According to a global study conducted by BLinC Invest, around forty percent of small businesses’ financial needs remain unfulfilled with an expected credit deficit reaching approximately ₹25T. Therefore, when it comes to managing cash flow, taking advantage of growth possibilities, and managing unforeseen expenses, having access to flexible capital could make all the difference for businesses. This is where the concept of revolving credit comes into picture. Explore the world of revolving credit to learn more about its definition, workings, and benefits across businesses of all sizes.
Revolving credit Facility (RCF) -meaning and purpose
A Revolving Credit facility (RCF) (also known as revolver) is a short-term financing arrangement which offers flexible access to capital for businesses, enabling them to make payments, and withdraw at any time over an agreed-upon term to the businesses. As the borrowing cycle is repetitive, it saves businesses from all the hassle of applying more new loans every time funds are needed.
Revolving credit facilities can help organizations to sustain their business operations and effectively manage their unpredictable cash flows with their uninterrupted access to credit. Since a revolving credit facility assures faster access to funds without any collateral requirement it has become a popular alternative financing solution for businesses.
Key Features of Revolving Credit Facility (RCF)
Cash Sweep
Revolving Credit facility (RCF) comes with the ‘Cash Sweep’ feature. The Cash sweep feature essentially enables borrower organizations to direct any surplus funds available towards repayment of outstanding debt. Early payment of outstanding debt reduces credit risk and debt obligation by leveraging cash reserves which in turn reduces the need to adopt costlier debt management procedures.
Interest expenses
Among the revolving credit facility’s most useful features is its inherent flexibility and simplicity. The borrower entity is obligated to pay interest expenses on the sum extracted by it, not on the total pre-authorised amount. The balance of the loan is still available for the borrower organization for use as needed. Borrowed funds can be repaid in a single lump sum or monthly installments with variable interest rates dependent on the lender’s prime rate in addition to a fee.
Maximum Sum Available
A revolving credit line can help an organization to swiftly address its cash flow deficiency while fulfilling financial obligations. The bank establishes a maximum borrowing amount for a revolving credit facility, which can be boosted annually based on a company’s consistent, strong cash reserves and consistent revenue, as well as the borrower’s credit score, to minimize risk.
Reusability
The primary reason for calling it a “revolving credit facility” is that it allows the borrower entity to access funds repeatedly post the satisfaction of the outstanding sum. In simple words, it is a recurring cycle of withdrawals, expenditures, and repayments for borrowers until and unless the arrangement duration ends.
Revolving Credit Facility (RCF)
Working of Revolving Credit facility (RCF) – Explained
The borrower entity makes an application for initiating a revolving credit facility with its preferred lender. The lender evaluates the borrower’s application and sanctions a specific credit limit. Next, a Revolving Credit facility (RCF) account is established to be operated in the borrowing organization’s name. The amount is automatically returned to the authorized credit limit after fees and interest are deducted whenever the borrower pays off the remaining debt. Every year the financial institution reviews the permissible amount for revolving facility and adjusts the permissible amount on the basis of the creditworthiness of the borrower’s organization. Therefore, it is necessary for the business owner to communicate the financial situation in order for loan amounts to be reduced or terminated.
Revolving Credit facility (RCF) explained with an example:
For instance, ABC Ltd. has secured a revolving loan facility from XYZ lending institution for an authorised sum of Rs. 5L. ABC Ltd. avails the revolving credit facility to fulfil its payroll expenses when it waits for accounts receivable payments.
Although the business uses up to Rs. 2.5L of the revolving loan facility each month, it pays off most of the balance and monitors the remaining credit limit. Now, another company has signed a contract worth Rs. 5L with ABC Ltd. where the former has agreed to purchase goods for the next five years, the ABC Ltd. has used remaining Rs. 2L of its revolving loan facility for purchasing the required machinery.
Advantages of Revolving Credit facility (RCF)
Revolving Credit facility (RCF) offers Flexible Repayment Structure
A business may require immediate operating capital for a variety of reasons, including investing in development potential or paying legal bills. In these circumstances, immediate access to finances is critical. With a revolving credit facility (RCF) in place, business entities can borrow funds, repay them and repeat the process up to the agreed term.
