1 Mar 2012

Survival tactics: how to get through recession

With recovery so slow, the expected wave of post-recession insolvencies has yet to hit – but it’s coming. Peter Bartram outlines how you and your clients can surf it and not get dragged under

The recent recession has left Britain with thousands of “zombie” companies – surviving rather than thriving. The business world’s living dead are hanging on by their fingertips – servicing their debts but with no spare cash to fund growth, says Frances Coulson, president of R3: the Association of Business Recovery Professionals. “They’re ticking over but nobody’s tipping them over the edge,” she says.

The staggering zombie firms are one of the reasons why the number of corporate insolvencies has not peaked, as it usually does during a recession. Instead of creditors putting the zombies out of their misery by forcing them into liquidation, they are keeping them going with a drip-feed of support measures, such as HMRC’s Time to Pay scheme, forbearance by trade creditors and agreements by landlords to renegotiate leases. Even the wicked banks have been tipped the wink by the government to go easy on small businesses in trouble.

Such support measures are not always enough. Total insolvencies in the fourth quarter of 2011 were 4,260. This is well below the peak of 7,116 in the fourth quarter of 2008. So far, a post-recession bounce in insolvencies – seen in the 1980/81 and 1990/91 recessions – has not happened. But that's not to say it won’t come later. The Q4 figures for 2011 were up 7.2% on 2010. The recession lag is happening more slowly this time – perhaps because we are still not out of recession. “The economy is taking longer to recover than expected,” says Coulson. “Historically, the lag comes when the economy recovers.”

A backlog of arrears spells trouble. But many SMEs in danger could steer clear of the rocks simply by improving their basic book-keeping

Neil Beck, managing partner at Wellers Accountants

That lag was particularly noticeable after the early 1980s and 1990s recessions. When the recession ended in the fourth quarter of 1981, there were 2,610 insolvencies – 8,000 for the whole of the year – but the number continued to climb during the 1980s, reaching a peak of 15,000 in 1985.

Similarly, in 1991 there were 30,000 insolvencies, but this rose to nearly 34,000 the following year. It was not until 1995 that the annual rate of insolvencies fell back to the pre-1990 recession level.

The absence of recession lag cannot be taken for granted. ICAEW head of enterprise Clive Lewis says it's the “dog that didn’t bark in the night”. “Insolvency practitioners have told me they’ve been not quite as busy as they expected,” he says, but adds, “The dog may bark in 2012.”

So what should small companies be doing to avoid becoming one of the casualty figures? Or one of the zombies? “It’s important for SMEs to have their fingers on the financial position,” says Bev Budsworth, managing director of the Business Debt Advisor. “So many of the companies we see have accounts at least 12 to 18 months old. Their management accounts are either not up to date or are non-existent. That’s the portrait of a company heading for insolvency, and it’s not a pretty picture."

A backlog of arrears and managers burying their head in the sand about their company’s financial position also spell trouble. But many SMEs in danger could steer clear of the rocks simply by improving their basic record- and book-keeping, says Neil Beck, managing partner at Wellers Accountants. He cites a London IT company client that was struggling to pay its bills, including wages and corporation tax.

“The main problem was that debtors over three months old were consistently in excess of £500,000,” he says. “We recommended the company prepare management accounts monthly and for directors to discuss a debtors listing each month.

“This has allowed the company to establish a more formal credit control system. The debtors have been reduced to no more than £100,000 and the new terms are consistently met. The directors can focus on their core business without worrying they may not be able to pay salaries at the end of the month. The business is now flourishing.”

SMEs should watch out for distress signs that could indicate the company’s position is worsening. R3 questions SMEs each quarter to monitor trends. The top signs identified in its most recent study, for December 2011, were lower profits, reduced sales volume and a fall in market share.

Other measures that indicate a company is heading into distress are pay cuts and freezes, loss of regular customers, cashflow difficulties, suppliers insisting on payment in advance, use of maximum overdraft facilities and difficulty paying invoices on time. Redundancies, key staff resignations and new borrowing to pay existing debt also indicate all is not well.

R3’s study presents a mixed picture, with many zombie businesses just managing to hang on. “In order to be considered healthy, a business must be able to grow and many are struggling to do so,” Coulson says. “Any change in circumstances or sudden disruption is likely to cause serious difficulty for those who are not showing many growth indicators.”

