Fashion companies in Poland. The influence of COVID-19 on liquidity assessment

This article consists of three sections. The first section describes the information crucial to liquidity. It points out the determinants of liquidity and the most important factors shaping it. It also provides an explanation of the relationship between liquidity and the business model of a company. Moreover, it indicates that liquidity will be analysed differently depending on the sector in which the company operates. The second section deals with the characteristics of the fashion industry, which is a part of the larger retail trade sector. It describes the size and importance of the fashion industry in the Polish economy and indicates trends; it shows the characteristics of the fashion companies. It also presents the changes that occurred in the fashion industry under the COVID-19 pandemic. Moreover, it identifies and explains from a liquidity perspective the most important elements of financial statements (especially those helpful to understanding the company's liquidity affected by the COVID-19 crisis).

This information allows for a reliable assessment of the company's condition. The third section is empirical, in which two dynamic panel models are estimated: the Arellano–Bover / Blundell–Bond linear dynamic panel-data estimation, with two-step estimation and no constants. The analysed data cover the 11 quarters from Q1 2019 to Q3 2021 and were obtained from the quarterly financial statements of the 108 public companies listed on the Warsaw Stock Exchange and NewConnect (21 companies operating in the fashion sector). The presented models made it possible to verify the hypothesis regarding the decrease in liquidity of companies in the retail trade and fashion sectors during the COVID-19 crisis. The liquidity was defined as a ratio of available cash and cash equivalents to total assets and as the ratio of cash and cash equivalents to trade payables. The empirical study also permits us to answer the question of which of the sectors (retail trade or fashion) was affected more strongly by the COVID-19 crisis. Moreover, the study provides evidence that the fashion sector is characterised by a higher level of cash than the retail trade sector as a whole.

The liquidity of an economic entity is its ability to repay its current – that is, short-term, payable within 12 months – financial liabilities. This is an apt definition, but not exhaustive of all aspects of liquidity. The degree of liquidity is determined by what proportion of assets can be exchanged relatively quickly and without losses for the cash required by the entity (Hayes, 2021). Additionally, the literature draws attention not only to the repayment aspect of maturing liabilities but also to the ability to purchase all the goods and services needed by the entity at any given time to meet its current production and consumption needs (Wojciechowska, 2001, p. 14).

The financial liquidity of an economic entity should be considered from the broadest possible perspective. This allows for determining the actual financial condition of an economic entity, which gives the entity a basis for active management of its liquidity. A comprehensive process of looking at liquidity is crucial in the context of developing and maintaining the competitive position of an enterprise. Moreover, in the long term, it also determines the solvency of such an entity. This is very important because insolvency leads directly to bankruptcy. Insolvency (as opposed to illiquidity) is considered over a long period of time and refers to a permanent loss of the ability to settle liabilities (these liabilities exceed the value of the entity's assets). A solvent company is capable of achieving financial surpluses in the long term, necessary for reinvestment in growth (Mioduchowska-Jaroszewska, 2005, p. 25). Even Polish law defines the solvency of a business entity. The conditions necessary to officially put an insolvent company into bankruptcy are stated in article 11 of the Act of 28 February 2003 – Bankruptcy Law. Sometimes the concepts of liquidity and solvency are used interchangeably, but it should be borne in mind that solvency is a broader concept.

The concept of liquidity should not be confused with profitability. Profitability is an indicator showing the efficiency of a given investment or activity. It is calculated according to a very simple scheme: dividing profit by the volume whose efficiency we want to measure. In the context of the company as a whole, the most commonly calculated key performance indicators are: return on equity (ROE), return on assets (ROA), and return on sales (ROS).

Each economic entity can be characterised by one of three variants of the situation: a normal level of liquidity, its deficiency, or its excess. The occurrence of any of these cases is associated with the fact that the enterprise begins to exhibit certain characteristics or lack of them, the so-called liquidity characteristics (Tokarski, Tokarski & Mosionek-Szweda, 2017, pp. 38–39).

