This study was aimed to examine the influence of innovation toward business performance and competitive advantage as a mediator. To test the empirical models, Structural Equation Modelling (SEM) was used. Among the software used to assist the analysis in this study were AMOS 21.0, SPSS 16.0 and Microsoft Excel 2007. The sample size of this research was 125 owners-managers of Small and Medium Enterprises (SMEs) in the Purwokerto Province, Indonesia. The result showed that innovation has positive effect on business performance, innovation has positive effects on competitive advantage, competitive advantage has a positive effect on business performance, and competitive advantage doesn’t mediate the influence of innovation to business performance.