From credit cards to bank loans, there are plenty of ways to access cash when you need it. One factor that businesses should be aware of is the difference between revolving and non-revolving credit. But what is a revolving credit facility, and how does it differ from other types of accounts? Here’s what you need to know.
What is a revolving credit facility?
To define a revolving credit facility, it’s first helpful to take a closer look at how revolving credit works. Any revolving credit account comes with an established limit, or maximum amount you’re allowed to spend. You can either pay a minimum balance each month or choose to pay the full amount. Whatever’s not paid off will transfer to the next month with interest, creating a revolving balance. The credit account can be used repeatedly provided your account stays open and all minimum payments are met. A credit card is a common example of revolving credit.
By contrast, a revolving credit facility refers to a line of credit between your business and the bank. You’ll be able to access funds when and where you like, up to an established maximum amount. Revolving credit facilities are also called bank lines or revolvers.
There are many reasons why you might find a revolving line of credit to be beneficial. For example, if you operate a seasonal business that experiences significant fluctuations in cash flow, revolving credit can keep you on your feet during slower times. It’s used to keep operations afloat, making it a useful form of short-term financing.
Revolving credit vs. non revolving credit
Credit cards and lines of credit are both examples of revolving credit. Instalment loans are non-revolving, because you must pay off the loan over a specific period with fixed monthly instalments. There’s far more flexibility involved with revolving credit in comparison to paying off a non-revolving credit balance.
Some examples of non-revolving credit include auto loans, mortgage loans, and student loans. Once you’ve paid the full non-revolving credit balance, the account is closed. By contrast, if you pay off your full revolving credit balance you can use it to spend again up to your limit.
There are also benefits to non-revolving credit. Instalment loans usually offer lower interest rates, and with a fixed payment schedule they’re easier to work into your budget.
Revolving credit facility features
When looking specifically at revolving credit facilities, there are a few key features to be aware of.
Interest is charged based on the withdrawal amount rather than the full line of credit. As more of the revolver is used, interest rates are applied accordingly. Interest rates might be fixed or variable depending on your bank’s terms and your credit rating.
Many revolving credit facilities have a cash sweep feature, which uses excess cash flow to pay down outstanding debt. This accelerates the repayment schedule rather than distributing excess cash to shareholders. The benefit is that a cash sweep reduces your business’s liability.
The amount you’re able to borrow will depend on the bank and your business’s credit worthiness. The revolver is usually reviewed at regular intervals, with the credit limit extended when your business is doing well. However, if your revenues are down from one year to the next, the maximum amount might be reduced accordingly.
Examples of revolving credit
We’ve already touched on a couple of examples of revolving credit above, which could include accounts such as the following:
Bank line of credit (Revolving credit facility)
Home equity line of credit
While credit cards offer an easy way to pay for expenses both large and small, a revolving credit facility is better for funding major business expenses or extensive repairs.
Another difference is that while you use credit cards to purchase specific items, lines of credit enable large cash transfers between the bank and your business account. Provided you meet minimum payments, you can use this cash for any purpose. In this way, revolving credit facilities provide the same benefits as a cash advance, without the high associated fees.
As an example of when a business might need to use a revolving credit facility, imagine a waterpark which serves most of its customers during the summer holidays. It would have a shortage in operating income during the winter season, during which time it might need a line of credit to retain core staff on payroll. It can access these funds for daily operations, repaying the credit in full when the season is back in full swing.
Eligibility requirements for a revolving line of credit
To apply for a revolving line of credit, you must furnish the lender with financial statements to prove your business’s credit worthiness. This includes things like your cash flow statement, bank accounts, balance sheet, and income statement.
Both non-revolving and revolving credit can be useful financial tools for any business, so it’s worth comparing your options carefully.
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