The best way for your business to survive a recession is to be prepared ahead of time. Unfortunately, few companies ever prepare for a recession while things are going well. This is a mistake.
Instead, most companies make changes after a recession has hit them. This delay limits their choices. This limitation forces companies to make rash decisions in response to worsening conditions. These decisions can have long-lasting negative consequences.
This article covers 13 things you can do to prepare your business for a recession. These actions will help your business regardless of how the economy is doing. But they will also protect your company when a recession strikes.
More importantly, you will be better prepared to take advantage of any opportunities that emerge during, or after, the recession. This preparation will position you ahead of competitors.
1. Manage invoicing and collections properly
When companies anticipate a recession, they usually start paying their vendors slowly. Invoices that were paid in 30 days now get paid in 40 or 50 days. Invoices that were paid in 45 days may take up to 60 days to get paid.
Companies pay invoices slowly to protect their most precious resource: cash. However, slow payments affect you negatively. This cash is owed to your company, and it’s money that you need to pay your own expenses.
Slow payments will sneak up on your company unless you have a solid program to collect slow-paying receivables. Collecting invoices is one of the most important functions of any business. It brings cash in. It also allows you to take the pulse of your client’s payment habits. In turn, this insight gives you an idea of your client’s financial health.
Invoice collections should be second only to sales and service. A good collections program:
- Offers 30- to 60-day terms only to good clients (see #2)
- Uses a well-written contract
- Implements a delivery acceptance letter
- Sends invoices promptly
- Follows up with clients regularly
- Handles disputes professionally
2. Offer payment terms carefully
Companies that sell to other businesses usually have to offer payment terms to clients. They offer terms because clients demand 30- to 60-day terms to pay invoices.
As a vendor, you don’t get much of a say regarding this demand. You have to offer terms if you want your client’s business. It is an unfortunate cost of doing business that can hurt small companies.
This leaves you with a problem. How do you determine if a client is creditworthy? Some business owners use client size and reputation as a way to determine if clients will be good payers.
Assessing client size and reputation can work – sometimes. However, some large companies with “stellar reputations” are actually bad credit risks. And there are also small, lesser-known companies that have excellent credit.
a) How can you tell the difference?
The most reliable way to determine the creditworthiness of a client is to run a credit report. The report can tell you how reliably your potential client is paying other vendors. Payments to other vendors are a good proxy for how well they will pay you.
Obviously, you should offer credit terms only to clients who have a good track records of paying vendors. Potential clients who don’t have a good track record should pay in advance or at delivery.
3. Transition “problem clients”
Every company has “problem clients.” These clients ask for extras, complain regularly, pay late, or even underpay. These clients will likely turn more problematic at the first sign of a recession.
You must ask yourself – are these clients worth it? Are they producing a net gain for your company? If they are, it’s up to you to keep them or not. However, if they are not producing a net gain, you should transition them out.
Clients who pay very late, or underpay, should be transitioned to “pay in advance.” Unprofitable clients should be thanked for their business and let go. On this last point, check your contract with them. You must fulfill all clauses before you can safely exit the contract.
4. Get credit from suppliers
Just as you have to give 30 to 60 days to clients, you want to get similar terms from your vendors. This strategy helps your cash flow. You want to get credit from suppliers during “good economic times.” As long as you remain a good payer, you will likely keep these terms with your vendors if there is a downturn. These terms will obviously help your cash flow.
5. Build a cash reserve
Every business should have a cash reserve that can be tapped during difficult times. Cash reserves buy you time and options. They are an important part of preparing for and surviving a recession.
Building a cash reserve is fairly simple, though it is not easy. All you need to do is divert some funds from your revenues into a reserve savings account. The hard part is to leave the account alone unless there is an emergency.
The cash reserve should be sufficient to cover your expenses for a little while. The actual size of a reserve is a matter of debate and personal choice. Some business owners feel comfortable with one month worth of expenses. Others prefer to keep a larger reserve. Look at your financial statements to help determine the right size.
