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How rocky is the road ahead for businesses?

Author: ICAEW Insights

Published: 26 Jan 2023

Bulging borrowing costs, balance sheet fluctuations and ongoing uncertainty call for caution, common sense and acute risk awareness in the year ahead, says insolvency and restructuring doyen Nick Hood.

Now that the company insolvency figures for 2022 have been published, we know the toll that the financial, political and geopolitical chaos of an extraordinary year has taken on UK businesses. There were 23,397 business failures, making it the second worst year on record, beaten only by the aftermath of the global financial crisis of 2008/9. This figure is up 26% on the pre-pandemic level in 2019.

What now for the commercial world in 2023? There has been some very cautious optimism in recent weeks, with suggestions that perhaps any recession in the UK and globally might be more shallow and less long lasting than feared and that inflation has peaked. It seems highly unlikely that many entrepreneurs and their accountants would agree, and certainly not yet.

Businesses are facing an unprecedented cocktail of pressures and adverse impacts, many of them outside their control and few likely to go away any time soon. When were profit and loss accounts and balance sheets ever so seriously challenged in so many places as they are now? Revenues are being restricted by the impact of the cost-of-living crisis on consumers’ disposable income, by ongoing supply chain disruption and by having to curtail operations because of severe labour shortages.

Gross margins are being slashed by material input cost rises running far ahead of consumer inflation. The Office for National Statistics reported that producer cost inflation in the year to October 2022 was 19.2%, while output prices had only risen by 14.8%. Average pay was up by 7.2% for the private sector in the quarter to November 2022, impacting both direct labour costs and administrative overheads. Lower down the income statement, the higher cost of borrowing is impacting bottom line profitability.

Looking next at balance sheets, if anything there is even greater damage from the pandemic and last year’s disruption from the conflict in Ukraine and the now abandoned zero-Covid policies in China. Intangible asset values are threatened by falling profitability and changes in business models. One listed company wrote off half a billion pounds of intangibles in its latest results, airbrushing away the seriousness by pontificating that it was a non-cash adjustment. 

Tangible assets are also at risk, whether they are commercial properties used in a business or residential properties supporting personal guarantees to lenders. Many businesses are overstocked, leading to inventory write downs. The credit risk in receivables has never been more difficult to assess or manage.

A seriously worrying aspect of many balance sheets is the bulging borrowings. A quarter of all UK businesses borrowed under the various coronavirus loan schemes, taking on board an extra £76bn of debt. Much as these facilities kept some viable businesses alive, default rates are now escalating as many borrowers have found that bouncing back is proving to be way more difficult than they or the government imagined back in 2020. This problem is particularly acute in smaller companies. A recent analysis of the latest accounts of SMEs in the hospitality, retail and construction sectors shows that overall, their debt levels have increased by between 200% and 300%. How are these vulnerable, fragile entities ever going to service these huge debt burdens, never mind pay them back?

The two greatest tests for most businesses are energy costs and labour shortages, where there is relatively little that management can do and where government help is essential. Unfortunately, many energy-intensive enterprises have been thrown to the wolves by an 85% cut in government energy price support after April 2023, with the exception of the manufacturing sector and some cultural activities. They are now at the mercy of global energy prices and dealing with yet more uncertainty. 

Labour market issues are so serious that urgent policy initiatives are needed – and certainly something that will produce much quicker results than vague talk of tempting economically inactive over-50s back to work. Vacancies may be falling very slightly, but there are still well over 1.1 million jobs to be filled, and returning early retirees are suitable for relatively few of these.

This is going to be a year for caution, common sense and acute risk awareness, but whatever happens it will be tough-going for those who own and manage businesses. Never has the role of the accountant as adviser, confidant and sounding board been more important, whether as part of the management team or external service provider. Equally, management must be willing not just to take advice from their accountants but to act on it. Of course, there will be winners in the dark days ahead, but for the losers the price will be high.

Nick Hood, Senior Adviser, Opus Business Advisory Group.

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