The Hidden Sides of Entrepreneurship (Part 3)
Lewis faces debt covenants on his commercial loan and learns to manage his financial obligations.
Have you ever found yourself in a situation where debt covenants put your business in a precarious position? It’s one thing to secure a loan, but it’s another to maintain one, especially when there are restrictive covenants attached to that debt.
About debt covenants
A debt covenant is a restriction or obligation that a lender imposes on a loan to reduce the risk of default. Debt covenants make the loan safer and more advantageous for both parties.
The 3 types of covenants
1 - Positive covenant
A positive covenant refers to an action the company must take, such as providing quarterly financial statements or performing regular equipment maintenance.
2 - Negative covenant
A negative covenant prevents the borrower from taking certain actions. For example, a lender may require the borrower not to issue dividends during the loan term.
3 - Financial covenant
A financial covenant relates to the company’s financial performance. Typically, these are performance thresholds imposed on ratios calculated from financial statements.
Why is it important to comply with covenants?
If the company breaks one of its financial covenants, the lender could demand immediate loan repayment, putting the company’s future at risk.
Recommendations
Adopt cloud accounting
Cloud accounting simplifies management: access reports from your phone, automate financial reports, track project costs in real time.
Purchase timing
Being strategic about purchase timing is important. Some purchases improve financial covenants, while others can make performance appear worse than it is.