Chancellor Rachel Reeves should help firms invest and hire staff by raising allowances and tax relief, says the Federation of Small Businesses.

Its Small Business Index says more than a quarter of Scottish small businesses expect to shrink as ongoing cost pressures take their toll on revenues.

But the UK and Scottish governments could take a number of practical measures to reverse the decline, it says.

Guy Hinks, FSB Scotland chair, said: “We must turn this around and enable small businesses to grow rather than having their ambitions held back, and in turn hampering economic growth.

“The economy cannot afford for small firms, which employ more than a third of Scotland’s total workforce, to stop hiring or cut staff.

“To that end, the UK Government should increase the Employment Allowance, which helps small employers offset the cost of National Insurance. That would offer some relief from the rise in employers’ National Insurance which was introduced in April and has made it more expensive to hire staff.

“Other positive steps could include a Statutory Sick Pay rebate, to help small employers manage the £5 billion annual cost to UK small businesses of sickness absence. Increasing the VAT turnover threshold to £100,000 would also encourage growth.”

Mr Hinks said the Scottish Government should seize the opportunity offered by its Community Wealth Building Bill to tackle some of the challenges facing small firms bidding for public contracts.

“This should include targets for increased spending with small and local businesses to ensure the Bill delivers on its aims,” he said.

The index for Q3 shows a drop in confidence in Scotland that was one of the steepest in the UK, with only the East Midlands and West Midlands experiencing a greater fall. The UK-wide SBI also fell, 14.1 points, to -58.1.

Nine in ten (89.4%) Scottish small businesses experienced increased running costs, with higher tax (56.8%), labour (55.3%) and utility bills (50%) being the biggest drivers.

Looking ahead, fewer than one in ten (8.7%) businesses expect to see an increase in profits over the next three months, which is significantly down on the previous quarter (30%).