A revolving loan facility, also known as a revolving credit facility or simply revolver, is a flexible form of credit issued by financial institutions. It grants the borrower the ability to draw down, repay, and withdraw funds repeatedly within an allotted period. This cycle of borrowing and repayment sets revolving loans apart from term loans, which provide funds followed by a fixed payment schedule.
Key Takeaways
- A revolving loan facility provides borrowers significant flexibility in repayments and re-borrowing.
- Interest rates on revolving loan facilities typically follow a variable line of credit, rather than a fixed rate.
- Businesses use revolving loan facilities to address working capital needs, maintain operations, meet payroll, and handle payables.
How a Revolving Loan Facility Works
A revolving loan facility typically involves a variable line of credit that can fluctuate with market interest rates. Financial institutions may increase the rate of a variable-rate loan if credit markets dictate higher interest rates. The rates, often aligned with the prime rate or other market indicators, are generally higher than those on other loan types. Additionally, institutions usually charge fees to extend these loans.
Approval criteria depend on the business’s stage, size, and industry. Financial entities scrutinize a company’s income statement, balance sheet, and cash flow statement to assess repayment capabilities. Strong financial performance, reflected through steady income, substantial cash reserves, and a good credit score, improves the chances of approval. The balance on a revolving loan facility can fluctuate between zero and the approved maximum value.
How Do Businesses Use a Revolving Loan Facility?
Revolving loans support business operations by providing contingent funds that can be drawn to address working capital needs and operational costs. They are particularly beneficial during periods of revenue fluctuation, enabling businesses to meet bills and unexpected expenses via debt. As funds are drawn, the available balance decreases, and when repayments are made, the available balance increases.
Annually, financial institutions may review revolving loan facilities. If a company’s revenue diminishes, the lender may reduce the maximum available credit. Business owners should maintain open communication with their financial institutions to discuss their circumstances, thereby avoiding potential reductions or termination of the loan.
Example of a Revolving Loan Facility
Let’s look at a practical example:
Supreme Packaging secures a revolving loan facility for $500,000. The company channels the obtained credit to cover payroll while awaiting payments on accounts receivable. Each month, Supreme Packaging taps into up to $250,000 of the revolving loan facility but diligently repays most of the balance, closely monitoring how much credit remains. Following a substantial five-year contract worth $500,000 with another company, Supreme Packaging utilizes $200,000 from the revolving facility to purchase essential machinery for fulfilling the contract.
How Long Do You Have to Repay a Revolving Loan Facility?
Unlink fixed-payment term loans, revolving loan facilities operate without a predetermined repayment term. Instead, businesses withdraw from the available credit limit, repay, and replenish the line of credit through variable cycles of borrowing and repayment.
Are all Revolving Loan Facilities for Businesses?
Primarily discussed concerning businesses, revolving loan facilities also apply to individuals through home equity lines of credit or personal lines of credit, adhering to similar operational principles.
Do You Pay Interest on a Revolving Loan Facility?
Yes, interest is applicable on revolving loan facilities, akin to other loans. Borrowers utilize the credit as needed, repaying the amount and incurring interest on drawn funds rather than a lump sum.
The Bottom Line
For businesses facing fluctuating income streams, establishing a revolving loan facility could be beneficial in managing payroll and unexpected expenses effectively. Consulting with your bank to set up this financing tool can be a astute move for financial resilience and stability.
Related Terms: term loan, line of credit, prime rate, accounts receivable, cash flow statement.
References
- Cornell Law School. “Revolving Credit Facility”.
