THE ABILITY TO HANDLE UNCERTAINTY AND DEAL EFFICIENTLY WITH CHANGE
Entrepreneur: SOMEONE WHO STARTS AND RUNS A BUSINESS AND HAS RESPONSIBILITY FOR THE RISKS INVOLVED. IN ORDER TO DO THIS, AN ENTREPRENEUR HAS TO BE ABLE TO MANAGE THE 4 FACTORS OF PRODUCTION EFFECTIVELY: LAND, LABOUR, CAPITAL, ENTERPRISE.
- small businesses are important to the UK economy as they are the origins of large sucessful businesses of the future.
- The EU 'small businesses have less than fifty employees
- The companies act, must meet 2 of: sales <£2.8 million, value of balance sheet <£1.4 million, <fifty employees.
- Different industries have different sized businesses e.g 100 accountants is large, 100 in manufacturing is small.
Motives for becoming an entrepreneur: 1.)escape an uninteresting job 2.)pursue an interest/hobby 3.)exploit a gap in the market 4.)market a new/innovative product FIVE.)innovative in terms of making the product SIX.)be their own boss & make own decisions: most quoted 7.)work from home and reduce travelling time 8.)have a second career 9.)provide service/product not for profit
opportunity cost: THE COST OF AN ACTIVITY EXPRESSED IN TERMS OF THE NEXT BEST ALTERNATIVE, WHICH HAS TO BE GIVEN UP WHEN MAKING A CHOICE. WHAT COULD BE DONE WITH TIME/MONEY?
Government support: small business vulnerable early stages, grants from variety of sources: central, local, EU, RDA awarded for: innovation, training, economic regeneration, encourage youths, business link
Government grants: SUMS OF MONEY GIVEN TO A BUSINESS FOR A SPECIFIC PURPOSE/PROJECT. CONTRIBUTE TO COSTS OF A PROJECT. DON'T NEED TO BE REPAID.
Generating and Protecting Business Ideas
Advantage: Knowing product/service : good knowledge of product features, entrepreneur has passion/interest so motivated to do well, good contacts in established market, may already have a good reputation in the market. Is there room for another competitor? Passion may not be shared, entrepreneur's passion may overestimate market size, knowledge isn't the only skill needed and person may not possess other skills needed for successful entrepreneurship.
Advantage: Spotting a gap in the market :by basing idea on customer's needs might improve chance of success, likely to enjoy first mover advantage, little/no competition when most vulnerable, easier to market new idea than persuade people to buy an established idea. Entrepreneurs have little/no expertise in market, is the gap real?. may have been tried earlier, competition may enter quickly, how long can first mover advantage last?
Initial small budget research: BUSINESS DIRECTORIES, LOCAL MAPS (to locate competition), LOCAL/NATIONAL DEMOGRAPHIC DATA (potential market features), SMALL SCALE RESEARCH (questionnaires and interviews), MARKET MAPPING (for market segments)
Generating and Protecting Business Ideas II
A franchise is a business structure in which the owner of a business idea sells the right to use that idea to another person in return for a fee and a share in any profit the franchise makes.
Benefits to the franchisor:
- can expand business quickly
- earns revenue from franchisees turnover, not profit
- risk is shared
- franchisee may have good entrepreneurial skills
Drawbacks to franchisor:
- loss of control over how product/service is presented
- more difficult to control quality with expansion
- coordination and communication problems may increase
- some franchisees become powerful over time
Generating and Protecting Business Ideas III
Benefits to franchisee:
- sell an already recognised/successful product or service
- marketing, training, etc provided by franchisor
- franchisor may have experience in market
Disadvantages to franchisee:
- proportion of revenue paid to franchisor
- may not feel business is his/her own and may not benefit from personal rewards of entrepreneurship
- right to operate could be withdrawn
Copyright: PROTECTION GIVEN TO BOOKS/PLAYS/FILMS/MUSIC Patent:AN EXCLUSIVE RIGHT TO USE A PROCESS/PRODUCE A PRODUCT FOR UP TO 20 YRS Trademark: A WORD/IMAGE/SOUND/SMELL THAT ENABLES A BUSINESS TO DIFFERENTIATE ITSELF FROM COMPETITORS. Due to protection of their ideas, businesses are more willing to invest, knowing their ideas are protected long enough to recover some of the invested money.
Transforming resources into goods and services
A business is a process whereby inputs are processed to produce outputs. An input is: something that contributes to the production of a product/service. An output is: something that occurs as a result of the transformation of business inputs.
