Journal of Small Business & Entrepreneurship
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The use of financial statements for decision
making by small firms
Shawn Carraher & Howard Van Auken
To cite this article: Shawn Carraher & Howard Van Auken (2013) The use of financial
statements for decision making by small firms, Journal of Small Business & Entrepreneurship,
26:3, 323-336, DOI: 10.1080/08276331.2013.803676
To link to this article: https://doi.org/10.1080/08276331.2013.803676
Published online: 14 Jun 2013.
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Journal of Small Business & Entrepreneurship, 2013
Vol. 26, No. 3, 323–336, http://dx.doi.org/10.1080/08276331.2013.803676
The use of financial statements for decision making by small firms
Shawn Carrahera and Howard Van Aukenb*
a
Oxford Journal Distinguished Research Professor, University of Cambridge, Cambridge, UK;
University Professor, Iowa State University, Ames, IA, USA
b
(Received 2 August 2012; final version received 9 January 2013)
This paper uses a sample of 312 small firms to examine the use of financial statements
by analyzing factors that (1) affect the use of financial statements and (2) owners’
comfort in interpreting financial statements. Financial statements provide important
information that should be used to help guide decisions. The findings showed that
owner comfort in using financial statements to make decisions was inversely associated with frequency of preparation and directly associated with level of revenues.
Additionally, the results showed that whether the whether the owner uses financial
decisions when making decisions was indirectly associated with education level and
having the statements prepared externally and directly associated with owner comfort
interpreting the information in financial statements. The results should be useful for
owners of SMEs and providers of services to SMEs to better understand which factors
affect the use of financial statements and the process by which financial statements get
incorporated into decisions.
Keywords: Small firm financing; Small firm decisions
Cet article utilise un echantillon de 312 petites entreprises pour examiner l’utilisation
des etats financiers par l’analyse des facteurs qui affectent (1) l’utilisation des etats
financiers et (2) la facilite d’interpretation des etats financiers par les proprietaires.
Les etats financiers fournissent des informations importantes qui devraient ^etre
utilisees pour aider a la prise de decision. Les resultats ont montre que la facilite
d’utilisation des etats financiers par le proprietaire pour prendre des decisions etait
inversement proportionnelle a leur frequence de preparation et directement liee au
niveau de chiffre d’affaires. De plus, les resultats ont montre que le fait que le proprietaire utilise les etats financiers pour la prise de decision etait indirectement lie a son
niveau d’etudes et au fait de faire preparer les etats financiers en externe, et etait
directement lie a la facilite d’interpretation par le proprietaire des informations contenues dans les etats financiers. Ces resultats devraient ^etre utiles aux proprietaires de
PME et aux prestataires de services aux PME pour mieux comprendre les facteurs
precis qui affectent l’utilisation des etats financiers et le processus par lequel les etats
financiers se trouvent integres aux decisions.
Mots cles: Financement des petites entreprises; Decisions dans les petites entreprises
Financial statements allow stakeholders to use available financial information to gain a
better understanding of and manage their firm. Although the use of financial statements
can help stakeholders and owners make better decisions, owners of small firms often are
poorly equipped to use financial statements effectively. In this case, even reliable, timely
financial statements are insufficient, if owners do not know how to interpret and use them
(Van Auken 2005).
*Corresponding author. Email: vanauken@iastate.edu
Ó 2013 Journal of the Canadian Council for Small Business and Entrepreneurship/Council de la PME et de l’entrepreneuriat
324
S. Carraher and H. Van Auken
Furthermore, the use of financial statements is closely linked to and supportive of the
firm’s strategic goals, because decisions made without regard to their financial impact can
lead to a confused company focus and financial distress (Horngren et al. 2009). The importance of the decisions is evident from the high discontinuance/failure rate among small
firms (van Praag 2003). Owners of small firms often lack strong finance skills and may not
fully understand the impact of their decisions; their inappropriate decisions threaten their
small firm’s viability and create extensive operational problems (Timmons and Spinelli
2004). Instead, firms must use the information contained in financial statements to evaluate
and generate investment opportunities (Breen, Sciulli, and Calvert 2004), gain information
to manage their business, and operate efficiently and effectively (Shields 2010). The effective interpretation and use of financial statements is especially important, considering that
poor financial management is a leading cause of financial stress and business failure (Carter
and Van Auken 2005; Coleman 2002; Headd 2003; Wiklund and Shepherd 2005).
