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Finance a la shmoop what is the going concern rule? I'm concerned that we're

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still going are we dead yet can we still pay our bills any major [Zombie man discussing going concern rule]

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contracts we're losing that will kill us any regulations coming that will also

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kill us so we ask again are we dead yet? okay not quite a fair comparison there

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when companies have to ask the question as to whether or not they are a going

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concern well something is very rotten in Denmark like Google's not asking those

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questions a going concern is one which is going living surviving even thriving [Pink rabbit playing drums]

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and if they're not well then a whole lot of bad things start to happen so let's

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say a given company has debt and one of the basic covenants is that their debt

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has to have a debt to asset ratio of no more than 3x but then they invested in a

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Chinese gambling company five years earlier which has done amazingly well [Chinese slot machine appears]

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and that asset balloon and ballooned in value upwards the good way and the

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company borrowed money against it as collateral

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using the valuation of its last private round of funding to peg the value of

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that asset okay debt to asset ratio remember got to be three but of course

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as things always do in shmoop finance videos the Chinese gaming company was

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hacked then it fell on hard times and it was regulated and eventually became an

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impaired asset and that asset was no longer a going concern and that's a big

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fat hairy problem for the company that was using that stock in that company as

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an asset or collateral against which to cover its bond covenants when that

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Chinese gaming asset became an impaired asset going in value from 50 million to [Chinese gaming company stock value graph appears]

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like two million. The hundred fifty million dollars in debt covenants were

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violated as the total assets owned by gambool went from seventy million dollars

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down to just 22 million so what happens now?

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well the bonds are by indenture immediately callable by the lenders and [Bond stamped callable]

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it's unclear as to whether the company can quickly raise enough cash to cover

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that debt that they owe... like they owe 150 million

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bucks and the value of this thing's 22 so they quickly need to have 28 million

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in cash or some asset that can be pledged against it so it doesn't violate

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that 3 to 1 covenant got it? so it's as if the financial disease that hit the

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Chinese gaming company has now leaked and infected the one that had invested

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in it as now with that 28 million in change urgently needed the investing

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companies own solvency is called into question yeah that's how we get to the

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going concern rule which just focuses on the notion of whether a company is going

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along just fine generally and that huge cataclysmic things like debt write downs

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and bankruptcy aren't in the immediate offing at its essence going concern [Pink rabbit playing concern drum]

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means that a company can continue to go or operate they can pay their bills good

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economy or bad one contract or loss they're generally immune to minor

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regulatory changes and any kind of debt they have or other production

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obligations the timeframe for determining whether or not there is [Timeframe for companies cause for concern appears]

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cause for concern that is going is usually a year from when the financial

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statements are released that is if a company has had five hundred million

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dollars in earnings before interest paid and then they pay four hundred million

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dollars in interest payments well, they have only a hundred million dollars

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of spread there but if suddenly their earnings drop another 20 percent well [Company earnings drop]

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then their existence is likely called into question because basically all of

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their pre-tax profits is going to pay down debt if revenues drop even another

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little tiny skosh well then they're bankrupt and they're no longer a going

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concern and well then investors would be concerned that they can no longer yo

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know, go [TV advert for prunes appears]

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