How to keep your head above water in the face of economic uncertainty, as told by Lucy Trott, Senior Associate.
Businesses in turmoil dominate the financial press. That depiction of financial distress is supported by monthly figures which make plain that the financial legacy of the Covid-19 pandemic is an increasing number of insolvencies. It is a trend which does not show any sign of abating.
For Balance, it is worth remembering both that the pre-pandemic period saw insolvencies at historically low-levels and that we aren't yet anywhere near the insolvency rate seen during the 2008-09 recession. Behind the headline figures, there are unprecedented levels of director-led insolvencies, which point to a different set of drivers as to why companies are entering insolvency processes and in turn provide some insights into best practices to avoid insolvency proceedings.
Financial trends post-pandemic
The forecast 'wave' of insolvencies expected in the immediate aftermath of the pandemic following the withdrawal of the government support measures did not materialise. What we have seen instead is a steady stream of increased insolvencies, which have been primarily driven by unprecedented levels of director-initated creditors' voluntary liquidations (CVLs). CVLs are an 'end of life' measure for a business, where there is no hope of rescue and the directors consider that trading conditions are such that the business cannot survive. The high numbers of CVLs as opposed to compulsory liquidations, which are creditor-led, reflect the tough trading conditions for businesses since the pandemic and demonstrates that directors are being proactive in closing businesses, as opposed to being forced into insolvency by creditor pressure.
So, what has led to the high levels of CVLs? The hospitality industry benefitted from many of the government support measures put in place through the pandemic and in its immediate aftermath, including the furlough scheme, "eat out to help out" schemes, bounce back loans, and temporary restrictions which, in many circumstances, prevented creditors from enforcing debts. Those measures have long since been withdrawn and many hospitality businesses continue to struggle both with debts accrued during that period as well as the resulting fundamental changes to the way in which people work and spend their free time.
No doubt the cost-of-living crisis, energy cost, sticky inflation (which for hospitality businesses often increases operational costs which cannot always be easily passed on to consumers), and high interest rates over a prolonged period have also all had part to play in the demise of many businesses which have struggled to adapt to a world of reduced profit margins, increased costs an increasing wage bills.
Many businesses reliant on external lending will have had to refinance since the interest rates spiked following the disastrous mini-budget of 2022 and will be feeling the continued strain of substantially higher interest payments. While interest rates are starting to reduce, it will be some time before businesses on fixed interest rates reap the reward of reduced payments, although inflation has now also reduced in line with the Bank of Englands's target levels, energy prices are due to increase again in October, at a time of year when both businesses and consumers are more heavily reliant on gas and electricity.
The outlook
It's not all doom and gloom for businesses though, as some of these difficult trading conditions show signs of easing. Interest rates have already started to decline and it is widely anticipated that there will be a further rate cut before the end of the year before a steeper decline in 2025. We await the upcoming budget from the new Labour government and, while the messaging around the budget suggests difficult decisions will be taken, the new government seems focused on growing the economy.
One of the key measures which the government intends to introduce is an overhaul of the business rates system to create a fairer trading environment for high street businesses, which will be welcome news to bars, pubs and restaurants. With a five-year term ahead for the new government, businesses will also have the benefit of some certainty for the purpose of business planning, which should provide reassurance following years of uncertainty due to the pandemic, the revolving door of prime ministers and the war in Ukraine.
Good business hygiene
What should companies do to keep their heads above water in the current climate? All businesses, whether in financial difficulty or not, should put in place systems to maintain good financial health. Cashflow forecasts should be regularly produced and reviewed, with minutes kept, and advice sought on any legal or financial issues on the horizon. Where new measures or rules are introduced by government, companies should consider the impact on their particular business and any challenges that may arise from them. If in doubt, seek early advice to assist with business planning.
This article was first published in Hotel Magazine and can be accessed here.
Lucy Trott