Cash flow problems can be dangerous to the growth of your business. Even if you’re experiencing a temporary issue with raising the working capital you need to get things done, any slowdown in your balance sheet can turn your company into a sitting duck. There are a variety of different ways to get the amount of money you need to keep things running smoothly, and you should consider the benefits and detractors of revolving credit facilities as you plan your next move.
What Is a Revolving Credit Facility?
Despite its somewhat misleading name, a revolving credit facility isn’t a place or a type of financial institution. Rather, it’s a line of credit that you can use to take care of everyday business expenses. You can arrange for a revolving credit facility with your bank, and this type of credit is similar to a business credit card in certain ways.
When your bank approves you for a revolving credit facility, you’ll be able to “draw down” from the credit limit that your bank has established. From there, you can pay back the loan amount or withdraw further funds whenever you need them. Instead of providing you with a single set amount of money as a loan, a revolving credit facility is a continuous relationship between you and your bank in which you can withdraw short-term loans from your available credit whenever necessary.
How Does Revolving Credit Work?
Revolving credit is a flexible type of loan that allows you to withdraw more funds or repay your outstanding balance at certain intervals. Since there is no specified repayment date for revolving credit, this type of finance is not a term loan. This type of loan is sometimes referred to as a revolving line of credit or simply a “revolver.” There are a few terms related to revolvers that will help you understand this type of finance better:
To gain access to the funds offered in a revolving credit agreement, you’ll need to provide a commitment fee up front. This fee shows that you’re committed to your new credit line, and it helps banks with their risk management objectives. Depending on your agreement, your commitment fee may be a flat fee or a percentage of the total size of your line of credit.
Your revolving credit facility will charge interest rates. However, these rates will only be applied to funds you withdraw. For instance, if your revolving credit facility covers £100,000 but you only withdraw £10,000, your bank will only charge you interest on the £10,000 you withdrew. Interest rates for these types of credit lines are usually relatively low, and your bank will offer you better rates if you have a good credit score.
Some revolving credit facility agreements include a cash sweep, which is sometimes called a debt sweep. To minimize risk, your bank may require that you pay back the amount you’ve withdrawn from your revolving credit facility before you spend money on anything else. If you have this type of provision in your agreement, you’ll have to pay off your loan before you pay your employees, investors, or shareholders, and you’ll have to make this payment as soon as you have adequate cash flow.
How Do Revolving Credit Facilities Evaluate Lending Eligibility?
Revolving credit is only useful in certain situations. If you think you want revolving credit but your bank determines that another type of finance might be better for your situation, you might be steered in another direction.
Before offering you a revolving line of credit, your bank will use a variety of criteria to evaluate your creditworthiness. To minimize the risk of lending to you as much as possible, your bank will evaluate your ability to repay your loan. Your bank might take a look at your character, which refers to your overall attitude and fiscal responsibility. You will also need to demonstrate that your cash flow is sufficient for debt repayment. Unlike other types of business loans, your bank will not ask you for collateral when you apply for revolving credit.
Revolving Credit in the Real World
Say you operate a lakefront resort. During the summer, you get a lot of business, and things also pick up around the holidays when families and other groups visit your restaurant. Throughout the rest of the year, however, business is slow, and you still need to pay operational costs.
You decide to reach out to your bank to ask about business loans. You think that the only available loans are those that will compound interest over time, which doesn’t fit your business model. However, your bank points out that a revolving credit facility might dovetail nicely with your needs.
With your new revolving credit facility, you’re able to access the funds you need exactly when you need them, and you only have to pay interest on what you withdraw. When your roof starts leaking in February, you can easily pull down £2,500 pay for maintenance, and when you have problems with payroll cash flow in October, you don’t have to lay off employees since you’re able to withdraw another £3,000. Since your agreement includes a cash sweep, you have to pay your bank back as soon as things start picking up during the summer.
Differences Between Revolving Credit and Credit Cards
One of the most notable differences between a credit card and a revolving credit facility is that revolving credit facilities don’t come with physical cards. This means that you can’t make purchases directly with your revolving credit facility; instead, money from this type of finance is transferred directly to your bank account, and you can then use it to pay off credit card debt or make any other type of bank transaction.
Revolving credit is more like a cash advance than a traditional credit card. In addition, most revolving credit facilities have significantly lower interest rates than credit cards.