Such usages and interpretations tend to be influenced by owners’ perceptions of their
firms’ potential. Entrepreneurs generally are optimistic—perhaps overly so—about their
firm’s financial potential, which can lead to inaccurate assessments of the probability of failure, ineffective decisions, and financial distress (Landier and Thesmar 2009; Smith 2011).
Assistance with interpreting the meaning of and appropriate usage of information contained
in financial statements therefore might help owners make better, more informed decisions
(Breen, Sciulli, and Calvert 2004). Yet Gooderham et al. (2004) report that small firms tend
not to seek external financial advice; instead, they rely on accountants as financial advisors
and express confidence in financial advice according to the quality of the services rendered.
To address the issues associated with owners’ use of financial statements, we examine
which factors determine the use of financial statements by small to medium-sized enterprises
(SMEs), as well as their owners’ comfort in interpreting them. Both issues are critical, especially considering that financial statements affect all stakeholders, yet most research on the
use of financial information and financial statements has focused on large firms, with few
examples of studies of how SMEs use financial statements in making decisions (Shields
2010). The important information in financial statements must be incorporated into any firm’s
operational and strategic decision-making processes though, because ignoring or misusing
that information can harm all areas of the firm: unreliable operations, ineffective marketing,
and an inability to hire qualified personnel (McMahon 2001; Timmons and Spinelli 2004).
Research issues
A key determinant of decision making tactics is the entrepreneur’s background and firm
characteristics (Avery, Bostic, and Samolyk 1998; Chaganti, DeCarolis and Deeds 1996;
Watson 2002). For example, business owners who lack knowledge about the likely impact
of their decisions on their firms may make choices that create risk and reduce potential
returns (Van Auken 2001). Romano and Ratatunga (1994) and Romano, Tanwwski, and
Smyrnios (2001) recognize that decision making in small firms is complex and involves
many factors, whereas Busenitz and Barney (1997) note that limited experience and overconfidence often leads to inappropriate decisions, in which case small firms are particularly
vulnerable to the impact of poor financial decisions because of their limited resources.
Owners’ comfort with using financial statements to make decisions
Owners who are not comfortable using financial statements to inform their decisions likely
use the statements less than do owners who are more comfortable. This type of comfort
Journal of Small Business & Entrepreneurship
325
may be affected by various factors. For example, firms that prepare financial statements
internally rather than externally have employees who are knowledgeable about financial
statements. Such internal expertise should facilitate greater interaction and explanations
between the owner and the hired expert (Smallbone, North, and Leigh 1993), which in turn
may make owners more comfortable with the use of financial statements.
Educational level also influences financial decisions (Watson 2002). Advanced levels
of education increase the likelihood that business owners have access to traditional debt
and investment funding (Carter et al. 2003). They also help owners understand financial
statements and communicate more effectively (Hanlon and Saunders 2007; Neeley and
Van Auken 2010). Cassar (2009) thus reports that owners with a stronger finance and
accounting background are more likely to use external sources for advice.
In terms of firm characteristics, the level of revenue, which can serve as a proxy for
firm size, affects many small firms’ decisions, including both operational and strategic
decisions. Higher revenue suggests that the firm has greater resource levels and access to
more resources. Changing levels of revenue also alter the firm’s perspective on its
resource constraints and needs (Byers, Groth, and Wiley 1997). Neeley and Van Auken
(2010) confirm that the level of revenue affects small firms’ decisions, and Busenitz and
Barney (1997) suggest that organizational size affects decisions, in that larger firms have
more resources and information on which to base their decisions. In turn, financial statements are critical to understanding how revenue levels affect small firms, because they
must plan for associated resource demands.
Finally, the frequency of preparation may be an indicator of an owner’s comfort in
using financial statements to make decisions. Firms that have financial statements prepared less often likely are less sophisticated and suffer from less understanding of their
importance for decision making (Cassar 2009; Cassar 2008). The reduction of uncertainty, especially in competitive environments, is directly associated with the frequency
of financial statement preparations. Small firms that have their financial statements prepared less frequently may perceive a benefit from the lower costs of infrequent reports.
