Characteristics of Successful Entrepreneurs

Enterprise and Entrepreneurs

Introduction
- Enterprise: The combination of attitudes and skills that helps an individual turn an idea into reality.
- Entrepreneur: Someone who makes a business idea happen, either through their own effort, or by
organising others to do the work
o Courage and initiative – to act quickly when an opportunity is present
o Understanding of the market – know what customers want and see how well current customers are
serving them
o Determination – to see through things even if there are difficulties
o Passion – to achieve something and not just to make money
o Persuasive abilities – persuade others in in the production process (e.g. supplying of goods on credit)
o Ability to cope with risk

Risk-taking
- Consider what they think will happen and what will happen different
- Foresee other possibilities so that plans can be made
- Compares all the risks with the possible rewards and makes a considered decision

Characteristics of entrepreneurs
- People who aren’t entrepreneurs
o Are very cautious – never want to take risks
o Assume that things are the way they have to be
o Like to be sure of their pay cheque
- Bad entrepreneurs
o Ignore risks – assume that own charisma/ skill will guarantee success
o Rush to bring in something new or make huge changes
o Trust that things will go as planned, spend freely at the start as they are sure that money will start
flowing in tomorrow
- Good entrepreneurs
o Take calculated risks, weighing up potential risks and rewards
o Launch new ideas in response to changing consumer tastes of attitudes
o Accept that the early days of a new business may be tough, so try to minimise spending

Motives for becoming an entrepreneur

- Looking for a challenge
- To prove oneself
- To gain greater satisfaction
- To gain control over working life
- Spotted an opportunity
- Building on experience as employee
- Made redundant
- To make money
- Couldn’t find a job

Government support for enterprise

- Only 2% of business get funding through grants given by government
- Main expenditure: Business Link network – offers free advice to those starting up plus a free consultation
with an expert nominated by Business Link
o Quality of advice is variable
- In 2010: Replaced Business Link network with online-only advice service to cut expenditure
- Wants to continue the long-standing policy to encourage an “enterprise culture” – create a spirit among
young people that being enterprising is cool
 o More people starting their own business -> Economy will develop dynamically
Issues for analysis
- Are real entrepreneurs born or made? – Can skills be learnt?
- Do entrepreneurs tend to be school underachievers whose success comes from their reaction against school
failure?
- Does the government do enough to help entrepreneurs? (Funding, regulations, etc.)
o Most new entrepreneurs use their own savings and plenty of their own time

Leadership and Management Styles

Introduction
- Leadership: Inspiring staff to achieve demanding goals.
- Management style: The way in which managers deal with their employees
o Autocratic managers: Managers who keep most of the authority to themselves, do not delegate
much or share information with employees but instead tell employees what to do.
 Authoritarian – tell employees what to do and not listen much to what workers themselves
have to say
 Know what they are doing and how they want it done
 One-way, top-down communication – they give orders but do not want much feedback
o Democratic managers: Managers who take the views of their subordinates into account when
making decisions, discusses what needs to be done and involves employees in the decision-making.
 Like to involve workers in decisions
 Listen to employee’s ideas and ensure people contribute to the discussion
 Communication is two-way – managers put forward an idea and employees give their
opinions
 Regular delegation of decision-making power to junior staff
 Approached in two ways:
 Management by objective – leader agrees clear goals with staff, provides necessary
resources and allows staff to make day-to-day decisions
 Laissez-faire – let it be attitude, do not take time to ensure that junior staff know
what to do or how to do it
o Paternalistic managers: Managers who believe that they know what is best for employees, tell them
what to do but will explain their decision and are concerned about the social needs of employees.
 Thinks and acts like a father
 Tries to do what is best for their staff – consultations to find out the views of the employees,
but decisions are made by himself
 Believes that employees need direction, important that they are supported and cared for
 Interested in the security and social needs of staff – interested in how workers feel and
whether they are happy in their work

McGregor’s theory X and Y

- Theory X managers tend to distrust subordinates and believe that employees do not really enjoy their work
and need to be controlled – that humans have inherent dislikes of work and will avoid it if they can.
o Likely to be self-fulfilling (if you think someone is lazy, they will stop trying to change your mindset
and be lazy) – makes employees focus on their wage packets instead of the company’s welfare
o Succeeds in a business employing many part-time workers or when a business face a crisis
- Theory Y managers believe that employees do enjoy work and that they want to contribute ideas and effort
– involves employees in decisions and give them greater responsibilities.
o More of a democratic leadership style

Charismatic leadership
- Absence of charisma
o People are not inspired by an individual or warmed to him
o Enormous difficulty in communicating in a way that makes people want to follow his lead
 - Too much charisma is dangerous – too much influence and may make wrong decisions

What is the best style of leadership?

- Depends on the situation
o Crisis – autocratic managers
o Stable – democratic managers
- Depends on personalities of the managers and workers
- Depends on abilities/skills of the managers and workers
- Depends on the nature of the task
- Depends on the time constraints
- Depends on the degree of risk
o A manager’s style should therefore change according to the particular situation and the people
involved

Does the style of management matter?

- The way a manager deals with his colleagues can have a real impact on their motivation and how effectively
they work
o Quality of their work
o Productivity of workers
o Rate of labour turnover
o Ideas produced
o Motivation of workforce
- The most common style of management
o Dependent on personality, the particular circumstances and culture of the organisation.
o Dependent on own experience – did they like how they were treated by previous boss
o More of a democratic style – employees expect more from work than they did in the past
 Greater participation – increased the move towards lean production and emphasis on
techniques such as total quality management (TQM)
 Managers trust in employees – given control over their own quality, authority to make
decisions over scheduling of work, expected to contribute ideas on how to improve the way
they are working

Issues for analysis

- May not be easy for managers to change their style – require effective management training to persuade
managers to be flexible
- Good managers and leaders can be born or made – requires the right combination of personal
characteristics and training
- Successful businesses mostly have strong management teams – good managers make effective use of the
firm’s resources, motivate staff and provide vision and direction
- Right style of management dependent on particular circumstances, nature of task and the individual’s
personality
Identifying a Business Opportunity

Building Demand and Managing Supply

Introduction
- Demand: A measure of the level of interest customers have in buying a product backed by the ability to pay
- Supply: The quantity of a product that producers are able to deliver within a specific time period

What makes a market?

- Market means all the buyers and all the sellers across the country
o Cash markets: where people make purchases with cash e.g. food and drinks
o Credit markets: where people make purchases with credit e.g. houses and cars
- High demand pulls prices up
- Weak demand forces firm to cut prices
- Prices rise when there is a supply shortage
- Prices fall when there is excess supply
o Not all markets operate this way – dependent on good and service and market structure

What should firms supply?

- Profit focused firms will want to supply at the level that makes as high a profit as possible (profit-maximising
point)
- Several factors that affect the quantity of product a firm would want to supply
o Operating costs – the higher the costs the lower the incentive to supply
o The price that can be reached within the market price – more attractive products will be able to
generate a higher price, resulting in higher potential profit per unit, hence the supplier would be
happy to increase supplies for higher profits
o Physical constraints – factors which cannot be changed or determined by firms

Drawing a supply curve

- Supply curve: A line showing the quantity of goods firms want to supply at different price levels
- The higher the price the higher the supply
- On the assumption that suppliers can respond quickly to changes in demand – stockpiled supplies, flexible
production process, etc.

