Financial covenants

A financial covenant is an entry in a loan transaction that a business enters into with a bank. It sets out parameters within which the business must perform. When you sign a loan document that identifies when payments will be made and for how much, that is a financial covenant the borrower is expected to keep.

Here's a more sophisticated example: Let's say a covenant in the loan document states that the borrower will maintain a certain ratio of current assets to current liabilities. If the company fails to maintain that ratio, that is technically a default on the loan by the borrower.

The most important questions to answer about covenants is are there any (other than the obvious payment requirements), do you understand them and can you perform on those covenants?