Here, we take an in-depth look at going concern, and what it means for companies – particularly as the number of businesses entering insolvency within the UK is on the rise.
What is going concern?
A company prepares financial statements on a going concern basis, under the assumption that they can continue operations for the foreseeable future. It is assumed that the company does not have the intention, or need, to liquidate its assets. It is, therefore, the responsibility of the directors of the company to provide fair and accurate financial statements to ensure the going concern assumption is appropriate.
Ultimately, there are three principles when dealing with an assumption:
- Assessing going concern
Assessing going concern
As mentioned above, it is the responsibility of the company directors to provide an extensive assessment as to whether their going concern assumption is appropriate, through half-yearly and annual financial statements. Directors cannot use the going concern basis if they are looking to stop trading, or even liquidate assets if that is the only alternative.
Companies that have more control over their cash flow and budget, and are ‘financially sound’, are going to be in a better position to make the going concern assumption. Those that prepare a budget for their financial year have a significant advantage at identifying peak periods for their business, and the times they are most profitable.
Whilst larger companies will be subject to an auditor’s report, procedures relevant to assessing the going concern basis for directors of larger and smaller companies will be:
- Budgets/forecasts: Directors should prepare a budget, their trading estimate and sales forecast to ensure all information is available.
- Borrowing: Directors should consider the terms and conditions of their borrowing arrangements, ensuring the entity can meet all obligations. If these instalments are not met, a lender could ‘call-in’ the loan, thus affecting their going concern assumption.
Directors that oversee medium and large business must provide more than budgets/forecasts and borrowing information. They must look to the long-term future, and will, for example, provide detailed data on:
- Cash flow timings
- Contingent liabilities
- Risk management
As stated above, the responsibility for concluding the assumption rests with the directors. For larger companies, they will be subject to a going concern audit. The auditor must gather enough evidence and assess evaluations to support, or rebuke, whether the company can continue operating as a going concern. The going concern audit does not evaluate a period longer than a year. The auditor should:
- Qualify the audit report if they believe uncertainty regarding the company operating as a going concern exists.
- Add an emphasis of matter paragraph to the report if they believe the going concern assumption is correct, and that all necessary information has been disclosed in the financial statements.
Issues that may cast doubt on the going concern concept, might include:
- Negative trends in cash flow
- Series of payment losses
- Loan defaults
- Denial of trade credit by suppliers
- Legal proceedings submitted against the company
Assessing going concern for smaller companies should be more straightforward than larger businesses. If a business is not subjected to an auditor’s report, an accountant may look over the statements, to ensure they are fair and accurate. Significant indicators that would suggest the accounts are not fair, and the assumption must be reassessed, might include:
- Insolvent balance sheet
- Negative cash flows and forecasts
- Not meeting payment installments for suppliers
- Loss of credit from suppliers
- Loss of suppliers
- Lack of significant contracts
- Pending litigation issues
If you are in any doubt as to whether your going concern assumption is correct, or you suspect your company is facing signs of insolvency, we urge you to seek advice immediately. The team at Business Rescue Expert can provide free, friendly advice as to the best course of action for your business.