Going concerns in the Technology Sector
Tasneem Bharmal · September 13th 2022 · read
There is a general consensus that the technology sector is doing well in the current digital era. Whilst this is generally true for most of the sector as the digital transformation is accelerating, we must not lose sight of the issues of certain tech companies which resulted in struggles in the pandemic. For example, a household name, Airbnb, experienced a record low result for 2020 as a result of the pandemic.
Things were also challenging for small tech start-ups / companies as they found it difficult to adapt to the changes necessary under lockdown conditions, due to lack of infrastructure, capital, exposure, etc. Some of these companies have fallen behind in their development, lacking the foundations for growth with a hybrid workforce and supply chain disruptions.
Evaluating potential going concern issues was a hot topic for companies and their auditors for 2020/21 year-end reporting. Many CFO’s and FD’s find that the business disruptions and uncertainties still remain from the COVID-19 pandemic and its economic impacts, together with the impact of the cost-of-living issues, continue to pose reporting challenges from both future directions and going concern perspectives.
What is going concern?
In the accounting profession, ‘going concern’ is defined as the entity’s ability to continue its operations for the foreseeable future, being 12 months from the date the financial statements are approved, unless specified otherwise.
The definition directly from FRS 102 (paragraph 3.8) is as follows:
An entity is a going concern unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so.
Management often don't pick up that the sale of a company's trade and assets could generate a lot of proceeds but if the company then has no trade, the accounts need to be prepared on a basis other than going concern. A basis other than going concern does not always mean insolvency or require impairment of assets etc.
As companies contend with the continuing uncertainties and economic impacts of the global pandemic and related risks, challenges and cash flow implications, management should be prepared for heightened auditor scrutiny in areas with going concern relevance. Management must also look at wider range of conditions for assessment; some examples of other factors might include: fuel costs (linked to oil and gas prices); supply chain disruption (this could be linked to the conflict in Ukraine, the covid lockdowns in Shanghai and other key Chinese cities, the shortage of HGV drivers which have helped drive delivery prices up, longer border checks following the UK departure from the EU); or weakening demand as inflation hits discretionary spending (look at the reduction in subscribers at companies like Netflix and Peloton).
Management must perform an evaluation of going concern at every interim and annual reporting date. This exercise is no longer routine as in the past and requires more than a review of budgets and short-term financial commitments.
Here are some key going concern considerations to be thinking about now and over the next 12 months:
- Revising budgets and forecasts: There may be a need to revise cash flow and profit and loss forecasts, or create multiple scenarios, if existing budgets and forecasts do not reflect recent changes in the economy and business operations Data used for assumptions and forecasts must be accurate and up to date, which is challenging in a changing environment, and the evaluation process needs to be consistently applied and well documented. On the budgets or forecasts, management should consider "covering a range of outcomes" as well. for example, if there is a new product launch, we may need to ask management to consider what the impact might be if the launch underperforms expectations. A failed launch could put considerable strain on limited resources.
- After updating the forecasts, management will need to assess whether it expects to remain in compliance with any financial covenants or other banking arrangements.
- Consider possible restructuring operations to reduce operating costs.
- Directors should also assess any requirement to negotiate with lenders to restructure and/or increase borrowing facilities.
- Communicate with key stakeholders early and often. Involve the audit committee, board of directors, and others within the organisation who can collaborate to have productive conversations about going concern issues for the next year and the impact of COVID-19 and the cost of living increases on operations.
- Provide clear and robust disclosures in all financial reporting, including relevant information about uncertainties identified in the going concern assessment, where relevant.
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