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What this accounting term means and why investors should take note
Thursday 04 Jun 2020 Author: Yoosof Farah

UK finance regulators are reportedly braced for a wave of listed companies to issue warnings about their ability to survive the coronavirus pandemic, which could see share prices plummet.

According to a report in the Financial Times, auditors have warned there is a backlog of annual reports from companies in the retail, leisure, hospitality and travel sectors which are likely to question their ability to continue trading as a going concern over the next 12 months.

Regulators like the Financial Conduct Authority and Financial Reporting Council (FRC) are reportedly in talks with the accounting industry over how many of these going concern warnings there could be, so they can assess the potential impact on stock markets.

WHAT IS A GOING CONCERN?

The term ‘going concern’ is an accounting concept. A company that’s able to meet its financial obligations when they come due is considered a going concern.

When auditors fear a company might default on some of its debt in the next 12 months, the company is required to report in its financial statements that there are doubts about its ability to continue as a going concern.

More firms look set to be caught up in the wave of going concern warnings after the FRC strengthened the rules in October last year, following ‘corporate failures’ like the collapse of Thomas Cook.

Auditors now have to ‘more robustly challenge’ management’s assessment of a going concern, and are required to provide a clear conclusion in financial statements as to whether management’s assessment is ‘appropriate’.

A recent high profile case involves oil and gas business Tullow Oil (TLW), which in March flagged material uncertainty about its ability to continue as a going concern in its full year results.

Its already bombed out share price fell a further 12% on the news at the time to 15.9p.

Significantly indebted, Tullow said the unprecedented market conditions amid major oil price volatility meant it may not be able to make the progress needed to repair its finances.

DON’T PANIC

A warning in a company’s accounts over its ‘ability to continue as a going concern’ is what most investors dread, and understandably so, but it’s important not to panic in such situations.

Just because a firm issues such a warning doesn’t mean it’s about to go bust. Companies might be able to get a loan or raise cash through a rights issue, while external auditors may not always know everything management are doing to shore up liquidity.

Tullow Oil is still trading and its shares have recovered to around 25p, after the firm sold an asset to help shore up its balance sheet.

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