How Are Working Capital Loans For MSMEs And SMEs Solving Cash Flow Issues

Introduction

MSMEs and SMEs are commonly known as firms operated by enthusiastic entrepreneurs. They have a propensity to give their best to solve a problem or seize an opportunity. This method yields tremendous benefits but may also take one off guard if things don’t go as planned. Enterprises are no exception to the rule that certain things in life are beyond their control. 

Additionally, as an entrepreneur, one might run into difficulties regardless of their plans and budgets, particularly when it comes to expenses. Company owners often borrow cash from a working capital loan for small businesses to patch gaps. This kind of corporate credit not only assists the company in avoiding a critical but momentary difficulty but also enables the company to concentrate on its top objectives. Cash for working capital may serve as the rope that secures the company’s place in the market and solves the issue of managing its cash flow statements.

Working Capital Loan For MSME

Micro, small, and medium-sized enterprises or MSME stands in the crunch of working capital at times. This can be due to a lack of proper cash flow management, insufficient cash flows, and credit risk. Individuals, MSMEs, small and medium-sized enterprises (SMEs), and startup businesses may all apply for finance under the msme working capital loan program. These loans are available from a number of different financial firms and are popularly known as working capital loans for small businesses. 

Customers may fulfil their requirements for operational cash and develop their operations with the assistance of a working capital loan for MSMEs. Loans for MSMEs often take the form of unsecured business loans. The borrower is not required to submit any collateral or security to the lending institution. Moreover, SME online lending websites make it possible for businesses to get financing.

When it comes to satisfying the needs for working capital, banks typically give clients cash credit or overdraft facilities. Overdrafts and cash credit facilities may sometimes fund working capital demand loans.

The period required for a business to convert its full net working capital into cash is known as the working capital cycle. Working capital is calculated by subtracting current liabilities from current assets. Good business strategies for maximising cash flow include selling and collecting money from clients as rapidly as feasible. It is possible to manage this cycle by keeping an inventory of sales and collecting revenue from customers rapidly.

Companies that experience positive cycles often have a need for finance to cover the time period that elapses before they are paid by their clients. In order to bridge this gap, businesses often use the financial loans offered by banks and NBFCs.

Working Capital Loan Types To Tackle MSME Cash Flow Problems:

• Credit line or bank overdraft facility

This is the most adaptable kind of loan for operating capital. The amount that the borrower is allowed to take out of the loan is predetermined by the lender. The borrower is responsible for ensuring that they do not go over the allotted amount of cash. In addition, the borrower is only responsible for paying interest on the amount that was actually withdrawn, not the amount that was authorised. Therefore, the borrower is urged to make a down payment equivalent to the amount borrowed in order to save money on interest.

• Trade credit

This short-term loan acts as working capital and is extended by prospective or current suppliers. The supplier may provide trade credit when placing a substantial order with a supplier. However, the granting of this loan is based upon the lender doing a thorough evaluation of their profitability, credit history, and trustworthiness.

• Bank guarantee

It is a loan for operating capital that is not dependent on a fund. A bank guarantee is something that either the buyer or the seller may secure in order to mitigate the potential risk that comes with an agreement being broken. It might be anything, from the promise of service to the payment for anything. The holder can only get out of it if the other party fails to execute its end of the bargain. The bank may require a specific security deposit or impose certain commission fees.

• Account receivables 

When applying for a loan for working capital, one always has the option of using their confirmed sales orders or account receivables as collateral. It is ideal, especially if the company does not have the funds to fulfil a sales order. To qualify for such loans, the firm must first establish a good reputation and a track record of timely debt repayment.

• Short-Term loans

The interest rate and the length of the payment period for the short-term loan are both set in stone. This is a loan against collateral. However, the trustworthiness of the borrower’s previous credit history and relationship with the lender will determine whether or not they will be able to acquire this loan without the use of collateral.

• Invoice discounting 

In this kind of transaction, an organisation will sell either all of its account payables or a portion of those payables to a third party. The accounts are opened at a value lower than their initial value. The name given to the third party is the “factoring service.” It accomplishes this goal by first purchasing the bills and then collecting the payments that are owed from the respective borrowers. This is the method through which it intends to fund its finances.

Required documents to obtain a working capital loan

The following documentation may be required to get a working capital loan for MSME:

1. If available, the company’s bank statement for the last 12 months.
2. Copies of owners’ PAN cards.
3. A copy of the owner’s Aadhaar card
4. Copy of partnership deed, if applicable.
5. Copy of the business’s PAN card
6. Evidence of business registration, such as a certificate of GST or VAT.

Working capital loan eligibility

It can be different for all the various banks and other financial institutions. Here are some general eligibility criteria that most financial institutions may follow: 

• Applicants’ Age: The borrower must be at least 21 years old when applying for the loan and no older than 65 years old when the loan matures.
• Ownership or Collateral Worthiness: Ownership of a property, which might be a dwelling, office, store, or godown, is an essential factor in qualifying for a Working Capital Loan that banks assess.
• The nature of the business: The type of firm determines eligibility for working capital financing. Individuals, sole proprietors, partnership businesses, private or public corporations, retailers, traders, or any other company owner involved in the service, manufacturing, or trading sectors that need consistent cash flows to keep their business’s working capital afloat.
• Business Vintage: Longevity is another criterion for working capital loan eligibility. Businesses should have been in operation for at least two years and have positive finances. However, it differs by institution for every bank.
• Business Turnover: The quantity of business turnover varies depending on the lending bank selected. For example, the loan can be divided into two categories: annual revenue of less than Rs. 10 crores and a yearly turnover of more than Rs. 10 crores.
• Business Experience: Business expertise and experience is the primary factor for any loan approval. In most cases, banks need at least two years of continuous operation at the current site.
• Financial History: Company should have a consistent and believable economic history of earnings during the years it has been in existence. 
• Source of Revenue: Another working capital financing eligibility is the business’s source of income. Every earning of the firm, whether through trade or investment, is eligible under the owner’s revenue source.
• Creditworthiness: A critical working capital finance qualifying requirement is the creditworthiness of the firm and the promoter. In the past, there should have been no loan defaults.
• CIBIL Score: In order to secure a business loan promptly, entrepreneurs will need a  CIBIL Score of at least 700, regardless of whether they are sole proprietors, an entrepreneur, or self-employed professionals.
• Financial Capability: The capacity of the firm or the promoter to repay the loan is an essential criterion for qualifying for a working capital loan. The company’s financial efficiency, profit and loss statement, and balance sheet, together with all other income tax returns, measure the capacity to repay the loan and provide a picture of the company’s stability and profitability.

Bottom Line

To cap it all, the cash flow statement is the primary thing that MSMEs and SMEs should follow for their business’s growth, even more than the Profit and Loss statement. For that, the safest thing to do is to reduce the credit period for payment for their customers, but sometimes it cannot be feasible as orders can be as big as hundreds of crores. Therefore, business owners are willing to accept the credit terms provided by their customers in order to secure that order. At that time working capital loan for MSME can be the best case scenario to solve the cash flow issue of any business.