Common financial covenants
Common financial covenants

The following Banking & Finance guidance note provides comprehensive and up to date legal information covering:

  • Common financial covenants
  • What are financial covenants?
  • Getting started—the critical issues
  • Minimum net worth
  • Gearing ratio
  • Leverage ratio or debt to equity ratio
  • Current ratio and acid test ratio
  • Cashflow cover ratio
  • Interest cover ratio
  • Loan to value covenants
  • more

This Practice Note explains certain common financial covenants used in commercial finance transactions including:

  1. minimum net worth test

  2. gearing ratio

  3. leverage ratio (or debt to equity ratio)

  4. current ratio (or acid test ratio)

  5. cashflow ratio

  6. interest cover ratio, and

  7. loan to value ratio

It explains:

  1. a typical starting point for each of those financial covenants

  2. some items which could be included or excluded from definitions within financial covenants, and

  3. some key accounting concepts which are used in financial covenants including earnings before interest, tax, depreciation and amortisation (EBITDA), current assets and current liabilities

Note that this Practice Note does not provide a detailed explanation of financial covenants on specialist transactions. However, the last section links out to further information on using financial covenants in various specialist transactions.

Where appropriate, this Practice Note highlights relevant provisions in the Loan Market Association (LMA) senior multicurrency term and revolving facilities agreement for leveraged acquisition finance transactions (the LMA leveraged facilities agreement) (available to LMA members on the LMA website).

The Association of Corporate Treasurers (ACT) Borrower’s Guide to the LMA’s Investment Grade Agreements (2017) and the Borrower’s Guide to the LMA Facilities Agreement for Leveraged Transactions (2008) (ACT Guides) both contain useful guidance on financial covenants in LMA documentation. Registration on the ACT website is necessary to access the ACT Guides. The LMA also