Not If but When: Preparing for a Recession
In recent weeks, the “R” word has been cropping up more frequently among economist and pundits when discussing the U.S. economy. I’m talking, of course, about recession. Now is a good time to take a proactive stance and begin preparing for a recession with contingency plans.
The current economic recovery started in 2009, making it the second-longest recovery during the post-war era. If it lasts through this summer, it will surpass the 10-year-long expansion of the 1960s in length. While there’s no law that expansions can’t go on indefinitely, they do tend to run out of steam eventually. This is certainly one factor in the majority (59 percent) of private economists in a recent survey conducted by The Wall Street Journal saying they think the current expansion will end sometime in 2020.
Other economic warnings signs include high volatility in the stock market, a global economic slowdown that will affect the U.S. eventually, and an economic phenomenon referred to as the inverted yield curve that occurred in December. This has been a historically reliable predictor of recessions — over the past 60 years, an inverted yield curve has preceded every recession.
A Recession Isn’t If, But When
Nobody knows when the next recession will start, or how long and painful it will be. But there’s little question that it’s not a matter of if, but when the current expansion breathes its last breath and the economy enters recession.
A recent article on CFO.com1 lists a number of steps mid-sized businesses can take for preparing for a recession, including the following:
Keep an eye on your on KPIs.
The beginning of a recession can only be seen in hindsight, since recessions aren’t even labeled as such until after there have been two consecutive quarterly declines in GDP. So if you wait until an official pronouncement of a recession to act, you’ll be too late.
Identify the key performance indicators (KPIs) that are most vital to your company’s success now and start monitoring them closely in the coming months. These typically include metrics like sales volume, profit margins, inventory turnover, accounts receivable and accounts payable days, and days sales outstanding (DSO).
Construct “what if” scenarios.
For example, what if your sales drop by 10 percent, 20 percent or more? What if your profit margins fall by similar percentages? What if you lose one (or more) of your biggest and most profitable customers? What kinds of changes can you make to your business operations to keep your company afloat if any (or all) of these things happen?
Focus on your balance sheet.
The stronger your balance sheet, the better chance you’ll have of weathering a recession with minimal financial impact on your company. Pay especially close attention to your debt-to-equity ratio, inventory levels and credit capacity.
Watch your payroll costs closely.
Now may not be the best time to make large commitments of fixed compensation and benefits to your employees. Instead, consider structuring your compensation plans so that employees are rewarded for improved performance, not just showing up and “punching the clock.”
Stay on top of accounts receivable.
During a recession, it’s not uncommon for accounts receivable collections to slow down as customers start stretching out their payables to accommodate their own cash flow struggles. The longer past-due receivables are outstanding, the less likely they are to ever be collected. As part of preparing for a recession, identify which customers tend to be slow payers now and devise a plan for staying on top of them if the economy slows down and their invoice payments start stretching out beyond your agreed-upon terms.
Identify your most popular and profitable items.
Which products and services are your biggest sellers and your biggest money-makers? You need to make sure that if any cuts are necessary due to a slowdown — such as employee layoffs or production shutdowns — they don’t impact these products and services. In other words, don’t kill the goose (or geese) that lay the golden eggs.
Positive Outcomes to Preparing for a Recession
Your company could realize a number of positive outcomes by making plans now for how you’ll respond to a recession. For example, you will:
- Minimize disruptions in your business.
- Maintain good relations with the right customer mix.
- Reduce the potential of lower sales and profits.
- Continue differentiating your company with new products and innovation.
Perhaps most importantly, proactively preparing for a recession will put your business on a path to emerge from a recession stronger than you were when the slowdown started.
The “R” word, or recession, has been cropping up more frequently among economist and pundits when discussing the U.S. economy due to a number of economic warning signs. The fact is, it’s not a matter of if, but when the next recession starts. Now is a good time to be proactive and start preparing for a recession. Acting in a role of project CFO or part-time CFO, a former enterprise CFO from a CFO services firm can help you start making recession contingency plans, so your business emerges from a recession stronger than you were when it started.
1 How to Prepare for the Recession on the Horizon; Matt Hare, Huron Capital; CFO.com; November 27, 2018
John W. Braine, Partner, CFO Edge, LLC