How Business Can Survive The Current Economic Downturn
The Key to Surviving the Current Economic Downturn
The pace of business is fast at the best of times. Unfortunately, the GFC has dramatically increased the speed at which business conditions can change which is forcing astute business leaders to undertake a range of risk management strategies to protect their businesses.
Market conditions are unstable, predicting the future is difficult and many executives echo the thoughts of Reserve Bank of Australia Board Member Graham Kraehe that ‘the economic climate has made forecasting earnings nigh on impossible’.
We are regularly seeing evidence of companies being sideswiped by a major change to their business and because they start to work on the problem after the event, by the time they have come up with potential solutions the impact has caused serious damage to earnings, cash flow and the overall viability of the business.
Regardless of the position your business is in, it is essential in our view to be undertaking detailed financial modelling and “what if” scenario testing to ascertain how various sudden changes in market conditions will affect your business and more importantly, what initiatives will management deploy to combat these challenges.
Stress testing in this context is about analysing base case and worst case revenue, margin and working capital scenarios in the current climate. Companies across Australia and overseas have been engaging in stress testing in order to agree on a range of initiatives in case market conditions deteriorate any further. In many cases they are engaging companies such as ours to ensure they have a totally independent and objective view when analysing the results. Independence and objectivity is even more important when it comes to devising the various strategies to restore earnings and cash flow.
Stress testing has a number of benefits including:
- It enables business to react quickly if conditions change suddenly.
- It forces business to ask ‘what if’ and create strategies to deal with given scenarios to minimise risk and maximize opportunity.
- It provides clarification around short to medium term capital requirements.
- It puts management in a stronger position if they need to negotiate with their financiers by showing they are prepared for change and able to handle challenges.
- It increases the confidence of key stakeholders.
- It will minimise the stress on the business when the tough decisions have to be made.
- It will provide management with an advantage over their competitors.
Rigorous stress testing has enabled organisations such as Brambles and Qantas to move quickly when market conditions suddenly changed. When yields slumped more than expected in March 2009, Qantas quickly slashed forecasts and initiated a range of dramatic measures to reduce operational costs. Although companies such as Qantas have been criticized it is the ability to rapidly respond to change that enables their survival.
The following is a selection of some of the key questions that will be posed if an effective stress testing program is undertaken:
- What is the new breakeven level for the business and how does it change from the previous level.
- What is the impact on revenue and earnings if you lost a major customer.
- If customers are demanding lower prices what is your tipping point and are you prepared to lose customers in order to maintain earnings. What changes will you need to make to your cost base to match the new lower revenue base.
- How is cash flow impacted if debtors take an extra 10 days on average to settle their accounts.
- Could there be a breach of banking covenants and if so, how will you respond to your financiers concerns.
- What changes will you require to your banking facilities and what would be your banks attitude to an increase in lending, if required.
- What decrease in staffing levels will be required and how will you deal with this (ie. move to a 4 day work week, pay reductions or retrenchments etc.). Do you have the cash flow to fund the expected redundancies.
- What overheads will you reduce and what capex plans may have to be put on hold to preserve cash.
- What non-core assets could be sold to reduce debt or provide additional cash flow.
- Are sales or productions levels too low to remain viable and would a merger or strategic partnership be required in order to maintain critical mass. If so, who would you approach.
Stress testing enables management to act nimbly when unexpected changes happen. This means that management can make prudent, sometimes lifesaving decisions very quickly. Those businesses that are able to adapt to change are the ones that will prosper in the future.
If you would like more information on how to conduct a stress testing program please do not hesitate to contact us.