As we've all experienced recently, the economy can change overnight with global events and uncertainty. If you're a small business owner during the time of the COVID-19 crisis, you're likely understandably worried. How will you weather this uncertain economic time? How will you afford to continue signing paychecks and keep the doors open?
As a financial analyst, I help business owners make sense of their company's finances and make sound decisions. There's rarely a more important time to make sound financial decisions in your business than during a time like this. In this blog post, I'll explain how to build your own model to guide your financial decisions in the days, weeks, and months to come.
First, a Word of Encouragement
Small businesses don't have to fail during economic duress. In fact, small businesses can sometimes be uniquely poised to tighten belts and weather an uncertain time in ways larger corporations cannot.
As a small business owner, you have what I call "financial levers" you can adjust at any time. These levers can be carefully calibrated and recalibrated as things change to make your company solvent. Let's review what those levers are and how to use them.
The Components of Sound Financial Accounting in a Downturn
When an economic downturn occurs, you need to have a clear picture of your "financial levers," which are all found on your income statement. We can make some assumptions first:
- Since we're talking about how to weather an economic downturn, we're going to assume revenue is likely to go down
- We assume that you, as the owner of your small business, get paid out of net profit and are not on payroll
With these assumptions in mind, we can turn to your income statement. Your income statement tells you about your five levers: revenue, cost of goods sold, payroll, operating costs, and net profit.
Using Excel, you can build a multi-scenario income statement by playing around with the numbers on your income statement (in other words, moving your levers up and down). For instance, you could see what would happen if revenue for this year was 30% lower than last year—how much would you have to cut from the other lines?
Here's an overview of each of your financial levers, and how they work.
Example Multi-Scenario Income Statement in Excel
Lever 1: Revenue
Your control over revenue is limited, for obvious reasons, especially during uncertain economic times. However, you can use your financial modeling document to move that lever down to see what happens to your financials. For example, you can reduce this to 75% or 50% of what you did last year to see what you need to adjust to achieve your goals.
In finance, we often model this in a good, better, and best-case scenario. The important thing is that you honestly reduce your revenue to the lowest point so that you can plan accordingly for the worst-case scenario.
Lever 2: Cost of Goods/Services Sold (Gross Profit Margin)
Cost of Goods/Services Sold is important to pay attention to if it is not scalable. For example, if your revenue was 50% of expected, would your cost also drop 50% (potentially not)?
Profit margin is a lever you don't have a lot of control over. You likely have been paying attention to reducing costs in this area for some time. If not, now is your opportunity to do so. If you have been finding efficiencies in production, then are there economies of scale that you are going to lose if you produce less? If so, adjust these costs up.
Lever 3: Payroll Expenses
Although we don’t want to talk about it, your survival as a company may depend on your ability to cut costs. Payroll is one of the most obvious places to start. Here are some ways to do this.
- Cut employees or contractors: Profitability is essential unless you have plenty of cash to cover wages during a period of reduced earnings. Considering this: your staff needs to reflect your gross profit. Make an HR plan to handle this contingency (we recommend Premier HR Solutions, based out of Austin, TX).
- Furlough: As an alternative to cutting people, furloughing is an option. If you anticipate business picking up in a set amount of time, offer a furlough for a period of 30, 60, or 90 days. Work with a HR professional to do this as well.
- Reduce hours: Another option is simply to cut a full-time employee’s hours or salary to three-quarters (or less) of what it was. You may experience some attrition as some people will not be comfortable with this. However, this avoids laying off individuals if all are highly valuable to your long-term success.
Lever 4: Operating Costs
Some costs are harder to get rid of then others, but there are plenty of operating costs you can take a look at to reduce in a downturn. For example, can you really get by without the internet? Probably not, so paying your internet service provider is essential. However, you probably don’t need to take your staff out to lunch. Look at your budget and see what things you spend money on that you can cancel or suspend. Work with a budget professional to categorize your expenses and then figure out where to cut.
Here are some ideas:
- What projects were you planning that you can postpone? Can that IT project be postponed for a few months? Can you get by with the same office furniture for another year?
- Do you have to take your staff out for every birthday? Perhaps do a birthday lunch every quarter instead of for each individual employee.
- Are there any subscriptions that you have been meaning to cancel?
- What things (tools, software, services) do you currently pay for that are not adding value to your company?
Lever 5: Net Profit
Finally, you can model your net profit. For Sole Proprietors and owners of LLCs, you get paid from the profit you generate. What do you absolutely need to live? Perhaps cutting your pay can be the key to keeping a necessary expense or staff that you really don't want to cut.
Stay Positive and Lead With Certainty
With the right financial tools in your corner, you'll be able to make sound business decisions, regardless of what the economy is up to. This also allows you to stay positive and lead your employees with certainty and stability.