Your Business Performance in the Next Four Months

Today, we are talking about two critical and interrelated points that affect privately-owned companies:
 1. Leverage and Debt levels in US Businesses and the US Economy
 2. Planning the Next Four months for Your Business

1. Debt levels in US Businesses and the US Economy
 
What's next on the road to recovery?
 
It is not possible for our government to cut interest rates any lower, so the only option that the Fed has left in its toolkit to accelerate and stimulate the economy is to buy Treasury debt. But, is that really such a good idea? The debt market does not seem to have much confidence in that approach right now - the difference (yield spread) between 2-year Treasury bills and 10-year Treasury bills has been collapsing. This is not good. A high spread indicates long-term confidence, while the current low spread indicates fear/nervousness/panic.
 
According to economists Carmen Reinhart and Ken Rogoff, the US is soon likely to cross the 90% Debt/GDP threshold, which they determine to be a point of no-return. Whether or not that is true, at least in the near-term, remains to be seen. One thing it does suggest, however, is that on this occasion, perhaps we would be better served by demonstrating patience, prudence and an attempt to get back to borrowing within our means, rather than trying to borrow more to speed up a recovery.
 
And if you wonder how we compare to other developed nations in Europe: Italy and Greece (both effectively bankrupt nations) have Debt/GDP of 115%. One difference, however, is that they are both an integrated member of the larger European Union, which can lend financial support. And as for Europe's GDP powerhouses: UK, Germany and France aren't performing much better with 68%, 73% and 78% respectively. However, they're still in a better Debt/GDP position than the US, which is expected to hit 94% this year. 
 
And if you want a visual representation of this trend, you can take your pick of the available charts showing the increases in debt levels going into this recession and you'll see unsustainable, exponential growth in debt/lending levels. We really shouldn't be looking for a return to those excesses, but instead for economic performance increases by adding VALUE, not LEVERAGE. This is not to suggest that you should not make capital investments, but instead that capital investments should be focused directly on adding value to the core of a business, or in the case of the US economy, the core of future GDP growth, while at the same time reducing deficits.
 
If you were to make an analogy of the US economy as a privately-owned business: drastically over-extending debt in times of trouble without contributing new equity takes away possible choices in the future. The road becomes narrower, the available options become fewer and the business owner is handcuffed to a weak capital structure. Take away all your options, hit a bump in the road and the wheels are likely to fall off.
 
At ClearRidge, we are not smart enough to accurately predict the performance of our economy or an industry, but we do know that throwing money at a problem and increasing debt leverage may give you more runway, but it doesn't fix the fundamental problems.
 
At any given opportunity, a business owner should be looking at ways to strengthen their business, focus on the core growth of the business and also take steps to ensure that their capital structure is not overly burdened with debt. You also need to be planning for future demand for your products or services. So, how do you strike the balance of preparedness for either an increase or decrease in demand for the rest of 2010?
 
2. Planning the Next Four months for Your Business 
 
In terms of predictions for the remainder of 2010, the crystal ball is very cloudy. There have been positive indicators of demand picking up, but still lots of negative news. So, how do you go about planning and forecasting for your business for the remainder of the year?
 
And notice that we are talking here about very short-term projections. You should still have long-range projections, but right now there shouldn't be much weight attached to them, unless your business is immune to fluctuations in the broader economy.
 
So, considering demand for the next four months, one useful economic indicator to keep an eye on when considering short-term demand changes is the Credit Managers' Index (CMI). The CMI is a monthly survey of credit and collection professionals who are asked to rate sales, new credit applications, dollar collections and amount of credit extended. They are also asked for negative factors including rejections of credit applications, accounts placed for collections, dollar amounts of delinquent receivables and filings for bankruptcies. The result is an indicator that provides an insight into the full commercial business cycle. The CMI has become popular in the business and financial community, because nervous participants in business are making capital decisions based on very short-term and sometimes emotional responses to their "feel" for the strength of our economy. The CMI is a useful indictor for that. So, what is it currently telling us?
 
Let's start with the good news: From mid-2009 through April 2010, the CMI had been on the up, which was a great sign for business. The month of May was down, but it only looked to be a temporary blip. Unfortunately, May was followed by a poor June and an even worse July (released early August). The CMI is now only hovering just above 50, back down to late 2009 levels, with little sign of imminent improvement. Sales also declined for the second straight month and are back down around December 2009 levels of 56.7, from being as high as 65.7 in April. It is likely that this challenging environment will remain through at least 2011.
 
So, should we respond to a demand pick up in the first half of 2010 and gear up for growth, or focus on the economic worries and prepare for declines?
The short answer: None of the above. And the main reason: the next twelve months will likely repeat the unstable and unpredictable pattern of the last twelve months, but that really doesn't give much on which to base a plan. Here's an alternative that we should all be focused on instead.
 
Where possible, replace broad business forecasts, with a more focused forecast applicable for your business. Demand should be broken out by product/service, geography, client type and any other metric that may be useful. Start with a fresh approach and brainstorm every different factor that could affect demand within each part of your business.
As we see how the next few months develop, we’ll be back in the fourth quarter with tips and insight into preparing your business plan for 2011.
Even with the best forecasting process right now, it is very difficult to accurately plan demand for most industries and businesses through the rest of this year. As a result, continue to focus management efforts on shortening lead times, improving systems, refining processes and more regularly testing the market for indicators that give us clues about demand.
 
If you can't predict future demand, focus instead on analyzing and clearly communicating whatever information you have. Spend time improving your responsiveness to demand changes and improve communication within your company to help the other departments perform more effectively.
 
And if you happen to find a reliable crystal ball, we'd love to hear from you.

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