Working Capital Loan vs Term Loan for Small Businesses
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For small businesses in India, choosing the right type of loan can directly impact cash flow, growth, and long-term stability. One of the most common dilemmas business owners face is deciding between a working capital loan and a term loan. While both are designed to support business needs, they serve very different purposes. At Saarathi.ai, we have observed that many MSMEs apply for the wrong loan type, leading to repayment stress or rejection. This guide clearly explains the difference between working capital loans and term loans for small businesses, when to use each, and how to choose the option that best fits your business goals in 2026.
What Is a Working Capital Loan?
A working capital loan is designed to manage day-to-day business expenses. It helps ensure smooth operations when cash inflows and outflows do not align.
These loans are commonly used to fund:
• Purchase of raw materials or inventory
• Payment of salaries and wages
• Rent, utility bills, and operational expenses
• Short-term cash flow gaps
Working capital loans focus more on cash flow and banking behaviour than long-term profitability.
What Is a Term Loan for Small Businesses?
A term loan is used for long-term business needs and growth initiatives. It is usually repaid over a fixed tenure through EMIs.
Term loans are typically used for:
• Business expansion
• Buying machinery or equipment
• Opening new branches or offices
• Technology upgrades
• Large one-time investments
Lenders evaluate business stability, profitability, and future growth while approving term loans.
Key Differences Between Working Capital Loan and Term Loan
Purpose of the Loan
The biggest difference lies in usage.
Working capital loans are meant for short-term operational needs.
Term loans are meant for long-term investments and growth.
Using a term loan for daily expenses or a working capital loan for expansion often leads to cash flow stress.
Loan Tenure
Working capital loans usually have shorter tenures.
Typical tenure:
• Working capital loan: 6 months to 24 months
• Term loan: 1 year to 5 years or more
Shorter tenure means faster repayment obligations for working capital loans.
Repayment Structure
Repayment structures differ significantly.
Working capital loans may offer:
• Monthly EMIs
• Interest-only payments
• Overdraft or cash credit limits
Term loans follow a fixed EMI structure, making them easier to plan for long-term repayment.
Interest Rates
Interest rates depend on risk, tenure, and loan structure.
In 2026, typical ranges are:
• Working capital loans: 11 percent to 24 percent per annum
• Term loans: 10 percent to 20 percent per annum
Working capital loans may appear costlier due to shorter tenure and flexible access.
Eligibility Criteria
Eligibility assessment varies.
Working capital loans focus on:
• Bank statement analysis
• Monthly turnover
• Cash flow consistency
• GST filings
Term loans focus on:
• Business vintage of 2 to 3 years
• Profitability and financial statements
• Credit score and repayment history
At Saarathi.ai, our AI-based eligibility check helps businesses understand which loan type they qualify for before applying.
Documentation Requirements
Both loans require documentation, but the focus differs.
Working capital loans usually require:
• Recent bank statements
• GST returns
• Basic KYC documents
Term loans often require:
• ITRs for last 2 to 3 years
• Balance sheet and P&L statements
• Business registration documents
Our paperless process on Saarathi.ai flags missing documents early to reduce delays.
Flexibility of Usage
Working capital loans are highly flexible, allowing repeated withdrawals within limits in some cases.
Term loans are less flexible, as the amount is disbursed once and used for a specific purpose.
Risk and Lender Preference
Working capital loans carry higher short-term risk, especially for seasonal businesses.
Term loans are considered more stable if the business shows consistent growth and income.
Different banks and NBFCs specialize in different loan types, which makes lender matching crucial.
Which Loan Is Better for Small Businesses?
Choose a Working Capital Loan If:
• Your business faces seasonal cash flow gaps
• You need funds for daily operations
• You have regular turnover but delayed payments
• You want flexible access to funds
Retailers, traders, manufacturers, and service businesses often benefit from working capital loans.
Choose a Term Loan If:
• You are planning business expansion
• You want to invest in machinery or infrastructure
• You need predictable EMIs
• You are building long-term assets
Growing MSMEs and established businesses usually prefer term loans.
Can Small Businesses Take Both Loans?
Yes, many small businesses use both types of loans simultaneously.
For example:
• A term loan for buying machinery
• A working capital loan for managing operational expenses
However, lenders assess overall repayment capacity, so over-leveraging can lead to rejection.
Common Mistakes Small Businesses Make
• Using term loans for routine expenses
• Taking short-tenure loans for long-term needs
• Ignoring cash flow planning
• Applying without checking eligibility
• Choosing lenders without comparing offers
At Saarathi.ai, we have seen that correct loan structuring significantly improves business stability.
How Saarathi.ai Helps You Choose the Right Business Loan
Feature | Working Capital | Business Term Loan |
Purpose | Covers short-term operational expenses (e.g., payroll, rent, inventory) | Funds long-term investments like equipment purchases, facility expansion, or new product launches |
Repayment Terms | Flexible and often revolving, allowing quick access to funds | Fixed repayment schedule with predictable monthly payments |
Interest Rates | Typically higher due to unsecured nature | Generally lower, benefiting from collateral security and structured repayment terms |
Collateral Requirements | Usually unsecured, making it accessible without significant assets | Often requires collateral or a personal guarantee, especially for larger loan amounts |
Risk Factors | Potential cash flow strain if frequently used; risk of accumulating debt | Possibility of asset loss if repayments aren’t met, given collateral obligations |
Approval Process | Faster approval, often with simpler documentation | More extensive review and documentation, resulting in longer processing times |
Saarathi.ai simplifies business loan decisions by offering:
• AI-driven assessment to identify the right loan type
• Access to 110+ banks and NBFCs in one marketplace
• Saarathi AI expert for instant guidance on eligibility and documents
• Saarathi Bazaar dashboard to compare interest rates, EMIs, and offers
• Transparent, paperless loan journey from application to disbursal
Our experience shows that businesses choosing the right loan type reduce financial stress and improve growth outcomes.
FAQs on Working Capital Loan vs Term Loan
Can a startup apply for a working capital loan?
Yes, some NBFCs offer working capital loans to young businesses with strong cash flow.
Is collateral required for these loans?
Many working capital and term loans are unsecured, but secured options may offer better rates.
Which loan is easier to get approved?
Working capital loans are often easier for businesses with strong cash flow but limited profits.
Can I convert a working capital loan into a term loan?
Some lenders allow restructuring, but it depends on policy and repayment history.
Which loan is cheaper in the long run?
Term loans usually cost less over time due to lower interest rates and longer tenure.
Conclusion
Choosing between a working capital loan and a term loan depends on what your business truly needs. Working capital loans keep your operations running smoothly, while term loans fuel long-term growth. Applying for the wrong type can strain cash flow and increase risk.
At Saarathi.ai, we help small businesses make informed borrowing decisions through AI-driven recommendations, expert support, and access to multiple lenders. Explore the right business loan option on Saarathi.ai today and build your business with confidence.
