The Performance of Small Firms : Profits, Jobs and Failures

Investigates the factors influencing job creation in small firms, firm survival and potential predictors of firm success. One key purpose of this study is to better understand market failures which might warrant public policy intervention. Part one conducts an analysis on a database of 636 manufacturing firms in the United Kingdom to determine the mechanisms of small firm profits and job creation; and part two assesses the use of financial ratios as a predictor of small firm survival. The selection of the companies is detailed, as are the companies' general characteristics. In particular, the authors have endeavored to develop a database that includes short-lived or failed firms. A subset of this database is reviewed to determine the typical ownership and management structure, accounting practices, and financing sources of small firms. Small firms tend to have family boards of directors and few non-director shareholders. Accounting practices tend to be unsophisticated and capital comes largely through borrowing. A summary of existing empirical research on the relation of firm size to growth and profitability is presented and found wanting because those earlier studies focused on relatively large firms. Accordingly, the authors apply the tests from earlier research to their database and document the findings and their differences from earlier conclusions. In particular, for small firms profitability increases with increasing size whereas for large firms profitability decreases with increasing size. Age of a company also has a significant effect on small firm performance but little impact on large firm performance. The role of profitability to job creation is examined to determine optimal forms of government assistance and delivery methods. Financial ratios of successful and failed small firms are subjected to univariate analysis, multiple discriminant analysis, and probit, logit, and factor analysis to determine the adequacy of financial ratios as a predictor of failure. Lastly, the use of qualitative variable to supplement financial ratios in failure prediction is examined and found to be useful. (CAR)