What Is a Revolving Loan Facility?
A revolving loan facility is a financial institution that lets the borrower obtain a business or personal loan where the borrower has the flexibility to draw down, repay and redraw loans advanced to it. This type of loan is considered a flexible financing tool due to its repayment and re-borrowing flexibility. It is not considered a term loan because during an allotted period of time the facility allows the borrower to repay the loan or take it out again.
How a Revolving Loan Facility Works
A revolving loan facility is typically a variable line of credit used by public and private businesses. Criteria of the loan depend on the stage, size and industry in which the business operates. The financial institution typically examines the company’s income statement, statement of cash flows and balance sheet when deciding whether the business can repay a debt. If the company has steady income, strong cash reserves and a good credit score, in most cases a loan is granted.
The balance on a revolving loan facility may move between zero and the maximum approved value. The financial institution typically charges a fee for extending the loan and a variable interest rate on the loan balance. The rate is often higher than rates charged on other loans and changes with the prime rate or another market indicator. Thus, when the Federal Reserve increases or decreases interest rates, charges on a revolving loan facility go up or down.
A revolving loan facility provides a variable line of credit that allows people or businesses great flexibility with the funds they are borrowing.
How Do Businesses Use a Revolving Loan Facility?
A revolving loan facility allows a business to borrow money as needed for funding working capital needs and continuing operations. This is especially helpful during times of great income fluctuations, as bills and unexpected expenses may be covered by the funds. Drawing against the loan brings down the available balance, whereas making payments on the debt brings up the available balance.
The financial institution may review the revolving loan facility annually. If a company’s revenue shrinks, the institution may decide to lower the maximum amount of the loan. Therefore, it is important for the business owner to discuss the company’s circumstances with the financial institution to avoid reduction in or termination of the loan.
Example of a Revolving Loan Facility
Supreme Packaging secures a revolving loan facility for $500,000. The company uses the credit line for covering payroll as it waits for accounts receivable payments. Although the business uses up to $250,000 of the revolving loan facility each month, it pays off most of the balance and monitors how much available credit remains. Because another company signed a $500,000 contract for Supreme Packaging to package its products for the next five years, the packaging company is using $200,000 of its revolving loan facility for purchasing the required machine.