\r\n\r\n\u201cSupply chains are highly fragile. Like glass, if they're broken, we need to build more resilience into them,\u201d says John Cooper, partner in EY-Parthenon\u2019s transaction strategy and execution team. According to the team\u2019s latest Profit Warnings report, the number of warnings issued by UK-listed companies in the first quarter of 2022 (Q1) increased 44% year-on-year. Overall, UK-listed companies issued 72 warnings in Q1 2022, marking the highest quarterly figure since the onset of the pandemic.\r\n\r\nA record-breaking 43% of warnings were due to rising costs, up from 27% in Q4 2021 and well-above the 2011-2021 average of 10%, as increased commodity and energy prices fuel inflation. \u201cWhen Covid hit, people reset their forecasts and expectations in light of supply chain issues, so the warnings abated at that point back to normal levels. Now, what we're seeing coming through is cost inflation, in addition to supply chain disruptions,\u201d Cooper says.\r\n\r\nDespite strong levels of consumer spending, EY reveals that warnings from consumer-facing sectors also reached its highest level of warnings since Q2 2020. The sector has been affected by supply issues with 67% of retail warnings citing supply chain disruption, 75% blaming increased costs and over half (56%) revealing staffing issues in the last six months.\u00a0\r\n\r\nUK-listed retailers in particular issued nine profit warnings in Q1 2022, accounting for 17% of all listed retailers, while over one-third of FTSE retailers (34%) have issued a warning in the last 12 months. FTSE retailers issued the most warnings in the first quarter of the year (9 in total), followed by FTSE Industrial Support Services (7) and Personal Care, Drug and Grocery Stores (6).\u00a0\r\n\r\nBut why is this being felt more now than in Q2 2020? \u201cGoing into the pandemic, supply chains were in pretty good shape so it took a while for the actual pandemic impact to come along. In Covid, we didn't just have supply troughs, we had massive demand spikes,\u201d Cooper explains. As the public were increasingly consuming products at home, there was a \u201crather unusual\u201d demand surge and supply restrictions at the same time. \u201cMost of the costs last year were benign, or they were hedged or contracted. What we're now seeing is people coming out of those hedges, and those costs and inflation are starting to come through strongly.\u201d\r\n\r\nMeanwhile, China, the world\u2019s second-biggest economy, has been hit with further coronavirus lockdowns as the country\u2019s president implemented a zero-Covid policy, alongside weakening global demand amid higher inflation levels dampening global consumer spending. According to the Financial Times, Chinese export growth slowed sharply last month as exports increased 3.9% year-on-year in April, the slowest rate in two years, after growing almost 15% the previous month.\r\n\r\nDuncan Brewer, partner in EY-Parthenon\u2019s consumer products and retail team, notes: \u201cAround 25% of Chinese manufacturers are closed because of their Covid restrictions, and the war in Ukraine is hitting basic commodity costs quite heavily.\u201d Additionally, the withdrawal of government support measures that were introduced in response to Covid came to an end in Q1 this year, and rising interest rates across the UK have increased borrowing costs for companies. \u201cAn increase in National Insurance contributions last month means consumers have less money to spend at the end of every month, and that's having a knock on effect on confidence,\u201d adds Andy Pear, partner at Moorfields Advisory.\r\n\r\nHow accountants can help\r\n\r\nAccording to Pear, accountants can help retailers with their supply chain issues and rising costs by producing more regular forecasts, including cash flow and profit and loss forecasting. \u201cMaking the forecasting more regular will certainly help companies in this uncertain economic landscape.\u201d\r\n\r\n\u201cSupply chain disruption is a difficult one for firms to deal with, on behalf of clients, because some of these things are way beyond the UK boundary.\u201d For example, the ongoing war in Ukraine is continuing to have a detrimental effect on commodity imports to the UK. According to the Office for National Statistics (ONS), the UK imported \u00a3270m worth of material manufactured from Ukraine last year, primarily iron and steel, and \u00a3200m of food and live animals, including wheat and rice, and \u00a3140m worth of vegetable oils and fats.\r\n\r\nOverall, 11% of warnings in EY\u2019s forecast cited the impact of the war in Ukraine, with most referencing the impact of sanctions and withdrawal from Russian markets. Therefore, accountants must assist companies in preparing forecasts for the next six to 12 months, under different assumptions. Pear says: \u201cFirms will have to assist with those assumptions based upon the potential range of raw material costs, and the extent to which these could increase.\u201d\r\n\r\nAs business advisors, He also notes that accountants \u201coften help companies deal with overhead reduction\u201d. As such, if a client has a large portfolio of high-street stores, accountants should work alongside specialists to reduce a clients\u2019 business rate costs, as well as their rental overhead. Businesses must also be agile and recognise the trends that are taking place in the market; as a result, many larger retailers can either shed underperforming stores to repurpose their store portfolio, or also negotiate rent on several stores.