Comparison of the Characteristics of
Small Businesses with Large Businesses
Small Businesses are generally defined as privately-held businesses that are small
relative to other firms in the industry and operated by an owner-manager. The Small
Business Administration’s (SBA) general definition of a small business is one that
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does not dominate the industry
is owned by a few individuals
meets the SBA Size Standards by Industry
The Size Standards are set according to NAICS codes and based on either revenues or
number of employees. The following table provides general guidelines for broad classes
of industries:
Industry
Revenues
(Millions)
Agriculture
$0.75 – $12.5
Mining/Oil & Gas
$7.0
Construction
$7.0 – $33.5
Manufacturing
Wholesalers
Retail Trade
$7.0 – $29.0
Transportation
$7.0 – $25.5
Information
$7.0 – $29.5
Finance
$7.0
Real Estate
$7.0 – $25.5
Professional
$7.0 – $25.0
Health Care
$7.0 – $34.5
Entertainment/Food Services
$7.0
Other Services
$7.0
Number of
Employees
500
500 – 1,500
100
500 – 1,500
500 – 1,500
500 – 1,500
Many small businesses tend to have local or regional operations and the owners
typically have personal exposure to the creditors of the business through personal
guarantees that are often required as collateral for loans.
Large Businesses are defined as publicly-held businesses in which management and
owners are different and which tend to dominate an industry. These firms have access to
the capital markets and generally have national or international operations.
Management of the Small Business
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The owner of business is usually the decision-maker
There is no outside board of directors
Generally limited in ability to hire professional management and must
manage all aspects of marketing, finance, operations, personnel, etc.
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Leads to centralized management style and an inability to delegate
responsibility and authority
The owner is good at handling the day-to-day operations of the
business
Engineer/scientists are often creative inventors but lack skills in
marketing and selling. They expect the product to sell itself
Other small business owners are great at promoting the product and
making sales. Often, however, they do not know the financial side of
business and will close sales at the expense of profitability.
No plan for succession. Key man insurance can pay death benefits
but no one has been trained to assume the duties and responsibilities
of the owner-manager to ensure long-term survival of the company.
Transfer/sale of ownership is difficult. Selling a closely held business
is difficult due to a “thin” market and often requires the owner to
provide seller financing.
Accounting and financial information is generally used for external
purposes – tax and bank reporting -- rather than recorded in a manner
that is useful for internal decision-making purposes.
Accounting systems are usually the minimum necessary which often
is inadequate, especially for managerial accounting (internal control)
purposes.
Many decisions are made by the seat-of-the-pants rather than through
careful planning, such as:
o Pricing – “we’ll meet or beat any competitor’s price”
o Expansion into unrelated, non-synergistic product
diversification.
o Poor asset management, particularly with respect to
investment in receivables and inventory and especially for
rapidly growing firms.
o The make or buy decision – it is often assumed that
manufacturing is cheaper than out-sourcing and controls
quality.
o Similarly, it is often assumed that owning the premises is
better than leasing.
o Capital Structure Decisions – level of debt and equity is
usually predicated upon availability rather than a conscious
policy decision
o Liquidity Levels – Proper levels of working capital and liquidity
are rarely calculated at an optimum level.
Operating and Financial Characteristics
The lack of access to, and availability of, capital is the driving force that differentiates the
small business from the large business in terms of operating and financial
characteristics.
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Small businesses tend to migrate toward the less capital-intensive
industries of service and retail while large businesses tend to be in the
more capital-intensive industries such as manufacturing, transportation,
mining, telecommunications, technology, etc.
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Retailers and Service companies have fewer assets relative to sales and
thus asset turnover is higher for small businesses (twice as great as large
businesses). The fewer the assets per sales dollar, the less capital that is
required to be raised, the faster the turnover, but the greater probability of
loss of sales due to inadequate credit, inventory or capacity.
Fewer Assets means fewer barriers to entry and thus competition in small
businesses is greater than in large businesses, which tend to be
oligopolies. Greater competition and lack of volume purchasing and
economies of scale means profit margins are squeezed and small
businesses generally report one-half the profit margin of large companies.
Retail and Service sectors have higher investment in working capital
assets (67% in current assets) while the manufacturing sector has a
greater investment in fixed assets (67% in plant and equipment). Since
working capital assets are more highly correlated to changes in sales
than fixed assets, most small businesses exhibit less variability in
turnover rates than large businesses.
Small businesses are survival oriented not maximization oriented, placing
greater emphasis on cash, liquidity and turnover. Large companies tend
to emphasize profitability and return in order to maximize their stock price.