In the case of liquidity, the opposite of an adequate level of liquidity will be its absence. Table 1 presents features typically beneficial or not to the enterprise. A summary of these characteristics and their effects is presented in Table 1.

Excess liquidity, on the other hand, is a situation that cannot be clearly defined as good or bad, as it has both advantages and disadvantages. Maintaining excess liquidity can be either a deliberate financial strategy or the result of a lack of cash management skills. For this particular reason, these situations should be assessed holistically from the point of view of both the plans and the adopted management method of the economic entity, the market situation, and the specifics of the industry in which the entity operates. The advantages of an above-average level of liquidity include stability and balance of payments, the low financial risk of the business, and the possibility of negotiating more favourable contracts due to the high flexibility of financing. As for the disadvantages, these include the opportunity cost of freezing cash (cash does not work for subsequent profit), lower efficiency of capital held, as well as low leverage, which has a direct impact on the profitability of assets (the higher the liquidity, the lower the expected profitability) (Tokarski et al., 2017, p. 40).

The characteristics described in the previous section are the result of factors that influence liquidity by shaping its nature and level. Knowing the determinants of liquidity and their effects on the economic entity allows us to understand not only the importance of the way in which risk is managed, but also the way in which corporate strategies function. It enables the financial manager to make conscious decisions regarding the selection of the most cost-effective solution.

The literature on the subject distinguishes between macroeconomic and microeconomic factors. Additionally, it identifies a subgroup of sectoral factors, which are characteristic only of a specific sector or branch of the economy, but just like the other macroeconomic factors, are not dependent on the enterprise itself (Wojciechowska, 2001, pp. 21–24). Macroeconomic factors influencing the liquidity of enterprises are represented by features and dependencies characterising the market environment in which a given economic entity operates.

Industry-specific factors affecting corporate liquidity will include industry-specific characteristics affecting all companies operating in a particular sector. Microeconomic factors depend on the internal aspects of the company's operations, which the company can actively influence with its decisions. The skilful management's adaptation to these factors allows an enterprise to maximise profit without losing the ability to settle its obligations on time. We can distinguish among internal factors related to the operational, investment, and financial activities of an enterprise.

The characteristics and determinants of liquidity described in Table 2 clearly indicate that it is very important for a company to measure and retain an adequate amount of free cash. It is the best guarantor of liquidity.

It is important to note that, in addition to its size, an entity’ business model has an impact on liquidity and the way the liquidity is managed in particular. The business model is defined in several ways. The concept proposed by M. E. Porter assumes that it is a kind of loose plan, positioning the company in the value chain and describing how it generates profits (in short, which elements of the value chain are key in the process of generating costs and revenues) (Porter, 2006, pp. 60–61). In turn, A. Osterwalder and Y. Pigneuer defined a business model as a series of premises through which a company creates value and generates profits from its activities (Osterwalder & Pigneuer, 2012, pp. 18–21).

In this article, we will only distinguish between the most basic business models, but before that, it is necessary to analyse the factors that allow a business model to be defined. Table 3 presents a list of the key factors influencing the construction of the business model, together with an assessment of the impact that these factors may have on the liquidity of the entity.

It is clear from the analysis presented in Table 3 that, in terms of liquidity, the volume of sales revenue, as well as capital expenditure (including replacement outlays), are the key items. In simplified terms, it can be assumed that liquidity mainly depends on the regularity and volume of sales; that is, sales are always of paramount importance. Of course, other aspects such as planning and the appropriate timing of receivables are very important, but without the generation of consecutive sales, there can be no planning needed. It is why establishing the right business model is so crucial. Three basic business models should be distinguished; they appear in virtually every study that deals with this topic. These models include:

B2C (Business to Customer) model. This is a model in which business entities sell their products or services to individual customers. In such a model, either the possibility of deferred payment does not exist at all, or payment in instalments is allowed (in the case of higher-value goods or the purchase of licences on which a royalty is charged at certain intervals). In terms of liquidity, this is a fairly secure business model, with individual customers in the vast majority of cases repaying their obligations as they are aware of the much greater market power of the operator. Unforeseen losses may arise in the event of a defect in a batch of goods, the complaints necessary to be acknowledged or the obligatory compensation to be paid. This model is characteristic of the retail industry and thus also of the fashion industry.

