Business Studies: Theme 2

INTERNAL SOURCES OF FINANCE: 

• Owner's capital - most likely to be used as a source of start-up finance.
• Retained Profit - capital left when all costs have been covered; probably the most safest and common for established businesses.
• Sale of Assests - cash generated by a sale of assets.

EXTERNAL SOURCES OF FINANCE:

• Family and Friends - may provide extra start-up capital, or may be taking an equity. 
• Banks 
• Peer-to-peer funding - relies on websites that match investors to start-ups who need finance; loans will generally be at a high rate of interest. 
• Business Angels - rich individuals who provide capital.
• Crowdfunding - obtaining finance from many small investments via the web.

Loans - providing a lump sum of cash which will be repaid over a period of time. It can be provided by banks, friends, families.  

Share Capital - when a private company is formed, the ownership of the business is split into shares; when the share is first sold, capital enters the business. 

Venture Capital - method of providing finance in higher risk investments generally through a combination of loans and shares. 

Overdrafts - facility offered by a bank to allow a customer to continue spending money even when their account becomes negative. It offers flexibility, as the business only pays interest when using the overdraft.

Leasing - when an asset is rented for a monthly fee for a set period of time. It is a sensible method for avoiding large chunks of cash outflows each time a major new asset is purchased. 

Trade Credit - when goods/services provided by a supplier aren't paid for immediately. 

Business Plan - document setting out a business idea and how it will be financed, marketed and put into practice. 

Interpreting cash flow forecasts: 

• Monthly balance (net cash flow) - shows the net effect of the month on cash flow (cash inflow - cash outflow)
• Opening balance - shows the amount of cash the business had at the beginning of the month.
• Closing balance - shows the amount of cash in the business at the end of the month, calculated by adding the monthly balance to the opening balance. 

The fundamental use of a cash flow forecast is to spot cash problems in advance so that action can be taken in time to prevent a major crisis. 

Limitations of cash flow forecasts include:

- if users trust the accuracy of the document too much, they may be lulled into a false sense of security. 

Purpose of Sales Forecasts:

• HR Plan - sales forcasts are necessary to ensure that in the medium-long term, the right number of staff with the right skills are employed.
• Marketing Budgets - to decide how to allocate its marketing budget, a business such as Mars, uses sales forecasts for each brand. 
• Production Planning - if a business is to satisfy demand for its product or service, it will need to ensure that enough products are made and before that, enough raw materials. 

Factors affecting sales forcasts: 

• Demographics e.g. ageing population
• Gloablisation
• Affluence
• Economic Variables e.g. recession

Difficulties of sales forecasting 

- most sales forecasts assume that past trends will continue (extrapolation), which isn't true. 

The ways to measure how much a business has sold inlcude, sales volume and sales revenue. To boost revenue, businesses can either increase their selling price, or increase their sales volume. 

Sales revenue = sales volume x selling price

FIXED COSTS - costs that don't change as output changes (linked to time) e.g. rent. 

• as these costs won't change as output changes, a rise in sales will spread these fixed costs over more units, meaning the fixed cost per unit is lower. 

VARIABLE COSTS - costs that change in direct proportion to the level of output, e.g. raw materials. 

Total variable costs = variable cost per unit x number of units produced (output)

TOTAL COSTS - cost of running a business for a period of time. 

Total costs = variable costs + fixed costs 

Break even - position where a business is selling just enough to cover its costs without making a profit. 

Break even = fixed costs / (selling price - variable cost per unit)

Contribution = selling price - variable cost per unit 

Features of a break-even chart:

• Fixed cost - flat line showing that fixed costs are the same at all levels of output. 
• Total cost - line showing the effect of adding fixed costs and variable costs together.
• Total Revenue - begins at point (0,0) since no revenue is generated if nothing is sold. 
• Break even output - identified by dropping a vertical line down from the point at which total revenue and total costs cross, to read off the amount of output that needs to be sold to cover costs. 

Margin of Safety - the distance between the actual output of a business and its break even output. 

• This shows how far demand can fall before the firm slips into a loss-making position. 

