How to Mitigate the Risk of the Next Downturn

The recession left many people wondering, “How could I have taken steps to secure my business earlier?” There is no crystal ball that can tell you when the stock markets will tank, when a political scandal will affect the course of business, or even when your biggest client will have to close its doors. But there is a way to anticipate how and when outside economic factors will affect your bottom line.

During this current recession, some business owners have taken a reactive, slash-and-burn approach, while others are sitting tight and waiting for the economy to rebound (or for their money to run out). The key to making the best decisions in a bad economic situation is by using timely, relevant financial information. A small business’s financial information can help owners and executives make more informed decisions, and consequently, mitigate the damaging effects of the next downturn.

Financial information helps provide early warning signs that a business will be affected by an economic event. At the same time, this information actually can help identify the specific effects of a recession beyond sales or revenue figures, and well beyond anecdotal information such as “the phone doesn’t seem to be ringing as much this week.” Specifics will indicate problem areas such as profitability, credit, staffing levels, and increased expenses and inventory levels, among others.

The smaller the safety net or margin for error a business has, the more often the owner should aggregate and review key indicators. The monthly profit and loss statement is important, but that just provides the macro view of whether a business is making or losing money from a historical perspective. It does little to identify the factors that are creating the profit or loss. The following list of financial information can be used to raise a red flag for a down trend before it damages your business.

CASH BALANCE

Establish the proper average daily cash balance for your business. Check for decreases in the cash balance that might indicate a potential cash-flow problem. A falling balance may be caused by late-paying customers, a drop in sales, or even an increase in expenses or overhead. Depending on the root of the problem, you can establish ways to reverse the trend.

For example, you can give customers incentives to pay early, ramp up collection efforts, create promotions to re-energize sales, take the maximum time to pay suppliers, and/or cut expenses or overhead. While it’s useful to analyze cash-balance trends, it’s even more useful to do so in conjunction with the review of other areas of financial information, such as accounts receivable.

ACCOUNTS RECEIVABLE AND ACCOUNTS PAST DUE +30, +60, +90 DAYS

One of the first recession indicators for many businesses is an increase in the number of days it takes for their customers to pay them, and specifically, an increase in invoices that are older than 60 days. As this number gets larger, cash flow gets squeezed, and the business has less flexibility to operate. Once this problem has been identified, a business owner can examine the collections process and increase efforts here, discuss late payments with large and long-term customers to determine issues they may be experiencing, create payment plans, or cut off future work with companies that are now bankruptcy risks.

DEBT LEVEL

Most businesses carry a certain amount of debt, whether it’s a line of credit, vendor debt, equipment loans, or corporate credit cards. Increasing debt levels raises a red flag in a number of areas. It may mean that the business is using debt to fund losses or to carry more inventory than needed.

PAYROLL LEVELS

Payroll is typically a business’s biggest expense. Payroll figures should compare with revenue figures. In professional service firms, such as law or engineering firms, it’s important to explore whether employees have excess capacity—especially if sales are falling. Business owners can decide to freeze salaries, cut salaries across the board, lay off employees, and/or deploy workers with excess capacity to other functions.

If a business owner fails to accurately balance payroll levels, they may end up using debt or their own savings to continue to pay employees until the business turns around. If the business is seasonal, it may be more costly to lay off and rehire employees than it is to carry some excess capacity, so each business also should consider unique factors that may affect their revenue.

OVERHEAD/EXPENSES

While a business owner may choose not to raise prices during a recession, their suppliers and landlord may not feel the same way. If expenses such as rent, insurance, equipment, and supplies are rising, while the business isn’t increasing what it charges, revenues will remain steady, but profitability will take a major hit. The choices are to simply raise prices to reflect these increased costs, or to work with suppliers, insurance carriers, and landlords to renegotiate costs. There’s also the option of shopping around for more inexpensive suppliers.

INVENTORY LEVELS