These firms likely fail to recognize the benefits of more timely financial information, are
not willing to incur higher costs, and feel less comfortable in using the information they
would obtain. These effects, in combination, lead to the following hypotheses:
H1: An owner’s comfort in using financial statements to make decisions is associated (a) positively with whether financial statements are prepared internally, (b) positively with the
firm’s total revenue during previous year, (c) negatively with how often the firm’s financial
statements are prepared, and (d) negatively with the owner’s level of education.
Owners’ actual use of financial statements to make decisions
Few published studies examine the use of financial statements by small businesses. Bruns
and McKinnon (1993) report that managers want better information and that the quality
of information they obtain determines the effectiveness of their decisions (Berger and
Udell 1998; Gibson 1992). Traditional finance theory assumes rational decision making,
but behavioral finance also acknowledges the potential influence of overconfidence and
optimism on decisions (Barberis and Thaler 2002; Ritter 2003). Sian and Roberts (2009)
report that owners’ understanding of financial statements varies widely, such that many
owners are confused by the information. The complexity of the statements makes them
less useful to SME owners, who instead rely on their accountants to explain the information to them. Owners who are not comfortable with their understanding of financial
326
S. Carraher and H. Van Auken
statements are less likely to use those financial statements when making decisions.
Whereas a lack of financial skills can signal a need for owner training on how to use
financial statements (Cassar and Ittner 2008; Berger and Udell 1998), owners with a
stronger finance and accounting background are more likely to use external accounts for
advice because they understand the importance of accurate statements (Cassar 2009; Sian
and Roberts 2009).
Holmes and Nichols (1988) also note that the use of annual financial statements is
associated with firm characteristics and demographics. For example, the frequency of
financial statement preparation varies with the use of outside funding and venture size
(Cassar 2009). Small firms also may tend to be less financially sophisticated (McMahon
2001; McMahon and Stanger 1995), so they rarely use financial statements when making
decisions (Halabi, Barrett and Dyt 2010). In addition, the type of financial statement prepared varies with firm characteristics.
Sales, often used as a proxy for firm size (Carter and Van Auken 2005), may help signal the likely complexity of a firm’s operations and financial reporting needs. Berger and
Udell (1998) suggest that smaller firms are more financially opaque but become more
financially transparent as they grow; accordingly, owners’ use of financial statements
should vary with sales. Higher sales imply higher resource needs, greater financial exposure, and the need for more financial information. Lower sales instead may motivate owners to devote more attention to the associated financial impact on their firm.
Not only are owners who are better educated more likely to use financial statements,
but so should owners of firms with higher levels of revenue be, because they have needed
to learn about financial statements as the firm grew. That is, they should be more likely to
use and more comfortable interpreting financial statements. In firms that prepare their
own financial statements internally, as we reasoned previously, the firm and its owner
should be more capable in using financial statements. Finally, firms that prepare financial
statement more often (e.g., monthly as opposed to annually) likely appreciate the value of
the information contained in the statements. This reasoning leads us to predict:
H2: An owner’s use of financial statements to make decisions is positively associated with (a)
the owner’s comfort with using financial statements, (b) the internal preparation of financial
statements, (c) the firm’s total revenue during the previous year, and (d) the owner’s level of
education.
Methodology
Sample and questionnaire
We developed the questionnaire for this study during the fall of 2010. In addition to findings from focus group discussions, we relied on prior research into small firm financing
decisions, including Van Auken (2005), Carter and Van Auken (2005), Busenitz et al.
(2003), Kuratko, Hornsby, and Naffiziger (1997), McMahon and Stanger (1995), Petty
and Bygrave (1993), and Ang (1992). After pretests and further revisions, the final questionnaire comprised two sections: (1) demographic information and (2) information associated with the use and understanding of financial statements. That is, the first section
asked respondents about the characteristics of their firms, including its age, organizational
structure, type, total assets, and revenue and the gender of the owner. The second section
focused on their use of financial statements, including the frequency of financial statement preparation, confidence in the accuracy of the financial statements, and ability to
interpret financial statement information.
Journal of Small Business & Entrepreneurship
327
The sample consisted of small firms located in a southwestern US state and was
designed to represent the structure of the region, following stratified sampling principles in
finite populations. The southern tier of the state was initially segmented into districts. The
population of firms included all SMEs located in these districts, and then we contacted the
owners of ten small firms within each district to ask for their participation in the study. If
the business owner declined, another business from the district was contacted. Nonresponse
bias thus should not be an issue, because nonresponding organizations were replaced by
similar organizations. Furthermore, the sizes and ages of the final sample did not differ
from the original sample at the .01 level.
