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Thomas Cook management under fire for litany of accounting failures

The directors of Thomas Cook have been savaged for accounting practices that led to the world's oldest travel company entering liquidation on Monday, as experts believe it is becoming too easy for firms to hide bad news in opaque reports.

24th Sep 2019
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Thomas Cook store Liverpool
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Eleventh-hour talks to secure a further £200m in funding – after a proposed injection of £900m – ended without an agreement and Thomas Cook went under at 2am on Monday morning.

AlixPartners UK LLP and KPMG will be appointed as special managers for the various parts of the business.

As it ceased to trade with immediate effect, the 178-year-old company left around 600,000 people stranded, including around 150,000 British citizens currently being repatriated.

The travel firm employs more than 22,000 staff around the world. Its 9,000 UK-based staff now face having to apply to the Insolvency Service for payment of wages after being informed they would not be paid their September salaries.

A litany of accounting failures

“It is obvious there has been no financial control in that company for some time,” said Adnan Sajid, corporate finance partner at UHY Hacker Young in Manchester. “Looking at the books, you can see a litany of accounting failures.”

He told AccountingWEB the firm did not have enough structural capital, would struggle to survive even minimal trading difficulties, and there had been no challenge of this at senior level.

“It’s a sad day for a British institution, that many people trust, but I don’t think it was unpredictable,” said Sajid. “This is a two-to-three-year problem, and they should have come to the experts a long time ago to help with things like migrating the business away from retail, better managing the balance sheet.”

Auditors Ernst & Young took over the reins from PricewaterhouseCoopers in 2018, and immediately warned it had “strongly recommended” to management that they strengthen the process over the “identification and approval” of exceptional items listed in its annual report.

EY’s late flagging of Thomas Cook’s tendency to classify costs as exceptional wherever could was ultimately not enough to avert the company’s doomed course.

Both EY and PwC declined to offer comment.

The Financial Reporting Council, the UK’s accounting regulator, told AccountingWEB it was monitoring the situation, and on Tuesday released a statement indicating imminent action.

“In light of recent developments at Thomas Cook we are considering whether there is any case for investigation and enforcement action as a matter of urgency and in cooperation with the Insolvency Service,” the FRC said.

“I would be angry if I was a shareholder, angry as an employee, and angry as a regulator,” said Sajid. “The regulators need more teeth at government level, and to be able to force firms such as travel companies to hold more capital in relation to sales.”

Burying bad news

The debacle ultimately highlights a much deeper problem with financial reporting, said Ian Smith, general manager and finance director at document management and purchase process provider Invu.

“This collapse shows there is a big problem with financial reporting in the UK and that it is too easy for companies to bury bad news in their reporting,” said Smith.

He said Thomas Cook’s Group accounts for the year-end September 30 contains a 194-page set of accounts, which presents positive earnings several pages before the losses are made clear.

“Only on page 118 do you see the profit and loss, and not until page 122 do you see the weak balance sheet,” he said. “The question you need to ask is, how many shareholders just judged them on earnings before interest and tax? Even if you argue that the buyer is ultimately responsible for properly checking the quality of what they’ve bought this still shows a big shortfall in accounts reporting. Surely, in this case, less is more?”

Air of desperation

Thomas Cook ran hotels, resorts and airlines for 19 million travellers a year in 16 countries, generating revenue in 2018 of £9.6bn, with £1.7bn of debt.

It had been meeting with potential creditors for several months, but the final request for an extra £200m sank the deal, as Royal Bank of Scotland baulked at the firm’s accounts.

Fosun, whose Chinese parent owns all-inclusive holiday firm Club Med, had initially proposed to pump £450m of fresh capital into Thomas Cook in return for least 75% of the tour operator business and 25% of its airline.

The travel company’s lending banks and bondholders were also to supply £450m and convert the existing debt to equity, giving them in total about 75% of the airline and up to 25% of the tour operator business.

The talks failed, however, leading to the implosion.

“There was an air of desperation around the negotiations,” said Sajid. “Directors of a PLC of this size should really be looking at themselves: have they really done the right thing for this company?” He said the negotiations amounted to “too little, way too late”.

“A few hundred million thrown in might have got them through the summer, but they would be looking at a January liquidation anyway,” said Sajid. “There was no point throwing £250m of taxpayers’ money into a black hole. A lot of people, not least senior management, have a lot of questions to answer.”

Another high street casualty

Thomas Cook now joins a list of British corporate failures with questionable accounting strategies, including Carillion, BHS and Patisserie Valerie.

Experts believe the rarity of such a travel operator going under is an indicator of further problems for Britain’s high street names, and may even point towards a recession.

“The past few years alone has seen established names such as Maplin, House of Fraser, and now Thomas Cook run into trouble, and 2020 could also be a tough year for businesses that aren’t able to react quickly to changes in market conditions,” said Cato Syverson, chief executive of credit checkers Creditsafe.

Although the firm claimed Brexit was having an impact, health secretary Matt Hancock denied the firm's worries were related to Britain’s departure from the EU and uncertain trading conditions.

