How Many High Street Names Will Survive to the End of 2011?

Traditionally UK retailers expect sales in the fourth quarter of the year(Q4) to be significantly boosted by pre-Christmas shopping and by year end sales.

However, according to figures released on January 21 by the Office for National Statistics retail sales volumes dropped 0.8% in December compared with November. It was said to be the weakest annual performance for any December since records began in 1988.

Among those that have already reported sales drops are Clinton Cards, with sales down by 2.1% in the last five weeks of the year, and Mothercare posting a drop of 4%. HMV reported falls in December sales of 10% in the UK and 13.6% in Ireland and issued a profit warning.  Next said it had lost £22 million in Christmas sales.

Many blamed the three weeks of December snow that seized up the UK’s transport system and even online shopping options were no help because many distribution services were unable to guarantee pre-Christmas deliveries.

Sainsbury’s, however, reported sales up 10.1% for the four weeks to December 25, compared with the same period in 2009.

The Q4 figures and further retail results may show that there has been some late-December cheer as consumers rushed to beat the January 4 VAT increase, from 17.5% to 20%.

But it is looking as if the end of year boost the retail sector traditionally relies on may not have quite materialised for most and may have left them less well placed to face the difficult trading conditions expected in 2011.

The most difficult issue facing retailers will be maintaining their profit margins. Margins may have been propped up in December-January by the rush to beat the VAT increase, especially on the larger items but commodity prices on basics like cotton, wheat, rice, maize and sugar are expected to continue to rise thanks to global financial speculation.

Without a fundamental examination of the business, cost cutting (wages, premises,  equipment etc) may not be sufficient for survival in current conditions.

Perhaps a high street retail presence is no longer sustainable and more fundamental and innovative solutions, such as moving the emphasis to online selling, may be the only way some retailers can survive.

The Focus Must be on Cash Management When Times Are Tough

Profit and turnover are, of course, important measures of business performance but when times are as difficult as they are at the start of 2011 and many businesses are finding themselves in difficulties the main focus must shift to cash.

Cash flow is the most immediate indicator of the way a business is performing and can also provide a warning signal that action needs to be taken to prevent a slide into insolvency.

Close attention to cash flow should give a clearer picture of the immediate state of the business but while it may be possible to adjust to strengthen incomings against outgoings this is only going to be a holding operation.

The business must also look at its business plan and business model, preferably with the help of a turnaround adviser.  An objective outsider working as part of the business team to secure its medium and longer term future may identify fundamental weaknesses that undermine the ability to control cash flow.

The first step in managing cash is to construct a 13-week cash flow forecast to help identify risks and actions that can be taken to reduce them. It should include income from sales and other receipts and outgoings, both to ongoing obligations such as rent wages and finance and to creditors.

The business also needs to control cash on a daily basis, with payments made on a priority basis with purchases approved by an authorised person who is aware of their impact on cash flow. This will avoid the risk of returned cheques. It is also advisable to talk to the bank and keep it aware of what is being done to keep things under control.

Tight control of cash coupled with a thorough look at the business model and a realistic business plan will go a long way to help a business survive in difficult trading conditions.

Businesses Should Prepare Themselves for the High Level of Inflation

One of the greatest worries in the predicted difficult conditions of 2011 for both businesses and consumers is price inflation thanks in part to the increase in VAT from 17.5% to 20% from January 4 but also to the rise in commodity prices including basic foods and oil. 

Coupled with rising energy prices and public sector job cuts, this is expected to lead to a drop in consumer spending on non-essentials.

Businesses therefore need to protect themselves to ensure their survival and consider whether to concentrate on profits in the short term rather than longer term growth.

A high inflation rate makes it difficult for businesses to set prices. Normally when the inflation rate is climbing too quickly or remaining consistently high, interest rates will be increased in an attempt to bring it under control and eventually reduce it.

However, in an interconnected global economy, where most countries are subject to the same external pressures from such things as commodity price speculation on basic foods, speculation on futures in oil and minerals that are the raw materials used by manufacturers, it is being argued that this will not work now.

Financial engineering is being carried out well outside the influence of the government and beyond any attempts by the Bank of England to use interest rates to bring inflation down.  The question is whether in fact inflation is something to be worried about in current circumstances.

