The findings of the Central South Report 2010, compiled by leading accountants and business advisers BDO, shows the impact of the recession on local businesses but crucially considers what might be on the horizon for companies in the region

The third annual Central South Report consolidates accounts of the region’s top 150 companies to provide a barometer of the economic climate for the region. Referred to as “the Group”, these companies employ over 315,000 people worldwide and make a pivotal contribution to the region’s economy.

Although there was shown to be a decline in profits and investment, the majority of companies in the report maintained their trading levels. In his Chairman’s statement for the report, Paul Lester, CEO of VT Group, comments that the figures in the report inevitably reflect the downturn in the economy but possibly not its full impact as the first six months of the current year are unlikely to show any improvement.

Richard Pearce, CFO of Xyratex has continued in his role as financial director for the Group, and notes the results reported this year reflect the start of the downturn and in particular the high energy costs of 2008. As the recession continued into 2009, companies across the region were forced to look closely at their business operations to eliminate unprofitable elements or undertake carefully managed restructuring plans. However, the real benefit of these actions is unlikely be felt until 2010 or – in all likelihood – 2011. But the fact that companies are putting renewed emphasis on operating leaner with lower costs bases gives room for optimism that the Group can manage itself through these difficult times.

The report looks at a number of key topics including the mergers and acquisitions and investments made by the Group, the potential for increased fraud during a recession and the need for proactive management of tax changes. The Group tax charge dropped last year, but not in line with profits, so the effective tax rate increased. The year ahead is likely to see tax demands becoming increasingly onerous. Companies are facing additional compliance burdens and higher earners have a new 50 per cent income tax rate to look forward to.

As predicted in last year’s report, the Group’s overall net investment has plummeted. Mega acquisitions are out and investment in old-fashioned organic growth is back in favour. There’s also been a surge in disposals as many Group companies have sought to bolster their cash positions. Against a backdrop of economic uncertainty and restricted availability of finance, the drop in overall investment is no real surprise. What’s encouraging is the Group’s willingness to reinvest in reinvigorating existing businesses: hopefully, this will pay dividends as markets recover. There appear to have been a fair number of relatively small deals. The year’s tough economic conditions threw up some tempting bargains, and a number of Group businesses made good use of their resources to make opportunistic buys.

The underlying message throughout the report is the importance of strategic and forward planning to manage potential business risks, not only for the region’s top companies, but for all local businesses in surviving the challenging times ahead.

Key risks and uncertainties
These are the key risks and uncertainties most commonly identified by Group companies:
• Economic and market risks - currently exacerbated by the tough macroeconomic climate and weak market conditions.
• Funding and liquidity risks:
– Uncertainty over exchange and interest rates.
– Access to credit and ability to comply with funding conditions.
– Liquidity and cash management.
• Competition - seen as fierce across all sectors.
• Staff recruitment and retention - moving up the agenda.
• Post-merger integration - also moving up.

Fraud
Some 80% of Group businesses will have suffered at least one economic fraud last year. At least, that is what fraud experts estimate. In corporate reporting, fraud is something of a taboo subject. Annual reports rarely mention it, even though its incidence is widespread and often damaging. Perhaps directors fear for their companies’ reputation – or their own.
In the depths of a recession, directors may regard fraud as the least of their worries, yet the risk is at its greatest in a downturn. Effective internal controls can help prevent and detect fraud at an early stage. Simple measures to take include:
• Segregate duties to eliminate opportunities to cover theft
• Stage surprise audits or counts to deter fraud
• Introduce additional checks for signing-off payments or authorising purchases
• Check-up on suppliers, contractors and significant customers to confirm their identities and ensure they are delivering value for money
• Monitor bank and credit card statements for unusual transactions
• Communicate staff expense policies and procedures and monitor compliance
• Check invoices against original purchase orders and the goods supplied
• Check references for all new staff
• Ensure business premises have adequate physical security protection including locks, keypads and alarms.

Losses caused by fraud can exacerbate recession-induced constraints on cash flow, liquidity and profits. Coping with even a small fraud will consume financial and management resources when these are already stretched. These measures could radically reduce Group companies’ exposure to asset misappropriation fraud.
Will they be taken? We hope so.

As well as providing a snapshot of recent activity, the report provides advice on how businesses of all sizes can achieve success in the difficult commercial environment.

One positive to come out of the recession is the rediscovery of a key strength in the Central South region: the manufacturing sector. It has been seen as a resilient and reliable part of the economy, having faced the same challenges as other sector groups, particularly in managing a global supply chain, but with notable success. Manufacturers have got closer to their customers, listened to what they want, and are now consistently making quality products that companies and consumers want to buy. As a result, they are generally facing the future with renewed optimism and an innovative, competitive manufacturing sector should emerge from the recession.

Other sectors in the region have fared broadly in line with the national picture, with retail, property and construction having faced some of the biggest challenges. Parts of the Central South have a heavy reliance on leisure and tourism and this sector may not have seen the worst of it yet. Hotels suffered most during 2009 but restaurants and bars also saw a double digit increase in their failure rate. Declining disposable incomes and changing consumer spending habits are likely to keep the sector shrinking through 2010 and beyond.

The impact of the recession on the Technology, Media and Telecoms sector has been uneven, with many start-up companies thriving as they secure new contracts but others struggling to attract investment and cash. As a result they have again begun to look overseas to exploit their intellectual property and take advantage of the wider market opportunities.

In looking to the future, the report calls on the businesses in the region to play to their strengths and seize new opportunities in emerging markets. It pinpoints a growing need in the modern world for innovation and knowledge and with that an increased demand in areas such as technology and research which have traditionally been areas of strength for the Central South region.

In parallel with these new areas of development, the report suggests that the region’s businesses need to pursue growth opportunistically in fields where they already excel. Across the Central South, there is strength in defence electronics, homeland security and related support services and training. Furthermore, there remains considerable marine and maritime expertise from centuries of sailing and trading.

The report also predicts the rise of new business models, with greater collaboration and partnership working to allow businesses to remain agile enough to take advantage of business opportunities whilst also maintaining a focus on profit and growth. The exploitation and even sale of our intellectual property presents a significant business opportunity for the region, and will allow businesses to reinvest in staying ahead of the competition. Our region has excellent universities with significant research capabilities and clusters in several key sectors. Our local governments are collaborating increasingly effectively and organisations such as Solent Synergy and Solent Innovation Growth Network are emerging to broker the interactions needed between the education sector, SMEs and large businesses to deliver a range of significant business opportunities.

There is little doubt that there are significant challenges ahead for business, but vigilance and careful management, combined with new working practices and ideas, could allow the Central South region to emerge from the recession stronger than ever.

Kim Hayward, lead artner from BDO in Southampton concludes: “The toughest recession since records began officially ended in January 2010. We don’t expect the recovery to be swift, but Group companies are expressing cautious optimism. Our view at BDO is that the UK’s business landscape will change significantly and there will not be a return to business as usual. There will be a shift from the industrial structures and models of the past to the digital, networked age of the future. The winners will be those who have applied these skills successfully and reinvented themselves; from new business models and propositions to new management structures. As a region, we are innovative and entrepreneurial and there is little doubt that we are well placed to take advantage of the growth industries of the future.”

Growth sectors of the future:
 

• Digital technology
  
• Biotechnology
  
• Stem cell research
  
• Robotics and cybernetics
  
• Nanotechnology
  
• Renewable energies
  
• Neutraceuticals and food science
  
• Marine science
  
• The creative industries, such as film, fashion and media

To view the full report go to

www.bdo.co.uk/centralsouthreport