Everything You Need to Know about Bank Debt Covenants

Everything You Need to Know about Bank Debt Covenants

Alma Bailey 0 Comments

The transportation industry has been hit with low volumes, low rates and poor cash flow. Financial consultants, business advisors and CFOs of trucking companies are all challenged beyond the norm to maintain the financial stability of the company they represent. Approaching a bank for an operating line of credit is usually the first consideration, but before you sign a loan agreement, be sure to understand the importance of debt covenants.
 
Debt covenants are a specific set of conditions in a business loan designed to impose limits and controls on the borrower. These covenants detail exactly what the business agrees to do, or not do, during the course of the loan. Every business loan agreement made between a bank and a trucking company includes covenants. These terms and restrictions are included in the contract for one reason only; to protect the bank.

Why Are Bank Covenants Used?

Covenants are commonly used by banks to guard themselves against credit risk and protect their profits. They are used by the lender to create boundaries for the company and its owners as a means to preserve the borrower’s ability to repay debt. Banks consider trucking as a volatile industry, and therefore conduct themselves with added caution when extending credit in this space. If you manage to find a bank willing to lend money to your trucking business, be prepared for the consequences. The tight controls they impose will require regular financial reporting on your part and audits by the bank to ensure the loan stays on their radar as a safe investment.

The last thing banks want is for a client’s loan to go into default and weaken their overall profits. A banker will use a broken covenant to exit any loan agreement with a client who’s showing signs of financial stress. In today’s state of the industry when transportation businesses are most exposed, banks are watching trucking companies very closely for this reason.

A banker will use a broken covenant to exit any loan agreement with a client who’s showing signs of financial stress. In today’s state of the industry when transportation businesses are most exposed, banks are watching trucking companies very closely for this reason.

Why Are Bank Covenants Important?

Too often business owners make financial decisions that violate bank covenants without even realizing it. This can prove to be a critical mistake with enormous negative impact on the success of the trucking company. If a covenant is broken, the bank has the option to back out of the loan agreement leaving the company without funding. Holding this level of control provides the bank governing power over the company’s access to funds and stifles the ability for stability or business growth. Every company’s financial decision-maker should thoroughly understand how bank covenants affect your trucking business prior to signing an agreement.

Types of Debt Covenants

Debt covenants are generally sorted under two types: affirmative covenants that require a borrower to perform specific actions, and restrictive covenants that limit a company’s financial independence.

What are Affirmative Covenants?

An affirmative (or positive) covenant states the specific actions to be performed by the borrower to maintain the financial health and well-being of the business. 

Examples include:

  • Provide regular financial statements to the lender for audit
  • Keep accounting books up to date
  • Maintain minimum credit score
  • Hold adequate levels of insurance
  • Pay all business and employment-related taxes

What are Restrictive Debt Covenants?

Restrictive (or negative) covenants are put in place to control the borrower’s ability to cross certain financial limits. These limits are generally expressed as ratios, that if exceeded may threaten the company’s ability to repay existing debt.

A few examples include:

What Happens when Debt Covenants are Violated?

If one or more covenants are violated, the bank has the right to take immediate action against the business. This will likely result in one of the following actions:

  • Assign the company to special loans
  • Force the business to sign a forbearance agreement
  • Demand early or immediate repayment
  • Seize the assets pledged as collateral
  • Initiate legal action

Any of these actions will force the company into a financial crisis that must be dealt with immediately and effectively, otherwise the trucking company faces imminent financial ruin. The best strategy to avoid this crisis is to protect your business from restrictive bank covenants.

You Have Options

If the company already has a line of credit with the bank, it’s time to familiarize yourself with the specific covenants attached to your loan agreement. Ensure complete compliance to avoid disruptions in funding. Meanwhile, research alternative forms of lending, such as Factoring Line of Credit as a backup plan in case the bank suddenly retracts the loan. When the loan is up for renewal, give serious consideration to voluntarily exiting the loan and replace it with the greater flexibility of a Factoring Line of Credit.

For companies who have been rejected by the bank, or for those just starting to investigate funding options, Factoring Line of Credit is the ideal cash flow solution for trucking companies with creditworthy customers.

What is Factoring Line of Credit?

Factoring Line of Credit is the most flexible funding solution for established fleets and growing companies. It combines the best features of a commercial line of credit with freight factoring. This cash flow solution is not a loan; it is the selling of accounts receivable invoices to build a cash reserve from which you are able to immediately draw from. It provides access to funds as needed with fees paid only on amounts drawn plus a small administration fee. This easy-to-manage funding solution comes with no strings attached, no covenants to uphold and no limits to hinder your ability to grow your business. The more invoices you submit, the more funds you gain access to.

Factoring Line of Credit provides easy access to working capital:

  • Keep ahead of your bills in slow periods 
  • Manage collections efficiently and professionally
  • Fill gaps in your cash flow cycle 
  • Support a turnaround 
  • Fuel your growth plans 
  • Take on larger customers 

Download our Factoring Line of Credit whitepaper to learn more.

Why Choose Factoring Line of Credit?

It takes hard work to build a trucking company into a viable business, allowing a bank to take control of the financials should be the last option to consider. It is far better to partner with a financial provider who supports independence, promotes growth and has your back during difficult times.

Accutrac Capital developed Factoring Line of Credit exclusively to support large fleets and growing companies. Our customers are long-term clients who use this alternative funding option to stabilize cash flow, improve accounts receivable management and fuel growth when the opportunity arises.

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