Although recessions are a normal part of an economic cycle, they often leave business owners feeling helpless and frustrated. There have been over 40 distinct recessions documented in the United States.
Some recession periods are temporary, while others might go on for years. For instance, the Great Depression was the worst economic downturn in American history.
More recently, lockdowns and other precautions in response to the covid-19 pandemic triggered a record drop in global consumer spending, retail sales, industrial production, and business income. All these events added up to bring about a decline in the global GDP.
There’s no way to know what exactly will spark an impending recession. However, there are several common indicators of a depressed economy that harm businesses.
When you know what they are, you’ll identify them as they begin to surface, perform a risk assessment, and foreplan processes that will help you weather a business slump without suffering a loss of profits or growth.
Signs of an Upcoming Economic Crisis
So, how do you tell when good times are ending? What symptoms indicate that you should build up on your cash reserves? You should pay attention to the following warning signs of an economic crisis.
1. A dramatic increase in the unemployment rate
One of the most obvious drawbacks of unemployment is that it reduces the amount of money a person has at their disposal.
The situation worsens if they don’t have an alternative or passive income stream, in which case they often have to burn their savings or take out loans to pay for taxes and necessities like food or rent.
Particularly challenging is the situation of the unemployed primary breadwinner who must provide for the demands of their family while also meeting basic needs.
Unemployment has repercussions that extend beyond the jobless individual. Communities with high unemployment rates typically have fewer job prospects, lower-quality housing, limited recreational options, little access to public transit, and fewer resources for education and healthcare.
But unemployment affects the economy too, and not just individuals and societies. When people are out of work, they have less discretionary income.
Hence, they save more and spend less, buying fewer products and services and generating fewer economic benefits.
As companies see a decrease in income, they will consider downsizing and laying off people. Thus, the decreased purchasing power of the unemployed can also put others out of work.
An increase in the unemployment rate is a classic indicator of an imminent economic depression. The greater the number of jobless people, the lesser the overall consumer purchasing power; therefore, the lower the market demand.
2. An extremely high inflation rate
The average annual percentage increase in the prices of a basket of goods and services measures the inflation rate.
When inflation is mild, it is good for the economy, as it triggers consumer spending. When prices increase slightly, people buy more now because they know the price will be higher later.
While this can be beneficial in the form of a fatter paycheck or a higher home or stock value, when inflation rises, the cost of living rises with it.
It implies that the price of essential goods has increased beyond the means of the vast majority of the population. High inflation has disastrous effects on a country’s financial health if not regulated at the time.
Zimbabwe’s 2008 hyperinflation is a case in point. With the inflation rate peaking at 79.6 billion % per month, the government had to resort to desperate measures like abandoning their national currency to bring inflation back down.
Simply put, mild inflation coupled with a salary hike and robust employment drives economic growth. However, when the inflation rate accelerates and stays high for an extended period, it reduces purchasing power and the value of pensions, savings, and currency notes.
Worried about their financial security, people withhold more of their money, thus lowering the demand for products and services. It could be a sign that a recession is underway.
3. Falling home prices & property sales
A decline in home prices and retail sales is another indicator of a possible recession. Consumers’ spending habits change when they feel uncertain about the future.
Buying a home is one of the amplest financial investments one makes in their lifetime. Fewer people can afford homes in a bad economy, especially if their income is unstable.
So, when a recession is inevitable, purchasing a home can be risky unless one is 100% confident they’ll be able to make the mortgage payments.
If more real estate is on the market and there are buyers, prices could fall to push sales. But overall, the market stays roughly the same.
True, raising interest rates is one-way governments can counteract inflation. But that makes it even more challenging for business owners to secure loans and other financial benefits.
As a result, the general population will also have to pay more for groceries and gas, and the vicious cycle will continue.
How to Manage Your Business in an Economic Downturn?
Though inflation circumstances are horrifying, there are three strategies you can use to capitalize on growth periods, withstand slowdowns, and meet your profitability and growth targets.
1. Prepare for the hard times in advance
As a business owner, it’s easy to get stuck in the day-to-day operations to increase profitability and reduce costs. It’s even easier to lose perspective when economic problems appear out of nowhere.
The first step to weather a potential downturn is to pay off your debts, reduce operational costs, and save more money. Keep track of every expense, from rent or rates on the property to insurance, utility, and the cost of goods used in manufacturing, or even marketing budgets.
The next step is to compile this data to identify revenue leaks due to inaccurately billed or unbilled products and services, deal slippage, and manual operations prone to human error.
