Mark Perrin, a consulting partner at accounting firm Menzies LLP, offers some advice ahead of the expected recession
WITH the economy slowing and UK inflation soaring at a record high, households across the UK are feeling the effects of the cost of living crisis and the situation is expected to worsen in the coming months, particularly when the energy ceiling is raised again in October.
A recent Bank of England Financial Stability Report warns that the UK and global economic outlook has “deteriorated significantly” and UK inflation is expected to top 11 per cent by the end of the year.
Although the UK economy grew slightly in June, its contraction over the previous two months suggests it could be headed for another recession.
Few companies expected to feel the pressure of another economic downturn so soon after the pandemic. However, those who have performed strongly in 2020 and 2021 will be best placed to weather the challenging times ahead.
Largely out of necessity, many companies adopted a more agile approach to decision-making and governance early in the pandemic, when orders were falling dramatically or disappearing altogether. In many cases, this agility has taken root and become part of their more resilient business model. Many companies also already have a strong network of external consultants to support their decision-making in the coming months.
know your customer
The deepening of the cost-of-living crisis, with its likely impact on consumer spending, is expected to bring other trade challenges for businesses.
Rather than switching products or services to increase sales, companies may need to mitigate risk in some areas by reducing their reliance on customers with higher financial risk – those who are most likely to be affected by a drop in consumer confidence.
Credit checks should be conducted regularly to track customer performance, and sales and procurement teams can also provide useful market intelligence. Organizations should also ensure they have a thorough understanding of what constitutes an “ideal” customer versus those who may have higher maintenance requirements or deliver less value due to lower operating margins.
Don’t get caught
Depending on the company’s operating model, an economic downturn could leave some companies stuck at the wrong point in their working capital. In other words, they could be left with excess inventory or work in progress that they can’t realize value from.
This could be a particular concern for companies affected by global material shortages, as many have opted to increase inventories and production rates to stay ahead of the demand curve of the recovery. Having a range of suppliers to deliver critical products and services is also important and mitigates the risk that a supplier will fail during an economic downturn.
Practice proactive cost and cash flow management
In a climate of rapidly increasing costs, the situation can quickly escalate into a financial crisis if revenues fall.
Businesses can take immediate action to mitigate cash flow risk through proactive cost and cash flow management. For example, better credit terms can be negotiated with key customers and longer payment terms can be negotiated with key suppliers.
Due to the high rate of inflation, all companies should keep an eye on their prices and, if necessary, pass on cost increases to customers.
Get more headroom
For many companies, the economic recession is both a time of opportunity and a time to close the hatches. However, in order to be able to take advantage of market opportunities, for example by recruiting skilled workers or assets, companies must have sufficient financial leeway. While there are costs associated with borrowing and repayments to be made, some businesses may want to secure a “safety net” now before financing becomes more difficult.
Focus on debt management
Another way to protect cash flow is to focus on debt management to ensure that any outstanding amounts owed to the business are paid as quickly as possible.
As interest rates rise and loans paid to the company become more expensive, some companies may wish to restructure their debt financing to reduce costs in this area.
Lead the workforce
Business owners need to lead from the start and take a proactive role in communicating and motivating the workforce. This will help them retain skilled employees and maximize performance, which is just as important now as it has been during the pandemic. During an economic downturn, employees may need extra support to keep their morale and well-being up.
look into the future
Whatever happens in the coming months and in 2023, companies cannot afford to be stuck in firefighting mode and need to maintain a long-term, strategic view.
Employing best-practice techniques such as scenario planning, supported by reliable financial information and forecasting models, can help companies make the most of growth opportunities during downturns.