Business Cycle Risk
Updated: Jul 31, 2018
A business basically has 2 broad based risk categories: 1) Business Specific Risk: that can be controlled by the business and are tied directly to decisions made my the owner; 2) Market Risk: that can't be controlled by the business owner and are tied to broader economy & competition. This article will discuss a component of Market Risk or Business Cycle Risk (that which is tied to the economy) and how to manage it.
During my long career in analyzing the value of businesses, I have come to understand that most if not all business owners large and small (as well as virtually all CFOs) are not informed enough to incorporate Business Cycle Risk into their financial planning process. Specifically, factors relating to the economy in their everyday business decisions. Basically, the the idea is that there are times in the economic cycle a business should be taking more or less risk depending on where we are in the economic cycle. In the earlier stages of an economic cycle higher risks should be taken whereas at the latter less due to risk of slower growth or even recession. Thus, a business needs to understand where the overall economy is in its growth cycle and then adjust risk accordingly. Further, a business needs to access how sensitive it is to the economic recovery so that the financial planning & forecasting of the business can be adjusted.
You can have the best idea in the world to expand your business or start a new business, but if that expansion/venture occurs at the wrong time in the economic cycle, then it may be doomed to fail before it even begins. Common sense dictates that if you have the wind at your back versus in your face, you’re likely more apt to potential success than failure. Thus, it’s not only important to understand the risks specific to the potential reward of a capital investment on its own (Business Specific Risk), but to consider the Business Cycle Risk. To be clear, that doesn't mean an owner should not take any risk, it just means any investment should have clearly defined returns, should require more return for higher levels of risk and be scrutinized closer for risk relative to the economic cycle.
Starting a business at the end of a business cycle as we enter a recession likely carries more risk and may be more apt to fail versus one started at the end of a recession and start of an expansion. Furthermore, more established businesses fail not because to an operational mistake of the business, but from making poor strategic decisions at the wrong part of the economic cycle. So where are we in the economic cycle? Well, according to the National Bureau of Economic Research (NBER) this current expansion (albeit a weak one on almost every metric namely GDP), which started officially in June 2009 is the SECOND LONGEST in US history, recently surpassing the 3rd longest which occurred in the 1960s and one that occurred in the 1990s/2000s (ending by the bursting of "internet bubble"). My point here is not to argue how long the current expansion may last, but to provide a risk perspective. The current cycle has lasted over 105 months while the longest, which occurred in the 1990s and into the early 2000s, lasted about 120 months. Can we eclipse the record? Sure it’s possible, but my point is BEFORE you put your hard earned capital to work either in a small business or in your personal lives consider where we are in the business cycle. Rising interest rates of late and the impact on growth should trigger a reassessment of risk by owners. Further the cooling of 1Q18 GDP growth expectations of the Atlanta Federal reserve should too as well.
As part of our service offerings for business owners we offer specific strategies to "risk adjust" a business. One is our unique measurement of the cash cycle and optimization process when we model & forecast your business. Another is by segmenting the costs associated with an investment one can better access the specific return (& risks) of the project. Furthermore, as part of our profit management offerings we can actively prepare a business for a slower period of growth as well. For more specific insight on our Risk Management strategies to gain from our insights please contact us or sign up for email updates via https://www.charlotteconsultantservices.com/news-update.