Working Capital Loan
Every business should have funds on hand to cover both planned and unexpected expenses. Cash reserves help cover the everyday fluctuations faced by the business. For those who don’t have the cash flow for everyday expenses, working capital loans help in wither the situation.
A working capital loan is used for everyday financial operations for businesses that are lacking current cash flow. Working capital loans are used for short-term needs rather than long-term needs, such as acquiring fixed assets or making investments. This loan type is used to sustain business growth daily to help you visualize long-term success.
Any business with a working capital gap is eligible for WC facility. The following types of business forms are eligible for a working capital loan:
- Sole Proprietorship
- Partnerships firms or Limited Liability Partnerships
- Private and Public Limited Companies
Working Capital Cycle (WCC) refers to the time taken by an organization to convert its net current assets and current liabilities into cash. The working capital cycle (calculated in days) is the time duration between buying goods to manufacture products and generation of cash revenue on selling the products.
The shorter the working capital cycle, the faster the company can free up its cash stuck in working capital. If the working capital cycle is too long, then the capital gets locked in the operational cycle without earning any returns. Therefore, a business tries to shorten the working capital cycles to improve the short-term liquidity condition and increase its business efficiency.
Banks bridge the gap between the conversion of its net current assets and current liabilities into cash by way of Working Capital Finance.
Any business with a working capital gap is eligible for WC facility. WC gap is the difference between stock days + debtors’ days-creditors days.
The following types of business forms are eligible for a working capital loan:
- Sole Proprietorship
- Private and Public Limited Companies
Factors affecting working capital requirement:
- Nature of business
- Size of the organization
- The phase of trade cycles
- Production policies
- Turnover of inventories
- Trading terms
- Length of the production cycle
- Seasonal Variations
The eligibility of Working Capital finance depends upon various factors, including the following important ones:
- Working Capital Cycle of the Business
- Credit Rating of the facility and Credit score of promoters
- Co-lateral value and type
- Other non-financial information
Purpose, Usage, Benefits, Disadvantages
Working capital, the fund required to cover all of a business’s short-term expenses, which includes purchase inventory, payments on short-term loans, and meeting operating expenses. It is critical since it is used to keep a business operating smoothly by meeting financial obligations in the short run, that is within a year.
The use of Working Capital loan is specific to such requirements. A business cannot use the fund for any other purpose such as buying fixed assets or for any investment purpose (Long term or short term) and blocking the fund in Non-current assets. The lender keeps a vigil eye on the end use of the fund and objects diversion of the fund than for which it is being lent.
Few of the working capital finance is given for specific nature of transactions, and such the fund cannot be used for any other working capital purpose too.
Working Capital loans are a must for business houses to manage day-to-day operational expenses, and it comes with a host of advantages:
The full potential use of collateral: For any working Capital loan, primary securities are the working capital assets or current assets of the business and other assets are called secondary or collateral. Having two lines of security, working capital loans are extended up to 100% of collateral value and certain cases even way more than the value of the collateral. A loan which is eligible to be covered under CGTMSE scheme can be availed without any collateral.
Speed and Flexibility: Working Capital is sanctioned as a limit, which can be used as and when the requirement arises. The availability of the fund is just cutting a cheque away. Once the limit is available, fund availability is the fastest than any kind of product. It comes with never thought of flexibility. High requirement because of seasonal demand can be managed, shifting of limit sanctioned from product to other, temporary cash crunch situation, all are a request away from being done.
Enhance Profitability: Proper application of working capital facility would enhance the company’s prospect of profitability in the long run. The fund can drive higher revenue, thereby profitability.
Liquidity and Better Bargain Power: It allows to keep sufficient liquid cash in the business at any point of time to pay operational costs and short-term debts. Suppliers provide cash discount on immediate payment. Working capital limit allows the extra cash cushion to pay suppliers immediately to avail the cash discount, thereby making the products more competitive in the market.
Spend at your discretion: Working Capital limits are for meeting day-to-day operation of the business, and fund requirement fluctuate based on activity level. Working Capital limit allows the borrower to withdraw fund as and when required and deposit back additional cash flow back into the loan account. This ensures the borrower pays interest on the fund used.
