Small company owners may make wise decisions during difficult times with the aid of a financial stress test. Here’s how to go about it.
Business leaders may assess how their organizations would fare in challenging financial conditions by using a financial stress test. The test is a technique for predicting the worst-case scenario before planning for it, which makes it particularly helpful in unpredictable times like our current inflationary environment. The primary advantage of doing one is that it enables you to make plans for the future, so you don’t have to wait until a risky company situation occurs.
A stress test is guided by two main questions:
- Do you have enough money to last through a slump of up to two years?
- Are there any impending dangers that could have a negative effect on sales?
You must run certain numbers in order to determine the solution.
How to conduct a financial stress test
Start a spreadsheet with three columns for the greatest results.
List all of the revenue—recurring revenue—that you anticipate generating over the course of the following year in the first column. List all of your estimated costs for the same period in the second column. List your accounts receivable—i.e., money you’ve already invoiced for but haven’t received—as well as the balance in your company checking account in the third column.
After that, add up each column’s values. Then, take the difference between your expected income (column No. 1) and your expected costs (column No. 2) to determine if your company can survive on the money it is receiving. You’re currently in good financial shape if the number is positive. And if the result is negative, you may add to it with the information in column 3 to see if you can make the result positive. But in the long run, you might need to do more.
You should take precautions to avoid burning through your bank account soon if your basic financial stress test indicates that you will. You can take a multitude of actions, such as:
- Setting spending priorities and making savings where possible.
- Implementing a hiring moratorium
- Pursuing extended payment terms with suppliers
Additionally, you may attempt to improve the income side of the situation by, for example:
- enhancing marketing and advertising to draw in new clients
- launching fresh products to reach new markets
- Establishing a line of credit as a fallback option in case your bank account is low.
Financial stress can result from a variety of things, such as unforeseen costs, poor sales seasons, and competition from bigger companies.
You may find potential issues early on and make the required adjustments to keep your firm solvent by taking the time to conduct a financial stress test.
In other words, the business considered the best ways to guarantee that the incoming income in the first column of the analysis was rising to more than pay the costs in the second column.
A more in-depth financial stress test
There are several financial stress tests outside the standard three-column one that take market dynamics into consideration.
The stress test took into consideration both the absence of income and all of the debt the firm owed, including agreements for ad expenditure.
Despite the fact that you have no influence over the economy, proposed laws, or even your customers, by keeping an eye on what’s happening in and around your business, you may also identify signs that you may need to reassess your strategy in order to protect the financial stability of your enterprise.
Making better educated choices about your marketing and expenditures will help you make sure that your business is profitable long-term. You should know whether your finances can endure a downturn of up to two years.