Business Cycle

By Entrepreneur Staff


Business Cycle Definition:

Periods during which a business, an industry or the entire economy expands and contracts

Many business cycles are anything but regular. They vary in intensity and length. Expansions and contractions of the economy, also sometimes referred to as booms and busts, are broad economic events that affect many industries and companies. The United States economy has experienced approximately 10 of these boom-and-bust business cycles since 1945. They've varied in length from the abbreviated six-month contraction that followed the five-year expansion from 1975 to 1980, to the 106-month expansion that spanned the 1960s. The characteristics of economic cycles include:

  • Fluctuations tend to affect durable manufactured goods more than services.
  • Wholesale and industrial prices tend to be affected more than retail prices.
  • Short-term interest rates track and amplify the cycles, moving in an exaggerated manner along with the economy.

Don't ignore the influences of fortune on your business. Wars, hurricanes, floods and fires can all have powerful effects on your business. Wars in particular have a tendency to affect the entire economy, producing booms in their early years as government spending mushrooms and followed by the dampening effects of inflation and, later, recession as the economy cools down.

Some random events can be beneficial to some businesses. A roofing company, for example, could see a boom in business immediately after a destructive hailstorm strikes its service area. It doesn't pay to structure your business around hoping for disaster, but you should be ready to swing into action when random events create extra demand for your products and services.

Much effort has been expended trying to develop ways to predict the turning points of business cycles. Few things are widely agreed upon, however. For example, falls in stock prices, profit margins and finally profits are generally seen as precursors of downturns. However, even experts disagree on the timing of these so-called leading indicators. It may be weeks or months after a stock market crash before the economy begins to show signs of receding. Then again, it may never happen. And there are many other indicators, such as housing starts, interest rates and price indices, that economists look to for help tracking and forecasting changes in business cycles.

The Conference Board Inc., a private, nonprofit New York City research organization, produces a monthly report that looks at recent figures on employment, income, prices, costs, inventories and many other factors. One of the most interesting features of these reports is the index of leading indicators, which is an attempt to peek at the near future of the economy. The leading indicators include average weekly hours worked by manufacturing employees, unemployment claims, new orders for consumer goods, building permits, interest rates and an index of consumer expectations. Unfortunately, because of difficulties in the timely collection of all this data, it is subject to revision for some months after a report has been released. Therefore, the "forecasts" of an upcoming recession are often made after the recession has arrived.

In general, economic forecasts aren't perfectly reliable. Neither, of course, are the hunches and intuitions of entrepreneurs. However, taken together and applied carefully in view of what you know about your particular industry and company, economic forecasts can help you to prepare for changes in the direction of the economy before or soon after these changes occur.

Business cycles are also affected by seasons of the year, holidays and other recurring events. Bathing suits and sunscreen, for example, sell well in spring and summer, poorly in fall and winter. The opposite is true of coats and gloves. Less well-known examples include fast-food outlets and other restaurants regularly suffering sales declines in the winter and boosts in the summer, especially in northern climes. Don't underestimate the potential effect of seasonality. Cooler maker Igloo's sales during June, its busiest month, are 10 times higher than those in its slowest months.

There are many things you can do to smooth out seasonality--and you should do some or all of them if you want to grow steadily. Seasonality is a management challenge; it makes it harder for your company to grow when you experience wide swings in demand. If seasonality is causing you problems, think of ways to generate steady sales. For example, one mail order flower company gets as much as 40 percent of its revenue from a flower-of-the-month-club program, which helps smooth out the seasonality of this business.

One of the best-known examples of the power of seasons on business is the year-end holiday sales boom that packs half the year's sales into a few months for many retailers. But the timing of holidays is even more sensitive than it may appear. Holidays that don't occur on the same calendar date each year may have different effects on business, depending on when they actually take place. Easter is a good example. It may occur during a broad spread of weeks in March and April. If it's early, retailers in the North may be hurt because they've displayed swimming suits that don't appeal to shoppers who are still wearing their winter coats. If it's late, on the other hand, retailers have to be ready to supply summer tastes in goods along with their Easter displays.

Highly seasonal businesses must avoid the tempting budgeting shortcut of taking the projection for first-year sales and dividing it by 12. If you have wide-ranging changes in cash flow needs, that kind of budgeting error could sink you. So enter sales and cash needs on a monthly basis, taking into account the expected effect of the seasons on each month. Otherwise, planning for cycles is largely a matter of recognizing that they exist. This may mean not assuming that the current good times will go on forever. Plan for tougher times by limiting the costs you add to your business. In particular, be wary of paying higher recurring expenses such as rent.

Entrepreneurs tend to take on unnecessary expenses when times are good, but this can sink you if a recession strikes. Look out for overly lavish expense accounts, over-reliance on high-priced professional advisors, products that don't carry their weight, and even marginal customers you'd be better off without. Trimming these costs when times are good will help your profits now and may make the difference between success and failure when the cycle turns the other way.

Also think twice before adding expenses that may be hard to cut, or even cost more to cut than they do to keep. Chief among these costs is people. It can be emotionally as well as financially painful to lay off workers in the event of an economic downturn. And the costs for severance pay, unemployment insurance, outplacement and retraining may also be steep. Remember: Even if your income statement and balance sheet are strong now, you have to practice cost containment to be ready for the next recession.

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