Memorandum submitted by The Institute
of Chartered Accountants in England and Wales
INTRODUCTION
The Institute of Chartered Accountants in England
and Wales (ICAEW) is pleased to be able to submit written evidence
to the Business and Enterprise Committee as part of its current
inquiry into financial support for small and medium size businesses
(SMEs).
As a public interest body, the ICAEW is committed
to working with Government and regulators as well as wider market
participants in order to help restore business confidence.
The SME sector forms a vital part of the UK
economy and its resilience in the current climate will be a key
factor in terms of the speed with which the economy begins to
recover. Many of the ICAEW's 132,000 members either advise or
run SMEs and this submission draws upon their insight and expertise.
EXECUTIVE SUMMARY
1. In the current economic climate, banks
are understandably more cautious about new lending as well as
the renewal of existing finance. They are also under conflicting
pressures on whether to improve capital ratios or to increase
access to finance for businesses of all sizes. (1.1)
2. Research undertaken by the ICAEW indicates
that this is likely to have a material impact on the ability of
SMEs to weather the current downturn, in particular as a result
of finance becoming more difficult to secure. ICAEW interviews
with businesses and firms across the UK support this research.
(2.1)
3. In the context of this limited availability
of credit, SMEs can act to improve their position by taking steps
to improve their management of working capital. (2.6)
4. For the proportion of SMEs who require
a statutory audit, there is an additional challenge of reporting
"going concern" uncertainties. Market conditions in
2009 are likely to result in a higher proportion of company disclosures,
together with an increase in the number of modified audit reports,
as compared to previous years. (3.3)
5. The ICAEW believes that there are practical
steps that can be taken by Government, regulators and the profession
to help mitigate the risk of damaging misinterpretations of company
disclosures and modified audit opinions by investors, credit reference
agencies and finance providers. (3.8)
6. While the recent Pre-Budget Report (PBR)
contained some welcome measures for SMEs, the ICAEW has concerns
regarding the effectiveness of both the headline VAT rate change
and the Government's access to finance package as measures designed
to help improve the credit environment for SMEs as well as the
wider economy. (4.1, 5.1)
7. The Government's Lending Panel, also
announced in the PBR, needs better sources of independent data
if it is to fulfill its monitoring role effectively. (6.1)
8. The ICAEW is committed to working with
Government, business bodies, banking institutions and the SME
sector in order to help publicise information and good practice
designed to improve financial management during the current downturn.
(6.2)
1. Challenges facing the Banking Sector
1.1 Given the current economic climate,
banks and wider financial institutions are understandably more
cautious about new lending as well as the renewal of existing
finance. Lending to businesses becomes more risky as a result
of poor trading conditions and falling assets prices. Consumer
lending becomes more risky as job insecurity increases.
1.2 The banking industry is also facing
conflicting challenges. The political community wants to see increased
lending to small businesses. Regulators have encouraged banks
to improve their capital ratios. Both are legitimate demands.
1.3 If banks increase their lending levels
this raises the risks they accept, capital requirements rise and
capital ratios weaken—which is why lenders are likely to
be increasingly unwilling or unable to make new loans to SMEs
or guarantee that existing financing arrangements will be renewed.
1.4 While the recent Government re-capitalisation
of banks has helped to stabilise the financial positions of a
number of major institutions, it is not yet clear whether these
interventions will be sufficient to significantly stimulate bank
lending.
2. Challenges facing SMEs
2.1 The ICAEW Quarterly Business Confidence
Monitor suggests that, in the increasingly challenging business
environment, access to finance is becoming more difficult and
careful cash flow management is essential for all sizes of entity.
2.2 The 2008 Q4 UK Business Confidence
Monitor shows that three in every 10 firms (30%) report that
access to capital has become a greater challenge to their performance
over the last 12 months—up from 12% last year. This trend
is apparent across all sizes of business. Firms are also increasingly
likely to report that bank charges have become more of a challenge
to business performance—up to 20% this quarter from 13%
in Q3.
IMPACT ON ORGANISATION'S PERFORMANCE—CHANGE
VERSUS 12 MONTHS AGO
% Greater challenge
| Q4 2007 | Q1 2008
| Q2 2008 | Q3 2008
| Q4 2008 |
| Your access to capital | 12% |
16% | 20% | 23% |
30% |
| Bank charges | 14% | 12%
| 13% | 13% | 20%
|
| Late payment from customers | 19%
| 18% | 18% | 22%
| 28% |
| |
| | | |
2.3 As the economic slowdown takes hold and access to
credit remains constrained, late payment from customers is emerging
as another major challenge for business—28% of firms identify
this as a greater challenge than a year ago (up from 22% in Q3).
Further information about the ICAEW Business Confidence Monitor
is contained in Appendix Two.
