SME Health Check Index - Q2 2018 - SEPTEMBER 2018 - CYBG
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SME Health
Check Index
Q2 2018
SEPTEMBER 2018
#SMEhealth Compiled by Cebr, in association with CYBG
DISCLAIMER Whilst every effort has been made to ensure the accuracy of the material in this document, none of Centre for Economics and Business Research Ltd (“Cebr”), CYBG PLC (“CYBG”), or any of their group companies, directors or employees will be liable for any loss or damages incurred through the reliance on or use of this report. This report does not constitute an investment or research recommendation, or any form of investment advice. This report may contain forward looking statements, based on assumptions and/or targets. Actual results may differ. Authorship and acknowledgements This report has been compiled by Cebr, an independent economics and business research consultancy established in 1992. The views expressed herein are those of the Cebr only and are based upon independent research by it. The report does not necessarily reflect the views, financial position, business strategy or intentions of CYBG, its group companies, or its directors or employees. All lending decisions are subject to status. London, September 2018
#SMEhealth | Q2 2018 REPORT
CONTENTS
Foreword 5
Infographic 6
Executive Summary 7
1 UK macroeconomic environment 8
2 SME business health nudges down in Q2 2018 9
3 In focus: SME Business cost inflation 16
4 Special Report: SME investment plans 19
5 Conclusions 27
6 Methodology 28
3
#SMEhealth | Q2 2018 REPORT
FOREWORD
GAVIN OPPERMAN
Group Customer Banking Director
The importance of SMEs to UK PLC needs no explanation. 99.9% of
British businesses are in the SME bracket, and every one of those 5.7
million enterprises makes a unique contribution.
CYBG has a unique insight into this between the last three months of We worked with YouGov who
diverse group of businesses and the 2017 and Q1 2018, as outstanding polled 504 UK SMEs as part of this
backdrop against which they operate. loan and overdraft balances quarter’s SME Health Check Index.
Every three months we take the decreased. Interest rate increases The findings of this survey portray
temperature of this critical sector in November and August added to low levels of confidence when it
and, regrettably, we report another the pressure on business investment comes to investing in business, with
quarter of mixed news. indicated by those trends. around half of SMEs choosing to
not increase the levels of investment
The SME Health Check Index fell There have been some much- in their businesses over the past 12
by 0.5 points in Q2 to 47.1 - its needed boosts, the Royal Wedding, months. Strong levels of investment
second lowest level since we began World Cup and warm summer are crucial in achieving sustained
tracking this data in 2014 – but weather all contributing to a pick- improvements to the productive
the individual indicators tell a much up in output growth. Retail and capacity of an economy and we have
less sombre story. The capacity construction businesses saw some historically been below the levels
indicator is improving, as is general of the greatest improvements over seen in other advanced western
confidence (which is at its highest the second quarter. That being said, economies.
level since the second quarter of general business confidence is likely
last year). Contracting lending and to be suppressed by the uncertainty Our critical task is to ensure that the
rising inflation put the squeeze on surrounding the arduous Brexit operating environment for SMEs
businesses across the country. discussions, which continue to – exporters, importers and entirely
arrogate a disproportionate share of domestically focused businesses alike
These top-line pressures are material, the airtime. – is as uninterrupted as possible.
but both capacity and GDP grew in As a lender, we are doing our bit,
most regions, with an encouraging We are hopeful that the timetable especially with our ongoing lending
balance evident across the country, on Brexit will impose some clarity commitment to SMEs across all
In addition the East of England and on this discussion and that British regions in the UK. We hope to
Yorkshire & the Humber regions saw businesses will have the insight they have better news to share in three
positive employment growth figures. need to plan for life outside the EU. months’ time.
However, it seems more likely that
Those are the headlines, but business will need to manage at least
businesses of course deal with the some level of continued uncertainty
reality on the ground. The lending for the foreseeable future.
indicator fell by 18 points to 38
5
S M E H E A LT H C H E C K I N D E X S C O R E
TA K I N G T H E Q2 2018
T E M P E R AT U R E
OF THE UK’S SME
PERFORMANCE £
Small and medium sized enterprises are
the engine room of the UK economy.
5.7 MILLION 60% £1.9 TRILLION
private sector of private sector SMEs combined
businesses employment annual turnover
OV E R A L L I N D E X S CO R E
100 - - 1.0%
90 - - 0.9%
80 - - 0.8%
70 - - 0.7%
INDEX SCORE
60 - - 0.6%
GDP (%)
50 - - 0.5%
Q2 2018 47 .1 40 -
30 -
- 0.4%
- 0.3%
20 - - 0.2%
10 - - 0.1%
Q1 2018 47 .6
0-
82.5
Q1
80.1
Q2
81.6
Q3
77.4
Q4
74.6
Q1
83.0
Q2
74.0
Q3
87.4
Q4
59.1
Q1
57.5
Q2
64.1
Q3
62.9
Q4
60.1
Q1
57.8
Q2
49.8
Q3
43.9
Q4
47.6
Q1
47.1
Q2
- 0%
2014 2014 2014 2014 2015 2015 2015 2015 2016 2016 2016 2016 2017 2017 2017 2017 2018 2018
SME Health Check Index GDP
Business Capacity Confidence Employment
Costs 41 (5 ) 57 (11 ) 66 (5 )
62 (2 )
GDP Lending Net business
creation Revenue
69 (4 ) 38 (18 ) 43 (-)
1 (1 )
changes above are compared to Q1 2018.
Q2 2018 Change from Q1 2018
East Midlands 53.5 2.9
East of England 49.6 10.9
London 44.9 4.4
North East 48.3 1.8
North West 25 4.9
Scotland 39.8 4.4
South East 39.6 7.3
South West 44 3.6
Wales 58.6 8.8
West Midlands 43.5 0.8
Yorkshire and the Humber 58.8 11.3
#SMEhealth | Q2 2018 REPORT
EXECUTIVE SUMMARY
Small businesses are the backbone of the UK economy. Accounting for almost all businesses in the UK, the
contribution SMEs make to the economy cannot be underestimated. As well as driving growth, opening new
markets, and encouraging innovation and creativity, the UK’s 5.7m SMEs also create jobs - employing a record
number in the private sector, equating to almost half the UK population.
