How to stress test your construction business to prepare for recession

No matter which side of the aisle you’re on politically, the COVID-19 crisis has touched you and your construction business. How do you ensure that your company will make it through this crisis or another like it? How do you know if you’ve saved enough, or have enough credit to weather the financial storm? Many companies run “recession stress tests” on their businesses to find out how they stack up. We’ll look at what these tests are, how to run them, and some ways to help recession-proof your construction company.

With the COVID-19 pandemic spreading throughout the world, many are worried about what sort of impact the stay-home orders will have on the American economy. Many locations have chosen to keep construction going as one of the vital business sectors, while some cities have shut it down completely to help slow the spread of the virus. Economic experts are warning that we’re heading for a recession. Contractors and suppliers can use this simple stress test to find out what impact a recession might have on their bottom line.

A stress test prepares contractors for a recession

A recession is when the economy slows down, and people aren’t buying or investing as much as usual. When you perform a recession test on your business, you pretend there is a recession and your sales are down. The test allows you to see what effect a recession would have on your financial statements.

Obviously, overall income will go down because you aren’t making as many sales. In reaction to this fact, you may lay off some of your workers or start selling equipment. That makes labor costs go down and gives you some extra income. Now what do the numbers look like?

You continue to play with the figures until you come up with a budget that you can live with at the lower sales volume. This is your plan for maintaining your business in a recession.

Once you have lowered your budget to where you feel comfortable with the profit you are making, you begin to cut your expenses (in the real world) to meet that budget. This way you are running lean and are ready to absorb a dip in sales without having to make any changes in spending.

Get recession-ready: How to stress test your construction business

The first thing you need to have is good financial records and reports, preferably for the last year or more. In order to analyze your financial standing, you must know where you are and where you’ve been. Basic reports such as an income statement, balance sheet, and cash flow statement are a good place to start. You will want to have monthly or quarterly reports for the last year readily available.

Review your financial status

1. Look at how much cash you are using. Your cash flow reports should show you how much cash came in and how much went out during the period you are reviewing. Looking at the ins and outs can help you spot trends and lets you know how much money you are using.

2. Predict how much cash you will need for the next 6-12 months. This may be difficult to do right now, when we don’t know what the total effect on the construction industry will be. Use your best judgement or wait a month and see if you have a better idea then.

3. Figure out how long it will take you to get more cash. There are several ways you can do this. Look at invoice factoring, traditional loans, savings accounts, credit cards, and lines of credit. If you don’t have these in place already, research your options and know how long it will take to get cash in hand.

4. Take your cash flow reports and make projections based on a reduction. What would happen if you lost 25% of your sales? Figure out where you can cut costs to stay at the same profit margin. Revise your budget accordingly and start taking steps to bring those costs down.

Apply before you need it

Once you see how much cash you may need in the next few months, you can start to apply for financing. There are several ways to increase your ability to get cash, such as lines of credit from your bank, credit cards, and short-term loans. Due to the pandemic and the potential economic crisis, there will be lots of financing available. The SBA has already announced that loans are available for businesses affected by COVID-19.

Stress test failed? 5 ways to recession-proof your company

Nothing is foolproof, of course, but there are ways you can make your company more resilient to economic downturns. Keep these strategies in mind as you prepare for the next one.

1. Talk to construction business experts

Consult with your CPA, lawyer, or other trusted business advisor and discuss how to plan for these types of events. They will be able to give you the best information for your situation and, since they want you to succeed, you can trust them.

2. Keep cash on hand

When you are busy and making money, start saving for a rainy day (or in this case, an economic downturn). Having a stockpile of ready cash is a great hedge against a slow-down. Don’t put it all in investments that will take a long time to sell off. Keep it as liquid as possible, like in a savings account or short-term CD.

3. Build lines of credit

Build up your credit options. Apply for credit cards, even those with a low limit, and use them and pay them off right away. After a while, ask them to raise your balance limit, and work your way up to higher limit cards. Having one or two cards that you can use in a pinch is a great safety net, but you have to use them even when things are good. Ask your bank for a line of credit, which is like an extension to your bank account. Shoot for an additional $50,000 to $100,000 in credit, depending on the size of your company.

4. Develop loyalty

Identify your most profitable customers and nurture those relationships. If you can get them to be loyal to you, then you will have consistent work even in a recession.

5. Diversify your construction business as much as possible

You don’t want any client providing more than 20% of your income, as this leaves you vulnerable if they stop buying. If you’re a subcontractor, network with other general contractors. Visit job sites and find out what other types of projects they are working on.

Ask your current GCs if there are other types of projects you could do with them, so you can expand your skill set.

If you are a GC, look at public works or other building types that you don’t normally work in. Ask all of your contacts about additional projects or even repairs that you can get in on.

In good times, prepare for the bad

The moral of the story? You can plan for events like a pandemic or an economic downturn. The key is to begin when things are going well. Watch your financial reports and key performance indicators (KPIs). Put money in savings when you can and cut as many frivolous expenses as possible.

Doing a recession test periodically can help make your construction company lean, mean, and ready to build – no matter what kind of economy comes next.

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