• Businesses in Scotland now have £35.6bn tied up in excess working capital
• Sustained growth has driven the pressure on firms in Scotland to increase working capital
• This could leave businesses exposed to greater risks if financial conditions deteriorated

Sustained economic growth and the fall in the Sterling exchange rate have put record pressure on businesses in Scotland to increase the amount of money tied up in working capital, leaving them at risk if growth were to weaken in the months ahead, according to a new report from Bank of Scotland.

Firms across Scotland now have around £35.6bn tied up in excess working capital – up 13 per cent from £31.5bn since the last report was released in May – meaning that firms could struggle to free up cash either to grow or to weather turbulent financial conditions.

The sustained growth seen nationally in the past 12 months – particularly in manufacturing and in the services sector – has increased the amount of cash tied up in the day-to-day running of businesses, with the impacts from the fall in Sterling, forward purchasing of inventory and a rise in input costs being fully realised.

Simon Quin, of Bank of Scotland Global Transaction Banking, said: “The increase in the working capital index in Scotland over the past six months is the highest of anywhere in the UK. Significantly, at 105.2, it now suggests Scottish businesses are now under pressure to increase working capital, whereas in April, the pressure was to decrease it.

“This is probably a result of the fact that GDP in Scotland has seen a bit of a resurgence during that time, outstripping the rest of Britain earlier this year, and aided by the small recovery in the price of Brent Crude.

“But by locking up cash in this way, it stops investment in other more productive areas of the business, whether that be investing in new people, creating new products or targeting new markets.

“With as many as one in three businesses nationwide telling us that their greatest concerns for the next 12 months are economic uncertainty or a fall in sales, this reliance on future growth prospects is concerning.

“Ultimately, every pound tied up in working capital is a pound that could be invested in other, more productive areas of a business and this is something that businesses in Scotland should be managing closely.”

The findings come from Bank of Scotland’s second Working Capital Index, a six-monthly report that uses Lloyds Bank Regional Purchasing Managers’ Index (PMI) data to calculate the pressure British businesses are under to either increase or decrease working capital.

Working capital is the amount of money that a company ties up in the day-to-day costs of doing business. Growing businesses tend to use more working capital, while companies focus on releasing cash from working capital when they are facing challenges.

An Index reading of more than 100 indicates pressure to devote more cash to working capital, while a reading of less than 100 indicates pressure to prioritise liquidity.

The current reading for Scotland of 105.2 is an increase of more than five points from 99.5 in April of this year.

The Index highlights that with the UK’s domestic outlook looking weaker, businesses are increasingly going to need to rely on exports for future growth.

While the current relative weakness of Sterling makes conditions for international trade benign, the practicalities of exporting mean that it often places even greater stress on working capital through shipping times and slower payments.

UK wide, one in four businesses said their customers had taken longer to pay during the past 12 months, increasing the value of firms’ outstanding invoices. At the same time, businesses are continuing to rapidly build up inventory, leading to more cash being locked up in stock.

With as many as one in three firms in the UK saying they are concerned by economic uncertainty or a fall in sales during the next 12 months, these factors could spell trouble for businesses in Scotland if economic conditions declined.

Simon Quin added: “Whether businesses expect to grow through exporting, or they anticipate challenges due to weakening domestic demand, firms in Scotland could benefit from the operational efficiency and cash flow boost that comes from working capital improvements.

“In the past, previous highs in this Index have coincided with improving financial conditions. The fact that the Index is currently climbing while financial conditions remain relatively low means businesses are taking on more and more risk.

“Our experience is that businesses that undertake a programme of working capital improvements can typically release around three to five per cent of turnover in additional cash, allowing them much more freedom to invest in growth, trade internationally, expand their product set or to give themselves a buffer to see them through more troubling times.

“But doing so successfully isn’t easy. It requires change across a number of business functions, and so the time to undertake that work should be ahead of embarking on further growth, a new exports programme, or before any possible future storm hits.”

UK variations

Although Scotland saw the biggest increase in its Index score, the pressure to increase working capital grew in every other part of the UK apart from the East of England, where the Index fell from 112.0 to 107.8.

Wales remained the region with the highest pressure to increase working capital with the Index climbing from 113.7 in April to 114.3 now.