This quarterly report for CYBG, level since Q2 2017. While the were seen in Yorkshire & the
owner of Clydesdale and Yorkshire annual rate of business creation Humber and the East of England,
Banks and its digital brand B, increased marginally, it remains which both bucked the trend of a
analyses the health of SMEs in very low by historical standards. slowdown in employment growth
the UK. The result of the analysis observed elsewhere in the UK.
is the SME Health Check Index, ⊲ A
lthough the labour market Scotland also experienced a
which combines various statistics continued to tighten over the notable increase in the SME
and indicators to evaluate the second quarter of the year, the Health Check Index, driven by
health of the business and the annual rate of employment a significant recovery in the
macroeconomic environment within growth slowed somewhat, confidence indicator.
which SMEs operate. The SME bringing down the employment
Health Check Index takes on values indicator. The value of SMEs’ ⊲ T
he number of people employed
between 0 and 100. A score of outstanding loans and overdrafts in the South East and the North
100 would indicate that all of the also fell between Q4 2017 and West was lower in Q2 2018
SME Health Check Index’s eight Q1 2018, which dragged down than at the same point last year.
indicators are at their highest level the lending indicator. Borrowing This, together with significant
since data collection began in 2014. in the early months of 2018 falls in the capacity and lending
A score of 0 would show that all will have been suppressed by indicators, contributed to these
of the eight indicators are at their the slowdown in economic regions seeing the largest
lowest level since 2014. activity and expectations of declines in the SME Health
future interest rate rises over the Check Index in Q2 2018.
The Q2 2018 report finds that: remainder of the year. Meanwhile,
steep increases in the price of ⊲ T
he SME Health Check Index
⊲ T
he SME Health Check Index physical inputs contributed to a score for the North East
fell by 0.5 points to 47.1 in the two point decline in the business remained relatively stable,
second quarter of 2018. This costs indicator. rising by one point to 48 in
means the Index is now at the Q2 2018, as a large fall in the
second lowest level since data ⊲ S
ix out of the 11 regions employment indicator was offset
collection began in 2014. experienced an improvement by improvements in the capacity
in the SME Health Check and confidence indicators.
⊲ T
he GDP and capacity indicators Index between the first and
improved in Q2, as the UK second quarters of the year.
economy rebounded following Most regions saw significant
a stuttering start to the year. improvements in the capacity and
This uptick in activity was also GDP indicators, while confidence
reflected in the confidence also continued to increase in
indicator, which rose to its highest many areas. The largest gains
7
#SMEhealth | Q2 2018 REPORT
1 UK MACROECONOMIC ENVIRONMENT
The second quarter of 2018 has seen the UK economy regain some momentum following a hesitant start to
the year. According to the Office for National Statistics’ (ONS) first estimate, the annual rate of GDP growth
rose from 0.2% in Q1 to 0.4% in Q2 of 2018. The most significant improvements were recorded in the
construction and retail sectors, which both received a boost from the good weather - the former through fewer
interruptions to work, and the latter through increased footfall on the high streets. These positive developments
were balanced somewhat by a second consecutive quarterly contraction of the manufacturing sector, meaning
that it has now entered a technical recession.
In August, the Bank of England’s However, the rate of earnings UK’s withdrawal from the EU on
(BoE) Monetary Policy Committee growth has since retracted while March 29th 2019, in order to
voted unanimously to raise its base inflation has remained relatively provide sufficient time for House of
rate by 25 basis points to 0.75% stable, meaning real earnings Commons approval and ratification
- the highest level in over nine growth for the average household by EU leaders. While both sides
years. This reflects the Bank’s view has all but vanished. Throughout maintain that a no-deal outcome
that the UK economy currently Q2, the annual rate of consumer would be highly damaging for either
has a “very limited degree of slack”, credit growth stood at 8.8% - party, the slow rate of progress in
and a series of gradual rate rises is below the level seen over the the negotiations thus far has meant
required in order to contain inflation, previous two years, but still high that businesses will increasingly have
which has now exceeded the BoE’s by historical standards. Flatlining to plan for what the UK’s foreign
2% target for 18 months. Over the incomes, together with the BoE’s secretary has dubbed a “no-deal
second quarter, the unemployment delay in raising interest rates, by accident”. This could act as a
rate averaged 4.0% - the lowest will have bolstered household significant drag on investment in the
level since 1975, and the number borrowing in recent months. A coming months as the March 2019
of vacancies in the three months substantial improvement to wage deadline approaches. Alternatively,
to July was the highest since growth is needed in the short to a large surge in imports prior to the
records began in 2001. While on medium term to avoid either an UK’s withdrawal of the EU could
one hand these figures do point to unsustainable build-up of household occur if businesses fear that their
an extremely tight labour market, debt or a slowdown in consumer access to European goods will be
underwhelming earnings growth spending, both of which would have severely restricted post-Brexit.
suggests that there remains some potentially major ramifications for
spare capacity, since firms are not the UK economy.
yet being forced to raise wages
significantly in order to attract Over the summer the likelihood
workers. of a ‘no-deal’ Brexit has increased
significantly, as the UK and the EU
At the beginning of the year, it remain locked in negotiations on
appeared that households were a number of key issues relating
poised to enjoy a period of stronger to trade and the Irish border.
real income growth following Any agreement will need to be
the prolonged squeeze in 2017. finalised some months before the
8
#SMEhealth | Q2 2018 REPORT
2 S
ME BUSINESS HEALTH
NUDGES DOWN IN Q2 2018
SMEs are a key component to the success of the UK economy. Making up more than 99% of all UK businesses,
SMEs’ commitment to achieving their goals helps drive the country’s growth. We are not only analysing different
variables that can be directly linked to the performance of SMEs, such as confidence and revenue, but also the
business and macroeconomic environment in which SMEs operate. The following section begins by presenting the
overall results of the SME Health Check Index and its indicators, before turning to regional comparisons.
