Finance

How to Protect Your Profit Margins, Recession or No Recession

July 27, 2022
The C2FO Team
Avoid the worst of any dropoff in your profit margins. Here’s how.

Avoid the worst of any dropoff in your profit margins. Here’s how.

Experts are sounding yet another warning about the coming months: Profit margins are almost guaranteed to shrink in the next year, according to Goldman Sachs

If the US sinks into recession, the median S&P 500 company will see its profit margins slip by 130 basis points (bps). Even if the country avoids a recession, Goldman Sachs predicts a decline of 70 bps in the typical margin. 

While this forecast should be taken seriously, it’s not inevitable that businesses will experience a collapse in their margins. There are still several options for mitigating the worst of any potential reduction.

Once implemented at scale, C2FO’s platform can help enterprises improve gross margins by up to 55 bps on average.* This would significantly offset the likely margin compression that lies ahead. 

Before digging into potential solutions, though, it might be helpful to talk about the typical profit margin right now. 

Soaring margins vs. runaway inflation 

Profit margins have actually jumped over the past year and a half. That’s partly due to the pandemic. 

Because of lockdowns and quarantines, many companies spent less on travel, real estate and other expenses, which boosted their bottom lines. At the same time, several companies enjoyed higher efficiency because they had invested in new technologies or practices, like remote work. 

And so — with the additional help of reopenings, high levels of household wealth and pent-up consumer demand — the net margin for the median S&P 500 company rocketed from 8.5% in Q2 2020 to 12.7% by Q1 2021. 

Unfortunately, last year also brought sharp and persistent inflation, which has continued to worsen this year. The Producer Price Index — an important measure of companies’ production costs — increased by 11.3% on a year-over-year basis in June.

The expectation is that higher costs will damage companies’ profit margins. And there have been signs of that, to a point.  

For Q2 2022, the net profit margin was 12.4% for the median company on the S&P 500, according to FactSet

That’s down from the 13% margin recorded a year earlier, but it’s also higher than Q1 2022’s 12.3% margin and the S&P 500’s five-year average of an 11.2% margin. 

Business owners meet to talk about their finances.

Recession-proofing your margins and supply chain

When a recession occurs, a few things happen. Sales and revenue will soften, and as a result, profit margins typically shrink. Cash flow tightens. Credit costs more and, in some cases, becomes unavailable for smaller companies. 

For larger enterprises, there is also a higher risk that your suppliers will go out of business. In situations like this, dynamic discounting can help you maximize the impact of your funds and strengthen your supply chain. 

You use your cash on hand to pay your invoices early in exchange for a small, customized discount from your supplier. (This type of early payment is a cornerstone of C2FO’s platform.) 

There are several benefits to this approach. For starters, by using your own cash to pay invoices early, the discount you receive is essentially a risk-free return on your funds.

Most asset classes, including bonds, have been volatile these past few months due to the uncertainty in the markets. With C2FO, you can set a target return for your cash, and you can tie that target to benchmark rates, so as rates rise, so do your returns. 

In a recession, though, some enterprises may prefer to hold on to their cash instead of using dynamic discounting. That doesn’t mean they can’t pay early, though.

Instead, these companies can use supply chain finance, or C2FO’s powerful version of it, Dynamic Supplier Finance

A third-party lender or financial partner pays your invoices early on your company’s behalf; your supplier still offers a discount in exchange for early payment. You then pay the lender, usually on the original due date, though some enterprises may negotiate a later due date in exchange for a fee. 

Accelerating payment is one of the best things you can do for your suppliers. You give them access to working capital quickly, so they can continue to pay their operating expenses, without taking on debt or shouldering the cost of interest. 

During tough economic times, that can be an important lifeline for smaller businesses. 

The bottom line  

None of this is intended to make recessions sound like a simple problem. For many smaller businesses, an economic slowdown is an existential threat. Even the survivors can walk away with lasting damage. 

But forewarned is also forearmed. By adopting tools like dynamic discounting and Dynamic Supplier Finance now, companies can bolster their supply chain and continue generating healthy profits.

* Source: Aggregated C2FO customer data

Working Capital. Working for Everyone.

C2FO provides working capital solutions for you, your suppliers and your customers.

Related Reading