UNIT - I

LESSON 1
ENTREPRENEUR AND ENREPRENEURSHIP
Vipin Kumar

INTRODUCTION
The concept of entrepreneurship has been around for a very long time. In the last two decades it has
resurged. The concept of entrepreneurship is an age-old phenomenon that relates to the vision of an
entrepreneur as well as its implementation by him. Entrepreneurship is a creative and innovative
response to the environment. It is also the process of setting up a new venture. Entrepreneurship is a
composite skill that is a mixture of many qualities and traits such as imagination, risk taking, ability to
harness factors of production, i.e., land, labour, technology and various intangible factors.

Usually any one who runs a business is called an entrepreneur. The more precise meaning of
entrepreneur is one who creates his own business, i.e., a person who organizes, operates and assumes the
risk of a business venture. An entrepreneur is a person who perceives a need and then bri9ngs together
manpower, material and capital required to meet that need.

Entrepreneurship implies a set of values, norms and traits that are conductive to the growth of a business
enterprise. It is the organisational culture that focuses on new opportunities and creation of an
organisation where these opportunities can be perused earnestly. An entrepreneur seeks the
opportunities, looks for ways and means to capitalize on the newer opportunities by organizing the
structure and the resources and gaining control on them. As against this, a manager is primarily
concerned with the resources under his control, the structure of his organisation and its relations to the
market. He is also concerned with matching the opportunities with organizational abilities. The
entrepreneurs are driven by the perception of opportunities. They seek changes in the political rules,
social values, consumer preferences, technology etc. On the other hand resources like money, manpower
and material they control, drive the managers.

ENTREPRENEUR AND ENTREPRENEURSHIP

An entrepreneur is a person who searches for change and responds to it by starting an enterprise. In the
words of Adam Smith, “Entrepreneur is an individual who undertakes the formation of an organisation
for commercial purposes by recognizing the potential demand for goods and services and thereby acts as
an economic agent and transforms demand and supply.”

Entrepreneurship is the process that involves all actions an entrepreneur undertakes to establish an
enterprise to give reality to his business ideas. According to John Kaso and Howard Stavenson,
“Entrepreneurship is the attempt to create value through recognition of business opportunity, the
management of risk-taking appropriate to the opportunity and through the communicative and
management skills to mobilize human, financial and material resources necessary to bring a project to
fruition,” This definition recognizes that entrepreneurship involves the fusion of capital, technology and
human talent to complete a project successfully and with reasonable degree of risk.

Entrepreneurship is also defined as the ability to create and build something from practically nothing. It
is a knack of sensing opportunity where others see chaos, contradiction and confusion. Entrepreneurship
is the attitude of mind seek opportunity, take calculated risks and derive benefits by setting up a venture.
Thus, it comprises of numerous activities involved in conception, creation and running an enterprise.

According to Higgins, “Entrepreneurship means the function of seeking investment and production
opportunity, organizing an enterprise to undertake a new production process, raising capital, hiring
labour, arranging the supply of raw materials, finding site, introducing a new technique, discovering new
sources of raw materials and selecting top managers for day-to-day operations of the enterprise.” This
definition highlights risk-taking, innovating and resource organizing aspects of entrepreneurship.

Entrepreneurship can be described as a creative and innovative response to the environment. Such
responses can take place in any field of social endeavour-business, agriculture, education, social work
and the like. The entrepreneur is an innovator, action-oriented and highly motivated, he visualizes
business opportunities, gathers the necessary resources to take advantage of the environment and
initiates appropriate action to ensure success.

The foregoing definition indicate that entrepreneurship is associated with the following activities or
functions:

(i) Perceiving opportunities for profitable investment;

(ii) Initiative in establishing a business;
(iii)Risk bearing;
(iv) Introduction of innovations;
(v) Provision of capital; and
(vi) Co-ordination of different factors of production.

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 EXHIBIT-1: Definitions of Entrepreneur and Entrepreneurship

“Entrepreneur is the co-ordinator and organizer of resources to design a business enterprise.”

- J.B. Say
“Entrepreneur is an individual who undertakes the formation of an organisation for
commercial purposes by recognizing the potential demand for goods and services and
thereby acts as an economic agent and transforms demand and supply.”
-Adam Smith
“Entrepreneurs are innovators who use the process of shattering the status quo of the existing
products and services to set new products, new services. He describes entrepreneurs as
innovators.”
-Joseph Shumpeter
“Entrepreneurship is the attempt to create value through recognition of business opportunity,
the management of risk taking appropriate to the opportunity and through the communicative
and management skills to mobilize human, financial and material resources necessary to
bring a project to fruition.”
-John Kaso and Howard Stavenson
“Entrepreneur is one who is involved in gathering and using resources to make use of
opportunities to produce results.”
-Peter Drucker
“Entrepreneurship is a systematic innovation which consists of the purposeful and organized
search for changes and in a systematic analysis of the opportunities such changes might offer
for economic and social innovation.”
-Peter Drucker

To sum up, the term ‘entrepreneur’ has been defined in various ways-a risk taker, a resource assembler,
an organisation to builder, an innovator, and so on. Truly speaking, an entrepreneur is all combined into
one. He introduces new ideas, carries on new activities, co-ordinates the factors of production and
decides how the business should be run. He has vision, originally of thought and ability to take calculate
risks.

EXHIBIT-2: What is an Enterprise

An entrepreneur is a person who starts an enterprise. The process of creation is called

entrepreneurship. The entrepreneur is the actor and entrepreneurship is the act. The outcome
of the actor and the act is called the enterprise. An enterprise is a business orgnanisation that
is formed and which provides goods and services, creates jobs, contributes to national
income, exports and overall economic development.

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Difference between Entrepreneur and Entrepreneurship

The term ‘entrepreneur’ is used to describe the people who establish and manager their own business.
The process involved is called entrepreneurship. Entrepreneurship is an abstraction whereas
entrepreneurs are living people.

Entrepreneurship is the outcome of complex socio-economic, psychological and other factors.

Entrepreneur is the key individual central to entrepreneurship who makes things happen. Entrepreneur is
the actor, entrepreneurship is the act. Entrepreneurship is the most effective way to bridging the gap
between scientific innovations and the market place by creating new enterprises. An entrepreneur is the
catalyst who brings about the change.

TYPES OF ENTREPRENEURS

Clarence Danhof, on the basis of his study of American Agriculture, Classified entrepreneurs in the
manner that at the initial stage of economic development entrepreneurs have less initiative and drive and
as economic development proceeds they become more innovating and enthusiastic. Basing on this, he
classified entrepreneurs into four categories:

(a) Innovating Entrepreneurs: An innovating entrepreneur is one who introduces new goods,
inaugurates new method of production, discovers new market and reorganizes the enterprise. It is
important to note that such entrepreneurs can work only when a certain level of development is
already achieved, and people look forward to change and improvement. Generally, they are
typical of developed countries.

(b) Imitative Entrepreneurs: These are characterized by readiness to adopt successful innovations
inaugurated by successful innovating entrepreneurs. They lap up innovations originate by
innovating entrepreneurs. Imitative entrepreneurs do not innovate the changes themselves, they
only imitate techniques and technology innovated by others. Such types of entrepreneurs are
particularly suitable for the underdeveloped regions for bringing a mushroom drive of imitation
of new combinations of factors of production already available in development regions.

(c) Fabian Entrepreneurs: Fabian entrepreneurs are characterized by very great caution and
skepticism in experimenting and change in their enterprise. They imitate only when it becomes
perfectly clear that failure to do so would result in a loss of the relative position in the
enterprises. They are lazy and shy and lack the will to adopt to new methods of production.

(d) Drone Entrepreneurs: Drone entrepreneurs are characterized by a refusal to adopt opportunities
to make changes in production formulate even at the cost of severely reduced returns relative to
other like producers. Such entrepreneurs may even suffer losses but they are not ready to make
changes in their existing production methods. They struggle to exist, not to grow. Thus, they are
laggards as they continue to operate in their traditional way and resist changes.

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NATURE OF ENTREPRENEURSHIP

(a) Economic Activity: Entrepreneurship involves the creation and operation of an enterprise.
Therefore, it is essentially an economic activity concerned with of value or wealth.

(b) Creative Response to Environment: Entrepreneurship involves innovation or introduction of

something new. It is a creative response to the environment. An entrepreneur recognizes the need
for change and initiates it. He does things in new and better ways.

(c) Purposeful Activity: Entrepreneurship is the purposeful activity of an individual or a group of

individuals who seek to earn profits through the production and distribution of economic goods
and services.

(d) Dynamic Process: Entrepreneurs thrive on the changing environment which brings new
opportunities for business. Flexibility is the hallmark of a successful entrepreneur.

(e) Risk Element: Entrepreneurs make decisions in the face of uncertainty. Therefore, risk is an
inherent and inseparable element of entrepreneurship. Until the new venture idea becomes
popular amongst the customers, it runs a family high degree of risk of incurring losses.

(f) Creator or Organisation: An entrepreneur assembles and Co-ordinates other factors of

production, i.e., land, labour and capital. Managerial skills and leadership are other very
important facets of entrepreneurship.

(g) Gap Filling Function: It is the job an entrepreneur to fill the gaps between needs and goods and
services. He has to complete the inputs and provides the knowledge about the production
process.

(h) Optimum Use of Resources: An entrepreneur optimizes the use of resources by arriving at the
most productive combination that will provide the society the needed goods and services.

NEED OF ENTREPRENEURSHIP

(a) Entrepreneurship as Career Option: An educated person has broadly two career option. One
is called wage or salary employment, wherein people are employed in government service,
public and private sectors and get fixed wage or salary. The other career option is entrepreneurial
employment under which people set up their new ventures. Wage employment does not generate
resources and is organized which in the existing wealth. Wage employment is self-saturating.
Once availed, it blocks the employment opportunity to others for another 10 years. On the other
hand, the latter contributes towards national wealth and has a unique characteristic of self-
generation. This starts a chain of activities that create unending employment opportunities.
Entrepreneurship promotes small saving amongst middle class individuals for investment into
new ventures. It also provides an outlet that creates an urge among individuals to attain
excellence in product design and related innovation. Thus, entrepreneurship provides a lasting
solution to the acute problem of unemployment.

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 Table

Wage Employment Entrepreneurial Employment

Nature Self Satuating Self Generating
Scope Limited Unlimited
Orientation  Routine Types  Creative
 Status Quo  Innovative
 Problem Avoiding  Problem Solving
 Dependent  Independent Decisions
Contribution Consumers National Wealth Generates National Wealth
Earning Fixed (Subsistence) Growing (Generating Surplus)

In the context of employment generation, the three terms, i.e., Income Generation, Self-
Employment and Entrepreneurship are often used interchangeably. Entrepreneurship refers to
identification of innovative ideas, setting up of a new enterprise. Whereas, self-employment
refers to full time involvement in ones own occupation. One may or may not be bearing the risk,
mobilizing inputs, organizing production and marketing the product or service. Income
generating activities, on the other hand, are part time, casual and practised with a view of raising
additional income. All entrepreneurs are self-employed and income generating persons. But all
self-employed and income generating persons may not be entrepreneurs.

Fig.: Income Generation, Self-employment and Entrepreneurship

The three, however, can be considered as initial, middle and final stages of Entrepreneurial
Growth Process.

(b) National Income: National Income consists of goods and services produced in the country and
imported. The goods and services produced are for consumption within the country as well as to
meet the demand of exports. The domestic demand increases with ever increasing population and
improving standard of living. The export demand also increases to meet the needs of growing

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 import due to various reasons. An increasing number of entrepreneurs are required to meet this
increasing demand for goods and services. Thus, entrepreneurship increases the national income.

(c) Employment Generation: Growing unemployment, particularly educated unemployment is an

acute problem of the nation. The available employment opportunities can cater to only 5 to 10
per cent of the unemployed. If a hundred persons become entrepreneurs they not only create a
hundred jobs for themselves but also provide employment to many more. As the time passes
these enterprises growth providing direct and indirect employment to many more. Thus,
entrepreneurship is the best way to fight the evil of unemployment.

Entrepreneurship helps solving problems related to:

 Employment generation
 National production
 Dispersal of economic power
 Balance regional development
 Harnessing youth vigour
NIESBUD

(d) Balanced Regional Development: The growth of industry and business leads to a large number
of public benefits like road transport, health, education, entertainment etc. When the industries
are concentrated in selected cities, the development gets limited to these cities. Till late sixties,
50 per cent of industrial enterprises were located in only six cities of India. A rapid development
of entrepreneurship ensures a balanced regional development. When the new entrepreneurs grow
at a faster pace, in view of the increasing competition in and around the cities, they are forced to
set up their enterprises in the smaller towns away from big cities. This helps in the development
of the backward regions.

If a region does not throw up a sufficient number of entrepreneurs, the needs of the local
population for the goods and services remain unsatisfied. The entrepreneurs from other places
step in and set up enterprises to fulfil the pent up demand of the local people. These alien
entrepreneurs do not invest the major part of the profits in the areas in which the unit is located.
Usually, the profit is invested at a place, from where the entrepreneurs come from. Such
entrepreneurs invest their profits in constructing their houses etc., at the place of their origin.
Thus, the backward areas do not get full benefits of business or industrial profits. This drainage
of wealth results in further deterioration of the area. The practice of siphoning the profits earned
through entrepreneurial activities based on local resources by alien entrepreneurs has been
compared with the blood sucking process practised by leeches, and termed as ‘leech effect’ by
Dr. M.M.P. Akhori.

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 Fig.: Siphoning of Profits through Entrepreneurship Activities
by Alien Entrepreneurs

(e) Dispersal of Economic Power: The world affairs have been dominated by power. There have
always been two types of power, i.e., muscle power and economic power. In the modern age, the
muscle power has lost its relevance and the world is ruled by the economic power. Economic
power is the natural outcome of industrial and business activity. Industrial development normally
can lead to concentration of economic power in few hands. This concentration of power in few
hands has its own evils in the form of monopolies. Developing a large number of entrepreneurs
helps in dispersing the economic power amongst the population. This in turn causes hindrance to
the growth of monopolies, which exist partly because of lack of sufficient number of
entrepreneurs. Setting up of a large number of enterprises for the goods helps in weakening the
harmful effects of monopoly.

When a society produces a small number of entrepreneurs, the enterprises due to lack of
competition grow into a few big business houses. This results in concentration of wealth in a few
families. This can have serious social and national implication. When the number of enterprises
is large national wealth is shared by a large number of entrepreneurs, thus, dispersing wealth.
This dispersal of wealth promotes the real socialism and makes the economy healthy.

ENTREPRENEURSHIP VS. MANAGEMENT

Quite often an entrepreneur and a manager are considered similar because of some overlapping in their
roles. In a small firm, the owner himself acts as the manager. But there are some important differences
between a entrepreneur and a manager which are discussed below:

(a) Venture Creation: An entrepreneur often sets up a new venture while a manager only runs an
existing venture.

(b) Innovation: An entrepreneur introduces new ideas to increase profits and is, therefore, an
innovator. On the other hand, a manager runs the business on established lines and often
maintains the status quo. An entrepreneur is a ‘change agent’ whereas a manager is the ‘product
of change’. Entrepreneurship involves combining to initiate changes in production whereas
management involves combining to produce.

(c) Risk Bearing: An entrepreneur assumes risk of economic uncertainties involved in the
enterprise. A paid manager, on the other hand undertakes no risk.

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(d) Status: An entrepreneur is his own boss and enjoys an independent status. In contrast, a manager
is an employee and dependent on the owner.

(e) Reward: For bearing risk, an entrepreneur earns profits which may fluctuate widely from one
time period to another. But the reward of a manager is the salary which is relatively fixed and
regular.

(f) Continuity: Management refers to the ongoing coordination of the production process whereas
entrepreneurship is a discontinuous phenomenon appearing to initiate change in the production
process and then disappears until it reappears to initiate another change.

Overlapping Roles of Entrepreneur and Manager

Joseph Schumpeter made a distinction between entrepreneur and manager. According to him, a manager
is one who deals with day-to-day affairs of a going concern. But an entrepreneur attempts to change the
factor combinations and thus increases productivity and profits. An entrepreneur launches a new
enterprise whereas a manager operates an existing enterprise. The roles of entrepreneur and manager
may, however, overlap in many situations. Entrepreneurs who start enterprises must use managerial
skills to implement their innovative ideas successfully. Similarly, managers must use entrepreneurial
skills in order to manager change and innovation to effectively deal with uncertain external environment
of business.

Table: Entrepreneur vs. Manager

Basis Entrepreneur Manager

1. Venture An entrepreneurs sets up a new A manager only runs an existing
creation venture and runs it. unit.
2. Innovation Entrepreneurship is another name of A manager is an employee of the
innovation. He works to find new business organisation. He cannot
methods, products, etc. operate independently.
3. Risk-taking An entrepreneur starts and runs his A manger takes less risk at
venture independently. He is self- compared to an entrepreneur. He is
employed and is his own basis. less tolerant to uncertainty. He does
not share business risks.
4. Status An entrepreneur takes calculated A manager need not be an innovator.
risk. He may even jeopardize his He deals with the day-to-day affairs
own financial security. He is of a going concern.
responsible for failure and financial
loss.
5. Reward An entrepreneur is motivated by A manager is motivated by rewards
profits. He may even suffer a loss. or incentives. His salary cannot be
negative.
6. Change An entrepreneur is responsive to A manager may not very receptive to
external environments and is always change, unless he is enterprising.
prepared to change.

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ROLE OF FUNCTIONS OF ENTREPRENEURSHIP
Role of Entrepreneurship In Economic Development

The entrepreneur is the key to the creation of new enterprises that energise the economy and rejuvenate
the established enterprises that make up the economic structure. Entrepreneurs initiate and sustain the
process of economic development in the following ways:

i. Capital formation: Entrepreneurs mobilize the idle savings of the public through the issues of
industrial securities. Investment of public savings in industry results in productive utilization of
national resources. Rate of capital formation increases which is essential for rapid economic
growth. Thus, an entrepreneur is the creater of wealth.

ii. Improvement in per capita income: Entrepreneurs locate and exploit opportunities. They
convert the latest and idle resources like land, labour and capital into national income and wealth
in the form of goods and services. They help to increase. Net National Product and per capita
income in the country, which are important yardsticks for measuring economic growth.

iii. Generation of employment: Entrepreneurs generate employment both directly and indirectly.
Directly, self-employment as an entrepreneur offers the best way for independent and honourable
life. Indirect, by setting up large and small scale business units they offer jobs to millions. Thus,
entrepreneurship helps to reduce the unemployment problem in the country.

iv. Balanced regional development: Entrepreneurs in the public and private sectors help to remove
regional disparities in economic development. They set up industries in backward areas to avail
of the various concessions and subsidies offered by the Central and State Governments. Public
sector steel plants, and private sector industries by Modis, Tatas, Birlas and other have put the
hitherto unknown places on the international map.

v. Improvement in living standards: Entrepreneurs set up industries which remove scarcity of

essential commodities and introduce new products. Production of good on mass scale and
manufacture of handicrafts, etc., in the small scale sector help to improve the standard of life of a
common man. These offer goods at lower costs and increase variety in consumption.

vi. Economic independence: Entrepreneurship is essential for national self-reliance. Industrialists

help to manufacture indigenous substitutes of hitherto imported products thereby reducing
dependence on foreign countries. Businessmen also export goods and services on a large scale
and thereby earn the scarce foreign exchange for the country. Such import sub-situation and
export promotion help to ensure the economic independence of the country without which
political independence has little meaning.

vii. Backward and forward linkages: An entrepreneur initiates change which has a chain reaction.
Setting up of an enterprise has several backward and forward linkages. For example, the
establishment of a steel plant generates several ancillary units and expands the demand for iron

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 ore, coal, etc. these are backward linkages. By increasing the supply of steel, the plant facilitates
the growth of machine building, tube making, untensil manufacturing and such other units.

FUNCTIONS OF AN ENTREPRENEUR

There has been a great deal of confusion and contradiction in literature on entrepreneurial functions.
Classical economists considered the entrepreneur as the owner of the business enterprise to which he
supplied capital. No distinction was made between the entrepreneur and the capitalist and as a result
profits and interest were lumped together. But in the modern corporation ownership is separated from
control. Ownership of business lies with shareholders who bear risks but do not exercise control. Control
lies with a small group of insiders known as Board of Directors. This group bears little risk and receives
a large remuneration even when no dividend in paid to the shareholders, i.e., the nominal owners. Thus,
the classical theory of enterprise fails in a large public company. A new theory of firm is required which
should take into account the income of an entrepreneur when he is not the owner of business.

Peter Kilby identified thirteen functions of an entrepreneur, which included some of the managerial
functions also.

These functions are as follows:

 Perceiving market opportunities

 Gaining command over scarce resources
 Purchasing inputs
 Marketing of the products and responding to competition
 Dealing with the public bureaucracy (concessions, licences and taxes)
 Managing human relations within the firm
 Managing customer and supplier relations
 Managing finance
 Managing production (control by written records,, supervision, coordinating input flows with
orders, maintenance)
 Acquiring and overseeing assembly of the factory
 Industrial engineering (minimizing inputs with a given production process)
 Upgrading process and product quality, and
 Introducing new production techniques and products.

Kilby suggested that these functions may vary according to the size, type and setting of an enterprise and
could be augmented through training and education.

We may classify the functions of an entrepreneur into three broad categories:

(i) Innovation;
(ii) Risk-bearing; and
(iii) Organisation and management

(a) Innovation: According to Schumpeter, an entrepreneur is basically an innovator who introduces

new combinations of means of production. Entrepreneurship is a creative activity and the

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 entrepreneur introduces something new in any branch of economic activity. The carrying out of a
new combination implies employment of productive means in a changed form. It is not necessary
that new combination is carried out by people who control the product or commercial process. A
new combination can be carried out by employing both unused and used means of production.
As an innovator, entrepreneur forsees the potentially profitable opportunity and tries to exploit it.
He is a problem solver and gets satisfaction by attacking problems.

Innovation is also different from invention: Invention implies the discovery of new ideas, new
articles and new methods. On the other hand, innovation refers to the application of inventions
and discovery to make new combinations and thereby produce satisfaction and profits.
Inventions may facilitate innovations but an invention in itself is of little benefit to mankind
unless it is marketable. The innovator provides this missing link. An invention becomes an
innovation only when it is embodied in a product or service that can be successfully sold in the
market.

Some people believe that innovations are carried out by big firms. The truth is that most of the
innovations are the handiwork of small firms. Large firms may have strong organisation
structures and management skills but they lack flexibility. Due to their intrinsic flexibility small
firms can react rapidly to new demands and easily exploit new ideas. A large firm working under
the constraints of size and competition tends to perfect existing lines of production in order to
increase profits. On the other hand, a small firm tries to exploit the gaps in the production
system. Unlike the giant, it is not obliged to engage in expensive conversion and can launch itself
on new, narrow or risky markets.

(b) Risk Taking: Risk taking or uncertainty bearing implies assuming the responsibility for loss that
may occur due to unforeseen contingencies of the future. An entrepreneur provides or invests
capital in order to establish and run the enterprise. He guarantees interest to lenders, wages to
employees, rent to the landlord. After making payment to these persons little or nothing may be
left for him. Economists like Cantillon, J.B. Say and others stressed risk-taking as the specific
function of the entrepreneur. An entrepreneur reduces uncertainty in his plan of investment,
diversification of production and expansion of the enterprise.

Business is a game of skill wherein risk and rewards both are great. Ability of the highest order
is required for success in entrepreneurship. An entrepreneur is an especially talented and
motivated person who undertakes the risks of business. He visualizes opportunities for
introducing new ideas and handles economic uncertainty. He is an enterprising individual willing
to assume the risks involved in innovations, new ventures and expansion of an existing venture.

(c) Organisation Building: Alfred Marshall recognized organisationa and management of the
enterprise as the main function of an entrepreneur. It implies bringing together the various
factors of production. The purpose is to allocate the productive resources in order to minimize
losses and reduce costs in production. An entrepreneur takes business decisions. In the initial
stage of the establishment of an enterprise the entrepreneur may take all decisions by himself.
But as the enterprise grows and the work of decision making becomes more complex, the
entrepreneur delegates authority to subordinate executives. However, the central function of the
entrepreneur remains the same. He alone determines what lines of business to expand into and

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 how much capital to employ. He determines the expansion and contraction of the size of the total
business and its various branches. Being at the helm of affairs, the entrepreneur is the final judge
in the conduct of his business.

An entrepreneur formulates business plans and ensures their execution. He coordinates the
agents of production, organizes and sets up the enterprise and supervises its operations. He thus
takes the final responsibility for the business. He makes the final choice concerning the business
and shapes the long-term policies of the enterprise. He is a decision-maker and derives
satisfaction by attacking problems.

Entrepreneurship And Environment

Entrepreneurship does not emerge and grow spontaneously. Rather it is dependent upon several
economic, social, political and psychological factors. These environmental factors may have both
positive and negative influences on the growth of entrepreneurship. Positive influences imply facilitating
and conducive conditions whereas negative influences refer to factors inhibiting the emergence of
entrepreneurship. Various environmental factors influencing the emergence of entrepreneurship are
given below:

(a) Economic Conditions: Economic environment exercises perhaps the most direct and immediate
influence on entrepreneurship. Capital, labour, raw materials and markets are the main economic
factors.

Capital: Capital is one of the most important prerequisites to establish an enterprise. Availability
of capital facilitates the entrepreneur to bring together the labour of one, machine of another and
raw material of yet another to combine them to produce goods. Capital is, therefore, regarded as
a lubricant to the process of production. As capital supply increases, entrepreneurship also
increases.

Labour: The quality and quantity of labour is another factor which influences the emergence of
entrepreneurship. It is noticed that cheap labour is often less mobile or even immobile. And, the
potential advantages of low-cost labour are negated by the deleterious effect of labour
immobility. The disadvantages of high-cost labour can be modified by introduction of labour-
saving innovations as was done in the USA. Thus, it appears that labour problems can be solved
more easily than capital can be created.

Raw Materials: The necessity of raw materials hardly needs any emphasis for establishing any
industrial activity and, therefore, its influence in the emergence of entrepreneurship. In the
absence of raw materials, neither any enterprise can be established nor an entrepreneur can
emerge.

Market: The fact remains that the potential of the market constitutes the major determinant of
probable rewards from entrepreneurial function. Frankly speaking, if the proof of pudding lies in
eating, the proof of all production lies in consumption/marketing. The size and composition of
market both influence entrepreneurship.

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(b) Social Factors: Social environment in a country exercises a significant impact on the emergence
of entrepreneurship. The main components of social environment are as follows:

Legitimacy of Entrepreneurship: The social status of those playing entrepreneurial role has been
considered one of the most important contents of entrepreneurial legitimacy. To increase the
legitimacy of entrepreneurship, some scholars have proposed the need for a change in traditional
values, which are assumed to be opposed to entrepreneurship.

Entrepreneurship will be more likely to emerge in settings in which legitimacy is high.

Social Mobility: Social mobility involves the degree of mobility, both social and geographical, a
high degree of mobility is conducive to entrepreneurship.

Security: Several scholars have advocated entrepreneurial security as an important facilitator of

entrepreneurial behavior.

Security is a significant factor for entrepreneurship development. This is reasonable too because
if individuals are fearful of losing their economic assets or of being subjected to various negative
sanctions, they will not be inclined to increase their insecurity by behaving entrepreneurially.

(c) Psychological Factors: Many entrepreneurial theorists have propounded theories of

entrepreneurship that concentrate specifically upon psychological factors.

Entrepreneurial class develop because it provides them psychological satisfaction.

(d) Governmental Influence: The government by its actions or its failure to act does influence both
the economic and non-economic conditions for entrepreneurship. Any interested government in
economic development can help, through its clearly expressed Industrial policy, promote
entrepreneurship in one way or other. By creating basic facilities, utilities and services and by
providing incentives and concessions, the government can provide the prospective entrepreneurs
a facilitative socio-economic setting. Such conducive setting minimizes the risks which the
entrepreneurs are to encounter. Thus, the supportive actions of the government appear as the
most conducive to the entrepreneurial growth. This is true of the Indian entrepreneurship also.
Table: Factors Influencing Entrepreneurship

Facilitating Factors Barriers

1. Technical knowledge 1. Lack of technical skills
2. Entrepreneurial training 2. Lack of market knowledge
3. Market contacts 3. Lack of seed capital
4. Family business 4. Lack of business knowledge
5. Availability of capital 5. Social stigma
6. Successful rolemodels 6. Time pressures and distractions
7. Local manpower 7. Legal and bureaucratical constraints
8. Capable advisors and supporters 8. Patent inhibitions
9. Supplier assistance 9. Political instability
10. Governmental and institutional support 10. Non cooperative attitude of banks and
other institutions

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Small Business As A Seedbed of Entrepreneurship

Small enterprises have low investment and simple technology. They use local resources and cater
largely to local demands through personal the same person may perform various roles simultaneously as
an owner, a capitalist, an organizer, a manager, a labourer and what not. We know that a person who
organizes, manages and takes risks involved in running a business or enterprise is commonly called an
‘entrepreneur’. This means there are as many entrepreneurs as are small enterprises. Thus, small-scale
enterprise precede entrepreneurs and vice-versa. The Government of India has given small enterprises an
important place in the framework of Indian economic planning for ideological as well as economic
reasons. As a result, small sector has achieved an impressive growth in the number of units, for example,
over the period.

In common sense, increasing number of small enterprises means increasing number of persons assuming
the entrepreneurial career. In other sense increase in the number of persons assuming entrepreneurial
career has exactly become sine quo non with increase in the number of small scale enterprises. In
pursuant of the Government of India’s new small enterprise policy titled policy measures for promoting
and strengthening small, tiny and village enterprises tabled in the Parliament on 6th August 1991 and
later passed, the small sector is sure to develop and expand in coming years also. It infers to inter alia
more chances for enterprising persons to assume the entrepreneurial career in future. Thus, small scale
enterprises serve as seedbed for the emergence of entrepreneurship in the country. To conclude, more
the small enterprise development, more will be opportunities for the entrepreneurial career and vice
versa. The Indian Punjab is a clearest example of how opportunities for entrepreneurial carrier
commensurate with the increasing number of small enterprises in the State.

