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  • Juanita Schwartzkopf

Where is the Tipping Point?

Focus Management Group - where is the tipping point

When the economic impacts of Covid-19 hit in March of 2020, most bankers, underwriters, business analysts and financial advisors anticipated an increased number of problem credits and restructuring situations. That has not materialized.

Why didn’t we experience a tipping point?

The Cares Act program provided financial relief to businesses, which allowed the businesses to continue to operate longer than their pre-Covid working capital and leverage would have allowed them to survive.

Payroll related expenses are usually one of the largest expenses of a business. Receiving a forgivable loan, the Payroll Protection Program (“PPP”) loan, equal to roughly 2.5 times average monthly payroll was a significant working capital improvement event. Additionally, PPP funds could be used to cover payroll related expenses and facility related rent/lease/payment costs.

When you couple the impact of the PPP loan with the payment deferrals many lenders and landlords offered, the working capital improvement is even greater. Facility carrying costs are typically a large component of the expense structure of a business. In many cases three to six months of payments were deferred.

In certain industry sectors, additional programs were offered. HHS administered the Provider Relief Fund to provide immediate cash resources to the health care industry, with recording of treatment of Covid-19 cases being a determining factor in the ability to receive forgiveness of the repayment requirements. The USDA provided food relief programs that food processors could participate in as they adapted to the evolving food service and retail food requirements, and programs were targeted to agricultural producers experiencing stress.

There were also EIDL loans, Economic Injury Disaster Loans, available to businesses. The Advance EIDL loans did not require repayment, and the terms of the traditional EIDL loans included low interest (3.75%) and extended maturities (30 years).

These programs masked problems.

A business that was struggling before Covid-19 impacted the economy could use these funds to survive longer than it would have otherwise survived.

A business that was struggling because of Covid-19 impacts could use these funds to survive during the economic impact of the virus.

Businesses struggling before Covid-19 or because of Covid-19 could use the program funds to re-invent the business and adapt to the NEW NORMAL.

Dealing with the underlying problems

While we can point to businesses that have certainly survived, reinvented themselves, and are thriving, there are many businesses that masked problems and have not addressed the underlying performance issues.

Lenders will need to pay close attention to the 2020 operating results to identify whether a business masked a problem or fixed a problem. Detailed analysis of revenues, expenses, and debt reporting will need to be evaluated from the perspective of 2019 results compared to 2020 results and then compared to the 2021 forecast.

Covid-19 will be the excuse we hear for months to come.

No one should make light of the significant financial impact of Covid-19 and the very difficult financial waters companies are dealing with. With that said, accepting Covid-19 as an excuse is not the answer.

The economy has permanently shifted in many ways.

Businesses that have addressed the NEW NORMAL of their industry, their geographic footprint, and the economy overall, coupled with the specific working capital and leverage position of the business will be best positioned for success as 2021 unfolds. Let’s discuss each of the factors that businesses and their lenders need to evaluate.

The industry:

Consider the $2.5 trillion dollar global fashion industry. Analysts anticipate this sector will contract up to 30% this year with the luxury market contracting even more at near 40%. A business operating in this sector will need to consider the supply chain going forward, their place in the industry and how to move toward a NEW NORMAL. Direct relationships with consumers via the internet, and changing style requirements are part of that planning. Virtual trunk shows and runway shows are now commonplace.

Think about the gym and fitness industry. Peloton stock has increased from $29.74 per share on January 1, 2020 to $112.03 per share on December 1, 2020 based on the trend toward in home fitness. On the other hand, Town Sports International Holdings (CLUB), who operated hundreds of gyms in the Northeast, filed for bankruptcy protection on September 14, 2020.

The geographic footprint:

Consider restaurants operating in Florida versus Illinois versus California. In Florida, restaurants can operate at full capacity with limited social distancing requirements, subject to local orders. In Illinois, the governor closed restaurants to indoor dining beginning November 4, 2020. The current estimates are that 5,000 to 21,700 Illinois restaurants will not survive these restrictions. In California stay at home measures have been reimplemented and restaurants are limited to curbside and take out service.

When considering restaurants, also evaluate the specific location of restaurants. Downtown locations relying on offices and entertainment venues for customers are especially hard hit. A family that owns seven Irish pubs in the Chicago area has already given up one location and is trying to sell a second one. A favorite St Louis downtown restaurant, Mango Peruvian Cuisine, will have closed permanently as of December 19, 2020 citing the lack of convention and hotel business in the downtown St Louis area and the capacity restrictions.

The economy overall:

The overall economy is certainly attempting to rebound and recover. However, there are changes that are indicative of a NEW NORMAL.

Consider changing consumer tastes resulting from the work from home (“WFH”) movement and the transition to online purchasing. Both of those trends existed before Covid-19 impacted the economy. Some studies have indicated that as of June 2020, 67% of the businesses that have adopted work from home strategies expect those programs to be long-term or permanent. In another study during that same time period, two-thirds of the business owners are re-evaluating their office footprints. These trends are continuing to accelerate.

The specific working capital position:

Each business has a different relationship with its vendors and its customers. Managing accounts receivable, inventory, and accounts payable has never been more important. A company that has been willing to serve as a bank to its customers and its vendors has increasing working capital problems. Use of the availability under a line of credit structure to fund operations can put a company in a working capital deficit position as the business restarts and more accounts receivable and inventory are required. If the borrowing base is 80% of accounts receivable and 60% of inventory, availability under the line of credit or increased accounts payable would need to fund 20% of the receivable and 40% of the inventory growth. Operating cycle analysis will be key as business performance fluctuates.

The leverage position:

The level of debt a company relies on increases its fixed costs, and its risk of being subjected to lender and stakeholder decisions impacting the ability of a company to continue to operate. Lower fixed costs provide a business with more opportunity to respond to negative influences.

What are the next steps?

Covid-19 definitely impacted and changed the economy. Many changes are long-term and permanent.

The key takeaway is that we have not felt the full impact of the changes. In part because individual businesses have been able to explain away or mask problems with the Covid-19 excuse or with cash from government programs. And, in part because the final impact on the economy is not known. For example, will restaurants return to some of these urban areas if office space is not filled. How long will it take for hotels and restaurants and entertainment venues to return to business and what will that business look like.

It is critically important to both understand Covid-19 has had an impact on business, and also to understand that businesses have to adjust and adapt. The ones that use their industry, their geographic footprint, the overall economy and their working capital and leverage position to accept the NEW NORMAL will be most likely to be successful. Lenders who analyze the performance of the business with a clear and thoughtful and detailed approach to move behind the reported numbers will be most likely to be successful.


FMG is producing a webinar series to assist lenders, investors, and stakeholders navigate the complicated financial reporting implications of the various programs, as well assisting in identifying real Covid-19 impacts versus the Covid-19 excuse. There will be a multi-part series available to provide analysis techniques for revenues, cost of goods sold, gross margin, operating expenses, other income and expense, working capital, leverage and capital structure.


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