Business activity is primary, secondary, tertiary or quaternary. Primary production: extraction of resources at the first stage of production, e.g. land and raw materials (farming). Secondary production: transformation of resources to produce finished goods and components (car manufacture). Tertiary production: transformation of resources to produce a service aka the service sector (retailing, selling of products from the primary and secondary sectors). Other examples: health care, education, transport, plumbers one in five people work in tertiary sector. Quaternary production: transformation of information (IT based businesses, consultancy) have grown as the 'knowledge economy becomes more important'.
Difficult to provide precise definitions of each sector as the significance of sector changes over time with evolving economies. Increasingly difficult to classify businesses as they expand and innovate (farms with shops).
Other inputs include: expertise, skills and information. Other outputs include: waste and pollution
Transforming resources into goods and services II
Added value: the difference in value between the price of the finished product and the cost of material used.
selling price ‐ cost of raw materials = added value
ways to add value: advertising (creates interest and convinces customer to pay more), branding (will pay more for a branded item), product features (customer feel improve benefits e.g. camera on phone), location (charge more if location is desirable), personal service (can differentiate product/service)
benefits of adding value:
- differentiation from competition
- charging a higher price
- reducing sensitivity of demand to changes in price
- higher profit margins
- targeting product/service at a different market segment
Developing a business plan
a business plan: is a document designed to allow a business to plan for the future, allocate resources, identify key decisions & prepare for problems and opportunities. Useful for business start-ups & for applying for finance/planning for growth.
- helps to plan for the future
- entrepreneur will understand the business better
- able to identify main courses of action need to start/run the business
- to set objectives against which business performance can be measured
- can present a request for extra funding, provide all info a potential lender needs
- is an essential planning tool; provide regular check on progress
Resources needed: time (not unlimited, many think loads in advance, more time, better plan), determination (determined to complete plan accurately and fully), vision (need clear idea of business and U.S.P), numbers (must be confident with numbers), planning (ability to be organised and multi planning)
Developing a business plan II
Executive summary: summary of main features, 1/2 pages long, most important part of plan, first part people see (only part people read), inc. highlights from each other section, meant to explain the basics in an interesting/informative way.
Business description: history of business, start-up plans, structure.
- start date for new businesses, how long been trading, history and previous owners
- type of business & sector of market
- legal structure
- entrepreneur's vision
product or service: key features, how customer will benefit
- what makes it different
- benefits the customer will gain
- plans for further development
- information on copyrights, designs or trademarks
Developing a business plan III
Market analysis: analysis of market and competition, analysis of customer needs
- the market, data about the size/growth of the market as a whole
- the customer, who and where they are
- competition, who they are strengths and weaknesses
- the future, future market changes and how businesses will respond
Strategy and implementation: analysis of key decisions/strategies, who's responsible for carrying them out, when, the money the have to do it.
- sales strategies
production strategies: location (owned/rented, ads/dis-ads), production (owned/leased, age, capacity in relation to forecast demand), systems (stock control, quality control, financial management, I.T)
Developing business plans IV
Management team: description of key members of the business & their skills and experience, data on number of employees, how business is structured and salaries.
financial plan: key financial documents e.g. profit&loss account, cash flow forecast, balance sheet, break-even analysis, key ratios, assumptions that have been made in putting financial forecasts together.
help and guidance:
- business link: detailed advice on contents of plan, templates, examples, case studies
- accountants&bank managers: offer a small business advice service, how to write and present a plan, Barclays offer guides, CDs, a local business manager and seminars.
- government agencies: 'create conditions for business success through competitive/flexible markets that create value for businesses, consumers and employers' offer help & guidance, winner of competition get £25,000 and grants.
Developing Business Plans V
- time, may not feel have time to put together a plan and want to trade ASAP
- money, not expensive but cost entrepreneur's time, any advice many cost money
- expertise, may not know enough about product/service/market to construct a plan accurately e.g. financial elements require forecasts
- opportunity cost, feel time spent on a plan in wasted, when could be trading
A business plan is worth the time and resources it uses, may depend on circumstances, e.g. someone with a clear idea of the market and good existing product knowledge not needing finance may decide a plan is less important than expansion or needing financial support from bank, venture capitalists, business angels.
Conducting start-up market research
- benefits of a business based on a hobby/interest include passion & knowledge of product
- disadvantage if entrepreneur assumes his interest will be shared by others and need evidence there is likely to be demand
- problem: gathering information is costly and money is short at start-ups. Need to balance need to gather data and need to keep costs as low as possible.