Small enterprises serve as the seedbed of entrepreneurship due to their following peculiar features:
(i) Small units create more self-employment opportunities with comparatively less capital
investment.
(ii) Small scale industries are usually based on local resources.
(iii) These industries can be located any where.
(iv) These units give quick return and have a shorter gestation period.
(v) These units cause relatively less environmental pollution and disruption.
(vi) The firms are viewed favourably because these lead to equitable distribution of income and
wealth.
(vii) These units facilitate industrial dispersal and avoid problems of unplanned urbanization.
(viii) Small firms require simple technology and low managerial skills.
(ix) These units help in better utilization of local resources and skills which might otherwise remain
unutilized.
(x) These units help to maintain and retain traditional skills and handicrafts.
(xi) Small units assist large and medium industries by acting as ancillaries.

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 LESSON 2

ENTREPRENEURIAL COMPETENCIES
Vipin Kumar

Entrepreneurial behavior requires certain knowledge, skill or personality profile. Generally, it is called
entrepreneurial competence or traits.

A competence may be defined as an underlying characteristics of a person which results in effective

and/or superior performance in a job. A job competence is an underlying characteristics of a person in
that it may be motive, traits, skills, aspect of one’s self-image or a body of knowledge which one uses.

Thus, success of an entrepreneur is governed by entrepreneurial competencies. If he has all these

competencies, he can be expected to achieve his entrepreneurial goals. Elements of entrepreneurial
competencies as follows:

(i) Body of Knowledge

(ii) Set of Skills
(iii) Cluster of Appropriate Motives/Traits.

(i) Body of Knowledge: Innovation is possible only through knowledge. The inventor or originator
of the idea that led to the knowledge or vision, of some thing new; the artist of creative
endeavour. Inventors include those who identify new technological processes, new forms of
plant life and new designs. Thus, inventions deal with new processes, or new technical
knowledge. In a simple way, knowledge means collections of information and retention of facts
that an individual stores in some parts of his brain.

Creative process provides imaginative people, geminate ideas, nurture them and develop them
successfully. This type of idea has a value. However, it must be proven useful or be marketable
and to achieve either status or achievement, must be developed. But innovation is the
development process which translates an idea into an application. It requires persistence in
analytically working out the details of product design or service, to develop marketing, obtain
finances and plan operations.

(ii) Set of Skills: Skill is the ability to demonstrate a system and sequence of behavior that are
functionally related to attaining a performance or goal. An entrepreneur is required to have
certain skills and these skills also constitute his leadership qualities. These skills are as follows.

(a) Anticipatory Skills––foresight into a constantly changing environment;

(b) Visioning Skills––the use of persuation and example to induce a group to act in
accordance with the leader’s purposes or the shared purposes of a larger group;
(c) Value Congruence Skills––the need to be in touch with employee’s economic, safety,
psychological, spiritual, sexual, aesthetic and physical needs in order to engage people on
the basis of shared motives, values and goals;
(d) Empowerment Skills––the willingness to share power and to do so effectively; and

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 (e) Self understanding Skills––introspective or self underskills as well as framework within
which leaders understand both their own needs and goals and those of their employees.

In practice, an entrepreneur who pursues the idea, planning its application, acquiring resources
and establishing its market through persistence, planning, organizing and leadership needs above
skills. With the help of these skills, entrepreneur is expected to perform well in his
entrepreneurial behavior.

(iii) Cluster of Motives and Traits: Motives deal with recurrent concern for a goal, state or
condition appearing in fantasy, which drives, directs and selects behavior of the
individual. Actually motive represents thought related to a particular goal, state.
McClellend opined that “need achievement” is social motive to excel that tends to
characterize successful entrepreneurs especially when reinforced by cultural factors.
According to Paul Wilken “entrepreneurship becomes the link between need achievement
and economic growth. Thus, need for achievement is guiding force behind
entrepreneurial activities. It is the desire to do well and it motivates the people to
undertake innovative activities.

The trait may be defined as a dispositional or characteristic way in which the person
responds to an equivalent set of stimuli. These responses represent intelligence, charisma
decisiveness, enthusiasm, strength, bravery, integrity and self-confidence. Thus, traits are
an individual’s personal characteristics. Traits are contents of leadership qualities. So an
effective leader is one who possesses intelligence, alertness to the needs of others,
understanding of the task, good communication skills, initiative and persistence in
dealing with the problems. It is important to note that personal elements that govern the
leadership ability are intelligence, self-confidence, the drive to accept responsibility,
good communication skills and education.

In this way, entrepreneur is required to have certain traits. These traits are necessary for
leadership qualities expected from an entrepreneur. An entrepreneur should be (i)
adaptable to situations, (ii) alert to social environment, (iii) ambitious and achievement
oriented, (iv) assertive, (v) cooperative. (vi) decisive, (vii) dependable, (viii) dominant
(desire to influence others), (ix) energetic (high activity level); persistent, (x) self-
confident, (xi) tolerant of stress and (xii) willing to assume responsibility.

Thus, for achieving success in his entrepreneurial behavior, entrepreneur is required to

have entrepreneurial competencies and these are consist of a set of knowledge, skills,
motives and traits.

Entrepreneurial Competencies Identified By The Edi

Entrepreneurship Development Institute of India (EDI) conducted a study under the guidance of David
C. McClelland, a reputed behavioural scientist, in three countries, namely, India Malawi and Equador. It
was found out that possession of certain competencies or abilities results in superior performance. An
entrepreneur may possess certain competencies and at the same time it is possible to develop these

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through training, experience and guidance. Various competencies required for superior performance by
the entrepreneurs (identified during the study) are:

(a) Initiative: It is an inner urge in an individual to do or initiate something. These is a popular

saying, ‘Well begun is half done’. It is the entrepreneur who takes the first move towards setting
up of an enterprise. Most of the innovators have got this urge to do something different.
Entrepreneur basically is an innovator who carries out new combinations to initiate and
accelerate the process of economic development.

(b) Looking for Opportunity: An entrepreneur is always on the look out or searching for
opportunity and is ready to exploit it in the best interests of his enterprise.

(c) Persistence: An entrepreneur is never disheartened by failures. He follows Try-Try Again for
overcoming the obstacles that come in the way of achieving goals.

(d) Information Seeker: A successful entrepreneur always keeps his eyes and ears open and is
receptive to new ideas which can help in realizing his goals. He is ready to consult expert for
getting their expert advice.

(e) Concern for High Quality: Successful entrepreneurs do not believe in moderate or average
performance. They set high quality standards for themselves and then put in their best for
achieving these standards. They believe in excellence, which is reflected in everything they do.

(f) Commitment: Top performers are prepared to make all sacrifices for honouring the
commitments they have made. Whatever they commit, they take it as a moral binding for
honouring their commitments, irrespective of the costs involved.

(g) Concern for Efficiency: Top performers are always keen to devise new methods aimed at
promoting efficiency. They are keen to evolve and try new methods aimed at making working
easier, simpler, better, and economical.

(h) Systematic Planning: Successful entrepreneurs evolve future course of action keeping in mind
the goals to be realized. They believe in developing relevant and realistic plans and ensure proper
execution of the same in their pursuit of attaining their goals.

(i) Problem Solving: A successful entrepreneur takes each problem as a challenge and put in best
for finding out the most appropriate solution for the same. He will first of all understand the
problem and then evolve appropriate strategy dealing with the same.

(j) Self-confidence: Entrepreneurs are not cowed down by difficulties as they believe in their own
abilities and strengths. They have full faith on their knowledge, skill and competence and are not
worried about future uncertainties.

(k) Assertiveness: An assertive person knows what to say, when to say, how to say and whom to
say. He believe in his abilities and ensures that others fall in line with his thinking, aimed at
promoting the interests of the organisation.

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(l) Persuativeness: A successful entrepreneur through his sound arguments and logical reasoning is
in position to convince others to do the work the way he wants them to do. It is not the physical,
but intellectual force he will use for convincing others.

(m) Effective Strategist: A successful entrepreneur possesses the ability to evolve relevant strategy,
aimed at safeguarding or promoting organisation’s interests. Strategy may be with respect to
facing future uncertainities or challenges posed by competitors.

(n) Effective Monitoring: Entrepreneurs ensure that every thing is carried out in their organizations
as per their wishes. They ensure regular monitoring of the working so that the goals of the
oganisation are achieved in best possible manner.

(o) Concern for Employees Welfare: Future of the organisation depends on its employees. If the
employees are dedicated, committed and loyal, the organisation is bound to perform well. A
successful entrepreneur tries to promote organisation’s interest through promotion of interests of
the workers. He takes personal interest in solving problems confronting works and generates the
feeling that there is interpendence of the interest of workers and the management.

Developing Entrepreneurial Competencies

Following steps are involved in developing entrepreneurial competencies:

(a) Recognising Process: Entrepreneurial behaviour starts with understanding and recognition of
the fact that in which area potential behavior is going to be noteworthy. Specific competencies
are meant for innovative behavior and that is why recognition process should give specific
competencies.

(b) Process of Self-Assessment: It deals with identifying the specific competencies among the
potential candidates for entrepreneurship. It is just like identifying a fact––does one possess a
given competence and if so how frequently one exhibit the same in one’s day-to-day operational
behaviour.

(c) Process of Practice: It covers the desired framework to what extent a potential candidate for
entrepreneurship lacks certain competencies. But being interested to undertake entrepreneurial
beahviour he would like to acquire these competencies and strengthen others. Entrepreneurial
development programmes provide help in strengthening this process.

(d) Feed Back Process: It relates with appraisal or seeking information about the newly acquired
behaviour. It also deals with introspection process to what extent new behaviour or act of
exhibiting a competence has been beneficial.

Thus, there are different types of competencies required for developing entrepreneurship. To become a
successful entrepreneur, it is must for his to have that competencies or leadership qualities like
innovative, initiative, risk assuming personality, sensitivity to environment, sense of work, commitment
and decisiveness.

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ENTREPRENEURIAL MOTIVATION, PERFORMANCE AND REWARDS

Motivation

Every individual acts in a distinct manner. Since people act differently, the basic question is ‘why they
do what they do’? The answer to this question lies considerably in the explanation of motivation. The
term, ‘motivation’ comes from the Latin word ‘movere’ which means ‘to move’. Motivation, as the
base-building block of human action has been studied extensively. Studies on motivation broadly refer
to two areas (a) motivating self, and (b) motivating others. Available literature suggests that it is
imperative to understand the underlying concept of motivation in order to formulate a theoretical base
for both the aspects. Motivational theories are based on the fact that behavior is essentially purposeful
and directed towards the attainment of a goal. Thus, the concept “motive” refers to the purpose
underlying all goal directed actions. All motives, however, may not be equally important to the context
of the goal. Some action arise from a biological or physiological need, over which people do not have
much control. Such motives are common to the entire animal kingdom. But there are certain crucial and
other higher order needs which are common to human beings. The distinctly human motives are largely
unrelated to biological and survival needs. These are related to feelings of self-esteem, competency,
social acceptance, etc.

Psychologists have described the term motivation as:

 The immediate influence on the direction, vigour and persistence of action;

 The process of arousing action, sustaining the activity in progress and regulating the pattern of
activity.
 An inner state that energises activities and directs or channels bahaviour towards goal;
 How behavior gets started, is energized, is sustained, is directed, is stopped and what kinds of
subjective reactions are present in the organism while all this is going on;
 Steering one’s action towards certain goals and to commit a certain part of one’s energies reacting to
them.

These descriptions help in answering any or all the following questions:

(i) What energises human behaviour?
(ii) What directs such behavior?
(iii) How is this behaviour maintained and sustained?

Significance Of Motivation

Motivation is an effective instrument in the hands of manager for inspiring the workforce and creating a
confidence in it. By motivating the workforce, management creates ‘will to work’ which is necessary for
the achievement of organizational goals. Motivation involves getting the members of the group to pull
weight effectively, to give their loyalty to the group, to carry out properly the purpose of the
organisation. The following results may be expected if the employees are properly motivated:
(i) The workforce will be better satisfied if management provides them with opportunities to fulfil
their physiological and psychological needs. The workers will cooperate voluntarily with the
management and will contribute their maximum towards the goals of the enterprise.

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(ii) Workers will tend to be an efficient as possible by improving upon their skills and knowledge so
that they are able to contribute to the progress of the organisation. This will also result in
increased productivity.

(iii) The rates of labour turnover and absenteeism among the workers will be low.

(iv) There will be good human relations in the organisation as friction among the workers themselves
and between the workers and the management will decrease.

(v) The number of complaints and grievances will come down. Accident rate will also be low.

(vi) There will be increase in the quantity and quality of products. Wastage and scrap will be less.
Better quality of products will also increase the public image of the business.

Maslow’s Need Hierarchy Mode

A.H. Maslow developed a conceptual framework for understanding human motivation which has been
widely acclaimed. He defined a person’s effectiveness as a function of matching man’s opportunity with
the appropriate position of hierarchy of needs. Process of motivation begins with an assumption that
behaviour, atleast in part, is directed towards the achievement of satisfaction of needs. Maslow proposed
that human needs can be arranged in a particular order from the lower to the higher as shown in below.
The need hierarchy is as follows:

Fig. Maslow’s Need Hierarchy

(a) Basic Physiological Needs: the needs that are taken as the starting point for motivation theory
are the so-called physiological needs. These needs relate to the survival and maintenance of
human life. They include such things a food, clothing, shelter, air, water and other necessities of
life.

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(b) Safety and Security Needs: After satisfying the physiological needs, people want the assurance
of maintain a given economic level. They want job security, personal bodily security, security of
source of income, provision for old age, insurance against risks, etc.

(c) Social Needs: Man is social being, He is, therefore, interested in conversation, sociability
exchange of feelings and grievances, companionship, recognition, belongingess, etc.

(d) Esteem and Status Needs: These needs embrace such things as self-confidence, independence,
achievement, competence, knowledge, and success. They are also known an egoistic needs. They
are concerned with prestige and status of the individual.

(e) Self-fulfilment Needs: The final step under the need priority model is the need for self-
fulfilment or the need to fulfil what a person considers to be his mission in life. It involves
realizing one’s potentialities for continued self-development and for being creative in the
broadest sense of the word. After his other needs are fulfilled, a man has the desire for personal
achievement. He wants to do something which is challenging and since this challenge gives him
enough dash and initiative to work, it is beneficial to him in particular and to the society in
general. These sense of achievement gives him psychological satisfaction.

Maslow proposed that the needs have a definite sequence of domination. Second need does not dominate
until first need is reasonably satisfied and third need does not dominate until first two needs have been
reasonably satisfied and so on. The other side of the need hierarchy is that man is wanting animal, he
continues to want something or the other. He is never fully satisfied. If one need is satisfied, the other
need arises. As said above (according to Maslow), needs arise in a certain order of preference and not
randomly. Thus, if one’s lower level needs (physiological and security needs) are unsatisfied, he can be
motivated only by satisfying his higher level needs. Another point to note is that once a need or a
certain order of needs is satisfied, it ceases to be a motivating force. Man lives for bread alone as long
as it is not available. In the absence of air one cannot live, it is plenty of air which ceases to be
motivating.

Factors For Entrepreneurial Motivation

A number of factors have been found to be responsible for the growth of entrepreneurship. These factors
can be grouped in three categories namely Entrepreneurial Ambitions, Competency Reasons and
Facilitating Factors.

(a) Entrepreneurial Ambition

(i) To make money
(ii) To gain social prestige
(iii) To secure self-employment or independent living

(b) Compelling Reasons

(i) Unemployment or dissatisfaction with existing job or occupation
(ii) To use technical or professional knowledge and skills
(iii) To put the idle funds of the entrepreneur to use

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(c) Facilitating Factors
(i) Previous knowledge, experience or association with same or similar of activity
(ii) Influence and encouragement by family member, friends and relatives
(iii) Imitation of successful entrepreneurs.

Internal And External Factors

R.A. Sharma has studied the factors that prompted new entrepreneurs to enter industry and has classified
them in two major categories: the factors that are internal to the entrepreneur and those external to the
entrepreneur. The internal factors make the personality of an entrepreneur and induce the person to
adopt entrepreneurship. Without the presence of internal factors entrepreneurial activity in a person
cannot start. However once the entrepreneurial tendencies germinate in a person, the external factors
start playing an important role in the person becoming an entrepreneur and starting his own business
venture.

Internal Factors
 Desire to work independently
 Occupational experience
 Technical/Trade/Qualification and knowledge

External Factors
 Supportive government policies
 Availability of financial assistance
 Ancillary support
 Availability of infrastructural facilities like industrial plot, electricity, technical facilities etc.

People become industrial entrepreneurs because of three main reasons:

1. Desire to do something independently in life.
2. Availability of technical/manufacturing or trade knowledge and skill with prospective entrepreneur.
3. Support from government and other agencies.

MANAGERIAL ROLE AND MANAGEMENT PROCESS IN SMALL BUSINESS

Introduction

Small business has its own distinctive features. The owner himself often acts as the chief executive and
looks after more than one functional area. Therefore, managerial strategies and practices used
successfully in large firms cannot be blindly applied to small scale units. Basic managerial functions in
the two types of business––large and small are the same. But the manner in which these functions should
be carried out can be different.

Managerial Responsibilities Of An Entrepreneur

The managerial responsibilities of an entrepreneur include the following:

(a) Management of self (entrepreneurial qualities and motivation)

(b) Management of enterprise.

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 Fig.: Managerial Responsibilities of an Entrepreneur

(a) Management of Self: The term ‘entrepreneur’ has been defined in various ways––a risk-taker,
a resources assembler, an organisation builder, an innovator, and so on. Truly speaking, an
entrepreneur is all combined into one. He introduces new ideas, carries on new activities,
coordinates the factors of production and decides how the business should be run. He has vision,
originality of thought and ability to take calculated risks.

Entrepreneurship refers to identifying and innovating ideas and services, mobilizing resources,
organizing production/services and finally marketing them with an effort to cover the risk and
constantly strive for growth and excellence. The person who performs all these functions is
called an entrepreneur. The term ‘entrepreneur’ may be used for individuals who incubate new
ideas, start enterprises based on those ideas and provide added value to society based on their
independent initiative. The entrepreneurs have a vision, commitment to constructive change,
persistence to gather necessary resources, and energy to achieve amazing results.

To perform the entrepreneurial role effectively, an entrepreneur has to be creative and

innovative. Innovation may pertain to new products or services, new methods of production,
adopting new sources of supply of raw material, adding new attributes to a product and
introducing new, multiple and optimum utilization of resources. It requires the use of
imagination and intuition for sensing opportunities.

It should also be noted that self-control self-determination and self-confidence are the
important attributes of successful entrepreneurs. They should feel that they can do the work
rather than being made to feel the same through outside forces. They should be capable of
moulding their destiny and destiny of their enterprise.

24
(b) Enterprise Management: There is a difference between operating an enterprise and managing
and enterprise which must be clearly understood by the entrepreneurs. Operating and enterprise
often involves buying or making goods and services, pricing, selling, and services. Although
different products/services require different operations, yet, these operational functions are
governed by common management principles. However, management is not the same as
operation. Operating is physical while managing is mental. For managing an enterprise
effectively, the first generation managers must learn to perform the basic management functions
of planning, organizing, staffing, directing and controlling.

An entrepreneurs must acquire management skills to manage his enterprise successfully.

Significance of Management:

(i) Determination of objectives or goals.

(ii) Efficient utilization of resources.
(iii) Sound organisation.
(iv) Integration of efforts and providing order to endeavours.
(v) Meeting challenges.
(vi) Nation’s growth and prosperity.

Planning Process

Planning is the process of deciding the objectives of business and choosing the most appropriate course
of action to achieve the objective. Planning is a rational process because logical reasoning is used in
setting objectives and in choosing course of action. Planning involves thinking and judgment and is,
therefore, called an intellectual process. Planning is a continuous process as changes in plans have to be
made from time to time to take care of changing environment. Planning is forward looking because
plans are prepared for a future period o time. Planning is a basic function as it lays the foundation for
other management functions.

Quite often a haphazard approach is adopted to planning in small firms. There is a misconception that
small firms are simple and do not require planning. The small scale entrepreneur does not want to
involve his staff in the planning process due to the desire to keep the secretes with himself. Personal
responsibility for results, lack of planning skills and absence of specialized staff are other major hurdles
to planning in small firms. Generally small scale units tend to take a short range view or problems and
seldom develop long range strategic plans.

Planning is very important for small business. It helps to focus attention on objectives, provides
direction to decision making, assists in facing uncertainty and change, improves efficiency of operations
and facilitates coordination and control.

Systematic planning in any business consists of the following steps:

25
(a) Mission Statement: First of all the basic mission or overall philosophy of the enterprise is
clearly defined. Mission statement should reflect the interest of the owners, customers,
employees and the society as a whole.

(b) Analysis of External Environment: Such analysis should cover economic conditions,
government policies and regulations, technological changes, political conditions and social
situation. It will reveal opportunities and threats which the firm is likely to face. Special attention
needs to be paid to market conditions and competitive situation.

(c) Analysis of Internal Environment: Situation audit is undertaken to judge the current position
of the firm in terms of market share, capacity utilization, sales turnover, profit margin, etc.
Appraisal of the firm’s resources (resource analysis) should be carried out to identify its
strengths and weaknesses. Physical facilities financial position, managerial capabilities,
marketing competence, etc. are covered in resource analysis. Financial and non-financial ratios
are often used to judge the resource position.

Analysis external and internal environment together is called SWOT (strengths, weaknesses,
opportunities and threats) analysis.

(d) Formulation of Objectives: On the basis of information collected through SWOT analysis, the
goals which the firm wants to achieve in future are decided. Goals should be challenging but
attainable. Goals should also reflect the mission of the firm. Goals are laid down both for short
period (next year) as well as long term (e.g. next five years).

(e) Development of Action Plans: Action plans refer to the future course of action to be adopted to
attain the objective. Action plans include the following:
(i) Priorities of different goals
(ii) Alternatives selected to exploit opportunities and to face threats in the environment
(iii) Timing of different courses of action
(iv) Action programmes for different functional areas of business.

Plans should be formalized in the form of working documents. Such formalization is necessary
for effective communication and implementation of plans.

(f) Execution and Review of Plans: Plans and action programmes are implemented. The plans are
reviewed on a continuous basis. Whenever necessary revision in the adopted plans and
programmes should be carried out. Such updating is essential to take care of changes in the
environment and capabilities of the enterprise.

Organising Process

Organising is an important function of management by which management brings together human and
material resources. This function must be performed when an activity involves two or more persons.
Organising involves determining the activities to be done, grouping the activities, assigning the grouped
activities to individuals, and creating a structure of authority and responsibility among the people to
achieve the objectives of the enterprise.

26
Urwick defined organizing as determining what activities are necessary to achieve and purpose and
arranging them in groups which may be necessary to assign to the individuals. The process of
organisation involves the determination of authority and responsibility relations in the organisation. An
important function of every manager is to determine the nature of the activities required to attain the
group goals, the grouping of these activities and the assignment of the activities to the individuals with
necessary delegation of authority.

The process of organisation involves the following steps:

(a) Determination of objectives;
(b) Identification and grouping of activities;
(c) Assignment of duties to individuals; and
(d) Development of relationships.

Types Of Organisation Structure

There are four main types of formal orgnaisation which are as follows:

(a) Line Organisation: In this form of organisation, a straight line command exists from the highest
to the lowest position. The authority and responsibility of every position is clearly defined. Each
subordinate is accountable to only one superior. But there is no specialization. Line organization
is considered to be most suitable for small scale units.

Chief Executive

Fig.: Line Organisation

(b) Line and Staff Organisation: As an enterprise grows management requires the services of staff
experts. These experts advise line managers but the final authority for taking decisions and issues
orders remains with true executives. Line and staff organisation provides the benefits of
specialization and unity of command. But there is danger of conflicts between line officers and
staff experts.

27
 Chief Executive

Fig.: Line & Staff Organisation

(c) Project Organisation: In this type of organisation, a separate team is created for every major
project. The team provides expert and focused efforts for timely completion of the project.

Fig.: Project Organisation

28
(d) Matrix Organisation: This structure is a combination of functional and project responsibilities.
In addition to the permanent functional departments, project team are created temporarily. The
staff for projects is largely deputed from functional department. On the completion of a project
the staff returns back to their respective departments. A small scale firm may adopt project
structure when several projects are carried out simultaneously and each project requires high
degree of coordination among several technical experts.

Fig.: Matrix Organisation

Principles of Sound Organisation:

(a) Division of Work: The work to be performed should be divided into meaningful tasks and one
employee should as far as possible concentrate on one type of work only.

(b) Unity of Command: Each employee should report and be accountable to only one superior.
Orders and instruction should come from a single boss.

(c) Parity Between Authority and Responsibility: The authority of every employee should be
commensurate with his responsibility. The authority and responsibility of every position should
be clearly specified in the form of job descriptions and organisation charts.

(d) Scalar Chain: The chain of command from the top position to the lowest position must be direct
and clear.

(e) Departmentalisation: Similar tasks should be grouped into the same department on an
appropriate basis.

(f) Balance Between Centralisation and Decentralisation: Proper delegation of authority should
be made to ensure that there is the right degree of decentralisation.

(g) Appropriate Span: Span of control means the number of subordinates reporting directly to one
superior. The span should be appropriate in view of the nature of work, ability of the superior,
competence of subordinates, degree of coordination required, etc. Generally, small enterprises
prefer a wide span as they cannot afford the cost of additional layers in the organisation.

29
(h) Human Use of Human Resources: The requirements of work should integrated with the
capabilities and aspirations of employees.

(i) Flexibility: The organisation structure should be able to adapt to changes in the internal and
external environment.

Staffing

After organizing the various activities to be performed, management is in a position to know the
manpower requirements of the enterprise at different levels in the organisation structure. After
determining the number and types of personnel to be selected to fill different jobs, management
proceeds with recruiting, selecting and training the people to fulfil the requirements of the enterprise. In
a running enterprise, staffing is a continuous process because new jobs are created in the enterprise and
existing employees leave the enterprise.

Staffing comprises of those activities which are essential to keep manned the positions created by the
organisation structure. It includes the task of determining positions created by the organisation structure.
In includes the tasks of determining the requirements with regard to number and types of people for the
jobs to be done, laying down qualifications for various jobs and recruiting, selecting and training people
to perform those jobs efficiently.

Staffing is concerned with both manages and non-managers. It is a function performed by managers at
all levels. Earlier, staffing was considered a part of organising. But with the recognition of the
importance of the human factor in industry and business, it began to be considered as a separate
function. Staffi9ng usually includes the following activities:
(i) Human resource planning.
(ii) Deciding sources of recruitment.
(iii) Receiving applications.
(iv) Testing and interviewing.
(v) Final selection and appointment letter.
(vi) Orientation and placement.
(vii) Training and development.

Directing

Direction is the process of guiding, supervising, leading and motivating the subordinates to work in a
way that is beneficial to the enterprise. The manager not only shows the right path but also leads the
subordinates to achieve the objectives of the enterprise. He creates a sense of belongingness, faith and
loyalty among the subordinates.

The direction function involves the following four elements:

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(a) Leadership: Leadership is the process by which a manager guides and influences the work of
others in choosing and attaining specified goals. According to Chester Barnard, leadership is the
quality of the behaviour of the individuals whereby they guide people towards the
accomplishment of some common goal.

(b) Communication: A manager has to tell the workers what they are required to do, how to do and
when to do it. It has to create an understanding in the minds of the subordinates of work to be
done. This is done by the process of communication.

(c) Motivation: It is the function of a manager to motivate the people working under him to perform
the work assigned. A successful manager has to make proper use of motivation to enthuse the
people to work harmoniously for the attainment of desired objectives.

(d) Supervision: Supervision is the process by which conformity between planned and actual results
is maintained. Effective supervision ensures greater output of high quality. It teaches the
subordinates the way their tasks are to be performed.

Controlling

According to Fayol, “In an undertaking, control consists of verifying whether everything occurs in
conformity with the plan adopted, the instructions issued and the principles established.” Controlling is
that management activity whereby the managers compare actual performance against the planned one,
find out the deviations, take corrective action to remove the deviations, incorporate positive deviations
in the plans and help ensure the realization of the specific goals.

In a running concern, planning and control go together because planning seeks to set consistent,
integrated and articulated goals or programmes, while control seeks to compel events conform to plans.
The most notable feature of the process of control is that it is forward-looking. A manager cannot
control the past but can avoid the problems in future by taking actions in the light of past experiences.
The control process consists of the following steps:
(i) Setting up of standards
(ii) Measuring performance.
(iii) Comparing performance with standards.
(iv) Taking corrective action.

Decision-Making

Decision-making is a process of selection from a set of alternative courses of action which is

thought to fulfil the objectives of the decision problem more satisfactorily than other. A decision a
course of action which is consciously chosen for achieving a desired result. It is something that takes
place prior to the actual performance of a course of action that has been chosen. To state this in terms of
managerial decision-making, it is an act of choice wherein a manager selects a particular course of
action from the available alternatives in a given situation. Managerial decision-making involves the
entire process of establishing goals, defining tasks, searching for alternatives and developing plans in
order to find the best answer to the decision problem.

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Characteristics of Decision-Making

The basic characteristics of decision-making are enumerated below:

(a) It is a process of choosing a course of action from among the alternative courses of action.
(b) It is a human process involving to a great extent the application of intellectual abilities.
(c) It is the end process preceded by deliberation and reasoning.
(d) It is always related to the environment. A manager may take one decision in a particular set of
circumstances and another in a different set of circumstances.
(e) It involves a time dimension and a time lag.
(f) It always has a purpose. Keeping this in view, there may just be a decision not to decide.
(g) It involves all actions like defining the problem and probing and analyzing the various
alternatives which take place before a final choice is made.

