The pandemic and the ensuing economic turmoil have put tremendous stress on businesses. Many companies that appeared healthy on the surface (on their financial statements) quickly realized they weren’t prepared for the unexpected.
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A so-called “stress test” of your company’s financial position and its ability to withstand a crisis can help prevent this situation from recurring in the future.
3 Steps of a Stress Test
In general, stress tests evaluate a company’s ability to handle an economic crisis. A stress test includes the following three steps:
1. Determine Your Risk Categories
Identify the operational, financial, compliance, and strategic risks your company might face.
Operational risks cover the inner workings of a company including people, policies, processes, and systems. Physical events, including dealing with a natural disaster, also are considered operational risks. The great resignation will continue to impact businesses as they struggle to recruit and train qualified staff. The additional onboarding results in less staff time focused on growing the business.
Financial risks involve how a company manages its finances, including the threat of fraud. Inflation will continue to have an impact on financial performance. Managing the cost of materials and when to increase prices will be a continued focus. With the threat of a recession and struggling economy, market and credit risk will need to be monitored.
Compliance risks relate to issues that might attract the attention of government regulators. Failure to comply with industry laws and regulations, internal policies, and industry best practices are included in the compliance risk category. These can cause a loss in company reputation, business opportunities, and business value.
Strategic risk refers to a company’s market focus and its ability to respond to changes in consumer preferences. Supply chain issues, increased costs of raw materials, and lack of inventory will continue to be a challenge through 2022. With all the focus on these issues and surviving the day-to-day, there is a risk of less focus on innovation, leading to stagnant business practices.
2. Develop a Risk Mitigation Strategy
Once you’ve identified these risks, it’s time to meet with your management team to improve your collective understanding of the threats facing the business, including their financial impact and the ability of your business to absorb that impact.
In addition to asking for feedback about the risks you identified, encourage them to share any additional risks and projections regarding the potential financial impact.
There are five risk mitigation strategies:
After identifying your risk factors, discuss how to handle them and which strategy fits each need. Some risks can be avoided or controlled, others you will need to accept as part of your business model.
From there, your management team can develop a game plan to mitigate risk. For example, if your company operates in an area prone to natural disasters, such as earthquakes or wildfires, you should have a disaster recovery plan in place. If your company relies heavily on a key person, you should develop a viable succession plan and consider purchasing insurance in case that person unexpectedly dies or becomes disabled.
3. Review the Plan
Risk mitigation is a continuous improvement process. New risks may emerge, old risks may fade away, and the best-laid plans may become outdated over time. Meet with your management team at least annually to review copies of your current plan and consider updating it.
If the risk management plan has been recently activated, ask for an assessment of its effectiveness and the changes that may need to be adopted in the aftermath.
We Can Help
A stress test can reveal blind spots that can affect your company’s future financial performance. This exercise is increasingly important in today’s unpredictable marketplace.
While risk is part of operating any business, some companies are more prepared to handle the unexpected than others.
Contact us for help conducting a stress test to assess your business’s risk preparedness and to identify and reinforce any vulnerabilities.
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