Credit facility: should you use one?

Whether you’re a self-employed carpenter, own a florist shop or build spaceships, things happen in business that you can’t possibly foresee. That’s when a credit facility can be very useful.

And it’s not just businesses who use credit facilities, governments do too. In September 2019, the Government of Bolivia secured a $99m credit facility from Agence Française de Développement (AFD), a public development bank. This was to help them finance their country’s energy transition.

But a credit facility might not always be the best option to your cash flow problems, which is why we created this guide to help you decide if it is.

What is a credit facility?

In its simplest terms, a credit facility provides you with capital that you can draw upon as and when you need it.  

How does a credit facility work?

A lender will offer you a credit limit, but you don’t have to borrow the entire amount. You just use what you need.

Your credit limit will be determined by the financial strength of your business, your cash flow and credit history. However, some credit facility lenders may extend this limit if you have a strong business case or you can demonstrate another means of being able to repay what you borrow.

Credit facility terms

The duration of the credit facility is normally restricted to between six months and two years. However, there are exceptions to these terms. For example, Nokia took out a five-year credit facility in June 2019 worth $1.5bn. It was also unique in that it was a sustainable credit facility, whereby the margin they pay is dependent on the company’s progress in reducing its greenhouse gas emissions.

With some credit facilities, you might be given the option to renew it at the end of the term. This is very much determined by how well you repaid what you owed leading up to the end date.  

Credit facility interest rates and repayment terms

As part of the credit facility, you’ll have to pay interest on the amount you draw down. These interest charges, and the date for their repayment, will be included in the repayment terms, which vary depending on the type of credit facility you have and the individual lender.

For example, if it’s a revolving credit facility, it will specify the minimum payment amount and the recurring payment dates. That’s because with this facility, you have the option to repay the entire outstanding payment at once, or just meet the minimum monthly figure required. But by not repaying all you owe, you will accrue more interest charges.

The repayment terms will also include the date when the facility matures and whether interest rates may change.  

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Credit facility legal provisions

If you do take out a credit facility, it will come with legal provisions. These cover the legalities and penalties of what will happen if you don’t meet certain conditions of your lending agreement. Such as, if you default on a payment.  

What is a revolving credit facility?

The main difference between a revolving and non-revolving credit facility is that with the latter, once you’ve paid off your borrowed funds, that credit is no longer available to you.

What are the differences between a credit facility and a loan?

How you receive the money

With a business loan, you’ll receive access to all the funds upfront once it’s been approved. There are exceptions to this, like a development loan. This type of loan is designed to help fund a residential development project. The first part of the loan is used to buy the land, then the second part is drawn down in stages to pay for the build.

With a credit facility, you can draw down the precise amount of money you need to borrow at any time during the term. Providing you don’t exceed your credit limit.

How you pay the interest

With a loan, you pay interest on the total amount of money you’ve borrowed. With a credit facility, you only pay interest on the exact amount of money you use.

For example, you have a credit facility with a limit of £10,000. You don’t use it for several months, but then suddenly a customer fails to pay an invoice and you’re £4,000 down on your normal income. To pay for new stock, you can withdraw £4,000. Then, once you finally receive your customer’s payment, you return the money but only pay interest on the £4,000 – not the full £10,000 credit limit you have.  

Access to capital

With a loan, it’s considered closed once all the monthly instalments are paid back. There’s normally no option to access more funds unless you apply for a new loan.  

A credit facility can be renewed on an annual basis, giving you continued access to money when you need it (within your credit limit).  

How you intend to use the funds

There are advantages and disadvantages of loans and credit facilities. It just depends on what you need the money for as to which is the most suitable option for you.

In general, a loan might be more suitable if you have a one–off large purchase or requirement that’s known about in advance. A credit facility is designed for more occasional support when unforeseen expenses land.  

Credit facility fees to be aware of

With iwoca's Flexi–Loan, it's free to apply, you can get a decision in minutes and there are absolutely no hidden fees whatsoever. Other credit facilities may come with a number of fees on top of the initial interest rate. Below are some of the fees you might be charged if you take out a credit facility.

Commitment fees – This is a percentage, usually 2% or less of your credit limit. It’s there to compensate the lender for providing access to a potential loan, as they’ve set aside funds, but they can’t actually charge interest until you borrow money from it.  

Annual renewal fees – This is only applied if you renew the credit facility, which tends to happen on an annual basis.

Availability fees – This is a percentage of the money that you didn’t borrow. It’s charged at the time when you pay the interest on the credit you did use.

Over limit fee – If you go above your credit limit, the lender could charge you a penalty for doing so.  

Advantages of a credit facility

Flexibility

A credit facility offers you a great deal of flexibility to help you solve any short-term cash flow problems. An example of how credit facilities can be effectively used is in the ‘seasonal’ sector, where companies like ski resorts can use them to keep going over during the warmer summer months.  

They are also flexible because you can use the money on whatever you like, from paying wages to buying materials. With other loans, you may have to specify exactly what you’re using the money for.  

No assets required as security

Some loans are secured, although you can also get unsecured business loans. With a credit facility, you don’t need to put down any business assets as security (such as a commercial property).

However, many credit facility lenders will require a personal guarantee. This means you’re personally and legally liable for repaying the money you borrow.

Speedy decisions

Due to integration with online accounting software and automated credit decisions, you can set up a credit facility very quickly. Usually within a couple of hours. Sometimes instantly.

Access to the funds can even happen on the same day that you apply, depending on the lender.

New agreements aren’t needed

Unlike with a loan, you don’t have to set up a new agreement every time you use a credit facility. You can just renew it (sometimes for a fee) at the end of the term, providing your lender is happy to do so.

Online portals for ease of use

Many credit facilities come with online dashboards, which makes them simpler to manage.

Only pay interest on the money you use

You might have a credit limit of £10,000, but you only ever pay interest on the amount you actually borrow. When you don’t have an outstanding balance, you don’t pay any interest. With a traditional loan, you pay interest on the total amount you borrowed, regardless of whether or not you used it all.  

No long-term commitment

You might only draw down on the funds once – and never use the facility again. Although you may still be charged fees for having the facility available to your business.  

Can help to keep your supply chain happy

Having reliable suppliers helps you to fulfil your customers’ requirements, which inevitably helps your business to grow. With a reserve of capital to hand, you can pay your suppliers on time, or even upfront, if you have a particularly large or urgent order.

A credit facility can grow with your business

If your credit facility is well managed and your business is growing successfully, your lender is more likely to renew it and even extend your limit so you can draw down more money when you need it.  

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