Primary market research data: data collected by the entrepreneur or paid to be collected, which doesn't already exist. Secondary market research data: data already in existence that has not been specifically collected for the purposes of the entrepreneur. Existing businesses have internal data, can help analyse performance of the business.
examples of secondary market research:
- BT phone book, yellow pages
- enterprise agencies
- companies that specialise in collecting data e.g. Mintel
Conducting start-up market research II
Random sample: one in which each potential member of a group has an equal chance of being in the sample. Quota sample: this is not random as not everyone has an equal chance of being included and results can't be used to predict the behaviour of everyone. Stratified sample: popular with researchers as it has the benefits of being random, thus reducing bias and is not as expensive/difficult as a full random sample.
Factors affecting sampling method:
- available finance
- nature of the product, new ideas less likely to have existing data, easier to research customer attitudes towards a physical product
- level of risk, never product is riskier thus greater need for research
- target market, clearly defined target market, easier to research.
examples of primary market research: observation (just watching people, IT observation), written questionnaire (large number distributed quickly, mix of open/closed questions), face to face questionnaire (difficult, time consuming, can respond on the spot), telephone questionnaire (all advantages of above and cheaper and quicker), focus groups (can reveal extra info and discover psychology of buying decisions) test marketing (sell to small group).
Conducting start-up market research III
Disadvantages to Primary Market research: 1. can be expensive, difficult for small businesses to afford it, 2. difficult to carry out accurately, 3. can be inaccurate > inappropriate decisions, 4. often lack time and skills to carry it out.
Quantitative data: data in numerical form, quantitative data is usually collected from larger scale research in order to generate statistically reliable results. Qualitative data: Data about opinions, attitudes & feelings, usually expressed in terms of why people feel/behave the way they do.
Quantitative data: good for establishing information about a business and its market, 1.) questionnaire, 2.) telephone surveys, 3.) online surveys
Qualitative data: information about attitudes/feelings/opinions, more revealing and useful but more difficult and expensive to collect, especially during business start-up. Examples are: in depth discussions and group discussions.
Quantitative data says what's happening & qualitative data says why
Local market: customers are only a short distance away. National market: a geographically dispersed market where customers are spread over a large area. Electronic market: no physical presence but exists in terms of a virtual presence via the internet. brick>click. There are businesses that exist to help others create an online shop e.g. shopcreator.com
Local market: very good relationships with & understanding of customers, communication with customers is easy and cheap, reputation spreads quickly & easily to customers and potentials, easy to collect primary data, changes in customer taste are apparent quickly, small market means limited possibility for continuous growth.
National market: more costly distribution of products/services, slower communication with customers, competitors nearer to customers, slow spread of reputation, larger potential market.
Factors affecting demand: price (sensitive to price changes), competition (actions of competitors e.g. price and product features), income (demand which is sensitive to changes in people's income), marketing (relationships between amount of money spent & demand for product), external factors (seasonality).
Understanding markets II
market segmentation: the technique where the market is broken down into smaller sections with similar characteristics. (A frequently used method is demographic segmentation e.g. age, gender, socio economic group).
benefits to segmentation: 1.) better understanding of the needs of a segment so a greater likelihood of meeting them, 2.) less expensive to develop products/services that attempt to meet a more distinct need, 3.) less wasteful than trying to sell to 'everyone', 4.) way of differentiating a product/service to charge a higher pricee.
limitations to segmentation: 1.) depends upon knowledge of the market, limited in small business start-ups, 2.) only an approximation of behaviour, 3.) may not be appropriate for small businesses with limited markets.
market share: the proportion of a total market accounted for by one product/company market growth; measurement of change in market size (percentage of original size), market size: measurement of size of total sales for a whole market, expressed in currency or volume of sales. Both market size & growth are likely to be affected most by external factors e.g. economic growth. Market share is the most precise measure of the success of an individual business. (value changed/original value) x100
Choosing the right legal structure
The earliest decision to make after deciding on the product/service to be offered. Affects matters like: tax and national insurance, records and accounts to be kept, liability of owner, sources of finance available, way decisions are made.
sole trader: most common and simplest, one person operating a business alone, little procedure in order to begin trading, keep basic records for tax NI and VAT, contribute less to total UK output.
Benefits: 1.) simple & quick to set up, 2.) inexpensive to set up, 3.) any profit is the owners to keep, 4.) complete control, 5.) close relationship between business and customer built up, 6.) hours of work tailored to entrepreneur.
Drawbacks: 1.) unlimited liability, 2.) difficult to raise additional finance, may have help with a good business plan, 3.) may not possess necessary expertise e.g. with finance and insurance, 4.) drive comes from owner.
unlimited liability: a feature of unincorporated businesses where the owners are personally liable for all debts incurred by a business. All sole traders and most partnerships have unlimited liability.
