What Is The Revolving Fund Method?

Table of Contents

What is the Revolving Fund Method?

The revolving fund is a method of financing that involves a fund or account that is replenished as money is spent, enabling it to be used repeatedly for ongoing operations or specific purposes (https://en.wikipedia.org/wiki/Revolving_fund). A revolving fund allows an organization to make expenditures, recoup costs through charges, and then use repaid funds to finance future operations without fiscal year limitations.

Essentially, a revolving fund operates by using income from operations to sustain itself. As opposed to a fixed budget that runs out after a certain period, the balance of a revolving fund remains available indefinitely. Revenues collected are used to replenish the fund as money is spent over time (https://www.merriam-webster.com/dictionary/revolving%20fund). This creates a sustainable and renewable pool of capital within an organization.

In summary, a revolving fund is a method of financing ongoing operations where expenditures are recouped and available capital is replenished through operational revenues. This allows organizations to sustain their activities over long periods using the same original fund.

History and Origin

The revolving fund method first emerged in the United States in the late 19th century as a way for government agencies to finance their operations in a more efficient and accountable manner. According to the Government Accountability Office, Congress established the first revolving funds for the Government Printing Office and the Navy Department in the late 1800s.

The main motivation behind the creation of revolving funds was to give agencies more flexibility and autonomy in financing their business-like operations. Under the traditional appropriations method, agencies had to receive new appropriations from Congress each year, which made it difficult to plan and manage longer-term investments. Revolving funds allowed agencies to reinvest revenue from sales and services to support their ongoing operations without going back to Congress annually.

By the early 20th century, revolving funds were being used across the federal government for activities like printing, shipbuilding, commissary operations, and forestry programs. The funds provided a self-sustaining model that improved efficiency, reduced bureaucracy, and enhanced agency accountability for managing their finances and delivering results.

How the Revolving Fund Method Works

The revolving fund method works by establishing a pool of money that gets replenished as funds get paid back into it cite url. This pool of money is then used to provide loans, grants, or other financing to recipients on an ongoing basis. As the recipients repay the funds they borrowed, that money goes back into the revolving fund to finance the next round of recipients.

For example, a nonprofit organization might establish a $1 million revolving fund to provide small business loans. They lend out $500,000 to 10 small businesses. As those businesses repay their loans with interest over time, say $600,000 total over 5 years, that $600,000 goes back into the revolving fund. Now there is $1.1 million available to lend out to a new set of small businesses. This cycle continually repeats as loans are repaid and new loans are made.

The key aspect that makes this a “revolving” fund is that repayments are used to make new disbursements rather than closing out the fund. As long as there is adequate cash flow into the fund from loan repayments and interest earned, it can keep revolving indefinitely.

Advantages

The revolving fund method has several key benefits that make it an attractive financing option for many organizations:

Reusability – The same pool of capital can be reused multiple times for various needs, reducing the need to raise new funds frequently (https://www.wallstreetmojo.com/revolving-fund/). This improves capital efficiency.

Flexibility – Funds can be reallocated to new projects once previous ones are repaid, allowing for adaptable financing as needs change (https://www.cdfa.net/cdfa/cdfaweb.nsf/pages/revolving-loan-funds.html).

Accessibility – The revolving structure makes financing accessible to more recipients over time compared to one-time grants (https://www.energy.gov/scep/slsc/revolving-loan-funds).

Lower Interest – Government and nonprofit revolving funds often offer below market interest rates, reducing borrowing costs for recipients (https://www.energy.gov/scep/slsc/revolving-loan-funds).

Ongoing Impact – Repaid funds are recycled to support similar outcomes in the future, creating an ongoing impact from the initial capital investment.

Disadvantages

The revolving fund method has some potential limitations and weaknesses to consider:

Cash flow restrictions – The size of the fund limits how much inventory can be purchased at once. This may restrict the ability to take advantage of quantity discounts or make large inventory purchases.

Repayment burden – Departments have to repay the revolving fund, which can create an additional financial burden on their budgets. This repayment obligation may limit their ability to fund other expenses.

Administrative workload – Managing the fund requires administrative work such as tracking loans, repayments, interest, and fund balances. This creates an ongoing administrative burden.

Fragmented purchasing – With each department managing its own purchases, purchasing activities are decentralized and fragmented across the organization. This can inhibit bulk discounts.

Less purchasing control – With purchasing dispersed across many departments, there is less centralized control and oversight of purchasing activities. This can make it harder to enforce purchasing policies.

Key Differences from Other Methods

The revolving fund method differs from other financing options in several key ways:

Unlike a petty cash fund which is designed for small or incidental purchases [1], a revolving fund is used for larger, recurring expenses related to operating a program or providing a service. The amounts in a revolving fund are usually much higher than a petty cash fund.

Revolving funds are also different from enterprise funds, which are self-sustaining through fees and charges [2]. A revolving fund may charge fees, but its primary revenue source is allotments from a general fund.

