Every business operates in context of the broader economy. When the economy is strong businesses benefit from increasing demand and new customers. Growth brings challenges, but these fall into a heading of “Good Problems to Have”. A contracting economy, on the other hand, typically brings unwelcome challenges. This can be especially impactful for small, founder-led businesses which often do not have deep reserve resources. At Heartwood Partners, we believe a softening economy can be an opportunity for founder businesses to thrive if they are planful and strategic. Planning mitigates risk by creating the opportunity to act purposefully rather than be reactive.
Recognizing Economic Change
The first step to strategically solving any challenge is recognizing the problem itself. In the case of economic slowdown this can be difficult, as there are many confounding indicators and expert opinions. The fact that slowdowns are often immediately preceded by a strong, fast-growing economy exacerbates the challenge. Still, there are reasonable leading indicators for many businesses.
To anticipate the impact of economic pressures, business owners should be mindful of whether their products or service are discretionary or required purchases for customers. Discretionary purchases face greater risk, although even mandatory offerings face risk of customers trading down to alternatives during difficult economic periods. Discretionary markets typically see early softness in demand as customers divert resources towards required buys. In this way, discretionary businesses serve as an early economic indicator for others. Economic indicators available to many businesses also include:
- US Index of Consumer Sentiment – Provided by University of Michigan, this index tracks consumer sentiment in the US and offers clue to the direction of consumer demand.
- Consumer Price Index – The CPI is a key indicator, especially for consumer facing businesses. When consumers face increasing costs for daily necessities, they have less money for other spending.
- Input Indices – Many industrial businesses rely on key materials or feedstocks. There are tracking indices for many of these inputs. Business owners should monitor spot and future pricing as indicators of economic pressure or opportunity.
- Supplier Lead Times – In a growing economy, many suppliers struggle to service their demand. Lead times extend and service delay issues surface. A change to this trend where suppliers begin being more responsive or shortening lead times may be an indication their business is softening. This can be an indicator that other customers consuming the same input materials are reducing orders.
Manage Working Capital
Managing the working capital invested in business operations is critical during changing economic periods. Economic change can catch business owners with illiquid assets that force undesirable decisions.
- Inventory – An economic downturn often arrives on the heels of a strong economic period. During strong economies businesses purchase additional raw materials and increase production to meet anticipated future demand driven by expectation of continuing prosperity. When the economy softens, customer demand may erode rapidly. Business owners can be stuck with cash invested in raw materials and finished goods inventory that cannot convert to cash to meet obligations. Strategic operators who recognize the early signs of economic softness can make decisions to moderate material purchases, confirm customer orders before incurring production costs, validate demand forecasts with customer expectations, and more. Early-movers may also be able to negotiate favorable sales with customers even if demand is lessoning. This may allow the business to convert inventory to cash when they otherwise would be stuck with illiquid stock.
- Accounts Receivables – When business is strong companies may aggressively pursue new business by extending credit and payment terms to customers who may not have the financial strength or integrity needed to survive hardship periods. Strategic business owners carefully manage customer credit and accounts receivable at all times, and even more so when economic trouble is approaching. Strategies include reducing payment terms on new accounts or new orders, raising credit standards, following-up immediately when there are signs of customers falling past due, converting to cash terms for past due customers. Any accounts receivable strategy must be mindful of customer relationships and long-term value. Accounts receivables represent value a business already delivered to customers but has not yet been paid for providing. It is reasonable, respectful, and expected for customers to pay. Strategic business operators take action to collect customer payments without damaging valuable relationships.
- Accounts Payable – Strong business owners invest time to develop both great customer and valuable supplier relationships. An economic downturn is an opportunity for supply partners to demonstrate commitments to customers and for customers to support their supply partners. In the event a business purchases commodity inputs, owners can approach supply partners with offers of purchasing volume for accommodation on pricing or other terms. Companies who purchase specialized materials or service have opportunities to collaborate on demand planning, consider consignment or deferment strategies, manage customer demand with make-to-order supply alignment. Suppliers succeed when their customers succeed. Strategic partners understand this and take action to reinforce one another’s business in good times and when times are challenging.
Small business operators manage expenses frugally. It is common for business owners to have a do-it-yourself bootstrapping culture, which is admirable. These attributes are often part of the fabric that make the founder successful in business. Even these cost-conscious environments can have considerable expenses for service, support, and staff.
- Discretionary Services – During strong periods, business owners may relax a bit, utilizing outside vendors for functions previously performed in house. Mindful operators quickly review their business cost structure when signs of economic softness begin to show.
- Marketing and Sales – Companies may have expanded marketing efforts to pursue new markets that have not yet developed. Many businesses’ sales teams conduct programs including retreats, trade shows, incentives, and other sales-related expenses. No business should impede its sales success; however, strategic leaders do evaluate and act where there are indications of expenses that may be excessive.
- Staffing – Many business founders are ferociously loyal to the team who helps them succeed every day. This is a wonderful trait and strong value driver. There are strategies for managing staff expenses while continuing to honor team loyalty. Examples may include deferring new hires. Business owners can communicate the economic challenges while asking for all team members to carry a little more weight. In this way existing team members can help buffer the business from stress. Some business owners may also be able to structure compensation to align with the company’s success. Strategies where team members succeed when the company succeeds can be rewarding and self-sustaining for everyone.
Financial Partners and Liquidity
Many business operators pride themselves in running their business debt free. This can be an admirable trait. Unfortunately, it can also exacerbate hardship at times. Similar to small business operators who take pride in their self-sustainability, Heartwood Partners operates using a low-debt model. We understand the value of financial leverage, but also understand that financing is a tool and not a crutch. We advise business owners to develop and sustain strong relations with at least one financial partner. It is important to invest in these relationships before you need them, otherwise it may not be possible when the need becomes urgent. The transition period from a strong economy to a softening one could be the opportunity to revisit the company’s financing and perhaps consider expanding a revolving line of credit while reinforcing the strength and vibrance of the business to financial partners. Financial relationships established in good times and reinforced in challenging times can be the difference between having the resources needed for liquidity and being forced to make unfortunate compromises.
At Heartwood Partners we focus on partnering with successful and strategic business founders and managers. We have the experience to succeed when the economy is strong and when it is difficult. We do this by collaborating with each business in its unique market to read the economy and take action. Our strategy keeps us ahead of the curve with the resources and momentum to thrive.