Factors affecting demand

- Price set by supplier – quality / price determines the value for money -> price affects the image for quality
- Competitors’ prices
- Fashion/ taste – consumers trends may change but well—run businesses respond to changing consumer
attitudes and desires
- The state of the economy – if future looks bleak (high interest rates and hikes in personal taxation), they will
save more and spend less, causing the economic slowdown that they had feared
- Seasonality
- Weather
- Marketing spending – amount spent on advertising

Drawing a demand curve

- Demand curve: A line showing the demand for a product at different prices
- The higher the price the lower the demand
- Drawn from gathered evidence about the likely level of sales at different prices

Interaction of supply and demand

- Market price: the price at which supply equals demand

Benefits of market orientation

- Businesses are sensitive to demand which is constantly changing
o Daily sales variations, seasonal sales variations, etc.
 - Anticipate varying demand by varying supply (factors of production – land, labour, capital)

Issues for analysis

- Analyse supply and demand in different circumstances to different businesses or markets
- Ability to separate what is from what could be – good judgement based on market orientation and a fine
understanding of what customers think, feel and want
- Forces of supply and demand provide pressure on business decisions, while established brands (business
decisions or marketing strategies) may provide changes in demand and supply
- Competition is a central factor in every day’s decisions – the sharp business analyst is the one who
understand the circumstances of different businesses
Evaluating a Business Opportunity

Market Research

Introduction
- Gathering of information about consumers, competitors and distributors within a firm’s target market
- A way of identifying consumers’ buying habits and attitudes to current and future products
- Data may be numerical (quantitative) or psychological (qualitative)

Conducting start-up market research through secondary research

- Discovering marketing fundamental
o Size of market – the value of the sales made annually by all the firms within a market
o Future potential of market – measured by the annual rate of growth
o Market shares of existing companies and brands – indicates the relative strength of the firms within
the market

Methods of secondary research: Finding out information that has already been gathered.
- Internet
o Googling the topic can provide invaluable information
o Online providers of market research information may charge for the service
- Trade press
o Every major market is served by one or more magazines written for people who work within that
trade
o Provision of lots of statistical and other information
- Government-produced data
o Government-funded National Statistics produces valuable reports
 E.g. Annual Abstract of Statistics, Labour Market Trends – provide data on population trends
and forecasts

Methods of primary research: Finding out information first-hand

- Retailer research
o The people closest to a market are those who serve customers directly – retailers
o They are likely to know the up-and-coming brands, the degree of brand loyalty and the importance
of price and packaging
- Observation
o Location of business is an all-important factor
 Observation of rate of pedestrian/ traffic flow past the potential site
- Used in new product development
o Product idea – Group discussions among purchasers
o Product test – A testing of product on purchasers in different locations
o Brand name research – Quantitative research using a questionnaire
o Packing research – Quantitative research using a questionnaire
o Advertising research – Group discussion run by psychologists to discover which advertisement has
the strongest effect on product image and recall
o Total proposition test (testing the level of purchase interest to help me sales forecast) – Quantitative
research using a questionnaire and product samples

Qualitative research
- In-depth research into the motivations behind the attitudes and buying habits of consumers
- Usually conducted by psychologists
o Group discussions
 May reveal a problem or opportunity the company had not anticipated
 Reveal consumer psychology – the importance of image and peer pressure
o Depth interviews
 Avoid the risk that the group opinion will be swayed by one influential person
Quantitative research
- Asking of pre-set questions on a large sample of people to provide statistically valid data
o Sampling – ensuring research results are typical of the whole population even though only a sample
has been interviewed
 Sampling method: The approach chosen to select the right people to be part of the research
sample – how to choose the right people for an interview and how large a number to
interview
 Random sample – involves selecting respondents to ensure that everyone in the
population has an equal chance of being interviewed
o Difficult to ensure “randomness”: Interviewing at a certain location/ time
would define a living pattern of an individual, requires random picking from
the electoral register and personally going down to interview
o Effective, but slow and expensive
 Quota sample – selecting interviewees in proportion to the consumer profile within
target market
o As long as interviewers achieve the correct quota, they can interview when
and where they want to
o Cheap and effective
 Stratified sample – interviewing only those with key characteristic required
o Can be found at random or by setting quotas (e.g. based on social class, age)
 Sample size: The number of people interviewed, this should be large enough to give
confidence that the findings are representative of the whole population
 Expensive to have large sample sizes – of good value if you can afford it
o Questionnaire – unbiased and meets the research objectives (Bias: A factor that causes research
findings to be unrepresentative of the whole population)
 Wording may influence respondents
 Should have clearly defined research objectives
 Ensure that questions do not point towards a particular answer
 Ensure that the meaning of each question is clear
 Mainly use closed question – limited number of pre-set questions to ensure quantifiable
results)
 Include a few open questions – provide more depth to understanding
 Finish by asking demographic and usership details – respondents’ sex, age, occupation and
buying habits
o Results – assess the validity of results

Other important considerations in primary research

- Response rate
o Are those who respond typical of those who do not respond
o Is there bias built into the consequence of low-response rate
- Face to face versus self-completion
o Face to face interviews
 High costs
 Risk of bias – more bubbly/ interactive interviewer may generate more positive responses
 High response rate
 Assurance that the interviewer could help to explain an unclear question

Market research today

- Technology advancement
o More internet and opinion polls
o Increase in data-base driven research – client firms supply research companies with database
information on customers
 Shoppers are grouped into categories so easier for quota sampling
- The avoidance of bias is still crucial
o Wording of questions
o Sample size
o Intelligent analysis of research findings
Issues for analysis
- Key role of market research in market orientation – basing decisions on the consumer rather than the needs
or opinions of producers
o Act on evidence obtained from research, not feelings
o However, innovations may be created through creativity and hunch, not evidence (e.g. Apple iPad)
- Requires a questioning approach to data – e.g. Is sample size large enough? Within budget?
- Importance of market knowledge – larger firms have more knowledge of consumer attitudes and behaviour,
built from years of market research surveys
- Management culture – firms with a positive, risk-taking approach to business, qualitative insights are likely
to be preferred to quantitative data

Understanding Markets

Introduction
- A market is where buyers meet sellers.
- The key elements are its size, the extent to which it can be subdivided and the extent to which the market is
dominated by one or two companies or brands.

Types of Market
- Local VS national
o Most new small firms know and care little about the size of the national market
 More concerned about the level of demand and level of competition locally
o Other firms are more focused on the national market
 Establish a national presence – competing effectively with national and multinational
competitors
- Physical and electronic (virtual)
o Electronic: Stock markets which exists only on computer screens
 Fiercely price competitive – huge pressure to keep costs low
 Do not rely on physical location
 Easy and cheap to enter market
 Provide a long tail of competitive and profitable small businesses – able to curve their own
little niche in markets (does not require labour, land or capital costs)

Factors determining demand

- Demand: The desire of consumers to buy a product or service when backed by the ability to pay
o Price
 The higher the price, the more people there are who cannot afford to buy
 The higher the price, the less good value the item will seem compared to other ways of
spending the money
 The higher the price, the higher the perceived value of a good/ image for quality
(psychological mentality that higher prices = better quality = higher value)
o Incomes
 Economic growth means everyone gets richer over time – increased incomes etc.
 The demand for most products and services grows as the economy grows – demand for
normal and luxury goods rises broadly in line with incomes
 Normal goods: Products or services for which sales change broadly in line with the
economy
 Luxury goods: Products that people buy much more of when they feel better off
 The demand for inferior goods decrease as income increases (people with higher incomes
turn to better quality goods)
 Inferior goods: Products that people turn to when they are hard up, and turn away
from when they are better off
o Actions of competitors
  The decrease in price of a competitor -> Increase in demand for competitor -> Decrease in
demand for own goods and services
o The firm’s own marketing activities
 Advertisement -> Increase sales of own goods and services -> Decrease in demand for
competitor goods and services
o Seasonal factors
 Variation is caused by patterns of customer behaviour
 Understanding and accurate prediction of seasonal variations in demand -> Firms can plan
for coping with these changes

