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Photo: Bloomberg
Photo: Bloomberg

How long before virus hits cash reserves?

The covid-19 shock could fast deplete cash holdings of an average firm, a new study on firms listed across the world shows

MUMBAI : Amid talk of a coronavirus-induced recession, businesses globally are facing liquidity and cash-flow problems. The shutdown of economic activity has led companies to slash dividends and layoff employees. New research in the Journal of Accounting and Public Policy suggests that an average firm’s cash holdings would last no longer than two years in the current crisis.

In the study, researchers Antonio De Vito and Juan-Pedro Gómez evaluate the stress caused by covid-19 on 14,245 listed non-financial companies across 25 Organization for Economic Co-operation and Development (OECD) countries and China. The authors test the impact of a 50% drop and a 75% drop in sales on three liquidity ratios: The cash-burn rate (which measures whether a firm has enough cash to sustain current operations), cash-to-current liabilities (a measure of short-term liquidity), and cash-to-total debt (a measure of long-term liquidity, indicating a firm’s ability to meet long-term debt obligations).

Using Compustat Global’s firm-level accounting data for 2018, the study finds an average firm’s cash holding to sustain operations for close to five years if it were functioning at full potential.

When the firms operate with partial flexibility, cash sufficiency drops to three years in the event of sales going down by 50%, and to two years if sales decrease by 75%. In such a scenario, the authors find the cash-burn rate and cash-to-current liabilities to turn negative. This may increase non-current liabilities up to 53% as firms raise debt to avoid insolvency.

The study finds that small firms with low profitability, higher leverage ratio and lower cash holdings are at greater risk of becoming illiquid within six months.

For firms to tide over the cash-flow crisis, bridge loans within six months of the shock may be more effective than deferring taxes, the authors suggest.

Also read: Estimating the COVID-19 Cash Crunch: Global Evidence and Policy

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