Business firms are affected differently by business cycles based on the nature of their business. For the economy as a whole, the growth is not steady or smooth due to cyclical variations. The effects on business firms during the expansion phase differ from the effects in the contraction phase. During the expansion the firm demand increases quite rapidly. Price rises more quickly than costs. As a result the profit margin rises. So manufacturers and Merchants generally feel happy during the expansion phase. Therefore, expansionary phase has a favorable impact on income, output, prices and employment.
It is at the height of the expansion phase the businessmen start feeling the pinch of the business cycle. The increase in the prices of raw materials, in labor costs and rents and interest rates, increases the cost of production of the business firm. Business firms find sales promotion more and more difficult. Business enterprises start competing severely for orders. Some businessmen reduce their stocks. They start cancelling their orders. Other businessmen fallow the. Prices have to be maintained with difficulty. Collections are slow. Banks and other trade creditors press for the settlement of their claims. Soon the recession starts.
During recession, there is lack of effective demand for goods. So firms find it difficult to sell their stocks. There appears over production causing lowering of prices and heavy losses to the firms. Severe depression may force the liquidation of many business firms.
During the contraction phase, all the difficulties of recession will be continued. Firms reduce the output, retrench workers and purchase less of raw materials. These variable costs are reduced. But overhead costs cannot be reduced. Firms have to maintain excess capacity. All these increase the costs. The financial losses will put the business units in grave difficulty. In fact, some business which are small sized may go insolvent while the large sized unit may survive the cycle.
Knowing the cyclical phases very well, the firm adopt its appropriate business planning or change the course of its business in tune with the overall economic situation of the country and save itself from undue losses.
