What is a revolving credit facility?
A revolving credit facility is a form of credit issued by a financial institution that offers the borrower the option of withdrawing or withdrawing, repaying and withdrawing again. A revolving loan is considered a flexible financing tool because of its repayment and re-borrowing of housing. It is not considered to be a term loan because, for an allotted period of time, the facility allows the borrower to repay the loan or take it out again. In contrast, a term loan provides a borrower with funds followed by a fixed payment schedule.
Key points to remember
- A revolving credit facility provides loans to borrowers with great flexibility in terms of repayment and re-borrowing.
- The interest rate on a revolving credit facility is generally that of a variable line of credit, rather than a fixed rate.
- A revolving loan or line of credit allows a business to borrow money as needed to fund working capital needs and ongoing transactions such as payroll and debt.
How a revolving credit facility works
A revolving credit facility is generally a variable line of credit used by public and private businesses. The line is variable because the interest rate on the line of credit can fluctuate. In other words, if interest rates rise in the credit markets, a bank could increase the rate on a variable rate loan. The rate is often higher than the rates charged on other loans and varies depending on the prime rate or some other market indicator. The financial institution usually charges a fee for extending the loan.
The criteria for loan approval depend on the stage, size and industry of the business. The financial institution typically examines the company’s financial statements, including the income statement, cash flow statement, and balance sheet to decide whether the company can repay debt. The chances of the loan being approved increase if a business can demonstrate stable income, strong cash reserves, and a good credit rating. The balance of a revolving credit facility can vary between zero and the maximum approved value.
How do businesses use a revolving credit facility?
A revolving loan or line of credit allows a business to borrow money as needed to finance its working capital needs and ongoing operations. A revolving line is especially useful in times of fluctuating income, as bills and unforeseen expenses can be paid by drawing down on the loan. Taking out the loan lowers the available balance, while making payments on the debt increases the available balance.
The financial institution can review the revolving credit facility every year. If a business’s income decreases, the institution may decide to lower the maximum loan amount. Therefore, it is important that the business owner discusses the business situation with the financial institution in order to avoid loan reduction or termination.
A revolving credit facility offers a variable line of credit that allows individuals or businesses great flexibility with the funds they borrow.
Example of revolving loan facility
Supreme Packaging obtains a revolving credit facility of $ 500,000. The business uses the line of credit to cover payroll while awaiting accounts receivable payments. Although the company uses up to $ 250,000 of the revolving credit facility each month, it pays off most of the balance and monitors the amount of credit available. Because another company signed a $ 500,000 contract with Supreme Packaging to package its products for the next five years, the packaging company is using $ 200,000 of its revolving credit facility to purchase the required machinery.