Banks generally set 3-4 key covenants on their loans. These covenants serve as “tripwires” that alert the bank to potential trouble ahead. Most companies don’t bust all of them, but many find themselves out of compliance with at least one of them at times. This is particularly true in a soft economy like we’re seeing in Houston these days.
In English, DSCR is equal to Net Operating Income divided by the cost to service the company’s debt. It basically measures your company’s ability to make its debt payments. You can see why this covenant is especially important to your banker…
Impact of Broken Debt Covenants
What does it mean to have broken debt covenants? Worst case, the bank can call your loan. Generally speaking, banks don’t want to do this, especially if it’s not part of a troubling pattern for your company. The more likely scenario is that your credit line could be frozen and your company will need to start surviving off only the cash flow generated from operations.
If you find yourself in the situation described above, don’t panic. By making a few changes, your company can free up cash flow to get a little breathing room until things turn around. Here are a few examples:
Ask key vendors to stretch their terms – Your vendors don’t want to own your company. When cash is tight, most vendors will work with you if you as long as you are willing to make regular payments, even if it’s not by the due date.
Have a designated collections person – Nobody likes making collection calls, so unless collections is someone’s job, it’s no one’s job. Having a dedicated collections person ensures that customers are paying within terms or have made arrangements to pay out past-due invoices, ensuring that your business has the cash to fund operations.
Invoice immediately – It may not seem like much, but getting your invoices out even a couple of days sooner can free up a considerable amount of cash. Make sure you get them out right away and that they are clear and easy-to-read to avoid payment delays.
Looking for more ideas to help free up cash? Click the link below to download our free list 25 Ways to Improve Cash Flow.