Revolving Loan Facility Explained: How Does It Work?

What Is a Revolving Loan Facility?

A revolving loan facility, also called a revolving credit facility or simply revolver, is a form of credit issued by a financial institution that provides the borrower with the ability to draw down or withdraw, repay, and withdraw again. A revolving loan is considered a flexible financing tool due to its repayment and re-borrowing accommodations. 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. In contrast, a term loan provides a borrower with funds followed by a fixed payment schedule.

How a Revolving Loan Facility Works

A revolving loan facility is typically a variable line of credit used by public and private businesses. The line is variable because the interest rate on the credit line can fluctuate. In other words, if interest rates rise in the credit markets, a bank might increase the rate on a variable-rate loan. The rate is often higher than rates charged on other loans and changes with the prime rate or another market indicator. The financial institution typically charges a fee for extending the loan.

Criteria for approval of the loan depends on the stage, size, and industry in which the business operates. The financial institution typically examines the company’s financial statements, including the income statement, statement of cash flows, and balance sheet when deciding whether the business can repay a debt. The odds of the loan getting approved increases if a company can demonstrate steady income, strong cash reserves, and a good credit score. The balance on a revolving loan facility may move between zero and the maximum approved value.

How Do Businesses Use a Revolving Loan Facility?

A revolving loan or line facility allows a business to borrow money as needed for funding working capital needs and continuing operations. A revolving line is especially helpful during times of revenue fluctuations, since bills and unexpected expenses can be paid by drawing from the loan. 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 a 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 machinery.

The Bottom Line

For businesses with fluctuating income, a revolving loan facility can be a great option for meeting payroll or covering unforeseen expenses. Establishing a revolving loan facility with your bank could be a wise move for your business.