I’ve breached my finance covenants – what action should I take and what are the implications on my accounts?

Many loan documents have covenants: measures by the funder to test business performance against plan and set at a level to provide an early flag that a business may potentially struggle with future debt repayments. 

If a covenant is breached speak early to the funder. Breaching a covenant should not mean anything other than an opportunity for pro-active dialogue with the funder. Explain why that covenant is breached and what action you propose to ensure future compliance. Should the breach be a temporary issue, the bank should issue a formal written waiver for that test – this formally waives the requirements to comply with the covenant. As well as any actual breaches, the letter should cover all anticipated future breaches so you don’t need to repeat the conversation later down the line. 

If the covenant breaches would appear to be more permanent in nature and likely to continue to recur, the bank should provide options including a review to ensure the covenant is still relevant in the context of the current business structure (some loans are taken out 5+ years ago and the overall balance sheet shape and cash cycle could now be very different). Other options will include a restructure of the loan (maybe over a longer period to protect cash). 

Turning to some year end financial accounting considerations, if you anticipate breaching a covenant prior to your financial year end, ensure you obtain the waiver letter dated on or before your year end. This should mean you don’t need to reflect the consequences of a breach in your statutory accounts for that period.  

To illustrate, if a consequence of a breach before or at year end is that your loan is repayable on demand, then technically that structured debt may need to be entirely classified as a liability due within one year in your statutory accounts. However, if you have a waiver letter from your finance provider dated before or at your year end date, then this change in classification wouldn’t be required. 

Obtaining the letter at or before your year end is important as you need to reflect your situation as at year end. If you negotiate a loan breach waiver post year end, technically that is a post balance sheet event and whilst important from a going concern perspective, it would probably not prevent your loan needing to be entirely classified as due within one year in your statutory accounts.

As covenant breaches can result in some significant accounting and financial reporting implications, please do discuss this with your accountant or auditor in advance of your year end if you anticipate you may be in this situation.