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Financial covenants compliance


Financial covenants compliance

For pharmacy owners who have variable loans, the steep rise in the base rate will have impacted not only on profits but also cash flow, as Vinku Shah explains…


The Bank of England (BoE) base rate is 5.25 per cent and the last time it was at this level was just over 15 years ago (in February 2008). Base rate was below one per cent for 13 of those years before shooting up sharply from one per cent in May 2022 to 5.25 per cent in August 2023.

The rise in the base rate was to counter unprecedented levels of inflation which peaked at 11.1 per cent in October 2022 and stood at 6.7 per cent as at September 2023. Inflation is likely to fall further in coming months and is expected to meet BoE’s target of two per cent in 2025.

For pharmacy business owners that have variable loans, the steep rise in the base rate will have impacted not only on profits but also cash flow as higher payments need to be made to service the debt.

Lenders are increasingly scrutinising management accounts, paying attention to performance of the business, debt serviceability and loan to value. So, what are the lenders looking out for?



This is the top line of your profit and loss and lenders like to see an increase in turnover or even stable turnover as a sign of a strong customer base and business stability. This is also an indication as to what more you are doing as company directors to ensure the business remains profitable e.g, are you pushing more services which add to profits, etc. Lenders will usually ask to see the monthly NHS statements (FP34s) to support any assertion that dispensed items are stable or increasing.


Gross profit

In the current climate with rising drug costs and shortages, it is inevitable that gross profit margin will dip by a small percentage. But where the cost of sales has increased by a larger amount than any increase in turnover, it will eat into the company profits.

This could mean one of two things – either there is a lot of cash held up in stocks or there is a need to improve the company’s buying practices i.e, scouring the market for more competitive prices/discounts, etc. The lenders will be keen to understand the reasons for a drop in gross profit margins therefore it is important to review your processes in line with company performance.

Regular stock takes (half yearly) would help identify optimal stock requirements, help work out accurate profitability and reduce amount of stock that is out of date. This should translate into better cash flow as money is not tied up in stock.



The business overheads also need to be monitored and where possible, deals sought for services. Apart from rent and rates, one of the main costs to pharmacy businesses is staff and locum costs. The company should be operating within acceptable benchmarks when it comes to staff and locum costs as a percentage of turnover for example, an owner managed business would expect the cost to be around six per cent to eight per cent of turnover.

Staff should be incentivised to deliver services that add directly to the bottom line, and this helps maintain motivation and keeps reliance on locums to a minimum.


Earnings before interest, tax, depreciation and amortisation (EBITDA)

EBITDA is a measure of the company’s profits from operating activities after deduction of all overheads and before any interest, tax, depreciation or amortisation. The lender will require the EBITDA to be adjusted for any drawings made by the directors from the business and any dividends paid and this is referred to as the “adjusted EBITDA.”

The reason for adjusting for directors’ drawings and paid dividends is because these amounts have a negative impact on the company’s cashflow and if in excess could be detrimental to the company being able to fund its working capital which in turn could lead to a default on the loan.


Debt service cost/cover

The debt service cost is the total of the capital repayments made plus interest paid to the lender during the reporting period.

As part of the lender’s requirements, a covenant will have been agreed as to what the level of the adjusted EBITDA should be in relation to the company’s debt service cost during the reporting period. This is the Debt Service Cover and ranges from 130 per cent to 150 per cent meaning that the adjusted EBITDA should be 130 per cent or 150 per cent of the total repayments (capital and interest) made to the lender.


Loan to value

This is a measure of the debt outstanding compared to the value of the goodwill of the business. The lender would have initially financed the acquisition of the pharmacy business based on a percentage of the goodwill value. The lenders like to see the value of the business increase so that they are assured that their debt is safe. The norm tends to be 80 per cent i.e, the total loan outstanding should not exceed 80 per cent of the goodwill value of the business at any point.

Regular monitoring of the company’s performance is key for the business to ensure it is on top of its finances. Company directors should be speaking to their accountants for quarterly management accounts and if possible, setting budgets, comparing actual performance against those budgets and taking corrective action immediately.

If the company defaults on the financial covenants on an ongoing basis, the lender could refuse to renew the loan, leaving the company’s directors to look for an alternative lender and in the current climate, it will prove difficult to find a new lender.


Vinku Shah is director-pharmacy at Silver Levene.











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