So, with most companies having a year end of December the hot topic in the City recently has been the issue of going concern. The going concern basis implies that the board of directors believes (but doesn’t guarantee) that the company will be in business in twelve months time from the date of signing the accounts and prepares its annual accounts on that assumption. The directors must have a reasonable basis for making the going concern assumption as they may be held financially liable if the business were to fail in the following twelve months. They should also take soundings from their advisors.

A partner in a leading mid-size law firm for AIM companies told me over lunch that his firm has been overwhelmed by the number of queries from companies about financial difficulties and going concern. So much so in fact that he has created a case study exercise to hone the advisory skills of his younger associates who haven’t been through such turbulent times before. The case study presents a rolling scenario in which a company goes through a number of events including a downturn in trading, the failure of a firesale of a division to raise funds, a customer going insolvent, an underperforming Finance Director and a falling share price. Sounds far-fetched? Not these days.

As if there weren’t enough challenges for companies with their trading, various people around the City have been telling me about the strains their clients are under with banks withdrawing unused facilities from companies often with little reason to do so other than to protect their own capital bases. A Corporate Finance Director in a Nomad with a large AIM client list told me of a profitable, cash-generative software client of his with a long term loan which was ‘asked’ by its bank to cut its dividend in order to accelerate repayment of the loan. The dividend cut has now been implemented and led to a 40% fall in the share price.

Banks are increasingly using noncompliance with covenants as a reason for withdrawing facilities. A covenant is a measure specified in the loan agreement with a minimum target the company must meet at regular intervals, often every month or quarter. For example a covenant could be that EBITDA is at least five times the interest charge on the relevant borrowings. Failure to meet the covenant target means that the lender is entitled to demand repayment of the loan, which in extreme cases can push the company into administration.

Therefore, as a private shareholder, you’d think information on banking covenants would be an important note in annual reports of companies, giving shareholders the ability to assess the likelihood of a company committing a breach. However, whilst you can usually find a swathe of unenlightening information in a company’s annual report, I expect you’ll be hard pushed to find any information on banking covenants for the company’s borrowings.

So, in that case, what should you look out for in the annual report? If it’s a nervous time being a director of a plc (and it is, believe me) then it’s an even more nervous time being an auditor of a plc. For that reason, go straight to the auditors report because the chances are that this year rather than being a bland page of standard wording you may find some words you haven’t seen in an audit report for some time.

“Significant doubt” about going concern doesn’t need translation. If you see this then it’s probably time to sell up and recover whatever you can for your shares.

“Emphasis of matter” is more subtle, and translated from auditor’s speak means “you really should read this bit as it will draw your attention to something in the accounts that is important”. It doesn’t mean that the auditors don’t believe the accounts to be correct, but if you see this in your company’s audit report then do read it in detail and make sure you understand the issue they’re referring to.

For the more rigorous private investor, I also suggest a read of An update for directors of listed companies: Going concern and liquidity risk published by the Financial Reporting Council (available at www.frc.org.uk/press/pub1781.html).

The FRC is not known for producing succinct readable documents but this is an excellent guide to the issues that boards ought to be considering when assessing whether their businesses are going concerns and how they should comment on these matters in communications to shareholders. It’s best saved for a wet Sunday afternoon but at least when you go to the company’s AGM you’ll be well prepared to find out if the directors have gone through a proper process in considering your company’s going concern. You can judge for yourself whether you’re convinced and will continue to hold shares in the company. Despite Spring having just arrived, I suspect we’ll be seeing more emphasis of matter statements than green shoots for some time to come

Ash Mehta is Chief Executive of Orchard Growth Partners, which provides Finance Director consultancy services. He is also part-time Finance Director of Northbridge Industrial Services plc, an AIM-quoted hire company, and he sits on the Executive Committee of the Quoted Companies Alliance. The views expressed are his own and do not necessarily represent the views of those organisations. This article was first published in the February 2009 edition of Aimzine, an online publication for investors in AIM-quoted companies.