Owners served as the respondents for this study because of their importance as
decision makers, and because their perceptions shape strategic behavior (O’Regan and
Sims 2008; Van Gils 2005). We obtained 312 useable questionnaires from this single
southwestern state. Such geographic specificity offered several advantages. First, it facilitated our data collection—a benefit that is especially relevant in the context of the
regional differences that might exist among owners of small firms. Second, using data
from a single state minimizes the number of extraneous variables. For example, various
states have different educational programs, different levels of support for small firms, and
variations in banking practices associated with financial statement requirements (Carter
and Van Auken 2005).
Variables
Dependent variables
We used two dependent variables and two different regressions. The first dependent variable measured owners’ comfort in their ability to use financial statements to make decisions. The variable was calculated at the (arithmetic) mean value of owners’ ranking (1–7
scale, 1 ¼ not comfortable, 7 ¼ very comfortable) of their ability to interpret an income
statement, balance sheet, cash budget, expense forecast, and sales forecast. These five
variables were combined into a single variable, because respondents’ rankings were
highly correlated. The second dependent variable pertained to whether the owner used
financial statements when making decisions. The variable took a value of 1 if financial
statements were used in decision making and 0 if not.
Independent variables
The first group of independent variables in the first regression analysis (dependent variable ¼ owners’ comfort with using financial statements to make decisions) was associated
with the firm’s financial aspects. Respondents indicated how often their income statement, balance sheet, and cash budget were prepared (1 ¼ never, 2 ¼ monthly, 3 ¼ quarterly, 4 ¼ annually). These responses were gathered into a new variable, “frequency,”
that included the very highly correlated frequencies of preparation of the four financial
statements. The second independent variable was whether the financial statements were
prepared internally or externally (1 ¼ internal, 0 ¼ external).
For the independent variable used in the second regression analysis (dependent variable ¼ whether the owner used financial statements when making decisions, yes or no),
respondents indicated how comfortable they felt with their ability to interpret income
statements, balance sheets, cash budgets, sales forecasts, and expense forecasts (1–7
scale, 1 ¼ not comfortable, 7 ¼ very comfortable). We created a new variable, “comfort,”
because the correlations of these responses were very high. The second independent
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S. Carraher and H. Van Auken
variable was whether the financial statements were prepared internally or externally (1 ¼
internal, 0 ¼ external).
Control variables
The control variables used in the analysis were the firm’s total annual revenues during the
previous calendar year (1 ¼ less than $10,000, 2 ¼ $10,001–$50,000, 3 ¼ $50,001–
$100,000, 4 ¼ more than $100,000) and the education level of the owner, as used in previous SME financial research. Revenue may be an indicator of the firm’s financial sophistication, because firms with higher revenues likely have greater financial controls and better
developed financial processes (Carter and Van Auken 2008). Education level (1 ¼ high
school, 2 ¼ bachelor’s degree, 3 ¼ graduate degree) may signal greater human capital and
suggests greater firm viability (Cassar 2004; Coleman and Cohn 2000; Storey 1994).
Analysis
The results were initially summarized using univariate statistics to clarify the characteristics of the respondents and the responding companies. Percentages for categories were
calculated for the educational level of the owner, gender, type of business, total assets,
and revenue. The t-tests of differences in (arithmetic) mean rankings also compared
responses by owners that did versus did not use financial statements to make decisions.
The Spearman correlations (Table 1) between the independent variables assessed the
significance of the relationships between the control and independent variables. Because
no significant correlations appeared among the independent variables, multicollinearity
was not a problem. The Spearman correlations coefficient estimation is a non-parametric
technique based on ranks rather than the value of responses. We used this non-parametric
technique because of our uncertainty about the population distribution.
Regression analysis is commonly used in entrepreneurship research, because it
appears to be the most suitable method for understanding the relationship between dependent and independent variables. It is especially relevant for analyzing how the dependent
variable changes as the independent variable shifts. We thus used two regression models:
a generalized least squares model when owners’ comfort in using financial statements
Table 1. Spearman correlations between variables (n ¼ 312).
