AdvisoryMatters

The expected recession: a complete guide

With so many factors conspiring against us, it’s important to keep our business heads above water. Here are some tips.

Let’s start with a few current economic issues: increasing energy costs; inflation; rising interest rates; supply chain issues; continued labour shortages in certain sectors; effects of the war in Ukraine; and aftershocks of the Covid-19 pandemic and Brexit.

Any one of these in isolation would have a negative effect on the economy. Collectively they herald an impending recession, as disposable income is squeezed and every business in the UK faces rising costs.

All that businesses can do is batten down the hatches and wait for the storm to hit, as it appears it inevitably will.

What effects will this recession have on business?

Going by previous recessions we can be confident that most businesses will experience some or all of the following:

  • Reduced sales, as consumer spending declines. This obviously has a domino effect on all but the most recession-proof businesses.
  • Increased bad debts. As turnover declines, businesses tend to extend supplier credit terms as far as possible. Be proactive in your credit control so that you are first in line to be paid, not last.  Make sure, too, that customers have the ability to pay, even if not necessarily within your normal credit terms. The insolvency of a large debtor may have terminal consequences for your own business.
  • Profits will fall and this will have a number of consequences.
  • Reduced sales and falling profits mean cash flow pressure and the need to be extremely disciplined in managing available cash.
  • Depressed profits may force cost cutting measures such as workforce rationalisation and reduction in operational activity. Businesses may need the protection of a Company Voluntary Arrangement to allow them to reduce fixed overheads, such as staff and property costs.
  • Capital expenditure will be postponed as businesses ‘mend and make do’, rather than spend precious cash resources. This, again, will have consequences for other businesses.
  • Lenders may decide to reduce available facilities, especially if management accounts show a declining financial position.
  • It will be harder to attract investment until it’s clear the recession is ending. Even then, investors may be reluctant to fill ‘black holes’ and instead prefer to invest into a newco which acquires a business through an insolvency process.
  • Product quality may deteriorate as businesses aim to cut corners to maximise the purchasing power of their cash.
  • Listed entities will see falling share prices. Although this will not affect the business as such, a falling stock market has a negative effect on consumer confidence.
  • Raising capital by listing will be harder.
  • The number of insolvencies will rise.

 It’s not all bad news

Pretty depressing stuff.  But there are some upsides, even if you need to search for them.

  • Inflation should eventually fall with reduced consumer spending.
  • When interest rates normalise, the cost of borrowing will fall. But the market expectation is for rates to continue to rise quite sharply in the medium term.
  • Businesses have the opportunity to redefine their business model. For example, a reduced workforce may require increased outsourcing. Businesses should critically examine every facet of their operation, making savings where possible, but also defining what makes their business unique. They can shed unprofitable service lines and underemployed staff without many of the usual unsettling ramifications.
  • A recession, like a pandemic, disproportionately affects those with weakness. For a business, it is all about surviving longer than the competitors (and maintaining a relatively healthy balance sheet). The survivors should obviously enjoy enhanced market share.

What is best practice during a financial challenge?

If a business is in financial difficulty, certain elements of good governance are essential:

  • Review your management accounts and forecasts regularly – fortnightly or even weekly would be appropriate. Are debtor days increasing or decreasing? Which suppliers need to be paid and which can wait? Are all employees essential? Are all service lines performing? Identifying issues is the first step to addressing and resolving them. 
  • Eliminate all unnecessary expenditure.
  • The management team should critically assess themselves too. Are they the right personalities for the situation? There is no room for unabashed optimists. Professional help may also be required. Find it as soon as you identify the need.
  • Keep minutes of board meetings that document the reasons for all business decisions. If it comes to the worst, a paper trail of the board’s thought process will be an invaluable defence to any accusations of mismanagement or wrongdoing.
  • Identify and protect your talent: there may not be a business without them.
  • To survive the recession, be brutally realistic from the start. Being pragmatic by preparing for the worst, is infinitely better than just hoping for the best.
  • If in doubt, seek advice from professionals

For further information, please contact Jenny Peck.

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