Significance of Decision-making

No business can survive without effective decision-making. Decision-making is an essential part of

every function of management. In the words of Peter F. Drucker, “Whatever a manager does, he does
through decision-making.” Decision-making lies deeply embedded in the process of management.
Decision-making spreads over all the managerial functions and covers all the areas of the enterprise.
Management and decision-making are bound up and go side by side. Whether knowingly or
unknowingly, every manager makes decisions constantly.

Decision-making and planning are deeply interlinked. The determination of objectives, policies,
programmes, strategies, etc. involves decision-making. The managers also take decisions on the
organizational design, staffing, directing and leading the employees in work situations and on regulating
performance in tune with pre-determined standards. In other words, all managerial functions are
preceded by certain managerial decisions.

The most outstanding quality of a successful entrepreneur is his ability to make sound decisions. A
manager has to make up his mind quickly on certain matters. It is not correct to say that he has to make
spur of the moment decisions all the time. While taking many decisions, he gets enough time for careful
fact finding, analysis of alternatives and choice of the best alternative. Decision-making is a human
process. When a manager decides, he chooses a course which he thinks is the best.

Steps in Decision-making

(i) Defining the problem.

(ii) Analysing the problem.
(iii) Collection of data.
(iv) Developing alternatives.
(v) Review of key factors.
(vi) Selecting the best alternative.
(vii) Implementing the decision.
(viii) Follow up.

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 Fig.: Decision-making

Management Of Time

Time is a very valuable resource especially for a small scale entrepreneur who is often burdened with
multiple roles in his business. The entrepreneur can achieve considerable improvements in his firm’s
performance through more efficient us of time. Management of time involves the following steps:

(a) Time Use Analysis: First of all a systematic analysis is made to find out the proportion of total
time spent by the employer and his staff on different activities.

(b) Setting Priorities: Critical or vital activities should receive greater time. Activities taking more
than the justified time need to be identified. Irrelevant or time wasting activities should be
eliminated.

(c) Time Allocation: A work-cum-time schedule should be prepared. Proper time should be
allocated to each activity. The tasks one wants to do but for which he does not have time should
be noted.

(d) Adhere to Time Schedule: The most difficult part of time management is to complete each
activity within the prescribed time period. For this purposes, it is necessary to delegate tasks to
subordinates, to organize every workday and to continuously evaluate the time management
system.

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 LESSON 3
PLANT LOCATION AND LAYOUT
Vipin Kumar
Plant Location

Location of an enterprise is an important entrepreneurial decision as it affects the operational as well as

financial performance. So entrepreneur is required to identify that location at which the enterprise will
have easy access to physical, economic and social endowments. The general objective in selecting a
location is to minimize total cost of production and distribution. The selected location should be in a
position to help in generating maximum revenue and provide an opportunity for further growth and
expansion. An entrepreneur is expected to evaluate his targets in terms of time and cost variable and try
to select a proper location and seek possession of the site before the zero date. Generally, financial
institutions are also interested to inspect the location or site of the plant before sanctioning any loan to
the enterprise concerned. Efforts should also be made by the entrepreneur to remove all uncertainties
associated with the site before the zero date. Entrepreneur should also know that any change in location
or site at a later date not only targets will be missed but even the viability of the project may also be lost.
Thus, ideal location site helps in smooth and efficient functioning of an enterprise. It ensures a reduction
in costs as well as improves productivity and financial viability of the enterprise.

Need for Enterprise Location

The need for location or site is generally government by the following circumstances:

(i) To promote the establishment of a new enterprise.

(ii) To undertake expansion, decentralisation and diversification necessary for meeting
(iii) To manage the situations arising due to non-renewal of existing lease of an establishment
demand of products.
(iv) To develop new location if existing location has been declared as undesirable or unsuitable.
(v) To arrange a new location by shifting from existing location due to change in market pattern,
depletion of raw materials, change in production processes and transport facilities, etc.
(vi) To open new branch or production facility at new places for increasing the volume of production
and distribution activities.

Importance of Enterprise Location

Selection of plant location or site is quite important due to the following reasons:

(i) It enables the enterprise to operate smoothly, efficiently and with the minimum cost.
(ii) It controls wastages in efforts and talents at the entrepreneurs.
(iii) It reduces uncertainty in results.
(iv) It encourages effective mobilization of raw-materials, labour and potential customers.
(v) it develops the area by attracting other potential entrepreneurs and endowments like physical,
economic and social variables.

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Steps in Enterprise Location

Following steps are important in selecting a particular location or site for the plant:
(i) Selection of the region.
(ii) Selection of the locality or community.
(iii) Selection of the exact site and
(iv) Selection of an optimum site.

Generally, entrepreneur is free to select and location or site for the plant development. However,
regulatory provisions of the government also affect the choice of plant location or site.

Location, Localisation and Planned Location of Industries

Location is concerned with a particular site where entrepreneur is interested to establish his enterprise or
plant having lowest cost objective. If a particular industry is concentrated mainly in one areas is called
as localisation of industries. For example, Kolkata and Mumbai are known for jute and textiles industry
respectively. Planned location of industries is a systematic approach by which location of industries is
planned to give each region or area or place a variety of industries to promote dispersal of industries. For
example, in Ludhiana, different types of industries have been developed and no particular industry is
concentrated in that particular area.

Factors Influencing the selection of the Location of an Enterprise or Plant or Project

Following are the important factors which are normally to be considered when selecting the location of
an enterprise or project:

(a) Availability of Land: Land should be large enough to meet out present requirement with
provision for further expansion. Land should be for industrial use (land usage pattern to be
adhered to) and proper layout of plant and equipment must be possible as per the technical
feasibility study. Drainage level of land, soil testing report (should be suitable for the
construction of the factory) should be favourable to the project requirements.

(b) Availability of Raw Materials: Availability of required quantity and quality of raw materials at
a reasonable cost. Cost of materials generally constitutes a major chunk of total cost of
production and thus, the impact of raw materials on location depends upon their nature and the
source of their deposits.

(c) Supply of Manpower: Every enterprise requires an adequate supply of manpower with
appropriate skills. Availability of skilled manpower, cost of labour, labour expectations, local
culture affect the supply of manpower to the enterprise. Sometimes, it becomes difficult to obtain
high skilled people to work at very remote places with big town facilities. Alfred Weber rightly
remarked that that “an industrial site will deviate from the point of minimum transportation cost
to the cheaper labour centre if the additional cost of transportation at the new centre is more than
compensated by the savings in labour cost.” However, this situation has been changed. Labour is
mobile and there is a level of minimum wages fixed by the Government from time to time.
Moreover certain industries are capital intensive and they require less labour.

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(d) Transport and Communication Facilities: Transport services are required for assembling of
materials and distribution of products. At the time of selection of a particular efforts should be
made to ensure that transportation facilities are easily available at reasonable rates. Site should
be well connected by road and rail or nearer to national highways, major railway yard etc.,
Transportation of equipment, material, product and personnel is an important requirement and it
should be ensured in time and in efficient manner.

(e) Proximity to the Market: Availability of consumer market also affects the viability of the
enterprise. An entrepreneur can improve his customer relations if they are available in nearby
areas and easily render rapid services to them. Enterprises engaged in the production of
perishable commodities and those producing for a local market are also interested to develop
their plants in potential consumer’s area as it would ensure a reduction in transportation cost
involved in distributing the finished products. Actually, an enterprise tends to disperse only if
they find a new consumer market.

(f) Water, Power and Fuel: Uninterrupted operations of an enterprise is the result of sufficient
supply of water, power and fuel etc. In this context, efforts are required to assess local sources of
water. Besides, required water supply to be assessed in terms of water conditions or sub-soil
water etc. Availability of power in the region is to be evaluated in terms of actual requirements.
Some industries consume lot power (aluminium) or water (Paper industry) and these variables
are a very important factor for them. Nowadays, industries are facing the problem of power
shortages and they are shifting to the fuel option––coal. For example, coal is the major source of
fuel for the iron and steel industry and these industries are located near the coal mines.

(g) Regional Development: In our country, government is pursuing the policy of balanced regional
development to solve the problems like slum, disparity of income and wealth and optimum use
of resources. In order to ensure balanced regional development, government has declared certain
areas as backward areas and zero industry areas. Government gives certain benefits like tax
benefits but it is necessary to evaluate the process to what extent they would outweigh the
disadvantages.

(h) External Economies: In some cases, an enterprise prefers to be located in those centres where
other industrial units are already located. There are certain facilities like transportation,
warehousing, banking, insurance, communication and factoring services etc. which are easily
available and industrial units tend to be concentrated in these areas. Besides, raw materials are
also available at cheaper prices and in large quantity. For example, by product of one enterprise
may be used as raw material by another enterprise. Enterprises working as distilleries are
generally located in nearby areas of Sugar mills because they supply molasses as raw materials
to distilleries.

(i) Personal Factors: Personal preferences and prejudices of an entrepreneur also effect the
selection of location. Entrepreneurial preferences are also affected by law and order, political
stability and safety etc. Thus, entrepreneurs prefer to locate their enterprises in those areas which
are safe and free from law and order problems.

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(j) Local Laws and Regulations: In certain cases local laws and regulations impose restrictions on
the development of industrial units in special areas. For example, consent of various agencies
like local Panchayat, municipality, government, state planning bodies is mandatory for the
entrepreneurs otherwise they cannot run their enterprises in municipal or local areas. Similarly,
high rate of income-tax, sale-tax, octroi, etc. discourage entrepreneur to develop their plant in a
particular area or state. But facility of tax holidays encourages them otherwise to develop their
units in a particular area or state.

(k) Ecological and Environmental Factors: Certain industrial units are required to be governed by
the ecological and environmental provisions of Pollution Control Act. Industrial units are
required to follow the norms of Pollution Control Board. They have to make efforts for the
disposal of effluents are directed by the pollution control authorities. They have to arrange the
nearest source where effluent (after treatment) could be discharged.

Government Locational Policy

Industrial location has received closer attention of the government and policy planners in recent times.
Actually, location policy is an extension of the policy of development backward areas and industrial
disposal. It deals with negative aspect and positive thrust. The negative aspect is concerned with
preventive measures for developing new units in the already advanced areas and urban, metropolitan
centres with the dictates of then government from time to time. But positive thrust deals with
instruments like concessional finance, investment tax incentives subsidies etc. which are being used by
the government to develop new units in backward and zero industries districts of different states. With
the help of positive strategy, government is trying to ensure effective dispersal of industrial units to
backward areas. The government has already formulated a policy that “The new unit should not be
located within the standard urban area limit of a large metropolitan city having a population of more
than prescribed limit determined by government.

The location of industrial units is further regulated by the local zoning and land-use regulations as also
the environmental regulations. Hence, even if the requirement of the locational policy as stated above is
fulfilled, but the local zoning and land-use regulations of a State government, or the regulations of the
Ministry of Environment do not permit setting up of an industry at a location, then the entrepreneur
would be required to abide by that decision.

Thus, selection of location of an enterprise is an important decision and entrepreneur should try to assess
the implication of the above factors. These factors affect the survival and viability of the enterprise in
the long run.

One study of locational considerations from small-scale units revealed that the native place or
homelands (personal factor) of the entrepreneur was the most important factor. Heavy preference to
homeland suggests that small-scale enterprise is not freely mobile. Low preference for Government
incentives suggests that concessions and incentives cannot compensate for poor infrastructure.

Table given below also suggests that the locational choice undergo change with differences in the levels
of development across the regions (hills and plains).

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 Table: Factors Affecting Location Decision

Entrepreneur’s Response
Considerations Hills Plains Total
No. % No. % No. %
Homeland 15 67 11 39 26 52
Government
3 14 1 4 4 8
Incentives
Availability of
0 0 1 4 1 2
Raw material
Availability of
2 9 0 0 2 4
labour
Availability of
0 0 5 18 5 10
market
Availability of
infrastructure 1 5 9 32 10 20
facilities
Others 1 5 1 4 2 4
Total 22 100 28 100 50 100

Layout

Layout involves determining the space requirement for the facilities and arranging them in a manner to
ensure steady flow of operations with minimum overall cost. In order words, a layout is a floor plan for
arranging the desired facilities, machinery, equipment in an optimum locations so as to permit the
quickest flow of materials and manpower at the lowest cost and with the least amount of in process
handling from receipt of raw material to shipment of finished products.

Since, a layout once made cannot be changed/modified easily and without incurring considerable cost on
one hand and disrupting the operations on the other hand, layout decisions are strategic decisions.
Hence, layout has to be considered at the time of planning a new venture. A good layout should result in
comfort, convenience, better appearance, safety, efficiency and profits. A poorly planned layout causes
congestion, disruption in flow of man and/or materials, accidents, delays, rejections leading to
frustration and inefficiency. In a production unit layout includes factory design, that is layout of
workshop, raw material stock yards, finished goods stores, generator, compressor room etc. In hospitals
it involves fixing the location of wards, operation theater, out-patient departments, canteen, doctors and
nurses duty rooms etc. At another level layout planning involves layout of different machines, work
stations etc., in the shop floor and patient’s beds, drug store, doctors and nurses seats and other facilities
in a hospital ward.

Considerations of Plant Layout

 Maximum use of the available space.

 Compatibility with the production technology and product mix.
 Minimum movement of materials as well as men.
 Provision of proper space for maintenance.

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 Arrangement of proper in-transit storage and stacking space.
 Promotes effective supervision.
 Proper lighting and ventilation.
 Provision of maximum flexibility.
 Safety of operators and other staff.
 Minimum handling of materials.
 Provision for future expansion.
 Security against fire, theft, detoriation etc.
 Maximum flexibility to accommodate changes in production volume and product mix.
 Should meet the specific requirement of the production process viz., air conditioning, air cooling,
dust control, humidity control and may be required.

Advantages of Proper Plant Layout

1. Increase in Productivity
2. Maximum utilization of Space
3. Effective Supervision and Control
4. Economy in Material
5. Improved Safety and Handling
6. Improved Working Environment and Morale
7. Better Quality Control.

Types Of Layout

As discussed so far the plant layout facilitates the arrangement of machines, equipment and other
physical facilities in a planned manner within the factory premises. An entrepreneur must possess an
expertise to lay down a proper layout for new or existing plants. It differs from plant to plant, from
location to location and from industry to industry. But the basic principles governing plant layout are
more or less same.

As far as small business is concerned, it requires a smaller area of space and can be located in any kind
of building as long as the space is available and it is convenient. Plant layout for Small Scale business is
closely linked with the factory building and built up area.

From the point of view of plant layout, we can classify small business or unit into three categories:

I. Manufacturing units
II. Traders
III. Service Establishments

I. Manufacturing Units

In case of manufacturing unit, plant layout may be of four types:

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(a) Product or line layout
(b) Process or functional layout
(c) Fixed position or location layout
(d) Combined or group layout

(a) Product or Line Layout:

Under this, machines and equipments are arranged in one line depending upon the sequence of
operations required for the product. The materials move from one workstation to another sequentially
without any backtracking or deviation. Under this, machines are grouped in one sequence. Therefore
materials are fed into the first machine and finished goods travel automatically from machine to
machine, the output of one machine becoming input of the next, e.g. in a paper mill, bamboos are fed
into the machine at one end and paper comes out at the other end. The raw material moves very fast
from one workstation to other stations with a minimum work in progress storage and material handling.

The grouping of machines should be done keeping in mind the following general principles.

(i) All the machine tools or other items of equipments must be placed at the point demanded by the
sequence of operations.
(ii) There should no points where one line crossed another line.
(iii) Materials may be fed where they are required for assembly but not necessarily at one point.
(iv) All the operations including assembly, testing packing must be included in the line.

A line layout for two products is given below;

Advantages: Product layout provides the following benefits:

(i) Low cost of material handling, due to straight and short route and absence of backtracking.
(ii) Smooth and uninterrupted operations.
(iii) Continuous flow of work.
(iv) Lesser investment in inventory and work in progress.
(v) Optimum use of floor space.
(vi) Shorter processing time or quicker output.
(vii) Less congestion of work in the process.
(viii) Simple and effective inspection of work and simplified production control.
(ix) Lower cost of manufacturing per unit.

40
Disadvantages: Product layout suffers from following drawbacks:

(i) High initial capital investment in special purpose machine.

(ii) Heavy overhead charges.
(iii) Breakdown of one machine will hamper the whole production process.
(iv) Lesser flexibility as specially laid out for particular product.

Suitability: Product layout is useful under following conditions:

(i) Mass production of standardized products.

(ii) Simple and repetitive manufacturing process.
(iii) Operation time for different process is more or less equal.
(iv) Reasonably stable demand for the product.
(v) Continuous supply of materials.

Therefore, the manufacturing units involving continuous manufacturing process, producing few
standardized products continuously on the firm’s own specifications and in anticipation of sales would
prefer product layout e.g. chemicals, sugar, paper, rubber, refineries, cement, automobiles, food
processing and electronics etc.

(b) Process Layout:

In this type of layout machines of a similar type are arranged together at one place. E.g. machines
performing drilling operations are arranged in the drilling department, machines performing casting
operations be grouped in the casting department. Therefore the machines are installed in the plants,
which follows the process layout.

Hence, such layouts typically have drilling departments, milling department, welding department,
heating department and painting department etc. the process or functional layout is followed from
historical period. It evolved from the handicraft method of production. The work has to be allocated to
each department in such a way that no machines are chosen to do as many different job as possible i.e.
the emphasis is on general purpose machine.

The work, which has to be done, is allocated to the machines according to loading schedules with the
object of ensuring that each machine is fully loaded. Process layout is shown in the following diagram.

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Process layout showing movement of two products:

The grouping of machines according to the process has to be done keeping in mind the following
principles.

(i) The distance between departments should be as short as possible for avoiding long
distance movement of material.
(ii) The departments should be in sequence of operations
(iii) The arrangement should be convenient for inspection and supervision.

Advantages: Process layout provides the following benefits:

(i) Lower initial capital investment in machines and equipments. There is high degree of machine
utilization, as a machine is not blocked for a single product.
(ii) The overhead costs are relatively low.
(iii) Change in output design and volume can be more easily adapted to the output of variety of
products.
(iv) Breakdown of one machine does not result in complete work stoppage.
(v) Supervision can be more effective and specialised.
(vi) There is a greater flexibility of scope for expansion.

Disadvantages: Process layout suffers from following drawbacks:

(i) Material handling costs are high due to backtracking.

(ii) More skilled labour is required resulting in higher cost.
(iii) Time gap or lag in production is higher.
(iv) Work in progress inventory is high needing greater storage space.
(v) More frequent inspection is needed which results in costly supervision.

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Suitability: Process layout is adopted when

(i) Products are not standardized.

(ii) Quantity produced is small.
(iii) There are frequent changes in design and style of product.
(iv) Job shop type of work is done.
(v) Machines are very expensive.

Thus, process layout or functional layout is suitable for job order production involving non-repetitive
processes and customer specifications and non-standardised products, e.g. tailoring, light and heavy
engineering products, made to order furniture industries, jewelry.

(c) Fixed Position or Location Layout:

In this type of layout, the major product being produced is fixed at one location. Equipment labour and
components are moved to that location. All facilities are brought and arranged around one work center.
This type of layout is not relevant for small scale entrepreneur. The following figure shows a fixed
position layout regarding shipbuilding.

Advantages: Fixed position layout provides the following benefits:

(i) It saves time and cost involved on the movement of work from one workstation to
another.
(ii) The layout is flexible as change in job design and operation sequence can be easily
incorporated.
(iii) It is more economical when several orders in different stages of progress are being
executed simultaneously.
(iv) Adjustments can be made to meet shortage of materials of absence of workers by changing the
sequence of operations.

Disadvantages: Fixed position layout has the following drawbacks:

(i) Production period being very long, capital investment is very heavy.
(ii) Very large space is required for storage of material and equipment near the product.
(iii) As several operations are often carried out simultaneously, there is possibility of confusion and
conflicts among different workgroups.

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Suitability: The fixed position layout is followed in following conditions:

(i) Manufacture of bulky and heavy products such as locomotives, ships, boilers, generators, wagon
building, aircraft manufacturing, etc.
(ii) Construction of building, flyovers, dams.
(iii) Hospital, the medicines, doctors and nurses are taken to the patient (product).

(d) Combined Layout:

Certain manufacturing units may require all three processes namely intermittent process (job shops), the
continuous process (mass production shops) and the representative process combined process [i.e.
miscellaneous shops].

In most of industries, only a product layout or process layout or fixed location layout does not exist.
Thus, in manufacturing concerns where several products are produced in repeated numbers with no
likelihood of continuous production, combined layout is followed. Generally, a combination of the
product and process layout or other combination are found, in practice, e.g. for industries involving the
fabrication of parts and assembly, fabrication tends to employ the process layout, while the assembly
areas often employ the product layout. In soap, manufacturing plant, the machinery manufacturing soap
is arrange don the product line principle, but ancillary services such as heating, the manufacturing of
glycerin, the power house, the water treatment plant etc. are arranged on a functional basis.

II. Traders

When two outlets carry almost same merchandise, customers usually buy in the one that is more
appealing to them. Thus, customers are attracted and kept by good layout i.e. good lighting, attractive
colours, good ventilation, air conditioning, modern design and arrangement and even music. All of these
things mean customer convenience appeal and greater business volume.

The customer is always impressed by service, efficiency and quality. Hence, the layout is essential for
handling merchandise, which is arranged as per the space available and the type and magnitude of goods
to be sold keeping in mind the convenience of customers.

There are three kinds of layouts in retail operations today.

(a) Self service or modified self service layout.

(b) Full service layout.
(c) Special layouts.

The self-service layouts, cuts down on sales clerk’s time and allow customers to select merchandise for
themselves. Customers should be led through the store in a way that will expose them to as much
display area as possible, e.g. Grocery Stores or department stores. In those stores, necessities or
convenience goods should be placed at the rear of the store. The use of colour and lighting is very
important to direct attention to interior displays and to make the most of the stores layout.

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All operations are not self-service. Certain specialty enterprises sell to fewer number of customers or
higher priced product, e.g. Apparel, office machines, sporting goods, fashion items, hardware, good
quality shoes, jewelry, luggage and accessories, furniture and appliances are all examples of products
that require time and personal attention to be sold. These full service layouts provide area and equipment
necessary in such cases.

Some layouts depend strictly on the type of special store to be set up, e.g. TV repair shop, soft ice cream
store, and drive-in soft drink stores are all examples of business requiring special design. Thus, good
retail layout should be the one, which saves rent, time and labour.

3. Services Centers and Establishment

Services establishments such as motels, hotels, restaurants, must give due attention to client
convenience, quality of service, efficiency in delivering services and pleasing office ambience. In
today’s environment, the clients look for ease in approaching different departments of a service
organisation and hence the layout should be designed in a fashion, which allows clients quick and
convenient access to the facilities offered by a service establishment.

Applicability Of Plant Layout

Plant layout is applicable to all types of industries or plants. Certain plants require special arrangements
which, when incorporated make the layout look distinct from the types already discussed above.
Applicability of plant layout in manufacturing and service industries is discussed below.

In case of the manufacturing of ‘detergent powder’, a multi-storey building is specially constructed to

house the boiler. Materials are stored and poured into the boiler at different stages on different floors.
Other facilities are also provided around the boiler at different stations.

Another applicability of this layout is the manufacture of ‘talcum powder’. Here machinery is arranged
vertically i.e. from top to bottom. Thus, material is poured into the first machine at the top and powder
comes out at the bottom of the machinery located on the ground floor.

Yet another applicability of this layout is the ‘newspaper plant’, where the time element is of supreme
importance, the accomplishment being gapped in seconds. Here plant layout must be simple and direct
so as to eliminate distance, delay and confusion. There must be a perfect coordination of all departments
and machinery or equipments, as materials must never fail.

Plant layout is also applicable to ‘five star hotels’ as well. Here lodging, bar, restaurant, kitchen, stores,
swimming pool, laundry, shaving saloons, shopping arcades, conference hall, parking areas etc. should
all find an appropriate place in the layout. Here importance must be given to cleanliness, elegant
appearance, convenience and compact looks, which attract customers.

Similarly plant layout is applicable to a ‘cinema hall’, where emphasis is on comfort, and convenience
of the cinemagoers. The projector, screen, sound box, fire-fighting equipment, ambience etc. should be
of utmost importance.

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A plant layout applies besides the grouping of machinery, to an arrangement for other facilities as well.
Such facilities include receiving and dispatching points, inspection facilities, employee facilities, storage
etc.

Generally, the receiving and the dispatching departments should be at eight end of the plant. The
storeroom should be located close to the production, receiving and dispatching centers in order to
minimize handling costs. The inspection should be right next to other dispatch department as inspections
are done finally, before dispatch.

The maintenance department consisting of lighting, safety devices, fire protection, collection and
disposal of garbage, scrap etc. should be located in a place which is easily accessible to all the other
departments in the plant. The other employee facilities like toilet facilities, drinking water facilities, first
aid room, cafeteria etc. can be a little away from other departments but should be within easy reach of
the employees. Hence, there are the other industries or plants to which plant layout is applicable.

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 LESSON 4
OPERATIONS PRODUCTION PLANNING AND CONTROL
Vipin Kumar
Introduction

Production and operations management play a crucial role in the success of small enterprises.

It helps the enterprise to produce quality and standardized and medium products at minimum cost. The
management process also helps in time management and scheduling of production and it control.

Production is the basic activity of all industrial units. All other activities revolve around this activity.
The end-product of the production activity is the creation of goods and services for the satisfaction of
human wants. The production activity is nothing but the step-by-step conversion of one form of
materials into another, either chemically or mechanically. This is done in factories which house
manufacturing processes. The basic inputs of the production processes are men, machines, plant,
services and methods. The products of the mine, farm, sea and forest are used as raw materials on which
the processing id done to create not always furnish a ready-made product for the ultimate consumption.
In a chain of manufacturing activities, the finished product of the processor sometimes becomes the raw
material (or component) for the other manufacturing firms falling next in the sequence.

“Production” involves the step-by-step conversion of one form of materials into another through
chemical or mechanical processing to create or enhance the utility of the products or services. According
to economists, production is an activity through which the form utility is either created or enhanced; e.g.,
a piece of wood has no doubt, some utility. However, when it is converted into a chair with some
mechanical processing, the utility of the material (i.e., a piece of wood) would enhance substantially.
According to E.S. Buffa, “production is process by which goods and services are created.

These days therefore both manufacturing and service organizations fall into the scope of production
management. Thus, production management which was formerly considered as manufacturing
management only, now after inclusion of services into its scope, is broadly known as operations
management. Many non-manufacturing organizations providing services like hospitals, banks,
transportation, farming, warehousing etc., are now covered by operations management.

Operations by formal definition is a process of changing inputs into outputs, with creation or adding of
value to some entity. The process of alteration or transportation of storage or inspection or any
combination thereof to add value to an entity is rightly called operations.

Operations in the services organizations has some unique features, different from those which has
manufacturing base. These are:
(i) Non-inventoriable output of service, since generally no stock is produced.
(ii) Variable demand.
(iii) Labour-intensive operations mostly.
(iv) Location of service is dictated by the location of the users.

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Objective Of Production Management

Production is an organized activity in a manufacturing organisation. Each organized activity must spell
out its objectives so that its existence can be justified on the basis of the degree of the attainment of
these objectives. Moreover, such identification of the objectives increases the consciousness of the
personnel working in the respective organistions in checking their efforts by verifying whether they are
in conformity with the stated objective of the organisation. The objectives of the production function are
classified as under: (I) Ultimate objectives, and (II) Intermediate objectives.

(I) Primary Objectives: The primary responsibility of the manufacturing activity is to produce a
product or products at (a) pre-established cost, (b) according to the specified quality, and (c)
within the stipulated time schedule.

(II) Secondary Objectives: Production is the result of various types of inputs, like men, materials,
machines and manufacturing services. The secondary objectives strive to attain the optimum
utilization of these various types of inputs. It should be noted that the output resulting out of the
inputs is measured in terms of the cost, quality and time which relate to the prescription of
aforesaid primary objectives.

Production Management

Production system is a system whose function is to convert a set of inputs into a set of desired outputs.
Production system is depicted under with help of chart.

Fig.: Production System

Production management involves the managerial decisions regarding design of the product and design of
the production system i.e. determination of production processes and production planning and control.

Production Design

In the development of the product, the design stage is the most crucial. Detailed specifications are listed
for a product at this stage. These specifications ultimately results in product quality. The product’s
design is translated in quantitative terms here. Compiling specification is not an easy task. It requires a

48
great deal of time. The profitability and competitiveness of the product depend upon its design which in
turn depends upon specifications. And so specifications should be carefully developed. Properly
formulated specification have the potential of controlling costs at the design stage. The task of setting
specifications is done in the face of sometimes conflicting views of different departments like sales,
engineering and production. We cannot over-specify as well as under specify. We have also to ensure
smoothness of the production line. Specifications are therefore clear and explicit, and preferably written.
Generally, specifications are prepared by a multidimensional committee (consisting of the design
engineers, the purchase officer, the marketing executive, the quality control executive etc.). Only after
the approval of the committee, the design in finalised. In case of most widely used and highly
competitive products, standard specifications are available.

Fig.: Product Design Process

Product development process is a continuous activity in an organisation.

Steps Of Production Planning And Control

Production Planning and Control (PPC) is a process that comprises the performance of some critical;
functions on either side, viz., planning as well as control.

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 Fig.: PPC Process

Production planning: Production planning may be defined as the technique of foreseeing every step in
a long series of separate operations, each step to be taken at the right time and in the right place and each
operations to be performed in maximum efficiency. It helps entrepreneur to work out the quantity of
material manpower, machine and money requires for producing predetermined level of output in given
period of time.

