Emerging from recession – the double edged sword for Midlands businesses
Rabjohns’ Partner, David Cornelius explains how survival during a recession can bring its own challenges for Midlands businesses.
Although the official figures suggest that the UK has emerged from recession, for many businesses it feels as though nothing has changed. Indeed, the Coalition Government's remedial actions intended to restore the economy - higher personal taxes, reduced public spending and benefits - may well mean that financial pressures on businesses will increase before things get better.
Experience and history show that more businesses struggle or fail on the way out of recession than on the way in; so the next few years will be crucial for the survival of many businesses.
Here are some of the reasons why.
Working capital
At the start of a recession, most businesses review stock and employee levels, reducing stock-holdings (the "de-stocking period") and reducing employee numbers. Although it might seem counter-intuitive, cash is often generated by these activities - payrolls fall, and cash tied up in high stock levels is reduced. A greater awareness of the risk of bad debts might also mean that credit control is improved.
This all means that in the first year or so of a recession, although business-owners know that business is not good, cash levels are often manageable.
As order books start to fill again, firms need to fill warehouses, buy raw materials, employ more staff - all before they collect the cash from increased sales. It is not uncommon to see companies with growing order books and apparent profitability fail simply because they cannot afford to fund the growth in sales.
Bank facilities
A feature of this recession has been the anecdotal evidence that many lenders have "held off" taking action early in the recession to recover funds owed to them. Political pressure on the major banks, combined with the collapse in asset prices has meant that in a large number of cases there has been little point in banks or other lenders enforcing their rights under lending covenants, if the business has been able to maintain interest payments, even where it was in breach of covenant.
As the recession eases, asset values will increase, and the political pressure will ease - particularly as the new government starts to focus more on the recovery of public funds used to support the nationalised banks, and becomes less concerned about business failure headlines. The time will come when lenders feel that there is no longer any need to hold back on enforcement of their rights.
HM Revenue and Customs
At the start of the financial crisis, HMRC provided support to companies struggling to pay VAT, Corporation Tax and PAYE due to cash-flow constraints. Many companies were able to use this breathing space to reorganise their affairs and reduce costs. In the last few months, HMRC's attitude has changed.
Firstly, they have announced that they now expect to be treated in the same way as any other lender or stakeholder in the business, and have made it much more difficult for companies to agree tax deferment plans. For tax sums greater than £1m, they have announced that they will be instructing an Independent Business Review from one of a panel of independent accountancy firms before agreeing any plan - which could cost the business £30k or more without any certainty of agreement. Secondly, they are becoming a major source of recovery actions, such as winding-up petitions, as they reach the anniversary of previous payment plans.
Prolonging the pain
Rapid corporate failures have been a feature of past recessions which, a scenario that has often improved the lot of remaining competitors. It was harsh, but with reduced competition in the market, those surviving were often in a stronger position.
The attempts to support weaker businesses this time, has meant that some companies have survived that perhaps would not have done in earlier recessions; merely prolonging the pain for all companies, instead of concentrating it on the few that would fail quickly. Even without the spectre of a double dip recession, the risk is that because of this more companies are weakened than would otherwise have been the case.
Survival tips:
- Understand your cash flow and cost base;
- Model, review and account for change in your financial forecasts;
- Monitor your competitors;
- Watch your customers - they are more likely to fail on the way out of recession, leaving you with bad debts;
- Continue to monitor and challenge cost increases;
- Monitor marginal profit contributions from each business line;
- Do not buy turnover, at any price;
- Renegotiate and renew bank facilities in good time;
- Know your banking covenants. If you think you will breach one, seek advice as soon as possible;
- Keep your bank informed;
- Make sure your management accounts are produced on time, are reasonably accurate and contain useful information;
If you need help surviving post-recession growth pains, please contact David Cornelius, on 01905 732100 or email dc@rabjohns.co.uk
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