Going Concern

Q: What does going concern mean in practical business terms?

Going concern refers to the expectation that a business will continue its normal operations for the foreseeable future and is not planning to liquidate. This enables the business to account for assets and liabilities as part of ongoing activities, providing confidence to creditors and investors.

Q: How do auditors assess a company’s going concern status?

Auditors review factors like recent financial performance, cash flow forecasts, access to funding, and loan agreements. If material uncertainties exist, they may require additional disclosures. A company's going concern status is evaluated on its ability to operate and meet obligations for at least the next year.

Q: What happens to financial statements if a company is not a going concern?

If a business is not a going concern, its financial statements must be prepared on a break-up or liquidation basis. Asset values may be reduced to their net realisable amounts, and new liabilities must be recognised. All calculations reflect the expectation that business operations will soon end.

Q: Why is the going concern concept important to investors and creditors?

The going concern assumption provides investors and creditors with confidence that a company will operate long enough to generate returns and fulfil commitments. It underpins valuations and influences lending or investment decisions.

Q: Can external events impact a company's going concern assessment?

Yes, external events such as economic downturns, pandemics, or regulatory changes can significantly affect a business’s outlook. Management and auditors consider these factors carefully when assessing ongoing viability and may increase scrutiny of cash flow and funding plans.

Finance Dictionary >Going Concern

The concept of going concern is foundational to financial accounting, underpinning how companies prepare their financial statements and make strategic decisions. Defined as the assumption that a business entity will continue its operations in the foreseeable future, going concern indicates that an organisation does not intend, nor is forced, to liquidate its assets or significantly curtail its operations.

One interesting insight is that the going concern assumption allows companies to defer recognising certain expenses and losses until future periods. This leads to more meaningful and relevant financial statements for all stakeholders, from investors to lenders, who rely on a company's ongoing operations for their decisions.

What is Going Concern?

Going concern means that a business is expected to remain operational and financially viable for at least 12 months beyond the balance sheet date. This assumption is crucial because it affects how assets and liabilities are valued, ensuring they reflect their intended purposes within ongoing operations. For example, fixed assets like machinery are recorded at cost less depreciation, assuming they’ll continually generate revenue rather than be sold off.

Consider a real-world scenario: a retail company with healthy cash flows, access to bank credit, and a stable market position. Auditors and management review sales trends, cash flow forecasts, and debts due within the next year. If those indicators suggest ongoing viability, the financial statements are prepared under the going concern basis. Conversely, if the company is at risk of closing or liquidating, the values and disclosures in its reports are adjusted significantly.

Historical Background and Importance

The idea of going concern dates back to early accounting practices and forms part of the fundamental assumptions set out by regulatory bodies and standard-setters. It matters deeply because financial statements would look very different if companies were assumed to be winding down. Lenders, investors, and suppliers depend on the presumption of continuity for accurate assessment of business stability. Without going concern, bank loans might not be granted, and investments would become highly speculative.

How Does Going Concern Work?

In practical terms, the going concern principle ensures assets are reported based on their value in continued use rather than liquidation value. For example, a business with specialist equipment—such as a manufacturing firm —can spread the cost of those assets over several years through depreciation, making profit figures more indicative of steady performance.

Management and auditors annually assess the company’s future prospects by reviewing key indicators. These include cash flows, loan covenants, forecasted revenues, and liabilities. If significant doubts arise—such as sustained losses, inability to meet financial obligations, or loss of access to capital—specific disclosures must be made, and a different basis of reporting may be required.

Practical Example of Going Concern Assessments

Imagine a small business whose revenue has declined due to market shifts. Despite recent losses, management projects a return to profitability by securing new contracts and reducing costs. They prepare a 12-month cash flow forecast and present contingency plans to address potential shortfalls. The auditors examine these forecasts, request further supporting evidence, and check the reliability of various assumptions.

If the business can reasonably demonstrate access to necessary funding—such as a credit facility or a new investment—the going concern basis is maintained. Otherwise, additional disclosures or a switch to a "break-up basis" may be required, fundamentally altering how assets and liabilities are valued in the accounts.

Key Considerations and Applications

The going concern assessment is not just about accounting theory; it has very practical impacts. Mergers, acquisitions, or seeking new finance all hinge on whether the business is seen as sustainable. For businesses facing financial strains, transparent forecasting and proactive communication are essential. Auditors must also highlight material uncertainties in the notes to financial statements if doubt exists.

It’s worth noting that exceptional circumstances—like the COVID-19 pandemic—can raise significant going concern risks, even for previously robust businesses. In such cases, detailed analysis of cash reserves, access to emergency funding, and the resilience of operational models become critical.

Related Business Terms

Understanding going concern is easier alongside related financial concepts such as cash flow, liability, risk management, and asset. Each plays a role in analysing the financial health and sustainability of an organisation.

Final Thoughts and Resources

Going concern represents more than just an accounting rule—it reflects the real-world resilience and future outlook of businesses. Staying aware of this assessment helps managers, entrepreneurs, and stakeholders better understand risks and prepare for long-term growth. If you are assessing the future of your own company or navigating periods of uncertainty, exploring business funding solutions may help in maintaining your organisation's stability and growth outlook.