Going concern – Assessing financial resilience in turbulent times

Most charities will soon complete one of the most challenging financial years in their existence and start to prepare their 2020/21 annual accounts. Respond, recover, reset, a report published by NCVO and project partners using responses received from nearly 400 charities in late 2020, showed that seven percent of respondents believed that it was quite likely or very likely that their organisation would no longer be operating in a year’s time.

While it is still unclear how well this represents the financial situation of the whole sector, it is likely that many charities will have to carefully assess their financial resilience to determine whether the going concern assertion is still appropriate. The trustees are responsible for assessing going concern of their charities, but auditors must evaluate, and now also robustly challenge that assessment and obtain sufficient audit evidence to support their conclusion. This means that charity finance staff and trustees should document and continuously update their going concern assessment. Not only will this support the audit process, but it will also allow trustees to be prepared during turbulent times and to respond more quickly to adverse variances or anticipate cash shortages when there is still time to take action.

Going concern assessments should not be confined to short-term liquidity assessments but also look at the medium to long-term financial resilience of the charity. This may involve stress-testing various scenarios that could threaten the business model and to explain how the charity will adapt their strategic positioning to mitigate potential existential threats. Trustees are encouraged to report on their longer-term resilience and strategic positioning in the Trustees’ Annual Report to reassure staff, funders, and beneficiaries that, while the future is uncertain, the charity’s leadership is actively working to maintain long-term financial resilience. This would also inform risk management better.

The going concern assessment depends on the organisation’s financial health and business model. Charities with large unrestricted reserves, healthy cash holdings, reliable income streams and low fixed costs are likely to find it easier to demonstrate their financial resilience.

There are no set procedures for a going concern assessment, but all charities should consider the following:

• Liquidity: The availability of cash is central to an entity’s survival and trustees should be clear about the timing of material cash inflows and outflows to determine if cash shortages are likely to arise and what options are available to counteract these shortages. Cash flow forecasts are a key component of the going concern assessment and charities with low unrestricted reserves should include sufficient detail to determine the level of unrestricted cash.
• Forecasts that allow for scenario-planning: During financial difficulties it is important to continuously update forecasts and to plan for different scenarios. This is particularly true during turbulent times. Trustees should consider the impact of the external environment such as continuing restrictions on charity trading and fundraising activities, the reliability of their material income streams and the charity’s ability to reduce costs when income levels fall.
• Free reserves: Free reserves are part of the charity’s unrestricted funds and are usually defined as those funds that are readily available for spending. This means that unrestricted funds held in the form of tangible fixed assets or funds designated for essential future spending or existing commitments are excluded. Charities need sufficient reserves to meet their working capital requirements, in other words, they need to be able to fund the charity’s daily operations and cover its short-term liabilities. Higher levels of free reserves provide a charity with longer-term financial resilience that can help charities mitigate the effects of a sudden fall in income and continued fundraising restrictions, or to invest in new ways of working or assets.

The financial projections used in the going concern assessments can only be as good as the information known to the person preparing it. If the forecasts and cashflow projections are prepared by staff for the trustees, it is important that trustees have a clear understanding of the assumptions that underlie the projections. Communication requires more time and effort where staff and trustees operate remotely, and trustees should take this into consideration when they review financial information and ask for clarification where needed.

The communication between charities and their auditors or independent examiners should also address the going concern assertion from the early planning stages. If trustees and finance staff understand early on what is required of them, they can prepare accordingly.

Early in the pandemic, the ICAEW Charity Committee issued guidance for charities that were preparing their annual accounts for the year to 31 March 2020, helping preparers of charity accounts to consider the sector-specific reporting implications. The guidance was updated in December 2020 to reflect the impact of the pandemic on later reporting periods and is aimed at preparers of a charity’s reports and accounts, the trustees (who are ultimately responsible for them and therefore need to understand the potential impact of COVID-19 in this context) and others who rely on, or have a particular interest in, charity reporting and accounts.

• Read the full guidance.

ICAEW guidance for going concern assessments, from both the preparer’s and the auditor’s perspectives, are linked below alongside other helpful guidance.

ICAEW guidance:

• Going concern considerations – a guide for FRS 102 preparers
• Considering going concern – a guide for auditors
• COVID-19 implications for charity accounting

Charities SORP guidance: Implications of COVID-19 control measures and charity financial reporting

Charity Commission guidance: Coronavirus (COVID-19) guidance for the charity sector