"Only when the tide goes out do you discover who’s been swimming naked.”
Warren Buffet memorably made his comment about company exposure during down economic cycles. We’ve had a rising tide for almost ten years. After such a long and robust growth period, many companies have forgotten what it’s like to operate in challenging times. Entrepreneurs under the age of 30 have, for the most part, never experienced a down market.
The tide is shifting. Valuation of pre-IPO companies are being challenged and post-IPO businesses are dealing with the scrutiny of quarterly financial reporting, the harsh judgment of the stock markets, and declining share values. Earnings for established companies are generally holding, but the stock markets are drifting south, and consumers are becoming more cautious.
While the tide may not go out tomorrow, next month, or even next year, like the tides at the shore they will go out. Now is the time to stress-test your business.
Ask yourself these 3 key questions:
How will my customers do during a downturn?
Do your customers have resilient businesses, or are they vulnerable to cost cutting by their customers? You can’t easily change your customers, but you can focus on those with the strongest fundamentals (healthy balance sheet, loyal customers) and market-cycle-resistant business models.
When my customers start cutting costs, how far down the list am I?
In other words, are you critical to how they make money, how they run their business, or how they live their daily lives? Are you a strong link in an essential value chain? If your customers can live without you or find a cheaper alternative, they will. If you are less essential, there are still steps you can take: strengthening customer relationships, investing to differentiate your offering, and making pricing and payment models more appealing. Happy customers are more likely to stick with you in a downturn.
Can I survive a 20% drop in sales?
For most companies, cash flow is their life blood. The earlier stage the business, the more often their cash flow is flat to negative as they acquire customers and build the business. Even the most mission-critical companies experience delayed payments or lose business entirely when the economy goes soft. Consumer-facing businesses are especially vulnerable. New venture funding dries up as VCs focus on protecting cash and keeping their portfolio companies alive. Loans and other short-term sources of money get tight.
Now is a good time to review your cash reserves, the age of your receivables, your available lines of credit, and the security and timing of future funding. Even if it might seem extreme, plan on losing 20% of your base revenue overnight, and stress-test your 12-month forecasted cash position against that gap.
Critically answering these 3 questions and taking proactive steps will help to keep your swimsuit on when the tide does go out.
Sage Partner Cedric Crocker contributed this Sage Advice