Tips for understanding your customer's bank credit line.(Brief Article)

A bank credit line (also called a revolving credit facility) is a working capital loan. Your customer may have, for example, a $10 million line of credit with their bank. This means they have the ability to borrow up to $10 million and, up to that amount, may increase or decrease their borrowing on a daily basis. The amount borrowed under the bank credit line is included when calculating most leverage ratios.

When analyzing your customer's financial statement, it is important to understand how close the company is to reaching their maximum borrowing under the bank credit line. Also, looking at trends will help understand if, over a period of time, they are increasing or decreasing the overall borrowing.

Seasonal fluctuations go hand in hand with credit lines. It is typical to see the highest credit lines just before and during the busy season when a company builds inventory but has not yet collected the sales from the busy season.

However, if it is not the busy time of year, and you see the customer being close to the total available on the line of credit, a red flag should go up. The balance sheet will show the amount borrowed. The total amount they can borrow under the bank credit line (called the availability) will probably be noted in the footnotes or management discussion. If your customer has borrowed their maximum in the non-busy season and will not have additional availability on the credit line when they need it, be aware they may stretch their payments to you to fulfill their working capital needs.

Even though a company may always have a certain level borrowed, in theory, a credit line is borrowed and repaid each day. Therefore, a credit line is usually shown in the current liability section of the balance sheet.

From time to time, you may receive a financial statement that has the credit line in the long-term section of the balance sheet. They justify the long-term classification as always having a certain amount ...