Can your business survive a 40% revenue hit?
Someone asked me recently how would he know if they had adequately disaster-proofed their business. That is, how much financial “stress” could be applied to the business without it failing? Could it survive a worst case event actually occurring?I asked him the same (drastic) question an old mentor of mine once asked me – can your business take a 40% hit to revenues and still survive? He thought it was unlikely. What about 20%? He wasn’t sure. 10%? Yeah, probably. I told him that he needs to find out if he is to answer his own question.
The answer lies in a company’s business plan and more specifically within its budgeting process. I’m not an accountant but I favour a multiple budgeting process (i.e. creating an optimistic budget, a realistic budget and a pessimistic budget). This allows you to flex your assumptions in and out depending on your level of optimism or pessimism. The items to flex will be based on your own assessment of future business risks but can include sales, margin, expenses, working capital (cash, debtors, stock) and capital management / expenditure. However, flexing sales is more important than anything else.
The Realistic Budget
The realistic budget takes the optimistic budget and applies a reality check to it. It determines what the reasonable risks are and adjusts the budget to reflect them. Essentially it assumes that some, but not all, of the risks identified in your business plan will occur. It also assumes that your risk mitigation strategies will mostly work. Depending on your business’ size flexing your sales downwards by 5-20% is a good start. This will drastically reduce your earnings and force you to consider improvement strategies for margins, expenses, working capital etc. If you can do this and survive or even prosper, then you’re in good shape.
The Pessimistic Budget
For the pessimistic budget take your realistic budget and reduce sales by 10-40%. The actual level of sales reduction will depend on your risk assessment but remember – be pessimistic! This will really stress-test your business and help determine how much you will need to downsize your cost structure to deal with a sales decline of this magnitude. The next stage is to determine where the savings will come from (or if, in fact, they are possible). If you can devise a mitigation strategy that allows you to trade successful with a 10-40% sales decline, then your business is solid.
You might find that you actually lose money in both the realistic and pessimistic cases. Most of the time things won’t get this bad, but they might. Knowing in advance what you’d had to do if you were hit by a 40% sales decline will improve your chances of survival (and success). Like my old mentor told me – it’s better to know this now rather than later on when you’re paddling for your life…