Revolving Credit Facility

Introduction to Revolving Credit Facility

Revolving credit facility is a line of credit which is extended by the bank or financial institution generally to its customers or business where the bank will enhance the credit limit provided to the customer to a certain fixed limit as the customer go on paying the debt and it allows the business or the individual customer access to that sum of money whenever the need arises i.e. the amount drawn by the customer can differ each month which is again based on the cash flow needs of the customer and his/her operating expenses.

Explanation of Revolving Credit Facility

Revolving credit facility as discussed above is a credit line which is provided by the bank or financial institution to its customers. They can use this money based on the operating expense and the cash flow required for running the business. The amount drawn each month differs. The credit line provided though remains fixed to a certain pre-defined amount and the customer can use it accordingly based on the needs. Revolving credit facility is a kind of line of credit or a credit card. They can be applied by both business firms and individuals. It provides a lot more flexibility to the customers in accessing the predetermined sum of money which is also known as the credit limit. As soon as the customer pays back the opening balance of the credit limit, the money is made available to be used again. This credit facility which is provided to both individuals and business are generally secured by assets belonging to the company or the individual where bank has got the right to take over the asset of the company if the debts are not paid back properly in the specified time frame.

Features of Revolving Credit Facility

The features are as follows:

• It is compared as a type of line of credit or sort of credit card.
• The borrower can withdraw or use partial fund, but this is stipulated only till the pre- approved credit limit set.
• The sum of the credit available decreases and then increases when the funds are used and repaid back respectively.
• The credit facility provided can be used again and again on a repeated basis.
• The borrower must repay subject to minimum repaying amount as consecutive payments, or he/she may repay full at a single time.
• During some events the borrower has to pay certain sum of money as fees for the amount of money which has been not utilized and this is very much seen when corporate banks giving revolving credit loans.
• The borrower is charged interest only on the borrowed part of the loan and not on the entire pre-approved amount
• To begin the revolving credit facility the bank must charge a fee of commitment which compensates the lender for keeping open access to the potential credit facility.

How does It Work?

Revolving credit facility work on a similar line as that of a credit card. While credit card is for a certain minor amount only, revolving credit facilities are generally used by business houses where the pre-approved limit is also comparatively higher than credit card. But both works on a same manner where one has to pay interest for the amount of credit utilized and as soon suppose the business utilizes 20% of the overall credit provided , the credit limit gets reduced by 20% and whenever the payment of the same along with interest is made , the revolving credit limit is again brought back to 100%. Here another difference from credit card is the fact that generally the revolving credit facility provided are back by assets of the company which can be seized by the bank if the customer or borrower doesn’t pay back the debt on time. The bank also charges a certain sum of commitment to the borrower for provisioning this kind of services of always keeping a loan provision open to the business.

Example of Revolving Credit Facility

Any typical business which is dependent on season trend will have their flow of income generated during the peak seasons and will have to survive with the generated income during the off seasons. Now, the business during off season cannot shut the business now or close it services. It has to keep the business going by paying of its basic operating activities or a business which has made a lot of credit sales has to wait for some time before getting back the account receivables. During these phases revolving credit facility provided by the bank comes very beneficial as it helps the business to stay afloat till the time when business goes back to normal.

Revolving Credit Facility vs Overdraft

Revolving credit is a facility provided by the bank to business over a period of short or medium term where the business has the access to utilize the pre-approved amount at any time up to the value which has been pre-approved. The interest is only charged on the amount of loan utilized.

Overdraft on the other hand is a short-term finance feature which is provided to business with fluctuating borrowing needs and temporary requirements which gives the business the needed liquidity at any point of time. Overdraft has got lesser restriction as compared to revolving credit facility.

Benefits of Revolving Credit Facility

The benefits are as follows:

• It provides liquidity to the business as and when required to carry on its operating expenses.
• The interest is charged only on the part of credit utilized.
• The chances of going default in this case is less because the credit facility is back up by the assets of the business.
• The funds become readily available and one does not need to go through an approval process.
• The rates of interest are lower than what one would have paid for using a credit card.

Drawbacks of Revolving Credit Facility

The drawbacks of revolving credit facilities are as follows:

• A certain commitment fee needs to be paid to the bank to keep the provision alive.
• They generally will have more interest rates than what a traditional loan will be having.
• The credit limit set is comparatively low than what traditional loan would have offered.

Conclusion

As discussed above we have seen the pros and cons of revolving credit facility and discussed the difference of it from overdraft or traditional loans. This is a very important feature which comes handy for every business house who utilizes this facility efficiently.

Recommended Articles

This is a guide to Revolving Credit Facility. Here we also discuss the introduction and how does it work? along with the benefits and drawbacks of revolving credit facilities. You may also have a look at the following articles to learn more –

1. Working Capital Loan
2. CRR vs SLR
3. Variable Costing Example
4. Loans vs Advances