How to Survive a Recession

LESSON 39: Cut Your Cost of Sales

One of the keys to surviving a recession is minimizing the time between cash revenues and direct cash expenditures necessary to generate those revenues.

Cutting your Cost of Sales (COS) or Cost of Goods Sold (COGS) is a critical component to positive cash flows during a recession.

This applies to inventory-intensive businesses such as manufacturers, distributors, and retailers, where inventory is a Cost of Goods Sold (COGS). It also applies to any business where capacity is purchased to generate revenues, such as consulting, legal, mining, construction, etc. Service businesses such as law and consulting firms treat their skilled personnel as “inventory”, for which the company pays salaries and benefits in anticipation of reselling their services. Mining, oil, and gas businesses invest in discovery, extraction, and storage capacity necessary to obtain resources and resell them at a higher price. Construction companies invest in labor and tools to profitably deliver building services. All of these businesses have direct costs associated with generating revenues.

Regardless of what industry you are in, it is critical to reduce capacity quickly and become very stingy about carrying excess inventories and revenue-generating staff. If you sell physical goods, quickly reduce or eliminate new inventory purchases, and dump the existing inventory as quickly as possible. If you sell services, lay off as many employees as possible and only keep a skeleton crew sufficient to serve current demand.

There are a variety of reasons to take these steps.

First, gross sales drop, which reduces inventory utilization. When this occurs, the company may begin expending cash at a faster rate than sales bring cash in.

Second, competitive pricing pressure reduces gross profit margins and profitability. In cases where there is too much inventory across the supply chain, end prices can easily fall below the cost of production. When this occurs (as it did for Berkshire Hathaway when it was a shoe factory), you should cease buying inventory at all and exit the market as soon as possible, either temporarily or permanently.

Third, product returns tend to increase during recessions, especially if you sell to distributors or retailers and have a favorable return policy. When this occurs, you may suddenly find yourself with inventory flowing back in the exit door and cash going back out as refunds!

Fourth, idle inventory is subject to spoilage, theft, damage, and obsolescence, leading to expensive inventory write-offs.

Finally, demand trends down over time as recessions accelerate. With downtrending demand, this month’s inventory requirements will likely be too high next month and so on. Since capacity takes some time to burn off, it is critical to begin cutting back as soon as possible and deeper than you first estimate. You can always purchase more products or skilled employees if demand increases again.