It’s important for a new business or entrepreneur to have money in order to grow and succeed. While business credit cards may seem like an easy way to obtain money, they are not without their limitations. Working capital loans offer you greater flexibility and better deals when it comes to managing your business’s money. This article will give you a clear view of working capital loan and business credit cards, helping you decide what is best for your situation.
Business Credit Cards Overview
Business credit cards are similar to personal credit cards, but only for business use. Benefits include:
- Easy Approval: Especially for startups and new businesses with little credit history.
- Rewards: Spending money and getting rewarded with prizes.
- Better Cash Flow: You have a little over a month to pay off your debt.
Disadvantages of business credit cards include:
- High Interest Rates: Rates can range from 18% APR to 29%, resulting in large long-term charges.
- Lower Credit Limit: Most of the time, credit limits are less than Rs 20 lakh for established companies.
- No Interest-Free Period: If you do not pay off your entire balance each month, you will start to accrue interest from the date of purchase.
- Rigid Terms: Limitations with fees and penalties for exceeding the credit usage rates or withdrawing cash.
Working Capital Loans Overview
Short-term working capital loans give companies the money they need to cover daily expenses and solve cash flow problems. Benefits include:
1. Significantly Lower Interest Rates
Credit cards have a high annual interest rate of up to 29 percent. Over time, as the unpaid balances increase quickly, credit cards can become very expensive.
Comparatively, you can get working capital loans with interest rates as low as 16-20% per year. You can reduce the effective interest rate to 11-14% per year by reducing your balance calculation. With secured working capital loans, rates can be even lower.
A Rs 10 lakh credit card bill with 24% interest accrues Rs 2,000 in interest each month. In just one year, the interest alone would have pushed your balance to Rs 12.4 lakh. The same Rs 10 lakh in working capital loans with an 18% interest rate will only cost Rs 1,500 per month, totaling Rs 1.5 lakh annual interest.
The interest savings that you could achieve by choosing working capital loans instead of credit cards over a period of three years is at least Rs 5 lakh. This is enough to fund a large portion of your needs for working capital! The difference in interest rates should be enough to convince you to choose working capital financing instead of credit cards.
2. Increased Loan Amount to Meet Business Needs
Even for businesses that are profitable and have a good credit rating, the maximum limit on a credit card is rarely more than Rs 15-20 lakh. This limits the amount of funding available to small businesses for growth.
You can also take advantage of growth opportunities by increasing your working capital, for example:
- Investing in business expansion and infrastructure upgrades.
- Placing bulk orders to get discounts from vendors.
- Managing extra inventory to meet seasonal or urgent demand.
A clothing boutique that receives a working capital short-term loan of Rs 30 lakh could use the money for:
- Renovating store interiors with a premium feel, costing Rs 10 lakh.
- Getting 20% off by ordering Rs 5 lakh in advance for inventory.
- Digital marketing and campaigns to acquire new customers, worth Rs 10 lakh.
- A Rs 5 lakh buffer for daily operating expenses not covered by other budgets.
Working capital loans can be repaid quickly if the incremental revenue and cost savings are greater than the interest rates.
3. Better Customized Repayment Terms
If you fail to repay, credit cards will charge steep interest, leaving very little room to deal with temporary cash flow problems that all businesses face from time to time.
Working capital lenders who are specialists in the field understand your business and offer a repayment period that can be tailored from 12 to 36 months. You can also choose to pay interest only monthly throughout the repayment period to better match your repayments with your revenue.
For example:
- The monthly outflow for a Rs 25 lakh loan on an 18-month term and interest-only is Rs 1.25 lakh.
- The same credit card that is outstanding at Rs 25 lakh would require you to pay Rs 6.25 lakh per month over a period of six months, increasing the cash flow pressure.
Flexible repayment plans allow you to manage your urgent funding requirements without financial stress. It ensures that your business is not negatively affected by capital constraints.
4. More Eligibility for and Accessibility
Often, it is difficult for new businesses to obtain credit cards with limits exceeding the very modest Rs 1-2 lakh. Most banks restrict startup financing through their internal lending policies.
Credit is available to new ventures with flexible assessment models that focus on the viability of their business.
The following criteria are considered critical for determining business loan eligibility for a working capital loan:
- Business Vintage
- Cash Flow Patterns
- Credit Profile
- Existing Leverage Levels
- Indicators of Revenue Quality and Sustainability
- Shared Business Plans and Future Prospects
Working capital loans are also available from specialized lenders, without the need to pledge personal or business assets as collateral. This can help overcome the collateral issue that is often encountered when trying to get funding for a startup from traditional lenders.
Scenarios Where Working Capital Loans Work Better Than Business Credit Cards
Working capital loans are highly beneficial for MSMEs in specific situations.
1. Finance Peak Season Inventory Ramp-Ups
Before peak sales periods, such as the festive months, retailers, manufacturers, and dealers often require urgent inventory infusion. They can also benefit from discounts on large orders of inventory from their vendors. For such large inventory orders, expensive business credit cards with modest limits are not viable.
Credit card payments that are due in 30-50 days can restrict the ability to channel sales revenue back into inventory replenishment. This limits order fulfillment capacity.
Work capital loans with increased limits and longer tenure allow urgent bulk stocking to be done at discounted rates. The longer repayment schedule allows for greater flexibility to channel peak season revenue back into inventory.
2. New Market Expansion Plans
Investing in new markets can require upfront investment such as:
- Market Research
- Hiring Regional Sales Teams
- Short-Term Promotional Costs
- Costs of Infrastructure and Operational Establishment
- Extra Buffer Inventory
Credit cards are not able to fund large-scale growth plans that require significant investments in the beginning.
Working capital loans can be tailored to match the cash flow expected from new market expansions, simplifying the process of entering new markets.
3. Financing High-Value Deals
Businesses that deal with large orders or clients will often have to invest substantial amounts of working capital in customizations, or hire technical teams to deliver. Variable costs associated with high-order value deals can be 5x-10x higher than average order costs. The card limit should be increased.
In addition, the 30- to 50-day deadlines for card repayment can place excessive pressure on clients’ ability to recover costs by paying their bills to avoid being charged interest. This can have a negative impact on bargaining power and deal structuring flexibility.
Working capital loans offer a greater amount and longer terms of repayment, allowing you to finance more large-ticket deals without external pressure. This provides greater flexibility in the delivery of orders.
Conclusion
Working capital loans are available in India at a lower interest rate and with a repayment plan that is tailored to your cash flow. They are therefore a better financing option for small businesses that have urgent cash needs.
Specialized lenders such as FlexiLoans offer a simplified application process, quicker loan decisions, and flexible options. This allows newer businesses with a limited credit history to access working capital term loan funds for their growth plans.
