Today’s business climate is proving a challenge for many industries. In 2018, the number of total company insolvencies has increased by a staggering 13% from 2017. The likes of Carillion and Toys R Us shut their doors for the final time. Many other worldwide brands, such as House of Fraser and New Look, have also faced severe financial difficulties, closing a large number of their premises.
As such, Business Rescue Expert – leading insolvency practitioners in the UK – are discussing the going concern assumption, and what it could mean for the future of your company.
What does ‘going concern’ mean?
Going concern refers to a company preparing financial statements on the basis they can continue to trade in the foreseeable future. The company does not have any plans to appoint administrators or liquidators, and is deemed solvent. It’s important to note that insolvent companies or those facing severe financial difficulties cannot be deemed as a ‘going concern’.
A going concern falls under a larger operation known as a Business Valuation, which is undertaken when a company is planning to sell all or a portion of its operations, or is looking to merge with or acquire another company. In this process, the going concern value may also be calculated, and it is considered as the default valuation assumption for a business. It is critical because it implies that the business will continue to have a base of customers, employees, licenses, and permits that will continue to be in effect.
Assuming going concern is the responsibility of the directors and shareholders. They must provide fair and accurate financial statements to ensure the assumption is appropriate. Any misleading documents can land director’s in a substantial amount of trouble, with severe consequences as a result. Take, for instance, House of Fraser, with investigations, currently, underway to asses the misleading going concern assumption.
What is involved in the assumption?
There are three principles to the going concern assumption:
- Auditor’s report
- Any disclosures
An extensive assessment is required to ensure the going concern assumption is correct. As mentioned above, it is the director’s who must take responsibility, producing half-yearly and annual financial statements to back-up their proposal. To be deemed a ‘going concern’, the company must be solvent. The directors must not use the going concern basis if they are looking to stop trading in their particular sector or liquidate any company assets. Essentially, the company must be ‘financially sound’. For the assumption to be correct, we suggest companies prepare budgets for their financial year, detailing previous expenses and financial history. The better prepared, the better position to make the assumption.
In this regard, accounting and data software can play a pivotal role in helping businesses maintain their financial health. Implementing specialized accounting software can streamline the financial management processes, enabling companies to track expenses, manage inventory, and analyze sales trends with precision. For instance, a wine business implementing winery management software will be able to efficiently monitor its costs, optimize inventory levels, and forecast demand based on historical data. Besides ensuring its ‘financial soundness,’ it can improve its overall profitability. Not only a wine business but also a retail clothing store struggling with inventory management and budgeting can adopt similar software. This will help them gain real-time insights into their stock levels and sales performance. Hence, a data-driven approach can assist businesses in making informed decisions, reducing overstocking, and enhancing their financial stability.
Larger companies will be subjected to an auditor’s report – as outlined below – but procedures relevant to the assessment will include:
- Budgets/forecasts: directors must prepare a detailed budget for the company, with sales forecasts, expenses and peak periods identified.
- Borrowing: directors must also consider any borrowing agreements and that the company can continue to meet all payment obligations. If the company fails to meet these obligations, the going concern assumption will be affected.
The above points are also vital for smaller companies to include. However, larger corporations must look to the long-term future and provide information on products, risk management, contingent liabilities and markets.
Companies will be subjected to an auditor’s report – evaluating a period of a year or below – with the auditor gathering evidence to support the assumption. Alternatively, the auditor may rebuke the assumption.
The auditor will outline if there is any uncertainty regarding the company operating as a going concern. Any negative cash flows, payment losses, loan defaults and legal proceedings against your company will contribute to this uncertainty.
If they do approve, they will add an ‘emphasis of matter paragraph’ stating all financial information has been disclosed.
As mentioned, larger corporations will be subject to an auditor’s report. For smaller companies, the assumption is a much more straightforward process. An accountant will, likely, look over the statements, ensuring the director has detailed fair and accurate financial information. Again, there are several indicators that suggest the company may need to reassess, including: insolvent balance sheet, negative cash flows, loss of credit and suppliers and any pending litigation issues.
Ultimately, the directors must disclose all necessary information. Any misleading information will see the directors investigated. Similarly, your company could be deemed insolvent if facing severe financial difficulties, which could even result in the closure of the company. You must always seek legal and professional advice before establishing whether your business is deemed a ‘going concern’.