Line of credit

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A line of credit is a credit facility that allows a borrower to take advances, during a defined period, up to the preset "line limit" and repay the advances at the borrower's discretion (with the exception that the entire principal balance plus accrued interest is due on the maturity date).

For businesses, an operating line of credit is used to provide liquidity during the operating cycle of the business. The level of control is determined by the perceived credit risk and the line limit. For smaller lines to companies with good credit, there may be no active controls on line of credit usage; that is, the customer can take advances and repay advances at will. Typically, line usage is only analyzed annually, or at renewal. If the line did not properly "revolve" during the year, the line of credit would generally be converted to a fully amortizing term loan and the line of credit closed out.

For larger lines of credit, and for companies deemed to be a higher credit risk, the line may be more closely monitored. For a fully controlled line, a borrower would be required to submit a daily accounting of accounts receivable and accounts payable along with a borrowing base certification calculating how much is available on the line and how much of an advance is needed that day. With a fully controlled line, all A/R collections are mailed by the payee directly to a bank lock box and all payments deposited to a bancontrol account not accessible by the borrower. The borrower requests operating funds via the borrowing base certificate process described above. The entire process is further monitored by annual or semi-annual A/R examinations in which the quality of a company's A/R is determined. The loan agreement for a fully controlled line of credit often states what type of receivables are acceptable as collateral (exclusions may include past-due A/R, foreign A/R, concentrations to one customer, etc.), and may specify a period of time when the company is to be "out of debt" as to use of the line. Many other controls are possible. A line of credit may also be used to support an import/export letter of credit often used with international transactions.

An operating line of credit is an important component of a company's finances and many businesses could not survive without this basic banking product.