The economic environment has become a persistently challenging one for UK SMEs hit by Brexit, the pandemic, and its after-effects, with business insolvencies rising sharply as Covid relief support measures have been withdrawn. Meanwhile, financiers of capital equipment and asset finance have also found themselves in the cross-hairs as they adjust to a changing funding landscape shaped by green agendas against a backdrop of inflation and high borrowing costs.
From January to July this year, the number of UK company insolvencies rose by 12.3% year on year (y/y) to 14,087, according to The Insolvency Service, an official government body, with the number of creditors’ voluntary liquidations rising by 5.5% y/y.
It is clear that while generous loans helped to keep businesses afloat, and the economy on life support during the pandemic, there were many struggling firms propped up that clearly could not survive when that lifeline was withdrawn and repayments had to be made.
It is a problem that has persisted, three years on from the Covid lockdowns, now in a worsening economic environment of high price and wage inflation, elevated borrowing rates and slowing demand, with increased running costs and debt servicing squeezing working capital.
Of course, the government can no longer afford to keep supporting consumers or businesses indefinitely with the public finances stretched. According to the Office for National Statistics (ONS), public sector net borrowing, excluding public sector banks, was £4.3 billion in July. This was £3.4 billion more than in the same month of the previous year and also the fifth-highest July borrowing since monthly records were first compiled by the ONS in 1993.
The latest figures also point to a general government gross debt burden of £2.5 trillion at the end of March 2023, or 100.5% of GDP. This is 6.3% larger relative to the year earlier.
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Invariably, all of this is raising concern that as insolvencies snowball, hitting larger firms, it risks creating second-round effects for smaller suppliers, and is clearly an unwelcome feature that seems likely to carry over into 2024.
SMEs are certainly coming to terms with a very difficult trading environment, believes Sean Neville, managing director of Bibby Asset Finance, who cites his firm’s latest Global Business Monitor survey.
“Despite a high degree of confidence in their own businesses, 46% of small business owners in the UK say current economic conditions are worse now than during the Covid-19 pandemic, and a further 29% have seen their customers fall into administration.”
“Some 31% say they have insufficient cashflow to grow, and 52% are more likely to seek third-party finance now than before the pandemic,” he adds.
Marrying the demand for, and supply of, finance is the key challenge in the current economic environment, especially to support sustainability, adds Steve Nichols, head of asset finance at Time Finance.
“Often this comes down to appetite, and what I regularly see in the industry is a greater desire from asset financiers to support more traditional assets,” he says.
Financing was still rising through July, with total asset finance new business (primarily leasing and hire purchase) rising in July by 14% y/y, according to the Finance & Leasing Association (FLA). The growth rate was the same over the first seven months of 2023.
Commenting on the figures, the FLA noted that in July asset finance growth was more broad-based, with higher levels of new business in both the equipment and vehicle finance sectors. Yet the question remains, will it last, and is the right finance available?
Nichols (of Time Finance) believes that what the sector as a whole needs to focus on is “becoming much more comfortable and confident in financing less traditional assets, such as those in the green or renewable space.”
Time Finance regularly assesses the market to understand what it is that SMEs are saying they need. At the beginning of 2023, its research discovered that half of businesses put sustainable investment as their key priority for the year. However, 40% believed access to finance would be their greatest barrier to investment.
“That’s something we as an industry need to change,” he remarks.
But while the success rate of SMEs applying for asset finance has remained high, the economic climate is darkening.
It hasn’t all been bad news of course. Inflation decelerated from 7.9% year on year (y/y) in June to 6.8% y/y in July, according to the headline consumer price index. It had peaked at 11.1% last October.
However, the Bank of England is still grappling with strong pay rises and energy prices that are now rising again. The spot price of a barrel of Brent oil is back up to almost $95/barrel as of mid-September.
With inflation at risk of pushing higher again, this is likely to encourage a very cautious approach to monetary policy to avoid second-round inflation effects and a wage-price spiral forming, but this could ultimately cause a recession.
The economy grew weakly in Q2 2023, and the latest monthly figures show GDP already falling in July in real terms, by 0.5%. It was not just due to weather-related setbacks, either, or labour strikes affecting retailing and healthcare. All of the major sectors were contracting.
In its latest interest rate decision (21 September), the BoE opted to bring an end to 14 consecutive rises and voted to keep rates unchanged at 5.25%.
Andrew Bailey, the Bank’s governor, issued a warning against talk of rates going down anytime soon, saying they will remain where they are, and perhaps go higher, “to ensure we get the job done”.
What is clear is that where the base rate stands today is already enough to undermine disposable incomes and add significantly to the cost of doing business.
“This is squeezing businesses from all sides, impacting cashflow and productivity. And there’s little cheer from the recent S&P Global/CIPS manufacturing purchasing managers index figures, which dipped again in August to 43.0,” remarks Neville.
It’s not all about exports either. The services PMI has fallen since April, to 49.5 in August, dipping below 50 for the first time since January, owing to weaker business and consumer spending, amid higher borrowing costs. All of which is flagging a sharp downturn.