Limitations of Break-even analysis:

• variable costs are assumed to increase constantly; they may increase more slowly at higher levels of output due to bulk-buying discounts. 
• it assumes that the firm sells all its output in the same time period which may be untrue. 
• it's based on a firm selling only one product at a single price. 

Budgets: A budget is a target for revenue or costs for a future time period. 

• Income Budget - sets a target for the value of sales to be achieved.
• Expenditure Budget - gives budget holders a limit under which they must keep their department's costs. 

Purpose of Budgets:

• expenditure budgets are set to ensure that no department/individual spends more than the company expects.
• both budgets can help motivate staff in certain departments to try to meet targets.
• all budgets provide a yardstick against which performance can be measured. 

Types of Budget:

Historical Budget - set using last year's budgets as a guide and then making adjustments based on known changes in circumstances for the department. 

Zero based budgeting -involves setting each budget to zero each year, then expecting each budget holder to justify a budget figure that they can work to for the coming year. It can be time consuming, but it can prevent the wastage of historical budgeting. 

Variance Analysis - the difference between a budgeted figure and the actual figure occurred.

• Adverse - when the actual figure is worse than the budgeted figure 
• Favourable - when the actual figure is better for the business than the budgeted figure.

Difficulties of Budgeting:

• it can be hard to ensure targets are realistically set and that budgets don't creep up.
• imposing budgets is less motivating than giving budget holders a say in setting their own targets.

Gross Profit = total revenue - cost of sales

Operating Profit = gross profit - fixed overheads

Net Profit = operating profit - (net financing cost and corporation tax)

Ways to improve profit:

• increase revenue
• reduce costs 

Gross Profit Margin = gross proft / sales revenue x 100

Operating Profit Margin = operating profit / sales revenue x 100

Net Profit Margin = net profit / sales revenue x 100

Ways to improve profitability: 

• increase selling price
• cut costs

Liquidity - a business's ability to pay its bill on time.

Balance Sheet (Statement of financial position) - shows what a business owns, what it owes and where it got its money from.

Current Assets - items a business owns that are in the form of cash/can be turned into cash quickly without a major loss in their value e.g. cash, receivables and stock. 

Current Liabilities - debts owed by a business that are due to be paid within the next 12 months e.g. trade creditors and overdrafts.

Current Ratio = current assets / current liabilities 

Acid Test Ratio = (total current assets - inventories) / current liabilities 

Working Capital - money available for the day to day running of a business

Managing working capital involves, ensuring that there's enough money in the system altogether, and making sure cash moves through the cycle as quickly as possible. 

Methods of Production: 

Job Production - involves making one-off items to suit each customer's individual requirements. 

• Benefits: higher price can be charged as products can be tailored to meet exact specifications
• Drawbacks: cost per unit is high due to high level of skill and low rate of production.

Batch Production - involves making a group of products to one specification at a time.

• Benefits: speedier than job production as making identical products speeds up production. 
• Drawbacks: cost per unit higher than flow production as machinery will need to be adjusted. 

Flow Production - continuous production of a single, standardised product. 

• Benefits: huge volumes allow huge demand in mass markets to be met 
• Drawbacks: high initial costs of installing production machinery 

Cell Production - involves organising workers into small groups or cells that can produce a range of different products quickly. 

• Benefits: group working allows ideas to be generated within the cell for improvements to processes. 
• Drawbacks: heavily reliant on people rather than automation therefore costs are relatively high.

Productivity - a measure of the efficiency of the production process. 

Productivity = total output / number of workers

Factors influencing productivity:

• quality and age of machinery 
• skills and experience of workers
• level of employee motivation

Efficiency - measures the extent to which the resources used in a process generate output without wastage. 

Labour intensive vs Capital intensive Production

Labour intensive - production process that relies on human input with little use of automation. 

• Benefits: offers greater scope for tailoring products to suit customer needs, thus adding value and allowing a higher selling price.
• Issues: labour costs will form a high proportion of total costs. 

Capital intensive - production which uses high levels of automation, reducing the role of humans. 

• Benefits: running costs will be relatively low
• Issues: initial costs will be very high, with the need to invest in a lot of specialist machinery.

Capacity Utilisation

Capacity utilisation - the proportion of maximum capacity used by the business. 

