Financial Reporting and Analysis Practices in Small Enterprises: Their Association with Growth Rate and Financial Performance

A substantial body of prescriptive literature has evolved dealing in whole or part with use of financial analysis by small enterprises. For example, recent financial management books written for small enterprise owner-managers emphasize the importance of developing skills in reading and interpreting historical financial statements to monitor financial health and progress (Rausch 1982, McMahon 1986, Meredith 1986, Walker and Petty 1986, Barrow 1988). In relevant journals, some articles strongly advocate use of financial analysis skills (Mayo and Rosenbloom 1975, Patrone and DuBois 1981, Van Voorhis 1981, Konstans 1982, Konstans and Martin 1982), while others do so with some reservations (Welsh and White 1981; Howell, Frazier, and Stephenson 1982). A number of recent publications deal with the distinguishing characteristics, problems, and needs of small growth enterprises (Hutchinson and Ray 1986, Stanworth and Curran 1986, Scott and Bruce 1987, Kazanjian 1988, Turok 1991). Without exception, these highlight the stresses produced in small enterprises by growth. The publications also detail the changes required in the organization and management of such enterprises in order for them to survive and prosper. As Hutchinson and Ray (1986) indicate, growth can result in financial stresses such as cash-flow difficulties and excessive use of debt. These financial problems create a critical need for improved financial control which can come about through an upgrading of financial reporting and analysis systems. Notwithstanding the abundance of prescriptive literature on financial reporting and analysis in small enterprises, there is very little empirical evidence to support recommendations made. Furthermore, theory development in the area is minimal and cannot adequately support the recommendations. The exploratory study described in this article attempts to find empirical justification for the prescriptions in the literature. For a sample of small growth enterprises, the study seeks possible associations between historical financial reporting and analysis practices and achieved rate of growth and financial performance. Petty (1991, 90) argues for an exploratory approach in these circumstances as follows: What is "good" research? Conventional wisdom teaches us that research should be theory based, where we first develop the theory, build our hypotheses from the underlying theory, which we then test empirically, i.e., deductive analysis. In an emerging, and immature, discipline, where we find ourselves with small-business and entrepreneurial finance, could we not also benefit from the skills of the pure empiricist? In other words, should we not value also inductive logic applied to purely exploratory, empirical research--what William Bygrave calls "enlightened speculation"? AVAILABLE ASSOCIATIVE EVIDENCE ON PRACTICE Exhaustive reviews of the literature (McMahon and Holmes 1990, 1991, 1992) reveal few published studies similar in focus to this article. The Bureau of Economic and Business Research (1961) of Temple University, Philadelphia, was the first to study the use of financial ratios in small businesses. Unfortunately, this report was largely descriptive and provided very little associative evidence. Of the remaining studies, Ray and Hutchinson (1983) investigated financial reporting and analysis practices in small growth enterprises, while Thomas and Evanson (1987) examined possible associations between financial reporting and analysis practices and performance characteristics. Ray and Hutchinson (1983) report on financing and financial control practices in small, rapidly growing enterprises up to and following listing on the London Stock Exchange. The researchers examined the financial records of a sample of 33 "super growth" enterprises for 10 years before their listing, and for 4 years after. To provide a benchmark, they also examined a matched sample of small enterprises that did not grow and achieve listing. …