Meaning
Legal constraints in credit agreements restrict borrowing capacity based on the quality and age of unpaid customer invoices. The inclusion of receivables covenants ensures that a lender is protected by a pool of liquid assets that can be converted to cash. These rules are common in asset based lending and revolving credit facilities.
Audit Metric
Financial reports must show that the majority of invoices are paid within a specific window, such as sixty or ninety days. Under receivables covenants, any invoice that is older than the limit is excluded from the borrowing base. This mechanism prevents a company from borrowing against bad debt that may never be collected.
Liquidity Protection
Borrowers must maintain a diverse customer base to avoid the risk of a single large default. Receivables covenants often set a cap on the percentage of the total pool that can come from one client. This capability ensures that the company has a steady stream of income to meet its own obligations.
Financing Risk
Violation of these terms can lead to an immediate reduction in the available credit line or an increase in interest rates. The cost of calling a receivable valid when it is actually disputed is a breach of the loan agreement. Maintaining a high demonstrated rate of collection is the primary way to satisfy these requirements and ensure continued access to capital.
