Measuring the Risk of Small Businesses

The motivation and reason for the paper is to examine the conceptual framework for measuring the risk of small businesses. Small businesses should fit into a neat theoretical framework but when practically applied there are several difficulties with each method. This paper uses a three dimensional conceptual framework (impact of growth, availability of long term data and existence of newly faced uncertainty and offers an additional approach using accounting base beta after testing a sample of small businesses and comparing these to large businesses.

Accounting betas were calculated from the annual financial statements of 209 small businesses, collected from 1984-1987 from the Waikato region. These were compared with 147 accounting betas of a sample of 147 listed companies from New Zealand over the same time period. The data showed that large listed businesses accounting betas corresponded with the market, while the small businesses betas were not normally distributed.

There is a difference between risk (which is measureable) and uncertainty (which is not measureable). The reason uncertainty is not measureable as it includes events such as technological obsolescence, changes by government to rules and natural disasters. It is important to have this distinction between risk and uncertainty when searching for a risk-based asset value. The paper stated four measures for small business investors, coefficient of variation (easy to calculated by does not consider growth or trend); overall trend of business activity (by adjusting the coefficient of variation however it is difficult to calculate the trend); trend adjusted future orientated risk (also difficult to calculate) and accounting beta (simple to use with two years of financial statements but relies to the accuracy of the statements).

Overall this paper fits in to the overall context of the literature. There are contradictory methods for measuring risk in small businesses while large listed businesses are not so difficult to calculate. Further research is required but this paper provides a framework with which to build on.