Debt Servicing and Loan Covenants – don’t trip up!

Loan providers are becoming much more stringent - could using a management accountant help?

23 June 2023 - Emma Clifton

The steep and rapidly escalating rise in interest rates has put extraordinary pressure on businesses with debt, particularly if they have fixed rates expiring on term debt.  Whilst the after effects of COVID 19 are still lingering, it is finance costs and inflation that are dominating the thoughts of many business owners.  Attracting and retaining staff is a challenge, and higher salary cost and wage pressure is driving inflation as business are forced to increase their prices to protect profit margins. Emma Clifton, Associate Partner within our Business Advisory department looks at why loan covenants are tripping businesses up and how to avoid having to make difficult decisions. 

During the Covid-19 pandemic, UK businesses took out over £77bn of government-backed loans, and it could be argued that these huge sums pumped into the UK economy could be one of the key factors driving current inflation rate rises. So far, 85% of these loan facilities have either been repaid in full or are meeting the monthly repayments as scheduled. Whilst this sounds like a high percentage, 8% of all facilities have been subject to default, which is resulting in a £6bn hole in the economy. I don’t think we’re likely to find that down the back of the sofa!  

So, what does this mean in reality? Put simply, it means that loan providers are being much more stringent with their new facilities and cracking down on existing ones. 

Do you have a loan covenant on your current facility? For a lot of business owners, the answer to this question is….. “I don’t know.” 

What is a loan covenant?

A loan covenant is a condition that can be either financial or non-financial that is attached to a loan between the business (you) and the lender (the bank or financial organisation). These conditions must be adhered to in order to satisfy the lender that you can meet the obligations for the loan. If these conditions are breached, the lenders are within their rights to revoke the loan and request immediate repayment in full.

We have previously seen a more relaxed approach by lenders on these covenants, however in the current economic climate, businesses are now coming under increased pressure to sign up to and meet these covenants as lenders become more risk averse.

How will this affect me if I need a loan? 

Lenders will require you to prove to them that you are meeting your covenants on a regular basis, which means that annual accounts are no longer enough. It is likely that lenders will also require sight of monthly or quarterly management accounts, linked to specific Key Performance Indicators (KPIs) to continue the facility.

Common loan covenants are usually structured around KPIs such as the Current Ratio, Gearing and interest cover. The lenders will also be very keen to see EBITDA calculations (Earnings Before Interest, Tax, Depreciation and Amortisation) and will use this and the other KPIs listed here to ensure that the business is trading within pre-determined parameters.

hese requirements can put businesses under additional stress to prepare timely and accurate management accounts, sometimes with a short timeline, to present to the lender. Given the importance and reliance placed upon these figures, it is essential that these are as accurate as possible and when you are already working ‘in the business’ it can be difficult to then take a step back and work ‘on the business’ to put together the management information required.

Within our Business Advisory department, our experienced team are already working with a number of clients to prepare monthly / quarterly management accounts. We know that time is a critical factor for our clients, so by engaging us to prepare the management accounts in the background, they can continue to spend their time working in their business, where it’s needed the most.

Additional benefits

By preparing these accounts on behalf of our clients, we can really get into the detail of their business and the industry they are working within. We can help to identify trends, cyclical trading and other external factors that are likely to affect their business. By identifying these early, we can work with the business owners to put strategic plans in place so that any subsequent issues arising from these factors are effectively dealt with before they have negatively impacted the business operations.

This strong working relationship with our clients also enables us to become their ‘trusted adviser’ and take their business journey with them. Our knowledge and experience means we can assist with decision making based on real-time data and challenge them on difficult decisions.

In my opinion, management accounts are one of the key considerations when running a business. Whilst there is undoubtedly an additional cost to this, working with an independent professional has to be seen as an investment. An investment in the future of the business and an ally to help plan and manage in difficult times. Year-end compliance work is historic and lacks the capacity to plan ahead, whilst regular and timely management information can enable a business to grow when the time is right and consolidate in times of uncertainty.

I leave you with two questions: –

  • Do you have any loan covenants on your debt?
  • How could management accounts work for you?

If you are unsure of the answer to either of these, please do reach out to me, and I’d be happy to talk you through some of the ways we can support you and your business.


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