Decision making across the business cycle A CIMA case study
Page 4: Downturn and recession
A downturn is a slowdown in economic activity. High levels of inflation in a boom can lead to businesses becoming uncompetitive. Inflation increases uncertainty as rising costs and prices are difficult to predict. In order to try to control demand when inflation is high, the government can increase taxes. In addition to this, the Bank of England can raise interest rates. These actions encourage saving and discourage spending. The result is that economic activity begins to decline.
A downturn can lead to a recession which is defined as when there are two successive quarters of negative economic growth. During a recession, demand in the economy is low and markets shrink. There are pressures for businesses to reduce costs, which can lead to increased unemployment as companies lay off workers. The resulting higher unemployment means people have less money to spend, thus contributing to the downturn in the economy. Some businesses may have to close down. In 2009 a number of well known businesses closed in the UK, for example, Woolworths. Other businesses reduced the number of outlets or stores they operated.
During a recession, the Board of Directors of a company needs to consider various options of managing lower revenues and therefore profits. In most businesses there are inefficiencies and instances where the costs of unprofitable customers or products are covered by other profitable ones. Management accountants can provide analysis to help focus on core profitable activities and identify where costs can be cut. They may provide detailed figures relating to options such as making redundancies, closing offices, shrinking capacity or even selling off assets like machinery and buildings.
Evaluating the outcomes of these different sorts of analysis could include:
comparing different degrees of activity, e.g. to cut costs by 10% or 20%
analysing the benefits or impacts of various options, e.g. what is the effect on profits of cutting back costs? How much cost saving would result from losing 5% of employees?
assessing impacts on stakeholders, e.g. how will customers feel if the range of products is reduced or delivery times affected?
However, the problem in making cutbacks is that it reduces the ability of a business to respond when the economy takes an upturn. The company may then have to invest in new machinery and equipment or try to regain skilled employees.
Management accountants may also help identify opportunities for immediate or future growth during a recession. Good deals may be available at this time. Investment in equipment or acquiring another business during a recession is likely to be cheaper than during a boom. This can put a company in a strong position to deal with increasing demand when the economy begins to recover.
CIMA Professional Qualification
Matthew Parker works for Topshop/Topman which is part of the Arcadia Group. He has completed the CIMA Professional Qualification. He describes his CIMA qualification as a commercial toolkit that enables him to break information down and make the most profitable investment decisions. By comparing the likely costs and revenues of different activities and products, Matthew is able to identify ones that are most likely to lead to higher and sustainable profits.
Scott Egan is the Commercial Director at Norwich Union Insurance. He is responsible for identifying new business areas which may be important to the business in the future. He also drives mergers and acquisitions in order to continue Norwich Union”s growth.
Management accountants are able to explore every way to reduce the impact of a recession, without resorting to impulsive decisions which may harm recovery. For example, they might consider particular human resource strategies. The introduction of flexible working or reduced hours can ensure skilled staff are still available for the recovery. The CIMA Professional Qualification provides skills and support for human resourcesspecialists.
Chartered Institute of Management Accountants | Decision making across the business cycle