- Created by: Alex Hastie
- Created on: 08-11-12 18:18
Most businesses aim to make a profit by selling products or servies. As well as making profit, businesses may have other objectives such as:
- Offering the highest quality goods and services
- Growth (increasing the market share, opening new outlets or taking over another business)
- Giving a good customer service
- Having a good image and reputation
- Going Green
- Diversifying (offering a wider range of products)
- Surviving (especially for new businesses)
Production - The employees who turn raw materials into finished goods or services that they can sell. They also monitor the quality of what they are producing.
Finance - A business has to keep a careful eye on their finances, hence why they keep financial records. They try and get the best value for money.
HRM - (Human Resource Management) Businesses must make sure they have the right number of employees with necessary skills at the right place.
Admin - Businesses have to run their own affairs as efficently as possible.
R&D - (Research & Development) Businesses may need to discover new ideas for products that might be needed in the future.
Key Business Essentials
Before a business can make a profit, they need certain things:
- Customers (Target Market)
When a business pays for raw materials, it then transforms them into finished goods and then sells for a higher price than what they paid for the materials.
Value Added - This is the difference between the cost of the raw materials bought and the price the customer pays for the finished product.
Surplus - This is what the value added leaves, which then the business uses to pay off other costs (wages, rent, electricity) and any money left over is profit.
High Value Added - This is things such as designer clothing, known as luxury items, which have a very large difference between the cost of the material and the price they sell it for.
Low Value Added - This is the basics for human life, such as groceries, utensils etc. Their is minimal differnce between the price the business bought if for, and the price the customer pays for it.
The greater the value added, the higher the profits.
Primary Sector - Industries that extract raw materials for natural resources (farming, fishing and mining). The UK primary sector is declining, as it is cheaper to import materials from other countries. In 1984 there were approx. 170 coal mines open around the UK - more than 150 have now been closed. Farming has also declined by half since the 1970's.
Secondary Sector - Processes the raw materials that come from the primary sector and manufactures and constructs them into finished goods. This sector has also been declining for the past 25 years, due to companies moving production to other parts of the world where manufacturing costs are lower.
Tertiary Sector (A.K.A. Service Sector) - Sells the finished goods to the consumer. This sector has expanded over the last few decades and the main growth has been in the financial and business services (banking and accouting). The proportion of people working in these jobs in the UK has doubled in the last 25 years.
Entrepreneur - A person (or one of a group of people) who raises the resources and organises the activities needed to start a business. They first of all have to have an idea, which they think will sell well to a specific market, and then organise the financial investment, staff, buildings, R&D and marketing.
Qualities of an Entrepreneur:
- Creativity - Innovators who have spotted a gap in the market (whether with a new idea or exploiting an existing idea or product)
- Perserverance - James Dyson took over 10 years with raising the finance, and prototyping his vacuum cleaner and 5 years of building the G-Force till someone invested in his idea.
- Risk-takers - Many entrepreneurs use their own source of finace to provide their start-up capital. If the business fails, they lose their investment, but motivated by profit if their idea succeeds.
- Organisers and Planners - Successful entrepreneurs plan what financial, technical and human resources they'll need and organise resources so that they're used cost-effectively.
To be a successful entrepreneur, they need to research profitable business opportunities. They can do this through:
- Brainstorming (or from personal experience)
- SWOT analysis - Strengths, weaknesses, opportunities and threats of each idea
- Successful entrepreneurs won't commit large resources till they are sure their idea will work
- Demand for their idea - Will enough people want to buy it for them to make a profit?
- Profitability - Entrepreneurs need to figure out how much money they'll make so they know their idea will be profitable
- USP - Unique selling point, it needs to be different than other products for people have the desire to buy. It could also be better quality, lower prices or a better customer service
- Price - The price of the product or service needs to be right. If it's too high customers won't buy and if it's too low the business will not make a profit or even breakeven.
The Government encourages entrepreneurs to set up businesses because an enterprise benefits the economy (creates new jobs and increases productivity). The Gov. has set up organisations like Business Link to provide advice and support to new and existing entrepreneurs. Finally, the Gov. also provides grants and incentives to encourage entrepreneurs and helps with the start-up capital.
