Debts have risen sharply during Covid and businesses must act before their bank does, says CRAIG ALEXANDER RATTRAY
The popular saying goes “another year older, another year wiser”. We are all certainly a year older, but are we any wiser? The twelve-month anniversary of lockdown was last week. When Boris Johnson gave us a very simple instruction to stay at home and said that the restrictions would be reviewed in three weeks, did anyone think that twelve months on we would still be living under continued restrictions?
It has been a devastating time for many with death, illness, financial issues, businesses ceasing trading, and ongoing uncertainty and challenges for many business owners.
We may not be any wiser, but many of us and our businesses are more indebted than we were this time last year.
The various schemes introduced by the government resulted in bank lending to SMEs increasing by 82% to £104 billion.
A British Business Bank report stated that 45% of small businesses applied for support last year compared to only one in eight the previous year, with 90% of those applying in the last twelve months doing so for Covid-19 reasons.
As a result, we can be confident that, in general, profitability is unlikely to have increased for most of these companies during the last year, so how will this debt be repaid?
In short, a lot of it probably won’t be.
The National Audit Office reported that up to £26 billion of the £38 billion of BBLS loans may never be repaid, and the Federation of Small Businesses stated that 40% of those who recently raised such government backed finance believe that their debt is “unmanageable”.
Over the last year, HM Revenue & Customs has openly permitted companies to defer and pay in instalments and this has added to the existing debt obligations of many companies.
The Finance Act 2020 made a change to the preferential status of some HMRC debt (VAT, PAYE and NIC) and reclassified it as a secondary preferential creditor in the event of administration meaning that only employee obligations and debts due to holders of fixed charges rank ahead of it. Corporation tax and other direct business taxes due to HMRC remain unsecured.
That will undoubtedly change the appetite of banks to lend as their security is eroded. Added to the existing debt obligations of many companies referred to above, what does that mean for businesses going forward?
In my view, it is an even more appropriate time to focus on good financial management and cash.
A multitude of accounting treatments can mask cash issues whether an overly aggressive build-up of work-in-progress, stock that is unlikely to be sold, historic trade debtors that are unlikely to pay, spreading of costs over a prolonged period, and omitted accruals and liabilities that should be included.
I have seen all of these over the years, resulting in the business owner showing an overly optimistic financial position from a profit and loss perspective, but wondering why there is no cash in the business.
That is generally when the bank panics and looks for action and things to change.
The key is getting there before the bank.
Owners must understand “where did the cash go” and more importantly, they must be clear on how they ensure cash generation going forward.
Clearly, the first part of that is to ensure a profitable business.
The second part is a focus on cash and working capital. Look at the change in debtor days and creditor days, and compare to credit terms – if there is a big mismatch then action must be taken. Look at stock days and work-in-progress. Is it too high?
These need to be actively managed and real focus placed on the short-term cash inflows and outflows.
The business owner needs to be realistic and to do that, needs good historic, current and forecast, and a robust plan.
By adopting that approach, we can all be less indebted and wiser in 12 months.
Craig Alexander Rattray’s column on issues affecting owner managers appears on alternate Mondays and his Cash Flow Tips appear every Thursday