Hancock said long-term problems with the business and the consumer move to online bookings, were part of many “systemic” issues it faced.

“Are other companies to follow? One hopes not,” said travel and tourism expert Dr Neil Robinson, of the University of Salford Business School. “Their price, promotion and how people actually booked Thomas Cook holidays did not keep pace with changing technology and demand, for example, they still had a lot of high street outlets, which incur rental and other costs.”

Replies (23)

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By Justin Bryant
24th Sep 2019 15:52

How were the banks so dumb as to lend them nearly £2bn in the 1st place (in the case of a travel firm you can't secure that on much I would have thought)?

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By SafeAsHouses
26th Sep 2019 12:40

Indeed.. Looking at the accounts over the last few years, in the years where they made a profit, the margin was usually in the 0.5% zone. Like £9bn sales and net profit £40m sort of thing.No margin for error, literally. And some years they lost a few million. With such tight margins and poor performance over such a long period, why would anyone lend them money or invest in their shares, it seems insane. Note the directors' bonuses were always a couple of million+ even in the years when they lost money!

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By flightdeck
26th Sep 2019 12:45

The scandal here are those directors for sure. Which is annoying because it gives the masses a use-case for curbing executive remuneration.

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By Poltergeist
29th Sep 2019 18:56

They own a fleet of aitcraft - worth a few pounds I would think.

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Replying to Poltergeist:
Hallerud at Easter
By DJKL
01st Oct 2019 09:48

A lot are on the never never.

Looking at their 2018 accounts the net assets are circa £291m and the balance sheet has >£3bn of intangibles.

In the words of Monty Python, Say no More.

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By john cottam
08th Oct 2019 16:37

Not really most of them are leased

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By James Samuels
25th Sep 2019 10:36

It's tragic to see another high street brand going pop. But as Dr Neil Robinson, of the University of Salford Business School said.“Their price, promotion and how people actually booked Thomas Cook holidays did not keep pace with changing technology and demand, for example, they still had a lot of high street outlets, which incur rental and other costs". Keeping up with changes in demand and technology is critical for any business leader. How did management miss such an obvious shift in the market? Probably spending too much time counting their pay packets.

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By AnnAccountant
25th Sep 2019 21:29

Uni of Salford employs a lot of hyper intelligent people with great insights. I'm amazed Salford isn't a wealthy area by now.

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By richards1
26th Sep 2019 10:07

It's about time Auditors were on the hook. If they were then this sort of thing would be less likely to happen.
As a business owner / director I have to sign a disclaimer that says I have been frank and honest and that the auditor relies on this.

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By flightdeck
26th Sep 2019 12:42

I know nothing about auditing and I am unclear on what responsibilities they have. They highlighted the misuse of exceptional expenses classification which is something an auditor should do. But should they have also highlighted the inadequacy of its structural capital? To be able to do that they would have to understand the business as a whole (not just the books) and be able to form an expert business not just financial opinion which doesn't sound like auditing to me. ???

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By paul.benny
26th Sep 2019 16:59

It seems that you do know something about audit. You are spot on when you say that forming an opinion on the business is not the role of the auditor.

Despite the best efforts of the profession, too many people blame auditors when a company fails. Whilst there are poor quality audits, the directors of a company are the people that run it and failure of a business is their responsibility.

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By jimbarr
26th Sep 2019 10:20

"Less is more" in financial reporting? The IFRS standard setters dictate otherwise.

It is up to the auditors to add into the reports anything that they consider should be in there which management have omitted.

If I understand correctly (without any inside knowledge) it is about the identification and disclosure of exceptional/extraordinary costs. If the auditors disagreed, they should have said so.

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By boblyddon
26th Sep 2019 15:11

Bad business decisions seem to have led to the debacle, rather than accounting. Selling out the FX bureau business to Travelex when it had a lot of legs left in it. Maintaining a big high-street presence when the business was moving online. Maintaining a vertically integrated business when competitors were switching to horizontal integration, e.g. it expands its aircraft fleet. Vertical integration leads on to disasters such as occurred in Turkey when the lira plummeted. Local costs paid to third-parties should have fallen compared to revenues received in £ and euro, delivering a windfall profit. Instead, TC owned major local assets through in local subsidiaries, which should at least to have meant no windfall profit, but TC had gone one better and loaded its subsidiaries up with debt in foreign currency, leading to a windfall loss when the lira lost value. From my perspective TC's history over the last 25 years - since it was sold by Midland Bank to Westdeutsche Landesbank - has been a litany of bad business judgement.

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By paul.benny
26th Sep 2019 17:05

Quote:
Although the firm claimed Brexit was having an impact, health secretary Matt Hancock denied the firm's worries were related to Britain’s departure from the EU and uncertain trading conditions

Whatever you think of the management of TC, Mr Hancock must be a very smart guy to have a better insight into the causes of a company's problems than its own management.

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By SafeAsHouses
26th Sep 2019 17:43

The management of course have an incentive to blame reasons outside of their control.

