In business, as in life, there are only two cycles: the good times and the bad times. The key to successful business management is to develop methods of recognizing where a company is in the cycles and determining what course of action needs to be taken.
Currently, many companies may find themselves in a downturn , a position that may be new to growing companies. It is important to understand that business is influenced by many factors that can’t be controlled: the economy, government legislation, technology changes, international issues, consumer tastes, and competition.
Good management requires that these factors be viewed broadly to understand how changes in these areas can impact a growing business.
A good place to start is monitoring analytically a company’s sales activity on a weekly basis. If a decreasing trend (not just a one-time affect) is seen in the numbers, a company should be ready to act. There are other signs of a down cycle that should also be monitored. Collections of receivables will slow down. Customers may go bankrupt. There may be more returns of sold goods.
Complaints might increase, as customers become more frustrated with their own situations. A company must listen to customers, advisors and employees.
What can a growing company do to reduce risk in a down cycle? Fortunately, there are many tactics to take.
– When Cash Is King
Becoming more liquid and conserving a company’s cash position will always be beneficial. However, the amount of cash a company has is the result of other actions; cash itself is not the determining factor.
For example, collecting receivables increases cash; paying payables decreases cash. Understanding what drives cash in a business and examining ways to influence cash flow is crucial.
It is important to remember that there are permanent and temporary influences on cash. For example, delaying the payment of a payable will only temporarily maintain cash, for eventually it will have to be paid. On the other hand, deciding not to have the annual company activity has a permanent effect on cash.
A business must concentrate on critical areas when looking for opportunities to conserve cash and should use financial statements to assist in this determination.
For example, inventory might be a major asset for a company. Decreasing inventory levels to increase liquidity is one path to take. Also, working with suppliers to see if they might assist by maintaining levels for emergency needs or possibly changing payment terms.
Examine old inventory: Get it sold or dispose of it. Even writing off disposals will increase cash by reducing income tax payments.
o Cut Costs
Costs must be reviewed in the priority of larger expense categories first. The basic question to be addressed is: Does the company really need to spend money on this item or this service? Eliminating costs is often a better course than a reduction since there is no future review necessary. A company must tighten approvals of purchases and must not be afraid to meet with vendors to discuss methods of reducing costs.
Think outside the box. There may be a different approach to consider which would reduce overall costs. For example, a company should consider outsourcing internal processes, if it is more cost-effective.
Another consideration is to defer fixed asset purchases to the extent of not affecting operations. This may increase repair costs, but will provide more flexibility if the downturn cycle is longer than expected.
Money once spent can’t be recovered, so delaying long-term purchases reduces overall risk. Leasing may be an attractive alternative to purchasing equipment.
A company could consider using temporary employees for possible overflow needs. It is much easier to immediately manage these costs when they are not employees.
o Maintain Reserves
Facility costs must also be kept under control. Right now facility costs are high, so this isn’t necessarily a good time to lock in real estate rental rates. If necessary, a company should keep shorter lease terms.
The bank may be open to increasing a company’s line of credit. The time to extend the line of credit is when a company doesn’t need to use it and the financial picture supports the addition.
Also, a company should discuss long-term notes on asset acquisitions to maintain current cash reserves. Rates are fairly low at this time and locking in interest rates should be considered.
o Manage sales and accounts receivable
This is one of the toughest areas to manage in a down cycle. Key management shouldn’t delegate away this responsibility.
With sales decreasing, sales personnel often are tempted to lower their criteria in order to keep sales up. In addition, customers will delay payments to assist their own cash flow.
A company must make sure that its sales criteria are working. Making a sale to a customer who doesn’t pay is a drain on cash flow.
A company must be firm on collections and not let customers use it as a bank. Sales limits and cash on delivery, where appropriate, should be considered.
A company must be smart regarding how to generate revenues. It should concentrate marketing costs on those potential customers that will generate strong and continuing sales and recommit its service to the best customers to protect important sales.
Visits to customers should be made to insure they recognize the company’s commitment and that they have no issues with the company. Don’t be afraid to let weak customers go.
– Keep Key Employees
Employees are generally on top of a company’s position. However, fear of the unknown can make insecure employees take action contrary to a company’s best interests. Some valuable employees will leave unexpectedly thinking the worst; competitors will try to steal away identified star players; and weaker employees may claim workers compensation rather than be let go without a paycheck. Active communication is imperative.
Management should identify key employees early on, make sure they know what the plan is for them and insure these employees are on board. Compensation for these employees should be at market value.
Remember that good employees always have options. These employees can help identify other key employees or potential troublemakers. A company must go forward with a cohesive team.
A company must also consider changes in employee compensation packages. That does not necessarily mean fewer dollars. Performance-driven compensation structures (bonuses, commissions, etc.) can be used. Non cash compensation such as stock options or ownership opportunities can also be considered. Stock options can be re-priced or new stock options can be issued, if the market price has become overly depressed. Nontaxable benefits may have more value to employees and may not cost as much as a company believes.
o Reduce Taxes
In a difficult year, there are potential cash flow opportunities in tax planning. First, quarterly estimates can be based on current year activity or projections that reflect lower overall tax liabilities.
If there is a beneficial net operating loss carry back opportunity to generate a cash refund, efforts should be made to increase the size of the current year net operating loss (more aggressive write-offs of receivables, disposal of old inventory, deferring cash basis sales, accelerating cash basis expenses and write-offs of fixed assets).
If it’s not beneficial to have a net operating loss, consider accelerating income and deferring expenses.
Lastly, senior management shouldn’t try to take on everything alone. Key employees and advisors should be used as sounding boards and resources. Management must keep a positive outlook for the company and employees. Like all cycles, this one will turn.
Lofgren, CPA is a partner with Lavine, Lofgren, Morris & Engelberg, LLP in San Diego.