Unlike a sinking fund which accumulates money over time for a specific future purpose, a revolving fund is an ongoing fund where expenditures are continuously made and reimbursements are continuously received.

The revolving method also differs from a grant or donation funded program. With revolving funds, agencies or departments fund themselves through reimbursements rather than relying on outside funding sources.

Overall, the unique aspects of the revolving fund method are its internal revenue source through reimbursements, its continuous self-sustaining nature, and its applicability for recurring program expenditures rather than one-time purchases or projects.

Use Cases and Applications

The revolving fund method is commonly used in several situations and organizations:

Non-profits and charities often utilize revolving funds to finance programs and operations. For example, a charity may create a revolving loan fund to provide small, short-term loans to local entrepreneurs to help them start businesses. As the loans are repaid, the money is lent out again to new recipients.¹

Governments establish revolving funds to support public programs and infrastructure. A government agency may set up a revolving fund for a specific purpose, like providing loans for renewable energy projects or financing transportation infrastructure. The loan repayments are used to issue new loans over time.

Businesses use revolving funds as a cash management tool and financing mechanism. For example, a company may create an inventory revolving fund to purchase new stock for their stores. As the inventory is sold, the money is used to replenish stock levels.

International development organizations often operate revolving loan funds in developing countries to provide access to credit for individuals and small businesses. These funds aim to be sustainable by recycling the capital as it is repaid by borrowers.

Community organizations, cooperatives, and associations employ revolving funds for pooling member resources. The members contribute to the fund and can take turns utilizing the money for needs like equipment purchases or operating expenses.

Implementing a Revolving Fund

Implementing a revolving fund requires careful planning and management. Here are some practical steps for setting up and managing a successful revolving fund:

Define the Purpose and Goals

First, clearly define the purpose and goals of your revolving fund. Consider what needs it will meet and how it will benefit your organization or community. Set targets for loan amounts, repayment rates, and administration costs.

Establish Policies and Procedures

Create comprehensive policies and procedures to govern the revolving fund. Outline eligibility criteria, loan terms, repayment plans, interest rates, and consequences for late payments. Define the loan application and approval process.

Secure Initial Capital

Obtain seed funding to launch the revolving fund from grants, donations, or your organization’s budget. Determine the initial amount needed to make loans and cover administrative costs. Fundraising can generate ongoing support.

Set Up Accounting Systems

Establish a separate bank account and bookkeeping system to track revolving fund income and expenses independently from other finances. Create forms and software tools to maintain detailed loan records.

Market the Revolving Fund

Promote the revolving fund to potential borrowers through advertisements, informational sessions, partner referrals, and networking. Focus marketing on your target loan applicants.

Offer Loans and Collect Repayments

Implement the application process and approve qualified borrowers. Disburse loan funds andmonitor repayments through site visits, statements, and reminders. Pursue payment from delinquent borrowers.

Sustain and Expand the Fund

Use loan repayments to issue new loans and cover expenses. Seek additional donations and grants. Review policies and operations periodically. Increase loan amounts and recipients once the fund is running smoothly.

Revolving Fund Accounting

Revolving funds require specific accounting practices to track the inflows and outflows of cash. According to the Financial Management Regulation from the US Department of Defense Comptroller, revolving fund accounts are authorized to receive collections, incur obligations, and make expenditures [1]. The fund is replenished periodically by recognizing the expenses as an asset and recording an offsetting liability. When the fund is replenished, the liability is reduced by the amount of the replenishment.

Typically, a revolving fund will have its own bank account. As money is spent, expenses are recorded in the accounting system. When the fund drops below a target threshold, a reimbursement request is made to replenish the fund up to its authorized level. This brings the cash balance back up. The replenishment is booked as a reduction in the liability that was established when the fund was originally created.

Ongoing accounting includes tracking expenses against budgeted amounts for control purposes. Periodic reconciliation of the bank balance to the book balance is also essential. With proper accounting treatment, revolving funds provide an efficient way to have cash accessible for small purchases while still maintaining oversight.

Future Outlook

The revolving fund method is likely to continue evolving and expanding in the future. Some key predictions for the future of revolving funds include:

Increased adoption by state and local governments – Revolving funds are becoming more popular at the state and local level as a way to fund various programs and initiatives without relying solely on annual appropriations. Many experts predict more state and local governments will establish revolving funds in areas like infrastructure, energy efficiency, and more. [1]
Expanded use in the private sector – While traditionally used in the public sector, revolving funds are now being adopted by some private companies and nonprofits as a way to self-fund various internal programs. This trend may accelerate going forward. [2]

Increased automation and digitization – Managing and accounting for revolving funds will likely become more automated and streamlined through software tools. This can improve oversight and simplify reporting. [3]
More performance tracking and impact analysis – There will likely be greater focus on tracking revolving fund performance and analyzing the impact and return on investment of programs funded this way.

While some operational aspects may change, experts expect the core principles and financial mechanics of revolving funds to remain mostly consistent going forward. Their flexibility and sustainable nature will likely ensure revolving funds remain a valued budgeting approach.