its tenure. Repaying the principal sum at the end of the tenure allows you to manage adequate cash reserves for day-to-day operations while you wait to receive client payments.
A business credit line should therefore provide the business with the amount of loan along with the flexibility to repay the loan. While business credit cards allow businesses to repay at any time before the due date if you want to avoid interest, however, other working capital loans like line of credit offer favorable repayment terms. Businesses can design these repayment schedules around their business cycle and expected realization of bills receivables. This really helps during periods of low sales. Such a favorable line of credit allows businesses to manage their working capital efficiently and thus increase profitability.
4. Tailored Finance to Suit Business Needs
No two businesses may have the same working capital requirements. This is why working capital loans come in various shapes and forms. Overdraft, short-term loans, term loans, letters of credit, accounts receivable, and post-shipment finance are some of the most common working capital loans. Each loan type comes with its own set of eligibility criteria, repayment terms, loan limits, etc., allowing you to choose a finance option that meets your specific requirements. In contrast, business credit cards are quite standard. Each comes with a sanctioned line of credit and a monthly repayment date.
Firms need to understand these differences well and make the right financial decisions. For example, an overdraft facility would be the obvious choice of funding during periods of cash crunch as it helps manage the expenses better.
5. Collateral-Free Finance Options
You don’t need to pledge property, security, or gold as collateral to avail of working capital loans. Most banks and financial institutions offer unsecured working capital loans without collateral requirements. You may have to opt for a secured loan only if your credit score is below par. Contrary to this, business credit cards require you to sign a personal guarantee. This guarantee makes you liable for non-payment of credit card dues and puts both your personal assets and credit score on the line.
Financing may not be easy every time, banks and other financial institutions usually prefer a low-risk financing, hence, prefer giving out a collateral based loan. LendingKart stands out as we offer collateral-free finance options, this comes as a boon for small business owners who are starting from scratch and may not have collateral to finance their business. Also, opting for collateral based finance to fund small and quick funding requirements may not be a smart idea, as that collateral can be used to get a bigger funding which can be used really efficiently.
Also Read: Small Business Loans – The Working Capital Angle
Conclusion
Available against attractive interest rates and flexible repayment tenures, working capital loans can help meet your day-to-day operational expenses. Moreover, you can choose the right type of working capital loan to meet your specific financial needs. That said, funding your business’s working capital requirements is a balancing act. It’s prudent to keep a business credit card handy for small expenses that you can repay by the end of the month. A working capital loan with flexible payment options is always better for sizable capital requirements.
Most firms suffer at the point of managing day-to-day expenses when it comes to running daily operations; slow periods for sales do not help. When it is just appealing to use business credit cards as a means of quick cash, the better alternative would be a working capital loan. Working capital loans will enable the business to pay employees’ salaries and restock the inventory without living in constant fear of the extremely high interest rates associated with most credit cards available these days. There are various types of working capital loans like business lines of credit, overdrafts, term loans, etc. These usually don’t require collateral, making the personal risk of the business owner lower. Business credit cards have fixed cycles, and high charges and interest rates. Also, business credit cards may not be suitable for bigger transaction amounts citing the fact that credit cards have a fixed repayment cycle, and failing to abide by the timelines may attract really high interest charges and late fees. Therefore, learning these distinctions will help the owners of businesses make an appropriate financial decision by enriching operational efficiency and thus supporting sustainable growth.
Frequently Asked Questions
Do Working Capital Loans Involve a Processing Fee?
Yes, working capital loans involve a nominal processing fee. While most banks and NBFCs charge around 2% of the loan amount as a processing fee, the percentage can vary depending on your lender.
Are all Working Capital Loans Unsecured?
Working capital loans can be secured or unsecured. In other words, you may or may not have to pledge collateral to avail of the loan. For secured loans, gold, securities, property, or the business itself is accepted as collateral. Lenders evaluate the owner’s credit history, tax returns, and credit score for unsecured ones.
Who can Apply for a Working Capital Loan?
Entrepreneurs, public/private companies, partnership businesses, sole proprietorship businesses, manufacturers, and traders can apply for working capital loans.
