A stress test can produce a playbook for surviving any downturn
By Andrew Lisa
Sue Rogers of Oregon Hot Tub knows timing is everything. Six weeks after she bought the Portland-based hot tub retail company in April 2008, the worst financial calamity in modern history roared across the country and the world, gobbling up homes, life savings, careers and businesses.
For Rogers, it was baptism by fire. The Seattle resident’s Small Business Association officer said her loan was the last the SBA approved in the state of Washington before the crash.
“Everyone talks about the recession bringing an end to the good years,” Rogers says. “We didn’t have good years.”
Unlike many other business owners, Rogers survived the onslaught. She emerged hardened but wary — and scarred by the experience. Her default setting became conservative financial restraint that she says bordered on compulsion, which made it impossible to grow and expand.
“I was like a child of the Depression,” Rogers says. “Maybe being too conservative and not leveraging finances because of fear leftover from ’08, ’09 and 2010.”
What if there were another recession? How much financial pressure could her business endure? What actions would she take if sales slowed down and revenue declined again?
If Rogers were going to break the chains of financial anxiety, she would have to know exactly how much stress her business could tolerate — and develop a plan if lean times returned.
Stress Tests: Preparing for the Future With an Eye on the Past
For Dan Cunningham, owner of financial analysis firm the Business Ferret, it’s not a matter of if the lean times return, it’s a matter of when.
“There’s no doubt we’re going to have a slowdown again,” he says. “It happens like clockwork. We’re in the longest peak-time expansion, but the biggest mistake you could make is to just assume that the sales will keep rolling forever.”
His outlook isn’t rooted in pessimism. It’s rooted in precedent.
The Great Recession spared few industries, and few businesses were hit harder or suffered longer than hot tub retailers.
The spa industry started collapsing as early as 2006 and didn’t fully recover until as late as 2015, years after the larger economy — including industries with similar customer demographics like RV and boat sales — crawled back into the black.
Today, the economy is roaring, and spa retailers are enjoying a nearly unprecedented run of booming sales, revenue and growth. But Cunningham points to a slowdown in bank lending, a scary shift in “real” interest rates, a tightening of money supply and a federal dismantling of stimulus policy as evidence that economic danger is looming.
Cunningham works with around 50 clients, including Rogers. He subjects his client businesses to a gloomy forecasting model called a “stress test,” which, as the name implies, simulates economic stress to find out how prepared his clients are for the arrival of another severe downturn.
Cunningham’s stress test assumes a 5 percent drop in sales one month, followed by 10 percent drop the next month, followed by another 5 percent drop the following month.
“I want to find out what things would you do first in a slowdown,” Cunningham says. “What about in a severe slowdown? What do you do other than cut staff if something bad came out of nowhere?”
Inventory Bloat: The Hidden Cash Consumer
Don Riling of Olympic Hot Tub in Seattle is a friend, mentor and former colleague of Sue Rogers. He’s also a survivor of 2008 — and one of Dan Cunningham’s clients.
Both the Great Recession and Cunningham’s stress test gave Riling what he calls “a lightbulb moment”: lower inventory turn equals more available cash for operating.
“If I can reduce our inventory turn by one day, that will give me $28,000 to put toward cash flow,” Riling says. “If I reduce it by five days based on our current business model, that would give me $140,000 to put toward the bottom line in cash, which I could use for other things.”
Rogers’ stress test — which simulated a worst-case scenario by mimicking her actual financials from the height of the crash in 2009 — revealed that when crisis strikes, she should first free up cash by reducing inventory. This is especially critical for hot tubs since the delay between receiving an order and making a sale can mask symptoms of trouble lurking in the books.
“If orders are going down but sales are high, it can appear that revenue is still fine, even if orders are going down 10 percent month over month,” she says. “That’s when it’s time to make sure inventory isn’t bloated and [that] my purchaser isn’t just buying units assuming the machine is running fine.” When revenue is high and orders are sliding, she says, it’s not time to buy what you don’t need.
For Cunningham, the benefits of lean inventory are simple: “It’s safer to have too little coming out of a stress test than too much,” he says.
Five Steps to Prepare for a Storm
Although neither Riling, Rogers or Cunningham expect a repeat of the Great Recession, all three join a chorus of experts and economists who predict a downturn is inevitable — and close.
As far as preparation, there’s no one magic bullet.
“It depends on your business size and your normal revenue, the number of locations you have and what you have for your support business versus what you have for your front-end business,” Riling says. Rogers and Riling learned from both the recession and their stress tests that actions during times of plenty determine how you’ll fare in an economic winter.
1. Reduce Debt and Expand Credit
There’s an old saying that in order to get a loan, you must first prove you don’t need it. Increase credit lines when the money’s rolling in so you’ll have a cushion when things tighten up.
“Banks love to give credit when you don’t need it, and refuse it when you do,” Rogers says. She suggests seeking higher credits lines now when things are hot while paying down unnecessary debt.
2. Take Owner Distributions
For Rogers, it felt strange taking owner distributions “after so many years of fighting the good fight.” The reality is that it’s good business to take distributions that don’t hurt the company. But you have to hoard those distribution in personal accounts, not in company accounts in full view of lenders and creditors.
“Manage it so you have enough liquid, but 80 percent of that liquid is in personal holdings,” Rogers says. “You can always give the company a loan later if you have to.”
3. Trim, Cut and Save — Especially When You Don’t Need to
Riling says good times “can allow you to get lazy with things you shouldn’t be lazy about.” He says this is the time to go to vendors and suppliers to try to cut expenses. “You don’t think about that when you’re paying the bills and you’ve got money in the bank, you’re giving bonuses and doing incentive programs,” he says. But the best time to do this is when business is the healthiest, he adds.
4. Break Out of Yesteryear Scheduling
For Riling, the spa industry is catering to 21st century customers with a 20th-century scheduling model, where companies closed Friday at 5 p.m. and didn’t open again until Monday.
“Those days are gone,” Riling says. “The world has changed into a 24/7 society. Our industry is still closed Sundays, with no service people available Saturday. This year, our service department is going to be open Saturdays. Nobody else does that in our region. We’re going to have people available on Memorial Day and Labor Day, too. For me, if we have a softening of the economy, I want to be the only business in the region that has someone available for people willing to spend this kind of money.”
5. Concentrate on Your Core Staff
When Rogers bought the company in 2008, she had the benefit of emotional detachment from employees she did not yet know personally.
“I didn’t know their wives and kids, and I didn’t see them grow up — so I was able to look cleanly at who was contributing and who was not,” Rogers says. “Those who felt entitled because they’d been there a long time, I had no problem…giving them the opportunity and tools to contribute, and letting them go if they didn’t.”
She downsized her staff to a loyal, grateful and all-contributing nucleus, most of which remains with her today.
For that handful of people you can’t live without, “Pull them into your inner circle, trust them and take care of them today, while you can,” she says. “Then they’ll be there for you when you can’t.”