The US economy has been on an upswing for the past decade, after recovering from the financial crisis of 2008. But economic growth is never linear, and signs of a future downturn are beginning to emerge.
2018 was the worst year for stocks since 2008, with the Dow falling 5.6% and the S&P down 6.2%. Higher tariffs and trade disputes with China have weighed on many companies, hitting B2B industries especially hard. Meanwhile, consumer confidence, while still high by historic standards, fell over 6% at the end of 2018 amid concerns about slowing growth.
We don't know exactly when the downturn will come, how bad it will be or how long it will last. What's clear is that the wind is picking up, the waters are getting choppy, and there are clouds on the horizon. It's up to individual companies to decide how to prepare their boats for the coming storm.
My advice? Cultivate a healthy paranoia. By this, I don't mean the sort of panic that can easily lead to bad decisions. Instead, I recommend preparing for worst-case scenarios now so you can avoid entering damage-control mode later.
Consider the following best practices for an uncertain economy:
#1: Take the worst case off the table
Start by asking yourself: How big a loss can I handle? Up to a certain point, losses are more temporary setbacks than business threatening crises. After all, the economy will recover from the next downturn, and a year or two of smaller margins won't mean much in the long term.
But some losses can create ripple effects that reverberate through your business for years. For example, losses that harm your relationship with your bank (or other funding sources) should be avoided at all costs. Determine how much you can afford to lose before you create a breach of covenant with your bank—as well as any other breaking points you can't afford to reach. For example, say you have a customer that’s responsible for 25% of your revenue. Since your business depends in large part on theirs, an economic event that brings them down could, if you haven't properly prepared, bring you down as well.
To insulate yourself against the worst effects of a case like this, you could take out a credit insurance policy now—before the storm arrives. This way, you'd pay a deductible if a major customer defaulted, but you wouldn't find yourself in an irreparable situation.
#2: Stay on top of changing credit
Most companies never pull credit again after the initial review. If they did, they’d be surprised to learn that many of their customers’ credit profile has changed. We find that more than half of our customers’ risk profile changes in some way over the course of a single year. While we could be approaching a slowing economy, it’s more important than ever to pull credit multiple times a year to avoid surprises.
#3: Enforce your credit policy
There’s no point in having a credit policy if you don’t enforce it. Make sure your team members are aware of your current policy and are communicating it to customers.
Every company has customers that make them nervous. Figure out how to lower the risk. This doesn’t mean you should start cutting off customers from credit, although if they are risky enough that just might be the most prudent thing you can do. Often however, your credit agreements already give you the means to influence payment through late fees, limits on credit lines, and refusal to deliver more product until past bills are paid. You just need to be able to resist complaints when you exercise your authority. Most customers will understand the need for fees and such, but those that protest the loudest are almost always the ones that are red flags.
#4: Review – and expand - your liquidity
When times get tough, banks have a high incentive to maintain tighter control over the companies they do business with, and they might prevent you from drawing on your own line of credit. For that reason, if you can get more credit now, you should take it. Paying on unused line fees is an ounce of prevention that might come in handy. Now’s the time to better understand what your bank’s rights are and what your own rights are.
For now, the macroeconomic indicators are still strong. But don’t ignore the lessons of previous market cycles and pretend we’ve eliminated recessions forever. We haven’t. The businesses that not only survive but thrive in the coming storm will be the ones that take precautionary actions now.
Written by Scott Simpson, CEO of BlueTarp.