As published in MicroCap Review Magazine
COVID-TRIGGERED GOING CONCERN EXPECTED TO RISE
By Corey Fischer, CPA
The impact of the COVID-19 pandemic has put severe strains on public companies, particularly microcaps. As company management tries to figure out what next week may bring, they must also ask “Will we still be in business a year from now?”
FASB’s standards require company management to look out a reasonable period of time (generally 12 months) past the date when it last issued financial statements and assess whether there is substantial doubt about its ability to continue as a going concern. The disclosure doesn’t necessarily only relate to staying in business, but if the company will be able to pay its debts and obligations as they become due.
“Substantial doubt” is defined by a “probable” threshold, which means “likely to occur.” However, it is exceptionally difficult to determine what is “likely to occur” during a global pandemic and the worst financial disruption since the Great Depression.
As part of a going concern assessment, management is required to make difficult decisions and predictions not only about their company, but also about their customers, vendors, bankers, and capital sources. In a sense, they are forced to predict the unpredictable, knowing full well that there are severe consequences if they over-estimate or under-estimate what the future may hold.
Crippled by months of complete and partial shutdowns, the uncertainty over viability will likely result in COVID-19-triggered going concern language to appear in a greater number of financial statements.
Although most of the country has been reopening in phases, effects of the COVID-19 shutdown, as well as the pace of economic recovery, are still very much unknown. Some of the assessments that management will continue to make include:
- Does the company have sufficient existing liquidity and working capital to survive, or can it access existing unused lines of capital and credit? Companies with a strong balance sheet and a strong cash position will be less affected.
- Can the company reasonably forecast that its existing liquidity and expected cash flow from operations will be sufficient to sustain operations over the next 12 months, and potentially longer? The company will have to prepare well thought out projections that will have to consider the effects of the current situation on its supply lines and customer base. This applies particularly to companies in industries that have been significantly affected by COVID-19, such as travel, entertainment and retail.
- Is there significant debt that is coming due within the next twelve months? There is no guarantee that lenders are going to renew existing credit and debt facilities, or that new financings will be available to the company.
- Can the company meet its contractual obligations (such as rent and equipment lease payments) due or anticipated over the next 12 months?
- Will prior banking relationships hold up? Going concern can trigger debt covenants and lenders may demand an increase in collateral, an increase in interest rates, or full immediate repayment.
- What about future operational disruption? Will another COVID-19 wave mandate yet another government shutdown, or further disrupt supply lines?
It is generally understood that management’s assessments are based on conditions or situations that are known — or could have been known — at the time of evaluation. The key is to make reasonable and supported projections based on reliable underlying information.
Management should be thorough, transparent, and very importantly, be diligent about documenting its assessments. History tells us that the good faith assessments made in a fog of uncertainty will be mercilessly scrutinized by regulators and litigators when the fog lifts. As we all know, hindsight vision is 20/20.
On a positive note, although every company’s management must address going concern, it would be incorrect to conclude that every struggling company will determine that it has “substantial doubt” and will therefore pull the going concern trigger. Even if they must, it’s not necessarily a death sentence – especially for those in the microcap space where it is understood that many companies are under-capitalized, and typically in need of additional financing.
Once having set foot on the going concern road, management is required to construct a mitigation plan to address substantial doubt. A well-crafted plan can help ease the ongoing concern of lenders, vendors, capital sources, and customers.
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Corey Fischer, CPA, is Firm Managing Partner of Weinberg & Company, a multi-office, PCAOB and CPAB-Registered firm specializing in the audit, assurance and tax needs of micro and small cap companies. He has more than 25 years of experience, having worked with the Big 4 accounting firms, and as an SEC reporting officer for a number of NASDAQ-listed companies. Based in Los Angeles, he is an expert in financial reporting, SEC compliance, raising debt and equity, mergers and acquisitions and structuring accounting operations. E-mail: coreyf@weinbergla.com or 310-601-2200. Visit www.weinbergla.com