B2B (Business to Business) model. This is a model in which companies sell their products or services to other businesses. It often involves the use of trade credit granted to counterparties. According to the analysis already presented, it is this type of unpaid obligation that generates payment bottlenecks in the economy. In this model, as a rule, transactions amount to much larger sums than in B2C, hence it is a riskier model in terms of liquidity.

C2C (Customer to Customer) model. This model allows for the direct exchange of goods between customers via a dedicated medium. This is the principle of online portals, which charge a commission for intermediation. It is a secure model from the point of view of liquidity since any exchange of goods or services cannot take place without the payment of the required fee. Hence, any sales traffic, such as on a website, will generate revenue, while the costs of maintaining and reaching customers worldwide via the internet are the lowest possible.

The first and most characteristic example is the trading industry. This is where stock monitoring is most intuitive, hence it is the origin of trade credit. Within this industry, it is very important to control the counterparties and the exact restrictions in the way trade credits are granted. To function efficiently, trading companies should have collection plans and procedures in place in case of late payment. According to the survey, about 60% of Polish SMEs do not have such procedures in place (Masiukiewicz, 2018, p. 49). In addition, 72% of companies experience payment delays and yet, perhaps surprisingly, as many as 76% of entities do not use provisions in their contracts to protect against or in any way recompense (e.g., through contractual penalties) such payment delays (Masiukiewicz, 2018, p. 49). However, it must be remembered that within the trade sector, the characteristics of the entities are very different. For example, in the food industry, time will be a very important factor, as products have a specific short shelf life. Suppliers of finishing materials for houses and flats will be dependent on the condition of the entire construction sector and a positive situation in the housing market; moreover, they will experience a change in the dynamics of consumption with a considerable delay (as the process of finishing a construction project takes from one to several years). In the apparel industry, on the other hand, production will follow seasonal cycles, and a misplaced collection will result in a drastic drop in revenue in a particular half-year or quarter.

The fashion sector has its own characteristics, which are important for managers, analysts, and many other market participants. First of all, it should be noted that the success of Polish companies in this sector is based, among other things, on extensive cooperation with many other entities, such as fabric and thread manufacturers, sewing plants (production of the main products for sale), furniture companies and assembly teams (construction and furnishing of showrooms), graphic designers, photographers, and marketing specialists (both the design of collections and their subsequent promotion), IT companies (management of shops, supply chain, warehouse, online sales), suppliers and transport companies (distribution and distribution of goods) (PwC, 2020, p. 6). This means that the situation in the fashion industry will affect several other entities, so possible problems such as lack of liquidity or insolvency will be significant for a large part of the Polish economy.

Trends related to globalisation, consumption, and high market competition also remain important issues when analysing fashion companies. Namely, there are two opposing approaches to defining the strategy of clothing shops (their sales strategy). So-called fast fashion and slow fashion are both available. The former appeared in Poland at the end of the twentieth century and filled the market with cheap, easily accessible, seasonally changing collections of clothes and accessories. The traditional division into spring/summer and autumn/winter collections within this strategy has blurred. The fast fashion strategy prioritises high sales volume and low prices. The collections can be changed in the shop every few weeks, giving consumers the impression that the new models will quickly be replaced by newer ones, so they need to be bought immediately, and the affordable prices make the decision easier. In addition, this strategy creates the need to own more things through frequent changes in trends and styles and low-quality fabrics. In this way, consumers have become accustomed to cheap, perishable models that can be replaced relatively quickly. A competitive response to the fast fashion trend is the slow fashion trend, which is based on the concept of environmental care (the production of cheap and frequently-discarded clothes is presented as environmentally unfriendly) and minimalism. As part of the slow fashion strategy, customers are offered more expensive clothes, of higher quality, that are created from recycled or environmentally friendly materials. This trend is a response to society's interest in the idea of responsible and conscious consumption (Włodarczyk, Małczęć & Pala, 2020, pp. 105–106).

