Introductory guide to financial covenants


Published by a ½Û×ÓÊÓƵ Banking & Finance expert
Practice notes

Introductory guide to financial covenants


Published by a ½Û×ÓÊÓƵ Banking & Finance expert

Practice notes
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This Practice Note provides an introductory guide to financial covenants (financial undertakings). It explains why financial covenants are used before discussing how financial covenants are set and tested.

It then 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

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 multi-currency compounded rates/term rates term and revolving facilities agreement for leveraged acquisition finance transactions (the LMA leveraged facilities agreement) (available to LMA members on the LMA website).

It should be noted that the LMA investment grade facility documentation does not contain financial covenants as they

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Key definition:
Financial covenant definition
What does Financial covenant mean?

Financial covenants are financial undertakings by the borrower and usually expressed as an obligation on the borrower to comply with certain ratios.

Read more

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