One of the most basic tools in business finance analysis is stress testing. The goal of a financial stress test is to assess how well a company is likely to perform under adverse, turbulent, or unforeseeable circumstances. Simply put, a stress test asks whether a company is likely to survive rough financial waters. You probably want to know how a stress test will work, so here are the basics.
Independent Testing
Most companies will want to hire a business finance consultant to conduct the stress test. Foremost, you'll get an independent perspective. The consultant will use their models to analyze how well your business might weather a variety of scenarios.
Working with an independent professional reduces the risk of bias in business finance analysis. Even if you have qualified staff members who know how to conduct a stress test, it's best to distance them from the work product. They can assist the consultant with retrieving data, but they should provide any input that might skew the model or the analysis.
Financial Modeling
A financial model can assess the potential impact of numerous macroeconomic and microeconomic factors. For example, a company will typically want to know how well it can expect to weather a prolonged global economic recession. A consultant can analyze how a drop in demand could affect the company's finances alongside shifts in commodities prices.
Stress testing extends to many other factors. You might wonder how costly an expansion effort could be. A consultant can assess whether your company has the financial means to handle accelerated growth. If not, the analysis might include recommendations on how the company can reconfigure its finances to allow expansion. Consultants can also analyze the impact of changing tax regimes, new competition, and fluctuating interest and exchange rates.
Projections
Much of the analysis hinges on projecting worst-case scenarios. For example, many models will try to calculate how well a company would survive something like stagflation. This is a recession scenario where inflation accelerates while the macroeconomy fails to expand. If a company's finances project to survive a stagflation scenario, then there's a pretty good chance the firm will weather most other scenarios, too.
Notably, a company may have micro factors that affect how it might perform in different environments. Some businesses are more sensitive than others to commodity prices, supply shocks, financial crises, or cultural trends. A business finance consultant will develop projections that account for a company's unique economic sensitivities.
If you need a business finance analysis, reach out to a consultant near you.
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