Page 2: The business cycle
Gross Domestic Product (GDP) is the value of all the goods and services produced in an economy over a period of time. When GDP rises, economic activity is increasing. This is called economic growth. The level of activity fluctuates over time. Periods of high growth are followed by periods of slow growth. Sometimes the economy experiences negative growth when there is a fall in GDP. These fluctuations are known as the business cycle.
There are four stages of the business cycle:
- Boom – this is when the economy is growing quickly. Demand in the economy is high and consumer spending grows.Business production increases to keep up with the demand.
- Downturn – growth starts to slow down. Consumer spending begins to fall and businesses invest less in capital equipment. There is uncertainty about the future of the economy.
- Recession – a continued downturn in economic activity can lead to a recession. Demand is low and firms may struggle to survive.
- Recovery – GDP starts to rise again as consumer spending increases and businesses produce more goods and services.
The business cycle has numerous impacts on organisations. These include:
- changing demand affecting profitability
- fluctuating staffing levels requiring recruitment or redundancies
- the need to alter production levels relative to demand
- the capability to expand or rationalise operations as necessary.
The illustration shows economic activity in the UK between 2006 and 2010. Although the business cycle follows a pattern, the changes in activity are not regular or predictable. It is difficult to assess the duration of any part of the cycle or how extreme the booms and recessions will be. Management accountants can help organisations to develop suitable strategies to cope with the business cycle. For example, during the 2008-9 recession, CIMA evaluated the situation and warned companies against ‘knee-jerk’ reactions to problems, such as trying to manage just by cutting costs.
Management accountants are equipped to take a longer term view. They understand that some costs are necessary to support the long term growth of business. The management accountant’s role is central to understanding, managing and even anticipating the impact of the phases of the business cycle in order to manage its effects.