Some businesses become fixated with figures that do not give a true picture of their health. Lewis recalls working for a company that trumpeted the number of tenders it had submitted each month. “It was a spurious figure,” he says. “The company only converted 5% or sometimes 1% of them.”

Companies that have a sound business but hit short-term trouble must find ways to navigate the crisis. HMRC’s Time to Pay scheme, which allows businesses to pay off tax arrears over time, has been credited with keeping hundreds of firms out of insolvency. Budsworth has just negotiated a £60,000 Time to Pay arrangement for an SME with 12 staff in northern England. “To be successful, you need to know what your liability is and to have been compliant and truthful in terms of filing tax returns on time,” she says.

She arranged for her client to pay off its arrears over 18 months, starting with repayments of £1,000 in each of the first two months and increasing afterwards.

As trading conditions get tougher, accountants have a responsibility to keep SME clients out of trouble. Many SMEs think they only need to see their accountant once a year when it’s time to produce the annual report and accounts. But Lewis says, “Businesses should have more regular meetings with accountants.” Lewis suggests that directors might contact the ICAEW’s Business Advice Service (BAS) for information.

But acountants also need to become more proactive, he says. “Every practice should have a conversation with clients at least every quarter,” he says. “Ring up and ask how business is going and what the latest trading figures show."

Smaller firms of chartered accountants could have their own difficulties as a result of the recession. “There are practices that have lost significant numbers of clients during the recession,” says Lewis. These practices need to look closely at their own costs. They also need new clients. “One of the metrics you should look at is the percentage of clients that are new,” Lewis says. “If it’s dropping, you should look at how to attract new clients.” 

Despite the depression, many SMEs continue to thrive. But can zombie firms return to the land of the living?

“There are risks for directors in not tackling issues,” says Coulson. “If you’re at the limit of your overdraft and just servicing the minimum debt you can, the risk is that if your creditors increase, you put yourself at personal risk.” Too often business owners are frightened by the imagined stigma of approaching an insolvency practitioner, she adds. “It’s like people thinking if you go to a solicitor and write your will, you die,” she says.

Coulson argues that an insolvency practitioner should be able to stand back, take a dispassionate view of a business and suggest moves to improve prospects in the long term. “That’s better than blindly going on hoping that something will turn up – probably the most dangerous thing to do.” So there is hope, even for the living dead. 

10 top tips for avoiding insolvency

  1. Understand the company’s key financial measures. Make sure all managers know which financial measures are critical and monitor them constantly. Take early action to deal with any adverse variance.
  2. Produce regular management accounts. Most SMEs will need to do this at least monthly or, if a business is under financial pressure, weekly. Share management accounts data with everybody who needs to know. 
  3. Monitor cashflow on a regular cycle. Decide which is most appropriate for your business – daily, weekly or monthly – and keep a close watch on actuals against budget. Use cashflow forecasts to take decisions about working capital requirements.
  4. Set realistic targets. In a volatile economy, past activity may not be a reliable guide to the future. Question assumptions behind cost, revenue and cashflow forecasts. Build in a contingency for unforeseen events.
  5. Establish tight credit control. Ensure customers understand terms and conditions. Monitor debtor days outstanding regularly. Consider incentives such as discounts for customers who pay early. Run credit checks on new customers.
  6. Focus on best-margin business. Put resources behind the products or services that provide the best margins or have the best prospects for growth. Review prices/terms for unprofitable business or customers. Explore ways to improve margins.
  7. Communicate with key stakeholders. If bad news is coming, investors, banks or key suppliers will be more supportive if they know early about difficulties and the steps you’re taking to deal with them. Building trust pays dividends in difficult times.
  8. Involve staff in cutting costs. They are more likely to rally round if they understand the reason for cuts. They may even suggest economies you hadn’t thought of. Update processes and invest in IT to reduce expense.
  9. Look at debt problems in the round. Does the company’s debt stem from the fact that the owners put a lot of their own money in the business and need some back? If so, tackle the problem holistically – company and personal debt together.
  10. Take advice early on. An accountant or insolvency professional will have specialist knowledge to bring to the problem – and can stand back and take an objective view. Have an open mind when taking advice from professionals.