Many small businesses try to minimize their tax liability and purposely
drive profits down, which hurts their ability to raise capital.
Small businesses are more sensitive to economic change since large
manufacturers can monitor retailer’s inventories to signal a decline in the
economy and make necessary adjustments.
Small businesses are innovators, producing 10 times as many patents
per dollar of R & D as large companies. Large companies are exploiters
and many times purchase the technology or the company then distribute
the product internationally through well establishes distribution channels.
Small businesses tend to have short term horizons and are poor long
term planners. Planning is time and cost consuming activities which do
not have an immediate effect on revenues or expenses,
Small Businesses tend to have higher degrees of business and financial
risk. Fifty to Eighty percent of all business start-ups un the US will fail
within the first five years.
By definition, small businesses have a small share of market, may be
dominated by suppliers or customers, and do not have access to the
capital markets.
Comparison of the financial statements and ratios of small and large firms.
I.
The Balance Sheet
 Small businesses have greater current assets relative to total
assets (retailers are concentrated in inventories and service
firms in receivables).
 Small businesses have greater use of current liabilities relative
to total capital (since short term sources finance the greater
current assets. Small businesses rely on trade credit twice as
great as larger firms).
 Small businesses have slightly greater use of total debt, but with
a much higher percentage of short term debt to long term
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liabilities. These short term liabilities place greater pressure on
the cash flow of the business and thus greater financial risk.
Small businesses may tend to have a greater use of leasing
than larger companies as an alternative source of capital.
Large businesses do not repay debt from earnings or cash flow.
When bonds mature, new debentures are issued (few have
sinking fund provisions). Small businesses are required to make
monthly payments and are amortized on a relatively short
maturity (5 to 7 years maximum). This requires the small firm to
use cash flow to repay existing debt and leaves little to expand
the company, forcing it to continually seek new external funds.
Small businesses pay out less of its earnings in dividends than
large businesses since retained earnings are the major source
of equity funds for expansion for most small businesses,
II.
The Income Statement
 Revenues may be concentrated with only a few customers,
making the risk of loss of a customer greater as the small
business becomes so dependent on the large customer.
 Profit Margins (both gross and net profit margins) may be lower
due to increased competition, less bargaining position, and no
economies of scale.
 Profitability may be distorted by the small businesses
manipulation of revenues and expenses for tax purposes.
 Smaller profit margins means the small firm operates closer to
the break-even point and thus fixed costs tend to magnify
changes in sales to a greater degree (up or down due to greater
operating leverage).
 Owner’s compensation tends to rise with increased profitability,
thus keeping profit margins low. (to avoid double taxation on
dividends).
III.
Financial Ratios
 Small Business have faster turnover and greater liquidity ratios,
with less variability.
 Large Businesses have higher profit margins with less variability.
 Leverage ratios are slightly higher for small firms but a higher
percentage of short term debt relative to long-term debt.
 Return on Assets (ROA) and Return on equity (ROE) are similar
between large and small firms, but with much less variability of
return exhibited by large businesses. Do equal returns
compensate for the difference in risk between large and small
firms?
 No public stock price, no dividend payments, erratic growth rates,
short track records make calculating the firm’s cost of equity
difficult if not impossible. What required rate of return or discount
rate do you use for investment decision making?
 Small Businesses do not have betas and are not part of the
“efficient markets”.
Characteristics of the Small Business Person
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Willing to make sacrifices – long hours, risk of failure, loss of personal
assets, lack of security, last to be paid, etc.
Need for achievement and independence – like giving orders, not taking
orders. Like to lead, not follow. Willing to work hard if receive the benefits
of those efforts.
High esteem in the community – often serve on boards, etc.
Interested in people, good interpersonal skills.
Usually high intelligence (not necessarily education).
High energy, stamina, drive, creativity, and insight.
Many are high strung with a temper, type A personalities.
May see opportunities that other do not see or pursue a passion until it
becomes a successful business.
Willing to take calculated risks.
Elements of Success and Failure
Many business persons prefer to blame the economy, or the bank, or
competition, or government regulation rather than admit their poor management created
the failure. Studies indicate the following are often times the cause of failure.
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Poor Financial Planning / Lack of adequate records.
Poor Location.
Poor coordination between functions.
Absence Management / Nepotism.
Government Taxes / Regulation.
Failure to adjust to changing conditions.
Poorly planned diversification / Uncontrolled growth.
Poor Credit Controls.
High Financing Costs / Lack of Capital
Competition / Domination of Big Business.
Labor Disputes.