Stress Testing Financial Models

Stress testing models is essential practice for successful financial modeling.

Follow these five steps to test the functionality of any three-statement model.

1. Firstly, look at the numbers

The best way to do this is on a print out away from the computer. Does it LOOK right? Are there any strange trends?

2. Stress test all the assumptions which are flat lined or zero

If the model has excess cash in every year force it to have a revolver by changing assumptions and vice versa.

3. Make a change to the operating profit of the company and see if it flows through

Do earnings go up by the profit less tax? Does retained earnings go up by earnings less tax and dividends, and does cash go up by a similar amount?

4. Make a change to sales

Do receivables, accounts payable and inventory all rise?

5. Use sparklines to the right of the last column to track trends visually

Does anything look strange or inconsistent?

Got any other questions? Leave a comment below.