Revolving Line of Credit
One of the most popular forms of finance for business owners is a revolving credit line, also referred to as a business line of credit. Many business owners use this form of credit to help fund various parts of their operations. It provides a great degree of flexibility that many other forms of finance can’t offer, and it can also be extremely affordable if it is used correctly.
If you’re planning on attaining a revolving credit line for your small business, it is vital that you are acutely aware of the various components of this form of finance. One of the biggest mistake business owners make in the first few years of operating is not knowing how their finance works. Depending on the lender you contact, there are various names for this form of finance, some call it a revolving line of credit, others call it a small business line of credit, you may even hear it referred to as a revolving credit facility – all these terms refer to the same thing.
This guide will provide you with everything you need to know about this unique and useful form of credit. It is imperative you take in all the information prior to deciding whether this form of finance is suited to your business.
Revolving Credit: An In-Depth Look
So, what is revolving credit? Revolving credit is a form of credit that is offered in various forms by many commercial and individual lenders. It is distinctly different from traditional forms of credit in that it has a different payment and usage structure.
Unlike a traditional loan, revolving credit does not provide you with a lump sum amount of capital which is then paid back over a set schedule. Instead, a lender will issue you with a credit limit which is a preset limit that you will be able to access. The amount you can access will be locatable in your revolving credit agreement. If you decide not to access any money from this limit, you will not have to pay any back, nor will you have to pay any interest on the money that was set aside for you to use. If you do decide to use some of the capital in your credit limit, your credit limit will be reduced by the amount that you borrow. If you end up paying back the amount you use, you will then be able to use that money again – hence the name ‘revolving’.
The term infers that you do not need to continue reapplying for revolving credit in order to access capital – you simply have to pay back the amount that you borrowed. This allows for a much more efficient lending process, instead of constantly reapplying for a loan, you simply pay back what you owe and continue to access your credit limit. In addition, if you pay back the money that you access prior to your statement date (which is typically once a month, but can vary) then you won’t have to pay any additional interest.
The flexible nature of this form of lending has resulted in it being a popular form of credit with both consumers and business owners.
Revolving Credit Examples
In order to get a better understanding of revolving credit at its core, it is useful to have a few examples of different types of revolving credit. There are two primary examples of revolving credit explained below:
- Revolving Credit Card – This is the most common form of revolving credit, it is used by consumers and businesses to pay for goods and services. A lender will issue you with a credit card with a set credit limit. You will then be responsible for paying a portion of what you use every month, what you don’t pay back will begin to accrue interest.
- Revolving Line of Credit – A revolving line of credit is the same type of finance that this article is based on. Unlike a credit card, a revolving line of credit is an account that you can withdraw or transfer money out of should you need to access capital. This form of revolving credit is used both by consumers and businesses.
What is a Revolving Line of Credit?
The revolving line of credit definition is not too dissimilar to that of revolving credit. As explained above, it is simply a predetermined limit of money that is extended to you with the understanding that you only have to pay interest on what you borrow. A lender will assess your application and provide you with a limit, you will then be able to use this money at your own discretion. If you end up leaving a balance, you will have to pay interest at the rate predetermined by the lender. Because this form of credit is typically an unsecured revolving line of credit, it comes at a higher interest rate than many forms of finance. For this reason, it is important not to overuse it.
How is a Revolving Credit Line Used in Small Businesses?
A revolving credit line is used by business owners for a variety of different things. Typically, many business owners will have a revolving line of credit in place in case of an emergency. It is useful to have one so that if a crisis arises you don’t have to apply for a loan and wait for approval.
Many business owners use it to fund small purchases or repair equipment. One of the brilliant things about a line of credit is that you don’t have to use it for any particular purpose. In addition, you don’t have to use it at all. This is why many business owners recommend you keep one for emergencies only. Aside from emergencies, business owners also use them to prepare for seasonal increases in demand. Many retailers use revolving lines of credit to purchase inventory prior to busy seasons. The cost of borrowing is far outweighed by the benefit of having enough product to take advantage of seasonal improvements in demand.
