Chief accountants and CFOs: don’t forget an important task before Christmas!

Companies’ credit agreements generally contain customer-specific conditions called covenants. December is the last chance to check whether the company is indeed in compliance with these covenants, especially considering how companies’ financial results have been impacted by the current ultra-rapid economic growth, rising prices and supply chain problems.

Covenants include financial prerequisites (ratios like DSCR, EBITDA), restrictions and prohibitions on actions (distribution of profit, pledging assets, taking additional debt), or they can also be not directly related to finances (restriction on changes to management members and owners, restriction on change in area of activity).

When must a loan be classified as a current liability?

Under the financial reporting standards (ASBG 2, art. 19) when an entity has breached the terms and conditions of a long-term loan agreement as a result of which the lender has the right to immediately call the loan at the reporting date, this loan must be classified as a current liability. Note that even if the lender has agreed after reporting date not to exercise their right to call the loan, this does not constitute a basis to not classify the entire loan amount as a current liability. What to do in such a situation? If a loan is fully recognized as a current liability, this means significant changes to financial reports and not in a positive direction!

Recommendation: get written consent from the lender

First off, run a forecast of whether the loan covenants will be fulfilled or not. Forecasting is a thankless job, because it is intrinsically imperfect. But if there is even a faint possibility that the covenants will not be met, you should immediately contact the credit provider, explain the situation and ask for written confirmation that they will not exercise their option to terminate the credit agreements prematurely. Two issues should be borne in mind when asking for the confirmation:

• the confirmation must be received from the credit provider before the balance sheet date and
• the confirmation must remain valid for at least 12 months after the balance sheet date.

Why are these two factors important?

If you send your financial reports to the bank only after the balance sheet date and the numbers reveal that the covenants were not fulfilled, the bank’s confirmation that they will accept the breach and not call in the loan is of no use anymore because in the sense of accrual basis, such a confirmation did not exist as at the balance sheet date. If the confirmation is obtained before the balance sheet date but is not valid for 12 months, it should be evaluated whether there is a possibility that the covenants will be violated later. Often achieving alignment with loan covenants overnight is not possible and violations may occur later, which is why the bank confirmation to not invoke the acceleration clause has to remain valid for 12 months.

Since getting a response from the credit provider can take some time, now is the right time to deal with this topic.