Regardless of their size, many companies use loan finance as a source of capital in their business often supporting growth or as part of acquisition finance.
Lenders are naturally concerned with the financial health of the companies they lend money to and usually include covenants in their loan agreements. Covenants are tests set by the lender to measure business performance and give an early indication that a business may struggle to service or repay the debt.
Therefore, it is vital that companies actively monitor performance against their loan covenants.
In this blog, we answer the following questions:
- What are typical loan covenants?
- What are positive and negative covenants?
- How can the consolidation reporting process help you actively monitor loan covenants?
Related article | Why outsource finance consolidation?
What are the typical loan covenants?
The most commonly used tests lenders set as loan covenants are related to the company’s EBITDA (earnings before interest, tax, depreciation, and amortisation). They include:
- Leverage: Debt to EBITDA ratio
- Interest cover: EBITDA/Interest Cost ratio
- Debt Service (or Cash Flow) cover: Cash Flow (or EBITDA)/Debt Service (i.e. interest + loan repayments)
- Debt to equity ratio
- Debt to assets ratio
- Minimum Net Worth: net worth of at least £x million
What are positive and negative covenants?
Positive covenants state what the borrower must do, for example:
- Achieve certain financial ratios
- Perform regular maintenance on capital assets
- Provide quarterly accounts and yearly audited financial statements
- Ensure accounting practices are in accordance with IFRS
Negative covenants state what the borrower must not do without the lender’s prior consent, for example:
- pay cash dividends to shareholders for the duration of the loan
- undertake certain agreements with outside parties
- take on more debt
- partake in certain M&A
How can consolidation reporting monitor loan covenants?
Loan agreements can contain a bewildering array of positive and negative covenants leaving borrowers worried about breaching and needing help to avoid an accidental breach. Whether accidental or otherwise, a breach would permit the lender to enforce certain obligations on the company which may include increasing the interest rate, charging additional fees or demanding immediate repayment before the loan’s expected maturity date.
The key is regular and active monitoring, but this is time-consuming with Excel spreadsheets and manual checking. CFOs need to look for finance consolidation reporting automation tools (like Konsolidator and Power BI) that can link to the source data and extract information directly from the accounting and other operational systems, in the same way, every month.
Consolidation-as-a-Service is a relatively new concept, but service providers like ireport can take the pressure off the finance team. They can ensure that, regardless of which tests are included in your loan agreement, debt covenants are monitored regularly, consistently, and accurately and that the debt covenant report is produced on time and in the correct format to meet the requirements of your lender.