We all are very familiar with this term. Loans are useful when it comes to businesses. There are different types of loans available like home loans, gold loans, business loans, etc. One such type of loan is a working capital loan.
Banks take something from us as collateral and give us money in exchange for it. You have to return the money over a period of time with some amount of interest. This is how loans work.
These days, loans can be taken for all sorts of things. Not just for businesses and homes, but all kinds of purchases. In this generation, you can even buy small things like mobile phones and laptops with loans. That too with no interest at all.
In this article, we are going to talk about working capital loans. It is very helpful for people who have small businesses and want to make them bigger and more successful.
But before we dive into the concept of working capital loans, we first must know certain things about loans themselves.
Keep reading to know what loans are, what are its types, how they work and in the end, what a working capital loan is.
What is a loan?
A loan is when some money, property, or any type of material good is exchanged between two parties with an agreement of future repayment of the loaned amount with the decided interest.
The interest or interest rate is the amount of money or any other good that the lender of the loan charges the borrower.
Let’s take an example to understand these terms in detail. Let’s suppose you need some amount of money for some expense but you don’t have that much amount right now.
So you ask a friend of yours, to give you that amount of money and promise to pay him back in monthly installments. Your friend agrees to give you the money, but with each installment, he wants 2% of the total amount of money extra.
Thus, the amount of money that your friend gave to you is a loan. While the extra money that he is charging you every month is the interest. And the interest rate is 2%.
The above-given example is a type of unsecured loan. There are two broad categories of loans. Secured and Unsecured. Let us see what they are with some examples.
What are secured and unsecured loans?
Secured loan: A secured loan is a type of loan which is backed by some collateral. Collateral is some kind of financial asset that the borrower owns.
The purpose of collateral is to make sure that the borrower pays the loan back. If for some reason the borrower is not able to repay the loan in the given period, the collateral is seized by the lender as a way of repayment.
Some examples of secured loans are car loans, home loans, gold loans, etc. In these cases, the collateral will be the car, the house, or the gold of the borrower respectively.
Unsecured loan: An unsecured loan is the exact opposite of a secured loan. Yes, you guessed it right! Unlike a secured loan, it does not require any collateral.
Even though there is no collateral involved, interest is still charged on the amount of money that is given to the borrower as a loan.
Some examples of unsecured loans are credit cards, student loans, personal loans, etc.
Banks give both secured and unsecured loans to its customer. But have you ever wondered why? Why do banks risk such a huge amount of their money? Let’s find out.
Why do banks give loans?
A simple answer to this question would be to earn money. Just like other businesses, providing banking services is also a type of business. Hence, banks also look for ways to get maximum profits for themselves. And providing loans is one of those ways.
While providing loans, banks charge such interest rates that the amount of profit they get from it easily counteracts the risk they take in giving the money.
In business loans, a huge amount of money is taken as a loan and hence the interest rate is also high. Thus, interest is the best way for banks to earn money!
Not just this, providing loans also leads to the economic growth of that region. When more and more banks start providing loans, more businesses can take loans and grow themselves. Thus, more entrepreneurs get motivated and have support to establish their businesses.
Thus, the system of loans helps the banks, businessmen, entrepreneurs, and common people as well.
Now you have read everything about loans in detail. How do they work, what’s their use, and what types of loans? So let’s look at the specific type of Working capital loan, which we discussed at the beginning of the article.
What is a working capital loan?
In simple words, a working capital loan is a type of unsecured loan given to businesses to fund their day-to-day necessities like paying the daily wages of some employers or workers and other payments like electricity bills of their factories and more.
This type of loan is especially useful to people who have seasonal businesses. People with seasonal businesses do not have a regular flow of capital throughout the year. So, in their off-seasons, they can use the loan money to fulfill their business needs.
For example, if you own a winter clothing brand, you won’t be having huge sales during the summer season. Hence, this is a type of seasonal business. So, to keep your brand going, you will need some capital in the summer season as well.
Since you can’t hire new employees each winter season, you will have to pay your current employees to make sure they don’t leave their jobs. So here you will take the help of working capital loans.
Thus, in situations like these, small businesses and start-ups can take the help of working capital loan and survive.
This is all about working capital loans. If you are curious and want to read more about them, you are free to Google your way through!