Financial Management and Capital Formation in Small Business

By Bryan, E. Lewis; Friedlob, G. Thomas | Journal of Small Business Management, July 1984 | Go to article overview

Financial Management and Capital Formation in Small Business


Bryan, E. Lewis, Friedlob, G. Thomas, Journal of Small Business Management


Financial Management and Capital Formation in Small Business

Willingness to lend is a function of risk. The greater the risk associated with a venture, the less willing lenders tend to be to provide capital. Thus, capital formation is more difficult for high risk activities. The Dun & Bradstreet (D&B) Business Failure Record documents a high rate of failure for small businesses. For example, in 1980, over 53 percent of all failures had been in business for five years or less, and of these failures, over 48 percent involved less than $100,000 liability, and nearly 95 percent involved less than $1 million liability.

These figures show that the typical business failure is a small business. The highest rate of failure noted by D&B was in retailing, with 61 percent of small retailers failing in five years or less.

The 1980 D&B failure record indicates that incompetence was an underlying cause of failure in 44 percent of all cases. Inadequate or unbalanced managerial experience underlay another 36 percent. It is our contention that one primary cause of the high failure rate is a lack of knowledge in accounting, particularly in the areas of (1) management accounting, and (2) internal control.

Clemson University's Small Business Development Center is typical of others around the country, where students and other center staff assist SBA loan applicants in completing required forms. (Some SBA loan applicants pay accountants as much as $800 for assistance in completing the forms, then submit the applications without understanding them.) The SBA loan application form nowhere asks the applicant to indicate any skill or experience in controlling and accounting for money.

D&B notes that the incompetence, unbalanced experience, and lack of managerial experience that lad to business failure are evidenced by problems in three areas which are usually controlled and managed in large part through the use of accounting data. These are operating expenses, receivables, and inventories.

Nationwide, growing attention is being given to managerial accounting and internal control. The Certified Management Accountant (CMA) designation was introduced by the National Association of Accountants in 1972, when 410 accountants sat for the examination. It is now being offered twice annually, and 10,080 candidates took the CMA examination in 1981.

Similar emphasis on managerial accounting and control can be seen in the growing number of Certified Internal Auditors (CIAs), who have passed the examination first given by the Institute of International Auditors in 1974, when there were 2,299 examinees. There were 11,132 candidates taking this test in 1982.

But where do these people go? Examine the rosters of the CMAs and CIAs. They are in big business, not small. Big business knows the importance of managerial accounting and internal control.

Small business is especially vulnerable to problems that stem from inadequate accounting and internal control. The entrepreneurs who seek advice at university-based Small Business Development Centers are typically independent and self-confident, but along with this entrepreneural spirit, the small businessperson must know how to handle money. If the owner/manager does not possess accounting skills, he or she must hire someone who does, either as a staff person or consultant.

The D&B business failure statistics appear to be the data most commonly cited to support the hypothesis that lack of accounting skills is a major reason for small business failure. Only a few empirical studies have been made which support this contention. One study, by Ronald Clute, examined Chicago firms seeking SBA assistance. Forty percent had financial difficulties because of accounting problems, and about 20 percent had no accountant. Another 18 percent had accountants who were either incompetent or indifferent.

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