Commercial Credit

A pre-approved amount of money that is issued by a bank to a company

What is Commercial Credit?

Commercial credit, also called a commercial line of credit, refers to a pre-approved amount of money that is made available by a bank or other lender to a company. The company can draw money from the commercial credit at its discretion to meet its financial obligations.

 

Commercial Credit

 

Understanding Commercial Credit

Commercial credit is a revolving loan offered to a company, allowing the entity to draw up to a pre-approved amount of money to meet its business expenses. Commercial credit is a common financing tool used by companies to maintain working capital requirements, purchase inventory, and fund the acquisition of capital assets.

Interest charged on commercial credit is only against the amount drawn out by the company. For example, if a company was pre-approved for a $100,000 commercial credit line but only draws $50,000 from the total credit amount, it would only need to pay interest on the amount drawn ($50,000).

In contrast, if a company was granted a $100,000 loan, the company would need to pay interest on the full amount of $100,000. Therefore, with a commercial credit line, a company can draw only the amount needed and pay interest on that amount.

 

How Commercial Credit Works

 

Types of Commercial Credit

 

1. Secured commercial credits

Secured commercial credit is secured by collateral. Examples of assets that can serve as collateral for commercial credit include accounts receivable, inventory, and capital assets. If a company is unable to return the amount drawn from commercial credit, the lender can assume ownership of the collateral and liquidate the assets to settle the outstanding balance.

 

2. Unsecured commercial credit

Unsecured commercial credit is not secured by collateral. However, a personal guarantee is almost always required for an unsecured commercial line of credit. Due to the higher credit risk, the company generally needs to demonstrate a strong credit profile and a financially sound and proven business to be approved for an unsecured line of commercial credit. As such, the pre-approved amount for unsecured commercial credit is generally lower and comes with a higher interest rate.

 

Example

ABC Company is looking to finance the purchase of inventory for sale during Boxing Day in Canada. To do so, the company secures commercial credit with a lender for $100,000, collateralized with the company’s property, plant, and equipment. The interest rate is a floating rate of prime rate + 2%, compounded monthly. Is this an example of a secured or unsecured commercial credit?

As the commercial credit is collateralized on the company’s property, plant, and equipment, it would be an example of secured commercial credit.

 

More Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • Bank Line
  • Debt Covenants
  • Recourse Loan
  • Revolving Credit Facility