Killian the second largest construction company in the UK with over 420 public contracts and a major contributor to the UK government yet in 2018 it failed spectacularly due to its very poor risk management its ability to manage its finances and its very aggressive accounting policies that itself and its external auditor applied so what exactly led up to its bankruptcy in 2018 well first of all who exactly are Killian and what do they do so Cilan was a UK multinational corporation which was based in wolver Hampton it was very successful and had an increasing dividend year on year it was formed in 1999 from a Dem merger from tarmac now for those of you that don't know a Demmer is a situation where a business undergoes a restructuring and components of that business is is split out into a special entity or its separate entity and this is exactly what happened with tarmac tarmac was a very large company and what they did was they decided to take its construction element out of the company by restructuring it and calling this construction company cillan which was then ultimately the constructing arm of tarmac between 1999 and 2015 Cillian performed exceptionally it had a dividend increasing year on year the executives were being remunerated extremely well and it was winning a lot of contracts it was one of the largest companies in the UK to be winning public contracts at the time so it had a very successful way of valuing projects and being able to extract that little bit from the competition yet in 2015 the shakes of the foundations laid in Cillian really took its toll when UBS an investment Bank signaled that ion actually had considerably more debt than it was making out to be what I mean by this is when you look at the financial statements and in particular the balance sheet there's a line item under the liabilities which talks about the short-term and long-term debts that you have and also you can calculate the total debt well UBS investment bankers and research analysts believed that this total debt was actually being underestimated and that Killian had considerably more debt that it simply wasn't disclosing one in the correct places or two not being disclosed at all as a result investors took short positions in Cillian instantly the share price plummeted and long behold in July 2017 Killian actually made an announcement stating that they are going to be taking a loss of 842 million on their estimated contracts they had basically overestimated the value of the revenue from the contract and the costs involved in these contracts which meant they were taking a loss of 842 million instantly the share price fell 70% and this is really where corillian began to collapse yet a couple months later KPMG the external auditor said that this company's accounts were fully accurate and there was no issues with them at all they also stated that Killian is a going concern and what this means in accounting terms is that the company is likely to be able to meet all of its short-term and long-term obligations which gave investors confidence that if an external auditor such as the big four has given this go-ahead that the accounts they look good and it's going to be a going concern it should be fine however in January 2018 literally 2 3 4 months later the company went into compulsory liquidation which meant that the current 420 contracts which were hospitals schools Care Homes were all abandoned also the people who had jobs the people who were suppliers to Cillian which was over 30,000 also realized they weren't going to get paid and this sent shocks throughout the UK economy but the question lies how on Earth did it manage to go from have an extremely good period between 1999 and 2015 to all of a sudden over the space of 3 years it's spectacularly failing and having to go into compulsory liquidation well there's several factors to this and I'm going to break down each of them in turn one of the reasons for the collapse of Killian was that its borrowings multiplied in 2009 the company had around 200 million in total debt yet by 2018 they had racked up a staggering 1.3 billion in total debt this was really driven by several reasons first of all Killian was financing all of the payments that it needed to pay to its suppliers so when it comes to a construction project they have to pay the suppliers for all of the materials used in the constructions of the projects for all of the labor which they offer and this can be very costly because Revenue isn't given to the company instantly as soon as they get the contract revenue is paid throughout the length of the contract and contracts can be 15 to 25 to even 30 years long that means they have to upfront the costs straight away and a typical way of doing this is through supply chain financing so Killian were heavily using supply chain financing and they were using something called reverse first factoring supply chain financing which is essentially using a third party to pay the suppliers and then they would Finance the fee through the third party the reason they did this is because it meant that the suppliers could get paid straight away which is more favorable to suppliers and the suppliers are likely to lower the costs which is going to mean more money for corillian so they were using this strategy however the issue wasn't the supply chain financing that they were doing rather it was the fact that they were not including these payments that it was making to the third party on behalf of the suppliers into its total debt calculation and as a result the total debt on the balance sheet was actually being underestimated quite significantly and that's what UBS noticed back in 2015 the company was a lot more leverag than was first thought and it meant that there was a lot of interest repayments that it was having to make secondly the reason why borrowings pretty much multiplied was because of numerous ill-timed acquisition now companies acquire other companies is to grow into another sector and basically the ultimate