In the second quarter of 2018, the Similar to the results revealed last loaded to the second quarter. This
SME Health Check Index dipped quarter, the movements of the suppressed first quarter output,
by 0.5 points to 47.1 – the second Index in Q2 are slightly at odds while elevating output in the second
lowest level since data collection with the historical trend, which has quarter, without significantly altering
began in 2014. An improvement generally seen the SME Health the economy’s long-term capacity.
in business confidence and the Check Index move in tandem with The following section analyses the
rate of GDP growth in Q2 were the rate of GDP growth. This can indicators of the SME Health Check
negated by a rise in business cost be attributed to the fact that the Index in more detail.
inflation, a slowdown in the rate of adverse weather in Q1, followed
employment growth and a fall in the by benign conditions in Q2 meant
lending indicator. that a lot of activity was back-
Figure 1: SME Health Check Index
100 - - 1.0%
90 - - 0.9%
80 - - 0.8%
70 - - 0.7%
GDP (%) quarter-on-quarter change
60 - - 0.6%
INDEX SCORE
50 - - 0.5%
40 - - 0.4%
30 - - 0.3%
20 - - 0.2%
10 - - 0.1%
0- - 0%
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
2014 2014 2014 2014 2015 2015 2015 2015 2016 2016 2016 2016 2017 2017 2017 2017 2018 2018
SME Health Check Index GDP
Sources: FSB, ONS, UK Finance, Cebr analysis
9
#SMEhealth | Q2 2018 REPORT
2.1 INDEX INDICATORS
Business Costs Confidence GDP
The annual rate of business cost Business confidence among SMEs The UK economy has recovered
inflation rose by 0.1 percentage - as measured by the Federation from a slow start to the year,
points to 2.9% in the second quarter of Small Businesses’ (FSB) Voice of expanding by 0.4% over the second
of 2018. This was driven by an Small Business Index1 - continued quarter of 2018. This pushed
acceleration in the rate of price to climb over the second quarter, up the relevant indicator by four
growth for physical inputs. Another reaching a one year high. This points to 69. The most notable
factor was an uptick in the rate of is likely to reflect the rebound improvements were registered in
inflation for construction output, in activity that took place in Q2. the retail and construction sectors,
which is likely to reflect the spike in However, it is worth noting that the which grew by 1.6% and 0.9%
demand following the widespread SMEs were surveyed in May. Since respectively over Q2. The rebound
disruption that took place in the first then, the possibility of a ‘no-deal’ in construction activity suggests that
quarter with the collapse of Carillion Brexit appears to have risen notably, significant portions of work were
and the adverse weather conditions. which is likely to be a significant delayed until the second quarter due
The rise in business cost inflation has concern for many SMEs. . to weather related factors. In less
not been matched by an increase in positive news, total exports in Q2
consumer price inflation, suggesting 2018 were 1.8% down on the level
Employment
that for now, many businesses are recorded during the same period
not passing through rising costs to The annual rate of employment in 2017. This reflects a cooling of
their customers. growth edged down to 1.0% in Q2, external demand from many of the
bringing down the Index score for UK’s key trading partners. One of
this indicator to 66. Despite the the major victims of this has been
Capacity
negative movement of this indicator, the manufacturing sector, which
A lower share of SMEs reported the continued rises in employment contracted for the second quarter
that they had operated below are encouraging given the existing in a row in Q2 2018, meaning
capacity over the second quarter, tightness of the labour market. that it has now entered a technical
which drove up the score for this The unemployment rate is now at recession.
indicator by five points to 41. This its lowest level since 1975 (4.0%),
is the first time that this indicator while the number of vacancies
has improved since Q2 2017. The is at record high. Given the ever
disruption brought about by the shrinking pool of available workers,
bad weather in early 2018 will a gradual slowdown in the rate of
mean that a lot of activity has been employment growth is likely in the
pushed back to Q2, lowering the coming quarters.
share of SMEs operating below full
capacity.
10 1
Federation of Small Businesses: Voice of Small Business Index – Q2 2018#SMEhealth | Q2 2018 REPORT
Lending to SMEs Net Business Creation Revenue
The lending indicator fell by 18 The annual rate of net business The revenue indicator is based on
points to 38 between Q4 2017 creation in the UK remained at 3.5% data that are released only twice
and Q1 2018, as the level of SMEs’ in Q2 2018, the lowest rate since a year therefore the indicator
outstanding loan and overdraft the SME Health Check Index began remains at 43 in Q2 – the second
balances fell by £842 million tracking data in 2014. At 256,000, lowest level since data collection
according to UK Finance’s lending the number of companies dissolved for the SME Health Check Index
data. SME borrowing in the first over the first half of this year is began in Q1 2014. The Q2 pick-up
quarter of 2018 will have been the highest since data collection in output growth observed in –
constrained by the interest rate rise began in 2014. The number of new among others – the construction,
in November the previous year, companies incorporated over the transport, storage, and restaurant
the overall slowdown in economic same period is also higher than in sectors suggests solid revenues
activity, and the expectation of any other year with the exception for SMEs in these industries.
future rate rises over the course of of 2016. This suggests that while Furthermore, retail sales growth has
the year. In the Bank of England’s technological developments have accelerated since April, supported
Credit Conditions Survey, lenders made it easier than ever to start a by solid consumer credit growth as
reported a significant increase in business, the challenging economic well as a number of one-off events
the demand for corporate lending conditions prevailing in the UK also such as the Royal Wedding and
from small businesses in Q2.2 This mean that more businesses are the World Cup. This points towards
suggests that SMEs’ borrowing being forced to close. strong revenues for consumer
habits were impacted to some facing businesses, particularly in the
degree by the economic slowdown food industry, which has seen sales
in Q1 and the subsequent bounce- rise during the warm weather the
back in Q2. UK has enjoyed in recent months.
