There are many ways to finance a business, but bank loans are among the most common. Many entrepreneurs, looking for additional cash for investment purposes or current payments, choose a working capital loan. These, in turn, can be available in two forms. An overdraft working capital loan and a line of credit, or overdraft working capital loan. What is the difference between the two? Which one to opt for?
What is a working capital loan?
A working capitalloan is a product that allows you to finance the current needs of your business, regardless of the form in which it is conducted. This is because a working capital loan can be applied for by the self-employed, sole proprietors, civil partnerships, commercial companies like limited liability companies, joint stock companies, limited partnerships and any other type of business.
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A working capital loan allows you to settle accounts receivable, make investments, purchase goods, make payments for taxes, Social Security contributions and virtually all costs associated with running a business. Thanks to the bank’s provision of additional cash in the current account, i.e. the one into which receivables from contractors flow, the entrepreneur has constant access to funds, even when contractors are late with payments.
Working capital loans are usually granted on the basis of both the account turnover itself and the income or profits of the business. The amount of credit granted also depends on them. Additional funds can be applied for at virtually any time, and the interest rates on working capital loans are usually quite favorable.
In Polish banking, we can distinguish two types of working capital loans for companies, and these include an overdraft and an overdraft, or so-called line of credit. The two differ primarily in their purpose, as discussed below.
Overdraft working capital loan
An overdraft working capital loan, as we indicated earlier, can be used for practically any purpose related to business operations. When granting an overdraft working capital loan, the bank is not interested in whether the loan proceeds will be used for investment, current fees or even repayment of debts incurred with other companies. What is important is that the loan be used for business-related expenses.
A working capital overdraft allows an entrepreneur to manage the company’s finances with peace of mind and helps maintain liquidity, even in times of economic downturn or temporary payment bottlenecks.
The big advantage of an overdraft working capital loan is its relatively low cost. The bank, providing the company with a certain pool of funds, is quite sure that it will be repaid as the company’s account is credited again and again. This is because the working capital loan is repaid automatically as soon as the funds appear in the account. This significantly reduces the interest rate on the loan, since it is calculated on the basis of the limit used and the time the entrepreneur used it.
An overdraft can be compared to the popular revolving limit, which is often used by consumers. The bank provides funds that can be drawn on at any time, and the debt incurred is repaid spontaneously as soon as new funds are credited to the account.
Revolving credit in a credit account (line of credit).
The second type of working capital loans for companies is the so-called “line of credit”, or more precisely, a working capital loan in a credit account. It differs from a typical “revolving account” primarily in two respects. First, the funds are made available in a separate bank account (credit account), and second, they can only be used for the purpose specified in the agreement. Thus, it is the purest form of special-purpose loans.
Read also: What is a credit promise and does it guarantee the receipt of a loan?
Working capital loans in a credit account usually relate to investments that a company wants to make, and if the bank decides to open a line of credit, the funds will only be used for a given purpose. Noteworthy, working capital credit in credit account can also be granted for other purposes, but they must be specified in the contract. It is possible to receive a working capital credit in credit account also for the purpose of settling liabilities, replenishing cash in the company’s coffers or purchasing goods.
Another difference between a working capital overdraft and a working capital credit in credit account is also the method of repayment of the obligation. In the case of the latter form of business financing, the loan must be repaid either in installments or in a single amount according to the term specified in the agreement. A line of credit usually cannot be automatically renewed unless the agreement states otherwise.
It is also quite important that because the funds under the line of credit are made available in a separate bank account, the institution can easily verify what they were used for. In the case of working capital overdrafts, this is extremely difficult.