Faliure of New Businesses
New start-ups are risky - lots of small businesses fail within a couple of years of starting up. It's often because:
- The entrepreneur lacks experience. Sole traders have to be the 'Jack of all trades', meaning they have to be responsible in all aspects of the business
- Entrepreneurs may have false expectations of what running their own business will be like - they expect high profits and lots of free time
- One of the main reasons is that they simply run out of money - entrepreneurs can underestimate costs, overestimate demands or simply can't control their cash flow
- If a business has an inaccurate or unrealistic business plan to start with
- Unexpected delays or a lack of available supplies can cause a business to fail - this is poor stock control
- Not doing enough market research, or not making sure that the research is reliable
- The wrong location can cause a business to fail, as can changing market conditions
Business and individuals who produce original work need to protect their ideas from being copied by others. You can protect them in several ways by:
- A Patent: If you have a new invention, you can apply for a patent. If you patent your product, or your method for producing it, no one else can copy it unless you give them a licence - and you can charge for the licence. A patent can last for up to 20 years.
- Trademarks: If you want to protect you business' name, logo or slogan, you can register it as a trademark so that nobody else can use it i.e. the McDonalds arches cannot be used by any other company. Trademarks last up to 10 years.
- Copyright: Copyrights give protection to written work and music. It's illegal to reproduce other people's work without their permission. Authors and musicians or their publishers recieve royalties (payments) every time their work is published or played on the radio. Lasts for 70 years after the authors death.
Franchises aren't really a type of business ownership as such. They're agreements (contracts) which allow one business to use the business idea, name and reputation of another business.
The franchisor is the business which is willing to sell, or license, the use of its idea, name and reputation. The franchisee is the business which wants to use the name.
Several well-known retail chains in the UK operate as franchises e.g. KFC, Burger King, McDonalds, Pizza Hut and the Body Shop.
Franchisee Benefits and Drawbacks
The franchisee gets these benefits from running a franchise business:
- A well-known name
- A successful and proven business idea - less risk of failure
- Training and financial support to set up a new franchise outlet
- Marketing, advertising and promotion are done nationally by the franchisor
- Buying is done by the franchisor - this helps franchise outlets keep costs down
- Expensive equipment can be leased from the franchisor
- It can be easier to finance a business if its a franchise - banks are more willing to loan money to people who want to buy a franchise as they are established
A franchise business has these drawbacks for the franchisee:
- They have to pay the franchisor for the right to use the name
- They have to pay the franchisor part of the profits or an agreed sum
- They have to run the business according to the franchisor rules - cant choose their own decor
- It might be difficult to sell the franchise - can only sell it to someone the franchise approves of
- The franchise could get a bad reputation if other franchisees give bad customer service
Franchisor Benefits and Drawbacks
The franchisor gets these benefits from franchising their business:
- Someone else runs bits of their business for them and saves them wage costs
- They get paid for the use of their name, and they get a share of the profits
- The more franchises there are, the faster the name of the business will spread
- The risk involved in opening an outlet in a new location is reduced because the franchisee takes on some of the risk
A franchise business has these drawbacks for the franchisor:
- They have to help the franchisee set up a new franchise
- They provide a good business concept, but they have to share the rewards with the franchisee
- If their franchisees don't have good standards, the franchisor's brand could get a bad reputation
Industrial Market: Where businesses sell to other businesses, such as wholesalers supplying retailers
Consumer Market: Where firms sell to individual customers e.g. high street stores Next etc.
Local Market: Where firms sell to customers who live nearby. Therefore a National Market means selling to people who live all over the country
Electronic Markets (A.K.A.) Virtual Markets: Where customers don't physically interact with sellers - instead, buying and selling is done over the internet through websites i.e. EBay
Business-to-business (B2B): Firms that sell their product or service to other companies i.e. a wholesaler to a retailer
Business-to-consumer (B2C): Businesses that sell to individual customers i.e. high street stores like Topshop, Tescos, Toni&Guy
Market Analysis lets businesses spot opportunities in a market by looking at the market conditions through the size, growth and market share.
Market Size - By volume and value: Businesses estimate the size of their market by the total number of sales (volume) in the whole market or by the value in pounds of all the sales in the market. Market size is calculated by adding together all the sales made by different firms operating in a particular market.
Market Share - Sales as a % of total market size: Businesses like to know what share of the market they have. If 1 out of every 4 PC's bought was a Dell, this would mean that Dell had a 25% market share (in terms of unit sold). If £1 out of every £10 spent on perfume was spent on Chanel, this would mean Chanel had a 10% market share (in terms of sale value).
Market Share = Sales / Total Market Share x 100%
Market Growth: Businesses need to know if the market is growing or shrinking. In a growing market, several firms can grow easily. Businesses may want to get out of a market that is getting smaller.
