Businesses use credit as a key tool in managing their finances. It can help your business grow, and it can be a lifeline to get you through short-term challenges and keep you afloat.
There are two main ways that a business can borrow money: installment credit and revolving credit.
Installment credit offers a lump sum loan amount that you borrow for a set period of time. You make regular payments, and at the end of the loan term, you’ve paid off the loan. Auto loans and student loans are examples.
- When a loan is fully paid off at the end of the term, it is called fully-amortizing.
- If there is a lump sum due at the end of the term, this is called a balloon payment.
Revolving credit, on the other hand, is a line of credit you can borrow against. If you don’t need it, you don’t have to use it, but when you do need it, it’s ready and waiting. Credit cards are the most common example.
What is revolving credit for business and how does it work?
Revolving credit is an open line of credit a business can use whenever it is needed. Think of it like an extra monetary resource a business can draw from, especially for corporate cash flow. Like any kind of credit, it comes with a few limitations and rules, that are triggered when you start using the funds.
Credit limits: Revolving corporate credit accounts have a maximum amount of money you can borrow at any one time. For example, let’s say your business credit limit is $10,000. If you borrow $2,000, you can still borrow up to $8,000 more. Once you pay the $2,000 back, you can borrow up to $10,000 again.
Interest rates: Like most types of credit, revolving credit comes with an interest rate. On top of paying back any money you borrow, you’ll also have to pay interest charges to the lender. The main exception is if you pay off everything you borrowed within a certain time, which is usually by the billing cycle due date.
Monthly payments: Once you start using this credit, you’ll need to make minimum payments on the outstanding balance you owe to keep the line of credit open.
A company with an established excellent credit history might only need to pay 1% or 2% of the outstanding balance each month. A new business with no credit history might have to pay 50% of the balance back each month, meaning you only get one extra month to pay it all back.
Some cards require 100% repayment of the full balance by the monthly due date. This might not be solely about your company’s credit history; sometimes it’s just how the card is structured. These are technically charge cards, not credit cards, but the terms may be interchangeable, depending on the credit program
What are the benefits of revolving credit?
There are many benefits to revolving credit. You can use it to pay for anything your business needs.
Unlike a car loan, for example, revolving credit isn’t tied to a particular thing. Credit cards can be used for anything from monthly supplies to office furniture. Lines of credit are even more versatile, giving your company extra cash for anything from rapid expansion to short-term survival.
What are the types of revolving credit?
Credit cards vs. lines of credit
Most revolving credit comes in one of two forms: a credit card or a line of credit. The main difference is that funds from a line of credit aren’t accessed via a credit card issuer. You can draw cash from the line of credit to your bank account to pay vendors or suppliers that don’t take credit cards.
Secured credit vs. unsecured credit
Revolving credit can also be secured or unsecured.
Secured loans require collateral — you attach something to the loan (known as collateral) that the lender can take if you default on the loan. Property, inventory or equipment are types of collateral for secured loans.
Unsecured loans don’t require collateral — the lender doesn’t have the automatic right to take anything if you default. These loans carry more risk for lenders, so they come with higher interest rates.
While credit cards are unsecured, a line of credit might be either secured or unsecured. Lenders don’t like to give new businesses unsecured credit because those businesses don’t have a credit history yet. One solution is for new businesses to give a lender cash as security for a line of credit.
Such lending allows businesses to build their credit history or creditworthiness. If you borrow small amounts and pay the money back every month, you may not have to pay any interest on the loan, and you can build up your credit history as a business.
Why your business should establish revolving credit, even if you don’t need it
One of the most common financial mistakes businesses make is not to think about revolving credit until they need a loan. Here’s when they do start thinking about it, often for the first time:
- An opportunity to expand and the business needs capital to pursue it.
- An unexpected challenge and the company needs cash to survive it.
Often when you wait until one of these triggers, it’s too late. You won’t have the credit history you need to get the loan, and if your company is in trouble, lenders will be less likely to help.
That’s why you should consider establishing a revolving line of credit before you ever need it. You may not need to use it. The key is to have it available, so you can take advantage of opportunities and navigate surprises as they come along.
What are the best uses for revolving credit?
Here are the two rules of thumb:
- Don’t use revolving credit for fixed assets. If you want to buy an expensive coffee machine for your cafe, for example, don’t use revolving credit for that. Instead, get a secured installment loan. Securing the loan shifts much of the risk away from you. If you had to default, the lender would just take the machine to recover any of the unpaid principal on the loan.
- Do use revolving credit for things you can’t secure. Let’s say your construction company has a job in progress, and you need a cash advance to buy supplies to finish. That’s a perfect use for revolving credit. You only need the cash to finish earning the payment you’ll get when the job is done.
Accountants refer to this second scenario as a gap between accounts payable (AP) and accounts receivable (AR) because you have to pay for those materials before you get paid by the customer.
Revolving credit smooths out your cash flow, giving you the upfront cash when you need it — like paying for those materials with a credit card. If you finish the job and get paid before your monthly bill is due, you may not have to pay any interest on that short-term credit card debt.
How often should you use revolving credit?
There are different business approaches about when and how to use revolving credit.
Should you use revolving credit for payroll?
Some finance professionals assert that you should never use revolving credit to cover payroll. Using credit to cover payroll can be a sign that your business isn’t profitable. Generally this is not the case, but the pandemic was a clear exception for many businesses.
Having revolving credit available to cover payroll and other monthly expenses in an emergency can mean the difference between business survival and bankruptcy.
How much should you borrow?
One business perspective is that you should borrow as much as you can because borrowing money shifts risk to the lender. That view depends in practice on the details. If you are paying high interest rates for the right to shift that risk, it might not be worth it.
Alternatively, some would contend, if you can earn a return on the borrowings that exceeds the interest rate, you should borrow as much as possible to accelerate the growth of your business. Instead of following a hard-and-fast rule, it’s generally better to make each decision based on the specific facts and terms of that situation.
How to stay in control of revolving credit
It is important to learn to use revolving credit responsibly. In order to stay in control the following can be helpful:
- Monitor your credit score
- Make payments on time
- Spend responsibly
Monitor your credit score
Revolving credit can help or hinder your business credit score. By making payments on time, remaining aware of all expenses incurred and keeping a close eye on finances, revolving credit can help establish and improve your company’s credit score history.
Make payments on time
Not keeping up on payments with a revolving line of credit can cause your company to incur late payments that could ruin your chances of increasing that line of credit. Ensure that purchases are made within limits and that payments are made on time.
Spend responsibly
Having more money available to you can be both helpful and harmful. Keep in mind what your existing balance is as you make new purchases and revisit the books to make sure spending is within the limits you have established for your company.
How BILL Spend and Expense supports companies building revolving credit
The BILL Divvy Card powered by Visa* is a perfect example of a charge card. You can use it to establish and build your business credit while also benefiting from a built-in expense management system that lets you control spending and set budgets in advance, so you can better manage your cash flow.
You can see how the BILL Divvy Card works and how it stacks up against other business cards here.
*The BILL Divvy Card is issued by Cross River Bank, member FDIC, and is not a deposit product.