Panel A: Owner’s Comfort in Using Financial Statements as Dependent Variable
Variables
Responsibility
Education
Finance
Revenue
Preparation
Education
Frequency
Revenue
1.0
.053
.110
.058
1.0
.094
.148
1.0
.262
1.0
Panel B: Financial Statements Used in Decisions as Dependent Variable
Variables
Responsibility
Education
Comfort in Interpreting
Revenue
Preparation
Education
Comfort
Revenue
1.0
.114
.046
.198
1.0
.123
.148
1.0
.227
1.0
Journal of Small Business & Entrepreneurship
329
was the dependent variable and a logit regression model when the owner’s actual use of
financial statements was the dependent variable.
The first regression with generalized least squares analysis examined the relationship
between the owners’ comfort in using financial statements to make decisions (dependent variable; 1–7 Likert scale ranking) and whether financial statements were prepared internally or
externally (independent variable), level of revenue (independent variable), how often the
financial statements were prepared (independent variable), and education (control variable).
The second regression used logit regression analysis to examine the relationship
between whether owners actually used financial statements to make decisions (dependent
variable) and the owner’s comfort with interpreting financial statements (independent variable), how often the financial statements were prepared (independent variable), level of
revenue (independent variable), and education (control variable). A logit model is particularly well suited for this analysis, because the dependent variable (i.e., whether owners
use financial statements) is an indicator variable (see Pindyck and Rubinfeld 1981).
The two regression models were as follows:
OC ¼ a0 þ b1Prepþ b2Rev þ b3Freq þ b4Edu, and
UD ¼ a0 þ b1OC þ b2Prep þ b3Rev þ b4Edu,
where:
OC ¼ owners’ comfort in using financial statements to make decisions,
UD ¼ whether financial statements actually were used to make decisions,
Prep ¼ whether financial statements were prepared internally or externally,
Edu ¼ owner’s level of education,
Rev ¼ firm’s total revenue during previous year, and
Freq ¼ how often financial statements are prepared.
Results
Sample characteristics
In Table 2 we reveal the percentage of respondents by category. Less than one-half of the
respondents’ highest educational level was high school, and just over half had a bachelor’s
or graduate degree. About two-thirds of the business owners were male, and almost half of
the firms were organized as sole proprietorships, followed by corporations (17.1%) and
partnerships (16.8%). The majority of respondents were retail (37.9%) or service (42.1%)
firms. A large percentage of responding firms had total assets greater than $100,000
(33.6%), and the distribution of other firms among the various categories was similar.
Correspondingly, their total revenue was mostly greater than $100,000 (39.1%), and again,
the distribution of other firms among the various categories was similar.
Regression analysis: owner’s comfort in using financial statements
The regression results in Table 3 (F ¼ 10.25, significant at 1%; R2 ¼ .1706) refer to the
analysis of the owner’s comfort in using financial statements to make decisions as the
dependent variable. The “revenue” variable (coefficient ¼ 0.178, significant at 5%) is
directly associated with owners’ comfort in using financial statements, in support of H1b.
Owners of firms with higher revenues are more comfortable using financial statements
than owners of firms that have lower revenues. This relationship suggests that owners of
330
S. Carraher and H. Van Auken
Table 2. Characteristics of responding firms (n ¼ 312).
Educational Level
Percent
High School
Bachelors Degree
Graduate Degree
Other
Gender
Female
Male
Legal Structure
Sole Proprietorship
Partnership
S-Corp
Corporation
LLC
Type of Business
Retail
Services
Agricultural
Manufacturing
Other
Total Assets
<$10,001
$10,001–$25,000
25,001–50,000
50,001–75,000
75,001–100,000
$100,000
Revenue
<$10,001
$10,001–$50,000
$$50,000–$100,000
>$100,000
43.4
35.7
16.1
4.8
34.6
65.4
49.3
16.8
7.1
17.1
9.6
37.9
42.1
5.1
6.8
6.8
17.7
10.5
11.2
14.8
11.2
33.6
15.9
26.5
18.2
39.1
firms with higher revenues are more financially sophisticated than owners of firms with
lower revenues. Higher revenues should be associated with a higher asset base and thus
higher financial consequences and risk exposure than firms with lower revenues and
smaller asset bases. Higher asset bases and financial risk exposure also may motivate
owners to learn about financial statements more, compared with firms with a lower asset
Table 3. Least squares regression analysis with owner’s comfort in
using financial statements as dependent variable (n ¼ 312).
Variables
Coefficient
Intercept
Preparation
Revenue
Frequency
Education
5.051
0.235
0.178
0.157
0.142
Notes: F ¼ 10.25.
