Build a Stress Test / Downside Case
This guide shows how to build a structured downside or stress case in Model Reef by creating a separate model with pessimistic but plausible assumptions and then reviewing its impact on cash and valuation.
Before you start
You should have:
A Base Case model that you believe is realistic or slightly conservative.
Key financing structures modelled, including debt terms and any covenants you track.
A view on what constitutes a plausible downside, for example demand shocks or margin compression.
If financing is not yet modelled, see:
Build a Capital Structure Model
Build a Debt Schedule and Covenants Model
What you will build
A dedicated downside model with:
Lower revenue or unit growth.
Weaker pricing or higher direct costs.
Potentially higher Opex or delayed cost savings.
A view of stress impacts on:
Cash and working capital.
Leverage and coverage metrics.
Valuation and investor returns.
Step 1: Identify downside drivers
Decide which assumptions you want to stress, for example:
Revenue and volume:
Slower customer growth.
Higher churn.
Pricing and margin:
Discounting to maintain volume.
Supplier cost increases.
Operating costs:
Delayed cost reduction programmes.
Funding conditions:
Higher interest rates.
Less flexible refinancing options.
Write down a narrative for the downside scenario so changes are coherent.
Create a downside model from the Base Case
Duplicate the Base Case model.
Rename it clearly, for example:
Company - Scenario - DownsideorCompany - Stress Test.
In the new model, adjust assumptions according to your downside narrative.
Try to keep the changes structured rather than random, so the scenario tells a clear story.
Adjust revenue and margin drivers
In the downside model:
Reduce growth in unit or customer drivers.
Introduce or increase churn where applicable.
Modify pricing and cost per unit drivers to reflect:
Discounting.
Supplier price increases.
Check that revenue and gross margin paths reflect a materially weaker environment compared with the Base Case.
Adjust costs, capex and working capital if relevant
Depending on your narrative:
Increase Opex in the near term if cost cutting is delayed.
Reduce or delay growth capex if expansion plans are scaled back.
Loosen working capital terms if customers pay later or stock levels rise, by increasing delays and inventory-like behaviour.
The aim is not necessarily to make all assumptions worse, but to build a realistic pattern of how management might respond under stress.
Examine cash, leverage and coverage
With the downside assumptions in place:
Open Cash Waterfall and Cashflow Statement:
Look for periods where cash becomes negative or dangerously low.
Check Change in Net Working Capital to see how much cash is tied up.
Review Balance Sheet metrics:
Net debt.
Leverage ratios if you track them.
Review coverage metrics in any debt or covenant dashboards you maintain.
This shows whether the business can survive or what mitigating actions might be needed.
Interpret valuation in the downside
Open the Valuation outputs for the downside model and compare to the Base Case:
Project NPV and IRR.
Equity NPV and IRR.
Money Multiple.
Payback period.
Consider whether:
Investor returns remain acceptable under downside.
The deal or strategy is still attractive given the risk profile.
You may choose to track both Base and Downside valuations as part of decisions around fundraising or acquisitions.
Check your work
The downside model is fully consistent and balanced.
Differences from Base Case are deliberate and traceable.
Cash trajectory and leverage look materially more pressured than in Base Case.
Valuation metrics reflect the increased risk and weaker performance.
Troubleshooting
Related guides
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