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Maximizing Business Flexibility: The Advantages of Revolving Loan Credit Facilities
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"Revolving credit lines offer unparalleled flexibility and liquidity, serving as a cornerstone for businesses seeking to navigate the unpredictable waters of financial management."
"Unlock your business potential with financial flexibility that adapts to your needs, not the other way around."
Beyond Traditional Loans: The Revolutionary Benefits of Revolving Credit
Introduction - Understanding Revolving Loan Credit Facilities
Business financing in Canada often 'revolves' around including revolving loans in your business finance mix. Businesses use a revolving credit facility for better working capital management. How does this type of credit facility work?
The Functionality of Revolving Loans
Revolving loans are a type of business credit provided by banks and other commercial lenders that allow a business to draw down on financing, continue repaying, and draw down based on cash inflows from receivables, etc.
These are known as 'facilities' in that they are a type of service such as a defined line of credit that revolves.
Integration into Business Finance Strategy
Revolving business credit lines are a vital tool in business finance and should be a part of your firm's overall business finance strategy.
These 'revolvers' allow you to meet day-to-day operating needs and plan for anticipated cash flows based on sales and cash collection projections. In more mature companies that are established, they are a part of the overall capital structure of the business and are complemented by other long-term financings such as term loans, leases, etc.
Leveraging Revolving Business Lines of Credit
A revolving business line of credit loans allows a company to access a defined amount, typically called a 'credit limit.'
Normal uses of this type of credit facility are for buying inventory from suppliers, maintenance and repairs, funding marketing, and addressing gaps in carrying larger amounts of a/r and inventory or seasonal requirements based on the industry in question.
The business's assets secure a Typical revolving credit line - the most common security being accounts receivable and inventory. In the case of asset-based lenders, they allow fixed assets owned by the company to be monetized within the same facility.
Typically, chartered banks do not include fixed assets as part of the' borrowing certificate ' that banks calculate monthly based on your levels of a/r and inventories.
Exploring Unsecured Lines of Credit
In some cases, commercial lenders may utilize the concept of an Unsecured line of credit - which provides a certain level of borrowing based on a general security agreement - 'GSA' on all the company's assets. Typically, the personal guarantees of the business owners play a key role in unsecured credit.
Flexibility and Key Differentiators
The key aspect of revolving business lines of credit is clearly 'flexibility'. The continual drawdown and repaying of the facility creates a 'pay as you go' scenario as businesses both use and consume cash as they run and grow their business. That's good news!
Understanding Limits and Borrowing Base
The key differentiator in business credit facilities that revolve is that it's not a term loan via that continual drawing down and repayment we just referenced. However, like term loans, they do often come with 'limits,’ but more importantly, they vary with your assets.
Borrowing Base Determination
Here an important distinction occurs. These pre-imposed limits are often fixed regarding bank credit lines and relate directly to typical receivables and inventory.
However, if you chose an asset-based non-bank line of credit via a commercial finance firm, that borrowing base typically has no upward limit if you, in fact, have growing sales and commensurate assets.
Establishing Borrowing Power
That monthly 'borrowing base' that banks and asset finance companies utilize comes with some basic formulas.
For banks utilizing receivables as an example, the borrowing base is 75% of your A/R; asset-based lenders typically lend against 90%. (In both cases, receivables must be under 90 days old).
Those calculations are a key part of a revolving credit facility agreement and establish your 'borrowing base', which the lender documents regularly with a 'borrowing base certificate'
Margining and Asset Valuation
Asset-based lenders and banks determine your borrowing power by 'margining' a discount factor against a specific asset based - most commonly receivables and inventory.
As an example, if an asset-based lender allows a discount factor of 90% on receivables, which is common, a 1 million dollar receivable portfolio can represent a revolving loan of 900,000.00. The same type of calculation applies to inventory, and asset lenders also allow your unencumbered fixed assets to be margined in the same manner!
Banks typically have revolving loan facility agreements around a/r and inventory only, with possible exceptions.
Nuances in Asset Valuation
Various nuances might exist in your A/R margining, typically relating to government receivables, high balance concentrations with one customer, etc.
Covenants and Pricing
Revolving loans from banks come with various covenants and restrictions. In general, we can make the statement there is a lot less restriction from non-bank asset lenders on this issue.
Pricing Considerations
What then are some of the key issues around pricing revolving loan credit facilities? No one disputes that Cdn chartered banks offer the lowest cost business financing rates - if you can satisfy the risk profile desired by the banks. That risk profile typically includes growing sales, profits, clean balance sheets and demonstrable cash flows. Let the 7 Park Avenue Financial team help you compare revolving credit facilities from different lenders.
Credit Risk and Eligibility
Interest rate pricing on non-bank asset financings varies proportionately to credit risk and come with fixed or variable rates. The good news is that almost any firm with sales and assets is eligible for asset-based credit lines. So, its overall credit risk and the amount and type of debt a company has are the drivers behind asset-based revolving loans and other alternative working capital solutions.
