Small businesses are uniquely at risk from recessions. According to J.P. Morgan, the average small business holds 27 days of cash in reserve. That means that if the company goes with no sales for a month, they would not be able to make payroll or keep the lights on. With hints of a recession starting in 2024, small business owners should take proactive measures now to fortify their companies.
The next recession could be ignited by the Federal Reserve’s recent interest hike campaign. Between March 2022 and July 2023, the Wall Street Journal Prime interest rate, the amount at which banks lend money to their most-favored customers, rose from 3.25 percent to 8.50 percent. Higher interest rates increase business costs, threaten consumer demand, and edge the economy toward economic downturns.
On average, recessions begin 11 months after the Fed’s last hike in its tightening cycle. The Fed’s last hike for this cycle may have been July 2023. If history repeats, the next recession could begin in June 2024. The opportunity for business owners is to make smaller, more tactical moves now to avoid cash shortfalls, layoffs, or closure in the tougher times ahead.
12 ways to protect your small business from a recession:
Don’t Pay Off Your Debts
That archaic advice of eliminating debt before a recession is a reflexive regurgitation of a cliché from a 1980s microeconomics textbook. As a business owner, you know that what you do in the trenches often differs from what is taught in the classroom. It may be tempting but don’t deplete your cash reserves. A U.S. Bank study found that 82 percent of failed businesses experienced cash flow mismanagement; 29 percent flat-out ran out of cash.
Secure Financing in Advance
According to the Senior Loan Officer Opinion Survey, banks expect to “tighten lending standards further across all loan categories.” During a recession, companies can find themselves locked out of financing opportunities. Work with your lenders now to obtain a line of credit with no pre-payment penalty. You can place any unused cash in an interest-bearing money market account. (I put my corporate cash in the Schwab Treasury Obligations Money Fund Ultra Shares, which yields about 5.2 percent.)
Cut Travel Cost
Video software and webinars allow businesses to continue meeting and training requirements while reducing expenses and becoming more productive.
Downsize Inventory
Holding inventory requires spending cash reserves. There will be less of a need to have products on your shelves or in your warehouse during a recession. Also, you’d be positioned to bargain for better prices when restocking inventory.
Conduct a Subscription Audit
You may be signed up for recurring billing on underutilized periodicals, networking groups, and software. Morgan, who owns a law firm in Greenfield, subscribes to a software program that allows him to create estate documents for states in which his lawyers are not registered. In early 2023, Morgan logged into the software’s diagnostic tool and learned that although his firm had a dozen subscriptions, only two were power users. Morgan called the software company and changed the agreement to two licenses and one “floating” license, allowing others to use it so long as they were not logged in simultaneously. This saved Morgan’s firm about $6,500 per month.
Collect Receivables
Ask your customers to pay you while they still have the cash to pay you.
Collect Deposits Upfront
Leah owns an environmental engineering firm in Bennington, Vt. Environmental engineering projects can take months to complete and are billed monthly as work is completed. Unfortunately, vendors who bill this way are familiar with the struggle of getting that last invoice paid. Leah requires a deposit equal to 20 percent of the estimated project cost, which is applied to the final invoice; she offers a 5 percent discount on that invoice to her best customers.
Sign Contracts
Many companies rely on the loyalty of their customers. However, business owners often mistake “inertia” for “loyalty.” If your customers fall on tough times, you may find that loyalty challenged. Glen owns a computer service business in Hadley. Expecting a recession, he is extending 18-month contracts to his hourly customers offering to forgo the typical upcharge for off-hours service as an enticement.
Freeze Hiring
Employees are expensive.
Take Care of Your Employees
Demand for goods and services will fall during a recession, but existing clients will require more time and attention to recognize your value. Employees will have to assume new responsibilities. Acknowledge the sacrifice and changing workload of your team and ask them to give you feedback on what non-expense support you can provide to them. Avoid making Elizabeth’s mistake of prioritizing profit over people.
Elizabeth runs an insurance agency headquarters in Hartford, Conn. Over the last few years, she has been acquiring several competitors, including several in and around Berkshire County. In 2023, there was a near-exodus of employees from the Berkshire-based branch because of the shift from a family-business culture to a corporate bureaucracy. Many of the remaining workers fit in just fine with the new organization. Still, some of them have rumbled about leaving, too. The company is not replacing the workers. While that is good for cash flow, the increased workload for remaining workers is deteriorating employee morale.
Postpone Major Initiatives
Delaying large purchases during a downturn is intuitive. Additional consideration should be given as to which low-cost initiatives should be rescheduled. Matt owned a mid-sized mortgage brokerage company based out of Cherry Hill, N.J. In 2007, Matt upgraded his company’s customer relationship management (CRM) software. The annual dollar expenditure was roughly the same. However, implementing a complicated initiative before what turned out to be a stressful time distracted employees from core services.
Strengthen Your Largest Client Relationships
Staying close to your most profitable customers always makes sense, especially during a recession. Your customers will also feel the pain of a recession. The difference is they could be forced to be reactive while you are being proactive. Their reaction may be to replace you. You can get ahead of that hazard in two ways. First, remind them of your value and ask them about any deficiencies they’d like you to address. Second, share what you’ll be doing in anticipation of tough times. They’ll appreciate your transparency, and your advice will help sustain their ability to keep working with you.
Recessions are painful, but they’re also inevitable. Since the Great Depression, there have been 14 U.S. recessions. On average, that’s an economic downturn once every six years. The key to weathering the next economic downturn is being proactive, not reactive.
This article first appeared in the Berkshire Eagle on November 8, 2023.