A starting point for an analysis of the business’ operating environment is to understand where we are in the economic cycle. Traditionally, these cycles can take several years to revolve and the position in the cycle at any given time is going to be a major influence on the health and fortunes of many businesses.
This is the economic cycle;
Pre-2008, we were mainly concerned about the economic cycle in the country in which the business was domiciled as long as that was where the business generated its major revenues and cash flows. However, as a result of the global credit crisis, most of the world’s economies are languishing in recession or troughs with the consequent negative impact on demand which has affected commodity prices and currencies, especially in emerging markets. So the analysis of the economic cycle and its impact on business drivers has taken on greater significance in understanding the current and future risks that a business faces.
Don’t make the mistake of assuming that every business succeeds or suffers at the same time or to the same degree. The good news though is that not all businesses are equally or even similarly affected by the position in the economic cycle. Some businesses will follow the cycle and will do well in good times and poorly in the bad times. These businesses are described as cyclical. Typical cyclical businesses are in the construction, mining and retail sectors, for example.
Some businesses “buck the trend” and actually do well when the economic cycle is in a downturn, that is, they do well when most others are struggling and struggle when others are doing well. These businesses are described as counter-cyclical. Typical business of this type are low-price clothing retailers, debt collectors, pawn shops and the like.
And then there are some businesses that are immune to movements in the economic cycle. That’s because they supply products that consumers will buy whatever the economic conditions because they are essential products. These are non-cyclical businesses. Think of businesses in pharmaceuticals, staple food production and distribution, toilet paper manufacturers and so on.
In determining which business is which, much will depend on the business’ product and the particular business strategy that it implements. Of course, a good way to identify which type of business you might be dealing with is to track its revenue trend over the past few years as economies have generally struggled.
Finally, keep in mind that the real value in understanding how the business is affected by the economic cycle is that you can get a better sense of how its near-future revenues and cash flows will perform on the basis of economic forecasts for the country.