An amazing ‘discovery’: economists are beginning to figure out that cashflow constraints hold back SMEs from growing their businesses!
…financing frictions can have a consequential effect on employment when firms face a constraint on working capital (Jermann and Quadrini 2012). This is particularly true among small or young firms that are in growth mode, as the mismatch between the timing of cash flow generation and payments to labor requires firms to finance their payroll through the production process - in advance of getting paid - and means that firms may have to cut back on hiring even in the presence of customer demand and adequate labor supply, due to an inability to pay workers in advance of receiving cash for their product or service.
Survey evidence indeed suggests that over 90% of small businesses pay their employees twice a month or more frequently, with nearly half paying their employees weekly (Dennis 2006).
In the presence of financing frictions, even small improvements in cash collection can have large direct effects on hiring due to the multiplier effect of working capital. To see why, note that a firm with $1 million of sales being paid 30 days after delivering its product always has $80,000 of cash ‘tied up’ in receivables at any moment in time. A shift in the payment regime from 30 days to 15 days therefore permanently unlocks $40,000 of cash for the firm on an ongoing basis. In the extreme where the firm was only able to support growth through internal cash flow, this will allow the firm to double in size, to $2 million, showing how seemingly small improvements in the working capital position for constrained firms can have consequential effects for growth in sales and in payroll.
Here is a link to the report: Can Paying Firms Quicker Affect Aggregate Employment?