What struggling businesses can do to weather the economic storm

What struggling businesses can do to weather the economic storm

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Rather than rebounding in 2022, economic conditions in the UK have deteriorated. Forecasts for growth in 2022 and the year after have been cut dramatically.

The reasons for this are well documented. Take your pick from soaring energy costs, supply chain disruptions, the impact of COVID-19 and post Brexit difficulties. All of these have led to rising uncertainty. And nor is the UK unique; all G7 economies have had their growth forecasts cut.

Such a strained economic environment is challenging for everyone. But prospects for small and medium sized enterprises (SMEs) are particularly bleak.

These are the builders, florists, design companies, coffee shops and countless other businesses which provide vital employment, services and tax revenue to the places where we live. There were 5.5 million SMEs in the UK at the start of 2021 accounting for 99.9% of all businesses, 60% of UK employment, and around 50% of private sector turnover.

A recent report suggests the number of businesses in “critical financial distress” is up by 19% in the first quarter of 2022 compared to 2021. Construction (up 51%) and hospitality (up 42%) are the two sectors struggling the most.

Government data backs this up. Company insolvencies in England and Wales are up 112% for the first three months of 2022.

SMEs as a rule tend to be particularly vulnerable to economic pressures. Typically they do not have large cash reserves and find it difficult and expensive to raise new capital. They also have limited options when it comes to weathering a financial storm.

One obvious and common response is to raise revenue by selling assets and making staff redundant. But our research challenges this conventional wisdom, and suggests they are not the best route to a business’s survival.

When it comes to selling off assets, the most attractive ones are the most likely to find buyers. A breakdown service, for example, may have no problem selling off its newest recovery truck for a quick cash boost. But holding on to that truck is likely to be key to the business’s long-term survival.

Likewise, we found that cutting labour costs, either by reducing wages or the number of employees is likely to potentially improve cashflow in the short run, but be damaging to morale and reduce the staff expertise required to build recovery in the long term.

A restaurant which lays off its head chef may make an immediate saving on its wage bill, but will also be left without leadership in a critical area when the business environment improves. They may also find that chef difficult to replace if the labour market subsequently becomes more competitive.

Bespoke approach

So what does work? We found that the most positive step a business can take to ensure its survival is to reduce debts – not by quickly raising emergency cash, but through careful management. There is wisdom in the “automatic stay” approach, common in many insolvency procedures, where a business is granted a period of grace during which their dept payments are paused.

Ultimately, this also benefits the business’s creditors who are more likely to be paid (albeit later than planned) if the business survives than if it fails.

This approach is supported by some in the UK business community, including one insolvency specialist which has urged the government to extend COVID loan repayment schedules to ease pressure. The Federation of Small Businesses meanwhile, is advising SMEs on steps they can take to deal with problematic debt, which might involve the business owner seeking external expertise – before a court appointed insolvency practitioner becomes involved.

But knowing what to do and what not to do is only part of successful recovery from impending insolvency. The way you do it is also important.

Car ready to be loaded onto a breakdown lorry.
Avoid a business breakdown.
Shutterstock/Nejron Photo

Research suggests that SMEs facing temporary financial distress are better advised by “turnaround” business experts rather than those who specialise in insolvency. Turning a situation around before insolvency occurs requires broader expertise and involves a sophisticated approach to saving the businesses we all rely on in our day-to-day lives.

It means there is business potential in seeking outside assistance to create a bespoke recovery plan, which takes individual circumstances into account, and carefully designing operational improvements that reduce costs and improve liquidity that don’t endanger a business’ core activity. Businesses should also exploit opportunities to increase revenue and maintain close contact with creditors.

These kinds of timely and specific actions are more likely to gain the support of creditors, employees and customers, on which successful recovery hinges.

SMEs are a vital engine of the economy. But they are also fragile by nature. Financial and tactical support are what many facing temporary difficulties will need – for their sake, and the sake of a much needed wider economic recovery.

The Conversation

Naresh R. Pandit does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.