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“GOING CONCERN VALUE”-ALL YOU NEED TO KNOW-COMPILED BY ER. AVINASH KULKARNI

Saturday Brain Storming Thought (131) 18/09/2021

COMPILED BY ER. AVINASH KULKARNI

GOING CONCERN VALUE

Going concern value is a value that assumes the company will remain in business indefinitely and continue to be profitable

Going concern value is often higher than the liquidation value

Goodwill is the difference between going concern value and liquidation value

Going Concern

Going concern is the accounting term for a company that has the resources needed to continue operating indefinitely until it provides evidence to the contrary

If a business is not a going concern, it means it’s gone bankrupt and it’s assets were liquidated

Going concern value calculation

1) Current ratio
Divide current assets by current liabilities to get the current ration

2) Debt ratio
Total liabilities divided by total assets provides the company’s debt ratio

3) Net income to net sales
This ratio measures how well the company is managing it’s expenses

Indicators of going concern problems

Negative trends

1) declining sales

2) increasing costs

3) recurring losses

4) adverse financial ratios

Employees

1) loss of key managers

2) loss of key employees

3) labor difficulties of various types

4) strikes

Systems

1) inadequate according record keeping

Legal

1) legal proceedings against the company

2) pending liabilities and penalties related to the violation of environmental or other laws

Intellectual property

1) loss or expiration of a key license or patent

Business structure

1) company has lost and been unable to replace a major customer or key supplier

Financing

1) company has defaulted on a loan

2) company unable to locate new financing

Going concern in real estate

It is effectively the sum of the value attributed to its

1) land

2) building and site improvements

3) furniture, fixures and equipments (FF & E) and operating supplies and equipment (OS & E)

4) goodwill and intangibles, if any

Importance of going concern concept

It shows the stability of the business carried on by the company

1) helps shareholders assess the financial stability of the company

2) helps business fetch loans

3) make investments on a long term basis

4) it gives comfort to creditors to do business with the company

Formula on determining the value of business

1) net worth of the business – liquidation value of the assets minus liabilities

2) your present earning power – annual earnings with an equal amount of net worth (15%)

3) add a reasonable annual salary for owner or manager

4) average earnings required (item 2 + item 3)

5) determine the average annual net earnings of the business (net profit before owners salary) over the last few years

6) extra earning power (item 5 minus item 4)

7) ask yourself over how many years you are prepared to sacrifice the extra

Example of going concern

1) General Motors went into bankruptcy in early 2000

2) Federal govt stepped in and gave GM a bailout and a guarantee

3) Hence General Motors is considered to be a going concern

Going Concern value represents

The monetary value that can reasonably be expected to be received from continuing business operations

Liquidation value represents

The total sales value of all company-owned assets

Key assumptions of going concern concept

A business will continue to exist in the near future
ie it will not liquidate or be forced out of business

Sale of going concern

The sale includes everything that’s necessary for the continued operation of the business, the business is carried on by you until the day of sale

Revenue recognition

The revenue recognition principle states that one should only record revenue when it has been earned, not when the related cash is collected

Selling the business as going concern conditions

1) the assets must be sold as part of the transfer of a business as a going concern

2) the same assets must be used by the buyer with the intention of carrying on the same kind of business

3) there must be no significant break in trade

4) if part of a business is sold it must be capable of operating seperatly

5) there are additional rules where land is concerned

Following situations will not be transfer of going concern

1) a change in constitution of a partnership

2) where there is no transfer of assets

3) the transfer of shares in a limited company

4) the transfer of a farm business to a farmer who is certified under the agricultural flat rate scheme

VAT treatment in transfer of going concern

1) buyer will not be able to reclaim the VAT as input tax

2) seller will have to cancel any VAT invoice and refund the VAT

Plans to ensure a company remains going concern

1) restructuring debts

2) selling assets to recompense debt

3) obtaining additional financing to avoid liquidation

4) reducing expenses to increase profitability

5) obtaining additional equity from owners or shareholders

6) improving business operating conditions

7) getting a third party guarantee to mitigate risks

Signs that a company is no longer a going concern

1) a very low current ratio – insufficient cash to pay short-term liabilities

2) long unpaid dues or loan defaults

3) inability to obtain a loan

4) denial of credit by a supplier

5) reliance on discounted sales

6) long term assets in financial documentation

7) substantial debt restructuring or selling of assets

8) consistently low sales score – decline in the demand for its products hence decline profits

9) continued losses year after year

10) current or recent lawsuit

11) plans to declare bankruptcy

Warning signals of company no longer be a going concern in future

1) growth in competition

2) loss of franchise, patent or license

3) loss of principal clients

4) failure to reinvest in new product development

5) difficulty in recruiting staff

6) substantial investment using an overdraft

7) inability to pay dividends

8) uninsured or underinsured catastrophe

Catastrophe

It is an event causing great and usually sudden damage or suffering, a disaster

Compiled by:-

Er. Avinash Kulkarni

Chartered Engineer
Govt Regd Valuer
IBBI Regd Valuer

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