No this is not for sanity, but rather is about putting the business through a financial model to identify best and worst case revenue scenarios in the current climate, to ensure lenders are making more informed decisions.
SMEs seeking funding from lenders must be able to demonstrate how they are tackling the downturn and planning to remain financially viable in the long-term, according to Prosperity Adviser director of business services & taxation, Michael Griffiths.
“Lenders will need to know how the business has been holding up in order to identify where and how you (business owners) have made changes to sustain the business through this downturn.”
Griffiths believes that lender’s need to know whether a company is viable and how they will tackle the challenges they face before they can provide funding, which is where stress testing comes in.
“Stress testing then comes into play, as it helps quantify what the capital requirements are over the short to medium term on a best and worst case scenario. It also provides the lender with a detailed analysis of the levels of risk the company faces, and can consequently make a more informed decision.”
Griffiths is encouraging all small businesses to ‘stress test’ their business, regardless of whether they require the funds now or not.
“There is a lot that can be learnt from undertaking the modelling because it makes companies more aware of any early warning signs, such as limits on slowing sales figures for example,” Mr Griffiths said.
Griffiths has provided the following tips for business owners on how to ‘stress test’ their business:
a) Ensure you have an accurate Profit & Loss and Balance Sheet for the eight months ended 28 February 2009. If weekly financial statements are available, even better.
b) If your monthly financial statements cannot be reviewed within a week or two of the end of the month in question, this will pose a problem. Effective and efficient internal accounting processes are required for you to manage your business.
c) How does your weekly or monthly ‘actual’ result, compare to your budgeted result? If you have no ‘budgets’, your lender will jump to the conclusion you have no controls and direction over where your business is going. To fix this problem, prepare a business plan including budgets for your Profit & Loss, Balance Sheet and Cashflow Statement projected 18 months into the future as a minimum.
d) After reviewing your results, prepare a bullet point list of what went well during the month, and what areas need improvement to meet the demands of the current economic climate.
e) Calculate your monthly breakeven point for the number of ‘widgets’ that need to be sold for the next few months. Similarly, determine the number of widgets that need to be sold to achieve varying levels of desired profit.
f) In this current economic climate, update your budgets for the future quarter, in advance, at the commencement of each quarter.
g) As part of this monthly ‘stress test’ of your business, prepare a sensitivity analysis of the next month’s budgeted results, modelling changes projected in your financial position, utilising your KPI’s.
h) Examine the effect on profitability if number of widgets sold varies to budgeted sales. Also examine any effect interest rate movements, material and labour cost movements, exchange rate movements (if applicable), average debtors days and average stock days being extended, average dollars held in Work In Progress (WIP) being extended, etc.
i) Review costs weekly / monthly and compare to budget. Always take a step back and question yourself, “How are these costs adding value to my business in our current economic climate?”
j) Promptly make the ‘hard decisions’ if they need to be made.