How to prepare your small business for an economic and liquidity crisis

By Kavan Choksi, a successful investor, business management and wealth consultant

Kavan Choksi

Small business owners are bracing for tough economic times ahead. With inflation already eroding profits and hiring difficulties still lingering amid a dearth of qualified candidates, most small business owners have expressed a negative outlook for business conditions over the next six months (source: NFIB). If the economy is headed toward an economic downturn, small businesses have reason to worry. Smaller companies are more susceptible to economic shocks than large businesses because they generally have less capital reserve, less ability to borrow funds, and less flexibility in staffing levels.

But, as we saw in the early periods of the pandemic, small businesses do have a key advantage in their ability to shift operations quickly and adjust to economic shocks. The small businesses that survived the pandemic-related recession were proactive in maintaining sales. As importantly, they were able to secure capital for continued operations.

Access to capital was key to maintaining operations during COVID-related stay-at-home orders, but the next crisis may present challenges for tapping liquidity. The Fed and other central banks have been raising rates steadily to combat inflation, increasing the costs of borrowing and threatening the health of debt markets. The recent failures of Silicon Valley Bank and Signature Bank sent shockwaves through the banking sector, with banking giants like Charles Schwab embroiled in the subsequent market sell-off. The next economic crisis may see liquidity dry up.

Lessons from The Great Recession

Tighter monetary policy may mean the next recession looks more like the recession of 2008 than the recent pandemic recession, which may be bad news for businesses. In 2008, financial sector woes led to a contraction in available credit, and the liquidity crisis hit businesses hard. Over 40,000 US businesses filed for bankruptcy in 2008, and over 60,000 businesses filed for bankruptcy in 2009, up from about 30,000 small business failures per year leading into the crisis. In comparison, the last two years have seen that number drop to less than 15,000 per year (source: Statista).

Liquidity is one key difference between the last two recessions. Small businesses should not assume that the US government will be able or willing to pump excess liquidity into businesses the same way it did in 2020. Small business owners concerned about cash flow should prepare now for a rough economy where borrowing is more difficult. Here are some tips to get started in shoring up for harder times ahead:

1.Assess your liquidity needs for the next six months

Assessing liquidity needs begins with understanding your cash flow and creating a cash flow forecast. Analyze how much cash is coming in and going out of your business each month, as well as the timing of those inflows and outflows. This will help you identify any potential cash shortfalls and take steps to address them. You can use historical data, such as your previous months’ cash flow statements, to help you make more accurate projections.

2.Monitor your working capital regularly

Calculate the difference between your current assets and current liabilities. If you find your working capital is negative, resulting from more short-term debts than short-term assets, you may be facing liquidity issues. Monitoring your working capital can help you identify any potential cash shortfalls.

3.Review your debt obligations

If it appears that debt payments due in the next six months could strain your cash reserves, you may want to proactively restructure your debt or renegotiate payment terms to improve your liquidity before any potential issues in the debt markets.

4.Reassess your cash reserve needs

Consider setting aside a cash reserve or increasing the amount in your current reserves to cover unexpected expenses or revenue shortfalls.

Raising Capital through Small Business Financing

By assessing your liquidity needs, you can take steps to ensure your business has enough cash on hand to meet its short-term obligations and weather any unexpected financial challenges. If you find that you need to raise capital, it’s better to explore your options now and have a plan in place in case you need to borrow money to fund operations during an economic downturn. There are several options for small businesses to consider, such as:

• Business line of credit:This is a revolving line of credit that allows businesses to draw funds as needed and repay the balance over time. Because the line of credit can be opened before the funds are needed, this can be an attractive way to prepare for potential cash flow challenges proactively.

• Small Business Administration (SBA) loans: If small businesses can’t obtain financing through traditional lending channels, SBA loan programs, including 7(a) loans, microloans, and CDC/504 loans, may be an option. These loans can be used for a wide variety of business purposes, including working capital, real estate acquisitions, equipment purchases, and debt refinancing.

• Equipment and invoice financing:Obtaining credit in a liquidity crisis often involves creative solutions, and these types of loans may be viable options. Equipment financing is used to purchase equipment or machinery for the business. The equipment is typically used as collateral for the loan. Invoice financing allows businesses to use their unpaid invoices as collateral for a loan. The lender pays a percentage of the invoice value upfront, and the borrower pays back the loan plus interest when the invoice is paid.

• Merchant cash advance: This is another potential solution if traditional financing is unavailable. With a merchant cash advance, a lender advances funds to a business in exchange for a percentage of future credit card sales. This type of loan will put pressure on profit margins, though, and can be risky in a period of declining revenue.

• Raising capital without borrowing: In times of constrained liquidity and economic hardship, borrowing may not be possible or may be prohibitively expensive. Small businesses may need to find other ways to raise capital. Some of the options include:

Equity financing: A business doesn’t need to go public with a large IPO in order to sell equity. Many small businesses have successfully found investors by tapping family and friends or pitching venture capitalists.

Grants: Grants do not have to be repaid, so they are an attractive option for businesses that do not want to take on debt or sell equity. During economic hardships, the government may increase funding for small business grants, an option worth exploring.

Strategic partnerships, licensing, and revenue-sharing agreements: Small businesses can partner with other companies through joint ventures and strategic alliances, which should be viewed as short-lived solutions. Licensing agreements and revenue-sharing agreements are other creative ways to raise funds without giving up equity or increasing debt.

Crowdfunding and peer-to-peer financing: Crowdfunding is a popular option for small businesses to raise capital without taking on debt or to borrow money from individuals or groups instead of traditional financial institutions. If you have an existing network to tap into, peer-to-peer financing may be an option preferable to public crowdfunding.

Making the right decisions for the current economy

Comparing today’s interest rates on loans to the interest rates from 18 months ago can be frustrating. Owners often fall into the trap of “anchoring” to the past when making business decisions, but it’s important to maintain a view of what’s best today.

Evaluate business decisions based on present circumstances, not historical events. If we can avoid taking on debt, that’s great, especially if we can’t afford the payments. However, if a loan will benefit our business, and the business can absorb the payment costs, it doesn’t make sense to avoid borrowing just because interest rates have doubled.

Likewise, don’t avoid posting a job simply because qualified candidates have been hard to come by recently. You can use financial data to project staffing needs but avoid basing your staffing decisions entirely on historical circumstances or by assuming future labor conditions. Evaluate your current financial circumstances and needs, and act accordingly.

It’s difficult to predict how the business environment will evolve over the next few years, and it can be scary to operate a business with troubling economic headlines. But as we plan and prepare for the future, I encourage business owners to make bias-free decisions grounded in the company’s present reality.

About the author:

Kavan Choksi is a successful investor, business management and wealth consultant. Working strategically with companies across fast-moving consumer goods, retail, and luxury markets — he leverages his vast experience to help clients turn around and revitalize their businesses. 

With his expertise in economics and finance, Kavan has developed a passion for investing over the years and enjoys helping others do more with their money. 

He provides thoughtful commentary to publications such as Business Insider, CEOWORLD Magazine, Finance Digest, Financial Express, Forbes, Fox Business, Global Banking & Finance, International Business Times, Money Magazine, to name a few. Kavan also serves as a regular contributor for Nasdaq, where he shares his expert insights on what’s moving markets and the global economy.