It wasn’t an MBA class or book I read. It was simply a life lesson my father instilled in me at a young age: “Expect the unexpected.” But even those who were taught to always prepare for the unexpected in personal, professional, and financial situations couldn’t have predicted an all-out global pandemic. Given the unprecedented nature of this change in everything from economics to leadership, the act of future-proofing your business has become an absolute necessity for survival.
Identify how your business is affected by economic cycles
The first step in preparing your business for uncontrollable circumstances is to better understand how your business is impacted by uncontrollable movements in the economy. For example, you should be able to identify how cyclical your business is, given its performance over the last year during the pandemic. In addition, if your business wasn’t around for previous recessions, you could easily benchmark how the industry you’re aligned with performed in previous recessions.
For the purposes of understanding this further, let’s look at a cyclical industry such as the airline industry. As the economy shifts into recession or depression stages, the airline industry’s performance will have a close correlation. And in the instance of the 2020 pandemic, we saw massive changes in this industry. For example, the worldwide airline industry underwent an estimated 61.2% loss of consumer spending on air transport—over a $500 billion change from 2019 to 2020. The airline industry was deeply impacted, but certain airline companies were hurt more than others. Why? Because some companies properly prepared for the unexpected while others didn’t. Moreover, while your industry’s cyclicality may be uncontrollable, your strategy and execution are always in your control.
Properly manage your financials for those lean times
There are many competencies within your business, but the most important competency of future-proofing is the proper management of the company’s financials. Healthy financials in good times help reduce the impact of any bleeding in difficult times. There’s a reason for the old “cash is king” mantra. Managing cash flow, payables, receivables, and outstanding debt structures to ensure liquidity is imperative.
Let’s start with managing your balance sheet. When assessing a company’s lending risk, specifically its liquidity ratio, I analyze something called the current ratio. As a former lender, the current ratio was one of the most important “liquidity ratios” I would analyze when considering business risk. The current ratio is an indicator of how a company can use its current short-term assets to cover the current short-term liabilities. And in a time of recession, ensuring you have enough short-term assets to cover your liabilities for a year is critical. This balance sheet ratio is derived by dividing the current assets by the current liabilities. Maintaining a current ratio above 1.1 is ideal for future-proofing.
In addition to the current ratio, a company must effectively squeeze its accounts receivable (A/R) and accounts payable (A/P). Some massive companies like Paychex have made—and continue to make—their fortune on interchange. This means that they take advantage of the timing between receiving money owed to them and paying it out to those they owe. If possible, negotiate your payable days to be below the industry standard in which you operate. This will allow for a healthy A/R aging report and for a quicker “A/R to cash on hand” conversion.
Speaking of A/R aging reports, when banks assess your lending risk, they’ll scrutinize your A/R concentration (the amount of credit your business has extended to clients). In an ideal situation, they don’t want you to have exposure to one client for more than 20% of total A/R. Why? Because of what we’re discussing: they’re future-proofing their risk of lending to your business. The exposure the bank has to a company when lending money increases if that business has only a couple big clients. What happens if one of those client contracts is terminated? The company is in trouble, thus decreasing the likelihood of timely repayment of debt obligations, increasing the operational risk to the bank.
Work to avoid an A/R concentration of less than 20%. You want to avoid one vendor owing your company more than 20% of your total accounts receivable. If one of those vendors, debtors, or clients has a business performance issue and therefore can’t pay the money owed to you, your company is at risk. The less concentration you have with one entity, the less inherent risk you take on as a company. Moreover, keeping your AR concentration with one entity below 20% will decrease your business risk and also appeal to lenders as they analyze your business risk.
Negotiate better payment terms with your vendors
Vendor management is another focus that seems to fall to the back burner when times are good. Yet, if managed effectively during times of expansion, you’ll future-proof your business when a recession occurs. Every vendor you work with should be diligently tried and tested. You should understand their mission, value-add, market position, financial health, and leadership. Always benchmark vendors against their competition to keep them honest. Doing this will lead to more advantageous pricing, which will of course reduce your overall expenses, increase your cash flow, and inevitably future-proof your business. Lastly, while out-of-pocket costs are important, so is negotiating for proper payment terms. Negotiate for everything possible and especially work diligently with your vendors to expand the number of days in which payment is due. Intuitively this makes sense: decrease the amount of time clients owe you and increase the amount of time you owe vendors.
In general, every business makes mistakes and has failures—annually, quarterly, monthly, weekly, and even daily. The businesses that grow the fastest are those that actively identify their failures and implement immediate solutions to ensure a stronger foundation for future performance. In this time of unprecedented change, we’ve seen innovation in its purest form. We’ve seen businesses built on retail brick-and-mortar leverage technology to reach their audience and the masses. We’ve witnessed businesses that depend on max capacity and high volume be creative, try new technology, and develop more effective operations management to stay afloat.
For example, world-class chefs, bartenders, and event planners who relied on people walking in the door have transitioned to online consulting, classes, training, and events. In this way, they’ve reduced their overhead and expanded their clientele nationally and internationally. These efforts have created a much larger maximum capacity and reach of clientele than pre-pandemic clientele. These innovators are no longer reliant on people walking through the doors of their business.
And in many instances, we’ve seen effective cost-cutting measures where inefficiencies have been identified. Times like this may be challenging, but they provide us with lessons that will make those who are creative, resilient, and adaptable better positioned and proofed for the future.
This content is for information purposes only and should not be considered legal, accounting or tax advice, or a substitute for obtaining such advice specific to your business. Additional information and exceptions may apply. Applicable laws may vary by state or locality. No assurance is given that the information is comprehensive in its coverage or that it is suitable in dealing with a customer’s particular situation. Intuit Inc. does not have any responsibility for updating or revising any information presented herein. Accordingly, the information provided should not be relied upon as a substitute for independent research. Intuit Inc. does not warrant that the material contained herein will continue to be accurate nor that it is completely free of errors when published. Readers should verify statements before relying on them.
We provide third-party links as a convenience and for informational purposes only. Intuit does not endorse or approve these products and services, or the opinions of these corporations or organizations or individuals. Intuit accepts no responsibility for the accuracy, legality, or content on these sites.