Size does matter

MANAGEMENT of a small business is different from that of a large one in many important ways, and knowing the difference can be a key to survival.

In 1981, an article appeared in the Harvard Business Review written by John Welsh and Jerry White titled: “A small business is not a little big business”. The main point of their article was to highlight the fact that small firms should not be viewed as posing the same management problems as large ones. This is due to the problem of resource scarcity, a major constraint for the small business manager not present in large firms.

This scarcity of resources is widespread and can include a lack of: money; time; employees; floor space; equipment; and managerial talent. Small firms cannot easily survive strategic mistakes, which many of their larger counterparts might simply write off somewhere in their balance sheets at the end of the financial year.

Most small firms are heavily dependent on continuous cash flow to keep solvent and cannot easily cope with sudden shocks such as changes to government policy, or the loss of a major client or contract.

Resource scarcity also affects small firms when they attempt to grow. By its nature, growth requires more resources than stasis and the small firm must find people, equipment and, of course, money to fund it all. Fast growth can be a killer for small firms if they lack the necessary working capital to fund the expansion, and then the managerial capacity to deal with the new workloads. If the cash flow cycle is not adequately planned for and managed, the small firm can find itself running towards insolvency despite having a full order book and a busy workforce.

As Messrs Welsh and White explained in their article, the difference between small and large firms is the magnitude of the changes that are produced by growth.

In large firms the relative rate of growth is typically modest; as such, their financial statements indicate a system that is mostly in equilibrium. By contrast, small firms are rarely in equilibrium; their working capital requirement fluctuates substantially, as does the cash flow.

The amount of cash at bank is the primary focus of the owner-manager in a small firm, but this will be determined by the firm’s break-even point, or the sales required for break-even. In a growth cycle the small firm’s break-even point will move as the business takes on more costs either variable or fixed.

Unlike the large firm, growth in a small firm often leads to overheads jumping in steps, which moves the break-even point significantly, while revenues rise in a linear manner.

What this means is that, for most small firms, cash flow is more important than profit or return on investment figures. Maintaining sufficient liquidity to meet working capital requirements is the most important issue. The small business owner-manager is also likely to be treated quite differently than their counterpart from the big firm. Raising money for large firms is usually easier than for small ones, as the latter lack the equity to use as leverage and often have negative equity in their balance sheet. The owner-manager is usually forced to put more risk over their family home to raise the necessary funds.

Little has changed since 1981. The global financial crisis has hit the cash flows of many small firms and the forthcoming return to growth will impose substantial challenges. Keeping an eye on the strategic goals is important for managers in small firms, but keeping watch on the basics is essential.

Summary

• Focus on cash flow as a priority.

• Forecast your working capital requirements against future planned growth and try to reduce this requirement over time.

• Monitor your break-even sales on a regular basis and adjust against cash flow forecasts.

• Recognise that turnover is less important than profitability, which is less important than liquidity.

SMEs confident in year ahead

SMALL business confidence has surged to new highs with profit outlooks at their best in almost 18 months on the back of growing consumer confidence, several recent surveys have revealed.

The Small Business Development Corporation’s Ready Response Network poll on small business expectations for 2010 indicate more than three-quarters of small- and medium-sized enterprises expect sales and revenue to increase in 2010.

Sixty-one per cent of respondents in the survey, conducted each December, expect their selling prices to increase this year, up from 49 per cent in 2009.

More than half (55 per cent) of respondents indicated they intended to explore new markets in 2010, while 35 per cent said they would look to employ more staff.

However, there is an expectation of higher staffing costs and challenges in finding new staff.

In the latest results of the NAB SME quarterly survey, small businesses with an annual turnover of between $2 million and $3 million recorded the biggest improvements in the December quarter, with that index up 13 points to 17.

SMEs with turnover between $5 million and $10 million rose by six to 14, while those with turnover between $3 million and $5 million increased by five points to eight.

Thee business conditions index for SMEs grew from five points last year to 13, while the profitability outlook index surged from 27 points to 35.

All states recorded increases in business conditions, with Western Australia recording a 13-point increase to three, moving into positive territory.

NAB business executive general manager, Geoff Greer, said the survey results followed a string of positive economic data, including a 20 per cent increase in the ANZ jobs series and an increase in consumer confidence.