What’s stopping small clients from investing?

A lot of worrying factors, according to accountants.

Rising business costs whether it’s raw materials, energy bills, inflation or increased rent are disproportionately affecting small businesses and SMEs. Larger businesses on the other hand, usually have the cash reserves and resources to swallow cost increases.

Increased costs are one reason why some SMEs are struggling to grow and invest – but there are other barriers, too.

PayPal’s 2024 Business of Change Report surveyed over 500 SMEs. It found that nearly half are pessimistic about their ability to grow and scale up over the next two years due to the difficult economic climate but also because they’re lacking in-house ‘technical expertise’.

Other reasons given included:

• Industry competition (35%)
• Changing consumer behaviour/fewer consumer purchases (37%)
• Insufficient marketing funds (21%).

But research from Purbeck Personal Guarantee Insurance in July actually found there was an increase in the number of small businesses looking to invest. They found that more small businesses applied for finance to support growth initiatives in Q2 2024 than at any other time over the past three years.

Even so, increased business costs continue to be a huge barrier for growth. It falls increasingly to accountants to play the role of business advisors to help and support small business clients through financially lean times.

We spoke to accountants in practice and in industry to find out if their small business clients are looking to invest and scale up – or if there are barriers preventing them.

Businesses are having to endure inefficient, older technology rather than taking a chance on investment

Ellis Harris-Boulter MAAT, Founder and Director, FieCo Accountancy & Marketing and AAT Tutor

Any time you want to think about how businesses act, I like to think about how we all behave in our daily lives. With high interest rates and difficult inflationary pressures continuing (note service sector inflation continues to be 5.7% as of June 2024, despite the overall level fall), we’re more reluctant now to buy a new car, and quicker to ignore that strange noise coming from the fridge.

In times of uncertainty, businesses are the same. My clients are generally following this exact pattern: enduring inefficient, older technology and avoiding committing to investment, in favour of building reserves and securing their position in the market.

Businesses have adapted to disastrous and untenable circumstances since 2020. These include the coronavirus pandemic, Russia’s invasion of Ukraine, skyrocketing electricity bills and a cost of living crisis supressing consumer spending, to name a few.

Right now, to me there doesn’t seem like a quick-fix to encourage growth. The new government has an almost insurmountable challenge to drive the growth they rely on so very much to avoid tax rises or a return to austerity.

Every small business owner I’ve spoken to is gritting their teeth and looking forward with a respectable, but not exactly confidence-inducing, steely resolve. Right now they need hope, and a period with just a modicum of certainty. It’s a big ask to get businesses to take a chance and invest right now, even with great long term benefit.

Verdict: Many businesses are gritting their teeth and enduring inefficient, older technology – taking a chance on investment for them seems like too big a risk.

A ‘test and measure’ mindset can help build confidence

Sara Daw, Chartered Accountant and Co-Founder, CFO Centre

Small business owners are remarkable individuals, often starting their organisations against the odds. They have specialist skills but when it comes to scaling businesses there’s much they don’t know. There’s a lot to navigate between this lack of knowledge and the current uncertain economic, fiscal and political environments with higher interest rates. The additional pressure to optimise technology and automation for productivity gains can lead to doing nothing and investment paralysis.

The main concerns I see are:

• fear of failure and unmitigated risk
• lack of financial resources
• limited knowledge and expertise about how to grow a business, particularly with the multitude of technological advances available
• access to the right talent who would know how to scale organisations.

I’d encourage business owners to continuously adopt a ‘test and measure’ mindset to build their confidence in investing while simultaneously managing risk. This innovative approach involves investing the smallest amount possible to prove concept, carefully measuring outputs, and doing more if it works but changing tack if not.

They should also tap into their networks to learn from mentors with proven track records and gain referrals to trusted professional experts who can guide their decision-making.

Verdict: Small businesses fear failure and unmitigated risk and lack financial resources – but adopting a ‘test and measure’ mindset can help build confidence.

Investment activities will be delayed until the new tax and legislative regime is clearer

Todd Davison, Chartered Accountant and MD, Purbeck Personal Guarantee Insurance

We have been running a Quarterly monitor assessing SME sentiment around current trading conditions and business finance since Q1 2021. In Q2 2024 we found that 19% obtained business finance to help fuel growth initiatives. Whilst this appears low, it is the highest proportion since our quarterly monitor started.

