by Mark J. O'Donnell
We are taking a two-month break from the financial statement series to share our thoughts on the near-term economic environment. This month, we will cover our “7 Deadly Sins” in the face of a recession.
What’s to come may be a recession (negative economic growth) or a period of slower growth. Each business must modify its financial strategy according to its industry and the timing and depth of economic slowdown, if any.
Consider our “7 Deadly Sins” for a slow growth/recessionary economy.
1. Ostrich Strategy AKA not planning for the possibility of a downturn
Failure to plan exists when one of four beliefs is present: A) It won’t happen. B) It won’t happen to me. C) I am too busy to think about it. D) I will deal with it when it happens.
2. Pulling too much cash out of business (distributions, owner bonuses, etc.)
Businesses struggle when they run out of cash, not when they run out of profit. Cash is the best source of ‘security’ in business. Don’t weaken your company when facing a challenging economy.
3. Shutting down marketing and sales activity
Expense reduction is a classic and appropriate reaction to slowing sales. Given that, your competition may reduce marketing and sales dramatically. That’s an opportunity to fund marketing and gain a competitive advantage…if you have the cash.
4. Failure to manage products and services based on expected demand and profitability.
It’s bad in good times; it’s much worse in hard times. Allocate resources to high-margin products and services you expect to be in demand in a slower economy. Sell off that slow moving inventory, it is an anchor. Margin velocity analysis can show the way.
5. Poor cash cycle management
Cash flow starts with money invested in inventory, sales convert inventory to receivables, which collections convert to cash. Keeping this cycle in tune requires constant review of inventory and accounts receivable. If these bloat, cash, the lifeblood of your company, will diminish.
6. Excess debt levels
It is typical for banks to reduce their potential loan exposure by tightening credit standards in a slowing economy. This is the time to minimize, not expand, your debt. Meet with your banker to discuss your plan for the near term. You need them on your side.
7. Capital expenditures
In the near term, significant investment and reinvestment in property and equipment will negatively impact cash and debt. Both are not good in a shrinking economy. Limit capital expenditure to only what is necessary, especially in the early stages of an economic slowdown (but see also next month’s article).
Our current ‘go to’ resource indicates slowing growth for the balance of 2023 and recession in 2024 for most segments of the economy. Opinions vary. What is apparent is that the next year or two will differ significantly from the last five. Minding these “7 Deadly Sins” will help you keep an eye on what makes you successful and keep both eyes on what might kill you.
Next month, we will cover strategies to prepare for the backside (recovery) of the recession/slowdown.
Mark O’Donnell, CPA, is Partner at Schmersahl Treloar & Co. He can be reached at 314.966.2727.