By Himanshu V. Kishnadwala
Chartered Accountant
Compiler’s Note: Evaluation of Going Concern by management and disclosure thereof in the Financial Statements is becoming a very important aspect, especially with Covid-19-enforced business disruptions and uncertainties. Given below is an illustration of a very detailed analysis and disclosure of the same in the financial statements of a large company having operations in multiple locations across the world.
TATA MOTORS LTD. (31ST MARCH, 2020)
From Notes forming part of Consolidated Financial Statements
Going concern
These financial statements have been prepared on a going concern basis. The management has, given the significant uncertainties arising out of the outbreak of Covid-19, as explained in Note (f)(ix), assessed the cash flow projections and available liquidity for a period of twenty-four months from the date of these financial statements. Based on this evaluation, management believes that the Company will be able to continue as a ‘going concern’ in the foreseeable future and for a period of at least twelve months from the date of these financial statements based on the following:
i.) As at 31st March, 2020, the Company reviewed its business and operations to take into consideration the estimated impact and effects of the Covid-19 pandemic, including the estimated impact on the macroeconomic environment, the market outlook and the Company’s operations. Expected future cash flows from operating activities and capital expenditure is based on the under-mentioned key assumptions in the business projections:
* Revenues based on latest total industry forecasts / estimates. Indian automobile industry volume forecast of about 2.78 million units and 3.18 million units for the financial year ending 31st March, 2021 and 2022, representing decreases of about 21% and 9%, respectively, compared to year ended 31st March, 2020 industry volumes of about 3.50 million units. A decrease in the Company volumes is somewhat less for the year ending 31st March, 2021 and 2022, compared to the industry assumptions referenced.
* Reduction in capital expenditure considering the macroeconomic environment by suspending certain programmes. Estimated capital expenditure for the year ending 31st March, 2021 is Rs. 1,500 crores for the Company.
* Working capital cash inflows due to lower levels of inventory and trade receivables along with increase in acceptances with more suppliers / vendors opting for the same resulting in a net cash inflow of Rs. 1,500 crores in the year ending 31st March, 2021 as compared to the year ended 31st March, 2020.
ii.) Available credit facilities.
* Long-term borrowings subsequent to 31st March, 2020 raised of Rs. 1,000 crores [Note 47(i)] and borrowings agreed with lenders of Rs. 3,000 crores.
* Various undrawn limits available with the Company amounting to Rs. 4,065 crores, under revolving credit facility and limits with consortium banks as at 31st March, 2020.
* Exercise of options by Tata Sons Private Limited (Note 23).
Based on the above factors, Management has concluded that the going concern assumption is appropriate. Accordingly, the financial statements do not include any adjustments regarding the recoverability and classification of the carrying amount of assets and classification of liabilities that might result, should the Company be unable to continue as a going concern.
Going Concern for Jaguar Land Rover business
Jaguar Land Rover business (JLR) has adopted going concern basis following a rigorous assessment of the financial position and forecasts of the JLR through to 30th September, 2021. In particular, careful consideration has been given to the impact of Covid-19 in recognition of the impact it has had on the global economy and automotive industry. The impact has been significant, requiring temporary plant and retailer shutdowns, thereby impacting production and sales and creating substantial uncertainty over the timeframe for economies and the automotive industry to recover.
Liquidity and funding
JLR ended the financial year 31st March, 2020, with substantial liquidity of GBP 5.6 billion (Rs. 52,379.38 crores), including GBP 3.7 billion (Rs. 34,607.80 crores) of cash and other highly liquid investments and a GBP 1.9 billion (Rs. 17,771.57 crores) undrawn revolving credit facility. Net debt was GBP 2.2 billion (Rs. 20,577.61 crores) after GBP 5.9 billion (Rs. 55,185.41 crores) of gross debt and net assets stood at GBP 6.6 billion (Rs. 61,732.84 crores).
