For an economy to operate efficiently there has to be an element of risk or trust involved in just about every business relationship. This is particularly the case where one business offers credit to another. Typically credit terms (how long a supplier waits to be repaid) will vary from a single month for the supply of goods and services to five or more years where a lease or bank loan is involved. The size of any debt and the time delay in receiving an expected payment will normally dictate the degree of due diligence applied by a creditor.
If a creditor needs to apply a high level of due diligence before agreeing to release funds in the case of a bank, or supply goods or services in the case of a trade creditor, the latest set of audited company accounts is normally the first and often the only source of information used.
When Carillion, a supplier of many government contracts, was recently forced into liquidation there was a big debate as to what went wrong. On 4 March 2018, a committee of MPs published a report which makes chilling reading for anyone relying on audited company accounts to make lending decisions.
In particular, the report concluded that over a prolonged period of time Carillion’s accounting treatments and assumptions were made to enhance the group’s profitability and net debt position which could have misled any potential creditor as to the true financial position of the company.
One scheme particularly worthy of mention was how Carillion was able to extend their credit terms with smaller suppliers using the government’s supply chain finance scheme launched in October 2012. Under this scheme, banks were obliged to lend small companies money against unpaid invoices from their large customers. This allowed Carillion to extend an estimated £250m to £300m of debt from an agreed repayment term of 30 days to 120 days and most importantly such debt was ‘off balance sheet’ and therefore invisible to anyone reading a set of their accounts. Many small suppliers were under the impression that the bank had paid their invoices on behalf of Carillion but later learned that the money provided was in the form of a loan which had to be repaid after Carillion went into liquidation.
The MPs report also made reference to ways in which Carillion deferred short-term payments and accelerated receipts ahead of producing their half year and annual accounts thereby issuing statements that masked the normal state of affairs. The true extent of their pension commitments was also thought to be underestimated.
The last set of consolidated accounts released by Carillion related to the year ending 31 December 2016. The document was 155 pages in length and the headline figures were not unimpressive – a net worth of £729m and profits of £129.5m but as we have seen above, accounts can be massaged. A closer look at the published information provided warnings, in particular, the importance of intangible assets within the overall value of the company. Goodwill (an intangible asset) was valued at £1,669m but goodwill accrues when a company accounts for the acquisition of another business, in the case of Carillion these included the purchase of Mowlem, Alfred McAlpine and John Laing. Goodwill is the difference between the price paid for a business and its net assets. The price paid is based entirely on the subjective assessment of the acquiring company and as such is deemed to be an intangible asset (i.e. there is no guarantee that the funds will be available in the event of liquidation). Professional lenders (banks and finance companies) tend to deduct the value of intangible assets from the net worth of a business when assessing the true net assets. Such an exercise applied to Carillion in the year ending December 2016 would have seen net assets of £729m become net liabilities of £940m, an altogether different situation.
Away from analysing a set of accounts, there are other clues as to the health of a business, all of which applied to Carillion. Firstly, a sustained fall in share price normally reflects the fact that professional investors doubt the long-term viability of a business. Carillion’s share price had fallen from £3.50 in 2015 to £1.90 by August 2017 and then to just 17p before the business collapsed early in 2018. This trend and volatility provided an early warning that all was not well. Secondly, a company taking ever longer to pay its bills is one which might be experiencing cash flow problems, many small businesses supplying Carillion reported real problems getting their invoices paid. Finally, the resignation of directors can often be a warning of management concern about the way a company is being run, four Carillion directors resigned between January and October 2017.
The demise of Carillion provides lessons for all of us.
Andy is an experienced sales and finance professional with over 25 years’ experience in sales aid leasing. Andy is widely recognised as an expert in business finance and has in recent years focused his attention on developing partner sales teams develop an understanding of how businesses secure project financing. His training programme – Finance Unlocked – is a highly rated customisable course and is offered at no cost to partners.
If you’re interested in helping your sales team overcome finance-related hurdles during the selling cycle, please get in touch with Andy on 07966 114 243 or email here.