Due to the recent tightening of monetary policy by central banks around the world to cool inflation, an economic slowdown is expected to occur, and in some ways, has already begun. This may affect businesses to varying degrees, as customers spend less, lenders make it more difficult to access credit, and persistent inflation keeps costs elevated.
There are several steps a business can take to address these financial headwinds, some of which are described below.
Build Cash Reserves
Businesses should consider building cash reserves in the short-term, in order to prepare for any cash shortfalls, and to strengthen their balance sheets. A general rule of thumb states that a business should set aside three to six month’s worth of expenses during a recession. If possible, a business should explore options for a line of credit or bank facility, which will relieve some pressure to accelerate operating cash flows. With this strategy, it is best to start sooner than later, and to work with existing lenders where possible, as it may become more difficult to gain approval as time passes.
Manage Receivables and Collections
It is important to evaluate the payment history of customers, and to understand how their businesses may be impacted by market forces. For example, if a customer’s business is declining, it may not be wise to extend credit, but rather enforce existing payment terms. However, if you believe that a customer’s businesses can weather the downturn, extending credit before a slowdown may strengthen your relationship. This analysis will assist in tailoring your accounts receivable strategy to maximize collections, especially for higher volume customers. Best practice is to communicate early and often with respect to receivables, in order to ensure that your collections are top of mind for your main customers. In addition, it may be beneficial to arrange a relationship with a factoring company that will provide financing based on existing receivables.
Reduce Expenses and Payables
Businesses should review expenses to reduce or minimize discretionary items or those that may be superfluous to their core operations. Consider travel, meals, entertainment, and other expenses, in this regard. In addition, plans for significant expenditures, such as increasing hiring, upgrading technology or equipment, amongst others, should be evaluated to ensure that they are in the best interest of the business in the short to medium term. Where possible, businesses can consider negotiating more favourable payment terms with key suppliers to secure better prices and/or additional time to make payments, in order to increase profits and flexibility.
Maintain Less Inventory
Inventory management is critical during a recession, as excess inventory ties-up cash, and can also impact storage costs, as well as those related to waste or spoilage. The correct level of inventory to maintain is often a moving target that fluctuates with industry and business cycles. With that said, a business can attempt to avoid accumulating a surplus of raw materials or holding excess finished goods that are unable to be converted to cash quickly. Analysis of historical inventory levels and movement should be conducted, in order to move closer to optimal levels, where possible.
Business owners may be faced with the difficult position to consider the efficiency of their operations, particularly with regard to staffing. It may become necessary to reduce costs by decreasing headcount, converting full-time roles to part-time, or outsourcing specific functions (e.g. administration, payroll, etc.). Businesses should review existing processes and automate manual tasks, in order to reallocate human capital on more critical business activities. The focus should be on increasing productivity and maximizing efficiency.
Analyze Cash Flow Projections
With the risk of a potential decline in revenue, it is important to analyze the impact on the business over different scenarios. For instance, consider the effect on cash flow if revenues decrease by 10%, 20% or more for a short or extended period of time. Develop estimates to consider how expenses can be managed to withstand unfavorable scenarios.
Expansion or Acquisitions
For a well-capitalized company, a recession may present attractive opportunities for expansion, either by increasing current services, adding revenue streams, or acquiring potential target businesses. Although the idea of acquiring a business in a recession may seem risky, proper evaluation of the pros and cons may reveal substantial net benefit. This may occur as other business owners may be compelled to sell in an environment with less competition amongst purchasers, which creates downward pressure on price, but not necessarily value. As Warren Buffett famously said, “Price is what you pay, value is what you get.”
Grewal Guyatt LLP can assist clients in a number of ways with respect to the opportunities and risks related to a recession, including consulting and advisory services regarding ongoing operations, business valuations, cash flow analysis, and more. Do not hesitate to reach out to learn more about how we can help you in this rapidly changing economic environment.
Adam Guyatt, CPA, CA, CFA, CBV, CFF, FVS
Direct: (905) 597-1702
Claudio Martellacci, CPA, CA, CBV
Partner – Valuations & Litigation Support
Direct: (289) 819-1744