2
Bank of England, July 2018: https://www.bankofengland.co.uk/credit-conditions-survey/2018/2018-q2
Figure 2: Sub-components of the SME Health Check Index
80
60
40
20
0 0
Business Costs Capacity Confidence Employment GDP Lending Net Business Revenue
Creation
Q1 2018 Q2 2018
Sources: FSB, ONS, UK Finance, Cebr analysis 11#SMEhealth | Q2 2018 REPORT
2.2 R
EGIONAL BREAKDOWN OF
THE SME HEALTH CHECK INDEX
While the previous section of the England, London, North East, North Humber – which continued its
report analysed the indicators of West, South East, South West, momentum from the start of the
the SME Health Check Index across West Midlands and Yorkshire & year – and the East of England,
the UK as a whole, this section the Humber), as well Scotland and which bounced back following a
investigates regional differences Wales. large fall in the Index score in Q1
in order to understand which 2018. Meanwhile, the South East
parts of the UK currently present Six of the UK’s regions experienced and the North West recorded
a more favourable business and an improvement in the SME Health the largest declines in the Index,
macroeconomic environment for Check Index over the second the latter likely a reflection of
SMEs. We divide the UK into the quarter of 2018, while five saw a the troubles that its crucial
nine English government office decline. The largest improvements manufacturing sector has faced so
regions (East Midlands, East of were seen in Yorkshire & the far this year
Figure 3: Regional SME Health Check Index
60
50
40
30
20
10
0
East East of London North East North West Scotland South East South West Wales West Yorkshire &
Midlands England Midlands the Humber
Q1 2018 Q2 2018
Sources: FSB, ONS, UK Finance, Cebr analysis
East Midlands received a further boost this SME Health Check Index, it is worth
The SME Health Check Index score month when East Midlands Airport noting that the score remains lower
for the East Midlands continued announced its intention to add than at any time prior to Q2 2017.
to climb in the second quarter of an additional 8,000 jobs over the One concern for businesses in the
2018, rising by three points to 54. next five years. Confidence among region is the retention of the young
This improvement was powered the regions’ SMEs also increased skilled workers produced by the
by an uptick in the annual rate of to its highest level since Q1 2017. region’s top universities. According to
employment growth. The region Despite the recent increases in the a study by Grant Thornton UK LLP,
12#SMEhealth | Q2 2018 REPORT
less than a fifth of the East Midlands’ London North East
university students plan to stay in the The SME Health Check Index score The North East’s SME Health
region after graduation.3 for London dipped to 45 in Q2 Check Index score edged up by
2018, down from 49 in the first one point to 48 in Q2 2018,
East of England quarter of 2018. The number of driven by strong improvements to
One of the largest gains in the SME people employed in the capital fell the confidence, capacity and GDP
Health Check Index was recorded by 29,000 between the first and indicators. Further increases to
by the East of England, where the second quarter, dragging the annual the Index score were inhibited by
score rose by 11 points to 50. This rate of employment growth to the very weak labour market figures
follows the seven point fall between lowest level since the start of 2017. It emerging from the region – the
Q4 2017 and Q1 2018. The is worth noting that London’s labour number of people employed in the
improvement last quarter was driven market has been booming in recent North East was 2.3% (or 28,000)
mostly by a substantial decline in years, and while the annual rate of lower in Q2 than at the same
the share of SMEs operating below employment growth in Q2 was low time last year. This is the sharpest
capacity. This is likely to reflect the by London’s standards, it remained rate of contraction since data
rebound in economic activity that well above the national average. collection began in 2014. Last
took place in Q2 following the The share of SMEs operating below month, Prime Minister Theresa May
slowdown in the early months of capacity actually edged up in the announced during a visit to the
the year. The East of England will second quarter, suggesting that the North East that plans for the North
have been particularly exposed bounce-back in activity was felt less of Tyne devolution deal would be
to this effect due to its large strongly in the capital than elsewhere formally approved “as soon as our
construction sector, which saw a in the country. While confidence parliamentary timetable allows”, with
marked acceleration in output as did improve in Q2, the uptick in local leaders hopeful that a May
work delayed due to the adverse sentiment among SMEs was also less 2019 mayoral election could still go
weather in Q1 was carried over into pronounced than in other regions. ahead. The deal would be the latest
Q2. A recent report by the Centre Concerns surrounding Brexit will in a string of devolution agreements
for Cities has found that cities in have intensified in recent months, as that have been implemented in
the East of England are set to see the chances of a ‘no-deal’ scenario recent years, which aim to transfer
significant labour shortages following appear to have risen, while limited more decision-making and spending
Brexit. Cambridge – the region’s progress has been made on agreeing power to local regions.
largest city – will be affected more the financial services sector’s access
than any other city in the UK, to the EU market post-Brexit. With
while two other Eastern cities formal plans reportedly in place
(Peterborough and Luton) also enter for many employees in this sector
the top 10.4 Maintaining access to to relocate in the aftermath of a
skills will be crucial in powering the disorderly Brexit, many firms will be
future growth of many of these concerned about their access to
cities’ high tech industries. labour in the medium to long term.
3
Grant Thornton, July 2018: https://www.grantthornton.co.uk/news-centre/uk-regions-struggling-to-retain-young-talent/ 13
4
Centre for Cities, August 2018: http://www.centreforcities.org/publication/withorwithouteu/#SMEhealth | Q2 2018 REPORT
2.2 R
EGIONAL BREAKDOWN OF THE SME HEALTH CHECK INDEX
North West Scotland gave mixed messages regarding the
The proportion of SMEs operating The health of SMEs in Scotland effects of the hot weather – some
below capacity in the North West improved over the second quarter reported a boost in tourist related
rose to the highest level since data of the year, with the SME Health activity while others said that the
collection began in 2014. This, Check Index score rising by four weather had reduced demand for
together with a decline in the lending points to 40. The confidence their output. This trend will be a
indicator, dragged down the SME indicator was the primary factor concern for the high proportion of
Health Check Index score to 25. underlying this shift, rising to its service sector SMEs in the South
Employment in the North West highest level in three years. Official East.
also fell by nearly 20,000 between figures recently showed that the
the first and second quarters of Scottish economy outperformed South West
2018. This region has recently the UK in the first quarter of the Falls in the lending, capacity and
faced severe disruption through year, driven by strong manufacturing confidence indicators were behind
delays and cancellations on its rail exports. They also showed some a four-point decline in the SME
network. Indeed, an analysis by the early signs that productivity growth Health Check Index score for the
Northern Powerhouse Partnership is beginning to pick up, which will South West in Q2 2018. It is worth
has estimated that the six weeks of be key in sustaining growth in the noting that the annual rate of
major disruption in early summer medium to long term. Less positively, lending growth in the South West
cost businesses £38 million. These the share of SMEs operating is the highest in the UK, despite
events will intensify calls to address below capacity increased over the the fall in the indicator last quarter.
