Line of Credit Underwriting: Cash Cycle, Borrowing Base, and the Resting Period

A revolving line of credit is the most commonly misused commercial loan product — and the most commonly misunderstood one in credit analysis. The line of credit is designed for one purpose: to fund working capital needs that are cyclical and self-liquidating. It is not designed for capital expenditures, real estate purchases, long-term equipment financing, or chronic operating deficits. When a line is used for those purposes, it ceases to revolve — and a non-revolving line of credit is a term loan in disguise.

Understanding the distinction between appropriate and inappropriate line usage is the foundation of commercial line-of-credit underwriting.

What a Line of Credit Is — and Isn't

A working capital line of credit is designed to bridge the gap between when a business incurs expenses and when it collects revenue. A contractor who must pay subcontractors in 30 days but doesn't get paid by clients for 75 days has a 45-day cash gap. A line of credit funds that gap. When the client pays, the line gets paid down. The line "revolves" — it goes up when the cash gap opens and comes down when collections arrive.

This self-liquidating nature is what distinguishes a working capital line from a term loan. Term loans are repaid from operating cash flow over time. Lines of credit are repaid from the collection of the specific receivables they funded. When a line stops revolving — when the balance stays permanently elevated and never returns to zero — that's the first sign that the line is being used for a purpose it wasn't designed for.

Cash Cycle Analysis

The operating cash cycle measures how long it takes for a dollar invested in the business to come back as cash. For a manufacturer: money goes out to buy raw materials, becomes work-in-progress, becomes finished goods, is sold on credit, sits as accounts receivable, and finally becomes cash when the customer pays. The length of that cycle determines how much working capital the business needs.

The cash cycle calculation gives you a theoretically supportable line size. Compare it to what the borrower is requesting. A request for a $2,000,000 line for a business whose cash cycle analysis supports $750,000 is a significant discrepancy that requires explanation — or a reduction in the line to a supportable amount.

Sizing the Line

Line of credit sizing uses whichever is lower of two calculations: the cash cycle method above, or the borrowing base — the eligible collateral calculation that determines how much the business can draw at any given time. The line limit is the ceiling; the borrowing base is the floor of actual availability at any moment.

Additionally, look at the peak line usage from prior bank statements (if the borrower has an existing line) or from projected cash flow analysis. A business that historically never uses more than $600,000 of a $1,000,000 line either has a line that's oversized — which is a different kind of problem — or has a business model where peak needs don't materialize as they should. Understand which.

Borrowing Base Structure

The borrowing base limits actual line availability to a percentage of eligible collateral — typically accounts receivable and inventory. It protects the bank by ensuring the outstanding balance never exceeds the collateral value that supports it.

Standard advance rates: 75-85% of eligible accounts receivable, 40-60% of eligible inventory. Eligible collateral excludes: AR over 90 days (too old to be collectible), intercompany receivables (circular transactions that aren't real), government receivables in some cases (special collection rules), foreign receivables (jurisdictional enforcement issues), and cross-aged AR (accounts where more than 50% of the customer's total balance is over 90 days).

Ineligible exclusions exist because the bank's advance rate assumes collectibility at the stated percentage. Including uncollectible AR at an 80% advance rate means the bank is lending against something that won't be collected — a direct path to an under-collateralized line that won't be resolved without a loss.

The Resting Period Covenant

The annual resting period covenant requires the line of credit to be paid to zero — or near zero — for a defined number of consecutive days each year. A common requirement: the line must rest at zero for 30 consecutive days annually. The purpose is to confirm that the line is truly revolving and not functioning as a de facto term loan.

A line that cannot achieve a 30-day rest period — because the business needs the availability constantly — is a business that either has a permanent working capital deficit or is using the line for long-term purposes. Both of those are situations that require a different credit structure, not a perpetually drawn line.

The Term-Out Scenario

When a line of credit has been used for long-term purposes and no longer revolves appropriately, the bank may convert it to a term loan — a "term-out." The term-out takes the outstanding balance and amortizes it over a defined period (typically 3-7 years) with fixed principal payments.

The credit consequence of a term-out is significant: the annual principal payment from the termed-out balance adds directly to the borrower's CPLTD, which increases the DSCR denominator. A line balance that carries at $500,000 and terms out over 5 years adds $100,000 to annual principal payments — which may push an otherwise passing DSCR below the covenant threshold.

This is why the DSCR + Line Term-Out analysis tool exists on BankLiterate — to model exactly what happens to coverage ratios when a line converts to a term loan. For loan officers in workout situations, this calculation often drives the negotiation on term length: longer term = smaller annual payment = better chance of covenant compliance.

Borrowing Base Certificate Monitoring

Lines of credit with borrowing base structures require regular BBC submissions — monthly for most active lines, quarterly for lower-risk or smaller lines. The BBC documents the borrower's current eligible collateral and determines the line availability for the upcoming period.

BBC analysis is a monitoring tool, not just a paperwork exercise. Trends in the BBC reveal early warning signals: AR aging deteriorating (larger percentage over 60 or 90 days), DSO increasing (slower collections), inventory growing without corresponding revenue growth. These are the signals that a relationship manager should be responding to proactively, not discovering at annual review when the line is already under water.