COVID-19: Preventing a corporate cash crunch among listed firms
The COVID-19 coronavirus pandemic constitutes a worldwide health crisis unprecedented in modern times. Besides the daunting cost this emergency poses in terms of human lives and social upheaval, its economic impact is equally dramatic. Many governments are imposing a lockdown of business and citizens for an undetermined period. Therefore, supply is disrupted in several industries, demand has plummeted overnight, and many fear for their jobs, both across countries and sectors (Baldwin 2020), increasing the prospects of a global economic recession (OECD 2020).
While SMEs and microenterprises are likely to have much lower reserves of liquidity and less access to credit lines, it is also important to analyse the preparedness of listed firms to cope with this crisis. Financially, public firms are sitting on a considerable amount of corporate debt amassed in recent years (BIS 2019). Several voices have already raised the need for an orderly debt-restructuring plan (Becker et al. 2020) to speed up economic recovery in the aftermath of the health crisis. There is an almost unanimous claim for government intervention to mitigate the drop in business activity and employment and to prevent massive bankruptcies (e.g. Baldwin and Mauro 2020, Bénassy-Quéré et al. 2020). However, before companies default on their long-term debt commitments, they will presumably exhaust their cash reserves and delay the payment of their outstanding commercial credit and short-term debts, at which point, they will be cash constrained. There is evidence that equity markets have started to discount this liquidity risk in stock prices (Ramelly and Wagner 2020).
What alternatives do listed firms have? The US Federal Reserve is relaunching the Commercial Paper Funding Facility (CPFF), created during the Great Recession, to purchase commercial paper and short-term, unsecured loans obtained by businesses for everyday expenses. US corporations are allowed to delay taxes up to $10 million for an extra 90 days past April 15. More than $500 billion in state loans and guarantees will be extended to small- and medium-sized firms as well as firms in specific sectors particularly affected by the crisis, like cargo and passenger airlines. Similar measures are replicated at various scales by governments around the world in order to provide firms with the liquidity that banks and capital markets may not be facilitating at the moment. As far as we can tell, however, there is no assessment of public firms’ short-term liquidity needs: How much time do they have before they become cash constrained? And what kind of interventions (i.e. lump sum money transfer versus tax deferrals) may be more effective in curbing the risk of a cash crunch?
In a new paper (De Vito and Gómez 2020), we contribute to this debate by answering these questions using the financial statements of 14,293 listed firms from 26 countries for the year 2018. We consider three distress scenarios; with low, moderate and high risk denoting drops in sales of 25%, 50%, and 75% respectively, relative to the base-case or the observed scenario. We perform stress tests of two liquidity ratios assuming that operating costs and the balance sheet remain as of 2018 for each firm.
- The first ratio, the ‘cash burn rate’, measures the number of years a firm is able to finance its operating costs without any further cash contribution from creditors or shareholders. In other words, it describes the number of years it would take for the firm’s current cash flow from operations to build up (if positive) or burn (if negative) its holdings of cash and more liquid current assets.
- The second ratio, the ‘cash flow to debt ratio’, can be interpreted as the percentage of current liabilities (including short-term debt) covered by the annual cash flows from operations, if these cash flows are positive. If they are negative, it can alternatively be interpreted as the expected growth in short-term liabilities.
Table 1 summarises the mean and median values of each ratio and the number and percentage of firms that would exhaust their cash holdings within six months. Figure 1 shows the distribution of both ratios in each scenario.
Table 1 Scenario analyses
Notes: This table presents the results of the stress tests for the base case scenario (Panel A) as well as for the low risk scenario (Panel B), moderate risk scenario (Panel C), and high-risk scenario (Panel D). Cash Burn Rate = (Cash and Cash Equivalents + Short-term Investments + Accounts Receivable) / Net Cash Flow; Net Cash Flow = Cash flow from Operations − Current Taxes – Interests; Cash flow from Operations = Sales − Operating Costs; Cash flow from Operations to Short-term Debt = Net Cash Flow / Current Liabilities.
