How to Prepare a Business for an Economic Downturn: A Finance Leader’s Guide

This article has been contributed by Swarupa Bhangvi, Finance Director, Landor.

An economic downturn is a significant decline in economic activity spread across the economy, lasting more than just a couple of months. Economies can slow down within a nation, a specific region, or on a global scale. 

Recessions in the 20th century include the Great Depression in the 1930s, the Oil Crisis of 1973, the recession of 1982, the 1997 Asian financial crisis, and the 2008 global financial crisis. They have each sent shockwaves throughout the world’s economy and the very recent COVID-19 crisis that severely affected and disrupted businesses and economies throughout the world. 

Reasons for recessions would include both internal and external factors such as loss of confidence in investment and the economy, high interest rates, post-war slowdown, wage-price controls, unemployment, stock market crash, etc.

When the Economy of a country is affected by recession, can the businesses remain untouched?

Some recessions cause short-term problems that disrupt the supply chain and others cause long-term ones, like the closure of businesses and an increase in bankruptcy cases.

While Economists throughout the world do warn about an increased risk of recession, one can’t prevent the fallout but can minimize its impact on the business.

Let us see how recession affects small businesses

Small businesses are organisations with about 100-500 employees, accounting for a substantial percentage of the economy, irrespective of their location. These are truly quite small in scale, lacking in the market power, financial cushion, and leverage needed to weather a recession.

Unlike larger companies, small businesses cannot raise funds during recessions by selling stocks or issuing bonds. They also are not able to lobby for funding.

All of these economic factors affect business owners, preventing them from withstanding dips in revenue caused by economic uncertainty and making small businesses vulnerable during recessions. Eventually, they either disappear or are gobbled up by larger businesses having similar interests.

How Recession Affects Large Businesses

Large businesses may fare better than smaller ones during recessions, but they certainly aren’t immune to the many pitfalls that arise during times of economic downturn.

For public companies, any decline in revenue will be published in quarterly reports. Investors see these numbers, and due to overall uncertainty and heightened risk, they may sell their shares, causing share prices to fall.

Of course, large businesses have access to more tools during recessions than small businesses do. For example, a large business can suspend pay raises or initiate a hiring freeze during recessions. Reduce or altogether eliminate dividends for shareholders. In some cases, a company may resort to a mass layoff, which helps cut costs and offers some degree of financial protection.

Large businesses have more wriggle room and resources at their disposal to weather economic recessions compared to small businesses.

What Happens During Such Economic Turbulence

Drop in Sales and consequent revenue

While the level of decline in revenue depends on the industry, most businesses are affected to some degree.

Nonessential goods and services are the first expenses that consumers cut during hard times, leading to sharp declines in revenue. Most manufacturers of products have to slow production as a result of declining demand.

Service industries such as Advertising companies are also significantly impacted by a decrease in overall advertising spending as businesses tend to cut back on marketing budgets, leading to lower revenue for agencies,

Bankruptcy and Financing Issues

Today’s lenders have decades of historical evidence showing the risks associated with lending during recessions. This perspective makes it harder for businesses to get short- or long-term loans to finance their needs.

Reductions in benefits and Layoffs and the Domino effect

During recessions, it’s common for layoffs to take place as a reaction to the uncertain economy. There is a chain reaction or domino effect that causes layoffs. It starts with economic decline, which results in reduced demand for goods and services.

Reduced demand means businesses require fewer workers to meet their targets, and this results in organisations reducing the need for workers and consequent lay offs.

We have experienced during COVID-19 where some companies reduced salaries while some delayed the payment. 

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Way forward on surviving the business downturn

The recession is scary, and there may not be a quick fix or established formula to beat it, but there are some steps that can keep you floating.

Increase Cash holdings

Asset diversification, along with a long investment timeline, helps protect your business during a recession. Cash holdings allow for quick and easy access to liquidity, especially during crashing stock markets.

Avoid Debt and Tapping into Your Reserve

Avoid debt and refrain from tapping into your reserve by paying as you go. Even if you can increase your cash holdings, you also need to be able to connect all business expenses to coordinating sales.

For example, if you need to purchase a piece of equipment, you could negotiate for payment in installments or try to defer the purchase as and when the cash flow improves. 

Request flexible payment terms from your suppliers.

Cost optimisation

Reduce nonessential expenses. Renegotiate contracts with suppliers. 

Rent unused space to another business (e.g., part of a warehouse or office).

Freeze hiring and consider voluntary departures

Work with universities to employ interns under workplace-integrated learning programs.

Focus on Customer Service and Improve the Existing One

Customer service is one of the best ways to create long-term stability for your business and will more likely get repeat sales.

Usually, getting new customers costs more than retaining current customers. Make sure your team is armed with the training and resources needed to provide the best possible customer service.

Revenue Diversification

Explore new market segments or product lines to reduce reliance on a single customer base. Consider subscription-based or retainer-based revenue models.

Focus on Collectibles

The collection of old outstanding balances from your clients is extremely important at all times and more so when the liquidity is drying up. 

Manage account receivables by offering flexible payment terms if they are struggling to pay your invoices. Constant monitoring of the Accounts receivables is the key to reducing or avoiding Bad debts.

Financial Planning

Develop a detailed budget and monitor financial performance closely. Assess potential risks and develop contingency plans. 

Communication

Maintain transparent communication with employees, customers, and partners about your business strategy during an economic downturn. 

Work closely with staff to generate ideas, redeploy and retrain, and keep morale high.

Conclusion

We conclude by stating that while Economic downturns are temporary and inevitable phases. Every business should proactively prepare for such contingencies and strive to navigate as there is always light at the end of the tunnel.

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