Everything Startups Need to Manage Cashflow in a Recession

There are many things that can stop these startups from making progress during a recession. Economic activity during these times often comes close to a standstill. Customers are not willing to spend as much as they normally would. Interest rates tend to go up, and securing investment becomes difficult.

All of this makes it highly difficult for startups to manage their cashflow, which, in turn, makes getting through a recession more difficult. Experts have predicted that the UK economy is expected to be in a recession throughout 2023. This means startups will have to go through some rough times throughout the year.

Learning how to manage cashflow in a recession can help small businesses reduce the damages and come out the other end. However, startups and entrepreneurs first need to understand what a recession is and how it can impact them.

What is a recession?

A recession is basically a decline in economic activity that lasts for a couple of quarters but can extend up to a year or so. However, a recession is only declared if a nation’s economy witnesses a negative gross domestic product (GDP) for two to three months in a row.

Although it’s hard to spot a recession early on, there are many factors that can help predict if it’s about to occur. Some of the telltale signs experts look at when forecasting a recession include:

• Income - a decline in income levels.

• Unemployment - a steady rise in unemployment.

• Economic activity - declining or reluctant customer spending.

• Stagnation - growth in production and sales begins to decline.

But, a simple fluctuation in one of these isn’t enough to declare a recession. To understand what a recession is, businesses need to think of these factors as a domino chain. If one of them witnesses a decline, it’ll have an impact on all the others.

Let’s say that people lose their job or go through a pay cut. This means they won’t be able to spend as much money as they normally would. Their lack of spending would affect a business's ability to make profits. So, businesses will be looking to cut costs either by laying off employees or stopping production. Altogether, these factors would lead to a decline in economic activity, which can lead to a recession if prolonged.

How can a recession impact startups?

A recession is generally caused by economic shocks that are triggered by several factors. Some of these include natural disasters such as Covid-19 or other geopolitical factors like the Russia-Ukraine conflict. These events lead to a decrease in customer confidence, higher interest rates and stagnation.

As a result of a recession, startups have to go through tough financial times. There are several factors that impact your business and influence growth during a recession. These include:

1. Low profits
   A lack of economic growth means customers are not spending or are reluctant to do so. From your perspective, this means that selling becomes increasingly difficult.
   

2. Reduced quality
   Manufacturing can come close to a standstill during a recessive economy. In such cases, you'll often look to new ways to cut costs and make profits. The most common way they do this is by reducing product or service quality because previous quality standards are no longer profitable.
   

3. Cashflow Management
   Startups often witness that their customers, regardless of the sector, have a hard time making payments. This means that you might even have to delay your own payment to vendors, suppliers, and utility providers. These insufficient finances mean you aren’t able to manage cashflow in a recession effectively.
   

4. Lack of funding
   During a recession, you'll likely notice a big reduction in funding opportunities. If angel or seed investors believe that a startup will not survive a recession, there's no reason for them to make an investment. In addition, availing other lines of credit also becomes difficult due to higher interest rates.

How can startups manage cashflow in a recession?

Startups face many challenges as economic activity continues to decline. But, being unable to manage cashflow in a recession is the biggest one you need to worry about. Inadequate cashflow management limits your ability to address other challenges.

Being able to manage cashflow in a recession can help you limit the impact of a recession. Plus, it'll help you effectively locate and utilise the capital needed to tackle various problems, like lack of investments and sacrifices made on quality. The good news is, there are lots of ways you can improve your cashflow management right now. Here's our advice...

1. Manage payroll

Salaries are one of the biggest expenses for a startup. And in a recessive economy, you'll likely have a fragile revenue stream. Without frequent sales, some startups simply can't meet this necessary expense. Which, in turn, leads to layoffs... which turns to reduced processes, and ends in trouble.

But, with effective payroll management, you buy yourself time, and essentially build yourself a safety net to avoid this downward drop. To do this, make sure that your payroll is aligned with your revenue stream. This way, you can make sure you always have cash on hand when it's time to write the paycheck.

Managing salary distribution is another way you can optimise payroll. During a recession, it’s important to have capital available, so if your revenue declines, your payroll doesn't immediately stop. A monthly payroll schedule instead of a weekly one is a great place to start. It'll allow you to have capital on hand for a slightly longer time.

2. Invoice promptly

One of the major factors that helps you manage cashflow, is keeping on top of invoicing.

Think of invoicing as a bill businesses give to their B2B or B2C customers for the product or service they provide. During a recession, the flow of money for both customers and businesses slows down and declines.

Startups encountering this problem are likely to see a lack of readiness from customers when it comes to paying the bill. This can create cashflow problems because you'll not have the capital needed to get materials, pay employees, and invest in new products. To counter this, you need to make sure that you're invoicing promptly.

This means encouraging customers to make payments when payments need to be made. It can also include reviewing the invoices and highlighting those that haven’t been paid. Sounds like a lot, but there are lots of digital solutions out there designed to make this a breeze.

3. Forecast cashflow

Creating a forecast is essential if you want to successfully manage cashflow. A cashflow forecast will show all the money coming in and going out of your business for a period of six months, or even a year. When forecasting, you must include payment received from all sources, including sales, bank interests, seed funding, and angel investors as well as all those expenses.

This is a really important practice for all businesses to use. It'll help you make informed decisions, and understand your business a lot better. But how can in help in a recession?

Forecasting allows you to recognise patterns, and plan for both best and worst case scenarios - and how you can optimise your processes to best fit the coming months.

4. Reducing expenses

The thing with a recession, is it doesn't happen overnight - and it certainly isn't announced as such! So, you need to keep on top of your cashflow before, recognise the patterns that suggest one's on the horizon, then act quickly. Expenses are a big part of this.

You need to know all the of the operating costs of your business. You should then rank them by levels of importance. You need to know, are they essential, or a preference?

By having this information, you can take emotion out of the process and reduce expenses quickly, with minimal or no damage to your startup's operation.

5. Optimise payment terms

Payment terms are agreed conditions about when and how customers pay for the products or services they buy. These vary from one business to another. But, they're generally two weeks to one month long.

You need to make sure that these payment terms are clearly mentioned on the invoices sent. Payment stagnation is common during a recession. It happens when sales and production are at a standstill. But, you can keep such things from influencing them by implementing clear payment terms. So, how can you do this?

Rewarding and penalising payments can help to make sure you receive payments on time. You could choose to offer a discount for payment made within fourteen to thirty days. You can also charge interest on payments that violate the agreed time period. Under the Late Payments of Commercial Debts (Interest) Act 1998, businesses are entitled to charge statutory interest for business-to-business transactions in case of late payments.

6. Use a business credit card

A business credit card is another great way to manage cashflow in a recession. You'll likely have lower capital in a recessive economy, and if this is so bad you can't meet the essential expenses, something's going to have to give. Business credit cards can allow you to increase payment periods and use credit instead of cash. Essentially, buying you time. But, you should use these wisely.

Pay attention to the deal your signing up for, and definitely do not take on more debt than your cashflow figures say you can pay back.

If you don't, you'll be making much more trouble for yourself down the line.

Key takeaways

A recessive economy can be challenging for businesses of all sizes. But, it's a greater threat to the survival of startups. A recession can be caused by various factors. Some of these include natural disasters, geopolitical conflicts, loss of customer confidence, and economic instability. During a recession, income levels decline, and customers aren’t willing to spend as much.

This leads to stagnation as growth in production and sales begin to decline. Such a scenario poses many problems for startups as you don’t have the required capital to function. However, learning to manage cashflow in a recession can help you minimise the impact of a recession.

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