Market Growth = Difference between size of old and new market / size of old market x 100%
Businesses try to increase their market share by increasing demand for their products among consumers. Increasing demand means an increase in sales, revenue and profit. The main factors that affect demand are:
- Price: As the price rises, demand tends to decrease. As the price falls, demand goes up
- Competitors: When one manufacturer increase its prices, demands for cheaper competitor products tends to rise
- Customer Income: When people have more money to spend (disposable income) there is more of a demand for luxury products
- Seasonality: Products varying demand by season i.e. ice creams during the summer have a higher demand than those in the winter
- Marketing: Successful marketing and promotion can stimulate demand
Analysing different parts (segements) of a market allows a business to focus on the needs of specific groups within a target market. Segementation can be done by:
- Income: i.e. Chanel is aimed at customers with high incomes and Primark is aimed at people with low incomes. Luxury products are also aimed at people with high incomes
- Socio-Economic Class: Based customers on the kind of job they have i.e. Blackberry's were originally aimed at Businessmen
- Age: Businesses can target different age groups i.e. Pop Magazine is aimed at pre-teens
- Gender: Most common type of market segmentation i.e. Make-Up for Women and Hair Jel for Men
- Geographical Region: i.e. the core market for Iron-Brew and Haggis is Scotland
- Amount of Use: i.e. Mobile Phone suppliers market different phones for heavy or light users
- Family Size: 'Family Packs' are a big part of advertising, i.e. KFC family bucket, Loo Roll, Breakfast Cereals etc.
- Lifestyle: i.e. Uni students and young workers tend to buy lots of microwaveable ready-meals so ready-meals might target this segment
Market groups are a constant change to constant market research must be done to be successful
Market Reserach is done for 3 main reasons:
- It helps businesses spot opportunities. Businesses research customer buying patterns to help them predict what people will be buying in thr future. A business will use research to help them spot growing and declining markets
- Helps a business work out what to do next. Businesses research before launching a product or advertising campaign
- It helps them see if their plans are working. A business that keeps a keen eye on sales figures will notice if their marketing strategy is having the right effect
Market Research can be expensive. Bad market research can lead to disastrous business decisions. Businesses need to plan carefully to make sure they get maximum benefit from market research.
Quantitative and Qualitative Market Research
Quantitative research produces numerical statistics - facts and figures. It often uses multiple choice questionnaires that ask questions like:
"When did you last buy this product? A: within the last day, B: within the last week etc."
These are called closed questions because they have fixed, predetermined answers. Closed questions answer with either 'yes' or 'no', which makes analysis easier, but sometimes does not give enough information.
Qualitative research looks into the feelings and motivations of consumers. It uses focus groups that have in-depth discussions on a product and asks questions like:
"How did this product make you feel?"
These are called open questions, where the answer is not restricted to multiple choice and the customer can give any number of answers.
Primary Market Research
Primary market research is where a business gathers new data (or employs someone to do it on their behalf).
- Data that is gathered with questionnaires, interviews, post/phone/internet surveys, focus groups or observations
- Businesses can use test marketing, in which they launch a product in one region and monitor sales and customer response before lauching it to the whole country
- Primary research uses sampling to make predictions about the whole market based on a sample
- Primary data is needed to find out what consumers think of a new product or advert. You can't use secondary research for this because there won't be any research on a brand new product
- Primary data is specific to the purpose it's needed for. This is great for niche markets - secondary data may be to broad or too mainstream to tell you anything useful
- Primary data is exclusive. No one else can benefit from it apart from the researcher
- Primary research is all up to date and current. Secondary data may be too old
- BUT primary research is labour-intensive, expensive and slow
Secondary Market Research
Secondary market research is done by analysing data thats already available.
- Internal sources of data include loyalty cards, feedback from company salesmen and analysis of company sales reports, financial accounts, and stock records
- External sources include Government publications like the Social Trends report, marketing agency reports, pressure groups and trade magazines
- Secondary data is much easier, faster and cheaper to get hold of than primary data
- BUT secondary data was gathered for different purposes and may be unsuitable. It may contain errors and it may be out of date
- Secondary data is often used to get an initial understanding of a market. A business may then do more specific primary research to investigate any issues or problems that are shown up by the secondary data
Market researchers can't ask the whole of a market to fill in a survey, so they select a sample. The sample tries to represent the market, therefore must have similar proportions of people in terms of things like age, income, class, ethnicity and gender.
The larger the sample, the better chance of it being representative of the market. But there is always a margin of error. And obviously the size of the sample depends on how much the business can afford.