Choosing the right legal structure II
Partnerships are the simplest way 2 or more people can be in business together, partners share risks, costs and responsibilities and profits & decision making, jointly and personally responsible for any business debts, no legal existence of its own so if one partner dies/resigns, the partnership is dissolved. A new partnership must be formed for the business to continue. Deed of partnership: how much finance each has contributed, control over decisions each has, profits shared, how partnership can be ended.
Benefits of a partnership: 1.) few procedures to follow to set up, 2.) expertise of more than one person can be brought into the business, 3.) different partners specialise in different areas, 4.) more sources of finance.
Drawbacks of a partnership: 1) unlimited liability, 2.) profits shared amongst partners, 3.) legally bound to honour the decisions of others, 4.) partnership ends on death/resignation of a partner, 5.) maximum of 20 people so limiting size of business.
- sole traders & partnerships: unincorporated businesses
- LTDs and PLCs are incorporated
- incorporation creates a legal identity so business debts aren't the owner's debts.
Choosing the right legal structure III
LTDs: owners are the shareholders, ownership determined by proportion of shares each person holds, must have LTD in the name, limited liability, required by law more complex process in order to trade, more detailed records so potential lenders can see company is being run properly, popular form for family and small well established businesses, shares can only be sold privately and with consent of shareholders.
Benefits of LTDs: 1.) access to funds through issue of shares, 2.) stable form of business structure, 3.) limited liability so risk more acceptable, 4.) incorporated so business exists even if shareholder resigns or dies.
Drawbacks of LTDs: 1.) banks may see business as a risk, 2.) more complicated set up process, 3.) limited liability, lenders may see it as a risk.
limited liability: a feature of incorporated businesses, which means the owners liability is limited to the amount they have invested in the business. separation of ownership and control: describes a situation in which the owners (often the shareholders) are not the same people as those controlling the business on a day to day basis (the managers).
Choosing the right legal structure IV
PLCs: shares are bought and sold publicly, shares can be bought & sold and this affects the share price, share price indicates how popular the business is, share price is a crucial factor in determining how easy it would be to take over by buying a proportion of the shares, initial sale of shares to the public is flotation.
Benefits of a PLC: 1.) scale of funds that can be raised from flotation, 2.) many investors wanting to buy shares in the initial share offer so large sums of money can be raised, future funds raised as banks see a PLC as stable & secure so more willing to lend large sums of money.
Drawbacks of a PLC: 1.) flotation is expensive, documents, legal fees, must have MIN £50000 share capital and 25 percent must be sold before trading, 2.) not possible to control who buys shares and takeover cannot be prevented, 3.) must provide regular, detailed financial information and anyone can see how the company is doing. 4.) separation of ownership and control can cause conflict.
Choosing the right legal structure V
Social enterprises: now 55000 social enterprises in UK employing 775000 people, £8.4 billion each year, does not have profit as main objective, aims to provide a social benefit, profits are reinvested back into the business so social aims can be met.
Benefits of a not for profit structure: 1.) earn a living doing something valuable so it's motivating, 2.) the more successful the social enterprise, the more society benefits, 3.) customers are more willing to buy from social enterprises, 4.) easier to recruit/motivate/retain employees, 5.) grants etc might be available from sources sharing the same aim.
Drawbacks of a not for profit structure: 1.) profits and social aims may conflict, 2.) entrepreneur will always have a lower return than with a profit making business as proportion of social profits go towards the social aim.
Internal sources of finance: come from owners of business e.g. personal funds, retained profit, income from sale of asssets. Some entrepreneurs borrow from friends and family.
Advantages of personal finance: 1.) no cost to using the money, 2.) sign of confidence to encourage other lenders, 3.) no worries about money being returned, 4.) no risk of interference in decision, FIVE.) all profits available for reinvesting, SIX.) friends and family rarely charge interest and are more willing to lend money. Disadvantages of personal finance: 1.) opportunity cost of the money, 2.) limit finance limits what the business can purchase, 3.) entrepreneur could lose everything, 4.) can cause strain on relationships if business doesn't do well.
Overdraft: a temporary arrangement which allows the business to draw out momre money than is in its account. Flexible/useful for managing cash flow, banks charge fee and interest, bank could recall it at any time, not a long term solution.
Advantages of overdraft: 1.)flexible, 2.)quick and easy to arrange. Disadvantages of overdraft: 1.) expensive with large amounts over time, 2.) arrangement & penalty fees are high, 3.) can be removed at short notice, 4.) business needs a bank account.
