Who Will Survive this Downturn?

Let’s face it! This economy is prone to recessions. It is part of life!

Who Will Survive this Downturn? Even though most businesses understand that experiencing downturns is inevitable, not all are prepared to weather these situations successfully, like the current one we are having in 2022!

At such situations, strategies are re-reviewed and plans change! Some metrics must be revisited and reconsidered to survive. Like Free Cash Flow (FCF), Debt-to-Asset ratio, monthly burn, Runway and many others. And it is always the challenge of boosting income and cutting costs to get through these tough times.

During times of crisis, we often question: Which businesses will be able to survive? Who will emerge stronger? What are the most effective survival strategies?

We will analyze this and try to have a better understanding of who may have more chances to survive and who may not.

What to Watch?

Cash Flow

80% of businesses fail due to a shortage of cash flow. Free Cash Flow (FCF) is the most important metric to assess any business capacity to survive and grow. In times of crisis, FCF will be one of the main metrics to watch, FCF is the measure of resilience and ability of any business to get through hard times.

By definition, FCF can reveal problems in the fundamentals before they arise on the income statement. it represents the cash available for the company to repay creditors and pay out dividends and interest to investors, it reconciles net income by adjusting for non-cash expenses, changes in working capital, and capital expenditures (CapEx).

While growth has been always the sought-after metric for startups, during downturns, growth that is not covered with enough cash flow will not save any startup. Growth only-focused strategies may not be the right approach during these times.

Growth that is not covered with enough cash flow will not save any startup at downturns

It’s important to mention that having a negative FCF is not bad in and of itself. If a company’s FCF is negative, it may be putting a lot of money into investments. If these investments pay off well, the plan could work out in the long run.

However, the safest bet is to keep consistent positive margins of FCF. During downturns, the main goal is to survive, not to only grow at all costs!

During downturns, the main goal is to survive, not to only grow at all costs!

Debt

At such tough situations, keeping a close eye on your company’s debt is an absolute must, this will deeply define your runway and what can be the shape of your business in the coming few years.

Alternatively – mainly for larger businesses- you can measure the total debt-to-assets ratio, which reveals how much of a company’s assets are financed by debt as opposed to equity. Calculating this ratio over time reveals a company’s progress in terms of both expansion and the accumulation of assets.

Keeping this ratio under control increases the immunity to markets turmoil. The optimal debt-to-assets ratio for a business depends on a number of factors, including the company’s size, industry, sector, and capitalization approach.

Even though the ratio is most relevant to larger businesses, knowing your own company’s debt-to-asset ratio can’t harm if you are running a seed-stage startup or small business. You want to be aware of trends, keeping a close eye on this ratio.

Survival strategies

Adopting lower cost strategies (other than layoffs)

Companies often resort to layoffs as the standard strategy for dealing with the pressure from factors like economy, business changes, modern technologies, lack of product market fit (for startups) and competition, etc.

However, studies suggest that layoffs are not always what top executives need to achieve their objectives. While layoffs may lower expenses rapidly, they make recovery harder. In tough circumstances, people avoid working with companies that cut staff.

So, the short-term gains may outweigh the long-term losses of negative publicity, loss of expertise, weaker participation, more voluntary turnover, and less innovation.

While layoffs may lower expenses rapidly, they make recovery harder

Layoffs are one way to cut costs, but they aren’t the only way. Companies can think about reducing hours, giving furloughs, and paying for performance.

A really good example is how Honeywell fired almost 20% of its workers after the stock market crash of 2000, and the company had a hard time getting back on its feet in the years that followed. So, when the Great Recession hit in 2008, the company took a different approach.

Honeywell gave employees unpaid or partially paid time off from work for one to five weeks. About 20,000 jobs were saved by that. Even though the Great Recession was much worse than the 2000 recession, Honeywell came out of it in better shape in terms of sales, net income, and cash flow by just managing to have less operational costs instead of layoffs.

New Markets? Go or no go?

No market is ever completely safe, regardless of how robust the economy or how secure the business.

Exploring new markets can be an attractive approach in some situations, however, this can be very dangerous bet!

Exploring new markets can be an attractive approach in some situations, however, this can be very dangerous bet!

Take Klarna, a huge European Fintech. In 2021, the company was Europe’s most valuable private tech company, at a $45.6 billion valuation, however this crashed to $6.7 billion in 2022!!

One of the main reasons of this crash is Klarna’s expansion to new markets like the US and Australia. While these markets are incredibly important, the amount of capital needed to penetrate such huge markets is insanely large. The company had to raise capital at a super lower down-round to maintain its position. At the time of writing this article, we do not know what the next round for Klarna will be.

Nevertheless, expanding the business to new geographies/markets/segments can be a smart choice in situations of lower barrier to entry and short-term gains.

Investing in technology

According to HBR, technology helps any business be more flexible, and productive. Katy George, a senior partner at McKinsey, says that the first reason to prioritize digital transformation before or during a recession is that better analytics can help management understand business, how the recession is affecting it, and where operational improvements could be made.

Second, Technology can help cut costs. George says that companies should give the most attention to “self-funding” transformation projects that pay off quickly, like automating tasks or using data-driven decision making.

The third reason is that IT investments make companies more flexible and better able to deal with the uncertainty and fast change that come with a recession.

Finally…

In his famous book “The Black Swan” Nassim Nicholas Taleb cited the fact that Black Swan events need a special level of preparation which should be so different than what the mainstream of financial experts might say.

The problem with experts is that they do not know what they do not know

Nassim Nicholas Taleb, The Black Swan

So working for the best and be ready for the worst is the right way to go for any business, either large enterprises or small startups!

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