Working capital is essential for smooth running of business operations. Usually, Small and Medium Enterprises (SME) face a shortfall of funds due to poor or delayed collections from clients. This is when they need working capital financing to keep the business going. However, SMEs usually have little or no collateral to offer banks and institutional lenders. Apart from this, such traditional sources of finance have inflexible lending policies, long drawn out due diligence, laborious paperwork, and slow disbursement. All these factors result in a lack of adequate and timely working capital financing for SMEs, hampering their growth prospects.
Working capital is mainly needed for funding OPEX (operating expenses) or short-term operations, so that the money can be rotated to generate more earnings. But SMEs also require working capital to enhance their solvency, increase goodwill, and improve their ability to face exigencies. Fortunately, in a changing financial landscape, there are newer and simpler sources for procuring working capital financing apart from banks and institutional lenders. These are usually offered by fintech organizations that leverage technology and the Internet to simplify and speed up working capital loans.
As an SME you can raise a working capital loan in any of the following ways:
- Receivables discounting: SMEs can use their credit sales invoices or receivables as security to raise a working capital loan. This is a form of asset-based funding, where the invoices act as an asset to secure the advance/loan given. Under this facility, the lender will discount the receivables and advance a certain amount to the SME. SMEs retain control on their receivables and have to collect them in order to pay back the lender. New age fintech companies call this form of working capital financing “supply chain finance”.
- Factoring: This form of working capital financing is like receivables discounting, where you can use sales invoices to secure a working capital loan. The only difference here is that the control and administration of the factored invoices is taken over by the factoring institution, which collects the money directly from your debtor.
- Merchant Cash Advance: This is another version of receivables financing where your credit card sales are used as an indicative measure to raise a working capital loan. This source of working capital financing can be used by merchants who accept payments for their services through credit/debit cards through a PoS (point of sale) machine. Some fintech companies are tying up with numerous PoS machine vendors to offer a wide range of merchant cash advance loans to small merchants across India.
- Online Seller Finance: This source of working capital financing is aimed at businesses that sell on online marketplaces. Online marketplaces like Amazon, Flipkart, PayTM, etc., tie up with a financing institution to customize and arrange working capital finance or a working capital loan at competitive rates for sellers on their marketplace.
- Pay Later Finance: This type of working capital finance is a revolving credit facility, much like the working capital limits laid down by banks and financial instructions. The facility includes a pre-determined and agreed upon credit amount that can be used by SMEs to pay their suppliers on time. The limit is reset when you repay the borrowed amount. You can use this for on-going working capital financing to regularly replenish your inventory.
- Crowdfunding: The working capital financing need is met by a group of people who come together on an online portal to finance a given business need. There are many peer-to-peer (P2P) funding websites where you can apply for a working capital loan. You can provide details about your project and the reasons for seeking additional finance. Investors on these websites or portals are usually people or non-institutional investors who invest in projects that meet their interest. The loan terms are pre-agreed between the P2P lender and the borrowing SME.
- Micro Loans: When SMES are unable to secure working capital loans due to lack of collateral or credit history, then can approach micro finance companies or fintech companies that offer small loan amounts, require less documentation and no collateral. These new types of lenders use technology to assess the creditworthiness of loan applicants. They have easy repayment terms and have mobile apps that make it easier for SMEs to monitor their loans and due dates for repayment.
- Bootstrap: This is one of the most common sources of funds in an SME’s early days. Using savings and borrowing from family and close friends requires no formalities and incurs no costs while providing greater flexibility in repayment and interest terms. Bootstrapping or self-funding is also an indicator of how much the entrepreneur is committed to his business. This can help in raising funds from investors at a later stage.
- Government: The Government of India has introduced various funding schemes to promote the development of the SME segment in India. One such scheme which enables SMEs to procure working capital financing is the Pradhan Mantri Mudra Yojana. Under this scheme, working capital loans or short-term loans can be disbursed to SMEs for amounts ranging from Rs. 50,000 to Rs. 10 Lakh without pledging security. Working capital loans made by banks and financial institutions under this scheme are secured by the Ministry of Micro, Small & Medium Enterprises, under the Credit Guarantee Scheme (CGS).
- Term Finance: Working capital term loans are a well-known way of raising business finance from banks and financial institutions. The working capital loan is usually given as a funded or a non-funded facility. Under a funded facility— a cash credit limit or an overdraft facility—the funding and assistance are given for purchase assets required for the business. SMEs can withdraw from their limit to finance their OPEX. Non-funded facilities include issuing Letters of Credit (LC) or giving guarantees to suppliers and service providers, on the behalf of the SME. This kind of working capital financing is available in Indian as well as in foreign currencies.
Many options, traditional as well as new age, are open for you as a small entrepreneur, to finance your working capital needs. New age fintech companies offer the added advantages of flexible repayment terms, quick disbursal, and unsecured loans.