Cash Pooling

Short term financing – lines of credit

| 17-04-2018 | treasuryXL |

Cash PoolingThere are many instruments that can be used to obtain short term funding. We have touched on some of them earlier in this series. This article is all about lines of credit. These are normally provided by banks of other financial intermediaries and help corporates with their short term funding needs. At first glance is might appear to be the same as a short term loan, but there are some clear differences. Normally, the financial institute that is the counterparty, will provide you with a line of credit – after appropriate inspection – which sets a specific limit on the amount of credit to be extended. Let us see how this works.

An agreed line of credit will contain, within its contract, a few simple terms:

  • The maximum amount that can be drawn
  • The minimum amount that can be drawn
  • The minimum and maximum tenor
  • If based on floating rates – the base will be specified
  • The additional margin rate above the index rate
  • The end date of the facility
  • The facility fee – usually expressed in basis points

Facility Fee

When a bank extends a line of credit, they are actually earmarking these funds in their books – they have a contingent liability. The facility fee can be seen as the cost of the arrangement. Normally the facility fee is paid monthly on the notional amount outstanding on the facility. In other words, if 70% of the facility was not being used, then a facility fee would be owed at the end of the month on a pro rata basis for this amount.

Drawdowns are communicated via the agreed channels and the bank credits the client. Lines can either be secured or unsecured – a secured line would attract a lower interest rate payable. Furthermore, normal corporate governance would apply in respect of bank compliance – agreed ratios must be maintained in order to keep the facility running.

The main advantage with a line of credit, is that the client has the flexibility to borrow exactly the amount that they require – given the contract conditions – and also have flexibility regarding the tenor. With a traditional loan, they would receive all the funds on the first day, irrespective of if they actually needed all the funds on that day.

Interest is only paid on the amount borrowed – not on the whole facility. For the balance, as mentioned earlier, a facility is payable. Due to its revolving nature, the facility can be used for many times during the agreed life of the facility. This gives the borrower enormous flexibility and ensures that they never need to borrow more than they actually require.

This product is normally used for operational issues, that are influenced by specific factors. It could be that a company is exposed to seasonal factors that result in a shortage of cash. A line of credit enables the company to smooth out these peaks and troughs and ease the bottlenecks restricting their operations. Additionally, due to the time lag inherent in many companies between delivering goods and receiving payment a line of credit ensures continuation of the daily operations.

The product can be renewed, but will be subject to a new inspection and, possibly, new terms and conditions at renewal. For companies that experience wide fluctuations in cash flows, this is a useful product to arrange their short term funding.


If you have any questions, please feel free to contact us.

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