What Is “Going Concern”?
A going concern is an entity that is expected to continue operating for the foreseeable future—generally interpreted in accounting and auditing as at least the next 12 months. When management and auditors conclude a company is a going concern, they expect it will be able to meet its obligations, use its assets in the ordinary course of business, and avoid liquidation or bankruptcy for that period.
Key Takeaways
– “Going concern” is both a business concept and an accounting principle used to determine presentation and measurement on financial statements.
– Auditors evaluate going-concern risk for at least one year from the date of the financial statements/audit.
– If substantial doubt exists about a company’s ability to continue, management must disclose the conditions and its plans; the auditor may add an explanatory paragraph or modify the opinion if disclosures are inadequate.
– A negative going-concern finding can reduce access to credit, harm supplier and customer relationships, and force restructuring or liquidation.
Understanding Going Concern (Accounting & Audit Perspective)
– Purpose: The going-concern assumption lets accountants record long‑lived assets at cost and defer recognition of liquidation values, because the business is expected to operate rather than shut down.
– Assessment horizon: Auditors typically evaluate whether there is substantial doubt about an entity’s ability to continue for at least 12 months after the reporting date (audit date).
– Standards: U.S. GAAP (FASB guidance) and IFRS require management to evaluate going‑concern conditions and disclose uncertainties when substantial doubt exists. Auditing standards (e.g., PCAOB, AICPA/IAASB) require auditors to consider management’s assessment and corroborating evidence.
Fast Fact
“Substantial doubt” doesn’t automatically mean bankruptcy—rather it means management and auditors must disclose conditions and plans; if feasible and likely, plans can mitigate the doubt.
Going Concern Conditions (Common Causes of Substantial Doubt)
– Recurring operating losses or negative cash flows
– Default or technical default on debt covenants; loans callable by lenders
– Inability to obtain refinancing or new credit
– Litigation threatened or pending that could impose large liabilities
– Loss of major customers, contracts, or key suppliers
– Loss of key management or inability to hire qualified staff
– Material adverse changes in industry, market, or macroeconomic conditions
Negative Trends (Red Flags)
– Several consecutive periods of losses or shrinking revenues
– Deteriorating working capital and liquidity ratios
– Overreliance on a single customer, supplier, or contract
– Increasing use of short‑term debt to fund operations
– Supplier credit withdrawals or demands for advance payments
Red Flags Checklist (Practical)
– Cash runway (months of operating cash remaining)
– EBITDA / net income trends (3–5 periods)
– Current ratio and quick ratio trends
– Debt covenant status (current/near-term breaches)
– Access to committed financing lines
– Contingent liabilities (lawsuits, guarantees)
– Concentration risk (customers/suppliers)
– Management succession planning
Why Going Concern Matters
– Financial reporting: Determines measurement and presentation (e.g., whether assets should be measured on liquidation basis).
– Stakeholders: Investors, lenders, suppliers, and customers rely on the going-concern conclusion to assess credit risk and the company’s survivability.
– Legal/compliance: Management is required to disclose uncertainties; auditors must evaluate and report appropriately under accounting and auditing standards.
Is a Going Concern Good or Bad?
– Good: Being a going concern signals financial stability and continuity—easier access to credit, supplier confidence, ability to attract investors, and normal accounting treatment for assets and liabilities.
– Bad: Not being a going concern signals high risk—creditors can demand repayment, new financing is difficult or costly, suppliers may require stricter terms, and the company may need restructuring or liquidation.
What Happens If a Company Is Not a Going Concern?
– Required disclosures: Management must disclose the conditions leading to the conclusion, along with plans to mitigate the risk and management’s assessment of their feasibility.
– Accounting consequences: If liquidation is probable, assets and liabilities may need to be remeasured on a liquidation basis (different measurement than going concern).
– Market reaction: Creditors and investors often revalue the company downward; stock price may fall; debt may become callable; new financing may be unavailable or come at much higher cost.
– Operational consequences: Suppliers may demand cash-up-front, and customers may seek alternatives—accelerating cash-pressure and increasing the chance of insolvency.
Implications of a Negative Report (Practical Effects)
– Loan covenants may be triggered; lenders can accelerate debt
– Borrowing costs rise; new lenders decline to provide credit
– Suppliers reduce or stop trade credit; customers may cancel orders
– Investors may seek to replace management or force a sale
– Board and management must implement turnaround strategies or negotiate restructuring
Practical Steps — For Management (If Going‑Concern Doubts Exist)
1. Early diagnosis
– Run a detailed liquidity forecast (daily/weekly for 3 months; monthly up to 12 months).
– Stress test scenarios (base, downside, worst-case).
2. Communicate with auditors early
– Share forecasts, assumptions, and any covenant breaches so auditors can evaluate timing and disclosure needs.
3. Develop a mitigation plan and document feasibility
– Cost reductions (headcount, discretionary spend, rent/leases).
