What Is the Business Cycle?

bizfluent article image

If you are a small business owner, chances are you know about the natural ups and downs of economic growth. After all, these trends affect your professional and personal livelihood. Otherwise known as the business cycle, these economy-wide fluctuations are events you need to plan for. Not only will a solid understanding of the business cycle help the success of your small business, it will also help you make better financial decisions.

What Is the Business Cycle?

All businesses experience profit and loss. It’s the way of life. When there is a rise and fall of product in your industry, you are experiencing a business cycle. Simply put, a business cycle reflects the fluctuations in the current economic conditions. But it can be broken down into a more detailed analysis of four phases: expansion, peak, contraction and trough. Each of these phases can be directly impacted by inflation, bank lending and how consumers are spending their money.

Expansion and Peak Phases

The expansion phase represents the growth phase of your business. Typically, the overall economy is strong, and people are making money. This can lead to an increase in wages and higher prices for products. The expansion phase leads to the peak phase. Both are good, unless the inflation is too much for your small business to keep up with.

Contraction and Trough Phases

If a business can’t keep up, it may head toward the contraction phase. This marks the end of the boom and starts the downward spiral to a potential bust. If your business is in a contraction phase, you’re probably decreasing spending and may be thinking about layoffs, which leads to the trough, or recession, phase. This is the bleakest of all four phases. It can lead to unemployment and a massive decrease in production and demand.

How the Business Cycle Affects Small Businesses

Depending on how long you’ve been in business, you may have worked through a few business cycles. As a small business owner, it’s important to understand that businesses operate in cycles. In other words, you are going to experience all of the phases of a business cycle. But because you own a small business, you may experience these cycles more intensely than a larger business that can absorb some loss. For example, during the contraction phase, a small business may have a tough time riding out the slow economic times before business picks up again. This is often where small business owners shut down, so planning ahead and being prepared for this phase can help keep you afloat.

How to Plan for the Business Cycle

When you understand the different phases of the business cycle, you have a better chance of making a plan to get through them. While each phase represents an opportunity to grow your business, it could also hurt your bottom line if you’re not paying attention. While in the expansion phase, resist the urge to go all in. In other words, hold some funds back for when the economic cycle dips again. The same is true for the peak phase when a seasoned owner will start to sense that things may soon face a downward turn.

The more experience you have, the easier it’s going to be to know when you are starting to head for the contraction phase. Your main goal during this phase is to survive. You may have to cut costs on products or decrease production. This is also the phase where layoffs or salary reductions can happen. If this downward spiral continues, you will be in a recession or in the trough phase. This is the period of time between contraction and expansion where the economy hits bottom. You may be operating with minimum workers or reduced hours during this phase. Hopefully, you held back some funds during the expansion phase. If so, this is where to use that emergency cash. If you can get through this phase, you eventually will get back to expansion.