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Many small businesses teeter as costs stay high while sales drop

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Many small businesses teeter as costs stay high while sales drop

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The U.S. economic outlook has brightened now that inflation is easing, the Federal Reserve is cutting interest rates and the stock market is vaulting to record highs almost daily.

Yet many small businesses are struggling to survive as they cope with more financial strains than they’ve felt in years, posing at least some risk to an expected “soft landing” for the economy that avoids a recession, loan advisers, trade groups and some economists say.

Despite slowing inflation and falling rates, small business labor and other expenses are still elevated and interest rates will have to decline much further before they make a tangible difference in the cost of loans, experts say. Meanwhile, sales are flattening as consumers pull back their discretionary spending following a post-pandemic burst, squeezing business owners’ profits.

The cash cushion that helped sustain many small companies through the ups and down of the past few years has run dry. Businesses have depleted the federal government’s pandemic rescue money, and loan payments that were deferred are now due.

“It’s a perfect storm,” says Ami Kassar, CEO of MultiFunding a small business loan advisory firm. “Their expenses are way up, demand is flat…A lot of them are on shaky ground. It almost feels like a silent pandemic.”  

Kassar estimates that about 20% of his small business clients are grappling with a severe cash flow crunch and some portion will likely shutter or declare bankruptcy.

Overall, most small firms are on solid financial footing despite narrower profits and many of those struggling will likely ride out a challenging period, economists say.

“The pandemic has shown us that small business owners can be quite resourceful, and this has helped them navigate current challenges,” said Shernette McLeod, an economist at TD Bank.

Yet their financial woes may pose a recession risk if a significant number shut down or dramatically increase layoffs to stay afloat, experts say.

“If small businesses start laying off workers, that can spread to medium-sized companies and it can cascade from there,” said Ryan Sweet, chief U.S. economist of Oxford Economics, adding he doesn’t think that’s the most likely scenario. “They’re the backbone of the labor market.”

Small businesses with fewer than 500 employees account for nearly half of U.S. employment and most job creation, according to the National Federation of Independent Business (NFIB) and the Small Business Administration (SBA). Enterprises with fewer than 100 employees employ about a third of private-sector payrolls, the Census Bureau says.

U.S. job growth has slowed substantially in recent months and much of that can be traced to small businesses. Since April, firms with fewer than 50 employees have shed jobs while large companies have added positions, according to ADP, a large business payroll processor. Paychex, another payroll processor, said the recent job losses at small enterprises it services are the first since March 2021.

Small businesses are scaling back as their costs have spiraled higher. Amid COVID-induced labor shortages, business owners sharply hiked wages to compete for workers with larger companies that can offer higher salaries and benefits. Interest rates on SBA loans have leaped to about 11% from 7% in 2022 as the Fed hoisted its key rate to tame inflation. And rent jumped 11% annually in July, twice as much as consumer rent increases, according to the Bank of America Institute, which researches consumer behavior and the economy.

Coventry Creations – which sells candles, oils, sprays and other spiritual and occult products – saw sales soar 85% in 2021 as Americans splurged with federal stimulus money and cash they socked away from staying home during the pandemic, says co-owner Jacki Smith.

The company, based in Ferndale, Michigan, makes some of its products, wholesales items to small stores, and sells online and at its own local shop. It had to add 13 employees to its staff of 17 to handle the surge in demand.

But sales for the 32-year-old company have declined each year since 2021, said Smith, who co-owns the firm with her sister, Patty Shaw. In 2023, revenue was 30% below the pre-crisis level and the business has been losing money.

Some of the stores that offer its products closed as the spread of remote work meant fewer office workers stopping in during lunch or on their way home, Smith said. At the remaining shops, revenue tumbled as Americans struggling with inflation and lower savings shifted to more essential, and fewer discretionary, purchases.

Yet since the pandemic, Smith has had to increase employees’ starting hourly wages from about $10.50 to $16.50. Supply costs have jumped about 30%. And the interest rate on her line of credit for operating expenses climbed from 7% to 11%, she said.

