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July 28, 2022

Lowering Risks Through Stress Testing: A Smart Consideration

The economic rollercoaster that ensued after the pandemic began in early 2020 put many businesses through the wringer. While companies seemed financially stable on the surface, their financial statements revealed significant unpreparedness for the challenges they faced. 

Stress testing your organization can provide a comprehensive look at how well your financial position can withstand a crisis. This is an invaluable insight to avoiding difficult situations in the future. And if the last two years have taught us one thing, it’s to expect the unexpected.

Stress testing focuses on assessing your business's ability to navigate an economic crisis, and it typically includes these three steps: 

1. Identify What Risks Your Company Faces

In a stress test to evaluate threats your organization might face in the future, the following five risks are examined:

  • Operational
  • Financial
  • Compliance
  • Reputational
  • Strategic

Operational risks that must be stress tested include any liabilities that deal with the inner workings of your company such as how you would deal with natural disaster impacts. It’s important to assess how your company manages its capital to evaluate both financial and fraud risk. Compliance risks are especially worrisome, since they involve issues that could bring regulatory agencies to your doorstep. Strategic risks cover your company’s ability to adjust its market focus to react to changes in consumer markets.  

2. Risk Management Planning

Knowing your business risks is the first step. The next step is meeting with your management team to educate yourselves about these threats, the financial implications, and how well your business can absorb their impact. Be sure to get your team's perspective on the liabilities you've identified, including any others they are concerned about, along with any possible financial consequences.

From that point forward, you and your team can collaborate and develop an effective risk mitigation plan. For example, if your facility is located in a part of California frequently impacted by forest fires, having a disaster recovery plan is essential to making sure that your business can survive such an event. Or, you might consider having a succession strategy in place in case a key stakeholder in your firm becomes disabled or passes away suddenly. This could include taking out additional life insurance and training team members on the duties of other colleagues.

3. Evaluate Your Plan Regularly

Risk management is not a one-and-done process. It involves continuous adaptation to new risks that could emerge and updating your plan when old threats become a non-issue. Try to conduct reviews annually with your team and consider what updates are necessary. You should request feedback on recently implemented risk management plans and any potential changes that are needed based on that review. 

We're Here to Help

Stress tests help recognize the blind spots that hide threats to your company's future financial performance. With the marketplace becoming more volatile, we cannot stress enough the importance of this exercise. Indeed, there is always risk in running a business, however, those that take extra steps to prepare often handle the unexpected better than others. Reach out to us if you would like additional assistance in conducting a stress test on your company's risk preparedness to recognize and protect against any discovered vulnerabilities. 

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