Market size and trends

- Market size is the measurement of all the sales by all the companies within a marketplace
o Volume measures the quantity of goods purchased
o Value is the amount spent by customers on the volume of goods sold
- Basis of calculating market share: the proportion of the total market held by one company or brand)
o Essential for evaluating the success or failure of a firm’s marketing activities
- Reference point for calculating trends – growth or declination of market
o Growth will provide opportunities for new products to be launched
o Growth will provide opportunities for new distribution initiatives to be successful

Market share
- The proportion of the total market held by one company or product
- More often measured by value no volume
- Key test of the success of the year’s marketing activities
- Measures a firm’s ability to win or loser against its competitors
- Rising market share can lead to the producer’s ideal of market leadership or market dominance –
establishment of a brand name and good reputation
o Sales are higher than anyone else’s
o Gets the highest distribution level without needing much effort to achieve it – success breeds
success
o Able to offer lower discount terms to retailers – higher revenues and profit margins per unit sold
o Much easier to obtain distribution and consumer trial for new products

Market segmentation
- The breaking down of a market into small sections in which customers share common characteristics
o May lead to increased customer satisfaction (they are able to buy products which target their exact
interest) – provides a scope for increasing company profits
 Research into the different types of customers
 Find out common tastes and habits of the different customers
 Devise a product designed for a particular segment where the market is big enough to be
highly profitable

Issues for analysis

- Precision: differentiation of normal, luxury and inferior goods
- Detailed market analysis on a regular basis: consider the market size, trends and share, degree of
segmentation, factors determining demand and type of market
o Buy retail audits to find out how retail sales are doing
o May suffer from paralysis by analysis – gathering of too much data, therefore they are unable to
make a decision

Identifying Business Opportunities

Generating business ideas

- Spotting a good business idea is based on a good understanding of consumers tastes and the needs of the
retail trade
 o Observation
o Brain-storming: where 2 or more people are encourages to come up without anyone criticising their
ideas
o Thinking ahead: considering future opportunities that will arise if weather changes
o Ideas from personal or business experience
o Innovation: new ideas brought to the market

Spotting an opportunity
- Society changes constantly, with different attitudes or fads marking out the generations.
o Think about changes to society
o Think about changes to the economy
o Think about the local housing market
o Use small budget research and careful market mapping

Small budget research

- To gain a general understanding of the market through:
o Geographical mapping: plotting on a map the locations of all the existing businesses in your market,
in order to show where your competitors are
o Check up prices, special deals, discounts, etc. of competitors
o Produce a market map: a grid plotting where each existing brand sits on scales based on two
important features of a market
 Identify market niches: a gap in the market, that is, if no one else is offering what you want
to offer
- May point towards new business opportunities

Market mapping
- Identification of the key features that characterise consumers within a market
- Place every brand on the grid which reveals where the competition is concentrated and may highlight some
gaps in the market
o Niche may be present but too small to provide an opportunity for a profitable business

Gaining a competitive advantage

- Input of resources -> Adding value to raw materials -> Outputs – increases competitiveness and profitability
- Added value: The increase in benefits of a good or service which are created at each stage of production
o E.g. branding, packaging, USP
- Added value = value of output - value of input

Franchises
- Starting a new business requires huge amount of planning, skill and luck – only 70% will survive for 3 years
- Franchise: a halfway house towards running your own business – gets the basic requirements of running the
business but does the day-to-day management by oneself
o Franchisee: a person or company who has paid to become part of an established franchise business
o Franchisor: the owner of the holding company and franchise
- Founding a franchise
o Franchisor needs to establish:
 A training programme so that franchisees learn the right way of managing the business
 A system of pricing that is profitable without putting off potential franchisees –
 Cost of franchise rights
 Cost of equipment, store fittings and supplies bought through owner
 5% royalty paid on all income
 3-5% to contribute towards the national advertising campaign
 A system of monitoring – to ensure that poorly run franchises do not damage the reputation
of the brand
- Becoming a franchisee
o Safer start up – business already has national reputation
o Marketing decisions will be handled by head office not franchisee
 o Rules of managing business set by owner – store decoration, staff uniforms, product range, product
pricing, etc.
o Management of staff recruitment, training and motivation
o Management of stock ordering
o Management of quality control and management
o Management of effective customer service
- Disadvantages to running a franchise
o No independence – no normal freedoms of decision making
o Some business may sell the promises of training and advertising support but supply very little after
they have pocketed the franchise fee – better franchise operators are members of the British
Franchise Association (BFA)
- Advantages to running a franchise
o Training towards becoming a full entrepreneur – development of missing skills
o Finance is easier and cheaper to get – interest rate charged by bank is lower

Issues for analysis

- Think about how easy a new business idea is to be copied
- Most entrepreneurs gain satisfaction from the challenge of creating and marketing a unique business idea –
something you cannot get from franchising
- Franchising involves the every slog of running a shop or managing semi-interested part-time staff – may
require a long time to fully develop skills to becoming an entrepreneur

Product Trial

Launching a new product

- Very risky, even for established businesses – 90% of new products fail
- High costs – advertisement, research and development, packaging, etc.
- Helpful to minimise the risk by trialling the product first

Testing the market

- Sales research – consumers are given an opportunity to test a new product
o Free samples
o Trial price
o Limited editions
- Controlled test marketing – making the product available in a few stores
- Actual test marketing – a full launch of the product in a restricted area
o Product is sold in usual outlets
o Promotional activity usually takes place in the same area

Benefits
- Save costs and prevent damaging of firm’s reputation if the trial proves to be unpopular or uncovers hidden
problems
- A good way to get a new product into customer’s hands
- Provides real consumer feedback which can be used to improve the product

Why firms stop trial products

- Time is of essence – prevent competitors from copying the product
- Major markets now use centralised distribution systems – difficult to get distribution for trial products
- Presence of new market research techniques – trials are no longer necessary
- Globalisation of brands – large multinational businesses are effectively using countries as test markets

New businesses and product trials

- Still useful for new businesses since:
o They are unable to afford a national product launch
o They are unlikely to have the same access to sophisticated market research as large firms
 o It enables them to build up brand recognition slowly
o They can react to customer’s feedback easily
o They can use feedback as an argument point to gain shelf space in markets
o They can avoid expensive mistakes
- However it would take time for the product to fully be launched in the market, which is crucial to a new firm

Opportunity Cost and Trade-offs

Introduction
- Opportunity cost: The cost of missing out on the next best alternative when making a decision
- Trade-offs: What an individual has to give up in order to get what he wants most, may not be quantifiable.
- The most important resources for new businesses are money and time.
o Time and money can only be spent once.
- Every business decision has an opportunity cost.
o Do not tie up too much capital in stocks – these cash could be used more productively elsewhere in
the business.
o Do not overstretch oneself – good decisions take time.
o Take care with every decision that uses up cash – a finite resource that is always needed

Opportunity costs in developing a business idea

- Personal opportunity costs
o On stakeholders – all those with a stake in the success or failure of a business (internal – staff,
managers, directors; external – suppliers, consumers, bankers, shareholders)
 Missing out on the opportunity to earn regular income
 Cost of investment spending could have been used for the benefit of oneself
o On stakeholder’s family
 Wear and tear on the individual’s family – largely time-consuming and wholly absorbing as
even when an individual is home, he may still be thinking about business which leaves family
feeling neglected or jealous
 32% of new entrepreneurs said that the experience had caused marriage difficulties
 42% of chief executives in fast-growing new firms said that the pressures and
exhilarations made their marriages stronger
- Opportunity costs of developing one business idea as opposed to another
o Only able to choose one business idea to invest in and one business to launch
o Require careful evaluation of both ideas – weaker idea should be eliminated

