Four Things You Should Know Before Applying for Working Capital Term Loan

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SMEs in India form the backbone of the economy as they employ almost 50% of the country’s total workforce. Moreover, they are highly anticipated to contribute to at least 22% of the Indian GDP by 2020, from their current input of 18%. However, most small and mid-sized units operate in an unorganised manner, and in many cases, as a continuation of family businesses. Such an impetuous mode of operation has now become a convention across industrial clusters in India. This, in turn, plays a major role in inhibiting an organisation’s ability to raise working capital for day-to-day operations and to further fuel business growth.

Traditional finance institutions such as banks and non-banking finance companies (NBFC) shy away from providing working capital term loan to SMEs. Banks are riddled with non-performing assets and are therefore extremely cautious about lending working capital to organisations that do not have their finances in order or to those businesses that suffer from seasonal fluctuations. To add a layer of security over the working capital term loans offered to SMEs, they also demand collateral, which most SMEs are seldom able to provide. The story is similar with NBFCs as well. With working capital finance hard to come by, most SMEs have to turn to informal banking channels such as local moneylenders. Not only do such lenders charge a hefty amount in the form of interest, but their working style is unprofessional and they do not maintain any degree of transparency in their working capital finance deals also.

Easy Access to Working Capital Finance on Digital Lending Platforms Over the past few years, due to the advancements in technology, there has been a proliferation of new-age FinTech lenders. Such organisations are well aware of the challenges faced by SMEs while seeking working capital term loans, and have designed their working capital finance products accordingly. All working capital term loan processing is done using modern data analysis techniques such as Big Data and decision science, and the latest algorithms are used to decide on the right working capital amount for a small business. The risk factors are calculated in a very transparent manner with the aid of technology. This speeds up the process considerably, and the working capital term loan application is decided within a few minutes. Once approved, the working capital finance amount is credited to the borrower’s account within three working days.

An SME often requires funds to meet its urgent working capital requirements, such as making payments to suppliers, payment of salaries to staff, maintenance of machinery, and for procuring resources to fulfil new orders. However, availing a working capital term loan has its own costs and responsibilities, and SMEs must ensure that they are well aware of the implications and have the right documents in place before applying for one.

Let us look at some of the key aspects to be considered before you apply for a working capital term loan.

  1. Determine the right working capital term loan amount: Unsecured loans come at a higher cost as compared to secured loans. Consequently, one must apply for only the right amount that is needed to fulfil the urgent working capital needs. For instance, a manufacturer might have received a new order from a large customer, but could be awaiting payment for a previous delivery. It makes sense for such a business to apply for a working capital term loan to start working on the new delivery. However, it should stay away from the temptation of utilising this working capital for other business needs that may arise, and spend the loan amount only on the purpose it was applied for. Similarly, a retailer might sell more during a particular season and therefore would want to stock up before the season begins. Such retailers should make an accurate estimate of their requirements and apply for sufficient working capital term loan amount to cover their needs. Further, solid justification of the loan amount applied for enhances the chances of it being approved faster.
  2. Keep all your documents in order: You need to keep all your financial documents in place before applying for a working capital loan. These include letter of incorporation, bank statements, tax return statements, identity documents, business receivables and previous working capital term loan statements. Having all documents in order would help strengthen your case for a loan and get your working capital term loan application processed faster.
  3. Be clear about the intent behind applying for a working capital term loan: You need to state explicitly the reasons as to why you need to apply for a working capital loan. For instance, the need could arise due to a delay in receiving payments for orders previously completed, and hence you could be short of working capital for day-to-day operations such as procuring raw material or paying for maintenance of machinery. Or you could be facing a sudden requirement of immediate funds to cater for an unforeseen emergency. Whatever be the justification for seeking working capital term loan, you would do well to keep all documents ready to support your loan application. The lender should be able to identify clearly the need for a speedy working capital term loan approval.
  4. Examine your ability to repay the loan on time: This is perhaps the most important parameter that must be clearly considered before you decide on the right working capital term loan amount for your business need. Never apply for a loan amount that exceeds your immediate requirement, as the working capital loan needs to be repaid on time. Failure to do so shall lead to a downgrade of your credit ratings, thereby impacting your ability to apply for future loans.

Small businesses have genuine working capital requirements and lending institutions, especially new-age FinTech lenders, understand it very well. However, small businesses on their part should not take a loan application lightly and must do their homework thoroughly before forwarding a loan application. A clearly defined loan requirement with proper supporting documents that reflect the business owner’s intentions to repay on time is very likely to be approved and would add more weight to the credit ratings of that business.