What is working capital?
Working capital is not a term that we use in our day-to-day conversations but it is a very important term used to run each and every business. It is the cash flow available with the company to meet its short-term/current obligations such as payments to its creditor’s vendors, expenses of running premises, etc.
You can find out the short-term financial condition of the company by calculating the working capital ratio.
Working capital ratio = current assets/current liabilities.
Net working capital indicates the amount you need to fulfill all the current liabilities.
Net working capital= current assets-current liabilities
To find out net working capital we have to deduct current liabilities such as payments to vendors, creditors, pending salaries, outstanding taxes, etc. From current assets such as trade receivables, debtors, and prepaid expenses.
To understand the proper working capital requirement, the company has to determine its projections for the next following years about the company.
Reasons To Take A Working Capital Loan!
- Generally, companies take working capital loans to carry out its day to day business operations and secure the capital of the company for expansion of business.
- It can also be used to buy materials in bulk to gain additional discounts.
- If a company has sudden demand for its product and there is a shortfall of capital to increase its production to fulfill such demand, then a working capital loan may be useful for them.
The working capital loans can be both SECURED & UNSECURED. Most of these types of loans are secured means backed by some type of Collateral (Property, Stocks, etc.) Unsecured working capital is tough to acquire as the credit history of the company and its owners/directors must be too high for the satisfaction and assurance that the loan will be repaid.
RBI guidelines: –
As per RBI’s new guidelines when we take a working capital loan (Overdraft limits like CC) from any banking institution, we should close all the other bank accounts with other banks and carry on the banking process with the same bank. The main reason for this is so that the lending bank can monitor all the transactions of the business happening. It also benefits the customer that all of his financials are in one place so he doesn’t have to check various bank accounts regarding his money.
Secured Working Capital Can Also Be Called A Loan Against Property (Lap)
What is lap?
An asset such as a house, a plot of land, or any other commercial or Industrial property can be used as collateral to borrow funds. Money makes the world go round. Faced with a shortage of funds to accommodate emergencies or urgent expenses, a Loan against Property can help you put all your financial worries to rest. You don’t have to sell your property a LAP gives you the freedom to avail multipurpose funds by mortgaging the same.
Advantages of loan against property working capital
- Up to 100%* of property value
Unsecured working capital loans don’t require any collateral but they are lent purely on the basis of the financials of the company, whereas if the loan is secured then the property value comes into consideration alongside financials and up to 100%* of property value can be acquired depending on the Bank’s policy and customer profile.
- Beneficial for manufacturers.
Generally, one can get a loan of up to 100%* on the property value but in the case of manufacturers, they are eligible for availing loan of up to 250%* of the collateral value, again depending on the Bank’s policy and customer profile with certain T&C.
- OD facility
In working capital, the borrower gets the benefits of having an OD(overdraft) account where they have to only pay the interest on the amount they withdraw till they deposit the amount back into that account.
- Increasing limit every year
In working capital overdraft limits like Cash Credit facility, the tenure of the loan is one year, and it is renewed every year, but after one year if the business has increased then the bank can increase the overdraft limit too considering the growth in business. This can benefit the borrower in getting more funds to use in the expansion of the business.
- Consider future projections
In other types of loans, only previous performance and financials of the company is taken into consideration but in working capital loan future projections are considered and the limit of the OD facility is set on the basis of these projections.
- Low rate of interest
The rate of interest on secured working capital loans is way too low compared to unsecured working capital loans
- Tax benefits
One can enjoy the tax benefits on a loan against property under sec37(1) only if they use the loan amount for business and not for personal expenses. Working capital loans are only given to businessmen having regular transactions and also a good business setup. It is the most beneficial type of loan for businesses having daily transactions so that there is money available in the OD account and they don’t have to pay a hefty interest on the money used.