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A going concern is a financial accounting term that refers
to a company that has enough cash flow to demonstrate its ability to stay
afloat and avoid bankruptcy for the foreseeable future. Learn about the
accounting standards and the various factors that influence this status.
What Is Going Concern?
Going concern is a financial reporting term that describes
companies with solid balance sheets and the ability to avoid potential
bankruptcy for an extended period of time. Companies that are not in this
status may have assets that are being liquidated. There are more disclosure
requirements when a company is no longer a going concern; financial statements must
show more information such as liabilities, audit reports, and other
expenditures. Legal proceedings, negative company opinions, and poor management
plans can all cause a business to fail.
How Is Going Concern Determined?
Certified public accountants (CPAs) use going concern
principles to determine whether a company has adequate working capital. Going
concern is included in generally accepted auditing standards (GAAS), but not in
generally accepted accounting principles (GAAP). A going concern assumption in
accounting standards is that a company's sale of assets does not impair its
ability to continue operations. For instance, restructuring (closing one small
branch to improve another) can still be considered a going concern.
In the eyes of auditors, the going concern basis of
accounting demonstrates firms that use assets and do not rely on liquidation
values for financial support. Audit procedures can also help inform how a
company moves forward once it has been determined to be a going concern; management
evaluations and auditor reports may determine how a company should proceed with
asset sales, expense reductions, or product strategy shifts.
Going Concern Conditions
The Financial Accounting Standards Board (FASB) stated in
2014 that financial statements must reveal substantial doubt that the company
can continue as a going concern. CPAs will determine an entity's ability to
continue as a going concern for the following year during an audit. To remain a
going concern, businesses must demonstrate clear upward trends, a lack of legal
issues, and credit approval.
4 Red Flags a Business Is Not Going Concern
When considering an entity, some red flags and audit
evidence may indicate that the company is no longer a going concern. Among the
indicators are:
1. Poor legal standing: Lawsuits can reduce stock value and
alter the public's perception of management. This can have a negative impact on
sales.
2. Liquidation basis: When companies sell assets, they may
require more liquid funds, which is not a good indicator of business progress,
investment, or growth.
3. Low current ratio: If a company has difficulty
paying its liabilities and debts on time, it may have a low current ratio,
which can lead to financial instability. A low current ratio indicates that the
company is not a going concern; anything less than one is cause for concern.
4. Loss of employees: When a company's employees leave,
it loses internal control and talent. Poor employee retention can indicate that
a company is in trouble, as high turnover can indicate employee
dissatisfaction, a lack of fair pay, or unpleasant working conditions.
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