Estimating the COVID-19 cash crunch: Global evidence and policy. #Covid19 #CashCrunch #LiquidityRisk #BusinessTaxes #FiscalPolicies #BridgeLoans
19 May 2020

Here we present the most relevant analyzes and conclusions of the study carried out by professors: Antonio De Vito and Juan-Pedro Gómez, recently published in Journal Journal of Accounting and Public Policy, 

The COVID-19 coronavirus pandemic constitutes an unprecedented worldwide health crisis in modern times. Besides the daunting cost this emergency poses in terms of human lives and social upheaval, its economic impact is equally dramatic. In the attempt to contain the spread of the coronavirus, 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 plus less access to credit lines (e.g., Schivardi 2020), how prepared are listed firms to cope with this crisis? In this regard, it is also important to highlight that public firms have accumulated a considerable amount of corporate debt in recent years (BIS 2019), to such an extent that several scholars have already raised the need for an orderly debt-restructuring plan (Becker, Hege, Mega-Barral 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 (Baldwin and Weder di Mauro 2020; Bénassy-Quéré et al. 2020). However, before defaulting on their long-term debt commitments, companies will likely exhaust their cash reserves and delay the payment of their outstanding commercial credit and short-term debts, at which point, they will become cash constrained. Consistent with this argument, recent evidence shows that stock markets have started to discount the liquidity risk in stock prices (Ramelly and Wagner 2020).


To the best of our knowledge, however, so far there has been no assessment of firms’ liquidity risk potentially arising from COVID-19. In a new paper (De Vito and Gómez 2020), we contribute to this debate by analyzing two research questions. First, we examine how much time companies have before they become cash constrained. Second, we examine what kind of government interventions (i.e., lump sum money transfer versus tax deferrals) may be more effective to curb the risk of COVID-19 cash crunch. Using the financial statements of more than 14,000 listed firms from 26 countries for the year 2018 – which corresponds to our base-case scenario – we consider two distress scenarios with moderate and high risk, denoting drops in sales of 50% and 75%, respectively. We perform stress tests of three liquidity ratios assuming different degrees of operating flexibility to adjust to an adverse shock.


-The first ratio, the “cash burn rate” measures how many years a firm is able to finance its operating costs without any further cash contribution from creditors or shareholders. In other words,  how many 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 current liabilities ratio” estimates the percentage of current liabilities (including short-term debt) covered by the annual cash flows from operations, if these are positive, or the expected growth in short-term liabilities, if the cash flows are negative.


-The third ratio is the “cash flow from operations to total debt ratio”, which measures the extent to which the cash flow from operations is sufficient to repay all liabilities, including noncurrent liabilities, if positive, or the percentage increase in noncurrent liabilities that the firm requires to cover its cash needs, if negative.Table 1 summarizes the mean and median values of each ratio and the number and percentage of firms that would become illiquid (zero liquid assets) within 6 months. Figure 1 shows the distribution of all ratios in each scenario.


Table 1 summarizes the mean and median values of each ratio and the number and percentage of firms that would become illiquid (zero liquid assets) within 6 months. Figure 1 shows the distribution of all ratios in each scenario. 

As can be seen in Table 1 and Figure 1, in the moderate-risk scenario, the average firm holds the equivalent of 3 years of operating cash flows in cash and liquid assets. However, this cash burn period would further shrink as demand contracts, and it would last about two years in the high-risk scenario (i.e., a drop in sales of 75%). Moreover, if sales were to drop by 50% and 75%, our results indicate that the short-term liabilities of the average firm with partial operating flexibility would increase beyond a sustainable level, with the increases ranging from 216.01% in the moderate-risk scenario to 779.26% in the high-risk scenario. These results suggest that the contraction in demand due to COVID-19 would also spill over negatively to suppliers. Hence, to prevent a cash crunch at the end of the cash burn period, firms with partial operating flexibility would have to resort to the debt market. Our findings indicate that the debt issuances would range from 30.27% to 53.05% relative to the level of noncurrent liabilities in 2018.


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 have only marginal effect: it would spare only 1 firm out of 1,367 from becoming illiquid within 6 months in the high-risk scenario. On the other side, if the government decided to give a bridge loan to each of the 1,367 illiquid firms for the amount necessary to prevent a cash crunch within 6 months, on average, 12 firms would be saved per USD billion loan from becoming illiquid within that period in the high-risk scenario.


To conclude, although providing liquidity to firms in the form of bridge loans would certainly imply a higher expenditure for governments, it seems justified given the efficacy of such measure relative to tax deferrals in preventing a global cash crunch.


About the authors:

Antonio De Vito - Assistant Professor of Accounting, IE Business School, IE University

Juan-Pedro Gómez - Associate Professor of Finance, IE Business School, IE University