Financial reporting in entrepreneurial SMEs : in search of significant areas of financial reporting information

Abstract: This study sets out from the contemporary discussion on the need of separate financial reporting standards for small and medium-sized enterprises (SMEs), and focuses on financial reporting information needs in the context of entrepreneurial and growth-oriented SMEs. The main purpose of the study is to sort out areas of financial reporting information that are likely to be of significance tomanagers of entrepreneurial SMEs in their provision of information to users. In order to fulfill this purpose data has been collected in several sequential steps where the results of each step have provided with significant input and structure to the carrying through of the following step/s. The first step consists of a literature study of previous empirical studies about accounting information in entrepreneurial contexts. In the second step, interviews have been conducted with accounting experts engaged in the current discussion on the development of accounting standards for SMEs. The third and fourth step consists ofdocument studies of comment letters to the Swedish standard setter Bokföringsnämnden’s (BFN) two drafts of the accounting standard Financial reporting in small companies (K2) and IASB’s Esposure draft of an IFRS for SMEs. According to the study results the continuous high demand for financial capitalis a great challenge to managers of entrepreneurial SMEs in their efforts to make their entities develop and grow. In this context, financial reports make up an important tool mainly for informing external capital providers, among which bankers are considered to hold a prominent position. The high demand for financial capital also makes risk capitalists and other external owners more important as financiers of entrepreneurial SMEs than what is the case in SMEs in general. Other important users of entrepreneurial SMEs’ financial reports are customers, suppliers, employees, potential acquirers and management. One of the areas of financial reporting information that have been sorted out in this study as likely to be of significance to managers of entrepreneurial SMEs in their provision of information to users is cash flow. Information on cash flow is likely to be significant in the entrepreneurial context not at least since the development of entrepreneurial activities puts a lot of pressure on managers to secure the continuous inflow of cash. The extent to which capital providers make use of cash flow information provides with further argument for its importance in the entrepreneurial context. Also, entrepreneurial entities tend to rely on intangible assets to a high extent, and these assets are in general not sufficiently reflected in the balance sheets. Cash flow provides in this respect straightforward and reliable complementary information that is important when assessing the prospects of the business. Besides information on cash flow, information on intangible assets is according to the results of this study likely to be significant in an entrepreneurial context. The possibility to capitalize expenses for intangible investments is crucial not at least to avoid the legal consequences of bankruptcy law, which may be critical to the very survival of development-intensive entrepreneurial SMEs. The importance of innovation as a central part of the entrepreneurial process also makes financial reporting information on intangibles highly relevant from an informational perspective. In addition, financial ratios in general, and financial ratios measuring various aspects of growth - i.e. growth ratios - in specific, have been sorted out as likely to be of specific importance to include in the financial reports of entrepreneurial SMEs. Besides disclosure of additional information on individual intangible assets, additional disclosure of information related to the collective earning capacity of ongoing projects - including the business concept of the reporting entity - has also been identified as significant in the entrepreneurial context.