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 business 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, and 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.
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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 a 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.
Pros and cons of using a revolving credit facility
Despite being a somewhat niche and novel method of financing a company’s operations, there are a host of reasons to use a revolving credit facility. It’s flexible, easy to get, and is often the right tool for the job. Equally, there are plenty of reasons not to use a revolving credit facility, from expense to available funds. Let’s take a detailed look at the pros and cons of using a revolving credit facility.
Pros of using a revolving credit facility
A revolving credit facility has a few main advantages on offer. First and foremost is flexibility. True to its name, a revolving credit facility grants borrowers what is essentially an ever-available pool of credit to draw from as needed. This is exceptionally convenient, as borrowers can dip into this pool for practically any purpose, from covering an emergency stock purchase to paying employees their salary. Equally, business owners can decide to leave their revolving credit facility untouched until they absolutely need it. This flexibility is an excellent advantage, one that other options can’t easily rival.
Another core advantage offered by revolving credit facilities, one that ties into the previous point, is the variety of eligible applications. A revolving credit facility can be used for practically any purpose, assuming your credit pool can cover the cost. This can be especially useful for struggling business owners, as a revolving credit facility can be utilised to plug the financial holes emerging in business accounts. This can help take the pressure off a struggling company’s cash flow, as the revolving credit facility can help cover the shortfall where necessary.
Cons of using a revolving credit facility
While there are good reasons to use a revolving credit facility, there are equally good reasons to avoid this form of finance. One of the most impactful disadvantages is cost. Although it is possible to use a revolving credit facility without adding too much to your expenses, this form of finance can be quite costly if used imprudently. Most revolving credit facilities come with fairly hefty interest rates compared to other forms of finance, on top of fees you’ll be expected to pay. This won’t necessarily have a major impact, but if you overuse a revolving credit facility while your company is experiencing serious financial difficulty, you might find it costs more than it’s worth.
Cost isn’t the only downside to using a revolving credit facility. In most cases, this form of finance will offer a comparatively small sum of money to draw from. While this might well cover the shortfall in a new stock purchase or another emergency payment, it isn’t usually enough for major expenses. For larger expenses, you will likely have to look for alternatives, such as an installment loan.
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 repayment date, 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 business’ 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 is, 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 allure 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.
Alternatives to using a revolving credit facility
For some companies, a revolving credit facility won’t be enough to get the job done. It might not be a cost-effective solution, it might not be able to raise enough money to cover the necessary expenses, or there might be other reasons that make it unviable. For companies in such a situation, alternatives will be necessary.
Occasionally, another form of finance can offer a better solution. Invoice financing, for example, could offer companies a low-cost cash injection that can help in the short term. This form of finance leverages unpaid invoices to raise money, and is fairly unique as far as finance goes. Alternatively, a Merchant Cash Advance might do the job. This form of finance gives a lump sum to a company, which will be repaid from the company’s sales over time. However, both of these alternatives, and many more like them, will only be truly effective for companies with short-term financial problems. If your company is dealing with a more persistent financial strain, you may find another solution more appropriate.
Closing a struggling company via Creditors’ Voluntary Liquidation
When all else fails, a Creditors’ Voluntary Liquidation (CVL) can be an effective solution to a potentially long-term problem. This procedure is available to insolvent companies, and offers directors a slate of incredibly valuable benefits.
As a CVL is a voluntary procedure, directors retain a degree of control over how the procedure is carried out. Most notably, directors can appoint a licensed insolvency practitioner of their choosing to the role of liquidator. While in this role, the liquidator will carry out the CVL procedure, ensuring the company is closed effectively and efficiently. The liquidator will identify company assets and dispose of them for the largest sum possible.
The proceeds will then be distributed amongst the company’s outstanding creditors. If any debts remain once all funds have been distributed, then they will be written off, provided they are not secured by personal guarantees. The company will then be closed and removed from the Companies House register, marking its end as a commercial entity.
CVL Benefits
In addition to being an effective method of closing an insolvent company, the CVL process offers some legal benefits, too. Once a company is entered into a CVL, it enjoys protection from legal action. In essence, this means that a company’s creditors cannot take any action against it, ensuring that compulsory liquidation cannot be enforced. This spares directors from the negative effects of compulsory liquidation, which is a strong benefit in its own right.
Furthermore, entering a company into a CVL demonstrates a willingness on the part of directors to act in their creditors’ best interests. This can be extremely advantageous, as it greatly reduces the odds of creditors making accusations of misconduct or mismanagement. In the event, these accusations are made and reach the courts, placing a company into a CVL shows initiative from the directors, making the allegations less likely to carry weight. If you would like to know more about Creditors’ Voluntary Liquidations, read our complete guide to the process.
Business rescue plan
For some struggling companies, closing via a CVL is not an attractive option. Such companies typically have a viable business model underneath all the financial difficulty, which could result in the business being profitable with a helping hand. Thankfully, a helping hand can be extended, in the form of a business rescue plan.
Business rescue plans can be implemented by licensed insolvency practitioners. They will assess your company, draft a rescue plan tailored to your company’s unique needs, and ensure it is implemented adequately. The specifics of this plan are difficult to quantify, as all companies are different from one another. That said, there are some typical courses of action. Your business rescue plan could include a thorough plan to repay debts in a structured manner, the removal of unprofitable parts of the company, or streamlining and cost-cutting methods. If you believe a business rescue plan could help your company, contact Clarke Bell today.
Conclusion
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 in the long term, then 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.