Raising Finance II
bank loan: a good source of finance for assets such as machinery/equipment and other startup costs. A sum of money lent for a fixed period of time, repaid over a fixed schedule. Rate of interest depends upon a range of factors including size of loan, length of repayment time and risk level.
Advantages of a loan: 1.) length of loan can be matched to length of need for loan so can plan for repayments, 2.) interest is fixed so easier to budget, 3.) loan guaranteed for the period, 4.) no need to give lender a proportion of the profits, FIVE.) lender has no say in how business is run. Disadvantages of a loan: 1.) interest paid regardless of whether the business is profitable or not, 2.) needs to be secured against an asset so at risk if payments aren't made, 3.) length of loan may be longer than the asset with it so business paying for what it no longer needs.
Incorporated: the process of forming a limited liabilty company. Involves creating a separate legal identity for the business & creation of shares/equity. Venture capitalist: professional investor interested in high growth, high risk businesses. Invest in return for shares & high return. Usually interested in two hundred and fifty thousand plus investments. business angels: a wealthy entrepreneurial individual willing to invest in a small high risk business who expects a high return. Likely to have a high growth potential.
Raising finance III
Sources of advice: Prince's trust: provides advice & support for young people starting up in business. Prime Initiative: advice for old people. Islamic bank: guidance, advice & finance for muslims. Small business loan guarantee scheme: help for businesses that can't get loans by BERR.
Share capital: 1.) investor to put money into a business in return for a share of the business & usually own a share of the business itself. 2.) also called equity as each share is an equal part of the business, 3.) people who invest aren't entitled to a proportion of any profit made, 4.) share capital is never paid back ao best used for long term purposes. FIVE.) shares are control and entrepreneur loses some control over the business, SIX.) small businesses grow by becoming incorporated so friends/family/private investors can buy shares for a lump sum investment.
Other options: business angels: differ from venture capitals as they are often individuals, not companies, look for investments from £10 to twenty five thousand, they would want a share of the business. Business angels work closely with the owners of the business.
Locating the Business
Different stakeholders have different priorities, for retailers being close to the customer is essential, to an employee transport is the most important factor so transport links become important, as IT influences more businesses are becoming footloose, for some location is determined by non business factors.
stakeholder:an individual/group with an interest in a business including employees, management, shareholders, customers, suppliers and competitors.
Factors that influence location: Quantitative factors: Fixed costs: 1.) cost of land & buildings, 2.) availibilty of government grants, 3.)cost of utility bills e.g. gas, 4.) cost of employing managerial staff. Variable costs: 1.) transport costs of material, 2.) cost of local materials, 3.) wage levels in the area, 4.) bulk increasing/reducing activity. Qualitative factors: 1.) working environment of the area, 2.) ease of access for staff/suppliers, 3.) quality of local infrastructure, 4..) quality of labour available, FIVE.) planning laws and restrictions, SIX.) nearness of competitors.
Locating the business II
Teleworking: technology is affecting location decisions for small businesses. Ability to work from home, home is an extension of the office or the office.
Advantages of teleworking: 1.) reduced cost, don't pay for premises, 2.) reduced risk, no commitment to rental period, 3.) reduced travelling time, more time can be spent working, 4.) can plan work around the other commitments, FIVE.) family on hand if needed. Disadvantages of teleworking: 1.) difficult to separate work from home life, 2.) initial set up costs, 3.) loss of social aspects, 4.) hidden costs e.g. house insurance, council tax, FIVE.) may not be able to avoid distractions e.g. children.
Costs: 1.) number of fixed costs including purchasing/renting a building, 2.) asset for resale, lower if in undesirable location, 3.) where areas are high cost, salaries tend to be higher, 4.)skilled staff are more expensive, especially when in short supply FIVE.) utility costs will need to be considered, SIX.) some costs may be reduced as incentives to locate in particular areas, 7.) variable costs differ e.g. skilled labour very different in some parts of the country.
Infrastructure: 1.) transport links will be a relevant factor, 2.) speed, reliability, flexibility of delivery could be a way to add value, 3.) being close to customers is a selling point, 4.) also includes waste disposal, health education etc.
Locating the business III
Market: 1.) small businesses, being close to the customer is essential, 2.) as they grow the customer base becomes more geographically dispersed, 3.) very significant for a bulk gaining product as cost of transporting product > cost of transporting raw materials. 4.) numbers of competitors , so locate new businesses away from competitors.
Qualitative factors: 1.) desire for a different kind of life, quality of local schools, hospitals, nightlife etc may all play a part, 2.) local planning laws and regualtions, 3.) quantity and quality of labour also relevant.
