Identify whether the following factors, which you have noted at Strawberry, indicate a risk that Strawberry is not a going concern, or not.
a. Major customer in trouble.
b. Net cash outflows projected.
c. Suppliers threatening legal action.
d. No dividend proposed.
The correct answer and explanation is:
To assess whether the factors at Strawberry indicate a risk to its status as a going concern, each of the listed factors needs to be considered in relation to the company’s ability to continue operations and meet its financial obligations in the foreseeable future.
a. Major customer in trouble: Risk to going concern. If a key customer is facing financial difficulties, it could significantly affect Strawberry’s revenue stream. The loss or reduction in sales from this customer could impair its ability to generate sufficient cash flow, potentially leading to liquidity issues and threatening its ability to stay in business.
b. Net cash outflows projected: Risk to going concern. If Strawberry is projecting net cash outflows, it suggests the company is expected to spend more than it earns. This could signal liquidity problems and indicate an inability to sustain operations in the long term unless external financing or operational changes occur. A consistent trend of negative cash flows could jeopardize the company’s financial stability.
c. Suppliers threatening legal action: Risk to going concern. Legal threats from suppliers may be a sign of unresolved disputes or unpaid debts. If suppliers take legal action or halt supply, it could disrupt operations, lead to additional financial obligations, and increase costs. This could impair Strawberry’s ability to continue functioning effectively and meet its short-term obligations.
d. No dividend proposed: Not a risk to going concern. While not proposing a dividend might indicate the company is prioritizing cash retention, it does not necessarily point to financial distress. Companies may choose to reinvest earnings rather than distribute them to shareholders, especially in times of uncertainty or to fund operations. However, it’s important to monitor other financial indicators in conjunction with this factor.
Each of these factors should be evaluated together with other financial conditions and management’s plans to address them. If multiple indicators suggest financial instability, the risk to the company’s ability to continue as a going concern increases.