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 objects, etc.
Usually, the foreseeable future is considered the next 12 months from the date of preparation of financial statements.
If a company cannot operate for the foreseeable future, then it must use the break-up basis to prepare its financial statements. This happens when the management of the company 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, it going concerned may be questionable. The responsibility to assess the going concern of a company lies with its management.
In order to assess the going concern of a company, its management will need to make judgements related to its future. When making these judgements, the management must take into account 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 the management of a company must consider when assessing its concern. These factors are mostly external, which means the management has to use several tools such as PESTEL analysis to assess going concern.
However, these factors can also be internal. Some of the main factors that management can use to assess the going concern of a company are listed below.
The management of a company must assess the level of competition of 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 go into losses and suffer cash flow problems, which will affect the going concern assumption of the management.
The management of the company must also the demand for the products of the company. If the demand of its products has declined, the company will have a difficult time generating profits.
Therefore, the demand of its products will also affect the going concern assumption of the company.
If a company has a history of being profitable but suddenly starts making losses on a regular basis, then its going concern assumption may be questionable.
This is mainly because of the profit-making ability of a company is one of the key indicators of its success and performance.
Similarly, if a company experiences a downturn in its profits, then its management will also have to reassess its going concern.
While most stakeholders only consider the profit of a company 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, the management of a company must also assess its cash flows when deciding whether the going concern assumption is correct.
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 the capital structure of a company but also comes with high-interest costs for the company. Therefore, it is an important factor when assessing the going concern of the business.
For a company to remain successful in the long-term, it must properly fund different business areas, especially areas that can affect the long-term success of the company.
These may include research and development, marketing, production, etc. If a company does not properly fund these areas, then it may face problems in the future, which is an indicator of problems with its going concern.
Going concern is an important accounting concept that requires the management of a company 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, then it must prepare its financial statements on a break-up basis rather than going concern basis.
To assess the going concern of a company, its management must consider several factors. Some of these factors include competition, demand of its products, profits, cash flows, debts and funding.