Latest Red Flag Alert Report - Q3 2012 - A divided nation

Zombie SMEs stagnating natural UK recovery cycle

The most recent Begbies Traynor Red Flag Alert research, published today (19 October), which monitors the financial health of “Corporate UK”, shows a starkly divided nation with marked increases in financial distress amongst businesses based in the North and SMEs, whilst Southern based and larger businesses have shown marked improvements in financial health. The quarter on quarter increase in ‘Significant’ distress levels amongst SMEs (up 10.5%) also indicates the growing impact of zombie businesses - those companies who are in debt and are only just generating sufficient cash to survive - and the choking effect they are having on the natural UK recovery cycle.

North South divide

Relatively stable levels of ‘Combined’ distress across the UK (categorised as companies experiencing ‘Significant’ or ‘Critical’ financial problems), up just 1% in Q3 2012 compared to Q2 2012, mask a clear divide in fortunes between companies in the North compared to the South. While Southern businesses (those based in London, the South East and the South West) witnessed a 7% decrease in ‘Combined’ distress levels in Q3 to 103,096 (Q2 2012: 111,206), businesses across the rest of the UK experienced a 9% increase in ‘Combined’ distress to 120,029 (Q2 2012: 110,137).In the South, the improvement in corporate health has been driven primarily by an 18% reduction in ‘Combined’ distress amongst London based businesses and a strong recovery in the financial services sector (down 33% compared to Q2 2012), media (down 27%) and the consumer facing sectors including bars & restaurants (down 31%), general retailing (down 26%), leisure & culture (down 31%) and sports & recreation (down 26%).

The deterioration in the financial health of businesses throughout the rest of the UK was driven by particularly marked increases in ‘Combined’ distress in the East of England (up 13%), the North West (up 12%), Scotland (up 12%), Yorkshire (up 8%) and the Midlands (up 8%) and in the construction and real estate sectors (up 34% and 135% respectively) and the industrial sectors (transport & logistics up 71%, manufacturing up 28% and print & packaging up 58%).

Ric Traynor, Executive Chairman of Begbies Traynor Group, commented: “These figures demonstrate a clear North/South divide in the UK, with the international nature of the London economy, combined with higher employment levels in the South and therefore slowly improving consumer confidence, supporting strong improvements across the important financial services and media industries as well as the key consumer facing sectors. However, the 9% increase in businesses experiencing ’Combined’ distress across the rest of the UK is indicative of the challenges facing the Government in re-balancing the economy by developing growth industries beyond financial services and reducing the inequality that exists between the regions.”

A twin track economy with SMEs in the slow lane

Across the UK, companies experiencing ‘Critical’ distress (the most severe risk level) were down 17% to 4,107 (Q2 2012: 4,947) compared to the previous three months, indicating a marked reduction in the number of companies with a high propensity to fall into insolvency in the next quarter. However, this fall in critical distress does not represent an improving picture of corporate health overall.

Actions measured within the ‘Critical’ problems category – such as the issuing of CCJ’s and winding up petitions - are typically at their lowest during Q3 due to seasonal factors including Court holidays. This has been exacerbated by both creditor forbearance and the fact that the majority of businesses, by instigating tougher credit control procedures and avoiding transacting with companies with poor credit scores and payment records, have reduced their need to resort to Court actions to recover unpaid bills.

However, companies in our ‘Significant’ problems category are an earlier stage indicator of the trend in the financial health of “Corporate UK” and these show a wide divergence in the health of SMEs compared to larger companies. Within this category, there has been a 10.5% increase in SMEs exhibiting signs of earlier stage distress to 208,067 (Q2 2012: 188,265) compared to a 61% decrease in large companies to 10,951 (Q2 2012: 28,123).

The increase in SMEs experiencing distress has been driven primarily by marked increases in specific sectors including; construction and real estate (up 41% and 148% respectively), transport & logistics (up 70%), print & packaging (up 52%) and hotels (up 66%). The regions showing the greatest increases in ’Significant’ distress amongst SMEs include Scotland (up 22%), East of England (up 20%) and the North West (up 20%). This increase may also reflect the considerable increase in the number of newly incorporated companies registered in the 2011/12 year, many of which have been formed by individuals pushed into starting their own businesses due to unemployment but, unaware of the risks involved in starting a new business, many are unfortunately already showing ‘Significant’ financial distress.

Julie Palmer, Partner at Begbies Traynor, commented: “These figures demonstrate that an increasing number of SMEs are bearing the brunt of the current challenging credit and trading conditions. It is evident that larger businesses are exploiting their scale by enforcing lengthier payment terms on SME’s. This, together with the disproportionate impact of higher energy prices and the limited availability of funding support, is combining to form a perfect storm for the UK’s SME sector.”

Julie Palmer continued: “Unfortunately the outlook for many of these SME’s is poor. These zombie companies are only just generating sufficient cash to pay the interest on their debts and keep creditors at bay. Whilst many of these SMEs may survive with the benefit of low interest rates and creditor forbearance, they are in no position to deal with unexpected costs, lost orders or bad debts or to fund increases in working capital and invest in growth. At a time when the hopes for a UK recovery are pinned on the private sector delivering growth and investment, it is clear that the Government needs to act quickly to ensure that credit conditions for SMEs are improved or risk choking off a recovery before it really gets started.”