6 lessons SME’s can learn from Debenhams going into administration

“Where am I going to buy my clothes if Debenhams closes down?” was a comment made by my wife when hearing they had gone into administration. This prompted me to take a look at Debenhams to understand what went wrong and the lessons that could be learned by other businesses.

The Guardian newspaper suggests the following issues at Debenhams:
1. They have too many stores (165) at a time when sales are falling and costs are rising.
2. Rents are too high at 13% of Sales with long leases taken out when sales were buoyant.
3. Online sales are improving but are only half the level seen by competitors (eg John Lewis)
4. Fashion ranges are not pulling in the customers as they did before.

Digging deeper into the financials for the past 6 years to 2018, they reveal a surprisingly consistent position given the analysis above. Prior to 2018 sales had remained broadly flat, gross profits remained at around 13% and retained profits (before exceptional costs) of 5%.
However, this hid the fact that store numbers in this period rose from 155 to 165. This backs up the Guardian’s comment that sales were falling (per store) due to the tough market conditions and lack of attractive fashion ranges.

From my analysis, there are six lessons that I think are relevant to SME’s. Please feel free to comment if you can see others that I have missed.

Lesson 1 – Financially assess investment opportunities.
In 2006 Debenhams had 120 stores and in 2019 they had 165, growth was 5 stores per year up until 2013 and 2 per year thereafter. Sales were dropping and profits were stagnating at best and they invested anyway. Growth is good but remember profits need to be improved to cover increased interest costs and investor covenants and expectations. Always financially assess the impact of investment opportunities to ensure they are viable before spending. I like Peter Cowgill’s attitude at JD Sports, where they seek opportunity driven investments rather than growth as a strategy in itself.

Lesson 2 – Failure to make hay when the sun shines
During the buoyant sales years, Debenhams failed to reinvest enough profit in the business (e.g. online offering, fashion ranges etc) and when things got tough it was too late. They needed to move with what the customer demanded and invest accordingly. Make sure you invest in the future whether it be with people, systems or infrastructure.

Lesson 3 – Keep a profit consideration in everything you do
Debenhams negotiated long leases at high rent during the buoyant years without due regard for future downsides. It appears that their growth strategy came before making profit. I talk about a profit consideration in everything you do in my article on working capital. Making a profit (and maximising shareholder wealth) should be part of any strategy.

Lesson 4 – Be careful about capitalising expenditure, it can come back to haunt you!
It can be seen that exceptional costs have been rising from £12m in 2016 to £36m in 2017 and £525m in 2018. This latter amount explaining why the reported loss was £394m in 2018 wiping out any profit before exceptional costs. The 2018 result was probably the “straw that broke the camel’s back” and lead to the lenders pulling out.

These exceptional costs related to goodwill, IT and onerous leases and restructuring costs primarily due to a downfall in projected sales. The lower sales lead to worsened financial projections leading to a requirement to create impairment provisions for items on the balance sheet. In other words, items were capitalised at some point in the past (e.g. goodwill on acquisition, IT costs, leasehold improvements etc) and they now needed to be expensed to profit. Delaying costs (e.g. by capitalisation or deferring expenditure) can come back to haunt you, always be cautious about carrying forward expenditure in this way.

Lesson 5 – Net current liabilities is not a sustainable position
Throughout the past decade, Debenhams were trading on negative net current assets, made possible because retailers tend to have high levels of cash. But in simple terms net current liabilities meant that they did not have enough cash to settle liabilities and conduct business. Not a sustainable position as we saw here. My article on working capital talks about ways this position can be improved.

Lesson 6 – Manage your cashflow as well as your profit
During the 6 years, Debenhams made profit before tax and exceptional costs of £605m, but in this period they only increased cash balances by £4.3m. There are things that make these two different (e.g. buying fixed assets v depreciating them) but not generating any cash can indicate stability issues (and creative accounting!). Running out of cash is the main reason for insolvency and was the problem Debenhams faced.

Cash movements as well as profit are both critical in the management of businesses and should be reviewed at least monthly within your MI.

I hope that a buyer will be able to restructure Debenhams and make it sustainable once more. Not least for the 25,000 staff who work there, but also for those Generation Xers and Millennials seeking fashionable clothes.

Kevin Thomas
Portfolio Finance Director at Finance Interim Ltd.

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