Carillion collapse, could it have been stopped?
03 May 2018
03 May 2018
A couple of months after its collapse, Connor Tracey, Business Consultant at Aspire Business Partnership, comments on Carillion, one of the largest construction companies in the UK who entered liquidation in January 2018.
Although the mistakes lie with senior figures from several parties, 20,000 workers employed by Carillion could have suffered. However, fortunately, the UK Insolvency Service announced over 10,000 jobs have been saved whilst 2,162 have been given redundancy notices through the liquidation process.
For umbrella companies, agencies and of course construction companies, there is much that can be learned from the mistakes of Carillion.
Poor Debt Management
Carillion’s ‘optimistic’ approach to business meant that they overborrowed from banks with the expectation that all contracts would go smoothly and payment would be received from customers on time. Carillion had not prepared a contingency plan for any incomplete projects, once again, highlighting poor management. It was clear that Carillion was running a highly geared operation, meaning they financed their operations through debt rather than shareholders funds. This method of operation is often more attractive for shareholders as they have to invest less into the business, however it comes at a cost as you have to pay back debt finance with interest.
In an effort to minimise cash flow problems, Carillion extended its payment terms to its subcontractors. This meant, in some cases, subcontractors were waiting 120 days for payment. Unfortunately, all this measure does is pass the cash flow problems down the supply chain, often bankrupting smaller companies. The small businesses that supplied Carillion have been hit with two major problems; 1) they will receive no future work form Carillion and 2) they will not be paid for work that they completed up to 7 months ago. To alleviate the problems caused by Carillion, Government has partnered with banks such as Lloyds Banking Group and the British Bank to provide £100million of lending to small businesses who are affected.
A recent report from FTI Consulting stated that during its hour of need Carillion were still underestimating the amount of funding needed to reverse the company’s fortunes. The board assessed that they needed £360million whereas FTI estimated Carillion needed £500million. Once again, it shows gross failings of corporate governance and accounting.
One of the biggest mistakes in business is assuming that everything will go to plan because, unfortunately, it almost never will. It is important to always have a contingency plan for when life doesn’t go your way. Carillion assumed everything would go according to plan, so they stretched their resources to the limit which ultimately backfired.
Late Payment Terms
In the construction industry, late payment terms have become commonplace. This often puts a strain on subcontractors’ finances, particularly if they are small businesses, as they cannot secure the same payment terms with their suppliers. The collapse of Carillion shows that these payment terms can leave a ‘black hole’ in the industry if a company commences liquidation proceedings. To try and stop large companies from aggressively negotiating long repayment periods, Government introduced the duty to publish a report on payment practices and performance. The Small Business, Enterprise and Employment Act 2015 section 3 highlights what to report and who needs to report it. See our previous news on this legislation here.
If your customer wants to extend their payment terms, it could be a sign that they have poor debt management and are trying to pass on their poor debt problems to you. Do some digging before agreeing!
Aspire Comment: Lessons to be learned
1. If your customer is trying to negotiate extended payment terms, it can be an indicator that they have poor debt management. If your client is asking for extended payment periods or is paying later, Aspire would suggest:
i. Call your client and ask if there is any reason for the late payment, will it continue being a problem?
ii. Consider any outstanding amounts from your client as bad debts. Would your business still be able to operate if these were never paid? If not, an alternative approach needs to be considered.
iii. Sell the invoice to a debt factoring company. The factoring company will usually charge 0.5% to 5% of the invoice value. The factoring company will pay 70% to 90% of the invoice value in cash and the remainder is kept as a reserve to protect the company against bad debts. If the client pays the invoice you will receive the remainder. If not, the factoring company will keep the reserve amount.
2. Always have a contingency plan. It only took a few delayed projects to bring down one of the largest construction companies in the UK. Would your business be able to survive if your largest customer delayed payment or switched supplier? If the answer is no, you may need to revise your business strategy.
3. Have realistic expectations. All of Carillion’s problems started because they overestimated profits on contracts and had to write down £845 million. It is likely that bonuses were related to company performance therefore inaccurate figures were provided to shareholders to ensure their satisfaction.
i. Ensure that targets are realistic so managers do not feel under pressure to manipulate figures and stretch the truth.
http://www.cityam.com/278754/carillion-timeline-did-things-get-so-bad
https://www.theguardian.com/business/2018/feb/22/mps-attack-pension-regulator-at-carillion-inquiry