SME Health Check Index - Q2 2018 - SEPTEMBER 2018 - CYBG

 
SME Health Check Index - Q2 2018 - SEPTEMBER 2018 - CYBG
SME Health
             Check Index
              Q2 2018

                           SEPTEMBER 2018
#SMEhealth                 Compiled by Cebr, in association with CYBG
SME Health Check Index - Q2 2018 - SEPTEMBER 2018 - 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
SME Health Check Index - Q2 2018 - SEPTEMBER 2018 - CYBG
#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
SME Health Check Index - Q2 2018 - SEPTEMBER 2018 - CYBG
SME Health Check Index - Q2 2018 - SEPTEMBER 2018 - CYBG
#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
SME Health Check Index - Q2 2018 - SEPTEMBER 2018 - CYBG
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
SME Health Check Index - Q2 2018 - SEPTEMBER 2018 - CYBG
#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
SME Health Check Index - Q2 2018 - SEPTEMBER 2018 - CYBG
#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
SME Health Check Index - Q2 2018 - SEPTEMBER 2018 - CYBG
#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
SME Health Check Index - Q2 2018 - SEPTEMBER 2018 - CYBG
#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

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#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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