Uncertain times generally do little to encourage bold actions, whether at a corporate or individual level. Despite the economy faring reasonably well in the years after the financial crisis, Brexit has introduced a new level of doubt around the UK’s medium- and long-term prospects, accentuating a pre-existing tendency for caution which has prevailed in recent years. A survey by Grant Thornton suggests UK companies are currently sitting on some £244bn in cash, while ICAEW’s economic forecast for the first quarter of 2017 found the percentage of cash relative to GDP in UK non-financial firms reached an all-time high of 32.5% in the third quarter of 2016.
“When there is uncertainty in the marketplace, natural human instinct is to regress, retrench and watch to see what happens,” says Royston Guest, CEO of consultancy firm Pti Worldwide and author of Built to Grow. “Indecision and paralysis can set in. It is the natural response in answer to the question of whether you’re playing to win, or not to lose. Most businesses swing between the two but in times of uncertainty the default becomes playing not to lose which can result in delayed decision-making on big investments or strategic decisions.”
Jagjit Chadha, director of the National Institute of Economics and Social Research, says on the face of it such caution does not appear to make sense in the current economic environment. “Given the very low cost of capital and declining real interest rates you would have expected an investment boom, but that’s not something we’ve seen,” he says. “There are all sorts of explanations for that, ranging from the need to fund pension liabilities to a lack of confidence or uncertainty around future prospects. But it’s a puzzle, and at the moment there is no sustained response from firms to what look like, historically speaking, very easy financial conditions.”
The longer-term consequences could be low levels of investment, falling productivity and ultimately a weaker economy, he adds, warning that such behaviour can become a self-fulfilling prophecy. “If firms think the economy has stalled then they may decide it’s preferable to hold cash until things become clearer,” he says. “This then tends to create a world where no one is terribly happy but no one wants to change their behaviour.”
Such a strategy can put larger organisations on a collision course with shareholders, suggests David Petrie, head of corporate finance at ICAEW. “Very large businesses are unable to sit on cash because they become vulnerable as takeover targets. Questions start to be asked about whether the cash should be used in the business, returned to shareholders, or used to make strategic acquisitions,” he says. “Investors expect a greater return on their money than having it sitting as cash on the balance sheet of the companies in which they’re investing, unless those companies are paying reasonable dividends.”
There is, in fact, some evidence that large firms are starting to spend, or at least more willing to engage in asset-based finance. Data from The Asset Based Finance Association reveals advances rose 13% to £21.2bn in 2016, despite concerns around Brexit. “A significant proportion of the growth in funding is among the larger clients, with bigger businesses waking up to how they can use their assets more effectively to unlock working capital, but also free up funding for growth or acquisition,” says Matthew Davies, director of policy and communications. “This has been a trend in the industry for some time. The challenge for the asset-based finance industry, as it is for all types of finance provider, is how to get more funding out to smaller businesses as well.”
There are a number of government measures designed to encourage businesses to invest more, rather than retain cash or withdraw it as dividends. Sarah Ghaffari, technical manager, SME business tax in the Tax Faculty at ICAEW, points to research and development (R&D) tax relief, which can see a business reducing its taxable profits by 230% of the amount it invests, subject to it meeting HMRC’s definition of R&D. “It has to be something that advances knowledge and there are very strict conditions on the criteria – certain materials, software costs, staff costs – so you have to keep a detailed log of what your expenditure is on,” she says. Even loss-making firms can benefit, if they choose to give up the tax relief in return for a cash payment of 14.5% of the amount invested.
The problem is that use – and knowledge – of the scheme varies according to sector. “There is a perception that you have to have some kind of lab coat,” says Wendy Smith, business development manager at R&D consultancy Jumpstart. “There’s also some anxiety for certain business owners that it’s a tax avoidance scheme rather than a genuine scheme to reward businesses that are seeking risk and innovation. We meet businesses that are putting in claims which are very much under the value that they could be, and others where they have completely dismissed it because they don’t think they meet the criteria when they do.” She gives the example of a digital agency which claimed back £100,000 through the scheme, enabling it to take on a further 17 developers without the founders having to sacrifice any more equity.
