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What is a going concern?
What is a going concern and what does the term mean? In essence it is a term used to describe the health of a business. A business operating as a going concern is expected to trade for 12 months or more without any threat of liquidation.
Going concern means it does not appear that the company is at risk of closing due to insolvency but instead is expected to survive and thrive.
However, if a company is experiencing severe financial decline – and insolvency is a credible threat – determining whether the company is a going concern is crucial.
A business that is not a going concern needs to cease trading to protect its creditors – a statutory obligation for limited company directors under many international insolvency laws.
Signs that a company may not be in good shape
The signs that a company is no longer a going concern, or is approaching that state, are specific. These include:
- Poor cashflow
- Inability to obtain credit or secure borrowing
- Growing levels of bad debt
- Difficulty in meeting existing liabilities – paying suppliers and banks, for example
- Existing or threatened legal action against the company
If any of these potentially damaging issues exist, directors should seek professional insolvency advice as soon as possible. If a company is headed for insolvency, acting quickly can save it from liquidation and closure.
Why do accountants use this term?
Classifying a business as a going concern or not allows accountants to decide what kind of financial reporting should appear concerning that business on the financial statements. For example, the valuation of assets could be reported at current liquidating value but would be deferred to cost in the case of a going concern.
Going concern principles also allow accountants to decide how a company should deal with the sale of assets and the reduction of expenses.
What else might indicate a company could no longer be healthy?
A company may not be a going concern if specific indicators or red flags are present. One of these can be listing the value of long-term assets, indicating that the company plans to sell them. The firm would not be considered a going concern if it cannot meet its obligations without selling such assets or restructuring.
Other factors which may make a business question its ability to continue as a going concern include negative operating results, loan defaults and losses, legal proceedings, and denial of credit. These may be uncovered as part of a routine audit.
How can board members check if the business is healthy?
It would be helpful for directors to assess the following:
- Management accounts compared to budget
- Cash flow projections
- Debts
- Loan agreements
- Litigation proceeding
- The company’s order book
Whether a company is a going concern is ultimately a decision for the directors and the board, although an auditor’s advice is always beneficial.
The health of a company should be accurately reflected in financial statements, and whether a company is a going concern or not must be stated on those statements.
Watch: How to read a financial statement even if you know nothing about accountancy.