Many business publications are talking about a coming recession. According to the traditional definition–two quarters of negative GDP growth–it’s already here. GDP, or gross domestic product, is the total amount of spending by end users in the economy.
But what is a recession? And what should your business do about it?
Navigating a recession can be a challenge, especially for small business owners. A recession can mean a drop in sales, uncomfortable budget decisions, supply bottlenecks, and more.
Planning for a recession is not only insurance against a likely future, it’s a good business practice in general. Most of the things you can do to prepare for a recession are things you should be doing as a business owner anyway.
What Is a Recession?
A recession disrupts the economic environment your business operates in. Traditional economic statisticians define a recession as two consecutive quarters of GDP decline. By that definition, we are already in a recession.
The business press is in disagreement over whether the present state of affairs is a recession. For one thing, unemployment–a hallmark of a recession–is not increasing as would be expected. Further, inflation–usually low and sometimes negative in a recession–is hitting record-breaking highs.
What Is the Definition of a Recession?
Given the current unusual business environment, it’s hard to say how the economists define recession who are declaring it not to be so. Most are looking primarily at jobs numbers, heartened by steady low unemployment and modest job growth.
Given the generally unpredictable nature of recessions, it’s hard to say that these countervailing conditions will last. Plenty of economists and top business executives are sounding the alarms for a coming recession if we aren’t in one already.
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How Do Recessions Happen?
Recessions are part and parcel of what’s known in economics as the business cycle. The business cycle describes fluctuations in several key economic indicators that tend to move together as the economic system changes.
Historically, recessions have been triggered by a collapse of the financial system. Effectively, investors expect consistent or rising profit growth from businesses. As businesses grow together, they collectively produce more goods and services than consumers can purchase, leading to a slowdown in profit growth.
With profits declining, investors pull out, leading businesses to cut costs more rapidly than they might have based on the profit numbers alone. This usually takes the form of layoffs and part-timing.
With people employed for fewer hours, the problem compounds. Businesses encounter even less demand in the market, and cut even more costs, further exacerbating the problem. The result is high unemployment, declining GDP, wage cuts, decreasing demand, and price deflation. Declining prices make planning for future growth very difficult.
How Likely Is a Recession?
There don’t seem to be any economists who have a rosy outlook on the short-term future of the US economy since the most recent GDP numbers came out. Judging by this, we might say a recession is very likely.
Consumer debt is growing rapidly, and with the budget reallocation occurring due to rising prices, it may collapse as we saw in the last recession in 2008. If real estate prices cool off, we might see a repeat of leveraged homebuyers falling underwater on their mortgages en masse.
Because debt is held as a bank asset, a large number of homeowners defaulting on underwater mortgages spells catastrophe for their depositors, who might attempt to withdraw their funds at the same time before there’s no money left. This is called a bank run and is another problem that is caused by and causes a recession.
What Is Stagflation?
The standard model of the business cycle says that inflation and unemployment move in opposite directions. This conventional wisdom was challenged in the 1970s, however, by a period of high inflation and unemployment spurred by a reduction in global oil supply due to OPEC coordination.
Because stagflation defies the tradition economic model, there aren’t well-developed theories on how to combat it. Traditional recessions are combated by expanding government spending and reducing interest rates. But these measures tend to exacerbate high inflation.
How Will a Recession Affect My Business?
Unemployment, inflation, GDP–these aren’t indicators that usually figure into your business practices. Even still, these factors will weigh heavily on the conditions your business faces in the marketplace.
How Will a Recession Affect My Customers?
With high unemployment and increasing part-timing, consumers will overall have less money to spend. This means you will likely see a drop in sales as consumers tighten their budgets.
With inventories sitting idle, your suppliers will likely also feel the pinch. Some may even go bankrupt, disrupting your supply chain and your ability to meet consumer demand.
How Will a Recession Affect My Employees?
We’re already beginning to see major companies laying off employees, with a focus on the tech sector. Since your payment obligations don’t drop when sales do, you will likely find yourself in the position of making cuts, too.
Laying off employees is a difficult decision not only emotionally but from a business perspective. Trimming costs must be balanced against the necessity of employees to fill the roles they do. Even with the most carefully planned layoffs, your business will likely suffer in terms of productivity.
How Will a Recession Affect My Bottom Line?
When it comes to running your business, there’s only so many costs you can cut. Rent, utilities, essential staff, debt payments, and software systems are costs you generally can’t escape, no matter how low your sales drop.
This will eat into your profits and probably stifle your ability to grow your business. In fact, you may end up paring your business back down. For most businesses, a recession is not a time of growth.
How Will Stagflation Affect My Business?
Stagflation eats away at your profits at two ends. On the one hand, the effects of high unemployment cut into your sales. On the other hand, the effects of rising prices cause your costs to rise.
You may find yourself in a very awkward position when it comes to pricing your goods. You want your prices to be high enough to cover costs, but your prices need to be low enough to attract a dwindling consumer base.
How Can I Manage My Business Through a Recession?
Managing your business through a recession is tricky work since you have a lot of forces going against you. Although growth should always be at the back of your mind, running your business in a recession often means doing what you can to ensure that business remains as healthy as possible.
Given that a large number of factors are simply out of your control, you may find that your efforts still result in lost business. Don’t panic! If you are being diligent about your finances and you are able to maintain operations, you are probably keeping your business from sustaining even further losses.
Preparing My Business for a Recession
The best way to make it through a recession is to get out ahead of it. Preparing for a recession isn’t really all that much more than operating with best business practices.
Doing what you can to reduce fixed costs now is a great step to relieving the pressure on your profits later. This may include things like paying down debt before it’s due, negotiating a new lease early, and contracting with vendors to pay in advance. Not only do these reduce costs, but they may also allow you to preempt the price inflation and interest rate hikes that come with stagflation.
Navigating My Business Through a Recession
Once a recession starts affecting your business, you will likely have to go into damage control mode. As sales drop you will likely have to make some uncomfortable cuts, rethink your vendor mix, and otherwise do what you can to cut costs to where you can still stay in the black.
It would be nice if you could simply see for example a 10% drop in sales and cut your business evenly across the board by 10%. Unfortunately, the nature of your inputs prevents you from doing that, and you will have to be strategic about what costs you choose to forgo.
While you can strategically cut things like software subscriptions without too much consternation, dealing with employees is another matter entirely. While to you cutting staff is an unfortunate part of doing business, employees seeing their coworkers disappear and being burdened with their responsibilities might hurt l morale, leading to productivity dips and sudden departures of those who remain.
The Importance of Sound Financial Management
Most business owners are not prepared to navigate their business through a recession because their expertise is in sales or operations, not financial strategizing. Finding the right strategy during a recession takes careful planning that many owners simply do not have the time or experience for.
Having a professional in a financial management role in your business is the best way to ensure that your financial needs are being met while you focus on getting your products to customers. For companies that can afford it, this responsibility usually falls to a chief financial officer.
Finding Help Managing Your Business During a Recession
Not every business can afford to bring on a full time CFO. For this reason, professionals experienced with CFO work offer their services to a number of companies part time, giving you the insights of a CFO without shouldering cost of hiring a CFO internally.
Michigan CFO Associates has been providing small and medium businesses financial insight with part time CFOs for over 15 years. Our CFOs work in many different industries and have seen downturns and recessions before. In serving many clients at the same time, our CFOs have a better feel for the overall business environment in a number of different industries.
We’re proud to serve clients in the Detroit area with our on-site services and nationwide with our virtual CFO services. Ready to bring on one of our CFOs or want to know more? Contact us for a consultation.
Featured Photo Credit: jcomp