What it means
A credit facility sits between a term loan and no borrowing at all. Rather than receiving the full amount on day one and repaying to a fixed schedule, the borrower draws and repays within an agreed limit over the life of the agreement.
That suits businesses whose cash needs move around with seasons, order cycles or customer payment behaviour. Facilities come in several shapes.
A revolving credit facility can be drawn, repaid and drawn again; a committed facility obliges the lender to advance funds if conditions are met; an uncommitted or on-demand facility can be withdrawn at the lender's discretion. The difference between committed and uncommitted matters enormously when conditions tighten, yet many borrowers never check which they hold.
The cost has more than one component. Interest is charged on the drawn balance, a commitment or non-utilisation fee is charged on the undrawn portion, and there is usually an arrangement fee paid upfront plus annual renewal or review fees.
A facility that looks cheap on headline interest can be expensive once these are included, particularly if the business rarely draws on it. Facilities almost always come with covenants and conditions: minimum interest cover, maximum leverage, regular management accounts, sometimes a clean-down requirement obliging the borrower to bring the balance to zero for a period each year.
Breaching a covenant can make the facility repayable immediately, which is why forecasting against covenant tests matters as much as forecasting cash. Used well, a facility is the cheapest insurance a business can buy against timing mismatches: paying suppliers before customers pay you, funding a seasonal stock build, or bridging a delayed milestone payment.
Used badly, it becomes permanent debt at short-term pricing, which is one of the most common funding mistakes in growing companies.
In practice
Real-world examples.
Example
A garden centre agrees a $600,000 seasonal overdraft that it draws heavily from January to April to build stock, then repays in full over the summer trading peak. Interest is paid for only four months, which is far cheaper than a term loan running all year.
Example
A recruitment agency uses an invoice finance facility that advances 85% of each invoice on issue, funding contractor payroll weekly while clients pay in 45 days. The facility limit grows automatically with the sales ledger, so funding scales with the business rather than needing renegotiation.
Example
A manufacturer holds a $10,000,000 committed revolving facility purely as backup liquidity and draws it in only one month of the year. It pays $47,500 in commitment fees for that standby availability and treats the amount as the price of being able to survive a delayed customer settlement.
Formula
Calculation
Total annual cost of a facility = (interest rate x average drawn balance) + (commitment fee x average undrawn balance) + annualised arrangement and renewal fees. The effective rate on money actually used = total annual cost / average drawn balance.
A distribution business arranges a $4,000,000 revolving credit facility. It draws an average of $1,500,000 across the year at an interest rate of 7.5%, leaving an average undrawn balance of $2,500,000 carrying a 0.5% commitment fee. The arrangement fee is $20,000, spread over the facility's two-year term.
Interest is $1,500,000 x 7.5% = $112,500. The commitment fee is $2,500,000 x 0.5% = $12,500. The annualised arrangement fee is $20,000 / 2 = $10,000.
Total annual cost is $112,500 + $12,500 + $10,000 = $135,000. The effective rate on the money genuinely used is $135,000 / $1,500,000 = 9%, meaningfully above the 7.5% headline. If the business could run on a $2,500,000 limit instead, it would save $1,500,000 x 0.5% = $7,500 a year in commitment fees alone.Case study
Seen in the real world.
Rowan Textiles is an invented company used here as an illustrative example of facility structure going wrong. Rowan held a $2,000,000 on-demand overdraft that had crept to a permanently drawn $1,850,000 over four years, funding not seasonal swings but the cash absorbed by steady growth in stock and receivables.
Because the balance never fell, the facility had become long-term debt priced and documented as short-term borrowing. When Rowan's bank reviewed the line and imposed a 30-day annual clean-down requirement, the fictional company had no way to repay $1,850,000 for a month without stopping purchases entirely.
In this illustrative resolution, Rowan refinanced $1,200,000 of the balance into a five-year term loan matched to the permanent working capital it was really funding, and kept a smaller $800,000 revolving facility for genuine seasonal peaks. The blended interest cost rose slightly, but the funding finally matched the shape of the need, and the clean-down became achievable.
Watch out
Common mistakes.
- Comparing facilities on headline interest rate alone. Commitment fees, arrangement fees and renewal fees can add several percentage points to the effective cost of the money actually drawn.
- Assuming a facility cannot be withdrawn. Uncommitted and on-demand lines can be reduced or cancelled at the lender's discretion, often precisely when the borrower most needs them.
- Using a short-term facility to fund long-term needs. Permanent working capital and capital expenditure should be matched with term funding, not with a revolver that must be repaid on demand.
Questions
People also ask.
What is the difference between a facility and a loan?
A loan advances a fixed sum repaid on a set schedule, while a facility sets a limit the borrower can draw, repay and redraw as needed.
Do unused facilities cost anything?
Usually yes, through a commitment or non-utilisation fee on the undrawn portion, typically a fraction of the drawn interest margin.
Does a credit facility appear on the balance sheet?
Only the drawn balance is recognised as a liability; the undrawn limit is disclosed in the notes as available but unused financing.
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