You might have heard about revolving and non-revolving loans before but do you know the difference between the two?
Under which circumstances should you choose one over the other? Let’s take a look at the difference between these two types of business loan facilities and which you should choose.
Non-revolving credit facility
When the term “non-revolving” is used, it basically means the credit facility is granted on one-off basis and disbursed fully. The borrower will typically service regular installment payments against the loan principal.
The most common form of non-revolving credit facility would be the unsecured business term loan.
If your working capital loan application is approved, you’ll receive disbursement in a lump sum which will be the principal loan amount. You’ll pay it back over a specific term ranging from 1 year to 5 years.
Another type of non-revolving facility is secured term loan or otherwise known as asset based financing. You’ll not receive cash and loan is meant to fund your company’s purchase of an asset, such as a commercial or industrial property, or equipment and machinery.
Your bank will pay directly to the asset’s seller the purchase price, including your portion of the down payment (typically 20%-30% for property purchase). You’ll then make monthly installment on the loan amount over an agreed period.
Unlike revolving lines of credit that are typically reviewed by the banks every 1 to 2 years, a term loan is fixed for the specified term of repayment.
Most term loans in Singapore are calculated on reducing balance monthly rest basis. Your original loan principal loan amount will be amortized throughout the term of the loan.
For a more detailed explanation, you can use this business loan interest calculator to find out amortization calculation of loans.
Unlike a revolving credit line, you’ll need to re-apply for a fresh loan if you require more funds, after the first loan's disbursement.
Typically, most banks will also levy an early repayment penalty if you redeem the loan partially or in full before end of tenure.
Some banks call this a “break-fund” cost. The early repayment penalty usually ranges between 1-5% of the outstanding amount redeemed. Some banks might charge the penalty based on the original loan amount instead.
As most term loans are amortized, it might not be cost effective to redeem loan especially during the later stage of the loan term.
The redemption penalty could be higher than the interest portion of the loan during the tail end of the loan tenure.
Revolving line of credit
A revolving line of credit is a facility which does not have a fixed term. You can then tap onto the credit facility repeatedly.
A revolving line of credit can be either secured or unsecured. If it’s secured, the financier has a collateral that you placed on lien for the credit line facility extended to you.
Usually, secured line of credit’s interest rate would be lower than unsecured since there's collateral pledged. Also, the credit limit granted could be higher as it can be based on the valuation of your collateral pledged.
When bankers use the term “revolving”, it essentially means that you can utilize repeatedly the credit line up to the limit granted. It works similarly like your personal credit card.
Let’s say your company have an unsecured credit line of $100K and you’ve already used $50K. You can still access the remaining limit of $50k on demand anytime.
When you repay the outstanding $50k, your credit limit goes back up to $100K again and you can continue tapping on the line as and when required.
In the SME loan Singapore context, revolving credit line financing facility offered by banks are usually either an overdraft or trade finance line.
Overdraft is a simple facility where you can withdraw cash on demand up to the credit limit granted by your bank.
Overdraft (OD) facility is not a popular facility banks grant in the local SME financing market. Banks have to lock up their finite overall lending limits when granting ODs and if the borrower does not tap on the OD limit, it's a waste of the banks' lending limits.
Trade financing line is more complicated than an OD. It still bears a credit limit like overdraft and is usually higher.
The key difference is you can’t withdraw cash on demand from a trade financing line, unlike overdraft accounts.
You can only utilize the trade finance line to fund payments to your suppliers by presenting your supplier’s invoice to the bank.
Transportation documents such as delivery order or bills of lading might be required as well if you request for your banks to make immediate payment transfer to supplier.
Almost all trade financing line will come with LC (Letter of Credit) facility which allows you option for instructing your bank to issue LC to supplier.
This is more commonly used when making overseas purchases from foreign suppliers.
Increasing your business line of credit
If your company has an existing credit line facility from banks or financial institution, you might want to increase the credit limit over time.
