An increase in insolvencies used to be a reliable signal that the economy was coming out of recession.
Six years after the Great Recession in 2008 we are being told that our economies are growing, the recession is over, SMEs are reporting increasing orders yet there is still no sign of an increase in insolvencies.
So what is going on?
The reason that insolvencies rise in an upturn is because two things happen.
Firstly companies start to get an increase in orders, but unless they manage their cash flow carefully, or have adequate reserves of capital they risk overtrading – essentially not being able to fund the growth.
Secondly, secured creditors generally only call in loans when they think there is a fair chance of recovering their money, therefore during an upturn and in particular when the secured assets increase in value.
The consequence is that when creditors start to demand their money back and a company is overtrading it can’t realistically pay off the loan – the result is insolvency.
So in our view, the recession is not yet over, markets remain jittery, confidence is still uncertain and asset values are falling, hence fewer insolvencies.
Have we simply papered over the cracks?