There are 3 main types of sample:
- Simple Random Sample: Names are picked randomly from a list
- Stratified Sample: The population is divided into groups and people are selected randomly from each group. The number of people picked from each group is proportional to the size of the group
- Quota Sample: People are picked who fit into a category (e.g. moms between 30 and 40). Businesses use quota sampling to get opinions from the people the product is directly targeted at.
Sole Trader: An individual who trades in his or her own name, or under a suitable trading name. Sole traders are self-employed i.e. shopkeepers, plumbers, electricians etc.
The essential part of being a sole trader is that they have full responsibility for the financial control of his or her own business and for meeting running costs and capital requirements.
There are several advantages of being a sole trader:
- Freedom: The sole trader is his/her own boss and has complete control over decisions
- Profit: The sole trader is entitled to all the profit made by the business
- Simplicity: There's less from-filling than for a limited company
- Saving on fees: There aren't any legal costs like you'd get with drawing up a partnership agreement
There are disadvantages too:
- Risk: There's no one to share the responsibilities of running the business with
- Time: Sole traders often need to work long hours to meet tight deadlines
- Expertise: The sole trader may have limited skills in areas such as finance
- Vulnerability: There's no cover if the trader gets ill and can't work
- Unlimited Liability: The sole trader is responsible for all debts of the business
The law allows a partnership to include between 2 and 20 partners, although some professions e.g. accountants and solicitors are allowed more than 20.
Patnerships need rules. Most partnerships operate according to the terms of a partnership agreement (A.K.A. a deed of partnership). It is a document which sets out:
- The amount of capital contributed by each partner
- The procedure incase of partnership disputes
- How the profit will be shared between partners
- The procedures for bringing in new partners and old partners retiring
Advantages and Disadvantages to a Partnership
There are disadvantages:
- Partners still have unlimited liability
- Each partner is liable for decisions made by other partners - even if they disagree
- There's risk of conflict between partners
- More owners bring capital to invest
- Partners can bring more ideas and expertise to a partnership
- Partners can cover for each others holidays and illnesses
Limited and Unlimited Liability
Sole traders and partnerships have unlimited liability:
- The business and the owner are seen as one under the law
- This means business debts become the personal debts of the owner. Sole traders and partners can be forced to sell personal assets like their house to pay off business debts
- Unlimited liability is a huge financial risk - it's an important factor to consider when deciding on the type of ownership for a new business
Limited Liability is a much smaller risk:
- Limited liability means that the owners aren't personally responsible for the debts of the business
- The shareholders of both private and public limited companies have limited liability, because a limited company has a seperate legal identity from its owners
- The most the shareholders in a limited company can lose is the money they have invsted in a company
Limited Partnership Act
However, some partners in a partnership can have limited liability, due to the Limited Partnership Act (1907), which allows a partnership to claim limited liability for some of its partners, they are known as sleeping partners. Sleeping partners can put money into the partnership but they aren't allowed to do anything to run the business. There also must be at least one general partner who is fully liable for all debts and obligations of the partnership.
Ltds and PLCs
There are private limited companies (ltds) and public limited companies (PLCs), which both have limited liability and are owned by shareholders and run by directors. The capital value of the company is divided into shares - which can then be bought and sold by shareholders. Both require a minimum of 2 shareholders and theres no upper limit on the number of shareholders.
Private Limited Companies: (They end their name with the word 'limited' or 'ltd.')
- Can't sell shares to the public. People in the company own all the shares
- Don't have share prices quoted on stock exchange
- Shareholders may not be able to sell their shares without the agreement of the other shareholders
- They're often small family businesses
- There's no minimum share capital requirement
Public Limited Companies: (They always end their name with the initials PLC)
- Can sell shares on the stock exchange with a quoted price
- Shares are freely transferable & can be bought and sold through brokers and banks
- They usually start as Ltds and then go public to raise more capital
- They need over £50,000 of share capital, and if they're listed on a stock exchange, at least 25% of this must be publicly available. People in the company can own the other 75%
The Companies Act
The Companies Act (1985) says that two important documents must be drawn up before a company can start trading. These are the memorandum of association and the articles of association.