Deciding between opportunities

- Successful business people are those who can make successful decision
o Estimating the potential sales that could be achieved by each idea
 Difficult to estimate
 Through market research or expertise of individual
o Considering carefully the cash requirements of each idea
 Some business requires low cash start-ups (e.g. electric markets)
 Some require more cash (e.g. physical markets require land, labour, capital)
o Deciding whether the time is right
 The state of the economy
 The economy for the industry it wishes to set up in
 The economy for industries that are related (e.g. production of materials)
o Deciding whether the skills needed fit your own set of skills

Trade-offs
- When starting up, trading off the start-up against more leisure time for oneself
- Trading off the aspects of the business you enjoy doing most against those that prove profitable
o E.g. a chef may enjoy cooking but interacting with customers may prove more profitable
- Trading off time today and time tomorrow
 o E.g. aiming for young retirement age (more time after retirement) but having to work hard now (less
time to spend leisurely as more time is spent on business)
- Key to success: be clear about what you and your family want from the business – what gives the owner
personal satisfaction
o Profits?
o Independence and freedom of running own business?
o Spending time with family?
Economic Factors Affecting Business Start-up

Introduction
- Economic factors deal with the macro-economy (economy as a whole)
- Individuals do their own things, but the actions and decisions taken by millions of people and businesses
make up the economy
- The economy is intertwined – when times are bad, almost every business suffers, leading to job losses.

Current economic climate: The atmosphere surrounding the economy (gloom and doom/ optimism and boom)
- The higher the confidence of consumers, the higher the expenditure.
- The higher the confidence of investors, the higher the level of investment.
- The higher the confidence of firms, the higher the level of investment in their future.
o All these increased spending can create an upsurge in economy activity.
o Influenced by changes in interest rates, exchange rate, unemployment and inflation, government
spending or taxation.

Changes in interest rates

- Interest rate: The price charged by a bank per year for lending money or for providing credit.
- Usually influenced by the bank rate: the interest rate that the central bank charges high street banks for
borrowing money
o Affects consumers demand
 The higher the rate of interest, the lower the number of goods bought on credit
o Affects the total operating costs
 The higher the rate of interest, the higher the operating costs and the lower the profit
o Affects the level of investment
 The higher the rate of interest, the higher the cost for banks to take loans and the lower the
level of investment

Exchange rates
- The measure of quantity of foreign currency that can be bought with one unit of domestic currency.
- Affects both the price of imported and exported goods.
- Determined by the supply and demand of local currency on international currency markets
- The higher the exchange rate, the lower the level of exports
o Higher prices for international markets -> Reduced competitiveness -> Reduced demand
- The higher the exchange rate, the higher the level of imports
o Lower prices for buying goods abroad -> Increased competitiveness -> Increase demand
- The lower the exchange rate, the higher the level of exports
o Lower value of good in international market -> Increased competitiveness -> Increase demand
- The lower the exchange rate, the lower the level of imports
o Higher prices for buying goods abroad -> Reduce competitiveness -> Decreased demand

Consequences for business of unemployment and inflation

- Unemployment: When the number of jobs falls in comparison to the number of people looking for work –
when the demand for labour is less than the supply of labour.
o Demand for labour
 High demand for goods -> High demand for labour
 High demand for jobs overseas -> Cheaper cost of production -> Lower demand for labour
domestically
o Supply of labour
 Demographic factors affecting the number of people of working age and the number of
migrants
 Willingness of employable people to look for work
 Weighed down by government welfare benefits e.g. unemployment benefits
 Boosted by setting of National Minimum Wage
o Long and short term factors in unemployment
 In the short term, the main single factor is the number of jobs available (dependent on state
of economy)
  In the long term, the main factors are as mentioned above
- Inflation: the measure of percentage annual rise in the price level – reduces the internal purchasing power of
money.
o Advantages
 Boost recorded profitability
 Encourages firms to increase its prices -> Firms costs may also increase
 Increase in prices but not sales volume makes a business look more profitable
o an illusion created by inflation – there has been no increase in sales in real
terms (changes in total revenue excluding the distorting effect of inflation)
 Firms with large loans repay more easily
 Inflation erodes the real value of money owed
 Rising income and rising profits allow loans to be repaid more easily
o Disadvantages
 Damage profitability
 Especially for firms that have fixed-price contracts that take a long time to complete
 Profit may be wiped out by the high cost increases due to high rate of inflation
 Harm a firm’s cash position
 Pushes up the price of new assets that need to be bought
 Harm a firm’s ability to compete effectively with foreign firms
 High inflation -> Higher prices -> Less competitiveness

Effect of government spending or taxation

- Government believes that short term pain is necessary for long term gain
o Increase in rate of inflation -> Increase in taxation -> Reduced disposable income -> Reduce demand
and spending -> Prices fall
o Increase in rate of inflation -> Decrease in government spending -> Reduce profits for business ->
Increase unemployment -> Reduced demand -> Prices fall

Issues for analysis

- Keep things simple – make a clear, direct link between the economic factor and the business
- Judging which economic factor is most important is dependent on the characteristics of the firm
 E.g. firm which relies on imports: high exchange rates -> cheaper value of imports
Economic Considerations

Impact on firms of economic factors

Introduction
- Economic factors: Factors that affect the whole economy

Economic growth and the business cycle

- What is economic growth and why does it matter?
o The rate at which output of goods and services produced by a country increases compared the
previous year.
o Caused by productivity advances e.g. technological innovation – more goods and services can be
produced with the same population
o Improves the standard of living – more goods and services for citizens to consume
o Creates more opportunities for consumers’ taste changes – easier to set up or expand businesses as
new gaps emerge in the market
- Business/ economic cycle
o Booms: Periods where the economy has grown rapidly
o Recessions: Periods where economic growth is decreasing – defined as two successive quarters of
falling output
o Slump: Sustained periods of negative economy growth
o Recovery: Periods where economy growth is gradually increasing
- Impacts of the business cycle
o Affects firms in different ways according to the type of goods or services it sells
o Accurate predictions of future state of the economy allows firms to plan and introduce changes
effectively and instantly when the economic changes
 In a boom
 Consumer and businesses are optimistic
 Consumer spending is high, low levels of saving where spending is supplemented by
credit
 Economic growth is strongly positive
 Unemployment rate is close to zero
 Inflation rate is high and possible accelerating
 Number of firms failing is low
 Firms are optimistic about the future – investment takes place for both replacement
and expansion purposes
 In a recession
 Consumer and businesses have doubts and low confidence
 Consumer spending is falling where spending financed by credit decreases too
 GDP begins to fall
 Unemployment is low but starts to rise
 Inflation rate is still positive but is falling, firms restrain from raising prices
 Number of firms failing is low, but rising
 Business investment is falling and expansion programmes may be postponed
 In a slump
 Consumer and businesses are pessimistic
 Consumer spending is falling as consumers save to pay off debts built up during the
boom
 GDP growth might be strongly negative
 Unemployment rate is high
 Prices may be stable or deflation may occur
 Number of firms failing is high
 Business investment is close to zero whereby even replacement investment may
have to be postponed to conserve cash
 In a recovery
  Consumer and business confidence is gradually returning
 Consumer spending increases and debts have now been paid off
 Economic growth is weak but gradually increasing
 Unemployment rate is high but decreasing
 Price is stable – no inflation or deflation
 Number of firms failing is falling
 Business investment is slowly rising, previously postponed projects are now put into
action
- Business objectives
o During a recession, a producer of luxury goods might need to change its corporate objective from
growth or profit maximisation to one of survival
o Main objective is to minimise losses through cost-saving measures which may permanently damage
the competitiveness of the business
- Marketing
o Some firms react to a recession by changing their marketing strategy to emphasise value for money
to prevent revenue from decreasing
o E.g. cutting price to boost sales – may be risky as a price cuts could cheapen the brand’s image ->
loss of sales and market share once the firm recovers
- Production
o Producers of luxury goods aim to cut production sooner than later
o Require notification of suppliers – minimum notice periods
o If production is cut only after sales start to fall, there will be a build-up of stock which is expensive to
store and ties up capital
- Human resource management
o Reducing the number of people in the workforce through compulsory redundancy
 Expensive
 Creates negative publicity
 Bad for staff morale
o Reduce wage bill via natural waste – suspending recruitment which is not replacing employees who
leave will cause the number of workers to naturally fall
o Firms may use the job insecurity created by recession to force changes in working practices that are
designed to reduce cost – job opportunities elsewhere will be scarce and ruthless managers use this
to their advantage
- Finance
o Firms aim to conserve as much cash as possible
 Carry out a programme of zero budgeting – trim any waste from departmental budgets as
managers now have to justify for every cent they request for
 Restrict the credit given to customers and chase up debtors who currently owe the firm
money
 Rationalise – sell off any under-utilised fix assets which can bring cash
 Take on additional loan capital – availability of credit tend to dry up as banks reassess their
attitude towards risk
o Managers will be able to use the profits made in a boom to increase their investment in new
products and production methods that will increase the competitiveness of their business
o Owners may set aside the profits made in a boom as cash reserve that will improve the firm’s
chances of surviving the next recession
o Banks relax their lending standards in a boom – easier and cheaper for firms wishing to expand by
borrowing funds

