A systemic business crisis (brought about by COVID-19) is upon us.
Reimagine a “normal” Balance Sheet
When you match the different classes of assets of many companies with the corresponding funding sources, the picture often looks as follows:
1.The working capital is funded by a combination of supplier credit and short term borrowing. The supplier credit is generally unsecured and often the debtors book has been used to secure an overdraft or a debtors discount facility.
2.The fixed and movable assets are usually funded by bank funding over an extended period, secured by the respective assets, and often with the personal surety of the shareholders.
3.The balance sheet may reflect an equity share of funding in each asset class as most banks don’t fund 100% – this could be depicted using fair valuations of the different asset classes as determined prior to the COVID 19 lockdown.
4.The balance sheet may also contain cash that was generated prior to the COVID 19 lockdown.
While this balance sheet represents a reasonable picture for any regular business, the effect that the COVID 19 lockdown is going to have on businesses, is devastating. Let us show you why…
The working capital position post-lockdown
Working capital, post-lockdown, will be impacted as follows:
1.The cash on hand which existed pre-COVID-19 lockdown will be consumed paying wages and salaries during lockdown and following lockdown.
2.Generally, as no production or services were delivered, business will have reduced (or no billings) and debtors will flat line.
3. The debtors’ book will remain static, as demand reduces and the payment cycle of debtors lengthen, as your clients do not have working capital either, and will withhold paying you.
4. Your stock may decline, as the supply chain is disrupted by COVID-19, or your suppliers cannot fund their working capital to deliver into the supply chain. This has a domino effect.
5. Your work-in-progress (WIP), meaning unfinished (unsaleable) stock will increase as the supply chain will take some time to become fully operational again and you will have to wait for inventory.
6. The equity in the working capital will decline as a result of the non-payment of debtors, slow or obsolete stock and WIP.
7. Your business creditors will convert the credit terms to cash terms as they don’t have the cash to fund their working capital.
You are in a cash-squeeze. How do you fund the business?
Banks will exacerbate the cash squeeze
Scrambling to find working capital upon re-start of the production cycle, it is likely that your business’ asset value will have collapsed and that your cash has all but dried up.
We project that as many as 35% of all businesses will not be around in the next two years following the COVID-19 lockdown. Capacity will be in over-supply (buildings/plant in certain industries) while there will be a reduction in demand due to consumption fall-off, as consumers generally have only 27 days worth of cash to live off.
COVID-19 lockdown will have destroyed the equity in many thinly capitalised businesses. Access to funding is going to become increasingly difficult, and normal Bank debt funding will only be provided where the business is properly capitalised with equity. So, banks are not going to provide funding to your business, they are going do the opposite.
This is what we call the “domino effect of working capital erosion”
The domino effect of working capital erosion
As the price of assets decline in the overall market, your assets will also decline, which will prompt the bank to call for a top-up in equity, which is most likely not possible for you.
Even if you seek to sell some of your movable assets, the prices of these assets will decline substantially as the supply of these in liquidation sales would be plentiful.
Remember, your competition is in the same situation and there is a dampening of demand for your assets.
The domino effect can start from any direction, either from your supplier not being able to supply you, or your customer not being able to pay you.
The entire supply chain is facing the same problem
Stop for a moment and consider that your customers and suppliers are facing the same reality as you. Most business owners are optimistically hopeful that when the lockdown is over, normal trade will resume.
This is not going to happen, due to the following domino effect:
1.Everyone will be cutting expenses, laying off employees or moving to short time for staff, resulting in less cash in the hands of consumers;
2.If the consumers numbers are declining sharply, sales number drop, which increases pressure on working capital;
3.Business restructuring would be unavoidable; retrenchments and other cost cutting measures will have to be undertaken;
4.Overall, the domino effect of the erosion of working capital will be felt across the board by most businesses. It will take up to 2 years to get back to the same levels, after a financial crises like this;
5.Some programs have been announced but they may not be suitable or sufficient for you to immediately deal with the dampened demand,
6.This leads to permanent reduction in consumer demand, as well as a reduction of the taxes collected, as SARS has a smaller tax base, this in turn means that the Government has less funds to invest into the economy which exacerbates the contraction in the economy.
A way to save your business
To save your business you have to immediately take the following drastic measures:
- Restructure the funding of the working capital of the business, enabling a shift in working capital cycle from 60/90 day credit terms to 30-day credit.
- Conserve and pay cash for supplies and employees. Cut costs by scaling down operations and staff to right-size the business for the new normal post-COVID-19.
- Protect your business from being sued by suppliers and Banks and to avoid further calls from the banks and landlords for additional security.
- Allow the business to build up a sustainable turnover over as short a period of time as new levels of demand is established for the product or service.
You cannot implement these strategies by yourself as you will be traversing a minefield and you may end up unknowingly committing an act of insolvency, which the sharp lawyers out there will pounce on you.
The best solution is place the business in rescue. A competent and experienced professional practitioner can provide you with the umbrella that will protect both you and your business and afford you the legal space and time to right size your business during the troubled times ahead.
Actions during business rescue
Rule Number 1: Find a competent practitioner
Business rescue provides wide ranging powers to competent, experienced professional practitioners to deal with creditors, staff and shareholders, which the Act refers to as affected parties.
The practitioner attends to all obligations that the company may have at the time of commencing with business rescue. This effectively means that practitioner has the power to stop paying some, while paying others and incurring new debt to ensure the business’ survival.
This is precisely why the directors should appoint a competent practitioner, who understands the risks associated in making these decisions. A competent practitioner understands that he (or she) can be held liable for reckless trading or for incurring debt which cannot be repaid during business rescue proceedings.
A practitioner has been given very wide ranging and effective powers to use in order for him to try rehabilitate the company which not available to ordinary directors during normal trade.