Memorandum of Association:
- This gives the company its name (either Ltd. or PLC), and it gives the company's business address
- The MoA says what the objectives of the company are
- It gives details of the company's capital i.e. £250,000 divided into 250,000 ordinary shares of £1 each
- It states clearly that the shareholders' liability is limited
Articles of Association:
- The AoA are the internal rules of the company
- They give the names of the directors
- They say how directors are appointed and what kind of power they have
- The AoA say what the shareholders voting rights are
- They set out when and how the company will hold shareholders' meetings
- The AoA set out how the company will share its profits
As their name suggests, not-for-profit businesses are not set up to make a profit. They have other objectives, i.e. to help people in need.
These businesses are run in similar ways to normal businesses, as in they have money going in and out, but their profit does not go to the owners or shareholders, but to the people in need.
Public Sector organisations providing free services to the public are not-for-profit businesses i.e. NHS hospitals, where their aim is to provide health care. Aswell as the fire bragade and the police, they do not charge people for their service and don't make a profit, but they are funded by the UK tax system.
Charities like the Red Cross and Oxfam are also not-for-profit organisations, where they make money from donations or charity shops, but this money is used to set up charitable activities e.g. setting up hospitals. Charities get tax reductions because of their not-for-profit structure.
Many local organisations and societies are also run as not-for-profit businesses i.e. amateur theatre groups might charge for tickets for a production, but the profit they make gets put back into the group for costs like rent, costumes etc.
Financing a New Business
Entrepreneurs need to find finance for their business if they want to turn an idea into reality. There are loads of different sources of finance, so it's a case of choosing the right one for you.
- Savings: Most entrepreneurs can use some of their own money to finance their business. Investing some of your own money shows faith and confidence in your idea - this can then encourage banks to give you a loan or other people who might want to invest. Some people don't have enough money to start-up their business so they may need other sources of finance too
- Loans: Entrepreneurs can get loans from banks for finance. They borrow a fixed amount of money and pay it back over a period of time with interest - the amount they have to pay back is determined by the interest rate. Loans are good for paying for assests (i.e.machinery). They are not good to cover day-to-day running costs. You can also get a loan from friends or family who probably won't ask for an interest rate and be more flexible with repayment - however this could have a negative affect on the friendship
- Overdarfts: This is where a bank lets you spend more money than you actually have in your account. This is noted as a negative figure. This is mainly used to cover the day-to-day costs of the business or short-term cash flow problems. They're not suitable for long-term problems
- Shares: If the business is set up as a Ltd, the entrepreneur can finance it using ordinary share capital - money raised by selling shares in the business. They can sell shares to friends/family/venture capitalist (professional investors who buy shares in new businesses that they think will be successful).
Advantages of Bank Loans:
- You're guaranteed the money for the whole duration (the bank can't suddenly demand it back)
- You only have to pay back the loan and interest - the bank won't own your business and you don't have to give them a share of your profits
- The interest charges for a loan are usually lower for an overdraft
Disadvanatges of Bank Loans:
- They can be difficult to arrange because the bank will only lend the entrepreneur money if they think the business is viable
- Keeping up with repayments can be difficult if cash isn't coming into the business quickly enough. The owner may lose whatever the loan is secured on (i.e. their home) - the bank can sell it to get their money back
- The entrepreneur might have to pay a charge if they decide to pay the loan back early
Advantages of Overdrafts:
- They're quick and easy to set up - banks will usually offer them to anyone, unlike loans
- They're flexible - the business can borrow any amount up to the overdraft limit, and only has to pay interest on the amount that it borrows
Disadvantages of Overdrafts:
- The interest rate is usually very high so they are expensive if they're used over long periods of time
- The bank can remove the overdraft facility at any time and demand all the money back
Cost-benefit analysis means weighing up the costs of an opportunity against its potential benefits.
Renting or buying somewhere is a big investment for a business. When deciding where to locate, businesses consider how each location will affect costs and revenues (i.e. rents and loabour costs in Newcastle are likely to be lower than in London). Businesses use quantitative analysis teachniques such as break-even analysis to measure this.
Businesses calculate how many sales they'll need to break even at each potential location. Where the costs of operating from a location are high, the break-even output will be higher. Its better to put yout business where break-even output is low.
Government and Location
Goverments usually want to attract businesses to ares with high unemployment.
In 1998, the UK Gov. set up 8 Regional Development Agencies (RDA's) to coordinate and encourage development. They can provide financial assistance to businesses through grants, loans, and equity (share) investment. They provide financial and management adivce, and can help businesses find the right location.
As another part of its regional policy, the UK Gov. has names certain economically less-developed parts of the country as assisted areas. In these ares Gov. grants are available to persuade manufacturing and service businesses to locate there. Cornwall and the Scottish Highlands are 2 examples of assisted areas.
