Small-business confidence strong despite economic challenges

Rising insolvency and profitability challenges aren’t destroying small-business confidence.

Of the 2.6 million businesses in Australia, 97 per cent have fewer than 20 employees, bringing them within the ABS’ definition of a small business.

Smaller businesses tend to have lower survival rates than larger ones. That said, the value of small businesses to the economy is growing, and there is cause for concern whenever insolvency rises.

The challenges

According to the Reserve Bank of Australia’s (RBA) Financial Stability Review, released last Friday (6 October), the level of business insolvencies has risen to around or above pre-pandemic levels. Those businesses entering insolvency are disproportionately small.

The major challenges faced by small businesses are the following:

1. Interest rates and inflation

Small businesses have been hit hardest by rising interest rates. Small businesses are more likely to take out variable interest rate loans, meaning that the terms of their repayments will fluctuate in accordance with market changes.

“Some small businesses have found it difficult to set prices in the current high-inflation environment and have consequently experienced unanticipated margin compression,” said the RBA.

2. Softening demand

While, according to the RBA, demand has been relatively strong over the past few years, allowing businesses to pass on higher costs, it has eased recently in response to high inflation and increasing interest rates.

“Demand has eased as high inflation and the increase in interest rates have placed pressure on household budgets,” said the RBA.

That said, data released by Xero in July found that, though inflation has caused growth in small-business sales to slow, “small businesses are still selling more goods and services than they were a year ago”.

3. Labour

Fifty-five per cent of surveyed SMEs found it more difficult to find suitable candidates in this current quarter compared to 12 months ago.

Not only have labour shortages placed constraints on small-business operations, but they have also led to an “upward pressure on wages”, according to the RBA.

Several panellists at the RBA’s Small Business Finance Advisory Panel, convened in July 2023, reported that their businesses were affected by the Fair Work Commission’s recent increase in the award rate and commensurate increases in wages for non-award employees.

Business sentiment

Despite the many challenges outlined by the RBA, a recent survey by Fifth Quadrant found that SMEs remain optimistic.

Not only has sentiment around the Australian economy reached its highest among SMEs since May 2022, but SMEs are more confident in the prospects of their own businesses.

It is likely that the spike in confidence has something to do with the month-over-month surge in profitability reported in September of this year. Fifty-three per cent of SMEs reported a profit over the past month, compared to 40 per cent the month before.

Additionally, although interest rates are high and some foresee coming hikes, concern around the rates fell from 87 per cent in Q4 FY23 to 79 per cent in Q1 FY24.

Not only are businesses less concerned, but the survey suggests appetites for additional financing are on the rise, now at the highest level of 16 per cent since July 2022.

“Although concerns may linger, this month’s data displays a positive picture for SMEs,” said James Organ, Fifth Quadrant managing director.

“The August results found bullish confidence among SMEs despite challenges, and the September results have vindicated this with increased profitability and greater confidence in the Australian economy.”