It has been a great economic run for many businesses these past 10 years. So good, in fact, that many are wondering when the other shoe is going to drop. While predicting the precise timing of the next economic pullback or recession is impossible for most business owners, there are things that you should be doing to prepare your company as best as possible.
Pay Attention to the Equity Section of Your Balance Sheet
As owner managed businesses generate profits, some of those profits are distributed to pay taxes, some are distributed for discretionary owner spending and some are retained to fuel the continued growth of the business. One of the best ways for a business to brace itself for an economic downturn is to have built up equity, typically through retained earnings, which is the aggregate amount of profits generated by the business over the years that the business has retained. The stronger your equity position, the less likely you are to be relying on debt to provide the working capital you need to keep your business going. And during economic downturns, lenders typically begin to pay closer attention to debt covenants, which means you want to be prepared to conform to their requirements. Therefore if you are contemplating any significant nonessential distributions, it could be prudent to delay those expenditures until there is more economic certainty.
Cautiously Invest in Growth
For many business owners, investing in the future and growth of the company is a must, and without that mindset, these past ten years wouldn’t have been as fruitful as they have been for many. It might be a good time, however, to shift your investing philosophy from one of an assumed ROI based on the results from the prior few years to one where the likelihood of achieving the desired ROI must be carefully vetted prior to committing to any significant investments. These investments may be in the form of increased headcount, machinery and equipment, buildings and leasehold improvements, etc. Those investments that are critical to the continued success of the business must still be made, however, those investments that might be fueled purely by a desire to grow or upgrade existing equipment or facilities should be weighed carefully to ensure that they aren’t made on the heels of an economic pullback.
Have a Contingency Plan in Place
Given that it’s no secret that we will experience some form of a downturn in the not so distant future, it is imperative that you outline what your response will be when it comes. For some businesses, sales may just flatten out, so the contingency plan may focus primarily on managing costs. However, for many other businesses, sales may decrease and decrease by 20% or more. Managing costs for those businesses won’t be enough. Proactively identifying what, where and how much to cut costs, before the emotions of it overwhelm your decision making, is the key to timely executing on a plan that can prevent a business from losing a significant amount of money, and quite possibly save the company. It is common for businesses to begin to run inefficiently during periods of growth, and if looked at appropriately, an economic slowdown can lead to the strengthening of a business. It requires owners to examine many facets of the business that they have been ignoring, and the difficult decisions that have to be made often lead to a leaner and more efficient operation.
No one has a crystal ball, so “timing the market” is not an option when preparing for an economic downturn. Most business owners feel a responsibility to their families and the families of their employees to ensure that the business can continue on in perpetuity. Being prepared for the inevitable is prudent, and by adjusting your mindset and giving some thought ahead of time regarding the changes that would need to be made to your business to ensure it is able to weather the storm, will have a significant positive impact on mitigating the hit that your business sustains. The business consultants at LGA are here to help you prepare for the future. Contact us today.
by John D. Geraci, CPA, Managing Partner