The Gov. often uses the 'carrots' and 'sticks' plan to encourage businesses to locate in deprived areas. I.e. a 'carrot' would be a grant given to a business locating in an area of high unemployment. A 'stick' would be refusing planning permission to build a factory in an area where there are already lots of jobs.
Small businesses might need to increase or decrease their staffing levels in the following situations:
- The business is expanding - businesses may need extra staff to cope with the increased workload
- Demand increases - extra staff might be needed so that the business can keep up with demand
- A change in direction - if a business decides to move into a new area (i.e. a hair salon might start providing beauty treatments), new staff with new expertise might be required
- Quiet periods - having too high staff levels at these times can cause problems for a business. They have to pay all their staff even if they dont really need them
- Seasonal changes - some businesses may only be seasonal (i.e. a swim wear shop in Brighton) therefore they may only need 1 or 2 employees during the winter as demand would be extremely low
Most businesses employ mainly full-time staff (working 35+ hours per week). However, full time staff are not always the best option for small businesses. Employing part-time staff can be better in certain circumstances:
- Save the business money. There's no point paying full-time staff to be at work all week if there's not enough work for them to do
- More flexibility to manage workloads - have the part-timers if demand increases
- P-T staff may have a better work/life balance, so less likely to take time off due to stress
- P-T staff can ease pressure off full-time staff is the workload it too large - this can decrease absenteeism in F-T staff
- A better work/life balance is likely to mean happier staff - this could lead to an increase in productivity
- Wider range of skills among the workforce - by increasing the number of employees, this increases the amount of skills and experience
- Can be difficult to find good P-T staff as most people want to be full-time
- P-T staff can sometimes be less dedicated and loyal - it's not as important to them
- P-T staff spend less time working there so may not have as much experience
- Recruitment and training processes are time consuming and expensive
Temporary or Permanent Staff
Permanent staff have an ongoing contract to work for a business and a guaranteed salary. You can only stop employing permanent staff by dismissing them (i.e. if they behave badly) or making them redundant (if the business no longer needs anyone to do their job). It's expensive to make permanent employees redundant - the firm has to give them redundancy pay.
Temporary staff work for the business for a fixed period of time (i.e. 6 months) or on a weekly basis. The business can renew the employee's contract if extra staff are needed for longer than this. A small business can employ temporary workers in high-risk periods when the business' future is uncertain - then they can easily reduce their number of employees without having to pay redundancy money.
A business plan is a document that states what the owner(s) want to do and how they intend to do it. There are several reasons for writing a business plan before starting a business:
- The main purpose of this plan is usually to get financial backing for the business. A business plan shows the financial risk involved in setting up the business - this important for potential lenders or investors who may want to help finance start-up. Banks and venture capitalists will want to see a business plan before they'll think about investing
- Setting down all the plans for the business in a report helps the entrepreneur to assess the business strengths and weaknesses, and allows them to see whether their idea is actually realistic. It also allows them to identify areas that they need to think about and plan more thoroughly
- Also the plan contains detailed business objectives, which the entrepreneur can then compare with the actual performance of the business once it starts trading in order to track its progress
Most business plans contain the following sections:
- Executive Summary: A general overview of the business, conatining key points
- Business Summary: Describes what type of business the entrepreneur wants to set up, what products or services the business intends to provide, why it wants to provide them, and what makes it different from/better than the competition. It also includes the legal structure of the business, and the entrepreneurs vision for the future of the firm
- Production Plan: Sets out how many products the business intends to produce, and how it will go about producing them i.e. how many workers will be required etc.
- Marketing Plan: The entrepreneur defines the market for the business and explains who its main competition are, who the target customers are and what the products USP is. It also includes details of any market research that the entrepreneur has done and any promotions they intend to run
- Human Resources Plan: Outlines the relevant qualifications and experience of the entrepreneur and other people involved in setting up the business. It also sets out how many employees the business intends to take on, and how much it itends to pay them
- Operations Plan: Gives details of where the business will be located, whether the business will own or rent property and machinery etc.
- Financial Plan: Covers all the financial forecasts for the business, how they will finance their business, their breakeven calculations and a cash flow forecast
Business plans are never 100% accurate because its impossible for a business to get accurate information about costs, revenue etc. before it has started trading.
Just because the business plan says that the business should be making profit of £2000 a month doesn't mean that this will actually happen - there is no way to know for definite. There is always risk when setting up a business. However, producing a thorough business plan reduces the risk of failure.
