Having a business escape hatch enables your company to achieve a new operational reality until the economic calamity is resolved.
The owner of a large construction company recently confided to me that he was extremely worried about current turmoil over immigration and tariff initiatives. These outside factors could reduce his revenues by 20% to 40%.
My question to him was this: “Do you have an escape hatch?”
His response: “What’s an escape hatch?”
An escape hatch is a predetermined contingency plan that helps you exit a difficult situation. If revenues fall dramatically, it can be executed quickly. Having an escape hatch enables your company to achieve a new operational reality until the economic calamity is resolved.
In another conversation, an operations manager once told me that he thought “financial types” make up half the financial numbers they report. There may be some truth to that … after all, we do make assumptions about the future when attempting to make projections, and those numbers are estimates to some extent. But, it’s important to preemptively project and calculate the impact of possible courses of actions in uncertain times.
Data Is the Key to Designing Your Business Escape Hatch
What are the components of a viable, achievable, and feasible escape hatch?
Draft a set of milestone events, dates, and related tasks that shape the “new reality.” Does the plan:
- Include a reduction in force?
- Require liquidation of assets?
- Contemplate a different emphasis on customers?
- Consider a change to the company structure?
The answer to these questions is “possibly.” But you can’t accurately answer these questions without gathering pertinent data. You must pre-emptively study your data and make key assumptions before you attempt to create an executable escape hatch plan.
You need data to formulate assumptions about revenue, expenses, and structure. If the economy spirals significantly downward, your bottom line will be immediately affected. Nothing will look the same, and what worked in the past won’t work going forward. Challenging your current parameters is the only way to secure a new existence in a reduced-revenue environment.
How Your Finances and Project Planning Need to Change
If you don’t track recuring revenue separately from construction contract revenue, now is the time to start. You will make different assumptions regarding gross profits realized on these two revenue streams. You will also make different assumptions about the viability of contract revenue vs. recuring revenue.
Consult your backlog regarding assumptions about future new construction revenue. Obviously, your assumptions will be tempered by the current percentage of completion of existing projects. Projects past the 50% mark will likely be completed. Projects that are less than 50% complete may be delayed or cancelled. Don’t count on revenue from any projects that have signed contracts but have not begun. The implications of revised immigration restrictions could impact the start-up of new projects due to labor shortages. For each contract in your backlog, estimate the percentage of remaining revenue expected to be earned within the next 12 months.
Annualize your most recent 90 days of recuring revenues as a starting place for your recuring revenue assumptions. If you have the data, also analyze how much and how quickly recuring revenue declined in the 2007-2008 recession.
Be cognizant of the industries you serve when making these assumptions. For example, due to possible tariffs, assumptions about serving auto dealerships will be significantly different from assumptions about servicing healthcare facilities.
Do Cost Reductions Have to Translate to Reductions in Force?
Can you lessen your support and facilities footprint? During the pandemic, a great deal of support services moved to work-from-home models and/or outsourcing. Since then, some of these costs have crept back in. Examine your ratio of revenue per support-staff units. If you lost 20% of your revenue and maintained the same support-person ratio, what would that count look like? Some individuals are more amenable to part-time work if they can work from home. Do you need a shift in policy? If you had less support staff, could you operate from a smaller facility or mothball part of your office to reduce utility and upkeep expenses? Could some of your design and engineering services be outsourced instead of maintaining in-house staffing?
Be aware of unintended consequences when working on cost-reduction assumptions. Variable expenses may not be as “variable” as you assume. In an attempt to keep skilled staff, a crew size might go from a foreman and two helpers to a crew of two foremen and one helper. This not only raises the average direct labor cost per crew but also drags other costs.
If a foreman normally uses a company truck, then you need to make guidelines regarding which foreman in the crew uses the truck (or run the risk of two trucks per crew). With GPS and fuel monitoring, it is also possible to ensure that vehicles remain parked on weekends. Unassigned trucks don’t stay parked. The only way to ensure that surplus vehicles aren’t put into “emergency use” is to sell them or pull their license plates if they’re stored.
A reduction in force is a drastic and painful course of action. During the last recession, some companies went to 30-hour work weeks for their field crews to preserve as much skilled labor as possible. Even before that point, these companies eliminated all overtime expense. The cost of these alternatives needs to be calculated and compared to the impact of reducing staff. It helps to have hard numbers when making these critical decisions.
When Building Your Business Escape Hatch, Cash Is King
In any recession, cash is king. What is your current cash reserve, and what might your cash-burn rate look like if you implemented your escape hatch?
If you have limited cash reserves, then your contingency plan must be drastic. Before the economy craters is the time to seek additional sources of funding. It’s also the time to ensure that your accounts receivable balances aren’t strung out too far. Be aware of any balloon debt that will be due in the next 18 months. Now is the time to negotiate a more extended payment schedule.
These comments are not intended to be a comprehensive list of the components that make up a well-thought-out escape hatch, but they’re a start. These comments are intended to help you get started on the road to creating a contingency plan.
Your revenue projections will be flawed, and your cost containment strategy will have errors. This is to be expected. When the boat is sinking, it’s critical to know where the escape hatch is located. You may never need to implement your contingency plan, but it’s wise to construct such a plan in advance. Being able to execute quickly is imperative if the economy takes a nasty turn.
Eric Morris served for more than 40 years in senior financial positions for private and publicly held construction companies, including Wayne Automatic Fire Sprinklers, where he recently retired after 25 years of service. Today, he consults with emerging entrepreneurs. Reach him here.
Want to learn more about controlling costs in this economic environment? Download our latest whitepaper, Tips to Reduce Risk in Product Procurement, which is full of product procurement tips.
