Being an MSME business’s owner, you would know the constant need of finance and cash flow within your business. From buying new inventory to paying salaries on time and rent, cash flow can be not just temporary but an ongoing challenge at least in the initial years for most MSMEs out there. To handle these financial challenges and to deal with them effectively, you might consider two common types of business loans: working capital loans and term loans.

What is a Working Capital Loan?

A working capital loan is a very well known short-term financing loan type which is designed to meet MSME and other business’s immediate cash flow requirements. This is one of the most practical msme loan options for growing MSMEs in India. The use cases of a working capital loan are the following:

• Inventory purchases: Restocking your shelves to meet customer demand on the go.
• Payroll expenses: Making on time salary disbursal to the employees.
• Supplier payments: Maintaining good relationships with the vendors and suppliers.
• Rent and utilities: Covering other ongoing costs like rent to be paid, electricity bills, and water bills and other miscellaneous expenses.

Key features of working capital loans:

• The Loan Timeframe: Typically, these loans have a shorter tenure which is mostly of less than a year.
• Repayment: You can often choose flexible repayment schedules to suit your cash flow, you can also negotiate the repayment schedule with your lender before both parties agree upon the loan.
• With or Without Collateral: Depending on your repayment capacity and credit profile i.e. your business’s credit history, you may stand a chance to get a collateral-free loan or a secured loan. In case of working capital SME loan there are many NBFCs who specialise in giving unsecured loans for MSMEs.
• Interest rates: When in comparison of interest rates usually terms loans may have better rates of interest favoring the borrower.

What is a Term Loan?

A term loan is a long-term financing option that provides a fixed sum of money upfront. This loan is suitable for funding specific business needs like:

• Business expansion: Opening new branches or expanding into new markets.
• Machinery and equipment purchase: Acquiring new assets to improve productivity.
• Property purchase: Buying commercial property for your business operations.
• Debt consolidation: Combining multiple debts into a single, manageable loan.

Main features of term loans:

• Long-term: Like the loan name says, these loans usually have a time frame ranging from 1to 10 years.
• Fixed repayment schedule: You’ll have to ensure that regular monthly payments are made over the loan term.
• Secured: Most term loans need the borrowers to give/pledge collateral to get the loan amount and unlike working capital they won’t come as collateral-free which could be a disadvantage from the borrower’s eyes..
• Lower interest rates: Compared to working capital loans, term loans often have lower interest rates due to their longer tenure and secured nature.

Which is Better: Working Capital Loan or Term Loan?

Whether to go for Term loan or a working capital loan is a subjective choice as the decision should be made on what goes well for a borrower. He/She will have to analyze both options and will have to decide on what would work best for their business’s growth. Different factors like rate of interest, terms etc would become crucial when making the final call :

• Need of the loan: If the fund need is very immediate, to cover your MSME’s short-term expenses, a working capital loan is more suited. For long-term investments and expansion plans, a term loan is a better option.
• Loan amount: If the amount needed for the business is not very large an MSME can approach an NBFC for Working capital loans which are typically smaller in size, while term loans can provide larger amounts.
• Repayment tenure: Working capital loans have shorter tenures, whereas term loans offer longer repayment periods.
• Interest rates: Working capital loans usually have higher interest rates than term loans.
• Collateral requirements: Working capital loans may be unsecured or secured, while term loans often require collateral.

Conclusion

Knowing the different aspects of working capital loan and term loans is very important for making sound financial decisions. By carefully evaluating your business requirements and financial capacity, you can select the right type of loan to propel your MSME towards growth and success.

Remember, it’s always advisable to consult with a chartered accountant advisor to discuss your specific loan needs and explore the best financing options available to you based on their recommendations, don’t take this blog as financial advice instead consider it as a direction/tips to consider.