Road to recovery

The last year portrayed a picture of an economy that was slowly but surely emerging from the first recession of the twenty first century – a downturn on a scale that hasn’t been seen since the depression of the 1930s and the recessions of the 1980s and 1990s. However unlike those periods, business insolvencies haven’t risen to the levels predicted by some economists. Nor did unemployment top the projected three million mark. On the face of it, by the end of 2010, it looked like UK businesses had somehow dodged and survived a deadly bullet.

The final quarter of 2010 seemed to be backing all expectations of a gradual but steady recovery for UK plc. As touted by the coalition government, manufacturing was leading the way with a 37 percent reduction in insolvencies from 761 for the full year in 2009 to 477 in 2010. Overall quarter four in 2010 across all sectors was another recovery quarter – compared with Q4 2009, administrations in total fell by 24 percent.

It was good news all round for UK PLC; even transport and logistics fared well with a 30 percent fall in insolvencies year-on-year, which could be seen as a spin-off of improvement in manufacturing as goods start to move around again. It was encouraging news for the supply sectors alleviating fears of the impact of recent adverse weather conditions and fuel price increases affecting trade.

False hope
However, things aren’t always quite what they seem. As the pessimism inevitably generated by recessions is replaced by cautious optimism, it’s tempting to think that we’re pretty much over the worst. But the truth is, for many businesses, the really tough times lie ahead.

It was in the first quarter of this year previous pessimism could be seen to take root. Administrations in England and Wales increased by 22 percent from Q4 2010 with manufacturing, which was previously leading the way to recovery, having a significant increase in insolvencies of 45 percent. This trend is reflected across all sectors. Historically insolvency increases in the first yearly quarter are not surprising, as traditionally it is a tough quarter for businesses. However, in some sectors, construction for instance, they are at their highest for nearly two years.

This shouldn’t surprise anyone who has lived through previous downturns. Strange as it may seem, it’s during periods of recovery that the bulk of insolvencies take place. In the past, this has largely been down to overtrading. As demand rapidly rises, companies rush to supply customers by ramping up production or hiring new staff. Such actions require upfront investment while payment may be deferred for several months. Unless the finance is in place, there exists a real danger of a cash flow black hole that may result in insolvency.

As we emerge from the 2008/2009 recession, the recovery we have seen has progressed slowly and steadily, so arguably the dangers of overtrading are not as great as in the past. However, there are other factors at work. There are various reasons for the apparent resilience of UK companies, not least the attitude of the taxman. HMRC has, until recently, given UK business plenty of room to breathe.

The prime mechanism for this has been the Government’s Business Payment Support Service scheme, which allows businesses with cash flow problems a one-off ability to delay or restructure their tax payments through ‘Time To Pay’ (TTP) arrangements, which have provided many businesses with a stay of execution. But the taxman isn’t the only creditor capable of pulling the plug on a cash-starved company. In the early days of the recession, we saw many retailers failing and many of those insolvencies were caused by an inability to meet the quarterly advance rent payments required by commercial property landlords. Then, of course, there are the banks and those who have granted credit through hire purchase and leasing deals.

However, the past leniency of the taxman has been generally mirrored by creditors in the private sector. For instance, hire purchase companies have been much slower to repossess equipment than was generally the case in the past. Landlords have also demonstrated a willingness to strike deals with tenants to ensure that business properties remain occupied. This is not altruism, by any means. Under new rules, landlords must pay business rates, even when properties lie empty. In the current climate, landlords cannot take it as a given that when one business tenant is ejected another will be on hand to take their place. It often makes more sense to change the terms of the lease agreement – for instance, charging one month ahead rather than asking for three months upfront, or granting a rental holiday period – rather than seeking an eviction.

Banking prowess
And then we have the banks. While lenders have been reluctant to provide many businesses with credit, they have proved themselves relatively sympathetic to business customers facing short-term difficulties. Provided a customer can at least make good on interest payments, current evidence suggests the banks won’t exercise their right to call in the loan.

This kind of forbearance has undoubtedly helped keep businesses up and running through the recession, albeit without representing a ‘get out of jail free’ card. The truth is a deferred payment to HMRC or a reduced monthly payment to a bank is only a short-term fix and potentially creates a longer-term build-up of debts that will eventually have to be paid. That puts more pressure on companies to raise sales and profits to a level where they can comfortably pay any deferred debts, along with new payments as they become due, while at the same time trying to remain competitive.

Close examination
In the case of the HMRC’s TTP scheme, it looks like crunch-time has come as less referrals are being accepted and first time applicants are facing greater scrutiny. However, prior to the election last year, the taxman was already tightening up the terms and conditions governing deferral agreements.  Any company with a debt of between £500,000 and £1m may only be granted a deferral after a HMRC review of its business prospects. If the debt is more than £1m the taxman will call in an independent accountancy firm to conduct a business review. With a more formal review process in place, HMRC has become more stringent about who it grants deferrals to and in what circumstances. In cases where a TTP is not granted, HMRC has the right to request that the company be wound up.

Hire purchase, loan and deferred payments to landlords will also have to be made good.

This is all coming at a time when businesses will need working capital in order to take advantage of the trading opportunities presented by the economic recovery. Evidence that businesses can service any current and in some cases, additional debt requirements it takes on will be top of the agenda for lenders and stakeholders. The danger here is that a significant number of businesses will collapse under a burden of debt. Therefore, the real squeeze could well be yet to come.