By Daniel Hunter

As the UK economy shows real signs of improving health, new research from Begbies Traynor, the UK’s largest insolvency practice shows the number of zombie businesses in the UK is at a four-year high, with real dangers ahead particularly for the vulnerable SME business sector.

This research, based on an analysis of the Red Flag Alert dataset, reveals that 1 in 7 of UK businesses are ‘zombie’ companies. In real terms this means 432,082 businesses are only just generating enough cash to pay the interest on their debts and keep creditors at bay.

This is a 16% rise since 2010 (371,185). Real estate and property services, support services and professional services sectors show the highest proportion of ‘undead’ with 78,415; 25,178 and 15,985 respectively in 2013. The South East, London and Midlands are the worst affected areas across the four years analysed.

Julie Palmer, Partner at Begbies Traynor, commented: “The sectors highlighted in our research are people and/or service based businesses, which have far less in the way of tangible assets to fall back on if there is a reduction in trading. Their net assets or liabilities therefore tend to be driven by activity and turnover levels and chargeable time. Conversely, they are also the businesses that might find it easier to adjust to an increased demand for their services as the existing workforce can work longer hours to cope with increased demand, then the company can make the decision to increase headcount if demand is sustained.

“The analysis shows that these corporate zombies have clung onto life over the last six years due to a low interest rate environment and increased creditor forbearance, but this benign climate will not continue forever. As unemployment rates fall fast, under Bank of England rules interest rates could rise as early as 2014. Even If they go up by only 0.5% insolvencies could increase sharply. Ultimately not all zombies are necessarily the same — some will go on to recover through access to funds and improving market conditions, whilst others seem destined to fail.”

There is clear evidence that these zombie companies are prohibiting the growth of healthy businesses and having a negative impact on the UK economy, the challenge now is how we restore some of these operationally sound but balance sheet hampered businesses back to good health. The sting in the tail being that many of these businesses will be desperate for new orders and will be particularly vulnerable to overtrading. Our experience shows that even the most experienced directors can simply run out of working capital.

Julie Palmer, Partner at Begbies Traynor, added: “Increasing working capital is key to servicing heightened demand on the back of a recovery. Access to trade credit is also vital in helping many companies manage cash-flow, allowing them to continue trading. But faced with negative balance sheets, a decision to extend trade credit becomes even more difficult.

“Lenders are becoming more prescriptive in risk assessment and suppliers are savvier with information which is more readily available. Credit scoring systems, such as Red Flag Alert, can be used to predict the continuing stability of the business, giving an indication of their health over the next twelve months. Similarly, Payment Performance Data details their recent payment history, which can give a clear indication of their repayment capabilities. A well informed supplier or financier can then decide if additional credit could be given without too much risk of default.”

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