The GBP 5.9 billion (Rs. 55,185.41 crores) of gross debt consists mainly of long-dated bonds [face value GBP 3.8 billion (Rs. 35,543.15 crores) outstanding as at 31st March, 2020] with various maturities out to 2027, a US$1 billion (Rs. 7,562.75 crores) syndicated bank loan with final maturity in 2025, a GBP 625 million (Rs. 5,845.91 crores) amortising UKEF facility with final maturity in 2024 [face value GBP 573 million (Rs. 5,359.53 crores) outstanding at 31st March, 2020], a GBP 100 million (Rs. 935.35 crores) short-term secured fleet buy-back working capital facility and GBP 540 million (Rs. 5,050.87 crores) of leases. The only contractual debt maturities over the review period are a GBP 300 million (Rs. 2,806.04 crores) bond maturity in January, 2021 and the amortisation of GBP 188 million (Rs. 1,758.45 crores) of the UKEF facility as well as the Black Horse fleet buy-back facility maturing in Q3 FY21. The undrawn revolving credit facility matures in July, 2022. The debt and revolving credit facility have no financial covenant requirements, with the exception of the UKEF facility which has a GBP 1 billion (Rs. 9,353.46 crores) global liquidity requirement, measured at quarter ends. This is not projected to be breached in any of the downside scenarios assessed and summarised later in this disclosure. (See Note 27, Interest Bearing Loans and Borrowings, for additional details.)
Subsequent to the year-end, JLR increased an existing short-term working capital facility from GBP 100 million (Rs. 935.35 crores) to GBP 163 million (Rs. 1,524.61 crores) and a wholly-owned Chinese subsidiary completed a GBP 170 million (Rs. 1,590.09 crores) equivalent one-year loan with a Chinese bank. The GBP 170 million (Rs. 1,590.09 crores) equivalent loan was then repaid in June and replaced with a new three-year GBP 567 million (Rs. 5,303.41 crores) equivalent facility with a syndicate of five Chinese banks. The GBP 567 million (Rs. 5,303.41 crores) equivalent syndicated loan is subject to an annual review customary in the Chinese banking market and a profitability and leverage covenant applicable only to JLR’s Chinese subsidiary, which are not expected to be breached in any of the scenarios tested. JLR has a strong track record of raising funding in the bond and bank markets and continues to expect it will have opportunities to issue new funding in the future as evidenced by the completion of the Chinese GBP 567 million (Rs. 5,303.41 crores) syndicated loan in June, 2020. In addition, JLR has had discussions to access part of the GBP 330 billion (Rs. 3,086,641.80 crores) of guarantees announced by the UK government to assist companies with Covid-19 but nothing has been agreed, so the going concern analysis does not assume anything for this.
JLR generally requires payment from retailers on or shortly after delivery of the vehicle. Most dealers use wholesale financing arrangements in place to pay for vehicles. These facilities do not involve recourse to JLR in general and as such are not accounted as JLR debt. JLR expects these facilities to continue over the going concern review period in all scenarios. In the event any of these facilities were not to continue and retailers were unable to settle invoices immediately, working capital would be negatively impacted, possibly significantly, but this risk is considered remote. In addition, JLR has in place US $700 million (Rs. 5,293.93 crores) debt factoring facility for selected retailers and distributors without such wholesale financing arrangements in place. At 31st March, 2020, GBP 392 million (Rs. 3,666.56 crores) of the facility was utilised. The facility matures in March, 2021 and JLR expect this to be renewed at that time. In the event any of these facilities were not to continue, working capital would be negatively impacted, possibly significantly, but this risk is considered remote.
Update on trading performance since year end
The Covid-19 pandemic and resulting lockdowns resulted in a sharp drop in sales first in China in late January and then other regions in late March with a peak sales decrease in April. JLR responded quickly to the Covid-19 pandemic with temporary plant shutdowns and rigorous cost and investment controls to conserve cash as much as possible. The China joint venture production plant was shut down in late January and reopened in late February. All plants outside of China were shut down from late March with most plants restarting from late May and production is expected to gradually increase as sales recover.
