Dealing with Economic Turbulence: COVID -19

It is possible that a business can still be reporting earnings but have trouble meeting its current obligations to both lenders and key creditors. Problems may develop as customers become slower to pay or, in some instances, don't pay at all. Problems may not be immediately recognised and could include changes in product/service demands, increasing overhead costs, use of obsolete production methods or increasing competition — some of these directly attributable to the decreasing economic climate. As a starting point, defer and/or eliminate all non-­essential expenses and capital projects, where possible. Identify whether there are any current commitments that can be put on hold or adjusted given the current environment. Further, accelerate receivable collections: Focus on customers that normally pay on time and have started to slow payments; offer discounts to pay now; keep on top of even smaller accounts. Cash must be closely monitored on both a short-and long-term basis.

Short-Term Cashflow Forecast

Prepare a 13-week cashflow forecast. This is often an eye-opening exercise and will effectively capture most companies' business cycles. The forecast will help navigate choppy waters in the near-term, as it will highlight shortfalls in needed cash balances and/or show borrowing requirements that fall short of actual borrowing availability from lines of credit. You will need to ensure that any forecast is subject to revisions in light of Coronavirus and the ongoing impact it has on the market. Cashflow forecasting is a very popular tool used with distressed businesses and can be helpful for entities going through a rough patch or for stronger businesses struggling in this economy. Maintaining an up to date forecast will allow you to be able to easily identify if there is an upcoming risk of the business running out of cash. Being in a position to be able to identify when this may happen, puts you on the front foot for being able to make arrangements to source more capital or to organise payment arrangements i.e. contact with your bank for extended loan facilities, contact with Inland Revenue to arrange payment plans and liaise with landlords to determine whether a rent relief period is feasible.  

A cashflow forecast will force you to take a closer look at all expected receipts and disbursements on a weekly basis and compare it to actual results. This way you will know right away if there is a collection issue with customers that needs to be addressed or if expenses are too high against expectations.

It will keep you abreast of how well the receivables are being collected on a short-term basis. In preparing the budget, be careful to select proper revenue assumptions (e.g., realistic sales, margins and/or receivable realisation), Be conservative in projecting revenues and cash receipts. On the disbursement side, control over inventory procurement and subsequent payments can be critical, as it is often the largest cash expenditure. Also, be sure to identify non-income statement items (e.g., payment for capital expenditures, loan principal, capita] lease principal obligations and/or interest) and nonrecurring items.

Factors to consider in developing a cash flow forecast include:

• Significant increases in the inventory balance could mean a business has too much cash tied up in working capital and that sales are shrinking or the wrong mix of goods exists.
• A drop in historical inventory levels could indicate that a company lacks sufficient capital to procure goods required to run its business. Further, the business could be experiencing issues with receiving key goods and services from overseas which are required to increase their inventory level.
  We encourage businesses to keep in regular contact with their suppliers to ensure they are fully aware of any possible delays and what impact these delays may have on the business. Are there any areas of risk in the business’s supply chain?
• Significant increase in accounts receivable, without a corresponding increase in sales, can be indicative of a business that is having difficulty collecting on its receivables.
• We suggest businesses conduct a regular review of their debtors and identify if any debtors are financially vulnerable to COVID-19. Contingency plans should be formed should any debtors be unable to pay or are placed into formal insolvency.
• A drop in accounts receivable may be reflective of a drop in sales or demand for a business’s goods/services.
• Significant increases in accounts payable can be an indicator that a business is having difficulty paying its trade obligations on time.
• An increase in the amount of debt used to leverage the business versus historical levels is a sign that a business may be unable to operate its business using operating cash flows.
• A decline in property, plant and equipment may indicate that a business has not been making the appropriate amount of capital expenditures to maintain expected sales or production levels or to keep up with competitors.
• Additional capital infusions (e.g., second lien loans, bridge loans, etc.), although not necessarily a sign of financial distress, may be indicative of a business that is experiencing liquidity issues or cashflow problems.

Long-Term Business Plan (1-5 years)

This plan, in addition to the cashflow statement, should also include a full income statement and balance sheet. Prepare this using a bottom-up approach. This means going to the divisional or cost-centre level to derive estimates for revenue and expenses. For example, a business plan for a retailer should be derived on a store-by-store basis for both revenue and store expenses, and corporate overhead should be derived on a cost-centre basis. In a manufacturing business, revenues and expenses should be estimated for each major product line.

In all types of businesses, the assumptions and initial estimates should be compared periodically against actual results to determine whether they are reasonable. In addition, outside influences should be addressed, such as the current economic environment, backlog of orders, discussions with buyers and customers, and whether trends are in line with the industry and competition.

