When it comes to the complex financial picture of a business, debt is a crucial piece of the puzzle. Carrying some debt is normal, but during a recession, highly leveraged companies are particularly vulnerable. As the economy contracts, demand falls, and so does revenue. Shrinking sales means less available cash on hand for funding operations. The cash required to meet payments for interest and principal becomes more difficult to scrape together, which heightens the risk of defaulting.
These factors add up to a vicious cycle. In a struggle to make scheduled payments, companies are forced to be more aggressive with cost-cutting measures. They can’t afford to invest in the business, and they might have to lay off staff. In the long run, replenishing the ranks of staff can cost much more than retaining them.
These survival measures impact productivity and limit a company’s options. It can force companies into making decisions that aren’t ideal for their financial future. It leaves them in a tough position because they can’t take advantage of beneficial opportunities that come their way.
Highly leveraged companies are particularly vulnerable during a recession. Global management consulting firm McKinsey & Company has conducted recession research that revealed firms that reduced their leverage more significantly from 2007 to 2011 came out of the Great Recession stronger than those that didn’t.
Pay Now or Later
If possible, try to pay down as much outstanding debt as you can manage before a recession even sets in. By increasing your monthly payments, you will reduce your bills over the longer term and end up with more available cash. When times get tough, you will have more flexibility. But remember that paying down debt will have an impact on your cash flow, so don’t over-extend yourself.
Running out of money is the kiss of death for a business. Without cash, the company will crash. Access to capital can slow from a healthy flow to a dribble during a recession as lenders pull away from risk, which can compound a company’s cash crunch even further. During deep recessions, banks claw back unused lines of credit to help them shore up their financial ratios. Having ample financing in place when a recession hits can lessen the stress of a challenging business climate.
Have a Safety Net
It is an unfortunate reality that banks prefer lending to businesses that don’t need the money, so it’s wise to put your financing plans in place before the downturn starts making a negative impact on your bottom line. Explore your options. Consider applying for credit even if you don’t need it. Or you could draw more down on your existing lines of credit. Even if you think you can survive a recession without taking on more debt, it is wise to examine your options before you desperately need the funds.
If you don’t need cash immediately, flexible financing such as a revolving line of credit could be a good fit for your business. In addition to loans, the Small Business Administration (SBA) offers lines of credit. They don’t provide the funding, but they guarantee a percentage of the amount for traditional lenders.
Take a cold hard look at all the existing debts held by your business. If you have multiple debts, do an analysis on each one, noting interest rates and maturity dates. This will help you decide which ones to prioritize for repayment, such as the loans with the highest interest rates. Make sure you are aware of all the covenants of your bank debts. If your debt levels get too high, you might end up being “out of covenant” with the lender.
Run The Numbers
As you plot your recession strategy, run various scenarios that take into account inflation and interest rates. With both currently on the rise, your analysis might show that hanging on to old debt makes sense, because the value of the money you borrowed has declined against the value of current dollars you will use to repay it. The interest rates on your older debt might be lower than money you borrow now. Balance the risks and benefits, but don’t just conduct your analysis once. Revisit the numbers and run the scenarios at regular intervals.
You can also investigate what disaster relief financing is currently available. The SBA offers low-interest disaster relief loans. There might be other loan programs offered in your state or city.
In the face of uncertainty about the economic future, surviving the downturn requires skillful financial management. That might mean getting rid of non-crucial assets that aren’t essential to your core operations. There is no better time than today to pull out your paperwork and start running the numbers. In the long run, you’ll be glad you did.