Look Ahead or Fall Behind: 5 Steps to Help Prepare Your Business for a Recession
No one can predict the future, but as we enter 2023, uncertainty regarding the state of the economy is running exceptionally high. After a year of record inflation and aggressive interest rate hikes by the Bank of Canada, expert and public sentiment is that we could be heading towards a recession.
While we can’t tell you if or when it’ll come, we can share a few strategic steps that you can take as a business owner to prepare your company for a recession.
Be Aware of the Signs of a Recession
The general definition of a recession is two successive quarters of negative gross domestic product (GDP) growth; however, there are a number of additional key economic indicators that you can watch out for, including:
- An increase in the unemployment rate. Rising unemployment suggests that businesses are cutting costs (e.g., salary) to adjust to slow economic growth and lower cash flows.
- An increase in consumer and mortgage debt. A slow increase or rapid spike in debt levels suggests that consumer and business defaults may be coming in the near future.
- A decrease in the Consumer Confidence Index. The Consumer Confidence Index (CCI) is a monthly survey which polls consumer attitudes, spending plans, and expectations for inflation, stock prices and interest rates. A decrease suggests that consumers are becoming pessimistic about the economy and purchasing habits may be changing.
- An inversion of the yield curve on debt. This happens when longer-term interest rates fall below short-term interest rates as investors move money to longer-term debt. This suggests that the market is becoming pessimistic about the economic near future and is generally held to be one of the most accurate predictors of a coming recession.
Manage Your Cash Flow
The age old saying that “cash is king” holds true even in the age of tap-to-pay, NFTs and crypto currency—the importance of cash flow management for the overall fiscal health of your business cannot be understated. The majority of business failures are the result of poor cash management, which can be difficult even during times of high economic growth. Consider the following points to prepare a financial cushion for your business:
- Try to create a three to six-month cash reserve
- Review your monthly expenses and reduce as much non-essential spending as possible without jeopardizing the long-term success of the business
- Consider holding off on major purchases until economic conditions improve
- Consider selling assets that are not fully utilized or are not considered essential for the long-term success of the business
- Create a cash flow budget and forecast the next 12 months. Try to anticipate when cash flow for the business will be tight, and don’t forget to factor in your monthly draws from the business for your personal costs
- Consider holding off on paying out dividends to shareholders to strength your company’s cash reserves
Manage Your Receivables
We hate to be the bearers of bad news, but you should have an expectation that receivables from customers and clients are likely to slow down, sometimes considerably, during a recession. In order to make sure you’re getting the most out of receivables when they’re smaller and slower than usual, consider the following to reduce the likelihood of late or non-payment:
- Be picky about the clients you take on, and don’t extend credit for client’s who have a history of late or non-payment
- Consider taking an upfront deposit for your goods or services
- Dedicate more resourcing to stay on top of collections
- Consider exploring and offering additional ways for clients to pay, such as through credit card, electronic means, etc.
Manage Existing Debt and New Financing
Paying off debt in a high interest environment may be tempting but can also deplete your company’s cash reserves quickly, leaving you in a vulnerable state. Before paying down any significant debt, you should consider the cash flow needs of your business and the type of debt you will be paying down. For a more in-depth look at how to handle your debt during times like these, read our previous article on strategies for protecting yourself from raising interest rates.
It’s not uncommon for a business to need additional liquidity or financing during a recession. Be proactive and consider obtaining financing such as a line of credit when your company is profitable since it’s generally more difficult to qualify for financing during a recession when your profit margin might be shrinking.
Reach Out to Your Advisors and Network
Economic uncertainty and recessions are a stressful time for everyone. For a business owner whose company might provide security and employment to several families, it can be something to lose sleep over. Don’t be afraid to fully utilize your professional network of experts, such as your lawyer, financial advisor, banker and—of course—your accountant. Your DMCL advisor will always be happy to help you plan your recession strategy and prepare you to weather any storm.
Article written by Michael Yoshida, CPA