Ability to continue as a going concern amid COVID-19

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Observations from the front lines

Background

The current market disruption as a result of COVID-19 is having widespread implications on many businesses, resulting in an increased focus on liquidity and a company’s ability to continue as a going concern. Substantial doubt about the company’s ability to continue as a going concern can have wide-ranging consequences on the company’s strategic agenda and its ability to: 

  • access credit and equity markets at desirable rates and commercially reasonable terms;
  • execute on both supply and customer contracts as customers and suppliers may doubt the company’s ability to fulfill its obligations under the terms and conditions of the contract; and
  • comply with covenants of existing debt and other contracts.

To the extent your company is experiencing challenges driven by the COVID-19 crisis, it is imperative that you proactively plan to mitigate adverse conditions to navigate through the unpredictable economic environment. 

Why it matters

US GAAP requires management to evaluate at each annual and interim reporting date whether there are conditions or events that raise substantial doubt about the company’s ability to continue as a going concern. When management identifies conditions or events that raise substantial doubt, management will need to assess: 

  • Gross risk attributable to the underlying conditions and events that create substantial doubt, and 
  • Net risk remaining after considering management’s plans intended to mitigate those conditions or events that raise substantial doubt. 

The outcomes of these evaluations will determine the company’s required interim and/or annual reporting period footnote disclosures, as explained below.

A going concern statement in the company’s footnote disclosures is required if management determines that substantial doubt about the company’s ability to continue as a going concern exists, and that doubt cannot be alleviated by management with operational and/or financial mitigation actions.

When management is able to alleviate the substantial doubt with operational and/or financial mitigation actions, management is still required to disclose information to help the users of the financial statements understand the principal conditions or events that raised substantial doubt and management’s evaluation of the significance of those conditions or events, as well as management’s plan that alleviated the substantial doubt.

Stakeholders expect transparency around the sustainability of a company’s operations and management’s ability to articulate and effect plans to navigate through the current market disruption and manage the variables resulting from the challenging  environment. A well-documented liquidity analysis and mitigation plan is therefore fundamental in building trust and retaining key stakeholder confidence.

Assessing if conditions and events raise substantial doubt

Management’s going concern assessment should be based on the relevant conditions that are “known and reasonably knowable” at the issuance date. To elaborate, that assessment should consider the most current information available before the financial statements are issued, including all relevant subsequent events after the balance sheet date. Management should assess relevant conditions in the aggregate and weigh the likelihood and magnitude of their potential impact on the company’s ability to meet its obligations. Unpredictability in the longevity of the market disruption will require management to objectively stress test key inputs and assumptions and may require multiple scenario analyses.

When assessing the impact of the current market disruption, management should consider:

  • Reviewing and revising forecasts: Existing budgets and forecasts may not appropriately reflect the rapidly changing economic environment. Management should assess whether revisions to current cash flow and P&L forecasts are required to evaluate, among others, the company’s liquidity, working capital and future debt covenant compliance. Given the unpredictable economic environment, companies may create multiple scenarios of potential cash flows. Such scenarios can help management capture potential upside and downside outcomes in a disciplined way and improve decision-making on how to proceed when the market stabilizes. 
  • Assessment of the company’s ability to access debt or equity financing: A company’s ability to access capital is key to evaluating its ability to absorb short-term cash shortfalls, to remain liquid and continue as a going concern. Such activities will likely need to be completed by management before the company’s filling date to be considered a probable mitigating action. 

Planning to mitigate adverse conditions or events — 5 key considerations

It is fundamental for management to proactively plan to mitigate adverse conditions or events to navigate through this economic environment. Potential actions that management could consider to help mitigate “substantial doubt” about the company continuing as a going concern include:


1. Debt and equity offerings

Accessing capital through public or private debt and equity offerings is a common mitigation strategy. Although it might enable continuity, the probability of a successful debt or equity offering will depend on the company’s ability to access debt and equity markets on commercially reasonable terms and for the needed amount. Such plans are therefore generally considered less probable to be effectively implemented unless they are completed before the company’s filing date.

Alternatively, entering into collaborative arrangements with strategic partners can be a non-dilutive source of funding that might provide the capital needed to keep the company liquid and able to fulfill its short-term obligations.

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2. Renegotiating existing arrangements

Companies with a limited ability to access new debt or equity financing might consider renegotiating the terms of existing arrangements with lenders and investors. Negotiating waivers, credit facility expansion, settlements and stock/debt transactions are actions to consider. Similar to accessing capital, the company’s ability to get commercially reasonable terms will determine the probability of a successful renegotiation. Such renegotiations may need to be completed before the company’s filling date to be effective.

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3. Selling, leasing or monetizing assets

When the current economic environment results in assets being underutilized, the company might reconsider buy-versus-lease decisions and explore sale-leaseback opportunities. Leasing is a common short-term cash flow solution that doesn’t require the use of the company’s own funds. Sale-leaseback transactions generate cash by selling assets but provide access to the assets through a leaseback arrangement.

The company's customers are also likely affected by the current market disruption, so cash collection periods are likely to increase. Companies might consider factoring or securitizing receivables to accelerate cash inflows from trade receivables to fulfill short-term commitments.

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4. Divestitures

Proceeds from selling assets can be used to repay debt and decrease debt service to relieve pressure from the company’s cash-flow forecasts. An understanding of the company’s key value drivers is fundamental to a successful divestiture. Selling a business or group of assets to secure short-term cash should not jeopardize the potential for future long-term growth when the economic environment stabilizes. 

The current economic disruption might put pressure on asset and share prices. If assets are sold at substantial discounts, management should be aware of the potential asset impairment implications.

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5. Strategic cost cutting

In times of economic uncertainty, companies will have to evaluate cost cutting measures. Strategic cost cutting can help prepare for growth, but it is critical to identify and understand the differences between bad costs, good costs and the best costs. Once a company’s costs are classified, strategic cost cutting becomes a process of minimizing exposure to bad costs and maximizing investment in the best ones. 

Management might also consider other measures, such as CAPEX rationalization and changing working capital terms. It is important to understand that some of these variables are co-dependent, and careful thought should be given to other resulting consequences. For example, management should consider topline impact as a result of cutting CAPEX.

Cost cutting measures generally need to be approved before management is able to consider the probability of such plans effectively mitigating the underlying conditions or events.

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Next steps

Timing is critical. Management needs to carefully assess the impact of current market disruptions on liquidity and the company’s ability to continue as a going concern. This often involves complex scenario planning across a wide range of the company’s operations. Conducting a thorough risk assessment is a good starting point for creating a well-documented, robust and feasible mitigation plan.

“Observations from the front lines” provides PwC’s insight on current economic issues, our perspective regarding the financial reporting complexities, and what companies should be thinking about to effectively address those issues. For more information, visit www.pwc.com/us/cmaas.

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