In June 2022, the U.S. inflation rate hit a record 40-year high at 9.1%. To combat inflation, the federal reserve enacted a second consecutive 0.75 percentage point interest rate hike in July.
These indicators show that an economic recession might be on the horizon.
While many experts don’t expect the recession to be prolonged, it is still a scary thought for many small businesses that are still recovering from the recession caused by the COVID-19 pandemic.
Unfortunately, these economic cycles are a natural part of life and are difficult to control as an individual.
Thankfully, there are effective ways to prepare your business for a recession so that you can cushion it from the effects of an economic winter.
What is a Recession?
The National Bureau of Economic Research defines a recession as a period characterized by a significant decline in economic activity. The period can last for several months (or years) and have far-reaching impacts on society.
For example, it can cause financial problems for individuals and businesses. As a result, many people find themselves out of work and unable to pay for their daily needs as organizations and businesses look to cut costs during a recession. Needless to say, layoffs and pay cuts are common.
While economists still don’t have a way to perfectly predict a recession, businesses do have ample options to reduce the economic impact of recession.
In this post, we share five tips to prepare your business for a recession like the one we are likely to experience.
Tips to Prepare Business for a Recession
While it’s possible to predict if a recession is going to happen, you cannot prevent it from happening at an individual level.
The best way to ensure your business continues to sustain regardless of the economic condition is to prepare for such eventualities in advance.
The following tips will help you prepare a business for a recession.
Secure Your Cash Flow
Since most businesses fail because of cash flow problems, protecting your cash flow is a crucial aspect to watch closely as you prepare a business for a recession.
A strong cash flow allows you to meet your financial obligations and pay the bills to keep the business running.
For this reason, you need to get serious about collections and invoices. As the economy slows down, you’ll notice that your clients take longer to pay their invoices to protect their cash reserves.
You’ll notice that an account that paid in 30 days now pays 45 days later, and one that paid in 45 days takes 60 days to pay their invoices.
Such delays cause cash flow problems that can cripple your business. To prevent this from happening, implement the following cash flow management practices to prepare your business for a recession.
- Ensure your contracts include late payment fines to reduce the risk of outstanding bills not being paid.
- Send invoices early and follow up regularly to ensure you are paid faster.
- Collect deposits for large jobs upfront to prevent cancellations.
- Give discounts for early payments.
Build Your Cash Reserves
Cash is king during a recession. With customers making late payments and some even defaulting on their payments, a cash reserve allows you to weather the storm for a while.
Therefore, building a strategic cash reserve is one way to prepare your business for a recession. Calculate how much you need to keep your business running for a month and save at least six times that amount.
For example, if it costs you $4,000 to stay in operation for a month, you will need to build a cash reserve of at least $24,000.
To build this reserve, you can choose not to reinvest your profits or pay them as dividends to shareholders. Instead, save the profits so you can use them during a recession.
Reduce Your Expenses
Another strategy to prepare a business for a recession is to cut non-essential expenses. Anything that doesn’t directly support income generation needs to go.
For example, that out-of-town bonding trip for all your employees that was planned for the holidays can wait until things get better. Right now, all your resources need to be directed to crucial income-generating activities.
However, you need to be careful when deciding what constitutes non-essential expenses. It’s easy to assume an activity like marketing isn’t essential, but this can be a costly mistake.
Marketing may not have a direct ROI, but it’s crucial in helping you stay relevant in the industry. You can cut down on certain aspects of marketing during a recession but don’t disregard it completely.
Renegotiate with Vendors
If you are worried about your cash flow position, you can get ahead of the curve by negotiating with your suppliers.
Your vendors are also struggling because of the recession, but they would still want to retain you as a customer. Take advantage of this and renegotiate your supply contracts with them.
Ask for better rates and more time to clear your debt as you sort out your financial issues.
Secure Business Financing Early
From this Incfile review, you can see the benefits of setting up your business in the right manner to qualify for loans from financial institutions.
When recession hits, many businesses need financial assistance to navigate the tough times. However, interest rates are higher during such times because of the high demand for credit facilities.
That’s why securing business financing early is a great way to prepare your business for recession. Your finances are also great at this moment, and this boosts your chances of getting approved for a line of credit.
There’s very little you can do to change the economic direction of the country and the world at large. The best thing you can do is learn to prepare your business for a recession to ensure the sustenance of your organization during these tough times.
By reducing your expenses, securing cash flows, and building a cash reserve, you will overcome the challenges of a recession and emerge as a strong business leader.
Brett Shapiro is a co-owner of GovDocFiling. He had an entrepreneurial spirit since he was young. He started GovDocFiling, a simple resource center that takes care of the mundane, yet critical, formation documentation for any new business entity.