How to Assess the Going Concern of a Company? ( 6 Important Factors to Consider)

Going Concern Concept

There are many different concepts that companies must follow when it comes to accounting. One such concept is the Going Concern concept.

The going concern concept of accounting requires companies to prepare their financial statements based on the assumption that they will stay in the company for the foreseeable future.

Staying in a company means carrying out commitments, repaying obligations, achieving objectives, etc.

Usually, the foreseeable future is considered the next 12 months from the financial statements’ preparation date.

If a company cannot operate for the foreseeable future, it must use the break-up basis to prepare its financial statements. This happens when management intends to liquidate the company or cease trading.

Usually, companies do not need to assess their going concern. However, in times of business downfall, they must assess their going concern.

For example, if, due to some internal or external factors, a company cannot continue to make profits or generate enough cash inflows to meet outflows, its going concern may be questionable.

The responsibility to assess a company’s going concerns lies with its management.

To assess a company’s going concerned, its management must judge its future. When making these judgments, the management must consider all available information about the future.

However, these judgments are based on various uncertain future outcomes of events to certain conditions. Usually, the management makes these judgments based on historical performance information.

However, sometimes, the management can also compare the current and expected performance of the company.

Factors that the management must consider to assess the going concern of a company

There are many factors that a company’s management must consider when assessing its concern. These factors are primarily external, which means the management has to use several tools, such as PESTEL analysis, to assess going concerns.

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However, these factors can also be internal. Management can use some of the main factors to assess a company’s going concerns.

1) Competition

A company’s management must assess the level of competition in the company. If the level of competition in the industry has significantly risen as compared to the past, it may mean that the company will have a harder time generating revenues and profits.

This, in turn, means that the company may suffer losses and cash flow problems, which will affect the going concern assumption of the management.

2) Demand

The management of the company must also meet the demand for the products of the company. If the demand for its products declines, the company will have difficulty generating profits.

Therefore, the demand for its products will also affect the going concern assumption of the company.

3) Profits

If a company has a history of being profitable but suddenly starts making losses regularly, its going concern assumption may be questionable.

This is mainly because the profit-making ability of a company is one of the critical indicators of its success and performance.

Similarly, if a company experiences a downturn in its profits, its management must also reassess its going concern.

4) Cash flows

While most stakeholders only consider a company’s profit as an important indicator of its performance, the ability of a company to generate cash inflows is equally as important.

If a company cannot generate cash inflows to meet its cash outflow needs, it can face many problems.

Therefore, a company’s management must also assess its cash flows when deciding whether the going concern assumption is correct.

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5) Debts

If a company cannot make profits or keep up with its cash outflows, it will have to resort to using alternative sources of finance to fund its projects.

Rising debts can also be a red flag for the going concern assumption of a business.

Not only does increasing debts disturb a company’s capital structure, but it also comes with high-interest costs. Therefore, it is essential when assessing the business’s going concerns.

6) Funding

For a company to remain successful in the long term, it must adequately fund different business areas, especially those that can affect its long-term success.

These may include research and development, marketing, production, etc. If a company does not properly fund these areas, it may face future problems, which is an indicator of problems with its going concern.

Conclusion

Going concerned is a vital accounting concept that requires a company’s management to assess whether the company can operate in the foreseeable future, which is generally taken as 1 year.

If a company cannot operate in the foreseeable future, it must prepare its financial statements on a break-up basis rather than going concern basis.

Its management must consider several factors to assess a company’s going concerned. These factors include competition, the demand for its products, profits, cash flows, debts, and funding.