There are so many types of working capital financing available in the market such as cash credit/bank overdraft, trade credit, purchase of bills/discount of bills, working capital loan, bank guarantee, invoice factoring, and letter of credit.
Working capital financing program outlines a major part of the daily activities of a finance manager. This activity is very important and requires attention because working capital maintains the daily business operations smooth. Without appropriate working capital financing, a small business can also get into difficulties. Inadequate working capital can also result into nonpayment of certain dues on time. Improper type of funding would cause loss of interest which directly hits the profits of the business.
Here are the 7 types of working capital financing;
Cash Credit/Bank Overdraft
These are valuable and appropriate forms of working capital financing that are mainly used by both small and large businesses. These cash facilities are provided by the commercial banks by which the borrower is approved a specific amount of cash that he can use for making business payments. Additionally in this setting, the borrower has to make certain that he does not cross the approved limit. The good thing is that the rate of interest is charged to the level the cash is used and not at the approved amount which encourages him to keep depositing the amount when possible to save on interest rate. Truly, this is valuable working capital financing.
This is a type of working capital financing that is extended by the present or potential supplier of a business. Trade credit is offered to businesses based on their creditworthiness, which is revealed by its profit records, liquidity situation and payment records. As other funding programs, trade credit also comes with some specific requirements and costs. The supplier will also thoroughly evaluate your business credit history before offering you money.
Purchase/Discount of Bills
For a small business, it is another good type of working capital financing provided by the commercial banks. Every business generates bills in their normal routine while selling products or services to debtors. In the end, that bill works as a document to get payment from the debtor. And if the seller needs cash, he will go directly to the bank with that bill and the bank will apply discount on the whole amount of the bill primarily based on the existing interest and pay the outstanding amount to the seller. The bank will collect the money on the maturity date of that bill.
Working Capital Loans
Working capital loans are used by small businesses to finance their day by day operations or raise their cash flow. Working capital loans are as good as term loans for a short duration. During financial difficulties, a small business can get help from this loan to pay for salaries, mortgages, rent and other expenses. You can also get this loan for financing your business permanent working capital requirements.
This is a non-fund based working capital financing. Bank guarantee is acquired by the client or seller to decrease the risk of loss to the other party due to non- performance of agreed undertaking which may be paying back the money or offering some services and so on. A bank guarantee is repealed by the holder only in case of non-performance by other party. Bank will charge some commission and may also ask for some security.
Invoice factoring is an arrangement in which a business sells all or some of the accounts payables to a third party at a value lower than the original value of those accounts. The third party in this setting is called the factor that offers factoring services to business. The factor provides financing by purchasing the bills and additionally collects the amount from the debtors. There are two types of factoring, recourse and nonrecourse.
Letter of Credit
This form is also known as non-fund based working capital financing. There is a little difference between letter of credit and bank guarantee. So, a buyer would purchase a letter of credit and send it to the seller. As soon as the seller sends the products according to the agreement, the bank would pay the amount to the seller and collects that cash from the buyer.