Liquidity crisis in times of COVID-19 (Coronavirus) — How to avoid financial constraints

How to get more liq­uid­i­ty in times of Coro­n­avirus. Tips from experts.

Con­fi­dence in the finan­cial mar­kets has weak­ened since the finan­cial cri­sis of 2008. Many com­pa­nies are cur­rent­ly ask­ing them­selves how to pro­ceed. Small and medi­um-sized com­pa­nies, in par­tic­u­lar, are fac­ing an unprece­dent­ed chal­lenge. Covid 19 — the virus that is turn­ing our entire eco­nom­ic sys­tem upside down has brought about unnec­es­sary and unfore­see­able lev­els of dis­com­fort.

In this con­nec­tion, the Ger­man gov­ern­ment has already announced tax mea­sures. The gov­ern­ment is plan­ning liq­uid­i­ty sup­port in the bil­lions which con­se­quent­ly means that Ger­many as an eco­nom­ic coun­try may be able to pro­tect its com­pa­nies with such pack­ages of mea­sures. But what about oth­er coun­tries?

The fact is that com­pa­nies have to man­age their finan­cial resources as best as I can. There must be suf­fi­cient liq­uid­i­ty reserves to pay employ­ees — even if no or lit­tle rev­enue can be gen­er­at­ed. The solu­tion? Increase liq­uid­i­ty and build reserves.

Accord­ing to experts, the virus will accom­pa­ny us for anoth­er 1–2 years. So what can be done to main­tain finan­cial resources for as long as pos­si­ble?

Liquidity crisis

A liq­uid­i­ty cri­sis can also arise in healthy com­pa­nies if cir­cum­stances such as Covid 19 (Coro­n­avirus) or the finan­cial cri­sis in 2008 occur, which result in short-term oblig­a­tions such as the repay­ment of loans and pay­ment of employ­ees no longer being able to be met. In order not to repeat the events of 2008, mea­sures must be tak­en ear­ly on to ensure that suf­fi­cient liq­uid­i­ty and reserves are avail­able to sur­vive in the mar­ket.

Definition of liquidity and liquidity ratios.

Liq­uid­i­ty can be defined as the abil­i­ty of the com­pa­ny to meet its pay­ment oblig­a­tions at all times, on time and in full.

A dis­tinc­tion should be made between rel­a­tive liq­uid­i­ty (finan­cial plan liq­uid­i­ty) and absolute liq­uid­i­ty (asset liq­uid­i­ty).

Finan­cial liq­uid­i­ty exceed­ing the avail­able cash of the due lia­bil­i­ties

Asset liq­uid­i­ty describes the liq­uid­i­ty of an asset, i.e. the pos­si­bil­i­ty of using or exchang­ing assets as means of pay­ment

Deter­mi­na­tion of the liq­uid­i­ty sit­u­a­tion

In prac­tice, the liq­uid­i­ty posi­tion of com­pa­nies is deter­mined by means of liq­uid­i­ty ratios.

Understanding Liquidity Ratios

Interpretation:

Quo­tient > 1: cur­rent lia­bil­i­ties cov­ered

Often: Cash ratio < 1*

*Some com­pa­nies, how­ev­er, have a first-degree liq­uid­i­ty of < 1, as not all cur­rent lia­bil­i­ties are due at the time of obser­va­tion and a high lev­el of cash and cash equiv­a­lents due to a lack of inter­est runs counter to the goal of prof­it max­i­miza­tion.

Quick ratio > 1**

**All the same, at least the 2nd-degree liq­uid­i­ty should be above 1 since in addi­tion to the short-term lia­bil­i­ties rec­og­niz­able from the bal­ance sheet, per­son­nel costs and oth­er expens­es whose due date is not evi­dent from the bal­ance sheet must also be set­tled.

Measures to increase liquidity

General liquidity management

  •  Prepa­ra­tion of a liq­uid­i­ty plan (Pre­pared Liq­uid­i­ty File down­load­able below!)
  •  Def­i­n­i­tion of spend­ing pri­or­i­ties
  •  Stop spend­ing

Fixed assets

  •  Sale of non-essen­tial assets (land, machin­ery, vehi­cles, etc.)
  •  Sales-and-lease-back
  •  Rent­ing of unneed­ed rooms, unused machines, vehi­cles
  •  Pos­si­bil­i­ties of out­sourc­ing cer­tain activ­i­ties
  •  Review planned invest­ment
  •  If nec­es­sary, lease rather than buy invest­ments

