Working capital loans

What working capital finance is for

A profitable business can still run out of cash, and most that fail do so for exactly that reason. The gap opens because money leaves before it arrives. You buy raw material today, convert it over three weeks, deliver, and then wait sixty days for the customer to pay. Your supplier, meanwhile, gave you thirty days. For that stretch you are funding somebody else's business with your own money.

The length of that stretch is the working capital cycle: days of inventory, plus days of receivables, minus days of credit your suppliers extend. A business with forty-five days of stock, sixty days of receivables and thirty days of payables is running a seventy-five day cycle. Every rupee of growth widens the hole, which is why fast-growing companies so often feel poorer than stagnant ones.

Working capital finance exists to bridge that gap. It is not growth capital and it is not for buying machinery — that is a term loan, repaid from profits over years. Working capital is short-term money that turns over continuously with your trading cycle, and the single most common mistake in Indian SME borrowing is funding a long-term asset with a short-term facility and then finding the limit permanently drawn.

Drawing power: the number that governs everything

A sanction letter for a one-crore cash credit limit does not mean one crore is available. What you may actually draw is the drawing power, recalculated every month from the stock and book debt statement you submit.

The arithmetic is consistent across lenders even where the percentages differ. Take paid stock — inventory you actually own, with anything bought on unpaid credit excluded. Add eligible book debts, usually only those under ninety days, because older receivables are treated as doubtful. Subtract creditors for goods. Then apply the margin the lender stipulates, commonly twenty-five percent on stock and forty percent or so on debtors. The result is your drawing power, and you may draw the lower of that and the sanctioned limit.

Two consequences follow, and they surprise borrowers constantly. First, a late or sloppy stock statement directly reduces what you can draw, and most banks levy a penal rate on any excess. Second, letting receivables age past ninety days does not merely delay your cash — it removes those invoices from the calculation entirely, shrinking your limit at precisely the point you need it most. Collections discipline is a financing decision, not just an accounting one.

How banks size the limit

Lenders in India assess working capital requirement through a small number of established methods. Knowing which one applies to you tells you what to expect before you ask.

The turnover method

Used for smaller limits, following the Nayak Committee framework. Working capital requirement is taken at twenty-five percent of projected annual turnover, of which the borrower contributes five percent as margin and the bank funds twenty percent. On a projected turnover of five crore, that indicates a bank limit of around one crore. It is simple, it is what most small units meet first, and it rewards realistic turnover projections — inflate the number and the bank's own verification will find it.

Maximum permissible bank finance

For larger exposures, banks work from the Tandon Committee methods. Under the first, permissible finance is seventy-five percent of the working capital gap, where the gap is current assets minus current liabilities other than bank borrowing. Under the second, more commonly applied, the borrower must fund twenty-five percent of current assets from long-term sources, so permissible finance is current assets, less that twenty-five percent margin, less other current liabilities. The second method demands more promoter contribution and is the stricter of the two.

Cash budget method

For seasonal or project-driven businesses, where an annual average is meaningless. The limit is set from month-by-month projected inflows and outflows, sized to the peak deficit. Construction, agro-processing and anything with a festival-driven cycle is usually assessed this way.

Whichever method applies, the working paper the bank builds it on is the CMA data — credit monitoring arrangement statements covering the last two or three audited years, the current year's estimate and the next year's projection, with the ratio analysis and fund flow the bank uses to test whether your projections hold together. Our business loan analyzer builds the same assessment from your figures and exports bank-format CMA data, which is a reasonable way to see how your file reads before a lender sees it.

Security, margin and guarantees

A cash credit facility is secured primarily by hypothecation of the current assets it funds — the stock and receivables themselves. That is the primary security and it is what drawing power is calculated against.

Most lenders also ask for collateral: property, fixed deposits or other assets, typically covering some meaningful proportion of the limit. The coverage demanded moves with the borrower's profile, the tenure of the relationship and the perceived risk of the sector. Personal guarantees from promoters and directors are close to standard for private limited companies, which means the liability does not stop at the company's door.

For MSMEs without adequate collateral, the CGTMSE credit guarantee scheme allows a lender to extend collateral-free facilities under a trust guarantee, with a guarantee fee charged to the borrower. It is worth asking about explicitly, because banks do not always volunteer it, and it is often the difference between a sanction and a decline for a young manufacturing unit.

What it costs

Floating-rate working capital facilities for MSEs are linked to an external benchmark, in practice the repo rate, under the external benchmark lending rate framework. Your effective rate is that benchmark plus a spread reflecting your credit rating, security cover and relationship. The spread is where negotiation actually happens; the benchmark is not negotiable and moves with policy.

Beyond interest, price the following, because together they often matter more than a small difference in rate:

• Processing fee at sanction and again at each annual renewal.
• Renewal and review charges, plus inspection charges for stock audits.
• Commitment charge on the unutilised portion of the limit in some sanctions — a reason not to take a larger limit than you will use.
• Penal interest on drawings above drawing power or on delayed stock statements.
• Valuation, legal and documentation charges where collateral is involved.
• CGTMSE guarantee fee where the scheme is used.

You can model the true cost of a facility with our loan calculators. If you are weighing a drop-line overdraft against a conventional structure, the DLOD calculator compares the two side by side over the full tenure.

Why applications get declined

Most rejections are not close calls. They come from a small set of recurring problems, nearly all of which are visible in the file before it is submitted.

• Inward cheque returns. Bounced cheques in the bank statement are read as a liquidity signal and weigh more heavily than almost anything else. A handful over twelve months can sink an otherwise sound file.
• Turnover that does not reconcile between GST returns, the audited financials and the bank credit summation. Lenders check all three against each other as a matter of routine.
• Current account conduct — balances consistently near zero, frequent excess drawings on an existing limit, or a large share of credits from a single counterparty.
• Diverted short-term funds. A cash credit limit permanently drawn to the ceiling, with the money visibly sitting in fixed assets or promoter withdrawals rather than turning over.
• Credit bureau history of the entity and of promoters personally. Overdue balances on unrelated personal facilities routinely stall business sanctions.
• Projections without basis. A projected doubling of turnover with no order book, capacity expansion or stated reason invites scrutiny of the whole file.
• Stale receivables. A debtor ageing dominated by balances beyond ninety days signals collection weakness and shrinks the eligible base.

The constructive reading of that list is that most of it is fixable with six months of deliberate effort before you apply — route turnover through the account you intend to borrow from, stop cheque returns, chase ageing debtors, and reconcile your filings.

How Rytvae helps

We work with business owners around Bengaluru to structure the facility against the actual cash cycle rather than a round number, prepare the CMA data and supporting file, and place it with lenders through our distribution partners. Before you approach anyone, the business loan analyzer will show eligibility, ratios and red flags from your own figures, and the credit risk assessment tool runs a fuller appraisal against RBI frameworks. For related facilities see unsecured business loans and loan against property.

Frequently asked questions