No doubt, owning a small business is part of the “American Dream.” But why do so many fail,
and what responsibility do banks have to make the odds of success better?
Small Businesses comprise approximately 99% of all companies in the United States and have
been responsible for approximately 63% of new job creation since 1995 (advocacy.sba.gov). Of
that 99%, only 1.5% of the businesses have gross revenue (sales) above $500 thousand annually.
Of that 1.5%, only .20% have gross revenue above $1 million.
Consider this: 68% of businesses survive the first two years, and nearly 50% survive for at least
five years. At ten years, the survival rate drops to 34%; at 15 years, only 26% of small
businesses still stand (SBA.gov). According to Visual Capitalist, 82% of failed businesses
cite cash flow as the primary reason for failure. This statistic underscores the crucial role that
cash flow management plays in the survival and success of a company. It’s not just a statistic but
a powerful reminder for all small business owners and banks to prioritize and improve their cash
flow management.
I’ve worked in the banking industry for 37 years, owned an eight percent or more share of two
community banks, and have owned my bank consulting company for almost nine years. I have
paid the dumb tax and have seen even more mistakes made by others. In my experience, it
seems that cash flow is not emphasized as much as it should be. Banks are good at calculating
cash flow on their commercial loan customers, but I have seen a troubling pattern in which banks
revert to collateral and projections for ongoing loan grades and servicing. It has been my
observation that after the projections show a positive cash flow and adequate collateral, then the
historical trends are ignored along with working capital trends and several other KPIs significant
to telegraphing the health of a business, whether it be commercial or agriculture.
For me, a projection is a set of assumptions based on history or industry applied through
accounting. However, the documentation of these assumptions in a credit memo is often
missing, and there are even fewer back-tests at the following annual review. We generally see a
new projection, almost always showing positive cash flow regardless of the historical trend. But
the analysis shouldn’t stop there. It’s crucial to back-test these assumptions and ensure they align
with the business’s actual performance and strategy, not just the projections.
In my opinion, at least annually and more often, if necessary, based on the business’s growth
strategy or complexity, the analyst or officer should review the projections (assumptions) versus
the actual performance and cash flow. Even though financials are generally a lagging indicator,
periodically reviewing them is an important opportunity. It is an opportunity to see if the
business is growing and needs more capital, maybe a new loan opportunity, or if it is struggling
and needs help. Either way, it’s an opportunity to help your customer. The odds are truly stacked
against them.
In my experience in this industry, I find that the business owners are generally damn good at
their craft but are terrible at understanding financials, or they don’t have an accounting system in
place, and more particularly, their tax returns are their accounting systems.
So, suppose 98.5% of all businesses have less than $500 thousand in gross revenue, and cash
flow is the number one killer of business. Why is there little emphasis on ongoing servicing,
cash flow reviews, and projections versus actual performance? Yes, collateral is necessary and a
critical component of a loan, but it rarely pays the bills unless it is an asset-based business.
Now, what can be done about it? How do we right the ship?
Maybe a better way is to perform the projection calculations, discuss in detail the assumptions
that were made, and continue with the comparison of the projection versus the actual historical
trend lines. Then, examine the variances (misses on the assumptions). Why were the variances
outside the trendline, and are they correctable? A stable business should not have erratic
variances and should not have, in most cases, multiple bad years over a specified time horizon.
Business owners who struggle with cash flow in their business also struggle with cash flow in
their personal lives. A small business in a growth stage can be very complex and tricky if the
owner and the bank are not brutally honest with themselves. When a small business has three
bad years out of a 5-year time horizon, a problem is not being addressed. Yet often, I see bankers
pass a loan, as do the examiners, because the projections indicate a more positive year. So, my
concern is that after the first year, the bank should be on top of the situation and the problem
already addressed, but we rarely see this occurring in loan reviews.
Now that we know that the failure rate for small businesses is high, with a 50% survival rate by
year five and 34% or less for businesses ten years old or older, WHY are we as an industry not
placing more emphasis on educating our customers, cash flow analysis, and ongoing servicing
requirements for commercial and agriculture loans so that we can improve the statistics and
hopefully improve people’s lives and their businesses? Isn’t that our charge in this industry?
Not only would this thorough annual review help the small business owner ( and therefore lift the
economy of your community), but it would also help the community bank’s success. After all,
we are meant to be customer service-oriented, not transactional.
McSwain Consulting can help your bank. Let’s have that conversation about how we can help
ensure that your bank stays proactive and safe through our services.