7 Steps to Prepare Your Company for Challenging Economic Times

By US TEC Speaker Edmond P Freirmuth

When the economy takes a turn for the worse, executives need to embark on two related courses of action. First, they should prepare their companies to ride out the economic storm. Then, they should get ready to take advantage of the recovery that will surely follow. This process requires seven essential steps:

1. Vigorously analyse your business

Get an accurate, up-to-date snapshot of your company's financial health. Using a spreadsheet, pull together a comprehensive five-year financial history of the business (paying special attention to the balance sheet) and begin looking for trends in key financial ratios. Then, use a benchmark to compare your data to other companies in your industry. If your trade association compiles performance metrics for your industry, that’s even better.

When analysing the data, pay close attention to the following:

• Current ratio
• Quick ratio
• Debt-to-worth ratio
• Return on sales
• Return on assets
• A/R turnover
• Inventory turnover
• Accounts payable days

The direction of these ratios tells you a lot more than the magnitude of the numbers. For example, suppose your sales have doubled in five years but your leverage (debt-to-equity) ratio has gone from 2:1 to 3:1. That may not be a healthy trend. In fact, it could represent a serious decline in your company’s financial stability. If your leverage ratio climbs to 3:1, or above, and operating losses arise, bankers get very nervous—especially when credit is being restricted. The 5 Cs of credit are back—Character, Capacity, Capital, Collateral and Conditions are old school foundations of credit that have become fashionable again.

Next, compare your company's performance to the industry as a whole, again looking for trend lines. If your industry has reduced leverage and increased profits while you're going in the opposite direction, that sends up a red flag of possible impending danger.

Search for signs of trouble within your industry. Is there excess capacity? Are too many players offering prices that don’t allow most market participants to operate profitably? Will further price erosion take place if the industry revenues flatten or drop? The more danger signs you see, the more likely that your industry could suffer during the downturn.