2.4 Qualitative research undertaken by the ICAEW in October
and November also suggests that businesses are facing significant
difficulties with regard to late payment of commercial debts as
well as withdrawn or reduced credit insurance facilities. In addition,
businesses complain of increased arrangement fees for finance
facilities and increased interest changes as finance providers
widen margins as part of the re-pricing of risk. Further qualitative
analysis is contained in Appendix One.
2.5 What is clear is that banks are becoming more cautious
about lending and are taking a much firmer line with companies
than in recent years. They face a particular difficulty in lending
to the SME sector due to its diversity and its size and as a result
tend to classify customers according to their size and assessed
credit risk. For many SMEs, bank lending decisions are based on
credit analysis supported by an automatic decision support system
(ie using a score card), supplemented by a final decision by a
relationship manager. There is generally no fixed review process
to assess the credit risk of smaller business while SME are often
unable to build a continuous relationship with bank staff.
2.6 In this context smaller entities can act to improve
their position, in particular, by adopting improved practices
for managing working capital.[38]
Further, where possible, SMEs should take steps to reduce their
risk profile, for example by improving the quality, quantity and
transparency of information they provide to lending institutions.
SME companies are required to provide financial reports whether
they are audited or not. Other SMEs will use financial reporting
information for specific ends such as engagement with HMRC or
for investment purposes.
2.7 An SME's management of its working capital will form
part of a bank's lending decision. Banks will want to see cash
flow forecasts, as well as historical accounts to be able to verify
that a company has sufficient cash flow to service a debt going
forward. Anecdotal evidence suggests that SMEs, especially unincorporated
sole traders, often have difficulty managing their cash flow properly.
Such entities need to be extra diligent about sound financial
management in the current climate. In particular, they should
focus on managing working capital, which includes: proper cash
flow forecasting, taking into account the impact of unforeseen
events, market cycles, loss of customers, early request for payment
by creditors and late payment of debtors.
2.8 There are a number of other common practices which
need to be reviewed in the current context:
— SMEs can often improve their basic credit management—how
they chase up their debts, the speed at which they invoice for
goods or services, and the payment monitoring arrangements they
have in place to check invoices on a regular basis.
— Some SMEs could improve reporting of financial
performance coupled with better forecasting systems of future
trading and cash flow.
— Many SMEs are inappropriately financed, placing
too much reliance on term loans and overdraft, to the exclusion
of factoring and invoice discounting, leasing and hire purchase.
— Some businesses concentrate on trying to achieve
good seasonal or quarterly results. Concentration on performance
in this way can lead to lack of attention to working capital performance.
— Many SMEs fail to prepare or put in place financial
contingency plans to help tide them over unexpected events.
— It is crucial that SMEs work to maintain good
credit ratings and a credit file that demonstrates to others that
they have successfully managed credit previously. Having a good
credit rating helps to reduce the cost of borrowing and makes
it easier for an SME to access funds.
— Good communication with customers and suppliers
is essential in avoiding disputes. Collaboration and understanding
of respective positions can go a long way in helping to manage
working capital.
2.9 In 2006 the ICAEW set up the SME Funding Adviser
Scheme under the chairmanship of Sir Michael Snyder, Partner at
Kingston Smith and former Chairman of the City of London Policy
and Resources Committee, and with the active involvement of BERR
and HM Treasury. The objective of the scheme is to ensure that
businesses receive independent advice on the most appropriate
form of business finance out of the range of available options
and to assist businesses to meet finance provider requirements
for financial reports and forecasts (profit, cashflow and balance
sheets etc).
2.10 For the larger end of the SME sector, the Corporate
Finance Faculty of the ICAEW has established a "Fundraising
on AIM" forum—a free platform for businesses to
attend aimed at fast growing, young companies considering flotation
as well as those looking for further funding.
2.11 The Faculty's "Funding for SMEs"
forum provides information on all aspects of the "funding
ladder": bank finance, government schemes, angel/venture
capital and flotation. The Faculty also publishes good-practice
guidelines and is currently working with DBERR to produce comprehensive
guidance on government funding schemes (debt and equity).
3. Challenges for audited SMEs
3.1 All publicly listed companies and companies that
exceed a threshold of staff numbers, turnover, or assets are required
to be audited. In addition, banks or lending institutions may
require businesses to be subject to an audit as a term of a loan
agreement. According to Companies House, 143,600 companies in
total submitted full audited accounts during the 12 months to
31 March 2008.
3.2 Although publicly listed companies are generally
large businesses, a proportion of companies that exceed the audit
threshold and a significant number of audit-exempt companies that
opted for an audit to fulfil the terms of loan agreements will
be SMEs in terms of the general definition of staff numbers (under
250). Listed SMEs are significant engines of economic growth while
SMEs that are audited for other reasons are likely to be ambitious,
high-growth businesses.
3.3 Given the current economic environment, the ICAEW
anticipates that a higher proportion of 2008 year end annual reports,
compared to previous years, are likely to contain disclosures
relating to "going concern"—ie the company's ability
to continue in business for the foreseeable future. Similarly,
the auditors will need to refer to the directors' disclosure of
this uncertainty in the audit opinion.
