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Coronavirus and the Economy — Severe Risk of Bankruptcy and Financial Turmoil for SME Firms

Kolja A. Rafferty
Mar 19 · 7 min read
A face mask over a red background — Coronavirus and the economical crisis
A face mask over a red background — Coronavirus and the economical crisis

COVID-19 has quickly evolved from a far-away tragedy, to what is now also a large economic threat to businesses all around the world. Due to globalization, supply-chain processes, and increased mobility for professional and recreational purposes, today’s economy has evolved into a complex system that is highly sensitive to disruption.

On the same channels goods and services travel from their far-east production plants, the virus has now entered developing countries and mature markets. It’s also becoming clear that many health care systems were not prepared to manage a pandemic of this magnitude and are now exceeding their capabilities.

Capital markets are just as sensitive. The arrival of the Coronavirus in the United States has so far resulted in a $3.18 trillion loss in the economy, which is the worst drop since 1987. Once President Trump declared a national emergency, a handful of companies, including Google, CVA, Target, and Walmart saw their stocks jump. However, it remains uncertain, if the hopes of the investors for a quick recovery are justified.

The Coronavirus Crisis: an Economist´s Assessment

While health should be at the center of our concerns, investors and executives must also prepare for difficult economic times ahead, as the quarantine may result in yet another drop in the economy. In order to assess the situation from an economic perspective, there are several realities we must first accept:

· COVID-19 will reach your workplace — Coronavirus is spreading exponentially. For the time being, it is expected that the number of affected persons will double every other week. It is very likely, no matter if a company is located in New York or Nebraska, in Leipzig or Leonberg, a direct impact within the community will be observed at a certain point in time.

· Coronavirus is here to stay — We first saw this in the Wuhan area, where a lockdown has been implemented since January and just recently relaxes. Italy and Spain have since joined, while other European countries have closed down schools as well as their borders. But, for how long? The question remains unanswered.

· The health care system is being challenged on an unprecedented level — With the amount of infected civilians increasing every day, world healthcare systems have been put to a test. As demand for intensive care begins to exceed available resources, governments are required to apply swift and resolute measures to control the outbreak from spreading.

The ultimate goal right now is to slow down the pace of infections. While governments are working to hinder the impact of the virus, the health care system continues to be hit by a massive attack.

In comparison to South Korea and Taiwan, Italy was slow to act. While the curve has begun to decrease in the two Asian nations, Italy has become a red zone, with police patrolling in the streets. Many countries are on lockdown at the moment, which is inevitably affecting both public and personal life in various ways.

Screen showing the number of deaths caused by Coronavirus in March 2020
Screen showing the number of deaths caused by Coronavirus in March 2020

The economic impact

The impact of a lockdown is only to a small degree industry sensitive. Industries with a high B2C exposure, such as entertainment, hospitality, and events, face immediate and fatal erosion of revenues. Yet, other sectors, such as manufacturing or business services, operating in the B2B field will also face the economic impact of COVID-19. The sudden diminishing of returns will call for immediate actions of the management in order to prepare for the present and future of the crisis.

“The question is not whether it will be a recession worldwide, but for how long” — BBC Global News Podcast, US and UK announce massive economic packages to counter the coronavirus pandemic.

3 Levels of Sector-Agnostic Impact in B2B Situations

· Customers — Given the situation, customers will avoid traveling abroad or other avoidable activities that require them to leave their homes. The frequency of B2B customer interactions is expected to decrease over the course of the crisis. Enforced regulatory aspects, for example, the amount of individuals allowed in one location at the same time, will likely hit the retail and service industries hard. Looking ahead, insolvency rates are expected to rise. As a consequence, the increase of bad debt, decrease of customer liquidity, and the decrease of consumer purchasing power will be faced.

· Workforce — The workforce is affected on multiple levels, both directly and indirectly. An increase in sick leaves can be reasonably anticipated, but the safety of the remaining workforce is also a major issue. Whereas blue-collar workers and others in related professions may be protected by general work safety measures, customer-facing service personnel, and to the highest extent medical staff, must also be protected from the risk of infection. Eligible equipment is scarce, costly and also, inconvenient for the staff. Additional costs occur, and productivity is likely to slow down. For office personnel, remote work may be enforced, which will require digital workflows such as shared servers, digital work processes, and VPN access. The shift for staff from on-site processes to home office is a transformation process likely to cause inefficiencies in productivity and also challenging IT support and admin resources.

