Thomas Cook collapse – breakeven and operation leverage
In the past few days, the Thomas Cook travel company has gone into administration – meaning it’s banks have taken control to recoup monies they have lended. The company dates back to 1841, and is (or was) a well-known brand in the holiday/tour sector.
Of course, here I am interested in the management accounting angle, with a teaching focus. There will no doubt be plenty of comments on the failure, but let others write that. A quote in The Sun (ok not the best source, I acknowledge) noted “the firm has been struggling with a £1.6 billion debt for years. It needs to sell 300 million holidays a year to break even.” I am not sure about the accuracy of the “300 million holidays a year” to break even, but regardless, it is quite likely Thomas Cook would have had to sell a lot of holidays to cover the costs of servicing a large debt (and making repayments) on top of its ongoing costs. What is probably more interesting it the operating leverage within a firm like Thomas Cook.
Operating leverage refers to the percentage of total costs which fixed costs compared to variable costs. If fixed costs are higher in proportion to variable costs, this is referred to as high operating leverage, and more profit is made from each incremental sale. More variable costs, on the other hand, is termed low operating leverage and results in a smaller profit from each incremental sale. Where would Thomas Cook sit on this scale? Well, it likely had high fixed costs (debt servicing, fuel, staff, lease payments on aircraft etc), so is probably on the high operating leverage end of the scale with lots of fixed costs. But, the package holiday (or even the airline sector) is historically a sector with low profit margins. With high fixed costs and low margins, this means a firm like Thomas Cook needed substantial sales volumes and cost controls to keep going (or even break-even) without further funding. It seemed not to be able to do this – 2018 loss after tax was £163m, 2017 profit was £12m, 2016 profit £9m, not great on revenues of about £8 billion.