Working capital is the lifeblood of any business. It is the money that businesses use to cover their day-to-day expenses, such as payroll, rent, and inventory. While some businesses have enough cash flow to cover these expenses, many others require working capital loans to keep their operations running smoothly.
A working capital loan is a type of business loan that is designed to provide the necessary cash flow to cover operational expenses. However, obtaining a working capital loan is just the first step in maximising its potential. In this blog, we will discuss the best practices and techniques for maximising your working capital loan.
What is working capital loan?
In essence, working capital loans are usually used to cover temporary gaps in cash flow, which may arise due to slow-paying customers, seasonal fluctuations, or unexpected expenses. The loan amount and terms of repayment can vary depending on the lender, the creditworthiness of the borrower, and the specific needs of the business. Working capital loans can be obtained from traditional financial institutions like banks, as well as alternative lending sources such as non-banking financial companies (NBFCs).
Types of working capital loans
There are several types of working capital loans that businesses can use to meet their short-term financing needs. The most common types of working capital loans include:
Secured working capital loans: These loans require the borrower to provide collateral, such as real estate, equipment, or inventory, to secure the loan. This lowers the lender’s risk and allows the borrower to access lower interest rates and higher loan amounts.
- Secured working capital loans: These loans require the borrower to provide collateral, such as real estate, equipment, or inventory, to secure the loan. This lowers the lender’s risk and allows the borrower to access lower interest rates and higher loan amounts.
- Unsecured working capital loans: These loans do not require the borrower to provide any collateral to secure the loan. As a result, they have higher interest rates and lower loan amounts compared to secured loans.
- Lines of credit: A line of credit is a flexible financing option that allows borrowers to draw funds as needed up to a certain credit limit. Interest is only charged on the amount borrowed, and the credit line can be renewed once the borrowed amount is repaid.
- Invoice financing: This type of financing involves borrowing against outstanding invoices, allowing businesses to access cash quickly while they wait for customers to pay.
- Merchant cash advances: This is a type of financing where the lender advances a lump sum of cash in exchange for a portion of the borrower’s future sales. Repayments are typically made through daily or weekly deductions from the borrower’s sales.
- Cash Credit: Cash credit is a type of short-term working capital loan that allows businesses to withdraw funds as needed up to a certain credit limit. Interest is charged only on the amount borrowed and not on the entire credit limit.
- Overdraft: An overdraft is a credit facility that allows businesses to withdraw more than the balance available in their bank account. It is usually granted to businesses with a good credit history and is repayable on demand.
- Letter of Credit (LC): A letter of credit is a bank guarantee that ensures payment to a supplier once the goods or services are delivered as per the agreed terms and conditions.
- Bank Guarantee: A bank guarantee is a promise by the bank to pay a specified amount of money to the beneficiary if the applicant fails to meet the agreed terms and conditions.
- Invoice Financing: Invoice financing allows businesses to borrow against their outstanding invoices, providing them with immediate access to cash while they wait for their customers to pay.
- Bill Discounting: Bill discounting is a type of working capital loan that involves selling a bill of exchange to a bank or financial institution at a discount. The bank or financial institution then collects the full value of the bill from the debtor at maturity.
The type of working capital loan that a business chooses will depend on its specific needs, creditworthiness, and ability to provide collateral. It is essential to compare interest rates, fees, and repayment terms before choosing a lender.
How to improve working capital loan utilisation?
- Determine your working capital needs: Before applying for a working capital loan, it is essential to determine your working capital needs. This involves calculating your current assets and liabilities to determine your working capital gap. Knowing your working capital needs will help you apply for the right amount of loan, which will save you from unnecessary interest payments.
- Use working capital for short-term needs only: A working capital loan should only be used for short-term needs, such as covering payroll, rent, and inventory expenses. It should not be used to purchase long-term assets, such as property or equipment. Using a working capital loan for long-term investments can lead to financial difficulties down the road.
- Negotiate loan terms: When applying for a working capital loan, it is important to negotiate the loan terms. Negotiating the loan terms can help you secure a lower interest rate and better repayment terms, which will save you money in the long run.
- Manage cash flow effectively: One of the best practices for maximising your working capital loan is to manage your cash flow effectively. This involves monitoring your cash flow on a regular basis, identifying areas where you can reduce expenses, and increasing revenue streams.
- Invest in inventory management: Effective inventory management is critical for businesses that rely on inventory to generate revenue. By investing in inventory management systems, businesses can reduce the risk of stock outs and overstocking, which can lead to financial losses.
- Focus on collecting receivables: Businesses that extend credit to customers should focus on collecting receivables in a timely manner. Late payments can strain cash flow and put businesses at risk of defaulting on their loans. To avoid this, businesses should establish a clear invoicing and collection process and follow up with customers who have not paid their bills.
How Razorpay can help with working capital loan?
Razorpay, a payment solution platform in India, has introduced borrower-friendly lending protocols to help small businesses and startups. One of their offerings, the Line of Credit facility, can be particularly helpful for businesses looking to maximize the use of their working capital loans.
With a low interest rate starting from 1.5% per month and a one-click withdrawal feature, borrowers can save significantly on their repayment amount. Moreover, there are no pre-closure or processing charges. By reducing excessive financial outgo, businesses can focus on revamping and expanding their operations.
To be eligible for this service, a business must be registered and generate an annual turnover of at least Rs. 20 lakhs for at least a year. The credit limit can go as high as ₹25 lakhs, and borrowers can use the EMI calculator on the Razorpay website to estimate their monthly repayment based on the borrowed amount, interest rate, and loan tenure.
Frequently asked question
Q1: What is the range of an ideal working capital turnover ratio of a business?
Ans. An ideal working capital turnover ratio of a business should be in-between 1.2 and 2.