Advantages of a Revolving Credit Line
- Flexible – Unlike a traditional loan, you never have to use it – this means that you don’t have to pay interest on capital you don’t need, and you don’t have to plan ahead. If you had to use a traditional form of credit as an emergency fund, you may never end up using it and you would still have to pay back the loan with interest.
- Unsecured – This means that you don’t risk losing your business or assets if you can’t afford to pay back the loan. Although it is important to note that some lines of credit are secured.
- Cash – Unlike a business credit card, you can access cash without having to pay cash advance fees or charges. This is an especially important advantage for those who need cash in their business.
Disadvantages of a Revolving Credit Line
- Cost – Because this is unsecured debt, the rates that you have to pay in interest can be extremely high. It is one of the most expensive forms of capital that is available to small business owners.
- Eligibility – It can be hard to attain a line of credit if you don’t have a lengthy lending history. Because loans are unsecured, lenders want to know that you have the ability to pay it back. This may also result in you having to provide lengthy and complex documentation.
How to Get Revolving Credit
The process of attaining a revolving line of credit can be quite difficult, but this depends on the avenue that you take. Traditionally, getting a revolving line of credit would require you to go to a commercial bank and fill out a series of forms. You would need to provide a full credit history, as well as additional information about your business and your business plan. Some lenders may also need additional information – you would need to check with each lender’s individual requirements. Because of the risk for the lender, this process could often take a long time – they want to make sure that you are a viable borrower who is able to pay back the amount of money that they extend you in your line of credit.
With the advent of technology, this process has changed. There are now various private lenders that extent business lines of credit to companies just using the internet. You can upload documents and other required information into an online platform – a decision is often made on your enquiry in only a matter of days, if not hours.
The route that you opt to take will depend on the urgency of your application. It will also depend on the industry that you are operating in. Like any form of financing, it is important that you review your various options prior to making any decisions. Every lender will have different limits, interest rates, and fees – it’s important that you consider comparing lenders part of the essential process. Many lenders will have a revolving credit calculator that will allow you to estimate that amount that it will cost you to access portions of your credit limit – it’s a useful tool to use if you want to better understand the potential implications of using a line of credit.
What is Non Revolving Credit
Non-revolving credit is effectively any form of credit that isn’t revolving. Two common examples of non-revolving credit include a traditional business loan and a mortgage. With these types of financial instruments, you are unable to re-borrow money that you have already paid off.
For example, if you attain a loan from a creditor in order to purchase a car, you will be required to make monthly payments on that loan at a set interest rate. As you make payments on the car, the amount that you owe to the lender will decrease. Eventually, if you make all of your payments, you will no longer owe any money on the car and you will own it outright. But if half way through paying the car off you decided that you need more money, you would not be able to go to the lender and simply withdraw this money. Instead, you would have to apply for another loan in order to receive any capital. In this sense, the credit is not ‘revolving’, as you cannot continually withdraw money from your loan once you have paid it off. Once you pay the money, it is the lenders, not yours.
The same goes for mortgages and any other type of loan.
I Need a Card for Employees, Should I Get a Revolving Credit Line?
The short answer is no. Most revolving credit lines do not attach a card facility to your credit limit. If you have vendors or clients that require you to pay with card or use credit card, a revolving credit line is not the perfect fit for you. As mentioned previously, revolving lines of credit are best for those who need access to cash. Although you can normally write checks or transfer money from your revolving line of credit, so there are other options available outside of cash when it comes to paying bills or invoices. Attaining a business credit card is a great way to get revolving credit with a card facility – although, on the other hand business credit cards will charge you outrageous fees to withdraw cash.
This being said, most small business owners that have a revolving line of credit often have a business credit card as well. Just because you have one, doesn’t mean you can’t have the other.
Is There Such Thing as Revolving Credit for Bad Credit?
