Maintaining a steady cash flow is essential for any business, but unpredictable expenses and delayed payments from customers can make it difficult. This is where revolving credit comes in — a flexible financial solution that gives businesses access to funds whenever they need them.
Unlike traditional loans, which provide a fixed lump sum, revolving credit allows you to draw money as needed, repay it, and then borrow again. This cycle of borrowing and repayment offers businesses greater control over their finances. In this guide, we’ll explore how revolving credit works, its benefits, and how to determine if it’s the right financial tool for your company.
What is Revolving Credit for Businesses?
Revolving credit is a type of business financing that allows companies to borrow up to a set credit limit, repay the balance, and then borrow again as needed. It works similarly to a credit card but is often used for larger business expenses.
Here’s how it works:
- Credit Limit: You receive a maximum borrowing limit (for example, $50,000).
- Draw Funds as Needed: Withdraw funds when you need them, whether it’s to cover payroll, inventory, or other business expenses.
- Interest on Borrowed Amount: Interest is only charged on the amount you withdraw, not the entire credit limit.
- Repay and Reuse: Once you repay what you borrowed, those funds become available to borrow again.
The flexibility of revolving credit makes it a valuable tool for handling short-term cash flow gaps, seasonal expenses, and unexpected emergencies.
How Does Revolving Credit Work?
To better understand how revolving credit works, let’s look at an example:
Suppose your business is approved for a $50,000 revolving credit line. You initially borrow $10,000 to purchase inventory. You then repay $5,000 a few weeks later. As a result, you still have $45,000 available to borrow ($50,000 limit – $5,000 balance). If another opportunity arises, you can withdraw up to $45,000 without reapplying for a new loan.
Here’s the process in steps:
- Apply and Get Approved: Your lender sets a credit limit (e.g., $50,000).
- Withdraw Funds: Borrow any amount within your limit (e.g., $10,000) as needed.
- Repay Borrowed Funds: Repay the principal and interest over time.
- Borrow Again: Your credit is replenished, and you can draw funds again up to the full $50,000 limit.
Unlike a term loan, where you receive a lump sum and make fixed monthly payments, revolving credit allows you to borrow, repay, and repeat. This ongoing cycle offers continuous access to working capital.
Types of Revolving Credit for Businesses
Revolving credit comes in several forms, each tailored to different business needs. Here are the most common types:
Business Line of Credit
A business line of credit allows companies to access funds as needed, up to a set credit limit. It works like a credit card but often comes with lower interest rates and higher credit limits. This option is ideal for managing cash flow fluctuations or covering short-term expenses.
Business Credit Card
Similar to a personal credit card, a business credit card provides a revolving line of credit that can be used for everyday business purchases. It often comes with cashback rewards, points, and perks like travel benefits. Business credit cards are great for covering smaller, ongoing expenses.
Merchant Cash Advance (MCA)
Although not a traditional revolving credit option, an MCA provides an advance on future sales, often repaid through daily deductions from credit card transactions. While it offers quick cash, MCAs have high fees and should be used with caution.
Supplier Credit (Trade Credit)
Some suppliers offer revolving credit, allowing businesses to buy goods and pay later, often with payment terms like “Net 30” or “Net 60.” This option allows you to purchase supplies or inventory and defer payment, helping you manage cash flow.
Benefits of Revolving Credit for Businesses
Revolving credit provides significant advantages for businesses looking to manage cash flow and stay agile. Here are some of the key benefits:
Access to Cash When You Need It
With a revolving credit line, you don’t have to wait for loan approvals. If a business emergency arises, you can draw from your credit line immediately. This is especially useful for handling seasonal fluctuations, urgent repairs, or last-minute inventory purchases.
Only Pay Interest on What You Borrow
Unlike a traditional loan, you’re not paying interest on the entire credit limit. Interest only applies to the amount you withdraw, saving you money in the long run.
Revolving Credit is Reusable
As you repay borrowed funds, your credit limit is restored, giving you continuous access to working capital. This “revolving” nature provides long-term financial flexibility.
Helps Build Business Credit
Consistently using and repaying a revolving credit line builds your business credit score. A strong business credit score improves your ability to qualify for larger loans or better financing terms in the future.
No Collateral Required (For Unsecured Lines)
Unsecured revolving credit lines don’t require collateral, making them accessible to startups and small businesses that may not have large assets to pledge.
Customizable Use of Funds
Unlike specific-purpose loans (like equipment loans), revolving credit can be used for a variety of purposes, such as payroll, marketing, or inventory purchases. This flexibility helps you adapt to changing business needs.
Drawbacks of Revolving Credit for Businesses
While revolving credit has many benefits, there are some potential downsides to consider:
Higher Interest Rates
Revolving credit often comes with higher interest rates compared to traditional loans, especially if you have a lower credit score. Rates can range from 8% to 25%, depending on the lender and your creditworthiness.
Fees and Maintenance Costs
Some lenders charge fees to maintain a revolving credit line, including annual fees, draw fees (when you withdraw funds), and inactivity fees (for not using the credit).
Can Encourage Over-Borrowing
Because credit is always available, businesses may be tempted to overborrow, leading to a cycle of debt. Without a solid repayment plan, it’s easy to fall behind on payments.
Requires Strong Credit for Approval
Unsecured revolving credit lines require a good business or personal credit score, often 680 or higher. New businesses or startups with limited credit history may have difficulty qualifying.
How to Qualify for Revolving Credit
Qualifying for revolving credit depends on the type of credit you’re seeking and the lender’s requirements. Here’s what most lenders look for:
Business and Personal Credit Score
Lenders typically require a credit score of at least 680 for unsecured lines of credit. If your credit is lower, you may need to apply for a secured credit line or business credit card.
Time in Business
Many lenders prefer businesses that have been operational for at least 6 months to 2 years. Startups may have difficulty qualifying without a strong credit history or collateral.
Annual Revenue
Lenders look for consistent cash flow and revenue to ensure you can repay borrowed funds. Online lenders may require monthly revenue of $10,000 or more.
Financial Documents
Lenders will ask for business bank statements, tax returns, and profit-and-loss (P&L) statements to evaluate your financial health.
How to Apply for a Revolving Credit Line
Follow these steps to apply for revolving credit for your business:
1. Gather Required Documents
Prepare the following:
- Business tax returns (1-2 years)
- Bank statements (6-12 months)
- Profit and loss statement (P&L)
- Credit reports (business and personal)
2. Choose a Lender
Consider online lenders, banks, and credit unions. Online lenders typically have faster approvals, while banks may offer lower rates.
3. Submit Your Application
Complete the application online or at a bank. Be sure to submit all required financial documents to avoid delays.
4. Receive Approval and Access Your Credit Line
If approved, you’ll receive access to your credit line. You can borrow funds, repay them, and repeat the process as needed.
Frequently Asked Questions
What’s the difference between a business line of credit and a term loan?
A line of credit allows you to borrow, repay, and reuse funds, while a term loan provides a lump sum with fixed monthly payments.
How much can I borrow with a revolving credit line?
Credit limits range from $10,000 to $250,000 or more, depending on the lender and your creditworthiness.
Do I need collateral to get a revolving credit line?
Some lines of credit are unsecured, meaning no collateral is required. However, secured lines may offer higher credit limits and lower rates.