In this, our third article of the series, we focus on managing going concern risk and how Directors can protect themselves and their businesses by preparing and maintaining a Directors Assessment of Going Concern, “DAGC”.
As a starting point, it’s important to be aware of the obligations imposed on Company Directors under Company Law & Accounting Standards as they relate to going concern.
Put simply, in order to meet their fiduciary responsibilities (particularly in a time of economic crisis), Directors must be able to reliably assess that their business has the ability to continue in operational existence (as a going concern) for at least one year ahead of present time in order to justify a decision to continue trading, or conversely, via the same assessment process, whether it might be appropriate to cease trading.
The gravity of this assessment cannot be understated, as should the unfortunate situation arise where a company enters into an insolvent liquidation, the question will be asked whether, when it became clear that the Company was in financial difficulty, that the Directors adequately assessed going concern and acted correctly in the best interests of the Company’s creditors.
Where this is judged not to be the case, sanctions can include the following measures against the Directors:
- Restriction from acting as a director for five years or disqualification.
- Personal liability for the Company’s debts where business was conducted in a reckless manner.
- Both criminal and civil liability where there was intent to defraud creditors of the company.
It’s also important to note that these sanctions can apply to both executive and non-executive Directors.
While of course this makes for unsettling reading, one of the key protections for Directors to demonstrate that they have always performed their duties and functions in good-faith, acting responsibly, is to have a robust and evolving Directors Assessment of Going Concern in place to support the decisions they have taken and will continue to take.
So, what are the key considerations for Directors and what should be included in a “DAGC”?
A DAGC should contain, at a minimum, the following information.
- Current Management Accounts of the Business – Any forecast or projection must have a sound and accurate starting point, and so, if your current MIS/Accounting system cannot provide up to date information, these should be upgraded immediately. Outsourcing might be another option to consider.
- Principal Risks and Uncertainties that affect the business should be documented as these will help determine some of the key assumptions that will be embodied into the Company’s forecasts. If your company does not currently have a Risk Register, now would be a good time to put this in place.
- Financial & Cashflow Forecast – This should include a monthly Profit & Loss Account, Balance Sheet and Cashflow Forecast for at least a 12-month period and should be capable of operating on a rolling basis so that at least one years’ forecast information is constantly available.
- Sensitivity Analysis – The forecast above should be constructed in such a way that the impact of changes in key assumptions can be easily accommodated – typical examples would be changed to expected sales volumes/prices and material/labour costs.
- Borrowing facilities -The forecast must be able to quickly identify where a covenant breach might occur within sanctioned banking facilities. This is vital as it affords the opportunity for early engagement with lenders before a potential breach occurs.
- Contingencies– The DAGC should document contingency plans available to the Company, such as cost reductions, and when they should be implemented should forecasted results start to fall below expectation. This would also include developing an insolvency contingency plan should it become the case that the Company may no longer be a going concern.
- Contingent Liabilities – It’s important that the assessment considers liabilities that might arise from a decision to change or curtail the activities of the business; redundancy costs and property lease terms would be good examples of what Directors need to be mindful of.
Conclusions on Managing Going Concern Risk
Having prepared their Directors Assessment of Going Concern, we would strongly advise that Directors:
- Hold regular, minuted, board meetings to continually review and update the Director’s Assessment of Going Concern.
- Take regular legal and financial advice as matters develop and keep a record of that advice. It is particularly important that Directors gain an external perspective on their DAGC that challenges the key assumptions made, while at the same time offering solutions and alternative perspectives.
- Actively engage with lenders and other key stakeholders early and regularly.
As always, we are here to help and can provide you with information, templates and advice in relation to going concern matters, or indeed in relation to any of the topics covered throughout this series, so please do get in touch with us should you need us.