Significant at 1%.
Significant at 5%.
Journal of Small Business & Entrepreneurship
331
base and financial risk exposure. Furthermore, the “frequency” variable (coefficient ¼
0.157, significant at 1%) is inversely associated with owners’ comfort in using financial
statements, in support of H1c. Owners who prepare financial statements more often are
less confident in their ability to interpret their financial statements. Conversely, owners
who prepare financial statements less often are more confident in their ability to interpret
their financial statements. These results suggest that frequency of financial statement
preparation is significantly associated with comfort; financial statements appear to be prepared more often by owners who are less confident, to help them compensate for their
unease. Owners who are more confident may believe that their enhanced perspective
allows them to interpret the longer-term implications of the information that financial
statements provide. Finally, the coefficients for preparation and education are not significantly associated with owner comfort with using financial statements, so we must reject
H1a and H1d.
Regression analysis: whether financial statements are used in decision making
Table 4 shows the logit regression results (likelihood ratio ¼ 47.603, significant at 1%)
for the analysis of whether the owner uses financial decisions when making decisions as
the dependent variable. In this case, we do not report the R-square value, because logistic
regression does not have an equivalent measure. The results show that the coefficient for
comfort (coefficient ¼ .06549, significant at 1%) is directly associated with whether owners use financial statements to make decisions, in support of H2a. Owners likely use financial statements to make decisions when they are more comfortable with their ability to
interpret financial statements. Conversely, owners do not use financial statements to
make decisions if they are less comfortable with their ability to interpret financial statements. These results suggest that owner training and understanding of financial statements
may help determine how information from financial statements applies to decision making. In addition, the coefficient for preparation (coefficient ¼ –0.029, significant at 5%) is
inversely associated with whether financial statements inform decisions, in support of
H2b. Owners are more likely to use financial statements when making decisions if they
have been prepared externally rather than internally. These results imply that owners
have more confidence in externally prepared financial statements and are more willing to
use them when making decisions.
Education (coefficient ¼ .440, significant at 1%) is directly associated with the use of
financial statements to make decisions, in support of H2d. Owners who have more education are more likely to use their financial statements to make decisions than are owners
Table 4. Logit regression analysis with financial statements used in decisions as
dependent variable (n ¼ 312).
Variables
Coefficient
Intercept
Comfort
Preparation
Revenue
Education
4.743
06549
0.029
0.293
0.440
Notes: Likelihood ratio (X2 ¼ 47.603), Score (X2 ¼ 43.070), Wald (X2 ¼ 37.008).
Significant at 1%.
Significant at 5%.
332
S. Carraher and H. Van Auken
with lower levels of education. Higher levels of education enable owners to understand
the information contained in the financial statements, as well as help them recognize how
important financial statements are when making decisions. Greater education can help
build confidence while also enhancing decision-making capabilities. Finally, the coefficient for revenue is not significantly associated with whether owners use financial statements to make decisions, so H2c is not supported.
Discussion
Understanding how owners use financial statements is important because of the role of
financial statements in decision making. Financial statements are among the most important sources of information; ineffective decisions in turn are associated with poor financial
management, one of the primary causes of firm distress and failure (Headd 2003).
Improved financial management can position the firm to remain viable and pursue profitable opportunities. Good financial decisions are predicated on reliable financial information and an ability to understand financial statements. Reliable financial statements
provide the information that is needed to make decisions that will help meet the firm’s
financial and operational goals. Even with reliable information, being able to understand
and interpret financial statements is a prerequisite for effective decision making.
The findings of this study provide greater insight into small firm owners’ use of financial statements. We focused on two aspects of the use of financial statements, namely,
their comfort in using them and whether owners actually used them to make their decisions. These dependent variables have pivotal roles in the use of financial statements
(Timmons and Spinelli 2004; McMahon 2001).
The degree to which an owner is confident about using financial statements may affect
how often they are used. Our analysis assesses factors that may affect owners’ comfort
with using financial statements; the negative relationship between owners’ comfort and
the frequency of financial statement preparation suggests that owners compensate for
their perceived lack of comfort by creating more financial statements. In contrast, their
greater comfort may lead owners to enjoy more confidence and believe that financial
statements can be prepared less often. Of course, neither comfort in their ability to interpret financial statements nor the frequency of financial statement preparation guarantee
good decisions by owners (Shields 2010; Timmons and Spinelli 2004). The quality of
their analysis of the financial information and their effective implementation are pivotal
issues affecting decision quality.
