TOUGH TIMES AHEAD? How to recession proof your business
Just as evolution in animals dictates that only the fittest survive, in an economic downturn it is survival of the smartest. Over the past six months the media has been all over the economic issues of inflation, rising oil and fuel prices, negative superannuation returns and a volatile share market. With all this negative economic sentiment, how do you recession proof your business and ensure your survival?
Obviously there is no magic bullet but the clear message is it’s time to spend more time working on your business and your accountant can play a key role in the process. In good times the weaknesses in your business can be concealed but when the going gets tough, the strengths and weaknesses will surface.
The best form of protection is early identification of the problems. Accountants have access to some software tools that are designed to weed out the weaknesses and identify the warnings signs. Early detection lets you amend the strategic direction of the business and hopefully get back on track.
I recommend the following strategies to my small business clients looking to recession proof their business.
1. Plan the year ahead
Historical data is important but you’ll ‘crash’ the business if you drive it by just looking in the rear view mirror. You can’t change the past but decisions you make today will impact on your future results.
If you don’t prepare an annual budget or have a plan in place you are asking for trouble when the economy turns south. It’s easy to get complacent during the good years but a budget creates a blueprint for the future that you can measure your actual performance against. Cash flow is usually the most common client concern, the most visible and therefore the most painful. By identifying all the activities that turn work into cash and then measuring those activities, the results can be immediate.
Most importantly, a budget can identify if and when you expect to need additional finance. While generally we prepare budgets at the start of each financial year, your budget should always be a work in progress under constant review.
2. Improve the quality of your financial records
In boom times it’s very easy for business owners to ignore the quality of their financial reporting system and turn a blind eye to financial management issues. Unfortunately when these bad habits spill over into difficult economic times it can become a serious issue.
This is supported by the fact that despite the introduction of GST some eight years ago, the majority of small business owners are still using accounting software beyond their business needs and level of accounting skill. The net result is they generally produce ‘computerised shoebox’ records that should not be relied upon when making critical business or strategic decisions.
If you don’t understand double entry accounting principles including debits and credits, it is time to review your accounting software. As a rule of thumb, you should have financials available within seven days of the end of each month. Up to date, accurate financial records let you and your accountant make informed business decisions.
3 Measure and monitor trends
The first casualty during a recession is usually your sales and it is important to identify the early warning signs. The first step is to review your revenue figures and compare them to last month, last quarter and the corresponding period last year so you can identify negative trends. Again, timely and quality financial data is essential.
The challenge is then to develop a strategy to counter the decline but forewarned is forearmed. Some intelligent software we use can then evaluate the impact of the sales downturn on the profit and cash flow of the business.
Another key area to monitor is your stock. Are your stock levels appropriate and are you holding obsolete or slow moving stock that is costing you money just to store? A careful review of which products are selling and those that aren’t is necessary. If your sales are seasonal you need to run down your stock levels leading into the slower period. Don’t tie up valuable working capital that could be used elsewhere in the business (i.e. marketing) during these periods.
Carefully watch your debtors and make sure all your customers are paying within your credit terms. Early detection can be the difference between getting paid and having bad debts. Get statements out on time and keep in contact with problem accounts.
On the flip side you can put pressure on your suppliers to lower their prices or offer better payment terms. In business, if you don’t ask you don’t receive. Shop around for alternative suppliers of critical materials for your business to ensure you can complete your obligations in the event a supplier ceases being able to supply you.
4 Benchmarking
Benchmarking the business’ performance against the competition lets business owners know what is working and what needs working on. It shows how the business stacks up against competitors and measures the business performance against the best and worst performers in their industry.
The financial data used in the benchmarking process includes performance indicators that largely centre on the profitability of the business. They include profit-to-revenue, gross profit margins and comparing wages to revenue and net profit. They provide a valuable insight into the performance of the business.
We also benchmark our clients against the industry statistics released by the Tax Office a number of years ago. We specifically look at gross profit margins, profitability and wages as a percentage of revenue. These indicators are used to let clients know if their business is likely to attract audit scrutiny.
5. Analytics
Historically, business analysis used to be a marathon session between the business owner and their accountant with spreadsheets fanned out on a desk and both parties looking for processes and strategies to improve productivity and profits. Business intelligence software has simplified the business advisory process.
Analysis software can provide clients with information to better manage their business and improve profitability, cash flow and overall business value. The process has been labelled ‘analytics’ and accountants can highlight the financial impact of making some specific operational and financial changes in a business. It’s easy to say to a client, “You need to grow 10% this year,” but what does that mean in real terms? How will that growth affect the need for capital? How will improving margins by half or one per cent impact cash flows and profitability? What kind of cash flow is necessary to accommodate the 10 per cent growth?
You take the basic financials (balance sheet and profit and loss statement) and transform the numbers into meaningful and understandable graphs, commentary and ratios. We use analytical software to uncover profit enhancement opportunities with clients and the graphs and analysis form part of the regular client report that is in essence a ‘financial health’ check.
Analytical software is used to uncover profit enhancement opportunities. Business owners are able to map out alternative scenarios to assist in making decisions that will maintain the viability of their business. Being able to understand the key drivers of your business profit, cash flow and value allows you to take decisive action.
6. The Pareto Principle
Also known as the 80/20 Rule, the Pareto Principle suggests that most of your profit is generated by the top 20 per cent of clients and the other 80 per cent take up most of your time. Be honest about your customers and their value to your business. Remember that there should be no sacred cows in your customer base.
Each year, look carefully at your customer base and don’t be afraid to cull. There are different ways of assessing the value of customers. It could be based on their sales value or how often they buy from you. Do they pay within your terms and are they pleasant to deal with? Often you will know which customers will struggle in tougher economic circumstances because they are the ones that struggle when times are good.
7. Finance options and debt reduction
Using your budget you can plan for the financial ‘troughs’. You increase your chances of getting the funding you need, when you need it, if you plan ahead. Too often business owners go to the bank for increased funding at the last minute. With financial institutions taking a tougher stance on credit, planning the timing and level of finance has never been more important.
In times of uncertainty and rising interest rates it is also time to review your business debt. What are your current lending arrangements? Are credit cards being used to provide a constant funding source as opposed to a more temporary option? Are you up to date with the Tax Office? A plan to consolidate debt then work out a debt reduction strategy can not only save thousands of dollars in interest but can also ease cash outflows.
8. Asset protection
It is simply not possible to plan for every contingency or future changes in tax law. Asset protection can be a trade off between legal tax minimisation and forward planning to take advantage of capital gains tax concessions. It is imperative that you review ownership of all your family and business assets.
Businesses that have been trading successfully for years can be brought to their knees very quickly by a large debtor falling over. As a result of one or two significant bad debts, the Tax Office could be chasing you and the banks won’t extend your credit. The assets that have been built up over many years, including your home, could be at risk.
Every business needs to be aware of where the potential risks are and then employ strategies to minimise the impact. What assets have been used as security to obtain finance or rental agreements? Is the main asset used for business security your home? Can other assets be used to secure finance? Is there an opportunity to transfer assets to your spouse?
9. Wealth creation
After all the risks, long hours, difficult customers and cash flow problems, what are you in business for? Wealth creation is a significant factor for a lot of business owners. Protecting your assets and putting strategies into place to grow your wealth is not just about making money. It’s also about keeping it.
➢ Superannuation. How much can you afford to put into superannuation and are you taking full advantage of the recent tax law changes? Do you know where your superannuation is and how it is being invested and performing?
➢ Property and Shares. There are tax concessions associated with ‘negative gearing’ which allows you to claim the inter