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 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 analysis) 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