goal is to capture more market share the issue here was these Acquisitions were ill times they were terrible for example the company acquired eaga for 300 million which was a company that really specialized in low carbon construction but this was purchased at a terrible time because the UK was currently going through a mild financial crisis and the government had to cut back on their subsidies towards low carbon product products and as a result the business model of EA was completely wiped out and it meant that this 300 million which it paid for this company had to be written down and as a result they've just paid 300 million for a company which has no longer got any value it's worthless but they've still paid for it so they still have this £300 million which is useless and to see this graphically again we can see the loan to asset ratio we can see how the loans actually massively increased yet the assets in the company really remain stagnated so they were really plowing in a lot of money through the use of loans but not getting much return if any at all to make matters worse they also had very poor risk management skills in the company the board the management and the external Auditors really were not playing their part at all in the risk management aspect of the company The company took a very interesting approach to trying to win contracts its approach was severely underbid on these contracts win them and just kind of keep your fingers crossed and hope that there's absolutely no issues that they are expecting in the project but this obviously is a massive risk to take and so big of a risk that it really didn't pay off in several cases so for example pillion won the contract for Royal Liverpool Hospital which is A330 million contract for a 646 bed hospital that they were going to construct when they were bidding for this they were actually the third out of five most competitive bids so they were quite out the game so from this kilan revised their offer they took a completely different appraisal method to the Royal Liverpool hospital as a result they managed to underbid all of the competition they managed to win the contract but at a massive expense they had underbid by 36 million Net Present Value which is significant on a 335 million pound contract so as a result they were running on razor thin margins margins which were so thin that they could not afford any issues at all however there was several issues there was structural Integrity flaws which meant that a lot of money was used to try and sort these out and there also was a very familiar issue of asbesto which also created a huge cost to corillian and in the end the disparity between the profit and the cost was actually £ 53.9 million and this was all because they had took a very aggressive appraisal method that they had underbid the nearest competitor by a net present value of 36 million which is absolutely insane what this meant was that it had extremely high costs and we not making a profit on these contracts so not only has the borrowing cost massively increased along with higher interest payments and more interest to pay back you also have these costs which are associated with this poor risk management so these two things are dramatically increasing the costs so you would have thought with increase cost there obviously got to be increased Revenue right no Revenue barely increased at all and if you look at it in comparison to the loan at to revenue ratio you can really see that Revenue stagnated but loans just massively catapulted upwards the final nail in the coffin was with its external auditor and the issues which were caused here investors are supposed to have confidence in the financial statement which firms published they're supposed to be financially accurate they're supposed to be credible they're supposed to give confidence to investors confidence that they know this company is truly reflected by the information that they're reading and so that they can make an accurate judgment over whether they want to invest in this company or not now the issue here was that the reverse factoring supply chain financing wasn't being included in the total debt figure and this was something which KPMG probably would have noticed but they didn't say anything about or they did but they didn't want to disclose it to the public and they pretty much hid it secondly KPMG would have recommended a very aggressive Revenue recognition strategy whereby they recognize all of the revenues in that period of time when the contract is received so they would have taken the present value and that would have been in the revenue they would have also had to estimate all the costs associated with these projects which were being run and this would have also been noted down into the income statement and given a profit now there's no problem with this method but there is a problem when you are overestimating revenue and you are underestimating costs and this is exactly what happened and this is why in 2017 kilan had to announce that it was cutting the dividend and that investors were likely to be affected by this 842 million pound adjustment on the balance sheet because they had underestimated the cost and overestimated the revenue and ultimately this is what led to the collapse because investors pulled all of their money out of the company they could see it failing from a mile away and sadly in 2018 many people will affected 20,000 jobs over 420 contracts which included schools hospitals Care Homes they were all negatively affected by this consequence and the UK government had to step in to try and prevent this sort of echoing effect across the UK economy this is ultimately the reason why corillian failed and the UK government didn't want to prop up corillian because it was so indebted that it would actually cause more of an impact now I hope you enjoyed this video give it a like please subscribe to the channel there going to be many more financial scandals which I'm going to be uncovering thanks for watching