For more information about the Bank of Scotland Working Capital Index visit http://business.bankofscotland.co.uk/business-resource-centre/insights-and-ideas/working-capital-management/

Leaders from Scotland’s main opposing political parties came together on Thursday (21st September) in a pledge to work together with the Scottish Chambers of Commerce to heed the concerns of business and prioritise economic growth.

The Scottish Chambers of Commerce Network held its Annual Scottish Business Reception on Thursday, hosted by Scottish Conservative leader Ruth Davidson MSP, and addressed by Derek Mackay MSP, the Cabinet Secretary for Finance and the Constitution.

The reception was the second milestone event of the week for the Chambers network, which two days previously hosted the Chinese Ambassador to the UK, HE. Mr Liu Xiaoming at a dinner for 200 Scots business people in Glasgow.

In his speech to the gathering of business people and politicians in the Scottish Parliament, Scottish Chambers of Commerce President Tim Allan called for elected members at all levels to put business first and to do all in their power to make Scotland a competitive place to do business.

Tim Allan said: “Scotland’s businesses are the creators of our jobs and our wealth. Collectively, they are the engine which grows our economy, pays for our essential public services and provides the opportunities for our people to reach their potential. It is essential that all of Scotland’s politicians from across the political spectrum understand this and deliver policies that support business growth and competitiveness.

“Scotland’s politicians must work hard to understand the issues facing businesses in their constituencies and regions, but with an active network of 26 local Chambers of Commerce across Scotland, our network is seeking to make that task an easy one.”

Ruth Davidson MSP congratulated the Chambers on the success of its China initiative and said that, after a period of successive elections and referenda, the three and a half years before the next Scottish Parliament election were an opportunity for business, led by the Scottish Chambers of Commerce to “put their heads above the parapet” and voice their concerns and needs to their elected representatives. “Politicians whatever their strip should do everything they can to help business.”

“Business, entrepreneurship, the ability to help build and grow is virtuous in and of itself, it helps the country, it helps our young people to have opportunities and it is a public good. There is a shared belief across all the parties that we all have a role in oiling the wheels and getting the Scottish economy moving.”

Responding for the Scottish Government, Derek Mackay MSP described the Chambers as “a force for good”, and his own government as “pro-business and pro-growth” he said: “There is a great deal of agreement [with Chambers] around the skills agenda, around employment, around the fair work agenda, infrastructure investment, internationalisation and empowerment. We appreciate all of the great work you do nationally and locally in mentoring and supporting SMEs. Your work is absolutely invaluable.”

Liz Cameron OBE, chief executive of the Scottish Chambers of Commerce said: “We are grateful to Ruth Davidson and to Derek Mackay for joining us at our Business Reception, and are very encouraged by their words of support for the Chamber Network.

“We sensed a renewed mood of constructive engagement between business and government, firmly placing the economy at the centre. We will continue to work hard to play our part in making Scotland the best place to do business and all Governments will be measured by the impact of their decision making.”

For UK businesses to the deliver the jobs, growth and investment needed to secure our long-term economic future, they need a competitive environment here at home. However, as we approach yet another General Election, the UK continues to lag behind its international competitors.

While corporation tax is decreasing, businesses remain disappointed at the lack of action on the high up-front taxes and costs of doing business in the UK. Companies continue to face unacceptably high input costs which weigh heavily no matter the stage of the economic cycle, company performance or ability to pay. The new tax year saw firms hit with a raft of changes adding to the upfront cost of doing business, including the introduction of the Apprenticeship Levy, Immigration Skills Charge, and a new National Living Wage.

Despite some improvements, the fundamental unfairness of the business rates system remains, with firms across the country continuing to pay the highest business property taxes in the developed world. In its current form, the business rates system creates a number of perverse incentives for business location, property improvement and plant and machinery investment. Businesses also continue to face significant difficulties in hiring staff with the right skills. The BCC’s Quarterly Economic Survey – the UK’s largest and most authoritative private-sector business survey – confirms that the proportion of firms reporting recruitment difficulties remains close to a record high.

Business communities are therefore calling for the next government to commit to no new up-front business taxes or costs until the end of the next Parliament in 2022 and further, more radical, reform of the broken business rates system. This must include the removal of plant and machinery from business rates valuations which does so much to undermine business investment.

The new government must also do more to protect the long-term health of the UK jobs market, including improving the transition from education to business by guaranteeing universal ‘experience of work’ in all schools for under 16 year olds, and delivering a future immigration regime based on economic need – rather an arbitrary migration target.