It is worth emphasising that, regardless of the sales, distribution, and replacement strategy adopted by a company for a particular collection, both the supply chain and the time that must elapse from the design of the collection to its actual production and presentation in the shop are just as important. It is very common practice to plan the process in a way that allows the manufactured goods to be repaid from subsequent sales. When a company decides to have two main collections in a season and one of them turns out to be unsuccessful and does not appeal to consumers, this automatically results in a loss of sales and can translate into difficulties in settling commercial obligations. An example of such a situation may be the significant drop in sales of the RESERVED brand owned by LPP S.A. in the spring-summer season in 2016 (the brand's collection at that time was not popular with customers, and RESERVED is the leading brand, responsible for almost half of the entire group's revenue, so the weaker results were reflected in price drops of LPP S.A. shares listed on the Warsaw Stock Exchange) (Rudke, 2016). In addition, when the supply chain is long and requires a longer time to transport products, most often from Asian countries to showrooms (outsourcing of production is a standard procedure in the fashion industry), a quick and effective reaction of the company to a failed collection is difficult (it is impossible to replace models in shops overnight). Continuing with the cited example, LPP S.A.'s experience with the 2016 collection prompted the company to produce the most key products in Poland – in Łódź, so that, if necessary, some of the unsellable models could be replaced with new ones relatively quickly and easily, without having to wait for containers to be transported from Asia.

Another characteristic of the Polish fashion industry is that by 2020, only 10% of sales were made through online channels. What is additionally important, in the e-commerce segment, the leading role is played by mobile applications such as Vinted (sale of second-hand clothes by application users) and Zalando (clothing and footwear shop with a portfolio of many different brands). The leaders are not at all the most popular clothing manufacturers, known from their stores in shopping malls. In addition, when moving sales in the industry to the online channel, the company must reckon with a higher number of returns – the fashion industry, along with the electronics industry, is characterised by the highest rates of returns on purchased goods. Data from merce. com shows that this amounts to approximately 5% of all sales. Moreover, customers usually do not return all the products they ordered, but only a part (e.g., 2 out of 4 articles of clothing bought in one order) (Klich, 2021). The risk of a significant number of post-purchase returns creates difficulties in forecasting sales and managing the liquidity of individual fashion companies.

In the analysis of the financial situation of companies in the fashion industry all the characteristics typical of entities from the retail industry are important: maintaining a large number of goods in stock (and the need to sell them out in the event of lower-than-assumed sales), the use of so-called reverse factoring, that is, accelerated financing of liabilities rather than receivables of the company (there may be differences in interpretation here – whether the qualification of this type of activity is a trade liability or a financial liability, and this may affect debt ratios and further credit limits and the evaluation of the entity's liquidity – on the basis of typical liquidity ratios). In addition, companies in the sector often lease or rent space or own property (such as warehouses). All of these cost categories may have specific implications depending on how they are presented in financial statements, for the liquidity analysis of the respective business entity.

The fashion sector is one of those industries that were very seriously affected by the COVID-19 pandemic. Particularly acute was the complete closure of shopping malls, which made it impossible to sell in a key channel. This resulted in decisions by many brands to terminate some of their leases (LPP S.A. terminated 29% of its leased space in Poland as early as spring 2020, but not all companies reacted as quickly. CCC S.A. decided to open all its shops in the country in May 2020, and Monnari only announced in February 2021 the termination of approximately 13% of its leased space in shopping centres [Money.pl, 2020]). In the case of foreign brands, companies have even decided to withdraw from Poland altogether (e.g., Camaieu, a clothing brand, and Salamander, a footwear brand).

