Line of Credit

A credit line operates as a revolving arrangement: the borrower requests advances up to the stated maximum, interest accrues on the outstanding balance at a floating reference rate plus a contractual spread, and repayments restore availability for future draws. Draws are typically documented as short interest periods that roll over until repaid or until the facility matures.

Pricing rarely consists of the drawn margin alone. Committed facilities carry a commitment fee on the undrawn portion, compensating the bank for reserving capital against the promise to lend. Arrangement or upfront fees are paid at closing, and some agreements add a utilisation fee once drawings exceed a threshold. The spread itself is often set on a grid that widens as leverage rises or the borrower's rating deteriorates, so the cost of the facility moves against the company precisely when it is most needed.

To compare a credit line against commercial paper or a banker's acceptance, express every charge as a cost per unit of usable cash and annualise it. Take the interest payable on the amount drawn for the borrowing period, add the commitment fee charged on the undrawn balance and any amortised share of upfront fees, then divide that total by the net proceeds actually available to the firm. Multiply by the number of borrowing periods in a year, or equivalently by 365 divided by the number of days, to obtain the annualised cost.

Two adjustments matter. If the bank requires a compensating balance, the denominator falls to the funds the borrower can genuinely deploy, raising the effective rate. And because commitment fees are incurred whether or not the facility is used, a lightly drawn line can display a very high effective cost per dollar borrowed even when the headline spread looks competitive.

Amounts drawn appear as notes payable or short-term debt within current liabilities, while the undrawn commitment sits off the balance sheet and is disclosed in the liquidity or debt footnote, usually with the maximum size, maturity, pricing basis and covenant terms. Analysts add committed undrawn capacity to cash when assessing liquidity, but only after checking that the borrower can still satisfy the conditions precedent.

Access is contingent. Financial maintenance covenants, typically leverage and interest coverage tests, must hold at each draw, and material adverse change clauses can allow a lender to refuse funding. Investment-grade issuers also maintain committed lines specifically as a backstop for commercial paper programmes; rating agencies expect such coverage, since a paper programme that cannot be rolled must be repaid from bank capacity.

At Level I the expected competencies are practical. Rank short-term funding sources by effective annualised cost, recognising that uncommitted lines are usually cheapest in headline terms, committed lines and revolvers cost more because of commitment fees, and asset-based or factoring arrangements sit at the expensive end. Identify which arrangement suits a borrower's credit standing, since weaker issuers are pushed toward secured borrowing-base structures with regular collateral reporting.

Candidates should also connect the facility to working capital management: a line funds seasonal inventory builds and receivable gaps without forcing permanent capital raising, and its size should be calibrated to the peak cash deficit in the forecast, not the average. Finally, be prepared to evaluate liquidity by combining cash, marketable securities and reliable undrawn committed capacity.