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July 3, 2016

Model the Sensitivity of your Business to Brexit

The population have voted to leave the EU. The impacts will be many and varied, and “head in the sand” is not an option. Businesses need to review how their profitability might be affected by the changes that leaving the UK may bring.

This need not be the onerous. At the very least you should build a fairly simple spreadsheet of your business’ costs and incomes. It doesn’t need to be too detailed but it does need to distinguish between costs and incomes that arise in the UK, those that arise in the EU, and those that arise elsewhere.
Here’s what to do:

1) Income:

UK Income: Income from customers in the UK may be impacted by a downturn in the economy as a result of the vote. It is worth modelling what a 5%, 10%, or even 15% reduction in UK sales might have. Depending on your own industry sector you may wish to model different scenarios.

EU Income. The Brexit vote may have an impact on the pound to Euro exchange rate. This may boost sales to EU customers and it is worth modelling this. On the other hand, the vote may damage European economies as well as ours, and the impact on sales may be negative. Again, various scenarios should be modelled – zero change, and, perhaps, both a 5% and 10% increase and decrease in sales.

When we do finally leave the Single Market, then the impact of possible tariffs needs to be factored in. These will depend on industry sector.

Other Foreign Income. Again a fall in the exchange rate may boost sales from customers outside the EU. Depending on the business you are in, anything from a 5% to a 20% increase might be worth modelling.

Many of our trade deals with countries outside the EU may, currently, be EU wide deals. Thus exiting the EU may impact on the tariffs that have to be applied to sales to customers outside the EU.
Combined, these income scenarios could easily give 20 different possible variations, but don’t be put off by that. The important thing is the range that these scenarios illustrate. There will be a “worst” outcome (the greatest negative impact on income); a “best” outcome (the least bad impact on income); and a “most likely” outcome (the area where most of the income scenarios fall). These three markers can then be used to model against the expenditure scenarios to illustrate the possible impacts on profitability.
2) Expenditure

Again we need to separate costs into those which arise in the UK; those which arise from the EU; and those which arise outside the EU.

The scenarios which should be modelling are similar to those for income, except that the exchange rate impact will be the reverse of that for sales: if the pound exchange rate falls (potentially boosting foreign sales), the impact on the cost of foreign sourced goods and services will be negative. Thus we should model a potential increase in the costs of goods and services sourced from the EU and other foreign countries. The size of that possible increase will depend on the industry sector in which you operate, but a 5% and 10% increase in costs would seem to be the very least you should model.

Of course if other economies suffer as well as our own, the net effect on costs may be reduced

Once we do leave the Single Market, then the comments made above about tariff also apply to goods and services which are imported.

It is difficult to judge the impact on costs which arise in the UK. A slowdown of the economy may result in a reduction in costs as demand drops. However, it is important to be clear about where the drivers of these costs lie: using a UK supplier who themselves import from abroad may mean that such costs rise.

Also it is difficult to be clear about where energy costs may go as these depend on global energy costs. Nevertheless, cost increases would seem unlikely in the short term, particularly if economic growth is damaged by the leave vote.

Modelling costs will reveal a range of scenarios from “worst” to “best”, with most scenarios falling in the “most likely” bucket.

To simplify the overall model, we can then run the “best”,“worst” and “most likely” income scenarios against the same three outcomes for costs to show the possible impacts on profitability. The hope is that the “worst” income scenario, together with the “worst” cost scenario won’t be too devastating; and that the “most likely” income scenario with the same cost scenario is manageable.

Plans to mitigate the potential impacts can then be made. It is impossible to provide general advice here, though reducing your reliance on foreign sourced goods and materials might be wise to reduce the potential impacts of foreign exchange fluctuations and tariffs.

Hoping it will go away is not a good response. The spreadsheet you build need not be too complicated, and it is worth making the effort to begin to understand what the range of outcomes might do to your business finances.

Good luck!