Relaxed Eligibility Criteria for Availing Revolving Credit Facility (RCF)
When assessing loan applications, conventional banks consider a number of variables, including the nature, credit score, and likelihood of success of the business being considered. However, a revolving line of credit has minimal eligible criteria and businesses who satisfy them are able to acquire capital despite other variables such as lower credit scores, making it a great alternative for small enterprises.
RCF’s Positive Impact On The Business Credit Score
Enhancing a company’s creditworthiness and improving its credit score through on-time repayments further improving funding prospects in near future.
Levelling the Competitive Field with Revolving Credit facility (RCF)
A line of credit can offer necessary funds for critical business functions marketing and advertising which can give a competitive advantage to the business among its peers.
Revolving Credit facility (RCF) Enables Effective Cash Flow Management
Revolving Credit facility (RCF) is an indispensable instrument for managing cash flow, covering recurring expenses, and seizing new possibilities without interfering with ongoing business operations.
Adverse Effects of Revolving Credit Facility (RCF)
RCF may Enhance the Risk of Debt Accumulation
The repetitive nature of revolving credit facilities could potentially entrap the borrower business into a debt buildup, particularly those who are too reliant on credit without an agreed upon repayment schedule. Further, holding balances for a longer period and making minimal payments can lead to a financial strain which can endanger the overall financial stability of a business.
RCF may Attract Variable Interest Rates
Several revolving credit accounts have fluctuating interest rates which may alter over time depending upon the market dynamics. It creates unpredictability in the borrowing costs for the business since the borrowing costs may increase due to rising interest rates in future.
RCF has Limited Use in Long-term Investments:
Revolving credit facility could be more appropriate to fulfil urgent and temporary requirements of a business. However, it might not work for long-term requirements of a business owing to high interest costs and variable interests.
RCF May Have Higher Interest Cost
Revolving credit facilities, as opposed to fixed-interest term loans, have fluctuating rates of interest and extra costs. Accordingly, it might not be appropriate for businesses going through difficult economic times or when market interest rates are rising. Prudent budgeting and intelligent financial management are required to limit the impact of interest charges on the bottom line.
RCF’s Carry the Risk of Over-extending.
Businesses regularly employing revolving credit facilities face the risk of overborrowing funds. It could be a strain on business budgets which leaves lesser funds to weather economic downturns or invest in growth prospects. Thus, businesses should be mindful while taking loans, repay loans on time and practice effective credit management strategies, etc. to reduce such risks.
Impact of Revolving Credit Facility (RCF) on Credit Score
While employing credit facilities like Revolving Credit facility (RCF) effectively, can enhance business credibility, its misuse or exploitation can have adverse consequences. A poor credit score may restrict financing options or, in severe situations, shut down the company’s credit availability.
Credit behavior such as higher credit utilization ratio, missed or delayed payments, etc. and similar credit behavior, etc. which could have adverse impact on the business’s creditworthiness. Thus, maintaining a good credit score requires strict monitoring and commitment to strong financial behavior.
Provided below are some of common factors which can have a positive impact on the credit score-
Payment history-
Credit scores are heavily influenced by payment history. Revolving Credit facility (RCF) accounts having prompt and regular payments reflect the business’s capacity to regulate debt and fulfil its financial commitments.
Credit utilisation ratio-
The Credit utilization examines the amount of credit availed by a business entity out of the total permissible credit limit. Lower credit utilization ratio has a favourable impact on credit scores. As a result, businesses who can maintain their credit utilization percentage below 30% demonstrate lesser reliance on credit and adoption of effective credit management practices.
Healthy Credit mix-
Businesses ought to have a diverse credit mix, including revolving credit, instalment loans, and other business loans. Lenders appreciate a diverse credit portfolio as prompt repayment of different types of credit fosters confidence, which in turn boosts credit scores.