Inventories

  •  Check stock lev­el (inven­to­ry turnover) and reduce
  •  Shift stock keep­ing to sup­pli­er
  •  buy on com­mis­sion
  •  Review and opti­mize the order­ing sys­tem
  •  Set pro­duc­tion to stock

Claims

  •  Invoice com­plet­ed orders imme­di­ate­ly (an invoice with deliv­ery) Issue par­tial invoic­es for par­tial­ly com­plet­ed ser­vices
  •  Agree cus­tomer pre­pay­ments and install­ments in the future
  •  Invoice fin­ished orders imme­di­ate­ly (an invoice with deliv­ery)
  •  Short­en pay­ment terms for cus­tomers
  •  Cre­ate pay­ment incen­tives (e.g. cus­tomer accounts)
  •  Push advan­ta­geous means of pay­ment (cash, direct deb­it, dis­count bill)
  •  Dun­ning over­due receiv­ables imme­di­ate­ly
  •  Check dun­ning sys­tem
  •  In case of unsuc­cess­ful reminder: judi­cial dun­ning pro­ce­dure
  •  Exter­nal debt col­lec­tion (a col­lec­tion agency)
  •  Mon­i­tor and doc­u­ment cus­tomer pay­ment behav­ior
  •  Avoid pay­ment defaults by cus­tomers through cred­it checks
  •  Fac­tor­ing
  •  Replace secu­ri­ty reten­tions with per­for­mance bonds
  •  Sales financ­ing via the bank

Equity

  •  Pri­vate deposits (pri­vate reserves)
  •  Recov­ery of out­stand­ing deposits
  •  Reduce pri­vate with­drawals (cost of liv­ing) to a min­i­mum
  •  Review con­tri­bu­tions to the pen­sion scheme
  •  If nec­es­sary, reduce con­tri­bu­tions to the com­pul­so­ry craftsmen’s insur­ance (exemp­tion from com­pul­so­ry insur­ance due to insignif­i­cance or ful­fill­ment of the com­pul­so­ry insur­ance peri­od, aux­il­iary craftsmen’s busi­ness, income-relat­ed con­tri­bu­tion)
  •  Tem­po­rary sus­pen­sion or pos­si­ble ter­mi­na­tion of life insur­ance poli­cies
  •  Check health insur­ance for pos­si­ble sav­ings
  •  Tem­porar­i­ly inter­rupt sav­ings con­tri­bu­tions (build­ing soci­ety etc.)
  •  Check dona­tions, mem­ber­ship fees, etc. and if nec­es­sary reduce or avoid them
  •  Accep­tance of new share­hold­ers (e.g. dor­mant part­ner, cap­i­tal invest­ment com­pa­ny)

Long-term loans

  •  bor­row­ing from rel­a­tives or acquain­tances
  •  Resched­ul­ing of exces­sive cur­rent lia­bil­i­ties
  •  (e.g. with LfA con­sol­i­da­tion loans)
  •  Agree­ment of a sus­pen­sion of loan repay­ments
  • Sub­sti­tute loan (e.g. in the case of pub­lic loans with too short a term)
  •  Repay­ment defer­ral
  •  Review of inter­est rates
  •  Agree on grace peri­ods when financ­ing nec­es­sary new invest­ments
  •  (e.g. pub­lic loans)

Current liabilities

  •  Increase of the work­ing cap­i­tal loan (e.g. cur­rent account cred­it line)
  •  Use pay­ment dead­lines for invoic­es (e.g. from sup­pli­ers) as far as pos­si­ble
  •  Select advan­ta­geous pay­ment type (for exam­ple, check/bill of exchange pro­ce­dure, bill of exchange, check)
  •  Pay­ment of urgent com­mit­ments in install­ments
  •  Make con­crete agree­ments with main cred­i­tors (e.g. pay­ment by install­ments)
  •  Reg­u­late rela­tions with small cred­i­tors (pre­vent insol­ven­cy fil­ing!)
  •  Arrange set­tle­ment with cred­i­tors (if nec­es­sary against debtor war­rant)

Expenses

  •  Explore ways to reduce per­son­nel costs
  •  Review vol­un­tary ben­e­fits and spe­cial pay­ments to employ­ees
  •  Reduce over­time instead of pay­ing out
  •  Reduc­tion of advance tax pay­ments
  •  allow tax pay­ments to be deferred
  •  A crit­i­cal review of all expens­es and, if nec­es­sary, reduc­tion

Proceeds

  •  Com­plet­ing orders that have already been start­ed as quick­ly as pos­si­ble
  •  Quick­ly deal with remain­ing work and com­plaints about indi­vid­ual orders
  •  Mar­ket­ing mea­sures

Com­ments: The mea­sures list­ed above serve to bridge short-term liq­uid­i­ty bot­tle­necks. It should be not­ed that these mea­sures lead to an improve­ment in liq­uid­i­ty in the short term, but that oth­er ways and means should be con­sid­ered in the long term.