Capacity utilisation = current output / maximum possible output x 100

Implications of under-utilisation: 

• Higher fixed costs per unit - with under used capacity, a greater amount of the revenue generated by each product must be used to cover fixed costs, which reduces operating margins. 
• Fear of job security among staff, which may damage motivation.
• Contribute to poor repuation for the business, especially in the service sector. 

Implications of over-utilisation: 

• The firm may be unable to accept new orders, potentially turning away new customers to rivals.
• There will be little/no time for maintenance on machines or train staff. 

Ways of improving capacity utilisation: 

• Increase current output - i.e through boosting sales volumes. Alternatively, a business could use its capacity to make products for other businesses looking to subcontract. 
• Reduce maximum capacity - i.e. through selling off assets or laying off staff. 

Stock - materials, partially made products and finished goods owned by a business, which havent't been sold. 

Features of a stock control diagram: 

• Maximum stock level - affected by the amount of space available 
• Minimum/buffer stock level - the amount of stock the business aims to always have available
• Re-order level - amount at which a new order of stock is triggered
• Re-order quanitity - the amount of stock that's ordered each time an order is placed
• Lead time - time between a re-order being placed and the delivery of stock arriving

Reasons to keep buffer stock of raw materials:

• If deliveries are delayed, buffer stock allows production to continue. If a batch of supplies is faulty, buffer stock can be used to continue production. 

Reasons for keeping buffer stock of finished goods:

• helps to ensure that the business can always supply customers when they need a product. 

Implications of too much stock:

• Increased storage costs - keeping stock costs money; it needs space and perhaps security.
• Increased wastage - too much stock may lead stock becoming obsolete.

Implications of too little stock:

• Lost customers - if customer doesn't receive their product they will turn to competitors. 
• Delays in production - if there aren't any materials, machinery and workers may be left idle. 

Just-in-time stock Management - approach to stock management which aims to eliminate buffer stock completely 

Issues to consider using JIT:

• suppliers must be willing to deliver frequently
• deliveries must be reliable, missed deliveries leave the firm without stock
• will smaller, frequent deliveries lead to a loss of bulk-buying discounts? 

Lean Production - range of Japanese techniques designed to eleminate waste from business processes. 

Waste Minimisation - aspect of lean production that focuses on reducing waste in several ways:

• Less stock is held - meaning there is far less likelihood of stock wastage. 
• Cash is not tied up in stock

Competitive advantage from JIT:

• higher levels of productivity, reducing labour cost per unit 
• less space used to hold stock, reducing fixed costs
• higher quality leading to better reputation and repeat custom
• faster development of new products, allowing firm to be the first to enter market with new ideas

Quality Control (QC)

• Involves checking output to find any faults in a production system. Inspection is carried out by a person who is not involved in the wokring on or making the product. 
• Benefits: It can be used to guarantee that no defective item will leave the factory and it requires little staff training. 
• Drawbacks: QC can be trusted when 100% of output is tested but not when it's based on sampling. 

Quality Assurance (QA)

• Focuses on producing methods to prevent quality problems arising. 
• Benefits: It makes sure that the company has a quality system for every stage in the production process.
• Drawbacks: QA does'n't promise a high quality product, rather a high quality process which may produce 'okay' products. 

Total Quality Management (TQM)

• Involves encouraging all staff to think about the business and 'buy into' the idea of getting things 'right first time'.
• Benefits: Once all staff think about quality, it should follow through to design and manufacture and after, sales service e.g. Lexus. 
• Drawbacks: To get TQM into the culture may be expensive, as it requires extensive training among all staff. 

Quality Circle - a group of staff who meet regularly to find quality improvements

Continuous Improvement (Kaizen) - this encourages staff to put forward a stream of small ideas on how to do things better, they key aspects include:

• cell production
• quality circles,
• small but frequent changes
• regular suggestions. 

