The economy is a complex system that is influenced by a multitude of factors, such as government policies, market forces, and global events. These factors can contribute to economic cycles, which are patterns of growth and contraction in the economy that affect businesses of all sizes, including small businesses. If you’re a small business owner, it’s not enough to just experience the economy as it happens, and try to react. You need to plan ahead and fully accept the reality that just like the economy moves in predictable patterns, so will your business. You cannot, and therefore should not, expect to be immune from the greater economic forces at work. A rising tide lifts all boats, but the tide going out will do the opposite.
There are four typical economic cycles: expansion, peak, contraction, and trough. Let’s explore each of these cycles and their impact on small businesses.
The expansion phase is characterized by an increase in economic activity, such as rising employment rates, GDP growth, and consumer spending. During this phase, small businesses typically experience increased demand for their products and services, as consumers have more disposable income and are willing to spend more.
As a result, small businesses may experience increased revenue, higher profits, and opportunities for expansion. However, this increased demand can also lead to increased competition, which can make it more difficult for small businesses to stand out in a crowded market.
The peak phase is the point at which the economy has reached its maximum level of growth and begins to slow down. During this phase, small businesses may experience a slowdown in demand, as consumers become more cautious with their spending and businesses cut back on investments.
As a result, small businesses may face decreased revenue, reduced profits, and increased pressure to cut costs. They may also find it more difficult to obtain financing, as lenders become more risk-averse during this phase.
The contraction phase, also known as a recession, is characterized by a decline in economic activity, such as falling employment rates, GDP contraction, and consumer spending reduction. During this phase, small businesses may experience a significant decline in demand for their products and services, as consumers become more frugal and cut back on spending.
As a result, small businesses may experience reduced revenue, lower profits, and may be forced to reduce their workforce or even close their doors. During this phase, small businesses may also struggle to obtain financing, as lenders become more cautious and risk-averse.
The trough phase is the point at which the economy has hit its lowest point and begins to recover. During this phase, small businesses may experience increased demand as consumers begin to spend more again and businesses resume investments.
As a result, small businesses may experience increased revenue, higher profits, and opportunities for expansion. However, it may take some time for small businesses to fully recover from the impact of the recession.
Impact on Small Businesses
During the expansion phase, small businesses may experience increased demand and opportunities for growth. However, this growth can be challenging to manage, and small businesses may need to invest in additional resources, such as staff, equipment, and inventory, to keep up with demand.
During the peak phase, small businesses may need to adjust their strategies to cope with a slowdown in demand. This may involve cutting costs, reducing staff, or diversifying their product offerings.
During the contraction phase, small businesses may face significant challenges as demand for their products and services declines. Small businesses may need to focus on reducing costs and preserving cash flow, as well as exploring alternative revenue streams.
During the trough phase, small businesses may have the opportunity to take advantage of the recovery and grow their businesses. This may involve investing in marketing and advertising, expanding their product offerings, or exploring new markets.
Although the information presented above is most definitely “evergreen”, meaning that it’s good for long-term thinking and planning purposes, this article is being written in early May 2023. For small businesses looking for answers to our current economic environment, our own in-house analysis puts the United States economy in the early stages of the contraction phase, with real estate, manufacturing, and smaller tech companies facing the worst of the situation at the moment. The rest of the economy will definitely follow. If you want to keep current on changes in the macroeconomy and learn how they may impact your business and personal financial situation, we strongly recommend following our Weekly Economic Updates by subscribing to our blog posts here.
If it is true that contraction is underway, your business needs to slow down or even temporarily terminate expansion efforts. Reduce expenses and stockpile cash reserves. Real estate, labor, and many of the commodities you’ll need to do business will become less expensive in the coming months, but purchases today may deflate in value in the days ahead. During the trough phase, if you have been savvy enough to seriously cut costs and pile up the savings, expansion efforts may give your company a very strong advantage as the economy turns the corner and heads back into expansion.
Please keep in mind that this entire cycle can take, typically, 8 to 10 years to complete, but major movements in investment prices and shifts in economic indicators often happen extremely quickly. Nothing can happen for years, and then years of changes can happen in a week or two. The key is to understand that after years of good times, the economy will necessarily correct and contract. This is a normal, fairly predictable, and inescapable occurrence. The smart business owner accepts this reality, watches for broader issues in the economy very closely, and makes strategic – not emotional – decisions once armed with that foreknowledge.
The Bottom Line
Economic cycles can have a significant impact on small businesses, as they can experience periods of growth and contraction that can affect their revenue, profitability, and ability to obtain financing. By understanding the typical economic cycles and their impact on small businesses, entrepreneurs can develop strategies to manage these challenges and take advantage of opportunities for growth when it is economically smart to do so. There is little reason to fight upstream against a down-turning economy.
As a small business ourselves, nVest Advisors is deeply committed to helping small businesses and their teams thrive and prosper. From financial planning for both the owners and employees of the business to 3(21) or 3(38) fiduciary management of your SEP IRA, SIMPLE IRA, 401(k), 403(b), HSA, college savings plans, and other benefits options, we strive to be an integral part of your team’s financial well-being.
If your company would like to receive professional planning and investment assistance, a competitive bid from us for your current company retirement plan, or if you need to start a new benefits plan from scratch, we’d love to partner with you. Feel free to schedule a complimentary one-hour due diligence meeting with CEO Jeremy Torgerson, to discuss your needs.