– Asset sales (non-core assets) and monetization options.
– Renegotiate terms with lenders (forbearance, covenant waivers, maturity extensions).
– Seek bridge financing or equity injections (identify potential investors or strategic partners).
– Secure supplier support (extended terms, partial shipments).
4. Prioritize cash preservation
– Reduce inventory levels where possible.
– Delay non-essential capex.
– Tighten receivables collection (discounts, factoring).
5. Legal and governance steps
– Engage external legal and restructuring advisors early.
– Keep the board informed and document approvals.
– Prepare transparent disclosures for financial statements and communications to stakeholders.
6. Implement and monitor
– Track KPIs tied to the recovery plan (cash flow, covenant compliance).
– Update scenarios and disclosures as assumptions change.
Practical Steps — For Auditors
– Obtain and evaluate management’s going-concern assessment and supporting evidence for at least 12 months after the reporting period.
– Perform sensitivity analyses on management’s forecasts and review available mitigating factors.
– Determine whether management’s disclosures are adequate; if substantial doubt exists and disclosures are adequate, include an explanatory (emphasis‑of‑matter) paragraph; if disclosures are inadequate, consider modifying the opinion.
– Communicate with those charged with governance about going-concern risks and planned mitigating actions.
Practical Steps — For Investors and Creditors
– Review cash-flow forecasts, covenant status, and management’s mitigation plans.
– Look for independent evidence of financing commitments or realistic asset-sale plans.
– Ask management targeted questions: runway (months), covenant waivers, committed financing, and timing of remediation steps.
– Consider downside scenarios and the recoverability of invested capital.
Sample Management Disclosure Elements (What to Include When Substantial Doubt Exists)
– Description of conditions/events giving rise to doubt (e.g., sustained losses, covenant breaches).
– Management’s evaluation of the likelihood that plans will succeed and the principal assumptions used.
– Specific plans to mitigate the conditions (e.g., expected asset sales, committed financing, cost reductions) and timing.
– Quantitative information where possible (expected cash inflows, reducing expenses by X%).
– Statement about whether management believes the plans will alleviate substantial doubt and the reasons for that belief.
Mitigation Options (Ranked by Typical Speed of Impact)
– Quick (days–weeks): tighten collections, delay payables, reduce discretionary spend, draw on committed facilities.
– Medium (weeks–months): negotiate covenant waivers, short-term bridge financing, inventory reductions, supplier negotiations.
– Longer term (months–quarters): asset sales, strategic equity investments, restructuring, bankruptcy/reorganization.
Example Scenarios (Illustrative)
– Company A: Single quarter loss but has committed creditors and strong cash balance → likely still a going concern if management can present credible forecasts.
– Company B: Repeated losses, loan defaults with lenders calling loans, no committed financing → management likely must disclose substantial doubt and pursue immediate mitigation or restructuring.
Checklist: How Management Should Prepare Before Year‑End Reporting
– Update cash forecasts to real‑time status and extend to 12 months.
– Identify debt maturities and covenant tests within 12 months.
– Confirm any financing commitments in writing.
– Stress-test forecasts versus plausible downside scenarios.
– Prepare disclosure language and get board approval.
– Coordinate with auditors early about presentation and timing.
Frequently Asked Questions
Q: How long is the going-concern assessment period?
A: Auditors typically assess the company’s ability to continue for at least 12 months from the reporting/audit date. Management’s planning horizon should align with applicable accounting standards.
Q: Does a going-concern disclosure mean immediate bankruptcy?
A: No. It signals substantial doubt about survival for the assessment period and requires disclosure; management’s feasible plans can mitigate that doubt. But it increases risk and may prompt creditors and counterparties to act.
Q: Who decides whether a company is a going concern?
A: Management performs the primary assessment and makes required disclosures. Auditors evaluate management’s assessment and determine whether additional reporting (e.g., an explanatory paragraph) is required.
The Bottom Line
“Going concern” is a cornerstone concept in accounting and auditing that signals whether a company is expected to operate for the foreseeable future (typically at least 12 months). Management must assess and disclose uncertainties, and auditors must evaluate those conclusions and report appropriately. Early diagnosis, realistic cash forecasting, clear communications with lenders and auditors, and prompt implementation of mitigation plans are the most effective ways to address going-concern risk and preserve value for stakeholders.
Sources and Further Reading
– Investopedia, “Going Concern” (Eliana Rodgers)
– Financial Accounting Standards Board, “Presentation of Financial Statements—Going Concern (Subtopic 205‑40): Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern”
– KPMG, “Going Concern: IFRS® Standards Compared to U.S. GAAP”
– Deloitte, “Going Concern — Key Considerations Related to Performing a Comprehensive Assessment”
– PwC, “US Financial Statement Presentation Guide: 24.5 Going Concern”
If you’d like, I can:
– Draft a sample going-concern disclosure tailored to a specific company scenario.
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