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Difference Between Working Capital Loan and Term Loan

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Posted on
Nov 12, 2022
Working Capital Loan vs Term Loan

Introduction

Loans and businesses are strongly linked. Almost all firms need a loan to grow or keep things running smoothly. Firms with varying needs might pick from a variety of options. A firm must choose loans wisely to guarantee that its demands are met as quickly as possible. 

Working capital loans and term loans are two typical loan options for firms. You may pick a proper loan term based on your firm’s cash flow and liquidity needs. It all simply comes down to finance, whether it’s for corporate growth or meeting day-to-day tasks. Knowing everything about these loans allows you to make an informed choice.

Both loans provide helpful features and conditions to keep your firm’s tasks running smoothly. Business term loans are typically the best choice between these two, especially for high-risk projects. On the other hand, working capital loans are suitable if the firm needs nominal sums to cover operating expenses.

Also, since term loans are often larger, prompt repayment may significantly boost corporate credit. On the other hand, working capital loans do not provide such credit score boosts. In any event, the kind of financing chosen will be mainly determined by the form of capital demand.

What exactly is a working capital loan?

Working capital is a vital source of funding for firms. This loan is the cash you get right away to cover the day-to-day expenses of your firm. It is often needed when your firm must pay its monthly rent, pay its workers’ wages, or meet particular seasonal needs that have arisen at the last minute. The aid your business gets from external funders allows it to return to work.

A working capital loan is a type of working capital help that you may get. You should know that you cannot utilise the working capital loan to make new investments, launch new projects, or grow your existing firm. These are short-term liquid loans. These loans are typically granted for no more than a year.

What exactly is a term loan?

Term loans, as their name suggests, are loans that last for a more extended period, ranging from one to ten years. These loans are used when you need funding for bigger projects, growth prospects, or to buy new equipment or tools. They often include larger sums of cash than working capital loans, and as a result, they are paid off over a longer time.

As mentioned earlier, the interest rates on working capital loans are high. Yet, the interest rates on term loans continue to rise over time, so you end up paying more in interest on term loans than on working capital loans. You can access a business loan calculator, which may assist you in figuring out the entire payback, including interest and principal. Since this is a long-term loan, there is a lot of paperwork and processes. So, it’s not simple to get a term loan. 

Differences between working capital and term loans

The following are the distinctions between working capital and term loans:

Duration

Working capital loans have a short payback duration of a few months. Term loans, in contrast, might be short, middle, and long-term. These loans often last from one to ten years, although some might go up to 30 years.

Goal

Firms often use a working capital loan to cover an operating capital deficit or support ordinary company tasks, such as paying rent, wages, vendor fees, etc. On the other hand, term loans enable a firm to grow by buying a new plant, equipment, or other capital assets.

Instalments

As a term loan is a long-term debt, it is repaid in instalments. The repayment of the working capital loan is limited due to the modest quantity.

Paperwork

Working capital loans are simple, especially if the firm has a solid credit history. It also does not need much paperwork since it is a short-term loan. A term loan entails a large amount of paperwork and processes. Before granting or rejecting a loan request, lenders must thoroughly analyse the borrower’s creditworthiness, income reports, repayment capacity, and other factors.

Loan amount

Working capital loans are often modest in size since firms use them to cover a deficit in operational cash flow. A term loan involves considerable cash since a firm uses it for growth.

Working capital loan vs term loan

Measure Term Loan Working Capital Loan
Loan term Short-term/medium-term/long-term Short-term
Interest rate Low  High
Loan amount Higher worth Lower worth
Type of loan Collateralised secured loan Mainly unsecured
Loan tenure Usually, it is between one and ten years, but sometimes it may be longer. It usually runs from three to 14 months.
Paperwork/Processes Hard and complex Easy and simple
Loan payment A longer time frame Easily disbursed to bank accounts

Conclusion

A working capital loan is ideal if your firm only needs a small sum of money to pay day-to-day expenses. Furthermore, timely repayment of term loans may significantly boost firm credit because the approved sum is often relatively large. On the other hand, working capital loans do not improve credit scores. As a result, the financing you pick is based on the type of money you need.

You must identify the aim for which you seek a loan as well as the form of cash you wish to obtain. Once you’ve completed both, you may quickly apply for a loan via a reputable offline or online platform. 

The specifics of financing choices may differ from one banking firm to the next. Hence, before pursuing any loan choice, you should properly review the facts and benefits to maximise your advantages.

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