For businesses with cash flow or debt problems, accessing a revolving credit facility can often seem like the quick way to bring more cash in without increasing sales. Unfortunately, for some businesses although a credit facility will boost cash flow in the short term, if a business has structural issues it may not be the best long term option.
If your business has underlying issues like high debt or shrinking profit margins, your business may benefit more in the long term from a restructure by a licensed Insolvency Practitioner.
For those businesses that are in good health, then a revolving credit facility can provide a cushion against market shocks or customers that pay late. Access to the financial flexibility offered by credit is often more valuable than the inhibitive cost of finance.
A revolving credit facility is a highly flexible way to give your business a financial cushion against any shocks. It provides borrowers with a means to borrow in a cycle, with the amount available increasing as repayments are made. In effect, this allows businesses to fund their projects in perpetuity, with far fewer restrictions than other forms of lending.
In this article, we will break down the relatively novel idea of a revolving credit facility. How it works, and the benefits it provides.
What is a revolving credit facility?
A revolving credit facility provides businesses with a cyclical form of borrowing. It offers a fixed amount of capital for you to borrow. Which can be used to fund purchases, expansions, or make emergency payments. Once the funds are used, repayments can be made. In this sense, a revolving credit facility is comparable to a traditional loan.
What makes a revolving credit facility unique is its cyclical nature. As the name suggests, this form of finance follows a revolving format; the required sum will be borrowed and used, regular repayments begin, but if more capital is needed before the loan is paid, a second loan can be taken. This can be repeated as you like, provided subsequent loans do not exceed the fixed amount. In a sense, this is similar to credit cards, in that the more you pay, the more you can borrow.
For example, suppose a business secured a revolving credit facility of £20,000. The full £20,000 was used to fund the replacement of old equipment, modernising the workplace. This precludes the business from taking out any further loans.
Suppose the business repaid £5000 after two months. This would make £5,000 available in the RCF account, with further repayments adding to this amount. Should an additional loan be required, the business could then borrow capital equal to the remaining amount in the RCF account. Otherwise, the business could repay the full amount and close the RCF account, continuing operations debt-free.
The costs of a revolving credit facility
Naturally, there is a monthly repayment that must be made, most often with a fixed minimum amount that must be met each month. These terms are agreed upon during the contract drafting process, so ensure you find the terms suitable before signing. Otherwise, you risk agreeing to terms that could put undue pressure on your business.
In addition to monthly repayments, a revolving credit facility has its host of fees. Interest will be charged on your loan, incentivising quicker payments. Of course, the faster you pay off your loan, the less you will have to pay in interest. In addition to this, you will be required to pay origination fees, alongside annual operation fees, if your account has been open for longer than 12 months. If you make late payments, you will also face a fee.
Business uses for a revolving credit facility
Revolving credit facilities can find good use in any industry, for almost any purpose. However, for businesses with high operating costs, it can be invaluable. This includes retailers, wholesalers, and restaurants, among others. The relatively high operational upkeep can be a tight constraint on such a business’s cash flow, leaving little room for much else. For a business wishing to grow, this constraint can lead to stagnation. A revolving credit facility can alleviate this, in addition to providing benefits to businesses that intend to repay regularly.
Revolving credit facilities can also be merged with other finance solutions. For businesses that would find it preferable, an asset-based revolving credit facility can be used. This would secure the loan against your assets, for example, your inventory or accounts receivables. While it does confer certain benefits, asset-based borrowing does pose considerable risks. Should your cash flow become unstable, you stand to lose the assets the loan was secured against.
Revolving credit facilities as an alternative to term loans
Revolving credit facilities differ significantly from term loans. As such, they can effectively meet your financial needs in situations term loans can’t, and vice-versa. To make the right choice, it is imperative to be knowledgeable of both.
Term loans have a fixed date of repayment, in addition to a fixed monthly amount to be repaid regularly. Interest and fees are also added to the amount that must be repaid. However, unlike a revolving credit facility, you will not be able to access the amount you repaid during the process. Once the loan is repaid, the account will be closed automatically.
A revolving credit facility, however, is much more flexible. Its balance can be accessed at any point, should you have the need for additional capital. The account is not closed automatically, allowing you to keep the facility open for as long as you might need it. This flexibility means you have more control over what you borrow and repay each month. But, it may make it more difficult to accurately budget.
When to restructure vs. obtain credit
For a company in good financial health, a credit facility can offer a way to fund growth or weather a storm. However, many businesses look to credit facilities because of a downturn in their businesses future prospects.
Often in search of credit, directors can sign personal guarantees that leave them bearing the brunt of unrepaid credit when the business’s downward spiral continues and the company is unable to service its debts.
It’s therefore important to assess your company balance sheet before deciding upon whether credit is the right way forward. In the event that the business does have high debt levels, or cash flow problems that are long term, it may be better to seek professional advice from an Insolvency Practitioner so that you can lay out all your options prior to entering any arrangement.
While the lure of short term cash may be attractive, it might not in fact provide a long term solution to a changing marketplace or mounting debt levels. By seeking independent advice in advance, an alternative course that provides a better future for the company could be found.
Revolving credit facilities can be used to fund a business’s growth with a great degree of flexibility. It can lessen the strain on a tight cash flow, and provide a reserve of capital that can be accessed throughout the repayment process. This can help weather unforeseen storms, picking up the shortfall if unexpected costs mount up. As revolving credit facilities have no fixed end, they can be used as much or as little as necessary.
Revolving credit facilities can also prove useful as a means to build an excellent credit score. As it is a revolving form of borrowing, with regular repayments over a long stretch of time, it can be a massive boost to your credit score. Because of this, and the aforementioned reasons, a revolving credit facility can be an indispensable tool for businesses looking to raise funding.
If, however, your business has underlying issues that mean it will continue to struggle then in the long term revolving credit facilities will not be enough to alleviate your business’s financial issues. If you think that you need independent advice prior to making a decision on whether to take out a revolving credit facility, Clarke Bell is here to help. We have decades of experience assisting businesses through corporate restructuring and the liquidation process, providing an expert level of support through MVLs, CVLs, and other services. Schedule a free consultation today and find out what we can do for you.