3.4 The ICAEW welcomes the guidance for directors recently
issued by the Financial Reporting Council (FRC) regarding going
concern and liquidity risk disclosures in the current difficult
economic climate. The guidance emphasised that many companies
will be faced with increased uncertainties and that these need
to be disclosed in an open and transparent fashion. The forthcoming
Accounting Practice Board (APB) bulletin on emphasis of matter
will also provide guidance for auditors when they consider these
issues. The ICAEW has encouraged the APB to publish guidance as
a matter of urgency, prior to the end of the year so that auditors
are able to plan their audit work accordingly.
3.5 The ICAEW believes that, in many cases, potentially
damaging investor reactions to these disclosures and modified
audit opinions may be caused by misinterpretations of the information—and
as such may be avoidable given sufficient market understanding
and awareness.
3.6 In particular, investors and other users of financial
statements need to be aware that, even in those cases where the
directors have concluded that there are going concern material
uncertainties, it does not mean that the company concerned will
cease to continue. Going concern uncertainty is less important
in many ways than the nature of the uncertainties and the proposed
management response.
3.7 Further, if auditors conclude that a material uncertainty
remains which may cast significant doubt on the company's ability
to continue as a going concern and this uncertainty has been adequately
disclosed in the financial statements, the auditor will modify
the audit opinion by including an "emphasis of matter"
explanatory paragraph highlighting those disclosures. Such a paragraph
does not affect the auditor's opinion, which is modified but "clean"
or unqualified. This distinction is very important.
3.8 Faced with the challenge of going concern the ICAEW
recommends that the Government, regulators, the accountancy profession
and banking industry work together to help ensure that:
— banks and lending institutions make every effort
to raise awareness about the difference between modified and qualified
audit opinions;
— directors and auditors follow the APB guidance;
— where modifications occur, investors and other
businesses respond in a measured and advised manner; and
— media reporting of emphasis of matter paragraphs
should avoid using misleading or emotive language that gives the
impression that a qualified audit opinion has been issued.
3.9 The ICAEW encourages wide public dialogue and parliamentary
scrutiny of the going concern uncertainty issue in order to advise
and educate the wider market. A full briefing on the going concern
issue is included in Appendix Three.
4. Assessing the impact of pre-budget report on small business
finance
4.1 While there were a number of welcome measures for
small business in the PBR the ICAEW has concerns regarding the
likely effectiveness of both the headline VAT rate change and
the Government's access to finance package in substantially improving
the credit environment for SMEs.
4.2 In regards to the temporary reduction in the VAT
rate from 17.5% to 15%, the ICAEW is concerned that:
— at a macroeconomic level, the temporary reduction
will have only a minor impact on consumer purchasing behaviour,
particularly for low income consumers;
— for many businesses the administrative burdens
and costs of pricing transition will outweigh any likely benefits;
and
— for those businesses that hold prices and thereby
benefit from the VAT reduction, the effects of that advantage
will be small compared to other cash flow difficulties—for
instance as caused by falling demand or higher import prices due
to the falling pound.
4.3 The ICAEW supports the Government's efforts to improve
access to finance for SMEs announced in the Pre-Budget Report.
However, given the relatively limited scale of intervention and
the significant amount of time that it will take to set up and
market new finance facilities, the ICAEW questions the overall
impact on business confidence that the proposed measures will
provide.
4.4 In the Pre-Budget Report, the Government announced:
— The creation of a Small Business Finance temporary
guarantee scheme to enable up to £1 billion of new Government
supported lending by banks.
— An Export Credits Guarantee Department's temporary
scheme to support a £1 billion facility to provide smaller
exporters with better access to short term working capital.
— An RDA Loan Fund totalling £25 million, modelled
on the Advantage West Midlands transition loan fund to help businesses
over the next six months.
— A capital fund of £50 million providing equity
or quasi-equity to SMEs who are overleveraged.
4.5 In the overall context of bank lending of £54
billion to SMEs, according to the British Bankers' Association
figures of 30 September 2008, the packages announced offer only
limited assistance to the financing difficulties faced by SMEs.
The ICAEW awaits details about how all of the above measures will
work, ie when they will be available and how businesses will access
them.
4.6 Within the overall small-scale equity market the
proposed capital fund scheme does not represent a significant
intervention. The ICAEW would also draw attention to the lack
of previous experience for RDAs (apart from Advantage West Midlands)
of RDA Loan Fund schemes to assist businesses in difficulties.
Consequently we are concerned about the amount of time it will
take to set up the appropriate structure to administer and market
the scheme.
