Is a backlog of insolvencies looming?

Many might assume that a significant number of businesses have already failed due to the pandemic. However, so far, the level of business failures has remained surprisingly low – in fact there were just 12,557 corporate insolvencies in 2020 which is a fall of 27.1% compared with 2019's figure of 17,224 (source: The Association of Business Recovery Professionals, “R3”). This has been largely due to the unprecedented range of support put in place by the UK government, such as Bounce Back Loans (BBLs) Coronavirus Business Interruption Loans (CBILs), furlough and the deferment of tax and VAT. These support systems remain in place for the time being, however they will not of course continue indefinitely and we know that in part some are aligned to the imposition of lockdowns and restriction in place which in themselves are influenced by the levels of new infection rates experienced within the community and the rate at which the vaccine roll out continues to progress.
 
However, it is inevitable that some of these support measures will in time be removed. As a result, we will continue to see businesses relying on this support to help them ‘tread water’ whilst they are unable to resume business as normal. All of this means of course that if none of this support was in place, we would have seen a significant number of business failures. It is likely therefore that as and when support is removed, there may well be several businesses who cannot get back on their feet and so it’s also likely that there is a backlog of insolvencies building.
 
To get an overview of the business environment, we tend to look at a number of indicators, which identify how businesses are performing, and one of those is the rate of failures in certain sectors and we look for any trends emerging. This information isn't as reliable now as it once was as businesses are not failing in the way we might have expected. Therefore, we are seeing an artificial picture of how the economy is faring. However, we know that despite the support measures in place, the crisis has led to one of the biggest economic downturns we have ever had.
 
We also know from previous recessions that we typically tend to see an increase in business failures at the point that we are coming out of a recession more so than we see going into an economic downturn.
 
Turning the lights back on
 
Let's take for example the situation where business has had the benefit of all the government support available to it and is just about keeping its head above water. As that support falls away, one assumes, due to restriction being lifted, the business then in theory could begin to open up once more. That might mean bringing people back from furlough, ordering stock and materials, all of which comes at a cost. So, the question becomes, how much cash will it take to get the lights back on? The even bigger question is, does the business have the cash available to flick that switch?
 
Depending on the type of business that you have, there could be a short or a longer lag between opening up operations and cash coming in. For the sake of a comparison, a business that can generate a reasonably strong and early cash flow – perhaps a service business that requires little more than getting its customers through the doors once more – may fair better than say a manufacturing business which has halted or reduced its production. That business may need an immediate, and significant, outflow of cash to cover raw materials, its workforce, and other overheads just to get production up and running. Even then there is the added production time and shipping goods to the end customers. All of which must be paid for before payment is received from the customer.
 
Worst hit sectors
 
While there are some sectors that we believe will suffer more, there are going to be challenges for any business coming out of its ‘lockdown hibernation’. It is going to be very difficult for businesses to get themselves back to their pre-pandemic trading positions.
 
But to narrow it down, there are some sectors that we believe will suffer more than others. Retail, unsurprisingly, would be the first to come to mind. After all, the evidence is there on the high street, where a lot of businesses had already been experiencing challenging conditions even before the pandemic. And there's a lot more pain to come, unfortunately. Other sectors acutely impacted include hospitality and leisure businesses and casual dining; these were the first businesses to close and most likely will be the last ones to reopen.
 
The return of growth
 
So, when will growth come back and in which sectors?
 
For those retailers that were clever about recognising how consumer habits have changed, and will continue to change, there is great opportunity. It’s about finding a niche that differentiates them from large retailers like Amazon, Asos and boohoo; they need a unique selling point to unlock growth. There is also the potential for retailers to become resellers, in the likes of an Amazon marketplace, so they can compete in that virtual world without necessarily incurring the substantial start-up costs of a traditional, physical retailer.
 
The aviation sector is one that looks promising. There is an expectation that the sector will start to grow again once the pandemic is over, because people will still want and need to travel. Maybe not as much as before but there still will be growth in this sector. We anticipate that it is going to take several years until aviation returns to the highs experienced before the pandemic. So, the sector will grow but growth will be much slower.
 
In healthcare – and specifically the care home sector – as many as 92% of operators had been affected by the pandemic, with more than half (59.4%) estimating that it would take between one-three years to recover (source: Christie and Co report). But despite its many challenges, the sector should recover during the year, especially against a backdrop of more testing and as the vaccine is rolled out. Occupancy levels will also start to increase again, which will help financially, but the issue of rising costs will remain. The businesses which will do well, will be those operators who have a sufficient cash surplus to get through the pandemic.
 
What to focus on now?
 
Preservation of cash continues to be the priority for businesses, who should continue to plan and pay close attention to their forecasting and consider more than one possible scenario within those forecasts. We know that many business owners aren't certain what the environment is going to look like or what it will mean for their business over the coming months. It is therefore vitally important to ensure that there is sufficient flexibility within their forecasts, so that they can be adjusted as circumstances require.
 
Some businesses do struggle with planning and forecasting, this can be for a variety of reasons. In some cases they may not have a dedicated finance director within the business. In other cases, it might be because the managing director wears several hats and is therefore overstretched. Business owners are also worrying about what further measures they may need to put in place when their employees return into the workplace. We know that many management teams are expending a lot of time each day on these issues and for many that may be limited to dealing with what they can reasonable predict in the short term and in some cases focusing purely on the next few days or weeks ahead only. It has been increasingly difficult for business owners to consider the next ‘what if’ scenario and to create not just plan A but plans B, C and D as well. There is an awful lot of second guessing going on.
 
Customer loyalty
 
A critical area that businesses must remain focused on is customer loyalty. To take restaurants as an example, some adapted quickly to the restriction placed upon them early in the pandemic by offering takeaway and delivery services, others didn't. Some may have increased engagement with customers through online and social media interaction and discovered new ways of staying in touch. Those that have not remained engaged may have lost their once loyal customer to their competitors and those same customers may have switched loyalties consequently. There remains an interesting debate around brands and brand loyalty particularly in relation to those brands that have ‘been there’ for us during the pandemic. Customers may have found that they have received a better quality of service and customer experience from brands in comparison to their old favourites. This could be a worry, not just for the retail and restaurant sector but also for many other businesses.
 
Building financial fortitude: more support for advisers and businesses
 
For more information, insight and support on the key issues businesses and professional advisers are facing please go to our Building financial fortitude hub at www.quantuma.com/fortitude. There you will find a series of video interviews, articles, and further support from experts across our firm.