Revolver Debt For Trades & Small Businesses
This guide explains what revolver debt is. Revolver debt makes up one of the few debt products that small businesses have access to during the early stages. It's important for all types of small businesses to understand the options they have when it comes to borrowing.
The decision of whether to borrow or not to borrow is less important than it is that all small business owners understand the possibilities. It's important to give yourself every advantage you can in business, and revolver debt is particularly useful for paying suppliers or contractors as we'll see here.
Revolver debt is one of the best financing options available to help businesses manage working capital funding gaps. If a tradesman needs to pay a contractor up front for work, but doesn't get paid by their end customer for 60 days, then the tradesman needs to finance that period of cash outflows. While this may be able to be negotiated in some circumstances, in other's it can't be.
Working capital funding gaps refer to the time period it takes a business from when they need to pay for materials, supplies, inventory, or upfront labor until they are able to collect full payment from their customers. Even though a business may be able to charge three times what it costs them to perform the labor or make the product, they still need to manage the period of cash outflows until they can get paid in full for their product or service.
Revolver debt is an excellent tool to help small businesses manage cash flow. In this guide, we'll look at two different types of revolver debt and how they work.How Revolver Debt WorksRevolver debt is a type of borrowing arrangement where the borrower has access to a maximum amount of credit that can be used at any time. It allows borrowers to make withdrawals, up to the predetermined limit, and only pay interest on the amount they have withdrawn. This type of debt is typically convenient, as it allows borrowers to withdraw money as they need it.
Revolver debt is typically contrasted with a common alternative: traditional term loans. With traditional term loans, the borrower borrows a fixed amount as an upfront lump sum of cash to be paid back with interest over a specified period of time. Term loans can be fully amortized, partially amortized, or non-amortized loans. Regardless of how they are structured, they require regular fixed repayment schedules. When these loans are paid off in full, the borrower no longer has access to that money, and will need to take out additional loans to help finance another expense. You can learn more about how traditional term loans work here.
Revolver debt works differently. Whereas term loans are really intended to finance the purchase of specific assets (like buildings, equipment, vehicles, etc.) revolver debt is intended as a cash flow management loan product. Here, the borrower gets constant access to a maximum predetermined amount, and they only owe interest on the amount they borrow against that. A principal advantage of revolver debt is that the business owners can borrow against the loan as they need, and the balance is always there for them. This arrangement comes with the advantage that the business owner doesn't need to reapply and get approved for many separate small loans. Instead, they can borrow against and repay the balance outstanding as they see fit and use this to manage the day-to-day cash flow of their business.
Two forms of revolver debt are common to small businesses. The first is credit cards, and the second is revolving lines of credit. Credit cards are a type of revolver debt that many people are familiar with because they use them in their personal life as well. We all understand how much easier credit cards make things for us in our everyday lives, but we rarely stop to think about how these are a form of revolver debt. Business credit cards offer small businesses the ability to finance charges for a thirty-day period. So, if a business has a cash outflow period of 20 days, but their credit card bill isn't due for 28 days, then they don't have a period of cash outflow to manage before they get paid by customers. They will use the customer's final payment to pay off the credit card balance.
The second type of revolver debt is known as revolving lines of credit. These are often more useful to businesses that have longer working capital funding gaps. This is because they often provide larger lines of credit to draw against than credit cards do. To understand this, let's look at a clothing retail business. It's important to note that this concept also applies to service businesses. If a business designs clothes and sells them on its website or in retail stores, it most likely needs to first have the clothes in order to sell them to customers. So, if this retailer places an order with a supplier for more inventory they need to pay up front and wait to receive it. If it takes their supplier 60 days to make, ship, and have the final product delivered, it takes another 7 days to inventory, stock, and distribute the clothes to the retail locations, then it takes 67 days before they can start to sell their clothing. If it takes another 30 days to sell that inventory, then in total, that retailer has a working capital funding gap of 97 days.
We can easily see how this same concept applies to tradesmen and construction businesses. Revolver debt helps businesses manage this. In our above example, say that the business paid their supplier with a line of credit allowing them to make payment in full on their supplies, but won't owe any interest until 30 days later. They could use that line of credit to reduce the working capital funding gap by 30 days. Additionally, they could finance the whole 97 days at the expense of the interest they owe to use the line of credit.
Most businesses understand how to charge a markup for their products or services. General contractors have no problem charging you 3 times their labor costs. Fashion businesses often charge this as a minimum markup.
The issue here is not profitability, it's cash flow management.
Revolver debt is useful in helping manage cash flows. To learn more about revolver debt, why it's useful, who provides it, and how it can help with cash flow management, we recommend our guide here.
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