Chief financial officers seeking to bolster their organisations’ recession preparedness should start by assessing their deal pipelines, testing the speed of their team’s financial analysis and ensuring their balance sheets can support countercyclical investments, according to Gartner.
The Gartner report titled “Recession Watch 2019: Corporate Recession Readiness in 9 Charts,” shows that while the largest organisations are well-capitalized for the next downturn, many small and midsized companies have become overleveraged, setting the stage for potential “fire sales” on future assets.
“Significant ongoing policy uncertainty has distorted many traditional indicators of an oncoming recession, such as the yield curve,” says Tim Raiswell, research vice-president at Gartner. “A more practical question for chief financial officers to ask is how well-prepared their own, and other, companies are to face a recession today; our analysis suggests that this answer varies drastically between larger and smaller companies and industry leaders and their less profitable peers.”
A future recession will exacerbate the declining profitability already witnessed across all industries. This will be particularly acute among small companies, which have fallen behind their larger peers. Smaller companies have become dramatically less liquid and taken on historically high levels of debt, according to Gartner’s analysis of S&P sectors covering large, midsized and small companies.
Among larger companies, there is an increasing divergence between industry winners and losers as the profitable low-hanging fruit from an extended run of growth has been picked, forcing chief financial officers to invest in projects with less clear-cut business cases.
“As the economic cycle has matured, the level of competition has risen. With that comes the temptation to fund more growth projects, but fewer of these will be winners,” says Raiswell. “It’s imperative that CFOs have a clear picture of their return on investments to ensure they are on the profitable side of an accelerating trend separating winners from losers.”
In analysing their organisation’s recession preparedness, Gartner recommends that chief financial officers focus on:
* Speed of financial analysis: CFOs should assess their team’s ability to quickly deliver CEO-level reporting on growth project costs and performance going back five years. With average profitability falling across all industries, screening for profitable capex and R&D investments, while having clarity about operating spend alignment with profitable growth goals, becomes paramount.
* Deal pipeline accuracy: Now is the time for well-capitalised companies to ensure their deal pipeline is current by reviewing the financial health of target organizations. While the average small US company has an interest coverage ratio above “3”–a level that conventional wisdom dictates is safe–that number has trended downwards rapidly since 2015. It looks to drop below the safety threshold in 2019, amid a higher interest rate environment.
* Countercyclical investment readiness: As smaller and less profitable companies come under increasing strain, companies prepared to invest counter-cyclically will realize significant potential for profit taking opportunities. Previous Gartner research has found that the investments of long-term growth leaders are significantly less correlated to GDP compared with a control group. This reinforces the need for CFOs to avoid stretching balance sheets with ambiguous growth investments – particularly in non-core areas – and maintain capital for potential discounted sales of distressed assets.