29 Apr Economic Recession Risk Management
It is our collective job as members of an organization to work towards mitigating and managing risks wherever we can, and this includes external risks that are often out of our control. In the case of a recession, while there is nothing a company can do to prevent this part of the economic cycle, an organization can prepare to lessen the impact and position itself to act decisively when one occurs.
What is an Economic Recession?
An economic recession is historically defined by a 6 month period of gross domestic product (GDP) decline. However, the National Bureau of Economic Research (NBER), the authority responsible for officially declaring a recession, considers more factors. The NBER defines a recession as a “significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” This period begins immediately after the economy reaches a peak of activity and will continue until the lowest point is reached.
How will we know if we’re approaching a recession? Well, we won’t. In fact, the NBER didn’t announce that the Great Recession in 2007 had begun until December 2008, an entire year later. This is why its crucial to be prepared at all points and actively assess your organization’s operations. Many economists calculate that a recession is already underway.
The Impact of a Recession
An economic recession is a large risk to companies, primarily in the loss of finances. This in turn limits potential growth and profit. A recession causes many unprepared companies to suffer severe setbacks or file for bankruptcy.
A recession can also limit access to credit as banks start to lend more cautiously and require more proof of reliable repayments. With a hit to profits, an organization is less likely to get the loan they want and at their preferred rates, raising the total cost of operations.
Company cash flow may also decline as customers begin to limit or cancel their normal spending, or even delay payments on current subscriptions or past purchases. For most, this becomes a period of survival rather than a period of growth.
Recession Preparation Practices
In the case of a recession, the biggest benefit is going to be having a financial cushion that helps get you through the period of lost profits. This reserve fund will help cover necessary costs such as employee wages, utilities, production, etc. Without an emergency fund, you may quickly find yourself in hot water as profits drop and you find yourself struggling to meet the customer demand that still exists.
Next, you will want to identify ways to reduce spending. This is another step that is crucial to complete before a recession, so you have time to properly evaluate your alternative routes. Leave time to properly perform third-party assessments, identifying reliable partnerships at the lowest cost. This ensures when you are in a recession, you do not switch to a low-quality third-party for the sack of saving some money. A common fear of cutting costs is the possibility of reducing the quality of products. In order to meet profit expectations, a manufacturing company could choose to order cheaper parts or a vendor could switch to a third party that charges a lower cost, for example. The potential risk to quality and the resulting reputational risk carries a large impact.
The last step is to do more with less. Consider where to save money in terms of cutting costs by halting investments in new products or ventures or reducing how much you spend on equipment or services. Don’t be afraid to call your vendors and ask for discounts, as they are often flexible and understand the need to optimize company budgets. Also. try enforcing a hiring freeze and instead learn ways to optimize current employees. Utilize software and increase the efficiency of current staff.
A comprehensive plan will protect executives from lawsuits for failure to exercise due care. Some organizations are even required to file annual resolution plans that dictate the organization’s strategy in the event of failing business or financial distress. This plan, which includes previously mentioned items, can highlight an immediate strategy such as dictating which assets to liquidate and even the temporary adjustment of employee compensation to stabilize funds. This plan should be reviewed annually and updated to show a list of assets including staff, machines, vehicles, products, etc.
Remember that recessions are a natural component of the economy and an unavoidable part of running your business. While this period may test and strain your company, it often is for the best as your organization learns where it can cut unnecessary costs and where to focus on success. Every recession is followed by a period of growth and recovery, helping your company if you can survive the trial. While your organization is successful and prospering, implement plans to survive this period and outlast competition.
Start developing your recession preparation plan today by using free RiskWatch assessments to take note of current company assets and practices or to evaluate third parties.