Types of Working Capital Loan: Which one does your Business need?

Running a business is a difficult task with many unforeseen challenges that may cause a financial strain on the day-to-day working of a business. In this case, applying for a business capital loan may be the way to go. Let us take a look at the types of working capital loans offered so you can decide the best one according to your needs

What are Capital Loans?

Capital loans are a short-term loan offered by a bank when a business is unable to cover day-to-day costs, allowing the business to bridge the gap until the end of a financial quarter.

A business may use this to cover a number of issues, such as:

• Salaries and Wages
• Rent Payments
• Utility Payments
• Inventory purchases
• Equipment payments
• Operational emergencies

These loans are short-term loans and are therefore not suitable for large purchases or for expanding a business.

Types of Working Capital Loans

There are a number of types of working capital loans. Below are the most common ones:

1. Term Loan (Short-Term Loan)

It is a lump sum disbursal of funds by the banks which allows for instant relief and has predictable EMIs, but is less ideal if your cash needs fluctuate.

2. Overdraft Facility

This type of working capital loan allows you to withdraw an amount that is greater than the cash that you hold.

It is ideal for salary obligations during cash-flow gaps and only requires interest on the overdrawn amount, not the total sum of cash, but it requires collateral, and you need good relations with the bank to avail this offering.

3. Cash Credit Facility

This bank offering works similarly to the overdraft facility, with the distinction that the loaned amount is secured against the business’s inventory.

It allows for a flexible line of credit but requires regular documentation and collateral.

4. Invoice Discounting

The bank offers a line of credit on the basis that the money be paid back through the unrealized invoices and is ideal for businesses who need immediate cash but do not have any inventory to offer up as collateral, but the fees can be high and might even be exclusive to businesses with an established client base only.

5. Line of Credit

It can be looked at as a perpetual loan that is offered by the bank to a business to use as they see fit. The difference is that only the amount disbursed by the company has interest applied to it.

6. Trade Credit

A trade credit is offered to wholesalers and retailers who need the potential sales revenue to repay the cost of the materials that are sold in their shops.

The loaned materials do not have an interest rate applied to their value but are only available to established wholesalers and retailers.

7. Merchant Cash Advance

It is a loan provided in exchange for a percentage of daily sales. The approval rates are high as the repayment aligns with the revenue but this method has very high interest rates.

Choosing between these numerous options might be overwhelming, but it all comes down to the type of business you run.

How to Choose the Right Type of Working Capital Loan for Your Business

Choosing the right type of working capital loan might be a difficult task but it helps to keep these points in mind:

1. Nature of Business

If the business is seasonal, a short-term loan or overdraft will be most apt.

If the business provides service or is service-oriented, an invoice financing option will be the better fit.

A retailer or an e-commerce owner may find themselves more inclined towards a merchant cash advance due to the sales-linked nature of their business.

2. Cash Flow Consistency

If your business has an unpredictable returns or revenue pattern, opt for a line of credit or an overdraft form of capital loan.

If your capital loan is stable but slow, a fixed-term capital loan may be the right fit for you.

3. Collateral Availability

Secured loans like Cash Credit and Overdraft may offer better interest rates but require property or inventory as security.

Unsecured loans or merchant advances are better for newer businesses but come at higher interest costs.

4. Loan Amount and Duration

For small amounts (under 15 lakhs), digital NBFCs are better as they offer fast disbursals.

For larger amounts, banks like HDFC and ICICI offer better options such as Cash Credit and Overdrafts.

5. Cost of Capital

Whether you obtain a capital loan from a bank or an NBFC, make sure that you look at the processing fee, interest rates, penalties, and annualized cost.

Steps to Avail Capital Loan

• Analyze your business to figure out the amount you will loan.
• Check the eligibility criteria of the loan you want to avail
• Compare and choose lenders and the loan type
• Prepare required documents such as PAN and Aadhar Card, Bank statements, and IT and GST returns.
• Submit a loan application online or in person
• Wait for Verification and approval
• Once the Loan agreement is signed, wait for the disbursed amount to be credited to your account.

In the end, a working capital loan is a major financial undertaking for any business and needs the complete focus of the borrowing party so that they do not make crucial mistakes in the loan process. Also, gathering and presenting the different working loan options might be a long and difficult process, which may cause mistakes. In this case, employing one of the top fintech companies in India would be beneficial to the borrowing party.

Also Read:
- Importance of Working Capital Loan for MSME in 2025
- What are Short-Term Working Capital Loans?