I am writing this for the benefit of government officials and employees of businesses so that they may understand the position that business owners and managers are in – in terms of the difficult decisions they have to make.
A small business depends on cash flow. Cash flow comes from sales after expenses are paid. Sales have to be secured to produce cash flow and expenses have to be maintained at a level less than sales. Profit is sales minus expenses including payroll, but profit is not cash flow. Cash flow is profit minus payments of debt service on any loans and after reserves. Most businesses are lucky if they can secure profit of 1% to 3% of total revenue (sales), i.e. 1 to 3 pennies on the dollar, which doesn’t leave a lot of room for error. And cash flow can be even less.
Profit provides the seed capital for next year’s investment – investment in new products, new employees, new plant or equipment; growth. Without profit, there is no capital for next year. Without sales, there’s no cash flow. If expenses are too high, there’s no cash flow.
This is why owners of small business get a little worked up when the government (local, state or federal) causes an unnecessary or sudden increase in expenses – or the Fed raises interest rates on business loans – or the government causes a recession that reduces sales. (Recent example – Obama signing last minute executive orders in January that will result in hundreds of billions of dollars of new costs for businesses.)
Take the case of a restaurant owner for example. When government plans in advance for an inflation based increase in the minimum wage, an owner can plan for and accommodate a reasonable increase with (hopefully) a price increase or incrementally increased sales. But when the government lurches the minimum wage up significantly, as it has in so many states recently, such a large increase causes wage inflation throughout the entire business and demands that the business owner magically and immediately increase sales by the same unlikely increase or cut expenses to offset the added cost. (Consumers may tolerate some price increase of 2% or 3%, but not more.) Since the cost of goods is not going down, (in fact, with a sudden and large increase in the minimum wage at suppliers, the cost of goods also also increases some to offset those wage increases), the restaurant owner is forced to reduce costs by laying off employees in order to keep the doors open.
This is why significant and sudden increases in regulations, government fees, or the minimum wage (above normal inflationary increases) causes higher unemployment.
Likewise, when the Fed raises interest rates or local government increases taxes or fees or the federal government increases regulations that cause more costs, small businesses are forced to lay employees off because the marketplace will not bear a significant and sudden price increase in their products or services. (Why do you think many restaurants are going to on-line or tablet orders – to reduce employment and lower the risk of a significant hit with the minimum wage increasing.)
The issue is especially acute in business to business sales, where a small business is selling to another business. The buying business will attempt to find either an alternative supplier, or move production to lower cost overseas locations, or they may try to get the selling business to cheapen their product to reduce costs, because the buying business can’t pass the increase on to their customers either.
This explains why so many large corporations move production overseas. The savings from the lower foreign tax rates, from lower wage and labor costs, and from no burden from U.S. regulations is a huge incentive in order to stay competitive, but of course moving production overseas reduces American jobs. That’s why the tax rates have to be reduced and regulations that aren’t necessary be removed so that U.S. companies, especially small businesses, can compete. Otherwise, we’ll continue to loose jobs and the U.S. will become a second rate nation as we continue to give away our jobs and our economy to other countries.
Up Against the Wall is a monthly column written by Terrence Wall and reflects his views and opinions, and do not necessarily reflect the views of the Middleton Times.