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Small Business

Manage Your Business

New study finds majority of small businesses unprepared for cash crisis

Neva Peterson founded a bookkeeping and consulting business in Las Vegas five years ago, mainly on a shoestring budget, working alone from a home office.

Before the first year ended, she'd grown Neva Knows Business enough to sublet office space, and hire a part-time employee. That employee worked more hours as Peterson brought in additional clients. Soon, it was time to hire again. Business was flourishing, but there were occasional cash shortages when Peterson needed to make payroll.

“When I increased my staff by just one person, it did create a cash crunch until I could get that person trained and bring on additional clients," Peterson says, noting that only then could she bill more hours. "Maybe it wasn't the best thing to do, but I took a cash advance from my credit card to cover payroll." Such advances typically come with very high interest rates. Fortunately, Peterson was able to pay herself back quickly.

Cash is king

A new report from the JPMorgan Chase Institute shows Peterson is hardly the only small-business owner to struggle with cash flow. Analyzing data from nearly 600,000 small businesses across the US whose owners hold Chase Business Banking deposit accounts, the report found that only half maintain a cash buffer large enough to support 27 days of typical cash outflows.

In the report, cash buffer days are the number of days of cash outflows a business could pay from its cash balance were its inflows to stop. The Institute estimated cash buffer days for a business by computing the ratio of its average daily cash balance to its average daily cash outflows.

Cash balances held by a business provide a cushion to absorb unexpected shortfalls in revenue or increases in expenses. Those unforeseen events could range from a client who doesn't pay to a vital piece of machinery breaking down. Yet, about one-quarter of small businesses maintain a cash buffer of just 13 days or fewer, making them particularly vulnerable to cash flow crises. And while many small business owners may be able to use credit or other resources to provide some protection, most have limited access to financing.

That was certainly true for Peterson when she tapped her credit card in order to meet her payroll obligations.

“Small-business loans are so hard to get," Peterson says. "It's practically like donating an organ, you have to jump through so many hoops. And, meanwhile, the clock is ticking."

Small businesses are fragile

The median cash balance held by all small businesses is $12,100, but these vary substantially across industries. Personal service companies, such as salons and dry cleaners, tend to hold the lowest average daily cash balances, at just $5,300. High-tech manufacturing held the largest, at $34,200.

Median inflows and outflows across all small businesses averaged just $380 per day (approximately $140,000 per year), indicating that the typical small business can provide few full-time incomes, for owners or employees, after covering other expenses. Only this year has Peterson consistently been able to pay herself a salary, partly because she has always believed in paying her employees first.

"I know that goes against the school of thought that says you should always pay yourself first," Peterson says. But she invests heavily in the people that work for her.

“When I started hiring people, I would try to find the best person for the least amount of money. But then I would train them, and they would leave to make more money elsewhere," she says. "I've learned that I'm better off paying more than I think I can afford for a good person. They get off the ground faster, can bill more, and pay for themselves in the long run."

Lessons learned

Peterson also believes that in her business it's important that clients see her being a good steward of her money.

“Dimes truly do make dollars," she says. So she maintains a very strict budget for office supplies, right down to paperclips and reams of paper, and purchases office furniture secondhand.

Peterson knows—from personal experience and from working with plenty of small-business owners—that struggling to manage cash flow and control expenses is not uncommon.

SCORE, a non-profit organization that helps small businesses, recommends maintaining cash reserves equaling three to six months of expenses; only a quarter of small businesses hold more than 62 cash buffer days. Restaurants maintain the least, with a median of 16 cash buffer days. Real estate companies maintain the most, averaging 47 days. Other professional services, such as Peterson's company, maintain an average of 33 cash buffer days.

Peterson says she's doing a little better than the average for her industry. She maintains about six weeks of cash reserves and feels comfortable there, since she has a solid client roster that pays her on time.

When asked about the three to six months of expenses benchmark, Peterson laughed.

“Three months would be heaven," she says. "I would go on a cruise if I have that much money in the bank."

To learn more about small business cash flows, balances, and buffer days, download the full report.

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