Interest rates are up. EIDL repayment is coming. Inflation is the highest since 1981.
What does the current economic environment mean for you? It means it’s time to plan.
At ASBTDC, we provide no-cost consulting to thousands of business owners each year, and we have a saying: ”Failure to plan is a plan to fail.” No, we didn’t coin that phrase, but it’s absolutely true for entrepreneurs navigating the messy middle of running a business in Arkansas.
Three indicators have our business consultants advocating for clients to start guarding against an economic downturn.
- It’s time to pay back Uncle Sam. Arkansas business owners received over $125 million in COVID-19 Economic Injury Disaster Loans. Most of them are starting to hit the deferred repayment time frame, which means a monthly loan payment bill is looming.
- Rising interest rates lead to rising loan payments. Lots of businesses have loans at variable interest rates. This means, as interest rates rise, so does the amount you have to pay back, which means less cash left over each month.
- Rate of inflation is high. We haven’t experienced inflation like this in a very long time. Your business has likely already experienced increased costs related to supply chain issues stemming from the pandemic. Layer on a widespread increase in the cost of doing business (inflation) and you have an additional squeeze on your business finances. The result is less cash left over. (See a trend here?)
We don’t have a crystal ball, nor do we claim to know everything. What do we know, though? When the economy slows down, people stop spending money. When people stop spending money, revenue decreases.
What happens when revenue decreases and expenses increase? You guessed it. A huge strain on your bank account, aka your cash flow, makes it really freaking hard to run a small business.
Spirit of planning, not fear
We aren’t here to play Chicken Little and scream “the sky is falling, the sky is falling.”
No, it’s not time to be fearful. Quite the opposite. It’s time to instill confidence in your business.
You do that by planning.
Build the plan, work the plan: 5 steps to sound financial footing
As business consultants, we obviously lean hard on making sure our clients understand the financials of their business. You don’t need to be a money expert, but you absolutely need to have a plan, understand it, and execute it.
Step 1: Get accurate historical financial data
First, you need to have a handle on your current numbers, as well as your financial history. This allows you to see baselines and trends for your business.
Our recommendation is to pull this information from your accounting system or ask your CPA/bookkeeper to provide it. Financial records from the past three years are perfect. This allows you to see pre-COVID and post COVID trends.
For younger businesses, go back as far as you can.
Once you have the historical data, our team can help you begin to develop a forward-looking plan.
Step 2: Trim the fat, improve the muscle
Once you have your historical financials in hand, it’s time to dig in.
Look for inefficiencies or gaps in your finances. This is where leaning on a trusted advisor will help. Utilize your CPA, financial advisor, or an ASBTDC business consultant.
Are you charging enough?
One of the areas to review first is your pricing. It’s one of the easiest levers to pull to improve your financial health.
Most business owners are scared to increase their pricing. They feel price is what sets them apart from the competition. Look, this article isn’t about marketing, but let’s face it: If your only competitive advantage is price, you’re in a race to the bottom.
Our team at ASBTDC can help do a competitor analysis and a price analysis to see what consumers are spending. This should help you gauge your pricing.
Remember, your expenses have gone up significantly due to inflation and interest rates. It’s time to re-evaluate your pricing strategy.
Expense column bloat
Another area to focus on is your expenses. We often see duplicate expenses that can be cut like subscriptions, software, over purchasing on inventory, etc. You may even be overspending in normal categories that need to be tightened up.
You aren’t looking to cut down to the bone, but you do want to be conservative and intentional as you look at your expenses during this time.
Cash is king
The goal of the first two points is to increase the amount of cash in the business. You do this by either improving cash coming in (pricing) or cash going out (expenses).
During any normal period of business activity, businesses should store up cash. We recommend at least 3-6 months cash parked in an emergency fund/business savings account. Your cash on hand becomes even more important when preparing for a downturn.
Step 3: Benchmark against your peers
Here is a bit of our secret sauce at ASBTDC. We firmly believe in making data-backed decisions. So, naturally we help our clients infuse data into their financial forecasts.
One of the best ways to do this is to benchmark your business against peers in your industry.
What to look for:
- Top-line revenue. This gives you insight on how much revenue your competitors are bringing in and if you are above or below the industry average.
- Gross profit margin. Are you below or above the industry average for profit margin? We can pull this information to give you insights which then can help you make decisions on pricing and cost structure. Your gross profit margin is a direct contribution to helping pay for that expense column mentioned above.
- Expenses. You can use this data to get an idea of how much the industry spends on certain expense categories like marketing, payroll, rent, etc. This will help you determine if any of your expenses are out of line.
- Operational margin. Not to throw a lot of terminology at you, but this is an important number. This number signifies how much profit or cash you have after you’ve paid all your operational expenses.
Getting these benchmarks in place and using them to help you build a solid financial forecast will set you up for nimble financial decision-making.
Step 4: Build a 12-month projection based on cash flow and goals
Now that the foundation has been set with financials to help identify trends and analyze opportunities for improvement, we can start to build a forward-looking plan.
Be conservative
Remember, when planning for a slowdown, this isn’t the time to inflate any numbers. Some would even say to forecast a scenario for a 25% revenue decrease to ensure your cash flow can handle that potential impact.
Plan for rain
Ensure the forecast has a built-in saving model that parks cash for an emergency fund.
Ideally, you want your rainy day fund to cover 3-6 months of operational expenses. When COVID hit, businesses that had the safety net of sufficient cash and working capital fared the best.
Step 5: Partner with a Certified Public Accountant
This step is too commonly missed. No matter the economic outlook, you should have a CPA that works with you throughout the year. Don’t let the only discussion with your CPA be around tax time. Enlist your accountant as a financial advisor and consultant to ensure your finances stay healthy and on plan.
As we wrap up…
The current and future economic conditions appear turbulent. The best day to start planning was yesterday, and the second best day to get started is today.
Reach out to your ASBTDC consultant or sign up for our services to get your financial health check and forecast today. Call 800-862-2040 or sign up online at asbtdc.org/consulting.