· Supply Chain — Being that many production sites are not fully operational at the moment, we are already seeing a disruption in the supply chain. If raw materials or other supplies are not available, this may lead to an interruption of production. Demand may remain unserved, revenues may be foregone and customers may switch to other suppliers.

Rough Waters Ahead

Decreasing GDP is known to be a main driver of insolvency rates and companies must expect decreasing revenues for the rest of the financial year. Given the complexity of the global supply chain, the deferred impact of the Coronavirus in different economies, and the remaining unknown around the actual virus itself, it is difficult to make a prediction of a final outcome. Also, we do not know, when and if, the global economy will return to the former level, once the measures show effect and the deadly threat will relax.

Crisis as an Opportunity

The current crisis holds a range of opportunities for businesses. It is intuitive to identify these opportunities for suppliers in the medical field (drugs, MedTech, medical equipment), as well as technology providers in the field of temperature measuring instruments. The list can be extended to include food suppliers, stationery, and personal hygiene products. In addition to the increasing, and often irrational level of demand from consumers, governmental entities are forced to increase their efforts to guarantee safety and support both to businesses and people. Public spending is increasing in this regard.

Closely observing competition will allow for growth initiatives. Addressing consumer demand as an organic growth strategy, as well as acquiring struggling competitors can create additional shareholder value.

Yet, at the heart of an executive’s responsibility must be the going concern of the firm. Completing a thorough risk analysis, closely managing OPEX, and aligning with relevant stakeholders to secure the integrity of business procedures and stability of liquidity are all essential steps.

If the firm shows too little adaptability towards the situation (or the impact is simply too strong), switching to distress mode (reducing the workforce, applying for Chapter 11 or similar instruments under other jurisdictions) can save the firm. Considering the sale of the business, while it still holds value, is another option that may help avoid severe financial loss. Waiting has never been a useful strategy when a situation appears to continuously worsen. From the analysis of multiple distress cases, we are informed that early preparation and anticipation of the situation is key to survival.

Blue-collar men wearing a face mask looking towards the sky during the coronavirus crisis
Blue-collar men wearing a face mask looking towards the sky during the coronavirus crisis

Conclusion

COVID-19 is a moment of truth for the business world and humanity as a whole. As it is creating a major disruption to the economy, it will, with certainty, affect businesses of all kinds. To a degree, the effects are indifferent to sectors, geographies, and business models. The decision by central banks to lower monetary policy rates indicates a considerable challenge, one that is already anticipated by the national economic authorities across the world.

For entrepreneurs, this will be a critical test. Running through some basic questions can enable business owners to assess the level of risk they are facing. Being prepared by minimizing operational costs, deferring CAPEX projects, or accumulating cash are essential for the survival of a firm.

Risk Analysis for Executives — 10 Crucial Questions for Going Concern Considerations Under COVID-19

To manage through the crisis, executives must conduct a thorough risk analysis. Crucial question should include:

1. How is the Business Model generally affected by COVID-19 within the local market? Will the impact be a direct result of changed consumer behavior or will effects arrive later as a result of a depression in the economy?

2. What will be the time horizon?

3. Given the Gross Margin of products and services, how much of a decrease in revenues can the organization handle before the monthly operative becomes negative?

4. Can operative costs be quickly reduced (reducing personnel, stopping OPEX intensive activities)?

5. Are any investments coming up, that can be delayed (stopping CAPEX intensive activities)?

6. How long allow retained earnings and cash reserves for a “dry” period?

7. Are financial reserves available (perform on accounts receivable, unlock illiquid assets, utilize reserves, apply for third party funding, are governmental support programs in reach, etc.)?

8. Can the Net Working Capital be optimized: Can accounts payables be extended? (testing waters for grace periods, down payment plans, etc. with banks and suppliers)

9. Are dependencies with suppliers critical? Is sufficient stock of crucial raw materials available? What are the main risk factors for the operations of the firm?

10. Is the stock of finished goods available, to a.) answer for immediate demand from customers, switching from failing competition, b.) buffer for volatility in the own workforce or supply chain.

https://medium.com/@tomaspueyo/coronavirus-act-today-or-people-will-die-f4d3d9cd99ca

https://ourworldindata.org/coronavirus

https://www.marketwatch.com/story/5-reasons-coronavirus-crushed-the-dow-and-left-global-financial-markets-broken-this-week-2020-03-13

This article was originally published at koljarafferty.com

Translations

German

Kolja A. Rafferty

Written by

Advisor, turnaround & transformation expert, with a strong bias towards strategy & corporate finance. Specialized in distress situations, Value Design, M&A.

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