Going concern warning

A going concern warning is a disclosure that there is substantial doubt about a company's ability to continue operating and meet its obligations as they come due. Under US GAAP (ASC 205-40), management must evaluate this each reporting period for the one-year period after the financial statements are issued, and the auditor adds an explanatory paragraph to its report on annual statements when it concludes substantial doubt exists.

How it works

Common triggers include recurring losses, negative operating cash flow, low cash relative to burn, upcoming debt maturities, covenant breaches or loss of a key customer or financing source.

• Management disclosure: appears in the notes to the financial statements in a 10-K or 10-Q, along with management's plans (raising capital, cutting costs, selling assets).
• Alleviated doubt: if management's plans are probable of resolving the issue, the company discloses the conditions and plans but states that substantial doubt has been alleviated.
• Auditor paragraph: in the annual audit report, flagged under a heading about the company's ability to continue as a going concern.

Why it matters for traders

A going concern warning tells you the company needs money soon. For small-caps and biotechs, that usually means dilution through an ATM offering, a registered direct or a PIPE, often at a discount. It can also trigger debt covenant defaults, hurt relationships with suppliers and customers, and, at the extreme, precede a Chapter 11 filing. The warning is frequently already expected for cash-burning companies, so the reaction depends on how much cash is left and whether financing is lined up.

Example

Northwind Therapeutics (ticker NWTX) ends the year with $30 million in cash and burns about $12 million per quarter. That covers roughly 2.5 quarters, well short of the 12 months after its 10-K is issued. The 10-K includes a going concern paragraph, and NWTX announces a $25 million registered direct offering the following week.

FAQ

Does a going concern warning mean bankruptcy?

No. Many companies raise money and continue operating. It means there is substantial doubt over the next year without new financing or other action.

Where do I find a going concern warning?

In the auditor's report and financial statement notes of the 10-K, and in the notes of a 10-Q when management identifies the doubt.