This article is part of our collection on Leadership and Management
The coronavirus pandemic has plunged businesses across the UK into a precarious position. We explore how to stress-test your business and what to do to improve its resilience.
Last updated: 13 May 2020 6 min read
While many things may feel out of our hands during this period of uncertainty, there are certain financial stress tests that businesses can apply to make sure they are operating from a point of full awareness about their financial position.
At the heart of the matter is cash flow. Even without the threat of coronavirus, many profitable businesses have gone under because they didn’t keep a close enough eye on cash flow. Which is why Alastair Thomson, finance director for a portfolio of SME clients and author of Cash Flow Surge, advises that a forward forecast is vital.
“It gives the business owner a clearer idea of their funding needs and allows a conversation with their bank in good time to cover any shortfalls in cash flow or cover any potential breaches of existing lending limits,” he says.
When looking at your cash-flow forecast you need to bear in mind that nobody knows how long the coronavirus pandemic will last.
“We should plan as if it will be autumn at the earliest,” advises Robert Hanna, managing director of litigation funder Augusta. “Owners should look at their cash flows over the coming six months with a fine-tooth comb and you should stress-test this by modelling that some of your debtors will sadly become less reliable than they may have been in the past, through no fault of their own.”
Todd Davison, MD of Purbeck Insurance Services, which provides personal guarantee insurance to small business owners and directors, recommends taking three views of your cash flow: realistic, optimistic and pessimistic. “Consider the failure of key customers, the possibility of being paid late or the impact of a failure in your supply chain,” he advises. “You will then have a good idea of the business’s financial position in a range of potential scenarios.”
He also recommends looking at your current ratio (ie your current assets compared with your liabilities) as this will help you understand your ability to meet short-term supplier and HMRC obligations. “This would apply if you have low gearing – that is, the low use of external debt such as bank loans,” he says.
Davison adds that if you have slow-moving stock, you should look at your liquidity ratio, which is your cash divided by your short-term borrowings. “Liquidity ratios determine a business’s ability to pay off current debt obligations without raising external capital,” he explains. “Ideally you want to target ratios of 1:1 or higher. You can even apply your own working capital buffer of, say, 20% to 25%, to get to a ratio of 1.25:1 to maintain an adequate level of contingency funding.
“Otherwise, if your business is highly geared, also give consideration to your debt service coverage ratios – that is, the operational free cash flow (earnings before interest, tax, depreciation and amortisation, or EBITDA) your business is generating to meet repayment obligations to external debt providers, including interest.”
For a large number of businesses, these stress tests will highlight some issues. If this applies to you, you’ll need to find ways to ease the pressure.
Davison recommends contacting landlords and loan providers to arrange a payment holiday. You can also seek support from the government, which ranges from the Coronavirus Job Retention Scheme to the Coronavirus Business Interruption Loan Scheme. Further details of these can be found at businesssupport.gov.uk .
If you decide to take advantage of the job retention scheme – which allows you to furlough workers, with the government paying 80% of each person’s wages up to £2,500 a month – you need to ensure you follow the correct procedure.
“Owners should look at their cash flows over the coming six months with a fine-tooth comb”Robert Hanna, managing director, Augusta
“Advice from specialist employment solicitors and HR advisers is going to be essential to minimise any potential claims down the line, for example, failing to consult about changes in employment status or the failure to treat all employees fairly and equally,” says Alastair Thomson.
For many businesses, HMRC is a significant recurring creditor. Davison recommends engaging with HMRC and, if necessary, looking to agree a Time to Pay arrangement to help ease immediate cash-flow concerns.
He adds that you should review your insurance cover and consider whether existing insurance policies potentially provide coverage for loss of business income and protection of personal assets in light of the coronavirus pandemic.
“While it is sadly unlikely that you will be able to claim on business continuity insurance, if you already have personal guarantee insurance in place, ensure you are making the most of the business support services offered to firms in financial distress,” he says.
Finally, remember that the current situation will not last forever and you need to be prepared for a possible upturn in business.
“I do believe that businesses can flourish again as things eventually settle,” says Gary Hemming, commercial lending director at ABC Finance. “Cash flow isn’t only tested as your business slows down; you also need to be ready to ramp up stock quickly as we come out the other side, or for increased demand during the crisis if your business is seeing an upturn.”
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Leadership and Management