Cash Versus Accrual Accounting and the Availability and Cost of Small Business Debt

Abstract:     
We examine whether the voluntary use of accrual accounting provides incremental information to capital providers above cash accounting, thereby lowering the firm's availability and cost of debt. We investigate these issues using a large, generalizable sample of small businesses that have discretion in their choice of cash or accrual accounting. We find that small businesses using accrual accounting have significantly lower interest rates after controlling for many factors associated with cost of debt. The findings are robust to controlling for self-selection of firms that apply for debt and the endogenous choice to use accrual accounting. However, we find limited evidence that accrual accounting decreases the likelihood of loan denial. In addition, third-party credit scores appear to partially substitute for the incremental information provided through accruals. Finally, accrual accounting and credit scores are only significantly associated with lending decisions for firms without long-term relationship with their lenders. The latter result is consistent with the soft information obtained through ongoing banking relationships providing a superior means for reducing information asymmetries between small business borrowers and lenders.

Keywords: accrual accounting, cash accounting, credit denial, cost of capital, interest rates

JEL Classifications: G12, G21, G33, M41, M44

Working Paper Series