Routing: Under this, the operations, their path and sequence are established. To perform these
operations the proper class of machines and personnel required are also worked out. The main aim of
routing is to determine the best and cheapest sequence of operations and to ensure that this sequence is
strictly followed. In small enterprises, this job is usually done by entrepreneur himself in a rather adhoc
manner. Routing procedure involves following different activities.

(i) An analysis of the article to determine what to make and what to buy.
(ii) To determine the quality and type of material.
(iii) Determining the manufacturing operations and their sequence.
(iv) A determination of lot sizes.
(v) Determination of scrap factors.
(vi) An analysis of cost of the article.
(vii) Organisation of production control forms.

Scheduling: It means working out of time that should be required to perform each operation and also
the time necessary to perform the entire series as route, making allowances for all factors concerned. It

50
mainly concerns with time element and priorities of a job. The pattern of scheduling differs from one job
to another which is explained as below:

Production Schedule: The main aim is to schedule that amount of work which can easily be handled by
plant and equipment without interference. It’s not independent decision as it takes into account
following factors.

(i) Physical plant facilities of the type required to process the material being scheduled.
(ii) Personnel who possess the desired skills and experience to operate the equipment and perform
the type of work involved.
(iii) Necessary materials and purchased parts.

Master Schedule: Scheduling usually starts with preparation of master schedule which is weekly or
monthly break-down of the production requirement for each product for a definite time period, by
having this as a running record of total production requirements the entrepreneur is in better position to
shift the production from one product to another as per the changed production requirements. This forms
a base for all subsequent scheduling acclivities. A master schedule is followed by operator schedule
which fixes total time required to do a piece of work with a given machine or which shows the time
required to do each detailed operation of a given job with a given machine or process.

Manufacturing Schedule: it is prepared on the basis of type of manufacturing process involved. It is

very useful where single or few products are manufactured repeatedly at regular intervals. Thus it would
show the required quality of each product and sequence in which the same to be operated.

Scheduling of Job Order Manufacturing: Scheduling acquires greater importance in job order
manufacturing. This will enable the speedy execution of job at each center point.

As far as small scale industry is concerned scheduling is of utmost importance as it brings out efficiency
in the operations and reduces cost price. The small entrepreneur should maintain four types of schedules
to have a close scrutiny of all stages namely an enquiry schedule, a production schedule, a shop schedule
and an arrears schedule out of above four, a shop schedule is the most important most suited to the needs
of small scale industry as it enables a foreman to see at a glance.

(i) The total load on any section.

(ii) t/he operational sequence.
(iii) The stage, which any job has reached.

Loading: The next step is the execution of the schedule plan as per the route chalked out it includes the
assignment of the work to the operators at their machines or work places. So loading determines who
will do the work as routing determines where and scheduling determines when it shall be done. Gantt
Charts are most commonly used in small industries in order to determine the existing load and also to
foresee how fast a job can be done. The usefulness of their technique lies in the fact that they compare
what has been done and what out to have been done.

Most of a small scale enterprise fail due to non-adherence to delivery schedules therefore they can be
successful if they have ability to meet delivery order in time which no doubt depends upon production of

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quality goods in right time. It makes all the more important for entrepreneur to judge ahead of time what
should be done, where and when thus to leave nothing to chance once the work has begun.

Production Control: Production control is the process of planning production in advance of operations,
establishing the extract route of each individual item part or assembly, setting, starting and finishing for
each important item, assembly or the finishing production and releasing the necessary orders as well as
initiating the necessary follow-up to have the smooth function of the enterprise. The production control
is of complicated nature in small industries. The production planning and control department can
function at its best in small scale unit only when the work manger, the purchase manager, the personnel
manager and the financial controller assist in planning production activities. The production controller
directly reports to the works manager but in small scale unit, all the three functions namely material
control, planning and control are often performed by the entrepreneur himself production control starts
with dispatching and ends up with corrective actions.

Dispatching: Dispatching involves issue of production orders for starting the operations. Necessary
authority and conformation is given for:
(i) Movement of materials to different workstations.
(ii) Movement of tools and fixtures necessary for each operation.
(iii) Beginning of work on each operation.
(iv) Recording of time and cost involved in each operation.
(v) Movement of work from one operation to another in accordance with the route sheet.
(vi) Inspecting or supervision of work.

Dispatching is an important step as it translates production plans into production.

Follow-up: Every production programme involves determination of the progress of work, removing
bottlenecks in the flow of work and ensuring that the productive operations are taking place in
accordance with the plans. It spots delays or deviations from the production plans. It helps to reveal
detects in routing and scheduling, misunderstanding of orders and instruction, under loading or
overloading of work etc. All problems or deviations are investigated and remedial measures are
undertaken to ensure the completion of work by the planed date.

Inspection: This is mainly to ensure the quality of goods. It can be required as effective agency of
production control.

Corrective Measures: Corrective action may involve any of those activities of adjusting the route,
rescheduling of work changing the workloads, repairs and maintenance of machinery or equipment,
control over inventories of the cause of deviation is the poor performance of the employees. Certain
personnel decisions like training, transfer, demotion etc. may have to be taken. Alternate methods may
be suggested to handle peak loads.

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 LESSON 5
QUALITY, PRODUCTIVITY AND ENVIRONMENT
Vipin Kumar

Quality Control

The introduction of quality control techniques in the small scale business is one of the most significant
factors in the rapid development of the economy of the country, for it has brought about improvements
in the quality of product without any additional capital investment. Several countries in the world,
particularly those which suffered a setback to their economy after the Second World War, have
recovered their economy and established firm foreign markets by improving the quality of their
products. The application of quality control techniques also brings considerable savings at various stages
production. For this purpose, standardization plays a fundamental role in the assessment, specification
and measurement of the quality of a product. With the help of standardization, it is possible to lay down
basic procedures for ensuring quality control.

It is obvious that for a proper quality control in small scale industry is essential to have suitable raw
materials of specified quality to produce quality products. It is also necessary to enforce quality control
in industry at all stages of manufacture because, with the complex integrated industrial system in the
modern world, unless control is effected at all levels, It may be difficult to ensure the quality of the end
product. At the same time, the cost factor should be considered to be of equal importance, for it is the
cost of a product which determines its saleability. In a sheltered or seller’s market, the cost factor and
even the quality aspect are often neglected; but when industrial recession sets in and competition in the
export market becomes keen, adequate attention to quality and cost is essential. India has of late been
facing improving quality and reducing the cost of production.

Quality control is one of the important responsibilities of the production department. It minimizes
wastage, reduces cost, builds up goodwill for product in the market, facilities advertising sales, and
brings increasing satisfaction to its users.

Meaning: Quality is a related concept, related to certain predetermined characteristics such as shape,
dimensions, composition, strength, workmanship, finish, colour, time, weight, etc. According to Alford
and Beaty, “quality control is the mechanism by which products are made to measure up to the
specifications determined from the customer’s demands and transformed into sales, engineering and
manufacturing requirements. It is concerned with making things right rather than discovering and
rejecting those made wrong. Quality control is a technique by means of which products of uniform
acceptable quality are manufactured.” In other words, it is the systematic control of those variables
which are encountered in the manufacturing process and which affect the excellence of the finished
product.

Importance: Quality control has distinct advantages:

(a) It facilitates distribution, increases the sales and builds up goodwill and the brand in the market.
(b) It leads to all-round efficiency in the organisation.
(c) It helps the entrepreneur (manufacturer) in determining the responsibility of individual workers
and of the production units.

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(d) It minimises the cost by reducing wastages, increasing efficiency, standardizing procedures,
machines, tools, materials and working conditions.
(e) It enables the entrepreneur to know the cost of a product in advance, so that he may determine
competitive price.
(f) The entrepreneur ca conform to the standards set by the Government (if any.

Quality standards are set only after carefully analysing the consumer’s requirements and the cost of the
product (if the quality standards are set very high and maintained effectively, they may involve a higher
cost which may be beyond the expected range of the consumers).

Benefits Of Quality Management

For Employees:

 Empowerment
 Job satisfaction
 Improved working environment
 High morale

For Company:

 ROI
 Sustained Growth
 Good Image
 Risk Mitigation

For Customers:

 High quality products

 Good available of products
 Responsible pricing
 Quick complaint redressal

For Suppliers:

 Better understanding
 Larger role
 Regular business

Control over Production: The variations in quality are caused by variations in the materials used, in
men, machines, tools, and equipment and in methods and procedures of production and inspection.
These variables need to be controlled if quality products are to be manufactured.

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Methods of Quality Control

(a) Inspection: Inspection is one of the very important steps in quality control.

There are three important aspects of inspection:

(i) Production Inspection: It is to ensure that the goods sent into the market for sale are free
of defects and conform to the set standards of quality.

(ii) Process Inspection: It is designed to check raw material, machines, etc. it saves time and
wastage of material, and prevents process bottlenecks.

(iii) Inspection Analysis: A careful analysis of inspection results enables an entrepreneur to

locate these points in the manufacturing process at which control is breaking down.

(b) Statistical Analysis: Statistical Quality control (SQC) is a special type of technique to control
the quality of a product. In this method, statistical techniques are used to gather and analyse data
with a view to determining ad controlling quality. It is based on sampling, probability and
statistical inference, i.e., it judges an entire lot by the characteristics of sample. It is divided into
three parts: the analysis of samples, the use of control and taking corrective action.

Statistical quality control is a diagnostic and preventive device of quality control. It is widely
used in process control of continuous process industries and in industries producing goods on a
mass scale.

Quality Control in Small Scale Business

Quality control in the small scale sector is as necessary, or even more necessary than, in the large scale
sector because of the greater use of manpower in the former during the manufacturing processes. But is
application raises certain problems because of several limitations, including, financial, technical and
managerial. For a successful application of quality control, small scale units must take case of quality
right from the choice of raw materials, selection of machinery and equipment, tooling, designing,
manufacturing processes, testing, marketing and after-sales service. To ensure its success, the small unit
has to be suitably assisted by Government organisations, associations and institutions, which will have
to provide technical, financial management assistance and training to the small industrialist and create
quality consciousness in him.

With the combined efforts of the Development Commissioners, Small-scale Industrial Organisation,
Indian Standard Institution and State Government agencies, the small units have successfully adopted
quality control measures in various fields. Amongst the other measures, their quality control is based on:

(i) Indian Standards specifications;

(ii) Quality marketing schemes;
(iii) Company Standards ( in case of ancillary units);
(iv) Any other standard specifications prescribed by the Government or other purchasing agencies.

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The Indian Standards Specifications have been of valuable guidance to small scale units and have
persuaded them to adhere to the quality of the product. Several units have obtained the ISI mark to
establish the quality of their product. The quality of the small scale industries products, however,
depends upon many other factors, one of the biggest factors being the availability of suitable standard
raw materials. In this connection, several standard specifications for raw materials have been laid down
which have greatly helped the producers in the manufacture of suitable raw materials. On quality control
itself, the following Indian Standards have been published:

(i) Methods of statistical quality control during production by the use of a control chart;
(ii) Manual on basic principles of lot sampling; and
(iii) Sampling inspection tables.

Several State Governments have been operating quality marketing schemes and standards for various
products. Small-scale units manufacture the items in accordance with these standards; and the Quality
Marketing Centres of the Government stamp the “Q” mark on their products which assures customers
that the items have been made to certain quality standards. Several light engineering items, sports goods,
textiles are covered under this scheme. The specifications laid down under this scheme may or may not
conform to the Indian Standards, but they are acceptable to State Governments, probably because they
have been found to be suitable for one purpose or the other. The Quality Marketing Centres sometimes
inspect the goods on behalf of the ISI, Export Inspection Council and the Defence Department. State
Governments have set up a number of common facility centres and testing laboratories to assist the units
to manufacture goods to prescribed standards.

The quality of the products manufactured by ancillary units is prescribed by the large unit either as per
the national standards or company standards; sometimes the large units provide detailed specifications,
drawings, samples, analysis of materials to be used, inspection procedures, and for storage of materials
to small ancillary units. They also help them to manufacture items are inspected by these large units
even during the course of manufacture to ensure that they are fabricated in accordance with the
standards laid down by them. This helps the ancillary units to adhere to the required quality, which may
otherwise adversely affect the sale of their end product.

For the purchases of the Central Government through the Director-General of Supplies and Disposal, the
standards for the quality of the products are laid down by the department itself. These standards may
also be national standards. Inspection in carried out by the department before purchases are made from
small scale and other units. Similarly, standards are laid down for purchases by the Defence Department
for its requirements. For consumer use, some standards are prescribed by the Civil Supplies and Weights
and Measures Departments or by similar agencies.

Productivity

Productivity refers to the physical relation between the quality produced (output) and the quantity of
resource used in the course of production (input)

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Output implies production while input means land, labour, capital, management etc., Productivity
measures the efficiency of the production system. Higher productivity means producing more from a
given amount of input or producing a given amount with minimum level of inputs.

In other words the more the output from one worker or one machine (or a piece of equipment) per day
per shift, the higher is the productivity. Higher productivity is not to be taken in sense of higher
workloads or faster machines alone but it is always elimination of waste of all type of labour (time and
skill) machine time, capital and material management etc.

Productivity = Output per unit of input

Productivity and production are two different terms. Productivity is a relative term indicating the ratio
between total output and the total inputs used therein on the other hand production is an absolute
concept, which refers to the volume of output. The volume of production may increase but productivity
may decline due to inefficient use of resource. Efficient use of input may increase productivity but the
volume of production may not increase. Production refers to the end result of production system whereas
productivity reflects its efficiency.

Significance

Benefits derived from higher productivity are as follows:

(i) It helps to cut down cost per unit and thereby improve the profits.
(ii) Gains from productivity can be transferred to the consumers in from of lower priced products or
better quality products.
(iii) These gains can also be shared with workers or employees by paying them at higher rate.
(iv) A more productive entrepreneur can have better chances to exploit export opportunities.
(v) It would generate more employment opportunities.

Measurement of Productivity

Productivity may be measured either on aggregate bases or on individual basis, which are called total
and partial productivity respectively.

This index measures the efficiency in the use of all the resources.

Partial productivity indices, depending upon factors used, it measures the efficacy of individual factor of
production. Following are productivity indices for individual inputs.

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Factors Influencing Productivity

Productivity is outcome of several interrelated factors, which may broadly be divided into two
categories- human factors and technological factors.

(a) Human Factors: Human nature and human behaviour are the most significant determinants of
productivity. Human factors include both their ability as well as their willingness:

(i) Ability to work: Productivity of an organisation depends upon the competence and caliber
of its people-both workers and managers. Ability to work is governed by education,
training, experience, aptitude, etc. of the employees.

(ii) Willingness to work: Motivation and morale of people are very important factors that
determine productivity. These are affected by wage incentive schemes, labour
participation in management, communication systems, informal group relations,
promotion policy, union management relations, quality of leadership, working hours,
sanitation, ventilation, subsidized canteen company transport, etc.

(b) Technological Factors: Technological factors exert significant influence on the level of
productivity. These include the following:

(i) Size and capacity of plant

(ii) Product design and standardization
(iii) Timely supply of materials and fuel
(iv) Rationalisation and automation measures
(v) Repairs and maintenance
(vi) Production planning and control
(vii) Plant layout and location
(viii) Materials handling system
(ix) Inspection and quality control
(x) Machinery and equipment used
(xi) Research and development
(xii) Inventory control

(c) Managerial Factors: The competence and attitudes of managers have an important bearing on
productivity. In many organisations, productivity is low despite latest technology and trained
manpower. This is due to inefficient and indifferent management. Competent and dedicated

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 managers can obtain extraordinary results from ordinary people. Job performance of employees
depends on their ability and willingness to work. Management is the catalyst to create both.
Advanced technology requires knowledgeable workers who in turn work productively under
professionally qualified managers. No ideology can win a greater output with less effort. It is
only through sound management that optimum utilization of human and technical resources can
be secured.

(d) Natural Factors: Natural factors such as physical, geographical and climate conditions exert
considerable influence on productivity, particularly in extreme climates (too cold or too hot)
tends to be comparatively low, Natural resources like water, fuel and minerals influence
productivity.

(e) Sociological Factors: Social customs, traditions and institutions influence attitudes towards
work and job. For instance, bias on the basis of caste, religion, etc., inhibited the growth of
modern industry in some countries. The joint family system affected incentive to work hard in
India. Close ties with land and native place hampered stability and discipline among industrial
labour.

(f) Political Factors: Law and order, stability of Government, harmony between States, etc. are
essential for high productivity in industries Taxation policies of the Government influence
willingness to work, capital formation, modernization and expansion of plants etc. Industrial
policy affects the size, and capacity of plants. Tariff policies influence competition. Elimination
of sick and inefficient units also helps to improve productivity.

(g) Economic Factors: Size of the market, banking and credit facilities, transport and
communication systems, etc. is important factors influencing productivity.

Environmental Analysis

Business environment may be defined as all those conditions and forces external to a business unit under
which it operates. These forces include customers, creditors, competitors, suppliers, government, social-
cultural organisations, political parties, international organisations, etc. Some of these forces may have
direct influence over the business firm while others may operate indirectly.

Opportunities In The Environment

Entrepreneurship does not emerge and grow spontaneously. Rather it is dependent upon several
economic, social, politic legal and other factors. An entrepreneur should understand the behaviour of
key environmental forces that have an implication on the enterprise and understand and get a grasp of
the techniques available for environmental scanning.

Sensing of environmental opportunities involves the following steps:

(a) Environmental scanning.

(b) Generation of ideas
(c) Identification of goods and services to the produced and sold.

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An overview of these steps is given below:

(a) Scanning of Environment: The word ‘scan’ means––to examine closely especially in search of
something. Scanning of environment means processes by which entrepreneurs monitor their
relevant environment to identify opportunities and threats affecting them. It also develops an
understanding of socio-culture, economic, political and other developmental factors in order to
ensure that perceived entrepreneurial opportunity is compatible with them. It helps in knowing
treads, issues and expectation from the environment changes.

(b) Generation of Ideas: While scanning of environment, an entrepreneur can take up thorough
study of different sources of business ideas to explore it. These ideas can come from talking to
friend and other, customers, brainstorming, visiting shops etc. it is mainly a conscious effort to
gather ideas from several sources with the purpose of finding a creative solution to a problem or
need of the society.

(c) Identification of Product or Service: After evaluating the various ideas received from different
sources, an entrepreneur can select the products or services for launching an entrepreneurial
venture.

The benefits of understanding the relevant environment of business are described below:

(a) Identification of Opportunities to Get First Mover Advantage: By keeping in touch with the
changes in the external environment, an enterprise can identify opportunities and find strategies
to capitalize on the opportunities at the earliest. For example if there is a change in the syllabus
for a particular class, a publishing company may bring out the revised edition at the earliest to
reap the first mover advantage.

(b) Formulation of Strategies and Policies: Environmental analysis helps in identifying threats and
opportunities in the market. These can serve as the basis of formulation of strategies to counter
threats and capitalize on opportunities in the market. Leading companies like Infosis, TCS, HUL,
Airtel, Hero Honda and ITC have engaged the services of experts to monitor trends in the
external environment. The inputs provided by the experts are used in making strategies.

(c) Tapping Useful Resources: A business gets various resources or inputs from the environment
and converts into desired goods and services for transfer to the customers. If the management of
a firm has a thorough knowledge of the external environment, it ca tap raw materials, technology
and even financial resources from the market at economical prices and at the right time.

(d) Better Performance: Proper understanding of the various elements of the external environment
is necessary to take timely action to deal with the threats and avail opportunities for the purpose
of improvement in performance of the firm.

(e) Sensitisation of Entrepreneurs to Cope up with Rapid Changes: A keen watch on the trends
in environment would help to sensitise the entrepreneur to the changing technology, competition,
government policies and changing needs of the customers. For example, Reliance Industries has

60
 always kept pace with the external environment and formulated strategies to avail opportunities
in emerging hi-tech areas.

(f) Image Building: If a firm is sensitive to the external environment, it will come out with new
products and services to meet the requirements of the customers. This would build the image or
reputation of the firm in the eyes of the customers and the general public. Because of sensitivity
to India consumers’ requirements, Samsung has been able to enhance its brand image in the
Indian market in a short span of time.

Analysis Of Environment

Environment analysis is the process of monitoring the economic and non-economic environment to
determine the opportunities for and threats to an enterprise. Such an analysis involves data collection,
information processing and forecasting to provide a rational basis for developing goals and strategic of
business can set his future direction only when he has visualized and perceived the opportunities and
constraints that lie ahead. Environmental analysis would enables the entrepreneur to predict future
developments and take timely actions to make a constructive use of these developments.

Environment scanning is crucial for spotting a business opportunity, identification of product or service
to the produced and in raising resources for launching the project. There is an interface between spotting
an opportunity and translating it into a sustainable and profitable project as shown below:

Fig.: Opportunity Project Interface

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Environmental Factors (Elements Of Environment)

Entrepreneurship environment refers to the various forces within which various small, medium and large
enterprises operate.

EXHIBIT: Business Environment at a Glance

1. Economic Nature of economic system, structural anatomy of economy, role of

government policies, the nature of factor endowment and markets.

2. Social-cultural Changing role of consumers, conduct of business, marketers and

social-cultural behaviour.

3. Political-Legal Stability of government, laws, judiciary and politics, consumer and

environmental protection.

4. Technological Technology and Ecology, Information Technology, Inventions, etc.

5. Physical/Natural Environmental concerns, natural resources, effect of improper

handling of natural resources and environment, Ecology and
Technology.

6. Historical Historical heritage.

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 Fig.: Environmental Forces Affecting Entrepreneurship

Economic Environment

Economic environment refers to the nature of economy (capitalist, socialist or mixed), economic
policies of the government, markets for material, labour, capital, etc., business firms and institutions
such as banks, insurance companies, transport companies, etc., and level of income of the people.

The economic environment is greatly influenced by the government through fiscal policies, economic
controls, industrial policy and import-export policy. For instance, if the government announces a cut in
the excise duty on the sales of business firms manufacturing air conditioners will go up. Similarly, if the
government allows liberal finance to export-oriented units at concessional rates, such units will get a
boost.

Politico-Legal Environment

(a) Political Environment: The viability of a business depends upon the ability with which it can
meet the challenges arising out of the political environment. The political environment of a
country is influenced by political parties, political stability, Government’s intervention in
business, constitutional provisions affecting business, foreign policy, etc. All these factors have a
bearing on business.

(b) Legal-Regulatory Environment: Legal regulatory environment of business is determined by

the constitutional provisions, economic laws, commercial laws, industrial and labour laws,
government regulations under various laws and court decisions. These help the government in
the regulation of economic is centrally planned and controlled, the business enterprises are
required to operate within the framework of legal-regulatory environment.

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Technological Environment

Technological environment refers to the state of technology in the areas of manufacturing, mining,
construction, materials handling, transportation, etc. and also information technology. Advancement in
technology leads to greater productivity, higher quality and lower cost of production for the business.

Historical Environment

The historical heritage of the country also influences the current environment of business. The business
environment in a number of newly independent nations has been largely determined by the colonial
status which those countries enjoyed earlier. The French Revolution had much to do with the emergence
of capitalist spirit of business and investment. World War I and the Soviet Revolution provided a
perspective to realize the ambition of a State-owned and controlled business system.

Physical Environment

Physical and geographical factors can play a predominant role in constituting the non-economic
environment and thereby affecting the business. The application of modern technology in industry leads
to rapid economic growth at a huge social cost––deterioration of the physical environment arounds us,
i.e. air pollution, noise pollution, water pollution, so on and so forth. The nature of such costs is being
assessed by biologists, ecologists, sociologists and conservationists. In the light of this, much talk is
there about the social responsibilities of business. Business now has to calculate social net profitability
(social benefit minus social cost) of its ventures. In this calculation, business must consider the physical
environmental factors such as the quantity and quality of existing forest wealth, possibility of artificial
rain, the exploitation of seas products like fish, the health hazards out of pollution, etc.

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 LESSON 6
MANAGING BUSINESS GROWTH
Vipin Kumar

Meaning Of Business Growth

Generally, the term ‘business growth’ is used to convey various thing such as rise in the total sales
volume per annum, an increase in the production capacity, an increase in physical output, an increase in
capital employed, an increase in employment and an increase in raw materials and power used. These
factors are in fact, indicators of growth. They do not provide a specific meaning of growth. Business
growth means an increase in scale of operations and resources of a firm usually accompanied by
increase in its size.

Some people use the terms ‘growth’ and ‘size’ interchangeably. But these terms are not identical.
Increase in size does not always mean growth. In fact, size is ones of the outcomes of growth. For
example, if an industrial firm with 1000 employees adds another 100 employees to its work-force, it
does not mean that the firm has necessarily grown. There may not be any increase in production because
of decrease in the productivity of the workers due to certain reasons. However, if the new employees are
placed in some new types of operations on new machinery and equipment resulting in higher production,
it can be concluded that some growth has occurred. It may be noted that it is easy to measure the size of
a business firm. The indicators of size may also be used as indicators of growth after careful analysis of
the given facts and figures about the change in the scale of operations and resources of a firm.

Stages of Growth

Business is an organ of growth. Every entrepreneur likes to see his enterprise grow in terms of sale and
revenue. This exemplified by the Four State Growth Model which highlight the stages under which an
entrepreneur has to move in order to grow and develop. These stages are:
(i) Pre-start up stage.
(ii) Start up stage.
(iii) Early growth stage.
(iv) Later growth stage.

An entrepreneur may make a humble beginning with a comparatively small enterprise. Small enterprises
are, however, vulnerable to even mild changes in the environment, change in people’s tastes, in
government policies, in fashions and in style of living-anything can affect a small and fledging
enterprise. Even well-managed units, in due course, may hit a crisis point and even face closure. Scarcity
of raw materials availability of substitutes in the market, obsolete technology or sheer lack of vision––
any of these may pose a threat to an enterprise. Sustainability, therefore, becomes a crucial managerial
function for an entrepreneur.

The analogy of birth of a child can be used to explain the problems involved in launching or floating a
new business enterprise. The person who has a business idea and takes steps to implement it is known as
an entrepreneur or a promoter. The entrepreneur has to act both as a mother and mid-wife because it is
he who faces various difficulties to bring the new enterprise into existence and brings it up into a
successful venture. That is why, business is also called a venture. The entrepreneur assembles and

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coordinates various factors of production, namely, human resources, machines, capital and materials to
start a new enterprise and keep in running. The ultimate success of a business depends upon the
entrepreneur’s skills to manage various problems with which he is confronted while starting a new
enterprise.

During the early growth stage, an entrepreneur concentrate on increasing the production and sale of
existing products. He will try to achieve efficiency, reduce cost of production and take steps to win new
customers and enter new markets. But at the later growth stage, the entrepreneur may go in for
modernization, expansion and diversification. Creativity and innovation will play a key role in growth
and expansion.

After the entrepreneur reaches the take off stage, where will he starts-earning reasonable profits, he will
like to consolidate the gains and maintain momentum for a period of 3 to 5 years. Consolidation stage is
very crucial as environment like changes in government policies, and tastes and preferences of
consumers, rise in the price of materials and rise in competition in the market. However, the stage of
consolidation cannot continue indefinitely. If it does, other entrepreneur in the field will increase the
competition and it may prove disastrous. So, after consolidating the enterprise, continuous efforts should
be made in increase the momentum to achieve growth. This stage of growth and development is
characterised by extending the range or replacing models and seeking new market opportunities.
Creativity and innovation play a key role throughout and strategies for expansion will rely on the
creative inputs that the entrepreneur can generate.

Need For Growth

As we have already said that business enterprise is like a human being, growth is a necessary stimulant
to most of the business firms. As a matter of fact, growth is precondition for the survival of a business
firm. An enterprise that does not grow may, in course of time have to be closed down because of its
obsolete products. The market is full of examples of very popular products disappearing from the scene
for lack of growth plans. For example, pagers vanished from the market because better technology
product i.e. cell phone were introduced. The reasons which drive business enterprises toward growth are
described below:

(a) Survival: In a competitive market no single enterprise can have monopoly. The competition can
be direct or indirect. Direct competition comes from other firms manufacturing the same product.
For example, there are many brands of shampoos available in the market. To survive the
competition the manufacturer of each brand of shampoo has to continuously bring new versions
of basic product to maintain an edge over his competitors. Indirect competition may come from
availability of cheaper substitutes. For example, the khadi industry faced a problem when
polyester emerged. Severe competition forces a firm to grow and gain competitive strength. Any
business firm that fails to grow can’t survive for long. A growing concern will be an innovator
and can easily face the risk of competition. Thus growth is means of survival in a competitive
and challenging environment.

(b) Economics of Scale: Growth of a firm may provide several economies in production,
purchasing, marketing, finance, management etc. A growing firm enjoys the advantages of bulk
purchase of materials, increased bargaining power, spreading of overheads, expert management

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 etc. this leads to low cost of production and higher margin of profit. This also ensures full
utilisation of plant capacity.

(c) Owner Mandate: The owners of a company get the ultimate benefit of growth in the form of
higher profits. They may direct the management to reinvest a substantial portion of the earnings
in the business rather than paying them out. Capable management may on its own like to take
carefully calculated risk and expand the size of the company.

(d) Expansion of the Market: Increase in demand for goods and services leads business firms to
increase the supply also. Population explosion and transportation led to increase in the size of
markets which in turn resulted in mass production. Business firms grow to meet the increasing
demand. Expanding market provide opportunity for business growth.

(e) Latest Technology: Some business firms invest in research and development activities to create
new products and new techniques, while other try to acquire latest technology from the market.
Rationalisation and automation results in more efficient use of resources and a firm may grow to
obtain them.

(f) Prestige and Power: The more the size of the business firm increase the more is the prestige and
power of the firm. Businessmen satisfy their urge for power by increasing the size of their
business firm.

