Amidst economic turbulence, UK SMEs have embarked on a challenging journey in recent years, contending with soaring inflation and regulatory complexities; however, glimmers of business support offer hope amidst the obstacles.

Clearly the past few years have proved enormously difficult for SMEs. Soaring inflation in particular has driven up borrowing rates, and businesses found they were no longer able to access the range of grants and subsidised borrowing terms available during the pandemic.

The cost of living crisis has certainly had a significant impact on businesses, especially SMEs, notes James Melvin, a partner at Cottons Group. “A combination of high inflation, rising wage demands and higher interest rates have squeezed businesses faced with higher input costs and tight consumer demand,” he says.

In a new Cottons Group report forecasting the landscape for UK SMEs in 2024, it notes the economy is now slowly improving, but SMEs continue to endure the “curveballs” of inflation and regulatory complexities arising from Brexit, not to mention labour shortages arising from a mismatch of labour skills.

David Raw, managing director of commercial finance at UK Finance says the demand for finance from SMEs has fallen as a result of these economic factors at play in 2023, and Martin McTague, national chair of the Federation of Small Businesses (FSB) agrees that the financing environment for small firms remains “somewhat less than rosy at the moment.”

Quoting the FSB’s Small Business Index report for Q4 2023, McTague notes that the views of small firms concerning the availability and affordability of new credit were distinctly negative (when surveyed), with only around one in seven small businesses rating it as quite good, or very good, and over half rating it as quite poor, or very poor.

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Among those small firms whose applications for credit were successful in Q4 2023, a third were offered a borrowing rate higher than 11%. That represents a new record for the Small Business Index he is keen to point out. 

McTague goes on to mention that the proportion of small businesses expecting to increase their capital investment remained virtually flat between Q3 and Q4, at around a quarter. This indicates that small firms were exuding a good deal of caution about committing funds for investment with interest rates at such high levels.

Figures from The Insolvency Service, an executive agency, sponsored by the Department for Business and Trade, meanwhile indicate a total of 2,102 registered company insolvencies in February 2024, a rise of 17% year on year; there were some 25,159 insolvencies racked up in 2023 in total. 

The latest UK Finance Business Finance Review found that SME financing activity was lower, on a year-on-year basis in Q4 2023, substantially below the pre-pandemic level, with gross lending down overall in 2023. 

UK Finance’s Raw points to the challenge of finance affordability for some SMEs given the cost of borrowing and also the cost of key inputs, including energy, which have put a squeeze on profit margins. The skills and labour shortages are also affecting the demand for finance, as are cash deposit levels built up by Covid lending schemes. These are now falling, but have been a factor constraining demand for financing.

Despite all this, SMEs have demonstrated resilience and adaptability, says Ed Rimmer, chief executive officer at Time Finance. “Many SMEs have demonstrated great agility, balancing cash flow pressures with investment, repaying legacy debts from COVID, whilst also responding to an ever-changing market,” he says.

Gross bank lending to small businesses declined in 2023, by 9% year on year to £59.2 billion, according to the British Business Bank, the government’s business development bank. However, this was still the third joint highest annual total, and moreover, small businesses are inclined to seek out alternative sources of finance. 

Some 59% of SME lending now comes from outside the big banks, according to Raw, who does not believe that lenders are being risk averse. He says the huge amount of finance provided from a highly competitive and diverse market to SMEs in recent years demonstrates the willingness to lend, and across all regions as well.

Rimmer concurs, noting that Time Finance achieved an all-time high of £188 million lent to SMEs as of November 2023, which marked a 23% year-on-year rise. He sees great optimism among small firms, with more building alternative finance into their long-term strategies. Echoing the views of other experts, he believes the right financial planning and specialist support can alleviate cashflow challenges to avoid insolvency, and maintains that viable businesses must be supported.

Government support and regulation

Encouragingly, the government has emphasised the SME sector in its final year in office, with Chancellor Jeremy Hunt using his final Spring Budget Bill to support small businesses and make 2024 what the Treasury has dubbed “the year of the SME”, with this plan assisted by the inauguration of a Small Business Council comprising SME professionals, which met for the first time in February. 

One of the budget measures is an extension of the Recovery Loan Scheme, which was due to end this June. This is to be renamed the Growth Guarantee Scheme, and it will run until the end of March 2026. 

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It aims to support thousands of businesses by providing participating lenders with a 70% guarantee on finance up to £2 million, thereby ensuring that businesses can access the funding they require to invest and grow.

Raw of UK Finance echoes the views of others by regarding it as a very positive move. A suitable alternative has been put in place, and with these assurances, SMEs “will be able to grow further and faster,” he says.

The FSB’s McTague adds that because of this move the banks will not overweigh the risk when considering lending to small businesses due to the government and British Business Bank underwriting 70%. Also, with this scheme in place, its terms could be enhanced as a rapid response to avoid a credit crunch, as occurred in the 2000s when the banks scaled back loans due to risk.

The Chancellor also announced in the budget that full expensing for capital allowances will be extended to incorporate leased assets. Although the timetable is unclear, businesses will be able to lease new equipment and offset the cost of this against their tax bill, lowering the tax by 25% for every pound invested. The government estimates this will boost business investment by £14 billion.

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“This will have an impact on the asset finance industry and the types of business that we see coming forward to make these investments, says Rimmer, adding that “prior to this tax break businesses that did not have working capital to invest were cut out of this tax break altogether.”