Non-EMI based Finance: Working Capital Loans are of Overdraft/Cash Credit, Trade Credit and Working Capital Term Loans. The former 2 are revolving in nature, and the later is with monthly repayment. The borrower needs to pay the interest as long as the limit is available on Overdraft/ Cash credit, and the transaction is in force in case of Trade Credit.
Though WC finance is a must for a business, it does come with its demerits. One has to know both benefits and disadvantages before having a limit.
Default with damage Credit Rating: Defaulting on the loan will damage the credit rating of the organization, and other lenders too may not come forward to help.
Business at Risk: Since WC loan has the first and exclusive right on the current assets of the company, defaulting on repayment of this loan gives a right to the lender to confiscate current assets, making further operational difficulties in running the business.
Does not support Long Term fund requirement: The inherent nature of the loan is to finance the working capital requirement. Even the business has used the working capital finance much below the limit sanctioned; the lender does not allow to use the fund for long term asset acquisition.
Non-Situational: Lenders fix working capital limits based on past data and do not acknowledge sudden changes in the market conditions. The time taken to respond to certain recent events is significant to impact business operations and profitability.
One can claim a tax deduction on the interest charged on the working capital loan as the loan is invariably used for business furtherance. The tax benefits also extended to the associated fees and charges incurred while taking the loan or keeping the loan. Interest, as well as the payables, can be claimed as business expenses under Section 37(1) of the Income Tax Act. There is no relieve on the principal repaid.
Working Capital Loans can be availed in three forms – Overdraft/Cash Credit, Trade Finance and Working Capital Term Loans.
Overdraft/Cash Credit: This is a fund-based limit, running account and runs parallelly till the time business operates. It is limit-based funding, where the borrower withdraws according to his requirement and deposits business collections. Interest is charged and payable based on the utilized fund.
Trade Finance: Trade Finance are loan extended based on transaction and can be of fund based or non-fund based. Few fund-based examples are Bills Discounting, Pre/post-shipment finance, LC Discounting and example of non-fund based are Letter of Credit, Bank Guarantee, etc.
Working capital Term Loan: Such loan is given to managing irregular cash flow due to longer working capital cycle, Lack of cash reserves for meeting sudden cash crunches or taking up new orders. Few lenders do bundle Term Loan along with the Working Capital loan to support expansion or acquisition of fixed assets.
Working Capital financing can be broadly classified under two types:
- Fund Based
- Non-Fund Based
Fund based lending is when the lending bank commits the physical outflow of funds. The various forms in which banks may make fund-based lending:
Fund based limit can be of:
- Cash Credit
- Working Capital Term Loan
- Bills Purchased/Discounted
- Packing Credit
- Inventory Finance / Channel Finance / Floor Funding
Non-fund-based lending, where the lending bank does not commit any physical outflow of funds. The fund’s position of the lending bank remains intact. Non-funding-based lending can be made in two forms:
- Bank Guarantees
- Letter of Credit
Products & Schemes
What is Cash Credit?
To meet working capital requirements of the company, the bank gives the CC limit against the hypothecation of paid Stock and Debtors. Further, a monthly or quarterly stock and debtor’s statement need to be submitted with the bank showing the position of the paid stock and ageing of the debtors.
It is limit-based funding, and the bank provides a running account, where the borrower withdraws according to his requirement and deposits business collections. Interest is charged and payable based on the utilized fund.
What is Overdraft facility?
An overdraft facility is limit-based funding that allows the business to use the fund as and when required up to the approved limit. The banker does not ask for monthly or quarterly stock or debtor position to fix the limit. It is a clean limit and renewed every year. The lender asks for higher collateral to offer this product.
How Cash Credit if different from Overdraft facility?
Though Cash Credit and Overdraft facility operates similarly, broad differentiation can be observed:
- Cash Credit facility generally offered at a lower rate of interest than Overdraft.
- Cash credit primary comfort is hypothecation of stocks, Inventory and receivables, whereas in Overdraft it is credit history, collateral and business stability. So, under Cash, Credit one has to submit the monthly or quarterly stock or debtor statement.
- Bankers do not have any limit while extending Cash Credit, whereas lenders try to limit the exposure up to Rs 3 Crs.
What is Ad hoc or Temporary Limit?