Yet there is often uncertainty around government schemes, which can deter people from taking advantage of them, contends Anna Valero, a research economist at the Centre for Economic Performance at the London School of Economics. “There’s a general lack of long-term commitment in government policies towards business,” she says.
“In the Coalition years there was a policy called GrowthAccelerator, which was meant to help small businesses grow, but it was abruptly terminated following the 2015 election, and quite a few businesses had invested a lot of time in it. More long-term frameworks in terms of business support policies and industrial strategies would help businesses invest in the longer term.”
She also believes there should be greater allowances for equity investors to help move businesses away from a reliance on debt funding. “Equity finance is more conducive to longer-term and riskier investments because you don’t need to pay dividends unless you’re making a profit.”
Chadha, meanwhile, points to the correlation between public investment in the form of infrastructure spending or on R&D, and private spending on growth initiatives. “I’m not saying that all government-inspired investment is good but the right kind of public investment does seem to have amplification effects,” he says. “There has been a shift away from government investment towards consumption and transfers. That’s something which I suspect is not helping the situation and, against a climate of a number of years of slow performance, doesn’t help the confidence of firms going forward.”
For those organisations which do have cash to spend, there are a number of investment options which could help the business grow. “Examples could include increased investment in IT systems or a distribution business acquiring additional floor space to build up warehouse capabilities,” says Gareth Jones, partner and head of entrepreneurial services at Mazars. “Obviously, such investments would require some capital spend but ultimately they could help to decrease the proportion of overhead spends and improve the operational ability of the individual businesses.”
Investing in another business – whether that’s acquiring a competitor or complementary organisation or taking a stake in a supplier – is another option. “There may be suppliers who are constrained because they don’t have sufficient capital,” says Chadha. “It used to be called disintermediation, which is lending made by firms on behalf of banks which aren’t lending.
In the world we’re in today that might be a very helpful process; if I’m a manufacturer of widgets there could be all kind of firms in the supply chain with which I could have a relationship and provide them either directly with loans or equity interest which could help my own production processes.” Another option is where two businesses offer complementary products, and could be stronger together than as two separate brands, suggests Guest.
Investing in the skills of staff is another area that can pave the way to future growth, says Valero, although many businesses fear the prospect of people then leaving to work for another organisation. “In the most recent Growth Commission we proposed having a tax credit for skills and investment,” she says. “That would be a way for businesses to improve performance, and you can always link investment in skills to some incentive for people to stay. That’s key to improving performance in UK businesses.”
Those who do not wish to invest in their own business will need to think about what they do with cash, believes John Buchanan, senior performance manager at HW Fisher & Company. “Holding on to cash is not great if you’re not getting a return on it,” he points out. “If it’s a long-term business and they’re renting a property then that could be better invested in purchasing a property, but it very much depends on the business and its strategy.”
Though investing in non-core assets is not well regarded by the City or private equity, Chadha says businesses should be realistic about the returns they can get on investments from cash piles, and firms should look to source genuine growth from broader economic opportunities. “If we are in a world of lower returns then one thing is clear: more savings, and that’s not typically what we want from firms,” he says. “The typical route is that households save, and they allocate that to firms that invest. The fact that has gone slightly upside-down is not terribly helpful.”
One of the best ways to generate cash – at least in the short term – is to raise prices, says Peter Colman, a partner and head of the UK B2B practice at pricing consultancy Simon-Kucher.
“Of the three profit drivers of cost, volume and price, pricing improvements have the largest effect on the bottom line and those benefits tend to keep accruing year-on-year,” he says. It is also the lever around which businesses tend to have the least skills, he adds, and in fact many companies under-value the service they provide.
“They often don’t realise that they’ve been leaving money on the table for a considerable period of time,” he says. “If they invest time to craft a robust pricing strategy incorporating factors such as value delivered, customer willingness to pay and the cost-to-serve they can generally charge much more.
Getting the pricing right is very important when it comes to innovation, he says, and this is another area where businesses often make mistakes. “Despite spending time, effort and money developing new products and services, our research shows that their chances of commercial success are slim – 72% of new offerings either fail outright or miss their profit goals,” he says
“There are a number of ways to avoid this trap, the most important of which is having in-depth pricing discussions with target customers.”