Beckway Insights: Covenant Storm Approaching…and Five Precautions You Need to Take

The recent rapid interest rate rises have caused headaches for portfolio companies with leverage. The prospect of weaker EBITDA expectations with increased debt obligations has caused covenant buffers to shrink. This is placing stress on the finance function and threatens to impact the broader enterprise.

All this is occurring in a market where sourcing and retaining finance talent remains challenging. We have seen a dramatic increase in support needs to sure up portfolio company defenses. Sources of friction include the following:

  • Less reliability in 13-week cashflow forecasts
  • Forecasts under-estimated the extent of interest rate increases
  • Longer term /2023 cashflow forecasts are out of date and lack detail
  • Customers are stretching out payments

Here are five proven activities to organize into a program and begin now:

  • Actively review and execute on near term liquidity opportunities
    • Have a detailed bottoms-up understanding of your receivables to spot gaps
    • Prioritize payables and have clarity around the communication messaging and timing of changes to terms
    • Review payment and credit authorities
  • Actively review near and longer term cashflow forecast
    • Document and understand where variances are occurring in actual vs. 13-week cashflow forecast
    • Don’t ignore the long-term forecast; Re-solicit the business input on assumptions for opex and capex in longer term forecast and calibrate with the business on what can be deferred /improved
  • Stress test scenarios – near and long term
    • Retest forecasts with much higher rates
    • Incorporate increased bad debts and weaker demand – it won’t be pretty, but it will allow you pre-emptively explore solutions
  • Communicate and align with your lenders
    • Confirm alignment on reporting and covenant expectations to avoid surprises
    • Demonstrate the changes being executed
  • Review and execute near term cost reduction – don’t stop with liquidity
    • Review discretionary, procurement and outsourced spending for quick improvements
    • Execute a profitability cube analysis to rationalize SKUs and increase margin
    • Explore what pricing changes can be executed