Quick, Responsive Forecasts and the Going Concern Assessment

Written by Johnny Kipps

In a business world of uncertainty, one thing is for sure: if management signs off on financial statements describing their company as a going concern, heads will roll if it folds in six months....

Fresh outbreaks of Covid, No-one realising there would need to be many more tests plus tracing staff if people followed Boris Johnson's advice to "get on yer bike and go back to work"—and with schools and universities re-opening. V, U and W shaped economic recoveries. Swathes of employees working from home. Public transport shunned by the public. Blue chip companies in travel and hospitality suddenly finding the chips are down. Yet with 20:20 hindsight it all looks inevitable.

“You can’t connect the dots looking forward; you can only connect them looking backwards. So you have to trust that the dots will somehow connect your future.” ― Steve Jobs.

Its all in the standards

Unfortunately, for those tasked with reporting their organisation’s results, hoping that the dots will connect isn’t enough. Whether you are reporting under UKGAAP, or a larger company choosing, or a listed entity preparing consolidated statements and required toreport under IFRS, the rules are clear.

FRS102, for those preparing their statements on a Going Concern basis, states:

3.8 When preparing financial statements, the management of an entity using this FRS shall make an assessment of the entity’s ability to continue as a going concern.
An entity is a going concern unless management either intends to liquidate the entity or to cease trading or has no realistic alternative but to do so.

In assessing whether the going concern assumption is appropriate, management takes into account all available information about the future, which is at least, but is not limited to, twelve months from the date when the financial statements are authorised for issue.

3.9 When management is aware, in making its assessment, of material uncertainties related to events or conditions that cast significant doubt upon the entity’s ability to continue as a going concern, the entity shall disclose those uncertainties.

For the IFRSers, the wording under IAS1.25 and IAS1.26 is for all intents and purposes the same (although para 1.26 does go on to provide a somewhat laizzez faire let out to management stating " When an entity has a history of profitable operations and ready access to financial resources, the entity may reach a conclusion that the going concern basis of accounting is appropriate without detailed analysis…. "

One wonders whether in this fast moving crisis the international standard setters won’t regret that apparent cop out?)

How events that take place after the balance sheet date should be treated is governed by IAS10 Paragraphs 14 &15 and expressed more clearly in FRS102 32.7a & b; both stating, - in other words - if there is no alternative but to close down or if the situation has deteriorated to such an extent that the going concern basis is no longer appropriate reporting – don’t report as a going concern and disclose and explain why!

So much for the legalese. The question is - when issues are changing with such speed, how to make a Going Concern Assessment where events and conditions are absolutely replete with material uncertainties?

Material Uncertainties

Should material uncertainties emerge the day before issue, these must be disclosed, even if the printers are locked down under Tier 3?

The Financial Reporting Council in its Company Guidance Update, states when assessing whether material uncertainties exist, boards should consider both the uncertainty and the likely success of any realistically possible responses to mitigate the uncertainty.

The Going Concern Assessment

There are no set procedures for preparing a Going Concern Assessment but understandably the availability of cash is central to survival.

The ICAEW outlines key issues to consider, first of which is Forecasting:

The forecast should -

reflect the current economic environment and recent post balance sheet activity.
be reviewed and updated regularly until the financial statements are authorised for issue;
include reasonable and supportable judgements.
run more “what if” scenarios than normal, taking account of wider economic and sector specific considerations.
possibly run reverse stress testing – which events, or combinations of events - would it take for the entity to fail and what can be done to mitigate this risk.

The ICAEW goes on to identify additional areas to consider, many of which will form part of the forecast; including how the business is likely to perform under Covid related situations, how working capital might be impacted including sources of finance and not forgetting those provided by UK Government and including equity and debt sources and their likely continuing availably and, importantly, whether debt covenants may be at risk.

It is also vitally important to document the detailed assumptions and judgements underlying the forecasts; these will be useful for disclosures, for auditors and in future for regulators.

To cope with this requires a comprehensive, fast and flexible forecasting package with a proven track record like Forecast 5 rather than an excel model with all its time-consuming formulae issues and balancing problems. rather than an excel model with all its time-consuming formulae issues and balancing problems.

Forecast 5 can quickly run multiple multi-layer “What if” stress test scenarios, forecast cashflow and balance sheet analyses from which working capital and fixed capital sufficiency – or shortfalls – can be determined, provide the base for all the debt covenant calculations and maintain within each run of the forecast the supporting Assumptions and Judgements for each forecast.

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This article was originally published November 2020. Edited October 2023