Red Flag Alert Report - Q2 - Rising debt and inflation drives a surge in companies entering financial distress

• 438,702 businesses across the UK in ‘significant’ distress; 8.5% higher than a year ago
• Rising interest rates increase pressure as debt costs rise and consumers rein in spending
• Construction and property businesses account for more than a quarter of this distress (118,295)
• Discretionary spend sectors particularly vulnerable
• Insolvency data reveals a surge in company collapses and points to the likely failure of thousands of ‘zombie’ businesses

Thousands of UK companies are running out of time as the burden of rising interest rates, unmanageable debt, subdued consumer confidence, higher material and labour costs, and wider economic uncertainty combine to put considerable pressure on businesses across the country, according to the latest Begbies Traynor Red Flag Alert. This latest data is sourced from a completely new Red Flag dataset that involved deep dive analysis of eight years’ company data by data scientists over the past two years to track key factors behind company distress and failure rates. The report revealed that 438,702 companies were classed as being in “significant” financial distress in the second quarter of 2023. This is an increase of 8.5% on the same period last year, and 3.7% higher than in the preceding three months.

Julie Palmer, partner at Begbies Traynor, said: “Higher interest rates are causing real pain across the whole economy. Whether that’s because consumers are cutting back on spending as they face higher mortgage and loan repayments, or businesses seeing the cost of their debt rising, it’s putting extra strain on many companies still suffering from the hangover caused by the pandemic, the impact of conflict in Ukraine, higher energy bills and spiralling inflation.
“As the Bank of England tries to battle inflation with almost monthly interest rate rises, companies are having to get used to the fact that the era of ‘cheap money’ is over, with rates now expected to remain at these elevated levels for years to come.

“For businesses that loaded up with debt during a benign inflationary environment, that’s a huge extra financial burden in an environment compounded by consumersreining in spending. It’s no wonder that the number of companies facing significant distress has jumped since last year.”

Of the 22 sectors monitored by Red Flag Alert, nine reported increases of over 10% in the number of companies in significant financial distress compared with a year ago. Sectors suffering the biggest increases in significant distress compared to last year were Sport and Health Clubs (+14.8%), Real Estate and Property Services, (+14.3%), General Retailers (+14%), Health and Education (+14%), and Food & Drug Retailers (+13.2%). The financial distress is clear with all 22 sectors experiencing an increase in significant distress rates, with an average increase across the sectors of 8.1%. Significant distress levels in businesses particularly exposed to discretionary spending – Sport and  Health Clubs, Bars and Restaurants, Hotels and Accommodation, Leisure and Cultural Activities, and Travel and Tourism – totalled 36,621 in the quarter, an annual rise of 8.8%, higher than the average increase across all sectors monitored by Red Flag Alert. Registering the highest count of businesses in significant distress was Support Services at 67,792 (15.5% of the total), Construction 61,423 (14%), Real Estate and Property Services 56,872 (13%), Professional Services 35,298 (8%), and General Retailers 29,675 (6.8%).

Ms Palmer added: “Construction and property have long been bellwethers for the health of the economy and their close links to interest rates and need for debt funding mean they are being hit hard and fast by the current environment, as the numbers show.

“Consumers are desperate to avoid mortgage defaults so it’s no surprise we are starting to see them cut back discretionary spend such as meals out and hotels. It’s very likely that this spending will fall further and businesses that depend on consumers splashing out on treats will come under increased pressure as the country adjusts to the new normal of elevated interest rates.”

Ric Traynor, executive chairman of Begbies Traynor, commented: “Official data from the Insolvency Service shows a marked increase in the number of companies that have collapsed. “Last week’s quarterly data revealed that 6,342 companies went into insolvency, a rise of 13% on last year and the highest quarter since 2009, highlighting that more and more businesses which have clung on until now can no longer withstand the pressure that the current economic climate is piling on them.

“Many of these will have been the so-called ‘zombie’ companies, which were marginally profitable in the era of low interest rates. Unfortunately, high inflation will make many of these businesses financially unviable and the reality is that many of them are likely to fail over the next year. “Although we are likely nearing the peak of interest rate rises, many companies have never experienced such elevated rates, for instance in the last 10 years alone more than 1.5m companies have been added to the Companies House register. The outlook looks particularly challenging for sectors which are especially exposed to these macro-economic headwinds, such as construction, property and leisure as is clear in our latest research.”

Top 10 Sector Ranking – Significant Financial Distress (Number of Companies in Significant Financial Distress)
1. Support Services (67,792)
2. Construction (61,423)
3. Real Estate & Property (56,872)
4. Professional Services (35,298)
5. General Retailers (29,675)
6. Telecoms & IT (28,877)
7. Health & Education (25,849)
8. Media (16,676)
9. Manufacturing (12,824)
10. Financial Services (12,739)