What it means
The word facility refers to the agreement itself, not the cash sitting in the account. A bank might grant a business a $5,000,000 revolving credit facility, which means the business is allowed to borrow up to $5,000,000 whenever it needs to, provided it keeps to the conditions in the contract.
Facilities come in several shapes. A term facility is drawn once and repaid on a schedule, a revolving credit facility can be drawn, repaid and redrawn like a company credit card, and an overdraft facility simply lets the bank account go negative up to a stated limit.
For a finance team, a facility matters because it is liquidity insurance. Knowing that $5,000,000 is available means the business can accept a large order, absorb a slow-paying customer or ride out a quiet quarter without scrambling for emergency funding at a bad price.
Facilities are rarely free even when nothing is drawn. Lenders charge an arrangement fee at the outset and a commitment fee on the undrawn balance, because they must set their own capital aside against the promise to lend.
Almost every facility carries covenants, which are promises about how the borrower will behave and perform. Break one, such as letting total borrowings rise above three times earnings, and the lender can freeze the limit or demand repayment, so headroom on paper is not always headroom in practice.
In practice
Real-world examples.
Example
A construction contractor wins a $4,000,000 civil works project that requires it to buy materials months before the client pays. It draws $1,500,000 on its revolving facility to fund the materials, then repays the drawing as milestone payments arrive, leaving the limit free for the next job.
Example
A software company negotiates a $10,000,000 term facility to buy a smaller competitor. The money is drawn in a single amount on completion day and repaid over five years in quarterly instalments, with a covenant capping net debt at 2.5 times earnings.
Example
A seasonal garden centre arranges a $600,000 overdraft facility each February. Stock is bought in early spring, the account runs heavily negative through March and April, and the balance returns to positive by June once the selling season peaks.
Formula
Calculation
Annual cost of a facility = (interest rate x amount drawn) + (commitment fee rate x undrawn amount)
Northbridge Tools holds a $5,000,000 revolving credit facility. It has drawn $2,000,000, leaving $3,000,000 undrawn. Interest on drawn funds is 8% a year and the commitment fee on the undrawn portion is 0.5% a year.
Interest: 8% x $2,000,000 = $160,000
Commitment fee: 0.5% x $3,000,000 = $15,000
Total annual cost: $160,000 + $15,000 = $175,000
Because only $2,000,000 is actually working inside the business, the effective cost of the money in use is $175,000 / $2,000,000 = 8.75%, not the headline 8%. That gap is the price of keeping the extra $3,000,000 on standby, and it is a price many boards decide is worth paying.Case study
Seen in the real world.
This illustrative example follows Ferndale Textiles, a fictional mid-sized fabric manufacturer. Ferndale had no borrowings at all and was proud of it, but its largest customer moved from 30-day to 75-day payment terms, and within two quarters the company was choosing between paying suppliers and paying wages.
Ferndale's finance director arranged a $3,000,000 revolving credit facility. In its first year the company drew an average of $1,100,000 at 7.5% interest and paid a 0.4% commitment fee on the undrawn average of $1,900,000, giving interest of $82,500 and a commitment fee of $7,600, or $90,100 in total.
The board initially balked at paying $7,600 for money it had not borrowed. The counter-argument won the day: the facility let Ferndale keep its early-settlement discounts with suppliers, worth roughly $140,000 a year, and removed the need to turn down orders it could not fund. The facility cost less than the opportunities it preserved.
Watch out
Common mistakes.
- Treating an agreed facility as guaranteed cash. Most facilities are repayable on demand or can be withdrawn if covenants are breached, so the limit is a permission, not a deposit.
- Comparing facilities on headline interest rate alone. Arrangement fees, commitment fees, minimum drawdown rules and non-utilisation charges can make a lower-rate facility more expensive in practice.
- Confusing the facility limit with the amount owed. Only drawn amounts appear as debt on the balance sheet; the undrawn portion is disclosed but is not a liability.
Questions
People also ask.
Does an unused facility cost anything?
Usually yes, through an arrangement fee at the start and an ongoing commitment fee of roughly 0.2% to 0.75% a year on the undrawn balance.
What is the difference between a facility and a loan?
A loan is a single advance of a fixed amount, while a facility is the standing agreement that allows one or more advances up to a limit.
Can a lender cancel a facility?
Yes, typically if a covenant is breached, if the business materially changes, or at a scheduled review date, which is why borrowers watch renewal dates closely.
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