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Understanding Loan Covenants and Financial Statement Requirements

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Has your company taken on any new debt this year?  A careful review of new debt or renewed line of credit agreements is essential to understanding financial requirements or covenants included in the agreements. Generally, there are three different types of covenants, each containing unique requirements, they are:

  • Affirmative covenants: These typically include the requirement to pledge and maintain collateral and to provide the lender with GAAP-basis financial statements that have been subject to a level of service provided by an independent CPA. The different levels of service- audit, review or compilation- have varied requirements in addition to differences in timing and costs.
  • Negative covenants: These may restrict a company from making distributions, disposing of certain assets, changing ownership of the company, or acquiring additional debt.
  • Financial covenants: These require a company to maintain certain financial ratios, which may include debt to worth, debt service coverage, working capital, or restrictions on capital expenditure purchases. These may be measured monthly, quarterly and/or annually based on the lender agreement.

Understanding affirmative and negative covenants and performing a preliminary review of calculations of financial covenants can alert you to potential issues with debt agreement compliance prior to month,quarter or year-end. In the competitive credit market, when these issues are identified early and all parties are aware of any potential problems, covenant violations may be resolved to the benefit of both parties.

If you have questions regarding covenants included in any debt agreements, please contact your CPA or a Berntson Porter advisor at 425.454.7990.