Guest blog: The impact of COVID-19 on Scottish SMEs’ liquidity and access to finance

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This blog was written by Dr Raffaella Calabrese of the University of Edinburgh, as part of a Fellowship with the Scottish Parliament Information Centre. The analysis and conclusions are made by the author. As with all guest blogs, what follows are the views of the author, not those of SPICe or the Scottish Parliament.

The COVID-19 pandemic has caused an unprecedented shock to the global economy. Small and medium-sized enterprises (SMEs) in Scotland have been adversely affected by financial instability and many have faced liquidity problems. This means that some businesses have not had enough liquid assets – such as cash – to meet their short-term obligations, such as paying employees, repaying loans, and paying operational costs. This blog summarises the main effects that the pandemic has had on Scottish SMEs, in terms of liquidity and access to finance. Generally, a SME is defined as a small or medium-sized enterprise with fewer than 250 employees, including zero employees.

In 2020, there were 361,875 registered and unregistered businesses in Scotland with less than 250 employees. This represents 99.3% of all private sector businesses in Scotland, meaning SMEs are a central plank of the Scottish economy. The two largest sectors are Professional, scientific and technical activities (13.3% of all Scottish SMEs) and Construction (13.2%).  

While SMEs represent the majority of the private sector business base, they only account for 56% of total private sector employment in Scotland. The two sectors with the largest number of employees are Retail (20.7% of the total number of employees in Scottish SMEs) and Accommodation and food service activities (17.6%). So, given the central role of SMEs in the Scottish economy, understanding the financial impact of COVID-19 on these businesses is central to developing recovery policy responses. SMEs drive employment, innovation, regional development and poverty reduction, and, ultimately, the growth of the Scottish economy.

COVID-19 impact on SMEs in liquidation

From merging the list of Scottish companies in liquidation in 2020 provided by Account in Bankruptcy (Scotland’s Insolvency Service) with the database FAME provided by Bureau van Dijk’s Fame, we can give an overview of some early trends on the impact of COVID-19 on Scottish SME liquidity. Our matching and analysis of these datasets revealed 171,107 solvent and 1,300 insolvent companies registered in Companies House. Readers should note our analysis does not consider unregistered companies, these are mainly those set up by sole traders and make up about half the Scottish business base.

Emerging findings from these initial datasets show that despite the severe effects of the pandemic on the Scottish economy, the number of businesses that went into liquidation in 2020 was 20% lower (1,304) than the number (1,652) that were liquidated in 2019. We believe this difference can largely be explained by both Scottish and UK Government lifeline support schemes that were provided to Scottish businesses in 2020, such as the COVID-19 Business Loan Support Scheme, and business-rates related reliefs and grants.

The emerging data illustrated on the map below shows the percentage of SMEs that went into liquidation by the total number of registered companies located in each Scottish Parliament Constituency area. The map functionality allows users to zoom in and out on Scottish Parliament constituencies at different scales and hovering over a constituency reveals the ratio of liquidations to active businesses and the total number of liquidations.

This map shows most of the liquidated businesses are generally concentrated in urban areas, such as Aberdeen, Dundee, and the central belt between Glasgow and Edinburgh. In particular, ‘Dundee City West’ and ‘Renfrewshire North and West’ have relatively higher liquidation ratios.

Most of the Scottish SMEs that went into liquidation were either involved in Professional, scientific and technical activities (24.7% of the total number of Scottish SMEs in liquidation) or Information and communications (13.5%).

However, if we look at the proportion of liquidated SMEs by sector relative to the total number of SMEs in that sector, we see the two sectors that saw the highest percentage of their SMEs going into liquidation were Information and communications (2.8% of Scottish SMEs working in the sector Information and communications) and Accommodation and food service activities (2.46%).These proportions are relatively small. However, as flagged previously these are only emerging trends in the data  and we would expect it to take a while for the full effects of the pandemic to become apparent in the data, especially as public sector support is unwound. 

To best support SMEs, policymakers need to be able to identify the main characteristics of the companies that are vulnerable to liquidity-linked failure. Emerging findings from our statistical analysis of the 2020 data reveal the following characteristics of registered Scottish SMEs:  

  • Public Limited Companies (PLC) and private unlimited companies were less likely to go into liquidation than private companies limited by guarantee and by shares.
  • Older companies (up to nine-years-old) were less likely to go into liquidation than start-ups.
  • Family-owned companies were more likely to fail than mutual and pension fund firms, showing their resilience to the consequences of the pandemic.
  • Medium size companies were less likely to go into liquidation, with the probability of this happening increasing as the size of a company decreases.

