Why are so many businesses struggling to stay afloat – and will they sink or swim?

Corporate insolvencies increased by almost a fifth in England and Wales in the year to February 2023, according to data released by the Insolvency Service. This dramatic increase should come as no surprise, as businesses struggle to meet rising costs, amid a stagnant economy. UK inflation recently hit 10.4%, which is the highest level seen in 45 years.

Simultaneously, the withdrawal of the Government’s support for businesses given during the coronavirus pandemic is beginning to bite. That welcome support helped viable businesses survive the lockdowns and pandemic restrictions. Yet they also artificially kept some companies afloat, which were already insolvent, or would otherwise have naturally become insolvent whether or not there was a pandemic.

This is illustrated by the fact that corporate insolvencies actually fell at the beginning of the pandemic as business support and government loan schemes were introduced. UK government figures show that as the pandemic hit in 2020, the number of companies becoming insolvent fell by 27 percent, compared to 2019. Some companies which would have become voluntarily insolvent in 2020 and 2021 are now belatedly working their way through insolvency following the withdrawal of pandemic supports.

The Government also introduced temporary measures to protect businesses from creditors during the pandemic. Creditors’ ability to pursue debts was significantly restricted for a time. Likewise, commercial tenancies were protected until quite recently. Those restrictions are now gone, and landlords and major creditors such as the HMRC are presenting winding up petitions against companies, which will inevitably increase compulsory liquidations. More aggressive creditor action is also likely to increase the number of administrations, company voluntary arrangements, and creditors’ voluntary liquidations, as directors look for alternative ways to deal with a company’s insolvency when the threat of a winding up petition looms.

Yet inflation and rising interest rates are perhaps two of the key factors driving the rising level of insolvencies we are seeing. Increased gas and electricity prices have hit energy hungry businesses hard. Many businesses which are carrying debt have also seen interest payments rise dramatically. After many years of very low interest rates, this may have come as a shock.

Businesses have difficult choices to make when it comes to managing inflation. If they pass on all their increased costs to customers too aggressively, they risk losing customers and reducing their overall business volumes. However, businesses which fail to pass on any increased costs risk becoming unprofitable. This is a difficult balance to strike.

ASDA took a strategic decision not to pass on all its increased costs to customers, which resulted in a 24% decrease in its annual earnings. One of ASDA’s owners, Moshin Issa, said, “We took a conscious decision to support customers by investing heavily to mitigate the impact of inflation and keep prices as low as possible.” He added that “Although this contributed to a decline in profitability, it was the right thing to do for our customers and will ultimately help to deliver long-term growth.”

Inflation can present opportunities for business too, according to Professor Palmer of Henley Business School, who says that “modest inflation can be attractive to consumer goods companies. It encourages buyers to buy now rather than to delay.” He also notes that “inflation can help to mask changes in price positioning for a brand.”

Professor Palmer suggests that “many underlying and inter-related factors may be driving inflation. Supply chain bottlenecks may be a short-term problem which will soon be worked through, but costs involved in transforming to a zero-carbon economy (“greenflation”) and the lingering effects of large volumes of money created by quantitative easing - forcing up asset prices - may be harder to overcome.”

We have however seen a surprising reduction in personal bankruptcies, when compared with pre-pandemic figures. This may be partly due to the introduction of the government’s Debt Respite Scheme, known as the Breathing Space Scheme. This gives individuals a period of time to take action to resolve their debt situation. There are two types of scheme; a standard scheme and a mental health crisis breathing space scheme.

The standard scheme entitles any individual with a problem debt to legal protections from creditor action for up to 60 days. A mental health crisis breathing space is reserved for individuals certified as receiving mental health crisis treatment by an approved mental health professional. In this case, the protections from creditor action last as long as crisis treatment, plus 30 days, no matter how long the crisis treatment lasts. This may help some sole traders and individuals to stay afloat through difficult economic times.

We can still expect the number of bankruptcies to increase in 2023. This will come down to increased living and mortgage costs which are impacting everyone. If more companies become insolvent, unemployment and underemployment will inevitably increase. The UK’s unemployment rates remain relatively steady so far, but one early warning sign is the fact that the number of positions vacant has decreased by 51,000 to 1.2 million.

Businesses which are themselves struggling cannot expand. Nor can they offer pay increases in line with inflation. Recent ONS figures suggest that after inflation is accounted for, pay rates fell by 3.5% annually, with total pay including bonuses down 4.4%. Unfortunately, these factors may result in those who are already in debt repayment arrangements ultimately defaulting on their agreed payments.

There is a rocky road ahead for the British economy. Yet individuals and businesses who implement sound financial strategies are better placed to successfully navigate high inflation and economic uncertainty. Those struggling with managing debt and rising costs should seek advice from an insolvency specialist at the earliest opportunity.

Annabel Whittaker is a partner and specialist insolvency lawyer at Excello Law

www.excellolaw.co.uk