The ad-hoc limit is the limit fixed by the bankers to its existing working capital borrower for a limited period. The time frame could be between 7 days to 90 days or can be extended further based on regulator (the RBI) guidelines. The reasons for which ad hoc or temporary limit can be sanctioned are:
- To manage sudden Bulk order results additional working capital requirement created
- The proposal of the working capital is either in the process of enhancement or renewal
In any other case which the bank thinks suitable justification for sanction of ad-hoc limit.
What are Working Capital Term Loan and its features?
Working capital Term loans are loans which are offered for a fixed tenure and repaid in periodic instalments along with interest. Working Capital Term Loan is offered, where other working capital products cannot be funded. Such loan is given to managing irregular cash flow due to longer working capital cycle, Lack of cash reserves for meeting sudden cash crunches or taking up new orders.
What is the Foreign Currency Term Loan (FCTL)?
Foreign Currency Term Loan (FCTL) is the replacement for Term Loan in INR. Foreign Currency Term Loans (FCTL) can be made in four currencies – the US $, Sterling, Euro and Japanese Yen with a maturity period of 6 months to 7 years. It can be repaid by bullet payment or in fixed instalments or by conversion to rupee term loans, as per the terms of the original sanction.
If the capital expenditure is in foreign currency, the borrower can save the conversion cost by borrowing FCTL.
Rate of Interest of FCTL is linked to LIBOR, and much lesser than Reference Rate prevailed in the Indian Banking industry. Interest on FCTL needs to be serviced through receivables in foreign currency only. This product is ideal too – the businesses who have naturally hedged through inflow and outflow of foreign currency and exporters having Export receivables. Where inflow of foreign currency is regular, part of those export receivables should be un-hedged, and the same can be used for repayment of FCTLs.
What is Gold Metal Loan (GML) and how it operates?
Gold Metal Loan (GML) is a mechanism under which a jewelry manufacturer borrows gold metal instead of rupees and repays the loan in gold too. The borrower enables the bank by giving it the equivalent money to import gold on their behalf, and with the imported gold, the Gold Metal Loan Contract is settled. GML can be taken for 180 days in case of domestic jewelry manufacturers and 270 days in case of exports. GML is given against SBLC or Bank guarantee for the benefit of the domestic as well as exporters of jewelry manufacturers.
- Fulfils working capital requirement of jewelry manufacturers
- Upfront delivery of gold with the flexibility of fixing the gold price within 180/270 days
- This enables the borrower to benefited from the fluctuation in the Gold Price
- The rate of interest of GML is linked to international gold interest rate, which is much lower than the fund-based working capital loan. GML is priced below 3% per annum.
- The disadvantages are that GML is subject to the availability of gold with the bank, and also the repayment is subject to the availability of gold in the international market. Interruption in the supply of gold results in sanctioned GML limits being converted forcibly to the higher interest-bearing INR denominated Working Capital Limits.
How Bills Purchased or Discounted function?
Discounting of bills or receivables is a type of working capital lending. The seller of the goods produces the bills; which carries a definite date of payment by the buyer; to his lender for discounting. Lender, release the funds before the credit period ends, after deducting the agreed commission. The bills could be an Invoice, Letter of Credit or Bill of Exchanged.
A borrower can get this facility without collateral if the biller is an AAA-rated corporate.
What is Factoring facility?
The selling of a company’s accounts receivables, at a discount to a factor that which then assumes the credit risk of the account debtors and receives cash as the debtors settle their account. This is a part of the Bills Discounting product.
What is Packing Credit?
A packing credit is a loan provided to exporters or sellers to finance the goods’ being procured before shipment. The bank will make the funds available to a letter of credit issued favouring the seller and a confirmed order for selling the goods or services.
Packing credit is the most commonly used trade finance tool by an exporter. The international sales cycle is longer when compared to domestic sales, which makes packing credit a very convenient and handy line of credit for the exporters. The advance is given to purchase raw materials, process, manufacture, pack, market and transport the required goods and services. In addition to this, the packing credit is also used to finance the working capital and meet the requirements of the wages, travel expenses, utility payments etc. for companies that are listed as exporters.
The facility of export packing credit supports the exporter’s supply chain by providing funds to bridge the gap until receipt of the final payment from the customer. The bank that issues the packing credit usually advances a partial or full proportion of the invoice, based on the assumed risk. The loan would be granted in either the exporter’s currency or another easily convertible currency that is mutually decided by both the exporter and the lending bank.
