5 ways to prepare your business for the next recessionFeb 15, 2023
70% of economists think a recession is coming in 2023.
But most businesses haven’t prepared.
Today, I’m going to talk about preparing for a recession,
and how you can come out the other side a winner.
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5 ways to prepare your business for the next recession
A December 2022 Bloomberg poll of economists placed a 70% chance of a US recession in 2023.
While more recent surveys have shown a sharp decrease in recession odds, public sentiment is still leaning heavily toward one.
While I can’t tell you whether a recession is coming or not, I can tell you that those who prepare are more likely to succeed.
Small businesses are especially vulnerable to recessions because of a lack of financial cushion and less leverage in markets, banking, and their industry.
But, a recession doesn’t have to be bad for your business. Research shows 9% of companies come out of a recession stronger than ever. So, how can you be in the 9%?
As I reflected on this, I came up with 5 things to address:
- Manage your cash
- Improve operational efficiency
- Stay informed
- Limit new debt
Let’s dig into each of these and discuss what you need to do.
Manage your cash
Too many small businesses ignore cash management.
Last week proved to me that you all are different… over 50% requested I write about “How to not run out of cash” in last week's email, so that will be coming to you next week.
Managing cash well is one of the most important things a business owner can do. Why do I say that? Like we saw in last week’s edition, running out of cash is the top reason for business failure.
And one of the biggest outside forces for businesses is the economy. So, of course, a recession is a big deal and one of the largest outside forces putting pressure on your cash.
To prepare for a recession:
- Grow your cash reserves. It’s typically recommended to have 2-6 months of operating expenses and debt payments. With a recession looming, I recommend between 6-12 of months of cash. This allows you to withstand an initial downturn and make decisions more rationally.
- Build a cash flow forecast. I’m shocked at how few businesses track their cash flow. Having a better understanding of cash helps you, as the business owner, feel more confident in every decision you make. To start, I’d suggest pulling 3 months of bank statements and manually tracking deposits, checks, and electronic transfers. This will get you a feel of how money is moving. As you understand this, use the Statement of Cash Flows for easy-to-implement solutions. If you need help with this, reach out and I’d love to help you get started.
- Revisit your customer & vendor terms. With most contracts, you sign and forget. Understanding your payment terms across your contracts will illuminate expired contracts (renew with better terms) and areas terms aren’t being followed.
- Clean up your receivables collection process. One of the first places you’ll notice the recession hitting your business is in Accounts Receivable. It’s easy to be lulled to sleep and forget to check on your receivables. Every business I’ve been a part of initially goes through cycles of diligence and laziness. It’s important to stay diligent by looking at your Aging Report weekly and contacting customers when payments are overdue.
Improve operational efficiency
In 2010, Harvard Business Review wrote an article titled “Roaring Out of Recession.” The article is the result of a year-long study they did analyzing corporate performance during 3 global recessions (1980-82, 1990-91, 2000-02).
They grouped companies into 4 groups:
- Prevention Focus: made primarily defensive moves
- Promotion Focus: made primarily offensive moves
- Pragmatic Focus: made a combination of offensive and defensive moves
- Progressive Focus: made an optimal combination of offensive and defensive moves
This alone deserves its own article, which I’ll likely write in the future.
Progressive-focused companies significantly outperformed all other companies, with prevention-focused companies performing the poorest.
When looking at who cut staff during the recession, progressive-focused companies only cut staff 23% of the time, where prevention-focused companies cut staff 56% of the time.
While it’s just one data point, this data point makes it clear: defense alone is not a good recession strategy.
By focusing on operational efficiency, instead of cutting staff, you keep your employees focused on the business and not on whether they’ll lose their jobs.
Efficiency improvements also have a long tail. Whether the recession happens or not, the improved efficiency will reduce long-term cost and lead to an overall healthier company.
- Supply chain
- Internal processes
- Ways to automate
I almost didn’t include this one, because I don’t want to encourage your bad [insert your favorite TV channel] habit.