(g) Government Policy: In a planned economy like India, business firms operate under a large
number of rules and restrictions. A big firm is in a better position to carry out the various legal
formalities required to obtain licenses and quotas. Business firms may plan for growth to make
use of the incentives provided by the government. The government provides certain subsidies
and tax concessions to the new industrial units in the backward areas and those producing goods
for export only.

(h) Self-sufficiency: Some firms grow the become self-sufficient in terms of marketing of raw
material or marketing of products. Growth in either or both of these forms reduces the
dependency of the firm over other firms.

Advantages of Growth

Business firms try to achieve growth in order to obtain the following advantages:

(i) For obtaining the economies of scale.

(ii) For exploitation of business opportunities.
(iii) For facing competition in the market by diversifying the product line.
(iv) For providing protection against adverse business conditions eg. Depression.
(v) For gaining economic and market power.
(vi) For raising profits and creating resources for further reinvestment into business.
(vii) For making optimum utilisation of resources.
(viii) For securing subsidies, tax concessions and other incentives offered by the government.

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Limitation of Growth

Business firms cannot grow indefinitely. Growth has its own limitations which are:

(a) Finance: Growth, especially external growth, requires additional capital investment which is
sometimes difficult for a small firm to arrange.

(b) Market: Growth can be achieved to the extent that the size of market permits. If a firm grows
faster than increase in the size of the market, it is likely to face failure.

(c) Human Relations Problems: In a big firm, management loses personal touch with employees
and customers. Motivation and morale tend to be low resulting in inefficiency.

(d) Management: Growth increases the functions and complexities of operations. As the number of
functions and departments increase, coordination and control become very difficult. If the
organisation and management structure is not capable of accommodating them, growth may be
harmful.

(e) Lack of Knowledge: Under conglomerate growth, a firm enters new industries and new markets
about which the managers know little. Managers find it difficult to find and develop manages
who can quickly handle new units and improve their earning potential against heavy odds. Many
growing firms could not succeed because their manages felt that they could manage anything
anywhere.

(f) Social Problems: From social point of view also big firms may be undesirable as they may lead
to concentration of economic power and creation of monopolies which may exploit consumers.
In their desire for growth firms indulge in combative advertising. The quickening growth creates
a cultural gap when society finds it difficult to cope with technological change.

Forms of Growth

One an entrepreneur understand some of the factors that influence growth and development, he can
choose a suitable way for achieving it. Business growth can take place in many ways. Broadly, various
types of growth can be divided into two broad categories – organic and inorganic growth.

Organic Growth: It can also be termed as internal growth. It is growth from within. It is planned and
slow increase in the size and resources of the firm. A firm can grow internally by ploughing back of its
profits into the business every year. This leads to the growth of production and sales turnover of the
business. Internal growth may take place either through increase in the sales of existing products or by
adding new products. Internal growth is slow and involves comparatively little change in the existing
organisation structure. It can be planned and managed easily as it is slow. The ways used by the
management for internal growth include: (i) intensification; (ii) diversification and (iii) modernization.

Inorganic Growth: It can also be termed as external growth. It involves a merger of two or more
business firms. A firm may acquire another firm or firms may combine together to improve their
competitive strength. External growth has been attempted by the business houses through the two

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strategies (a) mergers and acquisitions and (b) joint ventures. Merger again can be of two types: (i) a
firm merges with other firm in the same industry having similar or related products. This type of merger
leads to coordination problem between the two firms (ii) a firm merges with another firm in altogether
different lines of business and have little common in their products or processes such a merger is known
as conglomerate merger.

Inorganic growth is fast and allows immediate utilization of acquired assets. There is no risk of
overproduction as the capacity of the industry as whole remains unchanged. Merger leads to
combination of independent units to control competition, to gain economics of scale and also sometimes,
to modernize production facilities. But merger also leads to social problem of monopoly, problem of
coordination, strain on capital structure, etc. Thus, external growth involves problem of reorganization.

Growth Strategy

Under growth strategy, an enterprise is expected to increase its level of business operations than its
immediate past. Actually, in this strategy, a firm increases its expected performance in terms of market
share, sales revenue, earnings etc. “A growth strategy is one that an enterprise pursues when it increases
its level of objectives upward in a significant level.” The basic purpose of this strategy is to achieve
higher growth by initiating growth mechanism. These mechanisms are entering new market, capturing
large share of the markets by improved product, developing products, acquiring latest technology,
acquiring better resources and inculcating professionalism in management.

Growth Strategies

Intensive Expansion Integration Merger Diversification

i) Market Penetration i) Backward Integration i) Horizontal i) Merger &
ii) Market Development ii) Forward Integration ii) Vertical Acquisition
iii) Product Development iii) Product Development iii) Conglomerate ii) Joint Venture
iv) Concentric

Features of Growth Strategy: Growth strategy entails the following features:

(i) Strategy which involves holding the relative position of the firm in a high-growth product market
areas.
(ii) Increase market share in high growth market.
(iii) Increase market share in slow growth (matured markets).
(iv) Hold strong relative position in slow growth market: use excess cash flow, funds capability and
other resources to support penetration of multi-national markets with existing product line.
(v) Hold strong relative position in a maturing market: use excess cash flow, external funds
capability and other resources to support penetration of new product market areas domestically.
(vi) Hold strong relative position in multi-national markets with present product line, use excess cash
flow, funds capability, and other resources to diversify products.
(vii) Hold strong position in diversified product line domestically, use excess cash flow, funds
capability and other resources to diversify markets.

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Rationale of Growth Strategies: Following rationale are used in favour of growth strategies:

(i) Growth company holds better public image and ables to attract professional managers.
(ii) Growth firm easily adjusts itself with the changing scenario specially in terms of opportunities
available, technological changes etc.
(iii) Growth firm motivates management for high performance by initiating higher compensation
packages and satisfying power and recognition needs.

Approaches to Growth Strategy: Following approaches are used for growth strategy:

(a) Intensive Expansion: It deals with protection and development of product market line of the
firm. It helps the firm to expand its share of market, sales volume and profit volume. Intensive
expansion is possible in three ways: (i) Markets penetration, (ii) Market development, and (iii)
Product development.

(i) Market Penetration: In this process, company assesses the scope of its present product
in the market. If it is possible for the company to increase its volumes of sales and profits
by initiating aggressive marketing efforts then it will try to improve the product quality
and design. Because, these steps enable the company to increase its following steps: (1)
including customers through mass media to buy its products more frequently and in
larger quantities, (2) attracting existing customers by providing better service and
improving brand image of the product, (3) initiating price reduction and offensive
advertising programmes to convert potential customers into real customers.

(ii) Market Development: It deals with launching of existing products in new market.
Generally, it is possible through the appointment of sales agents and dealers,
development of new channels of distribution, franchising etc. Thus, in market
development process, the firm tries to move into new geographical areas with its existing
products. However, the firm should try to incorporate some minor modifications if any in
existing products the local conditions of that particular geographical area.

(iii) Product Development: It incorporates improvements in the quality and standard of the
existing product as well as launching of new product in the market. Product development
is made possible through (1) launching of new product through research and
development, (2) product innovation, (3) increase in product brand range.

(b) Integration: A company tries to expand externally. It is a growth strategy “wherein new
products or services are added which are complementary to the existing product or service line. It
is characterised by the extension of the firm’s business definition in two possible directions from
the present backward and forward. It is generally motivated by taking into account the growth
and survival possibilities. It is of two types:

(i) Backward Integration: It is the creation of facilities for production of raw materials and
components to ensure smooth current production behaviour. It is setting up of facilities

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 for the production of raw materials and components required for the current operation of
the firm.

(ii) Forward Integration: It is the creation of facilities for manufacturing products for which
current products as inputs for manufacture of another product of the same organisation.

(c) Merger: A merger is a combination of two or more business in which one acquires the assets
and liabilities of the other in exchange for cash, stock or both are companies dissolved and assets
and liabilities are combined and new equity shares are issued. According to Prof. L.H. Haney, it
is a form of business organisation which is established by outright purchase of the properties of
constituents, organisations and the merger is the result of forming new company by
amalgamating two or more existing companies or by absorbing one business enterprise by
another unit.

Types of Mergers: Major types of mergers are as follows:

(i) Horizontal Merger: It involves merger of two firms operating and competing in the same kind
of business activity. Its main intension is to avail benefit of economies of scale.

(ii) Vertical Merger: It occurs between firms who are in different stages of production operation.
This type of merger takes place when two or more firms are engaged in complementary
production bases. The rationale rests primarily on the costliness of market exchange and
contracting.

(iii) Conglomerate Merger: It involves firms engaged in unrelated type of business activities.
Conglomerate mergers are possible mainly on three lines: (1) Product-extension mergers broaden
the product lines of firms; these are mergers between firms in related business activities and may
also be called concentric mergers. (2) A geographic market extension merger involves two firms
whose operations have been conducted in non-overlapping geographic areas. (c) The other
conglomerate mergers which are often referred to as pure conglomerate mergers involve
unrelated business activities.

(iv) Concentric Merger: It involves combination of two or more firms which are related to each
other in terms of customer functions, customer groups or technology. For example, combination
of shoe company with a hosiery firm engaged in production of socks.

d) Diversification: It is a mode of business expansion. It involves addition of units that produce

different products that can be distributed through the same channel. Under this process a firm
switches over to new products and markets rather than continuing with the existing ones only.
Diversification can be achieved in there different ways.

(i) A firm can diversify internally by using standard organisation or new venture
organisation.
(ii) It can diversify through ventures or by forming mergers or amalgamation with other
business enterprises.
(iii) It can be achieved by forming a conglomeration.

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(i) Merger and Acquisition Process: It involves external diversification when a firm is
interested to take over another firm working in other new field or allied areas. Actually,
these are the areas where production units are adopting strategies to enter the field. These
fields are generally treated as sunrise industries. Mergers and acquisitions are the best
methods to achieve the target. Actually, it is possible for the firm to use securities in
obtaining other companies whereas it might not be able to finance the acquisition of
equivalent assets and capabilities internally.

(ii) Joint Venture: It involves mutual cooperation of two independent firms who are
interested to participate in a business venture. “Joint ventures are a special case of
consolidation where two or more companies form a temporary partnership for a specified
purpose.” In practice, and also allows to defend the strategic posture jointly against forces
which could be difficult to defend individually.

Basically, in joint venture, participants continue to exist as separate firms with a joint
venture representing a newly created business enterprise. The joint ventures are usually
described as having the following characteristics: (1) contribution by partners of money,
property, effort, knowledge, skill or other asset, to a common undertaking, (2) joint
property interest in the subject-matter of the ventures, (3) right of mutual control or
management of the enterprise, (4) expectation of profit or presence of adventure, (5) right
to share in profit, (6) usual limitation of the objective to a single undertaking or adhoc
enterprise.

Rationale for Joint ventures: Following are the main rationale for joint ventures:
(1) To augment insufficient financial or technical ability to enter a particular line of
business.
(2) To share technology and/or generic management services in organisation planning
and control.
(3) To diversify risk.
(4) To obtain distribution channel or raw material supply.
(5) To achieve economies of scale.
(6) To extend activities with similar investment that is done independently.
(7) To take advantage of favourable tax treatment or political incentives (particularly
in foreign ventures).

(iii) Conglomeration: It is another technique to diversity in other areas. Diversification

activities related with product extension and market extension are included in
conglomerate diversification process. The motivation on the part of the diversifying or
acquiring firm is in expectation that it has or will have excess capacity of general
managerial capabilities in relation to its existing product, market activities or
technological capabilities. It may also enable the firm to develop industry specific
managerial experience and firm specific organisation capital over time.

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 UNIT - IV
LESSON 1
MEANING AND FUNCTIONS OF ACCOUTING
Ms. Shikha Gupta
Accounting is a discipline which provide financial and other information essential to efficient
conduct and evaluation o the activities of any organisation. In the words of Smith and Ashburne,
accounting is “a science of recording and classifying the business transactions and events, primarily
of a financial character, and the art of making significant summaries, analysis and interpretations of
these transactions and events and communicating the results to persons who must make decisions or
form judgements.”

According to American Institute of Certified Public Accountants (AICPA), “accounting is the art of
recording, classifying and summarising in a significant manner and in terms of money, transactions
and events which are, in part at least of a financial character and interpreting the results thereof.”
American Accounting Association (AAA) has defined accounting as “the process of identifying,
measuring and communicating economic information to permit informed judgements and decisions
by users of the information.”

In the words of R.N. Anthony, an accounting system is “a means of collecting, summarising and
reporting in monetary terms, information about the business.”

On analysing the above definitions we find that accounting performs the following important
functions:

1. Maintaining Systematic Records: This is the basic function of accounting. Business

transactions are properly recorded, classified under appropriate accounts and summarised into
financial statements.

2. Communicating the Financial Results: Since accounting is considered as the language of

the business, its primary aim is to serve as a means of communication of various financial
information.

3. Meeting Legal Needs: The provisions of various laws require the submission of various
statements for different purposes.

4. Protecting Business Assets: Accounting maintains proper record of various assets and, thus,
enables the management to exercise proper control over them with the help of various
relevant information.

5. Planning, reviewing, revising, controlling, and decision-making functions of management are

well-aided by accounting records and reports.

Accounting summarises the classified information. It is done in a manner which is useful to the
business. External users of information are the investors, creditors, tax authorities, labour unions,
trade association shareholders, Government, etc.

Accounting provides the following useful information to the business:

(i) Availability of Capital and its form;
(ii) Assets and Stock position;
(iii) Purchases and Sales;
 (iv) Schedule of Debtors and Creditors;
(v) Gross and Net Profits (or losses);
(vi) Cost incurred for carrying out various business operations.

Nature of Financial Accounting

The nature of financial accounting may be discussed as under:

(i) Accounting as Language of the Business: Accounting is often referred to as the language of
business. The primary aim of a language is to serve as a means of communication.
Accounting is used to communicate financial and other information to people, organisations,
Governments, etc., about various aspects of business and non-business entities.

(ii) Accounting as Information System: Accounting is an effective means of communication of

financial information to various groups. Financial statements have been designed to suit the
information needs of various groups. In today’s society, many persons and agencies outside
the management are involved in the economic life of an organisation. These persons
frequently require financial or accounting information to make reasoned choice among
alternative uses of limited resources in the conduct of the business and economic activities.

(iii) Accounting as a Discipline: Accounting like any other discipline has to follow certain
principles. ‘Conceptually, accounting is a discipline that provides information of which
external and internal users of the information may base decisions that result in the allocation
of economic resources in society,’ stated Slavia and Reynolds. However, accounting is a
dynamic discipline in the sense that new accounting principles are constantly evolving on the
basis of various researches conducted by learned scholars. Basically, accounting is a
multidisciplinary discipline in the sense that it draws knowledge and concepts from various
disciplines.

(iv) Accounting as a Profession: It has successfully emerged as a noble profession. As a

profession, accounting is an organised and systematised body of knowledge. There are a
number of professional associations all over the world which recognise professional
accountants by different names in different parts of the world like Chartered Accountants,
Certified Public Accountants, etc. These accounting associations have developed a
professional outlook by issuing accounting standards from time to time.

(v) Accounting is both a Science and an Art: Science is knowledge based on well-known
principles. Accounting is a science in the sense that recording, classifying and summarising
of money transactions is done on the basis of certain rules or generally accepted accounting
principles (GAAPs). Art is action or doing a thing. Actual keeping of records of transactions
is an art. Hence, accounting is both a science and an art. It is worth noting that without a
thorough knowledge of accounting principles nobody can become a successful accountant.

(vi) Accounting as an Input-Output System: The inputs of accounting system are business
transactions and events which are processed with the help of accounting principles into the
outputs in the form of financial statements of the use of various interested parties inside and
output the organisation. Accounting as a system works within the economic, social, legal and
political environment.

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(vii) Accounting as a Tool of Social Welfare: In this era of economic transformation, accounting
is considered as a tool of promoting social welfare by communicating accounting information
to various parties. Accordingly, accounting information is made beneficial to the society as a
whole. By providing additional information through special disclosures it remains helpful to
future researchers. This branch of accounting is now known as Social Responsibility
Accounting.

Limitations Of Financial Accounting

Financial accounting is primarily concerned with preparation of accounting information for the
outsiders who do not have direct assess to the accounting information. It serves so many objectives
that it is called the language of business. But it suffers from a number of limitations which are
inherent in its nature. The following are the main limitations of financial accounting.

1. Financial Accounting is not absolutely exact: Financial accounting is not completely free
from personal bias or judgement. Though transactions are recorded on actual basis, but there
are many instances where estimates have to be made for calculating profits. The
determination of the useful life of an asset for depreciation purposes, provision for doubtful
debts, lower of the cost or market price for the inventories are some of the instances in which
estimates or personal judgement are needed and since there is no uniformity for such
estimates, the profit may vary if calculated by different persons.

2. Contradictions: Some of the principles of accounting, although valid, have contradictions.

For example principle of conservatism requires that stock be valued at cost or market price,
whichever is lower. Suppose there are two products sold by the same firm. In the case of one,
the market price is lower and in the other the cost is lower. Thus two different standards
apply to the same group of assets.

3. Financial Accounting does not show what the business is worth: The assets are recorded
in the balance sheet at cost less depreciation because they are meant for use and not for sale.
Hence, the balance sheet should not be taken to disclose the realised value of the assets on
sale.

4. Financial Accounting does not present the whole picture: Financial accounting
information does not include the qualitative aspects of the business enterprise. Accounting is
concerned only with those business activities which can be expressed in money. In this
manner, non-monetary transactions e.g. good labour relation, quality of the goods, established
management and efficiency of staff etc. are not considered at all. We can’t ignore such
important issues while diagnosing the true worth of the business.

5. Figures in Financial Accounting does not carry the level of their accuracy: Financial
accounting information is based upon various fundamental assumptions, concepts and
conventions based on experience rather than any specific enquiry. Attempts are often made to
violate the accounting principles for the purpose of distorting the factual position.

6. Window dressing in Balance Sheet: When accountants on the recommendations of

management decides to enter wrong figures to artificially inflate or deflate the figure of
profits, assets and liabilities, the income statement can’t exhibit the true and fair view of the
result of operations and Balance Sheet fails to provide the true and fair view of state of affairs
of the business.

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7. No effect of inflationary trends: As the money is not a stable unit of measurement, inflation
makes mot of the figures out of date.

Book-Keeping, Accounting And Accountancy

These three are sometimes considered as synonymous, i.e., having the same meaning. However,
there is a fundamental difference amongst book-keeping, accounting and accountancy.

Book-keeping: It is mainly concerned with record keeping or maintenance of books of accounts.

The maintenance of books of accounts includes the following four activities:
(i) Identifying the transaction of financial nature from amongst the various transactions.
(ii) Measuring the identified transactions in terms of money.
(iii) Recording the identified transactions in the books of original entry.
(iv) Classifying them into ledger.

The book-keeping function is routine and clerical in nature and can be performed by persons having
limited knowledge of accounting. At present this function in increasingly done by computers.

Accounting: Accounting starts where book-keeping ends. It includes the following activities:
(i) Summarising the classified transactions in the form of Profit & Loss Account and Balance
Sheet, etc.
(ii) Analysing and interpreting the summarised results. In other words, drawing the meaningful
information from Profit & Loss Account and Balance Sheet, etc.
(iii) Communicating the information to the interested users.

Thus, an accountant’s work goes beyond that of a book-keeper. However, in actual practice the
accounting process includes the book-keeping function also because on the basis of book-keeping
records, an accountant draws up periodically such financial statements as Profit & Loss Account and
Balance Sheet, etc. In a small concern, the accountant performs the work of a book-keeper also.

Accountancy: It refers to a systematic knowledge of accounting concerned with the principles and
techniques which are applied in accounting. It tells us how to prepare the books of accounts, how to
summarise the accounting information and how to communicate it to the interested parties.
According to Kohler, ‘accountancy refers to the entire body of the theory and practice of
accounting.’

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Distinction between Book-keeping and Accounting

Book-keeping differs from accounting the following respects:

Basis of Book-keeping Accounting

Distinction
1. Scope Book-keeping includes: Accounting in addition to Book-
(a) Identifying the transactions of keeping includes:
financial nature; (a) Summarising the classified
(b) Measuring the identified transactions:
transactions in terms of (b) Analysing and interpreting the
money; summarised results; and
(c) Recording the measured (c) Communicating the results to
transactions; and parties interested in them.
(d) Classifying them into ledger.
2. State Book-keeping is primary stage. It is the secondary stage.
Accounting starts where Book-
keeping ends.
3. Objective The main objective of Book- Its main objective is to ascertain
keeping is to maintain systematic the net results and financial
records of transactions of position of the business and to
financial nature. communicate them to interested
parties.
4. Nature of Job The Book-keeping function is The Accounting function is
routine and clerical in nature. analytical in nature.
5. Who Performs The book-keeping function is The Accounting function is
performed by junior staff. performed by senior staff.
6. Knowledge It can be performed by persons It is performed by persons having
Level having limited level of higher level of knowledge than
knowledge. that of Book-keeper.
7. Analytical The Book-keeper is not required to The Accountant is required to
Skill possess analytical skill. possess analytical skill.
8. Personal In all enterprises transactions are Methods of analysing,
Judgements recorded according to the interpretation and reporting may
principles of accountancy and differ in various enterprises.
personal judgement of the book- Hence, personal judgement of the
keeper is not required. accountant is essential.
9. Supervision Book-keeper cannot supervise and Accountant supervises and checks
and Checking check the work of an accountant. the work of a book-keeper.
10. Information for It does not provide any It provides information for taking
Managerial information for taking managerial managerial decisions.
decisions.

Lease Financing
Leasing is widely used in Western countries to finance investments. In USA, which has the largest
leasing industry in the world, lease financing contributes approximately one-third of total business
investments. In the changing economic and financial environment of India, it has assumed an
important role. What is lease financing? What are its advantages and disadvantages? How can a lease
be evaluated?

77
 LESSON 2
LEASE DEFINED
Ms. Shikha Gupta

Lease is a contract between a lessor, the owner of the asset, and a lessee, the user of the asset. Under
the contract, the owner gives the right to use the asset to the user over an agreed period of time for
consideration called the lease rental. The lessee pays the rental to the lessor as regular fixed
payments ove4r a period of time at the beginning or at the end of a month, quarter, half-year, or year.
Although generally fixed, the amount and timing of payment of lease rentals can be tailored to the
lessee’s profits or cash flows. In up-fronted leases, more rentals are charged in the initial years and
less in the later years of the contract. The opposite happens in back-ended leases. At the end of the
lease contract, the asset reverts to the lessor, who is the legal owner of the asset. As the legal owner,
it is the lessor not lessee, who is entitled to claim depreciation on the leased asset. In long-term lease
contracts, the lessee is generally given an option to buy or renew the lease. Sometimes, the lease
contract is divided into two parts––primary lease and secondary lease for the purposes of lease
rentals. Primary lease provides for the recovery of the cost of the asset and profit through lease
rentals during a period of about four or five years. A perpetual, secondary lease may follow it on
nominal lease rentals. Various other combinations are possible.

Although the lessor is the legal owner of a leased asset, the lessee bears the risk and enjoys the
returns. The lessee benefits if the leased assets operates profitably, and suffers if the asset fails to
perform. Leasing separates ownership and use as two economic activities, and facilitates asset use
without ownership.

A lessee can be individual or a firm interested in the use of asset without owning. Lessors may be
equipment manufactures or leasing companies who bring together the manufacturers and the users.
In USA, equipment manufacturers are the larges group of lessors followed by banks. In India,
independent leasing companies form the major group in number of the leasing industry. Banks
together with financial institutions ------- the largest group in terms of the volume of business.

Types of Leases

Two types of leases can be distinguished:

• Operating lease
• Financial lease
• Sale-and-lease-back

Operating lease: Short-term, cancellable lease agreements are called operating leases. Convenience
and instant services are the hallmarks of operating leases. Examples are: a tourist renting a car, lease
contracts for computers, office equipment, car, trucks and hotel rooms. For assets such as computers
or office equipment, an operating lease may run for 3 to 5 years. The lessor is generally responsible
for maintenance and insurance. He may also provide other services. A single operating lease contract
may not fully amortise the original cost of the asset; it covers a period considerably shorter than the
useful life of the asset. Because of the short duration and the lessee’s option to cancel the lease, the
risk of obsolescence remains with the lessor. Naturally, the shorter the lease period and/or higher the
risk of obsolescence, the higher will be the lease rentals.
Financial lease: Long-term, non-cancellable lease contracts are known as financial leases. Examples
are plant, machinery, land, building, ships, and aircraft. In India, financial leases are very popular

78
with high-cost and high technology equipment. Financial leases amortise the cost of the asset over
the term of lease; they are, therefore, also called capital or full-payout leases. Most financial leases
are direct leases. The lessor buys the asset identified by the lessee from the manufacturer and signs a
contract to lease it out to the lessee.

Sale-and-lease-back: Sale-and-lease-back is a special financial lease arrangement. Sometimes, a

user may sell an (existing) asset owned by him to the lessor (leasing company) and lease it back from
him. Such sale-and-lease-back arrangements may provide substantial tax benefits. For example, in
April 1989, Shipping Credit and Investment Corporation of India (SCICI) purchased Great Eastern
Shipping Company’s bulk carrier, Jag Lata, for Rs. 12.5 crore and then leased it back to Great
Eastern on a five-year lease, the rentals being Rs. 28.13 lakh per month. The ship’s written-down
book value was Rs. 2.5 crore.

In financial lease, the maintenance and insurance are normally the responsibility of the lessee. The
lessee also bears the risk of obsolescence. A financial lease agreement may provide for renewal of
contract or purchase of the asset by the lessee after the contract expires. The option of purchasing the
leased asset by the lessee is not incorporated in the lease contract in India, because if such an option
is provided the lease is legally construed to be a hire purchase agreement.

There are a large number of lease terminologies used in practice. Exhibit explains some of the
commonly used lease terms.
EXHIBIT: COMMONLY USED LEASE TERMINOLOGY

Two basic types of lease are: (a) financial lease and (b) operating lease. Finance lease
in further divided into (i) leveraged lease, (ii) sale-and-lease-back, (iii) cross-
border lease.

• Leveraged lease: Leveraged lease involves lessor, lessee and financier. Lessor
(leasing company) provides equity equal to about 25 per cent of the asset’s cost
while the equal to about 25 per cent of the asset’s cost while the remaining amount
is provided by the financier (a bank or a financial institution), mainly as loan.
Leveraged lease is a popular method of financing expensive assets.

• Sale-and-lease-back: As discussed in the main text, the lessee first sells asset
owned by him to the lessor and then leases it back from the lessor. This provides
liquidity as well as possible tax gains to the lessee.

• Cross-border lease: In case of cross-border or international countries. Because the

lease transaction takes place between parties of two or more countries, it is called
cross-border lease. It involves relationships and tax implications more complex
than the domestic lease. When the lease transaction takes place between three
parties manufacturer/vendor, lessor and lessee in three different countries, it is
called foreign-to-foreign lease.

There many other terms used by the leasing industry. Some of the are defined
below.

79
 • Closed and open ended lease: In the close ended lease, the asset gets transferred to
the lessor at the end, and the risk of obsolescence, residual value etc. remain with
the lessor being the legal owner of the asset. In the open ended lease, the lessee has
the option of purchasing the asset at the end of lease.

• Direct lease: it is a mix of operating and finance lease on a full payout basis and
provides for the purchase option to the lessee.

• Master lease: Master lease provides for a period longer than the asset’s life and
holds the lessor responsible for providing equipment in good operating condition
during the lease period.

• Percentage lease: Percentage lease provide for a fixed rent plus some per cent of
the previous year’s gross revenue to be paid to the lessor.

• Wet and dry lease: In the aircraft industry, when the lease involves financing as
well as servicing and fuel, it is called wet lease. Dry lease provides only for
financing.

• Net net net lease: In the triple net (net net net) lease, the lessee is obliged to take
care of maintenance, taxes and insurance of the equipment.

• Update lease: Update lease is intended to protect the lessee against the risk of
obsolescence. The lessor agrees to replace obsolete asset with new one at specified
rent.

Venture Capital

Of late, Indian economy has witnessed the arrival of a few venture capital institutions to cater to the
need of industrial ventures involving higher risk on account of technology development and
upgradation.

The concept of venture capital is nurturing under the dictum “no innovative concept shall meet death
in its womb for genuine need for finance for venturism”.

There is a constant need for such institutions which could mobilise the savings and channelize them
into enterprises with innovative and untried business ideas that lack proven track record. Venture
capital companies, a recent phenomenon, have arrived in India. The term “Venture Capital”
comprises two words: “Venture” and “Capital”. Venture means a course of proceeding, the outcome
of which of uncertain but which is accompanied by the risk of danger of loss; ‘capital’ means
resources to start the enterprises. Thus, ‘venture capital’ implies committing resources (capital) to
enterprise that has risk and adventure, i.e., funds made available for financing of new business
ventures from scratch are called venture capital. The definition incorporates all high risk, high
potential investments. Venture capital is to finance the early stage of new company that wants to
grow rapidly.

However, the term venture capital is used to describe a variety of investment vehicles. A much wider
range of activities than purely start up situations are undertaken by the venture capital companies. It
is the investment of long term risk finance in new and untried enterprises that are ‘lacking a stable

80
record of growth’. It is the investment wherein the uncertainties have yet to be reduced to the risk
which normal financial institution is willing to take. Thus, venture capital has now become an
important source of finance for new enterprises. Journal Central Bank U.K. defines venture capital as
“an equity by which an investor supports an entrepreneurial talent with finance and business skills
to exploit market opportunities and, thus, obtain long term market gains”.

Thus, venture capital, besides providing funds, also provides skills needed to set up the firm, design
its marketing strategy, organise and manage it. Thus, it is a long term association with successive
stages of the company’s development under highly risky investment conditions, with distinctive type
of financing, appropriate to each stage of development investors join the entrepreneurs as co-
promoters and support the project with finance and business skills to exploit market opportunities.
The primary return sought by the investors ins an eventual capital gain, rather than a steady interest
income or dividend yield. All this differentiates a venture capital company from a finance or a
development finance institution.