Reserves

In times of poten­tial bot­tle­necks, the for­ma­tion of reserves is anoth­er option, in addi­tion to improv­ing liq­uid­i­ty, for secur­ing the exis­tence of com­pa­nies.

Reserves = lia­bil­i­ties + com­po­nents of equi­ty.

A dis­tinc­tion can be made between open and hid­den reserves.

Open reserves = are shown open­ly in the bal­ance sheet and must not, in prin­ci­ple, reduce tax­able prof­it. They must be added to equi­ty for tax pur­pos­es.

Hid­den reserves (or hid­den reserves) = are dis­closed through the sale or with­draw­al of assets or the sale or dis­con­tin­u­a­tion of oper­a­tions. Tax­able prof­it must be gen­er­at­ed in the amount by which the dis­pos­al con­sid­er­a­tion or the going con­cern val­ue exceeds the book val­ue of the WG at the time of the sale or with­draw­al. A dis­clo­sure (real­iza­tion) of hid­den reserves occurs in the event of with­draw­al or the event of the ces­sa­tion or sale of busi­ness oper­a­tions.

How much reserves should one have?

The rule of thumb for pri­vate indi­vid­u­als is that one should have at least 3 net month­ly income reserves. For com­pa­nies, how­ev­er, the ques­tion is not so easy to answer. Here it depends on whether you are oblig­ed by law to pay a cer­tain amount or whether you can set aside vol­un­tary reserves. So there is no cor­rect lump sum here. How­ev­er, you should check whether you have to set aside mon­ey for tax and invest­ments.

Difference between reserves and provisions

 

ReservesAccrued Lia­bil­i­ties
Bal­ance of accountsEqui­ty cap­i­talBor­rowed cap­i­tal
- For­ma­tion accord­ing to the law or com­pa­ny statutes. These are used to pre­vent pos­si­ble loss­es (not known whether loss will occur at all)

- Should help com­pa­nies to secure future pay­ments and keep div­i­dend pay­ments con­stant

- Cre­ation of a reserve = increase in equi­ty with­out reduc­ing the prof­it

-Rep­re­sents expense & thus influ­ence the annu­al prof­it, which is reduced

- Pro­vi­sions are made to off­set future finan­cial loss­es and lia­bil­i­ties

- a lia­bil­i­ty is assumed to be cer­tain to mate­ri­alise when it is cre­at­ed

- Cre­ation of pro­vi­sions = cov­er­age of future lia­bil­i­ties

Oblig­a­tion yes (cor­po­ra­tions, depend­ing on law and arti­cles of asso­ci­a­tion) as soon as the sit­u­a­tion requires

Fixed pur­posefree of pur­posefor spe­cif­ic pur­pos­es
Effect on prof­itprof­it with­out effect on prof­itloss Min­imis­ing prof­it

A tip from the tax expert: Try to save taxes. You can use these saved taxes as a reserve.

Do you need help?

Here at DWP Dr. Wern­er & Part­ner, we are spe­cial­ized in inter­na­tion­al tax law and are hap­py to help you. Feel free to con­tact us via: info@drwerner.com or call us on +356 213 777 00.

We look for­ward to hear­ing from you.

About Philipp Sauerborn

In 2005, Philipp Sauer­born joined the firm of St. Matthew in Lon­don, one of the lead­ing Ger­man account­ing firms in Eng­land renowned for its exper­tise in cor­po­rate, com­mer­cial and tax law, as a depart­ment head. After three years, he was a part­ner and man­ag­ing direc­tor.
Towards the end of 2011, he decid­ed to move to Mal­ta, where he first worked at inter­na­tion­al law firms and con­sul­tan­cies in an employed and con­sult­ing capac­i­ty. Since the begin­ning of 2013, he has been a senior employ­ee at Dr. Wern­er & Part­ner. Mr. Sauer­born is cur­rent­ly com­plet­ing his ADIT ‑Advanced Diplo­ma in Inter­na­tion­al Tax.

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