Preparing for Recession: The Benefits of Revenue-Based Financing Over Traditional Lending
Does it really matter if there’s a recession? If you ask that question out loud, you’ll probably hear a collective gasp from economists, bankers, and financial prognosticators. After all, it’s what they’ve been projecting for the last year. If you’re an eCommerce merchant, you don’t necessarily care if the gross domestic product (GDP) has declined over six consecutive months. But what does matter is inflation and unemployment. Both impact the consumer’s buying power.
Inflation increases costs, so profit margins are lower. Unemployment reduces discretionary income, so consumers spend less. Money is tight, and borrowing is costly. So how do you prepare for a recession? You keep following the same sound business practices. You watch what you spend, and you look at ways to increase revenue.
In a recession, cash flow is crucial. You want to maximize your cash reserves and minimize your debt. However, financing may become necessary, in which case, evaluate your options before you need the cash. As you navigate the uncertain economic landscape, keep the following best practices in mind.
Watch Your Cash Flow
No one has to tell business owners to watch cash flow. It’s what keeps the business running. With a possible downturn looming, merchants need to pay close attention to the numbers. If you haven’t been projecting cash flow out three to six months, now is the time to start. You need that cash flow data to calculate what is known as your runway.
Your runway is determined by your burn rate, which is how much you spend each month. If you have $100,000 available and your burn rate is $10,000 per month, your runway is ten months unless you bring in added revenue. A spreadsheet is an excellent place to start because you will need to monitor cash flow every month and be able to perform what-if scenarios based on the numbers.
Related: The Importance of Borrowing and Spending Only What You Need to Maintain Healthy eCommerce Finances
Enter the expected monthly income and subtract the monthly expenses. At the end of each month, you should have a positive balance to carry over to the next. If the balance continues to shrink, you need to determine when you will run out of money and decide how to improve cash flow and extend your runway.
When business is booming, you may not pay as much attention to expenses. Little hikes in energy costs may go unnoticed, or monthly subscription fees may continue to accumulate. Look at each expense to determine if it is necessary and look for less expensive alternatives. Keeping expenses as low as possible helps improve cash flow.
If you were hoping to buy a new printer for the business, perform a what-if analysis to determine the impact on your runway. Does it reduce the length of your runway? If so, you may want to wait until your cash flow improves before purchasing. Another option may be leasing a printer/copier rather than buying a new one. The lease payment may fit into your budget.
Use Real-time Payments
If your current settlement process requires you to wait 24 to 48 hours for payment, you may want to consider real-time payments. Real-time payments use the Real-Time Payments Network (RTP) or the Federal Reserve FedNow program. With the real-time system, funds are made available at the time of the transaction, which can help with cash flow.
Many networks, data centers, and financial institutions have links to real-time payment networks. Check with your local provider to see if RTP is available. Any fees associated with real-time payments should be evaluated to ensure that the faster payment process does not intrude on your bottom line.
When products stay in inventory too long, it’s tempting to lower prices to increase sales. But remember, increased sales do not mean increased revenue. During a recession, you should protect your profitability rather than cut prices. Look at your product lines and identify the most robust revenue generators. Next, evaluate how to protect that revenue stream, even if it means adjusting your business model or pricing strategies.
Consider the following recommendations as you look to consolidate your operations to ensure profitability.
- Assess profit margins. If you have similar products, look at the margins and remove the item with the weaker margins. With similar products that are close in price, the consumer will usually opt for the less expensive item.
- Use left-digit bias pricing. Another term is just-below pricing, referring to using a value just below the price ending in $.00. However, be aware that the pricing strategy can backfire if you don’t look at your profit margins before setting a price.
- Consider volume discounts. Look at which products can be sold in larger quantities and run the profitability numbers to determine a reduced price that doesn’t cut into your margin.
- Try bundling. Look at your sales numbers. Are there certain items that shoppers tend to buy together? Is there a high-margin item that is sitting? Try bundling several items together at an attractive price.
Lowering pricing without looking at profit margins may appear to generate revenue, but over the long term, your business will not survive if you sell products below cost.
Controlling your debt can be challenging during a recession. Consumer spending slows, and interest rates rise. You need funding to cover the shortfall, but you’re not sure where to turn. Let’s look at some of the available options.
Many entrepreneurs use their credit cards to cover expenses. Applying for a business credit card helps protect your personal financial health. However, interest rates already exceed 30% for those with poor credit or insufficient credit history. Just making the minimum payment could overwhelm your cash flow, never mind paying the balance down.
Whether or not you apply for a business credit card, be sure to calculate payments into your monthly expenses. The recalculations will show whether the available credit is worth the payments in extending your runway.
Business loans require high credit scores and a good credit history. Many eCommerce merchants do not have the two-year history required for a conventional loan. Plus, these loans have a fixed payment that must be met regardless of your company’s financial position.
Related: Revenue-Based Financing Term Sheet: Guide for Understanding
Conventional business loans, even those through the Small Business Administration, have a lengthy application process. Monthly payments will be higher because interest rates are rising. Again, include the monthly loan payment in your projections to ensure the funds are sufficient to cover expenses until the economy picks up.
Lines of Credit
Although lines of credit operate as revolving credit cards, they still require a good credit history and score. The interest rate is lower than that for a credit card, but monthly payments must be made against borrowed funds. As with credit cards, making the minimum payment does little to lower the balance. If you aren’t careful, you can reach your credit limit before you realize it, leaving you without the financial resources to cover a cash flow shortfall.
As the name implies, revenue-based financing uses your anticipated sales to determine the amount of a loan. Online merchants can use their debit and credit card receipts to predict future sales. The revenue-backed financing is often called merchant cash advances, where the lender advances businesses money based on projected sales. The merchant then repays the loan in one of two ways:
- Some lenders have a repayment schedule that stipulates the monthly amount to be paid. Lenders with a repayment schedule expect merchants to make monthly payments regardless of monthly sales.
- Other lenders take a percentage of each online purchase until the loan is paid off. These organizations get paid when you get paid, placing less burden on cash flow.
Heading into a recession, eCommerce merchants should look at all of their eComm funding options. Even if the funds remain untouched, being prepared means you can operate without interruption should the need arise.
Is it a Recession?
For those who lived through the Great Recession of 2007, it’s understandable to be fearful of what another recession might mean. Yes, recessions are economically painful as unemployment and inflation both rise. However, businesses should be prepared rather than afraid.
Online merchants don’t need pundits to tell them when a recession hits. If they’re monitoring their cash flow, they are well aware that the economy is contracting. Merchants will live through the six months of decline long before the period is called a recession.
As you prepare for what’s ahead, consider the available financing options. You need an available resource to extend your runway. Waiting until you need the funds may be too late. You don’t want to be one of the thousands looking for financing as the economy moves through a recession.
When it comes to predicting recessions, everyone’s crystal ball is a little cloudy. If you find yourself in need of financing, schedule a call to speak with a member of our team about the financing options we offer, and see how we can help.