Research Summary
The report examines the financial health of small businesses, focusing on their debt profiles, interest payments, and potential impacts of higher interest rates. It highlights the sector’s financial surplus and robust balance sheets, while also noting potential sensitivity to interest costs and challenges in accessing alternative financing.
Key Takeaways
Small Business Debt and Interest Payments
- Debt Profile: Small businesses have a bimodal debt maturity profile, with half consisting of short-term loans and credit lines, and the other half being term loans with an average maturity of 7 years. Small business debt is estimated to be around 60-65% of the sector’s gross output.
- Interest Payments: Small businesses spend a larger share of their revenues on interest payments compared to large businesses, with an estimated 6% of revenues going towards interest payments in 2021. This is projected to increase to around 7% by 2024 due to higher interest rates.
Impact on GDP and Business Operations
- GDP Impact: The drag on GDP growth from higher small business borrowing costs is estimated to peak at 0.1 percentage point in 2021, with the growth headwind expected to wane in 2024 before rising modestly later in the decade as term loans are refinanced.
- Business Operations: Despite the increased interest burden, the small business sector is running a financial surplus worth 9.1% of sector revenues and 2.5% of economywide GDP, which could partially offset the hiring and investment drag from higher interest payments.
Financial Health of Small Businesses
- Balance Sheet Strength: The sector’s balance sheet is healthy, with cash ratios and net worth ratios near 40-year highs, and interest income set to rise roughly 0.4 percentage point cumulatively as a share of revenues.
- Access to Financing: One risk is that small businesses may prove more sensitive to interest costs due to difficulty developing new banking relationships and accessing alternative sources of financing. The share of businesses reporting that credit was harder to get relative to a few months ago stands at 8%, higher than before the pandemic but in line with the average share in the early 1990s.
Role of Noncorporate Businesses
- Contribution to GDP and Employment: Noncorporate businesses, which produce 15% of US GDP and pay out roughly 15% of employee compensation, account for a significant portion of the small business sector.
- Industry Breakdown: The professional and personal services, construction, and health care industries account for over half of all income generated by the noncorporate sector.
Actionable Insights
- Monitoring Interest Rate Trends: Stakeholders should closely monitor interest rate trends and their potential impact on small businesses, particularly in terms of increased interest burden and potential effects on GDP growth.
- Exploring Alternative Financing Options: Small businesses may need to explore alternative financing options to mitigate potential sensitivity to interest costs and challenges in developing new banking relationships.
- Investigating the Potential of Noncorporate Businesses: Given their significant contribution to GDP and employment, noncorporate businesses within the small business sector present potential areas of focus for policy and investment.