A higher credit limit is preferable for most SMEs, in fact the higher the better. Revolving credit lines provide the company with immediate access to credit that can be tapped during cash flow emergencies or to exploit unexpected business opportunities.
A higher credit limit will allow the company more options to maneuver in a situation where quick access to external funds is required.
Here are the 4 tips that will improve the chances of approval or your credit limit increase.
1. Ensure prompt repayment conduct
The banks will definitely keep track of your repayment conduct throughout the year when utilizing your credit line.
Making sure you have a spotless repayment record with your banks will go a long way in improving your chances of credit limit increase.
Keep your personal credit facilities such as credit cards, car loan and home loan payments healthy and prompt as well.
Most banks will also conduct credit bureau rating checks on director’s personal facilities repayment conduct on top of company’s records.
2. Have justifiable reasons
Carefully and thoroughly evaluate the reasons why you need a limit increase.
The banks' credit approvers will require justifiable reasons for approving your credit limit increase. Make their job easier for them.
Present to your bankers PO (purchase orders) or contracts with your customers that reflects a higher order volume than your usual capacity to fulfil.
If you’ve just been awarded a large contract, present to your banker the letter of award as well. Any document you have that justifies the reason for a limit increase should be presented for the bank’s evaluation.
3. Utilize your credit line often
Try to utilize your line of credit frequently. When situation calls for a limit increase request, the bank will be more favorable to your request.
The reason is simple. If the bank has already granted you a credit line and yet you don’t utilize it at all over a long period, they will be reluctant to increase your limit when you ask for it.
They will be skeptical whether if you’ll utilize the line if they do increase your limit. Without utilizing the line, the bank does not earn any interest income off your account.
Also, with the Basel 3 accord, banks are not able to be too liberal with the total aggregate credit extended in their loan books.
If you keep your credit line purely as standby funding and simply have no occasion to use it, try to utilize the line at least once every 2 to 3 months and make payments back quickly so you incur minimal interest.
4. Maintain updated accounts and financials
During the annual review of your credit line, always ensure your accounts and financial reports are up to date.
A strong factor that determines whether if the banks will increase your credit limit is your latest year revenue figures.
If your latest financial year turnover figure has increased compared to the previous year’s credit review, most banks will be quite open to increase your limit if you ask for it.
The percentage increase in your limit will usually correspond with your revenue increase. If you’re revenue improved by 5% to10%, do not expect the banks to increase your credit limit significantly.
Without up to date financials, the credit assessor will not be able to complete their review and this will lead to a delay.
Which type of SME finance facility should I choose?
This depends on your circumstance and more importantly, your financing requirements.
If you need financing for mid to long term, for example purchasing equipment, you should opt for a non-revolving term loan facility.
Acquiring other companies, purchasing property, new outlet expansion or any other business purpose that you foresee will take you 1 to 3 years to materialize ROI are situations where you should utilize term loan.
A revolving credit line on the other hand should be matched to short term financing needs.
Many SME owners use it as a ‘standby facility” as it can help deal with very short term working capital emergencies.
It’s a useful financing tool to plug any cash flow gaps temporarily and smooth out working capital cycle.
However, it is important to understand that revolving credit line such as overdraft are calculated very differently from term loan which is amortized.
Overdraft is usually calculated on accrued interest at daily or weekly compounding basis.
Compounding interest is the opposite of amortized interest and financing costs will be prohibitive if used the wrong way.
If you utilize overdraft like a term loan any intend to pay back the utilized amount over long term of say 1 year, the compound interest will soon snowball and balloon up to a large sum relative to the original amount utilized.
Use the overdraft only for short term financing situations such as funding payroll, expenses seasonal in nature or bridging cash flow gap when trading products.
The key point to make here when deciding between revolving and non-revolving facility is to match your funding needs time line to the appropriate facility.
Short term funding needs = Revolving facility
Mid-long term funding needs = Non-revolving facility