4.7 The Government also highlighted an EU announcement
that the European Investment Bank (EIB) will make a £1 billion
fund available to SMEs in the UK by the end of 2008. There are
only three banks utilising the existing EIB funding—Barclays,
Alliance & Leicester and Close Brothers. Their use of the
current facility is on a significantly lower scale than that now
proposed. Some banks, who are not part of the current scheme,
have expressed interest in negotiating a facility with EIB, however
these negotiations will take time. Even when these facilities
are in place it will take time for the new banks to train staff,
market the scheme and start receiving applications.
5. Wider pre-budget report measures designed to help business
5.1 The ICAEW welcomes the Government's announcement
to introduce flexible payment arrangements which will help taxpayers
struggling to pay tax bills. This approach will build upon HMRC's
approach to tax debt problems experienced by farmers during the
Foot & Mouth crisis. We believe that this system worked well
in ensuring the financial survival of many farmers who otherwise
may have faced ruin.
5.2 The ICAEW also welcomes the proposal to extend loss
relief carryback from one year to three years. This should help
businesses offset current losses against earlier profitable years
and thereby receive a tax refund. This announcement reflects a
similar measure introduced in 1991 at the time of an earlier economic
downturn. The three year carryback was maintained until 1997 when
the carryback period reverted to one year.
6. The lending panel and wider cooperation
6.1 The Lending Panel, announced in the PBR, to improve
monitoring of lending to households and businesses should include
representations from SMEs, company directors, auditors and lending
institutions. The ICAEW recommends that the Lending Panel obtains
better data if it is to fulfill its role of monitoring lending
to business. Current information consists of high-level aggregate
data from the Bank of England and the British Bankers' Association.
Independent, statistically robust data is required to inform its
monitoring of lending, particularly to the SME sector.
6.2 The ICAEW is keen to work with the government, business
bodies and banking institutions in order to provide information
to the SME community to raise awareness of the importance of sound
financial management in the current climate. In particular, this
information should focus on managing working capital, which includes:
proper cash flow forecasting, taking into account the impact of
unforeseen events, market cycles, loss of customers, early request
for payment by creditors, late payment of debtors.
APPENDIX ONE
THE IMPACT OF THE CREDIT CRUNCH ON UK BUSINESSES
INTRODUCTION
In October and November 2008 ICAEW Regional Directors visited
chartered accountants in business and practice across the country.
Issues relating to the economy were also discussed at length during
meetings of 10 Regional Strategy Boards across England and Wales.
This report assembles grass-roots evidence from finance professionals
dealing with the many ramifications of the recession. This can
be summarised by a comment from a member in the East of England:
"The situation appears to have deteriorated significantly
in the last 6-8 weeks. In September there was a feeling that only
certain sectors, such as property and banking were being affected.
Now there is significant lack of confidence spilling into most
sectors and businesses are looking to cut their costs".
THE AVAILABILITY
OF FINANCE
The banks are unwilling extend credit and they are exercising
their right to call in overdrafts. More damaging, for individuals,
is that they are also calling in personal guarantees—West
Midlands.
In the case of a company supplying home-ware, the bank reduced
the overdraft by one-third and refused to re-assign a personal
guarantee on the departure from the board of the guarantor. As
a direct result, the company called in receivers. The personal
guarantee is being exercised and the business is unlikely to be
sold as a going concern—West Midlands.
The re-valuation of assets is having a serious impact. The
view among SMEs is that banks should take a longer view of their
viability by accepting that property prices will stay low for
some time. A lower property valuation should not be a reason to
withdraw support if there is no pressing need to realise the value
of the assets—West Midlands.
Banks are still reasonably loyal to long-established customers.
However, they are widely thought to be using the pretext of the
financial crisis to shed their riskiest debts—West Midlands.
Banks are refusing to fund the cash-flow needs of SMEs. Owner
managers are putting their own money back into their companies.
But there is a limit to how much they can afford and how long
they will be willing and able to do so—West Midlands.
A manufacturing company which employs 110 people has been
asked by a leading bank to pay off its £75,000 overdraft.
It is likely the company will close as a result—West Midlands.
A leading bank wants to renegotiate the existing loan to
a charity with a very strong asset base from base +1.5% to Libor
+3.5% and charge four times the normal arrangement fee—West
Midlands.
A solicitors' practice found a leading high-street bank withdrawing
its overdraft and offering no further advances—West Midlands.
A leading high-street bank pulled an overdraft for a small
business when its overdraft was temporarily at zero. In this case,
staff agreed to work unpaid for one month before the business
received money due from a major customer—West Midlands.
Banks are raising their interest rates, fees and charges.
Because of the downturn, predicting sales, profits and cash flows
has become more uncertain. There is therefore greater risk, and
this is making the banks more cautious—Wales.
Many businesses are turning to Finance Wales who are reported
to be very busy (Finance Wales is a small investment bank, set
up with European funding, and managed by the Welsh Assembly).
There is a feeling that Finance Wales will be more understanding
of the difficult economic position; their interest rates are higher
than banks, but they will lend unsecured, which banks will not—Wales.
