How to Prepare Your Business for the Future
Navigating late stages of the business cycle
A decade after the start of the last recession, many experts predict that we have recovered and are headed for another round. This phase is the late stage business cycle. Late stages of the business cycle can be some of the most difficult times for executives and management to navigate. Optimism is high, but history tells us good times don’t last forever. Forward thinking leaders must act with discipline and at times take on contrarian views to best position their firm for the turn of the cycle. While many will charge ahead, over-shooting the cycle, good management will operate with a level of caution, knowing that the odds of continued excess returns have shifted. In this article we will review tactical items leadership should consider to maximize their position in the late stage of the business cycle.
Shorten Days Sales Outstanding: The first tactic management should consider in the late stage of the cycle is aggressive action towards shortening the overall Days Sales Outstanding. Aggressively collecting accounts receivable will reduce the DSO and improve the overall cash conversion cycle. Should the peak in the cycle come sooner than expected, the company will have fewer problems collecting receivables than their competitors and other market participants.
Begin Tightening Credit: Toward the latter half of the expansion phase, leadership should begin tightening credit. Close attention should be paid especially to customers with a history of credit problems or those who might have aggressively expanded during this latest expansion phase. A slow transition to new terms keeps from alarming these customers or scaring them towards the arms of the competition. Remember, most businesses are still aggressively expanding in the late innings of the expansion phase. If customers are making special requests for their own accommodations, use this as an opportunity to tighten credit terms with little pushback.
Tighten Inventory: Inventory levels stay consistent during the expansion to peak phase of the cycle. This is done to meet growing demand and avoid reduction of market share. However, management should begin focusing on reducing their Days Inventory Outstanding and avoid buildup of slower-moving inventory. Tightening inventory levels will create a lean operation at precisely the right time. This will help proactively adjust when demand peaks and slack in inventory begins to build. Cash tied up in inventory is a poor form of asset management and an added headache during economic slowdowns. Inventory buildup typically catches management off guard because of optimistic attitudes leading into peak phases of the cycle.
Strengthen Productivity of Labor: It is likely that management has already added additional labor to operations to keep up with new demand in the current phase of expansion. At this point of the cycle, management should refrain from aggressively adding any more labor positions to operations. During this phase of the cycle hiring costs reach all-time highs. Unemployment is nearing low points of the cycle, making it more difficult to find qualified labor. In addition, wage growth has pushed up market prices for new and current employees making the overall labor market very competitive. It is also at this time that most firms see Productivity of Labor decrease. Leadership should use this opportunity to strengthen productivity of labor within their own organization. Productivity is what drives the entire economy and it certainly can drive performance in a single firm.
Maximize Industrial Capacity: The late stage of the cycle brings expansion of both fixed investments and labor, typically creating overall excess capacity (available capacity) in business operations. Management should aggressively measure and monitor what current industrial capacity the firm has and at what level available capacity exist. Once clear understandings of industrial capacity are in place, leadership can aggressively look to maximize their current industrial capacity as opposed to over-expanding like many of their industry peers.
Extend Terms with Suppliers: Another lever management should adjust in the latter half of the expansion phase is terms and conditions with suppliers. Again, attitudes are optimistic because business is going well. Leadership should do what it can to improve terms that are currently offered by suppliers. Tactical items like extending day’s payable will improve the cash conversion cycle and better position the internal financials of the business.
Strengthen the Balance Sheet: The final tactic worth mentioning is the effort that should be made towards the balance sheet. Leadership should begin fortifying their balance sheet. Creating a healthy mix of long-term and short-term debt, along with appropriate debt-to-equity ratios will position the business to survive and thrive any downturn. Companies with strong liquidity ratios and surplus liquid assets will be the best positioned to take advantage of distressed asset prices when the cycle turns.
In Howard Marks’ latest book, Mastering The Market Cycle, he opens chapter one with the following statement: “The odds change as our position in the cycles changes. If we don’t change our investment stance as these things change, we’re being passive regarding cycles; in other words, we’re ignoring the chance to tilt the odds in our favor. But if we apply some insight regarding cycles, we can increase our bets and place them on more aggressive investments when the odds are in our favor and we can take money off the table and increase our defensiveness when the odds are against us.”
While Marks is largely referring to investment strategy within portfolio management, the same statement can be equally relevant for operators and executives managing strategically for business cycles. No one can predict with perfect accuracy how long each stage of the cycle will last, but we do have the ability to understand when the odds shift in and out of favor.
About Carter Johnson: Carter Johnson is a CVA with Singleton Valuations, a business appraisal and valuation firm in Denver, Colorado. He specializes in advising clients on profitability and value enhancement strategies. Carter can be reached via https://www.singletonvaluations.com/ or 720-330-354.