As you may be aware, one of the biggest building contractors in the UK, Carillion PLC, went into liquidation recently.
As business growth expert accountants we thought we would run our usual five year analysis that we do for clients on Carillion’s figures just for fun (yes, I know that’s sad). Although we did this as a very brief exercise and didn’t go into as much detail as we normally would do for our clients some trends emerge. We have noted some of the key points below that could provide lessons to small and medium businesses (SME’s): –
- Turnover growth is no guarantee of success – many business owners use turnover as the key (or in some cases the only) measure of success. Carillion’s turnover in the latest published accounts was £4,400 million. Not only this but turnover had grown consistently over the last three years. From 2013-2014 turnover grew by nearly 5%, from 2014-2015 it grew by 13% and in 2015/2016 it grew by over 11%. All of these growth figures are well above inflation and would represent good substantial growth for a business that size. Yet the business still goes into liquidation! A key learning point for small businesses is that there are many numbers that need to be looked at besides turnover. Sales alone cannot guarantee success and recent liquidations of Carillion, British Home Stores, Woolworths etc. are proof of that. There is an old cliché that “turnover is vanity, profit is sanity” but it is a cliché for a reason, which is that it represents a key truth.
- Quality of sales is more important than quantity – despite the substantial growth of Carillion’s sales over the last three years an analysis of the gross profit percentage (the amount that they keep after labour and materials and other cost of sales) shows a different picture. In each of the last three years the growth (or contraction) in the gross profit figure was roughly 9% lower each year than the growth in sales. There can be many reasons why the gross profit does not follow sales trends, and in our experience this is often to do with price although other areas such as efficiency’s, increasing cost prices etc. can be a factor. Although we do not know Carillion’s business that well it is very likely that they are in the business of accepting mostly tenders, which by definition tend to go to the lowest priced jobs. This ends up with a business chasing substantial amounts of sales with ever decreasing margins, in our view a sure-fire recipe for low profits or even worse. Large contracts from tenders and other areas may be satisfying in terms of sales but businesses need to keep track of the actual gross profit percentage to ensure the quality is still there. Otherwise they are simply working harder simply to stand still.
- Profit doesn’t guarantee cash flow – many businesses assume that if there is a profit on the bottom line then everything will be OK. The definition of any business going bust is that it has insufficient cash funds, something that is never shown on the profit and loss account. Carillion showed pre-tax profits of £147 million for the year ended 31 December 2016 yet still managed to go bust. It has also shown similar profits for each of the previous 4 years. Many SME’s, when we ask for their monthly financials, simply send the profit and loss account and seem to think that the balance sheet and other statements are irrelevant. This is often because those statements are more complicated to understand than the simple profit and loss account. They are however just as important, if not more so, than the profit and loss. We would recommend all SME’s produce regular cash flow statements to show where the money went as well as balance sheets. By understanding some of the key figures shown in these reports a business owner can get a great insight into where the business will be heading over the forthcoming months and years and in particular whether any cash flow issues will arise .
- Use borrowing wisely – all businesses that want to grow will at some time find themselves needing to borrow money and this is perfectly normal, indeed essential, to move forward. However, a keen eye needs to be kept on the level of borrowing. One important measurement for businesses is the gearing ratio, which measures the amount of money that is being injected into the business from outside parties such as banks etc. compared to money generated internally and left in by business owners and shareholders. There are key targets for this but generally, they will vary for each business. However, there should always be a plan and that plan should be measured against the actual figures. With Carillion’s own figures it is interesting to note that the gearing percentage rose from 106% to 216% from 2013 to 2016 a key factor in its downfall.
- Liquidity is key – one key number that can be obtained fairly easily from any balance sheet is the current ratio, which is a measurement of liquidity. In simply terms, it measures a business’ ability to pay its short term creditors with its short-term assets. It is the equivalent of a person with a job comparing their monthly net salary with their monthly outgoings. Again, target numbers can be provided for most small businesses but each would depend on their own situation. In Carillion’s case, the current ratio has been static for five years despite the good profits indicating that even though the business was profitable, liquidity hadn’t followed suit.
- It doesn’t matter what your profit is if you spend more – In all SME’s there is a golden rule that regardless of the level of profit if the business owners drawings (or dividends) are higher, then the business will always fail at some point. Profits need to be retained to cover things like tax, future investments in assets, cash flow requirements for growth etc. Whilst a business owner should always strive for a good level of personal income for their work and effort, it needs to be measured against the liquidity and profitability of the business. This doesn’t mean that they reduce living standards to suit but instead look at ways of growing the business so that their living standards can be maintained or improved. In a big company like Carillion, clearly there will be pressures from outside shareholders for a return on their investment that would not normally take place in a small business, but the principle applies in both cases- never pay out more than the available net profit after retaining money for growth and tax etc.
As mentioned at the beginning, all of our ambitious clients receive a detailed 5 year performance review based on their accounts figures and a detailed diagnostic. If you would like a free copy of this (no meeting required unless you want one) then simply email us on firstname.lastname@example.org or ring 01752 752210 and find out if you are a Carillion or an Apple!