As a result of the impact of Covid-19 on sales and production, JLR had negative free cash in April and May of about GBP 1.5 billion (Rs. 14,030.19 crores). This includes a GBP 1.2 billion (Rs. 11,224.15 crores) unwind of working capital resulting from the plant shutdowns. The working capital unwind primarily reflects the runoff of payments to suppliers for vehicles built before the plant shutdowns, offset partially by the sale of vehicles in inventory. Cash at the end of May was about GBP 2.4 billion (Rs. 22,448.30 crores), including about GBP 278 million (Rs. 2,600.26 crores) in international subsidiaries and the revolving credit facility of GBP 1.9 billion (Rs. 17,771.57 crores) remained available and undrawn. A free cash outflow of less than GBP 2 billion (Rs. 18,706.92 crores) is now expected in Q1 of FY21.
JLR is planning for a gradual recovery in the business as lockdowns are relaxed and economies recover. The pick-up in China has been encouraging with all retailers now open and retail sales of 6,828 vehicles in April, 2020 (down 3.1% compared to April, 2019) and 8,068 in May, 2020 (up 4.2% compared to May, 2019). The sales of Range Rover and Range Rover Sport have been particularly encouraging. Other regions have seen peak lockdowns in April with total worldwide retail sales of 14,709 vehicles in April (down 62.5% year-on-year), improving somewhat in May to 20,024 units (down 43.3%). Sales are expected to gradually recover in other regions following the reopening of retailers. Most recently, over 97% of retailers worldwide are open or partially open.
JLR plans to resume production gradually to meet demand as it recovers. The Solihull and Halewood assembly plants and engine plant in the UK, the Slovakia plant and contract manufacturing line in Graz (Austria) restarted from late May. The Castle Bromwich plant will reopen in due course, while the joint venture plant in China has been open since late February. Given the present uncertainties, Jaguar Land Rover will continue to manage costs and investment spending rigorously to protect liquidity. JLR has announced the Project Charge (now Charge+) transformation programme achieved a further GBP 600 million (Rs. 5,612.08 crores) of cash improvements in the Q4 of FY20, increasing lifetime savings under the programme to GBP 3.5 billion (Rs. 32,737.11 crores) since launch in the Q2 of FY19, including investment saving of GBP 1.9 billion (Rs. 17,771.57 crores) measured relative to original planning targets. (All savings attributed to Project Charge+ are unaudited pro forma analytical estimates.)
JLR has announced a Charge+ saving target for FY21 of GBP 1.5 billion (Rs. 14,030.19 crores) across investment spending, inventory and selling and administrative as well as material and warranty costs.
JLR has also implemented enhanced cost and investment reduction processes and controls complementing Project Charge in response to Covid-19. This includes reductions in non-product spending and lower margin and non-critical investment spending and numerous other cost control measures.
As discussed, the outlook beyond Q1 this year remains uncertain. However, JLR presently expects a gradual recovery of sales consistent with external industry estimates and improving cash flow boosted by the recovery of working capital as a result of the resumption of production, lower investment and other Project Charge+ cost reductions.
Going concern forecast scenarios
For the purposes of assessing going concern over the period from the date of signing of accounts to 30th September, 2021, JLR has considered three scenarios: 1) Base Case, 2) Severe, and 3) Extreme Severe. These scenarios are summarised below with more detailed assumptions provided in the appendix at the end of this disclosure.
As indicated, JLR had about GBP 2.4 billion (Rs. 22,448.30 crores) of cash and short-term liquid investments at the end of May, 2020. This includes the GBP 63 million (Rs. 589.27 crores) increase in short-term working capital facility and GBP 170 million (Rs. 1,590.09 crores) equivalent one-year loan with a Chinese Bank which were complete after March, 2020 and excludes the GBP 567 million (Rs. 5,303.41 crores) equivalent three-year loan facility which replaced the one-year China loan. As a result, total debt at the end of May was about GBP 6.5 billion (Rs. 60,797.49 crores).
Scenario 1: Base case
The base case scenario assumes:
* A global industry volume forecast of about 71 million units for calendar year 2020 and 81 million units for 2021, representing decreases of about 21% and 10%, respectively, compared to 2019 industry volumes of about 90 million units based on a number of external industry volume forecasts.