Keep in mind that having a cash reserve has one drawback. The money is sitting in the bank rather than invested in the business. Therefore, a large cash reserve can hinder your ability to take new opportunities.
However, there is one way to keep a cash reserve and grow: secure some emergency financing. You can combine a flexible financing product (see item #6) with a smaller cash reserve. This approach gives you liquidity while allowing you to use more cash. Keep two things in mind:
- Use the line only for emergencies
- During severe recessions, lenders can cancel lines of credit
6. Consider securing some financing
Having financing during a recession can help your business survive – and grow. However, getting financing during a recession can be difficult. It is easier to get financing while things are going well. Securing an emergency financing line while things are running smoothly is a good idea.
The most flexible financing option is a business line of credit. A revolving line of credit allows you to draw funds when needed and pay them back using a flexible schedule. Qualifying for a line of credit, however, can be difficult – especially for small companies. Lenders require three years of financial statements, substantial assets, and a track record of success.
An alternative for business-to-business companies is to get a line of credit secured by accounts receivable. Two common solutions are invoice factoring and ledgered lines of credit. Invoice factoring is intended for small businesses and enables companies to finance slow-paying invoices. Ledgered lines of credit are intended for more established companies, usually those that invoice a minimum of $200,000 per month.
7. Examine expenses
Companies should examine their expenses regularly and seek areas where costs can be reduced. Doing this ahead of a recession ensures that your company is in the best shape to manage future challenges. Many companies wait until they run into problems before they start cutting costs. This approach is understandable but is often the wrong strategy. Cutting costs early enough could help you avoid problems in the first place. However, business managers should be wary of cutting costs too aggressively. Overdoing cost-cutting efforts will most likely worsen the situation.
8. Optimize inventory
Managing inventory for a company can be difficult. Having too much inventory reduces your cash without adding to sales. On the other hand, having too little inventory can result in lost sales and, possibly, customers.
Manage inventory against existing orders and forecasted sales. Optimize the amount of inventory so that you have enough, plus a safety allowance. Adapt inventory levels as the market changes.
Getting stuck with excess inventory during a recession can be a serious challenge. Inventory does not move as quickly as it does during a normal economy. Moreover, if the economy really slows down, you may have to sell inventory at a discount – possibly at a loss.
9. Streamline operations
Most companies try to streamline operations when recessions hit. This approach may help. However, it is better to have a streamlined operation when times are good so that when the economy slips into a recession, your company is ready.
The best time to streamline operations is always now. Examine your expenses carefully and cut anything not needed for the business. Consider outsourcing functions (e.g., payroll, some HR, etc.) that may be offered cost effectively by vendors.
10. Drop unprofitable products/services
Work with your finance department (or CPA) to determine if you have unprofitable products/services. Unprofitable products or services should be cut. The only exceptions to this rule are products/services that you consider “strategic.” These items are sales that generate additional sales from other products/services to compensate for the loss.
11. Re-evaluate ongoing projects
Major projects and strategic initiatives should be re-evaluated regularly as market conditions change. Projects that no longer meet expectations due to market changes should be delayed or canceled until the environment improves. Otherwise, your business could invest additional resources into a project that will not yield the expected results.
12. Manage existing debt carefully
Your company will need to balance the risks and benefits of keeping existing debt on the balance sheet. Paying down debt early may look good but also affects your cash flow. On the other hand, maintaining high levels of debt could put your business “out of covenant” with the lender if the market deteriorates. Both scenarios have negative implications for your business. Examine your financial situation regularly and revisit forecasts as needed. Take the appropriate corrective action.
13. Apply savings towards sales and marketing
Lastly, consider applying the savings from the strategies mentioned in this article towards getting new sales. Companies often cut investments in sales and marketing during downturns. Not surprisingly, this cutting leads to lower revenues, creating a vicious cycle. Most experts recommend investing more in sales and marketing during downturns.
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