According to the National Bureau of Economic Research, the U.S. entered a recession in December 2007, far earlier than most businesses thought. Most economists forecast that this may be the longest contraction since the 1980 recession.

Unfortunately, retailers and their vendors are suffering along with other segments of the economy. Faced with this environment, careful planning and defensive measures are required not only to survive, but to avoid the pitfalls of bankruptcy litigation that can cause financial harm.

The Retail Environment
Retailers and their vendors are trying to survive a decline in demand unlike any experienced for many years.

Many retailers are already operating with minimal staffing and more restricted store hours. Just-in-time inventory management and bulk purchasing contracts combined with significant pre-purchasing commitments and stiff penalties have left vendors and retailers with arrangements that impose significant costs and limit their exit options. With a bleak consumer-spending outlook for 2009, profit margins may not cover operating costs, and the tight credit market has left few alternatives and virtually no access to additional cash.

The outlook for vendors providing goods and services into this retail environment is just as bad.

Increasing Bankruptcies and Restructurings
Retailers in 2008 saw Value City Department Stores, Steve & Barry’s, KB Toys, Linens N Things, Whitehall Co. Jewelers, Mervyn’s, and Circuit City all file for bankruptcy protection, ultimately leading to their liquidations. BankruptcyData.com listed 24 major retail bankruptcies in 2008.

Many bankruptcy specialists forecast that 2009 may witness the largest number of retail bankruptcies, turnarounds, and workouts in history. Vendors to those retailers will feel the harsh ripple effect as the contraction rolls across the economy.

Assess Customer Credit Quickly
Many retailers have been the subject of leveraged buyouts by private equity firms in the past five years. The increasing prices paid and easily available credit have left debt maturities and interest obligations that cannot be met in the current environment. Those that are able to service their obligations are frequently in violation of loan covenants. Citigroup identified Nordstrom, Inc., Kroger Co., Macy’s Inc., Target Corp., and Supervalu Inc. as among the most highly leveraged retailers.

The proliferation of different credit structures has added layers of complexity to an already complicated lending environment. In addition to traditional bank and nonbank lenders, there are securitized loans and their related trusts, and possibly a trail of transferred obligations to other parties such as hedge funds, distressed debt traders, and others. This growth in complexity can significantly shift the dynamics of a restructuring discussion and shorten available time frames to achieve an exit strategy. Changes in the bankruptcy laws have also reduced the time during which companies can attempt to reorganize.

The credit markets currently have little if any interest in funding a reorganization effort. While the government has taken steps to strengthen financial institutions and increase liquidity, the current credit environment has left struggling retailers with little “runway” to restructure. Those companies able to access credit markets will do so at higher costs.

Retailers and their vendors, therefore, must understand the tight environment and limited options available to them. It is essential to take significant actions as early as possible to enhance liquidity.

Planning Is Essential
While strategic options may be somewhat limited, careful planning and swift execution can help absorb the turbulence expected this year. Meanwhile, tight inventory management is crucial. Careful management of inventory mix, supply chain efficiencies, and labor productivity, as well as strict control over operating costs, can offset weaknesses in gross profits.

However, cash remains king. Maximizing capital efficiency and preserving liquidity are essential. The current credit environment requires careful cash planning driven by precise budgeting and accurate forecasting. Reducing working capital needs by lowering inventory, accelerating receivable collections, and managing the purchase/pay cycle can all help. Credit terms should be well documented and analyzed to see which customers are at risk. Factoring receivables may offer access to credit as well as some protection from the risk of customer default. Planning should include both customers and suppliers and a comprehensive review of all contracts, terms, and penalties. Lowering or eliminating non-essential capital expenditures, halting any share repurchases, and restricting or eliminating distributions to equity can offer other essential cash savings.

Regardless of the specific strategies used to preserve cash, care should be taken to comply with all borrowing base reporting requirements since lenders have stepped up the analysis and review of their collateral. Furthermore, given today’s risk of failure by financial institutions, companies should reassess the location, safety and diversification of their cash and cash equivalent deposit accounts.

Early Warning Signs
Today, signs of trouble appear almost everywhere in the economy. Nevertheless, specific warning signs can be observed and heeded to protect the vendor from undue risk of financial loss from its corporate customers.

Try to understand both yours and your customers’ working capital, or cash conversion cycles, i.e. days cash tied up in inventory, payables, and receivables. Carefully monitor current trends in the cash cycle for your goods, especially the days’ receivables for your customers. Benchmarking can be performed with public company data from SEC filings, Yahoo!Finance, Hoover’s Online, Bloomberg, and Thomson Reuters. Banking statistics from Risk Management Association might include a better cross section of smaller private companies. Declining trends in profitability and liquidity and excess leverage are sure signs of trouble.

Regularly obtain financial statements and monitor industry communications and news about key customers; watch for symptoms of ineffective working capital management such as high bad debt expense, inability to timely invoice customers and process cash receipts, poor on-time shipment performance, significant obsolete inventory, long lead times, high levels of inventory, strained supplier relationships, or rumors of poor communication with lenders.

Worsening trends in such broad management areas as overproduction, ongoing delays, excessive transportation, overprocessing, poor inventory management, unnecessary motion and internal inventory transfers, and product defects all point to a consumption of corporate cash that might leave creditors short of repayment. The key to surviving 2009 may well lay in tight fiscal planning, defensive management of customer relationships, and a proactive stance that maximizes adaptability and flexible responses. Hopefully by 2010 the world will be a better place for both retailers and their vendors.