US tariff trade turmoil ‘will result in insolvencies’

Companies operating just-in-time deliveries and in low margin sectors such as manufacturing, automotive supply chain and retail are likely to be hardest hit. Larger businesses with experienced management may be able to trade their way out of trouble, however, smaller and less well-resourced companies may not.

At the beginning of April, US president Donald Trump overturned economic orthodoxy with a return to high, near-universal tariffs on goods imported into the US, ending a decades-long pattern of the removal of trade barriers. The landscape for business has continued to shift since these changes, including a recent announcement of a trade agreement between the UK and the US. 

For companies heavily reliant on US sales, the measures are significant. The fact that the US administration has changed its mind more than once on whether tariffs apply and not fully clarified to whom they apply does not help companies attempting to navigate this new trading environment and prepare reliable financial forecasts.

In the UK, companies which supply parts to automotive manufacturers were initially particularly exposed. In response to the tariffs, certain automotive manufacturers initially decided to reduce the number of cars they planned to produce for sale in the US market. The recently announced UK/US trade agreement clearly alleviates the some of the pressure on this sector in particular, however it remains to be seen whether this relief will be broadened out to something which benefits UK businesses as a whole.

Retailers with a heavy reliance on selling into the US market will clearly struggle. Companies whose supply chains include suppliers exporting from China could face a double whammy, as very high Chinese tariffs could be levied on those sales on top of tariffs imposed on the retailer from the UK.

All of the above businesses typically operate on already low margins, meaning they will have little opportunity to pass the extra costs on to buyers. Companies will generally try to resist making knee-jerk decisions about their future strategy, particularly with US trade policy proving to be so volatile. US trade policy has changed so frequently in recent weeks that businesses will, understandably, want to hold off on making significant decisions and may not be able to prepare any financial forecasting with certainty until the trading landscape has stabilised. However, businesses will only be able to delay for so long.

Financial projections will need to be prepared and a trading forecast that weathers the storm will need to be demonstrated by the time accounts are due to be filed and covenants are required to be tested. The true financial impact of the new measures will start to become apparent in the coming months and businesses will need to identify strategies to address the challenges or accept that the challenges are too great and take steps to protect stakeholders. 

Some businesses will find that they cannot service their financing obligations; some will try but fail to renegotiate or restructure their debt; some will come to the conclusion that they simply can’t trade profitably and will look to wind down operations in an orderly way. However, some companies may delay too long and find themselves facing an unplanned insolvency and that should be avoided at all costs given the risks it carries for management.

Trading through the shock

Many businesses will manage to trade through the current uncertainty and come out a profitable business on the other side.

Businesses will often try, if they can, to pass the additional tariff costs on to customers and thereby maintain their margins. This is easier in the case of high-price consumer goods such luxury cars, but is nearly impossible if you are selling a commoditised or easily substitutable component that goes in someone else’s product.

If this is not possible you could seek out other, more stable markets to sell into as an alternative to the US. After the UK government’s announcement of new trade deals with India and the EU in recent weeks, this could become a more viable proposition.

Companies may need to go further than this. They might need to find cheaper suppliers to help absorb some of the new costs, or reconsider their supply chains if they are particularly exposed to suppliers located in China. They may also find it necessary to cut their own costs by restructuring their workforce or closing underperforming sites.

One of the most important factors in navigating the current trading landscape will be the experience of the management team. Medium-sized businesses with a chief financial officer and management team experienced in turnaround may have the experience, rigour and flexibility to steer their firm through these troubled times. Businesses of this scale are also more likely to have cash reserves to draw on to absorb unexpected cashflow shocks and see them through this uncertain period.

Companies lacking experienced management and or the benefit of cash reserves may find trading through the uncertainty much more challenging. Alternative financing options may need to be considered to improve liquidity or tough decisions to close or sell may be required.

Another significant factor will be lender support – does the company have a lender that will be willing to renegotiate or restructure its facilities and support the business in the future? Without this, many companies are likely to find themselves in breach of their financial covenants. Companies will be hoping that their lender will continue be supportive of their long-term prospects and will be willing to waive breaches or renegotiate covenants in the hope that the company’s difficulties are only temporary.

It is possible to navigate your way through something like this without resorting to formal measures but it is difficult and you often have to make some quite extreme changes. And in some cases this will involve analysing the business model and, if it something like buying goods from China and selling into the US, concluding that there just isn’t a viable business model there.

But companies’ first reactions will be to hold on, try to weather the storm and give the situation time to settle. There is, of course, risk in this approach too. As time goes on, companies will need to deal with the repayment of loans reaching maturity and must address going concern statements as their audited accounts become due. There is also no indication of when the situation will begin to stabilise. The one constant over the last few months has been unpredictability.