How does COVID-19 impact a typical company's financial statements?
COVID-19 have been impacting businesses globally. While some (e.g. e-commerce or food delivery companies) are flourishing at the current time, a typical company is more likely than not to experience some negative impacts to their financial health due to the unpredictable dynamics of the pandemic. The following analysis, primarily within the Australian context, is meant to discuss those negative impacts, which reflect in a typical company’s financial statements.
CASH FLOWS STATEMENT
Cash flows from operating activities: may be reduced significantly, in which
- Profit before tax: will probably drop by a large margin due to lost revenue from lockdown and social distancing. Companies may try to cushion some impact by encouraging cash purchase, e.g. discounted unit price or freebies
- Cash flow adjustment for depreciation & amortisation: may go up if the company choose to accelerate depreciation or instantly write-off some cost-based asset with permission from ATO following Coronavirus Economic Response Package Omnibus Bill 2020 [1]
- Payment collected for account receivables: probably will decrease in the medium and long term as customers are under strain and may not either buy or be able to pay on time.
- Payment for inventory: this line item varies from company to company, but I believe the stock will be stable because even though inventory demand reduces due to weaken sales, the company would likely suppress their inventory purchase and/or purchase inventory on credit
- Prepayment: will likely diminish as the company try to hold on to cash
- Interest paid: may be reduced as many banks are reducing their business loan interest rate and/or allow payment deferral for businesses impacted by COVID-19 [2]
- Unearned revenue: will likely drop, similar to prepayment, as the company’s customers also tend to hold off from paying in advanced
- Corporate income tax paid: will likely reduce, caused by lower profit before tax and higher depreciation
Cash flows from investing activities: may or may not change much depending on the company’s investment decision
- Investments in PP&E, intangible assets or financial investment: these line items will see a significant drop as business try to hold on to cash instead of expanding their investment. However, there may be some investment increase on equipment to enable employees to work from home (e.g. more laptop computer & cybersecurity equipment)
- Divestments of PP&E and other assets: may increase if the company is under cash distress and they have some investment for disposal
- Net fair value gains on FVPL and other financial instruments: will likely drop due to the current financial market downturn caused by COVID-19
Cash flows from financing activities: may or may not change much depending on the company’s investment decision
- Borrowing: will see a significant increase as the company wants to increase cash reserve and RBA (just like other central banks) provides lending support to businesses [3]
- Dividends paid: typically, will decrease or be obliterated for the year
- Borrowing repayment: may be reduced as banks provide payment deferral for businesses impacted by COVID-19 [2]
INCOME STATEMENT
- Revenue: complete lockdown (closure of facilities), social distancing and drop in consumer spending due to COVID-19 all lead to significantly reduced or delayed stream of income. Companies either cannot provide product/service or have to postpone that.
- Cost of Goods Sold: will drop in tandem with revenue
- Wages Expense: will likely decrease as the company terminate/stand down its employees or reduce their working hours
- Amortisation and depreciation: as mentioned in question 1, this may go up if the company choose to accelerate depreciation or instantly write-off some cost-based asset with permission from ATO following Coronavirus Economic Response Package Omnibus Bill 2020 [1]
- Selling & marketing expenses: variable expenses may drop due to lack of sales
- General and administrative expenses: apart from variable costs, some general costs such as donation expense will be cut as the company is tightening its belt.
- Finance Expenses: as mentioned in question 1, interest expense will likely fall. On top of that, the company may be affected by severely fluctuating foreign exchange rate, depending on where its financing activities are carried out.
- Investment Income or share of profit (loss) from associates, joint controlled entity: will likely fall because COVID-19 affects the whole economy in general, most probably including the company’s associates & JCE
- Corporate income tax paid: as mentioned in question 1, it will likely reduce, caused by lower profit before tax and higher depreciation.
- Net Income: will drop significantly as a result of reduced revenue.
BALANCE SHEET
Assets & contra assets:
- Cash & cash equivalent: though revenue is depleted, the company may be able to borrow some cash with support from RBA [3]
- Inventory: will likely shrink due to lack of sales but and some possible impairment. For example, business operating in non-essential sectors which have experienced significant sales reduction should consider if they should do an impairment assessment.
- Provision for inventory obsolescence: this new line item is needed if the company believe its inventory value has deteriorated, but they can only estimate the dollar amount of the deterioration.
- PP&E: plant and equipment can have accelerated depreciation of a complete write-off [1]
- Intangible asset & goodwill: will likely be stable
- Trade receivables: as mentioned in question 1, this will probably drop
- Provision for doubtful receivables needs to be increased as it is anticipated that many customers will face difficulty to make payment.
- Wages subsidy receivables: if enrolled, the company, as an employer, should record the wages subsidy (JobKeeper) [4] from the government as a separate item to keep track. Most of the time, the exact dollar amount will be offset by wages payable.
- Financial investment: if fair value is used, the company’s financial assets value will probably fall due to the current financial market downturn.
Liabilities:
- Trade payables: will likely drop due to weaken inventory demand.
- Wages payables: will reduce as company scale down their workforce.
- Provisions for onerous contracts, financial guarantees and restructuring: these new items are needed as the company is temporarily forced to downsize or close its facilities. These provisions for any potential associated costs need to be considered along with appropriate recognition of employee termination entitlements.
- Long term loans & debt: may increase if the company choose to leverage support from RBA [3] or issue more corporate bonds.
- Wages subsidy payable: similar to “Wages subsidy receivables”, this is needed should the company choose to enrol into JobKeeper.
Shareholders’ equity:
- Retained earnings: will probably drop due to reduced net income.
NOTES TO FINANCIAL STATEMENTS:
Disclosure on significant sources of estimation uncertainty, key assumptions and sensitivity analysis due to COVID-19 need to be included in the Notes to Financial Statements as this will be very important for users of those statements.
Apart from that, the company need to consider whether an event after the reporting period is an adjusting event and make necessary adjustment, e.g. bankruptcy of a customer may confirm a customer was credit-impaired. Regardless, the company need to disclose in the notes specific information on the nature of the event after the reporting period, justification as to why the event is or is not an adjusting event and an estimate of its financial effect, where material.
Furthermore, the company also need to consider all relevant future information such as new travel bans or new community restrictions to determine whether it is still a going concern, i.e. continue operating indefinitely until it provides evidence otherwise. If the company determines that it intends to liquidate or cease trading or has no realistic alternative but to do so due to COVID-19, either before or after the reporting period ends, the financial statements should no longer be prepared on a going concern basis. [5]
Last but not least, it is also worth to note that if a company provides essential products/services, most of the line items in its financial statement will also be impacted. However, the dollar value will move in the opposite direction with that of a typical company. For instance, Woolworths would observe its short-term revenue sky-rocketing, mostly due to panic buying, while a regular company would see a depleted stream of revenue.
References:
[2] https://www.abc.net.au/news/2020-03-19/rba-cuts-interest-rates-coronavirus-covid-19/12070494
[3] https://www.rba.gov.au/covid-19/
[4] https://www.ato.gov.au/general/jobkeeper-payment/
[5] https://www.aasb.gov.au/admin/file/content102/c3/AASB19009_COVID19_FA.pdf