Working Capital is the money required by a business entity for carrying out the operations by honoring its daily commitments. Working capital is constantly turned over to provide for an ongoing business cycle.
Let’s take a look at the various working capital types that a business owner may avail:
Permanent Working Capital
This is the minimum quantum of money that must be available for the company to remain solvent. This is also called fixed working capital.
Variable Working Capital
This is also called temporary working capital. This is an increased fund required to provide for incremental production or sales activity.
Reserve Margin Working Capital
This refers to a coffer of working capital created by the promoter. This is a mitigation tool in the event of an unforeseen situation.
Seasonal Variable Working Capital
Many businesses are heavily dependent on seasonality for their products’ demand. Companies in that ecosystem have additional working capital to see themselves through the phase of incremental demand, needing more investment.
Special Variable Working Capital
Every business reaches a stage where they need more funds to meet some specific overheads, such as geographical expansion, the launch of new products or services, a more intensive promotional activity, or disaster management. All these needed funds are called special variable working capital.
Running a business comes with its own set of challenges. It may not be possible for the promoter to have ready liquidity to cover all bases. Working capital loans provide the much-needed impetus in this regard.
In the following section, let us have a look at the different types of working capital loans that businesses can avail:
Short Term Loan
These are the type of loans offered by financial institutions to businesses in the form of secured loans that need to be repaid within a stipulated time period, with a prefixed interest rate. Typically, short-term loans are repaid within one year.
Under this arrangement, the lender provides a credit line in the form of an overdraft facility. A certain amount is pre-sanctioned, which may be utilized by the business as working capital. The interest is levied on the amount withdrawn and not on the entire limit
The suppliers of a business house provide this working capital loan. In this form of working capital loan, suppliers provide an extended credit line against material supplied.
Confirmed orders of a company, where a certain amount of money is a guaranteed income of a company, may be used as collateral for a working capital loan. The allowance of this type of loan depends on the creditworthiness of the company
Funding From Investors
This is insider funding, where the promoter invests from his or her own resources.
As per this arrangement, a third party picks up a stake in some of the account payables of a company. This is normally done at a price that is lower than the market.
Under such working capital loans, the business entity guarantees its banker to the seller. If the company, the buyer, in this case, fails to pay for the supplies, the bank will make the payment to the seller. Banks do so after obtaining security from the buyer.
In the current market scenario, multiple lending institutions are offering working capital loans at flexible rates and easy terms. Working capital loans are meant to serve the purpose of meeting operating expenses of business. An imprudent decision may find you in a debt trap. Therefore, it is advisable for the potential borrower to apply due diligence before going into the commitment. Before proceeding, Pros and cons of the various options of working capital loans should be weighed and matched with your needs.