Last year, I wrote a post recommending some defensive moves to protect annual profits and cash retention as economic worries intensified. I followed it up with an article on how to establish a protective profit buffer with 10 cost saving moves.
Since that time, world economic prospects have turned down sharply. China reflects substantially worsening growth prospects. Commodities prices are declining. Oil prices in particular are in free fall, and energy investment and employment have been heavily curtailed. The stock markets have recently been trounced, with China down 20% and US and other western countries with double digit losses.
It is certainly time to take defensive moves, and at the very least develop a contingency plan. This time I went back to my fellow partners for a more comprehensive response to the prospective downturn. Here are four steps they recommended for a contingency plan.
1. Manage the profit plan to minimize early deterioration
Most companies have a relatively narrow margin for error. A small decline in revenue could wipe out the entire bottom line of your company. Develop forecasts for optimistic, realistic and worst cases. Now formulate the buffer plan and agree on early warning signs, such as a shrinking order flow or backlog or a worsening pipeline. Consider the appropriate early communications to directors, investors and especially lenders.
2. Identify and then maintain your strengths and preserve your best customers
Take a close look at capabilities and skills and determine which are your most critical. Identify your highest-margin customers and clearly understand the value you add to them. Develop a game plan in the event of a downturn to protect and build on these strengths. Rather than cut costs indiscriminately, be ready to shift resources to these high-margin customers.
3. Determine what you can stop doing
Be ready to make changes to your cost structure. What will do the least damage to your strengths and improve your value proposition to what your key customers really appreciate? Comb through your cost structure to create a contingency plan for what you would cut.
Companies are familiar with investment schedules that have a calendar for initiating project expenditures. Consider developing an additional schedule for projects that are non-capital. Revisit both schedules from time to time as the metrics detailed above come in, that highlight problems.
Before you add or replace staff, think through the full expense implications. Consider outsourcing non-strategic functions such as payroll, human resources, accounting and even finance. Take a look at your current outsourced resources for opportunities for lowering costs, either through negotiation or competitive bidding
4. Manage cash as forcefully as profitability
A downturn might force you to deal with negative growth but also liquidity constraints. The cash conversion cycle reflected in receivables, inventories and payables needs to be examined. So does the capital spending plan. Days in the cash conversion cycle have declined in the last 15 years for all US companies from an average of 75 days to approximately 40 days. What decline in days have you managed to achieve in recent years? What could you achieve if circumstances dictated a more stringent approach?
John Kenneth Galbraith once said that “economists predict not because they know but because they are asked.” Contingency planning is not based on knowing. It’s just based on protecting the company ahead of time. These plans are not formed by one individual in a closed office. The management team need to agree together on the relevant early warning signs. From there, decide the necessary actions to take to avoid the worst of a downturn.