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What are the differences between working capital and small business loans?

On the surface, it may seem that there is not much difference between working capital and an SME.  After all, one may argue, it is granted to the business and the unit can apply it to business purposes as per choice. However, this is not true. The main difference lies in the timing aspect. In accounting, there is a concept called as a matching concept. This means that a long-term debt should be applied for long term capex purposes. Alternatively, a short-term working capital loan should be applied for operational expenses. A mismatch can lead to serious solvency crisis for the business. There is a difference between working capital and small business loans and we shall study that in this article.

Understanding Small Business Loans

Small business loans are extended by banks to business owners. The criteria to be eligible for such loans include a business operating period of at least 3 years, good personal as well as business credit scores and strong financial performance.

The banks insist on submission of assets such as property, equipment and/or vehicles that can be used as collateral cover. In the event of a default, the asset may be liquidated to recover the dues.

A small business loan application involves detailed documentation and submission of substantial supporting documents. The approval process is long drawn and time-consuming as the valuation of the assets has to be undertaken by a competent valuer. There is still a high chance that after the long waiting period and frequent correspondence with the bank, the loan may still be rejected.

It is mandatory thatan SME loanis used specifically for the purpose stated in the loan application. For example, if the funds were requested to purchase afixed asset, then the funds can only be applied for capex purpose. There is no scope to deviate from the initially declared usage, even if the business owner comes up with a better reason.

There is a heavy prepayment penalty in case of paying the dues and attempting to settle the loan.

Understanding a Working Capital Loan

A working capital loan isa relatively flexible business financing option. It is mainly availed to fund the routine business expenditure namely raw material purchase, payment to suppliers, wages and other operating expenditure. It can be obtained even by a new, relatively nascent business. This is because, irrespective of the vintage or size of the business, every business would undertake business activities.

A working capital loan application can be obtained from a fintech lender by an online application. In case the loan amount is less than Rs 10 lakhs, the evaluation process is complete within a day. Once sanctioned, the loan amount is directly credited to the registered bank account of the borrower.

In addition, business owners can use the funds for any operating purpose. The fintech lenders do not monitor or mandate the usage of the funds.

The repayment facility is also flexible in case of working capital loan. Rather than a lumpsum repayment, a regular, periodic repayment is made to the lender. Fintech lenders also enable early servicing of the loan with foreclosure charges.

In conclusion, while applying for a business loan, one must bear in mind the difference between a small business loan apply and working capital loan. Generally, a business loan implies a secured loan offered by banks. On the other hand, a working capital loan in the nature of unsecured business finance can be easily obtained from a fintech lender for business operations. Many times, the terms are used interchangeably in a loose manner with business loans broadly being categorized as secured or unsecured loans. Further, each of the above two segments offer short term working capital loans and long tenure term loans for capex needs.