What is the type of Packing Credit?
Packing credit can be of Pre-shipment and Post-Shipment.
Pre-Shipment finance refers to the credit being extended to the exporters before the shipment of goods for the execution of the export order. It refers to any loan granted to an exporter for financing the purchase, processing manufacturing or packing of goods. Pre-shipment finance is of particularly important to small scale manufacturers and exporters. They do not possess sufficient financial capability to meet the expenditure involved in the production of goods for export.
Post-Shipment Finance: Post-shipment finance is a credit extended to the exporters after the shipment of goods for meeting the working capital requirement. The commercial banks give it after the shipment of goods and submission of commercial documents to them for negotiation or collection.
What are the Features of Packing Credit?
The salient features of packing credit are:
- Credit to buy goods
- Covers manufacturing expenses
- A lower rate of interest
Flexible terms of credit.
What is Channel Finance / Inventory Finance or Floor Funding?
Channel financing is a structured program through which the bank offers short term working capital facilities to the supply chain stakeholders, i.e. the buyer and the supplier. Banks offer Channel Financing facility to the distributors/dealer or suppliers of large corporates. The loan account is monitored by the corporate too. The borrower has a right to transact in the account concerning the goods supplied or sold to the corporate only. Lenders do not generally ask for collateral, and the unpaid Inventory is the only collateral. Being the limit is dependent on Inventory level at the floor shop, it is also called as Inventory Finance or Floor Funding. The assessment of the limit also depends on the credit rating of the corporate. The limit could be given in the form of cash credit or bills discounting.
What Is Letter Of Credit (LC)?
A commercial letter of credit is a document that is issued mostly by a financial institution on the request of the buyer to the supplier of goods which usually provides an irrevocable payment undertaking. It may be Inland LC or Foreign LC.
In this case, the buyer bank gives a conditional guarantee on behalf of its client to supplier for supplying of material or goods subject to that invoices, bill of lading, shipment documents will come directly to the bank. Bank will mark a lien on the goods and will stand as lender/creditor in the books of the client (buyer).”
What Are the Different Types Of LC?
Different types of Letter of Credit:
- Revocable Letter of Credit
- Irrevocable Letter of Credit
- Confirmed Irrevocable Letter of Credit
- Transferable Letter of Credit
- Revolving Letter of Credit
- Credit available by instalments
- Back to Back Letter of Credit
- Anticipatory Credit or Red Clause
- Green Clause Letter of Credit
- Deferred Payment Letter of Credit
- Standby Letter of Credit
What are the different parties involved in an LC?
Below are the parties involved in a letter of credit:
- Issuing Bank, Bank of Importer
- Advising bank, which is in the exporter’s country, notifies the exporter about the opening of letter of credit.
- The confirming bank confirms the letter of credit if the exporter is not satisfied with the security offered by the importer.
- Exporter, who is the beneficiary
- Negotiating Bank, whom the exporter submits the documents.
What are the Advantages of an LC to an Importer?
Advantages of the Letter of Credit to an Importer:
- The importer is guaranteed to receive the timely delivery of goods.
- It makes structuring a favourable payment schedule easy.
- Expediting customs clearance and final delivery as the documents are received quickly.
- It gives an assurance to the importer that the payment will be made to the exporter upon receiving the documents evidencing the shipment of goods.
- It reduces the risk of non-performance of the exporter.
What are the advantages of an LC to an exporter?
Advantages of Letter of Credit to an Exporter:
- The exporter is guaranteed payment upon presentation of specified documents.
- It eliminates the risk of dealing with an unknown importer in a different country.
- It becomes more accessible for the exporter to secure pre-order financing.
- The importer cannot refuse payment by raising a complaint about the goods.
What is SBLC and how it works?
A Standby Letter of Credit (SBLC) is a guarantee that is made by a bank on behalf of a client, that ensures payment will be made even if their client cannot fulfil the payment. A standby letter of credit is a secondary mode of payment where the bank promises the payment if the seller fulfils terms. This means that if the buyer fails to pay, but meet’s the seller the requirement of the standby letter of credit, the bank will pay.