Entrepreneurs can get free help and advice on writing a business plan from a gov. organisation like Business Link, or a Small Business Advisor at their bank. They can give entrepreneurs sample business plans or CD's that guide you through the process of writing a business plan. Some websites also provide this aswell.
Also, established businesses can also write a business plan for certain situations, i.e. if a business is launching a new product. By creating a new plan, managers and directors can establish if the new product will be profitable. Finally, a business plan can be useful if the firm wishes to expand, especially if they need to find another source of finance to do so.
Cost, Revenue and Profit
Revenue: The value of sales. It is also known as turnover. It's the amount of money generated by sales of a product, before deductions are made.
Revenue = Selling Price x Quantity of Items Sold
Fixed Costs: Costs that dont change with output. Rent on a factory, senior managers salaries, cost of new machiner = fixed costs.
Variable Costs: Costs that rise and fall as output changes. Hourly wages, raw material costs, packaging costs = varibale costs.
Semi-Variable Costs: Costs that have both fixed and variable parts. Telephone bills are a good example, as businesses have to pay a fixed amount for their phone line plus a variable amount depending on the phone calls they've made.
Profit = Revenue - Costs
Net Profit = Revenue - (Fixed + Variable Costs)
Businesses can give their profits to the shareholders as dividend payments or they can re-invest their profits into new activities.
Businesses use cost information to set their selling price of their products and services. They set the price to make sure they'll make a profit.
If a business is a price-taker in a very competitive market, it doesn't have control of the selling price of its products, it takes whatever price the market will pay. Businesses in this situation need accurate costing information to work out if its profitable to make and sell a product at all. E.G. farmers have to sell milk, potatoes etc. to supermarkets for whatever the supermarkets are willing to pay - if they try to increase their price, the supermarket will just move to another farmer.
Businesses set budgets which forecast how much costs are going to be over a year. Managers need to know what costs they're incurring now, so that they know whether they're meeting the budget.
Opportunity cost: A benefit, profit, or value of something that must be given up to acquire or achieve something else i.e. if you have a test you haven't revised for, as well as a party, if you go to the party you will then fail the test. If you revise, you will miss the party.
Break-Even Analysis: A way of working out how much you'll need to sell to make a profit.
When sales are below the break-even point, costs are more than revenue = LOSS
When sales are above the break-even point, revenue is more than costs = PROFIT
Banks and venture capitalists thinking of loaning money to the business will need to see a break-even analysis as part of the business plan. This helps them decide whether to lend money or not. Established business may also create a break-even analysis to work out how much profit they are likely to make when launching a new product, and also predict the impact of the new activity on cash flow.
Contribution Per Unit = Selling Price Per Unit - Variable Costs Per Unit
Total Contribution = Contribution Per Unit x Units Sold OR
= Total Revenue - Total Variable Costs
Break-Even Output = Fixed Costs/Contribution Per Unit
Margin Of Safety = Current Output - Break-Even Output
Advantages of Break-Even Analysis:
- It's easy to do
- It's quick - Managers can see the break-even point and margin of safety point immediately so they can make quick decisions
- Lets businesses forecast how variations in sales will affect costs, revenue and profits and, most importantly, how variations in price and costs will affect how much they need to sell
- Businesses can use break-even analysis to help persuade the bank give them a loan
- Influences decisions on whether new products are launched or not i.e. if the business would need to sell an unrealistic volume of products to break-even, they would probably decide not to launch the product
Disadvantages of Break-Even Analysis:
- It assumes that variable costs always rise steadily - this isn't always the case
- Only good for looking at the success of one product - many businesses have lots of products
- If the data is wrong, then the results will be wrong
- It only tells you how many units you need to sell, it doesn't tell you how many you are actually going to sell
- It is only a forecast - doesn't mean it will actually work
Cash Flow: All the money flowing into and out of the business over a period of time.
Businesses need to pay money out for fixed assets (buildings/machinery etc.) and operating costs to fulfil an order before they get paid for that order. The money needed to run a business from day-to-day is called working capital.
This delay between money going out and money coming in is the cash flow cycle.
It's important to make sure there's always enough money available to pay suppliers and wages.
Cash flow calculations are pretty much the most important thing to a business in the short term. Businesses need cash to survive. Looking at the long term, profit is important - making profit is the main objective for a business.
Improving Cash Flow
Businesses try to reduce the time between paying suppliers and getting money from customers. They try to get their suppliers to give them longer credit period - and give their customers a shorter credit period.
