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Steadfast Monitoring Of Your Loan Covenants

The rules have changed. In the past, if your business failed to meet a loan covenant, you just asked your bank for a waiver and in most cases the bank agreed. Those days are gone. Today, bank regulators are pressuring banks to discontinue this practice and few banks will grant waivers so easily.

What Are Bank Covenants and Why Do Banks Require Them?

Banks use covenants as a means of monitoring a borrower’s operations to assure that the basis upon which a loan was made continues throughout the term of the loan. 

Monitoring Your Loan Covenants

No business owner wants to be surprised with a call from their lender that a loan covenant has been breached. Regular monitoring of loan covenants is important to be sure compliance is being maintained. Failure to meet covenant requirements can result in your loan being in default and the bank may “call the loan”.

Daily decisions with regard to operational or cash flow issues must include consideration of the consequences of the covenants associated with a loan. For example, the decision to make a cash distribution to the business owners may reduce the equity account to a level that breaches the Debt to Worth Ratio covenant. You need to read the fine print. Many loans allow only distribution for taxes in a flow-through entity such as S-Corps.

Dugan & Lopatka Loan Covenant Services

Dugan & Lopatka proactively assists business owners in establishing and overseeing a systematic method of periodically “testing” all loan covenants to assure continued compliance. We help identify potential breaches while there is still time to make adjustments. In addition, where a breach is anticipated to occur, Dugan & Lopatka can stand with you when dealing with the lenders and help achieve a satisfactory resolution for both parties -- avoiding extreme actions against the borrower such as calling the loan or adversely changing the terms and conditions of the loan.

Common Loan Covenants

Tangible Net Worth to Debt Ratio. The tangible net worth of a company is calculated by taking the net worth as shown on the company's balance sheet and subtracting the intangible assets — such as copyrights, patent and intellectual property. This leaves only the hard assets — land, buildings, equipment, inventory, accounts receivable and cash.

Banks use several versions of the debt to tangible net worth ratio. A common calculation is to divide total liabilities by the tangible net worth. In this ratio, total liabilities include current liabilities, long-term debt and tangible net worth.

Intangible Net Worth. Banks may require that you maintain a certain intangible net worth such as $1 million.

Debt Service Coverage Ratio (“DSCR”). This is the ratio of cash available for paying debt to total debt payments required (interest, principal, lease payments, etc.). The higher this ratio is, the easier it is to obtain a loan. Commercial banks generally establish a minimum ratio that is acceptable to a lender and one that is “tested” periodically to assure that the minimum ratio is being maintained. Our experience with clients suggests that banks are looking for a ratio of 1.2 or greater.

Debt to Worth (Equity) Ratio (“DTWR”). This is a financial ratio indicating the relative proportion of shareholders equity and debt used to finance a company's assets. Banks are looking for a lower ratio – meaning a less “leveraged” business.


If you would like to learn more about Dugan & Lopatka and how our specialization in serving small and mid-sized privately-held business can benefit your company, please complete the Contact Us form or call us at (630) 665-4440.


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By Dugan Lopatka - Accountants for Midsize Businesses in Chicago:  CPAs for Small Businesses

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Dugan & Lopatka, CPAs, PC, 104 E. Roosevelt Road, Wheaton, Illinois 60187 -MAP- T: (630) 665-4440 Fax: (630) 665-5030