Survival and Positive Growth during an Economic Downturn - Assignment Example

 Introduction: The paper aims to study a company’s survival and growth through a financial perspective during times of recession or depression. By clearly understanding the concepts of depression and recession the study will state facts and explanations on the various aspects of finance and accounting such as Working capital, Costing Systems and techniques, Management of resources especially scarce resources such as funding and management, and Budgeting. For this purpose the paper will quote information and facts from sources that speak of recession, depression, effects of financial crisis and explanation of the financial concepts mentioned above. It will then evaluate and arrive at a consensus regarding each of the financial aspects to provide a plan that will help the organization survive during a depression or recession and lead to a positive growth. It is therefore aimed at providing inputs from the financial perspective of business during the economic downturn. The idea of providing inputs or making changes and venturing into new arenas in terms of cost efficiency and management are discussed as they are the need of the hour. The whole economic system functions on the money supply in the market, and this supply is facilitated by the various business enterprises that are the back bone of every economy. To begin with let us get acquainted with the “Great Depression of the 1930’s” and the current economic down turn. The Great Depression: The Great depression was the worldwide economic downturns that lead to widespread poverty and unemployment as businesses failed. Though the exact cause of the Great Depression is unknown, it began with the Stock market crash by the end of 1929. A normal change in the business cycle that becomes a short recession can lead to a depression. During the ‘The great depression’ the construction industry came to a stunning halt in many countries with prices of crops falling by almost 60%, leading to widespread unemployment, as these sectors have few alternative employment options. However, the economy started showing signs of recovery during early 1933 and the economy stabilized thereafter leaving potential room for the growth of business. (Wikipedia 2009) The current economic downturn….. A report about recession where the Former US Federal Reserve Chairman Alan Greenspan commented “the current global recession will "surely be the longest and deepest" since the 1930s and more government rescue funds are needed to stabilize the U.S. financial system."To stabilize the American banking system and restore normal lending, additional TARP funds will be required," Greenspan said in a speech to the Economic Club of New York. The U.S. Treasury's Troubled Asset Relief Program designed to help bail out banks has been partially successful” (Recession.org 2009). The current recession too had the stock markets crashing with the heavy downturn in the construction industry segment. Greenspan further comments “a housing recovery is a necessary condition for the end of the financial crisis, and said that "the prospect of stable home prices remains many months in the future." (Recession.org 2009) The effect of this economic down turn is the huge cut down on spending by corporate houses leading to widespread unemployment. Let us look at the various aspects of finance an organization requires to monitor, strategize and control in order to survive the financial crisis. Working Capital Management: According to the Forbes Digital Company “Working capital management” means a “managerial accounting strategy focusing on maintaining efficient levels of both components of working capital, current assets and current liabilities, in respect to each other. Working capital management ensures a company has sufficient cash flow in order to meet its short-term debt obligations and operating expenses.” (Investopedia 2009) It is only in the implementation of an effective working capital management can companies see return on investment and better earnings. A few ratios such as the Current Assets to Current Liabilities ratio and inventory turnover ratio give insight on the workings of the investment in an organization. A ratio analysis will help an organization focus on areas like, cash management, and accounts receivables and accounts payables. Working Capital that meets the short term financial requirements of the company is essential for the smooth functioning of Day to Day business. As the proprietor of a paper making industry, effective working capital management is the backbone of the business. Profitability and liquidity being the main motives of the business, checking of accounts receivable days, inventories days, accounts payable days, and cash conversion cycle on return on total assets will help maintain liquidity and ensure an uninterrupted flow of business. An effective management of the above will help survive crisis during recession and build a strong foundation for growth. Raw materials procured, Cost of Direct Labour and other Direct overheads must be carefully monitored on a daily basis to ensure the right amount is required for targeted production. The inventory maintained between production and sale is also controlled and stocked based on market demand to allow further liquidity and ensure greater gross profit margins. Gross profit margins further leverage the prospects of increased net profit and greater savings for the unexpected future. Costing Systems and Techniques. Cost accounting of a firm is a vital function as cost of the finished product and the margin of profit determines the Selling price which in turn determines sales and turnover of any firm. Costing assists in management control, costing assists management to appreciate scare resources in increasingly challenging environments. (Basic college accounting 2009) (Eg: during a recession). The allocation of costs to every activity or input is essential to the cost of the processed output. An online article which explains worst case scenarios during a recession talks about ‘Deflation’ by saying “The opposite of inflation, deflation is when an economy enters a vicious cycle where people believe that stuff will cost less tomorrow than today, so they put off buying–which causes prices to fall, repeating the cycle over again. Some economists think we’ll have deflation instead of inflation. So basically, everything you own will become pretty worthless, more companies go out of business as they become unable to earn any profits, and wages spiral downwards.”(Centreblue 2009). In a paper manufacturing industry, cost accounting helps in product costing and profitability analysis. The activity based process model helps in building cost models for the most complex manufacturing models. When the business diversifies or opts for products that are cheaper and that can be combined and processed in the same industry with the same equipments. (Eg: The diversification of business or the development of by products that are less expensive like products that partly plastic) the costing system currently followed will still deliver results and insights in an effective manner. The support software used for the costing process understands the business logic of how materials, components and activities are consumed and how costs are accumulated and profitability eroded by non productive activities. The current costing technique followed by the firm which is the activity based process costing helps in: 1. Identifying core and most profitable products to customers. 