Small and mid-sized enterprises are considered the backbone of an economy, but they also tend to be among the first to feel the shifts in financial conditions.
When interest rates rise or currencies move around sharply, the effects are often visible within SMEs well before they turn up in headline economic data.
This is not coincidental, it’s down to the unique structural characteristics of smaller businesses and how they typically operate within financial systems.
Larger corporations usually benefit from diversified revenue streams and stronger balance sheets. They also tend to have better access to capital markets. Smaller firms typically operate with tighter cash buffers and fewer financing options. While this can encourage operational discipline, it also means that external shocks are absorbed far more quickly.
One of the fastest ways financial pressure turns up at SMEs is through borrowing costs.
When interest rates rise, the cost of business usually increases immediately and because many SMEs rely on this type of funding to manage cash flow, even a modest rate change can quickly push up monthly repayments. Businesses can sometimes respond by holding off on recruitment, cutting non-essential spending or delaying growth plans.
In this way, monetary tightening can begin influencing real economic activity through smaller firms before the impact is visible at a macro level.
Pricing power also plays an important role. Large companies (especially ones with established brands) are often better positioned to pass increased costs on to customers. Smaller businesses typically operate in more competitive environments and so they may not have the option to pass those costs on without the risk of losing their, likely smaller, customer base.
As a result, margin compression is often one of the earliest signs of financial strain within the SME segment.
Access to capital can become more constrained during periods of uncertainty. Financial institutions generally adopt a more cautious approach to lending when economic risks rise, and investors may favour larger, more established borrowers. While major firms can explore options such as bond issuance or syndicated lending, smaller companies often depend on a narrower range of credit providers.
This dynamic can make liquidity management particularly important during volatile periods.
Currency volatility is also another area where SMEs tend to feel the pain first. A depreciation in sterling, for example, can raise import costs quickly. Larger firms are more likely to employ hedging strategies to mitigate foreign exchange risk, whereas SMEs may have limited capacity to do so consistently.
In this sense, the SME sector can act as a useful barometer for the economy. Stress within smaller businesses does not necessarily indicate a broad downturn, but it can suggest that financial pressures are beginning to build.
For business leaders, this underscores the importance of preparation. Maintaining appropriate liquidity, diversifying suppliers where possible and regularly stress-testing financial forecasts can help strengthen stability.
Jason Tassie is the founder of Know Your Business, a recognised voice in UK business growth and strategy, with more than two decades of experience supporting start-ups and SMEs.