The majority of our customers are obtaining business finance (31%) for working capital purposes. For example, managing cash flow within the business to monitor supplier payment and credit control cycles.

Labour has indicated plans to cap corporation tax at 25% for the duration of its parliamentary term. It will include a new tax roadmap, including a permanent full expensing system for capital investments and enhancing the annual investment allowances.

It’s possible that some SMEs, in the build-up to the general election, delayed investment activities and will continue to do so until the new tax and legislative regime is made clearer.

The high inflationary environment of late 2022 and 2023 may have also delayed spending. Margins have been squeezed within business, especially given continued effects of late payments on cash flow. As inflationary pressures begin to ease, confidence should rise and encourage SMEs to invest capital into growth initiatives.

Business confidence has risen in Q2 2024. The British Chamber of Commerce shows that 58% of firms expect an increase in revenue in the next 12 months. It also showed that business conditions were returning to pre-pandemic levels when measured by sales and cash flow.

Verdict: SMEs may be delaying investment activities until the government’s new tax and legislative regime is made clearer.

Small businesses are trying to protect cash flow

Paul Guise, Director, Prime Accountants Group

Some small clients are hesitant about investment for a number of reasons. There’s uncertainty around the economic landscape due to the change of government and there are concerns around high interest rates.

Typically, investment requires lending and that is currently very expensive. With the change of government, rumours are circulating about the October budget and a change to some headline tax figures. We don’t know what that looks like yet, and that might be holding small businesses back.

Ultimately, businesses have got to protect their cash flow and are possibly inclined to look after their cash to keep something for a rainy day.

Small businesses need some tax incentives and interest rates to come down. The Super Deduction Capital Allowance Scheme (now closed) helped a lot of companies with plant and machinery acquisition, for example. We also need to incentivise businesses, but I think we are looking at the government tightening belts in some way.

The government is ramping up the rhetoric around housebuilding, which is a massive kick to the housing industry. So some sectors are talking big around investment, but others are being more cautious.

We have also got to think about the global picture. Recent news about the US economy stuttering could have a huge effect worldwide, as it is possibly tipping into recession. There is a lot of uncertainty across the world, not just in the UK.

Verdict: Small businesses are concerned about economic uncertainty and are trying to protect cash flow.

Temporary tax deferrals, banking incentives and grant programmes are desperately needed

Simon Michaels, CEO, HW Fisher’s Business Solutions

The innate entrepreneurial flair of small business owners is being challenged in this current market. Such business owners have appetite for risk but even they are questioning whether this is the right time to look for new opportunities or other investments.

The adage ‘cash is king’ is as strong today as it has ever been. Economic uncertainty has pushed businesses to retain cash where they can, ensuring sufficient working capital to weather a market downturn. In addition, increased interest rates and general business costs have resulted in less working capital and consequently fewer surplus funds to invest in non-core projects.

Only a few years ago, businesses were encouraged to borrow. Interest rates were at an all-time low, and banks were freely lending ‘affordable’ loans. Fast-forward two-to-three years and these loans are no longer so affordable.

Borrowing costs have increased significantly resulting in high interest, large monthly payments and consequently, less available cash. This has created the perfect storm with pressure on sales coupled with increased monthly costs.

I’d like to see:

• Temporary tax deferrals to improve cash flow for young, struggling businesses.
• Further banking incentives to provide low-interest or interest-free loans for SMEs with cash flow issues.
• Developing targeted grant programs to support SMEs in sectors hit hardest by economic downturns, such as retail and hospitality.
• Faster payment cycles and better cash flow will be achieved by introducing prompt payment initiatives by large companies and government agencies.
• Implementation of extended tax payment plans to reduce immediate tax burden on SMEs.

Verdict: SMEs have less available cash and high monthly costs. Temporary tax deferrals, banking incentives and grant programmes are desperately needed.

Would you like to contribute to future articles like this one? If so, please get in touch with Annie Makoff-Clark at [email protected].

Annie Makoff is a freelance journalist and editor.