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Revolving Loan Facility

Definition

A Revolving Loan Facility is a type of loan agreement in which the lender extends a fixed amount to a borrower, which can be drawn, repaid, and redrawn again over the term of the loan. It offers the borrower flexibility to manage fluctuating cash flow needs. Since it works similarly to a credit card, it is also known as revolving credit.

Phonetic

The phonetics of “Revolving Loan Facility” would be: ri-ˈvälv-ing lōn fə-ˈsi-lə-tē

Key Takeaways

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  1. A Revolving Loan Facility is a type of credit issued by a financial institution that provides the borrower with the ability to draw down or withdraw, repay, and withdraw again. It’s a flexible financing method primarily used for operating purposes.
  2. Interest rates on a Revolving Loan Facility are typically variable, and the rate is often tied to a base rate such as LIBOR or the Prime Rate. The borrower only pays interest on the money that they actually borrow, not on the entire credit facility.
  3. Revolving Loan Facilities are often used by businesses to manage cash flow fluctuations, providing a safety net for unexpected expenses or opportunities. They are usually considered short-term loans and are not typically used for long-term investments or assets.

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Importance

A Revolving Loan Facility is an important financial tool for businesses as it provides flexibility and ready access to funds. It essentially serves as a line of credit, where a business can borrow, repay, and borrow again up to a certain limit. This becomes critical for managing short-term cash flow fluctuations, addressing operational expenses or funding unexpected needs that a business may face. The provision to re-borrow funds offers an advantage over conventional term loans, making it a go-to option for businesses seeking continual access to capital. Therefore, a Revolving Loan Facility plays a pivotal role in maintaining the liquidity and financial stability of a business.

Explanation

The primary purpose of a Revolving Loan Facility is to provide businesses with access to flexible and readily available capital that can be utilized as per their immediate operational or investment needs. Given its characteristic of “revolving,” the loan facility offers the advantage of borrowing, repaying, and borrowing again, inherently behaving like a credit card for businesses. This convenience of repeated access to funds without reapplying makes it suitable for managing inconsistent cash flows, bridging short term funding gaps, financing seasonal bulges in inventory, or even for unexpected expenses or growth opportunities. Moreover, a Revolving Loan Facility can be used as working capital for businesses, thereby enabling them to sustain operations and meet routine expenses like salaries, rent, or supplies, especially during financial strain. Another significant utility arises from its line of credit feature. Businesses can draw down and repay their credit line multiple times within the agreed limit without getting penalized, which promotes financial efficiency. Hence, a Revolving Loan Facility serves as a flexible financial cushion for businesses, ensuring continued operations irrespective of financial volatility or market unrest.

Examples

1. Credit Cards: One of the most common examples of revolving loan facilities is credit cards. Creditors set a credit limit, which is the maximum amount the cardholder can borrow. The cardholder makes purchases up to the limit, then pays it off over time. If they pay off their balance, their credit availability is restored, allowing them to make new purchases. 2. Overdrafts: Some banks offer overdraft facilities to their customers, which is another example of a revolving loan facility. The bank allows the customer to overdraw their account up to a specified limit. These loans can be paid back periodically, and once paid off, can be used again whenever necessary.3. Business Line of Credit: Companies may establish a revolving loan facility with their bank, often known as a business line of credit. This provides a company with access to a certain amount of funds which they can draw from when needed, then pay it back over time. Once the loan amount is repaid, the company can withdraw it again. This allows a business to manage variations in cash flow, invest in growth opportunities, or cover unexpected expenses.

Frequently Asked Questions(FAQ)

What is a Revolving Loan Facility?

A Revolving Loan Facility is a type of loan made in a business finance context. It allows the borrower to draw down or withdraw, repay, and withdraw again in any manner and any number of times, until the arrangement expires. The amount can vary up to a specified limit.

What are the main features of a Revolving Loan Facility?

This type of loan allows for the flexible withdrawal of funds, repayments, and re-withdrawals. It has an established upper limit and often allows the borrower to only pay interest on the portion of the funds they have withdrawn.

How does interest work in a Revolving Loan Facility?

The interest in a Revolving Loan Facility is usually charged only on the amount that has been withdrawn, not the total credit limit. It’s typically variable, meaning it can fluctuate based on a base rate (like the prime rate).

When should a business consider a Revolving Loan Facility?

A Revolving Loan Facility is beneficial for businesses that experience drastic fluctuations in cash flow or those in need of short-term funding for operational costs, such as payroll, manufacturing, or other recurring payments.

How does a Revolving Loan Facility differ from a term loan?

Unlike a term loan, where both the principal and interest must be paid on a predetermined schedule, a Revolving Loan Facility allows flexibility in withdrawal and repayment and charges interest only on the amount withdrawn.

What happens when a Revolving Loan Facility expires?

When a Revolving Loan Facility expires, the borrower must either repay the entire outstanding loan or renew the facility with the lender. Some lenders may offer to transform the outstanding balance into a term loan at the end of the revolving period.

Is a credit card a type of Revolving Loan Facility?

Yes, a credit card is a common example of a consumer level Revolving Loan Facility. It allows consumers to use available credit repeatedly, up to a certain limit, while paying off balances over time.

What are the potential risks associated with a Revolving Loan Facility?

Like any loan, a Revolving Loan Facility carries the risk of the borrower being unable to repay the funds borrowed. Also, with its access and ease of use, businesses may be tempted to over-borrow. Furthermore, as interest rates are subject to change, this could impact the cost of borrowing.

Can a Revolving Loan Facility be secured or unsecured?

Yes, a Revolving Loan Facility can be either secured (backed by collateral from the borrower) or unsecured (not backed by any collateral). The terms and conditions, including interest rates, may vary based on the type of loan.

Related Finance Terms

  • Interest Rate: The rate that a borrower must pay to a lender for the use of borrowed money. In a revolving loan facility, interest rates may vary based on the amount of money withdrawn and the prevailing market conditions.
  • Line of Credit: This is another term for a revolving loan facility which is a type of loan where the borrower can draw down and repay the loan multiple times within a certain limit.
  • Commitment Fee: This is a fee that a lender may charge for making a revolving loan facility available. It is usually calculated as a percentage of the undrawn amount of the facility.
  • Maturity Date: This is the date on which the revolving loan facility must be fully repaid. Until this date, the borrower can continuously draw down and repay the loan.
  • Collateral: This refers to assets that a borrower offers to a lender as security for a loan. If the borrower fails to repay the loan, the lender has the right to seize these assets to recover the loan amount.

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