What is a Recession?
A sustained and widespread decline in economic activity characterizes economic recessions. These periods of the downturn can last for several months or longer and are typically recognized by a decrease in a country’s gross domestic product for two consecutive quarters.
Recessions are inherent in a capitalist system, where economic conditions fluctuate. Although recessions can be challenging for small businesses, it’s important to remember that they also present opportunities. By being informed about key economic concepts, protecting your business, and maintaining a positive outlook, you can prepare your business to weather any financial crisis.
How recessions impact small business
Starting a business can be both thrilling and demanding. Despite the hard work and dedication put into building a successful venture, it is still affected by external factors. Global changes, unstable markets, and economic downturns can make it difficult for small businesses to thrive.
However, facing these challenges can ultimately lead to more significant accomplishments. Economic recessions affect the entire economy, but small businesses tend to be the most susceptible to consequences.
During a recession, consumer spending typically decreases, which can lead to a fall in sales and revenue for small businesses. This can make it difficult for small businesses to meet their financial obligations and lead to a decrease in profits or even bankruptcy.
Additionally, during a recession, small businesses may find it more difficult to access credit, making it harder to invest in new equipment, expand their operations, or hire new employees.
Furthermore, unemployment rates tend to increase during a recession, which can lead to less spending power for consumers, leading to more pressure on small businesses. Recessions can be challenging for small businesses, and they need to have a plan to manage cash flow, reduce expenses, and access credit if required.
15 Tips for running a business during a recession along with managing Cash and avoiding debt
Here are some effective tips to follow:
1. You need to have patience
Research suggests that medium to large family-owned businesses perform well during economic recessions. This is attributed to the collective wisdom and experience of multiple generations, which enables them to navigate the ups and downs of the business cycle with a calm and level-headed approach. Their ability to ride out the storm is further supported by their low debt levels and lack of external shareholders’ pressure.
However, it’s essential to note that patience and complacency should not be confused. Patience requires having a solid foundation, which can be achieved by following practical advice and positioning your business to have the necessary support.
So, it is essential to keep patience while making cash and debt management decisions.
2. Find areas to increase revenue
Using unit economics to weather an economic recession is crucial to identify and protecting your most vital revenue channels. This may involve reevaluating your business model, optimizing pricing, and cutting products, services, or clients that don’t generate substantial profit margins.
Along with protecting existing revenue streams, it’s also essential to identify opportunities to increase revenue. This can be achieved by exploring new markets, introducing new products or services, or raising prices.
To achieve this, it’s important to think creatively and find ways to tap into new revenue streams using your current resources. For instance, you can explore the possibility of adding B2B customers if you sell directly to consumers or vice versa. Consider also expanding your reach by selling online.
3. Try to lower the overall costs
It’s crucial to take action to evaluate your operations and cut unnecessary expenses to strengthen your cash position, avoid debts, and be well-prepared to handle the recession. Focus on reducing costs without compromising the quality of your products or services.
This may include renegotiating vendor contracts, streamlining manufacturing processes, laying off staff, or lowering inventory levels.
4. Downsize inventory if required
Managing inventory is a complex task that requires attention to detail and careful monitoring. During a recession, inventory turnover may slow down, making inventory management even more challenging. When inventory sits for a long time, it becomes more susceptible to obsolescence, theft, damage, and increased storage costs.
While it may be tempting to downsize inventory to combat these costs, it’s crucial to maintain a balance between converting inventory to cash and fulfilling customer orders. Running out of stock can lead to lost revenue and damage customer relationships.
To increase cash flow, focus on reducing less popular, less profitable, and more easily replaceable inventory items. Also, evaluate your supply chain and consider stocking up on best-selling items.
5. Seek out additional funding
There are several ways for businesses to seek out additional funding during a recession:
- Government loans and grants – The government may offer loans or grants to small businesses during a recession. Look for programs such as the Small Business Administration’s (SBA) 7(a) loan program or the Paycheck Protection Program (PPP).
- Crowdfunding – Crowdfunding is an option to raise funds from many people, usually via the internet. Platforms like Kickstarter and Indiegogo allow businesses to pitch their ideas to the public and raise money in exchange for rewards.
- Angel investors and venture capital – Venture capital firms and angel investors might be willing to invest in businesses during a recession. These investors typically provide funding in exchange for equity in the business.
- Business lines of credit – A business line of credit allows businesses to borrow money as needed, up to a specific limit. This can be a useful option for businesses that need to manage cash flow during a recession.
- Factoring – Factoring is a way for businesses to sell their accounts receivable to a separate entity (third party) at a discounted rate to receive immediate cash.
6. Prioritize and manage cash flow
Monitoring cash inflows and outflows is crucial to ensure sufficient funds to cover essential expenses. To manage cash flow effectively, keep track of your current cash flow statement daily and consider creating a forecast of cash flow using three, six, and 12-month charts.
These charts can help you anticipate times when cash might be tight and allow you to implement strategies to mitigate potential challenges. Additionally, creating a budget that considers best and worst-case scenarios can help you prepare for unexpected challenges or successes.
7. Operate within your budget
Maintaining a budget and sticking to it is fundamental to good business management. Operating within your budget puts your business in the most vital possible position in case of a recession and helps you to manage your cash flow and debts.
In fact, adhering to a budget or operating plan is standard practice at all times. Some recessions, such as the one caused by the COVID-19 pandemic, can occur unexpectedly, so it’s essential to be prepared.
8. Don’t involve your personal savings
As a wise business owner, keeping your personal finances away from your business finances is crucial. Using your personal savings or borrowing against your house to keep your business afloat is not a sustainable solution.
