When General Motors published its annual report on March 4, it became one of the largest U.S. companies to state publicly that it is teetering on the edge of bankruptcy.
These days, however, GM has plenty of company. Companies of all sizes and industries are now grappling with the dreaded “ability to continue as a going-concern” warning from their external auditors.
Noring
“This economic contraction is going to impact a lot of companies,” says Paul Noring, managing director at Navigant Consulting. “This is something a lot more people are going to have to become a lot more familiar with over the next couple of years.”
GM and its auditing firm, Deloitte & Touche, said in the annual report that there’s “substantial doubt” the once-legendary automaker can survive. The company outlined scores of measures it is taking to sell off assets, shore up its current debt, and borrow more money (most notably from the government) to stay afloat. The stock still can’t even clear $2 a share.
While the GM revelation sent a chill through capital markets, it wasn’t necessarily surprising, Noring says. “We all know from the last four months just watching the news that the auto industry is in significant trouble,” he says. “If a company is about to get a going-concern opinion from auditors, it shouldn’t come as a surprise.”
That doesn’t make such a warning any easier to swallow. Companies fighting against economic conditions and troubled balance sheets should take measures now to brace themselves for any going-concern warning that might lurk in their own future, financial reporting experts say.
Noring says companies are getting acquainted with the notion of “stress testing” their balance sheets: applying worst-case scenarios to key performance metrics, and envisioning the pain. “If you can survive the worst-case scenario, then you’re a going concern, a viable entity,” he says. “But if you can’t, then comes dialogue with the auditor around what is the potential view over the next year.”
Gazzaway
Trent Gazzaway, a partner at audit firm Grant Thornton, says auditing standards require audit firms to determine, as of the date of the balance sheet, whether any issues might give reason to believe the company can’t continue as a going concern for the next 12 months. Auditors consider liquidity, loan defaults, recent layoffs, significant declines in business, cash flows, and a host of other factors to reach their determination, he says.
“If you can survive the worst-case scenario, then you’re a going concern, a viable entity. But if you can’t, then comes dialogue with the auditor around what is the potential view over the next year.”
— Paul Noring,
Managing Director,
Navigant Consulting
(The Financial Accounting Standards Board is working on a new accounting rule that would make the going-concern analysis a responsibility of management, but that standard is not effective yet.)
And while a going-concern warning always stings, Gazzaway says it shouldn’t necessarily be viewed as a death knell for the business. “Just as a clean audit opinion is not a guarantee of financial health, a going-concern opinion is not a guarantee of impending failure,” he says. “When people see a going-concern opinion they think the auditor is driving the nail in the coffin, but that’s not the case. It’s pointing out risk.”
Gazzaway says the markets should look at going-concern opinions in this economy the same way material weaknesses were viewed in the early days of the Sarbanes-Oxley Act: a problem many companies had, but few died from. “We found across the board that a material weakness disclosure wasn’t really a capital killer for companies,” he says. “For companies that disclosed and addressed material weaknesses, stock prices rose.”
The same should happen with the going-concern determination, in Gazzaway’s view. If companies are forthright about their problems, the red flag shouldn’t necessarily signal the end of the line, he says.
Start Talking
When companies are hovering near trouble, they should first be upfront with auditors and lenders, says Adele Hogan, a partner with the law firm White & Case. Assuming they remain within the parameters of what’s allowed by Sarbanes-Oxley, companies may be able to take measures working with auditors and advisers to keep clear of danger, she says.
Hogan
Early dialogue with lenders, for example, may lead to a relaxation of debt covenants, Hogan says. Many lenders don’t want any more non-performing debt on their books right now, “so they may be willing to constructively work with you.”
Carol Stacey, vice president at training firm SEC Institute and a former chief accountant at the Securities and Exchange Commission, says companies should stay in close touch with lenders to avoid having their lines of credit pulled—a turn of events that can quickly cause major headaches. “You don’t want to let them get nervous if they see your cash flow is declining,” she says.
GM 10-K
Below is an excerpt of GM's annual report, disclosing the risk of its ability to continue as a going concern.
There is substantial doubt about our ability to continue as a going concern.
Our independent public accounting firm has issued an opinion on our consolidated financial statements that states that the consolidated financial statements were prepared assuming we will continue as a going concern and further states that our recurring losses from operations, stockholders’ deficit and inability to generate sufficient cash flow to meet our obligations and sustain our operations raise substantial doubt about our ability to continue as a going concern. Our plans concerning these matters, including our Viability Plan, are discussed in Note 2 to the accompanying audited consolidated financial statements. Our future is dependent on our ability to execute our Viability Plan successfully or otherwise address these matters. If we fail to do so for any reason, we would not be able to continue as a going concern and could potentially be forced to seek relief through a filing under the U.S. Bankruptcy Code.