COVID-19 impact on SME access to finance

During an economic crisis, banks tend to decrease the amount of loans that they provide to SMEs, becoming more risk averse. To help SMEs gain access to external finance during the COVID-19 pandemic, both the Scottish and the UK Governments offered a range of business support interventions.

The UK Government has been the predominate source of loan finance interventions partly due to the scope of the Scottish Government’s devolved powers and its limited fiscal borrowing powers. Specifically, the UK government created two guarantee loan schemes (Coronavirus Business Interruption Loan Scheme (the interruption scheme) and its smaller counterpart the Bounce Back Loan Scheme (the bounce back scheme)). These schemes underwrote bank lending to businesses to the tune of 80% and 100%, respectively.

The scale of government intervention to the COVID-19 crisis has been unprecedented.

  • 93.1% of all debt funds provided by banks in the second (April to June 2020) and third (July to September 2020) quarters of 2020 were backed by the UK government. In normal circumstances, it is less than 5%.
  • The liability of this total UK debt is estimated to be around £70 billion, where £3.58 billion was provided to Scottish companies. Both these schemes closed on 31 March 2021 and have been replaced by the Recovery Loan Scheme.
  • The bounce back scheme offered around 86,000 loans in Scotland, which represented 6% of the total number of loans provided by this scheme, for a total value of loans offered around £2.5 billion.
  • These figures in absolute numbers are much lower for the interruption scheme that provided 4,144 loans to Scottish companies for a total value of around £980 million. However, the percentages of the total number of loans offered under the interruption scheme in Scotland (6%) and the percentage of Scottish companies that received these loans (6%) are in line with the bounce back scheme.

The data collected for the SME Monitor Finance survey can be analysed to investigate if the above schemes have been effective in supporting small businesses in Scotland.  

The two schemes have been effective at increasing the percentage of approved loan applications: 91.6% in the UK overall and 93.8% in Scotland - percentages comparable to approval rates during periods of economic growth (96% in Scotland in 2007).  The UK approval rate during the Global Financial crisis was only 70%. Nearly all the loans that were offered between April and September 2020 were backed by one of these two schemes (93.1% in the UK and 88.2% in Scotland).  

In the SME Monitor Finance survey, companies were asked if the business had a need for external financing.

  • In 2019, 4.7% of the interviewed Scottish companies expressed this need, which increased in Q2 of 2020 to 6.4% and then to 12.3% in Q3 of 2020 as the economy started reopening after the first lockdown.
  • Most of these were medium-sized or were hotels or restaurants.
  • Limited liability companies were both more likely to think about and then actually apply for external finance than single owner companies or limited liability partnerships.
  • Among the companies that had the need for external financing, the percentage of companies that actually apply for external finance increased from the second quarter (73.91%) to the third (76.74%) compared to 66.37% in 2019.

Other points from the SME Finance Monitor survey show:

  • The data show that the interruption and bounce back schemes were effectively supported companies with higher risk profiles. These types of companies usually find it more difficult to gain access to bank loans.
  • Some companies in need of financing did not apply for loans as they did not believe that their application would be approved. This was particularly the case for manufacturing companies and micro-size companies.
  • Most Scottish SMEs (around 70%) had no plans to seek any external finance. Indeed, only 19.22% actually applied for a loan between April and September 2020, against the lower percentage of 14.8% for all UK companies.
  • SMEs are most likely funding their operational and investment activities using internally generated funds, with loans only being sought when these funds are insufficient.
  • Most applications for external finance are for basic bank debt products, such as overdrafts and loans.

The above shows how in terms of access to finance the interruption and bounce back schemes were short-term lifeline policy interventions. However, looking forward the UK and Scottish Governments, along with the recently launched Scottish National Investment Bank (SNIB), will likely look to play a key role in promoting long-term schemes focused on growth-enhancing measures.

Given the reluctance of SMEs to apply for external finance during economic downturns, perhaps the SNIB could investigate implementing a support similar to the interruption scheme. The Scottish Government could also provide small grants to SMEs that will undertake new types of activities to adjust to the changes due to the pandemic. Finally, as the business landscape is rapidly changing, the Scottish and the UK Governments should monitor their interventions by analysing real-time data rather than relying on government surveys, which we believe is already an area of ongoing work.

Next steps

This blog presents some of the initial findings of this research project. The project plans to extend further this analysis using additional data sets, such as transactional data for SMEs and ONS databases. We also plan to develop a counterfactual analysis that will provide insights on the kind of companies that would have been in liquidation without the government financial support.

The author is grateful for the support provided by Marc Cowling, Yujia Chen, Paul Wagner  and Mustapha Douch

Dr. Raffaella Calabrese

Chancellors Fellow & Senior Lecturer (Associate Professor) in Data Science, University of Edinburgh Business School