Revolving credit facility: Overview, definition, and example
What is a revolving credit facility?
A revolving credit facility is a type of loan provided by a financial institution, typically a bank, that allows a borrower to access funds up to a predetermined credit limit, withdraw and repay funds, and borrow again as needed within the term of the loan. Unlike a traditional term loan where the borrower receives a lump sum and repays it over time, a revolving credit facility provides ongoing access to capital that can be used repeatedly, much like a credit card. Interest is typically charged only on the amount drawn, not on the total credit limit, and the borrower is required to make regular payments based on the outstanding balance.
For example, a business with a $500,000 revolving credit facility can borrow money up to that limit, repay portions of it, and then borrow again as needed during the term of the agreement, which may last several months or years.
Why is a revolving credit facility important?
A revolving credit facility is important because it offers flexibility for borrowers, particularly businesses, to manage their short-term capital needs. It allows for easier access to funds to cover working capital requirements, seasonal expenses, or unexpected financial needs without having to go through the process of applying for a new loan each time. It also provides financial institutions with a steady source of interest income, as borrowers pay interest on the outstanding balance.
For businesses, a revolving credit facility is a useful tool for managing cash flow fluctuations, enabling them to meet immediate financial obligations while avoiding the need for more costly short-term borrowing. For lenders, it provides a predictable revenue stream and the ability to assess the borrower’s creditworthiness over time.
Understanding revolving credit facility through an example
Imagine a retail company that experiences fluctuating inventory needs throughout the year, with larger stock purchases needed before the holiday season. The company obtains a $1 million revolving credit facility from a bank. Throughout the year, the company can borrow funds up to this limit to cover inventory purchases, repay the loan when sales come in, and borrow again when needed for the next round of purchases. If the company only borrows $500,000 at a time, it is only charged interest on that $500,000 rather than the full $1 million credit limit.
In another example, a small business uses its revolving credit facility to manage payroll expenses. The business has a $100,000 line of credit, and during certain months when cash flow is lower, it borrows against the credit line to ensure timely payments to employees. As the business generates revenue, it repays the loan and then draws from the credit line again as necessary.
An example of a revolving credit facility clause
Here’s how a revolving credit facility clause might appear in a loan agreement:
“The Lender agrees to provide the Borrower with a Revolving Credit Facility of up to $[X] million, which may be drawn, repaid, and redrawn by the Borrower during the term of this Agreement. The Borrower agrees to pay interest on the outstanding balance of the Facility at the rate of [X]% per annum, with payments due on the [X]th of each month. The Borrower may draw on the Facility at any time, provided the total outstanding balance does not exceed the available credit limit.”
Conclusion
A revolving credit facility is a flexible and valuable financial tool that allows businesses and individuals to access funds on an as-needed basis, providing a reliable source of capital to manage short-term cash flow fluctuations. It differs from traditional loans by offering repeated access to credit without the need to apply for new loans each time, making it particularly useful for businesses with variable financial needs. Understanding the structure and terms of a revolving credit facility helps businesses optimize their cash flow management and maintain financial stability.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.