Financial Statement Compliance

Doug and I were primarily responsible for audits and reviews and Currie & McLain CPA’s and this has rolled over to our new venture C.O.R.E. Services, LLC .  While we focus our efforts almost exclusively on audits of condo and homeowner associations, we also provide review services for clients of smaller CPA firms in Oregon and Washington who prefer to focus on income taxes. We think it can be a great partnership all the way around.

We conducted many financial statement reviews during 2017.  And, as odd as it sounds, each of them was facing a going concern problem.  While this is not a rehash of the new accounting standards for going concern, we did want to point out what we look for and what management needs to consider.  This can be very important with your year-end possibly approaching and you want the review to be completed early.

For the clients whose financial statements we reviewed this year, the number one driver of the going concern evaluation was non-compliance with bank covenants. For instance, your loan agreement may state that your business must maintain a current ratio of 1.25:1.00.  This means that you must have $1.25 in current assets – cash, a/r, inventory to every dollar of current liabilities – a/p, accrued payroll, current maturities of debt.

Another covenant we typically see is some sort of debt coverage ratio.  This is typically calculated as the current debt obligation divided by earnings before interest, taxes, depreciation and amortization (EBITDA).  if it says you must have a coverage ratio of 1:1, then if you have $1.0 Million of current debt obligations you need to earn $1.0 Million in EBITDA.

The problems arise when one or both of these are missed and missed by a lot or for multiple years.  Most of the financial statements we reviewed reported a second or third year where the current ratio and/or the debt coverage ratio were well below the requirement.  The problem is that, technically, the bank can call the debt, forcing the owners into very painful decisions.

What can management do?  Well, the first step is to admit the problem.  Non-compliance with bank covenants should not be a surprise to management, the owners or the bank.  Typically, the bank will require some sort of plan to address the covenant violation.  This may be as simple as a cash flow projection to a complex plan to sell assets and lease them back to generate cash to pay down a line of credit.  Whatever you do, don’t bury your head in the sand.

The second step is to prepare a disclosure for your financial statement.  Now, I know that typically you expect your accountant to write up the notes but this is one where you may want to be involved.  Your company is on the line and the reader, i.e. the credit officer at the bank, may well decide that your plan can’t deal with the problem and start creating solutions for you.

If you would like some ideas of how to disclose the going concern issue and your plan, let us know  by writing to info@core-acct.com and we will be happy to send you an outline of the disclosure we have clients complete.  The vital thing though is to provide enough detail that the reader can see the issue and understand your plan without investing so many hours that it distracts you from the issue of running the business.

The third step is to get the bank to issue a waiver or forbearance on compliance.  Stay in control here because this can become a circular problem since the bank will want the reviewed financial statement to know where your business is and the accountant will not want to issue the reviewed financial statement without the forbearance.  It requires a good deal of communication to make this work and it is very helpful if you can get them together for a conversation.

A going concern issue is possibly the single biggest financial statement headache you are likely to ever have to address.  Get in front of it early and work closely with your bank on getting approvals in place and with your accountant to draft the plan for inclusion in the notes and it is very likely that you can still meet a respectable turnaround time for producing the financial statements.

Have a great Monday.

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