My last column argued that financial markets over the next five to ten years will be characterized by volatility. For those who accept this conclusion, this article now describes what a business owner or manager might do about it.

Volatility does not necessarily mean that all news is bad: the recent appointment of a technocratic government in Italy headed by Mario Monti triggered a dramatic fall in interest rates on 10-year Italian treasuries from approximately 7.3 percent to approximately 6.5 percent – whopping potential savings on trillions of dollars of debt! It dramatically illustrates how confidence is at the cornerstone of our financial system.

Yet the dragons of massive indebtedness (in countries like Greece, Italy, US and UK) and of lack of competitiveness (and Greece, Spain, Portugal) are far from slain. There will be many more battles before the European Union truly operates like a union – especially in the financial sense. So volatility will persist as we lurch from crisis to crisis – the gyrations may even increase in intensity.

So for those who run businesses, if you accept a scenario of volatility moving forward, how might that affect your actions?

1. Increase the equity available in your business. Most businesses are financed by a combination of debt and equity. Lowering your debt/equity ratio increases the stability of your business, and allows you to weather storms more easily. This can be done by infusing fresh equity, paying down debt, or a combination of the two.

2. Be more cautious with your investment and expansion plans. Perform sensitivity analysis as to how your new projects or expansions will perform under more pessimistic scenarios. Is the project robust enough to perform adequately even under negative scenarios?

3. Reduce your “burn rate”. What are your monthly overhead expenses? To the extent that you reduce such fixed expenses, you improve the ability of your business to survive a possible diminution of revenues. Sometimes this can be done by cutting only fat, not muscle, from your operations. Cutting fat is a “no-brainer” – it simply needs to be done. Cutting muscle must be done much more carefully, fully weighing costs and benefits.

4. Restructure short-term debt to long-term debt. To the extent that you hold short-term debt, you may be at the mercy of financial institutions who may refuse to extend or renew your debt. Switching to long-term debt diminishes this vulnerability, as long as loan covenants are observed.

5. Allocate your portfolio. If you are holding large volumes of cash or securities over the longer term, consider balancing and hedging your portfolio. Gold and other precious metals, for example, may be a useful hedge or insurance policy should the world economy become seriously destabilized, and fiat currencies lose their value.

While inflation has been generally low in developed economies, due to the large amount of free capacity in the economy (high unemployment, etc.), the alarming increase in money supply in most developed countries may eventually trigger significant inflation. So in conjunction with point four above, to the extent you are able to obtain long-term indebtedness, under an inflation scenario you would do better with fixed rather than variable rate financing.

As Larry Summers wrote: “It’s the central irony of financial crises that they are caused by too much confidence, too much borrowing and lending, and too much spending – and they are only resolved with more confidence, more borrowing and lending and more spending.” As we lurch from crisis to crisis, governments will have little option but to rev up the printing presses and print even more money. It has been remarkable how little inflation has resulted from past exercises of Quantitative Easing. One cannot discount the possibility that eventually inflation – or worse, stagflation – will rear its ugly head. And inflation is one of the more unpleasant manifestations of volatility.

It has been a week of hell in financial markets: S&P downgrades US Treasuries, the Dow plunges below 11,000, stock markets all over the world give up trillions of dollars in value. Riots from the UK to Israel. Safe haven investments such as the Swiss franc and gold reach new highs … Where does this leave the average SME (small or medium-sized enterprise) owner? Consider the following five likely outcomes:

1. Revenue stagnation

What has happened in the past week or two is a sea change in the outlook of financial markets. Whereas two weeks ago financial markets seemed to reflect a cautious optimism that a slow global recovery was under way, markets now reflect a scenario of stagnation, in some countries potentially even a double dip recession. So unless you are in one of those fortunate niches that can’t keep up with demand (for example the entire supply chain of Boeing and Airbus is struggling to keep up with a five year backlog on aircraft orders), your revenue outlook may be considerably less optimistic today than two weeks ago.

2. Ongoing volatility

The best prognosis is that markets will continue to lurch from crisis to crisis. There is no credible solution yet in place for the debt problems of the peripheral European economies. The US will lurch between between slamming on the fiscal brakes (the Tea Party’s desire to reduce the size of government spending) and stimulus, in the form of new forms of quantitative easing and job creation programs – each with its own set of problems. Even China teeters on the edge of a contraction, according to some market watchers.

3. Liquidity will be at a premium

Companies will likely stretch their payables even more, cash will be at even more of a premium. Liquidity may become an even more important source of competitive advantage.

4. It may become more difficult to raise financing

Banks may become even more cautious in lending. Private equity will likely become even more cautious in cherry picking quality deals at more conservative valuations. M&A markets may become even more of a buyers’ market. Yet for business owners, it may be important to seek financing to ensure liquidity, even survival, in the potentially lean months ahead.

5. A shift in asset classes?

Many market observers are saying that now is a good time to buy equities, taking advantage of current low valuations. They may be right. But one must also ask the question: Is there a long-term shift among asset classes here? Just as the decade leading up to 2008 was a decade of soaring equity values and above-historical returns, the subsequent decade may go down in financial history as a decade of equity price stagnation, horizontal movement and volatility. Since 2008, an investment in commodities (e.g. gold) would have performed better than most equity portfolios.

The two major financial markets in the world – the US and Europe – each have their own sources of instability moving forward:

• The US highlighted its own political disfunctionality in not being able to resolve an artificial, self-inflicted, problem – namely raising the debt limit – until the eleventh hour. This does not bode well for creating the political consensus to solve the real (and infinitely more difficult!) issue, diminishing the vast imbalance between projected revenues and expenditures.

• Europe continues to suffer from the lack of centralized institutions, (giving it, for example, the ability to levy taxes, drive expenditures and issue bonds at the European level), an advantage that the United States enjoys vis-à-vis Europe. While the consensus for further integration does not (at least yet) exist, the lack of such centralized institutions makes it far more difficult for Europe to respond credibly to financial crises.

Working through both of the last two issues is optimistically a decade-long agenda for both Europe and the US. In the meantime, markets may lurch from crisis to crisis, which will either help create the incentive for political consensus to resolve the above issues, failing both the US and Europe will see huge difficulties ahead. Scenarios include the European Union losing members, or the US dollar losing its status as reserve currency.

Given the developments of the past week in financial markets, the worst approach by business owners would be to take the ostrich approach: to stick one’s head in the sand and pretend that nothing has changed. These are momentous changes. How does this change your business?