How to Prepare Your Business for a Recession
The last several years have seen unprecedented rises and subsequent falls in our nation’s economy. From COVID-related shutdowns to the war in Ukraine and ensuing inflation, business owners have faced everything from supply chain disruptions to labor shortages, not to mention a broad economic disheartenment from all corners of the country. As confidence in the economy continues to wane, it’s essential to take appropriate measures to strengthen your business- regardless of economic conditions.
The best time to prepare your business for a recession is before conditions deteriorate. Often, companies are put in the impossible position of making tough, even rash decisions due to the pressure placed upon them by economic conditions.
While the risk of an actual recession (defined as negative GDP growth for two consecutive quarters) is not imminent- Economists are warning Americans to brace for rising costs and slower growth.
While that is not great news for any business, there are things that companies can do to prepare for a downturn or eventual recession.
4 Ways to Prepare Your Business for a Recession
We are advising our clients to take the following four steps that will make them more resilient in the event of a slow-down.
1. Get Liquid
Keep enough cash and lines of credit in place to avoid a temporary liquidity crisis. When your business has enough liquidity to pay suppliers and meet payroll and other expenses for at least a few months, it is less threatening when a customer cuts back on an order or raw materials costs spike again. You won’t have to immediately look for ways to cut costs to cover your expenses.
Furthermore, a robust liquidity ratio signals to creditors (and potential investors) that your company is stable enough to withstand a recession or an economic downturn, with enough assets on-hand to weather a significant period of economic depression.
A low-liquidy ratio signals that your business is vulnerable and may be under financial stress.
Low-liquidity ratios are often considered the ‘canary in the coal mine’- and can help you anticipate whether your business will succumb to an economic downturn. If your company has a low liquidity ratio, take the time to liquidate certain assets before it’s too late.
Related: 5 Business Benefits To Practicing Proper Daily Accounting
Understanding your liquidity ratio will allow you to make smart, informed decisions about your company’s spending, allowing you to remain flexible if and when a recession occurs.
2. Scrutinize Receivables
Don’t overextend credit to customers that may not be able to pay you on time. Evaluate each customer’s payment history, and invest some time to learn how their businesses are doing (this is important for both new and long-standing relationships).
Knowing your customers’ business outlook can provide important information in any economic environment. A good customer’s business is expanding in the best-case scenario, and customers may ask your company to supply additional credit.
If so, you’ll need to incorporate that into your planning. If a customer’s business is declining, take a hard look at your receivables with that company and be prepared to cut back. It’s easy to become lax about cash flow management and account receivables when times are good, but when economic stability is rocky, its time to buckle down and ensure that your business provides your customers with clear communication about due dates, and any updates to your procedures that may arise during a downturn.
3. Monitor Inventory
As we learned during the COVID-19 pandemic and its ongoing aftermath, a firm handle on inventory is essential. But inventory management is a question that has challenged businesses since merchants first set up shops in medieval times: what is the right level of inventory (finished goods and raw materials) to hold?
There is no one-size-fits-all answer, but be wary of piling up too much in raw materials (even if you could buy them at a great price). With some cushion, avoid holding more finished goods in inventory than you need to fill firm orders on your production cycle. This strategy should be based on a month-by-month (or even week-by-week) analysis of projected demand, not what happened last year.
Bottom line: Inventory ties up cash, and in a recession- cash is king. Most (if not all) companies would be better off hanging on to cash than with extra inventory.
A forecasted downturn may also be the time to lean on digital tools and advanced data analytics to improve productivity and reduce quality problems and error rates in your manufacturing or production processes.
Digitalization of data allows firms to have a stronger grip on what drives demand each week and adjust inventory appropriately. Digital tools can also foster customer loyalty.
If you haven’t already, consider building an online or mobile digital platform that allows customers to check the status of orders, report a problem, access product information, and address other needs quickly.
4. Be Careful with CapEx
One of the significant challenges for companies during an extended period of economic instability is strategic resource allocation.
When making or updating your budget and forecasts, review all capital expenditures (property, buildings, technology, etc.). Is that new equipment required to meet healthy customer demand or ensure your business remains cost-competitive?
Be careful to distinguish between genuinely needed equipment versus a “nice to have” product promoted by a salesperson. Resist the temptation to ramp up to meet optimistic sales projections mainly in the “maybe” category.
There are items to keep in the budget when they truly make sense for the growth and profitability of your company- but try to avoid taking on debt to make big purchases, as it may become more difficult to service a higher debt load in a downturn when cash gets tight.
Read More: Working Capital Management: How to Stay in the Goldilocks Zone
In 2019, the Harvard Business Review studied how firms adjusted their resources during the financial crisis of 2007-2009, exploring how companies adjusted their strategic investments.
HBR’s findings suggested that firms that simultaneously “saved their way out of the crisis” (by reducing their workforce and CAPEX) and “invested their way out of the crisis” (by sustaining their R&D investments and CSR). Companies that managed to “save and invest” their way out of the crisis we’re in a better position to adapt to the challenges brought on by the Great Recession:
“We examine whether companies that sustained their investments in R&D and CSR perform better in the years following the economic meltdown. We find that indeed they do. They exhibit higher operating performance—as measured by the return on assets (ROA)—in the post-crisis years. In contrast, we find that companies that maintained their workforce and CAPEX did not achieve higher performance. We also find that firms that pursue the two-pronged approach of simultaneously maintaining their R&D and CSR while reducing their workforce and CAPEX achieve an even higher performance in the post-crisis years.
Is Worrying About a Recession or an Economic Downturn a Self-Fulfilling Prophecy?
It is often reported that worrying about a recession can cause a recession – in other words; there is an element of a self-fulfilling prophecy involved.
When business owners are overly concerned about a recession that might happen, they cut back on hiring and reduce inventories prematurely, so business activity declines.
That means hiring is reduced or frozen, making people worried about their jobs. In turn, those in precarious positions within the economy may spend less on consumer goods and services, which turns into a negative feedback loop.
So, businesses should not clamp down hard on spending in anticipation of a recession that is still seen as unlikely, as collectively, that can bring on the recession everyone is hoping to avoid.
In contrast, it is prudent to do the five things described above in a way that does not interfere with keeping your business humming.
This requires a certain level of forecasting and analysis that you may not have time to do or that requires expertise beyond what you have in-house with your current financial/accounting team.
That’s where G-Squared’s outsourced CFO services come in. Outsourced or part-time CFO services allow businesses to remain flexible during economic downturns or in case of a recision. Contact us for a no-obligation discussion about how we can help your business take these critical steps.
What Makes a Good CFO in Challenging Times? [4 Questions to Consider]: When rocky conditions are expected ahead, it’s crucial to have an effective, decisive CFO to lead your team through the storm.
Resource Allocation: How to Strategically Drive Company Growth: Explore the importance of strategic resource allocation and how to adjust your resource allocation needs to evolve over the lifespan of your business.
The Outlook for 2022 – Searching for Stability: Gene Godick, President of G-Squared Partners, shares his outlook on 2022 and what to expect in the years to come.