The “Stress Test” Sessions

We’d gotten urgent calls from two existing MacGillivray clients asking for help understanding the potential impact a major financial downturn might have on their businesses.

After giving it some thought, we decided to approach their Business Compass sessions with the idea that we were going to ”stress test” their businesses against deteriorating economic conditions (including declines in revenues, changes in cost structures, and slowing cash collections, etc). We did this by projecting their potential effect on their businesses, then developed possible contingency plans that could be put into action if those conditions became reality.

The results between the two sessions couldn’t have been more different.

In the first case, a major decrease in sales actually improves their cash flows in the short term - because it frees up cash that had been tied up in working capital (specifically inventory and accounts receivable). That took us a while to get our heads around!

We were able to quickly establish that they were well positioned to withstand an economic downturn, though cash collections would have to be carefully monitored and inventory levels managed on the way down. By the end of 2009, we projected that their operating bank line would be fully repaid and they would be left with a couple of million dollars in the bank. We hadn’t even factored in any cost savings through layoffs or other cost cutting yet. Not a bad place to end up a year into a recession. I can tell you that there was a visible sense of relief in the room when when we were finished.

The second case was quite different – A decrease in sales had major negative financial implications for them. They were a company that had grown significantly over the past 5 years and had historically been able to maintain a high gross margin on sales. They had always counted on sales to “replenish” their bank account on a regular basis. We projected that the amount of working capital freed up with decreased sales was not enough to offset the lower cash flows generated from sales. We projected that they would be unable to unable to support their current level of debt within 12 months.The realization that an economic downturn could hit them this hard was a nasty surprise to them.

The truth of the matter was that this business was far more exposed to an economic downturn than its owners had realized.  Armed with this information, they’ve begun putting plans into place to help them weather any storms that may appear on their horizon.

If you’re not sure how exposed your business might be to an economic downturn, we can help. Contact us at compass@macgillivray.com. You’ll sleep better.