THE FINANCIAL CHARACTERISTICS OF DYNAMIC SMALL ENTERPRISES: PREDICTING SUCCESS AND FAILURE

Abstract

This paper deals with dynamic small enterprises which grow to achieve stock market quotation and comprises three main sections: a review of theoretical arguments concerning the effects of growth on small enterprises’ financial characteristics; a consideration of the predictability of small enterprise failure and success; and an assessment of development of predictive models. Results of empirical work in the UK and Australia are reported. The first section of the paper deals with the development of a prior arguments concerning the effects of growth on financial characteristics. This links financial characteristics in the form of profitability, liquidity and leverage with stage of development of enterprises including that of growth. This includes consideration of the ‘finance gap’ and the effect of stock market flotation on small enterprises’ financial characteristics. The purpose of this theorising is to make explicit what might be expected in terms of the effects of growth on the financial characteristics of small enterprises. The section concludes with an explanation of the methodology for the empiricial studies carried out at the University of New England on this topic. The second section of the paper deals with the predictability of small enterprise success and failure. This includes: consideration of the financial characteristics of dynamic small enterprises as they approach and go past stock market flotation; a review of previous work on predictive models in general and those for small enterprises in particular; and discussion of the issue of the problem of distinguishing between success and failure. The third section deals with the issues involved in the development of predictive models. These include: statistical and theoretical issues; the reliability of financial statement data; and the incorporation of non-financial variables. The conclusions consider the implications for relationships with providers of finance, particularly banks, and for owner-managers of the dynamic small enterprise. The finding that dynamic small enterprises have financial characteristics in common with bankrupt enterprises raises questions as to the effectiveness of credit scoring techniques which make use of accounting data. This in turn raises the prospect of small enterprises being denied finance and the creation of a new ‘finance gap’. Finally, consideration given to the implications of the findings for financial institutions, small enterprise owner-managers and for future research.