Carillion, the UK construction company, can trace its roots back over 100 years but that was of little help when it finally ran out of cash and collapsed in January. What makes this insolvency newsworthy is its sheer size – 48,000 jobs at risk, 30,000 small business suppliers not getting paid and creditor losses of around UKP 2 billion.
The exact causes of the collapse will no doubt come out over the coming months as directors are grilled in a parliamentary enquiry and its professional advisers face further criticism, but what is known so far makes sobering reading:
- Profit warnings – Three profit warnings in five months gave a signal that Carillion was in serious trouble. The first came on 10 Julywhen the company shocked the market with a £845m write-down on contract values and the chief executive stepped down.
- Mounting debts – Spiralling debts and a huge pension deficit signalled the extent of the problems and ultimately proved Carillion’s downfall. The company’s debts soared by more than 50% to £900m between September and its collapse in January.
- Delaying payments to subcontractors – In July suppliers complained that they were being made to wait 120 days to be paid, double generally accepted 60-day maximum.
- Complex financing arrangements – Carillion was using increasingly unusual methods to secure finance – a sign it was struggling to access cash from more traditional sources.
Perhaps the most disturbing aspect of this, and perhaps also something we can learn from here in New Zealand, is the sheer number of small businesses, maybe as many as 30,000, that have been left out of pocket by the collapse.
A frequent comment by the principals of those businesses in the aftermath of the collapse was that they assumed Carillion was sound as they kept on winning government contracts even after the first profit warning had been announced. These principals assumed therefore that the government had carried out proper due diligence and therefore gave the green light for them to continue trading with Carillion. Was this a reasonable presumption to make?
As it turns out “No” is the emphatic answer when considering events in hindsight. However, it should also have been obvious to those business principals that that argument was also seriously flawed even before the collapse.
Firstly the relationship between the government and its contractors is different to that of a sub-contractor to contractor. Money is flowing in the opposite direction and the government is not exposed to credit risk.
Secondly the government never stated its role was that of performing due diligence on its counterparties on behalf of the commercial sector. Sure, you would expect that some due diligence would be performed as part of the governments contracting process but it is a stretch to suggest that this should encompass wider commercial risk.
It is to each particular business when considering entering into a credit relationship with a customer to perform its own due diligence and to also take into account the size of the exposure to its own specific financial circumstances. For instance a $200,000 exposure for a business with a turnover of $1 million is much different to the same exposure for a business with a $100 million turnover.
It is extremely difficult to predict corporate insolvency, and certainly prior to Carillion’s first profit warning back in July there were few tangible signs that trouble lay ahead. However, that first profit warning and the resultant share price slide (see image at the top of this blog) should have set alarm bells ringing for credit suppliers. That was the time for business owners to seriously review Carillion’s credit status, exposure in relation to their business size, contractual rights of recovery and termination, and security status.
As the Carillion collapse has shown smaller suppliers extending goods and services on credit cannot, and should not, rely on any due diligence performed by other businesses but conduct their own regular credit reviews to ensure the risk of being caught out of pocket is minimized.