GAAP Standards have been at the forefront of accounting conversations for more than two years now. However, with new standards finally taking effect for private companies in 2022, is there something business owners should be mindful of?
What Biggest Change Did We See in GAAP Standards This Year?
Your lease commitments that terminate greater than one year from your fiscal year end will now be recognized as long-term debt on your balance sheet. We see this particularly affecting real estate leases for office, retail, or manufacturing space. For example, perhaps you own the building that you are renting to your business over a five-year term. This would now be included as a long-term debt on your balance sheet.
If you have bank debt, there is a high probability that your loan agreement includes one or both of the following loan covenants: Debt Service-Coverage Ratio (DSCR) and/or Debt-to-Equity Ratio (D/E).
When we spoke with different referral partners, we found some discrepancies when it comes to how this long-term debt will now be evaluated when it comes to lending potential:
- Our CPA Partners must recognize this liability on the balance sheet, per GAAP standards and interpreted that it must be included in these ratio calculations
- Some of our Banking Partners did not require long term leases to be included in these ratio calculations
Despite what lending officers stated, CPAs are required to include this debt in these ratios unless the loan agreement is amended or in some cases that bank documents in a letter to the CPA that the long-term lease should not be included in the calculation.
If companies aren’t proactive in connecting their balance sheet with the bank’s original intention, they may fail this year’s loan covenants. The result will likely be that you will need to request a default waiver from your lender. You may likely be able to obtain that waiver, but that certainly becomes part of your business’s credit file.
The key is to discuss this with your banker and CPA firm now, before the end of the year when you still have time to be proactive.
What Do EIDL Loans Have to Do with Your Banking Relationship?
If you did use your EIDL (Economic Injury Disaster Loan) to pay off your existing bank loan (intelligently using this option as a “refinance”), you have some important things to consider.
If you want to take a new loan while making your current EIDL payments, your bank will no longer be in a ‘senior position.’ Instead, your lender would be seen as secondary, or at a ‘junior position,’ while the Small Business Administration would be primary.
As your bank has no desire to be in a secondary position, your EIDL loan has the potential to limit your ability to take out a new loan and/or change banks in the future.
For more information on this topic, see our previous article: COVID EIDL Loans Deferred.
In short, both your EIDL and your potential to miss this year’s loan covenants could greatly affect your banking relationship. Brank credit officers have a LONG memory and missing your loan covenant could affect you down the road.
The good news? You still have time to do something about it.
Do NOT wait until the end of the year to assemble a projection of your current covenant. Openly discuss this matter with all respective parties: your CFO, your Accountant, and your Banker. It’s best to get everyone on the same page and do it as early as possible. In fact, your lender will love that you are acting preemptively!
What will being proactive solve? At Kaplan CFO, we are optimistic for future outcomes. For example: you can request―and may be awarded―a loan covenant waiver from your bank. Additionally, getting your full financial team to collaborate will help alleviate future issues, especially when it comes to audit season.
Talking now leaves more time for resolution.