What will companies do when the next recession hits the U.S. economy? It’s a question that’s becoming more urgent as the long-term outlook for the economy becomes increasingly uncertain.
There are warning signals, such as the increasing frequency of triple-digit Dow Jones losses and warnings by forecasters, including 59% of private-sector economists who said the long-running economic expansion would end in 2020, according to a Wall Street Journal survey.
The current expansion began in 2009 and already has lasted more than nine years. That’s only one year shy of America’s 10-year economic expansion in the 1960s, which was the longest continuous economic expansion on record since 1945.
Business owners should look at their operations and balance sheets to review whether their recession plans are robust enough to survive a major economic downturn. Those that develop a contingency plan, reduce debt, carefully manage inventory, control payroll costs, and continue to invest in new products and services increase their odds of surviving or even capitalizing on the next recession.
Consider these steps to become recession-ready:
Don’t wait for the economists. Economists won’t officially declare a recession until two consecutive quarterly declines in real GDP have occurred. Smart companies get ahead of the economists by carefully monitoring their own core performance metrics and being prepared to respond in real time to red flags. Identify the core sales, production, and operational metrics that drive business and be prepared to adapt and adjust to any material changes.
Avoid a false sense of confidence. Certain businesses that provide essential products and services are less exposed to cyclical economic trends. Still, few businesses are truly recession-proof. In the hot Southwest, for example, a company that installs and repairs heating and cooling systems provides an essential service. But those same businesses must still be prepared for a slowdown in construction of new buildings.
Develop a game plan. It’s likely that sales and revenue will drop when a recession hits. Develop a plan to evaluate the impact a 5%, 10%, and 20% drop in sales will have. Figure out what cuts in operations are needed at each stage to stay profitable and to pay bills. Also, identify key customers and determine what would happen if one or more of those them were to be lost.
Be sure to include the core management team in the process and allow the board of directors to review the plan and provide input. If tough decisions must be made, having a plan in place that already has the support of the board and the management team will make it easier to implement.
Improve balance sheets now. Companies entering a recession with strong balance sheets, lower debt ratios, and larger untapped credit lines are likely to be better able to operate with greater financial flexibility during a recession.
Review compensation policies. Avoid committing to additional fixed compensation benefits as this economic expansion winds down. Now is the right time to consider adopting compensation policies weighted toward variable compensation designed to reward employees’ performance, rather than permanent raises.
Carefully manage inventory levels. When a recession hits, businesses with excess inventory can get stuck selling at below-market prices. Prioritize inventory management before and during a recession.
Review and assess accounts receivable. During a recession, some businesses will be strapped for cash and it will become even harder to collect from them, leaving even well-managed companies exposed to their customers. Some clients and customers might even go out of business. Typically, in a Chapter 11 or Chapter 7 bankruptcy, unsecured creditors recover only cents on the dollar for the debts owed.
Companies keeping close tabs on accounts receivable are less exposed to the outstanding debts of customers. If not done already, ask the finance team to identify which customers regularly pay their bills late and develop a plan to reduce risk.
Define essential products and services. A recession puts pressure on companies to cut costs by laying off employees, shutting down operations, and discontinuing underperforming products. But the cliche that companies cannot cut their way to profitability is often true. Companies should identify best products and services as well as the most profitable products and services. Identifying these parts of the business and protecting them from cutbacks in quality can help a company maintain its identity during a recession.
Resist product development cuts. New products and innovation often separate good businesses from average businesses during any economic cycle, and they and become more crucial during a recession. Even when overall demand for products and services decline, companies that differentiate themselves have a better chance of surviving and prospering.
Matt Hare is a partner at Huron Capital.