How to Prepare Your Business for a Potential Recession
Economic downturns are a fact of life for businesses of all sizes. And while no one can predict with certainty when or even if a recession will occur, it's important for every company to be prepared for one.
Not All Businesses Are the Same
By virtue of their industry, some businesses are likely to do better than others during a recession. Yet all should take similar steps toward protecting themselves.
“While no business is totally recession proof, some businesses that provide healthcare, education, professional and legal services, and essential consumer goods tend to be more resilient than other businesses," said Joe McHugh, head of Small Business Banking for City National Bank. “When an economic storm is brewing, business owners do well if they do as a household does: save for a rainy day and have cash on hand."
Small businesses, which City National broadly defines as companies with $5 million or less in annual revenue, have advantages and disadvantages compared to large corporations.
“On the one hand, small businesses often lack liquidity," McHugh said. “But they tend to be more nimble and able to shift resources more easily than larger businesses."
Some of the issues business owners may face in today's economic environment include rising costs of basic supplies and raw materials, the challenge of finding good employees for a reasonable wage, and a reduction in stimulus funds that kept markets afloat in recent years, McHugh said.
How to Operate a Business During a Recession
To survive and thrive during a recession, business owners may want to focus on building their resilience long before a down cycle in the economy.
“While every business is different, it's important to establish key performance metrics, such as revenue growth, profit margins, customer retention and inventory, that can be regularly monitored in any economic environment," McHugh said.
“For example, one of City National's clients monitors accounts receivable, cash on hand and their available line of credit to make sure the value of all those sources of liquidity is two times their monthly operating expenses. Any time that equation is off, they make some changes."
McHugh said that business owners, especially small business owners, don't always have a full team of advisors available. He recommends that they build relationships with their business bankers and accountants to help them monitor their business.
6 Best Practices to Consider During Recession
When a recession looms or when a downturn has begun, business owners can take several steps to improve their ability to weather the economic storm.
1. Assess Cash Flow & Build a Budget
Cash is king, especially in a recession, McHugh said.
“Every business owner should have liquidity in three different forms: cash, accounts receivable and a line of credit," McHugh said.
A line of credit is extremely important because it allows business owners to take advantage of opportunities such as a dip in supply costs or the need to hire more people if they acquire new customers, McHugh said.
Besides having a credit line, storing money in a Certificate of Deposit (CD) or a high-yield savings account can help it grow and be ready when a company needs extra cash the most.
Make a Budget
Business owners must understand their own financial statements and have a budget based on a forecast of their business and the economy.
“Business owners should 'stress test' their business under different scenarios," McHugh said. “For example, they should understand the impact and how they would handle it if sales dropped 10% and gross margins dropped by 5%."
Part of a budget evaluation should always be to look at debt.
“Business owners need to make sure they are careful to match the purpose of their debt with the type of debt vehicle they choose," McHugh said. “For example, you don't want to buy an expensive piece of equipment with your line of credit. Long-term assets should generally be financed with long-term debt."
A line of credit should generally be used for short-term needs and then repaid quickly to revolve the credit, McHugh said.
“Some business owners use commercial credit cards as financing and use the grace period to improve their cash flow," McHugh said. “But that gets back to matching the purpose of the debt with the vehicle. As long as you can repay the credit card balance each month, that's fine."
Before a recession hits, McHugh recommends reviewing your debt load to see if refinancing any debt into a longer-term loan would improve cash flow, even in the face of potentially higher interest rates. Depending on their needs, some businesses may be okay with carrying a balance.
“Look for any alternatives to your current structure that could improve your payment or interest rate," McHugh said. “A Small Business Administration loan may be an appropriate source of funding for some business owners where they provide banks with a loan guarantee. The bank can then be more flexible in underwriting and typically offer a longer amortization for the loan."
Cut Back on Unnecessary Expenses
An essential step in assessing cash flow before a potential recession is to evaluate all expenses and reduce or eliminate as much overhead as possible, including items such as travel.
“If you own real estate, this is the time to look into whether a balloon payment will be due soon and whether you can refinance to reduce your payments," McHugh said.
A balloon payment is the final larger payment due on a loan after a series of smaller payments.
If you lease space, you may be able to renegotiate or to reduce the amount of space you use depending on your business and the terms of your lease. Another potential opportunity to cut costs is to talk to your suppliers. Perhaps a bulk order, while more costly now, could reduce long-term expenses.
2. Grow Existing Customer Relationships
It's much easier to keep an existing customer than to acquire a new one, particularly during an economic downturn.
“The best thing a business owner can do is to build a solid reputation and provide good customer service, which in turn generates referrals," McHugh said. “The lack of communication is the root of all evil, so it's especially important to be candid with bankers, customers and suppliers."
3. Build a Referral Network
McHugh also recommends building a referral network, something that can be done by asking customers to refer you and by building relationships with other businesses to acquire new customers.
This can help lower customer acquisition costs and generate more revenue for you and other businesses.
4. Expand Product & Service Offerings
Whether or not you should expand your business depends on the type of business you own. While expanding services can be a great way to innovate and survive during a market decline, doing so could also put unnecessary stress on your business.
McHugh noted that new services don't have to be expansive. Instead, they can be small things that add value to your services.
“If you can expand your products or services with something complementary that adds value and a competitive advantage to your business, this could be a good time to do that," McHugh said. “But this may not be the time to start adding new products and services unless they are fully vetted and you're certain they can generate additional revenue."
5. Review Workforce
Labor costs, particularly on the West and East coasts, are extremely expensive. McHugh recommends evaluating each staff member's role and productivity.
“This may be the time to look into outsourcing some of your tasks such as payroll and accounting," McHugh said. “You may want to consider hiring a part-time CFO to review your operating costs."
One of McHugh's clients hired full-time and part-time staff all over the country, which eliminated office costs, and paid them relative to wages in their region.
“This impacted their margins significantly without hurting their business," McHugh said. “They found great workers in the Midwest where the cost of living is lower."
Build Company Culture
Even if layoffs become necessary during a downturn, it is more important than ever to build a strong company culture and to ultimately retain as many employees as possible. It typically costs more to train and hire new employees, especially in today's tight labor market.
“Small business owners have the ability to be more flexible than larger corporations, so they can offer things like a four-day workweek to attract talent," McHugh said. “They may consider offering work-from-home options that set them apart from other business owners."
Keeping employees engaged and happy is essential to help a business thrive and survive a recession.
6. Continue marketing
While many business owners instinctively cut their marketing budgets when a recession looms or cash flow is tight, McHugh said that marketing is even more important during a slow growth economic cycle.
“Your business needs to be seen by existing customers and potential new customers," McHugh said. “This is an opportunity to show people you're open for business."
If you must cut marketing spending, McHugh recommends increasing your presence on social media and finding other ways to remain visible.
Constantly Assess & Prepare for the Future
Recessions are temporary and are typically followed by a period of economic recovery. Consistent reassessment of your cash flow, key metrics and business plan should include a growth strategy that you can implement as soon as a recession begins to fade.
Communicating with your employees, customers, business partners and bankers can be an important mechanism to smooth the path from one economic cycle to another.
This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.