The development finance aims at promotion of industry without any consideration for new
technology or new entrepreneurial venture. In majority of cases, development finance is a loan with a
very small proportion of equity, whereas, venture capital is primarily for new entrepreneurial
ventures often involving the use of new technologies and assistance provided is predominantly as
equity. While the venture capitalist has an interest in the overall management of project and is
involved in the project till the end

The development finance aims at promotion of industry without any consideration for new
technology or new entrepreneurial venture. In majority of cases, development finance is a loan with a
very small proportion of equity, whereas, venture capital is primarily for new entrepreneurial
ventures often involving the use of new technologies and assistance provided is predominantly as
equity. While the venture capitalist has an interest in the overall management of project and is
involved in the project till the end, i.e., its entering production and providing an exit route for
liquidation of the investment, the institution supplying the development loan have not say in the
enterprise except safeguarding its interest as investor of funds with no right to interfere in
management except ensuring flow of information and adherence to statutory requirement of effective
management control.

Some financial institutions provide ‘seed capital’ as equity or semi-equity. It is very akin to venture
capital but is normally provided to meet the gap in promoters contribution for normal project finance.
Development finance and the seed capital is security-oriented and liquidity prone. The seed capital is
given to deserving entrepreneurs with bankable projects and sufficient expertise to manage their
projects but lacking the equity. This equity is normally an interest free loan, the entrepreneurs pays a
service charge of 1 per cent and has to return the funds (equity provided a soft loan) after 5 to 7
years. The institution providing the seed capital looks for returns of the funds within 10-12 years.
The general criteria for investment are: proven track record of the promoters, successful
management, sufficient cash generation to provide for returns and so on. Mostly, such assistance is
provided to non innovative projects of smaller size with lowest risk. The venture capital companies
look for the commercial viability, select high risk projects wherein the expected returns, in case of
success, are much higher, i.e., IRR at 30 per cent and above. Venture capitalist aims at higher returns
by capital gains from high risk projects and finance upto 40 per cent of the project cost. The DFIs
and nationalised banks have realised the ineffectiveness of seed capital as a vehicle to promote new
ventures involving new technology, a new product and enterprise in innovative areas usually
involving high technology and have also started venture capital financing.

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The main characteristics of venture capital are:

1. Investments are generally in equity instruments where investor’s return is taxed as capital
gains rather than ordinary income.

2. Investments are mainly made in new enterprises using new technologies to produce
new products in expectation of higher gains or spectacular returns.

3. The investors are involved in management of the enterprises. However, venture capital
investors cannot interfere in day-to-day management of the enterprise but keep close with the
promoter to protect and enhance the investment.

4. The approach of the venture capitalist is different from that of a stock market investor as well
as that of a banker.

5. Venture capital investment, unlike a loan repayment schedule, is highly illiquid, i.e., not
subject to repayment on demand. The investment is realised only on enlistment or sale of
security or it is lost if the enterprise is liquidated for unsuccessful working.

IFCI and ICICI have set up specialised venture capital companies, namely, Risk Capital and
Technology Finance Corporation Ltd. (RCTC) now renamed IFCI Risk Finance Ltd. And
Technology Development and Information Company of India now renamed as ICICI Ventures Ltd.
IDBI, SBI and Canara Bank have set up specialised venture capital funds. The India Investment
Fund is a Venture Capital Fund set up by ANZ Grindlays Bank, besides State Government of Gujrat
and Tamil Nadu have set up venture capital companies to finance high technology, high risk
innovative projects in their states. Presently 21 venture capital funds/companies are operating in
India.

Stages of Funding / The Venture Capital Spectrum

Traditionally, venture capital financing has been thought of as the early stage financing of relatively
small but rapidly growing companies. However, in reality, the venture capital is far broader and more
complicated. Venture capital finance is a different stage of an enterprises development. Each stage of
corporate development in venture capital spectrum has distinct characteristics. Each venture capital
fund/firm has distinct aptitudes and appetites for various stages of venture capital financing. The
venture capital industry recognises these stages and plans capital financing. The venture capital
industry recognises these stages and plans its involvement on the basis of risk and timescale involved
as shown in below table.

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 Table

Time scale of
Stages Risk Investment
(Years)
I. Early Stage Investment
1. Seed Finance Extreme 7-10
2. Start up finance Very high 5-10
3. First stage finance High 4-6
4. Second stage finance High 3-7
II. Later Stage Investment
1. Development/expansion finance Medium 1-3
2. Replacement finance Medium 2-4
3. Turnaround recovery finance Medium 3-5
4. Buy-out/buy-in Medium 1-3

Early Stage Financing––Seed Finance

Seed capital is defined as the financing of the initial product development or the capital provided to
an entrepreneur to prove the feasibility of a project and qualify for start-up capital. Objectives at this
point in the enterprises life cycle include developing a comprehensive business plan, hiring a
management team and proving that the concept is viable or that the prototype works or meets
customer needs. Seed capital financing has the distinction of being the earliest and riskiest stage of
venture capital investment.

Star-up Finance

The start-up is widely recognised as the essence of venture capital activity. Start-up finance is
required for the product development, initial marketing and establishment of product facilities.
Enterprises at this stage may be in the process of being organised or they may have been in business
for a short time (one year or less). Risks are quite considerable in start-ups. The failure rate is in the
order of one in three, but nonetheless, it is a low price risk. Risk here can be controlled better as
additional financing depends upon the right performance of the company. There has been reluctance
on the part of traditional investors to fund the start-up stage but venture capitalists support such
ventures.

First Stage Finance

First stage financing is provided to enterprises that have expanded their initial capital often in
developing, test marketing a prototype and require funds to initiate full scale manufacturing and
sales. More venture capital providers go for first stage financing as compared to earlier stages as it is
the first wherein the two fundamental aspects of a business are in place, a fully assembled
management team and a marketable product. The number of risk factors like challenge from
competitors, obsolescence risk and defection of key personnel remain.

Second Stage Finance

Second round financing attracts more venture capitalists than first stage financing. Second stage
financing is additional injection of funds for the expansion of an enterprise that is producing and

83
shipping and already has growing accounts of receivables and inventories. Although the company
has made progress, it may not be showing profits yet. The reasons could be due to internal or
external factors. If the venture capitalist is fully aware of the genuine reasons for the loss, he should
decide on second round of financing. At this stage, original venture capital investor may reduce his
holding and bring in others to spread the risk.

Later Stage Financing

Third Stage / Mezzanine Finance/Development or Expansion Finance

An enterprise having been established in a particular market, needs finance for capacity expansion
and setting up proper distribution network so as to reach critical operating levels at which economies
of scale can be made. It is easier to get this finances as it has lower risk associated with it. Venture
capital funds seek to invest a small portion of their capital at this stage, as a hedge against having all
of their investment in earlier stages.

Replacement Capital / Money-Out Deal

Replacement capital essentially means substituting one shareholder for another, rather than raising
new capital. Need for this arise due to variety of reasons like one or more shareholders in need of
cash may be forced to sell their shares; differences between shareholders, owners and management,
etc. In these cases, the entrepreneur, instead of offloading their shares in the stock market, sells the
shares to an investing fund.

Turn Around / Recovery Finance

It is a rare from of later stage finance, in which few venture capitalists are prepared to invest because
they have to accept a significantly higher degree of risk as most of the situations end up in failure
despite hectic efforts. Turn around situations arise, when established company runs into touble (even
bankruptcy) and needs money to prepare for a major restructuring to revitalize profit growth.

Management Buy-Out / Buy-in

This state is defined in two ways, “Management buy-out” and “Management buy-in”. In
management buy-out, venture capitalist helps the professional management of an enterprise to buy or
take over the ownership of the business venture. This would help the management to restructure and
reorganise the enterprise. In management buy-in, outsiders buy the existing business. Tough such
financings are less risky, the same are financed by the venture capital firms as a part of later stage
financing.

Financing Instruments

Venture capital funds/firms have sufficient flexibility in providing financial assistance to the selected
ventures. They -------- innovative financial instruments. However, the common instruments are as
follow:

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Equity

Venture capital funds/companies normally take a minority position in the equity of the assisted
enterprise. While participating in the equity, they reserve the right to appoint nominee(s) on the
board of directors, authority to examine the books of accounts and conduct a concurrent audit. The
timing of disinvestment is at the venture capital’s option. Normally, they want to enterprise to list its
shares on the stock exchange. However, on certain occasions, venture capital firms go in for
innovative shares on deferred ordinary shares or some similar innovative instrument.

Financing Instruments

1. Equity.
2. Quasi-Equity/Hybridized Debt
3. Normal Debt.

Quasi Equity Instruments

The two types of quasi-equity loans used are:

(i) A loan whose servicing is linked entirely to the enterprises performance. Venture capitalist
participate totally in the downside and significantly in the upside in a manner agreed upon.

(ii) A loan having a minimum contracted obligation (e.g., payment of low level of interest or
even repayment of only a part of principal) irrespective of performance and on upside a
sharing component.

Quasi-equity normally contains a charge on the assets, collaterals, a royalty on sales above certain
levels or a share in profits. Protective covenants like appointing nominee directors or converting a
part of loan into equity are often a part of the deal.

Normal Debt

It is the least preferred financial instrument, both from the point of view of the entrepreneur as well
as the venture capital fund/firm. Either of the two is interested in regular cash flows. However, a
small part of the capital structure of new venture consists of normal debt. Venture capital funds/firms
normally provide debt to meet short/medium term requirements and to tide over temporary cash
shortages. The common debt instruments used are: term loan, fully, partly or non convertible
debentures, deep discount bonds, etc.

It is evident that in India, venture capital financing has come to stay. In Asian countries, 30 per cent
of the investment in venture capital comes from corporate sector while in India, only 8 per cent of
venture capital funds come from the corporate sector, and over 60 per cent is accounted by the All
Indian Financial Institutions. Thus, the growth potential for this type of findings are tremendous.

It is seen that venture capitalists have adopted two distinct and different routes, i.e., venture capital
funds and venture capital companies. Since the criteria of selection of projects for conventional and
venture capital financing are widely different, a separate venture capital company does a better
justice to venture capital financing and is normally better equipped to impart managerial skills, a
very essential part of venture capital financing.

85
 LESSON 3
PREPARATION OF FINAL ACCOUNTS
Ms. Shikha Gupta

After having checked the accuracy of the books of accounts through preparation of Trial Balance,
businessman wants to ascertain the profit earned or loss suffered during the year and also the
financial position of his business at the end of the year. For this purpose he prepares ‘Final Accounts’
which are also termed as ‘Financial Statement’. These include the following:
1. Trading Account
2. Profit and Loss Account
3. Balance Sheet

Trading Account

Trading account is prepared for calculating the gross profit or gross loss arising or incurred as a
result of the trading activities of a business. In other worlds, it is prepared to show the result of
manufacturing, buying and selling of goods. If the amount of sales exceeds the amount of purchases
and the expenses directly connected with such purchases, the difference is termed as gross profit. On
the contrary, if the purchases, and direct expenses exceed the sales, the difference is called gross loss.
A Trading Account records the amount of purchases of goods and also the expenses which are
incurred in bringing that commodity to a saleable state. IN other words, all expenses which relate to
either purchase of raw material for manufacturing of goods are recorded in the Trading Account. All
such expenses are called ‘Direct Expenses’. According to J.R. Batliboi, “The Trading Account shows
the results of buying and selling of goods. In preparing this account, the general establishment
charges are ignored and only the transaction in goods are included.”

Sometimes, a Trading Account is also called ‘Good A/c’ because all the transaction relating to goods
are recorded in it. Such as (i) Opening Stock, (ii) Purchases, (iii) Purchases Returns, (iv) Sales, (v)
Sales Returns, (vi) Closing Stock, (vii) Expenses incurred on manufacturing of goods, and (viii)
Expenses incurred on purchasing and bringing the goods to the trading place. All such expenses are
summarised and recorded in the Trading Account at the end of the year.

Need and Importance of Trading Account

Preparation of Trading Account serves the following objectives:

1. It provides information about Gross Profit and Gross Loss: It informs of the gross profit
or gross loss as a result of buying and selling the goods during the year. The percentage of
Current Year’s gross profit on the amount of sales can be calculated and compared with those
of the previous years. Thus, it provides data for comparison, analysis and planning for a
future period.

2. It provides information about the direct expenses: All the expenses incurred on the
purchase and manufacturing of goods are recorded in the trading account in a summarised
form. Percentage of such expenses on sales can be calculated and compared with those of the
previous years. In this way it enables the management to control and rationalise the expenses.

3. Comparison of closing stock with those of the previous years: closing stock has to be
valued and recorded in a trading account. This stock can be compared with the closing stock

86
 of the previous years and if the stock shows an increasing trend, the reasons may be inquired
into.

4. It provides safety against possible losses: If the ratio of gross profit has decreased in
comparison to the preceding year, the businessman can take effective measures to safeguard
himself against future losses. For example, he may increase the sale price of his gods or may
proceed to analyse and control the direct expenses.

Preparation of Trading Account

Trading Account is a Nominal Account and all expenses which relate to either purchase or
manufacturing of goods are written on the Dr. side of the Trading Account.

Item written on the Dr. side of the Trading Account:

1. Opening Stock: The stock of goods remaining unsold at the end of the previous year is
termed as the opening stock of the current year. In other words, the closing stock of the last
year becomes the opening stock of the current year. Opening Stock will include the
following:
I. Opening Stock of Raw Material.
II. Opening Stock of Semi-finished goods, and
III. Opening Stock of Finished goods.

2. Purchases and Purchases Returns: Goods which have been bought for resale are termed as
Purchases and goods which are returned to suppliers are termed as purchase returns or returns
outwards. Purchase Account will be given on the debit side of the trial balance and Purchase
Return Account on the credit side of the trial balance. Purchase returns will be shown as a
deduction from Purchases on the debit side of the trading account. Purchases include cash as
well as credit purchases.

3. Direct Expenses: All expenses incurred in purchasing the goods, brining them to the godown
and manufacture of goods are called direct expenses. Direct expenses include the following:

I. Wages: Wages are paid to workers who are directly engaged in the loading,
unloading and production of goods and as such are debited to the trading account. It
should be noted that:

(i) If the item ‘Wages and Salaries’ is given in the question it will be shown on
the trading account. On the contrary, if ‘Salaries and Wages’ is given it will be
shown on the profit & loss account.

(ii) If wages are paid for bringing a new machine or for its installation it will be
added to the cost of the machine and hence will not be shown in the trading
account.

II. Carriage or Carriage Inwards or Freight: These expenses should be debited to

trading account because these are generally paid for bringing the goods to the factory
or place of business. However, if any carriage or freight is paid on bringing an asset,
the amount should be added to the asset account and must not be debited to trading
account.

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 III. Manufacturing Expenses: All expenses incurred in the manufacture of goods are
shown on the debit side of the trading account such as Coal, Gas, Fuel, Water, Power,
Factory Rent, Factory Lighting etc.

IV. Dock Charges: These are the charges levied on ships and their cargo while entering
or leaving docks. If dock charges are paid on import of goods they are shown on the
debit side of trading account. In the absence of specific instructions, these are debited
to trading account.

V. Import Duty or Custom Duty: Custom Duty is paid on import as well as on export
of goods. Custom duty when paid on the purchase of goods is charged to trading
account. In the absence of specific instructions, these are debited to trading account.

VI. Octroi: This is levied by the Municipal Committee when the goods enter the city and
hence debited to trading account.

VII. Royalty: This is the amount paid to the owner of a mine or patent for using his right
or patent. Royalty is usually charged to trading account because it increases the cost
of production. However, if it is specifically stated in the question that the Royalty is
based on sales, it will be charged to Profit and Loss account.

Items written on the Cr. Side of the Trading Account:

1. Sales and Sales Returns: Both Cash and Credit sales will be included in sales. The sales
account will be a credit balance whereas, the sales return account or returns inwards account
will be a debit balance. Sales return will be deducted out of Sales on the credit side of the
trading account.

2. Closing Stock: The goods remaining unsold at the end of the year is known as Closing
Stock. It is valued at cost price or market price whichever is less. It includes the closing stock
of raw material, Closing Stock of semi-finished goods and Closing Stock of finished goods.

Normally, the Closing Stock is given outside the Trail Balance. This is so because its
valuation is made after the accounts have been closed. It is incorporated in the books by
means of the following entry:

Closing Stock A/c Dr.

To Trading A/c
(Closing Stock transferred to Trading A/c)

When the above entry is passed, the Closing Stock Account is opened. On the one hand, it
will be posted to the credit side of the trading account and on the other hand, will be shown
on the Assets side of the Balance Sheet, in order to complete the double entry. Sometimes,
the Closing Stock is given inside the Trail Balance. This mean that the entry to
incorporate the closing stock in the books has already been passed. It would imply that
the Closing Stock must have been deducted out of Purchases Account. Hence, in such a
case, Closing Stock will not be shown in the Trading Account but will appear on the
Assets side of the Balance Sheet only.

88
Closing Entries Relating to Trading Account

The preparation of the Trading Account requires that the balances of all such accounts which are due
to appear in the Trading Account are transferred to it. The entries required for such transfer are
termed as Closing entries. These will be as follows:

1. Purchases Return Account is closed by transferring its balance to Purchase Account.

Following entry is recorded for this purpose.

Purchases Return A/c Dr.

To Purchases A/c
(Transfer of Purchases Return Account to Purchases (Account)

2. Similarly, the Sales Return Account is closed by transferring its balance to the Sales Account
as:

Sales A/ct Dr.

To Sales Return A/c
(Transfer of Sales Return Account to Sales Account)

3. Closing entry for those accounts which are to be transferred to the Dr. side of the Trading
Account:

Trading A/c Dr.

To Opening Stock A/ct
To Purchases A/c
To Wages A/c
To Direct Expenses A/c
To Carriage A/c
To Gas, Fuel & Power A/c
To Freight, Octroi & Cartage A/c
To Manufacturing exp. A/c
To Factory Rent & Lighting A/c
To Custom Duty A/c
To Royalty A/c
(Transfer of above accounts to the Dr. side of the Trading A/c)

4. Closing entry for those accounts which are to be transferred to the Cr. Side of the Trading
Account:

Sales A/c Dr.

Closing Stock A/c Dr.
To Trading A/c
(Transfer of above accounts to the Cr. Side of the Trading A/c)

5. Another Closing entry is needed to close the trading account itself. If the credit side of the
Trading Account exceeds the debit, the difference will be Gross Profit. The Gross Profit will
be transferred to the credit of a newly opened account called profit and loss account:

89
 Trading A/c Dr.
To Profit & Loss A/c
(Transfer of Gross Profit to the Credit side of P & L A/c)

6. If the debt side of the Trading Account exceeds the credit, the difference will be Gross Loss.
It will be transferred to the debit of P & L a/c by means of the following entry:

Profit and Loss A/c Dr.

To Trading A/c
(Transfer of Gross Loss to the Debit side of P & L A/c)

Form of Trading Account

TRADING A/C
(for the year ended……………..)
Dr. Cr.
Particular Amount Particulars Amount
Rs. Rs.
To Opening Stock By Sales
To Purchases Less: Sales Returns
Less: Purchase Returns or
or Returns inwards
Returns outward By Closing Stock
To Wages By Gross loss
To Wages & Salaries (if any) transferred to Profit
To Direct Expenses and Loss A/c
To Carriage, or (Balancing Figure)
To Carriage inwards, or
To Carriage on Purchase
To Gas, Fuel and Power
To Freight, octroi and cartage
To Manufacturing Expenses, or
Productive Expenses
To Factory Expenses, such as:
Factory Lighting
Factory Rent etc.
To Dock Charges and Clearing
charges
To Import Duty or Custom duty
To Royalty
To Gross Profit
Transferred to P & L A/c
(Balancing Figures

Notes: (1) In the heading of the Trading Account the words ‘For the year ended……’ are
used. Because it discloses the position of the business for the full accounting year and
not at a particular point of time.

(2) No separate column for date is prepared in the Final Accounts because the date will
be already mentioned in the heading itself.

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 (3) No column for L.F. is prepared in Final Accounts because these are prepared from trial
balance and not from ledge accounts directly.

Illustration:

Prepare a Trading Account for the year ended 31st December 2010 from the following balances:
Rs. Rs.
Opening Stock 4,00,000 Purchases Return 1,20,000
Purchases 20,00,000 Sales Return 2,00,000
Sales 50,00,000 Carriage on Purchase 80,000
Freight and Octroi 65,000 Carriage on sales 1,00,000
Wages 3,00,000 Factory Rent 1,20,000
Factory Lighting 1,08,000 Office Rent 75,000
Coal, Gas and Water 22,000 Import Duty 3,20,000

Closing Stock is valued at Rs. 6,00,000.

Solution:
TRADING A/C
(for the year ended……………..)
Dr. Cr.
Particular Amount Particulars Amount
Rs. Rs.
To Opening Stock 4,00,000 By Sales 50,00,000
To Purchases 20,00,000 Less: Sales Returns 2,00,000 48,00,000
Less: Purchases By Closing Stock 6,00,000
Return 1,20,000 18,80,000
To Freight and Octroi 65,000
To Wages 3,00,000
To Factory Lighting 1,08,000
To Coal, Gas and
Water 22,000
To Carriage on
Purchase 80,000
To Factory Rent 1,20,000
To Import Duty 3,20,000
To Gross Profit
transferred to
Profit & Loss A/c 21,05,000
54,00,000 54,00,000

Profit And Loss Account

Trading account only discloses the gross profit earned as a result of buying and selling of goods.
However, a businessman has to incur a number of expenses which are not taken to trading account.
Hence, a businessman is more interested in knowing the net profit earned or net loss incurred during
the year. As such, a Profit & Loss Account is prepared which contains all the items of losses and
gains pertaining to the accounting period. According to Prof. Carter, “A Profit & Loss Account is an
account into which all gains and losses are collected, in order to ascertain the excess gains over the
losses or vice-versa”.

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Need and Importance of Profit & Loss A/c

1. To Ascertain the Net Profit or Net Loss: A Trading Account only discloses the Gross Profit
earned as a result of trading activities, whereas the Profit & Loss Account discloses the net
profit (or net loss) available to the proprietor and credited to his capital account.

2. Comparison with previous years’ profit: The net profit of the current year can be compared
with that of the previous years. It enables the businessman to know whether the business is
being conducted efficiently or no.

3. Control on Expenses: Profit & Loss Account helps in comparing various expenses with the
expenses of the previous year. Also the percentage of each individual expenses to net profit is
calculated and compared with the similar ratio of previous years. Such comparison will be
helpful in taking concrete steps for controlling the unnecessary expenses.

4. Helpful in the preparation of Balance Sheet: A Balance Sheet can only be prepared after
ascertaining the Net Profit through the preparation of Profit and Loss Account.

Preparation of Profit and Loss Account

A Profit and Loss Account is started with the amount of gross profit or gross loss brought down from
the Trading Account. As such, all those expenses and losses which have not been debited to the
Trading Account are now debited to Profit & Loss Account. These expenses include administrative
expenses, selling expenses, distribution expenses etc. These are called ‘Indirect Expenses’. Profit and
Loss Account is a Nominal Account and as such, all the expenses and losses are shown on its debit
side and all the incomes and gains are shown on its credit side.

Items written on the Dr. side of Profit & Loss Account

1. Gross Loss: If trading account discloses Gross Loss, it is shown on the debit side first of all.

2. Office and Administrative Expenses: Such as salary of office employees, office rent,
lighting, postage, printing, legal charges, audit fee etc.

3. Selling and Distribution Expenses: Such as advertisement charges, commission, carriage

outwards, bad-debts, packing charges etc.
4. Miscellaneous Expenses: Such as interest on loan, interest on capital, repair charges,
depreciation, charity etc.

Items written on the Cr. side of Profit & Loss Account

1. Gross Profit: the starting point of the Cr. side of Profit and Loss Account is the gross profit
brought down from the Trading Account.

2. Other Incomes and Gains: All items of incomes and gains are shown on the credit side of
the Profit & Loss Account, such as income from investments, rent received, discount
received, commission earned, interest received, dividend received etc.

If the credit side of the profit and loss account exceeds that of debit side, the difference is
termed as net profit. On the other hand, the excess of the debit side over the credit side is

92
 termed as net loss. Net profit is added to the capital whereas net loss is deducted from the
capital.

Closing Entries relating to Profit and Loss Account

The preparation of profit and loss account requires that the balances of all concerned items are
transferred to it by passing the following closing entries:

1. Accounts of various items of expenses and losses are transferred to the debit side of Profit
and Loss Account by means of the following entry:

Profit and Loss A/c Dr.

To Salaries A/c
To Rent, Rates and Taxes A/c
To Printing and Stationer A/c
To Postage and Telegrams A/c
To General Expenses etc.
(Transfer of nominal accounts showing Dr. balances to the Debit of P & L A/c)

2. Balances of all the accounts of incomes and gains will be transferred to the credit side of
Profit and Loss Account by means of the following entry:

Interest Received A/c Dr.

Commission Received A/c Dr.
Rent Received A/c Dr.
To Profit and Loss A/c
(Transfer of nominal accounts showing Cr. balances to the Credit of P & L A/c)

3. For the transfer of credit balance of Profit & Loss A/c, known as net profit:

Profit and Loss A/c Dr.

To Capital A/c
(Transfer of net profit to Capital A/c)

4. For the transfer of debit balance of Profit & Loss A/c, known as net loss:

Capital A/c Dr.

To Profit and Loss A/c
(Transfer of net loss to Capital A/c)

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Form of Profit and Loss Account
PROFIT AND LOSS A/C
(for the year ending………….)
Dr. Cr.
Particular Amount Particulars Amount
Rs. Rs.
To Gross Loss b/d (if any) By Gross Profit b/d
(Transferred from Trading A/c) (Transferred from Trading A/c)
Office Expenses: By Rent from Tenant
To Salaries By Rent (Cr.)
To Salaries & Wages By Discount received
To Rent, Rates & Taxes or discount (Cr.)
To Printing & Stationery By Commission Received
To Postage & Telegram By Interest on Investments
To Lighting By Dividend on Shares
To Insurance Premium By Bad-Debts Recovered
To Telephone Charges By apprentice Premium*
To Legal Charges By Profit on sale of Assets
To Audit Fees By Income from other Sources
To Travelling Expenses By Miscellaneous Receipts
To Establishment Expenses By Net Loss (if any)
To Trade Expenses Transferred to Capital A/c
To General Expenses
Selling and Distribution Expenses:
To Carriage Outwards, or
Carriage on Sales
To Advertisement
To Commission
To Brokerage
To Bad-debts
To Export Duty
Packing charges
To Delivery Van Expenses
To Stable Expenses
Miscellaneous Expenses:
To Discount
To Repairs
To Depreciation
To Interest (Dr.)
To Bank Charges
To Entertainment Expenses
To Conveyance Expenses
To Donation and Charity
To Loss on Sale of Assets
To Net Profit:
Transferred to Capital A/c

Notes: (1) Those expenses which are not related to the business are not written in the Profit and
Loss Account such as (i) Domestic and household expenses of the proprietor, (ii)
Income-Tax, and (iii) Life Insurance Premium etc. These expenses are known as
Drawings and deducted from Capital at the liabilities side of the Balance Sheet.

94
 (2) Only those items of expenses and incomes are shown in the Profit & Loss Account
which have not been shown in the Trading Account.
* Income received by providing training to someone is called “Apprentice Premium”.

Illustration:
From the following particulars, prepare a Profit & Loss Account for the year ending 31st December,
2010.
Rs. Rs.
Gross Profit 21,05,000 Discount allowed 30,000
Trade Expenses 20,000 Lighting 7,800
Carriage on Sales 1,00,000 Commission Received 8,400
Office Salaries 1,58,000 Bad-debts 12,000
Postage and Telegram 7,200 Discount (Cr.) 6,000
Office Rent 75,00 Interest on Loan 22,000
Legal Charges 4,000 Stable Expenses 14,000
Audit Fee 16,000 Export Duty 23,000
Donation 11,000 Miscellaneous Receipts 5,000
Sundry Expenses 3,600 Unproductive Expenses 41,000
Selling Expenses 53,200 Travelling Expenses 25,000
Solution:
PROFIT AND LOSS ACCOUNT
for the year ending on 31st December, 2010
Dr. Cr.
Particulars Amount Particulars Amount
Rs. Rs.
To Trade Expenses 20,000 By Gross Profit 21,05,000
To Carriage on Sales 1,00,000 By Commission Received 8,400
To Office Salaries 1,58,000 By Discount 6,000
To Postage & Telegram 7,200 By Miscellaneous Receipts 5,000
To Office Rent 75,000
To Legal Charges 4,000
To Audit Fee 16,000
To Donation 11,000
To Sundry Expenses 3,600
To Selling Expenses 53,200
To Discount Allowed 30,000
To Lighting 7,800
To Bad-Debts 12,000
To Interest on Loan 22,000
To Stable Expenses 14,000
To Export Duty 23,000
To Unproductive Expenses 41,000
To Travelling Expenses 25,000
To Net Profit transferred to
Capital Account 15,01,600
21,24,400 21,24,400

95
Balance Sheet

After ascertaining the net profit or loss of the business enterprise, the businessman would also like to
know the exact financial position of his business. For this purpose a statement is prepared which
contains all the Assets and Liabilities of the business enterprise. The statement so prepared is called a
Balance Sheet because it is a sheet of balances of ledger accounts which are still open after the
transfer of all nominal accounts to the Trading and Profit & Loss Account. Balances of all the
personal and real accounts are grouped as assets and liabilities. Liabilities are shown on the left hand
side o the Balance Sheet and assets on the right hand side.

Definitions: A Balance Sheet has been defined as follows:

In the words of Karlson, “A business form showing what is owed and what the proprietor is worth, is
called a Balance Sheet.”

