How will the economy affect my business this year? If you’re the owner of a small or medium-sized business, it’s the question that keeps you awake at night.
While the U.S. economy currently remains steady, the Federal Reserve in November forecast a slowdown in 2020. Forecasters see real GDP growth dipping below 2 percent next year, the Fed said, but could exceed that level if trade disputes are resolved or slowing global growth improves. The Fed noted that real GDP growth slowed in 2019, but added that the longest U.S. expansion is hardly “on its last legs.”
Laura Gonzalez, associate professor of finance in the College of Business at California State University, Long Beach, suggests keeping an eye on the Purchasing Managers Index, or PMI, which measures the sentiment of supply-chain managers across several industries and suggests their expectations for the future economy. “When PMI is less than 50, the economy is contracting,” Gonzalez says. “Once it approaches 42, recession is believed to be around the corner. We are now at around 47.”
That said, economic trends for most small businesses are like the weather, according to Paul McCarthy, a small business owner and mentor with SCORE, a nonprofit association that aids entrepreneurs and small businesses. “What is happening in your backyard matters most,” he said.
“The strongest considerations are consumer confidence and the labor market locally, and the credit market nationally,” McCarthy says. “A regional downturn in the labor market, even if it is not national, will affect consumer confidence. Your regular clients will begin to cut back if they see their own neighbors having struggles.”
Stay close to your customers, adds Brad Farris, principal advisor for Anchor Advisors, a Chicago-area consultancy that works with business owners. “I would talk to my customers more than I have been and see what they are saying, how they're dealing.”
Unfortunately, there is no free lunch, says Christopher Thornberg, founding partner of the economic consulting firm Beacon Economics in Los Angeles. “There are no one or two data points you can look at. You’ve got to look at lots of things. You've got to be broadly educated as to what's going on in the world around us.”
Thornberg adds, “It’s the old ditty: Hope for the best, and prepare for the worst.”
Here are several ways to prepare your business to face any economic outcome.
“In a recession, cash is king,” says Farris says. “Cash is always king, but in a recession, it's really king. And so, holding on to a little bit of extra cash will put you in a good stead if there's a downturn.”
How much cash should a business keep in reserve even when the economy booms? At least enough to cover six months of expenses, CSULB’s Gonzalez says.
A stress test is a computer simulation to gauge your financial risk under different economic scenarios. The results can aid your financial planning and let you know where your business is at greatest risk in the event of economic hard times.
The best time to do a stress test is in the spring and summer, Gonzalez says, since “the biggest market crashes tend to occur in fall.”
Gonzalez advises asking yourself: Can my business absorb a loss of income and still meet my obligations? The results of your stress test can tell you whether to decrease your inventories, consolidate your debt, cut your payroll or something else.
Also look at your firm’s performance over recent history. “Based on historical firm performance and recent estimations of PMI, business owners can decide whether to invest in derivatives to hedge energy or inventory costs, or re-plan an investment decision as a series of milestones,” Gonzalez says. “In terms of debt—and since markets are expecting interest rates not to increase—the main decision is to decide whether it is a good strategy to borrow more.”
Speaking of borrowing, it’s a good idea to consolidate your debt when rates are friendly.
“Avoid excessive or slow-moving inventory, and stay on top of your accounts receivable,” McCarthy adds.
“Closely manage your necessary expenses (payroll, utilities, etc.),” McCarthy says.
With regard to your staffing, “from an operational standpoint, communicate transparently with your staff in a structured fashion,” McCarthy says. “Realistically, some have never experienced an extended downturn. The increased awareness can help consolidate a team effort to maximize efficiency and morale.”
"Even in a downturn, there's someone out there whose business is doing well. By staying close to your customers, you can kind of figure out what sectors might still be doing well and focus your marketing in places where there are still people that are not as impacted as others."
Ultimately, a business should know how and where it may need to cut its payroll in advance of a recession.
“If people are seeing a downturn and believe that tough times are coming, service businesses need to be willing to cut payroll, because it's really the only expense that matters for them,” Farris says. “If you've got people sitting on the bench, you can't keep paying them. That consumes the available cash that keeps you alive.”
Farris adds that it’s a tough call, particularly before things turn really bad. “There's a real tension,” he says. “Service business owners, they have struggled to hire those people, and then once they hired them, they trained them. And so those people are very valuable to them, so they tend to not want to let them go.”
The natural inclination during hard times is to cut marketing. Resist that impulse, our advisers argue.
“Plan on working harder to make a sale with creative marketing and an increased quality of service,” McCarthy says.
“I don't cut marketing in a downturn,” Farris adds. “I'm going to be smarter about my marketing. Even in a downturn, there's someone out there whose business is doing well. By staying close to your customers, you can kind of figure out what sectors might still be doing well and focus your marketing in places where there are still people that are not as impacted as others.”
“Get better at what you already do well, as opposed to testing new waters,” McCarthy says.
“Don't swing for the wall…every time the ball comes across the plate,” adds Thornberg. “You want to be a little cautious. Sometimes that's hard. You want to go gangbusters. But there is at some level always a degree of caution. You should keep [that] in mind when you're making any kind of plans. Simple as that.”
“What I will say is that [clients are] highly optimistic,” Farris says. “So, for instance, in the last downturn, I had one business owner that I was working with who said, ‘I refuse to participate in a recession.’ I'm like, ‘Excellent! That works out for you.’”
Farris adds, “I think that when people start talking about a recession, people can get really fearful, and fear is not helpful.” “Fear keeps us from doing the things we need to do to reach out and makes us vulnerable. And so, yeah, fear is not going to help.”