“How did you go Bankrupt?”
“Two Ways…gradually…then suddenly.”
(The Sun Also Rises, Ernest Hemingway)
Subject: financial planning

Ernest Hemingway, apparently knew more about business failure than some executives, scholars, and politicians gathered around the recent catastrophic collapse of Carillion PLC, the massive $ 7 billion UK contractor. (Reported on this site in February 2018)

“Gradually…”

The hundreds of failed contractor workouts my company completed for sureties over many years demonstrated that the seeds of contractor failure are sown during the profitable years prior to (what may appear to some as) an apparent sudden failure. In fact, contractors fail gradually.

“Then suddenly”

Why were so many people close to the Carillion failure so surprised? Didn’t anyone see it coming?

Carillion had annual sales of about $7 billion with debt reported at $1.2 to $1.8 billion and forecast losses exceeding $1.4 billion. They also continuously withheld subcontractors’ payments for 120 days, so they owed vendors $1.1 billion. That would make total debt $2.3 to $2.9 billion or an astounding 33 to 40% of sales. This amount does not include enormous pension debt reported to exceed $1 billion. If the pension liability is accurate, debt exceeded $3.9 billion or more than half of last year’s sales. As all this information became apparent the surprise balloon should have lost most of its air. It didn’t. Everyone was shocked and immediately set about trying to decide who should get the blame for the sudden collapse.

Who Was to Blame?

This question is, of course, disingenuous. Everyone is to blame, and no one is to blame. The more important question, and the more useful inquiry, is – What caused the company to fail, and why did no one see it coming?

Internal and Avoidable

The tendency to blame business failures on outside elements or events is a misdirected impulse. Years of research has proven that the elements of construction business failure are internal and recognizable, avoidable, and take place during profitable years. As construction businesses grow and thrive they go through substantial changes that look innocent, generic, and mostly beneficial to the enterprise but, in fact, can be insidiously dangerous, if not fatal when mismanaged.

Gradual Changes That Sow the Seeds of Sudden Failure

Changes in:

• SIZE OF PROJECT – Quantum leaps in scope and scale test management ability.
• TYPE OF PROJECT – Unfamiliar work imposes a costly learning curve.
• GEOGRAPHIC AREA – Remote work among strangers is fraught with pitfalls.
• KEY PERSONNEL – Expansion requires the use of untested personnel.
• MANAGERIAL MATURITY – Happens when management loses perspective or is unfamiliar with the risks their enterprise is becoming involved in underneath them.

The Carillion Example

Let’s take a look at the reporting surrounding the Carillion collapse to see if we can detect the seeds of failure listed above. The following quotes from press reports in Guardian Business unknowingly provide the answers:

• “Having grown since the 1990s from the merger of several medium-size contractors, the group expanded into operations-and-maintenance services. Its forebears were among the first to bid when the government began using P3s in the early 1990s…”
• “Carillion continued to win public contracts, recently including a four-year framework for substantial school buildings and two large deals for state-owned Network Rail.”
• “As Carillion fought for survival, the firm shed their CEO… and the senior management of the construction and services divisions.
• Carillion, in a joint venture… secured two design-build contracts, totaling $1.5 billion.
• …Liverpool’s nearly complete Royal hospital, being built under a 30-year public-private partnership.
• Carillion and financial investors have equity stakes in the Hospital Co., Liverpool, which sealed a design, build, finance and operate contract…

 Out of the Mouths of Babes

The article identified the causes of Carillion’s failure without even knowing it. The company expanded too rapidly into unfamiliar projects far and wide while changing top management and straining financial and management resources.

What a surprise! Who could have seen this failure coming?

Read More: Indicators of Financial Distress and Managing a Financially Stressed Company