As we pointed out in our last two blogs here and here, Carillion was less than transparent in its 2016 financial statements about its reverse factoring arrangements.
For a much better explanation of supply chain financing (an alternative name for reverse factoring), see Note 19 ‘Trade and Other Payables’ on page 177 of the 2018 financial statements of AstraZeneca Plc.
Since Carillion commenced the arrangement in 2012 , Carillion’s customers were taking longer and longer to pay – by 2016, receivables were 38% of sales. Carillion was taking even longer to pay its suppliers. By 2016, if you include the reverse factoring, payables were around 50% of sales, or six months.
As Carillion was a very low-margin business, its operating margin (operating profit/sales) over the 10 years from 2006 was highly variable, but was in the range of 1% to 4% according to the LBS article. Its earnings margin (earnings/sales) was between 2% and 3%.
But what did these numbers actually mean? Long-term contracting always rings alarm bells because it offers companies discretion over when to report the income from a contract, with the risk that they will be tempted to report revenues earlier and costs later. Carillion’s financial statements offered no clue as to how it was accounting for long-term contracts.
IFRS 15 on Revenue Recognition would have forced the company to write down retained earnings by well over £100 million, according to a 2017 disclosure note. Apparently, Carillion included the change in the reverse factoring creditor – essentially a financing cash flow – as an operating flow in the calculation of operating cash flow and thus in the calculation of cash conversion.
In the 2016 financial statements, Carillion reported operating profit of £145 million and an operating cash flow of £115 million, which is a decent cash conversion ratio. But that operating cash flow was increased by the approx. £200 million increase in ‘other creditors’ during the year. Without that, operating cash flow would have been £-85 million.
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