According to A. Palmer, “The Balance Sheet is a statement at a particular date showing on one side
the trader’s property and possessions and on the other hand the liabilities.”

According to J.R. Batliboi, “A Balance Sheet is a statement prepared with a view to measure the
exact financial position of a business on a certain fixed date.”

Need and Importance of Preparing a Balance Sheet

The purposes of preparing a Balance Sheet are as follows:

1. The main purpose of preparing a Balance Sheet is to ascertain the true financial position of
the business at a particular point of time.

2. It helps in ascertaining the nature and cost of various assets o the business such as the amount
of Closing Stock, amount owing from Debtors, amount of fictitious assets etc.

3. It helps in determining the nature and amount of various liabilities of the business.

4. It gives information about the exact amount of capital at the end of the year and the addition
or deduction made into it in the current year.

5. It helps in finding out whether the firm is solvent or not. The firm is solvent if the assets
exceed the external liabilities. It would be insolvent if opposite is the case.

6. It helps in preparing the Opening Entries at the beginning of the next year.

Drafting a Balance Sheet

Characteristics of Balance Sheet:

1. A Balance Sheet is a part of the Final Account. This is the reason that the Trading and Profit
&Loss Account and the Balance Sheet are together called ‘Final Accounts’. However, the
Balance Sheet is a statement and not an account. It has no debit or credit side and as such the
words ‘To’ and ‘By’ are not used before the names of the accounts written therein.

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2. A Balance Sheet is a summary of the Personal and Real Accounts, which are still open and
have not been closed by transfer to the Trading and Profit & Loss Account. Debit balances of
all Personal and Real Accounts are put on the right hand side known as Assets side, whereas
the credit balances are put on the left hand side known as Liabilities side.

3. The totals of the two sides of the Balance Sheet must be equal. If the totals are not equal,
there will be an error somewhere.

4. Balance sheet is prepared on a particular date and not for a fixed period. As such, it discloses
the financial position of a business on a particular date and not for a period. It is True only for
the date on which it is prepared because even a single transaction would cause a change in the
assets and liabilities.

5. It shows the financial position of the business according to the going concern concept.

Grouping and Marshalling of Assets and Liabilities in Balance Sheet

The Assets and Liabilities shown in the Balance Sheet are properly grouped and presented in a
particular order. The term ‘grouping’ means showing the items of similar nature under a common
heading. For example, the amount owing from various customers will be shown under the heading
‘Sundry Debtors’. Similarly, under the heading ‘Current Assets’, the balance of Cash, bank, debtors,
stock etc. will be shown.

‘Marshalling’ is the arrangement of various assets and liabilities in a proper order. Marshalling can
be made in one of the following two ways:

1. In the Order of Liquidity: According to this method, an asset which is most easily
convertible into Cash such as Cash in hand is written first and then will follow those asses
which are comparatively less easily convertible, so that the least liquid asset such as
goodwill, is shown last.

In the same way, those liabilities which are to be paid at the earliest will be written first. In
other words, current liabilities are written first of all, then fixed or long-term liabilities and
lastly, the proprietor’s capital.

Generally, sole proprietors and partnership firms prepare their Balance Sheet in the order of
liquidity. Proforma of a Balance Sheet in the order of liquidity will be as follows:

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 BALANCE SHEET
as on or as at………………….
Particular Amount Particulars Amount
Rs. Rs.
Current Liabilities: Current Assets:
Bank Overdraft Cash in Hand
Bill Payable Cash at Bank
Sundry Creditors Bills Receivable
Outstanding Expenses Short Term Investments
Unearned Income Sundry Debtors
Fixed Liabilities: Closing Stock
Long Term Loans Prepaid Expenses(3)
Reserves: Accrued Income
Capital: Fixed Assets:
Add: Net Profit Furniture
Less: Drawings Loose Tools
Less: Income Tax Motor Vehicle
Less: Life Insurance Premium Long Term Investments
Plant and Machinery
Land and Buildings
Patents
Goodwill

Notes: (1) The words ‘As at’ or ‘As on’ are used in the heading of the Balance Sheet. Because it is
true only for the date on which it is prepared.

(2) The total of both the sides of the Balance Sheet is always equal.

(3) Prepaid expenses are treated as current assets. Though Cash cannot be realised
from prepaid expenses, the service will be available against these without further
payment.

2. In the Order of Permanence: This method is exactly the reverse of the first method
discussed above. Assets which are most difficult to be converted into cash such as Goodwill
are written first and the assets which are most liquid such as Cash in hand are written last.
Similarly, those liabilities which are to be paid last, will be written first. In other words, the
proprietor’s capital is written first of all, then fixed or long term liabilities and lastly, the
current liabilities. Joint stock companies are required under the Companies Act to prepare
their Balance Sheet in the order of permanence.

It is essential to understand the classification of various assets and liabilities before preparing
a Balance Sheet.

Classification of Assets

According to the nature of assets, these may be classified into the following:

1. Fixed Assets: Fixed assets are those which are acquired for continued use and last for many
years such as Land & Building, Plant and Machinery, Motor Vehicles, Furniture etc.

98
 According to Finney & Miller, “Fixed Assets are assets of a relatively permanent nature used
in the operations of business and not intended for sale.”

As the purpose of keeping such assets is not to sell but use them, changes in their market
values are ignored and these are always shown in the Balance Sheet at cost less depreciation.

2. Current Assets: Current assets are those which are either in the form of cash or can be easily
converted into cash within one year of the date of Balance Sheet. In the words of Hovard &
Upton, “The current assets are usually defined as those assets which are convertible into cash
through the normal course of business within a short time ordinarily in a year.”

Current assets include Cash, Bills Receivable, Short Term Investments, Debtors, Prepaid
Expenses, Accrued Income, Closing Stock etc. While valuing these assets, Closing Stock is
valued at cost or realisable value whichever is less and a reasonable provision for doubtful
debts is deducted out of Sundry Debtors.

3. Liquid Assets: Liquid assets are those which are either in the form of Cash or can be quickly
converted into cash, such as Cash, Bills Receivable, Short Term Investments, Debtors,
Accrued Income etc. In other words, if Prepaid Expenses and Closing Stock are excluded
from Current Assets, the balance will be Liquid Assets.

4. Fictitious or Nominal Assets: These are the assets which cannot be realised in Cash or no
further benefit can be derived from these assets. Such assets include Debit balance of P & L
A/c and the expenditure not yet written off such as Advertisement Expenses etc. These assets
are not really assets but are shown on the Assets side only for the purpose of transferring
them to the Profit & Loss Account gradually over a period of time.

5. Wasting Assets: These are the assets which are exhausted or consumed over a period of time
such as mines and oil wells. Their value reduces through being worked. These also include
Patents and the properties taken on lease for a defi9nite period of time.

6. Tangible and Intangible Assets: Tangible asses are those which have a physical existence
or which can be seen and felt like Plant and Machinery, Building, Furniture, Stock, Cash etc.
Intangible assets are those which do not have any physical existence or which cannot been
seen or felt such as the Goodwill, Trade Marks, Patents etc. Intangible assets are as much
valuable as tangible assets because they also help the firm in earning profits. For example,
Goodwill helps in attracting customers and patents are actually the know-how which help in
producing the goods.

Classification of Liabilities

According to their nature, the liabilities may be classified as follows:

1. Fixed or Long-term Liabilities: Those liabilities which are to be repaid after one year or
more are termed as long-term liabilities. These include Public Deposits, Long-term Loans,
Debentures etc.

2. Current or Short-term Liabilities: Those liabilities which are expected to be paid within
one year of the date of the Balance Sheet are termed as current or short-term liabilities. These
include Bank Overdraft, Creditors, Bills Payable, Outstanding expenses etc.

99
3. Contingent Liabilities: These are the liabilities which will become payable only on the
happening of some specific event, otherwise not. Such as:

(i) Liabilities for bill discounted: In case a bill discounted from the bank is dishonoured
by the acceptor on the due date, the firm will become liable to the bank.

(ii) Liability in respect of a suit pending in a court of law: This would become an
actual liability if the suit is decided against the firm.

(iii) Liability in respect of a guarantee given for another person: The firm would
become liable to pay the amount if the person for whom guarantee is given fails to
meet his obligation.

Contingent liabilities are not shown in the Balance Sheet: They are, however, shown as a footnote
just below the balance sheet so that their existence may be revealed.

Difference between Trial Balance and Balance Sheet

S.No. Basis of Trial Balance Balance Sheet

Difference
1. Object It is prepared to check the It is prepared to know the true
arithmetical accuracy of the financial position of the firm.
books of accounts.
2. Information It is not possible to have Since net profit or loss is
about profit information about net profit or recorded in the Capital shown in
or loss net Balance Sheet, it is possible to
have the information about net
profit or net loss from a Balance
Sheet.
3. Necessity Though desirable, its preparation It is necessary to prepare a
is not necessary. Balance Sheet.
4. Headings The headings of its two columns The headings of its two sides are
are debit and credit. assets and liabilities.
5. Period It is normally prepared every It is normally prepared half-
month or whenever needed. yearly or yearly at the end of the
accounting period.
6. Types of All types of accounts whether Only personal and real accounts
Accounts personal, real or nominal must be are included in it.
written in it.
7. Closing Normally, it does not contain the It contains the item of Closing
Stock item of Closing Stock. Stock.
8. Adjustments It can be prepared without It cannot be prepared without
making adjustments for making adjustments for
outstanding expenses, prepaid outstanding expenses, prepaid
expenses, accrued incomes etc. expenses, accrued incomes etc.
9. Evidence It is not accepted by the court as It is accepted by the court as
documentary evidence. documentary evidence. It is also
helpful while making payment
of income-tax and sales-tax.

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Following points should be noted for preparing Final Accounts:

1. If a trial balance is not given in the question, it is better to prepare a Trial Balance first of all.
If there is a difference in the Trial Balance, the difference is placed to a ‘Suspense A/c’ and
shown in the Balance Sheet.

2. It should be remembered that all items which appear in the Trial Balance should be shown
only once whereas items which appear outside the Trial Balance, known as adjustments, have
to be shown at two places.

3. The items which appear on the debit side of the Trial Balance should be shown either on the
debit side of the Trading or Profit and Loss A/c or on the Assets side of the Balance Sheet.

4. The items which appear on the credit side of the Trial Balance should be shown either on the
credit side of the Trading or Profit & Loss A/c or on the Liabilities side of the Balance Sheet.

5. All accounts relating to Goods such as Purchases, Sales, Purchase Returns and Sales Returns
are written in the Trading Account. In addition to these, the Trading Account will also be
debited with all expenses which are directly related to either purchase or manufacturing of
goods. All the remaining expenses or the balances of the Nominal Accounts are shown in the
Profit & Loss Account.

6. The balances of Personal and Real Accounts are always shown in the Balance Sheet.

7. If the expenses in respect of ‘Rent’ and ‘Lighting’ are clearly stated as having been incurred
in respect of factory, these will be shown in the Trading Account, otherwise these will be
shown in Profit & Loss Account. For example, if ‘Factory Rent’ is given in the question, it
will be shown in Trading Account. Instead, if ‘Rent’ is given, it will be shown in Profit &
Loss Account.

8. If a trial balance is not given in the question, and it is not clearly stated whether a particular
item is expense or income, it will be treated as expense such as Discount, commission,
Brokerage or Rent etc.

9. The total of both sides of the Balance Sheet will always be equal.

Illustration:

From the following balances of Siya Ram, Prepare a Balance Sheet as on 31st December, 2010.

Particulars Amount (Dr.) Amount (Cr.)

Plant and machinery 8,00,000
Land and Building 6,00,000
Furniture 1,50,000
Cash in Hand 20,000
Bank Overdraft 1,80,000
Debtors and Creditors 3,20,000 2,40,000
Bills Receivable and Bill Payable 1,00,000 60,000

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Closing Stock 4,00,000
Investments (Short-term) 80,000
Capital 15,00,000
Drawings 1,30,000
Net Profit 6,20,000
26,00,0000 26,00,0000

Solution:
BALANCE SHEET
as on 31st December, 2010
Liabilities Amount Assets Amount
Rs. Rs.
Bank overdraft 1,80,000 Cash in Hand 20,000
B/P 60,000 B/R 1,00,000
Creditors 2,40,000 Investments (Short-term) 80,000
Capital Debtors 3,20,000
Add: Net Profit 15,00,000 Closing Stock 4,00,000
6,20,000 Furniture 1,50,000
21,20,000 Plant & Machinery 8,00,000
Less: Drawings 1,30,000 19,90,000 Land & Building 6,00,000
24,70,000 24,70,000

Illustration:

From the following Trial Balance of Radhe Shyam Trading and Profit and Loss A/c for the year
ending 31st December, 2010 and Balance Sheet as on that date. The Closing Stock on 31st December,
2010 was valued at Rs. 2,50,000.

Debit Balances Amount Credit Balance Amount

(Rs.) (Rs.)
Stock (1-1-2010) 2,00,000 Sundry Creditors 1,50,000
Purchases 7,50,000 Purchases Return 30,000
Sales Return 80,000 Sales 25,00,000
Freight and Carriage 75,000 Commission 33,000
Wages 3,65,000 Capital 17,00,000
Salaries 1,20,000 Interest on Bank Deposit 20,000
Repairs 12,000 B/P 62,000
Trade Expenses 40,000
Rent and Taxes 2,40,000
Cash in Hand 57,000
B/R 40,000
5,50,000
Plant and Machinery 16,00,000
Withdrawals (Drawings) 1,66,000
Bank Deposit 2,00,000
44,95,000 44,95,000

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Solution:
TRADING AND PROFIT & LOSS ACCOUNT
for the year ending 31st December, 2010
Liabilities Amount Assets Amount
Rs. Rs.
To Opening Stock 2,00,000 By Sales 25,00,000
To Purchases 7,50,000 Less: Sales Return 80,000 24,20,000
Less: Purchases By Closing Stock 2,50,000
Return 30,000 7,20,000
To Freight & 75,000
Carriage
To Wages 3,65,000
To Gross Profit c/d 13,10,000
26,70,000 26,70,000
To Salaries 1,20,000 By Gross Profit b/d 13,10,000
To Repairs 12,000 By Commission 33,000
To Trade Expenses 40,000 By Interest on Bank 20,000
Deposit
To Rent & Taxes 2,40,000
To Net profit
transferred to
Capital A/c 9,51,000
13,63,000 13,63,000

BALANCE SHEET
as on 31st December, 2010
Liabilities Amount Assets Amount
Rs. Rs.
B/P 62,000 Cash in Hand 57,000
Sundry Creditors 1,50,000 B/R 40,000
Capital 17,00,000 Sundry Debtors 5,50,000
Add: Net Profit 9,50,000 Closing Stock 2,50,000
26,51,000 Bank Deposit 2,00,000
Less: Drawings 1,66,000 24,85,000 Plant & Machinery 16,00,000
26,97,000 26,97,000

Note: The heading of Trading A/c and Profit & Loss A/c is put collectively as ‘Trading and Profit
& Loss A/c’. The first part of this Account is Trading A/c, whereas the second part is Profit
& Loss A/c. Trading Account, in fact, is apart of Profit & Loss Account.

Illustration:

From the following balances prepare a Trading, Profit & Loss Account and Balance Sheet.

Rs. Rs.
Carriage on Goods Purchased 80,000 Cash in Hand 25,000
Carriage on Goods Sold 35,000 Banker’s A/c (Cr.) 3,00,000
Manufacturing Expenses 4,20,000 Motor Car 6,00,000
Advertisement 70,000 Drawings 80,000
Freight and Octroi 44,000 Audit Fees 27,000
Lighting 60,000 Plant 15,39,000
Customer’s A/c 8,00,000 Repairs to Plant 22,000

103
Supplier’s A/c 6,10,000 Stock at the end 7,60,000
Duty and Clearing Charges 52,000 Purchase Less Returns 16,00,000
Postage and Telegram 8,000 Commission on Purchases 20,000
Fire Insurance Premium 36,000 Incidental Trade Exp. 32,000
Patents 1,20,000 Investments 3,00,000
Income Tax 2,40,000 Interest on Investments 45,000
Office Expenses 72,000 Capital A/c 10,00,000
Sales Less Returns 52,00,000
Rent 1,20,000
Discount Paid 27,000
Discount on Purchases 34,000

Solution:
TRADING AND PROFIT & LOSS ACCOUNT
for the year ending ……………………

Rs. Rs.
To Purchases Less Returns 16,00,000 By Sales Less Returns 52,00,000
To Commission on Purchases 20,000
To Carriage on goods Purchased 80,000
To Manufacturing Expenses 4,20,000
To Freight and Octroi 44,000
To Duty & Clearing Charges 52,000
To Gross Profit c/d 29,84,000
52,00,000 52,00,000
To Carriage on Goods Sold 35,000 By Gross Profit b/d 29,84,000
To Advertisement 70,000 By Interest on Investments 45,000
To Lighting 60,000 By Discount on Purchases 34,000
To Postage & Telegram 8,000
To Fire Insurance Premium 36,000
To Office Expenses 72,000
To Audit Fees 27,000
To Repair to Plant 22,000
To Incidental Trade Expenses 32,000
To Rent 1,20,000
To Discount Paid 27,000
To Net Profit Transferred to
Capital A/c 25,54,000
30,63,000 30,63,000

Note: If Closing Stock appears inside the Trial Balance, it will be shown only at one place, i.e., only
on the assets side of the Balance Sheet.

Illustration:
From the following balances prepare Final Accounts as on 31st December, 2010.
Rs. Rs.
Opening Stock 1,53,100 Capital 25,00,000
Purchase 8,24,000 Drawings 4,80,000
Sales 25,60,000 Sundry Debtors 5,70,000
Returns (Dr.) 40,000 Sundry Creditors 1,40,000

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Returns (Cr.) 24,000 Depreciation 42,000
Factory Rent 1,80,000 Charity 5,000
Custom Duty 1,15,000 Cash Balance 44,600
Coal, Gas and Power 60,000 Bank Balance 40,000
Wages & Salary 3,66,000 Bank Charges 1,800
Discount (Dr.) 75,000 Establishment Expenses 36,000
Commission (Cr.) 12,000 Plant 4,20,000
Bad-Debts 58,500 Leasehold Building 15,00,000
Bad-Debts Recovered 20,000 Goodwill 2,00,000
Apprentice Premium 48,000 Patents 1,00,000
Productive Expenses 26,000 Trade Marks 50,000
Unproductive Expenses 50,000 Loan Cr. 2,50,000
Carriage 87,000 Interest on Loan 30,000

The value of Closing Stock on 31st December, 2010 was Rs. 2,54,000.

Solution:
TRADING AND PROFIT & LOSS ACCOUNT
for the year ending 31st December, 2010
Rs. Rs.
To Opening Stock 1,53,100 By Sales 25,60,000
To Purchases 8,24,000 Less: Returns (Dr.) 40,000 25,20,000
Less: Returns (Cr.) 24,000 8,00,00 By Closing Stock 2,54,000
To Factory Rent 1,80,000
To Custom Duty 1,15,000(1)
To Coal, Gas and
Power 60,000
To Wages & Salary 3,66,000
To Productive Expenses 26,000
To Carriage 87,000
To Gross Profit c/d 9,86,900
27,74,000 27,74,000
To Discount 75,000 By Gross Profit b/d 9,86,900
To Bad-Debts 58,500 By Commission 12,000
To Unproductive By Bad Debts
Expenses 50,000 Recovered 20,000
To Depreciation 42,000 By Apprentice Premium 48,000(2)
To Charity 5,000
To Bank Charges 1,800
To Establishment
Expenses 36,000
To Interest on Loan 30,000
To Net Profit transferred
to Capital A/c 7,68,600
10,66,900 10,66,900
BALANCE SHEET
as on 31st December, 2010
Liabilities Amount Assets Amount
Rs. Rs.
Sundry Creditors 1,40,000 Cash Balance 44,600
Loan 2,50,000 Bank Balance 40,000
Capital 25,00,000 Sundry Debtors 5,70,000
Add: Net Profit 7,68,600 Closing Stock 2,54,000

105
 32,68,600 Plant 4,20,000
Less: Drawings 4,80,000 27,88,600 Leasehold Building 15,00,000
Patents 1,00,000
Trade Marks 50,000
Goodwill 2,00,000
31,78,600 31,78,600

106
 LESSON 4
BANK RECONCILIATION STATEMENT
Ms. Shikha Gupta

It is customary for a bank to send to its customer regularly a statement showing how his account
stands. Usually, there is a regular little book through which the bank informs the customer as to what
balance he has at the bank. This is the Bank Pass Book. It contains a copy of the customer’s account
at the bank. It stands to reason that the balance shown by the Pass Book should agree with the bank
balance shown by the Cash Book. However, often there is a difference even if there is no mistake.
The difference is due to the following reasons:

1. Cheques recorded in cash book but not yet credited by bank: Cheque received are entered
in the Cash book as soon as they are received. There may be a delay of a day or two in
sending the cheques to the bank. Moreover, the bank, usually, does not credit the customer
until the cheques are realised; if they are on other banks, it means delay. In the meantime,
therefore, the Cash Book will show more balance than what the bank shows in the customer’s
account.

2. Cheques issued but not yet presented for payment: As soon as cheques are issued, they are
entered in the Cash Book, but the bank, again, makes no entry until the cheques are actually
presented for payment and are paid. This makes no entry until the cheques are actually
presented for payment and are paid. This

3. Bank charges: The bank often makes charges for services it renders; these are known as
bank charges. If there is an overdraft, the bank will also charge interest. These bank charges
and interest are entered in the Pass Book and the entry is generally made in the Cash Book
only when the Pass Book is received.

4. Direct collections by bank: The bank is often entrusted with the task of collecting interest
on securities or dividends on shares or even the collection of amounts due on bills of
exchange or promissory notes. The bank will credit the customer as soon as the amounts are
received but the entry by the customer in the Cash Book must await receipt of information by
the customer from the bank.

5. Payments by bank as per standing instructions: The bank may also make payments
according to the standing instructions of the client or in respect of any special instruction
such as payment on presentation of documents for supply of goods for which a letter of credit
has been opened previously. Entries in the Cash Book in such cases are made on receipt of
advice from the bank.

These delays do not ordinarily matter, as sooner or later, both the bank and the client will make
entries. However, to know the position clearly and to be sure that no mistakes have been committed,
there must be a statement to explain why there is a difference between the balance shown by the Pass
Book and that shown by the Cash Book on a particular date. The statement is known as the Bank
Reconciliation Statement. It should be prepared every month at the latest. If bank transactions are
large in number, the statement may be prepared at the end of every week. It helps management to
check the accuracy of the entries made in the Cash Book and keep track of cheques, etc., which may
have been sent to the bank for collection. Preparation of the bank reconciliation statement is a very
important control technique. It often reveals frauds committed by the staff handing cash and cheques.
Apart from misappropriation of cash, recorded as sent to the bank but not really sent, it may reveal

107
 teeming and lading also––when cash meant to be banked is used by the cashier for his private
purposes and the banking is done out of a later collection. The dates of entries in the Cash Book and
the Pass Book in respect of cash should be the same or at the most different only by one day. Any
cheque remaining uncleared for an unreasonable length of time should be traced and reasons
ascertained for the delay.

How the Cash Book (bank columns) and the Pass Book should be compared will be clear from the
following:

CASH BOOK (BANK COLUMNS ONLY)

Amount Amount
Date Particular Date Particulars
Rs. Rs.
2005 2005
Jan. 2 To Cash 4,00,000 Jan. 5 By Rajesh & Co. 50,000
4 To Berco & Co., Ajmer 20,000 10 By Cash 60,000
8 To J. D’Suza 30,000 14 By S. Jain & Co. 45,000
15 To R. Bika & Co., Agra 25,000 20 By R. Plumber 60,000
21 To Cash 40,000 24 By B. Sirkiwala 35,000
26 To J.K. & Co., Rewari 20,000 31 By Balance c/d 3,30,000
27 To M/s. Ruf & Tuff 15,000
31 To J. Richardson 30,000
5,80,000 5,80,000
Feb. 1 To Balance b/d. 3,30,000

PASS BOOK

Dr. Cr. Dr.

Balance
Date Particulars Withdrawals Deposits or
Rs.
Rs. Rs. Cr.
2005 4,00,000
Jan. 2 By Cash 4,00,000 Cr. 4,20,000
7 By Cheque on Ajmer (Berco & Co.) 20,000 Cr. 4,19,900
To Bank Charges 100 Cr. 3,69,900
9 To Rajesh & Co. 50,000 Cr. 3,99,900
10 Cheque (J. D’Suza) 30,000 3,39,900
To Self 60,000 Cr. 3,39,900
16 To S. Jain & Co. 45,000 Cr. 2,94,900
18 By R. Bika & Co. Cheque on Agra 25,000 Cr. 3,19,900
To Bank Charges 100 Cr. 3,19,800
21 By Cash 40,000 Cr. 3,59,800
30 By Cheque (Ruf & Tuff) 15,000 Cr. 3,74,800
31 To Bank charges for the month 500 Cr. 3,74,300
By Interest collected on Government Securities 25,000 Cr. 3,99,300

108
The cash book shows a balance of Rs. 3,30,000, whereas the pass book shows a balance of Rs.
3,99,300. If one looks at the debit side of the cash book and the deposits column of the pass book,
and checks item by item, one will find that the following cheques deposited with the bank were not
credited by the bank 31st January, 2005:
Cheque received from M/s. J.K. & Co., Rewari Rs. 20,000
Cheque received from J. Richardson Rs. 30,000

Had these cheques been credited by the bank also, as they have been debited in the cash book, the
pass book balance would have been Rs. 4,49,300, i.e., Rs. 3,99,300 plus Rs. 50,000.

Now, looking at the credit side of the cash book, and the withdrawals column of the pass book, one
finds that the following cheques issued during the month have not yet been presented for payment
(and hence the bank has not debited M/s. Kohli & Son’s account in respect of these cheques):
Cheque issued to R. Plumber Rs. 60,000
Cheque issued to B. Sirkiwala Rs. 35,000

The two cheques total Rs. 95,000. Had these cheques also been paid like others, the balance at the
bank as shown by the pass book, would have been only Rs. 4,49,300 – Rs. 95,000 or Rs. 3,54,300.

Further, one finds that the bank has credit M/s Kohli & Son’s with Rs. 25,000 for interest collected.
There is no entry in the cash book. Had the pass book also ignored this item (as is the case with the
cash book) for the time being, the balance at the bank (as per pass book) would have been only Rs.
3,29,300, i.e., Rs. 3,54,300 – Rs. 25,000. Then again the pass book shows a debit of Rs. 700 as bank
charges on different dates for which, in the cash book, there is no entry as yet. Had the pass book
also ignored these items, the balance shown would have been higher; that is to say, it would have
been Rs. 3,30,000 i.e., 3,29,300 + Rs. 700 which agrees with the cash book balance.

The Bank Reconciliation Statement will appear as follows:

BANK RECONCILIATION STATEMENT

as on 31st January, 2005

Rs. Rs.
Balance as per Pass Book 3,93,900
Add: Cheques paid in but not yet credited by bank:
J.K. & Co., Rewari 20,000
J. Richardson 30,000 50,000

Add: Bank Charges not yet passed through the Cash Book 700
4,50,000
Less: Cheques issued but not yet presented to bank for
payment:
R. Plumber 60,000
B. Sikriwala 35,000 95,000
3,55,000
Less: Interest entered in the Pass Book, not yet passed through
the Cash Book
Cash Book 25,000
Balance as per Cash Book 3,30,000

109
The secret of the preparation of the Bank Reconciliation Statement is simple. Take the cash book or
the pass book balance, and then see what has been done or not been done in the other book. Thus, if
one starts from the pass book balance, one must see what has been or not been done in the cash book.
Then work out the balance as if the entries passed in the cash book had also been passed in the pass
book and the entries passed in the cash book had also been passed in the pass book. If one starts from
the cash book, one should follow the pass book entries.

The Bank Reconciliation Statement given above can also be prepared starting from the cash book
balance, thus–

BANK RECONCILIATION STATEMENT

as on 31st January, 2005

Rs. Rs.
Balance as per Cash Book 3,30,00
Add: Cheques issued but not yet presented to bank for
payment:
R. Plumber 60,000
B. Sirkiwala 35,000 95,000
Add: Interest credited in the Pass Book but not yet entered in
the Cash Book 25,000
4,50,000
Less: Cheques paid in but not yet cleared by bank:
J.K. & Co., Rewari 20,000
J. Richardson 30,000 50,000
4,00,000
Less: Bank Charges entered in the Pass Book but not yet
entered in the Cash Book 700
Balance as per Cash Book 3,93,000

The Bank Reconciliation Statement can also be presented in a different form. Two columns, plus and
minus, signifying positive balance and overdraft respectively, are provided. Items to be added are put
in the plus column and items to be deducted are put in the minus column. A balance is then struck.
The above statement can be presented as follows:

BANK RECONCILIATION STATEMENT

as on 31st January, 2005

Plus Minus
Particulars Rs.
Rs. Rs.
Balance as per Cash Book 3,30,000
Cheques issued but not yet presented to bank for
payment:
R. Plumber 60,000
B. Sirkiwala 35,000 95,000
Interested credited in the Pass Book but not yet
entered in the Cash Book 25,000
Cheques paid in but not yet cleared bank:
J.K. & Co., Rewari 20,000
J. Richardson 30,000 50,000

110
 Bank charges entered in the Pass Book but not yet
entered in the Cash Book 700
Balance as per Pass Book 3,93,900
4,50,000 4,50,000

Note: It is necessary to show the correct balance at bank in the Cash Book, specially at the end of
the year for the purpose of preparing correct financial statements. This means that all entries
that ought to be made. It is not proper to leave items like interest, bank charges or payments
made by the bank or incomes received by it unrecorded. Therefore, the proper method of
preparing a bank reconciliation statement is to first make the required entries in the Cash
Book, ascertain the correct balance, and then proceed to the preparation of the statement. In
the above illustration, the amount received as interest will have to be debited in the Cash
Book and the bank charges credited in it. The balance at bank will thus be Rs. 5,54,300.

