What is a Going Concern?

Hi guys , today we would be taking a look at the going  concern concept in accounting and symptoms of impending going concern problems and how they can be mitigated. Now, let’s begin with the concept idea of going concern. According to the international standards on Auditing No 570, going concern is fundamental in the accounting profession. The going concern concept assumes that the client’s business will be in operational existence for the foreseeable future with neither the intention nor the necessity of liquidation ceasing trading or seeking protection from creditors in compliance with laws or regulations.

The underlying assumption of the going concern concept is that the organization will be able to generate enough income to write off the associated expenditure at least within the next twelve months. This implies that the organization’s financial statements (Income statement and statement of financial position) do not have any intention to significantly curtail the scale of operations or to signify a shutdown of the business.

The shutdown of a company doesn’t just appear out of the blues, the company would have been showing prior indications way before any thought of a shutdown. These indications could be:

• Inability to pay its debt as and when they fall due (Financial factors). This could be as a result of the following:

1. Low liquidity ratio
2. High gearing ratios
3. Gross recurring losses or increasing operating losses.
4. Heavy dependence on short term funds for long term needs
5. Excessive investment in stocks
6. Existence of long overdue creditors
7. Financing out of long overdue creditors
8. Dividends in arrears
9. Default on loan or similar agreements
10. Borrowings in excess of limits imposed by debenture trust deeds
11. Diminishing relationships with bankers
12. Declining profitability
13. Change from credit cash on delivery transactions with suppliers

The above symptoms can be mitigated by the company’s ability to generate sufficient cash flows which could be done in any way or the combination of the following ways:

1. Dispose of assets without adversely affecting operations
2. Reschedule existing facilities
3. Obtain financial assistance from banks or sister companies without adversely gearing
4. Lease assets rather outright purchase
5. Postpone the replacement of assets
6. Raise additional capital by means of fresh issue or right issue
7. Rollover of existing loan facilities

• Problems that raise questions about the continuation of business other than financial (Qualitative factors):

1.  Loss of a key management staff
2. Strikes and other work stoppages
3. Heavy dependence on the success of a new product or asset
4. Heavy dependence on the success of a new product or asset
5. Excessive reliance on a supplier or customer
6. Loss of a key franchise or patent
7. Political risk
8. Undue influence by market dominant competitor
9. Technological developments that render a key product obsolete.

The above qualitative symptoms can be mitigated by the company’s ability to take alternative courses of action which could include:

1. Finding an alternative market where a key supplier or customer or franchise is lost
2. Employment of the right personnel with the requisite qualifications and experience where a key management staff is lost
3. Embarking on diversification exercise
4. Keeping abreast with technological developments.
5. Taking alternative courses of action in respect of resources.