Corporate finance activity has practically ceased. This is
regarded as the consequence of the banks' refusal to lend. "Corporate
finance has died. There's no money out there"—East
Midlands.
Certain corporate finance deals are still happening, such
as the sale and purchase of large corporates' non-core businesses,
at the £25 million to £50 million level. However, good
deals are failing to happen because they cannot be financed—East
Midlands.
The relationship between the small business and its bank
is very difficult at the moment because the local corporate banker
appears to have no authority and is micro-managed by his/her head
office—East Midlands.
The banks are pretty loyal to existing customers but are
largely shut to new business—East Midlands.
Personal guarantees are often required where they were not
expected and the amount of security demanded is higher than anticipated.
"At the moment things are hard if you are borrowing"—East
Midlands.
When Advantage West Midlands announced a £4 million
turnaround fund for SMEs in financial difficulty, the agency received
100 enquiries in two and a half days—West Midlands.
There have been no first-hand reports of businesses being
refused renewal of an existing overdraft or loan but plenty of
examples of their being refused relatively small increases in
borrowings, often to cover short term cash requirements—East
Midlands.
Smaller firms trying to raise money were experiencing difficulty
and it was reported that any firm needing to renegotiate finances
over the next 12 months "would be in for a big shock"—South
East.
"Banks are closed for business at the moment".
They are being accused of levying exorbitant fees. A general comment
was that the banks really need to do something now to break the
deadlock—South East.
Smaller firms are experiencing difficulty raising funds.
There is concern about activities of banks. It is difficult for
SME clients to find funding despite bank claims that they are
lending. Also, banks are consistently changing local personnel
making it difficult to establish working relationships—South
West.
A medium-sized construction company successfully re-negotiated
its credit facilities with its bank. But there was a considerable
delay between the date of the meeting and the final decision which
left the business teetering on the edge of a financial black hole—West
Midlands.
There is no evidence yet that the Credit Crunch is beginning
to ease. The liquidity that the Government has pumped into the
banking sector is not yet flowing through into easier terms or
access to working capital—Yorkshire & Humber.
There have been frequent reports of clients being moved from
overdrafts to term loans and/or invoice finance even if facilities
are not due for review—especially those clients who are
going to their bank to request an extension of an existing line;
this may well result in a complete renegotiation of all banking
facilities, and an unwelcome increase in rates charged—Yorkshire
& Humber.
Trade credit is drying up: nervous creditors are analysing
accounts and cutting credit limits; equally, the availability
of leasing or factoring finance is not easy—Yorkshire &
Humber.
That said, almost all lenders say that they are open for
business, and we were given examples of two corporate finance
deals that have completed safely, with no more than a 0.5% increase
in the rates being offered—Yorkshire & Humber.
Interest rates charged by banks still high, bad debts are
increasing. The costs of defaults will be three to four times
pre credit crunch levels. There will be insolvencies among large
businesses. Consumer confidence is underpinned by house price
inflation—London.
Smaller firms report that there is still CF activity, but
fewer deals are happening. More work around the renewal of finance,
where banks are variously reported as being far too risk averse
and charging higher interest than previously—4%-5% over
base is the norm where it was 2%-3% over base. To add further
fuel, renewal fees are also being increased significantly by banks—Northern
region.
Small businesses with bank overdraft facilities coming up
for renewal are finding rates increased from 2% above base rate
to 4.5% above base rate as a minimum. This applies to all sectors
and is soon expected to have an impact on small business profitability—East
Midlands.
Interest rates are far more geared to risk than they used
to be and "risky" customers will be charged significantly
more than 4.5% above base rate—East Midlands.
Banks' fees for arranging overdraft and loan facilities have
increased enormously. One interviewee reported increases of "thousands".
Another reported the most extreme case he had ever heard of—an
arrangement fee of £1,500 last year had grown to £30,000
in the summer of 2008 on a facility of £3 million—East
Midlands.
At the larger end of the market, one example given was an
arrangement fee in negotiation of £2-3million on a facility
of £50million, which must be renewed in six months time when
another fee may very well be charged—East Midlands.
Businesses have examples of overdraft and loan facilities
being increased between 2% and 4% upon renewal and arrangement
fees vary from £1,000 for relatively small amounts to 5%
for amounts over £100,000—North West.
KNOCK-ON
EFFECT ON
SMES
Cash-flow
Stable businesses finding issues paying VAT bills, and difficulties
finding funding from banks. This combined with increasingly late
payment, likely to cause business failures—South West.
Cash-flow has slowed as everyone is delaying paying bills—South
East.
Bad debts, and the time to taken to pay and be paid for goods
and services have all increased. Respondents felt that on balance
the delays were, as yet, more a result of prudence and caution
than an inability to pay—but this situation may well change.
Several accountancy practices are working closely with clients
facing challenges -in many of these cases there will be one or
more recent invoices still unpaid; there is a looming choice between
increasing exposure from continuing to act in the hope of nursing
the client through, or seeking to reduce exposure but making it
more likely that the client will fail as a result—Yorkshire
& Humber.