This has been addressed shortly in some of the previous sections of this post but it is still important to expand on. Having bad credit will be a major hindrance in your ability to get a line of credit. This is because it is typically an unsecured form of debt and therefore lenders have no collateral against you not paying them back. This being said, how poor your credit can be will depend on the individual lender. And many lenders may offer you a small line that can then be increased overtime if you manage to abide by the payment terms. In addition, it is likely that some lenders will allow you to secure the debt in order to help get you a line of credit. Although, it must be said that this means that some of your assets could be seized should you fail to meet your payment terms.
The Consequences of Too Much Revolving Credit
Because of the flexibility of revolving credit, and the ease at which it can be used, many business owners may ask themselves why they don’t just fund their entire operations using revolving credit. The benefits of revolving credit seem endless, but there are some serious consequences for having too much revolving credit in your business.
The first potential consequence of having too much revolving credit in your business is simply the fact that you may not be able to meet your debt requirements. As mentioned previously, revolving credit comes at an extremely high interest rate, meaning that you will be paying a high premium for its use. If you are unable to pay off the business line of credit quickly, serious amounts of interest charges will begin to accumulate. Not being able to service your debt can have serious consequences on the viability of your company. In the case that your line of credit is secured against assets in your business, failing to service the debt would result in these assets being seized.
The second disadvantage of having too much revolving credit is that it can impact your ability to access other forms of finance. Many lenders will view a company that has too much revolving credit as a potential risk in terms of lending. They may feel that you have the potential to rack up a serious amount of high interest debt, which could pose future financing problems.
Keeping the amount of revolving credit you have access to at a relatively reasonable level will ensure that you don’t get your business into a situation that it is unable to handle.
Tips and Tricks
There are various things you should do when you decide to apply for a revolving line of credit. Firstly, you should ensure there are no hidden fees. Many lenders do not have any hidden fees or charges associated with attaining a line of credit, but with many new lenders entering the market, this assumption is not always true. Make sure that your lender gives you a full breakdown of the potential things you may owe.
Secondly, as mentioned previously, never use a revolving line of credit for large purchases, or for starting a business. There are much more affordable ways to finance large investments or starting businesses. The interest you’re paying may not seem high at first, but if you accumulate the amount that you will owe over a certain amount of time it will certainly increase past your capacity.
Thirdly, when you compare individual lenders, don’t just look at the rates they are offering you. You should also be acutely aware of their reputation in the industry. The internet has made it extremely easy to look up lenders and determine how well they treat their customers. Never trust a lender that doesn’t have an online presence. In addition, it must be said that many of the larger commercial banks around the nation have horrible track records when it comes to conducting business with their clients. No matter how reputable you may think your lender is, always double check online. You’d be surprised about how miserable a bank can make your experience.
After reading this guide you should have a firm understanding of what a revolving credit line is. It may seem complicated at first, but the basic concepts are quite simple once you fully understand them. If you do think that a revolving credit line is a good fit for your business, it is suggested that you apply for one sooner rather than later. It can be extremely hard to get one at very short notice, this is because you will need to have a range of documents and additional information to show your prospective creditors. Many people wait until an emergency arises before they apply for a business line of credit, but this can result in you being poorly prepared to deal with the problem if you’re not approved. Remember, if you don’t use your line of credit you will never have to pay any of it back, so having one ready for an emergency doesn’t have any real disadvantage.
A revolving credit line should never be the sole source of finance in your company. Many business owners use it as part of a much larger funding structure. If you’re unsure that you will be able to use it responsibly, it is most likely not the best form of credit to attain. If you are using a commercial bank to attain a line of credit, you should consult with the bank about what forms of finance are best suited to your business type. Typically, if you operate in an industry that has seasonal gaps in cash flow, you will most likely need a revolving line of credit. It can be hard to pay bills and invoices when you are in low-season, and it can be difficult to budget high-season cash flow for year-round. You will see that many businesses that operate in tourism, or during specific seasons, have lines of credit. In addition, many companies that have expensive machinery that is a necessity for normal operations will also have a line of credit.
In the end, the best way to ensure the correct decision is to stay constantly aware of the various lines of credit available to you. You should also try and maintain as high of a business credit score as possible so that you can benefit from cheap finance in the future. The best business owners are those who put themselves in the position to benefit from their financial responsibility.