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How Small Business Owners Can Protect Against an Economic Downturn

March 11, 2015
Small Business
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If an economic downturn occurred tomorrow, would your small business be ready for the aftershock? During the recession from 2008 to 2010, a lot weren’t, as the U.S. economy lost more than 170,000 small businesses, according to The Business Journals.

The economy has been on a roll over the past few years, with the unemployment rate plummeting from 10.2% in 2009 to 5.5% in February. It may seem like there’s not much to be worried about from an economic standpoint, but for small business owners, it’s always a good idea to be prepared for the unexpected.

Here are some tips on how to protect your small business, so it will not only survive, but thrive during a recession — a period of temporary economic decline that results in less disposable income for consumers.

1. Take out a line of credit in advance

You may not need working capital now, but what if you need it in a year and can’t get access to credit due to poor economic conditions?

During the financial crisis of 2008, small businesses were less able to secure bank credit due to falling sales, weakened collateral and increased risk aversion among lenders, according to “The State of Small Business Lending” by Karen Mills of Harvard Business School. Taking out a line of credit before a downturn hits can be a smart decision, providing access to funds at a time financial institutions are likely to be less generous with credit.

Keep in mind that credit lines give you the ability to borrow up to a specific amount of money — say $10,000 or $20,000 — and you can continuously draw funds and repay the line as you please. You’ll get charged interest only on what you actually borrow.

This flexibility can be a great resource for small business owners, providing a quick source of funds when you need money to pay for unexpected expenses, bridge a short-term gap in cash flow (for instance, if you run a seasonal business that performs better at certain times of the year) or help manage a temporary slowdown in business.

On the downside, interest rates on credit lines tend to be higher when compared with term loans, mortgages and other borrowing options. The main reason is credit lines are often not backed by collateral, which means there’s nothing pledged as security for repayment of the loan.

If you pledge property like real estate or machinery to back a credit line, you’ll likely get a lower rate. However, not having collateral also means you won’t have to forfeit an asset to the lender if you happen to miss payments and default.

2. Improve cash flow

Improving cash flow means properly managing the money that comes in and out of your business. Higher cash flow means more money available to pay off debt, build up emergency savings and profitably grow your business, so it’s vital to develop the right strategies.

One idea is to collect on accounts receivable at a faster pace. For example, offering early payment discounts can encourage customers to pay their outstanding invoices sooner. A discount of 2% to 4% for early payment on a $10,000 invoice would save your customer $200 to $400. Although you lose this money, it also means the potential for cash in your bank sooner — money that can be reinvested in your business to grow sales or used to clean up your balance sheet by paying off costly debts. Plus, it can also strengthen the relationship with your customer.

Another idea is to hire an invoice financing company, which purchases your unpaid invoices at a discount. The advantage of invoice financing is it’s a quick and easy way to get cash with no collateral, loose credit requirements and funding as fast as a few business days. On the downside, invoice financing can come with costly fees, so make sure the benefits outweigh the costs for your business. Invoice factoring is similar — like invoice financing, you sell your unpaid invoices to a company at a discount but the factoring company is responsible for collecting the invoices, not you.

Michelle Dunn, an author and expert on credit and accounts receivable collections, says business owners can take several other steps to ensure customers pay them at the time of service.

“If you have big accounts, 10 days before the invoice is due you should call to make sure they have the invoice and have the correct address to send the check, and that there are no problems and it’s scheduled to be paid,” Dunn says.

If a business owes you money, Dunn says it can be a good idea to show your face and pay them a visit.

“If it’s a restaurant, go there for lunch. If it’s a printing company, get something printed or copied,” Dunn says. “Every time you walk in they will see you and it reminds them that they owe you money.”

You can also try to negotiate payment terms with suppliers and vendors, perhaps coming up with a payment plan that stretches out your payments over a longer period of time, lowering your total monthly cash outflow.

What about trying to cut your ongoing monthly expenses? Now’s the time to review all regular expenses and eliminate or reduce costs wherever you can, like cutting expensive business trips, canceling unused phone lines and limiting the purchase of office supplies you don’t need.

Other ideas include switching to energy efficient lighting and insulating your windows to reduce heating and cooling costs, downsizing your office to save on rent or negotiating your current lease. If you have any old or outdated inventory, or unused machinery, equipment, computers or office furniture, you can sell it for cash to build up your emergency savings.

Finally, consider working with an accountant to review your cash-flow projections for the upcoming year. An accountant can help you craft accurate cash-flow projections and help plan ahead for any potential cash-flow shortfalls.

3. Repay or refinance high-interest debts

Do you have numerous high-interest debts, such as credit cards, unsecured term loans or a mortgage? Now could be the best time to repay or refinance these debts with interest rates near all-time lows.

For example, what if your small business took out a mortgage with a bank back in 2006, when average rates on a 30-year fixed mortgage were 6.41%? Rates are down to 3.67% as of January 2015, according to Freddie Mac.

Refinancing to current interest rates could potentially save you hundreds, if not thousands of dollars annually: On a $240,000, 30-year fixed-rate mortgage at 6.41%, monthly principal and interest payments are $1,503 total, compared with just $1,101 per month at 3.67%, a monthly savings of $402, according to That’s $402 per month back in your pocket.

What if you took out a business loan or a credit line when your credit score was much lower and your business was just a few years old, with little cash flow? Shopping around for a new loan with a better rate and terms could be a good idea, as long as the money you’ll save on interest outweighs the cost to refinance your debt.

For example, if refinancing a mortgage costs $5,000 in closing costs and fees, or if a new business loan costs $1,000 in application and origination fees but both moves save you enough to recoup the initial costs within just a few years because of a lower interest rate and better terms, it’s likely worth your time.

The truth is no one can accurately forecast when the next economic downturn will occur. But by strengthening your business’s finances ahead of time, you’ll be prepared just in case a storm hits.

Steve Nicastro is a staff writer covering personal finance for NerdWallet. Follow him on Twitter @StevenNicastro and on Google+.

Image via iStock.