How Strong is the Link between Internal Finance & Small Firm Growth? Evidence from Survey of Small Business Finances

While a vast literature exists examining the link between firm investment and cash flow, few studies have examined the link between firm growth and internal funds, and those that exist have focused exclusively on publicly traded firms. This study posits that internal funds are critically important to small firm growth. While other studies have utilized Compustat and other databases containing responses from publicly traded firms, this study utilizes the Federal Reserve Board’s Survey of Small Business Finances, a database containing responses from non-publicly traded firms with fewer than 500 employees. We show that small growth firms are more likely than non-growth firms to have lines of credit, motor vehicle loans, capital leases, equipment loans, and loans from both commercial banks and finance companies. We find a strong, positive relationship between internal funds and employment growth across small, private firms. In addition, we find that the relationship between internal funds and employment growth is especially important for very small and women-owned firms. These results highlight the importance of programs that effectively reduce the costs of borrowing and increase net profits in fostering the growth of small businesses, especially for very small and women-owned firms. For the practitioner working with small businesses, this study suggests that while outside capital is often needed, internal capital is critically important for the growth of small businesses