Revolving credit

Definition

Revolving credit refers to a type of credit arrangement that allows individuals or businesses to borrow money up to a predetermined limit, repay it, and then borrow again.

What is revolving credit?

Unlike a traditional loan, revolving credit provides a continuous line of credit that can be used and repaid repeatedly, as long as it stays within the established credit limit.

The credit limit is the maximum amount a borrower can access through the revolving credit arrangement. It is determined by the lender based on the borrower’s creditworthiness, financial situation, and other factors.

Borrowers are charged interest only on the outstanding balance that they carry from one billing cycle to the next. The interest rate can be variable or fixed, depending on the terms of the credit agreement.

Unlike traditional loans with a fixed repayment schedule, revolving credit does not have a set timeline for repayment. Borrowers have the flexibility to repay the outstanding balance at their own pace.

Revolving credit provides a high level of flexibility and convenience, as it allows borrowers to have access to funds when needed without the need to reapply for a new loan.

Example of revolving credit

Let’s consider a manufacturing company, XYZ Corp, that has a revolving credit facility with a bank for $1,000,000. This credit line allows XYZ Corp to borrow funds up to the specified limit whenever they need additional working capital.

1. In January, XYZ Corp faces a cash flow shortage due to delayed payments from customers. They borrow $500,000 from their revolving credit line to cover operating expenses and payroll.
2. By February, XYZ Corp receives payments from its customers, improving their cash flow position. They repay $400,000 of the $500,000 borrowed, reducing their outstanding balance to $100,000.
3. In March, XYZ Corp secures a large contract that requires upfront investment in raw materials and production equipment. They draw an additional $600,000 from their revolving credit line to finance these expenses.
4. By April, XYZ Corp completes the project and starts receiving revenue from the new contract. They use the incoming cash flow to repay $500,000 of the $600,000 borrowed in March

This example illustrates how revolving credit can help businesses manage cash flow fluctuations and fund short-term financing needs as they arise, providing flexibility and liquidity to support operations and growth.