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a blog by Chris Barrow

Don't borrow money without a sensitivity analysis

There are lots of people asking me similar questions at the moment - those who are considering taking advantage of what appears to be a dental boom economy.

The questions are - "should I borrow money to....

  • open and kit out an extra surgery;

  • extend the property;

  • acquire a nearby practice that has come up for sale;

  • open my own private squat?"

The answer is always - "yes provided.."

Provided what?

Provided you have conducted what the accountants call a "sensitivity analysis".

That's a cash flow forecast that identifies the cost of servicing the debt as an addition to your running costs and the increase in productivity necessary to maintain your profit levels.

However, there is a little more to it than that.

It is called a sensitivity analysis because, done properly (and most people don't), the cash flow forecast has a number of iterations (versions) that take into account best case and worst case scenarios.

What happens if everything goes:

  • Better than plan (sales are high and costs are low);

  • On plan (sales and costs are as projected);

  • Worse then plan (sales are lower than expected and costs are higher);

  • Catastrophically wrong (take your pick - more lockdowns, hyperinflation, credit crunch, legislation, regulation, lack of consumer confidence, recruitment).

Some others have described these scenarios as BPO (best possible outcome) and WPO (worst possible outcome).

The challenge with business plans and financial forecasts is that, because we become enthusiastic about our own ideas and projects, our tendency is to focus on the BPO all the time.

I'm not being a party-pooper when I counsel my clients to base their decision-making on a WPO sensitivity analysis. What I'm simply doing is helping them to limit their downside if things don't go according to plan.

Now is a classic time to be considering WPO - business is booming, inflation is rising and we are all getting carried away with Freedom Day and football, with house price inflation and new car registrations. Classic signs of an impending cycle-shift.

Just be careful. It's OK to borrow money to grow your business but it's not wise to be caught with your financial pants down if the economic conditions take a turn for the worse.

Do the analysis (or ask me to help you do it).

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