A stress test will predict how something, whether it’s your heart or your business, will react under simulated strains.
As the year begins to wind down, many companies are putting the finishing touches on their financial and operations plans for 2012. Regardless of how far along you’ve gotten in your planning, you should consider adding a stress test if you haven’t done so already.
A financial stress test has much in common with the well-known cardiac stress test. In both cases, the goal is to determine how something—your heart or your business—will react under simulated strains while under the protection of a controlled environment. The process provides rich information as to the true health of the test subject such as underlying problems to be treated before they become acute crises. A stress test also helps determine where resources should be allocated to prevent future problems from occurring.
As Peter Drucker stated on numerous occasions, “The most serious mistakes are not being made as a result of wrong answers. The truly dangerous thing is asking the wrong questions.” An effective stress test measures your company’s ability to respond to acute and plausible situations that may arise. The “acute” part is important because it implies that the effect could be significant and your company will have little time to prepare in advance. The plausible part is equally important to avoid wasting time on the infinite universe of possibilities that could affect your business. Stress testing for a potential alien invasion might not be the best use of your time.
When devising your scenarios, it’s important to consider using a matrix approach that combines potential stressors at global, national, industry and company-wide levels.
Some examples of realistic and acute scenarios that you should consider stress testing are:
Global stressors
- The Euro as a currency collapses, leading to a global disruption of financial markets, a significant increase in interest rates and a severe credit crunch as U.S. banks rigorously try to compensate for their exposure to European sovereign debt.
- China decides to suspend its purchase of U.S. Treasury securities, favoring instead domestic investment to prevent a severe recession.
