Operating any business is never a walk in the park. Even with a star business idea, a loyal customer base, and a dedicated workforce, there will always be occasions when the cash feels tight. Payments are often late, and expenses always precede income. Salaries, rents, electricity bills, and payments to suppliers keep coming in, but customers can take weeks or months even to pay you for services rendered. Working capital is the big word that enters the picture here. 

In this blog, we will look into working capital in depth and will try to understand the what, how, and why of a working capital demand loan, along with its pros and cons, to hopefully bring you one step closer to seeing if a WCDL fits your business requirements. 

Introduction to Working Capital

The working capital is the difference between current assets, such as cash, accounts receivable, and inventory, and current liabilities, like accounts payable and short-term loans. It assesses the short-term liquidity and operational efficiency of a company.

In layman's terms, working capital funds are the amount of money a business requires to meet its day-to-day operations, such as paying salaries, buying raw materials, utility bills, and other operational expenses.

Several businesses, more so SMEs, find themselves in situations where working capital is not enough. During these times, a working capital demand loan can come in handy and provide financial support.

What is Working Capital Demand Loan? 

A Working Capital Demand Loan (WCDL) is a short-term loan provided by banks to meet a business’s day-to-day operational expenses. As the name suggests, it is repayable on demand by the lender, though usually sanctioned for a short fixed period. 

In essence, it is not supposed to be used for long-term investment or for the purchase of assets like land or machinery. It is only designed to serve as working capital to meet the company's day-to-day operations smoothly. It is like a lifeboat in the event of a temporary cash crunch; which supports the business until payments are realised from receivables or the revenues improve.

Features of a Working Capital Demand Loan

• Purpose: To meet short-term working capital requirements of businesses.
• Within the Assessed Limit: It is sanctioned within the working capital limits in general, assessed upon the borrower.
• Sub-limit Option: Can be availed under sub-limits of the funded working capital limit (cash credit/overdraft).
• Tenure: Usually available for a period of up to 12 months.
• Target Customer: This benchmark comes from RBI/IBA guidelines on WCDL eligibility for corporates. However, it’s not a universal rule across all banks. Some banks may extend WCDL to smaller corporates/SMEs too, but large exposures are the usual focus.
• Flexibility: It helps businesses take care of liquidity and sudden or seasonal requirements for funds.
• Repayment: It is usually repayable on demand, hence called a demand loan.
• Cost-effectiveness: Interest is charged only for the respective period and amount utilised, making it an ideal tool for short-term financing.

Eligibility for Working Capital Demand Loan

• Turnover Criteria: Corporations having a turnover of ₹500 Crores or above, annually. (However, it is not rigid. Some banks may allow slightly lower turnover corporates.)
• Credit Rating: Corporations have an AAA to A rating as far as the external rating goes. They must have a CIBIL score of 700 or above. 
• Leading Corporations Without Rating: Even large corporations that may not have credit ratings for their debt instruments but are well established, such as:
  • Central Public Sector Undertakings (PSUs): Maharatna, Navaratna, and Miniratna companies
  • Any other leading Corporations backed by government/strong business credentials.
• Minimum Exposure: In some cases, banks may take into account corporations having exposure (funded + non-funded) of ₹25 Crores or above.

On the whole, WCDL would mostly suit financially strong mid to large corporates having high turnover and good credit rating, or that are government-backed.

Why Do Businesses Need a Working Capital Demand Loan?

• Cash Flow Gaps: The payment deferrals from customers arrive late, while expenses are immediate- a working capital demand loan works in bridging the gap.
  • For example, a manufacturing unit may be shipping its goods today and receiving payment only after 60-90 days. Meanwhile, it needs to buy raw materials and pay wages. Working capital demand loan provides immediate liquidity to the business, allowing it to meet expenses while waiting for receivables.
• Seasonal Requirements: Seasonal spikes in business demands are common. For instance, a sweet shop during Diwali or a store for clothes during the festive season. A Working capital demand loan would act as a cushion for handling such temporary requirements.
  • For example, sweets during Diwali, clothes during festival sales, and ice creams during summer. By availing of a WCDL, a business can meet the short-term fund requirement and not have to shoulder long-term debt. The business needs to repay the loan once the season is over and the sales revenue starts coming in.
• Emergency Situations: Unexpected expenses such as equipment repairs, sudden market fluctuations, or supply chain disruptions can be managed with the help of a WCDL.
  • For example, a sudden breakdown of a machine in a factory or a rise in fuel costs affecting logistics. Being a short-term demand loan, a working capital demand loan acts like an emergency credit by which businesses can quickly draw funds whenever such an emergency arises.
• Business Continuity: Having a business demand loan ensures the payment of wages, supplies, and other obligatory operational expenses.
  • For example, client payment delays have made it impossible for the company to pluck out enough liquid cash to pay wages at the month-end. Working capital demand loan allows the business to honour its commitments and keep the company intact without downgrading morale or reputation.

Documents Required For Applying to Working Capital Demand Loan

• Duly filled Application Form with photographs of the parties to the agreement
• Bureau Consent Form
• KYC documents of borrowers and guarantors (self-attested)
• Partnership Deed(s), in case of a partnership firm
• The Latest Director list and shareholding pattern, in case of the company
• Income Tax Returns (ITR) for the last 3 years with computation of income, audited financials, and tax audit report (Form 3CA/3CB with Annexure 3CD)
• For liquid collateral-backed applications: Last 2 years' ITR
• Provisional Financials of the last financial year applicable from July onwards
• Month-wise sales and purchase data
• Filed GST sales returns
• Debtors age-wise report (party-wise as of date)
• Other Bank's Statements: New to Bank: Last 6 months bank statement of all accounts (for 3 months in case of liquid collateral).Existing to Bank: Last 6 months, if churn is below 80%.
• The latest sanction letter in takeover cases, along with the track record of the loan being taken over.
• Ledger of Debtors, Creditors, and Advances
• Income Tax Return of parties to the agreement for the last 2 years, with computation of income.
• Self-certified Net Worth Statement/Balance Sheet of Guarantors
• Schedules to Balance Sheet (list of Debtors, Creditors, Loans & Advances, etc.)
• Udyam Registration Certificate
• Charges for Title Search and Valuation Initiation (if applicable)

Risks Involved in a Working Capital Demand Loan

While WCDLs may be called for, they do raise certain risks:

• Sudden Repayment: The lender can ask for repayment anytime. Hence, the company must never allow funds to run dry.
• High Interest Rates: Working capital demand loans generally hold a higher rate of interest, typically ranging from 10%-24%, compared with secured term loans.
• Dependence: If businesses become addicted to Working capital demand loans, then their problems begin once the banks put a squeeze on the lending policies.

In Nutshell

Now that you have understood WCDL meaning, its features, and benefits, ensure to use it wisely in your business. Consider the risks associated with it, and most importantly, the scenario of sudden repayment.
My Mudra has a tie with several banks and financial institutions, offering instant working capital loans online. Speak to our team, and they will help you find a WCDL with the best interest rates possible.

Also Read:
- Types of Working Capital Loan: Which one does your Business need?
- Get Working Capital Loans for Small Business