Term loan or working capital? Matching the facility to the need

Ask ten business owners what kind of loan they need and a good number will simply say 'a business loan' without distinguishing between a term loan and a working capital facility. The distinction matters more than it sounds, because the two are structured around fundamentally different questions, assessed using different arithmetic, and repaid in completely different ways. Getting this wrong at the application stage is one of the more common, and more avoidable, reasons a proposal takes longer than it should.

What each facility is actually for

A term loan funds something with a defined life and a defined cost — a machine, a building, a vehicle, a one-time expansion. The loan amount is tied to that specific cost, and the repayment schedule is built around the useful life of the asset and the cash flow it is expected to generate. A working capital facility, on the other hand, funds the ongoing operating cycle of the business — the gap between paying suppliers and collecting from customers, the raw material and stock sitting on the shop floor, the receivables outstanding at any point in time. It is not tied to one purchase; it revolves with the business's day-to-day trading.

How each is assessed

A term loan is assessed largely on the project or asset itself: its cost, the means of finance (how much is debt versus promoter equity), the cash flow the asset is expected to generate, and whether that cash flow comfortably covers the repayment instalments — commonly checked through a debt service coverage ratio. Working capital, by contrast, is assessed on the operating cycle: how long stock sits before it is sold, how long debtors take to pay, how long the business itself takes to pay its own suppliers, and what gap that leaves that needs to be funded. Banks commonly arrive at an assessed working capital limit using methods built around this operating cycle, rather than around any single asset.

The repayment difference that trips people up

This is where the confusion most often causes real problems. A term loan is repaid on a fixed schedule regardless of how the business's cash position looks in any given month — miss enough instalments and the account starts moving toward stress classification. A working capital facility like cash credit or an overdraft, by contrast, is meant to fluctuate: drawn up when stock and debtors are high, paid down when collections come in, as long as the outstanding stays within the sanctioned limit and the account is used for genuine trade purposes. Businesses that use a term loan disbursement to plug a working capital gap, or that treat their cash credit account like a term loan by drawing it fully and never letting it revolve, often end up with a facility that does not match how their cash actually moves.

A worked comparison

Questions to ask yourself before you approach a lender

• Is the money for something I will own and use for years (asset, building, machinery) or for stock and receivables that turn over repeatedly?
• Does the need recur every trading cycle, or is it a one-time cost?
• Can I identify a specific repayment source — cash flow from the asset itself — or is repayment simply 'from the business generally'?
• Do I need the full amount on day one, or do I need the ability to draw and repay repeatedly as stock and collections move?

When a blended structure makes sense

Many growing businesses genuinely need both at the same time — a term loan for expansion and an enhanced working capital limit to fund the higher trading volumes that expansion will bring. That is a normal and common structure. The point is not to avoid combining them, but to have each component sized and assessed against its own logic rather than asking for one undifferentiated number and letting the lender guess at the split.

Moratorium and other structuring flexibility

Term loans for projects that take time to become cash-generating — a new plant that needs to be built and commissioned before it produces revenue — often include a moratorium period, where only interest (or nothing) is paid until the asset is operational. This is a structuring feature worth discussing explicitly with the lender if your project has a gestation period, rather than assuming a standard repayment schedule starting from disbursement is the only option. Whether a moratorium, a step-up schedule, or any other structuring feature is available depends entirely on the lender's policy and the specific proposal — it is not something that can be assumed or taken for granted in advance.

How security typically differs between the two

The two facilities are also usually secured differently, and understanding this helps explain why lenders treat them as separate exercises rather than interchangeable pools of money. A term loan is commonly secured primarily by the asset it funded — the machine, the building, the vehicle — sometimes backed by additional collateral security if the asset alone does not fully cover the exposure. A working capital facility is typically secured by a hypothecation charge over the stock and receivables it is funding, which by their nature change in value every month, so the security itself is monitored on a rolling basis through stock statements rather than fixed once at disbursement.

This has a practical consequence for seasonal businesses in particular. A business that builds up stock ahead of a festive season, or a harvest-linked trading cycle, needs a working capital limit that can expand and contract with that seasonality — which is exactly what a revolving cash credit or overdraft facility is designed to do, provided the sanctioned limit is set high enough to cover the peak, not just the average, requirement. Trying to fund a seasonal peak through a term loan, which disburses once and repays on a fixed schedule regardless of the season, is usually a poor fit and can leave the business either short of funds at the peak or carrying unnecessary debt in the off-season.