Henrietta Royle, Operis chief executive, explains why the unprecedented financial crisis caused by the global pandemic is giving rise to a reappraisal of the robustness of financial models that are critical in the monitoring of businesses previously thought to be bullet proof.
Financial models are built to consider a wide range of possible futures, but those futures only include eventualities that were considered plausible at the time when the models were prepared. In most cases, a period of very low revenue, or none at all, is not among them. When revenue falls below costs, few forecasts are likely to handle it correctly.
For example, we have seen one model that understates the extent to which the owners will have to put their hands in their pockets by a factor of around eight and that’s assuming that the bank doesn’t call its loan in.
Force majeure clauses will likely stop it doing that. Even so, the owners will need to evaluate the unpalatable alternatives of bailing out the business, or letting their asset go bankrupt, and maybe trying to buy it out of administration.
To make this choice they need a model capable of representing these adverse scenarios. Government help may be available to keep the business afloat, but that too will need negotiating and modelling.
While the people best placed to prepare new financial models are those within a company who know it well, not all companies will have analytical skills and resources in the quantity needed to respond at speed.
One thing the crisis has done, which will be a lasting impact, is to make people much more conscious of the need to do real sensitivity testing on the robustness and resilience of their financial models – and to be capable of remodelling when there are major shifts in basic assumptions.
We have long campaigned for good standards of flexible, auditable financial models so that investors and developers can review and re-evaluate their positions when circumstances change. That has never been more relevant than at present.
