Agreeing Banking Covenants – The Importance of Business Planning and Forecasting

Bank CovenantsSince the start of the COVID pandemic, the UK economy has been in a catatonic state. At the start of the crisis, Mr Sunak reacted by treating the sick patient with various measures to enable operational and financial challenges to be mitigated in the short term; businesses have been able to postpone payments and arrange deferrals to offset reduced revenues.

Government-backed loans have plugged balance sheet holes and cash flow shortfalls. Can the patient survive and indeed recover when the drugs are taken away?

As we are on a pathway out of lockdown, this is how the economic recovery post-lockdown could play out:

It is likely that an initial wave of increased consumer confidence will bolster economic performance early on. Whilst this is likely to be initially positive for UK businesses, it is also a risk as many companies will not have sufficient cash to buy stock, employ staff to deal with increased demand. When furlough schemes are removed, unemployment is likely to rise given the 4.7m employees currently furloughed.

As unemployment levels rise, confidence falls. Reduced spending impacts on businesses and this is when we may start to see an increase in the numbers of corporate failures/insolvencies which economic commentators have been forecasting.

As we (hopefully) emerge from a world in lockdown into an initial period of economic recovery, banks and other lenders are going to play a vital role. The more challenges faced by businesses, the more support that will be needed from the banks. In a move to support business during the crisis, banks have recently been adopting a more relaxed attitude to breached banking covenants and have been waving their right to take punitive action on their debtors for covenant breaches.

Covenants are meant to be flags around business performance – early warning signs for banks to consider if their capital is at risk due to worsening business performance.  The banks will soon be looking to re-introduce/re-set covenant terms and this will create significant challenge for directors and business owners given the uncertainties of what the new economy will look like. The banks’ current stance cannot and will not last forever.

Covenants and the active monitoring of performance against the agreed levels will be re-introduced and need to be set at the right levels. If set at incorrect levels (or based on inaccurate forecasts), covenants may become restrictive to businesses – increasing the bank’s scrutiny on their businesses, taking up management time and potentially increasing cost (through increased interest rates and or fees as the banks seek to reduce their risk through greater returns).

Financial forecasting is the key to avoiding this. EFM recommend that all its clients, and indeed any businesses, should be forecasting 12-24 months ahead. In preparing forecasts, directors and business owners should be asking themselves a number of questions:

  • what will my post-COVID revenues look like? (including if applicable factors such as social distancing on revenue and space)
  • what exceptional costs will the business face? (e.g. redundancy costs, holiday arrears being taken in a short period of time, COVID safety costs)
  • what are the repayment terms of existing debts? (rents, CBILs, deferrals, payment holidays etc. – these will all begin to expire in coming months)
  • what other unforeseen activity might impact my cashflow? (customers holding onto cash longer, suppliers changing payment terms)
  • Are there grants and other reliefs I can obtain to reduce any bank funding requirements?

Visibility on this position in cash terms is vital to identify problems ahead of time and this may lead to further questions:

  • is the structure of my existing facility/loan the right one for my business?

And also, importantly:

  • do I have the right type of debt (e.g. is an asset based loan better than a standard ‘term loan’? Debt versus equity? Invoice finance v overdraft?)

EFM is urging its clients, and any business that hasn’t revisited its existing forecasts to do so now – new forecasts, reflecting a post-lockdown world, will be used to support new banking covenants. If set at the right levels, based upon properly considered forecasts this will give businesses the best chance of freedom in their relationships with their lenders.

This advice on best practice in forecasting for uncertain times will undoubtedly help you keep your business under closer control over the coming months. Whatever the circumstances you find your business in, know that you are not alone – and that we’re here to support you.

If you would like to find out more about how EFMs bespoke, part-time financial management & business advisory services can benefit your business, contact the EFM team. Our EFM Experts can help you to construct & manage your financial forecast and business survival plan effectively. Get in touch via to arrange your free 1 hour 1-2-1 financial consultation.