Business Challenges Caused by COVID-19
The overall impact caused by COVID-19 is extraordinary. Many companies have weathered shutdowns and falling customer demand. Now, many are facing challenges with increases in direct costs (such as labor and materials), indirect costs, and added debt service. The companies that had strong balance sheets before the pandemic seem to have faired the best. But there is still a lot of uncertainty related to COVID-19. By early 2021, with the roll out of vaccines, many were optimistic that the economy would fall back in line with “normal times.” But, vaccine hesitancy and political divergence and misinformation has resulted in much of the population to be unvaccinated. This has resulted in a continual roller coaster of different virus strains. The Pandemic has hit some industries harder than others.
Some changes are thought to be temporary, while other changes will likely be more permanent.
Wages and Employment
Many front-line workers (such as grocery clerks), who were making minimum wage with no benefits, appear to have had enough and have left their job(s). Others, like hospitality employees, found themselves without jobs and likely reassessing their lives, due to the shutdowns. School closures added an additional complexity, causing many to leave existing jobs to be home with their kids. With businesses in dire need for workers, microeconomics’ supply and demand has caused a dramatic increase in wages across the country. Many employers who were paying employees minimum wage with no benefits are now paying above $15 with added benefits. Some business are able to adjust their pricing, while other have not. The latter, resulting in a decline of profitability.
In addition to labor costs, supply chain issues have caused a lot of problems too. Many American suppliers stopped production lines during the shutdowns. Others reduced production due to limited raw materials and lower demand. Products coming from overseas have also been hit by COVID-19 production shutdowns. Businesses have also suffered from the inability to ship/receive materials due to fewer cargo shipping containers, and added shipping costs. Supply and demand has resulted in a 10x increase in shipping costs for products shipped from Southeast Asia to the USA. A container which cost $3,000 – $4,000 a year ago, now costs $30,000 – $40,000. Although some of these pressures are expected to be alleviated in the near future, companies are reassessing their pricing and passing on the added costs to consumers, if they can.
Inflation is another major factor currently impacting businesses. The Consumer Price Index (CPI), a measure of inflation, rose in November. Prices climbed 6.8% year-over-year, the largest increase since 1982, and rose 0.8% over the past month. Major increases within the CPI were noted for gasoline, housing/shelter, food and vehicles. The gasoline index alone rose 6.1% in November. The Federal Reserve offers explanations, mostly related to supply and demand. One example is the airline industry which reduced pricing by 24% at the beginning of the pandemic when demand for travel plummeted. The depressed pricing remained throughout 2020, and increased in 2021 once the resurgence for travel led to higher demand. Likewise, the demand for vehicles dwindled during 2020. This led to reduced production and reduced pricing. Now, as demand has picked up, pricing has increased. Increased wages have also led to inflation, as companies try to offset costs through increased prices.
Impact on Business Value -Are business now worth less?
Every business is different, as the facts and circumstances will differ for each company. It is important to note that some businesses have thrived during the pandemic (from small liquor stores, to large business such as Amazon). But others have suffered significant setbacks.
As the pandemic lingers and new strains appear, the level of uncertainty and risks remains high. Although the reintroduction of shutdowns appear unlikely, shutdowns can happen again. Further, it would be reasonable to expect that the pandemic has reduced the pool of potential buyers as risks associated with a business’ cash flow, added debt service costs, and an added level of societal unease makes the pool of buyers more reluctant. Again, supply and demand would dictate that sellers would need to further reduce their selling price to attract buyers. This reduction is often reflected within marketability discounts. Accordingly, the pandemic has resulted in added marketability discounts, causing reduced values. See link for additional discussions related to business risk.
Another major change within the valuation industry is an increased reliance on discounted cash flow (DCF) model when considering an income based approach. This model relies on a projection of future expected cash flow. The other common model, capitalized cash flow, relies on historical cash flow as an indication of future expectations.
Relying on the past (with so many current internal and external factors / changes caused by the pandemic) may not be appropriate, as historical results may not be indicative of the future. This has caused many business valuation professionals to rely more heavily on a discounted cash flow model. It should be noted that many experts are still using a capitalized cash flow model (especially for small to medium sized businesses), but are reflecting a layer of additional “normalization adjustments” to adjust historical cash flow to reflect future expectations. Facts and circumstances may determine the appropriate income method, but clearly both methods should be considering the financial impact caused by the pandemic.
Impact will likely Continue
One thing seems for certain, the impact of COVID-19 will continue to wreak havoc on businesses and our economy for the near-term, and possibly much longer. Business Appraisers need to gain further understanding of its impact to capture the company’s value. Feel free to Contact us with questions, and to discuss your business and your valuation needs.