What Is Commercial Credit?
Commercial credit is a pre-approved amount of money issued by a bank to a company that can be accessed by the borrowing company at any time to help meet various financial obligations.
Commercial credit is commonly used to fund common day-to-day operations and is often paid back once funds become available. Commercial credit is usually offered as a revolving line of credit. as opposed to a non-revolving line of credit. Commercial credit is also commonly referred to as a "commercial line of credit" or "business credit."
Key Takeaways
- Commercial credit is a pre-approved amount of money that a company can borrow to meet various financial obligations.
- The funding of day-to-day operations is typically one of the main uses of commercial credit.
- Commercial credit is usually offered as a revolving line of credit, which is either secured or unsecured.
Understanding Commercial Credit
Commercial credit is a line of credit offered to businesses that allow them to pay for a variety of business needs when cash is not available. A business can use their commercial credit line to pay for inventory, working capital needs, capital expenditures, and any unexpected expenses that may arise from running a business. It can also be used by companies to help fund new business opportunities that fall out of daily business operations.
To obtain a commercial credit line, a company would work with a bank to get approved, based on an evaluation of the company's business profile. If the commercial credit line extended to a company is a revolving line of credit, like a credit card, with a maximum available amount, the company can draw on this at any time. The interest charged would only be on the amount drawn until it is paid back.
Types of Commercial Credit
There are two generally available types of commercial credit, which are primarily related to how a revolving credit facility can be set up. The two types are secured commercial credit and unsecured commercial credit.
Secured Commercial Credit
Secured commercial credit is a line of credit that is backed by collateral. If the borrower is unable to pay back the borrowed funds, then a lender can claim the collateral as payment, liquidate the collateral for cash, and use the cash to settle the outstanding debt.
Unsecured Commercial Credit
Unsecured commercial credit is a line of borrowing that is not backed by any collateral and is, therefore, riskier for the lender. Unsecured credit is usually offered with higher interest rates and with a lower limit of borrowing. Furthermore, the evaluation process is much more thorough, with the company having to demonstrate a sound financial profile.
Example of Commercial Credit
XYZ Manufacturing Inc. has the chance to buy a piece of much-needed machinery at a deep discount. Let's assume that the piece of equipment normally costs $250,000, but is being sold for $100,000 on a first-come, first-serve basis. Currently, XYZ has available cash of only $25,000 and no available assets to sell or marketable securities to unwind to raise the remainder of the money needed to purchase the machinery.
Six months prior, however, XYZ obtained a revolving line of credit with ABC Bank in the amount of $500,000 and has not drawn upon it as yet, leaving the entire amount currently available for use. In this example, XYZ Manufacturing could access its commercial credit line to get the required funds immediately. The firm would then pay the borrowed amount back at a later date.
