Accounting and Small Business Profitability

Abstract

We exploit survey data from the Panel Study of Entrepreneurial Dynamics to investigate the role
of accounting in the likelihood that a small business more quickly achieves and maintains positive
operating cash flow (profitability). We examine several potential aspects of accounting including
the entrepreneur’s: 1) accounting background, 2) intent to use various financial statements and
projections, and 3) intent to use professional accountants. We find that entrepreneurs with an
accounting background are more likely to achieve profitability. Perhaps more importantly, we
document that the intended use of certain statements (e.g., income statements) and projections
(e.g., break-even analyses) are associated with small business profitability. However, these
statements and projections are only associated with future profitability for entrepreneurs with an
accounting background, suggesting that the benefits of these statements primarily accrue to
entrepreneurs who have an understanding of accounting. Consistent with this notion, we fail to
find evidence that the use of professional accountants is associated with small business
profitability. Combined, our evidence suggests various aspects of accounting are associated with
profitability in the largely unregulated environment where small businesses operate.

Keywords: small business; accounting background; financial statement preparation; profitability