Table of Contents
- What Is Going Concern?
- Key Takeaways
- Understanding Going Concern
- Red Flags that a Business Is Not a Going Concern
- Fast Fact
- Going Concern Conditions
- Implications of a Negative Report
- Is a Going Concern Good or Bad?
- Why Is Going Concern So Important?
- What Happens If a Company Is Not a Going Concern?
- The Bottom Line
What Is Going Concern?
You might hear 'going concern' thrown around as a term for a healthy business, but it's actually a fundamental accounting principle. In accounting, a company is either classified as a going concern or it's not financially viable, based on an analysis of its financials, and this status is typically expected to hold for at least 12 months. So, when I say a company is a going concern, it means it's generating enough revenue to stay operational for the foreseeable future, unless evidence suggests otherwise.
Key Takeaways
If your company qualifies as a going concern, you can defer certain expenses and assets in your financial reports. On the flip side, if it's no longer a going concern, you'll have to start including specific additional details in those statements. Watch out for negative signals like credit denials, ongoing losses, or costly lawsuits, as these can indicate trouble. And remember, if there's any doubt about financial viability, the auditor has to add a going concern opinion to the audit report.
Understanding Going Concern
As an accountant, I use going concern principles to figure out what kind of reporting goes on a company's financial statements. If the company is a going concern, it can report long-term assets at cost instead of current or liquidating value. I generally believe that means the company is managing its assets well and won't need to sell anything off to pay bills. These principles also guide decisions on asset sales, expense cuts, or product shifts. GAAP covers going concern assessments, listing events and conditions that might raise substantial doubt about ongoing operations. According to GAAP, you have to make disclosures as soon as that doubt is identified.
Red Flags that a Business Is Not a Going Concern
Certain indicators can signal that a business might not remain a going concern soon. For instance, if you see long-term assets popping up in quarterly statements or on the balance sheet, that usually doesn't happen in a healthy company and might mean they're planning to sell them for cash. Another sign is failing to meet obligations without major restructuring or asset sales—if a company buys assets during restructuring, it could be intending to flip them later. A one-time event like a big lawsuit, loan default, or product defect can put the future at risk. When ongoing expenses far exceed revenue, or liabilities swamp operational income, profitability is threatened. A looming large debt payment that can't be covered with current resources, forcing borrowing to pay creditors, is a clear trouble sign. Finally, low liquidity ratios, high employee turnover, or shrinking market share make a company more prone to issues, raising doubts about its going concern status.
Fast Fact
Companies can end up bankrupt without ever being flagged with a going concern issue beforehand.
Going Concern Conditions
Accounting standards dictate what a company must disclose in its financial statements if there's doubt about continuing as a going concern. The Financial Accounting Standards Board mandates revealing the conditions leading to substantial doubt, along with management's take on them and plans to address the issues. In audits, I look for evidence that the company can survive for one year post-audit. Conditions raising doubt include negative operating trends, repeated losses, loan defaults, lawsuits, and supplier credit denials. To qualify as a going concern, a company often needs to handle major debt restructuring or financing changes. If not, it might require external funding, restructuring, or asset liquidation.
Implications of a Negative Report
A negative audit report carries several consequences. First off, the company looks like a risky investment, far riskier than others. It might get revalued at the request of investors, shareholders, or the board, which could help price it for acquisition or attract private investors. You'll need to take accounting steps to write down the company's value in financial reports. One big fallout is the credit squeeze—existing debts might become callable, and new lenders will hesitate to offer credit, especially at decent rates. This can affect suppliers too, who might refuse to provide materials or goods on credit.
Is a Going Concern Good or Bad?
A going concern means the company is financially stable and likely to survive at least the next 12 months—that's good. A company not seen as a going concern, in poor shape, might not make it another 12 months—that's bad.
Why Is Going Concern So Important?
Being a going concern backs up a company's financial health and shows confidence in its success and longevity. It keeps customers satisfied, ensures suppliers and vendors stick around, allows access to credit when needed, and helps attract new investors.
What Happens If a Company Is Not a Going Concern?
If a company isn't a going concern, management must disclose this in financial statements, including the reasons for the assessment.
The Bottom Line
The term 'going concern' marks a company as financially stable. A determination that it's not serves as a warning to customers, investors, and suppliers that the company's future is at risk.
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