Revolving vs Non-Revolving Credit Facilities

How do you decide when one is better than the other? Let's look at how these two types of banking facilities are different and which one you should choose.
revolving credit facility

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You may have heard of both revolving and non-revolving loans, but do you know what the difference is?

How do you decide when one is better than the other? Let’s look at how these two types of banking facilities are different and which one you should choose.

Non-Revolving Credit Facility

When a credit facility is described as “non-revolving,” it basically means that it was given only once and that all of the funds were disbursed at once. The loan principal will normally be serviced by the borrower in regular installments.

Unsecured business term loans are the most prevalent type of non-revolving credit facility.

The principle loan amount will be paid to you in a lump payment if your application for a working capital loan is granted. It will be repaid over a predetermined period of time, ranging from 1 year to 5 years.

Secured term loans, sometimes called asset-based finance, are another sort of non-revolving arrangement. You won’t receive cash, and the loan is intended to help your business buy an asset like a piece of commercial or industrial real estate, machinery, or equipment.

Your bank will pay the asset’s seller directly for the purchase price, which includes your down payment, which will typically be about 20% of the asset. Following that, you will repay the loan in installments throughout the specified time period.

A term loan is fixed for the defined payback term, as opposed to revolving lines of credit, which are normally evaluated by banks every one to two years.

In Singapore, the majority of term loans are computed using a reducing balance monthly rest method. Throughout the loan’s term, your initial loan principal will be amortized.

Use this business loan interest calculator to calculate loan amortization for a more thorough explanation.

When the first loan is disbursed, you must reapply for a new loan if you need more money, unlike with a revolving credit line.

If you pay off the loan in full or in part before the term is up, the majority of banks will often charge an early repayment penalty.

This is known as a “break-fund” cost by some institutions. The penalty for early repayment is typically 1 to 5% of the outstanding balance redeemed. Some banks might calculate the penalty based on how much money was borrowed in the first place.

Since most term loans are amortized, redeeming a loan earlier may not be financially advantageous, especially as the loan term nears its end.

At the end of the loan term, the redemption penalty may be greater than the loan’s interest component.

Revolving Credit Line

A facility without a fixed term is a revolving line of credit. The credit line can then be repeatedly tapped. As a short-term business lending option, this is helpful.

Revolving credit lines can either be secured and unsecured. If the line is secured, it simply means that the lender has collateral that you put up as a guarantee for the credit line facility that was given to you.

Because of the pledged collateral, the interest rates of secured credit lines are often lower than unsecured ones. Furthermore, credit limits for secured lines are also usually higher because of the collateral placed.

Revolving basically means that you can use the credit line repeatedly, up to the allotted limit granted. It functions much like your own personal credit card.

Consider that your business has an unsecured credit line of $100,000, of which $50,000 has already been used. You will still have access to the remaining limit of $50,000, that can be used at your discretion.

And as soon as the outstanding $50,000 is repaid, the credit limit reverts back to $100,000, where you can then utilize as you see fit.

Revolving credit line facilities are often either an overdraft or a trade finance line.

Overdraft is a straightforward feature that allows you to withdraw money as needed, up to the credit limit set by your bank.

Banks rarely offer overdraft (OD) facilities in the SME lending sector. When granting overdraft facilities, banks must lock up their limited overall lending limits. So if the borrower does not use the OD line, it will be a waste of the bank’s lending capacity.

Trade financing lines tend to be a little more complex than overdraft facilities. It usually has a greater credit limit than an overdraft line facility.

The main distinction is that, unlike overdraft accounts, trade finance lines do not provide instant cash withdrawals.

Only when you have given the bank a copy of your supplier’s invoice can you use the trade financing line to fund payments to your suppliers.

If you request that your banks conduct an instant payment transfer to the supplier, transportation documents like delivery orders or bills of lading may also be necessary.

The ability to tell your bank to issue a Letter of Credit (LOC) to a supplier is available with almost all trade financing lines.

