If you have ever had a bank loan or a line of credit then you have agreed to a bank covenant (It was in that mountain of paperwork that you signed, and read in detail). A covenant is a clause in the loan agreement that requires borrowers to do, or refrain from doing certain things. Before taking a loan from a bank you need to be confident that you can meet the financial goals in the projections that you provided to the bank.
We advise our clients to create three sets of annual projections:
1. The bank version: This is the conservative projection and the one that your entire management team believes is attainable. You should probably factor in a few negative what ifs in here to ensure that this is conservative. While you don’t want to undersell yourself you do want to show to yourself and the bank that if you didn’t achieve any or much growth that you could still meet your requirements.
2. The most realistic: This scenario is the most probable outcome. This might have your current sales increase continuing. So for instance if over the last 12 months your turnover has increased by 10% then you might project that it continue at 10% or have a slight increase to 15%. This is the one that you as a management team are working towards as your own goal and you believe that it is achievable.
3. The stretch budget: This is the potential result if all the stars were to align. This would be what you give your sales team, achievable but a stretch target on what you are currently achieving.
Despite the best of intentions companies can fail to meet their bank covenants. So if this happens what should you do? What is the best way to approach the situation?
We believe that the best way is head on! If based on your mid year results you don’t think you are going to meet the covenant then you need to do new projections, then put steps in place to remedy the situation. But don’t hide this from your bank, contact them and discuss the situation well before you have violated the agreement.
If you have violated the covenant and you haven’t discussed it with your banker then you need to do the following:
1. Provide the bank with new projections that clearly show how you are going to meet the covenant moving forward.
2. Consider putting more equity into the company or adding more collateral to the loan. This may mean you need to put more of your own money into the business or use your house or other personal assets as collateral.
3. Request a bank waiver. This may add charges and fees as some loan terms such as the interest rate may need to change.
Remember that your bank is a key business partner. You need to foster that relationship, keep them involved so that they can help you. We are experts in helping our clients with reporting required for banks and with relationships across all major banks we are only too happy to help you navigate this relationship. Speak to our team if you need assistance.
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