Revolving credit facilities: how a business line of credit works

A revolving credit facility is a flexible funding option that lets a business withdraw credit when it needs it and, once the money is repaid under the agreement, use it again. The British Business Bank describes it as working like overdrafts and credit cards, except that you do not use a physical card: the money is paid straight into your bank account.

In everyday use you will also hear it called a business line of credit. The British Business Bank describes a line of credit as a way to borrow up to a certain amount when needed, either as a lump sum or in smaller amounts up to the total agreed. A line of credit can either revolve or have a fixed end date, after which you reapply to keep access to it. Always check which one your agreement describes.

The lender agrees a limit, you withdraw what you need up to that limit, and you repay it on the schedule in your agreement. Once repaid, that money becomes available again without a new application, for as long as the facility runs.

The cycle is easiest to see with round numbers. This is an illustration of the arithmetic only, not a typical limit or cost.

Interest runs only on the amount drawn. The British Business Bank says you are charged for the days you withdraw funding rather than for the total amount of credit, which is the opposite of a term loan.

It also says revolving credit has a fixed interest rate, with repayments usually required daily, weekly or monthly, and that it tends to be available for short periods of three months to two years. You may be able to extend if you make every repayment on time and keep meeting the lender’s eligibility criteria. Your own agreement is what counts, so read it for the term, the repayment schedule and any review date.

It costs interest on the money you draw plus any fees the lender charges, and the British Business Bank warns that revolving credit tends to carry higher interest rates than other forms of funding. Providers also tend to charge fees for setting up the facility.

• Interest: charged for the days money is drawn, not on the whole limit.
• Set-up fees: the British Business Bank notes providers tend to charge them.
• Late repayment charges: some lenders charge extra interest if repayments are late, which could itself cause cash flow problems.
• Other fees: check the agreement for any further charges, such as for renewal or for a limit increase.

Compare facilities on total cost, not the headline rate. Our guide to APR explains what the headline rate does and does not include, and how to compare lender offers covers fees and terms.

A term loan pays out one sum and is repaid over a set term, while a revolving facility lets you draw and repay repeatedly up to a limit, and an overdraft is a facility on your business current account.

For the loan side, see our guides to short-term business loans and working capital loans. For the bank-account version, see business overdrafts.

It makes sense for short-term needs that recur or are hard to predict. The British Business Bank lists unexpected bills, losing a key customer, repairs, a seasonal decline in sales, settling a tax bill, paying staff and suppliers, and growth opportunities.

The pattern behind those examples is a timing gap. Money is due out before it comes in, and you expect it to come in. That is the situation described in our guide to what working capital is, and a facility that you draw and repay as the gap opens and closes fits it.

• A seasonal business that buys stock before the busy period.
• A firm waiting on large invoices while payroll and supplier bills fall due.
• A business that wants funding on hand for unexpected costs.

If customers pay slowly in a pattern that never changes, invoice finance funds that gap directly against the invoices.

The main risks are cost, personal liability and using a short-term product for a long-term need. The British Business Bank describes it as not a long-term solution: because of the interest rates and short lending periods, a business loan or another form of funding could be a better choice.

• Higher cost: rates tend to be higher than other funding, and late payment can add interest.
• Credit impact: failing to repay or paying late could harm your business credit score and limit future funding.
• Eligibility: revolving credit is usually only available to limited companies, so sole traders may find it harder.
• Reliance: drawing on the facility every month to cover costs suggests a structural problem that borrowing will not fix.

Most lenders do not require security or assets for revolving credit, according to the British Business Bank, but the position depends on the lender and the facility.

Start with what the money is for, then compare the term, the repayment schedule, the total cost, the guarantee and security required, and what happens at renewal.

• Work out the size of the gap using a cash flow forecast, and borrow for that gap rather than a round number.
• Check whether the facility revolves or ends on a fixed date.
• Ask how often you repay and what happens if you miss a payment.
• Find out whether a personal guarantee or security is required.
• Take advice from your accountant on how the borrowing affects your tax and accounts.

Our cash flow forecast guide shows how to size a gap before you apply.

Capzy is a credit broker, not a lender, and is paid by the lender. Revolving credit is one of the funding types we can introduce you to, and the lender directory shows the types of finance different lenders provide.

You can check your funding options with a soft search that does not affect your credit score. A full application to a lender may involve a hard search, and any offer is subject to status and lender criteria. Capzy does not give tax or accounting advice.