\r\n\r\nMeanwhile, Brewer suggests advisory firms must also determine the trade off between a retailer cutting its own costs versus passing that cost on to consumers, and then support the \u201crelatively complex\u201d executional tasks around how to pass those costs on, or how to simplify a retailers\u2019 range or supplier base. \u201cAll businesses have a social responsibility to the good corporate citizens, and they need to choose which levers they pull and how they pull.\u201d\r\n\r\nAdvisory firms can do so by working across silos to reduce costs in the business. \u201cYou can't do that just by looking at commercial aspects and just by looking at the supply chain,\u201d he says. Therefore, firms must break down those walls and look at how to build a system that's more efficient, more flexible, and cheaper.\u00a0\r\n\r\nFurthermore, Cooper asserts that accountants can help to diversify suppliers for retailers, and look at how to build more resilient supply chains for the future, albeit by nearshoring or changing the product range. \u201cWe have learned that our supply chains are highly fragile, so we need to build more resilience into them to deal with disruption, but also to create agility to build new business models, new behaviours, and to create flexibility to move from an efficiency whirl for supply chains into a more balanced one.\u201d\r\n\r\nAdditionally, Cooper explains that the demands being made of supply chains by retailers are \u201cimpossible\u201d and \u201cadd no value\u201d to the retailer. \u201cSupply chains are getting beaten up about not being able to satisfy the demands of retailers; they are asking for something that is almost impossible to do.\u201d Consequently, Cooper suggests that retailers must \u201cboil it down to the stuff we need to do\u201d, and give supply chains much simpler tasks to make everyone happy. \u201cThose conversations are sometimes quite hard to have in a big organisation. One of the biggest challenges will be getting the different parts of the business to talk to each other and make compromises.\u201d\r\n\r\nIs passing on costs the solution?\r\n\r\n\u201cThere is limited room for manoeuvre with all these costs going up, and you have to still be profitable, even if it's very close to breakeven,\u201d says Brewer. In the short term, businesses will do everything they can to minimise the impact on the most value sensitive customers. However, food prices are going up heavily and retailers don't have a huge buffer to squeeze into, so they have to pass those costs through at some point. \u201cCurrently, retailers are doing everything they can to mitigate that but there is no way that costs cannot be passed through or the business will go bankrupt.\u201d\r\n\r\nHowever, an alternative Brewer highlights is that advisors can help retailers determine how to invest in the business both from a customer perspective as well as a product perspective. This involves discerning not only how to improve the supply chain, but looking at things such as sourcing different products. Asking questions such as \u201cdo you have the same product only sourced from one location or do you source it from multiple different places so that you can flex?\u201d or \u201cdo you near-source so you're at less risk of supply chain disruption?\u201d is key to this.\u00a0\r\n\r\nLikewise, Cooper highlights that the more complexity that is built into a supply chain means the more difficult it is to make sure it's working all the time - another trade off that accountants must assist retailers to navigate, in terms of cost, agility, flexibility, and the responsiveness to consumers demand. This includes deciding whether products use particular raw materials that are unique or expensive, and how these can be substituted with different graded materials that are more commonly available, and at a lower cost.\r\n\r\n\u201cDuring the pandemic, people were quick to identify businesses that didn't align with the values that they wanted,\u201d Brewer adds, \u201cand that has driven\u00a0 some of the effects we're now seeing in the retail space\u201d. Customers are still choosing whether to buy from certain brands depending on their ESG values. Therefore, advisors can help shape the direction of a retailers\u2019 business to be socially and morally-conscious in order to retain consumer demand and confidence.\r\n\r\nWith that being said, how can accountants create efficiencies for clients? Firstly, visibility of an extended supply chain is \u201creally important\u201d, according to Cooper. Particularly, data visibility across a supply chain is key to ensuring that financial metrics are transparent and, consequently, are being monitored on an end-to-end, real time basis. This includes having transparency across the business regarding working capital, cash flow, and APAR performance.\r\n\r\nBy the same token, Pear adds that the management of data is key to creating efficiencies for clients. In the digital age, the majority of retailers are now relying heavily on managing data to track consumer spend and deal with returns more efficiently. \u201cWe\u2019re finding a lot more companies are using apps on consumers\u2019 phones to record customer activity and to engage with customers, so managing that data and using it to drive efficiencies in their business is important to take on board,\u201d Pear confirms.\r\n\r\n\u201cThe more forward-looking you are, the more you can do about it,\u201d Cooper concludes. \u201cHaving a strong model is also important so a business can assess the impact of price rises across the product portfolio, assess exposure to energy and commodity costs, and which products are going to suffer.\u201d As a result, businesses can determine what to do about these issues from a supply and cost perspective in advance.