A working capital loan is a loan that is taken to finance a company’s everyday operations. These loans are not used to buy long-term assets or investments and are, instead, used to provide the working capital that covers a company’s short-term operational needs.
Different Types of Working Capital Loans
Sometimes companies do not have enough liquidated assets to run daily operations. These operations include rent, debt payments, and payroll. During such times, they apply for working capital loans. In the simplest terms, working capital loans can be defined as the debt the company uses for its day-to-day operations. The loans can be both: secured and unsecured.
Below are the different types of working capital loans:
- Short-term loans
The short-term loan comes with a fixed payment period and rate of interest. This is a secured loan. However, depending on the credibility of your credit history and relation with the lender, you can secure this loan for no collateral as well.
- Credit line or Bank Overdraft Facility
- Trade Credit
- Account Receivables
- Equity funding from Investors or Personal Resources
- Factoring of invoices
- Letter of Credit
- Bank Guarantee
This is the most flexible working capital loan. The lender approves a certain amount to the borrower that he can use. The borrower must be careful not to exceed the limit of the cash approved. Moreover, the borrower is only charged interest on the amount withdrawn and not the approved amount. This encourages the borrower to deposit the used amount to save on interest.Potential or present suppliers provide this working capital loan. Suppliers offer a trade credit when you place a bulk order with them. However, this loan is only given after the supplier thoroughly evaluates your creditworthiness, profits, and credit history.You can always use your confirmed sales orders or account receivables to apply for a working capital loan. It is ideal, especially if your company lacks funds to fulfil a sales order. However, such loans are only secured if your company has a reputable history and proven track record of paying debts on time.This is the most resourceful capital loan. It is commonly procured from investments by family, friends, or home equity loans. They are the most practical loans for start-ups or have companies that do not have an established credit history.This is an arrangement where a business sells either all or some of its account payables to a third party. This is done at a lower value than the original value of the accounts. The third party is called the factoring service. It provides financing by purchasing the bills and collecting the amount from the debtors.The buyer can purchase a letter of credit from a lender. Then, the buyer will send the letter of credit to the seller. After the agreed order is sent by the sender; the lender will pay the seller the cost of the order. The bank then collects the amount from the buyer at the stipulated time.It is a non-fund based working capital loan. Bank guarantee is acquired by the seller or buyer to outweigh the possible risk due to non-performance of a certain agreement. It could be anything from a payment to the promise of service. The holder only repeals it on non-performance by the other party. The bank asks for some security or charges some commission.
Types of Working Capital Loan FAQs:
1. What is a permanent working capital loan?
Also known as fixed working capital, it is the minimum amount of investment required in working capital irrespective of the business volatility.
2. What are the pros and cons of working capital loan?
|1. On-hand cash to deal with cash flow problems||1. Have to repay the capital and interest in full|
|2. Always in control of the company||2. May need to put up collateral|
|3. May not need to place a collateral||3. High rates of interest|
|4. Can borrow and repay promptly||4. Defaulting on the loan can affect personal credit score|
|5. No restrictions on how you spend the money|
3. When do I require a working capital loan?
Subtract your business liabilities from your current assets. The answer, if positive and enough to cover your daily expenses, then you do not need a working capital loan.
4. What are the main components of a working capital loan?
The following are the main components of a working capital loan:
- Accounts receivables
- Account payable
5. What does working capital include?
Also known as the current ratio, the working capital ratio measures a company’s ability to settle current liabilities using current assets. It is the comparison between current liabilities and assets.