The effects of inflation on a firm’s financial position

- Introduction
o Inflation measures the percentage annual rise in average price level
o Reduces the purchasing power of money within an economy
o Increases the cost of living
o Increases wages
- Advantages
o Real assets become higher in value
  A firm with more valuable assets will have a more impressive balance sheet – easier to raise
long-term finance from banks and shareholders as business now looks more secure
o Real value of money owed is eroded
 Easier for firms with high borrowings to repay banks as income and profits rises
- Disadvantages
o Damage to profitability, especially for firms with fixed price contracts of long periods
 Profit may be wiped out by the unexpectedly high-cost increases created by inflation –
unable to increase negotiated price it is a fixed price contract
o Damage to cash flow
 Push up the price of machinery – firms requiring frequent replacement of machinery to stay
competitiveness tend to lose out
o Damage to industrial relations – relationship between business and staff
 Differences in inflationary expectations of businesses and staff representatives may cause
costly industrial disputes that may damage a firm’s reputation

Unemployment
- Created when the demand for labour relative to the available supply of labour falls
- Affected by factors such as emigration and immigration
- Benefits
o Theory X managers might use the fear created by unemployment and the potential for redundancies
to force workers to accept cost-saving changes in working practices
o Most employees would choose to stay where they are as job vacancies are scarce – labour turnover
falls which saves the firm money on recruitment, selection and training and productivity may rise as
the workforce gains experience
o Recruitment should become easier – firm would receive plenty of high quality applications for any
vacant position as people might be so desperate to find a job that they would take any
- Costs
o Create insecurity which could demotivate workers
o Affects consumer spending thus affecting firm’s revenue and profit
o Firms may be adversely affected by crime and other social problems in areas where unemployment
remains high and structural unemployment (unemployment caused by a declining industry) would
result in a situation where the unemployed do not possess right skills for other jobs (occupational
immobility)

Exchange rates
- Measures the quantity of foreign currency that can be bought with one unit of another currency
- High exchange rate
o The higher the exchange rate, the lower the number of exports – prices for foreigners increase,
decreased competitiveness
o The higher the exchange rate, the higher the number of imports – foreign prices are now cheaper
domestically, increased competitiveness
- Low exchange rate
o The lower the exchange rate, the higher the number of imports – prices for foreigners decrease,
increased competitiveness
o The lower the exchange rate, the lower the number of imports – costs more for domestic firms to
buy from foreign firms, decreased competitiveness

Issues for analysis

- How a business should respond to a change in economic factors – anticipation may prepare it, change of
market strategy may be essential
- What strategies should a firm carry out to protect itself from unknown economic changes in the future
o Ensure firm is always equipped financially? – evaluate importance high cash reserves and its
opportunity cost
o Business should keep borrowings low and liquidity high
Financing the New Business Idea

Sources of Finance

Introduction
- Where the money that businesses need comes from
- Needed for:
o Starting up – fixed and variable costs
o Growth – variable costs may increase, finance for investment, etc.
o Other situations – cash flow problem caused by changes in market conditions, when there is a large
order or when a major customer refuse to pay for goods

Internal and external sources of finance

- Internal sources: Money which comes from inside the business
o Existing capital can be made to stretch further
 Negotiate to pay bills later
 Get cash from customers earlier
o Profit made
 Reinvested profit: Profit used for investment
- External sources: Money which comes from outside the business
o Loan capital: Borrowing from a bank
 Bank loan
 For a set period of time
 Interest charged on loan
 Demand of collateral to provide security: an asset used as security for a loan which
can be sold by a lender if the borrower fails to pay back a loan
 Overdraft
 For a short period of time
 Higher interest charged than loans
 Banks allow firms to overdraw up to an agreed level – loans can be taken even if the
bank account balance of firms are negative
o Share capital: a market for buying and selling company shares which supervises the issuing of shares
by companies and a second-hand market for stocks and shares.
 If the firm is a limited company, it may look for additional share capital – private investors or
venture capital funds
 Venture capitalists: Investors interested in investing in businesses with dynamic
growth prospects, willing to take a risk on a business that may fail or do
spectacularly well
 If the firm is a public limited company, it may consider floating on the stock exchange to
obtain extra capital for investment

How much finance can the business obtain?

- The type of business
o A sole trader will be limited to the capital they can put into the business and limited loaned funds
o A limited company will be able to raise share capital – high share capital and good track record of
success will make borrowing easier as well
- The stage of development of the business
o As the business develops it is easier to persuade outsiders to invest in the business
o As the business develops it is easier to obtain loans as the firm has assets to security
- The state of the economy
o When the economy is booming, business confidence is high
 Easy to raise finance from borrowing and investors
o When interest rates are high, it is difficult for businesses to find investors and borrow
 Investors invest in more secure projects with low risks
 Higher cost of borrowing for firms
Advantages and disadvantages of sources of finance
- Internal sources
o Reinvested profit – Profit generated will provide a return for the investors and can be reinvested to
help the business grow
 Does not have an associated cost – does not have to be repaid and no interest charges
 May be limited – constraints the rate of business expansion
o Cashed squeezed out of day-to-day finances
 Reduces the amount that needs to be borrowed
 Short term solution – firm may lack day-to-day finances
o Sale of assets
 Dispose under-used assets – finance obtained without borrowing
 Assets may be leased back – obtain cash and has the use of the asset
- External sources
o Bank overdrafts
 The firm only needs to borrow when and as much as it needs
 Expensive – high interest rates
 Bank can insist on being repaid within 24 hours
o Trade credit
 Obtain goods or services from another business but do not pay for it immediately
 Boosts day-to-day working capital
 Other businesses may be reluctant to trade with the business if they do not get paid in good
time
o Venture capital: High risk capital invested in a combination of loans and shares, usually in a small,
dynamic business
 Getting outside investment for businesses that are unable to raise finance through the stock
riskier companies
 Compensate for risks by demanding a substantial part of the ownership of the company
 Might want to contribute to the running of the business
 Dilutes owner’s control
 Brings in new experience and knowledge

Finance should be adequate and appropriate

- Ensuring the business has sufficient assess to finance to meet its current and future needs
o Overtrading: Expansion of business without adequate or appropriate finance
- Matching the type of finance to its use
o Short term finance should not be used to finance long term projects
 Puts pressure on the company’s cash position
 Growth is a long term activity which requires appropriate long term finance to fund it

