Watch out for the Zombies!

A zombie company is defined by the Organisation for Economic Cooperation and Development (OECD) as one that cannot pay the interest on its borrowing from operating profit for three years in a row. These are businesses that are at risk of insolvency and could be pushed over the edge by a sudden unexpected event.

Zombie companies will be put under significant financial pressure when inflation rises above the 2% target and interest rates rise in an attempt to combat it. Indeed, the impact of high interest rates was felt with a 15% increase in corporate insolvency figures during the first half of 2023 compared to the same period in 2022. This follows the sharp increase in interest rates in response to the sharper rise in inflation through 2022. Whilst insolvencies are still on the rise, when compared to the first half of 2024 there is only a small 0.5% increase.

The increase in inflation has resulted in hikes in prices for various goods and services and has presented a challenge for zombie companies. When prices go up, consumer purchasing power decreases, which can affect the demand for goods and services. For zombie companies, who are already struggling with small margins, it may be difficult to transfer increased costs to consumers. This squeeze on profitability restricts their investment capacity in research and development or necessary upgrades, which means they start to stagnate and are unable to expand.

For companies with significant outstanding debt, the burden of repayment becomes heavier in an inflationary environment because central banks typically increase interest rates in a bid to control it. Zombie companies struggling to cover the interest on their borrowing will feel the pinch and this can ultimately lead to insolvency.

Whilst an increase in insolvencies may be seen in a negative light, if these entities that are failing to contribute to economic growth, is there an argument to say that their failure might make room for those who do contribute instead?

I appreciate that there can be a domino effect on a supply chain and those whose livelihoods are impacted will certainly not appreciate being collateral damage, but this is where caution should be taken when choosing who to trade with. Accounts departments, procurement officers and credit managers will be well versed in mitigating risk in the supply chain, however supply is key and there are only so many mitigation measures that can be adopted. A competitive market will assist corporate resilience though, and in making room for new entities and by freeing up funding opportunities, industries will progress and ultimately contribute to UK plc in a positive way.