Chartered Accountancy firms report that clients are concerned
about cash flow or already experiencing cash flow difficulties.
One partner with a portfolio of medium and large businesses reported
that approximately 20% of his clients were currently breaching
their bank facilities or struggling with their cash position.
Their only option is to trim their costs and their workforce—East
Midlands.
Late payment is becoming more of a problem. Businesses desperate
for sales are reluctant to turn down orders and are having to
chase debts more assiduously—East Midlands.
HMRC
Many practices found HMRC were not exactly sympathetic! Some
small businesses are struggling to pay VAT bills but HMRC using
discretionary powers to penalise. This is putting small firms
out of business unnecessarily. Given some leeway these businesses
are viable—South West.
The more punitive powers of HMRC towards businesses already
experiencing cash flow difficulties, is reported to have resulted
in business failures. There are two specifics: The first relates
to late payment of VAT which, after three consecutive late payments,
results in massive surcharges on the business; the second concerns
HMRC's powers to withdraw the Construction Industry Scheme as
a consequence of the employers' late payment of PAYE, causing
severe and sometimes fatal damage to a business' cash flow—East
Midlands.
CREDIT INSURANCE
Credit insurance has been highlighted in relation to the
US car-manufacturing giants but it is becoming a serious problem
for SMEs, who insure their credit risks for peace of mind and
sometimes because it is a condition of invoice discounting—West
Midlands.
"If insurers withdraw credit on a whole industry or
whole territory basis, rather than after a proper assessment of
the individual companies concerned, the wheels of commerce will
slow down even faster and the feared recession will become even
more a self-fulfilling prophecy"—West Midlands.
PROSPECTS FOR
2009
No-one believes that this will be a short recession. The
underlying causes and the lack of real solutions means that the
recovery will be retail led, and it will take some time to restore
consumer confidence. Most companies are looking at the first quarter
of 2010 before any real signs of recovery and a few, mainly in
the corporate events and hospitality sector are predicting a gloomy
2012—North West.
Business Links report that the number of New Start businesses
has not dropped in the last two months but there has been a 70%
drop in the number of enquiries. This is expected to lead to a
sharp downfall in new Starts in early 2009—North West.
At the moment very few businesses show signs that they might
not pull through a recession though weak businesses are struggling,
including early start-ups and/or undercapitalised businesses—South
East.
There is evidence to support the fact that Liverpool has
bucked the trend to some degree but this is due largely to 2008
being the year of European Capital of Culture. Many believe that
the city will have a harder time than other areas of the North
West in 2009-10 as the reality of the recession hits home—North
West.
Many companies are deciding not to replace staff who are
leaving and will rely on "natural wastage" as far as
possible. However, many believe that redundancies will be inevitable
as the recession settles in during 2009—North West.
It is believed that the majority of job losses in the financial
sector in Manchester and the wider North West related directly
to the recession will probably occur post Christmas period whilst
those associated with the re-structuring process will be seen
throughout 2009 and even into early 2010—North West.
Some companies feel that the pipeline of business is running
out and are concerned about what might happen in three to six
months. However, for some clients in the South East business is
still booming. Practices are not seeing businesses adopting large
scale redundancy programmes but the first enquiries on how to
manage such programmes are trickling in—South East.
While members are aware of many businesses attempting to
reduce their employee numbers, large-scale job losses are still
rare; it is more usual at the moment to look for early retirements,
or to seek not to replace a person who leaves—Yorkshire
& Humber.
The current situation will not change at least until Q2 2009;
it is not known when everything is going to be stabilised, confidence
is knocking everybody—London.
Insolvency practitioners say demand for their services is
still only "steady" rather than overwhelming. However,
they believe this is because many personal and corporate insolvencies
are being postponed until after Christmas, either on the grounds
that the festive season might just provide a financial lifeline
or, in the case of individuals, that they may as well eat, drink
and be merry while they can—West Midlands.
Start up enquiries are increasing. The RDA announced a £10
million package of measures recently, including assistance for
start up businesses. There is no sense from members that these
enquiries include an increased proportion of distress start-ups—Northern
Region.
APPENDIX TWO
THE ICAEW BUSINESS CONFIDENCE MONITOR
The ICAEW has been conducting the UK Business Confidence
Monitor since June 2003. The BCM provides a snapshot of the state
of the economy informed by our members; chartered accountants
who advise and run businesses of all sizes across every economic
sector in the UK. It is one of the largest and most comprehensive
quarterly reviews of UK business confidence—c1,000 interviews
each quarter among senior business professionals across all UK
regions, commercial sectors and sizes of businesses. Reports and
other materials are distributed to a wide range of national and
regional public policy stakeholders, reaching the highest levels
of government and parliament, including the Bank of England. The
BCM provides a robust tool on which government and regional authorities
can base decisions for developing both business and economic policy.
