What is an economic shock?

Covid-19 is the most recent and significant example of an economic shock. As governments around the world introduced public health measures to stop the spread of the virus, the flow of goods and people was rapidly constricted. This led to many businesses temporarily closing and economies stalling.

Businesses may face other types of economic shocks including the following:

1. Supply shocks are events that make production across the economy more difficult or costly due to rising costs of commodities.
2. Demand shocks happen when there is a significant shift in the patterns of consumer behaviour.
3. Policy shocks are changes in government fiscal policy that have a profound impact on consumer spending.

Any type of shock – whether macroeconomic or sector focused – is difficult to predict and can be highly disruptive to cash flow. General prudence, including having ‘rainy-day’ cash reserves and facilities to draw on will leave you better placed to survive a prolonged period of uncertainty. But for those businesses that are not well prepared for a shock may find their long-term viability under threat.

What are the key indicators?

The following indicators can help you establish if you are vulnerable to an economic or sector shock:

1. A lack of funding options. The recent Coronavirus pandemic has led to banks being used by governments to distribute emergency loans such as Bounce Back loans, CBILS, and CLBILS. This illustrates how, without government intervention, economic shocks can cause credit squeezes that may threaten the viability of your business.
2. A company being managed out of a business banking unit rather than having a relationship manager. In times of economic shock this can cause acute challenges for a business.
3. A lack of contact or interaction from their bank.

Team collaboration

When faced with an economic shock, it is vital that your key functions work collaboratively together.

Managing Director/CEO

The Managing Director/CEO needs to take control of the emerging situation by conducting a SWOT analysis to evaluate the impact of macroeconomic factors on the business.

The MD should evaluate flex budgets by taking into the account the current or oncoming shock and exploring options to mitigate the impacts of the shock on the business.

Finance Director

The Finance Director needs to take responsibility for identifying internal and external solutions to protect cash flow by ensuring sufficient facilities are in place to provide headroom in the event of a shock and assessing flexed budgets in relation to the shock and reviewing what facilities are needed.

Another priority for the FD will be maintaining and building sufficient banking relationships to support the company and maintaining multiple banking and other funding relationships.

Sales and Operations

The Sales and Operations teams need to support the MD and FD by constantly reviewing and amending trading terms, contracts and operational activities. Another priority will be to ensure that the business adapts to the shock and is correctly positioned to take advantage of any new opportunities it may present.

Key points

You must evaluate whether your capital structure could withstand a shock. It is important to ensure that your existing facilities provide sufficient headroom to withstand a shock and that your business is not over-leveraged. Make sure you manage your balance sheet to prevent a lack of capital placing pressure on your business and its growth ambitions.

I hope this article has provided some useful tips on what happens when a company is facing an economic shock and how your teams should work together to avoid bankruptcy.

We work with growing UK SMEs and small-cap PLCs that have funding needs in excess of £2m and regularly approaching £100m. Our clients’ needs will typically be for sophisticated finance products such as cash flow based lending or private equity investments. Our value lies in helping clients access funding that relies on confidence in future trading and cash flows. For a confidential, independent, no obligation discussion on the funding options available click the 'Let's chat' button.