How to Prepare for Recession: 7 Steps to Build a Recession Plan for your Business

How to Prepare for Recession: 7 Steps to Build a Recession Plan for your Business

Planning for a recession

While recessions are a normal part of the economic cycle, you can’t avoid what is all over the news cycle these days: Inflation, stagflation, recession. While it may sound like doomsday has arrived, there are some things you can do to prepare for recession.

Use various scenarios to build a recession plan

Historically, we know that companies that prepared for past recessions came through okay, and a percentage of them even flourished. What set them apart? They had built contingency plans, and prepared their business for recession by running various scenarios.

Ultimately, what recession can mean for each business stems from what might happen to your sales. Estimate how much you think your sales might decrease then run an anemic and awesome version of those. If your sales decrease by x amount you want to have a set contingency plan to get through it. Consider the following:

  • When should you cut back on operating expenses?
  • What if the recession lasts longer than forecasted?
  • When should you dip into your line of credit to protect it?
  • What key drivers are triggers for a shift in spending?

Once you begin to consider the effects of a sharp or even shallow decrease in revenue you can begin to properly prepare for recession.

7 ways to prepare for recession infographic

7 ways to prepare for recession

1). Build up your rainy-day fund

While your revenue is still strong use extra funds to build up your emergency fund… do you need a line of credit? This isn’t the first time we’ve mentioned the importance of a rainy-day fund in uncertain economic climates. Though how you go about it might be very different with interest rates climbing.

Cloud CFO Tip: Ideally you want to amass a fund that covers at least three to six months of operating expenses. That way if you experience a big impact to your revenue you have some breathing room. You can make strategic decions about expenses and avoid a knee-jerk reaction.

One problem with a line of credit to be mindful of, is that banks can come in at any time and remove your excess credit. This kind of thing happened all over the place in the Great Recession, “you’re not using that additional $200K? We’re changing your terms and removing it from your line of credit.”

2). Play offense and diversify

I like to think that if you know how to double-down to prepare your business for recession, your are more likely to emerge from it stronger than ever. After the great recession we saw the greatest market rally over the following 10 years. So how do you position your company to be one of those that thrive?

Think need instead of want. Then brand yourself accordingly. In fact, you want your brand to be indicative of your value. So, if you’re in the B2B space for example, and clients are focusing on where to make cuts, they have to think twice about your company because they know you provide such good value. Perhaps there is a way to diversify your revenue streams. For companies selling consumer products, can you pivot to also offer services in order to protect any loss in inventory sales?

Additionally, if you are in a good financial position more vulnerable companies might be open to be acquired. To make this happen you will need that rainy-day fund mentioned earlier.

Finally, one unique factor we’re seeing are many companies facing a labor shortage. By improving your employee retention strategy using professional development you inherently increase your company value and lower your risk of losing A+ staff.

3). Check-in with your budget

You do have a budget right? If not, our outsourced CFO services can help.

To prepare for recession, build budgets that trigger spending changes if your sales decrease by x amount. And if you’re already consistently seeing large budget variances, now is the time to tighten up.

Cloud CFO Example: For example, you might have a trigger so that if sales go down by 10%, you know how much you need to cut salaries by in order to maintain your operating margin. Plan ahead so you can quantify when and how much to cut expenses.

Think of the triggers as reverse drivers. Hopefully you won’t need to use them, but if you do, you can feel assured that you have a plan in place for a potential sharp downturn in revenue.

4). Cut expenses strategically

There are many ways to cut business expenses including

  • swapping fixed for variable expenses;
  • automating tasks to refocus staff on business development;
  • and reviewing monthly recurring expenses.

Specifically, the swap for fixed to variable is a good strategy even in normal times, but is especially useful in an unpredictable economy with a looming recession. Having more variable expenses allows you to be nimble. It allows you to quickly cut costs if sales go down more than you predicted.

Cloud CFO Tip: For example, you might wish hire staff to cover 50-75% of your expected workload- or whatever you can consistently maintain. Then utilize contractors to make up the remaining percentage if you get more work, i.e., revenue. Trust me, you’ll sleep better at night.

Contractors are available to hire if needed and you don’t have to worry about letting people go if the work isn’t there. You may be giving up some gross profit margin on the incremental work during the higher revenue months when you flex up. But, when you have a bad month, you’re not stuck paying fixed salaries for staff simply because you don’t want to let them go.

swap fixed costs for variable costs

Another alternative is to pay overtime to your current team instead of hiring subcontractors when you flex up. It’s a win-win, they make more money and you still pay less than you would contracting out. In general, overtime is a useful solution across industries not just those that use contractors.

Plus, companies that avoid layoffs and focus on operational improvements will see the increase in brand value we mentioned above.

5). Optimize inventory management

When you’re buying inventory for business as usual, you buy inventory with the expectation you’re going to sell a set amount next month. Let’s say you normally need $1 million of inventory on-hand. But if a recession hits and your sales suddenly get cut in half, you’ve now overspent, and have $500,000 cash tied up in inventory. And cash is really what you need in a recession.

Cloud CFO Tip: If you want a metric to determine if you’re buying too much inventory, you should refer to your planned inventory turnover ratio.

inventory turnover formula

If sales are down, your COGS will be down because you’re selling fewer items, so you should notice your inventory turn ratio go down as well. This is not what you want going into a recession. Instead, be cautious with your sales forecasts which ultimately drive inventory procurement.

6). Review the interest rates on your debt

You’ve likely heard economists discussing a possible stagflation: when sales and demand are decreasing but interest rates are increasing. In this case, companies with a lot of debt are the most vulnerable. In a recession, if you have variable interest rates on your debt, that could hit you hard right when your sales are decreasing. This is a scenario you want to plan for to prepare your business for recession.

That said, you might have a good deal on some of your older debt. Your recession plan should take into consideration the maturity dates and interest rates compared to current inflation. Holding on to old debt can make sense depending on the current rate.

7). Get financial reporting in order

Have your CFO ensure everything is up to date to you have your finger on the pulse when it comes to something like a sizable shift in cash flow. Finally, have your CFO run various modeling for different scenarios and identify which triggers will call for executing your plan for recession. A good CFO should be able to assess your risk tolerance in a volatile market. For most companies, the bottom line in a recession remains protecting your cash flow and profit margin.

Use these 7 steps to prepare your business for recession and you might not only survive but thrive in an otherwise unruly market. Need help with financial modeling? Get in touch to learn more about our outsourced accounting services.  

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