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A Look at Going Concern Indicators
Monday, November 28, 2016

On Dec. 15 a new accounting standard goes into effect that’s meant to bring more uniformity to companies’ disclosure of their ability to continue as a going concern. FASB adopted that standard, Disclosure of Uncertainty About an Entity’s Ability to Continue as a Going Concern, back in 2014 after complaints that GAAP offers little detail about precisely how one determines uncertainty and what a company should disclose.

Now that the effective date is upon us, Calcbench decided to take a closer look at the standard (read: we heard a podcast about it and thought, “Oh yeah, we should write about this”) and how our subscribers can use Calcbench databases to see which companies might fall into the going concern danger zone.

First, the standard itself. It directs management to assess, in every filing period, whether any events or circumstances exist that create “substantial doubt” about the company’s ability to continue for the coming 12 months. If the company does have substantial doubt, then it must assess how management plans try to mitigate that doubt, and whether those plans will actually be effective. All of that then gets disclosed in the footnotes.

We should stipulate two points here. First, most companies won’t find substantial doubt about their ability to continue as a going concern. In that case, you’re done; the standard is fulfilled and you have nothing else to do. Second, this new standard is for companies. External audit firms will still perform their own analyses of clients’ ability to continue as a going concern as usual.

What caught our eye was FASB’s definition of “substantial doubt.” That doubt only arises when circumstances and conditions in the aggregate make it probable that the company won’t be able to meet its obligations as they come due in the next 12 months.

“In the aggregate.” That means multiple small warning signs, which might not cause alarm individually, should be taken together to see whether they add up to a screaming red alarm.

Well, Calcbench can do that.

Finding the Red Flags

One warning sign would be whether a company is experiencing negative cash flow (that is, it’s losing money) from operations. So first we visited our Data Query Page and decided to search for all companies with $200 million or more in annual revenue, that experienced negative operating cash flow for both 2014 and 2015.

We found 102 companies that fit the profile. Next, we calculated the percentage change in their operating losses from 2014 to 2015, and then ranked the group according to that number—so we could identify those companies whose losses are growing most quickly.

But remember, we want to find multiple conditions that could suggest serious trouble when considered altogether. Yes, your losses from operations could be growing hand over fist—like, say, Amazon.com circa 1999, or Tesla Motors and Solar City today, or pharmaceutical companies that routinely lose money for years before a blockbuster drug wins approval. Steep operating losses can be offset by growing revenue (Amazon) or big cash cushions (pharmaceutical companies).

Step 2, then, is to take these 102 companies with growing operating losses and determine how also experienced declining revenue and declining cash in the same two years.

Again, Calcbench users can do that. Return to the Data Query Page. Select the “Choose Companies” button in the upper left; in the dialog box that opens, enter the ticker symbols of those 102 companies. (All our exports to Excel include ticker symbols by default, so they’re easy to find.) Then pull the reported revenue and cash for those 102 companies, 2014 and 2015.

Once we had that second dump of data, we calculated the year-over-year change in revenue and change in cash for all 102 companies. Then we ranked them by worst revenue and cash performance, and compared that to our list of worst losses from operations—and at long last, found 27 companies that suffered declining revenue, and shrinking cash on the balance sheet, and net losses from operations, for both 2014 and 2015.

Let’s recap. The new going concern standard requires companies to assess the circumstances and events that could create substantial doubt about their ability to meet obligations in the next 12 months. After 30 minutes of poking around our Data Query Page and fiddling with Excel, we found 27 filers whose revenue, cash, and operations were all going in the wrong direction for two years running. The worst 10 are here, ranked by losses from operations.

Putting the Data Into Context

None of this analysis means that these 27 filers are doomed to fail in the coming 12 months. They might, because those financial metrics do look bad—but management at those companies might also have plans to keep operations going. After all, these filers limped along with poor numbers for two years; by definition, they met their obligation for the previous 12 months somehow.

Our point is that poor financial metrics only create doubt; management still must offer plans to alleviate that doubt, and those plans are what investors want to know about.

That’s the subject for another blog post on another day. For now, however, we can say that Calcbench helps users identify companies that might face substantial doubt. We help you ask better questions. Then, in turn, you can find better answers.

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