After a tumultuous few years dealing with COVID shutdowns, supply chain issues and geopolitical turmoil, one thing we can all agree on is that the last couple of years have led to a tremendous amount of uncertainty.
History has proven that the economy is cyclical. We have seen booms and busts about every five to six years for the last 150 years. However, we have been on the upside of the cycle for almost a decade. The economy has been doing well, with unemployment remaining at historically low levels, increases in GDP aided by consumer spending, and a favorable interest rate environment with lower borrowing costs. Businesses have been able to capitalize on these factors by investing in facility expansion, purchasing equipment and hiring people.
The recent COVID disruption was something that has never been experienced in our lifetime and resulted in the entire world shutting down. This unprecedented health pandemic also led to massive layoffs from companies of all sizes with many people being out of work for an extended period of time. The Federal Reserve had no choice but to step in to try to save the economy by lowering rates to near zero in hopes of encouraging spending. At the same time, the federal government poured $3 trillion into the U.S. economy in various stimulus initiatives in a matter of months. With such drastic actions, along with current market conditions of supply chain disruptions, materials and workforce shortages, it was inevitable that inflation would proceed.
To date, the Federal Reserve has increased interest rates by 3% in the last six months in an intentional effort to slow down the economy. This has been the most rate hikes that we have seen in a single year since 1980. So, is it working? Are increased borrowing rates cooling the economy? There are signs the Texas economy is slowing; the August jobs report showed a slight increase in the unemployment rate, state employment was flat, and the labor force and wage growth eased. Nationally, we have also had two consecutive quarters of negative GDP; however, the consumer price index continues to rise.
Irrespective of where we are in the economic cycle today, history has proven that businesses with healthy margins, strong balance sheets and strong banking relationships are well-equipped to survive during downturns and thrive during economic booms.
During times of economic uncertainty, we encourage clients to focus on margin preservation in their business. Things are more expensive to produce, project costs are going up and sales that at one time generated a healthy margin may no longer be fiscally prudent. We advise our clients to take a deep dive into their revenue mix and determine if there are areas where they can increase or decrease to maximize profitability. Sometimes this may mean that there are certain product lines or offerings that may need to be discontinued or re-engineered to maintain a healthy margin. The same holds true when it comes to evaluating your existing customer base, which may require renegotiating terms to maintain the right level of profitability. We also encourage our clients to perform an audit of their variable expenses during an inflationary period, as it may help identify cost savings opportunities that can result in boosting the bottom line.
When profits start to decline, bankers look to the balance sheet and liquidity as an indicator of a company’s overall ability to weather a recession. There are many financial ratios that banks use to determine the financial strength of a company; one of these ratios is your working capital ratio which evaluates how your current assets compare to your current liabilities. The higher the ratio the more flexibility you have to sustain periods of decline. Focus on maintaining adequate liquidity or access to capital that will sustain your business during a downturn. You should also maximize your cash conversion cycle by doing things such as collecting on past due receivables, managing inventory and negotiating longer terms from your suppliers.
We can’t predict exactly where the current economy is headed but now is an important time to have a conversation with your banker. Having a good relationship with your bank is a critical step in preparing your business for different cycles. Your banker should know your business, your strategies, the industry in which you operate and the risks and opportunities associated with your specific company. As a strategic business partner, your banker can provide valuable insights which can help prepare you for a potential recession. Take the time to build that relationship with open, transparent and frequent communication.
Now is the time to ask, is your business prepared for a recession and how can my banker play a more impactful role in implementing these strategies?
With financial centers across San Antonio, Austin, the Hill Country and Dallas, Broadway Bank delivers modern banking, locally sourced and personally delivered.