Distinguishing Term Loans and Credit Lines
Commercial lenders clearly separate term loans from revolving loans/credit lines. Credit criteria for a term loan involve a firm's total credit profile focusing on clean balance sheets, profits, and the ability to generate cash flow as loan repayment over several years.
Operating Performance Focus
Regarding credit lines, business financing is all about operating performance. Credit lines don't require fixed payment terms, they 'revolve' and we can make the case they come with a maximum amount of financial flexibility.
A bank or an alternative lender offering non-bank lines of credit ultimately likes the facility to revolve and, at some point, be significantly reduced before it is drawn down again based on the needs of the business. When it comes to revolving loans from either a bank or an ABL lender, your revenue and operating performance allow you to access short-term operating capital.
Advantages of Revolving Loans
Most businesses eventually realize they need a proper business revolving line as a funding option to borrow money.
The advantages of revolving credit facilities tend to become very clear:
- The ability to draw on financing as you need it - flexibility with cash flow management
- The facility is already in place, and your company can access it immediately.
- Interest rates and cost of borrowing are generally lower and easier to understand
- Outside collateral to the business is generally not required - The business credit score and business credit history are less important in ABL finance.
- Businesses can pay down the facility at any time as cash flows into the business - No 'prepayment penalty.
- Your financing costs are commensurate with only what you are drawing on under the facility.
- Good relationships with your bank or commercial lender will always lead to higher revolving line of credit approvals as your business grows.
Key Takeaways
- Understand that these facilities allow businesses to draw funds as needed, providing critical liquidity without needing continuous loan applications.
- Flexibility in Repayment: Businesses benefit from the flexibility to repay and reborrow within the credit limit, adapting quickly to changing financial needs. Companies pay interest only on funds drawn down - i.e. not a fixed repayment schedule. Borrowers access pre approved funds under the facility under available credit - essentially access to on-demand financing as sales and assets grow
- Interest Cost Efficiency: Only the borrowed amount accrues interest, offering significant savings over fixed loans where interest is charged on the total loan amount from the start. Both banks or an ABL lender might request a commitment fee.
- Credit Score Improvement: Regularly utilizing and repaying draws from these facilities can enhance a company's credit profile, making future financial transactions more favourable.
These concepts form the foundation of understanding the value of revolving loan credit facilities, emphasizing their role in strategic financial management.
Conclusion
Revolving loans and bank or asset-based lines of credit provide a safety net for the business as the credit facility allows you to draw down on cash flow needs over time as your company generates sales.
Interest rates are often higher when accessing business capital via an alternative lender, but these 'ABL' lenders provide capital when a company can't access traditional bank financing, particularly for small and medium-sized companies that can't access public markets.
Searching for the correct type of credit facility for your firm?
Contact 7 Park Avenue Financial, a trusted, credible, experienced Canadian business financing advisor who can assist with your credit facility needs.
FAQ: FREQUENTLY ASKED QUESTIONS / PEOPLE ALSO ASK / MORE INFORMATION
What makes revolving loan credit facilities so beneficial for businesses seeking financial flexibility?
- They provide immediate access to funds up to a certain limit, offer flexible repayment terms, and charge interest only on the amount used, making them ideal for managing fluctuating cash flow needs.
How do revolving loan credit facilities differ from traditional loans?
- Unlike traditional unsecured loans from a bank or credit union that provide a fixed amount of money with a set repayment schedule, revolving loans allow businesses to borrow, repay, and reborrow funds as needed within the credit limit. Some smaller firms consider the Merchant Cash Advance, a sort of temporary short-term fixed business loan for working capital with minimum payments by installment.
Can revolving loan credit facilities help improve a company's credit score?
- Yes, by using these facilities responsibly and making timely repayments, businesses can help ensure strengthening overall credit profiles and demonstrate creditworthiness, potentially improving towards a good credit score. Supply chain funding is more accessible with ABL solutions.
What types of expenses are best covered by revolving credit facilities?
- They are beneficial for covering operational and emergency expenses or taking advantage of timely investment opportunities without lengthy loan approval processes.
Are there any downsides to using revolving loan credit facilities?
- While highly flexible, these facilities may have higher interest rates compared to traditional loans and require disciplined financial management to avoid excessive debt accumulation.
How does one apply for a revolving loan credit facility?
- Businesses typically apply through a financial institution, providing financial statements and other documentation, such as business bank account info/statements, etc, to demonstrate creditworthiness and operational stability.
What impact do interest rates have on revolving loan credit facilities?
- Interest rates determine the cost of borrowing; lower rates make it more cost-effective to use these facilities for short-term financial needs.
Can startups qualify for revolving loan credit facilities?
- Startups may qualify, but they might face stricter criteria as balance sheet, income statement, and cash flow data may not qualify for the amount of financing required. Many earlier stage and smaller firms access factoring as a line of credit solution.
