The real squeeze is yet to come

What’s wrong with this picture? It’s the first half of 2010 and the UK economy is slowly but surely emerging from the first major recession of the twenty-first century – a downturn on a scale that hasn’t been seen since the period leading up to the Second World War. Yet something is missing. Unlike the depression of the 1930s and the re cessions of the 1980s and 1990s, business insolvencies haven’t risen to the levels predicted by some economists. Nor has unemployment topped the projected three million mark. On the face of it, it seems that UK businesses have somehow dodged a deadly bullet.

But things aren’t always quite what they seem. As the pessimism inevitably generated by recessions is replaced by cautious optimism, it’s tempting to think that we’re pretty much over the worst. But the truth is, for many businesses, the really tough times lie ahead rather than behind.


This shouldn’t surprise anyone who has lived through previous downturns. Strange as it may seem, it’s during periods of recovery that the bulk of insolvencies take place. In the past, this has largely been down to overtrading. As demand rapidly rises, companies rush to supply customers by ramping up production or hiring new staff. Such actions require upfront investment while payment may be deferred for several months. Unless the finance is in place, there exists a real danger of a cash flow black hole that may result in insolvency.

As we emerge from the 2008/2009 recession, the recovery is expected to progress (at best) slowly and steadily rather than rapidly, so arguably the dangers of overtrading are not as great as in the past. However, there are other factors at work.

A taxing question

There are various reasons for the apparent resilience of UK companies, not least the attitude of the taxman. HMRC has recently given UK business plenty of room to breath.

The prime mechanism for this has been the Government’s Business Payment Support Service scheme, which allows businesses with cash flow problems a one-off ability to delay or restructure their tax payments through ‘Time To Pay’ (TTP) arrangements, which have provided many businesses with a stay of execution. But the taxman isn’t the only creditor capable of pulling the plug on a cash-starved company. In the early days of the recession, we saw many retailers failing and many of those insolvencies were caused by an inability to meet the upfront rent payments required by commercial property landlords. Then, of course, there are the banks and those who extend credit through hire purchase and leasing deals.

However, the past leniency of the taxman has been generally mirrored by creditors in the private sector. For instance, hire purchase companies have been much slower to repossess equipment than was generally the case in the past. Landlords have also demonstrated a willingness to strike deals with tenants to ensure that business properties remain occupied. This is not altruism, by any means. Under new rules, landlords must pay business rates, even when properties lie empty. In the current climate, landlords cannot take it as a given that when one business tenant is ejected another will be on hand to take their place. It often makes more sense to change the terms of the rental agreement – for instance, charging one month ahead rather than asking for three months upfront – rather than seeking an eviction.

And then we have the banks. While lenders have been reluctant to provide many businesses with credit, they have proved themselves relatively sympathetic to business customers facing short-term difficulties. Provided a customer can at least make good on interest payments, current evidence suggests the banks won’t exercise their right to call in the loan.

A growing debt burden

This kind of forbearance has undoubtedly helped keep businesses up and running through the recession, albeit without representing a ‘get out of jail free’ card. The truth is a deferred payment to HMRC or a reduced monthly payment to a bank is only a short-term fix and potentially creates a longer-term build-up of debts that will eventually have to be paid. That puts more pressure on companies to raise sales and profits to a level where they can comfortably pay any deferred debts, along with new payments as they become due.

In the case of the HMRC’s TTP scheme, crunch-time may not be far away. The former Labour Government had confirmed that the initiative would remain in place until the next Parliament and it will be interesting to see the approach taken by the new coalition Government. However, prior to the election, the taxman was already tightening up the terms and conditions governing deferral agreements. Any company with a debt of between £500,000 and £1 million may only be granted a deferral after a HMRC review of its business prospects. If the debt is more than £1 million the taxman will call in an independent accountancy firm to conduct a business review. With a more formal review process in place, HMRC is likely to be much more stringent about who it grants deferrals to and in what circumstances. In cases where a TTP is not granted, HMRC has the right to request that the company be wound up. (See HMRC plays hardball.)

Hire purchase, loan and deferred payments to landlords will also have to be made good. This is all coming at a time when businesses will need working capital in order to take advantage of the trading opportunities presented by the economic recovery. The danger here is that a significant number of businesses will collapse under a burden of debt. Therefore, the real squeeze could well be yet to come.