Total assets refers to the sum of the book values of all assets owned by an individual, company, or organization. It is a parameter that is often used in net worth debt covenants. The value of a company’s total assets is obtained after accounting for depreciation associated with the assets. Net worth, in the simplest terms, is the equivalent of total assets minus total liabilities.
What are Debt Covenants?
Debt covenants are restrictions or limitations that lenders (creditors, debt holders, investors) put on lending agreements to limit the actions of the borrower (the debtor) in a loan agreement. In other words, they are specific terms that the borrowing party agrees to adhere to in exchange for a loan. They are also generally referred to as “bond covenants.”
Total Assets: Use in Debt Covenants
Hence, total assets is an important and integral component to establish net worth in debt covenants. The covenants are typically measured using the balance sheet of the borrowing party. Net worth debt covenants are most commonly in use when the lending party is a commercial bank or financial institution. Some common examples of net worth debt covenants can be total assets to debt ratio, total net worth to debt ratio, minimum net worth, and many others.
For example, ABC Ltd. applies for a loan with XYZ Bank Ltd. for $800,000. After evaluating ABC Ltd.’s financial statements and credit history, XYZ Bank agrees to grant the company a loan for $800,000, provided the latter agrees to certain terms and conditions included by the bank in the loan agreement.
While evaluating the company’s financial statements, the bank noticed that the organization sold off a considerable value of its assets in the past financial year to settle a long-term loan. However, projections for the upcoming financial year showed a positive trend. Hence, the bank included a condition that it would lend to the company provided the latter maintain a minimum net worth of $1,000,000 for the duration of the loan. The above is an example of a net worth debt covenant.
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