Why covenants deserve active monitoring
When a Swiss SME enters into bank financing — working capital credit, commercial mortgage, structured leasing, or secured credit line — the contract almost always contains financial covenants: contractual obligations that tie the bank to the company's economic soundness. These are not suggestions: failure to comply constitutes an event of default that can lead to suspension of disbursements, acceleration of the debt, or a review of the terms.
For many SMEs the problem is not a lack of profitability, but a lack of visibility. Covenants are calculated using specific contractual definitions (adjusted EBITDA, net debt, tangible net equity) that rarely match the figures in the published financial statements or internal management reports. An entrepreneur may believe they are in compliance while the contractual ratio is already beyond the threshold.
This guide explains how to read covenants in the context of Swiss bank financing, which ratios to monitor as a priority, how to build a monthly monitoring system, and what actions to take before a breach becomes irreversible.
The most common covenants in Swiss bank contracts
Swiss banks apply different covenants depending on risk profile, sector, and financing structure. Here are the most common in SME transactions:
| Covenant | Typical formula | Usual SME threshold | Test frequency |
|---|---|---|---|
| Leverage ratio | Net debt / EBITDA | ≤ 3.0x – 4.5x | Semi-annual / annual |
| Interest coverage | EBITDA / net financial charges | ≥ 3.0x – 5.0x | Semi-annual / annual |
| Debt service coverage (DSCR) | (EBITDA – CAPEX) / (principal + interest) | ≥ 1.2x – 1.5x | Annual |
| Current ratio | Current assets / current liabilities | ≥ 1.0x – 1.5x | Annual |
| Minimum net equity | Shareholders' equity ≥ absolute threshold | CHF 100,000 – 500,000 | Annual |
| Gearing ratio | Net debt / net equity | ≤ 1.0x – 2.0x | Annual |
| Dividend distribution | Dividends ≤ % of profit or equity | Variable | Before each distribution |
Beyond financial covenants, contracts often include information covenants (delivery of financial statements within 120–180 days of year-end) and negative covenants (prohibition of additional debt, transfer of significant assets, change of control without consent). These too can trigger a default if breached.
Contractual definitions: where surprises arise
The critical point in monitoring is not the formula itself, but the definitions the contract assigns to each item. Two banks may use the same ratio name with different calculations:
Contractual EBITDA
It rarely matches accounting EBITDA. The contract may include adjustments: exclusion of extraordinary costs, add-back of operating lease payments, normalisation of management salaries, inclusion of cantonal subsidies or exclusion of gains on property disposals.
For a Swiss SME with 15 employees, the difference between management EBITDA and contractual EBITDA can easily exceed 10% — enough to trigger or avoid a breach.
Net debt
It typically includes all medium- to long-term financial debt, utilised credit lines, finance leases, and sometimes debt to shareholders or related parties. Cash and short-term investments are deducted, but with exceptions: restricted deposits or cash "trapped" in escrow accounts may not be counted.
Also watch for off-balance-sheet debt: lease commitments, joint and several guarantees, and personal sureties from the owner may be included in the calculation depending on the contractual wording.
Tangible net equity
Some contracts exclude intangible assets (goodwill, capitalised software, trademarks) and non-consolidated investments from net equity. For companies in the technology or professional services sectors, this adjustment can reduce "contractual" equity by CHF 200,000–500,000 compared to the balance sheet under Swiss GAAP FER.
Monitoring system: from theory to practice
Effective covenant monitoring requires three elements: a contractual matrix, monthly calculation, and a clearly defined early warning threshold (headroom).
Build the covenant matrix
Extract from the credit agreement every covenant with: exact definition, formula, threshold, test date, reference period (last 12 months, half-year, year-end date), and consequences of non-compliance. Store the document in a format accessible to the entrepreneur, CFO, and trustee. If the financing was negotiated years ago, check for any amendments or side letters that have modified the thresholds.
Calculate ratios on a rolling basis
For EBITDA-based covenants (leverage, interest coverage, DSCR), calculate rolling 12-month EBITDA every month — not only at year-end. This makes it possible to identify deterioration three to six months before the formal test date. Link the calculation to management accounting: same cost centres, same contractual adjustments, same lease treatment.
Define headroom and risk zones
For each ratio, set three bands: green (comfortable compliance, headroom > 15%), yellow (headroom 5–15%, activate corrective measures), and red (headroom < 5% or actual breach). A leverage ratio with a 3.5x threshold and a current value of 3.3x is not a breach, but it is a situation requiring immediate action — especially if the trend is worsening.
Integrate monitoring into monthly reporting
Include covenants in the management control dashboard alongside liquidity, DSO, and operating margin. A one-page monthly report — with current ratios, headroom, and trend versus the previous three months — is sufficient for most SMEs. Tools such as Accountex allow accounting data to be linked to contractual definitions, avoiding manual recalculations on Excel spreadsheets separate from the official financial statements.
