A working capital loan is a credit or funding option required by companies, self-employed professionals, startups, or micro, small, and medium enterprises (MSMEs) for managing their daily business cash flow and business operations. They are categorised under short-term loans as they aid businesses in fulfilling their instant requirements. Working capital loans cannot be used for investment purposes or for buying long-term assets.
Let’s dig deeper into working capital loans for MSMEs.
Working Capital Loan—Definition
A working capital loan is a loan that allows MSMEs to cover their daily operational expenses such as accounts payable, wages, etc. It is a perfect option for such businesses to generate working capital and elevate their growth graph. These loans have become highly popular in India especially among the MSMEs as it empowers them to tackle their unique financial needs. However, these loans cannot be used to buy long-term assets.
Generally, working capital loans come under unsecured loans but the ones with high risks require some collateral. A working capital’s duration ranges anywhere between 6 and 12 months and the interest rate varies from 11% to 16% per annum varying according to the policies of the lenders.
When Should MSMEs Avail a Working Capital Loan?
As mentioned earlier, the working capital loans are mostly availed for dealing with day-to-day business operations; however, that does not mean the loan cannot be availed for other reasons. Listed below are major conditions under which businesses can opt for working capital loans.
1. Fluctuation in Seasonal Sales
It is one of the common reasons to apply for a working capital loan. The borrowed amount can be used to meet the general expenses for the period when sales get slow mostly during the off-season.
2. To Meet Cash Reserve Limit
The loan comes in handy for the businesses when they run out of cash reserves, which is an additional capital used in case of an emergency.
3. For Maintaining Steady Cash Flow
At times, a business may take a longer period to pay invoices. Resultantly, it takes a lot of time for the inventory to bring the entire turnover. A working capital loan is an ideal option for elevating the cash flow to keep working in continuity.
4. To Capitalise on a Business Growth Opportunity
Nothing is as frustrating as losing growth opportunities due to a lack of funds. Working capital loans help the business owner grab those opportunities, proving to be fruitful in the long term.
Whether you own a seasonal business or often face challenges and risks that create issues in your business revenues, then a working capital loan is a perfect option. It absorbs the problems and risks of not having sufficient cash flow. It covers the daily operating expenses of the business and enables them to secure future business operations.
Working Capital Loan Eligibility for MSMEs
MSMEs get a working capital loan in India, given they meet the eligibility requirements.
Businesses looking for a working capital loan need to represent an enterprise that has been in operation for at least a year, or the enterprise should meet the set annual turnover limit. However, the eligibility requirements vary according to the business type.
Following are the basic requirements for working capital loan eligibility for different types of firms:
Here is the list of documents that are required to be submitted when applying for a working capital loan.
- Filled and duly signed loan application form
- Recent passport-sized photos
- A business plan
- Copy of PAN card or any other identity proof such as passport, voter’s ID card, Aadhar card, utility bills, driving license of the individual, company, and firm. Identity documents of co-applicants (if any) are also needed.
- Address proof as in voter ID card, ration card, passport, or driving license
- ITR of previous three years with profit and loss account, income, and balance sheet statement of the previous two years
- Bank statement of last 12 months
- Business continuity proof including ITR, Sales Tax Certificate, trade license of the establishment
- Business Registration Certificates including GST registration, company PAN card, business registration proof, rental agreement, partnership deed, etc.
- Loan statement including sanction letters (if any)
After arranging the necessary documents, you may apply for an MSME loan with any financial institution online or offline.
Ups and downs are an inevitable part of every business. Situations like negative cash flow or slow business can make it difficult for the owners to run their business in continuity. Small funding in the form of a working capital loan can help resolve various short-term issues. Moreover, it helps businesses to function efficiently and properly.
Further, it is important to invest in reliable accounting software like OkCredit as the lenders generally ask for the previous years’ financial reports of the business. Apps like these help businesses in managing their finances easily.
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Q. What asset security is required by the bank for approving a working capital loan application?
Ans. Some banks accept industrial, commercial, and residential assets as security. Alternatively, some of them even consider stocks, shares, book data, and gold as collateral.
Q. How is working capital different from a term loan?
Ans. Working capital loans refer to short-term loans. Its repayment period may last up to a few months. Whereas, term loans come with three types of durations—long, medium, and short term. The duration may range anywhere from 12 months to 10 years. In some cases, it can be extended up to 30 years.
Q. When to apply for a working capital loan?
Ans. A working capital loan allows MSMEs to meet their business’s short-term financial needs. You can apply for the loan to meet daily operating expenses at the time of the slow season, to accumulate (emergency) capital, for maintaining continuity of cash flow for your cyclical business, or for capitalising on the business growth opportunities.
Q. What are the different working capital components?
Ans. Working capital has four components including inventory, cash, accounts payable, and receivables.
Q. What is the maximum loan amount for a working capital loan?
Ans. The maximum loan amount for MSMEs is approximately INR 20 lakhs.