Earn What You Spend

When we read about the current economic crisis on the news, we read about it through two lenses: large companies such as GM, Lehman, Wal-Mart, or the individual consumer.  Yet in those stories, we are missing a significant part of the American economy: small businesses. This credit crisis is affecting them as much as their corporate brethren. 

According to one Raymond Keating chief economist with the Small Business and Entrepreneurship Counil, 

some 60 to 80 percent of new jobs come from small businesses … and more than 50 percent of private sector gross domestic product is created by small business. While big banks and automakers have the resources to demand attention to their woes, small businesses, he said, are “lost in this equation.”

Why are small businesses so affected? Not because they experimented with leverage the way the financial companies did, nor because they were uniformly betting on sub-prime mortgages.  Rather, it’s a cash flow issue as impacted by the lack of credit. 

Let’s take a simple example.  You manufacture furniture - let’s say tables and chairs.  You sell most of your inventory through warehouses and showrooms.  They buy them from you in bulk (note: of course you would likely be selling these on consignment, which would only make this situation even more difficult).  So this warehouse owes you $100,000 paid out net-60, meaning they will pay you within 60 days of receiving your invoice.  But you have to pay your employees every two weeks.  So you have a cost you cannot wait to pay - your employees, at say, $30K every month - and you know you have money coming to you in two months that would cover all of these costs.  You just don’t have that cash now - you’re short $60,000.  It’s a classic cash flow problem: learning to deal with the discrepancies of when you are paid versus when others pay you.  

That’s where credit comes in.  Lots of small businesses cover this cash flow by drawing from credit lines from banks - they know they can cover those costs in two months, so they will borrow the money in the interim.  Credit cards often perform the same function.

The NYTimes continues the profile of these entrepreneurs.  Some businesses are being forced to pay bills in the interim on their own credit cards, providing a sort of financing-of-last-resort.  According to one business owner of 21 years, who does their cash flow statements, frequently “wakes up at 3 o’clock in the morning because [he's] never quite been here before.”  According to another business advisor: 

“I have seen some tough cycles, but I’ve never seen owners of businesses as scared as they are now,” Mr. Thacker said. “Across the board, very few small-business owners I talk to are optimistic — all they can see is the short-term lack of credit.”

This is what the government was talking about back during the original bailout - when they threatened the livelihood of the American economy was at stake unless we freed up the credit markets.  They were right about that - this credit is vital for every business.  And we’re just now feeling the ripple effects of not having enough of it.