Melissa George

15th January 2018

Too big to fail? Not any more…

The defining moment of the 2008 financial crisis, when bank after bank slid towards insolvency, was when it became apparent that no company is too big to fail. The recent spate of corporate collapses, from BHS to Monarch Airlines and Toys R Us, reminds us of this truism.

Just this morning , Carillion PLC, together with five of the 169 companies within its group, applied for compulsory liquidation. Those businesses are now under the control of the Official Receiver (assisted by Insolvency Practitioners from PWC).

Indeed, each of these cases makes clear that, regardless of a business’s size, cash management problems can still cause the wheels to fly off with devastating effect. To survive, an organisation must be able to settle debts as they fall due and have sufficient liquidity to pay key stakeholders – from employees to suppliers, landlords, pension funds and HM Revenue & Customs. Being asset rich but cash poor won’t keep a business afloat.

The road to business failure

Carillion, Monarch Airlines, BHS and Toys R Us (to name but a few) all ran into difficulty because they were caught up in a perfect storm of economic turbulence, changing retail models, price competition, and regulatory and pension fund pressures. Combined, these struggles left them with insufficient liquidity to meet current and future liabilities. But how did this happen?

Nobody could have anticipated such a prolonged period of economic stagnation, with low productivity, historically low interest rates, a squeeze on business and household incomes, and weak investment returns. In addition, Brexit uncertainty has driven down the pound and created challenging forex markets.

What’s more, BHS and Toys R Us’s operations remained biased towards traditional bricks and mortar retail models, leaving them weighed down by the cost of renting and fitting out large stores. This meant holding large quantities of stock, kitting out shelves, hiring store employees, paying maintenance and decoration costs, and meeting high rents – unlike their online competitors. Add in a reduction in footfall, price competition (in no small part caused by discount retailers), and a consumer preference for an immersive lifestyle shopping experience, and it’s clear why these businesses hit troubled times.

Meanwhile, Carillion’s aim at the moment is to ensure continuity of service and alongside that, the best outcome for creditors. Its latest accounts (to 31 December 2016) reveal it has a turnover of £4.4 billion, with 169 companies and in excess of 30,000 employees.

Pension puzzle

 However, it’s not just economic and operation models that were the problem; each company offered defined benefit (final salary) pension schemes. Carillion, as with many other large businesses that have failed, appears to carry a substantial pension deficit, with many employees on final salary schemes. Unfortunately, such schemes remain in crisis, having been underfunded by low interest rates and poor gilts for years.

Indeed, the deficit of Toys R Us’s UK staff pension scheme is more than £25 million, while BHS’s deficit was £571 million at collapse. Both companies faced pressure to reduce their pension shortfall, but when combined with a reduction in footfall and a prolonged squeeze on margins, they simply didn’t have enough cash to continue trading or the time to effect change from the traditional models they operated.

Monarch Airlines faced a similar struggle as part of its reorganisation in 2014. Having been laterally squeezed by price competition and reduced passenger numbers, it had to look to the Administrators for protection (despite new investment), leaving thousands of customers stranded or seeking compensation from bonds/their credit card providers. While Toys R Us has put together a successful company voluntary arrangement (CVA), which prevents it falling into administration, BHS succumbed to liquidation and Monarch Airlines’ fate, which is now in the hands of the Administrators, remains to be seen.

The lessons to learn

There are many warnings to be gleaned from large corporate failures, from Carillion and Monarch Airlines to Woolworths, BHS, HMV, JJB Sports and Toys R Us. The most important lesson is that cash is always king. All businesses, whether small, family run or large multinational corporations suffer the same squeeze on margins and, no matter the size, a company will experience periods when it doesn’t meet its potential. This is where diligent financial management is key.

The collapse of Carillion is likely to have a significant impact on the businesses with whom it works, with many suppliers apparently already out of pocket suffering late payments. Like Monarch, this could well lead to a call on the public purse, both in maintaining public services and settling liabilities among employees, including a huge pension deficit.

Businesses need to maintain a strong cash flow to fund daily expenditure, capital investment and expansion, and to reward shareholders. While turnover and asset values are important, if a business doesn’t have the cash to pay its creditors or sufficient income to meet its ongoing obligations, it risks closing down. For example, while Monarch Airlines collapsed with £28 million of cash in the bank, recent income losses of around £120 million meant its debts were no longer sustainable. If it continued to trade, with its trend of declining profitability, its creditors would have been worse off.

Expansion is a common stumbling block. Naturally, organisations want to grow and expand, which usually happens through equity (share) investment or debt investment (most simply as bank loans). However, it is key to enact careful forecasting and to preserve steady income because at some point you’ll have to repay those debts and further funding may not be available. It’s not sufficient just to increase your turnover and asset base or indeed to distribute the increased profit to the shareholders; you have to maintain liquidity and focus on the cost of sales as this is the liability you need to meet on a regular basis.

What to do if your business is struggling

 If your company’s cash flow is depleting and you believe a perfect storm is brewing for you, it’s best to seek early financial advice to assess the costs of running your business, to forecast income, and to consider existing and new routes to market. You can then review the gap, the costs of change and the prospects of recovery. You may find there’s a positive income against expenditure, but that delta is liable to change as financial pressures increase, so you’ll need to establish how to reduce overheads in advance. At this point, it’s crucial to establish your assets, liabilities and liquidity.

Importantly, directors are legally bound to consider the interests of their creditors if the business reaches a point when it is struggling to repay them. It is also important that they secure legal advice to protect both the business and themselves. At this stage, if they do not act responsibly in the interests of creditors, they may be found personally liable to make a contribution to the debts of the Company. Directors are also often personally liable to lenders under personal guarantees, and therefore have a vested interest in acting responsibly and proactively whether that is in preserving or closing the business.

If your business is struggling, you may not have the experience and specialised professional advice that can better help you to identify solutions. For example, if cash pressures are made worse by B2B customers failing to pay on time, you could seek an available funding proposition, such as invoice financing. If you have a good income forecast, you may be able to reconstruct your business through a debt for equity swap, removing debt from the balance sheet in return for providing a shareholding stake. There are many options, but time and cost of implementation are also key – act early.

And if your business doesn’t have a positive forecast, solicitors in conjunction with insolvency practitioners can explore strategies with you to assess how to preserve it or maximise its existing value. This may involve a partial closure or part sale, placing the business into a CVA or administration or restructuring its debt to try to ensure survival.

At Thrings, we can advise directors, shareholders and creditors as soon as they realise there is cash flow pressure – we’ll help you assess the options and whether you should continue to trade. We can also work with the board and financial advisors to structure an appropriate reorganisation, a funding proposition or, if necessary, an insolvency proposition.

Are large company insolvencies likely to increase in the UK?

In short, yes, because price competition from the online marketplace leaves traditional retail models at a disadvantage. Combined with economic pressures, and ever-changing customer demands, it’s clear the market will continue to be turbulent. In difficult times, it’s more important than ever for businesses to put in place diligent financial management with thorough performance indicators and forecasting – and to always remember that ultimately cash is king.


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Melissa George -

Melissa George

The Paragon
Bristol BS1 6BX

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