Tag Archives | covenant

What You Should Know About Breaking Debt Covenants

What You Should Know About Breaking Debt CovenantsThe end of the first quarter of 2015 is approaching, and quarterly debt covenant compliance certificates are coming due. If your business is like many in our area, this thought probably fills you with dread. With so many businesses in Houston tied to the energy industry, the effects of the free fall in oil prices that started last summer will begin to be seen in this quarter’s results. Watch the video below to discover what you should know about breaking debt covenants.

What You Should Know About Breaking Debt Covenants

So what can you do if you’re out of compliance? Even though the situation may look bleak, there are several things a business can, and should, do when faced with broken debt covenants. Check out this video that addresses:

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What You Should Know About Breaking Debt Covenants

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What You Should Know About Breaking Debt Covenants

See also:

Daily Cash Report

Flash Report

Dynamic Cash Flow Projections

Bank Covenant Violations

How to Be More Credit Worthy

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Manage your Banking Relationship

See Also:
Financial Jargon
Categories of Banks
Finding the Right Lender
Funding Source Versus Lender
Interest Definition
Is it Time to Find a New Bank?

Manage Your Banking Relationship

In order to manage your banking relationship a key strategy is to establish lines of open communication with your banker. Treat them as your friend instead of an adversary. If you are in danger of breaking a covenant, you could very well have a much better experience if you make the banker aware of the potential problem than attempting to hide it or delay breaking the news. The earlier the banker is aware, the more likely it is that they can assist you in mitigating the problem and finding a suitable solution for you both. In addition, the more trust you build with your lender, the easier it may be for you to borrow in the future as your needs change.

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manage your banking relationship

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Loan Term

See Also:
Loan Agreement
5 C’s of Credit (5 C’s of Banking)
Self-Liquidating Loans
How important is personal credit in negotiating a commercial loan?
Loan Origination Fee
Term Deposit
What is a Term Sheet?
Preparing a Loan Package

Loan Term Definition

Loan term, defined as the period of time between when a loan is received and when the loan is fully repaid, is an important time in the life of any business. During the loan term, businesses must carefully watch finances as they have taken on a new liability which drains cash.

During the loan term a business experiences increased responsibilities. These include principal payment, interest payment, covenants (lender requirements), credit requirements, a certain risk to assets pledged as collateral for the loan, and more. All of these factors make the loan term a period of time in which a business must maintain professionalism. Though the loan term is explained above many people also casually refer to the covenants, or lender requirements which must be upheld for to avoid the lender revoking the loan, as loan terms.

Loan Term Explanation

Loan terms, explained simply, generally last up to ten years long. Loans shorter than one year are described as “short term” and loans with a life longer than one year are described as “long term”.

During loan terms, certain “covenants” must be upheld. Covenants, in short, are lender requirements which must be met to prevent the loan from revocation. Covenants start as simple as making interest payments and expand to requirements on debt and financial ratios of the business. As a rule of thumb, the more risk a lender experiences the more likely she is to extend loan covenants. Banks, in this manner, have more relaxed loan requirements than mezzanine debt financiers.

Additionally, the loan term becomes a big factor in matters of payment which are related to the loan. Logically, a short term loan in the amount of $1,000,000 will have to be repaid much faster than a 10 year loan amounting to the same sum. For tax purposes, loan terms have the same effect. A business can receive larger tax write-offs for a short term loan, though these write-offs extend to a longer period with a long term loan in the same amount. Though the loan term seems like a simple agreement related to when the loan is repaid, the effects extend into all matters related.

Loan Term Example

Chris is starting a web design firm. Chris, a student of web design and development since childhood, is an expert in his trade. He has, as luck would have it, found a great partner to market what he does best; create and manage usable web designs. Chris and his partner have had success as a startup, posses a growing collection of assets, and see company growth as their next horizon. They believe a loan will allow for this growth.

Evaluate

First, the two evaluate their options for a loan. Knowing that bank loans are usually some of the cheapest and simplest loans, the two young partners decide on using these. This is after they do their proper due diligence.

The two partners evaluate both short term and long term loans. They will begin by pacing their growth, so they decide on a small short-term loan. They realize that this decision should also be run by a tax accountant soon but decide to move forward for the time being.

Calculate

The two convene to calculate the mathematics which effect the loan. They set expectations for the total amount, interest and principal payments, loan term, and future value of the loan. These factors, together, create the loan condition and provide insight into the expectations and limitations of the company.

Loan Term Sheet

They then begin courting bankers. In this process they discuss several key issues related to the loan term sheet: total term, term of covenants, terms by which if covenants are briefly missed the loan can stay in place, common loan terms for their type of loan, and more. They make sure to find a banker that is educated in his trade.

Conclusion

Now, the two consult with their accountant. The accountant provides useful insight into the deeper matters affecting their loan. Overall, their meeting is a valuable and encouraging lesson. This is much more effective than scouring the web for a “loan payoff calculator”.

The partners eventually receive the loan they desired. They did this with the basis of understanding the environment around their loan. They are confident that if they continue to plan their business operations they can avoid costly mistakes and can create a future for themselves. Loan term amortization is not as frightening as it once seemed.

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Loan Term
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Loan Term

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Covenant Definition

See Also:
Company Valuation
Coupon Rate Bond
Fixed Income Securities
How to Manage Your Banking Relationship
Long Term Debt
Non-Investment Grade Bonds
Par Value of a Bond

Covenant Definition

The covenant definition is a restrictive clause in a bond contract. The purpose of the clause is to protect the lender (the party that invests in the bond) by imposing restrictions on the borrower (the party that issues the bond). Furthermore, the covenant amounts to the lender agreeing to lend money to the borrower as long as certain financial performance criteria are met and maintained throughout the duration of the loan contract.

Convenant Criteria

Covenants may cover criteria including the following:

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covenant definition

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covenant definition

 

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Financial Ratios

Monitoring a company’s performance using ratio analysis and comparing those measures to industry benchmarks often leads to improvements in company performance. Not to mention these ratios are often part of loan covenants. The following article provides an overview of the 5 categories of financial ratios and links to their description and calculation.

Use the following Financial Ratios to measure financial performance against standards. In addition, analysts compare these ratios to industry averages (benchmarking), industry standards or rules of thumbs and against internal trends (trends analysis). Furthermore, the most useful comparison when performing financial ratio analysis is trend analysis. They are derived from the three following financial statements:

5 Categories of Financial Ratios

The five (5) major categories in the financial ratios list include the following :

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5 Categories of Financial Ratios

5 Categories of Financial Ratios

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Breaking Debt Covenants

What should you do if you are currently violating or are at risk of violating your debt covenants (breaking debt covenants)? The following video addresses this issue. The key is to be proactive and not wait for it to fix itself.

Breaking Debt Covenants

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

Breaking Debt Covenants

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Breaking Debt Covenants

 

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Bank Covenant Violations Sets Off Bank’s ‘Trip Wire’

The Houston Business Journal interviewed The Strategic CFO regarding bank covenant violations and what steps you should take to manage the process.

Bank Covenant Violations Sets Off Bank’s ‘Trip Wire’

“Setting Off a bank’s ‘trip wire’ doesn’t have to be the end of road.”


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bank covenant violations

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