HookCarillion was profitable right up until it wasn't
On 15 January 2018, Carillion — the UK's second-largest construction firm, holder of hundreds of government contracts and employer of around 19,000 people in Britain — went into compulsory liquidation with roughly £29m of cash left against liabilities approaching £7bn. Months earlier, its published accounts had shown healthy profits. Then, in July 2017, it admitted an £845m write-down on major contracts: profit it had booked years before the cash ever arrived, on work that was quietly going wrong. It had also kept paying dividends throughout, while its pension deficit swelled to several hundred million pounds.
Carillion is the whole of 2.3 compressed into one story. Profit is an opinion — a figure shaped by accounting judgements about when revenue counts and what costs attach to it. Cash is a fact — either it is in the bank on the day the wages are due, or it is not. This section gives you the toolkit for telling the two apart: the statement of comprehensive income and its three profit lines, the margins that let you compare firms of different sizes, the liquidity ratios that were flashing red at Carillion for anyone who looked, and a framework for why businesses actually fail.
ModelThree profits, one statement
The statement of comprehensive income (the profit and loss account) runs downhill through three profit lines, and each answers a different question. Revenue minus cost of sales (the direct costs of what was sold) gives gross profit: is the core product economically sound? Gross profit minus operating expenses (rent, marketing, admin salaries — the overheads of running the business) gives operating profit: is the whole operation efficient? Operating profit minus interest (and, in the full statement, tax) gives net profit, or profit for the year: what is actually left for the owners?
The three-line structure is diagnostic. A firm with a strong gross profit but weak operating profit has a good product buried under bloated overheads. A firm with decent operating profit but feeble net profit is being eaten by interest — a warning about its debts, not its trading. Examiners build whole data-response questions on spotting which line the problem lives in, so never talk about 'profit' in the singular: name the line.
DataMargins — turning pounds into percentages so you can compare
Absolute profit tells you little on its own: £1m of profit is triumph for a corner shop and catastrophe for Tesco. Profit margins divide each profit line by revenue and multiply by 100, turning pounds into a rate: gross profit margin, operating profit margin, and net profit margin. Margins let you compare a firm against its own history and against rivals of any size.
What counts as 'good' is entirely sector-dependent — UK supermarkets grind along on net margins in the low single digits, while software firms can run past 20% — so a margin only means something in context. To improve a margin a firm must either raise prices (only survivable if demand is price-inelastic), cut cost of sales (cheaper suppliers, better purchasing — with quality risk), or cut overheads (with capability risk: the marketing you cut this year is the revenue you miss next year).
A Leeds clothing retailer reports revenue of £800,000. Cost of sales is £480,000, so gross profit = £320,000 and gross margin = 320,000 ÷ 800,000 × 100 = 40%. Operating expenses are £240,000, so operating profit = £80,000 and operating margin = 10%. Interest on its loans costs £16,000, leaving net profit of £64,000 and a net margin of 8%. Reading it: the product sells at a healthy markup (40p gross in every £1), but three-quarters of that gross profit is consumed by overheads before it reaches the bottom line. If next year's accounts showed the gross margin steady at 40% but operating margin down to 6%, you would know precisely where to look — the overheads, not the product.
ModelLiquidity — can you pay Friday's wages?
Liquidity is the ability to meet short-term debts as they fall due, and it is read from the statement of financial position (the balance sheet), which lists what a business owns (assets), owes (liabilities) and the owners' stake (equity) at a moment in time. Two ratios do the work. The current ratio = current assets ÷ current liabilities; a common comfort zone is roughly 1.5 to 2. The acid test = (current assets − stock) ÷ current liabilities, stripping out stock because it is the hardest current asset to turn into cash quickly; below 1 means the firm could not cover its short-term debts without selling stock.
Both benchmarks bend with the business model. Supermarkets run current ratios below 1 quite safely, because stock turns into cash within days while suppliers wait 30 to 60 days to be paid. A housebuilder with slow-shifting stock needs far more cover. That is why working capital management — chasing debtors sooner, negotiating longer credit from suppliers, trimming stock — is the day-to-day craft of finance: each lever frees cash, and each has a cost in goodwill or resilience.
A Midlands homeware wholesaler has current assets of £120,000 — of which £42,000 is stock — and current liabilities of £96,000. Current ratio = 120,000 ÷ 96,000 = 1.25. Acid test = (120,000 − 42,000) ÷ 96,000 = 78,000 ÷ 96,000 ≈ 0.81. Verdict: mildly stretched but survivable for a wholesaler whose stock sells steadily; alarming if that stock is seasonal stock in the wrong season. The same 0.81 is routine for a supermarket and a red flag for a construction firm — the interpretation mark always belongs to the sector context.
MechanismProfit is not cash — the distinction that kills firms
Profit and cash part company for reasons of timing. A credit sale creates revenue — and therefore profit — today, but the cash arrives in 60 days. Buying a year of stock drains cash today but touches profit only as the stock sells. Carillion ran this gap at industrial scale: it recognised profits on long contracts years before the money arrived, financed the wait with debt, and pushed its own suppliers onto payment terms reported to stretch to 120 days. On paper, profitable; in the bank, increasingly empty.
The same mechanism, run at start-up scale, is called overtrading: a growing firm takes on more and more orders, each requiring cash up front for materials and wages, with the revenue arriving months behind. It is entirely possible — common, even — for a firm to die of cash starvation while its order book and its profit forecasts have never looked better. This is why the exam repeatedly asks for the distinction, and why 'a profitable business cannot fail' is the single most dangerous sentence a student can write in Theme 2.
CaseWhy businesses actually fail
Edexcel wants causes sorted two ways: internal versus external, and financial versus non-financial. Internal financial: poor cash-flow management, overtrading, too much debt — Carillion's gearing left no slack when contracts soured. Internal non-financial: weak leadership, marketing failure, quality collapse, losing touch with customers. External: recession, cost shocks, new competitors, technological or legislative change that invalidates the model.
Thomas Cook, September 2019, makes the tidy contrast case. Around £1.7bn of debt (financial, internal — much of it legacy from a 2007 merger) met a structural shift to online booking (external, non-financial) plus a weak pound raising overseas costs and Brexit uncertainty suppressing summer bookings (external, financial). Roughly 9,000 UK jobs went, and about 150,000 British holidaymakers had to be flown home in the CAA's Operation Matterhorn — the largest peacetime repatriation in UK history. The exam-ready insight: failures rarely have one cause; a strong answer shows the interaction — debt (internal) removed the resilience that the external shocks then tested.
VocabularyKey terms the mark scheme pays for
TrapsMisconceptions that cost marks
ExamWhat examiners want
Ratio and margin questions on 9BS0 follow a fixed rhythm: formula, substitution, answer with unit, then one sentence of interpretation in context. The interpretation sentence is the mark students drop — '0.81 is weak for a construction firm holding slow-moving stock' scores where a bare '0.81' does not. Never judge a single ratio in isolation: compare it with last year, with a rival, or with the sector norm, and say which comparison you are making.
On 'assess' questions about a struggling business, structure the diagnosis with the section's distinctions: which profit line is sick, is the problem profitability or liquidity, are the causes internal or external, financial or non-financial. The strongest evaluation usually pivots on the profit-versus-cash distinction — a firm can trade its way out of a profit problem, but a liquidity problem can kill it within weeks, which changes what the management should do first. If the case includes a balance sheet extract, calculate at least one ratio even if the question does not explicitly demand it: quantified analysis is what the top level of the mark scheme describes.