Businesses can try to hold less stock, so less cash is tied up in stock.
Credit Controllers keep debtors in control. They set credit limits and remind debtors to pay up.
Debt factoring gives instant cash to businesses whose customers haven't paid their invoices. Banks and other financial institutions act as debt factoring agents. The agent pays the business about 80% of the value of the invoice as an instant cash advance. The agent gets the customer to pay up, and then keeps about 5% of the value of the invoice - debt factoring costs money and the agent needs to make a living.
Sale and leaseback is when businesses sell equipment to raise capital, and then lease (rent) the equipment back. That way, they get a big lump sum from the sale, and pay a little bit of money each month for the lease of the equipment. Of course, they don't get to own the equipment again unless they get enough cash to buy it back - and they have to pay the lease in the meantime.
Cash Flow Forecasts
Cash flow forecasts (A.K.A. cash budgets) show the amount of money that managers expect to come into the business and flow out of the business over a period of time in the future.
Managers can use cash flow forecasts to make sure they always have enough cash around to pay suppliers and employees. They can predict when they'll be short of cash, and arrange a loan or overdraft in time.
Businesses show cash flow forecasts to banks and venture capitalists when trying to get loans and other finance. Cash flow forecasts prove that the business has an idea of where it's going to be in the future.
Established firms base forecasts on past experience. New firms have no past data, so their forecast should consider the business' capacity, experiences of similar frims and customer behaviour trends shown by market research.
Cash Flow Forecast Problems
Cash flow forecasts can be used based on false assumptions about what is going to happen.
Circumstances can change suddenly after the foreacsts been made. Costs can go up. Machinery can break down and need mending. Comeptitiors can put their prices up or down, which affects sales.
Good cash flow forecasting needs lots of experience and lots of research into the market.
A false forecast can have disastrous results. A business that runs out of cash can go bankrupt or insolvent.
A budget forecasts future earnings and future spending, usually over a 12 month period. Businesses use different budgets to estimate different things. There are 3 types of budgets:
- Income Budgets: Forecasts the amount of money that will come into the company as revenue. In order to do this, the company needs to predict how much it will sell, and at what price. Managers estimate this using their sales figures from previous years, as well as market research.
- Expenditure Budgets: Predict what the business' total costs will be for the year, taking into account both fixed and variable costs.
- Profit Budget: Uses the totals from the income and expenditure budgets to calculate what the expected profit (or loss) will be for that year.
Budget Advantages and Disadvantages
Benefits of Budgeting:
- Budgets help control income and expenditure. They show where the money goes.
- Budgeting forces managers to review their activities.
- Budgets let heads of department delegate authority to budget holders. Getting authority is motivating.
- Budgets allow departments to coordinate spending.
- Budgets help managers either control or motivate staff. Meeting a target budget is satisfying.
Drawbacks of Budgeting:
- Budgeting can cause resentment and rivalry if departments have to compete for money.
- Budgets can be restrictive. Fixed budgets stop firms responding to changing market conditions.
- Budgeting is time-consuming. Managers can get too preoccupied with setting and reviewing budgets, and forget to focus on the real issues of winning business and understanding the customers.
Fixed budgets provide discipline and certainty. This is especially important for a business with liquidity problems - fixed budgets help control cash flow.
Fixed budgeting means budget holders have to stick to their budget plans throughout the year - even if market conditions change. This can prevent a firm reacting to new opportunities or threats that they didn't know about when they set the budget.
Flexible budgeting allows budgets to be altered in response to significant changes in the market or economy.
Zero budgeting gives a business more flexibility than historical budgeting.
Start-up businesses have to develop their budgets from scratch (known as zero-budgeting). This is difficult to do because they don't have much info to base their decisions on - they can't take into account the previous years sales or expenditure. This means that their budgets are likely to be inaccurate.
After the 1st year, a business must decide whether to follow the historical budgeting method, or to continue using the zero budgeting method.
- This years budget is based on a % increase or decrease from last years budget i.e. if a business is expecting 10% revenue growth, they might add 10% to the advertising, wages and raw material purchasing budgets.
- Historical budgeting is quick and simple, but it assumes that business conditions stay unchanged each year.
- Budget holders start with a budget of £0, and have to get approval to spend money on activities.
- They have to plan all the years activities, ask for money to spend on them, and be prepared to justify their requests to the finance director. Budget holders need good negotiating skills for this.
- Zero budgeting takes much longer to complete than historical budgets.
- If zero budgeting is done properly its more accurate than historical budgeting.