As a business grows and establishes itself, a time may come when additional finance is required. MSME loan schemes give this financial assistance to small or medium-scale enterprises. But there are two types of MSME loan schemes- term loans and working capital loans. The MSME interest rates are different for these two types of loans along with some other basic differences. Entrepreneurs must understand the differences between term loans and working capital loans to choose a plan that best suits their business requirements.
Working capital loans under the MSME loan scheme
MSME loan schemes give working capital loans on a short-term basis. The basic aim of these loans is to inject cash flow into the business to keep up with regular expenditures like rent, electricity, or the salary of employees. These loans are just extra support for a business during some unforeseen difficulties. Once the business again reaches a normal rhythm, the loan can be repaid and the business returns to its usual independent inflow and outflow of finance.
These working capital loans are quite easy to get sanctioned. The only criterion is timely repayment. This means that a business that has taken out a working capital loan and repaid it on time can easily get the sanction for another working capital loan at another time it may need it. Some businesses take regular working capital loans as part of their business strategy. If a business maintains its credit score, approval for working capital loans is never a problem in the MSME sector.
But MSME scheme loans of the working capital type cannot be used for business expansion or new large investments in the business. It is a short-term loan only to tide over the regular expenses of the business. These loans are usually approved for a period of one to twelve months at most. The loan has to be repaid within this short time frame.
Uses of working capital loans
- Working capital loans are a huge boon for businesses that conduct most of their operations seasonally. Working capital loans help the business continue its basic functions during the lull period. The business can then repay the loan during the seasonal boom.
- Another common problem that entrepreneurs face in the MSME sector is the pressure from vendors to make timely payments even when the business is facing a financial crunch. In these situations, working capital loans under the MSME loan scheme can help clear the dues for vendors.
- The most common usage for working capital loans is to stock up on extra inventory. Entrepreneurs can use the extra finance from working capital loans to buy supplies, office equipment, computers, and other essentials.
Term loans under MSME loan schemes
Term loans are high-value loans to make big investments like the expansion of the business or buying new machinery. Because the amount loaned out is large, these loans also require a longer period to pay them off, usually a few years. Term loans are generally approved to make all big business purchases that cannot be sold off for cash within a year. The money borrowed as a term loan can be used basically for almost all purposes by a business to improve itself.
MSME loan interest rates are usually kept low, but in the case of term loans, the rate is higher compared to working capital loans. Business term loans are approved for a longer period, so the MSME loan interest rate for them keeps going up every year.
But because of the larger financial commitment associated with term loans, these loans are harder to get approved. The financing organization conducts an in-depth analysis of the applicant’s credit score and borrowing history before approving their loan request. The applicant’s loan request can be approved or denied based on this data. The business’s bank statements are studied to give an idea about the applicant’s ability to repay the loan. The market reputation of the enterprise is also considered to understand its future potential and creditworthiness. Depending on the loan amount, collateral may also be asked for sanction of the loan amount.
Uses of business term loans
- Term loans are essential for businesses looking to give themselves a major upgrade. Businesses can overhaul their machinery or buy all new equipment for their facilities. Service-based industries can invest in technological upgradations.
- Another important usage for term loans can be to improve the manpower assets of a business. Entrepreneurs can hire new employees and train them without worry about the immediate inflow of income to pay their salaries. The term loan will also buy time for the business so that newly acquired employees have time to acclimatize themselves before having to produce concrete financial results.
- Besides improving the technical and manpower assets of a business, term loans can also be used for other large-scale business improvements. Businesses can upgrade their website or hold marketing campaigns to promote their product or service.
- Term loans can also be used by businesses to pay off any smaller debt they may have accrued.
The MSME sector makes up 40% of India’s output. Government schemes, as well as financial institutions, constantly come up with plans to vitalize this sector of the economy. MSME loan schemes are important for small and medium scale businesses to survive and compete in the 21st-century fast-moving economy. MSME loan interest rates are also kept low to make it manageable for businesses and to encourage more and more entrepreneurs to develop their ideas into successful enterprises. There are many credit options available for business owners to sustain and supplement their income. The only important factor is for them to be aware of the different loan types available to them and choose their correct fit. Working capital loans are small loans for short terms while business term loans are higher values for the long term. The size and type of business determine which of these options will be suitable for them.