Recent political and economic changes have created a complex environment for SMEs to operate in. Business confidence has notably declined recently, with the FSB Small Business Index decreasing to -24.4 in Q3 2024 – the lowest reading in almost two years – following the recent elections, further exacerbated by the latest Budget and the introduction of the new Employment Rights Bill. What are the challenges currently affecting the SME market, and what should SMEs be aware of to avoid these threats taking hold?
Challenges for SMEs
Low demand and cash flow issues, rising costs and significant operational challenges have created a challenging environment for SMEs to thrive. There are several current threats across the market that are affecting SMEs:
- Overleveraged PE-backing: SMEs backed by private equity often take on significant debt to finance their operations and growth. In the current economic climate, many are finding themselves overleveraged, leading to financial strain. Elevated levels of debt limit their ability to invest in new opportunities, innovate, or maintain day-to-day operations. Rising interest rates and uncertain economic conditions increase pressure to service debt, potentially leading to liquidity issues and insolvency.
- Persistent cost challenges: rising costs, including raw materials, labour, energy, and transportation, continue to challenge businesses across various sectors. SMEs, which are often operating on thinner margins than larger corporations, find these increased costs particularly burdensome. The recent Budget, with higher Employers’ National Insurance contributions and an increase in the National Living Wage, exacerbates these challenges. Businesses must find ways to absorb or pass on these costs without alienating customers or compromising their competitive position.
- Stagnating sales: many businesses are experiencing slowed or stagnant sales due to reduced consumer spending, increased competition, and market saturation. For SMEs, this stagnation can be particularly damaging as they may lack the financial resilience to weather prolonged periods of low sales. This situation necessitates a strategic review of product offerings, marketing strategies, and customer engagement practices to reignite growth and maintain market relevance.
- Tightening trade credit insurance: trade credit insurance, which protects businesses against the risk of non-payment by their customers, is becoming harder to obtain. Providers are withdrawing cover or tightening terms, making it difficult for businesses to secure necessary insurance. This creates significant problems for businesses relying on these policies to manage cash flow and maintain liquidity. Without this safety net, businesses face increased risk and may struggle to manage pay cycles, leading to potential cash flow crises.
Early warning signs
In the current environment, business leaders must be vigilant for early signs of trouble. While these will inevitably differ from business to business, there are some common red flags: loss of key customers or market share, loss of key personnel, tightening of credit availability from suppliers, loss of trade credit insurance cover, lack of investment, breach of banking covenants, and reduced sales. Recognising these signs early is crucial for taking timely action.
When facing any of these challenges, it is essential to act promptly. Producing accurate and meaningful management information to support financial support requests and clear and timely communication with key stakeholders is important. While short-term cash flow management is crucial to alleviate anticipated liquidity challenges, identifying the root causes of performance deterioration and building a realistic, properly costed turnaround plan is key.
A short-term cash injection may solve an immediate crisis but will not correct underlying problems such as loss of market share or an unattractive product offering. A financial turnaround plan only works if it is part of a wider holistic plan designed to address the root causes of underperformance.