When it comes to economic recession, sometimes the best definition is a relaxed definition. “If your neighbor is fired, it is a recession. If you are fired, it is a recession,” a writer joked. However, a more technical definition of a recession is two consecutive quarters of negative growth in gross domestic product (GDP). According to the National Bureau of Economic Research, the sign of a recession is “a significant decline in economic activity across the economy, lasting more than a few months.”
Both definitions are accurate because they indicate the same economic outcome: unemployment, decline in real income, slowdown in industrial production and manufacturing, and decline in consumer spending.
In this article, we will break down how the recession affects small and large companies—and what you can prepare as an investor. Although some companies may only experience moderate losses in a mild recession, as the recession drags on, companies large and small will tighten their belts.
How the recession affects businesses
- Recession is a period of general decline in economic activity, as well as a period of economic performance indicators such as unemployment rate and GDP.
- Due to tightening credit conditions, slowing demand, and general fear and uncertainty, the economic downturn has affected businesses of all sizes.
- Small businesses that do not have access to the financial and stock markets and are unlikely to receive government bailouts often face special challenges during economic downturns.
The impact of the economic downturn on large companies
Suppose an unnamed Fortune 1000 manufacturer is suffering from the economic downturn. As the economic recession develops, what happened to this company is likely to happen to other large companies.
With the decline in sales revenue and profits, manufacturers will reduce recruitment of new employees, or completely freeze recruitment. In order to cut costs and improve the bottom line, manufacturers may stop buying new equipment, reduce research and development, and stop launching new products (a factor in revenue and market share growth). Marketing and advertising expenditures may also decrease. These cost-cutting efforts will affect other large and small companies that provide goods and services used by large manufacturers.
Credit impairment and bankruptcy
One of the initial effects of a recession on companies is often the tightening of credit conditions. In the early stages of a recession, interest rates may initially rise and then fall as the currency gate opens, but throughout the recession, market lending standards tend to tighten, and lenders are more selective about the risks they are willing to take. Even large companies may face difficulties in repaying debts, most of which rely on funding for continued operations. Corporate debt relative to the size of the economy has hit a record high for ten consecutive years, leading to recent recessions.
The economic downturn will also restrain the company’s accounts receivable (AR), and liquidity issues will affect consumers and businesses upstream and downstream of the supply chain. Customers who owe the company money may be slower, late, or not pay at all. Then, as revenue decreases, the affected companies may be forced to pay their bills more slowly, later, or in smaller increments than the original credit agreement requires. Delays in payments or payment arrears reduce the valuation of the company’s debt, bonds, and its ability to obtain financing. The company’s ability to repay debt (pay interest on borrowed money) may also be compromised, causing defaults on bonds and other debts, and further damaging the company’s credit rating.
On the other end of the recession, the company’s debt may need to be restructured or refinanced, which means that creditors must agree on new terms. If the company’s debts cannot be repaid and repaid in accordance with the loan contract, bankruptcy may occur. Then, the company will be protected from creditors during the reorganization, otherwise it may go bankrupt completely.
Falling stocks and falling dividends
As the quarterly earnings report shows a decline in revenue, the manufacturer’s stock price may fall. Dividends may also fall or disappear altogether. Company shareholders may feel uneasy and may work with the board of directors to request the appointment of new company leadership. The manufacturer’s advertising agency may be dumped and hire a new agency. The internal advertising and marketing departments may also face personnel changes.
When a manufacturer’s stock drops and dividends drop or stop, institutional investors holding the stock may sell and reinvest the proceeds in better-performing stocks. This will further depress the company’s share price. If the company has such a plan, the sell-off and business decline will also affect the employer’s contribution to the profit-sharing plan or 401(k) plan.
Staff layoffs and reduced benefits
Companies may lay off employees, and more work will have to be done by fewer people. The productivity of each employee may increase, but as working hours become longer, work becomes harder, wage growth ceases, and fears of further layoffs persist, morale may suffer.
As the severity and duration of the economic recession increase, management and workers may meet and agree to make concessions to save the company and save jobs. Concessions may include salary cuts and reduced benefits. If the company is a manufacturer, it may be forced to close factories and terminate underperforming brands. For example, automakers have done this in previous recessions.
Reduce the quality of goods and services
Secondary aspects of goods and services produced by manufacturers affected by the economic downturn may also be affected. In order to further cut costs and improve its bottom line, the company may damage the quality of its products, thereby reducing the attractiveness of its products. This may manifest itself in many ways, and is a common response of many large companies in a severe recession.
For example, airlines may lower maintenance standards. They may install more seats on each plane, thereby further restricting the passengers who have already squeezed in. Routes to low-profit or loss-making destinations may be cut off, causing inconvenience to customers and harming the economy of cancelled destinations.
Large food suppliers may offer fewer products at the same price in the same size package. The quality of the food produced may also be reduced, affecting flavor and driving out cost-conscious consumers who may notice the change in brand loyalty.
Reduce consumer visits
As companies affected by the economic recession spend less on advertising and marketing, large advertising companies with millions of dollars in annual revenue will feel the pressure. In turn, the decline in advertising spending will weaken the bottom line of giant media companies in every sector, whether it is print, broadcast or online. As the effects of the economic recession affect the entire economy, consumer confidence declines, and as consumer spending declines, the economic recession will continue.
The impact of the economic downturn on small businesses
Small private companies with annual sales far below the Fortune 1000 actually performed at the same level as large companies during the recession. However, if there are no large cash reserves and large capital assets as collateral, and it is more difficult to obtain additional financing during difficult economic times, it may be more difficult for small businesses to survive the economic recession.
Small companies are usually unable to issue new shares to the public like large listed companies. When it comes to the distribution of government bailouts, loans, and other benefits, they are also often considered to be less systemically important, and are often not well-connected politically. The incidence of bankruptcy in small companies is usually higher than that of large companies. To some extent, these bankruptcies can provide other, usually larger companies with opportunities to purchase assets or enter the small business market. Since many small businesses are liquidated during the recession, consolidation of industries and markets is common.
The bankruptcy or dissolution of small businesses that serve the community (such as franchised convenience stores) will not only cause difficulties for small business owners, but also for nearby residents. After such bankruptcy or dissolution, the entrepreneurial spirit that motivates someone to engage in this type of business may be undermined, preventing any risky business ventures at least for a period of time. Too many bankruptcies may also prevent banks, venture capitalists, and other lenders from providing loans to start-ups before the economy improves.
Recessions come and go, some are more severe than others and last longer. But history shows that (so far) recessions will always end, and when they end, a period of economic recovery will follow.