Severe constraints that revolutionised the way of doing business in the fashion industry overnight and made the trends towards digitalisation an immediate priority led to significant changes. These include (Klich, 2021):

Significant increases in online sales. Inevitably, most brands have scored up to triple-digit increases in online sales, but despite this, for the most part, sales values have not even come close to those achieved in stationary shops. In addition, the demand for fashion products itself has fallen dramatically through the lack of meetings, conferences, and even the possibility of going to work or school every day.

The development of customer communication via digital and omnichannel channels. Social media promotion, and appropriate, consistent branding across all social media channels, has gained in popularity. The omnichannel trend is about providing the customer with the ability to purchase products across multiple sales channels at the same time, providing a better customer experience than if they only used one of them. During the pandemic, this has become an industry priority.

The introduction of fashion tech solutions. Virtual fitting rooms and video chat services are some examples. Technology and innovation became a priority during the pandemic. Thanks to modern virtualisation methods, the customer's contact with the product is made to resemble live contact. It has become necessary to allow the customer to interact with the product appropriately, and while not all brands are ready and technologically prepared for this, the market has recognised that this type of transformation is necessary and will continue.

Improving the warehousing of goods, the supply chain, and the return system for purchased goods. Many companies were faced with the need to store goods for longer than usual and therefore to control their stock in more detail. In addition, when a significant proportion of sales started to take place online, it became necessary to improve the logistics of picking, packing, and sending packages to customers. Due to the high number of returns, shops had to reckon with this in both sales forecasts and the restocking of returned parcels. The future in logistics and warehousing is the RFID system, implemented even before the pandemic at LPP S.A., which allows each item to be tracked using a special individual code.

When analysing the financial statements of fashion companies, especially after the COVID-19 pandemic, it is necessary to be aware of important aspects which can distort the true picture of liquidity in an assessed company. The financial data presented in the financial statements depend on the accounting principles adopted. The classic liquidity, profitability, and debt ratios, used to compare the financial condition of the companies, cannot be treated equivalently. Financial analysts cannot ignore the individual approach of each entity to accounting policy. Possible changes in, for example, accounting standards also cannot be overlooked, to ensure the year-on-year comparability of the analysed data. The above-mentioned details are very important to reliably assess the financial standing of the company.

Most large Polish companies, especially those listed on the Warsaw Stock Exchange, report their financials according to International Financial Reporting Standards (IFRS). However, companies that prepare their reports according to national regulations should also be assessed in a similar way. It is particularly important to carefully examine the explanatory notes to the financial statement.

For the assessment of the liquidity situation of companies in the fashion industry, the following information is relevant:

The going concern assumption, usually taken for granted until 2020. However, as a result of the deep crisis and the changes after 2020, this assumption will not be an obvious case for every company. Therefore, analysts should start by checking on what basis this assumption has been made. It is worth checking whether the going concern assumption is evidenced by sales forecasts, contracts already concluded, available emergency financing (e.g., banks, government support) or, for example, recapitalisation (done or possible) from the parent entity. This is the first step in determining the overall condition of the analysed company (Matusewicz, 2021a).

In order to verify the impact of the COVID-19 pandemic on fashion companies in Poland, two dynamic panel models were estimated.

The database analysed via the presented research is based on quarterly financial statements of Polish listed companies (listed on the Warsaw Stock Exchange and NewConnect) available in the Orbis database. The data cover the 11 quarters from Q1 2019 to Q3 2021. Companies from the fashion sector were classified similarly to the Warsaw Stock Exchange classification (21 companies both on the WSE and NewConnect). The companies classified as those from the retail trade sector are listed on the WSE too. The sample consists of 87 companies analysed by model no. 1 and 72 companies analysed by model no. 2.

Table 4 presents the definitions of the variables used in the model.

Table 5 presents the characteristics of the abovementioned independent variables.