She and her husband have stopped eating out, going to movies and taking vacations. And they buy groceries in spurts. “We wait til we get paid,” she said.

The business has rung up $700,000 in debt and fallen behind on payments to suppliers and other creditors.

“Most days, you think, ‘Do I even want to do this again’” she said. “It’s a constant vigil to make sure I’m not falling down.” Sometimes, she added, “I wake up in a panic.”But she said she’s working to beef up marketing for Coventry Creations’ online business and trying to tailor some products to more mainstream stores, such as gift shops.

“I’m determined this business will survive,” she said, though she has considered the possibility of bankruptcy. Her staff has shrunk back to 17 employees and she’s had to cut some of their hours.

Other small companies are coping with skyrocketing insurance and rent.

In July, 41% of small businesses owners said they couldn’t pay their rent in full and on time, according to a survey by Alignable, a small business networking platform.

At the same time, sales are flagging as Americans trim some of their purchases. In July and August, the gap between small firms reporting lower versus higher sales the past three months reached the second highest level since 2020, according to NFIB’s monthly survey in August.

Although large companies face similar obstacles, they have more diverse revenue streams and bigger cash buffers, said David Tinsley, an economist at the Bank of America Institute.

Big companies also have more flexibility to pass along their higher costs to consumers because they enjoy larger market shares and can offset higher prices on some products with lower prices on others, said Anthony Rose, chief financial officer of Kapitus, which provides funding to small businesses.

For entrepreneurs, the higher costs and lower revenue are eating away at their bottom line.

In July, 51% of small business owners said they were earning half or less of what they netted a year ago, up 9 percentage points from March, according to a July survey by Alignable. And 72% said they’re making less than they did before the pandemic, the highest monthly share so far this year.

Bank of America’s data shows that money flowing into small business savings accounts still exceeds outflows but the net gain is now below pre-pandemic levels.

For several years, many small companies relied on some remaining cash from the federal government’s Paycheck Protection Program – intended to pay employees’ wages early in the health crisis – to meet expenses. “That’s gone,” Kassar said.

But while the federal government repeatedly deferred repayments of other emergency aid, business owners had to start repaying those loans last year, adding another monthly expense, Kassar said.

Envision Tee, a Dubuque, Iowa-based custom T-shirt printing company, had to start repaying a $500,000 emergency loan last year, adding about $2,000 to its monthly costs, said CEO Tom Rauen.

That’s not much, he said, but it’s on top of a 50% rise in the cost of blank shirts and a 25% increase in wages the past few years. The company has been able to raise the prices it charges companies, sports teams and other organizations by just 10%, pinching its margins.

After being flat the past couple of years, revenue has dipped slightly this year, in part because of uncertainty about tax and other policies due to the upcoming election, Rauen said. His customers, similarly squeezed by higher rent, taxes and other costs, have been paying him late, compounding his financial stress.

“We’re going to be the last one paid,” he said.

Fed rate cuts should provide some relief by lowering borrowing costs, but not quickly.

“It’s going to take a while for rates to come down to make a difference,” said Lionel Felix, CEO of Austin, Texas-based Felix Media Solutions, which installs videoconferencing systems in company offices, The interest rate on its credit line has shot up to about 11% from 4% a few years ago, he said, adding that revenue for his business has been flat.

Some businesses are falling behind.

In July, the share of small businesses that were 31 to 89 days late on their loan payments climbed to 1.8% from 1.2% in early 2022, just above the pre-COVID level, according to TD Bank and Equifax. And the rate of severe delinquencies (90 days or more) was at 0.7%, also slightly above the 2019 mark.

“Some small businesses…are at the end of the road” and will likely shut down, says Holly Wade, head of the NFIB Research Center.

Others say the fate of many of the companies may depend on consumers’ spending appetite. “If demand holds up, (small businesses) will struggle through it,” says Rohit Aurora, CEO of Biz2Credit, which helps small firms find lenders. “If demand drops very quickly, we’ll see a sharp spike in bankruptcies.”

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