Depending on where you get your economic news, everyone is opining on the timing and severity of an upcoming economic downturn. Up until now, times have been good. Owners, investors, and bankers are happy. This continued success has allowed for investments in capital equipment, expansions of product offerings, and hiring of resources, along with increases in overhead and, in some cases, debt to support the growth.
But what happens when the economy does turn for the worst? Will your business be able to weather the storm? Whether it is interest-rate policy changes, Brexit, import or export tariffs, or the shortage of labor and resultant rising labor costs, you can drive yourself insane trying to figure out how any of these influences may impact your business.
Rather than stress about all the unknowns, it is best to be proactive and take a hard look at your business under several scenarios to see if you can find other sources of revenues or cut costs sufficiently enough to put your business in the best possible position, no matter what happens. And to do this, that means you must run a couple of different financial models under different levels of revenue erosion and/or cost escalation.
Whether you are in retail, wholesale, or consumer goods, the best time to look at your business is when times are good, you are in control, and you don’t have to make rash decisions without weighing out all the consequences. There is no better time to look at the future.
Before you start modeling, however, it is important to take a look at what is happening up to this point and establish your baseline. Companies should look at every aspect of their business, much like an outside investor would, starting with how well the business is executing against its plan. Developing and following your business plan is fundamental to your success but recognizing when plans need to be changed in response to outside influences is equally as important.
Looking at your historical performance will highlight areas where things are going better than expected, but also put a spotlight on any deficiencies.
Start with the top line and look at your customer base and see if there are any trends that might erode your revenue in the future. Is your sales and marketing effort getting the volumes you expected? Is your product mix giving you the contribution you expected?
Diving deeper into customer and product profitability will also provide some insight into both your pricing and cost structure. Take a look at the value proposition you bring to the marketplace and consider if consumers and businesses want to purchase your products and, if not, how you can change that perception. Lastly, don’t forget to look at what your competition is doing, especially regarding pricing, quality, and customer service, and make sure you are taking care of your customers. Because if you don’t, someone else will.
Next, break down each cost component of your business, variable and fixed, down to its lowest common denominator, so you have a clear understanding of what is driving these costs. Fixed costs can kill any business if the top line starts to erode and the business is unable to reduce the fixed cost components in line with the loss in revenue.
This also is a good time to look at your organization to make sure you have the right people and compensation structure in place. Another key factor to look at is process, whether on the shop floor or in the front office, from purchasing to order fulfillment, and even financial reporting. From there, look to reduce or eliminate all non-value-added steps.
If you are having a difficult time understanding or capturing your cost drivers, look at the software you are using to determine if it is capturing the key data points necessary to manage your business. Is your team using the system to its fullest capability? As your business evolves overtime, it is critical that its IT systems and process evolve at the same pace.
In business, cash is king, so looking at your sources and uses of cash throughout the year will provide you great insight into any trends you should be concerned with down the road.
It is crucial to monitor the historical trends of key performance indicators and financial ratios that are relevant to your business and industry. Whether it’s accounts receivable/payable days outstanding, inventory turnover, debt to equity ratios, or gross margin, recognizing you have an issue is the first step in implementing corrective action plans.
With a thorough review of your company’s performance, the next step is to develop one or two different “what-if” scenarios, some of which will forecast cash flow shortages or other significant headwinds that may impact your ability to service your debt or acquire capital assets.
Once you are comfortable with the impact of your scenarios, begin developing and modeling in your action plans to counteract the impacts modeled. Don’t focus your efforts on just one part of your business; be sure to take into account every aspect of the company and include input from each department.
It is relatively easy to model an increase in sales or decrease in costs, but it takes a team effort to execute action plans, so it is best to have everyone’s buy-in from the start. Your plans should be realistic but also include a little bit of a stretch, and the timing of implementation is critical.
You do not have to wait for downturn to start preparing; it is often prudent to take preventative measures now in order to minimize scrambling for solutions down the road. Consider:
- Eliminating or reducing all discretionary spending.
- Reviewing all past due receivables and customer credit terms and allocating enough resources to maximize collection. Update credit policy of at-risk customers.
- Investigating whether a consigned or vendor managed inventory arrangements makes sense for your business.
- Taking a look at your vendor payment terms, and where possible, requesting payment term extensions.
- Reviewing your plans for hiring to make sure the need justifies the cost.
- Reviewing upcoming capital expenditure requirements and eliminating or delaying any non-critical items.
- Create a short-term (13-week) cashflow forecast that monitors daily or weekly movements of cash and forecasts your business needs over the same period. If you have not had to do one of these before, I can tell you from experience that although it is tedious and time-consuming, once you get into the rhythm, you will find it indispensable.
- How you finance your capital expenditures can also have a significant drain on your liquidity. If you are flush with cash, perhaps financing isn’t necessary, but in general, you should be financing long-term assets with long-term money (debt) and short-term assets with short-term money (working capital).
In the long run, it pays to be precautious. Planning and strategizing throughout the year is a sound business practice and keeps key stakeholders up-to-date on key issues. Be proactive and take control of your own destiny, and remember it pays to be prepared.
Keith Chulumovich is a certified public accountant and director with Bloomfield Hills-based O’Keefe. For more information, visit okeefellc.com.