Scenarios that anticipate a contractual default
Some recurring situations among Swiss SMEs lead to covenant breaches. Recognising them in advance is the difference between a negotiated remedy and debt acceleration:
High investment and CAPEX
A production expansion, machinery purchase, or refurbishment of commercial premises reduces liquidity and, if debt-financed, increases leverage. DSCR falls because instalments rise before the new EBITDA materialises. Plan funding needs with 12–24 month simulations and inform the bank before the investment, not after.
Loss of a major client
For a services company with 30% of revenue concentrated on a single client, loss of the contract can erode rolling EBITDA within a few months. Interest coverage falls rapidly because the numerator drops while the denominator (financial charges) remains fixed. Monitor client concentration as an early indicator of covenant risk.
Dividend distribution and shareholder loan repayment
Distribution of a substantial dividend or repayment of debt to shareholders reduces net equity and may breach the minimum equity covenant or the distribution prohibition. Before every general meeting that approves dividends, verify all covenants affecting equity — not only the distribution requirements under the Code of Obligations (Art. 672 et seq. and Art. 675 CO).
Late VAT and tax payments
A deterioration in the current ratio due to accumulated tax liabilities (VAT, withholding tax, social security contributions) signals liquidity stress. Some contracts include a specific covenant on compliance with tax and social security obligations. A payment plan with the Federal Tax Administration (FTA), the cantonal tax authority, or the cantonal compensation office for social security does not automatically resolve the contractual issue with the bank.
What to do when a ratio approaches the threshold
Proactive management of a potential breach follows a precise sequence. In Switzerland, the bank–SME relationship is traditionally based on trust and transparency: communicating in advance is almost always preferable to silence.
| Phase | Action | Timing |
|---|---|---|
| Prevention | Reduction of discretionary costs, deferral of non-essential CAPEX, acceleration of collections, negotiation of extended payment terms with suppliers | Headroom < 15% |
| Bank communication | Present a turnaround plan with 6–12 month projections, explain temporary vs. structural causes | Headroom < 10% |
| Waiver request | Formally request a waiver (covenant waiver) for the current test period, with a possible waiver fee | Breach expected at test |
| Renegotiation | Adjustment of thresholds, conversion to an "equity cure" covenant, extension of term, or margin increase | Actual or structural breach |
| Equity cure | Additional capital contribution by shareholders to restore minimum net equity | Breach on net equity |
A covenant waiver is a written agreement under which the bank temporarily waives enforcement of the breach. It typically involves a fee (0.25–1% of exposure) and additional conditions: prohibition of new distributions, enhanced quarterly reporting, or supplementary guarantees. For SMEs subject to limited audit or that have opted out of audit (opting-out, Art. 727a CO), the auditor or trustee must still verify that the financial statements correctly report the liabilities and commitments arising from the financing.
Links with accounting and financial statements
Covenant monitoring is not an exercise parallel to accounting: it relies directly on general ledger data. Some accounting practices reduce the risk of surprises at the formal test date:
- Correct debt classification: the distinction between short-term and long-term debt affects the current ratio and net debt. Debt maturing within 12 months must be reclassified, even if originally contracted as long-term.
- Lease treatment: under Swiss GAAP FER 13, the accounting treatment of finance and operating leases affects the balance sheet and covenants differently. In periods applying IFRS, IFRS 16 provides a different accounting model. Verify how the bank contract classifies each type.
- Accruals and period-end adjustments: rolling EBITDA distorted by missing accruals (unallocated holiday pay, invoices to be received) produces unreliable ratios. Disciplined monthly closing is a prerequisite for reliable monitoring.
- Documentation of adjustments: every add-back to contractual EBITDA must be documented and justifiable to the bank. Unjustified "one-off" costs will be rejected by the credit manager.
Operational checklist for entrepreneurs and trustees
- ✓Covenant matrix completed with definitions, thresholds, test dates, and default consequences
- ✓Monthly calculation of rolling contractual EBITDA (12 months) and main ratios
- ✓Headroom monitored with green / yellow / red thresholds for each covenant
- ✓Simulation of the impact of investments, dividends, and new debt before approval
- ✓Proactive communication with the bank when headroom < 10%
- ✓Documented turnaround plan with projections and concrete corrective measures
- ✓Alignment between official accounting, management reporting, and contractual definitions
- ✓Verification of information covenants: delivery of financial statements and interim reports within contractual deadlines
Banking covenants are not an obstacle to growth, but a thermometer of financial health that the bank reads with rigour. An SME that monitors them with the same discipline it applies to liquidity and personnel costs turns a contractual risk into a negotiating advantage: it demonstrates control, transparency, and planning capability — qualities that in the Swiss credit market count as much as the balance sheet itself.