Benefits of Revolving Credit Facilities
A revolving credit facility gives you the flexibility you need to make purchases when you’re experiencing cash flow issues. This type of finance allows you to continue growing your business even when you don’t have adequate working capital, which helps you avoid periods of stagnation.
However, the interest rates for revolving credit are usually higher than interest rates for traditional term loans, which means that this type of credit works best when you use it as a stop gap to keep things running smoothly. Maybe you need to wait for the payment to arrive for outstanding invoices or wait for your cash flow to improve in other ways. If you avoid paying off your revolving credit for more than a few weeks, however, you could end up having to contend with relatively high-interest fees.
While many types of credit take a long time to set up, it’s usually possible to receive access to a revolving credit facility within a matter of hours. With this type of finance, it isn’t necessary to make a new loan agreement every time you need to borrow money; as long as your bank has your commitment fee, you can withdraw cash whenever you need to add to your working capital.
You don’t have to provide collateral to receive a revolving credit facility, and some banks provide simple online platforms you can use to keep track of your running balance and make payments. Plus, you can enjoy the convenience of using a revolving credit facility and other types of trade finance at the same time.
Problems with Revolving Credit
The major flaw of revolving credit is the commitment fee you’ll have to pay to access this service. While commitment fees are often relatively small, they still deduct from the working capital you have on hand to take care of expenses.
While they’re lower than the interest rates for credit cards, revolving credit facility interest is usually high enough to dissuade you from taking out cash for an extended period. If you aren’t careful, you could end up spending a lot just for the privilege of using your line of credit.
Cash sweeps are some of the most irritating aspects of revolving credit. Having to pay your bank back as soon as you have the necessary cash on hand is inconvenient at best, and if you aren’t careful, submitting to cash sweeps could even make your financial situation less stable.
It’s always tempting to spend money you don’t have, and if you aren’t careful, the convenience of your revolving credit facility could become a serious problem. In most cases, your bank can change the terms of your revolving credit agreement at any time, and if your credit score decreases, you could end up facing higher interest rates, or your bank could suddenly reconsider offering you a revolving credit facility.
CreditDigital and Revolving Credit
CreditDigital offers an alternative to revolving credit facilities that provides you with the cash advance you need without the risk. Like a revolving credit facility, CreditDigital gives you the funds you need to make purchases and keep your business afloat, but you don’t have to borrow the money you don’t have to access these funds.
Instead, CreditDigital provides you with advances on your invoices. If you have an invoice that won’t be paid for 30 days, for instance, but you have a big purchase that you need to make immediately, you can ask your client to pay through CreditDigital to get the money you need now.
When one of your clients makes a purchase from your company through CreditDigital, we give you access to the full value of the invoice immediately. While your clients are used to having to pay invoices within 30-90 days, we give your clients up to a year to pay their invoices.
No matter how long your client takes to pay, however, you get paid immediately. We even take care of chasing down bad debt and evaluating the creditworthiness of your clients before they get set up with our platform. Our cutting-edge service incorporates the latest advances in mobile and desktop interfaces to make it easy for you and your clients to access invoice information and make payments.
Neither you nor your customers need to go through lengthy application processes to use CreditDigital, and our platform is compatible with both traditional and e-commerce transactions. While borrowing money commonly involves paying high-interest rates, we offer 0% interest rates to keep your clients happy.
As you learn more about revolving credit facilities and take in all the benefits of working with us at CreditDigital, you might come across these related terms:
A term loan is a type of loan that a bank gives out for a specific period of time or “term.” With these types of loans, you have to pay back what you borrowed by a certain set date. Since revolving credit facilities don’t have any set periods, these types of loans aren’t term loans.
Line of Credit
A line of credit is a type of finance supplied by a bank that has a specific maximum amount. If you have a £10,000 line of credit, for instance, you can’t spend more than that amount without facing fees.
Trade credit is any type of credit that a company offers a client. If you make a sale to a customer on net-30 terms, for instance, that’s a type of trade credit, and the simple and intuitive service we offer at CreditDigital is also a type of trade credit.
Invoice finance is when you sell your invoices to a bank in exchange for cash up front. CreditDigital offers an alternative to invoice finance that provides you with more working capital.
Invoice factoring is a type of invoice finance in which a bank takes control of credit control and invoice collection for your business. In exchange, your bank offers you between 70 and 90% of your invoice value up front.
When you pursue an invoice discounting agreement with your bank, you retain control of your credit control and invoice collection procedures, and your bank usually offers you 90% or more of your invoice value up front.