APPENDIX THREE
ICAEW GOING CONCERN POLICY BRIEFING, 4 DECEMBER 2008
GOING CONCERN
ICAEW calls for greater understanding of the going concern
uncertainty expected in 2008 audited financial statements.
1. The "going concern" basis
"That the business entity is viewed as continuing
in business for the foreseeable future with neither the intention
nor the necessity of liquidation, ceasing trading or seeking protection
from creditors pursuant to laws or regulations".[39]
Financial reporting is at the heart of modern markets and
the going concern basis is a fundamental concept in financial
reporting. Normally, assets and liabilities are reported on a
going concern basis—ie that the company will continue for
the foreseeable future.
Company directors must prepare financial statements on a
going concern basis unless they intend to liquidate the business
or to cease trading, or have no realistic alternative but to do
so. In deciding whether the going concern basis is appropriate,
directors examine existing budgets and forecasts, assess borrowing
requirements, and review other information as needed. Directors
are required to take into account all available information about
the future which is at least, but not limited to, one year from
the date of approval of the financial statements. This is an exceptionally
difficult task in the current market climate.
The auditor evaluates the directors' assessment and considers
whether there are events or conditions which may cast significant
doubt on the company's ability to continue as a going concern.
As a result, the auditor may seek further audit evidence.
If, after obtaining further audit evidence, a material uncertainty
remains which may cast significant doubt on the company's ability
to continue as a going concern and this uncertainty has been adequately
disclosed in the financial statements, the auditor will modify
the audit opinion by including an "emphasis of matter"
explanatory paragraph highlighting those disclosures. Such a paragraph
does not affect the auditor's opinion, which is modified but "clean"
or unqualified. Alternatively, where disclosures are deemed not
to be adequate, the auditor will issue a qualified opinion and
provide the required additional disclosures.
2. What is the issue?
Given the current economic environment, the ICAEW anticipates
that a significantly higher proportion of 2008 year end annual
reports are likely to contain disclosures relating to going concern
and liquidity, together with an increase in the number of modified
audit reports, as compared to previous years.
The nature of the market reaction, and the full market implications
of a rise in these disclosures and modified audit opinions, will
be heavily affected by the levels of understanding and awareness
regarding the cause of this likely rise.
If investors and others do not respond proportionately to
emphasis of matter paragraphs explaining going concern uncertainty,
and do not take into account the current exceptional economic
circumstances, the issue has the potential to undermine wider
business confidence.
3. Why are modified audits expected to rise?
The economic environment is currently challenging, with low
levels of business and consumer confidence. The ICAEW 2008 Q4
Business Confidence Monitor found that UK business confidence
had fallen for a sixth consecutive quarter to reach the lowest
level since the monitor began. Commercial and domestic property
value, which underpins a large proportion of credit facilities,
has been falling. In addition, adverse trading conditions have
negatively impacted on profitability and cashflow. These factors
all reduce the likelihood that lending institutions, already inclined
to be more risk averse, will renew existing credit lines.
This may well result in directors concluding that there is
a need to disclose that a material uncertainty exists that leads
to significant doubt on the company's ability to continue as a
going concern. Similarly, the auditor will need to refer to the
directors' disclosure of this uncertainty in the audit opinion.
4. How might businesses and investors react to modified
audit reports?
If the wider market is insufficiently prepared and readers
of audit opinions do not understand why a company is including
going concern or liquidity risk disclosures or why an audit opinion
has been modified, there is the potential for a number of damaging
effects:
— A funder/lender may react by withdrawing or declining
to renew credit facilities, damaging an otherwise viable business
that may be reliant on those credit arrangements.
— In some cases, a modified audit opinion could
be interpreted as businesses having breached loan covenants.
— Suppliers may stop or interrupt providing credit
facilities to a business, disrupting its trading activities.
— Landlords may seek to enforce break clauses in
property lease arrangements.
— General business confidence and investor sentiment
may be damaged.
5. The importance of wider market understanding of going
concern uncertainty
Market participants need to be fully aware of what emphasis
of matter paragraphs mean in the current business environment.
Investors and other users of financial statements need to
be aware that, even in those cases where the directors have concluded
that there are material uncertainties, it does not mean that the
company concerned will cease to continue. Going concern uncertainty
is less important in many ways than the nature of the uncertainties
and the proposed management response. Conversely, where the directors
have concluded that there are no material uncertainties, and the
auditor concurs, it does not mean that the company is guaranteed
to continue in business until the date of the next financial statements.
The ICAEW believes that, in many cases, the damaging potential
reactions to modified audit opinions, summarised above, may be
caused by misinterpretations of the "emphasis of matter"
in those modified audit opinions—and as such may be avoidable
given sufficient market understanding and awareness.