A UK business trading only in the UK will face a tougher time than a UK business focused on export, which can target the emerging BRICs with expanding middle classes that provide capacity for economic growth.

UK focused businesses in 2011 are therefore likely to be caught between a rock and a hard place and it may be that businesses should consider carrying out a thorough review to identify any cost savings they could make before the going gets any tougher.

The Questions HM Revenue and Customs Asks to Assess a request for Time to Pay Arrears

Recently uploaded guidelines for HM Revenue and Customs case officers dealing with requests from businesses in difficulty for time to pay arrears of VAT, PAYE or tax, reveal the detail of what questions will be asked before the request for a Time to Pay arrangement (TTP) can be considered.

Applicants must be able to show that they have tried to raise the money they owe by other means beforehand.  Individuals, which includes sole traders and the self employed, may be asked to show that they have approached their bank or asked friends or family for a loan or that they cannot pay the debt via a credit card.

However, the advice to case officers also states that for individuals “it is unacceptable for us to insist that a customer has made every effort to secure a loan before agreeing TTP” because it would contravene Office of Fair Trading Debt Collection Guidelines.

Both individuals and larger businesses may also be asked whether they have any assets that can be easily converted into cash or any savings that they could use to settle the debt, even if early withdrawal might incur a payment penalty. This also applies to endowment or life insurance policies, although the HMRC cannot insist that these are cashed to pay a debt.

The HMRC distinguishes between debts below £100,000 and debts above that amount and for larger businesses HMRC would want to see evidence, usually a letter from the bank, that the company has approached their bank and discussed borrowing facilities beforehand as well as exploring options for raising money from: shareholders, Directors, book debt factoring and invoice discounting, stock finance, sale and leaseback of assets or venture capital providers.

The case officer will also consider the applicant’s previous history of paying on time, whether they have had a previous TTP and previous difficulties will weigh heavily in the final decision and whether the business is viable.

It would make sense, therefore, to have a thorough business review and the support of a rescue adviser or insolvency practitioner to assess the business viability and explore all these options and to document them before approaching HMRC.

HMRC’s Assessment Criteria for a Time to Pay Arrangement for Revenue Arrears

As businesses face continued tough trading conditions in 2011 a new series of guidelines has appeared on the HM Customs and Revenue (HMRC) website on the arrangements for paying arrears of tax, VAT and PAYE, known as Time to Pay (TTP).

Although the guidelines are aimed at those working in the revenue they are equally useful for businesses in difficulties in outlining the questions and conditions businesses will need to be prepared for if they are in arrears with revenue payments and looking for a manageable way to spread the repayments.

Firstly, in all cases the repayment period to be set will be as short as possible and usually no more than a year unless there are “exceptional circumstances”. However long the arrangement, interest will be charged while the debt remains outstanding.

There is no entitlement for a business to be granted a TTP.  HMRC officers must consider the timescale being requested by the “customer”, their previous payment history and the amount outstanding. 

Businesses must meet two further conditions and they are that the applicant must have the means to make the agreed payments as well as the means to pay other tax liabilities that become due during the TTP period.

Finally, the guidelines make it clear that the preferred method of dealing with TTP requests is by telephone, because it allows for detailed questioning of the viability of the business, and as part of the assessment of whether the situation is a “can’t” or a “won’t” pay.

The amount of detailed information that will be requested from the applicant will vary according to the level of the debt, divided into three categories, for debts below £100,000, from £100,000 to £1 million and for more than £1 million.

Whatever the level of arrears, for a successful TTP to be achieved any business in difficulty is strongly advised to be honest with itself and its advisers about all its outstanding debts and liabilities if it is to be able to stick to any TTP arrangement.

It is crucial that before the telephone conversation the applicant has all the required information on income and expenditure prepared and ready so that they can remain calm throughout what can be a stressful situation.

Guide to Company Voluntary Arrangements (CVA) and When to Use Them

A Company Voluntary Arrangement (CVA) is a binding agreement between a company and those to whom it owes money (creditors).

It is based on a proposal that will include affordable, realistic and manageable repayment terms. It normally allows for repayment to be spread over a period of three to five years and can also be used to offer to repay less than the amount due if this is all the company can afford.