The importance of each factor depends on: 1.) nature of product, bulk gaining or bulk reducing? 2.) service? services more likely to be influenced by customer location needs, 3.) do costs differ in different locations, 4.) how limited is the choice of location? FIVE.) what qualitative factors are important.
Full time employees: Benefits: 1.) higher output as work longer hours, 2.) available all the time for unexpected events, 3.) build better working relationships with each other, spend lots of time together, 4.) good relationships with customers & suppliers, FIVE.) can take more advantage of training opportunities. Drawbacks: 1.) high cost if their output falls, 2.) not as flexible in terms of capacity.
Part time employees: small part of overall labour, term time workers given upaid leave during school & college holidays, zero hours contracts, no fixed number of hours but hours change as demand for employee changes. Benefits: 1.) flexibility, operate for longer etc, 2.) can be used to cover peak trading, 3.) to extend production periods e.g. evenings at a supermarket, 4.) can manage work with other commitments so wider pool of labour, FIVE.) wider range of skills and talents, SIX.) business can retain valuable staff if they're no longer full time, 7.) business can build slowly. Drawbacks: 1.) may find it harder to access training opportunities, 2.) more difficult to communicate with part time employees, 3.) less able to build good customer relationships, 4.) cost the same as full time employees for administration.
It's illegal to treat part time employees less favourably. Employers legally have to consider full time to part time applications that are down to family commitments.
Employing people II
Temporary employees: one who is employed for a fixed period(s) of time. Often season workers and may work part time. Rarely have same benefits as permanent employees e.g. pensions and health insurance. Benefits: 1.) can keep level of staffing flexible, 2.) specific tasks that need work for a finite period of time, 3.) business may lack certain skills needed for a period of time, 4.) when need a type of labour for a certain time, FIVE.) may eventually become permanent. Drawbacks: 1.) may not know workings/culture of the business, 2.) not as motivated as permanent employees, 3.) constant changeover makes communication difficult, 4.) customers may not like the ever changing business, especially if it's a service.
Consultants: Businesses/individuals who provide professional advice on services for a fee. Often the advice is on how to make the small businesses more successful or to deal with a specific problem. Benefits: 1.) benefit from specialist skills without employing people full time, 2.) can add to skills base as & when they need to, 3.) can quickly adjust workforce up or down, 4.) avoids the need to search for and recruit staff, FIVE.) startups can gain specialist advice often for free or lower rates. Drawbacks: 1.) won't know the business as well as employees, 2.) may not be as motivated to work hard for the business as employees, 3.) sometimes consultants can be expensive.
Calculating costs, revenues and profits
Profit: what is left after costs have been deducted from revenue. TOTAL REVENUE ‐ TOTAL COSTS = PROFIT. Costs: Expenditures made by a business as part of its trading operations. Revenue: the value of sales made during a trading period. TOTAL REVENUE = SELLING PRICE x NO. OF ITEMS SOLD. Fixed costs: costs that do not change with the level of output or sales. variable costs: costs that change directly with the level of output or sales. total costs: fixed costs & variable costs.
profit is a surplus of the value of sales made by a business over its total costs of production, important because: 1.) used as a measure of success by the owners of the business who invested capital, 2.) lenders will be unlikely to want to lend to a business that doesn't forecast/make a profit, 3.) reward for the entrepreneur for taking risks with their capital, 4.) profit provides a source of finance.
why calculate the costs of production: 1.) forecast of profit/loss to be made, 2.) likely breakeven level of output, 3.) drawn up so financial planning is undertaken, 4.) pricing decisions can be made based on cost data, FIVE.) keep a check on forecasted costs versus actual costs, SIX.) costs may lead to raising the price of goods, 7.) calculating whether the business is profitable or not. Total profit depends on 2 main factors 1.) profit on each item sold (profit margin) 2.) quantity sold in the trading period.
using break even analysis to make decisions
breaking even is just earning enough sales revenue to pay for total costs. It's not making a profit but is a very important situation to aim for. Lenders will be very interested when the business plans to break even, the longer it takes, the riskier the business. For existing businesses just breaking even means the managers will have to take action to make a profit.
contribution and contribution per unit: contribution is one of the most important financial concepts this is the difference between sales revenue & variable cost of production. SALES REVENUE ‐ VARIABLE = CONTRIBUTION ‐ FIXED COSTS = PROFIT. contribution per unit: the difference between the selling price of one unit and the variable cost of producing one unit. total contribution: UNIT CONTRIBUTION x NO. OF UNITS SOLD
CpU can be increased by raising the selling price, can be increased by reducing variable costs per unit, not the same as profit per unit (fixed costs not subtracted), increase in CpU raises the potential profit a business can make, useful in business decision making e.g. setting prices & calculating breakeven output.
