From CBIA News, January 2001

Will your company falter if the economy fizzles? 

Pay attention now to four key areas of your business

By Diane Friend Edwards

Editor of CBIA News

Let’s face it: When times are good and the cash keeps flowing in, you might get away with less-than-stellar management practices. But what if the cash flow turns into a trickle? 

Economists are now saying we’re in for either a “soft landing” or an outright recession. Regardless of which viewpoint turns out to be right, you might want to take stock of your company’s situation. As Pierre Guertin, a partner with the assurance practice of Arthur Andersen LLP in Hartford, says, “We use the analogy of an iceberg: When the water’s high, you can’t see all the problems. But once you bring the water level down, all the warts show up.”

And the warts could be your undoing.

“Small businesses have a failure rate of about 50%. That gets worse during an economic downturn,” says Dr. Susan Coleman, assistant professor of finance at the University of Hartford’s Barney School of Business. “In a downturn, customer demand declines. Then your sales drop. If your sales decline and you have a lot of expenses that don’t decline, you’re going to get caught in the middle,” she explains.

Guertin agrees, saying, “The major warning sign is that the number of orders — the level of business activity — drops.”

Coleman and Guertin point out four areas that are particularly important for a small business to pay attention to: sales forecasts, debt load, cash management and working-capital management.

1. Have realistic forecasts. “When you’re in less-than-robust conditions, you need realistic expectations for the business’s performance. If you set a budget that’s not realistic, all the decisions you make based on that budget will be off,” says Guertin. 

“Small businesses tend to be overly optimistic about their sales prospects,” Coleman adds. “That can be fatal during a recession. It’s essential to have realistic forecasts.” She suggests creating a best-case scenario, a most-likely scenario and a worst-case scenario. “During a recession, you might have the worst case.” 
And, “Monitor the degree of softness in the economy and be flexible,” Guertin advises, so you can make any needed adjustments in your budget.

2. Watch your debt load. According to Coleman, privately held companies typically use a lot of debt, especially bank debt and credit card debt, to meet their financial needs. “That means you can have high interest payments. Make sure you don’t have a high debt burden going into a recession — especially credit card debt,” Coleman cautions.

Guertin also says that during a recession, companies sometimes fail to meet the terms of their loan contracts. “Be careful that you don’t trigger any noncompliance with debt covenants,” he advises. “And keep your bank informed about your situation. They’re the ones who made the capital available; you don’t want to tick them off.”

3. Practice good cash management. “The reason many small businesses go out of business,” Coleman says, “is that they run out of cash.” She says good cash management requires having a good cash budget. “Know when cash comes in and when it goes out. Know which assets you can easily turn into cash.” 

Guertin advises, “Discern which expenditures are real priorities. Some are discretionary and can be postponed. But some things you might think are discretionary really aren’t.” For example, he says, “You probably still want to do some research and development. You probably still want to make some investments in things that enhance productivity or to introduce technology that will be helpful to your customers.”

4. Follow good working-capital management practices. This involves three areas: cash, accounts receivable and inventories. “We’ve already talked about cash management,” says Coleman. “For receivables, you should have a system for monitoring and collecting [them] quickly and efficiently.” 

Guertin agrees: “Watch your receivables; you don’t want them to age.” He also advises taking “a good, solid look” at new customers’ credit-worthiness, to assure you’ll get paid.

As for inventories, Coleman says, “When sales drop, you can have a lot of inventory to mark down.” She says, “You’re better off cutting back your inventory levels than cutting prices. You see people marking things down to half-price; you can’t make money that way.”

Final advice

Guertin adds a final bit of advice: “Know who your key customers are; they’re probably going through the same things you are.” You want to be able to work with them, he says, adding that the same holds true for your vendors. “Know who your key suppliers are, too. During a downturn, people often stop paying their suppliers. If that happens, your supplier may not be able to ship materials to you, affecting your ability to satisfy your customers,” he says.

These management practices make sense regardless of economic conditions. As Coleman points out, “All companies at one time or another go through some down times, regardless of what’s happening with the economy. The good ones are the ones that develop good management systems and controls that let them get through the bad times.” 

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