* A decrease in JLR wholesale volumes somewhat greater for FY21 and somewhat less for FY22 compared to the industry assumptions referenced.
* Investment, inventory and cost improvements are broadly consistent with the GBP 1.5 billion (Rs. 14,030.19 crores) Project Charge target described above in FY21. There is not yet a Charge target for FY22 and so not all of the saving in FY21 are assumed to continue at the same level in FY22 for the purposes of this going concern analysis.
* Total liquidity including the revolving credit facility is forecast to remain more than adequate with significant headroom in this scenario.
Scenario 2: Severe scenario
The severe scenario assumes:
* Global industry volumes of about 55 million units for calendar year 2020 and about 65 million units for calendar year 2021, representing decreases of about 39% and 28%, respectively, compared to calendar year 2019. This represents a more L-shaped recovery from Covid-19, based on selected external industry downside forecasts.
* A decline in JLR wholesale volumes for FY21 and FY22 broadly similar to the assumed industry decline referenced.
* Investment, inventory and cost improvements broadly consistent with Project Charge targets indicated above but increased by about 15% in FY21 (and about 5% in FY22) to partially mitigate the lower volumes in this scenario.
* Total liquidity including the revolving credit facility was forecast to remain adequate in this scenario but with lower headroom than in the base case.
Scenario 3: Extreme severe scenario
An extreme severe scenario was assessed which is the same as Scenario 2 but with the following further sensitivities applied:
* A further volume reduction of about 5% in FY21 resulting in JLR wholesale volumes down about 35% in FY21 and about 27% in H1 FY22, compared to FY20.
* Partial non-achievement of target Charge+ targets with respect to inventory and cost savings including material costs, overheads and warranty.
* Modest incremental supply chain cash impacts results from Covid-19.
* A hard Brexit resulting in 10% WTO tariffs on UK vehicle exports to EU countries and increased logistics and other associated costs from 1st January, 2021 offset partially by the impact of a weaker pound expected in such a scenario.
* A number of smaller other sensitivities.
In this more severe scenario, JLR has identified a number of ‘tough choice’ mitigating actions within their control that would be implemented to maintain sufficient liquidity in the business to remain a going concern. These actions include:
* Further significant reductions in investment spending,
* Reductions in fixed marketing and other marketing related costs, and
* Certain other discretionary costs.
In this more severe scenario, and taking into account these controllable mitigating actions, total liquidity including the revolving credit facility was forecast to remain adequate (without breaching the UKEF quarter-end liquidity covenant) but with more limited headroom.
Going concern conclusions
As described above, JLR have considered going concern in three scenarios: 1) Base Case, 2) Severe and 3) Extreme Severe.
In each of these scenarios, sufficient liquidity is forecast for JLR to operate and discharge its liabilities as they fall due, taking into account only cash generated from operations, controllable mitigating actions and the funding facilities existing on the date of authorisation of these financial statements and as at 31st March, 2020, including the presently undrawn revolving credit facility. In practice, management also expect JLR will be able to raise additional funding facilities over the assessment period to increase available liquidity, considering the strong track record of raising funding in the bond and bank markets.
Management do not consider more extreme scenarios than the ones assessed to be plausible.
As described above, management, after reviewing JLR’s operating budgets, investment plans and financing arrangements, consider that JLR has sufficient funding available at the date of approval of these financial statements.
Appendix: Detailed assumptions
This going concern analysis is based on detailed assumptions on how the business normally operates and how Covid-19 might impact the business. The assumptions include but are not limited to the following considerations. Except where stated otherwise, the assumptions are the same for all scenarios.
Dealer network
Currently, over 97% of retailers worldwide are open or partially open although this varies by region and some dealers are open on a constrained basis. The shutdown of dealers during the pandemic has undoubtedly decreased the financial strength of the retailer network with announcements of layoffs and other actions to reduce costs. Jaguar Land Rover is continuously engaging with its retailers and at present is not assuming material risks associated with retailer distress in any of the scenarios.
