Financing and the Economic Environment for Small Firms

Small firms are important to the trajectory of the American economy. According to the Small Business Administration, firms with fewer than 500 employees comprised 99.9 percent of all firms and generated 44 percent of U.S. economic activity in 2019. The CFO Survey Q2 2023 results suggest that in recent months, these small firms have been less upbeat than large firms about the U.S. economy. Although optimism about the U.S. economy was low for all firms in the second quarter, optimism among large firms increased slightly in the second quarter, while optimism among small businesses decreased. Compared to large firms, small firms also reported lower expected revenue growth in 2023 and have been more likely to change their investment or spending plans because of access to or the cost of financing. These results suggest that challenges in the current economic environment are disproportionately affecting small firms, which might have fewer options with respect to pricing or financing.

Tightened Financing Is Constraining Small Firms

Rising interest rates and stress in the banking sector have created a tighter financing environment for all firms. However, small firms were more likely than large firms to report changes to investment or spending plans. According to the second quarter of The CFO Survey, 32 percent of small firms reported that since the start of 2023, financing conditions have constrained their firm's investment or spending plans, compared to only 19 percent of large firms.

An even larger difference between large and small firms became apparent when respondents were asked if they anticipate that access to financing will constrain their investment or spending plans between now and the end of 2023. Altogether, 40 percent of small firms have already or expect to change their investment or spending plans in light of tighter financing compared to only 26 percent of large firms.

Why Are Small Firms More Constrained Than Large Firms?

One explanation for the divergent experience of large and small firms is that large firms have access to more financing options than small firms, either because they are less risky to financial institutions or because they have other means of accessing funds. In fact, when asked why access to or the cost of financing was not constraining their investment plans, large firms were much more likely than small firms to reply that they faced favorable financing, while also being less likely to say that they don't finance spending with debt. In other words, large firms seemed more likely than small firms to have funding options.

How Is Access to Financing Constraining Firms?

If financing access did constrain spending or investment, most large and small firms reported that it prevented them from fully pursuing new business opportunities. Of the 14 large firms that reported availability or cost of financing as a constraint since the beginning of the year, 71 percent said that the impact was felt when pursuing new business opportunities; this was also true for 84 percent of the 81 small firms that reported changing investment or spending plans. Small firms were also more likely than large firms to report an impact on their ability to refinance or pay down debt and, to a lesser extent, repair or replace existing capital assets.

With small firms more likely than large firms to report constraints in pursuing business opportunities, perhaps it is not surprising that small firms are less optimistic than large firms about both the U.S. economy and their own-firm prospects.

Small Firm Optimism Is Low … and Falling

Small firms are less optimistic about the U.S. economy than large firms — and that optimism has been falling. Although own-firm and overall economic optimism among large firms remain below where they were in 2021, both measures have been growing since 2022. For small firms, on the other hand, optimism about the U.S. economy flattened well below its 2021 peak, and optimism about own-firm business prospects has been on a downward trajectory since the middle of 2021. This appears to be connected to the tighter financing conditions: Those small firms who either have had to or expect to change their investment or spending plans due to the availability or cost of financing had even lower optimism for their own-firm prospects.

Small Firm Revenue Expectations Are Lower

Since small firms are more likely to be constrained in their ability to finance new business opportunities, perhaps it is not surprising that their expectations for revenue growth in 2023 were also below those of large firms (median of 4 percent versus 5 percent). There was also a notable decline in small firms' 2023 revenue growth expectations from the first quarter. Of course, experiences within small firm categories can vary: In the second quarter, the 2023 revenue expectations were notably lower for the smallest firms, or those with fewer than 100 employees, than for firms with between 100 and 500 employees.

What's Next for Small Firms?

The second quarter of The CFO Survey indicates that the current outlook of small firms is noticeably worse than that of large firms. On average, compared to large firms, small firms report being more affected by tight financing conditions, are less optimistic about the economy and their own prospects, and expect lower revenue growth in 2023. However, there is one piece of good news: Small firm expectations for revenue growth in 2024 are quite optimistic — more optimistic, in fact — than those of large firms. It is possible that although this moment is more challenging for small firms, the future is brighter.