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CN100: How to spot the next Carillion

Carillion collapsed a few months after last year’s CN100 was published. In this year’s data, CN turned to new measures to gauge short-term stability and long-term liabilities and set about applying the critera to Carillion’s last set of accounts to find out if it was possible to predict the contractor’s demise.

Carillion’s unravelling from its £845m profit warning in July 2017 to liquidation six months later in January 2018 was messy, shocking and rapid.

Its last full-year accounts for the year ending 31 December 2016 showed an operating profit of £181.9m, which was the highest on last year’s CN100.

The Financial Reporting Council is currently investigating Carillion’s financial statements between 2014 and 2017.

Even with the knowledge that what we were shown by Carillion might have been distorted, a nagging question persisted when it came to compiling this year’s list: could we have flagged Carillion’s problems in the CN100 before it crashed?

One thing that is clear from Carillion’s demise is we needed to consider the assets and liabilities underpinning the contractor’s supposed industry-leading results.

With this in mind, we turned to new measures to gauge short-term stability and long-term liabilities, as well as how efficient firms are at using capital to generate profit.

The introduction of these factors was designed to help reveal whether any other impressive headline results were built on a questionable approach, so we applied them to Carillion’s last set of accounts for 2016 to see what they could have told us.

Short-term resilience

Our first new measure is working capital ratio, also known as the current ratio, which measures short-term resilience.

It compares current liabilities, which are payments that have to be made in the next 12 months, to current assets, which are assets that can be converted into cash in the next year.

If a firm has a ratio of one or more, then roughly speaking for every £1 of liabilities it has to pay out, it has £1 or more in liquid assets to cover it.

If it is less than 1 – a negative ratio – then the firm’s bills due in the next 12 months outstrip its available funds.

This could lead it to delaying payments to suppliers, chasing new work to get advance payments or taking on more borrowing to meet its obligations.

This does not necessarily mean a firm is facing imminent doom, but it is does make it more vulnerable to being caught short.

DRS Bond Management managing director Chris Davies says in an ideal world, all firms would operate with a ratio of “at least 1.25”, but that is not the case.

“Larger companies tend to operate with proportionately lower current ratios,” he explains.

“They also tend to hold proportionately higher levels of other people’s money through a combination of retention, unpaid payment certificates and longer credit terms.”

Carillion had a working capital ratio of 1.02, so for every £1 of current liabilities it had £1.02 of current assets.

This was the 21st lowest ratio – far from the best but not the worst either.

Reader in construction economics at Westminster University Dr Stephen Gruneberg says such low working capital cover makes life precarious for tier one contractiors.

“Larger companies tend to operate with proportionately lower current ratios. They also tend to hold proportionately higher levels of other people’s money through a combination of retention, unpaid payment certificates and longer credit terms”

Chris Davies, DRS Bond Management

“There is no room for error and negotiation,” he says. 

“One slip or a delay in receiving payment and it is a question of not being able to pay firms in the supply chain.

“No wonder firms are frequently in conflict.”

We know cash collection was an issue for Carillion, with its former chief executive Richard Howson telling MPs he felt like a “bailiff” trying get money released to the company, especially in the Middle East.

CPA economics director professor Noble Francis says firms with persistently cashflow problems that cannot cover their short-term liabilities tend not to survive as lenders lose confidence and step away.

“Lending more money to such firms is likely to fail to save them, as cashflow difficulties are generally a result of management failure, so lending to a firm under those circumstances may temporarily help, but it will not deal with the structural problems at the company,” he says.

Sure enough, Carillion’s failure to collect cash hammered its working capital and in its final interim results for the six months ending 30 June 2017, its ratio had turned negative at 0.74

This was the third-lowest across last year’s CN100 and the lowest for any tier one contractor. 


Carillion stopped trading because it ran out of money to pay its short-term liabilities, but it was also heavily weighed down by long-term debts worth £688.7m.

But instead of just looking at the raw value of the borrowing, we have to look at it in relative terms and see how dependent the company was on that debt to function.

When we look at total debt to total asset value, we find Carillion’s leverage was 15.5 per cent, which is the tenth highest in the top 100.

Debt is not inherently bad and can be used to invest in better equipment and process, or expand into new growth areas and increase margins.

Inefficient companies do not necessarily do this, however, and problems arise when borrowing is used to fund day-to-day activities.

“Too many companies borrow to fund working capital in what should be a positive cash flow sector,” Mr Davies says.

“A working capital facility is fine as a contingency,” he adds, “but far too many companies live in a permanent overdraft that grows year on year and eventually they run out of rope, with the inevitable consequence.”

EY construction lead Ian Marson says there has also been a trend for companies to use borrowing to increase their size without increasing efficiency.

“They’ve drawn down funding by raising debt and rather than using that to invest and improve the business, they’ve used it just to expand the business, they haven’t grown margin out of the back of it,” he says.

There is an argument that Carillion’s leverage should be much higher though.