A Standby Letter of Credit is different from a Letter of Credit. An SBLC is paid when called on after conditions have not been fulfilled. However, a Letter of Credit is the guarantee of payment when certain specifications are met and documents received from the selling party.
SBLC is also different from Bank Guarantee based on the legal aspects. Bank Guarantee is subject to the Civil Law, where SBLC is governed by International Banking Protocol – UCP 500. Hence, in international transactions, SBLC is preferred than BG.
SBLC is a standard instrument in cross border transactions and is long term as well as short term in nature. Many international companies, who do not have collateral in the foreign country take shelter of SBLC issued by the parent company to use as collateral to get financial assistance at the foreign land.
What are bank guarantees? How do they work?
Bank guarantee is a non-fund-based limit, where a bank offers surety and guarantees for different business obligation on behalf of the borrower within specific regulations. It is a promise made by the bank to any third person to undertake the payment risk on behalf of its customers. To put it straight, if a debtor fails to settle a debt or an executor fails to perform a certain act, the bank will cover the losses arising out of such transaction. Bank guarantee protects the third party from financial losses arising due to the borrower by the lender.
This facility enables the borrower to acquire goods, buy equipment and thereby expand business activity or draw down a loan or participate in work contracts or perform a work contract. It does not commit any outflow of funds until the time borrower pays the liability on time or perform the contract according to the stipulated guidelines laid down in the contract.
What are the types of Bank Guarantee available?
There are two significant types of bank guarantee used in businesses, which are:
Financial Guarantee – These guarantees are generally issued in place of security deposits. Some contracts may require a financial commitment from the buyer, such as a security deposit. In such cases, instead of depositing the money, the buyer can provide the seller with a financial bank guarantee using which the seller can be compensated in case of any loss.
Performance Guarantee – These guarantees are issued for the performance of a contract or an obligation. In case, there is a default in the performance, non-performance or short performance of a contract, the beneficiary’s loss will be made good by the bank. For example, A enters into a contract with B for completion of a certain project and the contract is supported by a bank guarantee. If A does not complete the project on time and does not compensate B for the loss, B can claim the loss from the bank with the bank guarantee provided.
What is the period of Bank Guarantee?
The Bank Guarantee is always issued for a period, which ranges from a few days until 10 years. The Bank Guarantee has 2 critical periods – Validity Period and Claim Expiry Period. The beneficiary can claim for the act/default occurred on or before the Validity Date but within the Claim Expiry period. Generally, both these dates are different, and Expiry Date ends one to twelve months after the validity period. The Bank Guarantee commission is changed based on the period inclusive of Claim Expiry period.
Though the business never gets that older that it reaches retirement age, the promoters though. Lenders prefer to fund businesses managed by promoters in the age group of 21-65 years. Lenders do insist on taking insurance cover in the form of loan shield, and the premium is dependent on the age of the promoters. The risk associated with higher age factor can be mitigated by adding one or more younger generation individuals to the promoter group and co-borrower or guarantor to the loan structure.
Turnaround time, in short TAT, is the time required for the lender to process the loan application. TAT starts from the login of the file and ends with loan disbursement.
Working Capital processing involves scrutiny of KYC, Financial documents, copies of co-lateral papers and working capital related information. Financial appraisal, scrutiny of title flow of the collateral and valuation happens simultaneously.
Sanction or Rejection of the proposal is decided in 2 weeks, which includes a valuation and legal scrutiny. One must keep in mind, providing a full set of documents and information in one go, helps the lender to decide faster.
On acceptance of the sanction and signing of the loan agreement, the amount is disbursed to the borrower. The total time taken from signing the application form to set a limit on to the borrower account can be completed in 2 to 3 weeks.
If the process involves the takeover of loan from another lender, additional time is elapsed in getting the co-lateral papers from the existing lender and creating mortgage in favour of the new lender. This process itself takes about 2 to 3 weeks, depending on the lender’s policy and place of document storage.