the transport gap in the North, second quarter. This suggests that More worrying for the region is the
which is seen by many as a key factor the rebound in activity in Q2 was significant deterioration in business
holding back the area’s economic less pronounced in Scotland than confidence, with sentiment now
convergence with London. elsewhere in the UK. weaker in the South West than
anywhere else in the UK. This,
South East together with a higher share of
The South East was one of the SMEs operating below capacity
worst performing regions in Q2 suggests that the Q2 rebound in
2018, with the SME Health Check activity was not felt so strongly in
Index score falling by seven points the South West. The region did
to 40. The region was one of receive a boost this month, when
the few to experience a decline the Chancellor announced an
in confidence over the second additional £65 million in funding for
quarter, while the annual rate the region’s burgeoning technology
of employment growth fell into sector.
negative territory for the first time
since 2015. There are signs that
the UK’s services sector could be
slowing slightly at the start of the
third quarter, with IHS Markit’s
purchasing managers’ index for the
sector falling to the lowest level
since March.5 Service businesses
14 5
HS Markit, August 2018:
https://news.ihsmarkit.com/press-release/economics-media/ihs-markit-cips-uk-services-pmi-0#SMEhealth | Q2 2018 REPORT
Wales West Midlands Yorkshire & the Humber
Wales showed one of the largest The SME Health Check Index for the Yorkshire & the Humber saw the
improvements in Q2 2018, with West Midlands remained stable at greatest improvement to the SME
the SME Health Check Index score 44 in Q2 2018. A 57,000 increase Health Check Index in the second
increasing by nine points to 59. in employment between Q1 and quarter of 2018, with the score
Business confidence soared to the Q2 brought the annual rate of rising by 11 points to 59. Significant
highest level since data collection employment growth to 4.7% - the improvements to the capacity,
began in 2014 and the share of highest in the UK. The corresponding confidence and employment
SMEs operating below capacity fell gains in the employment indicator indicators were behind this increase.
substantially. The share of SMEs were largely offset by a decline Yorkshire and the Humber has been
in the agricultural or construction in the lending indicator. The rise successful in attracting a number
sector is higher in Wales than in any in economic activity in the West of major investments in recent
other UK region. These industries Midlands implied by the positive months, which are likely to generate
were heavily impacted by the movements of the employment substantial spill over effects for
weather-related disruption in Q1, and capacity indicators is somewhat the local economy. These include
and will therefore have enjoyed a surprising given the struggles that Siemens’ plans to develop a new
notable spike in activity in Q2. By UK manufacturers have faced in rail factory in Goole, and Sirius
contrast to the rest of the UK, the recent months. This suggests that Minerals’ major potash mine near
annual rate of employment growth the local economy has been buoyed Whitby. The latter development in
accelerated in Wales to 2.2%, as by other sectors. For instance, recent particular has the potential to deliver
over 13,000 jobs were added Government figures have shown a significant boost to exports in the
over the second quarter of the that the creative, gambling and sports region, following the Government’s
year. Aided by its skilled workforce, industries contribute to nearly 7% of recent report which found that
enterprise zone and low rents the West Midlands economy, while Yorkshire is the largest exporter of
relative to London, Cardiff has been the number of tourists visiting the manufactured goods in the UK after
successful in developing a thriving region has also continued to grow London. Yorkshire & the Humber has
financial services sector. Indeed, according to the ONS’ International a well-developed financial services
a recent Centre for Cities report Passenger Survey. 7 sector. Indeed, a recent Centre for
has found that Cardiff has a higher Cities study has found that finance
proportion of exports coming from accounts for roughly 70% of total
finance than any other city in the service sector exports from Leeds
UK.6 This highlights the fact that it and York. While this relative strength
is not just London that is exposed in finance is very much a positive
to the consequences of a loss of for the region, it does leave many
access to the EU’s financial market. firms and workers exposed to a
possible restriction of access to the
crucial European market if the Brexit
negotiations yield an unfavourable
outcome.
6
Centre for Cities, July 2018: http://www.centreforcities.org/publication/london-links/
15
7
NS, August 2018: https://www.ons.gov.uk/peoplepopulationandcommunity/populationandmigration/internationalmigration/bulletins/migrationstatisticsquarterlyreport/august2018
O#SMEhealth | Q2 2018 REPORT
3 IN FOCUS: SME BUSINESS COST INFLATION
In this section, we explore the business costs indicator in greater detail in order to establish its contribution to the
overall worsening of the business climate in the second quarter of 2018, and the degree to which it has affected
SMEs in different regions.
Figure 4: SME Inflation Q1 2014 – Q2 2018
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
-0.5%
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
2014 2014 2014 2014 2015 2015 2015 2015 2016 2016 2016 2016 2017 2017 2017 2017 2018 2018
The annual rate of business cost by a double whammy of reduced the annual rate of inflation of this
inflation continues to climb and rose competitiveness in external markets category of input rose in Q2, but
to 2.9% in Q2 2018. This increase and higher costs for imported inputs remains below the overall average
was driven by a variety of factors. if further tariffs are implemented. rate of business cost inflation.
The price of basic metals, which While hostilities appear to have Meanwhile, the resurgence in
account for nearly 5% of total SME simmered down between the US demand for construction output
inputs, rose at an average annual and the EU following last month’s in the second quarter, following
rate of 7.7% in the second quarter, meeting between US President the disruption in Q1, appears to
compared to 5.6% in Q1. The Donald Trump and European have had an impact on prices
persistent strengthening of the US Commission President Jean-Claude – the annual rate of inflation of
dollar in Q2 will have driven up the Juncker, the trade war between construction output rose by 0.5
price faced by UK producers for China and the US has continued to percentage points to 3.4% between
many imported products, including escalate. Given the highly integrated Q1 and Q2 2018. This acceleration
metals. Similarly, the annual rate of nature of global supply chains, the is a key driver of the increase in the
inflation of chemical inputs increased consequences of this will extend overall rate of business cost inflation.
from 7.0% to 7.7% between the far beyond the directly impacted
first and second quarters of the countries. The UK’s housing market has been
year. The escalation of global trade cooling for several months, and
tensions in recent months has led Higher oil prices are likely to have there are signs of a similar pattern
to fears that businesses could be hit fed into transport prices. Indeed, in the commercial property market.
