Why should you stress test your business?
Monday, 06 February
We often hear that the banks are being stress tested to determine their ongoing viability. Do you just assume that this is ‘economics’ that goes way over our heads? Actually, we can apply similar principles to all types of business. It involves applying systems to identify potential problems, however extreme or unlikely, and then devising strategies to minimise or alleviate their effect.
It is relatively common for businesses to suffer from something entirely unexpected. We can take lessons from some high profile casualties in recent years; Woolworths, C&A and, more recently, BHS! Other disasters, such as floods or fire, may well be a significant threat to a smaller business, although with careful planning even these extreme cases can be overcome.
Although there might be nothing the owner can do to avert disaster, stress testing the business’s finances at least enables the owner to better understand risk, and perhaps take steps to mitigate that risk. Identifying potential risks, however remote they may seem, will enable the business to put a survival plan in operation as soon as possible.
Some risks will be quite extreme, as mentioned before, but others could be less obvious. For example, a competitor opening up or introducing discounts; lengthy roadworks near your business premises; or a shortage of available staff.
Other risks to a business’s finances could be:
- Loss of a major customer;
- Loss of a key member of staff;
- Currency fluctuations;
- A new competitor, perhaps one that is larger, or has a more established brand, with more staff and more money;
- Rising costs, including fuel, raw materials, energy, travel;
- A product becoming less popular or attractive over time.
There are many issues that could affect the viability of a business. Many of the businesses I work with are facing a skills shortage, and so we are talking about ways to recruit and retain key staff. Fluctuations in costs is another potential game changer. A prime example is fuel cost which affects every business, but if you are a haulage contractor a rise in price or shortage of supply would cause significant harm. You need to consider ALL aspects of your business, including customers, service providers and suppliers. It can be easy to focus on income, but what if your major supplier suffers a catastrophic event?
When considering threats to the business you should include various scenarios, varying in strength, with some clearly more severe than others. Certainly some scenarios are going to be pretty extreme, and these are going to be less likely. Others might be more likely, but all will need a plan in place to mitigate their effect. It is no good waiting until something happens to react.
As part of your stress testing it is important to consider the impact a particular event could have on the financial stability of your business. How would you deal with a loss of income for a couple of days, weeks or months? One event that happened locally recently was the closure of a river crossing which caused traffic gridlock for several hours, and local businesses reported significant losses of trade for the day.
How can you plan to lessen the risk posed by such threats? For example, if a large proportion of your sales are to a few customers, you probably need to sell more to others, or to attract new customers, to lessen that over-reliance. Look at ways to reduce costs, both for materials and other overheads. Do you have key staff, the loss of whom could adversely affect your business?
There are many ways to lessen the risk. Some might be quite simple such as having appropriate insurance cover in place, but others may require more consideration:
- You may need to broaden your customer base. I have been working with such a business recently, an accident repair business, where a significant amount of the work came from a single company.
- Consider a detailed costs review. Can you acquire your materials from more than one source, or purchase utilities a different way?
- How do I incentivise my staff to retain them? Do I need to offer them training?
A qualified accountant will be able to help you stress test your business. As an independent professional, they are well placed to assess risk and to judge whether your business could withstand certain things going wrong. They should also be able to suggest ways that you can reduce costs, boost the balance sheet or ease cash flow.
However, you must be happy that they are confident in providing this service, and fully conversant with your particular sector. They will certainly need to acquire a detailed knowledge of your business, especially if they are not your usual advisor. As well as identifying potential risks they should also be able to suggest solutions to mitigate any potential problems.
Investment in such a review will be money well spent. However, do not put the findings in a drawer and forget it. With all such things, it is important that it is a working document, with regular review and amendment where necessary. If you have any queries, contact me at email@example.com or telephone me on 01473 833411.