Going concern assessments

The coronavirus pandemic has dramatically changed the circumstances in which many businesses operate, and some are under threat, due to reduced consumer demand and restrictions on trade imposed by the government as a result of the pandemic. While the easing of lockdown restrictions earlier in the summer provided some respite for business, the recent tightening of restrictions in the North East and further afield, demonstrates that the future is anything but certain.

This makes the assessment of going concern (the ability of a company to continue in operational existence for the foreseeable future) an ever more important consideration as part of the annual audit process.

It is the responsibility of directors when preparing the accounts to carry out an assessment to ascertain whether the company is a going concern. The assessment should take into account all available information about the future, covering at least 12 months from the date on which the accounts are approved and signed-off by the directors. This assessment should be formally documented by the directors, which will require the preparation of forecasts which take into account a range of assumptions about the future.

The key factor in assessing going concern is whether a company will have enough cash and/or access to loan facilities to meet obligations as they fall due. Even profitable businesses can encounter liquidity problems where they can’t pay liabilities due to a shortage of cash. For example, manufacturing companies can have substantial working capital requirements meaning cash is tied up in stock, which can lead to cashflow issues if there is a slowdown in collecting debts from customers. Preparation of a detailed cashflow forecast looking twelve months into the future is therefore vital in identifying any possible shortfalls and what actions could be taken now to prevent them, with consideration of headroom and the availability of further external funding if required.

The majority of audited companies will already prepare annual budgets and forecasts, but unless it is business as usual, these will need to be adjusted to account for the change in circumstances brought about by Covid-19, whether those factors be industry specific or part of the broader economic environment.

Of course, preparing a forecast at any point in time is not a precise science, but a cautious approach should always be encouraged. Key assumptions should be applied consistently, with detailed notes on the basis used recorded and kept for future reference and discussions with the audit team.

Where possible, sensitivity analysis should also be performed on the forecasts, with a range of outcomes presented, such as a base forecast with best and worst case scenarios also considered, to determine just how bad a plausible worst case scenario is and whether this could be overcome.

If a company is reliant on external loans, then headroom calculations should also be included in respect of any associated covenants, particularly those that are affected by profitability, such as interest cover ratios. Potential breach of a loan covenant that leads to long-term finance being withdrawn by a lender will inevitably play a big part in assessing whether a company should be considered a going concern.

Where, following the assessment process, the directors determine that there is some uncertainty over the ability of the company to continue as a going concern, they should consider making additional disclosures in the notes to accounts and narrative reporting (Directors’ and Strategic Reports) so that a true and fair view is presented in the accounts. Such disclosures may enable an unqualified audit opinion to be issued even where there are uncertainties over going concern. However, because audit reports are required to refer to any material uncertainties regarding going concern, even unqualified audit reports may include an additional paragraph relating to going concern. This additional paragraph is something which we expect to be increasingly common in the future, given the difficulties faced when making assumptions and assessing going concern.

It has become clear in recent weeks that Covid-19 and its impacts are going to be with us for longer than any of us would want, meaning that the preparation of detailed assessments of going concern and in particular cashflow forecasts, are going to be of ever increasing importance for all businesses. Early action is often crucial in saving a business and forecasts can help identify areas of concern before they become unmanageable, so should be considered a key tool of all finance teams.

If you have any questions regarding the going concern assessment and the potential impact on your accounts and audit report, then please do get in touch with our Head of Audit, Grahame Maughan, who would be delighted to help.

Call Now Button