Globally, in the base-case scenario, the average firm holds the equivalent of 4.5 years of operating cash flows in cash and liquid assets and covers 26% of its current liabilities with annual operating cash flows. One and a half percent of the sample firms would burn their liquid assets within six months. In a scenario of moderate risk of insolvency (50% drop in sales), the average firm would become illiquid in 1.4 years, at which point the current liabilities would increase by 133% relative to their level in 2018 due to the unpaid operating costs. The number of firms that become cash constrained within six months increases to almost 19%.
In the most severe distress scenario (75% drop in sales), the average firm would become illiquid in slightly less than one year, at which point the current liabilities would almost triple relative to the 2018 level. In this scenario, one-third of the firms in the sample would be illiquid within six months. Firms more likely to become cash constrained are also more leveraged, less profitable and have lower gross margins. Expectedly, these companies hold significantly less cash in their balance sheets.
Figure 1 Distribution of cash burn rates and CFO to current liabilities for different scenarios
Note: This figure plots the distribution of the cash burn rate and the cash flow from operations to current liabilities for each of the four scenarios. The ratios are defined in Table 1.
The analysis by country unveils interesting results. Focusing on the moderate liquidity risk scenario with 50% drop in annual sales, about 22% of firms in each country in the sample would, on average, become cash constrained within six months. Four (five) countries would have a percentage of illiquid firms one-standard deviation above (below) the mean. In the high-risk scenario, the same exercise yields three (six) countries one standard deviation above (below) the mean percentage of illiquid firms (40%). Interestingly, the number of illiquid firms in China, Greece, Italy, and Spain is below the mean in both scenarios.
Finally, we study the policy implications of our analysis. We consider two alternative policies: tax deferrals and a direct provision of cash to firms as a lump sum akin to a ‘bridge loan’ granted by the government. The former policy decreases the operating costs, while the latter increases the firm’s cash reserves. Both, therefore, delay a corporate cash crunch. They are not, however, equally effective. A moratorium of current taxes for half a year would only have a marginal effect: it would spare only 49 (51) firms globally from becoming illiquid within six months in the moderate (high) risk scenario. Cost wise, on average, 1.8 (0.41) firms would avoid a cash crunch within six months per $1 billion in forgone taxes in the moderate (high) risk scenario. On the other hand, if the government decided to give a bridge loan to each firm for the amount necessary to prevent a cash crunch within six months, on average, 8 (4.3) firms would be saved per $1 billion loan from becoming illiquid within that period in the moderate (high) risk scenario.
To conclude, although providing liquidity to firms through corporate ‘helicopter money’ in the form of bridge loans would cost governments almost twice as much as a six-month tax deferral, it seems justified given the higher efficacy of such policy in preventing a global cash crunch.
Baldwin, R (2020), “Keeping the lights on: Economic medicine for a medical shock”, VoxEU.org, 12 March.
Baldwin, R and B Weder di Mauro (2020), “Mitigating the COVID Economic Crisis: Act Fast and Do Whatever It Takes”, CEPR Press VoxEU.org, 18 March.
Bénassy-Quéré, A, R Marimon, J Pisani-Ferry, L Reichlin, D Schoenmaker and B Weder di Mauro (2020), “Europe needs a catastrophe relief plan”, VoxEU.org, 10 March.
BIS (2019), Annual Economic Report, Bank for International Settlements.
Becker, B, U Hege and P Mella-Barral (2020), “Corporate debt burdens threaten economic recovery after COVID-19: Planning for debt restructuring should start now”, VoxEU.org, 21 March.
De Vito, A and J-P Gomez (2020), “Estimating the Covid-19 Cash Crunch: Global Evidence and Policy”, Working Paper.
OECD (2020), OECD Economic Outlook, Interim Report March 2020, Paris: OECD Publishing.
Ramelli, S and A Wagner (2020), “Feverish Stock Price Reactions to COVID-19”, Working Paper.