It’s a challenging time for the economy. Both now, in the midst of strict lockdown regulations, and looking ahead – as the Chancellor Rishi Sunak has warned – into the dark tunnel of a deep recession.
With all this doom and gloom, it’s no wonder that any business severely affected by COVID-19 will need to consider whether this casts doubt over the company’s ability to continue as a going concern.
Assessing whether the going concern assumption is appropriate will probably be the number one talking point between Directors and their auditors.
Directors have a responsibility to assess whether the company will be able to continue to trade for at least the next 12 months from the date of accounts approval – taking into account all available information about the future.
Your auditors will then review this assessment, and will likely want to talk through your assumptions and ask you to provide evidence to demonstrate that your conclusions are reasonable.
It’s hard to think of a time when the outlook for sales and profit – and therefore debt and cash – has been more difficult to predict. Much will depend on the ability to re-open facilities within the constraints of new safe working practices. Nobody has a crystal ball, and assumptions will have to be made.
A good starting point is to prepare a cash flow forecast for at least 12 months, which demonstrates whether a company is able to manage within its available cash facilities.
“Reverse Stress Testing” or (RST) can be a useful exercise and provide a different viewpoint on going concern. Starting at the worst case scenario, the point where the entity might fail or become unviable, you then work backwards, identifying the sequence of events that could lead you to that point and then consider what can be done now to avoid this. The ICAEW recently published a guide on RST, which you can find here.
Preparing forecasts shouldn’t just be an academic exercise to get your auditor comfortable. It should inform the decisions you then take about the costs you should save, the cash you need to generate and the investments you can afford to make.
Look at maximising the cash reliefs and funding packages available. Loans, government grants and support such as deferral of VAT payments or time to pay arrangements may all help with avoiding critical crunch points in your cash headroom. You may also be able to negotiate rent or rates payment holidays, or defer loan repayments in some cases.
Many of these liabilities will still fall due at some point however, and this should be reflected in your cash flow assumptions.
Decisions might also be made about deferring unnecessary expenditure, such as capital expenditure or refurbishment programs. Many businesses are freezing salary increases, postponing dividend payments and holding back discretionary bonus payments. All areas of expenditure should be reviewed to identify where cash savings can be made.
Some costs may be reduced whilst the ability to trade is curtailed. For example, you may be incurring lower utility bills, negotiating reduced rental charges, or taking advantage of the ‘furlough’ scheme.
It’s important, however, that any forecast makes reasonable estimate for where overhead costs and the cost of selling may increase as a result of the pandemic.
Margins may be depressed reflecting the difficulties in sourcing certain items or materials efficiently within a global supply chain. And the cost of raw materials and inputs may increase as manufacturers pass on their supply chain and capacity difficulties.
The costs of preparing for safe working and social distancing, such as deep and regular cleaning, investing in new signage and store markers, safety equipment, and PPE should be considered. Staff training may need to take place. And stock holding costs may increase as companies hold excess stock and require additional storage facilities.
Stock will need its own set of strategies in terms of where savings can be made or stock repurposed, e.g. by rolling it over to future seasons. New stock purchases will need to be made at some point, and Next PLC put it perfectly when they said, “You can’t stop buying coats just because you have too many t-shirts”.
Taking advantage of government support or extending borrowing facilities will generate much-needed cash. If you’re increasing your borrowings, there may be additional fees, interest and capital payments to factor in.
Take care to check terms associated with your borrowings. If covenants have not been renegotiated, it may be that certain conditions such as interest cover or gearing ratios may be breached. And that could result in the loans becoming technically repayable on demand.
Be mindful that once trade restarts, you may not be able to trade at normal levels, and cash receipts from customers may be delayed, or at greater risk of default.
You may be thinking about the sale of non-essential assets to generate further cash for the business. Next PLC and Sports Direct have both recently announced sale and leaseback transactions for their Head Office and Warehousing operations.
Bringing it all together
If you can present a well thought out forecast and demonstrate that you can work within it, that will be a basis to enable sign off on your audited financial statements.
That’s not to say there might not be additional disclosures in your financial statements or audit report – emphasis of matter or material uncertainty disclosures will be necessary around going concern in some cases. This will depend on your specific circumstances and will require careful judgement on a case by case basis.