16#SMEhealth | Q2 2018 REPORT
Figure 5: Breakdown of costs faced by SMEs
22.4% Physical inputs
29.7% Employment costs
5.0% Rent and utilities
15.7% Construction
3.6% Transport and storage
20.5% IT, business and financial services
3.1% Other
Indeed, the annual rate of price down marginally to 2.5% in Q2, alongside a 0.3 percentage point
growth of commercial rents fell driven by declines in the rate of fall in the annual growth rate of
by 0.3 percentage points to 1.6% wholesale price growth for food, consumer prices. This shows that
in Q2. This component weighed tobacco and alcohol products. businesses are not fully passing
down on overall inflation last The slowdown in wholesale food through their rising costs to
quarter. Meanwhile, employment price growth also benefited the consumers, indicative of a decline
cost increases continued to push accommodation and food services in margins for many firms. We
up business cost inflation, despite sector, where the annual rate of expect earnings growth to tick up
recent declines in the overall rate cost inflation fell by 0.4 percentage slightly over the next year given
of earnings growth. Wages in the points to 2.2%. the tightness of the labour market,
construction sector rose at an which would exert further upward
annual rate of 4.7% in Q2, again The rate of business cost inflation pressure on business cost inflation.
highlighting the resurgence of increased in all regions with the If the EU and the UK fail to reach
activity in this sector, as well as exception of London, where it an agreement on trade and other
a shortage of skilled labour – a remained broadly stable at 2.6%. The matters prior to the UK’s withdrawal
longstanding issue for the industry. relatively low share of manufacturing on March 29th 2019, there is the
and construction SMEs in the South possibility that importers could face
The soaring prices of physical East contributed to a lower than significant tariffs on EU products.
inputs drove up the annual average rate of cost inflation in The depreciation of the pound that
rate of cost inflation for the this region in Q2. All other regions would likely accompany any such
manufacturing sector to an average recorded an annual rate of business outcome would lead to further
of 4.1% in Q2. This is likely to be a cost inflation of 2.9%. import cost rises. Therefore, a ‘no-
contributing factor to the sector’s deal’ Brexit represents a significant
weak performance last quarter. Interestingly, the increase in the downside risk for the business costs
Conversely, the annual rate of cost annual rate of business cost inflation indicator.
inflation for the retail sector edged between Q1 and Q2 occurred
17#SMEhealth | Q2 2018 REPORT
SPECIAL
REPORT
18#SMEhealth | Q2 2018 REPORT
4 SPECIAL REPORT: SME INVESTMENT PLANS
Business investment is a significant part of the economy, accounting for around 9.5% of the UK’s GDP. The
volatility of business investment relative to other components of GDP such as household or government
expenditures means that it is often a key driver of fluctuations in economic performance.
Business investment refers to Spending on these types of goods the levels seen in other advanced
spending on goods that are not is also referred to as Gross Fixed western economies. The collapse
consumed today, but are instead Capital Formation (GFCF). 8 in confidence following the 2008
used to generate output in the financial crisis led to a sharp decline
future. This includes expenditures on Strong levels of investment are in investment levels in developed
physical assets, for example building crucial in achieving sustained countries, which most have yet to
structures, transport equipment, improvements to the productive fully recover from. This is likely to
machinery and IT equipment, as well capacity of an economy. In the have contributed to the anaemic
as intangible assets such as research UK, GFCF as a proportion of productivity growth that the UK has
and development and software. GDP has historically been below seen in recent years.
Figure 6: Gross fixed capital formation as a % of GDP
24%
23%
22%
21%
20%
19%
18%
17%
16%
15%
14%
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
UK Italy France USA Germany Euro Area
8
https://www.ons.gov.uk/economy/grossdomesticproductgdp/articles/ashortguidetogrossfixedcapitalformationandbusinessinvestment/2017-05-25
19#SMEhealth | Q2 2018 REPORT
Levels of business investment are business investment. Business closely with the confidence
related to several of the indicators confidence is another key factor indicator and to a lesser extent
in the SME Health Check Index. underpinning investment spending. with the revenue indicator, as
Many SMEs rely, to some extent, Finally, as discussed above, business shown below. There are few signs
on borrowing to finance investment investment has a significant impact of any consistent relationship
projects, therefore business on the overall economy and will between the lending indicator and
investment will be influenced by therefore be related to the Health business investment growth, which
movements in the lending indicator. Check Index’s GDP indicator. emphasises that borrowing is just
Another source of funding for one possible avenue through which
investment comes from firms’ Analysing the historical data shows SMEs can finance investment.
own profits, hence the revenue that the annual rate of business
indicator is also likely to feed into investment growth has moved
Figure 7: Relationship between business investment growth and confidence and revenue indicators
100 - 8%
90 - 7%
6%
80 -
5%
70 -
4%
60 -
3%
50 - 2%
40 - 1%
0%
30 -
- 1%
20 -
- 2%
10 -
- 3%
0- - 4%
Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017 Q1 2018 Q2 2018
Confidence indicator Revenue indicator Business investment annual growth rate
Source: ONS, FSB, Cebr analysis
Steadily increasing borrowing costs a significant slowdown in business to survey 504 small and medium
and the uncertainty generated by investment in the coming quarters. sized businesses across the UK.9 The
the continued lack of progress in In order to gain an insight into remainder of this section presents
the Brexit negotiations, as well as SMEs’ investment plans and the the findings of this survey.
escalating trade tensions emanating key factors that will shape these,
from the US have led to fears of CYBG commissioned YouGov plc
20 9
Total sample size was 504 SMEs. Fieldwork was undertaken between 15th August and 21st August 2018.
