Recessions are a part of the economic cycle, which means they’re inevitable. Fortunately, they typically last only 11 to 12 months. However, a recession can cause significant harm to a business that is unprepared for one. As the economy contracts, unemployment rates increase, profit margins weaken, and credit is harder to get. Service-based companies feel the effects of a recession through their client base. These businesses typically experience a delay in payment from clients, fewer new clients requesting their services, and fewer long-term clients renewing their contracts.
With these effects in mind, it’s imperative that you prepare your business for the inevitable by taking steps to ensure your company remains financially stable. Listed below are a few steps you can take to ensure your business is adequately prepared for a recession.
- Make sure you have enough cash on hand. Leveraging cash is the best way to ensure you’re prepared for a recession. Making sure you have enough cash at your disposal provides your business with some financial security, as doing so means that you can cover your expenses during months where you experience cash flow issues.
We recommend having 10 percent of your annualized revenue in cash. However, the higher the percentage, the more expenses you’ll be able to cover if you do run into cash flow problems during a recession. If you’re unable to build cash, we recommend troubleshooting the issue by taking a look at your current business model. Most of the time, this issue indicates a problem with a business’s profit margin, which should be roughly 10 to 15 percent of your total revenue.
- Extend your current line of credit. Having a line of credit is another line of defense during a recession, as it can help you cover your expenses during the lean months. Therefore, if you can extend your current line of credit, we recommend doing so. If you have a line of credit that is equal to your cash reserve (which is roughly 15 to 20 percent of your current sales), then you can cover expenses as needed during a recession. Extending your credit line allows you to cover even more costs should you run into cash flow issues.
- Address any inefficiencies in your operations. Fine-tuning your processes and procedures to ensure your business runs as efficiently as possible during a recession is essential. The leaner your operations are, the fewer resources you have to put towards running your business and earning income, which can make a huge difference during a recession when money to cover expenses is tight.
Some of these changes can be as simple as tightening your accounts receivable timeline or looking into ways to reduce your response time when it comes to your sales cycle. These small changes can have a significant impact on generating income and ensuring that your payments are received in a timely fashion during a recession.
Following the steps listed here is a great way to increase your chances of surviving a recession. With that said, it’s also crucial you recognize that recessions are regular occurrences. Doing so will encourage you to continue employing practices that will ensure the financial health of your business for years to come.
At Summit CPA we offer multiple resources to assist and help your business grow. If you’re ready to get an edge on your competitors? Contact our office at (866) 497-9761to schedule an appointment with our advisors.