Rate of Interest is positively correlated with the risk involved in the lending. The other guiding factors which govern the rate of interest are Credit Score, Credit Rating, Loan amount, Risk Profile, Product etc. Usually, such loans are offered with a floating interest rate and range between 9.50% to 11%. Floating rate of interest is linked to the reference rate. Reference Rate is dependent on the risk profile of the lender, and Rate of Interest is decided based on the Spread the lender wants to keep over and above the reference rate. Loans covered under CGTMSE scheme are priced higher. As per direction issued under CGTMSE, the rate of interest cannot be more than 14% by Banks and 18% by NBFCs on the credit facility extended by them and covered under CGTMSE scheme.
Working Capital loans are offered for less than 12 months and are revolving in nature. The lender renews the limit on or before the expiry of the tenure of the limit. Working Capital has multiple products under one umbrella, which are transaction-specific and are designed to ease trade transaction. Few of the working capital products have tenure linked to the tenure of a particular transaction which could be as low as 30 days. Working Capital Term Loan is sanctioned between 1 to 7 years tenure.
Following Credit rating agencies are authorized by RBI to provide a credit rating for Commercial Papers:
- CRISIL (Credit Rating Information Services of India Ltd.)
- ICRA (Investment Information and Credit Rating Agency of India Ltd.)
- CARE (Credit Analysis and Research Ltd.)
- FITCH Rating India Ltd.
- Acute Rating
The assessment of working capital loan takes a holistic approach by assessing the financial and non-financial aspects of any business. Financial information such as Working Capital Gap, Debt to Equity ratio, Total Outside Liabilities vis-a-vis to Total Tangible Networth, Receivable cycle and Inventory turnover days, Current Ratio, growth in business and interest coverage plays crucial aspects of the decision-making process. Non-financial aspects such as Industry outlook, macro-economic environment, promoters experience and controlling stake in the business, external credit rating, quality of collateral offered are vital parameters which lenders emphasize upon. The overall fund-based limit should be under MPBF guidelines.
A pre-payment penalty is an amount that lenders charge borrowers who pay off loans before time. Some loans like auto loans and home loans are typically scheduled to last for a certain number of years, with the loan balance reaching zero at the end of the term.
Tandon committee was set up by RBI to suggest guidelines for supervising end-use of funds, make recommendations for obtaining periodical information about borrower’s business, make suggestions for prescribing inventory norms for different industries and suggest method assessing working capital requirement.
According to the notification of RBI dated on 21st Aug 1975 accepted the following recommendations of the Tandon committee:
Norms for Inventories and Receivables: The committee suggested 15 industries excluding engineering industries. These norms were suggested in the following forms:
- For Raw materials: Consumption in months
- For Work in Progress: Cost of production in months
- For Finished Goods: Cost of Sales in months
- For Receivables: Sales in months
Methods of Borrowing: It introduced the concept of a working capital gap which the excess of current assets over current liabilities other than bank borrowing. They also suggested three progressive methods to decide the maximum limits according to which banks should provide finance.
LIBOR stands for London Inter-Bank Offered Rate. The London Interbank Offered Rate is the average interest rate at which leading banks borrow funds from other banks in the London market. LIBOR is the most widely used global “benchmark” or reference rate for short term interest rates. Libor is calculated by the Intercontinental Exchange (ICE) and published by Refinitiv. This also can be obtained from www.bankrate.com or www.global-rates.com.
LIBOR is used as a reference rate for Loans offered in foreign currency by banks and other financial institutions. Rises and falls in the LIBOR interest rates can, therefore, have consequences for the interest rates on loans linked to LIBOR. Based on the currency dealt with, LIBOR is used.
In any foreign exchange transaction, involves the conversion of the foreign currency to home currency. The conversion takes place at the prevailing market rate, which may result in gain or loss. Forward Cover Contract or option involves sale or purchase of a currency at a fixed price on a fixed future date. This is an arrangement to hedge against adverse exchange rate fluctuations. An exporter or importer, where the money transaction is to be executed on expiry of credit period, the forward cover is taken to ensure the inflow or outflow of domestic currency is decided and certain.
Forward or Future rate is decided based on the Interest rate difference between both the currency country and past performance of the exchange rate between the currencies.
To calculate the forward rate, the spot rate is multiplied by the ratio of interest rates and adjusted for the time until expiration. So, the forward rate is equal to the spot rate x (1 + foreign interest rate) / (1 + domestic interest rate).