The value of goodwill and intangibles on its balance sheet was £1.57bn, 35 per cent of its total asset value and by the far the largest among last year’s CN100.

CompanyGoodwill £m (CN100 2017)Goodwill proportion of total assets
United Living Group 61.2 53%
Balfour Beatty 937.0 38%
Amey 735.8 37%
Carillion 1,571.0 35%
Lakehouse 47.3 32%
Renew 56.3 29%
ISG 171.4 27%
Severfield 54.7 24%
Interserve 437.0 24%
Kier 522.8 21%

Carillion’s goodwill represented the hard-to-quantify value of the people, client relationships, access to markets, brand recognition and so on, which it acquired when it bought up Mowlem, Alfred McAlpine and Eaga.

Mr Davies says sureties typically disregard goodwill and other intangibles when assessing balance sheet strength because their value is often not realised.

This was certainly true in the case of Eaga.

The business was consistently loss-making for Carillion and chairman Philip Green told the Carillion inquiry the acquisition had been a mistake.

And yet the Eaga goodwill added to Carillion’s balance sheet in 2011 – worth around £330m – was never written down.

If we look at Carillion’s debt to total assets with the goodwill removed, the company’s leverage jumps from 15.5 per cent to 24.9 per cent, the fourth-highest in the CN100 last year.

A question of efficiency

Carillion’s £146.7m pre-tax profit for 2016 left it with a margin of 3.3 per cent, far beyond the -0.5 per cent average for last year’s top 10.

However, decent margins do not necessarily mean efficient trading.

If a company has had to commit billions of pounds of assets with hundreds of millions in debt and pension liabilities, all to squeeze out a margin of 3.3 per cent, is that really efficient?

If it is not, then is it sustainable?

One way of gauging this is to look at the company’s return on capital employed (ROCE).

“Contractors target the return on the capital employed and shareholders are more interested in it,” professor Francis says.

Capital employed is defined as a company’s total assets minus its current liabilities, which tells us how much is being invested in the firm to generate profit on an ongoing basis.

Current liabilities are subtracted because any assets needed to cover these cannot be invested to make future profit, and capital, by its definition, must produce ongoing returns.

Carillion’s ROCE was not too bad at 8.2 per cent, but it was far from the best in the top 10.

Galliford Try, which had the second-highest operating profit at £157.5m, had a ROCE twice as good as Carillion’s at 17 per cent, meaning it needed far fewer assets to generate a comparable profit.

Similarly Mace and Morgan Sindall had ROCE figures around 14 per cent in last year’s CN100 findings, meaning that while they made less operating profit than Carillion, they also did not have to use as much capital and support such a large balance sheet.

Simply put, despite its chart-topping profit, Carillion was not very efficient at all.

Inefficient use of capital will not bring a company down over night, but over years it can weaken the business.

A lot of capital must be pumped in to maintain a margin, capital that could be invested in better systems, better equipment, better training and so on.

Carillion’s profit was good, but the company was a juggernaut, labouring with a bloated balance sheet that it had to keep feeding.

When the environment turned against it and its footing became unsteady, that big balance sheet acted like ballast, dragging the firm down.

Carillion’s fate

On the three measures we have introduced to this year’s CN100, Carillion wasn’t the worst performer in any of them.

But its poor showing in each category would have been enough to raise serious concerns, in spite of that eye-catching profit.

Its working capital ratio was low and vulnerable to sudden outflows, especially considering the firm was already heavily reliant on the £500m early payment facility provided by banks at their discretion.

Its leverage was high and worryingly so when looked at without the goodwill element, which made long-term investors weary and added tens of millions of pounds in interest payments.

“A working capital facility is fine as a contingency,” he adds, “but far too many companies live in a permanent overdraft that grows year on year and eventually they run out of rope, with the inevitable consequence”

Chris Davies, DRS Bond Management

Its return on capital employed was far from the worst, but also far from the best and showed that the company was bloated and required a lot of capital to maintain its profit levels.

If we had used these measures last year, we could not have said definitively the company’s days were numbered, but it would have changed how those industry-high profits were viewed and how good a business Carillion really was.

All of this comes with a caveat though – our analysis can only be as good as the information we have been provided with, and the reliability of Carillion’s accounts is wide open for dispute.

The MPs inquiry into the firm’s failing said Carillion’s accounts were “systematically manipulated” and the firm carried out “aggressive accounting” to improve the picture of its financial state.

This occurred, the inquiry said, as the company’s auditor KPMG was “signing off the directors’ increasingly fantastical figures” and failed to “exercise professional scepticism”.

Our measures show the company faced problems, but the extent of these are alleged to have been hidden to all but those at the top of Carillion.

For now, we can only hope that the other firms on the CN100 do not subscribe to the same accounting practices as Carillion and that the numbers we are shown, for better or worse, are a true reflection of the state of the business.

If they are not, the market will expose them sooner or later.

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