Eight strategies for boosting profits, cutting costs, and reducing risk.
Sound cash management practices are essential for any business. However, businesses in a cyclical industry have unique issues that require special diligence.
A cyclical industry—like construction, airlines, oil and gas—is sensitive to the business cycle, meaning its revenue is generally higher in periods of economic prosperity and lower in periods of economic downturn.
“Cyclical industries need to plan meticulously for downturns, ensuring they have adequate cash reserves, whereas noncyclical industries may have more consistent revenue flows,” says Jack McCullough, president of the CFO Leadership Council. “Feast or famine is a reality, more so in cyclical industries.”
Consider these eight strategies for cutting costs, saving money and reducing risk—some of which might be useful for noncyclical businesses as well.
- Plan for the Worst
Eric Kraft, Dallas/Fort Worth commercial banking executive for First Horizon Bank, says conducting a strategic planning session at least once a year is important for all businesses and critical for a cyclical business. Companies should produce an operating plan, complete with financial projections, that considers three potential outcomes: a best-case scenario, when the economy performs well and all other factors fall into place; a worst-case scenario, when the economy falters; and a likely scenario, when things go as expected.
The cyclical companies that do the best job of planning are able to withstand difficult economic times. One best practice is to invite employees from several organizational layers to take part in the early-stage planning sessions. “Front-line employees can offer significant insight into customers’ and suppliers’ operating resilience,” Kraft says. “The companies that fail at planning don’t get the right people in the room, or they don’t allow them to freely share their thoughts.”
He recommends having a third-party consultant supervise the planning process, so the business owner is freed up to take part in the planning.
- Cushion Yourself for Downturns
Companies in cyclical industries should have significantly greater capitalization and liquidity than companies that don’t cycle often; they should position the company during peak times to allow a cushion for downturns, according to Kraft.
“You need to be able to withstand these downturns and absorb losses for a certain period of time without materially cutting your fixed overhead,” he says. “If you find yourself in a situation where you need to cut costs, there are only so many levers you can pull, like laying off employees. We saw that in the pandemic, where restaurants closed locations and then when business returned, they weren’t able to get their employees back.”
When asked their priorities for 2024, more than half (51%) of midmarket business leaders put growth at the top in a recent WSJ Intelligence survey. Growth, like customer experience and increasing operational efficiency—ranking second and third, respectively—hinges on effective cash management.
- Reduce Balance Sheet Leverage
Cyclical companies should generally have lower balance sheet leverage. “When they do borrow, it’s prudent to shorten the term of the debt to a period that is well less than the useful life of the underlying asset. By doing this, they will deleverage more quickly, relieving interest costs and creating the potential to refinance in a downturn,” Kraft says.
- Factor in the Changing Interest Rates
Dana Moore, director of treasury management sales for First Horizon Bank, says companies should reevaluate the value of their cash in light of recent interest rate increases.
“Prior to the recent rate hikes, we were in an ultralow interest rate environment for over a decade. Debt was cheap and invested cash earned less than 1%. During this period, businesses lost discipline around cash management because the time-value of money was almost irrelevant. Now is the time to revisit that discipline; this higher interest rate environment creates opportunities to apply idle cash to pay down revolving credit or park in short-term investments,” she explains. “The markets right now are offering extremely favorable interest rates for liquid instruments, so companies are really missing out on an income opportunity or a savings opportunity if they are not using their cash in the most effective way.”
- Use Lines of Credit as a Buffer
A line of credit should be used as a buffer during downturns, not as a primary source of funding, McCullough says. “It’s essential to avoid maxing it out; instead, maintain a balance to ensure availability during unexpected challenges,” he cautions. “Regularly review the terms and conditions of the credit line to ensure they remain favorable and meet the company’s needs.”
- Consider Purchasing Cards
Moore notes that businesses may not realize the benefits of using purchasing cards, which are payable in full each month and available to commercial entities. “These cards usually have larger credit limits and are best used to pay suppliers,” she says. “The suppliers receive their money in a timely manner, while letting the company extend those payables up to an additional 45 days.”
- Keep on Top of Cash Management
McCullough says some of the most common mistakes he sees among cyclical businesses are not diversifying revenue sources, overextending during peak times and neglecting to regularly revise and update financial forecasts.
“To avoid these mistakes, companies should maintain a conservative financial stance, regularly review their cash flow projections and aim for flexibility in both operations and financial commitments,” he says.
- Focus on Business Efficiency
Cash management cycles have changed considerably over the past five or six years, Moore says. “When people started to work from home during the pandemic, everyone was forced to become more nimble,” she says. “Businesses moved from paper to electronic transactions to be more effective—for both receivables and payables. Traditionally, cash management has been about accelerating receivables and delaying payables to the extent possible, while having visibility into the organization’s cash flow. The next evolution is to use advancing technology to take on the more mundane accounting tasks, freeing staff to perform higher-value functions. It’s time to embrace cash management again as part of the strategic business plan.”
Brooke Chase Associates, Inc. was not involved in the creation of this content.