4% of firms face debt payment problems if base rate rises

Nearly 80,000 UK businesses are worried about the impact a base rate rise could have on their debt payment problems, according to recently published figures from R3, the Association of Business Recovery Professionals. The survey was published in early June, when the Bank of England’s Monetary Policy Committee narrowly voted to maintain the base rateRead More

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Nearly 80,000 UK businesses are worried about the impact a base rate rise could have on their debt payment problems, according to recently published figures from R3, the Association of Business Recovery Professionals.

The survey was published in early June, when the Bank of England’s Monetary Policy Committee narrowly voted to maintain the base rate at a historically low 0.25%, by a margin of just five votes to three.

Under the new schedule of MPC meetings, there is not another base rate decision until August, which coincides with the publication of a quarterly Inflation Report by the Bank of England, and might now seem a likely bet for the first base rate increase in over a decade.

As of July 2017, the base rate has remained unchanged at 0.25% since August 2016, and the last time it increased was July 2007, when it was set at the substantially higher rate of 5.75%.

The low current base rate generally means low interest is paid on savings accounts, but also crucially that low interest rates are charged on debts – although at 8.25%, the statutory interest rate chargeable on overdue invoices is still relatively healthy.

But for businesses already struggling to pay their way, even a slight increase to 0.5%, which is now likely to occur very soon, could quickly lead to unmanageable debt payment problems.

Z-Day for zombie firms

R3 found that one in 20 UK companies, equivalent to 5% of the total or nearly 100,000 firms nationwide, are already only able to cover the interest charged on their debts, and are not paying off any of the actual balance of borrowing.

Around 25,000 – 1% of UK businesses – find it hard to pay debts when they are due, and 3% or about 56,000 companies have already renegotiated payment terms with their creditors.

These are key indicators of financial difficulty, although it is worth noting that both numbers have fallen significantly in recent years: in May 2013, 8% of all UK businesses cited difficulty paying due debts, and in November of that year 10% said they had asked creditors for less stringent payment terms.

But those factors relate to the current position, when it is the near future that could bring Z-Day, the day when a significant proportion of so-called ‘zombie businesses’ are pushed over the brink by a common economic event such as a base rate rise.

Zombie firms are those that are able to just continue trading by clearing the interest on debts, but are not managing to do any more than break even – if costs were to increase for any reason, they would be driven immediately into the red.

To put this in context, in September 2016 20,000 businesses said a small rise in interest rates would mean they would be unable to pay their debts, compared with the 79,000 in this latest survey.

How to spot a zombie

R3 spokesperson Andrew Tate said: “Only paying the interest on debts is not necessarily a sign that a business is in distress; it may be that a company is taking advantage of low rates to invest in its operations or assets.

“But only repaying the interest is also a common characteristic of a zombie business – a business only able to keep going because of an ultra-low cost of borrowing and with little chance of survival. The research shows that there are tens of thousands of firms currently walking a very tight line.

“Rising inflation may also lead to a double whammy for struggling businesses: it may increase the chance of the Bank of England raising interest rates, and it would undermine the consumer spending that has driven the economy over the last year.”

As his comments recognise, inflation is a major influence on monetary policy – the MPC has a commitment to keep inflation at around 2.0% over the long term, and with an Inflation Report due to be published in August and the rate in recent months exceeding wage growth, it may be time for the base rate to rise.

Reaching out, holding hands

If the base rate increases in August, or indeed in any near-future month, it’s important to be aware that this could lead to payment problems for a small but significant percentage of your client base.

Even if only the numbers quoted in the R3 survey materialise in your cash flow, that’s still potentially 4% of invoices that are likely to go unpaid for longer in the event of a base rate rise – and a rate increase is almost inevitable in the coming months.

But no business has a ‘typical’ client base, and your exposure to previously unnoticed zombie businesses could be greater than these figures suggest; plus, of course, any debt payment problems arising from the base rate are only likely to become more severe and widespread if the MPC increase the rate further in subsequent meetings.

R3’s figures show a steady decrease in the number of businesses asking their creditors to renegotiate payment terms since late 2013, from 166,000 to about a third of that number, 56,000.

It might be wise to take a proactive stance to your payment terms, by offering incentives for prompt payment, putting a sensible cap on some credit limits, accepting payment by instalments, or even by offering longer payment deadlines where this does not add unnecessarily to the risk of non-payment.

Equally, there are some more hard-line approaches you can employ to make sure you get paid what you are owed, including demanding deposits or part-payment upfront, taking swift and stern enforcement action on overdue and unpaid debts, and refusing to supply customers who fail a basic background credit check.

These more robust methods to protect your own cash flow can sound harsh, but they make good business sense, and can even help to protect the debtor against entering into a supply agreement that they cannot afford to pay for: you may literally help a company to avoid insolvency by refusing to supply them.

What to expect

Nobody knows exactly what the MPC will decide, or when they will decide it: in extreme circumstances, a currently unforeseen economic disaster could still see the base rate drop to an unprecedented zero.

However, the most likely move now is upwards to 0.5% at some point in the near future. The split decision in June makes it more likely that this will happen soon, and the Inflation Report due to be published in August is likely to have a major influence on that month’s decision. (There is no MPC meeting in July under the new schedule, which has the MPC meeting only eight times a year, instead of every month.)

If and when the base rate rises, you should be ready for it. Be aware that some of your existing customers may be ‘zombies’ in the sense of only just covering their outgoings – and a higher interest rate on business debts could leave them unable to pay you on time, in full or even at all.

Have a plan for this. Take the hard line and enforce payment through the appropriate legal channels, or take a softer approach and encourage payment by instalments, or offer a small discount to make the amount more manageable. It’s up to you – the important thing is to get as much of your money as you can, as quickly and easily as possible.

Debt recovery agencies like the CPA will be here to take on any collections you don’t want to handle yourself, and this can be especially useful if you want to take the hard line, but have always been very friendly and approachable to your customers in the past.

Remember too that this is an ongoing concern, so any new customers should be thoroughly vetted by obtaining background credit ratings, and setting their credit limits accordingly.

Finally, if you have any outstanding debts to chase, a rise in the Bank of England base rate should allow you to charge a higher rate of statutory interest – a likely 8.50% instead of 8.25% – and while this will probably add up to a few pence in the short term, it makes a change in the rate a great time to remind any non-paying debtors that their exposure to additional costs has just gone up.

Whatever happens, if you are a creditor, interest rates are in your favour as a way of raising additional funds on client debts, or as a bargaining chip to encourage prompt payment; so an imminent base rate rise, while it has the potential to disrupt the unprepared, is good news for those trading in the black over the long term.


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