The proposal is sent to the Company’s Creditors along with an independent report on the proposal by an insolvency practitioner acting as Nominee.

Creditors are invited to respond to the CVA proposal by voting to either accept it, or reject it, or accept it subject to modifications that the Creditor proposes as a condition of their vote for acceptance. The votes are counted by value of claim where the requisite majority for approval is 75% of the votes cast. This is subject to a second vote to check that 50% of the non-connected creditors approve the proposals.

A CVA can only be used when a company is insolvent but it can be used to save a company rather than close it when creditors are pressing including when a debt related judgement can’t be satisfied or a creditor has filed a Winding Up Petition (WUP).

In addition to proposing terms for repaying debt, it helps to include details of any restructuring and reorganisation along with a business plan so that creditors can assess the viability of the surviving business. The proposals must be fair and not prejudice any individual or class of creditor including those with specific rights such as personal guarantees. These include trade suppliers, credit insurers, finance providers, employees, landlords and HM Revenue and Customs, the latter often being key in view of the arrears of VAT and PAYE that many companies have built up.

A CVA should only be used when the company’s directors are willing to be honest with themselves and face up to the position the company is in, preferably with the advice and guidance of an insolvency practitioner or experienced business rescue advisor but used properly it can improve a company’s cash flow very quickly by removing onerous financial obligations and easing the pressure from creditors.

Save Your Company by Terminating Onerous Contracts to Cut Costs

Many directors are afraid of terminating contracts and agreements when their companies are in financial difficulties normally out of a concern that termination will lead to a cancellation payment that the company cannot afford.

If a company is experiencing fewer orders or lower sales, for example, generally it will need fewer staff but the worry is that terminating contracts of employment will trigger costs, particularly where senior staff are involved.

Similarly, a reduction in orders may mean that the company only needs two of the five fork lift trucks it has where terminating a hire purchase, hire or lease arrangement ahead of the agreed contract period will trigger a termination settlement or a contract termination liability.

Equally it might now no longer be able to afford the 12-month advertising contract it agreed six months previously. Even terminating contracts with advisers can be expensive.

A company in financial difficulties does not have the surplus cash to meet these obligations.  But while it puts off terminating arrangements it no longer needs it continues to bear the costs.

It is often better to cut the cash flow if this reduces costs that mean the business is viable: profitable with positive cash flow. There are remedies that can be used if necessary to deal with the crystallised liabilities when a company cannot afford them.

Negotiating terms for informal arrangements with creditors is sensible. It may involve negotiating terms of payment, such as a Time to Pay (TTP) arrangement with HMRC for PAYE or VAT arrears, which have been very effective in helping companies out of insolvency.

Many companies leave it far too late to reach informal arrangements that would have allowed them to terminate contracts before the company finally runs out of money.

But there is a solution that allows companies to terminate contracts and not pay for them immediately on termination. A Company Voluntary Arrangement (CVA) avoids liquidation of the business and closing it down. It allows for paying the contract termination out of profits.

Guide to Insolvent Liquidation and When and How it is Used

Insolvent Liquidation involves a formal process to close a company. It happens when a company is insolvent, which means it does not have enough cash or liquid assets to pay its debts and the directors have concluded that continuing to trade will be detrimental to creditors.

There are four tests (set out in the Insolvency Act 1986) any of which can be used to establish whether a company is insolvent.  The tests don’t necessarily mean that the company will have to close down, although often directors assume that it must.  However, there are remedies that could save the company if at this stage it calls on a licensed insolvency practitioner or business turnaround adviser, who would carry out a review of the accounts, the assets including property, stock and debts and the liabilities. With help from the adviser, the company can develop realistic plans for it to survive and trade out of insolvency.

Once it is decided that the company is insolvent, and cannot be rescued, it should be closed down in an orderly fashion which means via a liquidation process. This involves the company’s assets being turned into cash and used to pay off its debts to creditors.

There are two types of liquidation, one compulsory and one voluntary and both are legal processes.

Voluntary liquidation through a Creditors’ Voluntary Liquidation (CVL) is when the directors of the company themselves conclude that the company can no longer go on trading and should be wound up.

Normally they would engage an insolvency practitioner to help guide the directors through the formal procedure, which involves a board meeting to convene shareholder and creditor meetings.

