Be afraid of low company insolvency figures

2 November 2011
Recession, what recession? Company insolvencies are now at 30-year record lows, measured as a percentage of active businesses registered at Companies House. In the year to June 2011, insolvent liquidations, which make up more than 80 per cent of all insolvencies, were just 0.7 per cent of active companies. In the aftermath of the last major recession back in 1993, the percentage was 2.6 per cent. Measured over the past 25 years, the average rate has been 1.3 per cent. So what on earth is going on? The global economy has just experienced its sharpest correction in 80 years, the UK has had a seriously rough time and the economy is bumping along the bottom, apparently vulnerable to vagaries such as too much snow, Japanese earthquakes and royal weddings. Surely, businesses should be dropping like flies, shouldn’t they? Well, maybe not. The history of recessions over the past 40 years tells us that business insolvencies peak between one and two years after GDP first turns positive again after the dip into negative territory. The counter-intuitive reason is that it’s not recessions that sink companies but recoveries. For sure, there are victims during the down phase, but most management teams hunker down, sell surplus assets, cut investment, conserve cash and survive. But they eat their fat and emerge with little or nothing in reserve. The trouble starts with the first hint of revenue growth. What so many managers forget is that increased activity requires more working capital. By the time they wake up to the problem, it’s either too late or the pool of available bank funding has already been exhausted by those who have been quicker off the mark or have a more persuasive case in a post-recessionary world where lending fever has been replaced by risk aversion. This time round, the number of failures has been kept in check during the immediate aftermath of the dip by a combination of support measures. HMRC’s ‘time-to-pay’ scheme provided cash flow succor to around 250,000 companies at peak, some of which would have failed but for the “no questions asked” payment holiday they were given. Banks have been far more helpful than in any other recession in living memory, driven by unusually low and uncertain asset valuations, which means that it hasn’t been worth calling in facilities because of the poor value of their security. They’ve also been understandably nervous about being seen to be aggressive in pushing their commercial customers over the edge. They hardly need another reason to be hated. And of course interest rates have been at a record low for an exceptionally long time. Some commentators have joked that it has been almost as difficult to go bust in the UK in the past two years as it was in Ireland during those fondly remembered days of the Celtic Tiger economic boom. This has been an unlikely but extraordinarily helpful cocktail of positive factors. But things will not always stay this way. Time-to-pay is being wound down and there are limits to just how long the banks can go on playing “extend and pretend, delay and pray” games. And there will be growth, however patchy it may be across the economy and however muted. As the situation returns to whatever passes for post-recessionary normal, procurement and supply chain managers need to take a long hard look at their suppliers and begin to stress test those that are key or mission critical for the impact on them of growth. And they need to build into their risk profiling a reality that is different to the last few recessions. This time round, the most savage damage was felt in the financial services sector, and especially in the banking sector. Not only are bankers much more risk averse and aware than ever before, they have less money to lend as they continue to rebuild their balance sheets. And there is another unique aspect to the sector now. Good old-fashioned high street retail banking is now out of fashion among those who set the strategy for today’s mega, multi-national banking behemoths. Capital is being deployed elsewhere, mainly into investment banking and securities trading, not to mention overseas expansion. The pool of funding to support growth in the UK domestic economy is relatively small and will undoubtedly struggle to support any sustained growth. The laggards at the back of the borrowing queue are going to come away empty handed, especially those with fragile balance sheets, assets with dubious collateral value and a questionable business model. So those responsible for financial risk management in the supply chain should be looking hard at those customers who are growing and start asking some serious questions about their ability to fund that expansion and continue to perform. “Greed is good” is certainly an outdated maxim, but “growth is good” might also come to be a tarnished epithet. Caution is surely a better strategy, particularly where the failure of one or a small number of suppliers can cause significant disruption. * Nick Hood is head of external affairs at Company Watch
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