The government also raised the VAT threshold from £85,000 to £90,000, while, as Melvin points out, Prime Minister Rishi Sunak announced in a speech held in Warwickshire after the budget the government’s plans to fully fund the cost of training under apprenticeships in small businesses for anyone under the age of 21. Also, in a significant reduction of red tape, the size thresholds for micro and small businesses will be extended by 50% with reduced non-financial reporting requirements for SMEs.

Welcome as all of these changes are, however, Raw notes the fact that UK investment rates are below the OECD average, and he is not alone in calling for more from government and regulators to address this.

“I think they should look at some of the capital requirements which inhibit bank lending to bolster investment,” he urges, “This is something we said HM Treasury should consider in our submission to the 2024 Spring Budget.”

McTague meanwhile notes the challenge of imposing personal guarantees for relatively small sums, for SMEs looking to borrow. The FSB has raised this with the Financial Conduct Authority, and although it does not want them banned completely, personal guarantees do have an impact on business growth.

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He also mentions that the government could do more to target business support for small firms and ensure they can access the funds they need. There is also the looming threat to access to finance for small firms due to the impending removal of the SME Supporting Factor, enabling lenders to hold less capital to counterbalance lending to SMEs. “The Prudential Regulation Authority should change its mind about this aspect of Basel 3.1 to support lending to smaller businesses,” he says.

Optimism gradually building  

After a tough year when inflation skyrocketed and the Bank of England tightened liquidity, it is encouraging for SME viability and business growth the economy now seems to have turned a corner.

According to the Office for National Statistics (ONS), in January the monthly measure of GDP showed a real terms increase of 0.2%, following a decline of 0.1% in December, underpinned by services output growth.

There are still myriad challenges ahead of course, including the developing conflict in Ukraine, the attacks on Red Sea commercial shipping lanes, and other geopolitical risks including the US presidential election and UK general election all potentially impacting business confidence.

However, the latest Purchasing Managers Index (PMI) readings are reinforcing a more favourable outlook. According to S&P Global, the manufacturing PMI rose to 49.9 in March from 47.5 in February, a 20-month high, thus closing in on the 50 mark dividing expansion from contraction, with the output index rising to 50.2 from 48.3. Predictions vary, but UK GDP is likely to expand by up to 1% in real terms in 2024, a below-par pace perhaps, but one that is much improved on the 0.1% provisional outturn for 2023.

Helping matters, annual inflation measured by the consumer price index slipped to 3.4% in February from 4% in January. The various core inflation measures decelerated in February too, and the producer price index declined by 2.7%.

Meanwhile, the Bank of England held fire on an interest rate cut at its latest meeting, keeping the Bank Rate at 5.25% after increasing it to that level last August. However, the monetary policy committee members now appear to be less hawkish. Economists too are anticipating that a rate cut will be sanctioned before too long, possibly in June, an expectation underlined by the 10-year gilt yield sliding below 4%.

Brighter outlook for UK SMEs

Finance industry experts are certainly becoming more optimistic about the outlook for SMEs and financing than at this point last year, despite the fact the mood among SMEs has not shifted greatly.

Although smaller and newer SMEs are struggling, some 59% of SMEs do feel good about their business, according to the latest SME Finance Monitor by BVA BDRC for UK Finance, which finds that profitability levels have returned to pre-pandemic levels.  

SMEs have coped well and shown remarkable resilience, notes Raw at UK Finance. There are signs that SME demand for new finance may have turned a corner at the end of last year.

“Approvals for new loans and overdrafts increased and the rise was broad-based across all sectors,” he says, adding that “this could be a sign that confidence is gradually improving and SMEs are starting to plan and invest for the future.”

Some £3.5 billion was lent to SMEs in Q4 2023, the first time the total did not fall since Q2 2022. There was also a rise in the volume of loan and overdraft approvals as business confidence began to improve.

As inflation and interest rates fall, and the demand outlook improves, he is hopeful that UK businesses will thrive. This will see the demand for finance increase and the banks and other lenders have the capacity and willingness to fulfil this. However, business owners must understand all of the financing options that are available to them, particularly as almost 60% of SME lending is now obtained from non-bank lenders.

Of course, SMEs must cope with late payments impacting on cash flow and poor access to capital. Too many only use internal sources of finance, with just 30% of SMEs seeking external finance in the past three years according to the British Business Bank. 

There is a naturally cautious attitude among SMEs to finance and an unwillingness to speak to the banks about repayment difficulties. The majority would appear to want to deleverage, however, says Melvin, with the cost of credit, lack of collateral and a perception of a lack of success in applying constraining the appetite for borrowing.

Consequently, there is broad agreement that businesses should be aware of the funding solutions that are available to them.

“That’s where funders and financial intermediaries come in,” says Rimmer at Time Finance, who adds that business investment is on an upward trend. He sees this in the uptake in financial solutions from year to year, be it asset finance, invoice finance, loans or asset-based lending. 

Raw adds that lenders are willing and able to support businesses. Many are signatories to the government’s SME Finance Charter, which includes a pledge that they are open for business and ready to lend, he says. The Charter, devised in 2019, and updated since the pandemic, sets out a commitment to responsible lending and a pledge from the government to work with the British Business Bank to support SMEs (among other features) and there are presently 26 lenders signed up to it.