These days, there is a lot of buzz in the air about a looming recession
. The Fed is raising interest rates in an attempt to fight inflation, energy prices are sky-high, and consumers are switching back to a pre-pandemic spending mix, leaving retailers and their suppliers with excess inventory.
As famed Harvard economist
Larry Summers said
sometime last July, "We have had soft landings because we tightened at moments when the inflation rate was low and the unemployment rate was high… We have not had soft landings for moments when the unemployment was below 4 and the inflation was well above 4… Never happened in the United States going back 60, 70 years."
And so, with that in mind,
today’s newsletter is about how to prepare for a
recession in the near future.
Potential is the operative term. It is next to impossible to consistently predict turns in the economy. So don’t do things now that in a
economy will hurt your business.
However, there are four key things worth doing now to prepare for an upcoming recession, whenever it may arrive.
#1. Act now to maintain liquidity.
Cash is king. So put tools in place and use them to manage near-term liquidity. As I have mentioned
that is best done using a rolling, 13-week cash flow projection.
Begin now to review the projection weekly so that you develop the discipline. Look out 13 weeks and learn from surprises regarding those things that you were unable to correctly anticipate.
Project your financial statements for the next 12 to 36 months.
Don’t forget to calculate cash flow the accounting way (derived from the income statement and balance sheet). Run recession scenarios (learn how,
). Project loan covenants and the
Fixed Charge Coverage Ratio
or FCCR. If the FCCR is under the 1.1 to 1.25 range, cash will be tight and you should put a plan in place should that situation arise.
If you have a borrowing base credit line — the amount that can be borrowed is a formula based on accounts receivable and, sometimes, inventory — make sure to factor that into these financial projections.
Stay on good terms with your lenders and take the time to tighten your relationships.
There may be actions you can take with lenders now that will provide flexibility in the future. For example, a prospect of mine financed a great deal of 20-year-life equipment with 5-year term loans. The company is now struggling to make those payments. The attorney wanted me to help restructure the debt in bankruptcy to a longer term that would lower monthly payments. But his client’s lenders came around and it looks like the company will restructure these loans outside of court.
Develop relationships with other lenders to provide flexibility,
should your business need a new lender in a recession. Include both banks and non-bank lenders. If your business has a lot of working capital or equipment, consider talking to asset-based lenders. These lenders lend on the collateral and sometimes can lend more than traditional cash flow or Commercial and Industrial lenders.
Look for unlevered assets.
This can be real estate or plant and equipment items. If you own the business, don’t forget personal assets, and for other ownership structures, options include subsidiary guarantees, capital calls, and so forth.
All in, t
he goal here is to have a sense of how much additional capital your business might need in a downturn — and a plan to get it.
#2. Create an adjustment plan, should sales drop.
Take the time now to consider
cuts that could be made in the face of reduced sales that would not harm the business long term.
This requires having a good sense of your business drivers: direct labor per boxes / units shipped, calls per repairman, service rep, etc. Track these drivers now, so if the sales decline and the drivers head south, action can be taken.
For example, when I was in the food service business, we had a sense of how many salespeople, warehouse workers, truck drivers, and customer service representatives were needed per $1MM in sales. We adjusted accordingly, including buying or selling delivery trucks and material handling equipment.
In other words, we looked at more than just staffing.
Look at inventory levels, too, and be ready to cancel orders if needed.
#3. Prepare for liquidity challenges from customers, vendors, and suppliers.
During a recession, your customers may have challenges paying you.
Even customers who do pay but take more time doing it will affect your business’s liquidity.
Further, liquidity-challenged vendors can have difficulties supplying you.
Review credit policies
and make sure they are being followed.
This includes time periods and dollar amounts where
pursuing legal remedies require a higher level of improvement.
Consider buying credit insurance on customers that carry a large A/R balance.
Get updated financial information on bigger customers. I have written
about the risks of customer concentration; take measures now to decrease that.
Minimize sole-source suppliers.
Try and get multiple vendors for critical materials, parts, services, and so forth. Try and monitor the financial situations of critical vendors. Public companies have public financials and there are various rating services. For private companies, consider sources such as Dunn & Bradstreet.
#4. Be ready for opportunities.
I helped a client get through a steep pandemic-caused drop in business. He then took advantage of the new capital structure I put in place to buy several companies in his industry on favorable terms that were in different markets than his.
In general, look for weakened competitors or businesses in adjacent markets: e.g., geography, product type, industry structure.
Remember, too, that when evaluating
buying the business is not the only alternative.
Think about pirating the sales force and other key employees. My client in the prior example picked up some great senior management talent from a competitor that was still financially struggling from the pandemic.
And, if your business can maintain service levels, inventory availability, etc., go after the customers of your competitors that can’t.
A recession is coming, of that I am certain… just don’t ask me when.
So, begin preparing for one now, before it happens. You will be in a much stronger position financially and competitively and may even uncover some previously unavailable opportunities.