Downside Case
Executive Summary
Key Takeaways
- ✓ The downside case is a modelled scenario in which key assumptions are set at values less favourable than those used in the base case, representing a plausible adverse outcome rather than the most likely outcome.
- ✓ The downside case is constructed by revising specific base case assumptions to less favourable values.
- ✓ Lenders use the downside case to assess whether the DSCR will remain above the covenant minimum under adverse conditions.
- ✓ The downside case is a scenario (a defined set of assumptions for all inputs simultaneously).
Definition¶
The downside case is a modelled scenario in which key assumptions are set at values less favourable than those used in the base case, representing a plausible adverse outcome rather than the most likely outcome. The downside case is used to test whether a project, investment, or business can service its obligations and meet minimum performance standards under conditions that are worse than expected.
The downside case sits below the base case in the scenario hierarchy and above the stress case, which uses more severe assumptions:
| Scenario | Purpose | Assumption Level |
|---|---|---|
| Upside | Best plausible outcome | Optimistic |
| Base Case | Most likely outcome | Central estimate |
| Downside | Adverse but plausible | Pessimistic |
| Stress / Lender's Case | Severe scenario | Very conservative |
Construction of the Downside Case¶
The downside case is constructed by revising specific base case assumptions to less favourable values. Common downside adjustments include:
- Revenue: lower volume, lower price, or delayed ramp-up relative to base case
- Costs: higher operating costs, construction cost overrun, or maintenance cost inflation
- Financing: higher interest rate, wider margin, or earlier refinancing
- Timing: delayed completion, longer ramp-up period
The magnitude of downside adjustments should be justified by reference to historical precedent, market data, or defined stress parameters agreed with the lender or investor. An arbitrary downside that cannot be justified by reference to a plausible scenario does not provide meaningful risk information.
Downside Case in Lender Analysis¶
Lenders use the downside case to assess whether the DSCR will remain above the covenant minimum under adverse conditions. A project that achieves a DSCR of 1.35x in the base case but falls to 0.95x in a plausible downside is a more significant credit risk than a project that falls to 1.20x in the same downside.
The lender may define their own downside scenario (the "lender's case" or "bank case") using their own stress parameters rather than accepting the borrower's downside. The lender's case is typically more conservative than the borrower's downside.
Relationship to Sensitivity Analysis¶
The downside case is a scenario (a defined set of assumptions for all inputs simultaneously). Sensitivity analysis varies one input at a time while keeping all others at base case values. Both are required for comprehensive risk assessment: sensitivity analysis identifies which individual inputs matter most; the downside case tests how the model performs when multiple inputs are simultaneously adverse.
Common Errors¶
- Constructing a downside case by applying uniform percentage reductions to all base case assumptions without assessing which assumptions are correlated
- Using a downside case that is merely a less optimistic version of the base case rather than a genuinely adverse scenario
- Failing to test covenant compliance in the downside case (not just the base case)
- Using sensitivity table outputs as a proxy for a properly constructed downside scenario
Continue Reading¶
Prerequisites¶
- Excel Financial Models — the parent pillar
Related Technical Guides¶
- Sensitivity Table Integrity — the check that verifies sensitivity outputs reflect the current model
Related Glossary¶
- Base Case — the central scenario relative to which the downside is defined
- DSCR — the coverage metric tested against its minimum in the downside case
- IRR — the return metric compared between base case and downside
- Sensitivity Analysis — the complementary analytical approach that varies one input at a time
Related Products¶
- Financial Model Audit Engine (FMAE) — deterministic structural auditing referenced throughout this guide
How OXXON tests thisRun a free structural check with FMAE
Related Articles
Base Case
The base case in a financial model is the central scenario that represents the model developer's primary projection of expected outcomes. It uses the most likely or central estimate for each assumption, rather than optimistic or pessimistic values. All other scenarios (upside, downside, stress) are defined in relation to the base case. The base case is the scenario used for investment decisions, credit approvals, and board presentations unless otherwise stated. Its key outputs — typically IRR, NPV, DSCR, and equity returns — are the primary reference metrics for any decision made in reliance on the model.
Sensitivity Table Integrity in Financial Models
Sensitivity table integrity refers to whether the results displayed in an Excel data table in a financial model reflect the current state of the model's calculations or whether they represent stale values from a previous calculation state. An Excel data table runs a series of calculations by substituting different input values into designated cells and recording the outputs. If automatic calculation is disabled, if the data table's input cells are incorrectly specified, or if the data table has been converted from dynamic to static values, the sensitivity results displayed may not correspond to the model as it currently stands. This is a high-risk structural failure because it provides false assurance about the model's sensitivity to changes in key assumptions.