Going Concern

I’m concerned that we’re...still going. Are we dead yet? Can we still pay our bills? Any major contracts we’re losing that will kill us? Any regulations coming that will also, um...kill us? So we ask again, "Are we dead yet?"

Ok...not quite a fair comparison there.

When companies have to ask the question of whether or not they are a going concern, something is very rotten in Denmark. A going concern is one which is…um…going. Living. Surviving. Even thriving. If they’re not, then a whole lot of bad things start to happen.

So let’s say a given company has debt...and one of the basic covenants in that debt is that they have to have a debt-to-asset ratio of no more than 3x.They invested in a Chinese gambling company 5 years earlier, which has done amazingly well...and that asset ballooned and ballooned...and the company borrowed money against it, using the valuation of the last private round of funding to peg the value of that asset.

But the Chinese gaming company was hacked...then fell on hard times, and was regulated, and eventually became...impaired. And that asset was no longer a going concern. And that's a big fat hairy problem for the company that was using its stock in that company as an asset against which to cover its bond covenants.

When that Chinese gaming asset became an impaired asset, going in value from 50 million to 2 million, the $150 million in debt covenants were violated, as the total assets owned by Gambool went from $70 million down to just 22 million.

So what happens now? Well, the bonds are, by indenture, immediately callable, and it’s unclear whether the company can quickly raise enough cash to cover the debt they owe.

It’s as if the financial disease that hit the Chinese gaming company has now leaked, and infected the one that had invested in it...as now with $30 million urgently needed, the investing company’s own solvency is called into question. The going concern rule just focuses on the notion of whether a company is going along just fine…generally...and that huge cataclysmic things like debt write downs and bankruptcy aren’t in the immediate offing.

At its essence, going concern means that a company can continue to operate. They can pay their bills, good economy or bad, won contract or lost. They’re generally immune to minor regulatory changes and any kind of debt they have, or other production obligations. The timeframe for determining whether or not there is cause for concern that is, um…going...is usually a year from when the financial statements are released.

That is, if a company has had $500 million in earnings, and $400 million in debt payments, they’re just squeaking by, using half the remaining million dollars each year to pay down debt. But if suddenly their earnings drop another 20%, then their existence likely depends on them getting yet more financing, and if they don’t get it...well, then investors would be concerned that they can no longer, um…go.