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Liquidity and debt restructuring for business viability

Liquidity and debt restructuring for business viability

What is business viability made of? We have written extensively over the past few weeks about business resilience and what our local companies ought to be doing to survive the present unprecedented crisis, while building a robust strategy towards recovery in the new business paradigm that is evolving.

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renos-ioannides

Board Member, Deal Advisory

KPMG in Cyprus

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From a balance sheet point of view, there are two critical survival drivers: liquidity accessibility and cash availability and the ability of the business to adequately service its debts and meet loan covenants.

A lot of discussion has been triggered recently among analysts whether the existing level of indebtedness in the local corporate sector should deter the granting of extra liquidity funding to businesses (with or without state guarantees). The argument states that burdening businesses with additional debt, at a time when a large number of them is already over-indebted, is not economically rational.

Debt (re)structuring

It is an indisputable fact that excessive debt has been burdening most of our corporate world for a number of years now. Cyprus has traditionally exhibited one of the highest private sector debt ratios over the last few decades. The level of private sector debt is one of the major local macroeconomic imbalances and creates severe vulnerabilities in these times of substantial disruption and speed-of-light changes in the competitive landscape.

Ill-managed capital and debt structures can prove fatal, especially in periods of crisis. Yet, a large number of local businesses have not attempted or have not been successful to work out a sustainable, life-saving debt restructuring strategy. The same probably applies for credit institutions, which may have not managed to offer suitable restructuring options to a number of their borrowers, particularly smaller-scale businesses. Possibly, the parties involved may not have appreciated that the stakes are massive; they have not acknowledged that not proactively managing corporate capital and debt structures will have profound effects which will ultimately undermine the sustainability and survival of the business sooner or later.

We cannot recommend strongly enough the need for a thorough assessment and restructuring of corporate debt, so that the debt service burden is closely aligned with the business’s inherent, underlying cash generation capacity. This is definitely one of the critical foundational points which determine business resilience; debt servicing challenges will certainly not magically go away.

Liquidity

So then, should these over-indebted businesses not be afforded with additional liquidity facilities to see them through the unthinkable repercussions of the Covid-19 pandemic? The simple answer is certainly not, but with certain provisos as we shall discuss later.

We have taken great pains in previous articles to point out the significance of liquidity. A lack of liquidity will jeopardise the immediate viability of a business. If inadequate cash reserves exist, businesses will be unable to pay their day-to-day obligations, such as payroll and commercial creditors, as well as to meet loan commitments and obligations to state authorities.

It is evident that such ‘cash drainage’ situations have far-reaching repercussions, since business failure has a multiplier chain effect on the economy, with extensive ramifications on employment levels, the financial health of suppliers, banks and state authorities.

As a result, a diligent plan of having access to adequate core and contingent liquidity facilities and cash sources is indeed critical for any business’s immediate survival.

A practical action plan

We have established that both adequate liquidity and a sustainable debt service burden (aligned with the business’s cash generating ability) are critical factors in building business resilience and are foundational for the short-term survival and the longer term recovery and viability of any business.

Business leaders and bankers should strive to accommodate businesses on both counts: liquidity and debt restructuring. Although a number of arguments is recently being put forward in respect of whether businesses should be afforded additional liquidity funding or not - whether this funding should come in the form of bank debt or direct payments (e.g. governmental grants) or equity stakes in the business, etc. - one thing is absolutely certain: businesses need liquidity now and they ought to take a longer view vis-à-vis capital-debt (re) structuring now. Any further delay may simply be fatal for them and for the business community.

Consequently, business leaders, on the one hand, should act decisively and in a composed way to reorganise their debt structure, repayment profile and related terms, conditions and covenants, and to get access to adequate liquidity sources underpinned by a diligent financial plan.

Bankers, on the other hand, should fully facilitate, with speed and efficiency, the efforts of business leaders to restructure their debt and obtain the required liquidity to get them through these uncertain and cash-depleted times.

There is one major condition, or overriding principle, for the above action plan. It presupposes that support to businesses must be grounded on the premise of viability and cooperative behaviour. Businesses to be supported must have a reasonable survival and sustainability probability; and, certainly, they must be cooperative and strategically behaving in a rational way to safeguard their future while protecting their workforce.

This simple overriding principle should inform all decision-making relating to the action plan needed for securing the viability of local businesses. 

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