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Small businesses are often more vulnerable to the volatility of the economic cycle than larger companies. However, the past few years have not only presented a challenge in terms of reduced demand for products and services, but have also stress-tested cash flows and balance sheets as lending conditions tightened. This year’s State of Business Report shows that firms are still reporting issues with delayed payment. For smaller businesses this can mean the difference between survival or being defeated by the subsequent cash flow constraints.
The FSB ‘Voice of Small Business’ survey reveals that, over the past 12 months, SMEs have used a variety of methods of funding within their business operations, with the most frequently used being a bank overdraft (28%), followed by personal savings (24%) and finally any retained profits from the business (24%). These figures help to reveal not only the degree to which small companies are unwilling or unable to utilise debt facilities with personal savings and profits being used to fund activities, but also the complexity of the current financial conditions within the market. One would expect, given a historically low base rate, that debt utilisation would be attractive given the low cost of borrowing, but is the cost of borrowing as low as the base rate suggests?
The truth, is, probably not. The financial crisis meant that the banking sector had to recapitalise. This subsequently limited the degree to which banks could reduce the rate at which borrowing for business takes place. Anecdotal evidence suggest that banks have reduced SME overdraft facilities without consultation, increased the fees associated with business accounts, increased interest rates to borrowers and reduced the rate to savers. The median interest rate on new SME variable rate facilities as reported in the Bank of England’s Lending Trends publication shows that, whilst the cost has stabilised for SMEs with a turnover of between £1 million and £25 million, the cost of borrowing for smaller SMEs has been increasing.
It could be suggested that, despite some SMEs being able to demonstrate a viable business model, conditions remain restricted and more expensive. This is the result of the increased levels of bad debt, higher levels of uncertainty, and the risk-averse nature of the banks’ lending decisions given the shock that occurred to the financial sector. Is it the case that the many are paying for the few, and what will such conditions mean for SMEs in the next 12 months and economic growth in the future?
Cash flow will remain key to the performance of the SME sector given their limited ability to smooth significant variations and lags in income. This is especially important going forward given the potential for further reductions in public expenditure, whereby prompt payment (on projects that are still deemed viable) should help to mitigate against issues of cash flow.
Although mitigation will help some businesses, one should not underestimate the potential of the public sector cuts to harm SMEs. Once again, the FSB ‘Voice of Small Business’ survey reveals that “over half (56%) of annual sales are with customers in their local area while a quarter (25%) are with customers in another part of their region. A further quarter (26%) of annual sales is with customers in the rest of the UK.” This would suggest that Q2-Q3 of 2011 is likely to be a key period for SMEs as departmental and local authority cuts feed through into their primary work streams.
In this respect the private sector’s resilience and ability to grow will be important, and there are some positive signs that the private sector may recover sooner than originally anticipated. The latest GDP figures have been above analysts’ expectations, and will have helped to reassure businesses and investors and bolster confidence levels. Consumers, despite remaining cautious following the financial crisis and recession, have reacted by spending less and reducing their liabilities over the past 12 months. Although this has reduced demand within the economy, these actions in the medium term are likely to improve their financial prospects, ensuring that they are financially in a healthier position to resume increased levels of spending as market confidence returns.
Business of all sizes have also reacted strongly to the recession, allowing flexible working conditions reducing the possibility of redundancies, and looking for efficiencies to ensure that they can maintain competitiveness over their rivals. Surprisingly, although there are fewer funds available to support green investment such as renewable energy generation, the recession has helped to drive efficiency and green business initiatives. These initiatives are not aimed at being perceived as the ‘greenest’ supplier, but genuinely carry cost efficiencies. Ironically, the recession may have encouraged the UK’s businesses to take action, increasing energy efficiency and reducing fossil fuel reliance. This has the potential to place the UK in a competitive position in tomorrow’s world of ever decreasing raw material supplies and escalating costs.
ACE’s State of Business survey reveals that, generally, companies feel that the level of redundancies will not deteriorate further going forward, but there was still some concern as to the potential impact of the public sector cuts. Within this it is important that government recognises the impact of policy changes, especially on SMEs. Issues currently under review such as maternity, paternity, pensions contributions, and flexible working conditions are all likely to place additional strain on SME finances both in terms of funding and in both one off and continuing administration costs.
The government has been clear in its continuing efforts to provide efficient processes under which businesses pay tax liabilities (such as online submissions), and the establishment of the Office for Tax Simplification, which according to HMT’s Office for Tax Simplification framework document, will:
“Provide the government with independent advice on where there are areas of complexity within the UK tax system with the potential for simplification”
“Conduct inquiries into complex areas of the tax system, to collect evidence and advise the government on options for reform”
Whilst this process should benefit businesses, it is important to have information on the cost effectiveness of policies, detailing where the incidence of taxation will fall, and the sectors in the economy that will both lose out and benefit from such measures. This is of particular importance if taxes are collected on a local basis as both residences and businesses would feel far more engaged if the process was more transparent. Once again it is important to recognise that the level of tax burden changes significantly across small to medium enterprises. The self-employed will usually undertake such activities; as companies grow their interactions with outsourced accountants will increase and personal involvement decrease with regards to the preparation of accounts, until the point at which they can employ a full time member of staff to undertake financial activities.
Despite some of the concerns mentioned above, it is encouraging that such measures are being considered as part of wider reforms. The recent Comprehensive Spending Review has helped to outline the public sectors spending intentions, providing some degree of certainty for businesses. However, of particular interest will be next year’s Budget which is due to be held on 23 March 2011, as this should start to outline the government’s plans to improve confidence and promote economic growth.
This budget should see the emphasis begin to shift from those companies that are surviving the recession to those that have fared better during the recession, and provide substantial growth opportunities. For these companies, investment will be key to their expansion. Interestingly, we are back where we started insofar that lending and liquidity will be the key driver of the economy. The key determinate here will be as to whether companies bring forward investment expenditure in line with expectations of interest rates increases, or if economic uncertainty remains and is deemed too high to undertake such risks.
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