Working Capital Loan
Any business whether big or small, struggling or efficient requires a working capital. This amount depends on the strength of the business. This too brings us to the question: What is working capital and why do business require it? What is a working capital loan?
Net Working Capital
Net Working capital is defined as the excess of current assets over current liability. This excludes any bank finance. Both the promoters and a working capital loan funds this new working capital.
Just to make things clearer, any asset on the balance sheet which could be converted into cash in one year or one operating cycle is classifies it as a current asset. Also, any liability on the balance sheet which is repayable in a year or one operating cycle is classified as a current liability. For example, short term bank deposit is a current asset and a working capital loan is a current liability.
Net Working Capital is mathematically defined as capital + long term loans – fixed assets – non current assets – intangibles. Net working capital is a measure of the promoters stake in day to day operations of the business. It also gives an idea about diversion of funds by the unit.
Uses of Working Capital Loan
During day to day operations of the unit blocks up some amount of funds. The uses for this fund include stocks, raw materials, semi finished goods, consumables and receivables. Working capital is the monetization of these current assets by taking a working capital loan against pledged to the debtors of these assets.
Not all current assets can be pledged to debtors and working capital loan cannot be availed against all assets. The bank may provide working capital loan based on its assessment of the requirements of the unit. Working capital loan may carry a fixed or floating rate of interest and is generally repayable in one calendar year or one operating cycle. A bank may subject a loan to restrictive covenants as per its assessment like ceiling on market credit, ceiling in new investments and others.
Almost every company requires a capital loan as many promoters are unwilling to reduce their stake in the company by bringing in equity infusion from new partners. Also, the interest rate for working capital loans is generally less than the rate at which credit is available in the market.
Advantages and Disadvantages
A working capital loan enables a company to monetize its assets at a competitive rate. At the same time, it provides an avenue to increase its business. Though it has many advantages there are also some downsides. For example, irrespective of the limit, one generally pledges all current assets to the bank. Also, the bank may impose certain conditions on the management in running the business. These conditions may interfere in day to day business decisions. In the worse cases, the bank may even takeover the management of the unit.