How Does a Recession Affect You as a Business Owner?

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Due to economic issues from the pandemic, high inflation and slowed growth, the United Nations ranks the U.S. among the nations that could face another recession soon. As a small business owner, an economic recession can harm your bottom line in many ways as well as require you to make serious decisions to cut costs and retain customers. Along with facing lower revenue, it can also become harder to get financing when you need it. Therefore, you'll want to examine what a recession means for your small business and prepare accordingly.

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Background on Recessions

As you might have noticed over your time as a business owner, economic activity naturally goes through a cycle with swings of economic growth and economic decline. When the economy is growing, businesses benefit as demand rises, employment is high and customers are willing to spend money. However, an economic downturn has the opposite effect as customers prefer to save rather than spend, job losses occur and businesses can experience tough times.

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According to the National Bureau of Economic Research, an extended period of time of strong economic decline – such as several months – leads to a recession before the business cycle bottoms out and then begins an upswing again. Economists specifically often look at whether the U.S. economy's gross domestic product (GDP) has gone down significantly for two consecutive quarters since this is a recession warning sign. However, consumer spending and unemployment rates are some other recession indicators.

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The Congressional Research Service notes a recession can occur for reasons such as an overheated economy, external events or specific asset bubbles. When a recession does happen, the Federal Reserve goes to work to implement monetary policies to help the economy recover. For example, it can lower the federal funds rate to make borrowing cheaper, boost consumer spending and cut unemployment rates. The Federal Reserve Bank of St. Louis highlights the Fed's decision to set the rate to around zero in 2020 due to the pandemic, though it's since raised rates several times as the economy heated back up.

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As a small business owner, an economic recession can harm your bottom line in many ways as well as require you to make serious decisions to cut costs and retain customers.

Reduced Revenue From Customers

A financial crisis like a recession changes consumer spending habits so that your revenue could decline significantly. Customers usually tighten their finances when they're worried about getting laid off or have less confidence in the U.S. economy. The Bank of America Institute explains that trends particularly show a decrease in discretionary spending on items like furniture, electronics and cars. However, customers even turn to cheaper options for everyday essentials like groceries and personal care items.

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As a result, you can find it harder to get business from your existing customer base or acquire new customers. However, how hard your sales get hit will depend on your industry since some are more recession-proof than others. If sales slump, you may feel the need to lower your product or service prices to attract budget-conscious customers. You might also find the need to adapt by offering new products or services that customers will demand or refocusing your efforts on your most profitable offerings.

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You'll also want to keep in mind that changes in consumer spending can harm your cash flow in another way if you let customers buy on credit. Some customers might struggle to pay their bills on time so your accounts receivable turnover becomes slower. This makes it even harder to cover your operational costs until the cash arrives.

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Necessary Cuts to Business Costs

Even when a recession causes your business to earn less revenue, you'll still need to cover expenses in all areas such as manufacturing, marketing, accounting, shipping, supplies and human resources. Especially early during a recession, above-average inflation could increase some of these costs further until prices stabilize. Despite these factors, you'll want to still earn a decent profit and not need to dip into your cash reserves.

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Therefore, you must closely look at your business's spending and uncover ways to save money by becoming more productive, automating tasks and optimizing your supply chain, suggests CNBC. For example, you might cut production or keep less inventory on hand if customers demand fewer products. You might also need to postpone decisions such as expanding your business or creating a new product or service.

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As seen during the recent recession in the spring of 2020 due to the pandemic, businesses often opt to size down their workforce to cut costs, shows the Cleveland Fed. While job losses harm employee morale and are a difficult decision, you might try layoffs if other measures don't help cut costs. You can consider other options such as sizing down employee benefits or offering lower wages for new workers. However, you'll want to proceed carefully to preserve your business's reputation and avoid losing loyal employees.

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Business Financing Difficulties

Cash flow issues during a recession can warrant looking into a business loan or line of credit or using your credit card to cover costs. The Federal Reserve usually cuts interest rates to encourage consumer spending and borrowing, and this could help you get cheaper financing if your business needs it. However, getting approved might be harder than you expect, especially if you already have debt and little collateral.

According to the National Community Reinvestment Coalition, previous recessions resulted in lenders implementing stricter credit standards due to seeing borrowers as higher risk in a troubled economy. Banks typically see you less favorably if your business's liquidity or revenues have significantly declined. Even if you're approved, you might need to pay a higher interest rate to compensate for the risk, or you might get offered less credit.

If you do end up struggling to find suitable traditional financing, you could look into options such as Small Business Administration loans or local small business assistance programs.

Risk of Business Failure

All of the financial challenges of a recession increase the chance of your business failing unless you take steps to make your company more recession-proof. Falling revenue and poor cost controls can put you in the red and drain any cash reserves you have. If you try to seek credit in that situation, the lender would likely see you as high risk and either not extend credit or offer unfavorable terms. You could face bankruptcy if you have creditors to pay or need to shut down your shop if you can't afford to operate.

How Business Leaders Can Prepare

Due to the current economic uncertainty that businesses face, the U.S. Chamber of Commerce suggests that entrepreneurs examine their business plans and practices to better withstand the next recession. For example, you can start looking for costs you can cut right now and put the saved money in your cash reserves in case of an emergency. You should also look at your past financials and forecasts to better examine your financial performance.

At the same time, Allianz suggests that you look into ways to grow your business, prepare for financing and acquire new customers before tough times come. By continuing to market your business, you can build a strong customer base that might help compensate when demand falls. Making sure your credit is in good shape and even extending credit lines now could help you later if your business struggles and needs the extra help. Also, research ways your business could better adapt to changing economic conditions.

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