The nominated liquidator normally sends out notices to shareholders and creditors having obtained their details from the directors and helps directors prepare the necessary formal documentation that is legally required.

The nominated liquidator must be a licensed insolvency practitioner who provides his consent to act which must be available for inspection at the meeting.

If the directors have left consulting too late they can then find themselves facing the court winding up procedure rather than having the option of a CVL.

Compulsory liquidation is triggered by a creditor formally asking the courts to have a company closed down by submitting a Winding Up Petition (WUP. In this case the court decides whether or not to support the petition by ordering that the company be wound up (compulsorily liquidated).

Upon a winding up order being made, an officer called the official receiver is automatically appointed to take control of the company to oversee the process of closing it down.  The official receiver may, if he/she wishes, appoint a liquidator to assist in dealing with recovering and selling any assets.

Dealing with the Bank When Considering a Company Voluntary Arrangement

The large number of companies in financial difficulties is swamping the banks and as a result there is a lack of experience in banks when dealing with companies in the process of restructuring.

If a company is subject to a Winding-up Petition (WUP) the bank can be held liable for any funds that are paid out of its bank account once the Petition has been advertised in the London Gazette. As a result banks tend to freeze the accounts of any company with an outstanding WUP as soon as they become aware of it. The only way for a company to free up money in a frozen account is via an application to Court for a Validation Order.

When attempting to save a company where there is no WUP, however, the lack of experience among banks means that in some instances they are behaving as if there were a WUP and this is getting in the way of attempts to restructure because banks do not understand the distinction between the various restructuring tools.

An example of where this is happening is when a Company Voluntary Arrangement (CVA) is being proposed.  The process of agreeing a CVA involves notifying creditors of the intention and allowing time for a meeting to be set up for creditors to approve the CVA proposals. Usually there is a hiatus period of at least three weeks between notification and the meeting, which allows creditors to consider the proposals and make any comments or request adjustments before the meeting.

However, banks’ inexperience of CVAs is leading some of them to freeze company accounts during the hiatus period and this has an adverse effect in that the company is no longer able to trade. While banks generally do not have the right to freeze their clients’ bank accounts unless there is either a WUP, an order by the Court or a breach of contract, they may take precautionary action out of fear when they don’t know what is going on. Concern about fraud can always be used to justify such an action.

It therefore makes sense for a company to talk to its bank beforehand to let them know what’s going on. Where the company is overdrawn clearly the bank is a creditor and should be notified of any restructuring proposals, in particular where there is a CVA.

An Outline of Shareholder and Director Liabilities When a Business is in Difficulty

When a company is insolvent the duties of the directors as its officers move from a primary duty to shareholders to a primary duty to protecting the interests of its creditors.

Shareholders’ liabilities are limited to the value of their equity and are protected from liability to creditors under what is known as the “corporate veil”.

However, if the shares are only partly paid for and the company enters formal insolvency the creditors can, via the appointment of a liquidator, demand that the shares be fully paid in order to discharge the creditors’ liability.

It is also possible that a company’s shareholders might have given a personal guarantee at some stage during their involvement with the company.  It might be that at start-up for instance, particularly when a family member has started a small business, or when the company subsequently entered a contract such as a lease, some or all of the shareholders personally guaranteed the contract and then later forget about it, especially if they are no longer directors or officers of the company as they may have been in its early days.  It can also be an issue after the shareholders have sold their shares but not discharged their personal guarantees.

Directors, on the other hand, can be held to be personally liable under the Insolvency Act 1986 for money owed to creditors. They must not sell any assets under their market value. They must not pay some creditors and not others in a way that seeks to prefer those being paid.  The fiduciary duty imposed on the directors of an insolvent company leaves them with personal liabilities that are not imposed on shareholders.

However, it is often the case with small companies that the director and shareholder are one and the same and in those situations the director must remember that he or she wears different hats as director, shareholder, employee and also as a creditor, if they have lent money to the company. This is in particular an area where repaying director loans can attract a charge of preference referred to above.

It therefore makes sense to get outside help from a business turnaround or rescue adviser if you are involved in a business as both a shareholder and as a creditor. It is in the advisor’s interests to offer realistic solutions to help restructure the company.