using break even analysis to make decisions II
breakeven level of output: the level of output or the number of customers that earns enough revenue to cover total costs of production. margin of safety: amount by which the existing level of output is greater than the breakeven point. BREAKEVEN OUTPUT = FIXED COSTS/CpU
effects of changing variables on breakeven output: 1.) analyse the impact on the breakeven output & potential profit levels of a change in either variable costs or price. 2.) sometimes called 'what if' analysis, 3.) allows managers to ask certain questions, 4.) breakeven charts & breakeven formula can be used for this analysis.
strengths: 1.) relatively simple concept, formula can be used and understood by most entrepreneurs, 2.) information can be vital when taking decision whether to go ahead with a business proposal, 3.) widely used to support loan applications from the entrepreneur, 4.) quickly adapted to make diffferent situations for consideration so reinforces usefulness. weaknesses: 1.) assumes all output produced is sold, no stock keeping, 2.) over simplifies business situations, assumed averages but there are variations, 3.) many firms sell more than one product so more difficult to apply. 4.) assumes 'steady & consistent' increases in costs, FIVE.) misleading, inaccurate date = inaccurate forecasts, SIX.) only helps to consider situations.
Using cash flow forecasting
cash gives 'immediate spending power', used to pay expenses e.g. rent & taxes & wages & suppliers, without enough cash bills cannot be paid & the firm will be forced out of business, amount of cash held is never consistent changes with the made/received payments.
cash flow: total cash payments into a business, the total cash payments, liquidation: turning assets into cash & may be insisted on by courts if suppliers haven't been paid. insolvent: when a business cannot meet its short term debts. cash inflows: payments in cash received by a business e.g. from customer/bank. cash outflows: payments in cash made by a business e.g. to suppliers & workers.
cash is always important, if payments aren't timed correctly it may run out of cash (even if profitable), suppliers/creditors can force business into liquidation of the business's assets if it appears insolvent.
why so vital?: 1.) new businesses are given much shorter credit periods, 2.) lenders may not believe new business promises, they'll expect payment on time, 3.) finance is very tight at start ups so more significant for new businesses.
using cash flow forecasting II
cash inflows: 1.) owners own capital injection, 2.) bank loans received, 3.) customer cash purchases, depends on sales, how accurate may this be? 4.) debtors payments, difficult to forecast, when will they pay?
debtors: customers who bought goods on credit & will pay cash at an agreed future date. credit sales: value of goods to customers who do not pay cash immediately.
cash outflows: 1.) lease payment for premises, 2.) annual rent payment, may increase rent, 3.) utility bills will vary, 4.) labour cost payments, base on demand forecast & hourly wage, FIVE.) variable cost payments, vary with demand, how much credit offered.
cash flow forecast: estimate of a firms future cash inflows and outflows, net monthly cash flow: estimated difference between monthly inflows and outflows, opening balance: cash held by business at start of the month, closing balance: cash held at end of the month, next months opening balance.
using cash flow forecasting III
there are 3 basic sections: cash inflows, cash outflows, net monthly cash flow & opening/closing balance.
advantages: 1.) additional finance plans can be put into place, 2.) if negative cash flow is too great, cut down on purchases, 3.) proposal won't progress if lends can't see a cash flow forecast.
disadvantages: 1.) mistakes can be made by inexperienced staff, 2.) unexpected cost increases can lead to major inaccuracies, 3.) wrong assumptions can be made due to poor market research so inaccurate forecasts.
good tool but use cash flow forecasrs with caution.
budgets: financial targets for the future income & expenditure over a certain time period.
key benefits: expenditure budget: set spending limits so costs shouldn't get out of control. income budget: motivating factor if realistic employees will try to achieve them. Delegated budgets mean most employees have some financial responsibility and can judge managers performance. profit budgets: provide clear goals & targets so motivating and allow quick monitoring of performance. budgets must be included in new business plans is the business viable?
expenditure budgets: a fixed some of money to be spent in a given time period by a department. budget holder: a person who is accountable for seeing a budget is kept to. income budget: the sales revenue target for a department/whole business. delegated budgets: giving some control in the setting/spending of budgets to departments/individuals. profit budget: target profit for the business over a certain period of time.
