Why are Business Insolvencies on the Rise?
Over the last two quarters, Insolvency Service data has shown a sustained increase in corporate insolvencies. Total company insolvencies are now at their highest since the credit crunch in 2009. It is even more startling to note that voluntary liquidations are at their highest since records began, more than 60 years ago. Meanwhile, the business ‘birth rate’ officially dropped below the ‘death rate’ in 2022.
It is important to put this in perspective. Total insolvencies fell away rapidly after the credit crunch, then fell again due to the significant support (and indeed restrictions) in place during the Covid 19 pandemic. There was always bound to be some form of normalisation.
Likewise, events have been moving swiftly in the last few years. Brexit was followed by the pandemic, followed by Russia’s invasion of Ukraine, which then led to high energy prices and soaring inflation across the globe. Such significant disruptions were never going to pass by unnoticed.
However, it is still interesting to ask why the rise has happened now. The pandemic has passed, energy prices have stabilised, and recent months have seen inflation ease.
Interest rates and better options
One factor behind the rise is undoubtedly interest rates. These have shot up as fast as they dropped following the credit crunch: a far cry from the years of almost zero rates in between.
During those years, debt finance costs were low, so even marginally profitable ventures were viable. This was the era of the zombie business: heavily indebted and unviable by historic standards, but still officially undead.
The scope of Covid support exacerbated this trend. With credit offered on distinctly uncommercial terms, there was really no reason for firms to close their doors.
Higher interest rates have once again imposed financial discipline on businesses. Since funding working capital is expensive, cash generation has regained its importance. There is no doubt that borrowing costs are behind many of the recent insolvencies, and that this process will continue over time.
There is also another side to this though – one with a more positive message. Higher rates of return on cash mean that owning marginally profitable businesses is no longer appealing.
The particular increase in voluntary liquidations shows that business owners are not simply being forced into insolvency. Instead, they are choosing to close their companies, often to focus on other, more profitable ventures. Seen in this light, the rise is less alarming.
Delays in the data and by directors
In technical terms, insolvency statistics are always going to be a lagging indicator. Before companies become formally insolvent, they first need to face financial distress, then this needs to be picked up by management or by creditors, then action needs to be decided upon, then action needs to be taken. Only at the end of this process will the statistics reflect what has happened.
Also, this assumes that action is taken swiftly. If you add in a delay or reluctance by management to take action, the lag becomes even greater. Unfortunately, directors are notoriously bad at identifying when their companies are insolvent, and often seek advice far later than they should. Many simply hope that something will turn up, even when it is obvious their business is no longer viable. In these circumstances, the confidence and optimism that helps to grow companies can actually work against them.
In short, not only are some businesses still coming to terms with high interest rates, but some are still coming to terms with previous shocks, such as the impact of Covid and inflation.
This also means there is little sign of any respite. Even if underlying economic conditions improve, existing factors will take time to work their way through.
Making good decisions
So faced with these tough conditions, what should business owners do?
Unfortunately, there is no easy answer. Insolvency statistics are aggregated across many different companies. Some of those companies were badly run or unviable from the outset. Others were well-run and successful, then became the victim of circumstances outside their management’s control.
However, there are still simple ways to improve your chances. For example:
- You should ensure you have adequate and timely management accounts so you can spot problems before they become too large to solve.
- You should be realistic and objective about the prospects for your business.
- If you have any concerns, you should take professional advice. That way you understand the risks of action – and inaction.
Here to Help
Insolvency is a highly complex area of law, with strict processes to follow, so creditors should always seek expert legal advice at the earliest opportunity. This can significantly increase your chances of securing a positive outcome.