Working Capital Finance Sources Explained

A consistent flow of operational capital is necessary to ensure smooth day-to-day operations, optimum liquidity, and seize growth opportunities. Operational liquidity is essential in meeting outflow requirements like salaries, wages, raw material costs, utilities, etc. A deficit in operational capital requirements can stall production, leading to business stagnation. To avoid this, companies can opt for various sources of operational capital finance.

What is Working Capital Finance?

operational capital financing simply offers businesses funds to meet their day-to-day operational expenses. This type of financing helps businesses pay for short-term obligations, maintain stability, and keep operations running smoothly. Such finance options are generally used to manage short-term cash flows rather than being used for long-term investments or asset purchases. Operational capital finance provides a way through which businesses have the freedom to make various expenses without straining the cash reserve. It facilitates companies to manage fluctuations in cash flow, hence enabling them to pay their suppliers, payroll, and handle other operational needs in due time. This is necessary for maintaining smooth business operations with minimal interruptions.

Short-Term Sources of Operational Liquidity Finance

Short-term sources of working capital financing can be internal or external. In the short term, taxes and dividends can be classed as internal sources of operational capital. While these are current liabilities, the funds remain with the company until payments are made. External sources include:

Short-Term Working Capital loans

Businesses, especially SMEs, can secure short-term operational liquidity from banks and NBFCs at concessional interest rates. These are usual operational capital granted for a shorter repayment tenure of up to 12 months. These can be secure/unsecured business loans, depending on the lender selected. Additionally, these loans come with flexible repayment terms, a digitised application process, minimal documentation, and easy eligibility criteria, making them hassle-free sources of  operational liquidityl financing.

Overdraft/Cash Credit

Banks extend their current account holders a pre-approved overdraft or cash credit limit facility. In other words, the individual can withdraw more than the funds available in the account. Since the bank charges interest only on the overdrawn sum, overdrafts remain one of the most cost-effective operational capital finance options for entrepreneurs looking to meet limited short-term expenses. The bank decides on the overdraft limit after evaluating the individual’s creditworthiness.These facilities are flexible sources of financing for businesses to manage short term capital requirement. It allows the entrepreneurs to access more capital with an increased convenience, enabling them to manage unforeseen expenses. The interest charges are applied only to the overdrawn amount, making it a great solution for managing liquidity.

Also Read: What is the difference between Cash Credit and Overdraft?

Account Receivable Financing

Account receivable financing is a short-term source of working liquidity finance where the company can use its accounts receivable as collateral to raise funds from a bank. The short-term loan granted against account receivables (unpaid invoices) generally accounts for 80% of the collateral value. Once the customer pays the invoice, you receive the rest, minus the lender’s fees. Since this type of short-term operational capital finance involves the risk of customer defaults, it is good only if you have a reliable customer base.

Customer Advances

Acquiring advance payments from customers can be one of the easiest ways to secure working liquidity finance. Businesses insisting on advance payments, especially for bulk orders, can secure funds needed to improve cash flow and meet the short-term operational capital requirements. Since no interest payments are involved, customer advances remain one of the most cost-effective sources of working liquidity in India. This helps businesses with immediate cash flow without the burden of paying interest. Requesting advance payments, especially for bigger orders, can help businesses improve their liquidity position and ensure that they have enough funds to cover operational expenses.

Bill Discounting

Businesses sell goods and services to customers on credit, allowing deferred repayments over 30, 90, and sometimes 180 days. However, this deferred payment blocks cash inflows, creating a working liquidity crunch. Under bill discounting (invoice discounting), the bank purchases your unpaid sales invoices, due at a future date. The bank credits the due amount to the account after deducting a commission from the same. The bank collects the outstanding amount directly from the customer on the due date. Most lenders offer bill discounting facilities for up to 180 days.

Public Deposits

Businesses can also raise funds for short-term operational capital requirements using public deposits. Companies invite employees, shareholders, and the general public to invest funds in the business, paying them a higher interest rate than bank deposits. Depositors earn higher interest rates than bank deposits, while companies benefit from a cheaper line of credit, making public deposits a mutually beneficial source of operational capital finance.

Long-Term Sources of Working Capital Finance

Long-term sources of working liquidity finance generally offer funding for day-to-day operational expenses and business growth and expansion. Again, these sources can be divided into internal and external options. Retained profits are an important internal source of operational capital for companies, while the following represent external sources:

Long-Term Loans

Long-term loans are a preferred source of operational capital finance in India. Term loans in India come with a tenure of over 84 months and lower interest rates than short-term operational capital loans. Moreover, businesses can use these loans to fund their long-term growth plans, like upgrading equipment, expanding operations, etc. Since these loans are repaid in a fixed term with usually a fixed repayment, it becomes easier for the business to manage the expenses efficiently.

Equity Financing

Under this type of long-term working liquidity funding, businesses sell the company’s equity or ownership stakes to investors to raise capital. Equity funding can be obtained from different sources, including friends, venture capitalists, and the general public. The success of equity financing depends on factors like the company’s reputation, perceived profitability, and others. Also, sometimes the company can onboard business veterans with equity financing. This not only helps with raising funds but also helps with getting great people onboard which can help grow business exponentially.

Issue Debentures

Issuing debentures can be one of the best long-term sources of operational capital finance for a company. Companies can issue debentures to raise capital from the general public, investors, and other companies. Unlike shares, the company has to announce the interest payable before issuing the debentures. Since this binding interest obligation holds even if the funds remain unutilised or the company runs into losses, issuing debentures can be a risky way of securing working liquidity finance. 

Also Read: Term Loans: Definitions, Classification, Benefits & Eligibility

Conclusion

Assessing and understanding the different sources of operational capital finance can help business owners carefully navigate their funding requirements. Working liquidity needs evolve, with different sources of working liquidity financing becoming appropriate at different times. Thus, companies need to constantly evaluate their funding needs and choose the right sources of operational capital finance to ensure profitability while managing short-term and long-term cash flows. The maintenance of a clear understanding of the financial status of the business will always help it in making better decisions about the use of short-term loans, vendor financing, or equity funding. Checking cash flows and working capital ratios regularly help identify gaps so that companies may address liquidity issues before such issues affect the operations and growth of companies.

Frequently Asked Questions

What are the Most Common Types of Working Capital Finance Options in India?

Short-term working capital loans, overdrafts, bill discounting, and accounts receivable funding are some of India’s most common working capital financing options.

Can I Get a Working Capital Loan without Collateral?

Yes. You may be eligible for an unsecured working capital loan depending on the lender you pick, your credit score, and business profitability.

What are the Primary Sources of Working Capital Finance?

Internal and external sources are two primary sources of working capital finance in the short and long term.

How Much Can I Use from my Overdraft Account to Fund Working Capital Requirements?

The bank determines the overdraft limit on your current account based on your creditworthiness. Lenders evaluate your CIBIL score, financial history, and repayment track record.