Setting budgets II
how to set budgets: 1.) set clear objectives for the firm,must be reflected in sales budget, 2.) undertake market research to provide information to base sales on, 3.) construct a sales budget showing target revenues from each product/region, 4.) based on a sales budget, set budgets for labour, material/energy costs, promo spending, FIVE.) set profit target based on sales & cost budgets.
budget rules: 1.) use spreadsheet software, keep updating records regularly, 2.) set budgets min. 12 months as most new businesses make a loss in the first few months, 3.) great importance to monthly sales forecasts, key factor, 4.) all costs of operation involved in producing/delivering product are included, FIVE.) keep a cumulative month to month total of profits/loses, show trends & breakeven. SIX.) monitor each major budget monthly and take corrective action ASAP.
monitoring budgets: keeping a check on progree towards achieving targets during budget period. 1.) money from each expenditure isn't being misallocated, 2.) all costs are being accounted for, 3.) major cost excesses are being reported to senior managers before expenditure is agreed, 4.) revenue & profits are meeting target levels, informing senior managers if not.
setting budgets III
problems: 1.) future is never certain e.g. economic recession, inflation etc make the budgeting process less effective, 2.) managers with delegated authority try & raise their spending budgets so more likely to reach other targets, 3.) inaccurate budgets may be demotivating, 4.) short term decisions to keep rigid budgets may damage long term reputation, FIVE.) easily achievable budgets won't promote the motivational incentives, SIX.) key sales revenue budget is affected by so many external factors, so very difficult to plan a certain sales level.
however virtually every business will undertake budget setting & will monitor performance.
assessing business start ups
sixty five percent of entrepreneurs set up own business due to personal satisfaction from bein independent, 43 percent liked the idea of doing things their way, 37 percent they were looking for profits & capital groeth, sixteen percent wanted to pass something onto their children.
business objectives: clearly defined targets for a business to achieve over a certain time period. profit satisficing: making enough profit without profit without risking too much stress or loss of control through employment of too many professional managers. profit maximisation: trying to earn as much profit as possible.
survival: primary objective in the first few years of a new business or for any business that enters a crisis stage in its development. sales growth: try to make as many sales as possible, may believe growth increases chance of survival, also larger businesses benefit from economies of scale. social objectives: with social entrepreneurs main objective will be to correct one of society's problems, may have financial requirement to break even.
Assessing business start ups
why set objectives: 1.) give direction & focus to owners/workers, 2.) well defined target so the owners can make plans to achieve them, 3.) inform lenders of business aims, 4.) guideline for assessing the performance of business over time.
Specific: clearly related to only that business
Measurable: helps when assessing performance
Agreed: by everyone involved so increase motivational impact of objective
Realistic: should be challenging but not impossible, could demotivate staff
Time Specific: so performance can be assessed effectively.
How to assess success: 1.) begin with original objectives, 2.) compare sales growth with sales aim & profit levels with profit target, if these are the primary initial objectives. 3.) businesses with survival aims have failed if have gone bust within 12 months, 4.) with social enterprise, social value indicators should be used e.g. how many people helped, FIVE.) each social enterprise creates five jobs & £10000 training, gives £100000 benefits to society, SIX.) social benefits different from business profits.
Assessing business start ups II
risks of business start ups:
1.) lack of business & management skills, lack of action during crisis, so failure. Attend training courses and seek advice of experienced consultants.
2.) lack of knowledge of legal requirements, detailed laws involved. Training courses, specialist legla advice, partner with a legal background.
3.) competition, competitors with more experience & finance. Monitor decisions & actions of rivals, give a better service.
4.) increased taxes/interest rates, finance short during start up. Plan ahead.
FIVE.) changes in consumer taste, if demand falls, no other product. Keep in close contact with customers.
SIX.) technology, changes in IT can quickly wipe out the competitive advantage of a new business. Training course, accept change well, try & stay ahead of changes.
nearly sixty percent of new businesses fail within 4 years of being established.
assessing business start ups III
Why they fail: 1.) insufficient capital: underestimating the amount of money made, overestimating income, low breakeven point etc, shortage of capital forces the business into insolvency.
2.) poor management skills: some entrepreneurs start business with a huge handicap sometimes sheer enthusiasm will pull the business through but owners need to seek help quickly or the business will fail.
3.) poor location: for businesses dealing with the public, need other ways to attract customers. A poor location could end a good business idea with a well organised owner.
4.) lack of planning: must use accurate and current information. Planning should be a continuous feature of a start up & requires regular study of market research & customer data.
FIVE.) over expansion: success is confused with quick expansion, trying to handle rapid growth with no assisstance or enough capital, leads to stress and insolvency.
SIX.) external factors: unexpected in demand or unavailability of suppliers are beyond entrepreneurial control. Interest rate increases etc. Lack of finance & high dependency on borrowed capital makes start up businesses particularly vulnerable.