From trade treaties to people movement and exchange rate volatility to logistics, the range of Brexit concerns for Irish business are significant. Given the ever changing predictions on what the final outcome may look like, it’s tempting to take a ‘wait and see’ approach.
In the face of such uncertainty, our approach is to encourage businesses to scenario plan for various outcomes with an emphasis on worst case scenarios. In order to achieve this, key aspects of the business that are at risk from Brexit process should be identified, followed by assessment of potential extent of the impact on each area and on the business as a whole.
Depending on the extent of UK sourced content in your supply chains for example, or the location of certain operations, Brexit could pose fundamental questions. Consider what it will cost to serve customers in certain markets and, by extension, how you strategically approach those particular markets, product lines and customers post Brexit.
With a two year headline timeframe set for the negotiation of a post- Brexit trade agreement between the UK and the EU, the time has come to uncover the detail of what Brexit actually means for your business.
Would re-introduction of trade tariffs and VAT impact on the viability of the business and if so to what extent?
How exchange rate volatility on the various strands of the business would actually manifest themselves? Would this impact on overall performance? These are some key questions that businesses must face.
Although initially the concept may seem daunting, the process is best approached in a structured and rationalised manner. Relevant financial data of the business is gathered, including actual financials per accounts and future financial projections for the relevant time frame based on management assumptions. The relevant scenario term can usually span from 3 or 5 years up to 20 years, depending on the industry sector, asset useful economic life and/or financing structure.
Separately, a financial model is constructed to mathematically represent the performance of the business. This can be prepared in-house or outsourced depending on the level of financial modelling expertise in the organisation. A model is usually bespoke to a business and takes into account specific parameters relevant to that business. Typically the model includes Profit and Loss, Balance Sheet and Cash flow reports along with a dashboard presenting targeted graphs and key performance indicators (KPI) selected by management as critical business drivers to monitor.
A model is constructed with a key set of variable parameters (inputs) which can be changed as required, whilst the construction of the underlying mathematical model remains unaltered. The business can then assess various ‘stress cases’ to identify the impact of changes to various parameters on the business versus the base case (un-stressed scenario). This allows prediction of the outcome on the business as a result of the change or ‘stress’ should it occur.
Some key variables (inputs) which may be particularly useful to run stress scenarios on include – exchange rate movements, haircuts to revenue and/ or asset disposal values, changes to tax or depreciation policy and interest rate movements on debt. However the options are vast and specific parameters are usually set for the unique business needs. Usually, key error flags are also incorporated to trigger when an undesired outcome has occurred. This will target management attention to the event to avoid miscommunication or misunderstanding when interpreting financial results.
The outcomes of various scenarios should be assessed to determine overall impact on the business. Some main areas of focus include impact on debt covenants and cash flow over the term of the model. Other key variables to monitor include gearing ratios, debt service cost ratios (DSCR), internal rate of return (IRR), weighted average life (WAL) and maturity term of debt.
In light of the array of potential impacts that the Brexit process will inevitably carry in tow, there is no doubt that a sophisticated financial model which accommodates scenario analysis will serve as an invaluable tool to management in order to navigate their business decisively through the complexities in the period ahead. In short, forewarned is forearmed.