Businesses should be constantly assessing the market environment and be working to identify how they can adapt to the overcome any threats identified (i.e. flexible working). Following the Government’s economic response to COVID- 19, if businesses are experiencing cashflow issues, we encourage companies to review the three packages offered by the government to determine whether any relief can be provided and to contact their finance provider to determine what support can be provided by them also. These Government packages available are discussed further below.

Some additional items to think about when preparing a long-term business plan include:

• What factors (internal or external) caused the financial problems, and are they temporary or permanent?
• What direction should this business take (e.g., grow, stabilise, sell off non-core assets, etc.)?
• What products/businesses are most profitable and which customers are more profitable to the company?
• What are the strengths and weaknesses of the company (e.g., management, markets, industry, competition, etc.)?
• What assets should be liquidated or expanded?
• What amount of funding is necessary to implement the business plan?
• What commitments need to be maintained by the company and which can be deferred for a period of time?
• What employment issues may arise in the near future (i.e. health & safety), is there too much capacity within the company?

Preparation of sound business plans, both long and short-term, can provide you with renewed confidence during times of economic stress.

The administrative and operational cost structure of all companies tends to grow disproportionately in good times, without a corresponding reduction when the economy and business volume slow. In order to maintain liquidity and manage debt, management must quickly determine core needs and shed excess costs. Take a look at the following items:

• Have expenses as a percentage of sales increased?
  • Is cost containment a necessity? — Have margins decreased?
  • Have variable and fixed costs been identified?
  • Are plant or profit centre costs increasing?
  • Have corporate overhead or other general and administrative operating costs increased?

• Are expenses significantly out of line with projections, historical results, industry and/or competitors?
• Are there unprofitable customers that may need to be pruned or contracts renegotiated?
• Are there unprofitable product lines?
• Is there efficient inventory management?
• Is it time to consolidate facilities, make the business more scalable through outsourcing of functions, eliminate redundancies in operations and head count, close selected store locations, or sell excess assets?
• Is it time to conduct a risk assessment of business operations?

Consideration of closing unprofitable business lines/segments is daunting and counter to most entrepreneurs, but it will free up working capital to devote to more profitable areas, improve liquidity and/or reduce debt levels. Ultimately, this will reduce strain on the capital structure.

A comprehensive action plan and time line will include, at a minimum, implementing a cost reduction programme, improving inventory controls, enhancing purchasing procedures, accelerating cash flow and implementing cash retention. Today's business environment calls for fine tuning the entire business enterprise and making sure all the components work effectively together to maximise value.

Too often, businesses react to information two to three weeks after month-end. Effectively reacting to changes in this turbulent business environment requires timely information for revenue analysis, gross margin management, product line profitability analysis and administrative cost controls. Most data can now be collected and reported on a daily basis. The ability to have this information gives you the opportunity to create weekly comparisons to budgets. This allows management to react in real time to deteriorating earnings and unexpected market changes.

In addition to keeping timely reports, it is important to document these real time decisions that are being made and why these actions are being taken i.e. why are you continuing to trade? Why are these actions in the best interest in creditors? It is important to document these decisions in real time with the information at hand as this will help avoid any potential criticism in the future

Health and Safety

All Businesses should be constantly reviewing and updating their health and safety policies to minimalise the effect of COVID –19 in their workplace.

Some key areas to consider are:

• Are employees being reminded about the importance of personal hygiene in the workplace?
• Have employees been provided with information on how to prevent the virus from spreading?
• Have health and safety processes been reviewed and updated accordingly?
• Is a record of staff travel being maintained and monitored?
• Have you reviewed your insurance policy with your insurer?
• Are there plans in place to isolate and protect critical staff and teams who are unable to work from home but are key to the running of the business?
• Are employees sitting a safe distance from each other? Or do the workplace seating arrangements need to be reviewed?

Updates to these policies should be circulated to all employees and it should be clearly communicated to employees the steps that should be taken should they start to feel any of the COIVID 19 symptoms.

Businesses should keep a close eye on the Ministry of Health New Zealand website for updates relating to any restrictions imposed.

​Businesses should formulate an action plan that covers the technology requirements of the business and any employees that are required to work from home.

This should include the following;

• Ensuring there is the right technology in place to allow them to complete the requirements of their jobs with minimal disruptions
• Have security settings been assessed for remote access? Are additional security measures required to keep the business network safe from any cyber-attacks?
• Checking that all employees have the ability to work from home and access the information they require
• Is the location of all important documentation known and easily accessible if need be?

Businesses may be forced to suspend operations from their premises, consideration should be given to what possible solutions there could be for the business if this did happen and what the implication of premise closure would be.

Government Coronavirus Business Package

On 17 March 2020, the Government released an announcement that they would provide a $12.1 billion coronavirus business package.

