Borrowing money is a part and parcel of running a business. Even the smallest businessman often needs working capital loans regularly. Every businessperson should be aware of various types of working capital loans available in the market.
There are four types of working capital loans available for business purposes today. These include:
- Line of credit/ CC Limit
- Bank loan
Advantages of Relying on Creditors for Working Capital Loans are:
- Working capital loans can be obtained with minimum formalities and at zero interest. Suppliers can be convinced to offer longer credit period. Extra time can be used to generate cash and make payments quickly.
- Finalizing such working capital loans involve few formalities. Banks check credit reports and charge interest. Getting more time to pay bills may work as an interest free loan option.
- Other working capital loans options remain open.
- No contractual obligation to offer credit. Banks do not demand repayment of short term working capital loans before due date. Creditors can and often do so.
- Irregular repayment will affect credibility in market amongst other suppliers.
- Not suitable if working capital is required to pay labor and bear other expenses.
One can pledge future credit card revenue, stock in hand, debtors and other current assets in exchange for working capital loans. Such loans
- Are easily available to almost all merchants
- Provides instant cash
- Are less expensive as compared to other options
- Bad debts or damage to stock can lead to huge losses due to loss of productivity and burden of loans
- There may be little scope for securing extra funds in emergencies if all current assets are tied up
Line of Credit/ CC Limit
A reputed business with goodwill and credibility can seek formal working capital loans sources like banks. A line of credit offers
- Assured sources of funds. Such lines are opened for a specific duration or value.
- Complete independence to use working capital loans as one thinks fit
- Freedom to use other current assets to generate emergency funds
On the flip side, such loans are
- Comparatively expensive as compared to other interest free options.
- Complicated to obtain
- Risky as banks may require collateral or guarantors.
Short term loan/ Personal Loans/ Credit Cards
Securing a lump sum short term loan is often the best option amongst all working capital loans for many businesses. Advantages include
- No collateral required as loan offered on personal credibility.
- Prompt repayment boosts credit score
- Multiple instances of such working capital loans can be applied for.
- Most expensive form of working capital loans.
- Not suitable for those not good at financial discipline.
Formal working capital loans charge interest and require collateral. Informal sources of working capital loans are cheaper but cannot always be relied. A good mix of both options will help proper execution of business plans.