The ICAEW welcomes the guidance for directors recently issued
by the Financial Reporting Council (FRC) regarding going concern
and liquidity risk disclosures in the current difficult economic
climate. The guidance emphasised that many companies will be faced
with increased uncertainties and that these need to be disclosed
in an open and transparent fashion. The forthcoming Accounting
Practice Board (APB) bulletin on emphasis of matter will also
provide guidance for auditors when they consider these issues.
The ICAEW has encouraged the APB to publish guidance as a matter
of urgency, prior to the end of the year so that auditors are
able to plan their audit work accordingly.
6. Background to audit reports and the role of company
directors and auditors
All publicly listed companies and companies that exceed a
threshold of staff numbers, turnover, or assets are required to
be audited. In addition, banks or lending institutions may require
businesses to be subject to audit as a term of a loan agreement.
Although publicly listed companies are generally large businesses,
a proportion of companies that exceed the audit threshold and
a significant number of audit-exempt companies that opted for
an audit to fulfil the terms of loan agreements will be small
and medium sized businesses. According to Companies House, 143,600
companies submitted full audited accounts during the 12 months
to 31 March 2008.
Directors have a requirement to prepare the financial statements
on a going concern basis unless they intend to liquidate the business
or to cease trading, or have no realistic alternative but to do
so. In making these assessments, if management is aware of material
uncertainties that may cast doubt on the entity's ability to continue
as a going concern, they need to disclose these uncertainties
within the financial statements. They may however conclude that
the financial statements cannot be prepared on a going concern
basis. This also needs to be disclosed with details of why the
business is not a going concern and highlight the basis on which
the financial statements are prepared.
The auditor reviews the information used by directors in
drawing their conclusion that the going concern basis is appropriate.
The auditor also considers disclosures about going concern and
liquidity risk made in financial statements. If the auditor concludes
that the disclosures are not adequate to meet the requirements
of accounting standards, including the need for financial statements
to give a true and fair view, they are required to qualify their
opinion and to provide their reasons for doing so.
Where a material uncertainty exists that leads to significant
doubt on the company's ability to continue as a going concern,
the auditor has the following choices:
Where the directors have concluded that the going concern
basis is appropriate:
— Where the uncertainty has been adequately disclosed
in the financial statements, the auditor will issue an unqualified
opinion, modified by including an emphasis of matter paragraph.
If there are significant multiple other material uncertainties,
auditors may disclaim their opinion instead of adding an emphasis
of matter paragraph but these material uncertainties can relate
to matters other than going concern.
— Where the uncertainty has not been adequately
disclosed in the financial statements, the auditor will issue
a qualified opinion, stating the reasons why, or give an adverse
opinion.
Where the directors have concluded that the going concern
basis is not appropriate:
— Where the directors have followed an alternative
basis, to which the auditor agrees, and have provided adequate
disclosure in the financial statements, the auditor can issue
an unmodified report (in relation to going concern) Such situations
are rare.
An audit opinion without reference to going concern is not
a guarantee that a business is a going concern.
For further details on the processes for assessing going
concern uncertainty for audit opinions, please see the Financial
Reporting Council guidelines.[40]
The FRC, in its press statement of 27 November 2008, says
that it:
"recognises that the global liquidity squeeze and its
impact on the wider economy increases the challenges for directors
in preparing corporate reports this year ... more time may need
to be spent by directors and audit committees planning the year
end activities, reviewing key assumptions and models used in financial
reporting and in reviewing the significant accounting and disclosure
judgements". The FRC has therefore published an Update
for directors of listed companies on reporting on going concern
and liquidity risk.
The ICAEW plays a key part in making sure that the responsibilities
of all parties are clarified and understood whether they be directors,
auditors or other third parties (such as investors and lenders).
7. Recommendations
The government, regulators, accountancy profession and banking
industry should work together to help ensure that:
— banks and lending institutions make every effort
to raise awareness about the difference between modified and qualified
audit opinions;
— directors and auditors follow the APB guidance;
— where modifications occur, investors and other
businesses respond in a measured and advised manner; and
— media reporting of emphasis of matter paragraphs
should avoid using misleading or emotive language that gives the
impression that a qualified audit opinion has been issued.
The ICAEW encourages wide public dialogue and parliamentary
scrutiny of the going concern uncertainty issue in order to advise
and educate the wider market.
December 2008
38
Working capital management refers to the management of current
or short-term assets and short-term liabilities. Components of
short-term assets include inventories, loans and advances, debtors,
investments and cash and bank balances. Short-term liabilities
include creditors, trade advances, borrowings and provisions.
The major emphasis is, however, on short-term assets, since short-term
liabilities arise in the context of short-term assets. Back
39
Paragraph 3 of International Auditing Standard (UK and Ireland)
570 Going Concern. Back
40
http://www.frc.org.uk/images/uploaded/documents/Bulletin2006_6%20web%20optimized.pdf
and The Auditing Practice Board's International Standard on Auditing
(UK and Ireland) 570 (ISA (UK and Ireland) 570) Going Concern
guidelines for auditors. Back
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