Submitted by Tim Mazzarol on Fri, 11/19/2010 - 15:28
Management of a small business is different from that of a large one in many important ways, 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 that was 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 problem as large ones. This is due to the problem of resource scarcity, a major constraint for the small business manager that is 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. The majority of 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 impacts on the small firm when it attempts 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 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 the small firm is rarely in equilibrium, the firm’s 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 sees overheads jump 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 later 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 recent 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.
In summary:
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Focus on cash flow as a priority.
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Forecast your working capital requirements against future planned growth and try to reduce this requirement over time.
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Monitor your break-even sales on a regular basis and adjust against cash flow forecasts.
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Recognise that turnover is less important than profitability, which is less important than liquidity.
This article was first published in WA Business News.
©Tim Mazzarol (2010)