By: Elaine Pofeldt
April 23, 2014
Quick: What separates thriving businesses from those that struggle? Is it an amazing idea? A well-crafted business plan? Attracting an influential board? Being in the right place at the right time?
A new report released today suggests a far-different answer. The secret may be the owners' discipline in managing their personal finances and business cash flow, which for many tiny businesses are closely intertwined, according to findings from "In Search of Solid Ground: Understanding the Financial Vulnerabilities of Microbusiness Owners," a report based on a survey by the Corporation for Enterprise Development (CFED). CFED is a nonprofit that aims to help low- and moderate-income households build and preserve their assets. The research was funded by MasterCard's Center for Inclusive Growth, which focuses on building sustainable growth and financial inclusion. It was designed to find out what financial products these entrepreneurs need and how much the marketplace is meeting them.
To conduct the research, the CFED did an online survey among 716 microbusiness owners and a telephone survey of 214 counterparts in Miami and Minneapolis. By microbusiness, the CFDE means firms with five employees or less, including the owner. The CFED calculates that 92% of all small businesses in the U.S. fall into this category. Among such firms across the country, the CFED found, half have a household income of $50,000 or less, below the national median of $53,046.
Revenues of the businesses in the CFED's survey ranged from less than $49,000 to more than $1 million annually, and in most cases, the business was the owner's primary job. The entrepreneurs in the phone survey tended to be older and more experienced than those in the online survey. The majority of both groups brought in less than $200,000 a year in revenue. Most respondents had completed two or more years of college.
What the CFED found about both savings rates and cash-flow management among the owners was startling.
* Among the online respondents. 55% said they could only cover a single month's business expenses with their savings-and 30% had no business savings at all. "We were shocked," said Lauren Williams, one of the survey's authors. (Just 17% of the online respondents had three months' of business savings.)
* Even among the more established owners who responded to the phone survey, 49% said they had two months' business savings or less.
* Asked how they would handle an emergency business expense of $1,000, 41% of the online respondents said they would have to tap personal savings, and 31% would have to borrow on a personal credit card. Some operate in constant jeopardy: A full 15% said they could not cover such an expense at all.
* Forty-seven percent of owners of businesses from one to three years old said they had a damaged or insufficient credit history that affected their ability to borrow. For businesses over 10 years old, this problem affected 19%.
* Problems managing cash flow plagued businesses of all ages and sizes. For the online survey respondents, 40% sometimes lack the cash on hand to meet business expenses. The picture was not much better for the more seasoned owners on the phone survey, among whom 37% have the same problem. Forty-two percent of that group attributed their cash crunch to a gap between the delivery of products and services and payments, and another 35% cited low sales.
* When businesses experience cash-flow problems, their household income suffers, because owners often skip a paycheck. Among respondents who had experienced a cash crunch, 66% skipped a paycheck in the past year.
*Many owners are not able to save any money personally. Among the phone survey respondents, 32% said their households weren't saving. And among owners with cash flow problems in their business, 51% said they have no household savings.
In interpreting the results, it helps to understand the demographics of the sample.
In the CFDE's phone survey, the average number of years in business was 17.5. Among that group, the largest subset of owners generated $50,000 to $199,000 in revenue, representing 35% of respondents. The average age was 52.
In contrast, for the online survey, most firms had been in business for four years or less. Among them, 61% of entrepreneurs brought in $49,000 or less in revenue, making up the largest subset. The average age of respondents for the online survey was a little younger: 48.
There was a slight oversampling of African American and Hispanic entrepreneurs. While 7.1% of U.S. entrepreneurs are African American, 24% of respondents to the online survey and 11% of phone survey respondents were. Nationally, 8.3 percent of small business owners are Hispanic, but in this research Hispanics made up 23% of phone survey respondents and 16% of online respondents.
Although the sample is not as representative as, say, a national Gallup poll might be, my experience in reporting on entrepreneurship tells me that the findings are relevant for owners at all income levels and in many demographic groups. I have seen many founders give up on a new business reluctantly because they could not balance the cash flow equation or were putting so much of their own money into a business that it was putting a strain on their families. Even if you are running a multi-million dollar business, poor cash flow can destroy it.
So what can entrepreneurs do to avoid cash shortages and save more?
Seek advice. If your sales are low, some part of your business needs fixing and it is probably time to get an outside perspective. I'd suggest talking with successful entrepreneurs you know, joining an association in your industry where you can expand your marketing efforts by attending low-cost events, or paying a visit to your local Small Business Development Center, where you can get free help.
Stay organized. Entrepreneurs who kept records of income and expenses using Excel spreadsheets fared better in managing cash-flow than those who used software, interestingly. Only 22% of those who use Excel spreadsheets and 40% who either used software, outsourced record-keeping or had an employee tackle it reported cash-flow problems. The entrepreneurs who had the worst cash flow problems were the ones who simply relied on saving piles of receipts. Among this group, almost two-thirds have cash flow problems. (Some good news: Only 8% of owners use this method).
Why is Excel more effective than online software? The researchers didn't probe deeply into this but it appears that the folks who use Excel may have more financial know-how. "An assumption we started to make is there is a chance that people using Excel have the training or knowledge to set it up," explained Williams.
My suggestion is to experiment until you find a method that you will use consistently and then stick with it. I tried Excel sheets and one popular software early in starting my freelance business and found that I was always playing catch-up because I dreaded using them. Once I switched to an inexpensive cloud-based accounting system that is designed for freelancers, I actually came to (almost!) enjoy keeping records and checking on my cash flow and other metrics.
Stretch out payments. Respondents to the survey who used a credit card and checks to manage expenses, instead of paying with debit cards and cash that depleted their bank accounts more quickly, had better cash flow. Among those with cash-flow problems, 47% used cash or debit cards to cover expenses, rather than checks and credit cards that left money in their bank accounts a little longer.
Of course, given that many of the owners of younger businesses said they had poor or inadequate credit, credit cards may not be an available option for them. But as the report points out, most businesses have a checking account. Buying yourself a few extra days to make a payment that way could mean the difference between delaying your paycheck-or not.