Small businesses are often hit the hardest during an economic downturn. Staff cutbacks, sluggish demand and reduced cash flow are the frequent signs we hear about during recessionary headwinds. Over the past 10-plus years since the recession of Q3 2008-Q1 2009, the macroeconomic conditions have improved, and the economy has performed very well with low unemployment rates, increased consumer confidence and increased spending. The economic expansion, in fact, has continued, uninterrupted, for more than 120 months since the downturn. But what goes up inevitably must come down. We are already seeing some slowdown in certain sectors, and many finance experts predict the next recession will come in the next 12-24 month time frame, triggered by a multitude of factors including international trade war tensions, geopolitical uncertainties and recalibration of the stock equity and debt markets.
Obviously, not every business is the same, and economic downturns impact specific companies and industries differently. There are a number of steps that business owners can take to adequately prepare themselves for a potential downturn. These range from understanding the unique issues and demands in your industry and how economic turbulence has affected the industry in the past, understanding a company’s operating flexibilities, reducing leverage in the business and providing balance sheet flexibility, organizational simplification and understanding which areas in the business drive the most value. I’d like to highlight one important step: the need to have a clear focus on the financials.
It’s All About The Numbers
Understanding your numbers and financial statements is important to operate your business effectively and allow management to make smart decisions during good times and bad. The numbers can highlight the areas of the business that serve as a proxy for either growth and investment, improvement or divestment and cutting back.
The balance sheet informs you of the resources in the business at a point in time. It measures many things. How much cash do you have? How much do others owe you? How much you owe others? What is your ability to pay current liabilities with current assets (i.e., working capital)? How much is left in the business after all liabilities are addressed (equity)? The income statement highlights the profitability for the business over a period of time, such as a month, quarter or year. Some of the important metrics you can measure for a specific period from the income statement include revenue and growth, cost of goods, gross margins, operating expenses and net income (profitability). Also, if a business tracks income and expenses by profit centers (sales, marketing R&D, G&A), the business will be able to see where to make adjustments. Lastly, the cash flow statement highlights the sources and uses of cash in the business. Money in, money out. Where did it come from and where did it go? Having up-to-date financial statements at any point in time allows companies to compare themselves and their current performance against historical performance (you versus you), benchmark themselves against their industry and peers (you versus others) and project future performance (pro forma).
Understand your business, inside and out, and get close to your finances, including your proforma forecasts. If you have not done so, create a detailed budget of projected income and expenses going into the new financial year. Look for ways to continue revenue growth at or above expectations while paying close attention to expenses. In some cases, reductions may be necessary for the overall, long-term sustainability of the organization. Great companies thrive during economic downturns by staying close to their numbers and managing their finances and operations very well.
Lastly, look to speed up your accounts receivables (A/R). You may typically give clients 30 or 60 days to pay off their balance, but you may want to speed up those payments to make sure you can put away cash and keep up to date on your accounts payables (A/P) if business suddenly slows. Pulling that income forward will help with cash flow.
There are a number of strategies that you can deploy now during times when the business is growing and the economy is prosperous that will ease the potential burden in the future while navigating the next inevitable downturn. The good news is that, with preparation, a downturn doesn’t have to have the same devastating effects as prior recessionary periods. Businesses that plan ahead may gain a competitive advantage over those that are not looking ahead.