What it means
Bank credit is best understood as a ceiling rather than a balance. The bank agrees a limit, the business draws what it needs beneath that limit, and interest is charged on the drawn amount rather than the whole facility.
A commitment fee is often charged on the undrawn portion, which is the price of keeping the option open. Available credit is the difference between a temporary cash squeeze and a genuine crisis.
A company with $700,000 of unused facility can absorb a large customer paying three weeks late without missing payroll or delaying its own suppliers. Banks size credit against three things: cash flow, collateral and track record.
Asset-based facilities go further and set the limit by formula, advancing a percentage of eligible receivables and inventory. That formula, known as the borrowing base, is recalculated monthly, so the limit rises and falls with trading.
Covenants come attached to almost every facility. Typical ones require a minimum level of interest cover, a maximum ratio of debt to earnings, or delivery of management accounts within a set number of days after month end.
Breaching one can allow the bank to withdraw the facility even if every payment has been made on time. Bank credit is also a macroeconomic measure that economists watch closely.
Total bank credit in an economy signals expansion or contraction, and when banks tighten their lending standards, credit growth slows and business investment usually follows within a few quarters.
In practice
Real-world examples.
Example
A seasonal garden centre agrees a $500,000 revolving facility that it draws heavily in February to buy stock and repays by July from spring sales. Interest is charged only on the months the money is actually out.
Example
A recruitment agency funds its payroll through an invoice finance line advancing 85% of approved timesheets. When a large client is placed on stop for slow payment, the borrowing base falls and the agency's available credit drops overnight even though nothing else changed.
Example
A restaurant group with three sites breaches its interest cover covenant after a poor quarter. The bank does not demand repayment but reprices the facility, adds monthly reporting and requires a personal guarantee before granting a waiver.
Formula
Calculation
Available bank credit = the lower of (facility limit, borrowing base) - amounts already drawn - outstanding guarantees and letters of credit.
A wholesaler has a $2,000,000 asset-based facility. Its borrowing base advances 80% against eligible receivables of $1,100,000, which is $880,000, plus 50% against eligible inventory of $600,000, which is $300,000. The borrowing base is therefore $880,000 + $300,000 = $1,180,000, which is lower than the $2,000,000 limit, so the base governs. The wholesaler has drawn $400,000 and has letters of credit outstanding of $150,000, a total commitment of $550,000. Available credit is $1,180,000 - $550,000 = $630,000.Case study
Seen in the real world.
Northgate Fabrics is a fictional textile distributor used here as an illustration. It ran with a $1,500,000 facility and had never drawn more than $600,000, so the finance team stopped tracking availability closely and assumed there was always headroom.
When its largest customer stretched payment terms from 30 to 75 days, receivables ballooned and the borrowing base initially rose, but the bank then reclassified anything over 90 days as ineligible. Availability fell by $310,000 in a single monthly certificate, at precisely the moment the company needed the cash most.
The illustrative point is that bank credit is not a fixed cushion. It is a calculated number that reacts to the same trading problems that create the need to borrow, which is why availability deserves a line in the weekly cash report rather than an annual review.
Watch out
Common mistakes.
- Treating the facility limit as the amount you can actually draw. Borrowing base rules, outstanding guarantees and covenant tests can all reduce real availability well below the headline number.
- Ignoring covenants until something goes wrong. A covenant breach is usually visible in the forecast months before it happens, and lenders react far better to early warning than to a surprise.
- Drawing a revolving facility to fund long-term assets. Short-term credit can be reduced or withdrawn, and matching it against equipment that takes years to pay back creates a refinancing trap.
Questions
People also ask.
Does unused bank credit cost anything?
Usually yes, in the form of a commitment or non-utilisation fee, typically a fraction of a per cent a year on the undrawn balance.
Is a business credit card part of bank credit?
Yes, card limits sit alongside other facilities, count towards the bank's total exposure to you and are considered when a new loan is assessed.
How can a company increase its bank credit?
By improving reported cash generation, tidying up the receivables ledger, offering additional security, and giving the bank timely, credible management information over several reporting periods.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%