From a U.S. equity investor’s standpoint, 2019 was an outstanding year, with the S&P 500 returning roughly 29% for the year. But, from a manufacturing business owner’s perspective, 2019 was something of a mixed bag. Positives, such as a respectable level of demand in the domestic market, were offset by various headwinds including the ongoing U.S./China trade disputes, a tight labor market and volatile commodity prices. If we had to choose a theme that characterized this environment for many manufacturers, that theme would be “uncertainty”.
It appears likely that this uncertainty will continue during 2020. While Phase 1 of a trade agreement with China was signed, there is uncertainty as to how, when (and even if) its terms will be met. Countries in the EU continue to struggle, with near-zero inflation and economies that appear to be stuck in low gear. Growth in the U.S. manufacturing sector is predicted to slow in 2020 – the ISM’s Purchasing Manager’s Index slipped below the critical level of 50.0 in the second half of last year – and being a presidential election year certainly adds more uncertainty.
While the risk of an actual recession (defined as negative GDP growth for two consecutive quarters) is still seen as fairly low, many economists and market watchers are predicting a slowing economy in 2020. While that is not great news for any business, there are things that small & mid-sized manufacturers can do to prepare for a downturn, if that’s what happens. We are advising our clients to take the following five steps that will make them more resilient in the event of a slow-down.
5 Ways to Safeguard Your Business from a Slow-Down
- Get Liquid – Keep enough cash and lines of credit in place to avoid a temporary liquidity crisis. When your business has enough liquidity to pay suppliers and meet payroll and other expenses for at least a few months, it is less threatening when a customer cuts back on an order or raw materials costs spike. You won’t have to immediately look for ways to cut costs to cover your expenses.
- Scrutinize Receivables – Don’t overextend credit to customers that may not be able to pay you on time. Evaluate each customer’s payment history, and invest some time to learn how their businesses are doing (this is important for both new and long-standing relationships). Knowing your customers’ business outlook can provide important information in any economic environment – in the best-case scenario, a good customer’s business is expanding and your company will be asked to supply more. If so, you’ll need to incorporate that into your planning. If a customer’s business is declining, take a hard look at your receivables with that company and be prepared to cut back.
- Monitor Inventory – It’s a question that has challenged businesses since merchants first set up shops in medieval times: what is the right level of inventory (finished goods and raw materials) to hold? There is no one-size-fits-all answer, but be wary of piling up too much in raw materials (even if you could buy at a great price), and avoid holding more finished goods in inventory than you need to fill firm orders based on your production cycle, with some cushion. This should be based on a month-by-month (or even week-by-week) analysis of projected demand, not what happened last year. Bottom line: Inventory ties up cash (see #1 above).
- Be Careful with CapEx – When making or updating your budget and forecasts, review all capital expenditures. Is the new equipment required to meet firm customer demand, or to make sure your business remains cost competitive and can meet quality standards? Those are the items to keep in the budget, but try to avoid taking on debt to make big purchases, as it may become more difficult to service a higher debt load in a downturn when cash gets tight. Be careful to distinguish between equipment that is truly needed versus a “nice to have” that is being promoted by a salesperson. Resist the temptation to ramp up to meet optimistic sales projections that are largely in the “maybe” category.
- Embrace Digital Tools – Use digital tools and advanced data analytics to improve productivity, reduce quality problems and error rates in manufacturing processes, get a better handle on what drives demand week to week and adjust inventory appropriately. Digital tools can also foster customer loyalty. Consider building an online / mobile digital platform that allows customers to check the status of orders, report a problem, access product information, and address other needs quickly.
Is Worrying About an Economic Downturn a Self-Fulfilling Prophecy?
It is often noted that worrying about a recession can cause a recession – in other words, there is an element of a self-fulfilling prophecy involved. When business owners are overly concerned about a recession that might happen, they cut back on hiring and reduce inventories prematurely, so business activity declines. That means hiring is reduced or frozen, which makes people worried about their jobs. That means they spend less on consumer goods and services, which turns into a negative feedback loop. So, businesses should not clamp down hard on spending in anticipation of a recession that is still seen as unlikely, as collectively that can bring on the recession everyone is hoping to avoid.
In contrast, it is prudent to do the five things described above in a way that does not interfere with keeping your business humming. This requires a certain level of forecasting and analysis that you may not have time to do, or that requires expertise beyond what you have in-house with your current financial/accounting team. That’s where G-Squared’s outsourced CFO services come in. Contact us for a no-obligation discussion about how we can help your business take these five important steps.