After a slew of profit warnings this summer, last quarter's record onslaught of insolvencies is likely to be just the first wave in a tsunami of dissolutions.
The latest figures show UK insolvencies surged 81% year on year in the second quarter, amid record inflation and an all-time slump in consumer confidence.
More companies could be up for sale or dissolution this year after the number of profit warnings issued by British businesses jumped two-thirds in the first half of this year.
Several major retailers, insurers and finance companies have issued profit warnings this year, with Made.com Group PLC (LSE:MADE) and Credit Suisse Group AG (NYSE:CS) among those to issue multiple warnings, each issuing three warnings in less than a year.
Analysts at audit firm Ernst and Young (EY) estimate that company insolvencies can be predicted using a three-profit warning rule. According to the auditor, a fifth of companies become insolvent within a year of their third profit warning.
EY-Parthenon’s latest analysis of recent profit warnings found that warnings by UK-listed companies rose two-thirds in the first half of this year. More than half of these companies, 58%, cited rising costs as a factor behind declining profits.
Its report found that 136 profit warnings were issued in the first half, up from 82 in the first six months of 2021. The findings were that 72 warnings were issued in the first quarter and 64 were issued in the second quarter, double the number of profit warnings in the equivalent part of 2021.
Creditors’ voluntary liquidations, where directors choose to liquidate a company, accounted for a vast majority of the recently reported insolvencies, as many as nine out of 10.
Samantha Keen, UK turnaround and restructuring strategy partner at EY-Parthenon, said this first wave of insolvencies is likely to include companies that “struggled to stay viable” without government support provided during the pandemic.
Insolvencies may take a while to translate into business closures, as some of those businesses may go through a restructuring or sell their assets off to new investors.
UK government data showed that the number of UK business closures rose 8% in the quarter that ran from April to June, the highest quarterly level since 2017, which could rise further as a result of the latest wave of insolvencies. These were businesses that were removed from the Inter-Departmental Business Register.
The Office for National Statistics recorded 113,700 business closures in the period, which were across a majority of industries, with the “most significant increase coming from retail” where the number of shuttered businesses rose by 40%.
Mail order and online retail sales were the two main industries “contributing to the increase in closures within retail”, the ONS said.
More businesses closed during the period than were set up, for the fifth consecutive quarter.
Future insolvencies could affect bigger businesses that fail to adapt to prevailing market conditions, according to EY analysts.
“We expect further insolvencies in the year ahead among larger businesses who are struggling to adapt to challenging trading conditions, tighter capital, and increased market volatility,” Keen said. “As profit warnings increase, we’re seeing more companies issue multiple warnings with many approaching the ‘three warning rule’ where, on average, one-in-five companies delist within a year of their third warning, most due to insolvency.”
EY chief economist Peter Arnold said in an interview last month that the UK could be heading into a recession in the autumn as consumer spending is hit harder. The accountancy firm downgraded consumer spending growth in 2022 to 4.1% in its summer forecast down from 4.9% expected in February.
“The impact from the slowdown in consumer spending is likely to be felt in the autumn, just as many retail and hospitality businesses gear up for the all-important ‘golden quarter’,” said Keen. “These businesses, which are highly sensitive to fluctuations in consumer demand, will be most vulnerable.
“While many companies have been grappling with rising costs and supply chain issues in the first half of the year, falling consumer confidence and demand is likely to be the next significant headwind.”