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There are times when businesses do not have enough resources to cover day-to-day expenses and must rely on loans to stay afloat. People apply for a working capital loan during these times.
What exactly is a working capital loan?
A working capital loan is a type of debt that a business uses to fund daily operations such as rent, debt payments, and payroll. The loan is intended for short-term needs rather than long-term assets or investments.
Because working capital loans are linked to the business owner’s credit, their credit score may suffer. Let’s look at the situation between manufacturers and retailers. Retailers will need to rely on a business loan because they do not have consistent or predictable revenue throughout the year. During the holiday season, retailers may sell more products than at any other time of year.
Manufacturers with this business model frequently require a working capital loan to cover wages and other operational expenses. The loan is typically repaid during the company’s busy season, when the financing is no longer required.
Request a Working Capital Loan
Working capital loans are divided into the following categories:
Here are some examples of working capital loans to help you understand them better.
Overdraft/Cash Credit (CC):
Cash credit (CC) is a short-term loan given to businesses to meet their working capital needs. A bank overdraft loan, on the other hand, is a long-term loan provided by banks to individuals or businesses that allows them to withdraw money even with a zero balance.
Cash credit and bank overdrafts may appear to be the same thing, but they are not. CC is intended to assist customers in purchasing raw materials, managing receivables, and maintaining stocks, whereas bank overdraft is intended to keep businesses operational.
The rate of interest is the focal point for both small and large businesses. The rate of interest in CC is calculated on the amount withdrawn, whereas the rate of interest in bank overdraft is calculated on the amount used by the customer.
Guarantee from a bank:
When a borrower or lender fails to repay a loan, a bank guarantee comes into play. The losses will be covered by the bank or financial institution.
Participants in the bank guarantee:
The applicant is the customer who requests a bank guarantee and a creditor loan.
- Beneficiary: The person who receives a portion of the guarantee.
- Bank: A financial institution that will sign and guarantee full payment if the borrower is unable to repay the loan.
- Process:The applicant asks the beneficiary or creditor for a loan.
- Both parties agree that a bank guarantee is required to move the loan process forward.
- The applicant requests that the bank sign and guarantee a bank guarantee.
- The bank now provides a bank guarantee and may charge a commission or require a security deposit.
Credit Letter:
(Micro, Small, and Medium Enterprise) loans are designed to assist businesses in funding their working capital requirements as well as other expenses such as raw materials, machinery, and fixed assets.
A Letter of Credit is a working capital loan that does not require funding. It is like a bank guarantee loan, except that the bank issues a letter of credit, and the bank is responsible for the entire payment if the applicant fails to pay.
It is a document in which the bank guarantees that the seller will receive the agreed-upon amount from the buyer on time. By providing the letter of credit, the bank will charge a fee, calculated as a percentage of the letter of credit.
Factoring of invoices:
Invoice factoring, also known as “receivables financing,” is a short-term loan. Let’s delve a little deeper into receivables financing.
Manufacturers sell goods and services on credit to large customers such as wholesalers and retailers. It denotes that the customer is not required to pay for the goods immediately. The buyer receives an invoice with the amount due and the due date.
Manufacturers must now consider their day-to-day operational needs as well as pay their employees. Companies choose invoice financing when their customers are slow to pay or when they have immediate needs.
Loans for Working Capital
An SME working capital loan is a programme designed to assist and encourage entrepreneurs to establish SMEs and MSME.
CGTMSE (Credit Guarantee Fund Trust for Micro and Small Enterprises) is a programme designed to assist MSME with their financial needs. It is a trust that offers credit guarantees to financial institutions, assisting entrepreneurs.
The interest rate in CGTMSE is relatively low and is determined by the customer’s profile, business requirements, and project cost.
Purchase/Discount on Bills:
Bill purchasing/discounting is another good source of working capital for SMEs.
As we all know, the bill is essential in the purchase of goods and services. That bill serves as a document to receive payment from the debtor in these types of working capital.
If the seller requires cash, he takes the bill to the bank, which gives him a discount on the entire amount of the bill.
The discount is primarily based on the existing interest, with the remainder paid to the seller.
Credit for Trade
It is a business-to-business agreement in which customers do not have to pay the full amount upfront when purchasing goods or services. On the scheduled date, the buyer pays the amount to the supplier.
Consider trade credit to be 0% financing that improves the financial condition of the company in exchange for goods and services. It is a buyer benefit that allows a company to purchase, manufacture, and sell goods before paying for them.
This process assists businesses or buyers in receiving a revenue stream sufficient to cover the cost of goods sold.