The package is broken down into the following components;

• $8.7 billion for business and jobs including wage subsidies and tax changes
• $2.8 billion for benefits
• $500 million for extra support to the health system

If businesses qualify, the business and jobs package could provide businesses with temporary cashflow pressure relief.

The business and jobs package is broken down into the following schemes;

• Wage subsidy scheme ($5.1b) – wage subsidies will be available to businesses that have had a 30% decline in revenue due to COVID 19 between January 2020 – June 2020 (compared to last year) and they have talked to their banks about assistance. Eligible firms will received $585 per week per full time employee and $350 per week per part time employee for 12 weeks up to a cap of $150k per employer. The scheme will be in place for an initial 8 week period, at which time the Government will reassess and the scheme is available to all businesses in all sectors nationwide, and includes the self-employed and sole traders.
• Business Tax Changes – this includes a number of changes to help increase business cash flows and stimulate investment. The tax changes are as follows;
• The reinstatement of depreciation deductions for commercial and industrial buildings at a 2% diminishing value applying from the 2020-21 tax year (generally beginning next month);
• Increasing the threshold for provisional tax from $2,500 to $5,000 applying from the 2020-21 tax year (generally beginning next month);
• Increasing the threshold for writing off low value assets to $5,000 for the next tax year, before reverting to $1,000 in the longer term;
• Giving a time-limited discretion to Inland Revenue to remit use of money interest (the interest on tax debt) if a taxpayer is unable to pay on time due to the impacts of COVID-19.
• Leave payment scheme ($126m) – a leave payment scheme which will be equal to the wage subsidy scheme for up to eight weeks, is being introduced to incentivise self-isolation by employees, the self-employed and contractors. This scheme will provide support to those unable to work due to being in self-isolation, are sick or are caring for dependants who are in any of these situations. There is an entitlement period of 14 days for those self-isolating, and for the entire period of sickness for those who contract COVID-19. Eligibility for the leave scheme is open to all firms, the self-employed, and for contractors, but not for those who can work from home

With the announcement of the Reserve Bank of New Zealand reducing the OCR from 1.0 percent to 0.25 percent, it has provided Banks a degree of flexibility to provide support to their clients during this time of uncertainty.

Banks are advertising for clients to get in touch to discuss what options (if any) are available to them. We would encourage any businesses seeking assistance to make contact with their banks to get the conversation started and a see whether they are willing to offer assistance.

Further, even if businesses that do not currently require any additional support from the bank, it could be a good time to familiarise yourself with your loan documentation to determine whether any potential future financial strain caused by COVID-19 which affects the performance of the business, has the ability to trigger any default provisions and any other provisions that could be applied during this time.

Enterprise value is usually built up over decades. Declines in enterprise value are usually evidenced by deteriorating revenue and operating profit, impaired operating cashflow, limited liquidity on bank lines, and not having enough money to meet all the business’s needs.

Sometimes the deterioration reflects shortfalls versus expected performance. In most instances, there is a lack of communication or shared expectations between the business and its external stakeholders.

As such, it is extremely important to be aware of who your main constituents are. Find a lender that understands your business and has a knowledge base in your industry. Keep in constant contact in good times and bad — surprises are never the way to go. , especially given the current tightened credit environment and the potential difficulty of finding a new lender in today's economy. In addition, a complex debt structure, which may include first and second lien holders, can create hurdles when a company is negotiating a workout.

The most successful restructurings are completed when all creditors and lenders are part of the process and on board with the plan to move forward.

As mentioned earlier, we also recommend constant communication with key suppliers and vendors. They may be willing to increase payment terms for special circumstances if they are aware in advance.

Some industries are very small and many creditors know one another, so your business’s financial misfortune may be common knowledge. It is always better that the business’s story comes from you.

In our experience, the most successful restructurings are completed when all creditors and lenders are part of the process and on board with the plan to move forward.

Management and the board must be aware of their duties to all stakeholders, including creditors and shareholders. When a company has a deteriorating financial situation or is operating in the vicinity of insolvency, creditors may look to hold management and the board to higher standards with respect to their fiduciary duties. It is important, therefore, to keep this in mind and to plan appropriately and to document all decisions made.

Creditors may look to hold management and the board to higher standards with respect to their fiduciary duties.

Sometimes even following all these guidelines isn't enough and it's best to call in an expert to lend a hand. Skilled business turnaround professionals should be able to look at your situation from an outside perspective and assess what changes are needed to adapt to the new business environment. Working together, you can gain a high-level understanding of the issues at hand and your options for dealing with them. But be sure to contact someone as soon as a critical situation is recognised. Waiting too long can mean that the time, money and patience needed to best address the issues at hand will be in short supply.