Our business, the success of our Viability Plan and our ability to continue as a going concern are highly dependent on sales volume. In 2008, global vehicle sales declined rapidly and there is no assurance that the global automobile market will recover or that it will not suffer a significant further downturn.
Our business and financial results are highly sensitive to sales volume, as demonstrated by the effect of sharp declines in vehicle sales in the United States since 2007 and globally during 2008. Vehicle sales in the United States have fallen 40% since their peak in 2007, and sales globally have declined 23.5% since their peak in January 2008. The deteriorating economic and market conditions that have driven the drop in vehicle sales, including declines in real estate values and household incomes, rising unemployment, tightened credit markets, weakened consumer confidence and volatility in oil prices, are not likely to improve during 2009 and may continue past that year. Our Viability Plan is based on assumptions that vehicle sales will decline further in 2009 but that they will begin to recover in 2010. Sales volumes may decline more severely or take longer to recover than we expect, however, and if they do, our results of operations and financial condition and the success of the Viability Plan will be materially adversely affected.
The success of our Viability Plan and our ability to continue as a going concern depends on our compliance with the terms of the UST Loan Agreement, and on the availability of additional financing from the United States and certain foreign governments.
The terms of the UST Loan Agreement require us to submit a written certification and report detailing our progress in implementing our Viability Plan on or before March 31, 2009. This report must identify and explain any deviations from the restructuring targets contained within the UST Loan Agreement and explain why such deviations do not jeopardize our long-term viability. The report must also include evidence that: (1) the labor modifications described in “MD&A—Recent Developments” have been approved by the unions and ratified by their membership, (2) all necessary approvals for the voluntary employe beneficiary association (VEBA) modifications (other than regulatory and judicial approvals) described in “MD&A—Recent Developments” have been received; and (3) the exchange offer described below in “MD&A—Recent Developments” has commenced. Under the terms of the UST Loan Agreement, unless we receive certification under the UST Loan Agreement that we have complied with the requirements of the agreements, the maturity of the UST Loan, which totals $13.4 billion at February 28, 2009, will accelerate and become due and payable.
If the maturity of the loans under the UST Loan Facility is accelerated, we do not currently have means to repay or refinance the amounts that would be due and payable. If we failed to repay the amounts due under the agreement, an event of default would occur, which would permit the UST to exercise its remedies under the agreement, including foreclosing on the collateral pledged to secure our obligations under the agreement. These circumstances would trigger events of defaults in certain of our other significant agreements, potentially requiring us to seek relief through a filing under the U.S. Bankruptcy Code.
Source
General Motors 10-K (Dec. 31, 2008).
If the going-concern warning is imminent, companies would be wise to deal with it constructively rather than engaging in tactics to stall or head off the disclosure, Hogan says. “You need to have very candid, detailed, unemotional-as-possible conversations with accountants,” she says. “Discuss your cash-flow needs, your sources, and uses of cash, [and] things you could be doing like layoffs or downsizing.”
Stacey says companies should also do some careful forecasting to craft a plan for how they will address the challenges ahead. Making judgment calls about sales projections and coming to an agreement about those projections with auditors is tricky at best, she admits.
Stacey
The forecasts should look at the full range of possibilities, she says. Investors and auditors want to see the big picture: “This is our typical working capital plan. This is our conservative plan, and this is our back-up plan—and have a back-up plan.”
Bruce Pounder, president of accounting education firm Leveraged Logic, says credible, truthful answers are essential when auditors, lenders, or investors start asking questions. “The worst thing a company can do at a time when it’s under scrutiny is try to hide things,” he says. “Even if it’s not positive, tell the truth. Otherwise it will get worse for you.”
Companies should emphasize whether the problems they’re facing are the result of economic factors beyond their control, Pounder says. That won’t necessarily change whether the company should be considered a going concern, “but it does help shape how that opinion may be interpreted by investors, creditors, and analysts,” he says.
Pounder
Another wise move: Understand now what the company might look like if it did indeed have to liquidate or file for bankruptcy, in case investors start asking to see that picture. “It’s better to know what the company would look like if that were to happen, than to be ignorant of that while trying to resolve the issue of whether we’re a going concern,” Pounder says.
If there’s an upside to the situation, Gazzaway says, it’s that the going-concern warning might not carry its usual negative stigma in the marketplace these days.
“There’s going to be a volume of them out there,” he says. “Investors are going to be looking for clarity of the plan and transparency. If we get out in front of it and handle it as early as possible, it will be much easier to deal with than when it becomes a fire drill.”
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