Entrepreneurship in the UK is increasing with 608,100 new companies opening for business in 2015 – up 4.6% on 2014.
Taken at face value a high start-up rate appears to be a positive indicator for the UK economy, signalling a high degree of confidence among new UK entrepreneurs. However if we look a little closer, historical data suggests that approximately half of these businesses are likely to fail. A study of London based small and medium enterprises (SMEs) found that despite a stellar start-up rate, 61.6% of the city’s small and medium sized businesses closed in 2014. On a national level, a report from The Office of National Statistics revealed that 44% of SMEs founded in 2011 had failed by 2014.
So why do so many UK businesses fail and what steps can government take to reduce the failure rate among the next generation of entrepreneurs? Our first clue comes from a 2013 investigation undertaken by the BBC which reported that the government’s welfare to work scheme was encouraging jobseekers into self-employment in order to reduce the welfare bill. BBC 5 Live spoke to several jobseekers who had been encouraged to become self-employed despite lacking the necessary skills to start their own business. Jobseekers had been advised that they could turn skills such as gardening or ironing into a business that would give them an income and increase their eligibility to earn tax credits. In turn this would reduce their burden on the welfare bill. However one of the most alarming aspects of the scheme was that jobseekers weren’t given any robust financial training before declaring themselves self-employed, a pre-requisite for most small businesses.
Phil Hall, AAT’s Head of Public Affairs and Public Policy, points out that start-up statistics are further inflated by companies such as Uber and Deliveroo whose drivers have been classified as self-employed until very recently. At the time of writing Uber is currently appealing a court ruling which declared its fleet as ‘workers’ which would grant Uber drivers the national living wage among other rights. If the appeal fails, 42,000 drivers in London alone are likely to be reclassified and may drop out of the start-up figures in 2017. Digging even deeper, a survey conducted by BIS in 2014 revealed that 62% of all SMEs were sole traders which forces yet another reconsideration of the seemingly stellar number of new start-ups in 2015.
The need for growth
Growth is a clearly a key issue for UK SMEs too. Research commissioned by AAT in 2015 revealed that a third of SMEs had failed to grow at all over the last five years. When these responses were examined the study revealed that 58% of small business owners admitted to not having any kind of business plan. Even more striking was the 10% surveyed who said they ‘wished they had a business plan’ but ‘did not know how to put one together’.
Founder and Managing Director of Routes Healthcare, Andrew Healing takes a strong view. “If you don’t understand your business model and how that translates to numbers you’ve got to be incredibly lucky.” Healing took his company from zero to 700 staff since founding the organisation in 2009 and is now one of the largest providers of health and social care in the North of England. Healing had an advantage though – not only had he studied business management, he seemed to have a natural aptitude for numbers and was passionate about developing and stress testing plans before putting them into practice.
Keeping on top of cash flow and invoicing may not be a natural part of small business owners’ skill set but are clearly essential to the success of most businesses. In July this year AAT launched Informi, a site designed to provide tools and advice for established and potential entrepreneurs. AAT product manager Darren Nicholls says financial literacy is the key to small business success. “We talk to a lot of school leavers who are very passionate about their creative discipline and have a lot of determination to get funding, develop a media plan and work for themselves. But, when you talk to them about numbers or the importance of good management it’s clear there’s something missing. So we set-up Informi to provide a one stop shop where people can go to get financial information and guidance. We want to give sound advice and tools to help people manage their finances.”
Research commissioned by London Institute of Banking and Finance (LIBF) revealed that 57% of students receive no financial education whatsoever and of those that do only 38% could remember their last lesson on the subject, with 85% getting their education from their parents. LIBF contributes to The All Party Parliamentary Group on Financial Education for Young people, which advocates the need for a greater emphasis to be placed on financial literacy in schools. Managing Director of Financial Capability and Community Outreach at LIBF, Alison Pask says “financial literacy is as important as reading and writing. It’s an essential skill for full participation in society.”
Darren agrees.“A big part of running any business is knowing ‘where is my money going?’ and ‘where is it coming from?’. You need to be able to draw conclusions from the numbers, you need to be able to interpret them. A finance professional is a fantastic resource to have but the more you are able to understand the numbers yourself the better placed you’ll be to make a success of your business. Often it’s micro businesses who are most at risk. They may not necessarily perceive themselves as ‘a business’. They’re just doing what they love and sometimes the financial side is not even secondary – it’s tertiary. It’s only when things start going wrong that numbers become important.”
Andrew agrees. “There is definitely a lack of understanding of some of the basics. If I was to drop a net on a cohort of people in business, there are far more people that don’t understand how to arrive at a percentage than people who do – and that’s frightening. When you start to plan your business out, you explore your idea, you explore your vision and decide what you want to do and how you want to do it and where you’re going to sell your product or your service. You need a huge amount of qualitative information but crucially, you need to verify that with numbers. You need to take those scenarios then you need to sense check them with the numbers to find out how much your ideas are going to cost.”
Managing growth and cash flow
If we create a hypothetical situation – for example let’s say the market for a product or service is set to double next year, increasing from £50m to £100m – businesses who had anticipated this growth would need the ability to physically process their requirements and put in place infrastructure to deliver increased sales. Businesses need financial controls, they need to manage invoicing, control debtor days and control cash flow – because growth requires cash. A business might be profitable but the requirement for cash and liquidity increases in the short term with fast growth. If a business is going to invoice significantly more money, they’re going to incur significantly more overheads, particularly in a business which relies on the provision of staff with a weekly or monthly payroll.
“Our business requires an awful lot of working capital because we pay every week on a Friday but we may not get paid for up to six or eight weeks by our client so we have to fund a six to eight week payroll. If, for arguments sake, you’re growing by £10m that’s a significant amount of payroll to finance over a six week period. You have to build those scenarios in to your plan. Can a business that is profitable get into trouble? Yes they can. As a business you can be profitable and have a really good model but if you run out of cash because you haven’t anticipated the cash burn required to deliver that growth – you’re toast!”
As a business you can be profitable and have a really good model but if you run out of cash because you haven’t anticipated the cash burn required to deliver that growth – you’re toast!
The next generation of entrepreneurs
Clearly financial literacy and the ability to forward plan is crucial to the success of all businesses. And the bigger a business gets, the more important it becomes. Chief Executive of AAT, Mark Farrar emphasises the message;.”Having the necessary financial skills and a clearly defined business plan are essential tools to help firms expand successfully.” So when is it necessary to get bring in external help? Healing says, “Begrudgingly, as an entrepreneur you feel that you you can do everything yourself, and I did for a number of years but there comes a times when you need to bring in outside expertise. Forming a senior management team and bringing in an external Financial Director gives us a more objective view and puts the company in a much stronger position. Since then our internal finances are stronger and better reported than they have been before.”
They have had some success as the topic is now a mandatory feature of the national curriculum. Yet Hall points out “only 50% of schools follow the curriculum and a large majority only pay lip service to the government’s requirement to teach financial literacy.”
It’s clear then that a great deal more needs to be done. Schools and colleges provide the perfect opportunity to teach financial literacy and at the very least stress to students the link between financial acumen and the success of a business venture. Phil sites graphene, a material that is 100 times stronger than steel, as a classic British failure to capitalise on its intellectual property. Despite being invented at The University of Manchester, the US and China hold thousands of graphene patents, whilst the UK has just a few hundred. So it’s not only the next generation of small business owners, but the next generation of scientists and inventors who are in desperate need of basic finance and business skills.
Benjamin Berry is the Content Manager for AAT The Association of Accounting Technicians and the former editor of Yahoo.
The content team are the owners of AAT Comment.