Last year was a bad one for company closures. January 2018 saw the collapse of construction firm Carillion (aka ‘the company that runs Britain’), which went into liquidation with debts of around £1.5bn.
From hiding debts through ‘creative accounting’ to invoices that never get paid, here are some red flags.
1. The business is haemorrhaging cash
As the Carillion case showed, discrepancies in figures can often be overlooked. Having worked on Heathrow Terminal 5 and Liverpool FC’s stadium, in 2016 Carillion boasted sales of £5.2bn – a 14% year-on-year rise. Yet cash reserves increased by a mere 1.6%. Its contracts proved less lucrative than they seemed.
“The most important thing you can do on a balance sheet is run your fingers down the current and historic year, looking at the differences between the two,” says Steer. “If a company’s sales are up 10%, then it’s reasonable to believe all other balances on the sheet will be up 10%”. Anything materially out from that figure is worthy of investigation.
“Remember: the only thing that is a fact on the balance sheet is cash. Every other number is a matter of opinion.”
2. Accrued income
Accrued income is basically the income that a company claims to have earned, but hasn’t yet invoiced the customer for (or indeed received).
Accrued income proved problematic for Carillion. Its receivables grew by a mind-boggling 114% over the five years to 2016. Yet, during the same period, sales rose by only 3%. “Carillion was thinking it was owed more from accrued incomes, which told me the quality of its current assets was going down,” says Steer. “But it hadn’t even invoiced the client!
3. When the CEO suddenly starts flaunting a flashy lifestyle on Instagram
The spending splurges of bosses have always aroused suspicion – with good reason.
The lavish lifestyle of Dennis Kozlowski, former CEO of US security firm Tyco, included $2m (£1.5m) birthday parties for his wife and $6,000 shower curtains. It was later revealed that Kozlowski and his fellow executives paid themselves $150m in bonuses – a move that landed them hefty jail sentences.
4. The accounts are as easy to read as books on quantum theory
For most people, annual reports are boring. But maybe that’s the point: by presenting charts and figures in a baffling way, outsiders are deterred from scouring through and unearthing the juicy numbers lurking within.
When Sherron Watkins, an employee at US energy firm Enron, stumbled on a complex Excel spreadsheet in 2001, she knew something peculiar was going on: the company’s unfathomable accounts were concealing huge debts. After she exposed the fraud, $74bn of shareholder funds were wiped out, with thousands of workers losing jobs. Today, it’s considered the world’s biggest accounting scandal. Steer’s tip? “Companies often hide losses in ‘development costs’. Look for that in a balance sheet – it’s where all the naughty stuff is hidden.”
5. Non-stop acquisitions
Alarm bells should ring at any company that gobbles up other firms like it’s going out of fashion. Carillion adopted this strategy in the 20 years before its implosion, with many of these freshly acquired firms failing to deliver growth. As Steer says: “What’s the point of buying these companies if they’re not moving profits ahead? An acquisition strategy is rarely a passport for moving the share price up.”
6. It’s taking ages for the company to get paid…
Notice any outstanding invoices in the annual report? They can also hint at problems. Take Carillion (again!). In 2016, its sales grew by 14%. Yet the amounts owed to the company for construction projects and other receivables grew by 70%. Such payment delays damaged its bottom line. “I could tell something was awry because Carillion was taking a very long time to get paid by customers,” says Steer. “It indicated to me that clients were quarrelling over the bills, saying: ‘No, we don’t owe you for that.’” His suspicions proved well founded.
7. Any time you come across the word ‘goodwill’
When one company buys another, the goodwill figure represents the difference between what was paid for the firm and the fair value of its net assets (such as its technology and patents).
Quite often, this figure is unsubstantiated. The 2016 annual report for outsourcing group Mitie estimated that its recently purchased healthcare company, MiHomecare, was worth £145m, which included £107m of goodwill. In reality, the acquired firm was racking up serious losses. MiHomecare was sold in 2017 for just £2, with Mitie forking out £9.5m to get rid of it.
8. Exiting execs
When senior management start bailing en masse it suggests the company could be heading for a brick wall. If these defecting directors start cashing in shares before leaving, that’s another warning sign. A good example is the execs at ailing housing group Connaught, who sold £16.6m of shares between 2008 and 2010.
9. Failing to adapt to tech disruption
Whether it’s the likes of Netflix forcing VHS emporium Blockbuster to shrink from 9,000 stores to just one (FYI, it’s in Oregon), or Kodak floundering due to the rise of digital photography, the list of companies that have failed to evolve in the face of tech disruption is long.
Socio-political factors can also play a role – see Monarch Airlines, which went into administration in 2017 after terrorism in North Africa (a key area for its business) and a slump in the pound battered its revenues.
10. Look around the office
In many workplaces, the cracks are often visible long before the business collapses. Think toxic office morale or senior execs emerging from secretive meetings with harried expressions on their faces. Then there are the more obvious harbingers of doom – an announcement, say, that the company HQ is moving from a gleaming skyscraper to a warehouse on the edge of town, or a decision to cut health benefits.
However, these measures don’t always spell disaster: HSBC, the civil service and Jaguar Land Rover have all announced hiring freezes in recent years.
Christian Koch is a contributor for AAT's members magazine, AT.