Forward premium is when the forward exchange rate is higher than the spot exchange rate. Forward discount is the opposite of forwarding premium, it when the forward exchange rate is lower than the spot exchange rate. Forward premium or discount is normally expressed as an annualized percentage of the difference.
Interbank rate is the at which financial institutions to buy and sell foreign currencies. The interbank rate or interbank exchange rate is the current value of any currency as compared to any other currency. The interbank exchange rate is made out by taking the midpoint between the buying and selling currency rates on the open market. There are also generally different rates depending on whether you’re buying or selling a currency. The Buy or sell rate of a currency is known as Spot Rate. While providing the foreign exchange to customers, the banks keep a margin above the interbank rate, called as premium, and that is the margin the bank keeps above the interbank rate to cover its cost and make a profit.
The charges for availing loan may include initial Login fee, Processing fees, documentation charges, stamping, hypothecation & mortgage charges, affidavit and Notary fees etc.
Certain charges like Documentation Fee, Legal & valuation fees, affidavit and Notary fees are absolute figures. In contrast, Processing fee, stamping, hypothecation and mortgage fees are a percentage of the loan amount. Documentation, affidavit and notary fees put together ranges from Rs. 5,000 to Rs. 10,000 depending on the terms of lenders.
The processing fee ranges between 0.25% to 1.50% of the loan amount. Stamp duty, Hypothecation and mortgage charges are at actual, which is a fee charged by the State Govt on the lending and mortgaging the assets. This is limit-based funding, and borrower withdraws fund at his discretion. If the borrower’s average use of the fund is not above a certain minimum level of limit, the lender may charge a fee as a non-utilization charge.
Being working capital is a revolving facility; the limit needs to be renewed at the end of the sanctioned tenure, which is usually 12 months. Upon renewal, the lender charges a renewal fee, which is in the range of 0.10% to 0.25%. The borrower bears all these charges. The borrower either pays upfront or the same is deducted from the loan amount.
A working capital facility may have two kind of limit – running limit and one-time limit repayable over a specified period. The running limit carries periodic interest payment, and the repayable limit has an interest as well as principal repayment.
The interest due is charged to the account and same need to be paid by self-induced credit to the account within 7 days. For the repayable loan, repayment is made through NACH, ECS or SI. The lender set the repayment mode for each loan account to ensure automatic repayment on a specified date. If payment is not cleared through the set process, it is termed as default in payment.
The lender generally collects un-dated PDCs for security purpose and may present whenever EMI get bounced or to take legal steps to recover the outstanding loan.
Working Capital loan is based on a working capital gap, collateral value and requirement. There is no upper limit for this kind of facility. However, the fund-based working capital limit is restricted to 20% of the last reported Turn over-under Maximum Permissible Bank Finance (MPBF) guidelines.
Eligible entities can avail Working Capital limit up to Rs. 2 Crs without any collateral under CGTMSE scheme. Secured constant OD has preferred between Rs. 10 Lakhs to Rs. 3 Crs depending on policies framed by each lender.
Working Capital Finance is a business-centric product which caters to the working capital requirement of a business. It is very data-oriented and is guided by the calculation suggested by various committees set up by RBI from time to time. The calculation depends on two major theories – a working capital cycle in a year, and lender finances the difference between Working Capital Assets and Working Capital Liabilities.
Lenders abide by this concept and adopt various mechanism to estimate the Turn Over and the working capital gap. Few of the schemes which evolve from these are:
- Assessment method based on historical financial returns
- The average working capital gap from last 6 months data
- Turn over assessment based on monthly GST returns filed
- Assessment of expenses
- Assessment based on future projection and order book
WC facility is subject to renewal every 12M, and Top-up concept does not apply. Based on the business growth and requirement, the limit may be enhanced.
Foreclosure or Pre-payment is the process when one repays the loan before the loan tenure ends. Generally, foreclosure of loan comes with penal charges. Lenders specify the pre-payment or foreclosure charges in the Sanction Letter or Loan Facility Agreement.
However, according to BCSBI’s Code of Bank’s Commitment to Micro and Small Enterprises, 2015, any floating rate loans extended MSMEs are exempted from pre-payment charges. The relevant notification can be retrieved from http://www.bcsbi.org.in/Pdf/StatementOfChangesMadeIinMSECode2015.pdf. RBI through their Master Direction on MSME sector vides No RBI/FIDD/2017-2018/56 dated 24th July 2017 has emphasized on following BCSBI’s Code of Bank’s Commitment to Micro and Small Enterprises, 2015. Many lenders do not charge if the loan is closed from their fund.
