Academic journal article Journal of Accountancy

Loan Covenants Tighten Up

Academic journal article Journal of Accountancy

Loan Covenants Tighten Up

Article excerpt


In the first quarter of 2009, 22% of CPA financial executives said previous sources of credit had dried up, according to the AICPA/UNC Kenan Flagler Economic Outlook Survey. As a result, many businesses are shopping for new loan sources. Consider the following before you talk to a lender:

* Negotiate and monitor ratios. You know your business better than your lender does. Covenants usually include a loan-to-tangible-net-worth ratio and often quick-and-current ratios. Banks used to pad ratios by 20% to give the borrower wiggle room, and the borrower would have to be out of compliance for two consecutive quarters to be in default. "I'm not seeing those kinds of things being done anymore," says Sam Thacker of consulting firm Business Finance Solutions. However, Thacker says ratios can be negotiated upfront. Ed Lette, CPA, chairman and CEO of Austin-based Business Bank of Texas, says in order to be prepared for a ratio discussion with potential lenders, look up ratios provided by the Risk Management Association. Most importantly, track your key financial ratios monthly

* Prepare to be audited. "In the last 12 months we are seeing a trend where smaller companies are being asked to provide audited financial statements more than ever before," Thacker says. Although it is important to consider all costs associated with maintaining loan covenants, for an unaudited business to provide audited financial statements--especially for the first time--is a major undertaking that can be very costly. It will take many hours of staff and management time to formalize accounting policies in accordance with GAAP, train staff, and set up and test internal controls.

* Watch out for a positive cash flow covenant. "One new covenant that I'm seeing is 'Maintain positive cash flow measured on a quarterly basis,'" Thacker says. If your business cycle is longer than 90 days or you are borrowing against lagging accounts receivable, this could be an unacceptable covenant for your business.

* Get ready for new rate structures. …

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