RR49 - The Financial Management of Small Firms - an Alternative Perspective
Jarvis, Kitching, Curran and Lightfoot, 1996
Executive summary
How small firms use financial management information to plan and control their operations and make decisions has been of interest to researchers and policy makers for a number of years. Of particular interest is how small firms manage their cash flow and measure performance. Observers have tended to be very critical of the financial management practices adopted by small firms and have concluded that small firms, in the main, do not adopt 'best practice' models of financial management and show poor financial management skills.
In recent years more and more advice has been available to owner-managers of small firms on financial management techniques and systems. It is claimed (Berryman, 1983; Shaw 1994), however, there has been little overall improvement in the practices employed by firms. Although the literature tends to focus on the high failure rates of small firms, citing poor financial management practices as one of the reasons, a large proportion of small firms do survive. This suggests that the 'best practice' models advocated are not necessarily appropriate to small firms in all cases and alternative approaches may be viable.
It is questionable whether the research methods adopted in the past were able to elicit high quality information on the actual financial management practices adopted by small firms. An alternative research strategy, with a more in depth approach is offered and shown to be more appropriate to studying small business owner financial management strategies.
A sample of 20 owner-managers of small firms were interviewed, ten drawn from manufacturing and ten from the service sector. Each owner-manager was interviewed twice. Interviews were in-depth and semi-structured with questions reflecting sensitising propositions adopted to elicit detailed information.
The data collected from the interviews was analysed using a framework based on three models of rationality. Through this framework it is possible to understand owner-managers' motives for their adoption of particular practices and to examine the values of the owner-manager in their working environment. The rationale for adopting particular financial management practices is affected by the owner-managers' attitudes to growth. It is assumed in much of the literature that growth is a prime objective for the owner-manager. However, none of the owner-managers interviewed sought growth as a major objective.
Owner-managers perceived some 'ideal size' for their firms. The 'ideal' size of the firm of those owner-managers interviewed was either the current size or a size only a little larger. Substantial growth was not a declared goal of any respondent. Control issues were found to be important in owner-managers' perceptions of the 'ideal' size of their firm. For example, maintaining control through personal involvement in the day-to-day operations of the firm enabled owner-managers to avoid delegating responsibility to others which might be a result of growth.
Owner-managers use a variety of measures to assess business performance. Profit measures were of less importance than conventional views suggest. Cash flow indicators were seen as crucial. But these often took distinctive forms or were linked closely with other indicators. Other performance indicators included the number of customer telephone enquiries and the quality of output. The owner-managers took a specific standard of living as a reasonable indicator of business success. However, a number were adamant that they would not plunder their firms just to provide themselves with what they considered to be a desirable standard of living.
The terms 'cash flow' and 'cash' mean different things to different people. It is only when these terms are examined contextually that an adequate interpretation of their meanings can be established. Cash flow management is important to small business owners. It is used primarily to assist them in their survival rather than for other goals such as growth.
Although credit control theory is based on the maximisation of profits, the strategies adopted by the owner-managers were strongly influenced by industrial sector norms regarding acceptable credit terms and what was considered to be 'appropriate' behaviour in practising credit management.
The overall conclusions drawn are that the financial management strategies actually adopted by small firms differ from those identified by previous researchers. The practices are driven by motivations of owner-managers which tend to be ignored in the literature. The outcomes, in terms of the operational procedures adopted and the impact on the business, are complex but in many instances are highly effective even when assessed by conventional measures of business success. It is more appropriate, however, to assess financial management strategies in relation to owner-managers' notions of 'success' and the social and other contexts in which the firm operates. Policy Implications
- The implications of this research for policy are clear. Currently, much small business policy is based on the assumption that growth is, or should be, the prime overall objective of the financial management strategies of small business owners. But the evidence is that the majority of small businesses do not pursue this objective as conventionally defined. The motivations of the owner managers of small businesses are often complex and they tend to have a range of business objectives. Survival and stability are often more important goals. Policy should therefore explicitly support these objectives. For example, policy should give more attention to creating conditions which help enhance small business owners' feelings of security by encouraging more stable external financing and prompt payment.
- The financial management practices of large firms have been used as a template and benchmark for small businesses. But it is apparent that small business owners have different motivations and cost structures and these differences should be recognised. Performance measures employed by large firms, for example, are often totally inappropriate to small businesses. Accounting systems introduced for control purposes are influenced by the relationship between the owner and the business. In the case of small businesses, the owner-manager and the business are often inseparable and a different emphasis is given to control reflected through the accounting information system.
Accountants therefore need to develop alternative financial strategies that specifically address the needs of small firms.