What is the small business optimism index?
In this primer, we will explore the small business optimism index. If you are a small business owner or an employee working in a small business, you may be aware of it. If not, don’t sweat it. We’ll tell you all you need to know about this indicator. Let’s get to it!
Small business optimism index is an indication of the health of small businesses in the US. The small business optimism index is released on the second Tuesday of every month by the National Federation of Independent Businesses (NFIB).
NFIB has collected small business economic trends every quarter since 1973 and monthly surveys since 1986. The small business optimism index is released every month from surveys drawn from NFIB’s membership – it boasts of hundreds of thousands of small businesses in the United States as its members.
What is the small business optimism index?
Think of the small business optimism index as a sort of mood meter for small businesses. Higher the index, more optimistic are small businesses.
100 is taken as the baseline — any value greater than 100 is considered a positive outlook on the economy. For example, the last index in August was 103.1, which is considered positive. When businesses are positive they hire more and increase their spending, they also expand. Anything in low to mid 90s points to an economy in recession — for example, the optimism index was 94 at the start of 2008 and kept slipping to the mid-80s through 2008-2010 — in the two years between 2008 to 2010 about 170,000 small businesses closed down.
Small businesses are usually hit harder than their bigger counterparts because they don’t have the cushion of capital or infrastructure. Also, small businesses find it harder to secure credit owing to their lack of collateral.
“A top in the market is the point of maximum optimism, and a bottom in the market is the point of maximum pessimism.” – Ned Davis
How is the small business optimism index calculated?
The small business optimism index takes into account several critical components that measure the mood of small businesses — the index is derived from 10 components:
- Plans to Increase Employment
- Plans to Make Capital Outlays
- Plans to Increase Inventories
- Expect Economy to Improve
- Expect Real Sales Higher
- Current Inventory
- Current Job Openings
- Expected Credit Conditions
- Now a Good Time to Expand
- Earnings Trends
These 10 components can be considered as the building blocks of the small business optimism index. Any decrease or increase in these components affects the overall index. You may wonder – how are these components measured?
These components are measured from surveys sent to members (small businesses) of NFIB, the survey consists of questions related to the 10 components and based on responses the components are evaluated. The survey is detailed and asks specific questions such as “Do you think the next three months will be a good time for small businesses to expand substantially? Why?” — this question ties in with the 9th component – ‘Now a good time to expand’ — if many small businesses answer the survey by responding positively, this index would increase which would have an overall positive impact on the optimism index.
Why do sentiments matter?
Economies are complex because they depend to a greater extent on the feelings of people. If a single business feels pessimistic about the economy it doesn’t make a difference but if hundreds of businesses have a negative outlook on the economy it is enough to make a dent. If businesses are fearful — they would stop hiring, stop spending and stop expanding and if hundreds of businesses do this it would hurt the economy.
The importance of small business optimism index
Small businesses make up about 50% of the US workforce (US Census Bureau, Business Dynamics Statistics, 2014) and contribute to 44% of all US economic activity. It is safe to say that the health of small businesses to a greater extent influences the well being of the overall economy.
The small business optimism index also gives some important insights such as:
- What is the biggest problem small businesses are facing currently?
- Are businesses hiring or laying off workers?
- Whether businesses are planning to increase prices of goods/services
If you are a small business owner you may want to know what other businesses are up to currently. This would help plan your own business, because if a majority of the businesses are finding it hard to recruit skilled workers, you may want to ensure you retain your employees by increasing compensation. If many businesses are planning to expand, then it means they have a healthy look on the economy and are spotting opportunities. You may too want to jump on the bandwagon and expand.
A word of caution
Now that you have understood the optimism index, you may want to know something about the nature of such indexes. People have only two feelings when it comes to the economy — optimism or pessimism. One must keep in mind, market sentiments are usually exaggerated. One must respect the index and what it has to say, but sometimes it is better to stay still, not react impulsively and see how things play out.
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