Debt Covenant Compliance
Companies often require external funding to maintain their cash flows. While equity financing is popular for raising funds, organizations prefer debt financing. Financial institutions offer debts to companies based on their creditworthiness. Lenders might refrain from distributing loans to organizations in financial distress. A company’s financial performance might deteriorate even after the approval of the loan.
Debt Covenant Compliance reporting helps lenders with this problem. Lenders rely on debt covenant reporting to meet loan conditions or agreements. Borrowers also maintain covenant compliance to avoid increases in interest rates, contractual breaches, and collateral seizure.
Read on to understand the tools and techniques used for debt covenant compliance reporting.
What Exactly is Debt Covenant Compliance Reporting?
Before delving deeper, it is essential to understand the significance of covenants in debt financing. Covenants are agreements, restrictions, or conditions a debt/loan agreement defines. Covenants are decided by the lender and followed by the borrowing organization. Lenders use covenants to protect their capital throughout the debt tenure. Lenders use financial covenants, which are metrics or ratios representing the borrower’s financial performance. Remember, lenders also impose operational or reporting covenants. Borrowers follow the actions specified by positive covenants, such as frequent reporting, protection of collateral, and maintaining financial ratios. Restrictive or negative covenants prevent borrowers from taking some actions.
Must Read: Maximizing Efficiency: How Banking Outsourcing Services Benefit Financial Institutions
The management is responsible for providing the lender with covenant reports for debt extended to a company. A debt covenant compliance report proves that the company follows the loan terms. Debt covenant reports can be issued monthly, quarterly, or annually based on the lender’s demand. A debt covenant report can include financial indicators, liquidity/solvency ratios, profitability ratios, and other metrics the lender requires. Lenders monitor the performance of borrowing companies at their end. They also depend on covenant compliance reports to make informed decisions. Debt covenant reports are essential for maintaining the lender-borrower relationship and trust.
Tools and Techniques Used for Debt Covenant Reporting
Here are some tools and techniques used for debt covenant compliance reporting:
Accounting and ERP Systems
You must deep dive into the company’s financial records to determine financial metrics, ratios, and indicators. Accountants might need more time to compile financial reports manually, relying more on accounting-based software solutions. These software solutions help generate timely financial reports required for covenant reporting. Many organizations rely on ERP (Enterprise Resource Planning) systems to effectively manage and report financial data. When financial data is readily available to the concerned professionals, they can create covenant reports easily.
Must Read: Why Mergers and Acquisition Services Are Vital for Businesses?
Spreadsheet Software Solutions
Small businesses and local companies might need more funds to purchase customized accounting or ERP systems. They prefer free or trial-based ERP solutions for financial data management and accounting. Many small businesses use spreadsheet software solutions to track financial metrics. Microsoft Excel is a popular tool used to perform covenant calculations for reporting purposes.
Automated Covenant Reporting Systems
AI, ML, and other automation technologies have changed the covenant reporting landscape. Automated covenant reporting systems are now available for companies. These systems automatically collect financial data from different sources. After data collection, these systems generate automated and ready-to-use covenant reports.
Data Visualization Tools
Besides the accountants and financial experts in the company, other employees might also want to know the financial metrics. Senior professionals within the organization are always aware of the covenant and its quality. Data analytics usually use visualization tools to generate charts, graphs, tables, and infographics. Statistics and quantitative values might only be understood by some in the organization. Charts, graphs, and infographics help understand financial metrics easily, and including them in covenant reports only makes them better and easier to understand.
BI Tools/Systems
Companies also rely on BI (Business Intelligence) tools for debt covenant compliance reporting. Many companies create customized dashboards for covenant monitoring with the help of BI tools. You can also use BI tools for data visualization when not using a separate system for creating visuals. Visuals and dashboards developed via BI tools can help monitor financial performance in real time.
Besides the abovementioned tools and techniques, companies seek third-party help for effective covenant reporting. Lenders only partially rely on covenant reports for decision-making. They also use covenant monitoring solutions to evaluate the financial performance of borrowers. These monitoring solutions generate alerts when the covenant quality deteriorates.
Conclusion
Debt covenant compliance reporting is mandatory for borrowers. Companies give an assurance of sorts to lenders through covenant reports. Lenders also rely on covenant reports for alerts and decision-making. Besides traditional accounting, ERP, and data visualization systems, companies now use automated reporting solutions for minimal manual interference. Automated covenant monitoring tools are also available for lenders in the market.
