What Would a Stress Test of Your Organisation Show?

Even those who do not closely follow the news will have noticed that the world, and the economic environment in which organisations operate, appears increasingly volatile and exposed to a wider range of risks. Universities, charities and housing associations know many of these pressures first-hand. Rising costs, uncertain income, changing demand, funding constraints and higher borrowing costs can place strain even where the underlying financial position remains resilient.

In this environment, financial stress testing can provide a clear view on an organisation’s capacity to withstand shocks. Although stress testing is sometimes associated with extreme downside scenarios or organisations approaching failure, its purpose is usually far more constructive. A well-designed stress test can demonstrate where an organisation is financially strong, identify the assumptions on which that resilience depends and help boards determine which risks should be monitored closely.

It can also provide assurance. An organisation that performs well under a demanding scenario can demonstrate to trustees, lenders, and other stakeholders that it has sufficient liquidity, reserves, and financial flexibility to respond if circumstances change.

To explore this topic, we reviewed the published accounts of 30 randomly selected organisations: ten universities, ten housing associations, and ten charities. We modelled how a prolonged income shock over three years could affect these anonymised organisations, considering the potential implications for liquidity, investment sales, borrowing and financial reserves.

What did the model test?

The model used the latest available year of published financial information as its starting point. We then applied the following assumptions: income would be 3%, 5% and 7% below the base year in Years 1, 2 and 3 respectively, while expenditure would increase by 1% each year. This represents prolonged pressure rather than an immediate crisis. It assumes normal cost control but no major restructuring, exceptional savings or other significant action.

The model assumed a set order for meeting funding needs. Organisations would first use short-term resources remaining after current liabilities and a 30-day liquidity buffer, then available long-term investments and, finally, additional borrowing.

What did the model show?

Under the scenario, ten organisations were classified as resilient, thirteen as pressured and seven as vulnerable based on the financial state of the organisation after three years. A resilient organisation retained its minimum liquidity buffer without selling investments or borrowing. A pressured result indicated limited headroom or a need to use investments or borrowing. A vulnerable result meant the modelled resources and indicative borrowing capacity did not meet the requirement, or that loss-absorbing reserves were exhausted.

These are indicators of relative resilience, not predictions of failure. The useful question for a board is which category its organisation might occupy, why and how quickly that could change. Management would normally respond before the full impact developed.

Different sectors, different pressures

Universities largely occupied the middle ground, with three resilient, six pressured and one vulnerable. Seven required some additional borrowing, although only one had a residual gap after applying the balance-sheet proxy. This points more towards gradual liquidity erosion than immediate balance-sheet weakness: valuable estates and substantial net assets do not prevent cash or refinancing needs if deficits persist.

Housing associations performed more strongly overall, with four resilient, four pressured and two vulnerable. Six required no additional funding during the scenario. However, their larger asset bases should not be confused with available cash. Social housing properties are operational assets, may already be pledged as security and cannot necessarily be sold without regulatory and service-delivery consequences. The vulnerable results also show the importance of starting leverage and existing headroom.

Charity outcomes were the most widely dispersed, with three resilient, three pressured and four vulnerable. Income may depend on donations, grants, contracts and legacies, while reserves may be restricted or designated. The model did not use reserves to fund deficits; a sector-adjusted share of net assets was only a loss-absorption check. Outcomes therefore reflected accessible resources and operating pressure, not an assumption that all reserves were spendable.

What does a detailed stress test add?

This exercise uses published accounts and standardised assumptions. It is a useful external screen, but not a substitute for detailed cashflow analysis. Annual accounts do not necessarily show payment timing, restrictions on cash, investment maturities or whether borrowing facilities remain available.

A full review would model more frequent cashflows and separate individual income and cost drivers. For universities, this might include student recruitment, continuation rates, research funding and accommodation occupancy. Housing associations might test rent arrears, voids, development sales and repairs expenditure. Charities might examine donations, contracts, grants and restricted income.

The analysis should also consider:

• accessible and restricted liquidity;
• investment maturity and settlement periods;
• working-capital delays;
• debt covenants and refinancing dates;
• committed capital expenditure;
• combinations of adverse risks; and
• realistic management responses.

Reverse stress testing can be particularly valuable. Rather than asking only what happens if income falls by a predetermined percentage, it asks how far income could fall before liquidity, covenant or funding thresholds are breached.

More advanced techniques include historical scenarios or probability distributions, including Monte Carlo analysis, to show a range of cash, borrowing and covenant outcomes. They can also focus on individual subsidiaries, service lines, developments or planned expansions, helping boards assess downside risk and project affordability. Added complexity is useful only where assumptions are robust. Standard scenario testing can also explore specific operational risks by asking practical ‘what if’ questions, such as the failure of an operational bank, the withdrawal of a major donor or the cancellation of grant funding.

How Arlingclose can help

Arlingclose can support universities, charities and housing associations with independent financial resilience and liquidity stress testing.

Our work can bring together cash flow forecasts, investments, borrowing, covenants, reserves, capital plans and management actions into a controlled and decision-focused model.

The result provides management teams and boards with a clearer understanding of their financial capacity, the risks that require monitoring and the actions available if circumstances begin to move away from plan.