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Table of Content |
| Introduction |
| Pros and Cons of Revolving Credit for Your Business |
| Conclusion |
Introduction
For any MSME, having money at the right moment is extremely crucial. If you are a small shop owner or a startup owner, or if you are operating a large organization, cash management is the key to success. One of the ways many companies manage their finances is by revolving credit. This is an adjustable loan where a company can borrow, return, and borrow again whenever necessary.
Revolving credit is not the same as a regular business loan. In a standard loan, you receive a sum of money and repay it in installments. However, in revolving credit, you have a limit, and you can draw the money when needed. When you repay, you can draw the credit again without taking or applying for a new loan. It is much like a credit card but is for business purposes.
As with any financial instrument, revolving credit has advantages and disadvantages. Understanding the pros and cons is important to figure out if choosing this option is right for your MSME.
Also read: Buying a Business? Watch Out for These Financial Red Flags
Pros and Cons of Revolving Credit for Your Business
Pros of Revolving Credit
1) Flexibility in Usage
- One of the best advantages about revolving credit is that it lets businesses do what they need whenever they want to borrow some amount. Even if they’re short a bit of money now and running a bit low on cash reserves, they can just take a credit line. They can dip into it and use it over and over, whenever necessary. Thus, they can stay on top of things even when they have unexpected financial challenges. With traditional loans you get just one big amount all at once. Revolving credit, on the other hand, provides access to money at any given time up to the credit limit. This can be extremely beneficial for managing surprise expenses, buying stock, or filling cash flow shortages on an immediate basis.
2) Easy Access to Funds
- In business, situations and crises can occur unexpectedly. Revolving credit provides you with money at all times without waiting for loan approval. This helps MSMEs handle important money matters quickly and easily.
3) Only Pay for What You Use
- With a regular loan, you pay interest on every single rupee that you borrow. In revolving credit, you only pay interest on the amount you have used. If you do not withdraw money, you do not pay interest, making it a cost-effective solution.
4) Enhances Business Credit Score
- Using revolving credit responsibly and timely payment can enhance your business credit score. A good business credit score facilitates easy access to loans on favorable terms in the future.
5) No Reapplying Needed
- Once you have been approved, there is no need to apply for a loan each time you require money. Provided that you remain within the limit and pay on time, the credit may be reused again and again.
Also read: The Power of Gold Loans: A Reliable Financial Option for Every Indian
Cons of Revolving Credit
1) High-Interest Rates
- Revolving credit has one of its greatest disadvantages in that it usually has higher interest rates than a conventional loan. If the borrowed funds are not paid on time, the interest will tend to add up rapidly and become expensive.
2) Risk of Overspending
- Because revolving credit is just so easily available, some business owners tend to use it way too much than necessary. This can result in debt buildup, and it becomes challenging to pay back the amount later.
3) Variable Interest Costs
- Unlike fixed loans where you are aware of the amount of interest you will pay, revolving credit typically has variable interest rates. This means that the cost of borrowing may rise if interest rates go up.
4) Debt Trap Possibility
- If an MSME borrows and keeps using credit lines over and over but doesn’t ever pay back the loan, it could really go into a debt cycle. The amount you borrow, the higher the interest, and the more challenging it is to settle the obligations. This also affects the MSME’s credit score very badly, where you will not be eligible for any loans in the future.
5) May Involve Collateral or Personal Guarantee
- Other lenders might request collateral (e.g., property or shares) or a personal guarantee of the owner. This is because if the business cannot repay, the owner will have to use their personal or business assets to pay it off. And if this happens, it can badly affect the goodwill of the business.
Conclusion
Revolving credit is a convenient business financial tool for MSMEs that requires flexible funding sources. It gives immediate access to money, assists in cash flow management, and can enhance the business credit rating. It also comes with risks, including high interest charges, overspending, and the possibility of a debt trap as well.
NBFCs are major contributors to providing financial support to businesses, particularly MSMEs, and most of their business loans are collateral free business loan. They provide easier loan sanctioning mechanisms compared to commercial banks, hence making it less difficult for firms to access cash at short notice. NBFCs offer flexible repayment plans, and good interest rates to enable firms to efficiently manage their financial requirements.
Photo by Mikhail Nilov: