While recessions typically come around every 10 years or so, it can still be hard for small business owners to be fully prepared. I have been through many recessions, and I am still surprised when the economy stops growing!
In the early 1990’s recession, I had just been fired from my job and decided to start my own business. Then, when the dot-com bubble burst in 2001, I was fortunate to have already sold my company and started to invest in startups as an angel. During the Great Recession of 2008, some of my customers prospered enough that it had a blunted effect on me. And most recently, in the COVID recession, I turned from in-person speaking events to focusing on mergers and acquisitions of small businesses.
By strict definition, we are now in a recession: two consecutive quarters of negative GDP growth. But not everything in the current economy is following this definition; unemployment is still low, and the U.S. is adding jobs when in a recession these trends typically go the other way.
Whether we’re entering a recession or not, this is what you can do to prepare and make your small business healthier for whatever the future holds:
- Track and preserve your cash
- What directly affects your cash flow
- Manage profitability
- Lower fixed costs
- Keep employees variable and available
- Pay less rent
- Lower employee turnover
- Diversify your revenue streams and customer base
- Decide what to quit
Track and preserve your cash
In a recession, revenue and payments from customers tend to shrink or slow down. Depending on the services or products you offer, your small business sales will likely go down. The customers you do have may take longer to pay their invoices, as they likely have less cash flow to pay their bills on time.
For your small business, cash is the gas that makes your business engine run. Without cash, your business stalls and can’t grow or even pay its financial commitments on time. In other words, cash isn’t just king; it’s every other winning card in the deck! On the other hand, if you have enough cash in a recession, you can make investments that are typically less expensive due to lower demand.
In this economic climate, the essential financial report to understand is your cash flow statement. Most basic accounting software packages offer a standard cash flow report, but few small business owners are trained on how to read it, so it isn’t reviewed as often as it should be (at least on a monthly basis).
Find out from your financial statements which sales — and which customers — give your business the best gross sales margin. Change your sales mix to prioritize them.
In financial terms, cash flow is defined as cash receipts minus cash payments received over a given period (usually a month). It’s the movement of money in and out of your business. The major formula for cash flow combines your monthly accrual profit, the change in accounts payable, the change in accounts receivable and the change in inventory. Other things like borrowing money or paying down long-term loans can also affect cash flow. The higher your monthly cash flow number, the healthier your company is — and the better it can withstand any downturn in a recession.
What directly affects your cash flow
- Change in accounts receivable: If accounts receivable goes down and the change is negative, it’s a source of cash. In other words, your company is collecting money faster. If this change goes up and the number is positive, it’s a use of cash; customers are taking longer to pay their invoices. You can collect your invoices faster — which will always boost your cash — by billing immediately upon delivery of products or services, asking customers to pay by credit card or offering a discount for paying early.
- Change in accounts payable: If this goes down and the change is negative, it’s a use of cash. If this goes up and the change is positive, it’s a source of cash. A positive change means your company can pay its bills later and hold onto its cash longer.
- Change in inventory: If this goes down, it’s a source of cash, meaning less money is tied up in inventory and it’s typically selling faster. If this number goes up, it’s a use of cash or more money is tied up in inventory. Selling inventory faster and keeping your inventory levels lower will accomplish the same thing. Buying inventory only to have it sit on the shelf for months can take a lot of cash out of your business. Consistently check your reorder points and reorder quantities to maximize the turning of your inventory.
Focusing on profitability is particularly important during a recession; in the long run, profitable companies can produce more cash flow. But not all products and services you offer have the same gross profit. Find out from your financial statements which sales — and which customers — give your business the best gross sales margin. Change your sales mix to prioritize selling more of those specific products or services to those customers.
For example, one of my customers found that when their maintenance team worked on their clients’ common plumbing and electrical issues, their margin was four times greater than their construction projects for the same clients. There was unmet demand for maintenance projects, so they decided to shift their team resources to focus on doing the higher-margin work. Over six months, this increased the company’s gross profit by 25 percent.
Lower fixed costs
Small business revenue usually dips during a recession, so it’s important to reduce any fixed costs. The largest fixed costs are usually overhead employees (who aren’t directly involved in sales or services), health insurance and rent.
Keep employees variable and available
For many companies, the biggest business expense is payroll. Especially in a recession, underutilized resources are a waste of money and a drag on the bottom line. This often happens with employees who don’t work at their maximum potential because the pace of the business alternates between very busy and extremely slow due to inconsistent demand. Try to pay people only when they’re working; this can be achieved by using freelancers or other outsourced talent.
Pay less rent
Unless you run a retail store, look to lower the cost of your rent. Many companies don’t need a large central office for all employees to work. Technology has enabled most companies to collaborate effectively from remote workspaces. Think about how you can lower your rent expense by becoming a virtual company or using shared office space.
Lower employee turnover
Many employees stay at a company two years or less; that’s a 50 percent turnover rate. This is especially true post-pandemic. Turnover is expensive; it costs upward of 20 percent of an employee’s salary to replace them.
Talk with your best team members every other month to ensure their career goals are being fulfilled and they feel they are fairly compensated.
But not all costs can be measured in dollars. Having a high turnover rate can prevent existing employees from making loyal connections with each other. This lack of a committed culture lowers productivity. And if you need to hire quickly, you run the risk of rushing the decision and making a bad hire.
To help retain your best talent, regularly evaluate your employees. Talk with your best team members every other month to ensure their career goals are being fulfilled and they feel they are fairly compensated.
Diversify your revenue streams and customer base
Recession usually affects industries unevenly. During COVID-19, it was much more profitable to own a bicycle store than a movie theater, for instance. Demand for various products or services may vary over time, so it’s a good idea not to “have all your eggs in one basket.” Auto dealers, for example, could not source new cars during COVID-19, but their servicing and sales of used cars skyrocketed.
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Your clients are likely from a variety of industries and a variety of sizes. They will all be affected differently by a recession, so make sure you diversify your customer base. Also, identify your best customers — who are most likely to stay loyal to your business during a downturn.
Decide what to quit
Typically, small businesses have room to experiment with strategies that aren’t yet profitable or core to the company — which is fine when business is booming. But for economic safety, look at every part of your business to see what actually makes money and what’s worth investing in for the future.
Throw out all the assumptions. For example:
- Do you need to offer all your products and services to all your existing customers? Are some things done out of habit or history?
- Which expenses contribute to making sales or servicing frequent customers? Which expenses are truly overhead or just a convenience?
- What’s not making money? What parts of your operations are a waste of time or just a nice-to-have vanity project?
Businesses that prosper during a recession are tightly focused and know how to conserve their financial resources. Even if a recession doesn’t come soon, practicing these guidelines will make your company stronger in any economic environment.
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