What is a going concern?
A going concern is an accounting term stating that a business will remain operating indefinitely. It essentially means the company shouldn’t face foreclosure or bankruptcy within the next 12 months. When a significant change occurs that causes you to lose finances, you must create a financial report stating that your organization still has enough earnings to operate efficiently.
Possible examples of a going concern include:
- A small cleaning product business receives unexpected government restrictions stating a chemical in their product may not be safe and that they’re prohibited from selling it. The company has to pull that product and substitute the ingredient. Since they sell other products, they should still be able to cover enough of their finances to remain operating, making them a going concern.
- A business starts losing money and failing to make regular payments. The government notices this and issues a bailout to pay for its outstanding debt. Since their financial status is low, but they’re receiving enough funding to keep them operating, they’re considered a going concern.
How to determine if your business is a going concern
Follow these steps to determine if your business is a going concern:
1. Use ratios to determine where your company stands financially
When you experience a large financial setback, work with your accountant, auditor or other financial professional to determine the status of your business. There are three main ratios to use to determine if the company is performing well:
- Current ratio: Divide your current assets by its current liabilities to find the current ratio. This measures how well your company can pay any short-term debt using assets you’ve converted to cash. Your auditor will continue monitoring this current ratio every month to ensure you’re continuously making more cash than you’re spending.
- Debt ratio: This number helps you better understand if your total debt is more than your total assets. If so, the business is considered insolvent and significantly threatens your going concern status. Get this number by dividing your total liabilities by its total assets.
- Net income to net sales ratio: This helps you understand how effectively your business is managing expenses. If your total net income is lower than how much you’re paying to keep your business operating, you may not be making enough for your business to remain a going concern.
2. Prepare your annual financial statements
If you realize your business could be a going concern after using financial ratios, meet with your board of directors. Assemble an annual report with your current income, expenses and other assets listed. This report should prove your business’ ability to gain enough profit to make payments on any current debts.
The board of directors reviews it and writes their decision in the footnotes. If they decide you’re a going concern, the board will list any possible factors they believe could threaten your going concern status.
3. Continue monitoring the business and identifying negative trends
After the board meeting, your auditor reviews your financial status throughout the year and reports these findings to the board. If the auditor identifies any negative financial trends like loan denials, repossession of your assets, low operating income or loan defaults, they’ll report this to the board of directors. If this happens, your business is considered a negative going concern and may face potential foreclosure or bankruptcy.
Frequently asked questions about your business being a going concern
Is a going concern good or bad?
A going concern is considered good for the time being. It means your business is facing financial distress but is still able to make payments to keep it operating.
How do you determine if a company is a going concern?
You determine if your company is a going concern by analyzing your company’s income and assets to determine if you have enough money to stay in business. The board of directors makes the financial decision of whether your company is a going concern.
What is the opposite of going concern?
Since going concern refers to your company being financially stable enough to continue operating, the opposite would be bankruptcy or foreclosure. This means your company no longer has enough funds to pay outstanding debts and stay in business.