Does my Business need a Revolver?!

As businesses grow and have more of a needcredit limit. A similar calculation is done for
for working capital a valuable financing tool is theinventory.
‘operating line of credit ‘. This facility isThe inventory calculation is a little trickier. Why?
also commonly called a ‘revolver’ byThat is because the bank understands receivables
finance professionals.and could step in to collect them if they had to
What is the revolver? It is a financing facility,– however, they don’t understand
most commonly done with a bank that providesinventory, and their customers have all types of
credit against the customer’s receivables andinventory! Our experience is that as a rule the
inventory.banks will pick an amount close to 40% for the
How does the facility work? After the facility isinventory portion of the credit line. So if a
approved and negotiated with the bank thecustomer has a month end balance of 200,000.00
customer submits, usually monthly, a detailed listin inventory the bank will arbitrarily allow them to
the firms account receivables and inventory. Thewrite cheques of 80,000.00 against the inventory.
bank calculates what is known as a ‘marginThe bank has now calculated the facility based on
limit ‘and advises the customer that theour above A/R and inventory figures.
business can write cheques against thatIt is very important to know that the whole
overdraft, or line of credit up to the maximum ofexercise with the bank is subject to a number of
that margin limit.other factors, such as the profitability of the
That new limit is of course approved until thebusiness, the risks associated with the customers
next month’s receivables and inventory areindustry, and any personal guarantees that also
reported on by the customer.   We would saysupport the facility.
that in 99% of industries the reporting by theIn summary, operating lines of credit are
customer is done once a month, but on occasionimportant, dare we say critical, to a customer
it can be more regular with some customers, andthat is growing and needs working capital.  More
on rarer occasions it can be less often.cash is available, per our formulas, as the business
How does the bank or financial institution calculategrows.  Problems can arise when a business is no
the approved amount? Typically the bank looks atlonger growing though – the bank restricts the
the accounts receivable and calculates how muchborrowings, less cash is available, and supplier
of the receivables less than 90 are days old.payables place pressure on the company’s
Banks assume there is a high level ofworking capital.  It is also important to note that
uncollectibility on receivables older than 90 days.if the operating lines of credit are significant the
This may or may not be the case according tocustomer may lose focus on profits and
the customer – but the bank makes theoperations, thinking he or she has all the cash
assumption on the conservative side. (What athey need. That’s not good.  Business
surprise!)  Given that the bank now has anowners are cautioned to used operating lines
amount of A/R less than 90 days they take 75%properly, and also focus on their profits and
of that amount, typically, and use that as theoperating capabilities.