In my 20s, I used to be into politics. I even had dreams of one day running for office.
I’d take in newspaper articles, pundits on TV shows, and took pride in always being in front of the trends.
It was even a running joke with my wife that no matter the story she brought up I had already heard about it. Sorry honey…
But then, one day I reflected on how I felt. Anxious, angry, and helpless.
With fears of recession, this gets even worse.
So when I say “stay informed,” I’m actually telling you DON’T WATCH THE NEWS.
Instead, talk to your customers, suppliers, and local movers and shakers.
It’s through these networks and conversations that you’ll get the real news.
They’ll have a better pulse on things that could directly affect your business, which is all you need to actually “stay informed.”
Reactiveness and defensiveness is a sure way to struggle in a recession.
Decision-making can always be a struggle, but especially when in the middle of the fog of the unknown.
That’s why you need to prepare before the recession comes.
A few ways to invest:
- Employees. Investing in employee training and development during the good times will make the hard times better. Employees who fill supported will work hard to help you find solutions, ideally uncovering things you couldn’t uncover yourself.
- Technology. (see operational efficiency, too) Businesses of the future will be driven by technology. Being proactive in implementing new technology will lead to higher margins, which helps with resiliency in hard times.
- New markets. During a recession, reactive companies have to offload good assets at low prices. Prepare yourself for these investments before they’re available. Ask yourself where you might want to expand and start the research process today. Maybe even take steps to test them out with small bets before the recession arrives.
- Depth in current markets. It may seem counter to the previous point, but they can work hand-in-hand. As other companies struggle, you have an opportunity to capture new clients and deepen your relationship with current ones by expanding your offerings within your current market. You are already an expert in what you do, so you’re in a prime position to uncover product/service differentiators quickly.
But limit new debt
Yes, I told you to invest. But this has limits.
New debt reduces cash reserves and increases risk, the opposite of what you want in times of uncertainty.
A 2017 study looked at the relationship between housing prices, unemployment, and business closure. They found that businesses who started a recession with higher debt-to-asset ratios were more likely to fail during the recession.
More debt results in a higher structural cost, which means you need more cash to continue to operate. While principal payments are paying down the asset, interest payments offer no such benefit to the business.
To make payments, businesses have to make sacrifices elsewhere, which often wound the business. This falls under a defensive focus which is forced by debt.
When leading up to a recession, be care to not:
- Take on too much new debt
- Pay off current debt early
Consider debt-to-equity or debt-to-asset ratios for your industry to assure you’re debt load won’t eat of the cash of the business.
Here in Oklahoma, we have a lot of bad storms. Hail, tornadoes, and ice storms wreak havoc on our roofs… meaning every roofer makes huge money when bad storms happen.
Every time I talk to a roofer they say “I never want the storms to happen, but they’re really good for business.” Do I believe them? Absolutely not…
In the same way, no one wants a recession. But, if your business is prepared and others aren’t, it can create a competitive advantage.
So, if after reading this you’re thinking… “I don’t want a recession, but it’d be good for business,” I don’t blame you.
Never waste a good crisis.
What should I write next?
Next week I write how to not run out of cash. Tell me what you want to see in 2 weeks.
- This post was partially inspired by Sieva Kozinsky and his thread on what he’s doing personally to prepare for a recession. He writes a newsletter, which I’m a big fan of. You can check it out here.
- In researching for this post, I found this article that dives into 7 companies that survived (and thrived) past recessions. Different strategies were used, such as advertising, pivoting on product, acquisitions, actively managing cash flow, and rewarding employees for good work. One of the best ways to learn is by watching what those before you have done.
- I referenced this HBR article above, but it’s a really good article looking at what made businesses successful in & after a recession. The 4 types of businesses is really interesting and they give some concrete things you can do during a recession to increase your likelihood to come out the other side stronger.
What did you think of this week's edition?
If you have questions, feedback, or want to work with me, reply to this email. I reply to all emails and would love to get to know all of you!
See you next week,