A “crazy” idea
A “crazy” idea
Each situation is different. That is a main doctrine of Fifth Way. Theories can’t tell you how to best confront each situation. Let’s take an example. You have an old car that breaks down all the time. In a few months you may get a promotion. In that case you will be able to buy the car you always dreamed of. If you do not get the job, you will have to settle for something cheaper. Most likely you will wait to see what happens before you buy the car. Most people will wait to see what happens with the coronavirus before they spend considerable amounts. The same is true for companies.
Let’s take another example. A meteorite will fall on Earth and 5% of the population will die. Scientists do not know where it will fall. You may be on that 5%. What would you do? You would enjoy life as much as you can because you may be among those who will die. You will travel, go out a lot and spend a lot of money. Unfortunately in the case of coronavirus you can not do that because of the safety measures. You may though want to catch up with everything you lost and celebrate the fact that you stayed alive, when the problem is gone.
The reason that companies can not adjust to circumstances is fixed costs. This brings them at an output level below break even point. While variable costs can adjust to output, fixed costs can only adjust in the long term. Rent, buildings, machinery, are fixed costs. Wages, utilities, materials used in production are variable costs. Mixed costs are part fixed and part variable. Electricity is an example. Even if a company does not use electricity at all, it will have to pay some amount.
This is shown in both diagrams. Total revenues (TR) are in both diagrams presented by a straight line. At zero output, revenues are zero. Revenues are price x output. At zero output, there is a cost which is fixed. In the first diagram variable costs are presented by a straight line. The second diagram is more realistic and variable and mixed costs are presented by a curve. If TC (Total Cost) is greater than TR (Total Revenue), we have loss and in the opposite case we have profit. When they are equal we have a break even point. In the second diagram we have two break even points. We have loss not only below 200 units but also above 300 units.
This by itself does not make a company insolvent. This is the reason behind it. A company becomes insolvent when it can not make payments. Insolvency is a cash flow problem, not a profit/loss problem. These are closely related but not the same. Companies are supposed to have a cushion of cash and liquid assets. They do that but they have not predicted a virus pandemic which is a very unusual situation.
In a recession, companies see a decline in their revenues and lay off workers to cut costs. Some companies close and lay off all their workers. Unemployed cut considerably their consumption and this has an effect on all companies. They lay off more workers and some close. It is a vicious spiral. In a recession a company’s output level drops slowly and stays low for a long time. The case of coronavirus is unique. Once the drug and the vaccine have been found, most likely things would get back to normal and even better. In this case who have a steep decline that should be followed by a steep increase.
Some measures should be taken against coronavirus. So, restaurants, bars, cafeterias, movies, malls, theaters, airlines, hotels will see a big drop in their business that may even reach zero if they are obligated to stay closed. Remote work should be used as much as possible. Still companies may have to lay off workers and this may initiate a recessionary cycle. Deferment of payments will solve the cash flow problem but may create a debt problem. It will prevent many companies from going bankrupt and that is something positive.
If companies defer payments to workers, workers will have to defer payments to landlords, banks, taxes etc. These will have to defer payments to others and it will go on and on. It will increase employees debt i.e. liabilities but also increase their assets because companies will owe them money. Their net value will not change and probably will improve because what is owed to them will be more than what they owe. The question is if companies can manage that debt.
Another alternative is an almost complete shut down. Only the absolutely necessary operate. Payments can be either deferred or canceled. In the first case they are owed and in the second they are deleted. There is no need for installment payments to be canceled. Deferment with no additional cost works just fine. The loan period will be extended. What is left is salaries and rents for companies and rents for people.
If companies are not operating they should not pay or owe salaries. People will not have income but they would only have to pay for food and will not owe anything. It is possible that the government assists everyone or those that are in need. Prices would have to drop at cost the supermarkets by law. It is totally unethical to make money in such situation.
There are also many shades of gray between the almost complete shut down and the case where almost everybody goes to work. An alternative is to divide a payment into three; a) paid b) deferred c) canceled. This means that there will be a reduction in payments during the period of crisis. This is part (c), canceled or deleted. Another part will deferred and owed and a third part will be paid.
Companies could work for less hours per week. This will decrease labor costs. Shut down time could be periodical. There are thre parameters. One is what closes and what stays open. The subcategories are when and how long. The other is what is paid, what is deferred and what is canceled. The third parameter is who pays or owes it, governments, companies or employees. The alternatives are endless.