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Would your business finances pass the stress test?

A financial stress test considers an organisation’s ability to withstand a crisis. Large international banks have been stress testing their own balance sheets for decades, and more recently, financial regulators around the world have been carrying out their own stress tests to examine the robustness of banks.

Although small businesses don’t need to carry out complex stress tests, they should at least consider how various crises might affect their finances, suggests Becky Ames, small-business advisor and partner at chartered accountants Larking Gowen.

“Small businesses are often faced with problems that come out of the blue and threaten their financial health and well-being,” she explains. “Sadly, in the most severe cases, some businesses don’t survive.”

Risk analysis

Carrying out basic ‘stress tests’ might enable a small business owner to better understand the risk they face. “With more minor risks, protecting your business is more achievable,” she adds.

Ames says risks can include losing a major customer or key employee, currency fluctuations or a new competitor emerging, ones that might be larger, more established and better resourced than you, which can impact your sales.

“Your costs could suddenly rise significantly, affecting your cash flow and profitability. A key supplier might suddenly go out of business and you might not get the same value from a new supplier. Threats vary and you need to think about which ones your business faces and their likely impact on your business finances.”

What if?

Ames identifies rising costs as a key issue for many of her SME clients. “Fuel is just one example. If you’re a haulage business, a sudden increase in fuel prices can really put pressure on your cash flow.

“Other costs are rising, too. Ask yourself what if one of your main suppliers suddenly increased their costs by 5%? Or 10%? Or 15%? What if you were suddenly getting less value for money when buying stock from overseas, because of the value of the pound? Could your finances withstand that?

“There are many things to consider when stress testing. What if you lost a major customer or your general sales suddenly fell by 10%, 20% or more? What if you’re the only person who works for your business and couldn’t work for a few months because of sickness or injury?”

Mitigating risk

Ames recommends taking steps to mitigate risk where possible. “Waiting until something goes wrong might mean you’ve left it too late. Have contingency plans. Cut your costs where possible. Tighten up your credit control. Have appropriate insurance if it could help you to withstand a serious problem. Try to attract new customers if you’re too reliant on one or two. Don’t rely too much on a limited number of suppliers, markets or employees.”

Stress testing your business finances, even in a basic way, can give you a much better understanding of potential threats and how to mitigate them. Ames adds: “If more extensive analysis is required, a qualified accountant with experience of working with small businesses might be able to help you find ways to mitigate financial risk.”

Related articles:

How to cut costs in a small business

The seven golden rules of cash flow management

Next step:

Use the HSBC online business plan tool to create your own business plan