Pros and Cons Of A Working Capital Loan
06 Dec 2016
Working Capital is essential for the smooth functioning of a business. Though fixed capital is the back-bone of an organization, working capital is the lifeline. If the working capital is affected, the organization would suffer. Given its importance, businesses ensure their working capital is strong to execute day-to-day operations without bottlenecks. But what if the funds run low? How will the working capital requirement of the business be met?
As working capital is essential for businesses, easy finance options are available for meeting any shortfall in the working capital requirements. One such source of finance is a Working Capital Loan from a company like SummitFR.com.
What is a Working Capital Loan?
A working capital loan is a short-term loan which is granted to businesses so that they can meet their day-to-day expenses like wages, payments to creditors, etc. These loans cannot be used to buy long-term assets and are to be paid back within a short period of time. Businesses which have seasonal cycles require working capital finance when their revenue is low during off-seasons.
Are these Loans beneficial?
Just like there are two sides to every coin, working capital loans also have their pros and cons. Here are the list of such advantages and disadvantages of a working capital loan:
- Essential funding is provided in a cash crunch
The sole purpose of working capital loans is to provide the required liquidity at times when working capital in the business runs low. Thus, these loans are a source of short-term funding for the business.
- Ensures smooth operation of organizations
When working capital of the business is healthy, daily operations are run smoothly. There is no hiccup in the targeted production or management of a business, if it has a steady source of working capital funds. Working capital loans helps in this regard.
- Beneficial both at the time of a lull and a boom
Businesses facing a drop in revenue experience a shortfall in working capital. Since the daily expenses have to be met irrespective of the revenue earned, a working capital loan is the best solution. Businesses can execute operations even when there is a lull in their earnings.
Similarly, when demand is high, businesses invest in extra production. Since goods are initially sold on credit, a source of funding is required to finance the production. A working capital loan comes in handy in these situations too.
- No equity dilution
When businesses are in need of finance, they look at various sources to meet their financial requirement. This financing might result in extending ownership to others for their capital investments (in case of sole proprietorship or partnership business). Companies with shares might have to dilute their equity to raise the required funds. A working capital loan prevents this sharing of ownership or equity dilution by meeting the financial requirement. These loans help in retaining ownership of the enterprise.
- Sometimes, lenders ask for security
While usually working capital loans are unsecured loans, lenders might ask for a collateral security for small businesses. This requirement of collateral acts against the interest of small businesses and thus qualifies as a drawback.
- Higher interests
If the loan offered is unsecured or collateral free in nature, the interest charged is quite high. This is because of the risk undertaken by the lender for offering the loan without security. A higher interest rate is an additional expense for the business.
- These loans can’t fund long term expenses
Working capital loans are short-term loans. The ticket sizes are also smaller when compared to large business loans that are undertaken to finance huge requirements. Therefore, businessmen can only use these loans to execute operations and achieve short-term business growth.
Despite these drawbacks, a working capital loan is a very good solution for businesses to raise the required finance to keep the business running.