On Monday, the New York Times detailed how the worsening credit conditions are affecting small businesses, as banks take on an increasingly risk adverse approach to lending and credit lines. Yesterday we talked about how small businesses are getting squeezed by increasingly late payments. Today, the Dow closed above the 10,000 mark for the first time in a year, buoyed by better than expected earnings from a few bellwethers and early signs of improving consumer confidence. The common thread in all of these events? Conditions do indeed seem to be improving for many of the nation’s large businesses. Unfortunately, a dual credit crunch conspires to thwart similar growth by the small businesses that make up the majority of the nation’s jobs engine and 50% of the GDP.

The NY Times article covered the familiar credit crunch: small businesses can’t get the loans and credit lines they need to expand operations, grow payrolls and pay their bills. In contrast, Cortera’s new Small Business Index™ focuses on the other side of the credit coin: Trade credit. Trade credit focuses on payments terms and behavior for advance products and services (e.g. inventory) – and more specifically cash flow.

What is interesting is that big companies are forcing their smaller customers to pay them faster, yet within our SBI we can see that these same small businesses now are taking longer to pay everyone else. And the Times reported, “As the financial crisis has largely eased in recent months, big companies have found credit increasingly abundant, with bond issues sharply higher.” Thus large businesses have been largely immune to the dual credit pressures facing small businesses.

To understand this dual credit crunch and its implications, one need look no further than cash flow. Many small businesses live under a tight cash conversion cycle so if they are pushing cash out the door quickly for one class of suppliers (big companies), but not being paid quickly enough by their own customers (other small businesses) then they can’t pay their own bills. Given that small companies have less access to other forms of lending (the larger credit crunch) that once they get behind it’s hard to catch up and harder to reinvest in business growth.

You can see how this starts to spiral if small businesses can’t tap other sources of lending to manage these cash crunches. Small businesses lack a financial cushion that large businesses enjoy through alternative cash sources like securitizing accounts receivable, new bond offerings, and new equity. Their only choice for a short term loan is to use their suppliers and stretch out payments. Essentially small businesses end up paying their smaller suppliers (that likely have less clout) more slowly as a form of a short term loan until more cash comes in the door (or they have to make cuts in other areas with layoffs, reduced hours, less inventory etc…).

The all too often result is, at best, little investment in growth (new products, hiring, expansion) and at worst leads to even more cost cutting (pay freezes, reduced hours, layoffs or even closures).

Such conditions require far more diligence when it comes to evaluating the credit viability of business partners and customers, and they require keeping a close eye on the changing payment behaviors of existing partners to detect early signs of risk.

As a small business owner, how are you managing this crunch? We’d love to hear your story and tips for surviving.

Posted in Economy, Small Business, Smalll Business Index
Permalink: http://blog.cortera.com/2009/10/14/dual-credit-crunch-conspiring-against-a-recovery/