Navigating the Finance Function in Light of Recession Risks

In light of recent warning signs of recession, finance leaders need to keep the following at the front of their mind: panic breeds bad decisions. Making choices in the heat of the moment is a risky practice that can have catastrophic results for your business, especially when revenues are down over thin margins. In an economic downturn it is of paramount criticality for business leaders to follow a calculated, data-driven strategy. Failure to do so endangers both your employees and the future of your organization.

Volatility means you need to take a step back, breathe, and make well-informed decisions rather than emotional ones. To this end, this post will discuss the context of recent recession warning signs, and the best ways you can use data to guide your business strategy during uncertain times.

Recent Warning Signs

The optimal outcome for the U.S. economy involves the Federal Reserve fine-tuning monetary policy enough to reduce inflation, but not to the point that consumers stop buying and GDP growth stalls. It is for this reason that raising interest rates without tipping the country into recession is referred to as the “Goldilocks” scenario. In such a scenario, everything for the Federal Reserve works out just right: inflation in the country dramatically lowers, with strong employment and no recession. Additionally, CFOs get to worry less about absorbing higher materials costs, squeezing more yield out of production lines, and driving away customers with transportation surcharges and higher product prices.

However, a smooth outcome for the U.S. economy during or after a campaign of interest rate increases is all but certain. On April 6th, San Francisco Federal Reserve Bank president Mary Daly predicted the economy could “teeter” from tighter monetary policy but it would avoid slipping into a recession. The job markets can likely withstand less monetary accommodation, as the unemployment rate was 3.6% in March and businesses had 11 million unfilled positions. But the strength of the overall economy is nonetheless in question.

To elaborate further: last week, the Atlanta Fed GDPNow growth estimate for the just-finished first-quarter dropped to 0.9% from 1.5%. Economists at The Conference Board forecast real GDP growth was 1.7% in the first quarter and expect 1.3% growth in the second quarter (and about 3% for the year). In March, FOMC members had a similarly optimistic outlook: their median projection in March was GDP growth of 2.8% for 2022.

In March, the Federal Open Market Committee projected it would raise interest rates six more times this year (25 basis points each at each meeting), reaching an upper bound of 2%. More hikes, possibly as many as five, would follow in 2023. That’s three more rate hikes than in the last tightening cycle, from 2015 to 2018, in roughly half the time.

Since the March meeting, there have been some robust economic reports. Fed funds futures have shown a high probability of the Fed getting more aggressive early on — raising Fed funds by 50 basis points in May and June and pushing the benchmark rate range to 2.5%-2.75% by year-end.

Given the projections, Roberto Perli, director of global policy research at investment bank Piper Sandler, said the Fed’s Goldilocks expectations might turn out to be just that: a fairy tale. If the Fed Funds rate rises as enunciated, the rate will breach its “neutral” level, Perli said — the theoretical point where monetary policy is neither restrictive nor accommodative.

The neutral rate is usually estimated at between 2% and 3%, but it’s hard to nail down. Perli’s research shows that nearly every time the Fed funds have tightened in the “vicinity of or above” the neutral rate, a recession has followed.

Powell addressed the neutral rate issue in a speech to the Chicago Economic Club on March 21: “If we have to raise rates above neutral, then that’s what we’ll do.” In other words, if the Fed needs to risk a recession to beat back inflation, it will.

Capitalize on Relevant KPIs For Crises

During downturns like recessions, organizations become understandably concerned about declining revenues that may no longer cover fixed costs. You could be losing customers or finding it increasingly difficult to acquire new ones. In order to endure a crisis, your organization must find how to keep revenue flowing, control costs where you can, and monitor cash reserves closely. Refocusing on the Key Performance Indicators (KPIs) most relevant to those goals can help you find new and insightful ways to keep the lights on. Such KPIs are as follows:

Revenue

In a recession, it’s no surprise that businesses and individuals cut back on their spending. That’s why paying attention to top-line revenue KPIs is critical. Keep an eye on the following:

1. New leads/opportunities

Each month, your sales and marketing teams generate leads and opportunities. Fewer of either coming in month over month translates to lower revenue down the road. Be sure to keep an eye on that number so you’re not caught by surprise.

2. Customer churn

If your business includes any recurring revenue streams, you should focus on not losing customers. It’s always cheaper and easier to do repeat business than it is to acquire new business. You’ll want to know ahead of time if they’re in jeopardy in order to minimize any unnecessary decline in revenues. Analyze the customer satisfaction scores and take action before problems arise.

3. Close rate (%)

The total number of leads generated each month is only one measure of trends in the customer acquisition process. The close rate is also required to get an accurate picture. For example, a consistent amount of incoming leads will be deceptive if the sales team can’t close at the same rate it could before the crisis.

Average deal size

What’s the average value of each customer? The impact here is fairly common sense thinking: if the average dollar value of each new customer goes up, bookings and revenue increase. If the average value decreases, so do your bookings. Ultimately, cash follows suit as well. If you know your average deal size during certain times, you should model the impact of any predicted change in size during uncertain times.

Recession in particular creates pressure to lower the average deal size. The ability to model various scenarios around increases or decreases in average deal size is indispensable for uncertain times.

1. Payroll to gross revenue

Payroll costs can be very financially burdensome, especially when employees are sitting idle. You need to keep an eye on whether or not your business can continue to employ all its workers. Monitoring the ratio of your payroll costs and headcount to revenue can tell you objectively whether or not you need to take action.

2. Expenses

Maximizing revenue is a priority to every business, but minimizing your costs can be just as helpful, and arguably an easier task in a downturn. Here are some KPIs that will provide insight into which expenses you might need to cut back on.

3. Customer acquisition cost

As it becomes more difficult to acquire new customers, be careful to watch for a corresponding rise in the cost to acquire them. Optimizing your marketing strategies is crucial in the face of volatility. There’s no cash to waste on ineffective tactics, so pay attention to this metric.

4. Inventory turnover

If your business is product-based, you’ll most likely need to refine your supply chain and inventory plan for the pandemic. Monitoring your inventory turnover will help you adjust to the new levels of demand and avoid any unnecessary inventory costs (extra housing, oversupplying, etc.).