What Does Going Concern Mean?

What Is Going Concern?

Going concern is an accounting term for a company that has the resources needed to continue operating indefinitely until it provides evidence to the contrary. This term also refers to a company’s ability to make enough money to stay afloat or to avoid bankruptcy. If a business is not a going concern, it means it’s gone bankrupt and its assets were liquidated. For example, many dot-coms are no longer going concern companies after the tech bust in the late 1990s.

Key Takeaways

• Going concern is an accounting term for a financially stable company that can continue its business for the foreseeable future.
• Certain expenses and assets may be deferred in financial reports if a company is assumed to be a going concern.
• If a company is no longer a going concern, it must start reporting certain information on its financial statements.
• Negative trends that lead to no longer being a going concern include denial of credit, continued losses, and lawsuits.
• An auditor can give a going concern opinion when they have doubts about the financial longevity of a company.

Understanding Going Concern

Accountants use going concern principles to decide what types of reporting should appear on financial statements. Companies that are a going concern may defer reporting long-term assets at cost. A company remains a going concern when the sale of assets does not impair its ability to continue operation, such as the closure of a small branch office that reassigns the employees to other departments within the company.

Accountants who view a company as a going concern generally believe a firm uses its assets wisely and does not have to liquidate anything. Accountants may also employ going concern principles to determine how a company should proceed with any sales of assets, reduction of expenses, or shifts to other products.

Going concern is not included in the generally accepted accounting principles (GAAP) but is included in the generally accepted auditing standards (GAAS).

Going concern is an example of conservatism where entities must take a less aggressive approach to financial reporting.

Red Flags Indicating a Business Is Not a Going Concern

Certain red flags may appear on financial statements of publicly traded companies that may indicate a business will not be a going concern in the future. Listing of long-term assets does not normally appear in a company’s quarterly statements or as a line item on balance sheets. Listing the value of long-term assets may indicate a company plans to sell these assets.

A firm’s inability to meet its obligations without substantial restructuring or selling of assets may also indicate it is not a going concern. If a company acquires assets during a time of restructuring, it may plan to resell them later. Sometimes, one-time events are enough to cause a company to go bankrupt. Consider how a single substantial lawsuit, default on a loan, or defective product can jeopardize the future of a company.

A company may not be a going concern based on the financial position on either its income statement or balance sheet. For example, a company’s annual expenses may so vastly outweigh its revenue that it can’t reasonably make a profit. On the other hand, a company may be operating at a profit but its long-term liabilities are coming due and not enough money is being made.

There are also a number of quantifiable, measurable indicators that auditors use to measure going concern. Companies with low liquidity ratios, high employee turnover, or decreasing market share are more likely to not be a going concern.

Companies can go bankrupt without ever having been a going concern issue.

Going Concern Conditions

Accounting standards try to determine what a company should disclose on its financial statements if there are doubts about its ability to continue as a going concern. In May 2014, the Financial Accounting Standards Board determined financial statements should reveal the conditions that support an entity’s substantial doubt that it can continue as a going concern. Statements should also show management’s interpretation of the conditions and management’s future plans.

In general, an auditor examines a company’s financial statements to see if it can continue as a going concern for one year following the time of an audit. Conditions that lead to substantial doubt about a going concern include negative trends in operating results, continuous losses, loan defaults, lawsuits against a company, and denial of credit by suppliers.

In order for a company to be a going concern, it usually needs to be able to operate with a significant debt restructuring or massive financing overhaul. Therefore, it may be noted that companies that are not a going concern may need external financing, restructuring, asset liquidation, or be acquired by a more profitable entity.

Implications of Going Concern

If a company receives a negative audit and may not be a going concern, there are several implications. First, the company will now be seen as a declining investment opportunity. Companies that are not a going concern represent a significantly higher level of risk compared to other companies.

If a company is not a going concern, the company may be revalued at the request of investors, shareholders, or the board. This revaluation may be used to price the company for acquisition or to seek out a private investor. There are often certain accounting measures that must be taken to write down the value of the company on the business’s financial reports.

One of the larger repercussions of not being a going concern is potential credit challenges. If a company is not able to meet debt covenants, its debt may be callable. New lenders will likely be reluctant to issue new credit, or any new credit issued will be prohibitively expensive. This credit crunch may trickle down to suppliers who may be unwilling to sell raw materials or inventory goods on credit.

Is a Going Concern Good or Bad?

A going concern is often good as it means a company is more likely than not to survive for the next year. When a company does not meet the going concern criteria, it means that a company may not have the resources needed to operate over the next 12 months.

Why Is Going Concern So Important?

Going concern is important because it is a signal of trust about the longevity and future of a company. Without it, business would not offer nearly as much credit sales as suppliers, vendors, and other companies may not pay the company if there is little belief these companies will survive.

What Happens If a Company Is Not a Going Concern?

If a company is not a going concern, that means there is a risk the company may not survive the next 12 months. Management is required to disclose this fact and must provide the reasons why they may not be a going concern. Management must also identify the basis in which the financial statements are prepared and often disclose these financial reports with an audit report with a going concern opinion.

The Bottom Line

Going concern is an accounting term used to identify whether a company is likely to survive the next year. Companies that are not a going concern may not have enough money to survive, and this fact must be publicly disclosed when an auditor audits their financial statements. A company may not be a going concern for a number of reasons, and management must disclose the reason why.