Issues for analysis

- Sources of finance are dependent on:
o Use of finance – ensure that finance is suitable for the business in its particular circumstance
o Stability of business – risky businesses should use safer forms of financing
o The owners’ attitudes to sharing the business – borrowing VS share capital (less control)
- Balancing conflicting interest
o Internal sources of finance may be limited
o External sources of finance may be risky and dilutes control
 Consider the business objectives, stage of development of business and reasons for funding
requirement

Choosing the Right Legal Structure

Introduction
- The legal structure of a business is crucial in determining how serious the financial impact will be for the
owners if things go wrong, which has an impact on the taxation levels to be paid by the business and its
owners.
Businesses with unlimited liability
- Unlimited liability: The finances of the business are treated as inseparable from the finances of the business
owners
o Sole trader: An individual who owns and operates his or her own business with unlimited liability.
 Person who makes the final decisions about the running of the business
 The only one who benefits financially from success, and face the burden of any failure
 If unable to pay bills, the courts can allow personal assets to be seized by creditors in order
to meet outstanding debts – may even be declared bankrupt.
 Little finance is needed to set up and run the business
 Customers demand a personal service
 No formal rules to follow or administrative costs to pay
 Complete confidentiality as accounts are not published
 Limited sources of finance available
 Long hours of work involved
 May have to run the business even if sick
o Partnerships: Exists when two or more people start a business without forming a company with
unlimited liability.
 Partners must trust each other – if debts occur one may run away and liabilities are all
burdened on other partner
 If the partners fail to draw up a formal document, the 1890 Partnership Act sets out a series
of rules which governs issues such as the distribution of profits
o Advantages of a partnership
 Additional skills: The new partner may have abilities that the sole trader does not possess
which may strengthen the business.
 More capital: More partners will inject more finance into the business than one person
alone, which makes expansion and development easier.
 Shared strain: More partners can share the worry of running the business and take on a
share of the workload which reduces stress and allows holidays to be taken
o Disadvantages of a partnership
 Sharing profit: Profits gained must be divided between the partners according to their
partnership agreements which may lead to disagreements about fair distributions of
workload and profits.
 Loss of control: No individual can force an action on the business since they are all owners
and decision making must be shared.
 Unlimited liability: All owners are liable for the mistakes made by their partners as well.

Business with limited liability

- Limited liability: The legal duty to pay debts run up by a business stays with the business itself, not its owners
or shareholders.
- The business must go through a legal process to become a company – Incorporation: the creation of a
separate legal identity for the organisation
o Register with the Registrar of Companies: the government department which can allow firms to
become incorporated, located at Companies House where Articles of Association, Memorandums of
Association and the annual accounts of limited companies are available for public scrutiny.
o Submission of the Memorandum of Association – the relation of company and the outside world
(e.g. company name, size of capital)
o Submission of the Articles of Association – the internal management of the company
- Encourages individuals to put forward capital because the financial risk is limited to the amount they invest
- Advantages of forming a limited company
o The benefit of limited liability – increases confidence to expand
o Able to gain access to a wider range of borrowing opportunities – funding the growth of the business
potentially easier
- Disadvantages of forming limited company
o Must make financial information publicly available
o Have to follow more and costly regulations than unlimited liability businesses
Private limited companies
- The shares of private limited company cannot be bought and sold without the agreement of the other
directors – cannot be listed on the stock market
o Maintains close control over the way the business is run
o May be profit focused or different objectives
o Must publish detailed accounts
o Limited liability protects shareholders from business debts – a risk that business people might start a
company, run it to the ground and then walk away from its debt
 Cheques of limited companies are not as secure

Public limited companies

- Minimum share capital requirement of 50000 pounds
- Must publish far more detailed accounts
- Able to float on the stock market – allows any member of the general public to buy shares
- Increases the company’s access to share capital – able to expand considerably
o Forces the firm to grow more quickly or the new shareholders might wonder where their investment
funds have gone to
 Profits become the only objective
 More pressure to profit maximise – City analysts and business journalists criticise
heavily any business that is not making more money this year than last
 Maintaining control of an organisation is limited
 The amount of control is determined by the sale of its shares on the stock control
 Publicly quoted companies are always vulnerable to a takeover bid
 Divorce of ownership and control
 Shareholders are owners who do not make decisions, have little detailed knowledge
on the firm’s operations
 Directors have control though shareholders have power
o Directors may pursue the interests of their own careers and bank balances
rather than the best interests of the business and its staff
 Short termism
 The lack of concern about long-term future may lead to directors focusing too much
on the short term (e.g. lack of training for staff and investment for future growth)

Other forms of business organisations

- Cooperatives: Worker-owned or customer-owned businesses (workers/ customers have a share in business)
o Offers a more united cause for the workforce than the profit of shareholders
- Not-for-profit organisations
o Mutual businesses: firms with no shareholders and no owners which exist solely for the best interest
of its members/ customers
o Charities – ensures that those who fund the charity are not liable for any debt and provides
significant tax benefits

Issues for analysis

- Financial risks involved – industries which require larger capital for production factors may require limited
liability
- Image a business wishes to portray – XX Ltd sounds more professional and established than XX Company
- Weightage of the benefits to be gained against the costs incurred and the short term benefits/costs against
the long term benefits/costs if considering a move from public to private company status
- Limited liability helps firms to take reasonable risks as owners are less threatened by big debts – gives scope
for dubious business practices and unethical behaviour, but may be solved by government intervention to
protect the consumer
- Business owners which have the courage and initiative to take risks should be rewarded with success
- No proof that stock exchange listing leads to short-termism – focus on short term share prices and worries
about shareholder pressures or takeover bids may distract managers from building a long term business
Measuring the Potential Success of a Business Idea

Calculating Revenue, Costs and Profit

Introduction
- Revenue is the value of total sales made by a business within a period.
- Costs are the expenses incurred by a firm in producing and selling its products.
- Profit is the difference which arises when a firm’s sales revenue exceeds its total costs.

Business revenues
- Sales may be low if:
o Product is not well known
o Unable to produce large quantities of output
o Difficult to charge a high price for a product which is not established on the market
- Sales revenue = Volume of goods x Average selling price
o Sell more or at higher price to increase revenue
- Low output keeps costs of production low
- Low price approach: In competitive markets where products are homogenous, products are likely to be at
very low prices to increase the amount of output
- Revenue-orientated approach to maximise sales: If few of its costs vary with the level of its output (high
inelasticity of supply), it will seek to maximise revenue

The costs of production

- Assess the profitability to supply the market at the current price
- Allow comparisons with their forecasted costs of production – able to make judgements concerning the cost-
efficiency of various parts of the business
o Fixed costs: Costs that do not vary directly with output but may vary in time
 In the long term, fixed costs may alter – expansion of production may require larger land size
for larger factory, larger shop space, etc.
o Variable costs: The cost of producing one unit
 Total variable cost: All the variable costs of producing a specific output level, calculated by
variable costs per unit multiplied by the number of units sold
 Variable costs rise as the level of output increases – as the business gets larger, it is able to
negotiate better prices with suppliers and hence get lower unit prices when orders are large
o Total costs: The total amount of fixed and variable costs.
 If a business has high fixed costs as a proportion of total costs, it is likely to maximise sales to
ensure that the fixed costs are spread across as many units of output as possible, lessening
the impact of high fixed costs.
 If a business has high variable costs as a proportion of total costs, it is likely to maximise
revenue by increasing the prices of their products to a level that may reduce demand.

