Written by Team 365 finance
Revolving credit is a type of credit that allows a business to borrow a certain amount of money, up to a predefined borrowing limit.
Most businesses use revolving credit for operational purposes. With revolving credit, a business can steadily fund their operations without having to rely on incoming cash to pay their suppliers, employees and other creditors.
For startups, small businesses and large, capital-intensive businesses alike, revolving credit is an essential part of financing. Below, we’ve explained what revolving credit is in more detail, as well as the important role it plays in business finance.
What is Revolving Credit?
Revolving credit is a type of credit that grants a business access to money until it’s borrowed up to its credit limit. As the business repays the balance and interest, it regains the ability to borrow from the revolving credit line.
If you’ve ever borrowed using a credit card, you’ve used a form of revolving credit (although at a significantly smaller scale than most businesses).
Unlike a conventional business loan, revolving credit typically doesn’t have a set borrowing and repayment schedule. Instead, it’s available on an as-needed basis for a business to pay its staff, buy necessary items and make other operational expenses.
Revolving Credit vs. Non-Revolving Credit
The key difference between revolving credit and non-revolving credit is the availability of credit after a business pays off the account.
With revolving credit, a business can borrow as needed, as long as it hasn’t reached the credit limit. For example, if a business has up to £500,000 in revolving credit and has already spent a total of £400,000, it can borrow a maximum of £100,000 before hitting the credit limit.
If the business reaches the credit limit, it can repay some or all of the balance. For example, if the business above (which just maxed out its credit by borrowing £500,000) uses £250,000 to pay off half of its balance, it can borrow another £250,000 as needed in the future.
Obviously, this borrowing comes with interest and fees. Just like a typical credit card, revolving credit for a business requires paying interest whenever the account has a balance. The more a business borrows, the more it will need to pay in interest to the bank every month.
With non-revolving credit, such as a conventional business loan, credit can’t be used a second time after it’s paid off.
For example, if a business borrows £500,000 from the bank, it receives the entire sum at once and agrees to pay it back on a fixed schedule. With each payment, the balance decreases until the entire loan is paid back.
If the business has repaid half of its £500,000 loan and decides it needs to borrow £250,000, it can’t do so using the same loan. Once the loan is paid off in full, the account is closed and the business will need to take out a new loan if it needs to access more credit.
Advantages of Revolving Credit
The biggest advantage of revolving credit is that it allows a business to manage its cash flow on a day-to-day basis without having to worry about using incoming cash from accounts receivable to fund its operations.
For example, a company that manufactures car parts might work out a trade credit agreement with the car companies it supplies that allows them to pay once every quarter. This makes life easier for the manufacturing company’s customers and helps fuel the company’s growth.
However, the manufacturing company might need to pay its suppliers every month and its staff every two weeks. Revolving credit lets the company make these payments, then use the cash from its customers to settle its revolving credit as cash flows into the company.
Another advantage of revolving credit is that companies are free to use it only when it’s really needed. This means that the company can borrow only for a short period of time, reducing the total amount of interest paid on the account balance by shortening the loan period.
Finally, revolving credit is flexible. If a company runs into unforeseen expenses and needs cash to pay them, revolving credit allows the company to quickly access the money it needs without a long, slow approval process.
Disadvantages of Revolving Credit
Revolving credit also has several disadvantages, the biggest of which is its cost. Compared to a conventional business loan, revolving credit is usually expensive. The interest rates are typically higher and the fees are larger than those applied to a long-term, non-revolving loan.
Many banks even also charge a fee for undrawn revolving credit, meaning a business could pay for access to revolving credit even if it doesn’t actively use it.
Another disadvantage of revolving credit is its limited purchasing power. While a business might be able to access £1 million or more in credit through a conventional business loan, it’s common for banks to only offer a fraction of this as revolving credit in order to manage risk.
Because of these disadvantages, most businesses use revolving credit for short-term borrowing and rely on traditional financing for larger, longer-term loans.
Revolving credit is one of several forms of credit available for businesses. It’s typically used for managing cash flow, allowing a company to fund its operations without having to depend on the cash it receives from its customers and clients.
Used effectively, revolving credit can be a powerful tool for businesses. With the right approach, a business can use revolving credit to fund its operations and growth, all while limiting the total cost of its borrowing by paying off its outstanding balance as cash flows in.