Going concern guide for directors
ICAS has published a new going concern guide for directors.
The chair Gary Connel CA, Chief Financial Officer at Fotech and ICAS Business Policy Panel member, introduced the discussion. He noted that raising finance can be challenging for SMEs, particularly those in the technology or service sectors where holding assets that can be readily transformed into cash and demonstrating strong future cash flows for lending applications can be a struggle.
Managing funding challenges and going concern
For early-stage SME businesses that are part debt and equity funded but struggling with uncertain cash flow and unable to increase their bank funding, the board faces difficult decisions. We discussed with one private technology company how they weathered the storm.
Our business policy panel also provides tips from their experience. The case study forms part of a series of CA directors’ case studies, which includes analysis of how directors’ decision-making met their duties under the Companies Act (section 172).
In this example, an early-stage business with a bright future relied on equity finance. Without reliable profits, bank debt finance was not available and asset finance was not an option for a technology business that offered fewer tangible security options against which to secure debt. There was no appetite for further equity funding from the company’s existing shareholders.
The challenge was that wider economic circumstances had a detrimental effect on orders and revenue was becoming increasingly variable. Funding needs were based on sales forecasts which were deteriorating, resulting in a widening funding gap and increasingly tight cash flow.
The directors had to take action. This included:
Seeking independent expert advice
The potential for liability for directors arises at the point they know, or ought to know, that there is no reasonable prospect of avoiding insolvent liquidation or administration based on both the company’s current position and its realistic prospects. This is not just a simple judgement about whether the company meets a test for insolvency, it’s also about the overall picture. It’s possible for a company to be temporarily insolvent yet remain a going concern.
We published an article on wrongful trading which explains the provisions, and outlines the actions that directors should be taking (and advising parties should be recommending that they take) to be able to demonstrate a defence to accusations of wrongful trading. It also contains some practical steps for directors.
In our case study, the directors engaged external professional insolvency advisers (insolvency practitioners and lawyers) to offer an external, independent expert view to evaluate assumptions and assess whether their approach and judgments were reasonable and in accordance with the law. The insolvency practitioner was also able to offer practical advice on the next steps and how to sustain the business when cash was tight.
A good understanding of the business’s fixed and variable costs is important. Reducing unnecessary costs as quickly as possible could optimise the ability to continue to operate. There may be an investment required to achieve cost reductions, such as notice or redundancy pay for staff. Having an early plan is essential or you could find yourself in a position of being unable to afford the very step needed to ensure survival.
Management of working capital
Working capital management is critical. Cash, inventory, trade debtors and trade creditors all need a thorough review and proactive management. To this end, cash flow monitoring was undertaken by the company on an increased basis.
Where bank funding is involved, speak to your bank early. As circumstances change, identify if any covenants risk being breached and explain to your banker how the business is mitigating risks. This will help build lender/investor confidence and facilitate the discussion of potential options such as a capital repayment holiday. Options are discussed further in our SME finance webinar.
If the company cannot pay a tax bill, HMRC can be contacted to discuss the support available. It may be possible to agree to a ’Time to Pay’ arrangement. How to contact HMRC depends on the tax in question – HMRC provides detailed guidance on what to do.
Where appropriate, speaking to other creditors early, for example, landlords and suppliers, may help to manage exposure and provide valuable time for the company to implement its plans.
Financial and management information
Further to the first point, financial and management information was key to making informed decisions. The directors frequently monitored progress and checked if any assumptions were not being met. They held additional ad hoc meetings, as scheduled board meetings were too infrequent for the needs of a dynamic, ongoing issue.
Conducting a sensitivity analysis can be a useful tool when forecasts may become challenging due to variable and uncertain conditions. Considering the impact of a sales shortfall (or even an unexpected sales increase) will proactively highlight working capital requirements. See also our guide to managing business finances in an inflationary environment.
Other learning points – directors’ Section 172 responsibilities
The CA directors’ case studies analyses the application of statutory responsibilities.
In this case study, the relevant duties considered were:
- The likely consequences of any decision in the long-term (paragraph a in the legislation)
- The interests of the company’s employees (paragraph b)
- The need to foster the company’s business relationships with suppliers, customers and others (paragraph c)
- The need to act fairly as between members of the company (paragraph f)
The business had a viable business model which attracted investors, however, capital requirements for a technology business were high. It relied heavily on long-term, patient finance and this created pressure on working capital. The directors had identified the issue and were managing it.
Timing is critical and directors are responsible for getting this right. Failing to explore the options for the company’s survival as exhaustively as possible is not in the best interests of members, employees or suppliers. Yet being too late can risk trading insolvently. For further guidance please refer to the ‘considerations for directors’ section of the article on wrongful trading.
Taking appropriate external advice at an early stage helped to provide assurance that directors were undertaking their responsibilities in a proper manner. And doing all they could in the circumstances to keep the business a going concern and maintain jobs.
Managing working capital requirements involved negotiating payment terms with debtors and suppliers to help improve a positive cash flow and ensure sufficient funds were available to stay solvent.
A guide to Building Resilience in Business has been published by the British Business Bank. It provides information and support to help smaller businesses manage their costs, boost their long-term profitability, and increase their resilience
For other case studies on directors’ duties read CA directors’ case studies.