Is Your Business Recession Ready?
Based upon news articles and the opinions of many experts, we are headed for a recession. There is not a lot of agreement on how big it will be or when it will arrive but it is important to prepare your business to be ready for it. In this blog we will explore some of the key ways to help you understand if your business is ready and if not, how to prepare.
Current Financial Health
The first key to understanding if you are recession ready is to have a clean set of books from an accounting and bookkeeping perspective. Without these the metrics we reference below will not be accurate and could lead you to the wrong conclusion. The health of a business always starts with the quality of the balance sheet and then moves to the income statement. Here are some of the items we look at:
Do you have enough capital?
Heading into a recession the first question we ask always revolves around cash and if a business has enough of it to maintain their operations. We recommend having around 3 months worth of operating expenses available in cash in your business. This will ensure that you have time to adapt.
Current Ratio
The current ratio measures your ability to pay your short term obligations. Essentially this means looking at your cash and accounts receivable and comparing it to your accounts payable and your debt payments for the next year. This is important because even if you are sitting on a large amount of cash right now, if you also have a large bill to pay you may not be in the strong financial position you thought you were.
Debt Analysis
How much debt are you holding compared to the assets you have? What are the terms on the debt you own (variable interest rates, payable on demand, etc.?)
Sales Analysis
What direction are sales trending on a monthly basis? Are they increasing or decreasing? Do you have a large customer concentration which may be a risk in a recession?
Gross Margin Analysis
Is your gross margin (sales minus the cost of goods/service you sold) staying steady or are they eroding?
Labor Efficiency Ratio
How effective is your labor cost being at producing gross margin dollars for you to spend on the operations of the business?
How Do I Improve Financial Health?
Once you understand your current financial health then you can start considering the ways to improve it. Below is a brief look at the places we typically start.
Access to capital
We always recommend building your own cash reserve but sometimes that is not possible. Also, it is always easier to get access to capital when you do not need it than when you do. As a result, we recommend locking in lines of credits and other capital options when things are going well so you can be prepared (we will have a future blog post covering different ways in which you can get access to capital).
Improve your cash flow
We understand that it is easy to say “just improve your cash flow” but much harder to do in practice. The two areas we typically start with are cutting discretionary spending (things that do not drive the business forward) and improving your cash conversion cycle. Your cash conversion cycle is how long it takes to convert your spending on labor and materials into cash from sales. Cash conversion cycles can be improved by reducing your accounts receivable days or increasing your accounts payable days.
Diversify Revenue
Revenue concentration always increases the risk associated with your business. Revenue concentration is when a significant portion of your sales come from one customer or segment of your business. If a recession would greatly impact that customer or segment then it could be detrimental to your business. If you have a revenue concentration, now is the time to start working to diversify it.
Deepen Client Relationships and Communication
The deeper your client relationship and communication with your clients is the better it will protect you in a recession. The open deep relationships mean that they will not want to cut their spending with you and the open communication inclines them to give you a heads up in advance if they are going to need to draw back on their spending.
Stay Adaptable
One of the most important things you can do heading into a recession is to stay adaptable. Be open to new opportunities, and be willing to pivot your business if necessary. By being flexible and adaptable, you can ensure that your business will continue to grow and thrive, even during tough economic times.
As always, we are here to help you through this journey and are willing to dive into the above items with you to make sure that your business is recession ready.