Understanding Debt Covenant Report
The term debt has evolved over the years. The days are gone when business loans were the only option for corporate entities. Today there are better funding options for them. Companies and lenders often indulge in debt agreements.
A debt agreement allows the corporate entity to get the funds required to manage operations or other business activities. On the other hand, the lender will have the right to draft the terms & conditions of the debt.
With the increasing demand for debt agreements, corporate entities are spending more on covenant analysis. Since they have to prepare covenant reports. Read on to understand debt covenants and associated reports.
Understanding the concept of debt agreements and covenants
A debt agreement is between a lender and a corporate entity. The lender could be anyone, a financial institution or an individual. The lender might want to limit the borrower’s actions with a debt agreement. Often, lenders find ways to reduce the involved risk.
A debt agreement gives freedom to the lenders to reduce the level of risk. A standard business loan allows borrowers to use funds as they wish. On the other hand, a debt agreement helps lenders to align the interests of the principal amount. Not to forget, a lender will also restrict several actions with a debt agreement.
A debt agreement uses covenants to restrict some actions for the borrower. Debt covenants are restrictions the lenders apply to the debt agreement. Since covenants are mentioned within a debt agreement, none of the parties can ignore them. Most people think of debt covenants as an additional burden. But these are not an additional burden on borrowers, as they protect lenders from unwanted risks. Once a borrower takes a debt, it indulges in covenant analysis to ensure all conditions are met. A debt agreement will consist of positive covenants.
Positive covenants are actions that are mandatory for the borrower, such as
- Achieving the required financial ratio
- Protecting and maintaining high-worth equipment
- Applying the asked accounting practices
- Submitting financial statements at regular intervals
A debt agreement will also consist of a few negative covenants.
Negative covenants are actions prohibited by the lender. If the borrower ignores the negative covenants, they will breach the debt agreement. Some common negative covenants applied by lenders are as follows:
- Selling critical equipment or assets
- Borrowing debt from other lenders without paying the existing debt
- Signing other contracts without fulfilling the existing one
- Signing a merger or demerger deal
What exactly are covenant reports?
Now that you know about covenants, let us understand the importance of covenant reports. Companies create debt covenant reports to ensure the conditions mentioned in the debt agreement are being followed. With the help of covenant analysis and covenant reports, a company can check its performance concerning conditions laid by the lenders. A covenant report will also consist of goals that the company has achieved and goals that are yet to be achieved.
A company’s management team is required to provide the lenders with covenant reports. With the help of covenant reports, lenders will cross-check the performance of the borrowing company. One can also refer to covenant reports as compliance checks. Covenant reports ensure that the company is staying compliant with the covenants mentioned in the debt agreement.
The pros of covenant reports for companies are as follows:
- Any risk related to non-compliance is eliminated with the help of covenant reports
- With the help of covenant reports, companies can ensure they don’t default on debt conditions
- Covenant reports also help companies to determine the amount of extra debt they can take
- Since covenant reports are cross-checked and audited, they boost the financial credibility of the corporate entity
How to ensure covenant monitoring in 2022?
Covenant analysis and monitoring might get challenging at times. Even a little mistake can result in breaching the debt agreement. The best way is to choose an automated solution for covenant monitoring and reduce the risk of human errors. An automated solution will identify deteriorating covenant quality in real time. Invest in an automated covenant monitoring solution now!