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Back to Black – How to stress test your finances

By Todd Davison, MD of Purbeck Insurance Services

The most recent ONS survey data on the impact to businesses from Covid-19 offers reasons for positivity, but also underlines the severe impact the pandemic has had on business cashflow. While 30% of firms expected their workforce to decrease at the beginning of the pandemic, this fell to 10% in the most recent survey. Access to supplies has also improved for firms, since the start of the crisis. However, 75% of the businesses surveyed say their turnover is substantially lower than normal, a 4% increase from the first survey.

As a business solely focused on enabling business owners and directors to mitigate their financial risks through personal guarantee insurance, Purbeck has first-hand experience of the impact of COVID-19 on UK SMEs. In January, February and March, applications for personal guarantee insurance doubled year on year as small businesses shored up their defences.

Many of our customers have already contacted landlords and current loan providers to arrange a payment holiday and are utilising other measures such as the Job Retention Scheme and VAT deferral to alleviate short term trading concerns.

The Government’s support has been vital but the loan schemes in place have a shelf life; they must be used to sustain businesses rather than help them grow; and they may even impact a small business’s future ability to borrow.

As lockdown measures start to ease, businesses need to look at how they can recover and rebuild and the first step in that process is to stress test their finances. Only by going through this process can you really understand the measures that need to be taken to build financial resilience.

Stress testing business finances
• Look at cashflow and forward project how it might look in 30 days, 60 days and 90 days’ time to help identify any gaps in the working capital position.
• Take a realistic, optimistic and pessimistic view for each of those timelines.
• Consider the failure of a key customer or customers, the possibility of being paid late or the impact of a failure in your supply chain. This will provide a good idea of the business’s financial position in a range of potential scenarios.
• Look at your current ratio – that is your current assets compared to your liabilities which will help you understand your ability to meet short term supplier and HMRC obligations. This would apply if you have low gearing i.e. the low use of external debt such as bank loans.
• If you have slow moving stock you need to look at your liquidity ratio. Liquidity ratios determine a business’s ability to pay off current debt obligations without raising external capital.
• Target ratios of 1:1 or higher. You can even apply your own working capital buffer of, say, 20-25% to these ratios to get to a ratio of 1.25:1 to maintain an adequate level of contingency funding.
• If your business is highly geared, the current/liquidity ratios are important but also consider your debt-service coverage ratios i.e. the operational free cash flow (Earnings before interest, tax, depreciation and amortisation) your business is generating to meet repayment obligations to external debt providers including interest.

Additional Finance
Some businesses will want to invest in marketing, technology, machinery to support recovery and growth. Access to finance to fund this investment may not be easy – all the signs point to a lending market that will be more risk averse and therefore more demanding of Personal Guarantees as security against a loan.

If your businesses has already secured loans via CBILS or BBLS, when you start looking for additional finance, you will have to prepare loan interest/repayment serviceability to demonstrate you are able to repay your obligations with these loans in place.

Your choices could be limited as it is likely that many lenders will have a restricted credit risk appetite and focus on existing clients and forbearance measures. Furthermore, many non-bank lenders who are institutionally funded/wholesale funded may also be resistant to allow funds to be advanced to small businesses particularly if the lender has a credit impaired loan book.

The additional factor is that from 1 December this year, HMRC will become a preferred creditor in a business insolvency for certain HMRC debts. This will leave less funds in the pot to settle any outstanding business loans and offset any Personal Guarantees signed to secure finance, following business failure. This applies to where Personal Guarantees are attached to business finance facilities with floating charges and where Personal Guarantees are attached to unsecured business finance facilities.

Demand for Personal Guarantees
All this means that where finance facilities are available they are highly likely to demand a Personal Guarantees as a condition of the loan. Where finance is offered on the condition of a personal guarantee, Personal Guarantee Insurance should be considered. This covers up to 80% of the loan and can be a key tool in helping businesses build their confidence and financial resilience as part of the recovery process.

Part and parcel of cover is mentoring and support services to firms in financial distress. It is as much in our interests that we help businesses survive this crisis and indeed future challenges, as it is our clients.

There is little doubt that the value of personal guarantee insurance has really come to the fore in the last few months and this will remain the case as lockdown eases and the recovery process begins.

We are all looking to the numbers for signs of positivity. 28% of businesses in the ONS survey reported they had temporarily closed or paused trading, but by the latest survey, 37% had restarted trading. That figure should keep growing and as these firms get back to business they will be focusing on ways to build their financial resilience. A stress test of their finances would be a good place to start.