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Working Capital Demand Loan v/s Term Loan: All That You Need to Know?

Published on 25 Apr, 2024
Author CredAble Team

Banks and other financial institutions offer a wide range of loan options to their customers. The loan products can also be customised as per the requirements of the customers.

For businesses, the need for finance is a constant necessity. From traditional bank loans to alternative options, businesses have several avenues to secure the necessary funds for their operations and growth. From the array of loan options MSMEs can now leverage two of the most popular ones which include term loan and working capital demand loan.

In this blog, we will outline the detailed difference between demand loans and term loans to help you make the right choice.

What are Term Loans?

Term Loans are financing sources for small businesses which extend over a period of 1 to 10 years. These loans are long-term and taken by borrowers for which the schedule and interest rates are fixed by the lender and the borrower when the loan is disbursed. However, these loans are dependent on the financial health and creditworthiness of the borrowers.

What are Working Capital Demand Loans?

Working Capital Demand Loans are short-term debt instruments that meet their immediate cash requirements in order to run their daily operations smoothly. Demand Loans are especially useful for start-ups as they help them overcome their short-term financing challenges. These loans offer businesses flexibility to maintain their liquidity without tying up revenue generated by them.

The repayment tenure for these loans may be from any time after a week of disbursement of the loan upto a year.

What are the Benefits of Working Capital Demand Loans?

Demand loans have several benefits as they have a significant impact on MSMEs leveraging them, including:

1. Flexible funding: the funding structure is flexible for small businesses to meet their short-term cash flow requirements.

2. Flexible repayment schedules: MSMEs can easily access credit facilities at competitive interest rates and mutually set a repayment schedule which suits both the borrower and the lender.

3. Repay-as-you-use: the interest rates charged and the repayment amount for demand loans is dependent on the amount that is actually used by them instead of the entire amount sanctioned for them by the lender.

4. Minimal requirements: minimal documentation and eligibility is required by banks and other financial institutions for these loans.

5. Minimal terms & conditions: there are no restrictions involved with regard to the end-usage of these loans.

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Why are the Majority of MSMEs in Need for Short-term Demand Loans?

Small businesses often face periods of lower sales or large numbers of unpaid receivables which leads to the disruption of their liquidity. Working Capital Demand Loans are very effective short-term debt instruments for businesses facing a temporary cash crunch.

Working capital demand loans are ideal for replenishing a company’s funds for short periods of time and filling the cash flow gap between the inflow and payout periods.

For businesses with cyclical operations, the demand for products generally rises during specific periods and then reaches a steady or dormant state. Demand loans help these businesses meet all their financial requirements between the lean and peak seasons.

These loans do not have any effect on the borrower’s equity and the company has complete control over how the loan amount is spent.

Why Demand Loans are a preferred choice over Term Loans?

Besides working capital demand loans, banks and other financial institutions provide MSMEs with multiple working capital solutions, several businesses avail term loans. Working capital term loans are long-term business loans with a repayment tenure of 1 to 10 years. Businesses opt for this method of financing when they require funds to fulfil any business-related expenditures. Majority of these business loans are taken by business owners to fund capital expenses such as business expansion, asset purchase, upgradation of equipment, etc.

While working capital term loans have longer repayment terms, MSMEs will not have immediate access to finance. Due to the mandatory collateral requirement for term loans, the documentation and eligibility requirements are much more extensive than for demand loans, making the disbursement time for these loans much longer.

Demand loans are better than Term Loans for MSMEs since they meet their short-term working capital requirements to cover their day-to-day operational costs.

Demand loans are ideal to meet the needs of MSMEs looking to raise capital for their startup businesses to purchase materials from their suppliers, pay salaries, rent, etc.

MSMEs find demand loans especially advantageous since interest on the loan is only charged on the amount that is withdrawn from the account by the borrower and not the entire sanctioned amount. The repayment tenure is usually dependent on the lender, however, repayment for the loan may only take place after a period of 7 days and generally does not exceed 12 months.

Customers can use the capital acquired from the demand loan to meet several of their financial obligations. Banks can differentiate a demand loan’s components over differing maturity periods which are completely dependent on the borrower’s requirements.

Difference between Demand Loans and Term Loans

Demand LoansTerm Loans
Loan AmountThe loan amount sanctioned by lending institutions is usually smaller. Term loans offer relatively higher loan amounts.
Loan TypeDemand loans cater to the short-term working capital requirements of the borrowers. These are long term loans.
Repayment TenureThese loans do not exceed more than 12 months and have shorter repayment periods.Term Loans may be repaid from 1 to 10 years depending on the repayment tenure agreed upon by both the parties.
CollateralDemand loans do not have any requirement for collateral.Borrowers are required to pledge security in the form of collateral.
Rate of InterestBeing unsecured loans, lenders charge higher interest rates.Since term loans use collateral as security, the rate of interest charged by the lender is much lower.
PurposeThese are secured to cover the working capital requirements of any business entity.Borrowers avail of term loans to finance expansion, purchase new assets, or to cover business expenses.
Eligibility CriteriaTo acquire demand loans, the borrowers do not require paperwork. For the approval of Term Loans, businesses require extensive paperwork and procedure compliance.
Credit ScoreDemand loans have no impact on the borrowers and their credit scores.Term loans improve borrower’s credit scores.

In conclusion, working capital demand loans emerge as a lifeline for MSMEs, offering vital flexibility and immediate financial support for their operational needs. With minimal documentation and no collateral requirements, they prove advantageous over term loans, particularly for short-term cash flow management. MSMEs benefit from quick disbursement, tailored repayment options, and the ability to utilize funds without restrictions.

These loans sustain business continuity during lean periods, ensuring smooth operations and growth potential. As the backbone of many economies, MSMEs find in demand loans a reliable partner in navigating the dynamic landscape of business finance, fostering resilience and agility in their operations.

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