The debt cliff: is your business prepared?

28 July 2020

Andrew Sallway , Partner, Business Restructuring |
Shaun McKinnon , Partner, Advisory |

Due to changes in the JobKeeper and JobSeeker schemes this article, originally posted 19 June 2020, has the below updates: 

The Federal Government Economic and Fiscal update on Tuesday 21 July 2020 announced the extension of the JobKeeper and JobSeeker scheme with new rates and revised rules. For more information about these changes please see our recent Technical Update.

To stay up-to-date with COVID-19 related stimulus measures, please see Australian Government Coronavirus (COVID-19) Stimulus Measures.

We’ve seen fundamental changes to the Australian business environment in a short period as a result of COVID-19, with many business owners asking – what’s next?

While restrictions begin to ease in Australia, it’s evident that for business, risk will remain for some time – especially for high-risk industries. The sudden change to business environment we felt in March, doesn’t quite work in reverse. While we are seeing green shoots as businesses reopen, a return-to-normal will be slow and gradual and we will likely see sluggish economic activity as a result of the recession we are now in.

Over the past few months, we’ve seen many businesses go from panic, to information overload to an understanding of how they will make it through. Yet, while most businesses can see themselves making it through now, many aren’t thinking too far into the future.

With many relief packages – both public and private – ending in September, there’s a growing concern that without a transition plan, many Australian businesses deferring payments will now face a ‘debt (or fiscal) cliff’, and if unprepared, won’t survive.

While it’s true that Directors need to be planning for the here-and-now, they must also plan to deal with their accrued debts and assess whether they will make it past this debt cliff.

In this article, we take a recap on what’s happened, analyse the debt cliff that’s coming and direct businesses to rethink a way forward, to come out the other side.

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A quick recap

It’s important to understand what’s just happened, to understand what’s coming.

The panic phase | 12 March -22 March

As COVID-19 cases started growing, the government responded by enacting social distancing measures, restricting movement of its citizens and enforcing closures of certain businesses.

As this unfolded the response from our clients and businesses generally was concern and even a hint of panic. By mid-March our clients started to see revenues falling and many businesses were forced to close. The rising cases, rapid slowdown in economic activity and uncertainty of the situation was causing a lot of concern and this was reflected on the ASX, with the All Ordinaries bottoming in March (after a peak only a month earlier).

At this time, we were advising our Partners and clients on the use of Safe Harbour, risks of insolvent trading and restructuring options. There was genuine concern for solvency of many clients and contacts we spoke with. Those in tourism, retail, hospitality, sports, entertainment, hotels, accommodation and education were most impacted.

The information overload phase | 22 March, through to 7 April

As COVID-19 cases were rising and the economic impacts were rapidly emerging, the Government (and other stakeholders) announced new support measures almost every other day. We were beginning to see the evidence the Pandemic was having on trading revenue. Businesses went from panic, to a holding stage with cautious optimism as new measures were explained. The discussions we were having around Safe Harbour and insolvency were no longer critical, with the announcement of the suspension of insolvency laws until September.

During this time, our conversations were around understanding support measures, encouraging clients to build cash flows and understand their runway. As more measures were announced and understood many businesses came back from the brink – but only in terms of short term cash flow. 

The realisation phase | 28 April 

With the government announcing plans to ease restrictions, and government and other stakeholder support measures now released, some businesses were starting to see revenues stabilise and new norms understood – with the ability to now comprehend and forecast for the immediate future.

This was the first time businesses were able to forecast with some level of confidence since the Pandemic swept Australia. Most businesses were able to trade through on a cash flow basis for 6 months because of liability deferrals and Jobkeeper assistance. However, there were exceptions, with COVID-19 being the impetus for Australia’s first major corporate collapse, seeing business failures including Virgin, Tigerlily, Techfront, and Colette, who all went into Voluntary Administration.

A debt cliff coming

The next phase | September 2020 will be a critical juncture for business

With public and private institutions pumping money into business and households to reduce the financial impact of the Pandemic, many businesses have found they can carry on. However, while this is positive, very few businesses are looking beyond the six month period which ends in September.

Businesses need to remember that the stimulus money is only temporary. We’re yet to see if the Government will take a phased approach to cutting off these measures. So far it’s looking unlikely.

Some economists believe that Australia is in a position to be government-supported through a long, slow recovery stating that a sudden stop to government support could be detrimental to the economy. 

At the same time, business debts are ‘ballooning’. Debts such as ATO debt, rent, payroll tax and loan repayments continue to accrue.

There is a security blanket that will be ripped out from under them in September… can businesses trade out the other side?

 What other factors will impact recovery?

At the peak of the debt cliff are the various economic scenarios that are interdependent to Australia’s recovery, including: consumer behaviour, the recession, the health and safety of people and risk of further shutdowns to all, or parts of industry and community.

With Australia now in its first recession for 29 years, there will be higher unemployment rates – it’s predicted these will go into the double digits before sitting at around seven percent. It’s projected that house prices will decrease and this, coupled with COVID-19 concerns will likely drive lower consumer spending and economic activity. While restrictions begin to ease, trading won’t return to normal, but the pace of business will be gradual.

While the threat of COVID-19 remains in our community, there’s also material risk for individual businesses. For specific businesses that require close person to person contact – such as manufacturing, real estate and construction – extra precautions to keep people safe will impact efficiency, but limit the risk of more shutdowns. For businesses, there may be periodic shutdowns if cases occur amongst staff, or clusters emerge in the local community – or worse still if a second wave community outbreak were to occur – seeing a ‘w’ shaped economy return, rather than a ‘v’.

These considerations need to be factored into scenario plans alongside the debt cliff.

An industry perspective

It’s expected that while the shutdowns caused widespread pain for many industries others have fared better. This table looks at who benefited, who will bounce back and who is at most risk of longer tem pain.

Rethink: are you prepared for the debt cliff?

Businesses need to be planning now for the cliff and looking ahead to profitability or solvency once support measures expire. It’s also important to consider the other factors impacting recovery. This will mean a rethink on the way businesses do business. There are number of considerations your business should be looking at now to avoid falling from the debt cliff, including:

  • When will your ATO / Payroll tax debts increase? Currently, deferrals end in September
  • When will your bank debts increase? Loan repayment deferrals for mortgages and SME loans will end or moving to interest-only shortly
  • When will landlord payments be due? Landlord / tenant code of conduct expires in September
  • Will you be trading while insolvent? The insolvent trading moratorium ends September
  • Will you have enough cash flow to pay staff? Job keeper expires in September
  • Do you owe employee entitlements? These continue to accrue while on stand down
  • How long will the goodwill last?

BDO’s COVID-19 Webinar Series

Watch the latest webinars from our experts across Australia, as they discuss the needs for your business now.

The top four things you can be doing now

Businesses must be looking at strategies that will see them through such as:

  1. Businesses need to accept and understand the debt cliff and begin pre-planning. Some businesses will fail if they are not planning for the repayment of their deferred liabilities
  2. Engage with stakeholders early and assess options. Stakeholders are more receptive to early intervention over late intervention and will look more favourably on you
  3. Constantly review your business models. As we move forward, some businesses will need to restructure to survive
  4. Continually assessing the macro and micro impacts is critical – there is still a high level of uncertainty. This includes the global impact which has the ability to impact local businesses.

As businesses begin to open up, there is optimism in the business environment. To ensure businesses put themselves in the best position beyond recovery, it’s important they plan beyond September. If you would need advice on your business, cash flow, solvency or business model, contact your local Partner today.