Stress Test

As banks undergo stress tests, shouldn’t your business do the same even without mandate? The Sarbane Oxley (SOX) Act of 2002 was put in place for public companies as a reaction to a number of major corporate and accounting scandals including those affecting Enron, Tyco International, Adelphia, Peregrine Systems and WorldCom. Privately held companies remain shielded from stress tests and SOX, but shouldn’t they subject themselves to tests ensuring the viability of continuity of their business models?

For a start, companies will need to better understand the key drivers behind their bottom line. Then different scenarios will need to be reviewed to understand the inherent risks. Following is a sample list of key drivers that would need to be subjected to testing:

• Sales: What portion is sustainable, comes from repeat business, or is dependent on one large account? Are your products diversified?
• Cost structure: Fixed versus variable. Does your company have a good understanding of cost per unit? Do you need Activity-Based Costing and allocations to better control your cost per unit?
• Debt structure: What was reasonable a couple of years ago might be obsolete now. Do you just trust your CFO’s opinion or should you get independent advice?
• Liquidity: How long can you survive a downturn?
• Brand and client satisfaction: How much can you downsize before service and delivery suffer, thus hurting you long-term image?
• Pricing: How healthy are your margins? Can you leverage pricing on a short-term basis to gain market share?

These are general drivers however every industry and in some cases every company has different drivers. Historical views are necessary but not enough. Companies need to leverage analytics and perform simulations to better understand risks.