Tackling these longstanding issues has come even more pressing with the UK economy set to enter a more challenging period. The first estimate of UK GDP growth indicated that the UK economy suffered a loss of momentum in the first quarter of 2017. With inflation rising it is likely that the Q1 slowdown is the start of a sustained period of weaker growth, as the UK’s over reliance on consumer spending becomes increasingly exposed.

Yet you wouldn’t really know this from reading the various party manifestos that have just been published with political posturing largely put ahead of the need to create the best possible conditions for long-term economic growth. While there were some bright spots, notably promise of further action on business rates and improving digital and mobile connectivity, these were largely offset by proposals for higher personal and business taxes, significant market interventions and cuts in immigration. While business confidence remains relatively strong this may not last if such short-term political thinking is put ahead of securing our long-term economic future.

Tackling these fundamental concerns will help ensure that our economy successfully navigates through a world full of turbulence, both political and economic, and crucially remains a great place to do business through the Brexit process and beyond.

Today’s news that inflation has jumped to 2.7% has confirmed long-held expectations and highlighted growing concerns over the capacity for businesses to contain rising costs and the potential threat to consumer demand, as disposable incomes become squeezed. Liz Cameron, Chief Executive of Scottish Chambers of Commerce, said:

“Whilst part of the reason for this latest increase in inflation might be due to the timing of Easter and the consequent impact on the cost of flying, the fact remains that there are continued upward pressures on prices from a range of sources and the Bank of England last week said that it expected inflation to continue upwards to almost 3% later in the year.

“The impact on Scottish business and the Scottish economy is two-fold. Rising prices impact on businesses’ costs and their ability to invest and create jobs, whilst weakening real incomes could depress consumer spending, which has been the strongest driver of economic growth in Scotland over the past few years.

“These challenges, coupled with ongoing political uncertainty represent a risk for the Scottish economy, which our politicians must respond to. With a General Election campaign in full swing, politicians of all parties must remember that it is Scotland’s businesses that are the creators of jobs, wealth and growth in our economy, and businesses will be examining the various Parties’ plans to address this situation with keen interest.”

After a weak start to the year, the economic picture is improving in the US as we move into the second half. There is a positive outlook for equities over the medium term, as softer data from the first quarter has been replaced with a clutch of figures that indicate an accelerating economy, although this does bode poorly for bonds.

This confluence of positive developments, though constructive for equities, is quite the opposite for bonds, as it increases the likelihood of a rate rise. The Federal Reserve (Fed) is already tapering its asset purchases, with the latest edition of quantitative easing drawing to a close in late October/early November. As this date approaches, a more natural supply/demand dynamic should take hold, and interest rates again will be determined by market participants rather than by a buyer with a printing press. Additionally, the cost of living continues to increase: US inflation climbed by 0.3% for the month of June, in line with the consensus forecast, bringing the gauge up 2.1% year-over-year. This marks the second consecutive month in which inflation has been higher than the Fed’s target of 2.0%. The combination of strengthening economic data and above-target inflation increases the probability of rising interest rates, perhaps even sooner than the Federal Reserve currently contemplates.

Interest rate increases will put downward pressure on the prices of fixed income securities, leading to mark-to-market losses for bond portfolios. We have expressed concern about rising rates for some time, and have advised clients to shorten portfolio duration, rotate from fixed-rate to floating-rate debt, and from public to private markets. We have been focused on taking credit risk (rather than duration risk), allowing us to remain comfortable with an overweight in high yield bonds for much of 2014, though recent developments warrant a reassessment of this positioning.

Absolute yields and credit spreads for the high yield complex have fallen to levels that suggest an increasingly asymmetric risk-return profile for the asset class. The deterioration in credit underwriting standards for the leveraged loan market is also troubling. This is a trend that has been a focus of our concern for some time now, and recently has been highlighted by the Federal Reserve as a source of potential problems if it continues unabated.

Given these concerns, we have taken the decision to lock-in profits in high yield bonds and leveraged loans, and rotate the proceeds into cash, for the short term. This brings our high yield allocation to a neutral stance in portfolios, and a strongly underweight position at the broader asset class level (high yield and emerging markets bonds). We expect the overweight cash position to be a temporary one, and will redeploy funds as assets are re-valued in light of rising interest rates.