The results presented in Table 6 concerning the covid variable show that cash holding (cash to total assets) increased during COVID-19, while cash ratio (cash to current liabilities ratio) decreased in this period of time. This is because the companies postponed the payments of their trade liabilities longer than usual (being aware of the lower sales volumes), and this process has affected the cash ratio. Nevertheless, the cash holding kept during the uncertain time of the COVID-19 pandemic increased. This trend to raise the cash holding during uncertain times/recession is a usual managers’ behaviour described in the literature (Nehrebecka & Białek-Jaworska, 2016b). Hypothesis 1 is verified positively only by model no. 2. In model no. 1 the next variable fashion indicates that the cash holding of the fashion companies is lower than those in the retail sector. A similar trend is observed in model no. 2: here also the cash ratio in the fashion industry is lower than in the retail sector. It means that hypothesis 2 is verified by both models. Moreover, model no. 2 indicates that the cash ratio during the COVID-19 period in the fashion industry was higher than in the retail trade companies. The result is exactly the opposite to the assumptions presented by hypothesis 3, as well as the dependence proved by positive verification of hypothesis 2. The not significant variable did in model no. 1 suggests that the level of total assets may be more important to judge during the crisis. Asset level defines a potential possibility: to exchange them for money. On the other hand, at the same time the cash level may be artificially higher (due to additional credit lines or potential government support). Hypothesis 3 is verified negatively only by model no. 2.

The variable size indicates that smaller businesses have a higher level of cash holding and a lower level of cash ratio than large companies. The variable profit, which is only significant in model no. 2, proves that profitable companies have higher cash ratios. It is important to mention that the outcome of variable mktbk confirms that investors value more highly the companies characterised by a higher level of immediately available cash and higher liquidity resulting from the cash ratio. The next effect presented by the subsequent variable shows that companies with higher growth opportunities are characterised by higher free cash holding and higher liquidity. Additionally, it is confirmed that the higher the investments (CAPEX) are, and the higher is the entity's debt to fixed assets ratio, the lower are the cash holding and cash ratio. The additional variables presented by model no. 2 indicate that companies characterised by higher inflation expectations will have a lower cash ratio. In addition, the tightening of the requirements for the maximum credit limits and the deterioration of banks’ capital position during the COVID-19 pandemic positively affect the cash ratio of the companies. Finally, the increase of industry risk, which further means tightening changes in the banks’ credit policies, is negatively reflected in the companies’ cash ratio.

The findings presented in this article demonstrate that assessing the level of liquidity of companies in the fashion industry requires understanding and careful analysis of their business models and adopted accounting policies. It is crucial to be aware that the industry's characteristics often determine how financial information is presented (reverse factoring, impairment of assets, assets valuation method, and lease agreements under IFRS 16). Knowledge about the technical nuances of the financial statements allows a reliable assessment of the entity's liquidity level. Due to a major collapse caused by the COVID-19 pandemic the market has changed significantly. Many unplanned remedies were introduced by the companies. In this situation, when the possibility of continuing business activity is particularly threatened, it becomes doubly important to know how to read the financial statements and how to reliably assess the liquidity condition of entities in the fashion industry. It is especially important to be aware of the fact that the existence of fashion companies is very important for the Polish economy. This article also verified the three hypotheses concerning the liquidity condition of the fashion and retail trade sector: 1. Liquidity decreased during the COVID-19 crisis; 2. the fashion sector is characterised by a lower liquidity level than the retail trade sector; 3. the liquidity level in the fashion sector was lower than in the retail trade sector during the COVID-19 crisis. The estimated models, via Arellano–Bover / Blundell–Bond linear dynamic panel-data estimator, prove that COVID-19 had a negative impact on the cash ratio, and at the same time had a positive impact on the cash-to-total-assets ratio (cash holding). The liquidity level in the fashion sector was lower than in the retail trade sector, regardless of the ratio taken as a dependent variable. Conducted research proves (counterintuitively) that the liquidity measured by the cash ratio was higher during COVID-19 in fashion than in the retail trade sector. This dependance turned out to be exactly the opposite of the general rule verified by hypothesis 2, and to the assumption made in hypothesis 3 (which therefore had to be rejected). It means that model no. 1 verified positively only the second hypothesis and model no. 2 verified positively hypotheses 1 and 2, whereas the second model rejected hypothesis 3.