By Taylor Gibson, Consulting CFO, Optima Office INC.
Do you have 20/20 vision for the long-term health of your company? There are conflicting financial signals to evaluate when considering the course of the U.S. economy and how it may impact your company. Fortunately, there are some key indicators which provide insight and should enable you to plan accordingly and position your company for future events.
First, a look at the broader landscape. The U.S. economy appears strong when you consider unemployment is at or near record lows, consumer spending is strong, and the stock market is near record highs. An optimist will correctly point out that we are currently experiencing the longest run of continual quarterly Gross Domestic Product (GDP) growth in United States History. A pessimist will argue that the globally linked economy is weak and that several large investment banks have expressed concern that the nascent trade war between the U.S. and China may bring about a recession.
Key Indicators
Regardless of whether you are a pessimist or an optimist, several key indicators point to a looming recession, including:
The most prominent of these is the inverted yield curve. On a basic level this means that short term interest rates are higher than long term interest rates. This makes lending by banks less profitable and leads to a curtailment of the extension of credit. According to the San Francisco Federal Reserve Board, ‘every U.S. recession in the past 60 years was preceded by an inverted yield curve.’ 1 Unfortunately, the actual onset of recession has occurred between 10 and 36 months following the inversion. The yield curve first inverted since the Great Recession in 2018.
With the unemployment rate bouncing at historic lows it would be wise to watch any uptick in this indicator. A study by the St. Louis Federal Reserve Board indicates that, ‘On average, since 1969, the unemployment rate trough occurred nine months before the NBER-determined recession trough, while the yield curve inversion occurred 10 months before’.2 Recreational Vehicle (RV) sales, which range from between $20,000 and $300,000 are another indicator because they represent discretionary purchases of both the middle and upper class income brackets. The recent decline in RV sales with ‘multiyear drops in shipments have preceded the last three recessions’.3 Taken together, all of these argue that preparing for a recession is a prudent course of action.
How to Protect Your Business During a Recession
Predicting the exact time of the next recession is difficult but planning for one is not. Recessions are a natural part of the business cycle and typically are accompanied by declining sales revenue and profits, rising unemployment, potential insolvency, and tighter access to credit. Most economists predict that the next recession will be mild and short lived. A healthy company able to withstand these headwinds will have a relatively consistent upward trend, or at least level, growth in revenues and cash balances in tandem with a good profit margin.
Prepare for the eventuality of a recession by examining your current financial status and looking at trends. A good place to start is with key financial ratios. The Securities and Exchange Commission (SEC) provides a free analysis tool that calculates numerous ratios and compares them to other companies in your industry. Even if you are not a publicly traded company or believe your company is too small this provides a good guideline to start any analysis. You should also compare them with recent trends and against the same period for prior years at your company.
The first ratio to look at is your Current Ratio or Current Assets / Current Liabilities. A healthy company will have a value greater than those in their industry and one that is roughly level over time or trending up. Too high a ratio – in general, more than two – indicates that a company could be managing their current assets and or short-term credit more proficiently. A value of one or less indicates you may have difficulty meeting near-term obligations and should be looked at in conjunction with operating cash flow.
- Receivable Turnover Ratio
Another cash related ratio to keep your eye on is the Receivable Turnover Ratio or Net Receivable Sales/ Average Accounts Receivables. This ratio varies widely depending on industry and other factors like seasonality, so comparisons to competitors and historical trends are key to a proper analysis. A low or declining ratio indicates that you need to tighten up your collection practices or that your customers are having difficulties meeting their own obligations. This may be the first indication that a recession is underway, and you should take action accordingly.
Although it is difficult to predict when the next recession will occur it is clear that there are several warning signs that the U.S. will experience a downturn in the near future. You can prepare for this by examining some key financial ratios and making any necessary changes in operations before the storm hits.
Sources:
- https://www.frbsf.org/economic-research/publications/economic-letter/2018/march/economic-forecasts-with-yield-curve/
- https://files.stlouisfed.org/files/htdocs/publications/economic-synopses/2018/06/01/recession-signals-the-yield-curve-vs-unemployment-rate-troughs.pdf
- https://finance.yahoo.com/news/recession-warning-rv-sales-hit-the-skids-184504512.html
DISCLAIMER – Due to the daily changing environment and guidelines being provided by the government, this information could be outdated. Please contact our office for the latest updates and guidelines. Optima Office is not responsible for any actions taken due to the information provided. The information provided here is for instructional purposes and does not represent legal advice being given by Optima Office.