The survey was carried out online. The figures have been weighted and are representative of SMEs in the UK.#SMEhealth | Q2 2018 REPORT
4.1 SME INVESTMENT IN PAST YEARS
According to ONS data, business the last three months was higher about the same over the past year.
investment growth in the UK than the level during the same This highlights that a considerable
has remained positive in recent period last year, compared to 16% number of small businesses are
quarters, albeit at a rate below that who have reduced their investment not feeling confident enough to
observed in the years prior to the expenditures over the past 12 expand their investment. The
EU Referendum. Our survey also months. most commonly listed categories
suggests that collectively, SMEs of investment spending over the
have continued to increase their Another interesting finding is that past year were ICT equipment,
investment levels over the past 12 a majority (51%) of SMEs in our machinery and building structures.
months. Over a quarter (26%) said survey stated that their level of
that their investment spending over investment spending has remained
Figure 8 Change in the level of SMEs’ investment spending over the last three months compared to a year ago
60%
50%
40%
30%
20%
10%
0%
Significantly Higher About the Lower Significantly
Higher same Lower
Source: YouGov / Cebr analysis
The survey then goes on to the products they provide, while a optimistic outlook for the overall
examine the factors that have quarter (25%) said that more profits UK economy as a motivating factor.
driven SMEs to increase their available for investment were a This suggests that the investment
investment over the past 12 factor. Both of these factors are decisions of those SMEs that
months. 46% of SMEs who closely related to a company’s increased their investment spending
increased their investment spending revenue, which highlights that this were shaped primarily by firm-
over the past year stated that this is a key determinant of investment. specific factors, as opposed to the
was driven by a greater demand for Meanwhile, just 19% cited a more wider macroeconomic environment.
21#SMEhealth | Q2 2018 REPORT
4.1 SME INVESTMENT IN PAST YEARS
Figure 9. Factors driving an increase in investment spending over the past year
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Greater More profits A greater Greater Higher Lower Increased
demand for available for number optimism available borrowing availability of
the goods investment of viable regarding returns on costs credit
and/ or investment the outlook investment
services that opportunities for the UK
my business economy as
Source: YouGov / Cebr analysis
provides a whole
Turning to SMEs who decreased economic uncertainty in the UK has on the long term viability of these
their level of investment spending indeed caused a significant number potential investments.
over the past year, uncertainty of firms to rein in their investments.
appears to have been a major While much has been made of
contributing factor. Two in five Only one in ten (10%) SMEs in our the Bank of England’s recent rate
(41%) answered that uncertainty survey who have decreased their rises, the results of our survey
surrounding the UK’s future investment spending over the last suggest that this is yet to have had
relationship with the EU and the year said that this was due to a lack a major impact on firms’ investment
overall economic outlook for of viable investment opportunities. decisions. Indeed, just 3% of SMEs
the UK has contributed to them This highlights that most SMEs do who decreased their investment
reducing their investment spending see opportunities to grow, but the spending over the past 12 months
over the last 12 months. This uncertainty that they now face cited higher borrowing costs as a
provides evidence that the prevailing on multiple fronts is casting doubt contributing factor.
22#SMEhealth | Q2 2018 REPORT
Figure 10. Factors driving a decrease in investment spending over the past year
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Uncertainty Uncertainty Less optimism Fewer profits Lower A lower Increased Lower Reduced Higher
surrounding surrounding regarding the available for demand for number risk of trade available availability of borrowing
the UK’s the UK’s outlook for the investment the goods of viable restricitions returns on credit costs
future overall UK economy and/or investment investment
relationship economic services that opportunities
with the EU outlook my business
provides Source: YouGov / Cebr analysis
Since 2016, political and economic survey asked all SMEs (regardless of said that their investment plans
uncertainty in the UK has risen due whether they increased, decreased have not been affected. While this
to a number of events including the or held stable their investment postponement will have inevitably
vote to leave the EU, a heightening spending over the past year) about suppressed growth in recent
of global trade tensions and the the degree to which they have quarters, it also suggests that there
loss of the ruling Conservative delayed their investments. We could be a spike in investment if
Party’s majority. A key theme of the found that 43% of SMEs are indeed a favourable outcome is reached
UK’s economic discourse in recent postponing their plans to some in the Brexit negotiations, as
months has been the possibility that extent. Among these, 14% have businesses implement investment
many firms are postponing their postponed all of their investment projects that had previously been
investment plans as a result of this plans and 26% have postponed put on hold.
uncertainty. To examine this, our most of their plans. Meanwhile, 43%
23#SMEhealth | Q2 2018 REPORT
4.2 SME INVESTMENT IN FUTURE YEARS
30% of SMEs in our survey expect expected expenditure over the next Meanwhile, just under a third (31%)
the level of their business’ investment year. This points towards the ever- said that less uncertainty regarding
spending to increase over the next growing role of technology in the the UK’s economic outlook would
year, compared to 15% who think UK’s SMEs. incentivise them to invest. This again
that it will decrease. Meanwhile, highlights that investment plans are
nearly half of SMEs (46%) said that 44% of SMEs stated that a greater formed primarily by firm-specific
they expect their level of investment demand for the products that they conditions, although macroeconomic
spending to remain stable over the provide would encourage them to factors do play a significant role.
next year. ICT equipment is the increase their investment spending
most commonly listed category for over the next year.
Figure 11. Factors that would encourage SMEs to increase investment spending in the coming year
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Greater Less Less More profits Greater Higher A greater Reduced Lower Increased
demand for uncertainty uncertainty available for optimism available number risk of trade borrowing availability of
the goods surrounding surrounding investment regarding returns on of viable resrtrictions costs credit
and/or the UK’s the UK’s future the outlook investment investment
services that overall relationship for the UK opportunities
my business economic with the EU economy as
provides outlook a whole Source: YouGov / Cebr analysis
When examining the factors that demand for the products provided the EU: a third (33%) of SMEs in
would most discourage investment by the SME. Following this was our survey said that this would
over the coming year, the most increased uncertainty surrounding discourage them from investing
common response was a lower the UK’s future relationship with over the next year.
