5 Steps To Follow While Choosing The Right Working Capital Partner
No matter how big or small a business is, every enterprise needs steady working capital to ensure long-term growth. Here, working capital refers to the ratio of a company’s current assets and current liabilities. When the liability portion weighs more than the asset, the need for working capital financing arises.
Working capital financing is a debt instrument used to cover a business’s short-term liabilities to continue its daily operations smoothly. This type of financing is common among medium and small businesses with inconsistent cash flow. However, even big enterprises often need working capital financing when they take on bigger projects than usual. This financing option is a simple credit solution that helps businesses continue operations even when there are cash shortages.
However, the availability of various working capital financing options in the Indian market can often confuse an entrepreneur in choosing the right option. Potential entrepreneurs can opt for invoice discounting from KredX, an online platform providing quick access to working capital to businesses.
5 Steps For Choosing An Effective Working Capital Financing
Below are mentioned the five essential steps for choosing the right working capital financing for businesses:
Find Out If It Is Collateral Based Or Not
The first step of selecting a perfect working capital financing is to find out if the particular financing option is collateral-based or not. But Wait! Do you know how many types of working capital financing options are available in the market?
Before delving deep into selecting the right working capital financing, it is important to know the various options. So, basically, there are different types of working capital financing options. Most common types include short-term loans, accounts receivable loans, trade creditor, factoring loans, bank overdraft, equity funding, line of credit, invoice discounting, etc.
Usually, working capital loans are collateral-free as these financing options help meet short-term liabilities or day-to-day operations. Companies/businesses can avail working capital financing like ‘Short-term loan‘ without giving away any collateral.
Alternatively, ‘Asset-based finance’, such as ‘Invoice discounting’ provides companies or businesses with working capital against unpaid invoices or accounts receivable as collateral (pseudo-collateral).
Therefore, depending on the availability of collateral and requirements, businesses can choose the right financing option.
Compare Eligibility Criteria
The eligibility criteria are closely related to the point mentioned in the earlier paragraph. The eligibility criteria change depending on the type of working capital financing chosen.
Suppose a company/enterprise is willing to take a secured financing option. In that case, that company/enterprise will have to meet easy eligibility criteria as lenders have collateral to safeguard the money provided. Here, businesses can easily fulfill eligibility criteria and get the loan sanctioned. Businesses with good credit scores can easily obtain ‘Short-term loans.’
On the other hand, while taking an unsecured working capital financing, businesses must have a decent credit score and repayment history to secure the loan. Wondering why a credit score is essential for availing an unsecured loan?
A credit score is an essential parameter that helps lenders assess a borrower’s creditworthiness (here businesses). As the name suggests, unsecured loans are not backed by collateral, lenders prefer businesses with a high credit score. Businesses with a bad credit history or no credit history (such as startups) can opt for ‘Equity funding’ (by giving equity of the business to the lender). Remember, the eligibility criteria varies from one lender to another.
Figure Out The Overall Cost Of Borrowing (Including Additional Charges)
While availing a working capital financing, businesses must know the overall cost of borrowing, i.e., interest rate/ total loan amount/ tenor, as well as the calculation of interest rate for a particular financial product.
For instance, ‘Short-term loan comes with a fixed interest rate for 12 months, meaning businesses have to pay EMIs for the borrowed amount throughout a predetermined tenure. In short, for a loan of Rs. 30000 at a 10% interest rate for 12 months, businesses have to pay 10% interest on the specific loan for that specific period.
Alternatively, suppose a business/company takes ‘Bank Overdraft’ as a working capital financing. In that case, businesses/companies will have to pay the interest amount only for the withdrawn money and not on the entire loan amount. Sounds confusing? Let’s take an example. Suppose a small company offers a cheque of Rs. 50000 to a supplier of raw materials, but that company has a shortage of Rs. 5000. The concerned bank will allow that company to use the overdraft facility and withdraw Rs. 5000. Regarding the interest rate and payment method, that company has to pay interest only on Rs. 5000 and not on Rs. 50000. The interest calculation will be on a daily basis. Further, businesses must find out the additional charges, such as processing fees and be aware of other hidden charges to avoid future discrepancies. Usually, working capital finances have a one-time processing fee.
Note: The cost of borrowing is always higher for unsecured working financing options than a secured option as there is an increased risk of default without any collateral.
Find Out The Processing And Disbursement Time
Another major step for choosing the right working capital financing is to find out the processing time. Businesses/companies with a decent credit score can avail a working capital financing in no time.
Working capital loans are popular financing options due to their faster approvals and processing time. Lenders understand the significance of cash crunch in a business and the necessity to immediately cover the gap to offer businesses the opportunity to continue their operation without lag.
Businesses can unlock money tied up with unpaid invoices (via Invoice Discounting) and resolve working capital issues with leading cash flow solution providers. At the KredX platform, a business can sell invoices at attractive rates, which potential investors can buy. The complete process is digital, offering faster disbursement within 24-72* hours. This can help businesses ensure uninterrupted business operations.
However, the processing time may vary from one lender to another. Businesses have to choose a working capital financing provider according to their urgency and requirement. They can utilise the money taken wisely and invest in areas needed to restore their position in the market.
Assess The Repayment Tenure And Options
The last step of choosing the right working capital financing involves evaluating repayment options and tenure flexibility.
The repayment tenure can range from 12 months to 84 months, depending on the type of working capital finance chosen. For instance, short-term working capital financing tenure is as low as 9-12 months. Here, businesses need not plan for long-term EMIs (Equated Monthly Instalments) for availing such loans. However, the sanctioned loan amount is relatively low for this type of financing.
On the other hand, long-term working capital financing comes with a repayment period of more than 12 months and up to 5-7 years. Here, the offered loan amount also is usually very high and can be used for investing on a large scale project.
Therefore, a business must choose a financing option and a lender that offers flexibility and facilities like loan foreclosure any time without extra charges and others.
Bottom Line
The Indian market is over beaming with different working capital financing options. Here, the ultimate decision of choosing a working capital financing option depends on the entrepreneur’s cash requirement and eligibility. For instance, if a company requires a small amount of money, it should opt for short-term working capital financing. On the other hand, if a company wants a lower cost of borrowing, it should consider taking secured working capital financing or maintaining a decent credit score to avail unsecured financing at favourable (and negotiable) terms. Hence, businesses must identify their needs, compare lenders and their terms, and choose a financing option that best suits them.
