Updated: May 11, 2020
(10 Simple Steps To Emerging On The Other Side)
In every recession we hear calls from the Fed for banks to run stress tests (Here's a recent example press release from them on the topic). These tests help managers understand the various scenarios that could become reality in the future and what their organization might look like if they do.
Every private company manager, owner, and board should be doing this now.
Top consulting firms are increasingly, and wisely, giving guidance that non-bank companies should run stress tests as well. As unprecedented fluctuations in our economy unfold and we hopefully edge closer to a post-Covid world, every private company manager, owner, and board should be doing this now. While the term “stress test” has become synonymous with big banks and might sound overwhelmingly complicated, it doesn't need to be. Running a stress test on your business can be surprisingly easy.
The steps below may appear complex, but our companion spreadsheet with all built in Excel formulas provides a simple platform from which to get started. If you’d like a copy, please reach out.
...The next step is the sensitivity analysis. This step is the crux that sets what you are doing apart from almost all other financial analysis you’ve done on your business.
Most business owners should be able to run through the below steps without much trouble. If you usually leave the details to your accounting or finance folks, then pass this on to them or give us a call for assistance. The important thing is that this gets done.
If you already have a 3-statement (income statement, balance sheet, and cash flow statement) pro forma, which you should, then running the stress test will be as simple as adding some functionality to that. We use Microsoft Excel's “Data Table” function to run the mechanics and a bit of understanding about the business to determine which variables to plug in. Just as owners of businesses with any type of asset or liability (which is most of them) need to understand all three of these statements to understand true value creation (more on this here), a comprehensive stress test needs to run through all three statements as well.