Shawn has a masters of public administration, JD, and a BA in political science.
Nearly every business starts 'small.' In this lesson, you'll learn how a small business is defined, some characteristics of a small business, and the importance of them in the economy. You'll also learn why some small businesses fail.
Small Is Relative
Small businesses are not necessarily as small as many people think. Business size in the United States is typically defined either by the number of employees a business has or by the size of the revenue generated by the business. You may be surprised how big some small businesses really are.
In some industries, the number of employees employed by the business defines its size. For example, the size of manufacturing, mining and wholesale trade businesses are defined by the number of people employed. The Small Business Administration (SBA) considers any manufacturer with no more than 500 employees as a small business. Wholesale trade businesses, on the other hand, are considered small if they employ 100 people or less. Generally speaking, most people will view a business with 100 or fewer employees as the common, everyday definition.
The size of a business is often based upon the revenue they generate, broken down by specific sectors of the economy. The Small Business Administration considers any general construction business that has revenues of $31,000,000 or less as small. Retailers can generate as much as $6,500,000 per year and still be considered small.
Business and personal service companies, such as law firms, accounting firms, medical practices and other companies that provide personalized service to customers, also may generate $6,500,000 and still be considered small. Architectural and engineering firms can generate $4,500,000 in revenues and still be small. Agricultural business, however, can only generate $750,000 per year and still be considered small.
Microenterprises - Tiny Businesses
When you think of a small business, you are probably thinking about a microenterprise. A microenterprise is a business that is owned by one or just a few people and employs no more than 10 employees. In fact, many don't employ anyone. Most microenterprises provide goods or services for their local communities. Examples include lawn care services, real estate agents, auto mechanics, clothing boutiques, used bookstores, house cleaners, plumbers, roofers, at-home daycare providers and small restaurants.
Small Business Dominates Economy
There is power in numbers. Any one small business doesn't have a significant impact on the United States economy, but in the aggregate, small businesses dominate the economy. According to the Small Business Administration, there are about 23 million small businesses operating in the United States, and they generate 54% of the sales in the U.S. The SBA also notes that small businesses create 55% of all jobs.
Characteristics of Small Businesses
Let's take a look at the characteristics of a small business as it evolves. Meet Steve. Steve worked at a 9 to 5 grind in a cubicle for most of his adult life, but his hobby is woodworking. About five years ago, Steve decided to abandon the cubicle, throw out his ties and start his own custom cabinetry business. Unlike a big business, he cannot go to an investment bank and hope to obtain investors who will buy stock in his small company. Steve uses his personal savings and a small business loan to start his new business.
Steve is frugal. In the beginning, he runs the business out of his house. His garage is his workshop. And, like many small business owners, when Steve first needed to hire employees, he started with his family. His wife managed the company's books, and his son worked part-time to help out in the workshop to fill orders as needed.
Over the next five years, the reputation of Steve's business grows, as does his customer base. He's able to convince some local custom home builders to use his business as a subcontractor for cabinetry. Steve now leases a commercial space and is hiring more employees. In fact, his company employs 15 people by its five-year anniversary, and gross sales revenue is approaching $3,000,000.
Why Small Businesses Fail
Steve's business is successful so far, but he does face many hurdles that can cause his business to fail. One of the biggest reasons any business fails is poor planning. A successful entrepreneur will plan out all aspects of his business before opening the door. You need to make sure you have a product or service that is in demand. You need to plan your operations, including your location, financing, hiring needs, budgeting and forecasting growth. In other words, you need a business plan.
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Another reason that small businesses fail is errors in expansion. Expanding a business, such as adding new locations or adding to your products or services, is expensive. The risk increases when you expand beyond your home territory or start offering goods or services outside your core business. For example, a lawn care company moving into snow removal will have to make significant equipment purchases, gain competency in removing snow and face different and unfamiliar competition.
As the old cliché goes, 'it takes money to make money.' One of the biggest reasons small businesses fail is inadequate cash flow. If you don't have the cash to pay your employees, suppliers and lenders, your business will not last long. It's vitally important that small businesses carefully monitor the money coming in and going out of their businesses, so they can plan accordingly.
One of the greatest advantages of owning your own business is that you're the boss. But, this is a double-edged sword. Since you don't have to answer to anyone in your company, there's no one to force you to abandon a bad business strategy. Sometimes a business will fail because its owner will simply refuse to alter a strategy that is failing.
Customers are the lifeblood of a business. No business can survive without customers. The erosion of a small business's customer base is another major reason for business failures. Sometimes this decline in customers may be due to mistakes the business makes, such as poor customer service, and sometimes it's out of the business's control, such as when a big chain retail store moves into town.
Seldom does a business fail overnight. Usually, there will be warning signs, such as declining sales, increased expenses, customer complaints or the entrance of a new competition into your market area. However, if you don't pay attention to the warning signs, you can't be proactive and attempt to correct the course of your business.
Let's review what we've learned. The size of a business is usually defined either by the number of employees it employs or the amount of revenue it generates. Small businesses can have hundreds of employees and millions in revenue and still be considered small.
A microenterprise, on the other hand, is a tiny business that is owner-managed and may employ nobody. Small businesses are usually owned by one or just a few owners, are financed through personal savings and bank loans and often employ family members. Small businesses may fail due to poor planning, mistakes in expansion, cash flow problems, following failed strategies, erosion of customer base and a failure to see warning signs and act accordingly.
After you have finished with this lesson, you should be able to:
Explain the factors that define a small business
Identify examples of businesses defined as small by the Small Business Association
Describe factors that may cause a small business to fail
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