Finally, take stock of your assets and liabilities. See where you can cut expenses. Start by putting aside at least $5000 or the equivalent of one month’s overhead costs. Aim for an emergency fund with a three- to six-month supply of money to get by on rainy days.
Perhaps, you can’t decide how much of your revenue to put toward debt repayment and how much toward the emergency fund. Well, you’re not alone. According to conventional wisdom, you should ideally do both.
Make frequent partial payments to retire the loan sooner. If there’s an upswing in your net income, put it away in the emergency fund.
If you run an early-stage startup, you can struggle during a recession due to the lack of liquid assets. In that case, think of free and low-budget ideas to expand your product portfolio and diversify your income streams.
But if your business is growing, it might be time to invest in business process automation (we’ll talk about it below).
2. Run financial stress tests for market risk
Sometimes, it’s necessary to take one step backward to move two steps forward. Look at historical data and see how the previous economic downturns impacted your business, industry, and clientele.
How many drops in income did you witness? What do you think ate into your profit margins? Were the “effects” brief and acute or long and gradual?
Get your finance team to design a financial model that projects an income statement, balance sheet, cash flows, and, if necessary, a borrowing base calculation.
You can use this model as a stress test to see how well your business would do if the next economic downturn affected your revenue and profits the same way previous recessions did.
You can also run different what-if scenarios in the model to test changes in fixed and variable costs, revenue, pricing, margins, and other characteristics.
All this information will ensure that you accurately determine your business’s financial health and long-term sustainability. This will, in turn, help you make informed decisions on how to ensure that the revenue from sales covers your expenses, even when you’re in the midst of an economic crisis.
3. Use technology to streamline and automate business processes
When there’s economic uncertainty, consumer spending takes a hit. As your profit margins begin to shrink, you might discontinue the employee benefit schemes for the time being. When that happens, you can expect a few employees to leave their jobs for greener pastures.
While a low turnover rate isn’t necessarily a good thing, a high turnover is often costly and disruptive to your business.
This is especially true if the unexpected departure of key personnel means losing knowledge of important yet repeatable business tasks, managing contracts being one of them. Filing and tracking paper-based agreements is hard.
Be it an equipment lease agreement from the procurement team or a product sale agreement from the sales team, contract management becomes ten times more difficult when the individual controlling the negotiation is gone.
If you saw many promising business deals fall through recently, perhaps the reason is that you don’t use contract management software to digitize the entire contracting process.
In business, contracts govern the flow of nearly all capital into and out of an organization. This is why companies of all sizes are increasingly investing in contract management systems like Contractbook to streamline the processes of requesting, reviewing, and updating contracts.
Other than business agreements, contract management software can also automate workflows and manage essential documents for various business functions.
For HR, for instance, no matter how many positions you need to fill, complete all of the necessary paperwork, including job descriptions, employment contracts, legal disclosure agreements, employee handbooks, offer letters, evaluation forms, and reference check guides necessary for setting expectations and ensuring compliance.
With contract management software that allows for unlimited e-signatures and file shares, you don’t only build a talent pipeline and reduce your cost-per-hire as your business grows—you also free up your HR manager’s calendar for more meaningful tasks like creating strategies to reduce employee turnover.
Similarly, with hundreds of standard contract templates available on their dashboard, your sales team won’t have to start with a blank page when drafting and negotiating the terms.
Even if some contracts need customization, your staff is less likely to make errors and omissions—which might delay contract approval—if they use a pre-approved template. That way, they will concentrate more on the value proposition and close the deal faster.
To summarize, your employees are your company’s greatest asset. When you automate their otherwise time-consuming and repetitive tasks, you’re essentially helping them perform better by improving the accuracy and consistency of their workflows.
As a result, your employees will feel valued and want to stick around longer, thus helping you pull through difficult times.
When times are tough, the obvious choice would be to reduce costs, but this is not the only available option. You should also contemplate ways to ensure a steady flow of income.
These include expanding the range of products you sell or marketing your services to a different group of consumers.
It might also be an excellent opportunity to find a scalable solution for automating your business processes to maintain profitability, efficiency, and workplace productivity.
About the Author!
Qurat-ul-Ain Ghazali, aka Annie, is the growth manager at Contractbook and looks after all the organic channels. She has been with tech startups and scaleups for a couple of years with a B2B focus. You can find her socializing, traveling, indulging in extreme sports, and enjoying the local desserts when she is not working.