Ultimately in 2018 60% of British people took a foreign holiday, up from 57% the previous year. People are going abroad, they're going on holiday, it's not really Brexit is it. 1.6bn pile of debt, astronomical overheads, not moving the business model with the times, profit margin of less than 0.5% in recent years even before 2016 (and sometimes a loss).. come on, these are fundamental problems that could ruin any business.

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Replying to SafeAsHouses:
By ireallyshouldknowthisbut
27th Sep 2019 10:18

The "brexsh*t" angle is that people have been delaying booking holidays for 2020 due to the very real uncertainty around whether or not they will be able to (a) travel freely in the event of no deal, and (b) the cost of the local currency in summer 2020. This has lead to a very low advance booking across the whole industry. Remember not inconsiderable number of people book 12 months in advance when 'repeating' a holiday, especially older customers who tend to be more likely to book with old school companies like this. We have a couple of clients in the industry and they are really on their backsides at the moment due to this. There is also a general fear of recession which tends to mean people don't book in advance, for both fear of losing their job, and also the hope for bargains to be had next year if they are OK, but others are not.

As TC is in the brown stuff, it has been using that advance booking cashflow to essentially pay off 2019 holidays.

They have also not fully reflected the currency drop in their UK prices, so are getting burned on the 20%+ fall in the value of the £ which is certainly Brexit related, and the significant fluctuations. Remember they are setting prices 12-18 months ahead of time in GBP based on expected EUR and $ FX, which are all over the place.

So whilst I would agree Brexsh*t is certainly not a major strategic reason for the collapse, its probably whats pushed it to a quicker conclusion than it might otherwise have had in a more gentle economic climate. Ie it brings focus onto poor management and poor businesses who might otherwise have been able to limp along.

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Replying to SafeAsHouses:
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By paul.benny
27th Sep 2019 14:31

The point is not so much whether or not Brexit was a contributor to the demise of TC but how Mr Hancock would know better than the management, despite being untroubled by actual knowledge of TC, the travel industry, or even having an accounting background.

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By AndrewV12
27th Sep 2019 11:53

ooohh dear I have just looked at Thomas Cook's Financial statements for the year ended 30/09/2018 and the bold writing on the front of the report reads 'CUSTOMER AT OUR HEART,'

My gosh the debt did ratchet up in year ended 30/09/2018, the Company paid £124 million in interest, however if they would have received further funding the interest on the loans would have been even more crippling.
In other words short term the loans would have saved them, long term the loan interest would have killed them.
As i understand it the Company was selling off some off the more profitable parts of the business, sooner or later there was no more family silver to sell off.

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By Poltergeist
29th Sep 2019 19:02

Everyone is busy blaming brexit, climate change, the management and anything else they can think of. Seems to me that the bottom line is that either their in house accountant / FD obviously did a [email protected] job and didn't warn senior management that they were in trouble, or, he did warn them and they ignored him, in which case he should have had the courage to go public.

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Replying to Poltergeist:
Lone Wolf
By Lone_Wolf
30th Sep 2019 10:18

Poltergeist wrote:
, in which case he should have had the courage to go public.

Easy to say when you're posting anonymously on an internet forum. Much harder when it could result in you getting the boot and struggling to find future work when you're branded a whistle-blower.
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Hallerud at Easter
By DJKL
01st Oct 2019 10:09

To be clear they did not hide anything, anyone reading the 2018 accounts really has to have reservations, the liquidity and net assets were wholly inadequate when viewed from the perspective of level of activity, a turnover of £9.5bn but net assets of £291m is hardly comfortable. (pages 120-123)

https://www.thomascookgroup.com/investors/insight_external_assest/Thomas...

I have no idea these days what auditors are obliged to say but at page 110 there is quite a bit of comment by them re Going Concern.

Re management, it is not as if they were blind sided by the squeeze they were under, they were well aware, in 2018 they appear to have managed to negotiate a relaxation of covenants and they did spend a lot of time trying to put together a restructuring package but just could not join the dots.

I more view the demise of TC as an event like the extinction of the dinosaurs but without the possible space debris, the model was flawed, the market was flawed. This has been apparent in the travel agency industry for at least the last 19 years ,since say 2000, I used to back then act for a high street travel agency that earned about £450k commission a year, the same agency last year , operating from smaller premises, now earns sub £100k.

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By Agutter Accounts
02nd Oct 2019 11:59

When looking at a balance sheet, I always focus first on a company's working capital - or lack of it.

In Thomas Cook Group's accounts, the truth shouted loud and clear.

Worse, the accounting statements themselves were overly complex and I suspect constructed on a "smoke and mirrors" basis.

The best description of bankruptcy I ever heard was many years ago at a creditors' meeting for insolvent company. It was simply the inability to pay your bills as they became due. With such a huge hole in its balance sheet where cash to pay its bills should have been, the sad demise of Thomas Cook had surely been inevitable for some time.

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By john cottam
08th Oct 2019 16:41

If directors are paying bonuses higher than the operating profit they are depleting the underlying capital of the business which is the only protection creditors have. Auditors should give an opinion on the sustainability of executive pay and bonuses.

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