IN 2004, while serving as FD of the RAC, I was on the board of a joint venture with HBOS. It had been a successful partnership for many years, but strains were emerging. As one of their directors explained, they were required to make a minimum 20% return on any investments, and we kept putting forward proposed schemes that did not achieve that threshold. I pointed out that our business was designed to work on lower returns. Another director of the bank commented that 80% of their mortgage advances were in fact remortgages – people taking equity out of their homes to spend on new cars or holidays.
In 2005, I joined Morrisons in the aftermath of the acquisition of Safeway. This had caused some pains, and shareholders were not backward in coming forward with opinions on what I should do to fix the business. Numerous hedge fund managers pressed me to sell our property (worth more than £6bn) and lease it back. A self-confident banker from Goldman Sachs offered to finance such a transaction within 72 hours. “What about due diligence?” I asked. “We don’t need any,” came the reply.
Before the downturn, I worried about the next generation of financial leaders. They were working in an environment where the old order had been challenged, and nay-sayers dismissed. It became normal for due diligence to be cursory, for mind-bending layers of debt to be introduced into the balance sheet and for all talk to be about EBITDA, irrespective of any I, T, D or A characteristics.
It was a difficult environment. Stars of the future were recruited into private equity or banks where they were encouraged to rip up the rule books. More sober souls, who remained in the many businesses still run on sound principles, must have wondered if they were missing out on a genuine change to the world order.
We all know what happened, but despite the calamity many businesses run by wise heads avoided being directly involved in the car crash. Unfortunately, the sages were not to be found at the top of banks, regulators or political parties.
The aftermath of the Lehman Brothers crash has been painful indeed, and there is every prospect that full recovery will take longer than was the case after the Great Depression. But the correction was necessary, and it has been a cathartic process. Accountants have had a good war – the finance function is once again listened to in the boardroom and the principles of sound finance have been re-established. Those coming through the ranks have been tested and will never forget the lessons learned.
Cashflow discipline, cost control and prudent accounting will be tools in their toolkits. They know the importance of understanding the liabilities in businesses and of close stakeholder management of all creditors. As simple examples, they’ve learnt:
• That a tweak of the IAS 19 assumptions may magic away an accounting issue with the pension scheme – but does not change the reality that those liabilities will land one day.
• That, although a set of upward-only, long-term lease liabilities may not appear on the balance sheet, it will still have to be paid.
• That little disclosure about the degree to which a business is funded by trade credit insurance doesn’t mean that, as a tranche of credit, it can’t rapidly destabilise the financial position of the company.
They also know that the accounting and disclosure obligations are incidental to the prudent management of their business. No amount of regulation or worthy risk-review processes can compensate for experienced leaders exercising sound judgement and common sense. After all, I recall my head of risk and internal audit at RAC envied the glossiness and sophistication of the reports we used to get from his opposite number at HBOS.
Richard Pennycook is formerly FD of Morrisons and has a portfolio of non-executive roles. He was awarded the Lifetime Achievement Award at our inaugural Business Finance Awards in March
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