2. Optimize the product customer mix. 3. Point out non value adding processes that erode profitability 4. Discover potential bottlenecks and unused capacity 5. and lastly maximize return on investment (ROI) and return on assets. (sbm 2006) Scare resources: Funding and management. The allocation of scare resources like, funding and management during an economic downturn especially, when the down turn hits the industry in terms of decreased turnover and mounting costs. It is vital to explore and find the key areas in business that are vital for the functioning of the firm and the not-so-important areas that only lead to costs and yield no revenue. Eg : In the event of a recession when the company is looking to diversify or change its line of products funds should be diverted to that process of change if the results of the change are a positive one. Similarly change management has to effectively deal with the change especially with regards to the change of job that will affect labor in the production unit. An e article on motivation tools “Job survival in an economic down turn states the following “Fighting Change - People who fight changing technology want to maintain their comfort zone with familiar surroundings. (Status quo) As pressure for change grows, they depend on others to protect their comfort zone through politicians, unions or other bureaucratic organizations. During their youth, they learned a professional skill and plan to ride it till retirement, like their parents did. In the meantime, they do repetitive tasks (hourly, daily, weekly or monthly) waiting for their turn to be promoted. As fighters resist change, their efficiency falls further behind and in time their professional skill has no value to anyone.(Webb L. 2003) (Employees who think that a new product the firm has diversified into is alien to them and the resistance they show in learning the process or in delivery of the output is called fighting the change in this context) Embracing Change - People who embrace changing technology thrive on challenges. They are independent thinkers who seek new opportunity, which is found in change. They are leaders of efficiency and they are the leaders of blunders. Trial and error produces blunders and this is the only way to find what works. The casual observer does not recognize increased efficiency of these people, they remember their blunders. The person who depends on proven methods can’t understand how blunder’s get promoted ahead of those who maintain the status quo. (Webb L. 2003) (It is necessary to allocate funds and divert the concentration of the management to see the employees through this change as positive one that is indented for the growth of the business and the employee. Besides, terminating employees who fight change will lead to additional costs in hiring and training new resources.) The website of the Improvement and Development Agency of UK in its part to ease the economic downturn and provide a small incentive to consumers and business to retailers reduced the cost of parking. It reports “Barnet Council has introduced some seasonal goodwill by reducing the cost of parking throughout the borough. The scheme is designed to encourage Barnet residents to shop locally and bring shoppers in from neighboring areas.”(IDEA 2009) Just as this is a small incentive to encourage economic activity and consumption in that area. The firm will also provide small incentives to employees and units that adapt themselves to change and cuts down on unnecessary costs. This will promote a healthy and competitive work environment, and also increase productivity and profit margins. Budgeting for change: Matching expenses to revenue in a normal business cycle is a difficult task. The same during times of an economic downturn with dropping revenues and mounting costs is definitely an uphill task. In an article by Glen Curtis in the website ‘Investopedia’ states the six steps for effective business budgeting as 1. Check business standards: To cross check with other business regarding the budgeting standards. 2. Make a spreadsheet: To see the costs under the different heads and the total allocation. 3. Factor in some slack: To always ensure that an excess of budget is available in the case of unforeseen financial or revenue mishaps. 4. Look to cut costs: Cutting unnecessary costs in the course of business always helps in creating that extra liquidity. 5. Review the budget periodically: In order ensure that the expenses of the business are aligned with the budget it is important to review the budget periodically. 6. Shop around for suppliers: It is important to keep looking for new suppliers who offer materials at competitive or cheaper prices without compromising on quality.(Curtis 2009) The above mentioned points are one’s that have to be kept in mind while making a budget for change. In addition to this the expected loss on revenue and the rising costs of raw materials, transportation and overhead costs must also be accounted. The budget made for change must be a zero-based budgeting and no values, or formulas should be derived from previous budgeting spreadsheets. It is important to factor in the costs involved in change management and the diversification of business. Besides, the loss in productivity during the learning phase and the ‘worst come situation’ revenue that can be expected has to be budgeted for accordingly. Conclusion: The effect of a recession or an economic downturn cannot be eradicated but to a large extent controlled or minimized through efficient and effective financial administration, and capital management. The maintenance of a healthy financial system starts from day one or the inception of the business. If the above mentioned inputs in terms of working capital management, Budgeting, costing and funds and resource management are followed it will definitely help the business to survive and grow in a positive direction in the face of recession. References: 2006. ‘Costing and reasons for its importance’ ‘Basic college accounting’ Available from: http://basiccollegeaccounting.com/costing-and-reasons-for-its-importance/ [22 April 2009] 2006. Manufacturing Cost accounting. SBM Solutions. Available from: http://www.productcosting.com/cost_accounting.htm [22 April 2009] 2008. ‘10 Things that could happen if we do nothing of the economic crisis’ ‘The Centreblue Organization’ Available from : http://centerblue.org/2008/10/01/ten-things-that-could-happen-if-we-do-nothing-about-the-economic-crisis [ 22 April 2009]. 2009. ‘London borough of Barnet’ ‘Improvement and Development Agency’ The Government of United Kingdom. Available from: http://www.idea.gov.uk/idk/core/page.do?pageId=9215625 [22 April 2009]. 2009. ‘Worst recession since 1930’s’ ‘Recession’ Available from: http://recession.org/news/worst-recession-since-1930s [22 April 2009] Curtis. 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