7 Key Differences Between Term Loan and Working Capital Loan

Every business requires finance for smooth running. Funds are needed for routine business operations as well as for future expansion. To meet such requirements, both internal and external finance is required.

External finance comes in the form of a loan. You have to identify the type of requirement to take a loan because different loans serve different purposes. For smooth business operations, you can take a working capital loan. For business expansion, you can take a term loan. Let us understand the difference between the two.

A working capital loan is a short term loan availed for running the day-to-day expenses of the business. In short, it is taken to meet the working capital requirements of the business.

On the other hand, a term loan is a long term loan availed for expansion, purchase of capital assets, or to meet other capital expenses. Here are a few features of term loan and working capital loan to help us differentiate between the two.

1. Purpose of the loan

A working capital loan is taken to meet the working capital requirements of the business. It can be used for maintaining a healthy cash flow, purchasing inventory, and payment of overhead costs. One of the features of term loan is that it is taken to finance expansions, buying new assets, and meet capital expenses.

2. Repayment tenor

A working capital loan is a short-term loan with a short repayment period. It means that you can repay the loan amount as and when you receive payments. However, a term loan can be a short, medium or long term loan usually taken for one to ten years.

3. Documentation

A working capital loan requires less documentation as it is a short term loan. It can be availed with a good credit score and minimal paperwork. On the other hand, one of the features of a term loan requires a lot of procedure compliance. It is because it is a long term loan. Owing to its long term tenor, the lender checks specific parameters of the borrower thoroughly.

4. Interest rate

The interest rate on a working capital loan is high as it is an unsecured loan. Term loans usually come with a lower interest rate. It is as it is backed up with some financial security, though the difference is not much between the two.

5. Amount of loan

A working capital loan is taken for a small amount as it is only required to meet the daily operating cash flow of the business. But, a term loan involves availing a higher amount of loan to expand the business or purchase capital assets.

6. Collateral guarantee

A working capital loan may or may not require collateral, but term loans generally require collateral as it is a secured loan.

7. Loan types

A working capital loan comprises three types - Account Receivable Loan, Business Credit Line and Factoring or Advances.

A term loan is of three types – Short term loan, Intermediate-term loan and Long term loan. Looking at the features of term loan and working capital loan, you can assess the financial requirements of your business.

This way, you may apply for a loan accordingly for smooth business operations. Now that you know the difference between a term loan and a working capital loan, you can decide which credit facility you want to avail of based on your needs and budget.

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