Running a business often involves financial challenges, whether it’s covering everyday expenses or funding major projects. Business loans can be a helpful solution to meet these needs. Among the most common options are working capital loans and term loans. Understanding how each works can guide you in choosing the right fit for your business.
What are Business Loans?
Business loans provide financial support to businesses for various purposes, such as covering operating costs, expanding operations, or handling emergencies. They come in many forms, but the two most popular are:
- Collateral-free working capital loans: For short-term needs.
- Collateral-free term loans: For long-term investments.
Understanding the difference between the two can help you make an informed choice that aligns with your business goals.
Working Capital Loans
A working capital loan provides businesses with short-term funds to cover daily operational costs like rent, inventory, or employee salaries. These loans are meant to help maintain smooth operations during cash flow shortages and are typically repaid within a year.
When to Consider a Working Capital Loan:
- If your business faces seasonal ups and downs.
- When there’s a delay in customer payments, causing a cash flow gap.
- To handle unexpected operational costs.
- To buy inventory or stock for your business requirements.
Advantages:
- Quick access to funds: Approval for working capital loans is fast and hassle-free.
Flexibility: You can utilize the funds for various purposes within your business.
Drawbacks:
- Higher interest rates: As these loans are short-term and entirely unsecured, their interest rates are typically somewhat higher compared to other loan types.
- Not for big investments: The loan amount isn’t fixed; it depends on factors like the business’s income, turnover, and CIBIL score.
Not for Personal use: Working capital loans are meant to help your business, not cover personal expenses. Imagine borrowing money to pay suppliers or grow your business but instead using some of it for personal needs. At first, it might seem like a quick fix, but soon, you’ll run out of money for your business. This can lead to missed payments, slowed growth, and extra stress in your life. To avoid these problems, always use working capital loans for your business. That way, you’ll stay on track and set yourself up for success.
Term Loans
A term loan is more like a well-planned financial commitment designed for long-term goals. Businesses typically use term loans to finance major investments such as purchasing new equipment, expanding their premises, or launching a new shop/outlet for your business. These loans have a fixed repayment schedule, typically lasting 2-3 years, giving you the flexibility to repay gradually while benefiting from the growth your business achieves through the investment.
When to consider a term loan:
- If you’re looking to invest in growth opportunities.
- When you need to purchase expensive equipment or New Land/ Shop/ commercial property for your business.
- To support a large-scale vision for your business with planned outcomes in mind.
Advantages:
- Lower interest rates: Because of the longer repayment period.
- Predictability: Fixed installments make it easier to manage finances.
Drawbacks:
There are a few drawbacks to obtaining a term loan. However, approval depends on your business transactions and credit score. To improve your chances, ensure you have all necessary business documents, including a GST certificate. Having a GST certificate can increase your likelihood of securing a term loan by up to 90%.
It’s important to maintain a healthy balance and regular transactions in your current account, as financial institutions like NBFCs and banks will look for stable funds. Understanding the reason behind this is crucial, as this is an unsecured loan. This means you won’t need to provide any collateral, such as property or land. The loan is granted based purely on trust, which is built by maintaining a good credit score and a healthy bank account.
Comparing Working Capital & Term Loans
| Feature | Working Capital Loan | Term Loan |
| Purpose | Day-to-day operations | Long-term investments |
| Repayment Period | Short-term (up to 1 year) | Long-term (up to 3+ years) |
| Loan Amount | Smaller | Larger |
| Interest Rates | Slightly Higher | Slightly Lower |
How to Choose the Right Loan?
To figure out which loan suits your business, start by asking these questions:
1. What’s the purpose of the loan?
Is it for day-to-day expenses or a big investment?
2. How quickly do you need the funds?
If it’s urgent, a working capital loan might be better.
3. How stable is your cash flow?
Consistent cash flow makes term loans easier to manage.
4. Do you have a valid business document or not?
Having valid business documents, including a GST certificate, is crucial for securing a term loan. A GST certificate can increase your chances of approval by up to 90%.
Documents Needed for a Working Capital Loan and Term Loan
To apply for a working capital or term loan, you’ll need the following documents:
- Business documents:
- Business Registration Proof: Certificate or document showing your business is legally registered.
- GST Certificate: Your GST registration certificate increases your chances of approval.
- Income Tax Returns (ITR): Filed ITR for the last 1-3 years to show your business’s income.
- Financial Statements: Profit and loss statements or balance sheets to show your business’s financial health.
- Bank statements:
- Current Account Statements: Bank account statements for the last 6-12 months to show stable transactions.
- Identity and address proof:
- Identity Proof: A government-issued ID like an Aadhaar, PAN card, or passport.
- Address Proof: Documents like utility bills or rental agreements to verify your business address.
- Credit information:
- Credit Score Report: A recent credit score report to show your repayment history.
Keeping these documents ready will make the application process smoother and increase your chances of approval.
Conclusion
Choosing the right business loan is about understanding your needs and the options available. Working capital loans are great for short-term cash flow management, while term loans are ideal for long-term investments. Take the time to evaluate your business’s goals, cash flow, and repayment capacity. With the right loan, you can address immediate needs and set your business up for future success.
At OPEN Capital, we simplify the loan process for businesses by offering transparent terms, fast approvals, and dedicated support in the form of a relationship manager.
OPEN Capital is a platform designed to support all types of businesses, whether SMEs, MSMEs, or small enterprises seeking a business loan. Our focus is on ensuring you get the loan that fits your needs, not just what benefits us. With a simple and straightforward process, we cater to your business requirements while understanding that business owners are often short on time due to managing their operations. That’s why we provide dedicated support to eliminate stress, confusion, and concerns about submitting piles of paperwork. With just basic business documents and your bank statement, you can have your working capital or term loan approved and disbursed within 2 days.
