For any business, securing a line of finance is vital for longevity. Stock must be purchased, salaries must be paid, and opportunities to expand must be seized upon if a business wishes to continue long into the future. Small businesses, in particular, must stay on the lookout for expansion opportunities, as they often toe a fine line between financial stability and insolvency, with growth being one method of maintaining a stable business. Naturally, all this costs money, and it isn’t typically cheap.

One method of raising capital is to obtain a revolving credit facility. This fairly unique form of finance allows businesses to access funds as and when necessary, ensuring they have as much or as little as they need at any given time. In this article, we will discuss revolving credit facilities, how they work, and whether they might be beneficial for your business’s financial needs. Let’s get started.

What is a revolving credit facility?

A revolving line of credit is a form of finance that allows businesses to access capital when needed. This line of credit can be opened at a bank, after agreeing upon certain terms, such as the maximum amount of capital that can be withdrawn, interest rates, and so on.

A revolving line of credit is most appropriate for businesses that have recurring costs, thereby needing a recurring line of credit from which to draw a steady supply of capital. This can also act as a buffer against an unstable financial situation, as capital can be drawn to mitigate the effects of a sharp drop in a business’s cash flow. In short, a revolving line of credit acts much the same way as a credit card, allowing borrowers to draw capital to cover short-term expenses. As such, it is mostly used as a short-term finance solution, and any withdrawal is repaid quickly.

Also Read: Is a Secured Loan a Good Choice With Bad Credit?

Key features of a revolving credit facility

Revolving credit facilities have a few key features that influence how they work. These are:

  • Cash sweep – A revolving line of credit functions as a cycle, one where the borrower will withdraw capital as needed, and make repayments as it can afford. For many revolving credit facilities, this is done by means of a cash sweep. In practice, this will take any excess funds from the borrower’s revenue stream and pay it to the lender. This quickens the rate at which the loan is repaid, but forces the borrower to budget carefully and forgo frivolous spending.
  • Cap on withdrawals – Although the borrower can withdraw capital when it is needed, there is a cap. This cap is set at the start of the revolving credit facility, as agreed upon with the lender. However, this cap can be renegotiated annually if it is deemed to be insufficient and the borrower has the means to repay larger amounts. Conversely, if the borrower’s finances deteriorate, the lender can lower the cap to protect against losses.
  • Cyclical – The main feature of a revolving credit facility, the one that makes it work, is its cyclical nature. Money can be withdrawn from the pot to cover expenses and repaid when possible, and the process can repeat as many times as needed throughout the duration of the facility. The terms can then be renegotiated if either party wants, then renewed, allowing the cycle to continue for another term. This is in stark contrast to other forms of finance, where once a loan is repaid, it cannot be used again without another application process.

How do revolving credit facilities work?

As mentioned earlier, a revolving credit facility works similarly to a credit card. While similar in function, revolving credit facilities are overwhelmingly used by businesses for commercial use, and tend to be of much higher value than most credit cards can offer.

Similarities to credit cards become obvious in the function of revolving credit facilities. Borrowers will draw money from a reservoir of capital as needed, which will have a percentage of interest applied to it once repayment rolls around. But repayments don’t have to be made immediately. If the borrower prefers, money can be drawn in batches, provided draws don’t exceed the cap. The value of each draw will be deducted from the overall cap, essentially creating a new and lower cap. With each repayment, the withdrawal cap will be restored, with full repayment completely restoring the cap to its initial value. In short, withdrawals can be made when capital is required, and repayments can be made when the business can afford it, adding back to the pot of accessible capital.

Also Read: Are Small Business Loans Considered Secure or Unsecured?

Benefits of using a revolving credit facility for businesses

Revolving credit facilities have several benefits they can offer businesses. Here are some of the most notable:

  • Easy access to capital – The most notable benefit of revolving credit facilities is accessibility. Money can be drawn from a pot when a business needs, and repaid at their convenience. Moreover, once your line of credit is set up, you won’t have to seek approval for withdrawals. Money can be accessed the instant you need it. For businesses with regular expenses, this can be invaluable.
  • Interest is flexible – With revolving credit facilities, interest is only applied to the amount of money you withdraw. If you so choose, you could opt to draw nothing at all. This would naturally mean you pay nothing, though your lender may reduce the cap of your facility. If you withdraw 20% from your revolving credit facility, you would only pay interest on that 20%. This makes revolving credit facilities efficient from a cost perspective.
  • Interest rates are lower than credit cards – As revolving credit facilities work similarly to credit cards, you may be wondering why you shouldn’t stick to a card. While there are a few reasons, one significant reason is that credit cards are more expensive. Interest rates for credit cards are considerably higher than for revolving credit facilities, even if you withdraw the same amount.

Wrapping up

All in all, revolving credit facilities are an excellent source of capital for businesses, especially those with recurring costs. A line of credit can support these regular expenses for businesses with weaker cash flows, or it can enable projects and purchases that are infrequent but expensive, such as expansion opportunities. However, it isn’t without fault, and other solutions may be more appropriate for your situation. For best results, you should carefully research your situation and available options before making a decision.