A line of credit is a right granted to a company once or periodically to use borrowed funds at the bank (but only within the agreed limit and for a certain period of time).
This service allows entrepreneurs not to withdraw funds from circulation, thereby eliminating financial gaps by referring to open credit limits. The receipt of the amount (within the credit limit) can be carried out both immediately and in full, as necessary and in parts, depending on the type of credit line.
Types of credit lines
A non-revolving credit line (with a disbursement limit) implies the provision of borrowed funds in installments within a specified period and a credit limit (disbursement limit). In this case, the borrower can use credit funds at a convenient time in the manner determined by the loan agreement. Repayment of a part of the loan does not increase the disbursement limit.
A revolving line of credit (with a disbursement limit) implies the provision of funds in installments within a specified period and a credit limit (debt limit). Repayment is made at any time during the crediting period. In this case, the outstanding amount of the principal debt cannot exceed the established debt limit. The part of the loan repaid by the borrower increases the debt limit.
Enterprises whose activities are of a seasonal nature get a framework credit line, which is opened for a bank client to be able to pay for deliveries at a certain frequency (for example, only in summer) within a specified time period and amount. Also, such a credit line can be opened for the implementation of several payments within one project.
There are also less common types of lines of credit – oncall credit line where the credit limit is renewed after a portion of the loan is repaid. And a contract account, when an account is opened from which you can not only withdraw funds but also replenish it (the debt is paid off automatically, upon receipt of funds).
Benefits of a credit line
- The company does not need to withdraw cash from circulation to cover temporary cash shortages;
- The funds can be used not immediately and in full, but as needed, in parts;
- The borrower has the right to withdraw any amount within the established limit;
- You can spend funds for any purpose, the bank will not ask for confirmation of spending;
- Saving time to attract financing: you can open a credit line in advance and use it if necessary;
- Interest is paid only when funds are used. And interest is accrued not on the entire amount of available funds, but only on the amount borrowed by the borrower;
- Lack of a payment schedule, the agreement specifies only the allowable period for the return of funds, depending on the characteristics and specifics of the borrowing company.
Disadvantages of a credit line
- It is often possible to get the service only at the bank;
- The credit limit directly depends on the financial performance of the borrowing company. And if its income decreases, then the limit also decreases;
- To open a credit line in a large volume and for a long term, collateral may be required;
- Short-term, usually open for up to 1 year.
How is the size and cost of loans determined?
The main conditions for providing a credit line – the size, rate and term of the loan – are set for each borrower individually. Factors taken into account when making a lending decision:
- The financial condition of the borrower;
- Average business turnover;
- Quality of the loaned project and business development prospects;
- Position of the borrower in the market and the state of the industry;
- The borrower’s credit history and business reputation;
- Availability of collateral.