Inflation - the percentage rate at which average prices rise during a year within the whole economy

The circumstances in which inflation has a major effect are:

• when rates of inflation are significantly above 2%
• when prices are rising faster than average earnings
• when UK inflation is higher than that in most other countries

Effects of inflation on businesses:

• If inflation in the UK is higher than in other countries, UK businesses may lose competitiveness against foreign rivals whose costs are likely to be rising more slowly.
• Firms with substantial long term borrowings will find the real value of the money they repay will be lower following a period of high inflation, as inflation has the effect of reducing the real value of money. 

Exchange rate - the value of one curency expressed in terms of another 

If the '£' appreciates;

• UK exports get pricier, so sales volumes slip
• UK imports get cheaper, making it harder for UK firms to compete

If the '£' depreciates; 

• UK exports get cheaper, so sales volumes rise 
• UK imports get more expensive, so UK firms can compete more effectively 

• Strong
• Pound
• Imports
• Cheaper
• Exports
• Dearer

Interest Rate - the amount charged by a lender per year for borrowing money; expressed as a % of the money outstanding. 

Effects of interest rates on businesses:

• consumers are likely to have less money to spend as payments on mortgages or other borrowings will increase - this is likely to reduce demand.
• consumers are less likely to 'borrow to buy', so products that are often bought on credit e.g. sofasm will see a demand fall, as the credit will cost more. 

Effects of the Business Cycle on businesses:

• the key impact that the business cycle has on businessess, is primarily related to demand for products

Effects of employee protection on businesses:

• Minimum wage - increased labour costs, which may lead to increased automation in the longer term and therefore increased unemployment. 
• Right to a contract of employment - can reduce employers' flexibility in how they use their staff
• Increased right to sick, maternity/paternity leave - increased cost of paying for cover for these staff, however staff may feel more valued = lower staff turnover
• Redundancy - reducing capacity becomes expensive due to statutory payments made to staff made redundant. 

Effects of environmental protection on business:

A range of legislation now governs how businesses treat the environment, major areas include:

• materials that firms use for certain products
• processes firms are allowed to use to make certain products
• the need to use recyclable materials for certain products
• landfill tax

Effects of competition policy on business:

Governments seek to ensure that there is competition in all markets through the Competition and Markets Authority (CMA), which is responsible for:

• investigating proposed takeovers and mergers
• investigating allegations of anti-competitve practices
• taking legal action against those who collude to maintain high prices within a market, such as cartels 

Cartels - group of companies opertaing in the same market who make agreements to control supply and thus prices. 

The work of the CMA should enusre that:

• companies have to set competitive prices
• companies to do collude with others in their market to the detriment of consumers
• mergers and takeovers that will create overly powerful firms are prevented

Effects of health and safety on business:

Health and Safety law is designed to protect employees and customers in the workplace. The legislation, the Health and Safety at Work Act 1974 places the burden on employers, key aspects include:

• safe physical conditions
• precautions that firms are required to take when planning their work
• the way in which hazardous substances should be treated in the workplace

Pros:

• should prevent incidents that create negative publicity
• should help to motivate employees

Cons:

• need to pay for extra safety equipment
• need to pay to adjust physical working conditions

Monopoly - single business that dominates supply in a given market

A market dominated by a single business (monopoly) is bad for consumers because:

• consumers have little choice
• prices tend to be high
• there is little incentive for the firm to innovate or provide greater customer service

A key focus of becoming a monopoly is providing barriers to entry which include: 

• patents and technological breakthroughs 
• strong brands and high advertising budgets

Oligopoly - market dominated by just a few major suppliers

• Companies in an oligopoly rarely compete on price as they fear a price war would start, decreasing profit margins, therefore they turn to non-price competition...
• Non-price competition in oligopolies focus on aspects such as, branding, product features, product design, advertising, and technological innovation.

Big Markets 

• larger markets offer scope for new competition, therefore in a large market there is likely to be a fair degree of competition

Small markets 

• in a smaller market with fewer customers and lower total sales, it may be easier to build up barriers to entrym carving up the market between just a few businesses. 

Business responses to a tougher competitive environment

• Price cutting - attracting new customers could be achieved by cutting the selling price; unless this is paired with cutting the costs of production, profit margins will fall. 

Increased Product Differentiation

• finding new ways to show that a product is different to rivals is likely to be the key to success in a tougher environment. Methods of differentiation could include, branding, product features/design, advertising.