With the inflation rate in the UK remaining stubbornly high and the base rate at its highest level for 15 years, businesses are continuing to face an uncertain financial environment.
We have seen little evidence of a direct impact on the volume of special situations and turnround activity since interest rates started increasing 18 months ago. But in our discussions with contacts in the market, there has been a noticeably heightened awareness of the cost of borrowing and the likely longer-term effects this will have on businesses, especially around refinancing discussions.
Cost inflation is already being felt across the board. Particularly over the past 6 months, this has driven a steady increase in the number of businesses looking for external support and advice around issues like cash and working capital management, cost base rationalisation, product and customer reviews, operating footprint optimisation, debt advisory and stressed / distressed M&A opportunities.
In the longer term, the increased cost of living that every household is facing will inevitably have an impact on consumer-led businesses, such as those in the retail, leisure, casual dining and travel sectors. The housing market will also feel the effects of increased borrowing costs as mortgage rates remain high, with a knock-on impact on construction and house builders, building materials suppliers and ancillary services. Manufacturing, too, is unlikely to remain unscathed by the slow-down in trading environments.
Cost of debt concerns
One particular area of concern for many businesses is the spiralling cost of debt, with companies increasingly looking for advice on issues like capital structure/financing options across all available debt markets and products, raising or refinancing debt facilities and renegotiating debt facilities.
Until recently, companies have enjoyed a relative benign credit market with historically low interest rates, and this has driven significant deal activity supported by borrowing. But rising interest rates have come at a time when some of that cheap debt is maturing and borrowers need more liquidity to manage inflationary pressures on their working capital.
In addition, lenders are responding to economic uncertainty by deploying capital more selectively and conservatively, meaning those borrowers who need to raise finance are finding it more difficult to do so.
In this context, releasing liquidity internally through improved working capital strategies can help borrowers access cash more efficiently and cheaply than external debt, as well as reducing the level of external debt required.
Options for working capital funding
As margins are squeezed by inflationary pressures, conventional financing, usually by way of a revolving credit facility (RCF) - the terms of which are based on an expected level of trading performance - may see covenant pressure or may not provide access to the level of debt required.
This is one of the key reasons behind the increasing popularity of other working capital funding options, such as asset-based lending (ABL). There is an established ABL market in the UK capable of providing flexible financing against trade receivables, inventory and fixed assets, typically at a lower cost than comparable RCF finance and usually with lighter covenants. ABL may also provide access to larger levels of debt than conventional financing, especially where EBITDA is being squeezed.
Alternatives also exist to leverage specific working capital components, through supply chain financing programmes, non-recourse receivables purchase and specialist inventory financing solutions, for example.
How KPMG can help
With interest rates and inflation looking set to stay at elevated levels for the foreseeable future, businesses need to get comfortable with trading in a much tighter financial environment than they have been used to in the recent past. This will inevitably bring new pressures on cash flow, working capital and cost of debt.
KPMG’s Special Situations and Debt Advisory teams work with clients across the UK to advise and support them through financial and operational stress. Drawing on substantial turnaround, crisis management and debt advisory experience, we work to quickly stabilise businesses and provide strategic solutions to help organisations navigate the challenges of financial uncertainty.
For more information on how to get manage debt concerns, borrowing and working capital, get in touch with our team:
Brian Horn, Special Situations and Turnaround Group
Marc Finer, Debt Advisory