The results also show that owners’ comfort in their ability to interpret financial statements is positively associated with the level of revenue they earn. This finding is consistent with Neeley and Van Auken (2010) and Busenitz and Barney (1997), who report that
firm size affects not only the nature of decision making but also the firm’s reliance on
financial information to make decisions. Owners who are more comfortable with their
ability to interpret financial statements own firms with higher revenues; owners who are
less comfortable operate firms that bring in less revenues. Because higher revenues suggest more capital is at risk, comfort in interpreting financial statements is important. Owners likely have gained experience or the education needed to manage the firm as their
revenues grew.
Regarding the factors that affect whether financial statements actually were used to
make decisions, we expected and found a direct association between using financial statements and educational levels. More educated owners are likely to be better trained in the
interpretation and importance of financial statements, whereas less educated owners
Journal of Small Business & Entrepreneurship
333
might not be and thus are less likely to use financial statements to make decisions. Educational level previously has been found to be directly associated with small firm success
too (Carter et al. 2003; Cassar 2009; Hanlon and Saunders 2007).
The results showed a direct association between whether owners used financial statement to make decisions and their comfort with interpreting financial statements. Being
comfortable with interpreting financial statements reflects their understanding of the
importance of the information and familiarity with the information contained. It also
should lead to greater use of financial statements, because owners can understand the
information and believe it is valuable. They may still rely on advisors to draw conclusions
about the information in the financial statement before making their decisions, but these
owners also use their own judgment and analysis. On the flip side, they may be overconfident in their judgment and ability to use financial statements when they interpret the
information. This sequence matches behavioral finance theory, in which decision makers
form beliefs that influence their practice (Barberis and Thaler 2002; Ritter 2003).
The external preparation of financial statements may signal the firm’s financial
sophistication and internal expertise (Breen, Sciulli, and Calvert 2004). Firms with weak
internal financial expertise outsource their financial statement preparation, whereas firms
that have appropriate financial expertise can prepare their own financial statements. The
preparation of financial statements by external experts would give firms greater confidence in using the statements to make decisions, and in turn, these owners with confidence in the reliability of the financial statements likely use the financial statements to
make decisions (Shields 2010).
Conclusions
This analysis of the factors associated with whether SME owners use financial statements
and are comfortable with their ability to interpret financial statements is based on a sample of 312 SMEs located in a southwestern US state. Few studies previous have examined
the role of financial statements in decision making by SMEs. This article therefore is
important, considering the critical role of financial statements for stakeholders and the
financial impact of owners’ decisions on firm sustainability over time.
Owners who have their financial statements prepared less often are more confident in
their ability to interpret their financial statements, and this greater confidence leads to
firms that have higher revenues. This outcome may result because owners use financial
statements to make decisions when they are more comfortable with their ability to interpret those financial statements. Training to ensure owners’ understanding of financial
statements thus can determine how the information contained in financial statements is
used in decision making. Owners are more likely to use financial statements when making
decisions if those statements were prepared externally; that is, owners appear to have
more confidence in externally prepared financial statements and are more willing to use
the statements when making decisions.
The results of the study should be useful for owners of SMEs and providers of services to SMEs. Financial statements provide important information that should be used,
both by external evaluators and internally, to help guide decisions. Both owners and providers of services can use the information to understand which factors affect their use of
financial statements. Such an understanding of what factors have this influence may
improve the process by which financial statements get incorporated into decisions.
The several limitations of this study also provide avenues for further research. The
study could be expanded to other areas of the US and world to explore differences by
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S. Carraher and H. Van Auken
region, ethnicity, type of business, and rural versus urban areas. We did not examine the
specific relationship between financial statement use and the impact on the firm either.
Finally, we collected our data at a single point in time. A longitudinal study could provide
further evidence regarding how financial statements get used at different stages of a firm’s
development and over the business cycle.
Notes on contributors
Shawn Carraher is the Hodson Endowed Chair at n Indiana Wesleyan University and a Oxford
Journal Distinguished Research Professor. His research focuses on the behavioral and human
resource issues within global entrepreneurial organizations.
Howard Van Auken is a University Professor of Management at Iowa State University. His
research interests are in the area of small firm financing.
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