Stress TEST YOUR BUSINESS!

Stress Test your business. The 2020 pandemic has wreaked havoc on the worldwide economy and businesses of all sizes. Not surprising, small business owners have suffered the most. Originally applied by regulators strictly to banks and other financial services companies, it is an equally relevant survival tool for small businesses of all types. This cash and liquidity analysis needs to be done sufficiently in advance to allow for the development of a plan for positive action and improved results. The goal is to understand how many months you can survive an assault on your cash and liquidity reserves. As we’ve seen, the current economic debacle has exposed a liquidity shortfall in many businesses. Many operate on a week to week or month to month basis. Any cash net income hiccup can be disasterous. While the SBA’s EIDL and PPP loans have injected needed capital into many businesses, a good number are already seeking additional funding as the pandemic continues longer than originally forecast.

The stress test goal is to quantify a negative economic event’s impact on your financial results beyond what you had been expecting. This event might be solely applicable to your business (a fire or loss of a major customer), or your industry (hospitality), or on an even broader basis as we’re experiencing with the 2020 pandemic crisis. This evaluation will help you measure the degree of cash and liquidity sources available to weather any temporary downturn.

As a rule of thumb, six to nine months of cash on hand and liquidity access will ensure a business’ survival of most events. A year or more is better, particularly if there is access to unused borrowing facilities. More seasoned firms may have built a larger retained earnings surplus. Some smaller firms will say that’s not practical or doable and that may be true. They operate knowing there’s no margin for even a single month’s cash loss. Every business owner should want to know how close they are to possibly going out of business because of insolvency. If there is no good way out, it’s better to know sooner than later. The reality of most business failures is that there wasn’t sufficient capital to remain a going concern. More than 50% of small businesses fail within their first few years for this very reason.

A Stress Test is essentially a cash basis evaluation of your business. It helps identify how long your business can remain cash solvent under less than normal conditions. Your 18 to 24 month future period pro forma or budget is the starting point for such a review. Using your forecasted financial performance, both income statement and balance sheet, you then superimpose such stressful events as a sales decline, a competitive price drop, a higher cost of goods sold, or an increase in operating expenses.

This more critical look quickly identifies whether the business will continue to generate actual cash net income. If not, then you’re in a net cash “burn” scenario drawing against your operating reserves. That’s where advance planning needs to kick-in. What revenue, expense, people, capex actions can be taken, easy ones first and, if necessary, then the more difficult decisions that have to occur to help your survival chances. It’s not enough to be resilient, to fight the good fight, it’s to survive such a catastrophic time period and go forward.

Projected Cash Sales – Jan – Mar$53,900$64,800$71,500
Select Stress Level: 5% Down = .050.050.10.15
Stress Cash Sales $51,205$58,320$60,775
Stress Test of Sales Decline

As illustrated in the sample above, the stress impact on this business was a three month reduction in sales (and cash) of $19,900 or 10.5%. Being able to quantify such a shortfall, in advance, is key to managing your way out of it. Western Equity can help your business create a stress plan and determine alternative strategies. Please contact us for more information.

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