During this time of year, businesses are evaluating results of the past year and building forecasts and budgets for the next - a ritual I affectionately refer to as “The Annual Rain Dance."

Unfortunately, this year looks pretty ugly, and next year won’t win any beauty contests. A weakening economy in 2001, further jarred by the tragic events of September 11, has forced many companies to cut expenses and lay off employees. And the uncertainty of a prolonged military campaign and its effects on the economy are causing skepticism about next year. After September 11, it seems that trickle-down economic theory became tumble-down economic reality.

Glenn Hubbard, Chairman of President Bush’s Council of Economic Advisers, said in early October the terrorist attacks on September 11 increased significantly the likelihood that the economy is in a recession. However, he’s optimistic about a recovery, believing that consumer and business confidence will be robust again … but not until at least the middle of next year.

So, if you’re reading this column waiting to find a silver lining in these dark clouds, I’m afraid I’m going to disappoint you. In fact, I have some more bad news: If the recession is playing havoc with your business, don’t look to your bank to bail you out. After analyzing some FDIC data and having conversations with executives of major lenders, I can only conclude that we are in a really serious credit crunch, similar to that of the early 1980s.

We have experienced it firsthand with several of our recent clients, who had problems with minor bank-loan covenant defaults that a few months ago would have been overlooked. Now, their banks are demanding that these companies either put in more equity or get re-financed. And for some, who are already experiencing financial stress, it will be next to impossible to do either in today’s capital environment.

Lenders are getting tougher because they are seeing more distress in their existing portfolios, some of which could not have been predicted before the terrorist attacks of September 11. Not surprisingly, some lenders are reacting to that distress by being very careful with new borrowing requests. They have also virtually stopped making “cash-flow” loans, and are uneasy about more unconventional forms of financing; deal flow for mezzanine financing is down approximately 20 percent in the past six months and financing for “roll-up” transactions is basically dead.

Lenders are simply trying to cut their losses and eliminate as much risk as they can. It seems that the banking industry is in as much trouble as the rest of the economy, according to these trends in the FDIC’s quarterly banking profile, comparing the second quarter of 2001 to the second quarter of 2000:

• More than one out of every ten banks with assets less than $100 million (11.6 percent) were unprofitable in the second quarter of 2001;
• Banks set aside $8.8 billion for future loan losses during the second quarter of 2001, an increase of 22.3 percent;
• Banks charged off $7.9 billion in bad loans during the second quarter this year, an increase of 50 percent;
• Commercial and industrial loan charge-offs totaled $3.1 billion, up $1.4 billion (76.7 percent) from a year ago.

Because of these trends, lenders are getting stingier with their credit, tightening their standards, and turning away loan requests that were getting funded not too long ago. For businesses that need financing to get through a difficult period, this is not good news.

It’s also nearly impossible to get help from the equity markets. The stock market is responding to the uncertainty of a retreating economy, the expectation that third quarter earnings will be the bleakest earnings period in a decade, and worries about the cost and length of a sustained military campaign and more possible attacks on U.S. soil. Venture capitalists, who had already slowed their money flow to a trickle due to the dot-com collapse, have tightened the spigot even more in the post-terrorist attack uncertainty. Third-quarter venture investments totaled only $6.7 billion, down 72 percent from the same quarter a year ago, according to the venture capital newsletter VentureWire. The number of private companies receiving venture capital dropped 67 percent from a year earlier and 39 percent from the second quarter.

Now, I know this picture looks bleak, but as Joe Friday used to say, “Nothing but the facts, ma’am.” What is important is that businesses be aware of this difficult capital environment and not bury their heads in the sand, believing that it won’t affect them. Well, wake up and meet the“work-out department” because eventually it will effect everyone.

In particular, businesses that have loans up for renewal, that have year-end projections coming up short, or have projections for 2002 showing weaker results than this year’s should start thinking about how they will deal with the capital calamity.

If you have a credit line, you should be prepared to get less, pay more for what you get, and live with tighter loan covenants. In general, lenders are lending only under extremely conservative structures. According to some people I recently talked to in the banking industry, major lenders were lending up to six times cash flow in 1998, but are now only lending up to three times cash flow. One major institutional lender told me they did 25 cash flow transactions in 2000 but had only done five similar deals so far in 2001.

Lenders are doing more transactions based on collateral instead of cash flow. And if they do a cash flow transaction, they want more equity than in recent years; i.e., the debt-to-equity ratio will have to be lower. Lenders are also paying closer attention to their ratings, and are therefore underwriting transactions based on how those transactions may impact their bank ratings.

Businesses that don’t have credit lines should assume that it is next to impossible to get a loan. Instead, they should focus on stockpiling cash. It’s generally considered prudent to have two to three months’ worth of cash on hand. Look at cash flow over the next 90 days and determine how it may be affected by the current situation. Businesses with customers in the airline or hospitality industries, for example, should expect that those customers will be processing their payables more slowly than they usually do.

Next, find ways to stretch out payables and speed up receivables. Call vendors and explain that you have to pay more slowly than usual for the next several months. Call unaffected customers and ask them to speed up their payments. By paying closer attention to cash flow, it’s surprising how quickly you can build up a nice little nest egg.

It would make sense to also go through customer lists and make revised sales projections assuming lost sales due to a recession. It’s wise to err on the side of caution. Listen to your more conservative managers and prepare for the worst-case scenario.

Then look for places to cut. More than 70 percent of companies are currently planning to maintain or reduce their workforces, according to a recent survey by Manpower. A survey by the Bureau of National Affairs found that production and service workers should expect sharp employment declines, and that only 10 percent of companies plan growth in hiring clerical and office staff.

Keep in mind, though, that recessions eventually end and don’t cut too deeply. We advise clients to cut the fat, but not the muscle. Keep layoffs on the “last resort” list. Think first about freezing salaries and not filling new positions, eliminating perks, cutting back on travel, using old equipment longer, and getting rid of everything unnecessary. Delay big spending initiatives such as developing a major new product or expanding a plant. Get rid of excess inventory. Carefully monitor the bottom line in every area of the business.

Do what you can to keep your sales and marketing efforts going, though, so you don’t lose ground in the marketplace. And communicate what you’re doing to your employees so they understand that you’re trying to save jobs. That will make them more likely to support you and contribute their own cost-cutting ideas.

Hopefully these ideas will help businesses survive the capital squeeze. The tragic events of September 11 have changed our lives in so many ways. Don’t let them destroy your business, too.