Small Biz Economy Woes

From smSmallBiz

A weakening U.S. dollar, slumping home values and higher prices on everything from postage to tomatoes are taking their toll on independent companies. The biggest threat to revenue growth and positive cash flow, however, is the record-high cost of gasoline, which has tripled since 2002. To be sure, "higher energy costs are going to affect everyone across the board," says Raymond J. Keating, the chief economist at the Small Business & Entrepreneurship Council in Oakton, Va. But "small businesses may [even] be impacted harder."

Take Todd Acklam, for example. He has worked as an independent truck driver in the California Bay Area for the past 25 years. As such, he's seen his fair share of boom-and-bust economies. Today, however, he says fuel costs eat away 35% of his revenues, compared to 12% a few years ago.

"It has definitely put a crimp in our style," says Acklam, who spends between $250 and $400 filling up his truck’s mammoth 280 gallon fuel tank just a third of the way each day. To fill the entire tank with diesel fuel, which on average in California costs $4.38 a gallon, would mean paying a whopping $1,226. Independent drivers, as a group, can increase their rates, says Acklam. But with competitors waiting in the wings, "it's a difficult business to make a profit in," he says. "When it's good, it's good, but when it's bad it's ugly."

Small businesses already pay more for most types of energy than big businesses, according to a recent study from the U.S. Small Business Administration's Office of Advocacy. For example, manufacturers with fewer than 50 employees pay 35% more for electricity than the industry average, while the largest manufacturers (those employing 1,000 or more workers) pay 17% less than the average. The cost differential is typically a product of big businesses simply being more productive than smaller firms using the same relative resources, says Chad Moutray, chief economist for the SBA in Washington. Plus, big businesses often negotiate lower prices on energy contracts, he adds.

The same is true for the price of raw materials. Big businesses (think Wal-Mart Stores) can typically negotiate lower input prices than smaller firms. That means any increase in food and energy prices will be felt fastest among smaller businesses, Moutray says.

While future cost increases may spell trouble, many enterprises are already feeling the pinch. In March, for example, the Department of Labor's consumer price index rose a modest 0.3% — and 0.2% for items when food and energy are taken out of the equation. However, producer prices, which surpassed an expected gain of 0.5%, surged to 1.1%, following a 0.3% gain in February. "This would indicate that businesses are probably eating those costs on the back end," says Moutray.

Rob Fairlie, a professor of economics at the University of California at Santa Cruz, says small businesses are especially vulnerable to economic turmoil. "They don’t have the resources to borrow against future years," he says. "It's not like [smaller enterprises] can have negative profits for three or four years either."

In addition to profits, cash flow, which gauges how much cash flows in to and out of a business, is an important indicator of business health. In April, 44% of small businesses experienced cash-flow issues over the last 90 days, according Discover's Small Business Watch, a monthly survey of 1,000 business owners with fewer than five employees. While that number was slightly better than the 47% that reported cash-flow problems in March, the survey also found that more business owners plan to trim spending in the next six months.

Another report, released this week, indicates that business owners are increasingly cutting benefits. The 2008 American Express OPEN Spring Monitor, a semi-annual survey of business owners with fewer than 100 employees, revealed that 6% of businesses reduced their health care coverage offerings in the last six months while another 6% eliminated coverage altogether.

Additionally, fewer businesses plan to hire over the next couple months, according to the National Federation of Independent Business Small Business Economic Trends survey, released in April. Although that depends on the region of the country, as "hiring is weak in New England and strong in the South," says Bill Dunkelberg, chief economist for the NFIB in Washington. And a company's industry affects hiring decisions, too. "Anything tied to housing is weak, while the most stable part of the economy is the services sector," he says.

But even as doom and gloom seem to pervade popular parlance these days, Alice Bredin, a small business advisor to American Express OPEN, warns that business owners may go too far. "If they make too many cuts right now, they'll be faced with the added expense of hiring back workers when things turn up again," she says. Business owners should instead look at this slowdown as an opportunity to refine business practices like collections and inventory procedures. "Now's the time for business owners to focus less on eliminating jobs or benefits and more on tightening up on the way things operate overall," she says.

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Write to Diana Ransom at dransom@smartmoney.com .