Solving the insolvency risk

Most of us are feeling the economic squeeze in our pockets, with the growing cost of utilities, groceries and mortgage repayments refusing to let up. The credit crunch has had a sizeable impact on affordability and has forced consumers across the country to rein in their spending. But it is not just individuals who are feeling the pinch, with many businesses also struggling to cope with the economic downturn.

A decrease in sales in a range of sectors has had a major impact on profits and UK firms are facing a tough time ahead as the current financial climate continues to bite. Smaller firms in particular are likely to take a pummelling as interest rate rises and a fall in the availability of funds has left many owners unable to secure loans from banks.

At the beginning of May, alarming figures were released by the Insolvency Service which showed that the number of company liquidations in England and Wales in the first quarter of 2008 had risen. According to the report, there were 3,210 liquidations from January to March 2008 – up 2% on the previous quarter and 4% on the same period in 2007.

Commenting on the figures, Ken Baird, Head of Restructuring and Insolvency at legal firm Freshfields, said that the credit crunch had ‘triggered a marked downturn in fortunes across all sectors’, adding that the longer it continued, the more difficult the situation will get for firms. He said that while for some businesses the problem may just cause a ‘temporary liquidity crisis’ for others it will ‘boil down to whether solvency - and therefore long-term survival - can be guaranteed’.

According to the report, the industries hardest hit in the first quarter were retail and travel, while homebuilding firms and pubs were also badly affected.

Mike Jervis, of the business recovery services practice at PricewaterhouseCoopers, warned that businesses should be prepared to manage their way through the downturn ‘as soon as they see signs of financial distress’.

He added that there are a number of ways in which small firms in particular can mitigate financial ruin including reviewing their business strategy and ensuring they have access to adequate finance and cash. Mr Jervis also recommended firms continue ‘managing and communicating with their stakeholders’ as well as ‘looking at their operational capability to ensure it is correctly deployed around the profit making areas of the business’.

Historically, Mr Jervis notes, companies that tend to emerge unscathed from such downturns are those which ‘proactively undertake a strategic, financial and operational review now, while carefully and positively managing their stakeholders differing agendas’.

This month a survey by global consultancy Hay Group found that the majority of businesses in the UK admit to having been unprepared for the economic impact of the credit crunch. In its Fight or Flight? report the group found that 51% of firms were caught out by the financial troubles and 26% had not changed their business strategy, despite the gloomy economic forecast.

It also revealed that nearly half of the 18% of businesses that did have a system in place admitted their company will be too slow to put it into practice.

Andrew Perry, Director of Special Risks at broker Miller Insurance Services Limited, said that a specialist credit insurance policy can be one way in which firms can help protect themselves against this kind of commercial disaster.

He continued, stating that while many large and medium-sized companies may have a risk management strategy in place, many will not have had the chance to test whether it would succeed when implemented. "One inherent problem is by the time the financials of a company are released they can be over ten months old," he said, adding that ‘a lot can happen in that time’.

"Mitigation via internal credit monitoring, tight collection disciplines, site visits of buyers' premises and sitting in industry credit circles/forums is one thing; however, what happens if the company you are trading with unexpectedly does go insolvent? Mitigation of losses is an option but other areas to consider are mitigating higher financing costs and reduced lines of finance. Credit insurance can help counter all these problems."

A spokesman from the Association of Insurance and Risk Managers said that he was not aware of any of the organisation's members entering administration recently, but added: "To succeed in business you have to take risks, and even well run firms do fail from time to time.

"Good risk management will significantly reduce a company's exposure to adverse events such as the credit crunch by making the Board aware of their exposures and enabling them to plan accordingly."