Profits
- A comparison of revenues and costs.
- Total revenue – total costs = Profit gained
- Dependent on the objective of a business
o Types of profit
 Operating profit: The amount remaining once all fixed and variable costs have been
deducted from total revenue but before tax has been paid
 Operating profit – tax = real profit – used for payments to the owners of the business and
reinvestment into the business

Importance of profit
- Provide a measure of the success of a business
- Best source of capital for investment in the growth of the business
- Attract further funds from investors enticed by the possibility of high returns from their investment
- A reward to owners who put money into the business
Issues for analysis
- Accuracy and reliability of forecasted costs and revenues
o May underestimate costs or overestimate revenues – lower profits
o Stakeholders and investors interested in the business may look at forecasted figures before
committing money
o Suppliers may look at forecasted figures to be assured of payment before agreeing to supply raw
materials
- Relationship between the price charged and the volume of sales
o Requires considerable judgement to choose the right price
- Consumers demand is dependent on quality of the products and how strong the competition is
- Are profits the best measure of success for a new business?
o May be the establishment of a customer base and reputation – more long term gains as compared
to the short term success of high profits
o Take into account the general state of the economy when measuring success through profits

Break-even Analysis

Introduction
- Compares a firm’s revenue with its fixed costs to identify the minimum level of sales needed to cover costs

Calculating break-even
- Requires the knowledge of:
o Selling price of product
o Fixed costs
o Variable costs
- Breakeven output = fixed costs / (selling price per unit – variable cost per unit = contribution per unit)
o Contribution: Total revenue - variable costs – useful for businesses that are responsible for a range
of products
o Total contribution : Contribution per unit x Quantity sold

Break-even chart
- A graph showing a business’s total revenues and total costs at all possible levels of demand or output
o Where the breakeven output is
o At which level of output will firm make a loss
o At which level of output will firm profit
o Margin of safety: The amount by which current output exceeds the level of output needed to break
even – Current sales volume - breakeven output

Change and break-even analysis

- Changes in total, fixed or variable costs will change the breakeven price and output
o Increase in costs will result in a higher breakeven point
o Unchanged costs but fall in prices (less revenue) will result in higher breakeven point
- Lines only shift parallel if total costs and fixed costs change
- A rise or fall in variable costs will make the line rise more or less steeply but starts at the same point
- A rise or fall in price will make the revenue line rise more or less steeply but starts at the same point

The value of breakeven analysis

- Strengths
o Estimate the future level of output needed to produce and sell to meet given objectives in terms of
profit
o Assess the impact of planned price changes on profit and level of output needed to breakeven
o Assess how changes in fixed or variable costs may affect profits and the level of output needed to
breakeven
 o Take decisions on whether to produce their own materials or whether to purchase from external
sources (variable costs differences)
o Support applications for loans from banks and other financial institutions – use of breakeven analysis
make indicate good business sense and forecast profitability in the long term
- Weaknesses
o Assumes that costs increase constantly and firms do not benefit lower costs from bulk buying
o Assumes the firm sells all its output at a single price – may offer discounts to get rid of stock or
cheaper prices if bought in bulk
o Assumes that all output is sold – may have excess supply if overproduced or low demand
o Only as good as the data which it is based on – data may be inaccurate

Issues for analysis

- Changes in revenues or costs will change the level of breakeven output
- Working out the fixed and variable costs will help the managers to make better decisions
- Financial institutions will require financial information before lending any money to someone aspiring to run
a business
- Breakeven analysis allows the changing revenues and costs to give a valuable guide to potential profitability

Income Statements (Profit and Loss Accounts)

Introduction
- An income statement is an accounting statement showing a firm’s sales revenue over a trading period and all
the relevant costs generated to earn that revenue
- Provide information to various stakeholder groups on how a particular business has performed during a
given period
- Profit is a major criterion to measuring success of a business
o Shareholders
o Government agencies – calculate the liability of a business to corporation tax
o Suppliers – establish firm’s reliability, stability and creditworthiness before agreeing to supply
o Potential shareholders and bankers – assess financial position of firm before committing funds

Uses of income statement

- Measure the success of a business compared with previous years or other businesses
- Assess the actual performance compared to expectations
- Help obtain loans from banks or other lending institutions – evidence that firms are able to repay loans
- Enable owners and managers to plan ahead – future investments

Measuring profit
- Gross profit – the measure of the difference between income and the cost of manufacturing or purchasing
the products that have been sold
o Calculated without taking costs/ expenses/ overheads into account (administration, advertising,
rent, wages, etc. costs)
o Revenue - cost of goods sold = gross profit
- Net profit/ operating profit
o Calculated by taking costs/ expenses/ overheads into account
o Gross profit - (cost of goods sold + expenses/ overheads) = net profit
- Profit quality
o Not just the amount of profit, but also the continuity of the profit – how long can this profit source
sustain for
o High-quality profit is trading profit that is expected to last for a number of years

Determining profit
- Calculation at regular intervals during a trading period – assists managers in the running of the business
- Public companies must comply with International Financial Reporting Standards (IFRS)
 o Bring about greater similarities between the ways in which companies in different countries report
on their performance
 Makes it easier to compare the financial companies in different countries
 Makes it easier for firms to invest across national boundaries
- Income statement
o Gross profit – revenue - cost of goods
o Operating profit – gross profit - (cost of goods + overheads)
o Profit before taxation – operating profit + (interest received - interest paid)
o Profit after taxation – profit before taxation - amount of tax payable
- Calculating gross profit
o Cost of goods – shows the expenses incurred in the making or buying of products that have been
made in the current financial period
= opening stock (amount from previous financial period) + purchases - closing stock (leftover stocks)
- Calculating operating profit
o Expenses – payments for something that is of immediate use to the business e.g. wages, rents,
electricity, insurance, distribution costs
o Operating profit – minimum target by firms:
 Up by at least the rate of inflation compared to previous year
 A higher percentage of capital employed in the business than the cost of that capital (e.g.
interest rates)
 At least as high a percentage of capital employed that rival companies achieve
 High enough to ensure that shareholders can be paid a satisfactory dividend but still have
enough money left for reinvestment in future
- Financing costs – may be added or subtracted
o Borrowings/ loans to and from firm
- Profit before and after taxation
o Corporation tax
o Profit after taxation = company’s earnings
- Using profits – distributed or retained
o Distributed profits: company directors will decide on the amount to be paid out to shareholders in
the form of dividends
o Retained profit: managers may use some of the profit made to reinvest in the business for the future

Examining income statements

- Business name – shows whether the firm has limited or unlimited liability, private or public firm
- Year-end date – businesses may experience seasonal fluctuations in demand which may or may not be
included
- Record of information of at least 2 years’ trading – assists stakeholders in identifying trends, which helps in
making judgements about the financial well-being of the business

Public limited companies

- Required by law to publish their accounts
- Availability of income statements for scrutiny by banks, investors, owners, competitors, etc.
- Include as little information as possible

Income statements and the law

- Companies Act 2006 – Demands the production of financial statements including an income statement
- Income statements does not have to detail every expense incurred, but summarises the main items under
standard headings
- Compulsory disclosure of
o Auditor’s fees
o Depreciation amounts
o Total of directors’ pay and fringe benefits
o Average number of employees – costs of wages and salaries and costs of National Insurance and
pensions
o Exceptional items – large, one-off financial transactions arising from ordinary trading activities which
may be so large as to risk distorting the company’s trading account
 o Extraordinary items – large, of-off financial transactions outside the normal trading activities of a
company which are not expected to recur (e.g. a closure of factory)

Issues for analysis

- Income statement provides an insight into the performance of a business – analyse and identify trends
which provide evidence about the success of a company
- Gives details of how well the company is controlling its costs – analysing the trends in gross and operating
profit e.g. rising gross profits and falling operating profits implies expenses of firm is not well-controlled
- Look at the performance of the business over a number of years and compare various elements to gain
further insight
- Rising level of operating profit may not prove that firm is successful – short term profit maximisation VS long
term objectives
- When analysing a firm’s success, take into account:
o Growth/ declination of the market
o Rate of new competitors entering the industry
o The firm’s main corporate objectives
o Quality of profit

