Working capital is a must to run any business on a day-to-day basis. The working capital of a company can be defined as the excess of current assets over current liabilities. However, when the current liabilities exceed current assets, it creates inadequacy of funds to run a business smoothly. To manage short-term needs, businessmen need funds to address the operating expenses of their businesses.
The working capital is not used to acquire fixed assets for the business. Instead, it is used for different purposes such as salaries and wages, payment to suppliers, insurance premiums, managing overhead costs, purchasing raw materials, etc. However, several business owners are choosing between a working capital loan or a Loan against Property. Let’s dig deeper to understand which one is better for you.
Who requires Working Capital Financing?
If you do not have sufficient working capital, the fund requirement can be fulfilled with a working capital loan. Business organizations often apply for a working capital loan to finance the monthly expenses, accounts payables, bills, wages, etc. Working capital loans are generally required when the sales activities are low during the off-season. Due to reduced business activity, the inflow of cash is subdued, creating insufficiency of funds.
Small and medium business enterprises (SMEs) require such a form of financing to manage their business’s daily operations. It is also suitable for seasonal or cyclical businesses with low sales during the off-season and generates high revenues during peak season. Hence, to maintain the business’s smooth operations during the off-season, working capital financing is a good solution. In the wake of the COVID-19 pandemic, India announced emergency guaranteed working capital loans* for eligible MSMEs.
When do you need Working Capital Financing?
To run a business effectively, you need adequate funds. Situations arise when a company requires short term financing to –
- Manage sales fluctuations depending upon seasons and low demand
- Act as a cushion against the shortage of funds and maintain liquidity.
- Boost cash flow in the business that helps in running business operations without hassles.
- Avoid stock-out
- Capitalize on business opportunities for growth
- Fuel business growth with increased revenues
Hence, banks and non-banking financial companies offer working capital loans at best interest rates and low processing fees that facilitate expansion and growth. The upcoming Union Budget 2021** is touted to bring in much-needed respite for MSMEs, with more liquidity being infused for working capital financing.
Uses of Working Capital Financing
Liquidity is the essence of any successful business. In case a company faces liquidity issues, it becomes difficult to operate effectively. A working capital loan can meet the need of short term financing for business operations. The loan amount can be used for different business purposes such as –
- Acquiring raw materials
- Clear pending account payables
- Maintain liquidity in the business
- Payment of overhead costs such as lighting, maintenance, rent, wages, and salaries, etc.
- Purchase goods
With that established, let’s understand why a loan against property is better than a working capital loan.
5 Reasons Loan against Property is better than working capital loan
Lower Interest Rates
A loan against property is a secured loan; hence, the bank’s interest rates are low. But in the case of a working capital loan, the interest rates would naturally be higher and also depend on your credit history, which the LAP does not.
Get a Higher Loan Amount
If you take a collateral loan, the lender sanctions a higher sum ranging from 75%-90% of the property’s current market value. The ratio varies in case a property is residential or commercial, occupied or rented. The mortgage amount can be used for running the business and paying off the current liabilities.
Apart from the higher loan amount, you can get a loan against property for a longer tenure, which can last up to 20 years. A low-interest rate and a long term offer an excellent solution for short-term financing. If we compare it to a working capital loan, a businessman cannot leverage the longer-term benefit.
Tax benefits on Interest Payments
Another important feature of a loan against property is the tax benefits of the bank’s interest payments. You get a tax deduction under Section 37(1) of the Income Tax Act***, 1961 when you take a loan against property for business purposes.
Meet Higher Expenses
With a loan against property, you get a higher amount with a lower interest rate enabling you to use a higher amount for more extensive business operations. Expenses like insurance premiums, accounts payable, purchase of raw materials, lighting expenses, maintenance expenses, as well as expansion can be made with the loan amount.
Other Benefits of availing Loan against Property for Working Capital
- Quick Approval – The process of applying for a LAP is easy and convenient. You need to submit general information and minimum documents for the approval of the loan. As it is a secured loan, the approval process is quick.
- No interference of lenders – For both LAP and working capital loans, lenders do not ask for information regarding expenditures. Lenders never interfere in business matters, and hence the loan amount can be used as per your discretion. If you take a LAP, you get a large amount as a loan that can be used to meet your short term requirements of a business.
- Pre-approved loan offers- Many lenders offer pre-approved loan offers based on the borrower’s credit reports, credit score, and health of the business. Both LAP and a working capital loan can be offered as a pre-approval loan by lenders.
Looking at the benefits we can understand that getting a loan against property is a much better option than availing a working capital loan. Undoubtedly, it is the quickest and easiest way to arrange for quick financing of the working capital for your business.
At Finance Zone, our mission is to help you get ahead with your finances. We know that money isn’t everything and some people have more than others. We believe it’s not what you have, but what you do with it. We are one of the best write for us finance