Should A Business Loan Be Taken To Meet Working Capital Needs?

Is a business loan the best option to meet your working capital needs? Understand the factors to consider before taking a business loan here!

22 Jan,2023 10:43 IST 1937
Should A Business Loan Be Taken To Meet Working Capital Needs?

Working capital refers to the funds a company uses daily to run its operations. Utility payments, employee wages, supplier payments, and rent payments fall under working capital expenses. Having free-flowing working capital is critical to a company's efficiency. Consequently, many businesses use business or working capital loans to ensure operations run smoothly despite tight cash flow.

What Is A Working Capital Loan?

A Working Capital Loan covers a business's daily operations, which include paying employees' wages to cover accounts payable. Sometimes businesses need capital to maintain operations as they don't see regular sales or revenue throughout the year.

A seasonal business cycle or cyclical sales typically necessitates this kind of loan. Others may need it during festive seasons or times of reduced business activity. It depends on the loan amount and the business's financial health whether you are required to pledge collateral to obtain such a loan.

Working capital loans help businesses manage their short-term liabilities while preparing for long-term goals. Small and medium-sized businesses can apply for working capital loans through NBFCs, and the repayment period typically varies between 36 and 48 months. The interest rates depend on many factors, including credit ratings, turnover, business vintage, and other important factors.

Working Capital Loans: How Do They Work?

These are the most common purposes for which SME owners apply for working capital loans.

• Monitor Cash Flow Levels

Cash is the backbone of any business. Maintaining and monitoring cash levels is easier with a small business loan. A company's cash flow serves several purposes, such as disbursing payroll, repaying creditors, covering daily expenses, restocking inventory and paying dividends.

Payment delays towards any liabilities adversely affect business operations. For example, failing to replenish inventory or upgrade equipment during market peaks often leads to sales losses. Using a business loan, a company can restock inventories or buy new machines to ensure adequate supplies.

Many companies require additional funding to fulfil their payment obligations to suppliers. The use of working capital loans can help businesses avoid such critical situations. It prevents entrepreneurs from falling behind on scheduled payments, such as paying employees and suppliers.

• Prepare For The Rainy Day

Several external factors beyond control can restrict the achievement of predetermined goals, regardless of the business plan and vision’s robustness. There are a few factors a business owner cannot control, including raw material shortages, fluctuations in the economy, rate changes, and natural disasters.

A breakdown of equipment, a cancellation of an order, obsolete inventory, and a lag in receipts can also halt business operations. In such cases, a business loan can provide a cushion against mishaps and make it easier to carry on business as usual.

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• Foster Growth

A business's success depends on growth and expansion. An organisation with extra working capital can take advantage of opportunities as they arise, allowing the company to grow to its full potential. A business loan could open new stores, upgrade equipment, or launch new products and services to attract more customers.

In addition, entrepreneurs can apply for business loans to launch marketing campaigns, spend on advertising, enter the online marketplace, and enter growth-oriented business deals.

• Leverage Seasonal Upswings

Businesses have extraordinary opportunities to maximise sales during favourable seasons when consumer spending spikes. During this time, businesses can make more money if they prepare properly. However, additional funds are necessary for a company to manage its business efficiently during occasional shopping rushes.

Increasing marketing expenditures, employee bonuses, and excess inventory require capital. An SME loan can be a valuable funding option to handle the additional burden.

Steps To Choose A Business Loan For Working Capital

To obtain a Business Loan, you must have a well-planned strategy. Consider these key factors.

• Calculate The Funds Required

The funds needed depend on the current stage of the business cycle. A business must prioritise its needs and choose an appropriate loan amount. For example, a company may need working capital to pay for expenses, expand, or maintain liquidity.

• Enhance The Credit Score

When evaluating a loan application, the credit score is the most important factor. It is more likely that an application will be approved if the credit rating is higher. Lenders may reject your application instantly if you have a low credit score. SMEs with high credit scores may also qualify for a lower interest rate on their Business Loan.

• Factor In The Extra Costs

The total loan cost includes several other charges in addition to the interest rate. Calculate the actual value of the loan before signing the agreement, including late fees, processing fees, and prepayment fees.

Get A Business Loan From IIFL Finance

Expand your growing business or tack on a little extra for your retail business during hard times and get an SME loan online from IIFL Finance. These business loans provide quick access to money while being affordable and attractive. Take advantage of IIFL Finance business loans today!

Frequently Asked Questions

Q1. What is a working capital loan?
Ans. Working capital loans are business loans companies can use and repay as their liquidity fluctuates. Working capital loans are used for various reasons, including purchasing inventory, paying for utilities and wages, paying suppliers in advance, managing seasonal demands, etc.

Q2. Is a working capital loan a long-term loan?
Ans. A working capital loan provides cash to cover a company's day-to-day operating expenses. These are short-term debt instruments and should not be used to pay off long-term debt or for long-term investments.

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