Modelling Brexit Uncertainty with Jazoodle
Should the UK leave the EU without a trade deal, how will this affect your business? Brexit comes with many unknowns. We do know that should no deal occur, then some goods may attract World Trade Organisation tariffs (these are like a tax on goods at source). For instance, if your business sources goods from European suppliers, it is possible that your input costs could increase by the amount of the tariff imposed. For instance, if you are a florist in the UK and you buy your flowers from Holland, a no deal Brexit would likely mean that your flowers increase in the cost that you pay. If for instance your costs increase by 10%, what would that mean to your business? Equally, some tariffs will be removed on some goods, meaning your direct costs may reduce. Below, we give you some potential scenarios that you can model in your business very quickly, and very simply.
Log into the Jazoodle platform here
Once logged in, go to My Companies and click the “Connect to Xero” button and refresh your data. If you haven't yet connected your accounting platform to Jazoodle, see our support pages for detailed instructions
Go to the modelling tab and your latest forecast model will have been refreshed for the current year. Now you can assess some different Brexit scenarios.
Exercise 1 – Your Direct Input Costs Increase or Decrease (note we’re using demo data here for explanation purposes)
Go to the COGS slider and change this +/- %
Modeling a 10% tariff increase on direct costs
In this case, we've modeled an increase in Cost of goods sold by 10% and assumed that should tariffs of 10% come into force, this full amount is passed on by the supplier.
Instantly, you can see the forecast profit reducing by about half for this organisation. Click on the Profit and Loss drop down and select Balance Sheet:
If you look at the cash position in the balance sheet – (circled), you will see a dramatic reduction in cash available to, in this case, a significant negative figure
Now do this for your business.
What will be your projected year end cash figure? How will the changes to your direct costs affect your business?
Building a more complex scenario
We certainly do not expect any business to wear these costs alone. You can help model that too in Jazoodle. Let’s now suppose that you increase prices by 3% to minimise any reduction in demand – you know your customers will likely stand a 3% increase in price. On the revenues slider, increase these by 3%
How will your profitability and Cash Balance be affected..?
Check your performance metrics
Click on the health area of the model. Now look at your key solvency ratios by clicking on the Health area:
Look at liquidity ratios. You may see your liquidity levels reduce as a result of this – which, if cash is affected as we have discovered, would certainly be an area for concern. Now, how can we mitigate this…?
Check your performance metrics
Have a look at your aged debtors time under the Efficiency area.
In this case, our company on average, takes around 90 days to collect its client debts. We’ve already seen that a 10% increase in direct inputs from tariffs, and a 3% increase in revenues (price in this case) will lead to a significant negative cash position.
Now, suppose you implemented a policy to reduce your debtor days by 10 days ? 20 Days ? 30 Days? What would the effect on cash be in your business?
From the above, a reduction to about 80 days would mean that cash positions year end would be little more sustainable. Cash positions improve significantly as debtor days reduce. This is a great instrument for understanding how changes to your business, can mean big changes to the fundamentals of your business. in this case, by changing client payment terms, and reducing debtor days, this would in fact mean that, in this example, additional, and expensive and possibly risky, financing would not need to be made. The solution would in fact save you heaps of time and money in not having to add debt financing.
How are your other indicators doing?
Looking at some of your key ratios after this, we see negative changes to profitability measures, liquidity measures (even though we have shored up cash), and improvements to asset utilisation.
Whilst both net and gross margins have reduced from the impact of these tariffs, net margins are still positive.
Liquidity has fallen – because direct input costs have increased, therefore greater cash outpayments and trade payables increased:
But, we see that interest coverage, or the ability to cover its debt financing from reserves has actually increased, as the cash at bank figure increases (because you are more efficient in collecting client debts)
Pulling it all together
Now you’ve built your first scenario – it’s time to understand what this will really mean for your business. Remember, scenarios are not actuals, but they help you understand what could happen if a set of circumstances were to happen. Jazoodle allows you to do this quickly and painlessly. It also allows you to understand the impact on your business of multiple scenarios. For instance, it is prudent to build best, worst and mid range scenario. Understanding the impact on your business may give you time to put into place arrangements to help you deal with a particular scenario.
This could mean arranging a line of credit in advance and before you are likely to need it – financiers prefer you to do this. It could also mean changing your default client payment terms. You can model these too in Jazoodle.
Try modelling your business' Brexit scenarios
A no deal Brexit with 0% tariffs on COGS, but a general 3% increase in other overheads. Also think about modelling a downturn in revenues as a result of the wider economy going into recession. Try modelling a 5% reduction in revenues also
Expenses Slider Increase by 3%
Revenues Slider Decrease by 5
A Free trade Brexit, but uncertainty in the economy reduces spending by 1% / 5% / 10%
Reduce revenues slider by 1% / 5% / 10%
A Brexit deal with a boost to the economy and causes a 1% / 5% / 10% increase in revenues. At the same time, inflation increases and both direct costs and overheads rise by 3%
Increase Revenues Slider by 1% / 5% / 10% in turn
Increase COGS Slider by 3%
Increase General Expenses slider by 3%
Note down the effect of this scenario on your:
Cash Balance in the balance sheet
What tactics do you need to put into place to protect profitability? Protect or increase cash holdings? Protect your margins? Protect your liquidity? Protect your solvency? Protect your returns?
How will you generate sufficient cash levels sustainably? Can you reduce your receivables periods? Re-Negotiate longer payment terms to your suppliers? Can you increase debt financing?
Can you raise other equity from friends and family, other financial institutions? What effect will this have on your business?
What is the overall health score of your business after this model? Ensure it is above 1.8 for most businesses.
If it falls below this, you may need to enact other tactics to shore up your health, such as increasing revenues or an injection of equity into the business – NB, it is far better to be aware of such a scenario in advance rather than when you are panicking and desperate for a cash injection!