A working capital loan is based on the working capital requirement of the business. Having multiple loans in business or personal capacity, do not affect the eligibility. However, the lender would be evaluating the endues of the loans in the business use and how effectively the business has used the fund for growth.
If borrower has sufficient funds, but not enough to pre close entire loan amount, then part payment option can be considered. Such payment brings down the EMIs and the total interest paid and to be paid. This is easy, but an effective way to save on the interest outgo during the tenure of the loan.
Working Capital is a revolving limit, part-payment concept and does not become applicable. If the borrower has an additional fund, he can park the same in the loan account and save interest cost. If a borrower wants to reduce the liability, he can apply the lender to reduce the limit.
Upon borrowing, the borrower creates the mortgage in favour of the lender and hand over the original documents to the lender. The lender has the responsibility of safekeeping the securities, documents, title deeds till the loan is fully repaid.
The borrower has always had a concern – how quickly one can get back once the loan is repaid and how safe the documents are with the lender. The Banking Codes & Standards Board of India (BCSBI) constituted by the RBI has recommended banks to put in place mechanisms to ensure that securities and title deeds of borrowers are adequately preserved. Also, banks are to return all securities, documents, title deeds within 15 days of the payment of all dues.
Banks and NBFCs store documents in strong rooms and non-basement storage places that could help against floods and fire. Nevertheless, on a safer side, we recommend all borrowers to keep a set of photocopies of all the documents submitted to the bank and a letter from the lender listing out the documents in their custody.
Another aspect of document safety is the copies of documents submitted may get misused by fraudsters. To protect from any fraudulent activity, it is advisable to scribe “Submitted to XYZ Bank for Loan Application” on each and every photocopy of a document submitted.”
ROI can change according to the quality of the collateral offered. Co-lateral which are self-occupied and residential, commands best of the interest rate. A let out a residential or commercial property as collateral may increase the rate of interest by 0.50% to 1% than self-occupied residential property as collateral. Liquid co-lateral like Fixed Deposits would enable the borrower for a rate linked to the fixed deposit and which is the lowest rate a borrower can get.
For any working Capital loan, primary securities are the working capital assets or current assets of the business and other assets are called secondary or collateral. Having two lines of security, working capital loans are extended up to 100% of collateral value and certain cases even way more than the value of the collateral. A loan which is eligible to be covered under CGTMSE scheme can be availed without any collateral.
Working Capital Finance is the facility given to the business. An NRI / OCI / PIO can be part of a business which is looking for working capital finance. There is no restriction on funding, such as businesses. However, lenders to insist on knowing the individuals who run the business on a day to day basis. For relatively smaller businesses, the lender insists on personal guarantee of the local management individuals.
Under working capital finance, each business is treated separately for assessment of fund requirement. Multiple businesses cannot be added to arrive at eligibility. However, multiple business borrowing working capital limit can leverage common co-laterals.
There may be a situation where business and collateral located in a different place. In such case, valuation and legal of the co-lateral is initiated in a place where the property is located, and Income document verification along with discussion happens at the borrower’s business place. The accounts are maintained at the location, where the business operates. One must choose a lender who has facility or operation at both the location to make the process easy.
Recent loans taken affect the creditability of the customer by decreasing credit score if there are multiple Enquiries but few disbursements. Recent loans in the sense that loans are taken in the last 6 months. It indicates that customer is credit hungry unless proper justification of the end-use of the recent loan is given. There is no restriction on the number of recent loans taken provided borrower (the business) is eligibility and customer has justified the purpose of the recent loans. If any long-term fund taken has been put to for working capital purpose, the lender may reduce the limit as such portion of working capital requirement has been sufficed by borrowing long term loan.
Businesses have established more than 3 years are considered stable, and business more than 5 years are most preferred by lenders. A business which is less than 3 years has to prove the growth prospect of the business and lender may ask for higher collateral.
Working Capital Finance is the facility given to a business. An individual can not avail such facility in the personal capacity. The usage of the fund also restricted for business use only.