Supplier base
The business is carefully monitoring the impact of the Covid-19 shutdown on the supply base and readiness of suppliers to support the gradual resumption of production underway. Many of our suppliers are large well-capitalised companies, with others being smaller and medium-sized suppliers who tend to have less financial flexibility. At present there are a limited number of known supplier issues, which at this point are not materially different to historically experienced levels. JLR is therefore not presently assuming these represent a material risk compared to historically experienced levels in the Base Case and Severe Scenarios – supplier claims in May, 2020 are below prior year levels in terms of number and value. The Extreme Severe Scenario assumes a modest increase in supply chain cash costs related to Covid-19.
Suppliers are on payment terms ranging from seven to 64 days, with the standard terms being 60 days and the average 58 days. No change in supplier terms is assumed in the going concern analysis compared to historical experience.
Covid-19 and production restart considerations
JLR’s production facilities have been modified to protect the safety of our employees and to comply with social distancing legislation. Production ramp-up post lockdown has been managed to ensure that these changes within the facilities are embedded quickly and JLR don’t expect them to have a lasting impact on the variable costs of production. Restart plans have been coordinated with our supply base to ensure that all our suppliers can support the production schedule effectively.
Production facility restarts have been demand-led in order to ensure that JLR manage the impact on variable profit margins. Given the high level of uncertainty, JLR has ensured that they remain flexible and react to changes swiftly.
Employees
For the purposes of this going concern analysis, no structural changes are assumed to the permanent employee base in any of the scenarios. JLR has participated in the UK job retention scheme whereby the government partially reimburses the wage and salary costs of furloughed workers. At its peak, about 20,000 employees were furloughed providing about GBP 50 million (Rs. 467.67 crores) of monthly subsidy. However, participation is now decreasing with plants reopening and it is assumed the programme will not continue after October.
Working capital
Working capital movements in cash flow are significantly driven by volume levels and changes. This is because supplier payment terms are about 58 days on average although payment terms for individual suppliers can be longer or shorter, while payments for vehicles are received in most countries within a few days of dealers being invoiced. Inventories can also vary to the extent wholesale volumes deviate from forecast before production can be adjusted but in general JLR has set a Charge+ inventory target of GBP 3 billion (Rs. 28,060.38 crores) or lower.
JLR had negative free flow in April and May of about GBP 1.5 billion (Rs. 14,030.19 crores). This includes a GBP 1.2 billion (Rs. 11,224.15 crores) unwind of working capital resulting from the plant shutdowns. The working capital unwind primarily reflects the runoff of payments to suppliers for vehicles built before the plant shutdowns, offset partially by the sale of vehicles in inventory. Cash at the end of May was about GBP 2.4 billion (Rs. 22,448.30 crores), including about GBP 278 million (Rs. 2,600.26 crores) in international subsidiaries and the revolving credit facility of GBP 1.9 billion (Rs. 17,771.57 crores) remained available and undrawn. A free cash outflow of less than GBP 2 billion (Rs. 18,706.92 crores) is now expected in Q1 of FY21.
As production volumes resume, this effect is assumed to reverse and wholesale revenues are assumed to increase while payments to suppliers will lag because of the difference between supplier and dealer payment terms described.
Intra-period volatility
There is a certain degree of volatility in cash flows by month and within months. Historically, this has averaged about GBP 188 million (Rs. 1,758.45 crores) intra-month with only a very limited number of exceptions over GBP 400 million (Rs. 3,741.38 crores). It is assumed this level of volatility varies with sales and production volumes and so would be smaller in lower volume scenarios. While not assumed, this could be reduced through more active day-to-day management of receipts and payments.
Brexit
The Scenario 1 and Scenario 2 assumption for Brexit is that a deal is agreed to avoid a hard Brexit. Scenario 3 assumes a hard Brexit. A hard Brexit is assumed to result in 10% WTO tariffs on UK vehicle exports to EU countries and increased logistics and other associated costs from 1st January, 2021, offset partially by the impact of a weaker pound expected in such a scenario.