Caution the buzzword
With the OECD predicting year-average real GDP growth of 0.3% for 2023, and 1% in 2024, this will mean the UK lagging other major economies, such as France, Germany and the US. “At times like these we often see the whole supply chain proceeding with caution,” warns Nichols.
“An SME may think twice about investing in new assets if their pipeline is slowing. Investment plans are re-prioritised and rather than securing new assets, businesses may turn to solutions like re-financing as a way to release equity and inject more capital back into their business.”
Neville stresses that leasing has always been an extremely valuable way for small businesses to manage cashflow and maximise capital, especially when it comes to investing for long-term growth and expansion.
“In times of economic constraint, the relevance and value of leasing and asset finance generally increases significantly as traditional sources of third-party capital become harder to access. This is the scenario we see playing out for many of our customers right now,” he says.
Additionally, he mentions there is a legacy of pent-up demand from businesses that were unable to fund new assets during the pandemic and the subsequent equipment supply shortages exacerbated by Russia’s invasion of Ukraine. This means there is a healthy appetite to acquire new hard assets, such as plant and machinery, or refresh and refinance older kit to release hidden equity.
“The FLA data shows that lending into the SME market is up so far this year, bolstered by significant gains in both the new car and commercial vehicle markets, dominated by the original equipment manufacturer (OEM) finance captives.
“We’ve seen an upsurge in providers over the past six or seven years, seeking to meet this demand, which is good news for SMEs,” Neville enthuses.
“Small businesses will also benefit from the greater degree of scrutiny which the Financial Conduct Authority (FCA) is spearheading to ensure new market participants – both introducers and funders – provide appropriate levels of rigour and transparency in the products and services they offer.”
Now might be an opportune moment for SMEs to investigate the new ‘full expensing’ rules introduced in the government’s Spring Budget earlier this year, he says, which allow companies to claim 100% capital allowances on any qualifying plant and machinery investments.
Bibby’s Global Business Monitor research found that 21% of UK SMEs are planning to invest in machinery or equipment (including commercial vehicles) during the remainder of 2023.
To some extent, business survival or failure is a sectoral story, Neville claims. However, the combined impact of high-interest rates, high costs of energy, raw materials and wages, and reduced consumer demand has certainly dampened confidence, hampered cashflow and eroded margins across the board.
“Agriculture, food production, retail, hospitality, manufacturing and transport are all showing signs of distress, and we anticipate that the situation will worsen post-Christmas,” he says.
It's the construction industry that seems to be caught in the eye of the storm, currently. An increasingly depressed housing market, and stalled or cancelled infrastructure projects mean many of these firms are feeling the pinch. In August, construction accounted for 16% of all corporate insolvencies.
Asset financiers have a key role to play in helping SMEs across sectors weather the storm. By structuring deals that enhance cashflow they can enable businesses to remain resilient and realise their growth ambitions. Neville says that at Bibby Asset Finance they are strengthening support for SMEs and are working with customers across the sectors, helping to finance a wide range of both hard and soft assets.
“This dual capability is something we hope sets us apart from the wider market.”
Nichols adds that the traditional sectors that asset financiers support, such as engineering, manufacturing, construction and transport, tend to remain resilient in times of economic uncertainty, and financing often plays an important role here.
It provides businesses with access to assets that typically hold their value. They can be re-financed to inject capital back into the business, and this enables them to maximise the economic life of an asset. All of this helps to support cash flow and maintain growth when times are tough.
“In the same respect, businesses outside of these sectors that might feel a greater impact from economic turbulence can struggle to prioritise investments,” he adds.
This could be assets that would be typically classed as more of a discretionary spend – such as a new coffee machine or a hotel refurbishment – if consumer spending is down and business is slower.
“When investments are ‘nice-to-haves’, but cash flow is tight, those plans fall by the wayside. A smart business is one that adapts its priorities to its surroundings, and when there’s economic instability, it will weigh up non-essential investments with more essential ones.”
Invariably, all of this caution won’t last forever, and throughout it all businesses should remain optimistic about the future, he says rather more comfortingly.
“In our experience, what business owners seek in times of uncertainty is simply stability. Where the Asset Finance industry offers that peace of mind is by equipping SMEs with the ability to plan and forecast effectively, while at the same time helping to invest for the future.”
The path forward
Neville says that in the wake of supply challenges post-Covid, secondary values on assets such as commercial vehicles soared. However, these values have tailed off more recently as the supply of new products has largely recovered.
“This variation and volatility we see now in asset values, both new and used, across many sectors, has to be factored into the lending judgements we make. This can make life, shall we say, a little more interesting!
“As much as we need to know our clients, customers, vendors and brokers well, it is as important now to have a robust understanding of the assets we finance, allied to the dynamics of the industry they are employed within.”
It is worth reiterating that the UK economy is entering a very uncertain period. GDP growth has slowed and is even declining in tandem with rising borrowing rates, with unemployment also creeping higher.
There is always room to remain optimistic, however. As Nichols says: “The coming months may look challenging, but with access to the right funding support, UK businesses can put themselves in a stronger position as they enter 2024.”