Instead, it’s essential to ensure that your business has the financial resources to support itself. The bootstrapping mentality is often promoted as a way for entrepreneurs to succeed, but it can be a dangerous trap.
Mixing personal and business finances can lead to financial ruin if the business struggles. It’s essential to stay focused on the numbers and understand that there will be fluctuations in revenue and expenses. Instead, it’s better to plan for these fluctuations and have a cash reserve or access to credit to face any financial crisis.
9. Develop a business emergency fund
An emergency cash fund is an essential investment for businesses, particularly for small companies that may not have access to traditional forms of credit. This emergency fund should be designed to cover important costs, such as payroll, inventory, and utilities, for up to six months.
This will ensure that the business has sufficient resources to manage unexpected financial challenges during a recession or other difficult times.
One way to build an emergency cash fund is by aggressively collecting receivables, which can provide additional cash flow. Another option is to consider business continuity insurance, which may provide financial coverage in unexpected disruptions or other challenges.
It’s vital to understand your financial position clearly and that having a cash cushion can help mitigate risks and provide stability. This is why financial planners often recommend it for both individuals and businesses.
10. Re-evaluate big investment decisions
During a recession, it’s crucial to re-evaluate your spending and examine your cash flow strategies to ensure that your business is well-positioned to face a crisis. Decreasing business spending may seem counterintuitive, but protecting your company’s interests is necessary. This may involve delaying larger purchases or making do with current resources to ensure your business can survive until the next economic upswing.
During economic growth, big decisions such as opening a new office, signing a new commercial lease, or buying new equipment may seem financially sound. But, they can become a liability during a recession.
These types of investments require significant financial resources, which can become a burden if cash flow is tight. It’s essential to consider the long-term implications of these decisions and weigh the potential risks and benefits before making any commitment.
11. Prioritize payments and negotiate payment terms
If you cannot pay your bills immediately, it’s essential to prioritize payments based on the most critical expenses. This includes creditors that could potentially take legal action against you if you don’t pay, such as taxes or payroll. These payments should be made first to avoid any potential legal consequences.
It’s also important to communicate with your creditors and try to negotiate payment terms, if possible. This could involve extending payment deadlines or reducing the amount you need to pay. Creditors may agree to work with you if they know you are making a good-faith effort to pay your debts.
It’s essential to be transparent and honest with your creditors about your financial situation and develop a plan that works for both parties. It’s also important to keep a record of all the communication, agreements, and payments made to creditors.
12. Maintain strong cash reserves
In addition to managing and taking on debt, it’s essential to focus on building cash reserves for your business. Cash reserves can provide a safety net during difficult economic times and help your business survive a recession. You can take several steps to strengthen your company’s cash reserves.
For example – instead of putting profits back into the business or distributing them to shareholders, it may be wise to use that fund to pay off debts or save some excesses to use as a financial buffer during difficult times. This can help ensure the business has enough cash to deal with financial trouble.
13. Manage debts effectively
When facing a recession, it’s essential to evaluate the interest rates on your existing debt and prioritize the debt payments with the highest interest rates. This can help reduce the overall cost of your debt and free up cash flow for other expenses.
If cash reserves are low, it may be worth exploring financing options, especially if your business experiences seasonal cash flow issues. Having a line of credit established with a lender beforehand can provide peace of mind during difficult times.
However, before taking on new debt, it’s crucial to carefully assess the additional costs and possible payment amounts to ensure that you manage debt and won’t add to any systemic financial issues in the company.
If possible, avoid taking on new debt and pay off existing debt. If new debt is necessary, be sure to shop around for the best interest rates and terms.
14. Be prepared to pivot
In business, pivoting means adjusting your approach to meet your customer’s evolving needs and preferences. Pivoting is not a complete overhaul but a shift in how you utilize your existing business. This change can be planned, but it often requires quick decisions in response to a declining market. Pivoting can be a strategy to protect your business during a recession or survive a decline in a specific market.
To pivot successfully, it’s essential to keep a close relationship with your customers and be open to new ideas.
Examples of successful small business pivots can be seen in the restaurant industry, such as restaurants switching from fine dining to takeout meals or cafes transitioning into small grocery stores. To be prepared for change, you should be open to new possibilities and be ready to adapt your business model if necessary.
15. Seek advice and Stay Informed
Consulting with a financial advisor, accountant, or small business counselor can help you develop a plan to manage cash flow and avoid debt. However, it’s essential to consider the number of people involved in the process, as too many people can lead to inefficiency. Having one person on the task may be better than having multiple consultants.
Being a business owner, it is crucial to stay informed about economic developments and anticipate how they may impact your business. This includes closely monitoring your expenses and ensuring that they have a positive return on investment in the long run.
It is essential to keep personal and business finances separate. But it’s also important to know that your business may need additional funding at some point and to plan accordingly. This may involve paying yourself consistently, even if it’s not a large amount, to ensure that you have enough resources to support your business.
Bottom Line
Managing cash flow and avoiding debt during a recession can be challenging for business owners, but it can be achieved with the right strategies and determination. The key is maintaining patience, increasing revenue, reducing costs, managing budgets, diversifying investments, and building an emergency fund.
Additionally, it’s important to maintain cash reserves and personal savings and pay off any existing debts. While borrowing credit for funding can aid business development, it’s important to avoid taking on too much debt.
About The Author:
Lyle Solomon has extensive legal experience, in-depth knowledge, and experience in consumer finance and writing. He has been a member of the California State Bar since 2003. He graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, in 1998 and currently works for the Oak View Law Group in California as a principal attorney.