A working capital loan provides short-term financing for a company’s daily operations, such as payroll, rent, and debt payments, rather than long-term investments. It’s a form of corporate debt borrowing used to fund a company’s daily activities.
Why should a business consider getting a working capital loan?
A business may consider getting a working capital loan to address short-term financial needs, such as covering operational expenses when there is a cash flow shortfall, funding seasonal fluctuations in demand, taking advantage of growth opportunities, or managing unexpected expenses. A working capital loan can help a business maintain its daily operations and ensure that it has sufficient cash flow to meet its financial obligations.
Typically, this applies to businesses that experience fluctuations in demand throughout the year or those with cyclical sales patterns. However, other companies may also need a working capital loan during slow business periods or holiday seasons.
Features of working capital loan:
The features of a working capital loan can vary depending on the lender and the specific terms of the loan, but some common features include:
1. Short-term financing: Working capital loans are usually designed to be repaid within a year or less, making them a short-term financing option
2. Unsecured loans: Working capital loans are often unsecured, meaning that the borrower does not have to provide collateral to secure the loan
3. Fast approval and disbursement: These loans often have a quick approval process, and funds can be disbursed rapidly to the borrower
4. Flexible repayment terms: Repayment terms can be flexible, with some lenders offering the option to repay the loan in instalments or as a lump sum at the end of the loan term
Types of working capital loan:
There are several types of working capital loans available, including:
1. Line of credit: A revolving credit line that provides businesses with access to funds on an as-needed basis, up to a predetermined limit
2. Invoice financing: A loan that allows businesses to receive funds based on the value of outstanding invoices, which are used as collateral
3. Short-term loans: A loan with a fixed repayment term, often used for a specific purpose, such as covering seasonal expenses or purchasing inventory
4. Merchant cash advance: A lump sum of cash provided to a business in exchange for a percentage of future credit and debit card sales
5. Asset-based loans: A loan secured by the borrower’s assets, such as inventory or accounts receivable, with the amount of the loan based on the value of the collateral
How to qualify for a working capital loan: Common mistakes to avoid
To qualify for a working capital loan, businesses typically need to have a strong credit history and financial stability. Here are some common mistakes to avoid when applying for a working capital loan:
1. Lack of an effective business plan
If a business does not have a well-crafted business plan, it means they don’t have a clear idea of how to use their resources and expand their operations. Having a robust business plan is crucial because it allows lenders to comprehend a company’s future aspirations and expected financial results. A well-crafted business plan can increase a business’s likelihood of obtaining working capital loans with favourable terms
2. Inaccurate documentation
Businesses must provide accurate and up-to-date financial statements, irrespective of whether it is profitable or incurring losses. Although businesses may experience financial hardships sometimes, it is advisable to explain the reasons for reduced profits or losses and devise strategies for improvement. Lenders will reject the loan application if they detect any inaccurate financial information.
3. Poor credit score evaluation
Another significant mistake that businesses make before obtaining a working capital loan is failing to assess their credit score. If a business has a low credit score, it may portray the borrower as a high-risk entity, leading lenders to either reject the loan application or impose higher interest rates.
4. Opting for an incorrect loan
Lenders have varying loan options, and business owners should choose the one that aligns with their requirements and helps them achieve their objectives. For example, selecting a loan with a high-interest rate will escalate borrowing costs. Therefore, businesses must take adequate time to evaluate and select a credit option that does not adversely impact their financial well-being in the long term.
5. Applying for multiple loans
Applying for numerous loan applications concurrently is a mistake that businesses frequently make. Studies reveal that such actions hurt your credit score and increase financial strain. Additionally, lenders view this as credit-hungry behaviour. As a result, borrowers should avoid doing so and instead take the time to choose a lender who can meet all of their financial needs.
6. Borrowing excessive loan amount
Businesses may qualify for a sizeable loan amount at times, but it is a mistake to borrow the full amount. Taking on excessive debt increases the repayment burden and can lead to financial difficulties. Therefore, borrowers should adhere to their initial financial plan and only borrow the necessary amount.
7. Not reading the terms and conditions
A typical mistake that new businesses make when obtaining working capital loans is neglecting to review the terms and conditions outlined in the agreement. It is essential to scrutinise the fine print, comprehend fees, foreclosure conditions, late payment penalties, and other details thoroughly. Doing so will assist them in avoiding last-minute challenges and loan refusals.
How can businesses apply for working capital loan from Razorpay?
Did you know? Businesses can now easily get a working capital loan without undergoing tedious documentation and application processes.
Razorpay Line of credit is one such facility that allows businesses to gather a substantial loan amount of Rs. 25 lakhs. Only by having an annual turnover of Rs. 20 lakhs and being operational for a minimum of 1 year, businesses will qualify for the credit facility. Even the credit option comes with no collateral and additional charges which help businesses lower their loan expenditure.
Frequently asked questions
Q1. Is it possible to get a working capital loan with a lower credit score?
Ans. With credit facilities like Razorpay Line of credit, business owners can access considerable loan amounts with lower credit scores. Businesses that are functional for a minimum period of 1 year with an annual turnover of Rs. 20 lakhs can easily avail the credit option.
Q2. Is it possible to get a working capital loan without pledging collateral?
Ans. Yes, there are multiple financial institutes and neo-banking platforms from where businesses can take a working capital loan without pledging any collateral.