24#SMEhealth | Q2 2018 REPORT
Figure 12. Factors that would discourage SMEs to increase investment spending over the coming year
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Lower Increasing Less optimism Fewer profits Increased Higher Lower Increased Reduced A lower
demand for uncertainty regarding the available for uncertainty borrowing available risk of trade availability of number
the goods surrounding outlook for the investment surrounding costs returns on resrtrictions credit of viable
and/or the UK’s UK economy the UK’s investment investment
services that future overall opportunities
my business relationship economic
provides with the EU outlook Source: YouGov / Cebr analysis
4.3 SME BORROWING FOR INVESTMENT
A majority (59%) of SMEs in Indeed, 59% of SMEs in our survey most frequently cited motivations
our survey rely to some extent stated that a one percentage point for this were to invest in fixed capital
on borrowing to finance their increase in the annual interest rate assets, with 31%, 25% and 17%
investment spending. However, only on business loans would have some of relevant SMEs saying that they
9% of SMEs said that most of their impact on their level of investment obtained finance in order to invest
investment spending was financed by spending. While this size of increase in machinery, building structures and
borrowing. This finding could account in borrowing costs is not likely to ICT equipment respectively. Just 7%
for the limited association between be realised within the next year of SMEs who successfully applied for
the lending indicator and business given the BoE’s anticipated path of finance over the last 12 months did
investment growth, since many rate rises, it does highlight that the so to cover existing employee costs,
SMEs are able to tap into alternative normalisation of interest rates will while 11% did so in part to service
sources of funding. That being said, enter firms’ thinking as they form existing debts. This shows that most
it is conceivable that an increase their investment plans. SME borrowing is directed towards
in borrowing costs could have an productive investments designed to
impact on the level of investment 31% of SMEs in our survey have increase their capacity, as opposed to
spending for a significant share of successfully applied for some form more defensive manoeuvres such as
small and medium sized businesses. of finance over the last year. The covering existing costs.
25#SMEhealth | Q2 2018 REPORT CONCLUSIONS & METHODOLOGY 26
#SMEhealth | Q2 2018 REPORT
5 CONCLUSIONS
There was no major movement in the overall SME Health Check Index for the UK between Q1 and Q2,
although the score fell by 0.5 points to 47.1. Economic activity rebounded in the second quarter of the year, as
firms made up for lost ground following the weather-related disruptions that occurred at the start of the year.
This resurgence in activity is reflected by the GDP and capacity indicator, the latter showing a notable fall in the
share of SMEs operating below their full capacity.
These gains were undermined by The relative stability of the UK wide of their investment spending
a deterioration in the employment Index score in Q2 2018 belies a remained stable over the past year.
and lending indicators. The first number of significant shifts at a Economic and political uncertainty
of these can be explained by the regional level. The East of England is currently acting as a significant
existing tightness of the labour and Yorkshire & the Humber both drag on investment, with 43% of
market, which means that some recorded 11 point gains in the SMEs postponing at least some of
slowdown in the annual rate of SME Health Check Index, both their investments as a result. The
employment growth is to be driven by marked improvements Bank of England’s interest rate rises
expected. The slowdown in the rate in the confidence, capacity and appear to have had a limited impact
of lending growth in Q1 suggests employment indicators. Meanwhile, on investment levels so far, although
that firms’ demand for finance the regions that struggled most 59% of SMEs indicated that a one
was impacted by the economic last quarter – namely the North percentage point rise in the annual
slowdown that quarter, as well as the West and the South East – have rate of interest on business loans
prevailing expectation at the time of actually registered falls in the level of would have at least some impact
a more rapid escalation of interest employment over the past year. on their investment plans. The
rates than has taken place. overriding finding of the survey
Business investment is related to a is that demand for the specific
Looking ahead, employment number of factors including SME products that an SME provides
growth is likely to continue to slow, confidence, revenues, access to is the primary determinant of
weighing on the employment credit and overall levels of demand. investment decisions, although the
indicator. Meanwhile, the increased As such, it is an excellent bellwether wider macroeconomic environment
likelihood of a no-deal Brexit may of the health of SMEs and the remains an important consideration.
well impact upon SME sentiment wider economy. Our survey finds
as the Brexit negotiations approach that a greater share of SMEs
their denouement. These trends have increased their investment
suggest that the SME Health Check spending over the past year than
Index may experience some further have decreased it. However, a
declines in the coming quarters. majority reported that the level
27#SMEhealth | Q2 2018 REPORT
6 METHODOLOGY
The SME Health Check Index is designed to measure small business performance and the business and
macroeconomic environment within which SMEs operate. The Index includes measures that can be directly
linked to SME performance as well as components that relate to the wider economy. Specifically, the following
measures are included:
Business Costs Confidence Lending
The Index measures the annual SME business confidence data For the lending indicator, we used
change in costs faced by a typical also come from the FSB. The data from UK Finance to calculate
SME and the main data source Index indicates how confident the annual change in lending
for this measure is the Office for businesses are about their short- balances. The following measures
National Statistics. Higher costs term prospects over the next three are included: Value of overdrawn
are associated with a deteriorating months. Higher business confidence balances and value of loan balances.
business environment as companies has a positive effect on the SME
will either have to pass these on Health Check Index. Net Business Creation
to their clients in order to protect The data come from the Insolvency
profit margins or accept lower profit Employment Service Statistics and measure the
margins in order to secure market Data for this sub-component is annual growth rate in the number
share. taken from the ONS and measure of registered companies. The higher
the quarterly change in absolute the growth rate in the number of
Capacity employment figures. Higher registered companies, the higher
The data for capacity comes from employment figures are associated the score.
the Federation of Small Businesses with an improving macroeconomic
(FSB) and measures the proportion environment and may signal Revenue
of SMEs operating below capacity. improved confidence about future Data come from the FSB and
If firms operate below capacity, this workloads. measure the net percentage
could have negative implications for balance of SMEs reporting an
hiring and investments intentions. Gross domestic product increase in revenues.
Therefore, a higher proportion of Gross domestic product figures are
SMEs reporting to operate below taken from the ONS and measure
capacity will have a negative impact the quarterly percentage change
on the overall SME Health Check in economic growth. For the
Index. regional breakdown, we estimated
the quarterly figures based on the
previous relationships between a
region’s GVA and overall UK GDP
growth.
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