Forming loan agreements is something you normally are involved with when you’re giving out loans. Rarely it’s something someone getting a loan needs to do because it’s the risks of the loan giver that need to be covered. Whilst it’s a communication and agreement between parties, there’s still one party that’s in a driver’s seat sort of say.
Now, if you ever find yourself in this seat, there are a few things you need to make sure are set out in the formal agreement. And yes, the agreement needs to be formal or at least written because how else would you prove you ever gave a loan? Continue reading
As we already mentioned in our previous post, on occasions when some of your expenses are being compensated, there’s one key question you must ask. Do you know it for certain? The most important element when it comes to recognizing anything on your financial statements is the level of certainty – is it below or above 50%. As it is hard to determine, it’s something the management has to estimate.
So in a situation where the management has estimated that it’s definite the compensation is received, it needs to be recognized on the financial statements. The expenses themselves are recognized as always – debit the expense account and credit the liabilities. When the payment is done later on, you debit the liabilities and credit cash. Sounds easy enough, right?
There are numerous businesses, where some of their expenses are being compensated by another party (i.e. party they are made for or who gets something out of it). Simply put you make an expense and this very same expense is later on either in full or partly being paid up by this someone else. You are the one paying for the supplier and you will receive compensation for it. Now the question is however, how do you recognize it all in your accounting?
Your expense is obviously an expense and should be recognized the same – under the income statement group it has always belonged under to. Hence also the liabilities and eventual cash payment is still done the same.
In case you have loan contracts which include some sort of covenants, there are a few things you want to keep in mind. Since often times the loan liabilities are considerable, proper dealings are a “must”.
First and foremost you have to agree with the bank on how various covenants are measured, what is and isn’t included into the calculations and how exactly the bank understands one-off deals. You want to agree on this to ensure you’re both on the “same page”. Creating a situation where you would think that everything is okay and the bank is on a different opinion is not a place you want to be.
In case you are not meeting the agreed covenants, you do want to inform the bank as soon as you became aware of it and try to negotiate getting a waiver from the bank. A waiver usually means that the bank is not exercising its right to call back the loan in full.
When taking a loan from a bank, the contract may or may not include special conditions named as covenants. Usually, when the loan taken is in a small amount and with minimal risks, the banks do not see the need to add any special covenants to conditions of the agreement. However, the bigger the amounts and risks go, the higher is the probability you will find covenants from the agreement.
Covenants are ratios the borrower’s financial statements have to meet. They are usually connected to the amount of assets, cash inflows, EBITDA (earnings before interest, tax, depreciation and amortization), net profit etc. Mind you that for every agreement those covenants are negotiated and agreed as reasonable and reachable. The bank just wants to make sure the borrower is able to fulfill its obligations and serve the loan.