What Does It Mean For a Business To Be “Going Concern”?
In the world of business finances, the concept of a business as a going concern is paramount, particularly when evaluating whether a company can be sold as a going concern. there’s a term that can send shivers down the spine of any owner: “going concern.” But what exactly does it mean, and why is it so important for an auditor to assess this?
Imagine a business as a car. A going concern is like a well-maintained vehicle, operating as a going concern. Running smoothly and expected to keep driving for the foreseeable future, the company is a going concern. Conversely, businesses facing insolvency may struggle to secure funding and may ultimately have to liquidate their assets. a business not considered a going concern might be more like a car on its last legs, sputtering and likely headed for the junkyard.
What It Means For A Business To Be A Going Concern
Here’s a breakdown of what it means for a business to be considered a going concern and the implications of a company continuing as a going concern:
Financial Stability
A going concern is expected to operate for at least the next 12 months and beyond, continuing as a going concern in the foreseeable future. This means it has a good handle on its finances, which is an indicator of a strong going concern status, can meet its obligations (like paying bills and loans), and is generating enough revenue to cover its costs, avoiding potential insolvency.
Ability to Adapt
The business can adapt to changing market conditions and overcome challenges to continue as a going concern. This could involve adjusting product offerings, Exploring new markets, while ensuring the business can continue as a going concern, or streamlining operations.
No Threat of Liquidation
There’s no imminent threat of the business being forced to close down and sell its assets (liquidation) to pay its debts.
Why is “Going Concern” Important?
The concept of going concern is crucial for several reasons: it impacts how financial statements are prepared and whether the company can be considered operating as a going concern.
- Financial Reporting: An audit report can provide vital insights into whether the company is a going concern. Accountants use the going concern assumption when preparing financial statements. This assumption allows them to value assets based on their expected future use, rather than their potential liquidation value (which would be much lower).
- Investor Confidence: Investors are more likely to put their money into a business considered a going concern. After all, a business must ensure it remains operating as a going concern. who wants to invest in a company that might not be around much longer?
- Loan Approvals: Banks and other lenders are more likely to approve loans for businesses deemed going concerns, as they indicate a lower risk of insolvency. They want to be confident that the business will be able to repay the loan and continue as a going concern.
Red Flags That a Business Might Not Be a Going Concern:
- Mounting Debts: This can be a significant liability for a business and might necessitate measures to ensure the company can continue as a going concern. A business that’s struggling to pay its bills is a red flag and could be an indicator of insolvency.
- Negative Cash Flow: If a business is consistently spending more money than it’s bringing in, it’s a sign of financial trouble.
- Loss of Key Personnel: The loss of critical employees can hinder a business’s ability to operate effectively.
- Declining Sales: A consistent decline in sales can indicate a shrinking customer base or a product/service that’s no longer in demand, raising concerns about whether the business can continue as a going concern.
The Bottom Line
Understanding the concept of going concern is vital for any business owner, as it indicates the ability to continue operating. It provides a way to assess your financial health and identify potential issues before they become critical. If you’re concerned about your business’s going concern status, an auditor can provide clarity. it’s wise to consult with a financial advisor or accountant. They can help you develop a plan to address any challenges and ensure your business continues to thrive for years to come.