Working Capital Loan and its Pros and Cons Explained

Working Capital Loan

Working capital is the finances that a business needs to fund its day-to-day expenses like rent, utility bills, wages, etc. Shortages in the working capital can lead to problems in business continuity. Hence, firms opt for a working capital loan.

What is working capital loan?

Working capital finance is a loan that firms avail to meet deficits in their funds to cater to regular expenses and avoid business burnout. The loan is not to invest or purchasing long-term assets. It is a short-term loan to fund short-term obligations.

Pros of a working capital loan

A working capital loan is an unsecured or collateral-free loan – borrowers don’t have to mortgage an asset to avail it.

Some of the features of these loans include:

1- Short-term tenors

Repayment tenors for working capital loans usually extend up to 60 months. Shorter tenors help keep the cost of loan low, exceptionally beneficial for small businesses.

2- Loan approval within a day

Financial institutions generally approve working capital finance within 24 hours. Quick approval helps firms to address gaps in their working capital without any delay.

Also see A Short Note Guide on Government Business Loans

3- Adequate financing option

Borrowers can avail loans up to Rs. 30 Lakh and invest it in their business as they want to. They should to apply for the right loan amount, an amount they are easily eligible for, to avoid rejection. Lenders may deny the loan application if the amount asked for is too high.

Using a loan eligibility calculator is one of the ways to find the loan amount you are eligible for. This online tool tells you the funds you can avail based on your monthly income, expenses, and other factors.

4- Few documents needed to apply

Lowering the hassle of businesses even more is the few documents needed to apply for working capital loans.

Lenders require borrowers to submit the following:

  • KYC documents (Voter ID, Passport, PAN, Aadhaar, Driving License, etc.)
  • Relevant financial documents (Balance Sheet, Profit & Loss Account statement, etc.)
  • Proof of business (GST registration, Trade License, Memorandum of Association, Articles of Association, RoC certificate, SSI registration, Partnership Deed, etc.)
  • Bank account statement of the last month.

 Customers may have to submit documents in addition to the ones mentioned above.

5- Easy to fulfil eligibility criteria

Individuals within the ages of 25 and 55 years with a business that is at least 3 years old can apply for working capital finance.

Cons of a working capital loan

1- High credit score is mandatory

A minimum credit score of 750 is one of the mandatory eligibility criteria when applying for working capital finance. Lenders consider the CIBIL score as security since these loans don’t require collateral.

Further, missing out on EMI payments of your working capital loan can lower your credit score.

2- Low FOIR required

Fixed Obligation to Income Ratio (FOIR) is the ratio between your monthly expenses and income. Financial institutions give more preference to applicants who hold a FOIR of 50% or lower. Having a low FOIR gives you more cash in hand to pay your loan EMIs and lowers the chances of default.

Applying with a low FOIR is one of the reasons your loan was rejected. Hence, it is best to foreclose existing loans and clear credit card debt before you apply.Opting for a working capital loan is one of the ideal solutions even with these cons. Now that you know the working capital meaning, apply for financing online and keep your business operational.

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