Year-end reminder: review your loan covenant compliance

Why this matters and what you should do before 31 December

Year-end means preparing financial statements, but many businesses overlook one critical aspect: whether the covenants of long-term loans are compliant with the indicators agreed with the bank as at the balance sheet date.

What are covenants?

Covenants are conditions agreed in a loan agreement to mitigate the lender’s risk and ensure that the company’s financial position stays within permitted limits. Generally, there are two types of covenants.

1. Financial covenants

These require the company to meet specific financial ratios.

The most common examples include:

• EBITDA level or EBITDA margin;
• DSCR (Debt Service Coverage Ratio) – the company’s ability to service debt;
• net debt / EBITDA ratio;
• minimum equity level;
• short-term liquidity ratios.

2. Non-financial covenants

These are not linked directly to numerical metrics.

Examples include:

• obligation to insure the company’s assets;
• restrictions on dividend payments;
• requirement to maintain a specific governance or reporting system;
• restrictions on taking on additional debt;
• obligation to keep funds and perform certain transactions with the lender’s bank.

Breaching either type of covenant gives the bank the right to demand immediate repayment of the loan.

If the covenants are not met, the loan automatically becomes a current liability, which significantly impacts the balance sheet structure as well as liquidity and other financial indicators.

Why is this important for accounting?

The Accounting Standards Board guideline RTJ 2 clarifies that the classification of liabilities as current or non-current depends on the payment term and the lender’s rights as at the balance sheet date.

If a company breaches its covenants, the bank is contractually entitled to call in the loan immediately.

In such a case, the loan must be classified as a current liability, even if the bank does not actually intend to demand repayment.

RTJ 2 paragraph 19 (corresponding to IAS 1.74 under IFRS)

If a company breaches the terms of a long-term loan and the lender has the right to call in the loan immediately, the loan must be presented as a current liability—even if a waiver is obtained after the reporting date stating the bank will not enforce its right.

How to avoid the problem? Request a waiver in time

If you see that financial indicators may not meet the covenants, you should request an official waiver from the bank before the balance sheet date. This waiver must explicitly state that the bank will not enforce its right to demand early repayment due to the covenant breach.

Such a waiver enables the company to continue presenting the loan as a non-current liability.

A confirmation received after the balance sheet date is not sufficient to keep the loan classified as non-current (RTJ 2 paragraph 19).

Practical year-end checklist

✔ Review all long-term loan agreements.

✔ Verify compliance with all covenants (EBITDA, DSCR, equity, net debt, etc.).

✔ Forecast year-end results.

✔ If there is a risk of breach, contact the bank early.

✔ Request an official waiver before 31 December.

✔ Communicate the information to accounting and the auditor.

Why is this check necessary?

Incorrect classification (non-current vs. current) may affect:

• solvency and liquidity indicators
• the company’s creditworthiness and going concern assessment

 
We wish you a seamless year-end close!