Let the Good Times Roll (Over)!

A recovering economy, ultra low interest rates, a vibrant stock market, and rapidly escalating home values has prompted high inflation, a rising rate environment, and the threat of a potential recession.  Add to that the global unrest, and we have a recipe for the perfect storm.

Sounds a lot like 2006, doesn’t it?  And we all know how that unfolded.  Once the Fed started raising rates, the ensuing recession took down a substantial number of banks and businesses. The recession was not short, it was brutal and unforgiving, and it took many years for businesses and the banking industry to recover.  The banking industry lost a lot of community banks, and has been unable to replace those valuable institutions.  Instead, we now have mergers and acquisitions that create increasingly larger financial institutions, and acquisitions of the few remaining community banks by credit unions.

Rising rates, rampant inflation and a looming recession can and will impact you, your customers, and your employees.  Don’t underestimate it, or wait till it’s too late to prepare.  It is much better to begin preparing now, rather than waiting for a recession to transpire, and being caught flat footed.  You will be glad you did, and regardless of what happens, your business will be stronger for it.  And whether you’re currently with a large regional institution, a community bank, or a credit union, even if a recession does not unfold, your banking relationship will likely be impacted by a merger either now or in the future.  So, let’s consider ways to prepare for a slowing business cycle, while making your business stronger (and more recession proof) in the process.

Here’s five risk management steps you must consider to help improve the financial strength and performance of your business:

• Cash is King – This rule is always at the top of the risk management list.  Your best defense against a slowing business environment and higher costs is to maintain plenty of liquidity….this means maximizing cash, maintaining access to credit (including supplier credit), and increasing the availability of shareholder/owner capital.  Your action plan should include converting unnecessary, illiquid assets to cash; reducing expenses, keep lines of credit open and available; and, doing the same with owner’s personal financial condition.

• Produce both a revenue and expense, and cash flow forecast – A wise boss once told me the three things I could do to be a better risk manager is anticipate, anticipate, anticipate.  In an inflationary environment, anticipate higher costs of everything from raw materials and inventory, to equipment and real estate, rent, utilities, IT, credit, and personnel expense. Review your Profit and Loss statement for each expense category and consider what’s happening with costs now, and give thought to anticipated future price increases.  Expect longer lead times for raw materials, equipment purchases, service responses and production.  A cash forecast of revenues, expenses, and AR collection will help do that.

The key to a good forecast is to first forecast revenue and expenses for the period, then focus on the timing (day or week) of the related cash inflows and outflows.  The difference between these two models is, the revenue and expense forecast is a projection of sales, direct costs, and overhead expenses over the entire period; the cash flow forecast then breaks down the revenue and expense forecast into a projection of WHEN the revenue will actually be received (inflows), and WHEN the expenses will be paid (outflows).  The cash flow forecast may be structured as a daily or weekly model, and should always include the resulting daily or weekly cash balance.  Both models should be a rolling forecast that is updated weekly or monthly.  A good model to start with is three months forward looking for the revenue and expense forecast, and eight weeks forward for the cash flow.  Forecasting farther than that becomes increasingly more difficult to project with reasonable accuracy.  Once you have these models in place and functioning appropriately, you can adjust as needed.

• Know and manage your Financial Position, Financial Performance and Expense Structure – Understanding your financial position begins with having a good accounting system and producing accurate and regular (at least monthly) financial reports. If you don’t have a good accounting system and related processes, and trusted, knowledgeable bookkeeper, get them in place NOW.  This will help you manage amd adjust your pricing, your expenses, and your cash flow as needed, and be able to gauge the impact on profits, debt structure and liquidity.  Scrutinize overhead expenses, eliminate unnecessary costs (including employees), and sell or dispose of unproductive assets.  You can’t get your boat to shore with an anchor in the water!

• Anticipate tightening of credit – Increase access to credit now, even if you don’t think you need it.  This includes increasing supplier credit, extended terms, bank lines of credit, maybe even purchasing/financing that piece of equipment than can improve efficiency and reduce costs.  In a slowing economy, your customers will likely experience the similar financial problems and obstacles, so know your customers and their financial health. If you’re selling on credit as most businesses do, review your customers’ payment histories, and be wary of those slow paying accounts.  Make adjustments to or eliminate or significantly reduce those chronically late accounts.  For other accounts, anticipate slowing receivables collection, and respond quickly when customers run past due.  Usually, the squeaky wheel gets the grease!

• Stay close to your banker – If you are borrowing money and don’t know your lender, shame of both of you. It’s not too late to call and invite them to your business, let them meet your management team, and learn what it is you do.  Share with your banker how you’re doing (including your financials), show them what you’re doing to prepare, ask for their thoughts, and inquire what they see happening with other customers.  Ask them for their advice, and what actions other customers are taking.  This is free advice that comes with your principal and interest payments each month.

So, there’s five actions to consider to begin your preparation for a slowing economic environment.  It’s not bullet proof, but it will make your business much stronger and better able to withstand a weak economic season.  At least until the storm passes, and the flowers start to bloom again.