You can’t predict, but you can prepare.
The past year was turbulent and full of unsettling financial news. We had bank failures, increasing interest rates, growing inflation, geopolitical conflicts and a troubled real estate market—all clear indicators that serious trouble is on the horizon, if not already here.
Experts discussed their economic forecasts in interviews, which didn’t help our understanding of the situation as most of them contradicted one another in their changing interpretations of risk probabilities. Rates and inflation were predicted to go up, sideways or possibly down, and depending on who you believe, the economy was headed for either a hard or soft landing.
These circumstances are challenging for construction company managers. With numerous potential outcomes and changing forecasts, how do you prepare your companies for 2024 in an environment full of uncertainty and potentially extreme outcomes?
Managing financial uncertainty
I usually manage complex and uncertain circumstances by simplifying them. My preferred approach is to consider the extremes, which provide a good framework of potential outcomes.
With one extreme, the economy could perform better than expected. The problems are not as bad as forecasted, and we could have a normal year.
The other extreme is more concerning. In this scenario, the forecasts with the worst outcomes prove correct: a prolonged recession, real estate problems and other issues. This environment could put many companies out of business.
The best strategy
I don’t know how the economy will perform, and I suspect that most economic forecasters don’t know either. For me, this uncertainty rules out trying to forecast the near-term future; the best strategy is to prepare.
The safest approach is to develop a strategy that offers protection against the worst-case scenario. Your plan should be flexible enough so you are well-positioned to capitalize on opportunities if things turn out better than expected.
I also suggest developing a robust “information filter” and focusing only on forecasts that could alter your opinion or strategy. Everything else is noise that only adds to the uncertainty.
1. Build cash reserves
A sizeable cash reserve is essential for the survival and success of every company. Reserves enable you to handle problems quickly so they don’t develop into expensive emergencies. Opinions differ on the proper size of a company’s cash reserve, but the amount depends on your company’s particulars and risk tolerance. While I prefer larger reserves that offer a better margin of safety, a three- to six-month reserve works well for most companies. A reserve that is smaller than one month is too risky.
2. Evaluate customer credits
When cash is tight, most companies delay paying their vendors, which creates problems for vendors expecting those payments to cover business expenses. Increase your chances of getting paid on time by running credit reports on your commercial clients to help reduce invoice delinquencies and improve cash flow. Always run credit reports before offering net-30 terms to clients. A company’s credit quality can change quickly, so examine long-term clients’ credit reports quarterly, not just at the start of a contract.
3. Clean up expenses
Unnecessary expenses, like unneeded, ongoing maintenance contracts, seldom-used services, subscriptions, etc., often accumulate over time. Each of these costs tends to be small and go unnoticed, but collectively, and over time, they can add up to a substantial amount. Examine your company’s expenses and determine if any can be cut or modified.
4. Examine capital expenditures
Consider delaying any large capital expenditures until the economic outlook stabilizes. The last thing you want is to buy additional equipment (at expensive rates) that will be underutilized.
5. Anticipate financing
Lenders are tightening their credit standards and strictly enforcing covenants, making getting—and keeping—a loan more challenging. If you anticipate needing financing in 2024, and I suspect it will be harder to get mid-year, consider accelerating the application timeframe and preparing your accounting before applying for financing to increase your chance of success.
These conservative strategies focus on protecting against a bad outcome and can be changed if conditions improve.