Probably everyone has at least daydreamed of starting their own business. A trendy restaurant, a vintage clothing shop, striking it rich with a new killer phone app these are the dreams that keep entrepreneurs in the game.
But a new study released this week shows that however creative the concept, small business owners often lack the financial literacy to understand what theyre getting into. And thats a big reason why something like half of all small businesses fail within about five years.
Small businesses dont fail because its a bad business. They fail because of cash flow problems, Chris Wheat, director of business research for the JPMorgan Chase Institute and the lead researcher on the study, told me this week.
The study, titled Growth, Vitality, and Cash Flows: High-Frequency Evidence from 1 Million Small Businesses, is based on data from business accounts held at JPMorgan Chase, the nations largest bank and an important backer of small-business education programs.
To boil down a mountain of data, the study reports that holding a cash buffer remains crucial to survival for a small business. Also critical is understanding the pattern of cash flow money in vs. money out.
Some types of businesses see more volatile cash flow patterns than others. Case in point: Restaurants. The life expectancy of a restaurant among the JPMorgan Chase account holders is just 3.7 years, the shortest of 12 industries studied.
Least life expectancy
Restaurants can be victimized by the double whammy of unexpected expenses and uneven revenues. Expenses can vary because theyre buying supplies all the time at often rapidly changing prices; and revenues fluctuate according to the day or the season. That pinches the amount of cash they have on hand, as evidenced by the amounts in their bank accounts, Wheat said.
Restaurants we consistently find have more pronounced small business challenges, he said. Restaurants tend not to be holding a lot of cash in their accounts. And if you put that together with any amount of volatility, its not surprising to see they have the highest likelihood of exiting.
Longest life expectancy
On the other end of the spectrum, real estate firms enjoy the longest life expectancy nine years. They benefit from the opposite pattern that afflicts restaurants. Both revenues and expenses tend to be more stable and predictable in the real estate world, so its easier to keep a cash buffer.
The policy implications of all this are clear. More financial literacy is the key to small-business survival.
Small business owners ought to take as much advantage of training and mentoring programs as they can. There are business incubators, training regimes like the Goldman Sachs 10,000 Small Businesses program, technology transfer offices at local universities that help commercialize important research, and much more. It takes more than wishing and hoping to make a dream come true.
How long small businesses last in U.S.
Real estate: 9 years
Health care services: 8.8 years
High-tech manufacturing: 6.9 years
Other professional services: 6.5 years
Metal and Machinery: 6.4 years
High-tech services: 6.2 years
Construction: 5.1 years
Personal services: 4.9 years
Wholesalers: 4.7 years
Repair & maintenance: 4.6 years
Retail: 4 years
Restaurants: 3.7 years
Source: JPMorgan Chase Institute research