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Revolving credit facility vs. overdraft?

An overdraft is a sort of revolving credit, in the strictest sense. Revolving credit facilities, on the other hand, refer to a particular type of lending arrangement that is geared toward businesses. Overdrafts vs. revolving credit facilities.

So how does a revolving credit facility differ from an overdraft? Technically speaking, an overdraft is a form of revolving credit. However, the term ‘revolving credit facility’ usually means a different sort of credit arrangement and one that is specifically aimed at business customers. Revolving credit facility vs. overdraft.

It’s fairly well understood what an authorized overdraft is – a facility that allows you to have a negative bank account balance, up to a pre-determined limit. It is basically a line of credit that your bank has agreed to extend to you up to a predetermined amount. Even if your account balance is zero, you can still withdraw money from it. A lender other than your bank may offer you a revolving line of credit.

A business revolving credit facility – also known as operating line or bank line credit – allows a company to borrow as many times as they like, as long as their total debt doesn’t exceed a pre-agreed credit limit. Borrowing in this way has been described as taking a series of short-term loans without the need to apply separately on each occasion.

Revolving credit facility vs. overdraft.

Ways in which these differ from overdrafts include:

  • Revolving credit facilities are essentially new credit agreements because they aren’t tied to a bank account. If you have a bank account, you already have an overdraft option. Revolving credit facilities require taking on additional debt, but that doesn’t mean you’ll wind up with a negative amount
  • A revolving credit facility is set up with a specified term, so a smaller business might find that it can’t get a facility for longer than two or three years. However, if you demonstrate a good repayment record, it’s often possible to extend the term or take out a new arrangement with the same lender
  • If you’re a small firm, you may not be able to secure a revolving credit facility for more than two or three years. In some cases, if you have a strong payment history, you may be able to extend the loan term or take out a new agreement with the same financial institution
  • Your overdraft must be provided by the bank that holds your current account; you have no option in the matter. However, you can apply for a revolving credit arrangement with any of a number of companies. There are many lenders to select from if your firm has been in operation for some time and has a good credit history, especially if you just need the revolving credit facility for six months to two years
  • Revolving credit facilities from specialized lenders are now more common than bank overdrafts, according to several firms. Many businesses report that it’s now easier to obtain a revolving credit facility from a specialist lender than to persuade their bank to agree to an overdraft
  • While individual consumers can replicate some aspects of a revolving credit facility through an overdraft or credit card, these types of revolving credit facilities are specifically designed for business customers – you almost certainly need to be a limited company, rather than a sole trader or a partnership to be considered for this form of funding. One of the most attractive features of these facilities is that businesses can make flexible repayments, paying back larger amounts when business is good, and perhaps making a repayment closer to the minimum payment at other times. This means that revolving credit facilities are especially popular amongst businesses whose turnover is seasonal, or might be unpredictable; or amongst those who are seeking security against the potentially damaging effects of a large and unexpected bill
  • Larger sums can often be borrowed with an open-ended account. However, a small business may be eligible for up to £250,000 under this type of arrangement, although each individual withdrawal may be regulated at one month’s turnover.

Businesses frequently use revolving credit facilities for reasons such as:

  • Developing new products and services
  • Increasing the size of their workforce, covering the costs of recruiting and training new staff 
  • Short-term cash flow management – while it might be concerning if a business had to borrow to pay expenses such as salaries, rent, and utilities on a regular basis, as we have already seen, revolving credit facilities are often especially suitable for businesses whose turnover might be expected to fluctuate
  • Purchasing stock or equipment
  • Providing a ‘safety net’ should there be any emergency or unexpected bills, such as large-scale repairs
  • Allowing them to access additional credit – some businesses take out both revolving credit facilities and traditional business loans

One of the biggest advantages of revolving credit is the freedom to take out a loan whenever and wherever you want, without having to go through the application process each time. All purchases, big or small, can be made here. Although “revolver” loans have many advantages, you must also be aware that they carry a significant risk: the terms of credit are never clear or fixed. If you don’t read the fine print, you could be in for a nasty surprise later on. The terms of an overdraft are straightforward, with no unnecessary clauses regarding interest rates and annual fees. Overdrafts are a far better and more convenient way to keep track of your spending than revolving lines of credit.

While revolving credit facilities are often easier to obtain than overdrafts, your application will still be carefully scrutinized. Some providers won’t consider anyone who has been trading for less than one year. Your credit history is an important factor; and any prospective provider will certainly want to see your financial statements such as balance sheet, income statement, and cash flow statement. They may also ask one or more of the directors of the business to provide a personal guarantee before an application is approved. In order to keep one’s finances in check, revolving credit and overdraft facilities are both beneficial. Revolving credit cards are more popular among retail customers than organizations and small businesses.

The application process, however, is often very simple. Read the fine print and consult with a Funding Bay financial advisor before making a final decision. Get in touch with the team at Funding Bay to find out more and to make an application with one of our lenders on our roster. Lenders include iwoca, Just Cashflow, or FIBR.

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