Most of Your Small Business Customers May Be in Dire Straits

After two years of battling the Covid economy, inflation pressure and the prospect of a recession have put many small businesses up against the ropes. According to a June 2022 study by Digital.com, nearly two out of three small businesses say that continued inflation could force them to close shop. The study surveyed 1,000 owners or co-owners of businesses with fewer than 500 employees.

The pandemic caused a boom in small business formation. According to US Census Bureau data, there were 9.8 million new business applications filed in 2020 and 2021. Juxtaposed against this wave of startups, statistics compiled by the US Bureau of Labor, consistently show that more than 30% of new businesses fail before they reach their second anniversary. Within this context, the Digital.com survey is projecting customary small business failure rates to double.

Here are some additional insights about the small businesses that say they are ‘likely' or ‘very likely to fail if inflation does not moderate:

• • 62 percent of the businesses were founded since 2020
  • 73 percent of the business were founded between 2017 and 2019
  • 57 percent of the business were founded between 2007 and 2011
  • 55 percent of the business were founded before 2007

Under normal circumstances, older businesses have a distinct advantage over startups in terms of their customer base, when hard times arrive. Businesses survive when loyal customers keep them afloat. Unfortunately, Covid has disrupted those ties in many industries. The following chart provides an industry breakdown of small businesses likely to close:

Survival Tactics Equal Red Flags

In terms of causing distress, the top two factors were pandemic-related issues and the loss of customers, both cited by 50% of the survey respondents. A decline in revenue (46%), supply-chain issues (44%), labor shortages (43%), and higher-than-average staff turnover (31%) were the other major factors.

To survive, there are several things a small business owner can choose to do. Topping the list are employee layoffs, salary cuts, and raised prices. These and other changes your small business customers may make are clearly signs they may be in distress.

Credit executives, therefore, need to be vigilant, especially in regard to the small businesses in their AR portfolio. Any small businesses that are critical customers should be watched very closely. A good rule of thumb for defining a critical customer is provided by the concept in the accounting of materiality, which in this case would be defined as 5% or more of a company's pre-tax income. The loss of such a customer could not only cause a substantial bad debt loss but would also impact sales going forward.

In addition to the prioritization of the accounts to watch very closely, you should increase monitoring of all your small business accounts and be more aggressive in your collection strategies with those accounts. Of course, this takes added time and effort. To offset that, you may also want to consider migrating your smallest purchasers or sales under a specific threshold to credit card or cash in advance. This will decrease the number of customers and transactions that require monitoring and collection follow-up.