Measuring and Increasing Profit

Introduction
- Net profit: the profit left after all the operating costs have been deducted from revenue
- Net profit margins: The percentage profit compared with the sales revenue of the business

Measuring performance
- Dependent on the nature of the organisation
- Most common measure of success: Net profit

Net profit and net profit margin

- Net profit margin = Net profit / Sales x 100 = profit per sale
- Typical net profit margin will vary from one sector to another
o Dependent on number of competitors in an industry – more competitors -> low profit per sale but
high sales
o Dependent on type of good – luxury (high profit margin but low sales) or normal good (low profit
margin but high sales)

The return on capital

- Profit as a percentage of the capital a firm invests in a project
- Profitability measures profit in relation to some other variable
- Capital: money invested
- Return on capital = Net profit / Capital invested x 100

Return on capital and the net profit margin

- Dependent on quantity sold and the profit per sale (net profit margin)
- Sale of same amount of products but with a higher profit margin -> Return on capital increase

Methods of improving profits

- Increase profits
o Increase revenue
 Make changes to the product – higher appeal to customers
 Better distribution – wider availability
 Changes to promotion – customers are more aware of its benefits
  Ensure that rising costs do not outweigh rising sales revenues
o Decrease costs
 Less staff – reduced labour cost
 May cause reduced customer satisfaction as they have to wait longer for a good or
service
 Switching suppliers – from higher costs to lower costs
 Reduce current costs – weigh the benefits of extra marketing, etc.
 Reduce unnecessary costs – sell unused assets, etc.
 Increase the efficiency of a product by using fewer inputs of paying less for the inputs used
 Ensure that quality is not compromised by reduced costs

o Increase revenue and decrease costs
- Managers must weigh up the consequences of any decision to reduce costs

Methods of increasing profit

- Increase the price
o Boost profit per sale
o Demand may decrease and quantity sold may decrease
 Sales overall may fall so much that overall profits of the business are reduced
o Dependent on the price elasticity of demand – the greater the PED, the greater the fall in demand,
the less likely that a firm will want to put up its price.
 However, if prices are reduced, the greater the PED, the greater the increase in demand and
the increase in overall profit may outweigh the decrease in net profit margin
- Cut costs
o Better bargaining to get the supply prices down
o Better/ more efficient ways of producing -> lower costs of production per unit -> high profits per sale
 Ensure quality is not damaged

Profits and the functions of business

- Operations management – determine how much can be produced and sold
- Human resources management – determine the employment level and costs of staff
- Marketing decisions – determine sales and revenue earned

Issues for analysis

- Presence of government or private charity which survives without profit
- Internal causes (reasons which are within the control of the management e.g. poor decision making) or
external causes (state of economy) of decreased profits
- Advantages and disadvantages of various methods of increasing profit or cutting cost
- Timescale of the decision making – temporary or permanent loss/ gain, action to be taken immediately or
after waiting to see if circumstances change
- Suggestions made in exams are too obvious – show the maturity to see that firms are already doing all they
can to tackle the problem
Putting a Business Idea into Practice

Developing Business Plans

Introduction
- A business plan is a document setting out the business idea and showing how it is to be financed, marketed
and put into practice, and is crucial in an attempt to raise finance from outside sources such as a bank.

Purpose
- Coordination of different tasks to come together at the right time
- Need to find capital to start up – a persuasive business plan is able to obtain funding and capital
- A good business plan can steer the novice business person towards his goals

Contents of a good plan

- Persuasive to an outside investor in order to obtain finance
o Bank – start-up should be a safe investment so loans can be repaid
o “Dragon” type of investor who buy ownership stake in the business – interested in the change of
making a huge profit
- Mainly based on the competitive advantage – features of a product or service that will make it succeed
against/ stronger than its competitors (unique selling point, high quality product, new innovation with
patents, etc.)
- Or product or service may be stripped down to make it the cheapest in the market
1. Executive summary – brief highlights of a report placed at the front, so the top executives can
glance at the main points without having to read the whole thing
a. Who you are
b. Customers’ frustrations
c. Product which will solve the problem
d. Why your team is ideal
e. How much capital is needed
f. How much capital is invested by owners
2. Product/ service
a. Analysis of product from customer’s point of view (how it benefits them)
b. What is different about the product
3. Market
a. Current market trends – market growth rate
b. Brief analysis of key competitors
4. Marketing plan
a. Methods of communicating to target customers
b. Price of product – explanation and justification
c. Forecast of likely sales per month for the first 2 years
5. Organisational plan
a. Who will be in the team
b. How they will be managed and organised
6. Operational plan
a. How the product will be produced and delivered
b. Business deals made with contacted suppliers
7. Financial plan
a. Cash flow forecast – prediction of monthly cash out and cash in from the start of the
business until at least 2 years after the firm has started trading which shows the bank
the need for finance
8. Conclusion
a. Ideas of the longer term plans for the business
b. Includes ‘exit strategy’ if any

Benefits and problems of business plans

 - The business plan is only as good as the information inside – most are estimations which may be inaccurate
and unreliable
- Advantages
o Forces the entrepreneur to think carefully about every aspect of the start-up, which should increase
the chances of success
o May make the entrepreneur realise that he lacks the skills needed for part of the plan and try harder
to employ and expert or buy in advice
o If the plan is well received by investors, they may compete to offer attractive terms for obtaining
capital
o Many entrepreneurs have the whole plan in their head, not on paper – if illness or accident strikes,
others will only keep things going with a paper plan
- Disadvantages
o Making a forecast does not make it happen – entrepreneurs may confuse a plan with reality
o Problems arise if the plan is too rigid – increased flexibility may allow entrepreneurs to be prepared
for what to do if sales are poor or unexpectedly high
o Plans based on high sales will include lots of staff to meet the demand – risks are lower if the
business starts with a low cost and low sales expectation
o Business success is often about people, not paper – an over-focus on a perfect plan may mean too
little time is spent interacting with stakeholders e.g. visiting suppliers or talking to shoppers

Sources of information and guidance

- Government agencies
o Department for Business, Innovation and Skills runs the Small Firms Loan Guarantee Scheme which
encourages high street banks to lend to high-risk small firm by guaranteeing to take on 75% of the
risk that the loan might not be repaid if the firm collapses
o Local Enterprise Partnerships – the partnerships between local councils and local businesses will be
charged with providing advice and help for new firms starting up
- Banks
o Rarely provide financial help to small firms
o Provide a business plan toolkit
o Wants the firm to open their business banking account with them
- Accountants
o Those with no business knowledge may get accountants to help check cash flow and profits forecast
o Provision of invaluable advice on tax issues – technical issues that accounts may know more
- Small business advisors
o Local Enterprise Partnership help entrepreneurs get in touch with local advisors
o Invaluable to have a mentor: an experienced advisor
o May not be cheap to hire
- Prince’s Trust
o Lend up to 4000 pounds on a new business start up
o Applicable to unemployed or disadvantaged people up to the age of 30
o Regular attending of sessions with a free mentor
 Mentors are often quite high-powered businesspeople who offer invaluable advice

Issues for analysis

- Creating a business plan allows entrepreneurs to think harder about every aspect of the start-up and
perhaps start to see a few potential problems
o Even if they are used just for obtaining finance and discarded after, the process of preparing the plan
would have already brought further insights to the owner
o Solutions to problems may be put into place before the business actually starts up
- A good business idea is based on strong understanding of the customer and the competition
- Entrepreneur requires the personal abilities and qualities to build effective relationships with other
stakeholders
- If entrepreneurs focus on the business plan paper work too much, they may neglect the more important
tasks
- Business plans can help to get investment from outsiders
- Business plans may help a disorganised entrepreneur make fewer mistakes, but the entrepreneur requires
strong enterprise skills as well