Directors' Outlook 2023: Risk of insolvency

As we welcome the start of a new year, the economic conditions for businesses look challenging to say the least. Continuing difficulties resulting from Brexit, Covid-19 and more recently Russia's invasion of Ukraine have created challenging economic conditions for companies.

2023 is likely to be a critical year for the global economy with rising interest rates, ongoing geopolitical tensions and shifting regulatory considerations. Global insolvencies are expected to rise significantly this year with retailers in particular feeling the heat – Made.com, Joules and M&Co all filed for insolvency towards the end of 2022.  Indeed, the UK's Insolvency Service reported that UK company insolvencies in November 2022 rose by a fifth compared to the previous year.

Over the coming year, directors will make business decisions in a challenging environment and will play a pivotal role in steering their companies through uncertain times.  It is therefore vital that directors are aware of the increased risks of insolvency and carefully monitor financial performance throughout the year to ensure business survival.

What we are expecting to see in 2023

Increased risk of insolvency

In a survey we recently conducted in partnership with TRI Strategy, 70% of directors said that they were concerned about the impact of an impending recession on their business. This is hardly a surprise given that market volatility, impacted by the economic downturn and geopolitical events, will make access to materials increasingly difficult and / or expensive throughout 2023.

Rising energy costs, inflation and interest rates will put an added squeeze on cashflow and, combined with the cost of living crisis and the burden on organisations to support struggling employees, the risk of insolvency will become all too real for many businesses.

In addition to keeping their own house in order, businesses will need to prepare for the impact of insolvencies within their supply chains and, in worst case scenarios, potential supply chain collapse. As we discuss in our supply chain risk predictions, preparation is key when it comes to supply chain management and resilience.

Rising costs from cyber-related threats

Economic distress and geopolitical unrest are likely to increase the threat posed by cyber breaches in 2023. The Covid-19 pandemic has had a transformative effect on our economy and the shift online, together with a greater use of technology, has increased opportunities for cyber criminals to target businesses.

Many businesses have yet to properly assess their increased risk profile, which has been created by accelerated digital transformation, and the heightened risk may prove costly in the event of a cyber breach. The latest government figures report that the average cost of a cyber attack on medium and large businesses is £19,400. This may increase sharply should a company face investigation by the Information Commissioner's Officer (ICO), who can impose fines up to £17.5m or 4% of a company's annual global turnover, whichever is higher. Read more in our cyber risk predictions.

ESG as a measure of business performance

An increased focus on climate change, growing pressure to consider environmental, social and governance (ESG) factors and a changing regulatory landscape is likely to put sustainability high on the corporate agenda for 2023.

As we outline in our ESG survey report, ESG is fast becoming an essential measure of business performance. Investor and consumer confidence and consumer expectations are increasingly impacted by a company's ESG credentials, which in turn affects profit, but we are now seeing the repercussions of this extend further.

We see time and again, and very recently in the collapse of FTX, that poor governance is often at the root of, and exposed at the time of, business failure. In an insolvency process, the decision making of a company's directors in the period leading up to the insolvency will usually be examined from a financial perspective. However, as ESG is gaining prominence in the corporate world, directors are beginning to come under greater scrutiny when it comes to their decision making and consideration of non-financial factors is increasingly important. Directors and decision makers must recognise that engaging meaningfully with ESG is as much about risk management and business performance as it is about sustainability. Read more in our ESG predictions.

Steps you can take to manage the risks

• Prepare a business plan with reasonable and justifiable assumptions to demonstrate the long-term viability of the business.
• Carefully monitor the company's operations, trading and financial performance throughout the year. Keep a particularly close eye on cash flow. If cash flow is tight, consider invoicing more regularly, reducing expenses or collecting in money to mitigate the risk.
• Consider the risks of insolvency in your supply chain. Try to build resilience into your supply chain by spreading risk across several suppliers and watch out for the early warning signs of supplier insolvency (for example, inconsistent deliveries, delays, attempts to renegotiate payment terms, evasive finance teams or changes in management).
• Keep up to date on cyber-related threats, make sure the company's most sensitive data is protected & appropriately safeguarded and if a breach is identified, act quickly to identify what steps can be taken to limit the damage caused by the breach and/or to recover the data.
• Identify why ESG is relevant to your business, ensure you have clear messaging internally about sustainability and integrate ESG factors into the company's overall strategy to counter any risks to your brand as a result of the increased scrutiny in this area. With the introduction of additional mandatory climate related financial information disclosures expected, companies should consider their reporting and disclosure capabilities.
• If redundancies are to be made as a result of financial pressures, be aware of the collective consultation and notification requirements and ensure that all formalities are complied with.

The final word

These are troubling economic times and all of the indications suggest that businesses are in for a tough year, with significant cost pressures, uncertainty and a growing number of insolvency events in 2023. Many businesses are likely to be affected by insolvency, if not directly, then indirectly by the insolvency of suppliers, customers, competitors or those around them. The directors who recognise the increased risk of insolvency, put in place contingency planning measures, conduct ongoing monitoring and take early action will be best placed to steer their companies through these choppy waters.