Rate of distressed businesses falls in 2010, with sector-specific risks in medium term

The financial health of UK businesses is improving but there are significant risks in the medium term, say two respected accountancy firms.

Begbies Traynor and Deloitte have both released surveys on the levels of businesses in distress. The following is a report and analysis of their findings.

Begbies Traynor's Red Flag alert has shown that the number of companies experiencing financial distress has fallen by 21 per cent, whilst Deloitte has pointed out that the number of administrations in the last six months has fallen by 43 per cent compared to the same period last year.

Deloitte appears to be more upbeat than Begbies Traynor but they monitor actual formal insolvency situations whereas Begbies Traynor monitor a range of indicators such as outstanding county court judgements and late filing of accounts.

Begbies Traynor's recent Red Flag statistics for the second quarter of 2010, show that the 127,000 companies experiencing distress in the period was a marked fall of 21 per cent from the 161,601 registered for quarter one, and was 31 per cent down on the peak levels of 185,813 from quarter two 2009.

Ric Traynor, the executive chairman of the group, said it appears the post-recession stress is migrating away from the small to medium-sized businesses and beginning to take effect in larger companies. This, he warned, proves ominous for the threat of greater job losses and serves to emphasise the fragility of the UK's economic recovery.

"We believe that a combination of lenient creditor attitudes and temporary government support measures – including the extensive use of monetary instruments, such as quantitative easing and low interest rates – have all had an effect on reducing the volume of adverse actions, providing a welcome respite to many companies that may have otherwise found it difficult to survive," he said.

"We are concerned, however, that the levels of business distress will increase again, potentially for the first half of 2011, once the effects of the coalition government's fiscal tightening measures impact the economy and particularly among those private sector businesses most dependent on public sector contracts."

In past recessions, the level of insolvencies continued to grow strongly for two to four years after the GDP stopped shrinking. However this time, companies have learnt to be flexible and adaptable, with employees being willing to work fewer hours or taking a small pay cut.

However, with regard to actual insolvency situations, Lee Manning from Deloitte said, "The summer months traditionally see lower levels of administration activity, particularly given the periodic absence of key decision makers taking summers holidays.

“We expect this decline to continue into Quarter Three.” Confidence has been on the rise, with consumer spending holding up better than expected, and corporate confidence being felt more widely. For example manufacturing, one sub-sector impacted, has experienced improved output,” he said.

While the numbers of businesses experiencing 'significant' or 'critical' financial distress dropped from the figure for quarter one, their cumulative debt significantly jumped by 26 per cent - from £55 billion to £69.5 billion. In terms of average debt per company, this represented a 60 per cent increase from £340,000 in quarter one to approximately £545,000 in the second quarter. This figure, Begbies Traynor reported, betrayed the increasing average size of the businesses facing trouble.

The growing debt levels followed the rise in corporate credit availability reported in the Bank of England's credit conditions survey. The increasing availability was, however, not as strong as many had expected it to be: just 7.1 per cent of the lenders actually reported an increase; nowhere near the 22 per cent who had previously indicated that they were expecting one.

This failure to meet expectations is further reflected in the diminishing outlook going forward. For the third quarter of 2010, availability is predicted to reach its lowest level since the end of 2008, with the balance of lenders expecting an increase falling to just 6.5 per cent. In comparison, the levels for the previous five quarters to quarter one of 2010 were between 20.5 and 28.9 per cent.

More stringent scrutiny by HM Revenue and Customs (HMRC) of applications to its business support scheme will also likely lead, Traynor said, to more difficult conditions for those seeking corporate credit.

“HMRC’s increased scrutiny for applications to its time to pay scheme provide early indications that it is taking a more selective stance towards businesses over their outstanding liabilities with a focus on helping businesses that have a genuine chance of survival," he said.

The report confirmed fears by many people in the construction, business services, IT, advertising and recruitment industries that they are in line to be most harshly hit by the government's austerity measures in the coming months. Businesses experiencing difficulties in these sectors alone topped 52,000 in the second quarter of 2010 – and that was before feeling any sort of effect from the government cutbacks.

The construction and IT sectors in particular have shown to be struggling to establish similar rates of recovery as other sectors in quarter two 2010. They have grown year-on-year by just 17 and 16 per cent respectively – fractions of the average improvement rate of 31 per cent.

Traynor said in the event that the country does not enter a 'double-dip' recession, there remains the risk of a dual speed recovery, with the comprehensive spending review, due in October, likely to be a watershed moment for construction and IT contractors.

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