Run a Stress Test to Gauge Your Franchise’s Financial Resiliency
The drumbeat of recession is getting louder every day.
According to a recent article in The Wall Street Journal, two-thirds of economists at 23 major financial institutions expect the U.S. to experience an economic downturn in 2023.
If those predictions come to pass, are you and your franchise ready to weather the storm? To find out, we can adapt a common medical test and apply it to the business world to look for clues.
Why a “Stress Test” Can Help Recession Proof Your Franchise
A physical stress test measures your body’s ability to handle exertion — how your heart responds to walking briskly on a treadmill, for example. Doctors use stress tests to gain insight into a patient’s heart health in a controlled clinical environment.
A “franchise stress test” can provide insight into the health of your franchise, too. Do you know how your business would fare in the face of stressors like declining revenue, increasing costs and volatile interest rates? If not, you should!
Subjecting your franchise to a stress test serves two important purposes.
The first one is internal. Running your business requires that you have an accurate picture of your financial health. A stress test can help you spot weaknesses before they become more serious, and help you take steps now to find remedies before they become more urgent.
The second is external. Your creditors and investors are likely to become more cautious if we fall into a recession and require additional financial analyses and more frequent financial reporting. Similarly, creditors may want a deeper look into your ability to meet ongoing financial obligations and debt payments.
A stress test arms you with the information you need, so you’re ready to have these conversations with your internal team and external stakeholders when and if the time comes.
Franchises in Particular Need the Insight a Stress Test Can Bring
For franchisees, a stress test is particularly important for a number of reasons. Unlike most other small business owners, you’re bound to a franchisor who dictates many of your actions.
Perhaps your agreement stipulates that you update your equipment or facilities on a certain schedule. These are expenses that you must incur regardless of the economic climate.
You’re also limited in your opportunity to generate revenue from new sources. You can’t start selling cheeseburgers if you’re a cookie franchise, for example. This means you have to make do with whatever sources of revenue the franchisor supplies as part of your franchise agreement.
Also, if your franchise is considered a luxury or a non-essential item, your product may be among the first to be left behind if consumers begin cutting back to save money.
How to Run a Stress Test on Your Franchise
Step one for running a stress test to gauge the health of your business is to introduce a “shock,” or an event that creates instability. Shock events must be substantial and more than just a blip on your radar.
For instance, you could project the effects of an immediate, 50 percent drop in revenue or a steep downturn in your membership base. Continue the exercise to model the impact of a sustained decline in revenue over several years. How would you support your business under those conditions?
Step two is to brainstorm options for coping with the shock you have modeled. How would you stay afloat? What would it mean for cash flow? Would you have to cut staff, increase prices, decrease membership fees? How long could you hold out? How could you financially cushion any losses? How could you supplement revenue? Would a capital infusion from you and/or outside investors be necessary?
During this exercise, it will be most useful if you keep other aspects of your business constant so you can evaluate only the effects of the initial shock. Done correctly, a shock/stress test like this can even help identify opportunities to grow your business. If you could turn to them in a time of crisis, why not turn to them now when times are good?
You may even want to make running stress tests a regular part of your business regimen – an exercise that helps you understand both the business’ vulnerabilities and opportunities ahead.
Take the Financial Health of Your Franchise to the Next Level
Stress tests are great, but if you’re ready to take the health of your franchise to the next level, RKL Virtual Management Solutions can help you get there. We can help develop solid financial models and projections to put you in a better financial position today, so you’re ready to thrive no matter what the economy has in store tomorrow.
And if you already outsource your financial management to us, even better! Armed with our unique knowledge of your business model and your historical data as well as our franchise accounting expertise, we can help you foresee and tackle challenges before they even arise.
To learn more about how to recession proof your franchise or conduct a “franchise stress test,” reach out to your advisor or use the form below to contact us today.
