Fee paying schools and 'Going Concern'

Henry Briggs comments on concerns over the pitfalls of potentially insolvent trading at fee paying schools and whether to report your financials on a Going Concern basis.  

What is Going Concern?

All schools have been facing difficult operating conditions in 2020, which have brought new challenges and uncertainties. One of which may only just be coming to light with this round of annual audits; the issue of Going Concern in schools financials. Accounts are all prepared on a ‘Going Concern’ basis, that is an assumption that the entity will continue to trade for the next twelve months. Otherwise, accounts have to be prepared on a ‘Break Up’ basis – i.e. closure and fire sale. Governors, directors and trustees will be asked by auditors to provide evidence to support the view that they consider their schools will still be running as viable entities at least a year after the date when the 2020 accounts are signed off. This kind of talk will raise concerns amongst those responsible for the school’s governance; the first of which might be how they would be held to account should the school fail. Where schools are Limited companies (many charitable ones are, in the format of being ‘limited by guarantee’), or have trading subsidiaries or arms that have limited liability, then one of their regulators is Companies House (or the Companies Registration Office – ‘CRO’ – as it is now called). In return for shareholders having limited liability, CRO police compliance with their rules. One of these is that directors will be held to account if they are trading whilst knowingly insolvent. If they are held to be doing so, there are draconian penalties – such as the removal of their right to hold office of a director – or even imprisonment; as well as public shame. All this for a voluntary unpaid role for Governors!  

Ignorance is no excuse

Either of the rules or of the entity’s financial position. It is something which needs to be constantly under review for all the school’s operations and may pass under the radar for trading subsidiaries. If, say, a school runs an events business for lettings in the holidays and it is suffering from trading difficulties, the likelihood is that the holding company – school – may be supporting it throughout this time. If the trading company fails to meet its debts as they fall due, then a wrongful trading case would follow against its directors. For a charitable school this can also threaten its charitable status. A charity may not provide support to a commercial entity in the form of working capital. Although this may not be material in financial terms for the whole operation, it could well cause problems for the status the school. In reality, the important thing is that the directors of a limited company do not enter into contracts which they know they may be unable to fulfil, due to the lack of liquidity in a limited company, which then fails. It only takes an aggrieved creditor, such as a leasing company or a bank, to follow a bad debt with a claim and a notification to CRO. Whilst there are a welcome plethora of grants and deferments available to entities suffering from the effects of the pandemic, many of the liabilities (such as delayed VAT and PAYE) are only deferred. Cash flow might be holding up, but the balance sheet is not. This is dangerous territory.  

How to protect yourself

Governors must protect themselves as well as the school; and they can do this by usual good practice, but with much tighter, more frequent reporting being demanded of the management. Financial resilience tests should be done by showing how figures forecast vary on a band of assumptions. Cash flow, revenue and forecast balance sheets should be prepared and regularly and frequently updated to monitor and control solvency. Key Performance Indicators, such as pupil members, teaching costs as a percentage of income and, of course, money in the bank should be provided more often than may have been needed in the past. Governors need to think and question forensically – are they being given all the financial information they need to know and is it accurate? The less financially literate should make sure that they understand that they are overseeing a viable entity and must not rely on others who are closer to the figures. Some school heads and governors do not like being the bearers of bad news. Schools taking these precautions and such a management approach will find then that not only are they addressing the concerns of the Governors, parents and staff, but can report robustly to their auditors that there are no issues over the application of the Going Concern basis of preparing accounts.  

For advice on preparing your accounts on a Going Concern basis in your school, get in touch with one of our experts.