This is more frequently utilized when buying from foreign vendors who are located abroad.

Increasing Your Credit Facility Limit

If your business already has a credit line from a bank or financial institution, you may want to raise the limit over time.

Most SMEs would rather have a higher credit limit. In fact, the higher the limit, the better. Revolving credit lines give the company quick access to credit that can be used in case of cash flow problems or to take advantage of unplanned business opportunities.

If the company needs quick access to money from outside sources, a higher credit limit will give them more options.

Here are 4 things you can do to improve your chances of increasing the limit of your credit facility.

1. Pay on time

When you use your credit line, the banks will keep track of how you make payments throughout the year.

Making sure you have a perfect record of paying back your loans on time will go a long way towards getting your credit limit raised.

Keep your credit cards, car loans, and home loans in good shape and make your payments on time.

On top of the company’s records, most banks will also check a director’s personal loan repayment history with the credit bureau.

2. Have a good reason

Think carefully and carefully about why you need a limit increase.

The bank’s credit department will want to know why they should increase your credit limits. Give them proper reasons to justify the increase.

Show your purchase orders (POs) or client contracts to your bankers. And while you are at that, try to present larger volume numbers to them.  

If you just got a big contract, you should also show your banker the letter of award. Any proof that reflects the need for a higher limit should be shown to the bank so that they can do a proper evaluation.

3. Make full use of your credit line

Try to use your line of credit as often as you can. When you need to ask the bank to raise your limit, they will be more likely to say yes.

It’s easy to understand why. If the bank has already given you a credit line but you don’t use it at all for a long time, they will be hesitant to raise your limit when you ask for it.

You need to show the banks that you have been utilizing your credit line. If you don’t utilize the credit line, then the banks don’t earn any interest. 

Also, because of the Basel 3 accord, banks cannot be too generous with the total amount of credit they give out in their loan books.

If you intend to keep your credit line as a backup source of cash, try to use it at least once every in every 2 to 3 months and pay it back quickly so you pay the least amount of interest.

4. Update your company financials

Whenever your credit line is reviewed every year, make sure your accounts and financial reports are up to date.

Your last year’s income is a strong indicator of whether or not the bank will raise your credit limit.

If your last financial year’s turnover was higher than the year before, most banks will be willing to increase your limit if you ask.

As your revenue grows, so will your credit limits. Therefore, if the revenue increase is not significant, then neither will your credit limits.

If the bank’s credit department does not have your company’s updated financials, they will not be able to do a proper review of your company’s current financial strength.

Which business credit facility should I choose?

Your situation and, more significantly, the amount of financing you need will determine this.

A non-revolving term loan facility is the best option if you require funding for a mid to long-term project, such as the purchase of equipment.

Using a term loan is a good idea when you want to expand your business, buy real estate, open new locations, or accomplish any other business goal that will take 1 to 3 years to pay off.

On the other hand, a revolving credit line is more suited to short-term funding requirements.

Since it can assist with very urgent operating capital needs, many SME owners use it as an “emergency fund”.

Revolving credit lines can be an effective and helpful financing tool for tiding over cash flow gaps, and to ensure that your company will have enough working capital to operate smoothly.

It is important to note that revolving credit lines, like overdrafts, are assessed very differently from amortized term loans.

The average overdraft is determined by compounding interest on a daily or weekly basis.

Incorrect usage of compounding interest, which is the opposite of amortized interest, will result in exorbitant borrowing expenses.

If you treat an overdraft as a term loan and plan to pay it back over a lengthy period of time, the compound interest will quickly snowball and balloon up to a significant amount in comparison to the original amount borrowed.

Use the overdraft solely when you need short-term financing, such as to cover payroll costs, expenses that are seasonal, or to bridge a cash flow gap when you are trading products.

Short term funding needs = Revolving facility

Mid-long term funding needs = Non-revolving facility

Matching the timeline of your financial needs to the proper financing facility is crucial when choosing between revolving and non-revolving facilities.

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