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Accounting & Audit Alert- Consider stress testing to lower risks

The pandemic and the ensuing economic turmoil have put tremendous stress on businesses. Many companies that appeared healthy on the surface, on their financial statements, quickly realized that they weren’t prepared for the unexpected. A so-called “stress test” of your company’s financial position and its ability to withstand a crisis can help prevent this situation from recurring in the future.

In general, stress tests evaluate a company’s ability to handle an economic crisis. A stress test includes the following three steps:

1. Determine the types of risks the business faces

Identify the operational, financial, compliance, reputational and strategic risks your company might face. For example, operational risks cover the inner workings of the company and can include dealing with the impact of a natural disaster. Financial risks involve how the company manages its finances, including the threat of fraud. Compliance risks relate to issues that might attract the attention of government regulators. Strategic risk refers to the company’s market focus and its ability to respond to changes in consumer preferences.

2. Develop a risk-management plan

Once you’ve identified these risks, it’s time to meet with your management team to improve your collective understanding of the threats facing the business, including their financial impact and the ability of your business to absorb that impact. In addition to asking for feedback about the risks you identified, encourage them to share any additional risks and projections regarding the potential financial impact.

From there, your management team can develop a game plan to mitigate risk. For example, if your company operates in an area prone to natural disasters, such as earthquakes or wildfires, you should have a disaster recovery plan in place. If your company relies heavily on a key person, you should develop a viable succession plan and consider purchasing insurance in case that person unexpectedly dies or becomes disabled.

3. Review the plan

Risk management is a continuous improvement process. New risks may emerge, old risks may fade away and the best-laid plans may become outdated over time. Meet with your management team at least annually to review copies of your current plan and consider updating it. If the risk management plan has been recently activated, ask for an assessment of its effectiveness and the changes that may need to be adopted in the aftermath.

We can help

A stress test can reveal blind spots that can affect your company’s future financial performance. This exercise is increasingly important in today’s unpredictable marketplace. While risk is part of operating any business, some companies are more prepared to handle the unexpected than others. Contact us for help conducting a stress test to assess your business’s risk preparedness and to identify and reinforce any vulnerabilities.