Credit history length-
A positive credit history over a long period signifies financial discipline and sound credit management. Hence, businesses could boost their credit score through maintaining a positive credit score over a long period (i.e. above 700).
Difference between Revolving Credit facility (RCF) and Term Loan
The most obvious difference is the loan amount and tenure. While RCF is for day to day working, term loan generally funds the long term needs of any business. Find below a list of major differences between the two types of credit facility.
Revolving Credit facility (RCF) |
Term Loan |
| A revolving credit facility is a short-term financing arrangement which helps businesses to borrow and repay funds over a recurring borrowing cycle. | A term loan is a long-term financing tool which allows businesses to borrow specific sums to be repaid over a prolonged period. |
| The Revolving Credit facility (RCF) is automatically renewed once the amount has been repaid in a continuing cycle. | Term loans are disbursed as a one-time payment for the stipulated repayment period. |
| Revolving Credit facility (RCF) only charges interest on the amount borrowed, not the entire pre-approved credit limit. | The term loan interest charges are based on the overall principal amount. |
| Revolving Credit facility (RCF) is ideal for meeting short-term working capital requirements. | Term loans are repaid over a certain time period and are intended for long-term investments. |
Difference Between Revolving Credit facility (RCF) and Overdraft
While both give access to capital to any business the essential difference lies in the fact that OD is overdrawn on your own cash or funds, while RCF is funds of the bank that a business uses for its working capital requirement.
Revolving Credit facility (RCF) |
Overdraft |
| Revolving Credit facility (RCF) is a temporary financing arrangement that provides businesses with flexible access to capital by enabling businesses to access, pay back, and draw funds in a recurring cycle. | A business overdraft is a type of revolving line of credit tied to an entity’s official corporate account which enables organizations to draw funds more than the amount available in account. |
| Revolving Credit facility (RCF) is available by a lender other than the financial institution where the borrower holds an official business account. | Banks offer overdraft facilities as part of the process of opening a current account or upon request from a corporate entity. |
| Revolving Credit facility (RCF) is generally primarily utilized for short-term operating capital, but it might also be used to fund growth prospects to boost revenues and long-term viability. | Business overdrafts are short-term funding options that help organizations to manage a business cycle through trading cycles to maintain smooth business operations. |
| Revolving Credit facility (RCF) is only available for limited companies. | Usually, small business entities like sole proprietors are able to maintain a separate personal as well as business account, with the business overdraft facility to help with cash flow. |
| May require a corporate or personal e guarantee. | Does not require a guarantee. |
Final Words
Finally, a revolving credit facility is an invaluable financial instrument which helps businesses to fulfil short-term fund needs with flexible repayment terms. Swift access to funds could be a life-saver for organizations functioning across seasonal and unstable industries. Nevertheless, businesses should also be mindful regarding potential dangers, including interest costs, the possibility of overleveraging and its impact on business’ creditworthiness.
When used effectively, revolving credit can be an invaluable tool to navigate the intricacies of business capital, offering the liquidity required to prosper in cutthroat marketplaces. We at BankKeeping help SMEs navigate their banking journey with ease.We are equipped with latest technologies and expertise to help SMEs negotiate better terms and be on time with critical documentation and projections whenever called for. To help reduce your borrowing cost connect with BankKeeping or Request Demo. BanKeeping is the only Indian SaaS organisation that has designed a “loan management software for Borrowers.”
FAQs
What is a revolving credit facility (RCF)?
RCF is a short-term financing arrangement which offers flexible access to capital for businesses. This capital can be repaid, withdrawn and used at any time during the agreed time frame for a predetermined limit.
What are appropriate conditions to use RCF in Business?
RCF can be used for seasonal businesses, to fill cash flow gaps and for sudden short term requirements.
Is interest on RCF fixed or variable?
The interest on RCF is generally variable, but the interest is charged only on the amount withdrawn and not on the whole sanctioned limit.
Is collateral required to get RCF?
Generally Not, but it may be a prerequisite set by certain banks depending on the profile of the business/business owner as a security against the loan offered.