Illustration:

On 31st March, 2005 the Cash Book of M/s. Balaji Enterprises showed a balance of Rs. 27,600 at
bank. They had sent cheques amounting to Rs. 9,00,000 to be bank before 31st March, but it appears
from the Pass Book that cheques worth only 8,40,000 had been credited before that date. Similarly,
out of cheques for Rs. 8,50,000 issued during the month of March, cheques for Rs. 25,000 were
presented in April, the remaining having been paid in March itself.

The Pass Book also showed the following payments:

(a) Rs. 33,200 premium (On the joint life policy) according to standing instructions; and
(b) Rs, 50,000 against a promissory note, as per instructions.

The Pass Book showed that the bank had collected Rs. 60,000 as interest on Government Securities.
The bank had charged interest Rs. 500 and bank charges, Rs. 200. There was no entry in the Cash
Book for the payments, receipts, interest, etc.

It was found that Bank Reconciliation Statement as on 31st March, 2005

Solution:

BANK RECONCILIATION STATEMENT

as on 31st March, 2005
Plus Minus
Rs. Rs.
Balance as per Cash Book 27,600
Cheques paid in but not yet credited by bank* 60,000
Cheques issued but yet not presented 25,000
Payment made by bank, entered in the Pass Book but not yet 83,200
entered in the Cash Book
Interest on Government securities, entered in the Pass Book 60,000
but not yet entered in the Cash Book
Interest and bank charges, charged by bank, entered in 700
the Pass Book but not yet entered in the Cash Book
Error in totalling the bank column (credit) on 20th March 1,100
Overdraft as per Pass Book 32,400
1,45,000 1,45,000

111
Minus items being more than the plus items, the difference denotes that at the bank an overdraft is
being shown against M/s. Balaji Enterprises.

If the balance at bank as per Cash Book is properly corrected, it will be Rs. 2,600, thus––

Rs.
Balance as already shown 27,600
Add: Interest collected by Bank 60,000
87,600
Less: Payments made by bank: Rs.
Premium 33,200
Promissory Note 50,000
Correction 1,100
Interest 500
Bank Charges 200 85,000
2,600

The Bank Reconciliation Statement will then appear as follows:

Rs.
Balance as per Cash Book 2,600
Add: Cheques issued but not yet presented 25,000
27,600
Less: Cheques paid in but not yet credited 60,000
Overdraft as per Pass Book 32,400

*Out of cheques worth Rs. 9,00,000 deposited, Rs. 8,40,000 worth have been cleared in the month of
March itself; hence only Rs. 60,000 worth of cheques remain to be cleared.

Illustration:

The cash book of a firm showed an overdraft of Rs. 3,00,000 on 31st March, 2009. A comparison of
the entries in the cash book and pass book revealed that––

(i) On 22nd March, 2009, cheques totalling Rs. 60,000 were sent to bankers for collection. Ouot
of these a cheque for Rs. 10,000 was wrongly recorded on the credit side of the cash book
and cheques amounting to Rs. 3,000 could not be collected by bank before 1st April, 2009.

(ii) A cheque for Rs. 40,000 was issued to a supplier on 28th March, 2009. The cheque was
presented to bank on 4th April, 2009.

(iii) There were debits of Rs. 26,000 in the pass book for interest on overdraft and bank charges,
but the same had not been recorded in the cash book.

(iv) A cheque for Rs. 10,000 was issued to a creditor on 27th March, 2009 but by mistake the
same was not recorded in the cash book. The cheque was, however, duly encashed by 31st
March, 2009.

112
(v) As per standing instructions, the banker collected dividend of Rs. 5,000 on behalf of the firm
and credited the same to its account by 31st March, 2009. the fact was, however, intimated to
the firm on 3rd April, 2009.

You are required to prepare a bank reconciliation statement as on 31st March, 2009.

Solution:

BANK RECONCILIATION STATEMENT

as on 31st March, 2009

Rs.
Bank Overdraft as per cash book 3,00,000
Add:
(i) Cheques deposited but not collected 3,000
(ii) Interest on overdraft and bank charges not recorded in cash
book 26,000
(iii) Cheques issued to creditors but not recorded in cash
book 10,000 39,000
3,39,000
Less:
(i) Cheques wrongly recorded on the credit side of the cash
book, Rs. 10,000 × 2 20,000
(ii) Cheques issued but presented for payment on 4th April 40,000
(iii) Dividend collected by bank but not yet recorded in cash
book 5,000 65,000
Bank overdraft as per pass book 2,74,000

Illustration:

From the following, find out adjusted bank balance as per cash book and prepare thereafter bank
reconciliation statement as on 31st December, 2009 of Jatin Brothers:

Rs.
Bank Overdraft as per cash book 8,00,000
Cheques deposited as bank statement but not entered in cash book 30,000
Cheques recorded for collection but not sent to bank 1,00,000
Credit side of bank column cast short 10,000
Bank charges recorded twice in cash book 1,000
Customer’s cheque returned as per bank statement only 40,000
Cheques issued but dishonoured on technical grounds 30,000
Bills collected by bank directly 2,00,000
Cheques received entered twice in cash book 50,000

113
 CASH BOOK (BANK COLUMNS ONLY)

Rs. Rs.
To customers, cheques deposited By Balance 8,00,000
with bank but not recorded By Credit side cast short, rectified 10,000
earlier 30,000 By Customers, cheque dishonoured 40,000
To Bank Charges, recorded twice By Customers, cheques received
earlier 1,000 By Customers, cheques received
To Suppliers, cheques dishonoured Entered twice in cash book 50,000
on technical grounds 30,000
To Bills Receivable Account / Bank
for Collection of Bills A/c 2,00,000
To Balance c/d 6,39,000
9,00,000 9,00,000
By Balance b/d 6,39,000

Rs.
Adjusted Bank overdraft as per Cash Book 6,39,000
Add: Cheques recorded for collection but not sent to the bank 1,00,000
Overdraft as per Pass Book 7,39,000

114
 ACCOUNTING PROCESS – I
Journal, Ledger and Trial Balance

ACCOUNT PROCESS OR ACCOUNTING CYCLE

‘Accounting Process’ is a complete sequence of accounting procedures which are repeated in the
same order during each accounting period. The sequential steps involved in an accounting process
are as follows:

Step-1 Journalising: Record the transactions in the Journal or subsidiary books as and when
they take place.

Step-2 Posting: Transfer the transactions (recorded in the Journal or subsidiary books), in the
respective accounts opened in the ledger.

Step-3 Balancing: Ascertain the difference between the debit and credit side of each ledger account.

Step-4 Trial Balance: Prepare a list of ledger balances of each and every account to verify whether
the total of debit balances is equal to the total of credit balances.

Step-5 Income Statement: Prepare Trading and Profit & Loss Account to find out the profit or loss
of the enterprise for the accounting period.

Step-6 Position Statement (or Balance Sheet): Prepare the Balance Sheet to ascertain the financial
position of the enterprise as at the end of the accounting period.

The duration of the accounting process (or accounting cycle) is normally twelve months. When these
steps are completed, the process begins again for the next accounting period.

The accounting process may be shown as below:

JOURNAL

Journal is one of the basic books of original entry in which transactions are originally recorded in a
chronological (day-to-day) order according to the principles of double entry system.
Proforma of Journal

115
 JOURNAL

Date Particulars Ledger Amount Amount

Folio Dr. Cr.
Rs. Rs.
(1) (2) (3) (4) (5)

The columns have been numbered only to show how the Journal is written up, otherwise the columns
are not numbered.

1. Date: In the first column, the date of the transaction is entered. The year and the month is
written only once, till they change. The sequence of the dates and months should be strictly
maintained.

2. Particulars: Each transaction affects two accounts out of which one account is debited and
the other account is credited. The name of the account to be debited is written first and the
word ‘Dr.’ is also written towards the end of the column. In the second line, the name of the
account to be credited is written. The credit account starts with the word ‘To’, a few space
away from the margin to make it distinct from the debit account (A practice is now
developing to omit the writing of the words ‘Dr.’ and ‘To’ from Journal entries).

Narration: After each entry, a brief explanation of the transaction together with necessary
details is given. This explanation is called ‘Narration’. The narration helps to know in future
the reason for the entry and also as to why a particular account was debited or credited.

3. Ledger Folio or L.F.: All entries from the Journal are later posted into the ledger accounts.
The page number or folio number of the ledger account where the posting has been made
from the Journal is recorded in the L.F. column of the Journal. For example, if we make a
posting in Machinery A/c which is prepared at page 40 of the ledger, we shall write 40 in the
L.F. column against Machinery A/c in Journal.

4. Amount Dr.: In the fourth column, the amount of the account being debited is written.

5. Amount Cr.: In the fifth column, the amount of the account credited is written.

According to double entry system, at least two accounts are affected from each transaction. Hence,
before recording a Journal entry, it is essential to analyse a transaction in order to determine the two
accounts which are affected. Then, on the basis of rules of journalising, it must be decided as to
which account is to be debited and which account is to be credited.

Rules of Journalising

Transactions are recorded in journal according to double entry system. However, prior to
understanding the double entry system, it is essential to understand the meaning and form of an
‘Account’.

116
MEANING OF AN ACCOUNT

An account is a record of all business transactions relating to a particular person or item. In

accounting we keep a separate record of each individual, asset, liability, expense or income. The
place where such a record is maintained is termed as an ‘Account’. Such as the Account of
Ghanshyam, the Account of Ram, the Account of Machinery, the Account of Salary, the Account of
rent and likewise. All transactions entered into with Ghanshyam will be recorded in the Account of
Ghanshyam and similarly, all transactions relating to Ram will be record in the Account of Ram.

All accounts are divided into two sides. The left side of an account is arbitrarily or traditionally
called Debit side and the right side of an account is called Credit side. In the abbreviated form, Debit
is written as Dr. and Credit is written as Cr. for example, the transactions relating to cash are
recorded in an account, entitled ‘Cash Account’ and its format will be as given below:

Debit (Dr.) CASH ACCOUNT Credit (Cr.)

The above account resembles English capital letter ‘T’. As such, it is often called ‘T’ shape account.
An Account is abbreviated as A/c.

Double Entry System

According to this system every business transaction affects atleast two accounts in opposite
directions. For example, if the furniture is purchased in the business, furniture is increased whereas
the cash is decreased. There can be no transaction in the business which affects only one account or
which has only one aspect. As such, both the aspects (i.e. Debit and Creidt) of every transaction are
recorded under this system. It may, however, be noted that the double entry does not mean that a
transaction are recorded under this system. It may, however, be noted that the double entry does not
mean that a transaction is recorded twice. But it means that atleast two accounts are affected by a
transaction –– one account receiving a benefit and the other account yielding a benefit. The person or
the account receiving a benefit is debited and the person or the account who gives something to the
business is credited. The amount of every transaction is written twice, once as a debit and again as a
credit. For example, we received Rs. 5,0000 from Harish. This transaction affects two accounts ––
Cash Account and the Harish’s Account. Cash account is receiving a benefit (as cash is coming in )
and hence Cash account will be debited, whereas Harish is yielding a benefit and hence his account
will be credited.

“Every business transaction has a two-fold effect and that it affects two accounts in opposite
directions and if a complete record were to be made of each such transaction, it would be necessary
to debit one account and credit another account. It is this recording of the two-fold effect of every
transaction that has given rise to the term Double Entry System.”
–– J.r. Batliboi

Double Entry System is based upon the principle that “Every debit has a credit and every credit has a
debit.”

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Advantages of Double Entry System or Causes of its Popularity

1. Scientific System: Under this system, the transactions are recorded according to certain
specified rules and as such, the system is more scientific as compared to any other systems of
Book-Keeping.

2. Complete Record of Every Transaction: In double entry, all the accounts are divided in
three parts, i.e., personal accounts, real accounts and nominal accounts and both the debit and
credit aspects of a transaction are recorded in these. Hence, the complete record of every
transaction is maintained in this system, so that if the need arises full details of every
transaction can be easily made available at any time in future.

3. Preparation of Trial Balance: In double entry system, the amount recorded to the debit
sides of various accounts will always be equal to the amounts recorded to the debit sides of
various accounts will always be equal to the amounts recorded on the credit sides of various
accounts. As such, a trial balance can be prepared to check the arithmetical accuracy o the
accounts.

4. Preparation of Trading and Profit & Loss Account: With the help of the trail balance, a
Trader can prepare a Trading Account to find out the amount of gross profit or gross loss.
Similarly, a profit and loss account can be prepared to find out the net profit earned or loss
suffered during a particular period.

5. Knowledge of Financial Position of the Business: At the end of each accounting period
every businessman wants to know the financial position of his business, i.e., value of the
assets, liabilities and capital of the business. In double entry system, separate accounts are
opened for each and every asset and liability of the firm and as such, a Balance Sheet can be
prepared which is a screen picture of the financial position of a business at a certain moment.

6. Knowledge of Various Information: In double entry system the accounts are maintained in
such a way that the information regarding the following is readily available at any point of
time:-

(i) What is the amount of sales, purchase and closing stock?

(ii) What amount is due to be received from customers or in other words, the total number
debtors and the amount in each case?
(iii) What amount is due to be paid to suppliers or in other words, the total number of
creditors and the amount in each case?
(iv) How much amount has been paid on account of each head of expenses separately?
(v) How much amount has been earned on account of each head of income separately?

7. Lesser Possibility of Fraud: This system of book-keeping records each transaction in two
accounts, as such there is hardly any scope of forgery and manipulation as compared to other
systems. If at all some manipulation takes place, it can be easily detected.
8. Legal Approval: Complete record of each transaction is maintained under this system
according to certain specified rules. As such, the system meets legal requirements and books
of account maintained under this system are accepted as true and reliable by the Companies
Act and various other Acts.

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CLASSIFICATION OF ACCOUNTS

In order to keep a proper record of the two aspects of a transaction, accounts may be classified as
shown below:

Accounts

Personal Accounts International Accounts

Real Accounts Nominal Accounts

Types of Accounts Meaning Examples

(i) Personal These accounts relate the persons and
Accounts enterprises. These may be classified
into:
(a) Natural Persons Accounts
(b) Artificial Persons Accounts
(c) Representative Persons Accounts
(ii) Real Accounts These accounts consist of properties of
the enterprise and may be classified
into:
(a) Tangible Real Accounts
(b) Intangible Real Accounts
(iii) Nominal These accounts may be classified into:
Accounts (a) Expenses & Losses
(b) Incomes & Gains
such as Rajan’s A/c; Capital A/c;
Drawing A/c.
such as Emami Company’s A/c;
MTNL A/c; Bank of India.
such as Outstanding Salary A/c;
Prepaid Insurance A/c.
such as Cash A/c; Stock A/c;
Furniture A/c
such as Goodwill A/c; Patents A/c
such as Salary A/c
such as Commission Received A/c

ILLUSTRATION:

Classify the following Accounts:

1. Capital; 2. Drawing; 3. Cash paid; 4. Cash received; 5. Commission paid; 6. Commission

received; 7. Purchases A/c; 8. Sales A/c; 9. Furniture; 10. Cash A/c; 11. Bank A/c; 12. Bank
Overdraft A/c; 13. Debtors A/c; 14. Creditors A/c; 15. Travelling Expenses; 16. Goodwill; 17.
Patents; 18. Salary A/c; 19. Salary Outstanding A/c; 20. Insurance A/c; 21. Insurance Prepaid A/c.

(i) Personal Accounts 1, 2, 11, 12, 13, 14, 19, 21

(ii) Real Accounts 3, 4, 7, 8, 9, 10, 16, 17
(iii) Nominal Accounts 5, 6, 15, 18, 20

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Notes: (i) Salary A/c is a nominal account whereas Salary Outstanding is a personal account
because it is the account of some unnamed debtor.

(ii) Insurance A/c is a nominal account whereas Insurance Prepaid is a personal account
because it is the account of some unnamed debtor.

(iii) Bank A/c is not a real account. It is a personal account since it is the account of
some banking company or firm which is an artificial person.

(iv) Purchases A/c and Sales A/c are real accounts because goods is a thing of value.

Meaning and Rules of Debit and Credit:

Debit means to enter the amount of a transaction on the left side of an account and credit means to
enter on the right side of an account. The rules for Debit and Credit are as follows:

Type of Accounts Rules for Debit for and Credit

(i) For Personal Accounts Debit the receiver and credit the giver
(ii) For Real Accounts Debit what comes in and credit what goes out
(iii) For Nominal Accounts Debit all expenses and losses and credit all incomes and gains

1. Personal Accounts: the accounts which relate to an individual, firm, company or an

institution are called personal accounts. Account of Harish, Account of Ram Chander
Krishan Chander, Account of D.C.M. Limited, Account of Delhi University, Bank
Account, Capital Account of the proprietor, Drawings Account of the proprietor etc. are
examples of Personal Accounts.

Rule: Rule for recording a transaction in personal accounts in simple words is ‘Debit the
receiver and credit the giver’. In other words, “Debit that person’s account who receives
something from the business and credit that person’s account who gives something to the
business”.

Example 1: Paid Rs. 2,000 to Ravi

In this case, two accounts affected are Ravi’s A/c and Cash A/c. According to the rule of
“Debit the receiver”, Ravi is Account will be debited in the entry as he is the receiver of
Cash. Simultaneously, the account of cash will be credited, as cash has gone out. They entry
will be:

Ravi (Debit the receiver) Dr. 2,000

To Cash A/c 2,000

Example 2: Received Rs. 1500 from Rajesh

In this case, cash account will be debited as cash has been received, and Rajesh’s account will
be credited according to the rule of “Credit the giver”. The entry will be:

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 Cash A/c Dr. 1,500
To Rajesh (Credit the giver) 1,500

Objects: Object of preparing a personal account is to ascertain as to how much amount a

personal account owes to the business, i.e., how much amount is due to be received from his
and how much amount is owed to a personal account from the business, i.e., how much
amount is payable to him.

2. Real Accounts: The accounts of all those things whose value can be measured in terms of
money and which are the properties o the business are termed as Real Accounts. Such as,
Cash Account, Furniture Account, Machinery Account, Building Account, Goodwill Account
etc.

Rule: Rule for recording a transaction in real account is ‘Debit what comes in and credit what
goes out’.

According to this rule, whenever any property comes into the business, it is debited and
when it goes outside the business, it is credited.

For example, if furniture for Rs. 15,000 has been purchased for cash, furniture account should
be debited according to the rule of “Debit what comes in”, while cash account should be
credited according to the rule of “Credit what goes out”. Entry will be:

Furniture A/c (Debit what comes) Dr. 15,000

To Cash A/c (Credit what goes out) 15,000

Objects: These accounts represent the value of various properties owned by a business in
terms of money and indicate the financial position of the business.

3. Nominal Accounts: These accounts include the accounts of all expenses and incomes.

The examples of nominal accounts relating to expenses are Salaries paid, Rent paid, Discount
allowed, Bad Debts etc.

The examples of nominal accounts relating to incomes are Commission received, Interest
received, Discount received etc.

Rule: rule for recording in nominal accounts is, “Debit the expenses and losses and Credit
incomes and gains”.

Examples 1: Paid Rs. 7,000 for Salaries. In this case the two accounts being affected are
Salaries A/c and Cash A/c. Salaries represent expenses and as such, Salaries Account will be
debited according to the rule lf “Debit the expenses”. On the other hand, Cash Account will
be credited according to the rule of “Credit what goes out”. Entry will be:

Salary A/ct (Debit the Expenses) Dr. 7,000

To Cash A/c (Credit what goes out) 7,000

Examples 2: Received Rs. 4,000 for Commission. In this case the two accounts being
affected are Commission A/c and Cash A/c. Commission A/c is a nominal account and

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 represents an income. As such, Commission A/c will be credited according to the rule of
“Credit the incomes”. Cash A/c is a real account and as Cash is coming in, therefore Cash
A/c will be debited according to the rule of “Debit what comes in”. Entry will be:

Cash A/c (Debit what comes in) Dr. 4,000

To Commission A/c (Credit the incomes) 4,000

Object: Nominal accounts are those accounts which are in name only and which do not
really exist. These accounts are opened simply to explain the nature of head for which Cash
has been paid. In the absence of nominal accounts it will be very difficult for the management
to know the amount paid separately on account of salary, rent, commission etc. As such, the
nominal accounts provide information regarding the following:

(i) Amount spent on various heads in a particulars period;

(ii) Income received on various heads in a particular period.

Meaning of Goods

Goods are those things which are purchased for resale. In other words, goods are the commodities in
which the business deals. For example, if a cloth merchant purchases cloth, the cloth will be termed
as ‘purchase’. But if the same cloth merchant purchased will not be termed as purchases, but will be
an asset of his business and in this case ‘Furniture A/c’ will be debited instead of ‘Purchases A/c’. It
means that the purchases of asset are not termed as purchases in accounting terminology because
these assets are not meant for sale.

Goods Account is classified into five accounts for the purpose of passing the Journal entries:

1. Purchases A/c: When good are purchased, instead of debiting Goods A/c ‘Purchase A/c’ is
debited. While passing a Journal entry ‘Purchase A/c’ should always be debited because of
the rule of “Debit what comes in”.

2. Sales A/c: When goods are sold, instead of crediting Goods A/c ‘Sales A/c’ is credited.
While passing a Journal entry ‘Sales A/c’ should always be credited because of the rule of
“Credit what goes out”.

3. Purchases Return A/c: This account is also named as ‘Return Outward’. The account should
always be credited because of the rule of “Credit what goes out”.

4. Sales Return A/c: This account is also named as ‘Return Inward’. The account should
always be debited because of the rule of “Debit what comes in”.

5. Stock A/c: In the transactions relating to the purchase and sale of goods, it has to be decided
whether a transaction is for cash or for credit, because the entry is passed accordingly. If, in
the transactions relating to purchase and sale of goods the word ‘Cash’ is stated clearly, only
then will it be a cash transaction otherwise it will be taken as a credit transaction. Such as:

(i) Goods for Rs. 2,000 sold for cash: It will be taken as cash transaction
(ii) Goods for Rs. 3,000 to Rajiv for cash: It will be taken as cash transaction
(iii) Goods for Rs. 5000 sold to Rajiv: It will be taken as credit transaction

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ILLUSTRATION

Enter the following transaction in the Journal of Rakesh:

2009 Rs.
June 1 Rakesh started business with cash 10,00,000
2 Purchased goods for cash 2,00,000
4 Purchased goods from Amar 1,20,000
5 Purchased Furniture for cash 60,000
7 Sold goods for cash 1,30,000
9 Sold goods to Ram 1,50,000
10 Paid cash to Amar 80,000
12 Received cash from Ram 1,00,000
16 Purchased goods from Harish for cash 75,000
17 Purchased goods from harish 50,000
18 Sold goods to Sudesh for cash 1,26,000
19 Sold goods to Sudesh 70,000
24 Withdraw cash from office for personal use 25,000
27 Paid rent 4,000
30 Paid salary to Ganesh 12,000
30 Received Commission 2,000

SOLUTION:
JOURNAL OF RAKESH

Date Particulars L. Amount Amount

F. Dr. Cr.
2009 Rs. Rs.
June 1 Cash A/c 10,00,000
To Capital A/c 10,00,000
(Cash brought into the business by Rakesh as capital)
June 2 Purchase A/c 2,00,000
To Cash A/c 2,00,000
(Goods purchased for cash)
June 4 Purchase A/c 1,20,000
To Amar A/c 1,20,000
(goods purchased from Amar on credit)
June 5 Furniture A/c 60,000
To Cash A/c 60,000
(Furniture purchased for cash)
June 7 Cash A/c 1,30,000
To Sales A/c 1,30,000
(Goods sold for cash)
June 9 Ram A/c 1,50,000
To Sales A/c 1,50,000
(Goods sold to Ram on credit)
June 10 Amar A/c 80,000
To Cash A/c 80,000
(Cash paid to Amar)
June 12 Cash A/c 1,00,000
To Ram 1,00,000
(Cash received from Ram)
June 16 Purchases A/c 75,000

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 To Cash A/c 75,000
(Goods purchased for cash)
June 17 Purchase A/c 50,000
To Harish A/c 50,000
(Goods purchased from Harish on credit)
June 18 Cash A/c 1,26,000
To Sales A/c 1,26,000
(Goods sold for cash)
June 19 Sudesh A/c 70,000
To Sales A/c 70,000
(Good sold to Sudesh on credit)
June 24 Drawing A/c 25,000
To Cash A/c 25,000
(Rent paid)
June 27 Rent A/c 4,000
To Cash A/c 4,000
(Rent paid)
June 30 Salary A/c 12,000
To Cash A/c 12,000
(Salary paid)
June 30 Cash A/c 2,000
To Commission A/c 2,000
(Commission received
Total Rs. 22,04,000 22,04,000

Explanation of the above mentioned entries

June 1. Rakesh started business with Cash: A business is always considered to be separate and
distinct from the proprietor. All the transactions are recorded in the books of the business
from the point of view of the business. Cash coming into the business will be debited
according to the rule of real account, i.e. ‘debit what comes in’. Proprietor is the giver of
cash to the business, therefore, his capital account will be credited according to the rule of
personal account, i.e., ‘Credit the giver’.

June 2. Purchases goods for Cash: Both the accounts affected in this transaction, i.e., purchases
account and cash account are real accounts. The rule for real account is ‘Debit what comes
in and Credit what goes out’. As such, purchases account will be debited because the goods
are coming into the business and cash account will be credited because it is going outside
the business.

June 4 Purchased gods from Amar: When the name of the seller is given and it is not mentioned
that the goods have been purchased for cash, it will be assumed that the goods have been
purchased on credit. Goods are coming into the business, therefore, purchases account has
been debited according to the rule of real account, i.e., ‘debit what comes in’. Amar is the
giver of goods, as such, his personal account will be credited according to the rule of
‘Credit the giver’.

June 5. Purchased Furniture for Cash: Both the accounts involved, i.e., furniture account and
cash account are real accounts. Furniture is coming into the business, therefore, it will be
debited and as cash is going out, it will be credited.

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June 7. Sold goods for Cash: In this transaction also, both the accounts involved, i.e., cash
account and goods account are real accounts. Cash is coming into the business, therefore, it
will be debited and as goods are going out, the sales account will be credited.

June 9. Sold goods to Ram: In this transaction the name of the purchaser is given and it is not
mentioned that the goods have been sold for cash, it will be assumed that the goods have
been sold on credit. Ram is the receiver of goods, as such, his personal account has been
debited according to the rule of personal account, i.e., ‘debit the receiver’. Goods are going
out of the business, as such, sales account ahs been credited according to the rule of real
account, i.e., ‘credit what goes out’.

June 10. Paid Cash to Amar: Amar is the receiver of cash, as such, his personal account has been
debited according to the rule of ‘debit the receiver’. Cash is going out, hence, it will be
credited according to the rule of real account ‘Credit what goes out’.

June 12. Received Cash from Ram: Cash is coming into the business, therefore, the account of
cash will be debited. Ram is the giver of cash, therefore, the account of Ram has been
credited.

June 16. Purchased goods from Harish for Cash: Purchases account will be debited because the
goods are coming into the business and cash account will be credited because it is going
out of the business.

June 17 Purchased goods from Harish: The word ‘cash’ is not mentioned in this transaction, as
such, it will be treated as a credit purchase of goods from Harish. Goods are coming in,
therefore, purchase account will be debited and as Harish is the giver of goods, therefore,
the account of Harish will be credited.

June 18. Sold goods to Sudesh for Cash: The two accounts affected in this transaction are Cash
and Goods. Cash is coming into the business, therefore, it will be debited and as goods are
going out, the sales account will be credited.

June 19. Sold goods to Sudesh: The word ‘cash is not mentioned in this transaction. Therefore, it
will be treated as a credit sale of goods to Sudesh. Sudesh is the receiver of goods, as such,
the account of Sudesh will be debited and as goods are going out, the sales account will be
credited.

June 24. Withdrew cash from office for personal use: When the proprietor introduces cash into
the business, it is credited to his capital account and when he withdraws cash from the
business for his personal use, it is debited to his Drawings account. Drawings account is a
personal account of the proprietor. In this transaction, Drawings account will be debited, as
the proprietor is the receiver of cash. Cash account will be credited because it is going out
of the business.

June 27. Paid Rent: This transaction affects Rent account and cash account. This transaction affects
Rent account and cash account. Rent is a nominal account and because this is an expense
of business, as such, the Rent account will be debited according to the rule of ‘debit all
expenses’. Cash account will be credited, as cash is going out of the business.

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June 30. Paid Salary to Ganesh: The two accounts affected in this transaction are ‘Salary account’
and Cash account’. Purpose of paying to Ganesh is ‘salary’ ad when purpose of payment is
given in the question, the personal account of receiver is not debited.

Salary is a nominal account and because this an expense of business, as such, the Salary
account will debited according to the rule of ‘debit all expenses’. Cash account will be
credited, as cash is going out of the business.

June 30. Received Commission: The two accounts affected in this transaction are ‘Cash account’
and ‘Commission account’. Cash account will be debited, as cash is coming into the
business. Commission is a nominal account and because this is an income, as such,
commission account will be credited according to the rule of ‘credit all incomes’.

Discount

Discount is of two types:

1. Trade Discount, and

2. Cash Discount

1. Trade Discount: The discount allowed by a seller to its customers at a fixed percentage on
the listed price of goods is termed as Trade discount. No separate entry is passed for the
Trade discount, as it is deducted from the cash memo or invoice of the goods. For example, if
a trader sells goods of the list price of Rs. 1,00,000 at 20% trade discount for cash, the entry
will be:

Cash A/c Dr. 80,000

To Sales A/c 80,000

If the goods sold at trade discount are returned by the customer, the amount of trade discount
is again deducted from the list price of the returned goods.

2. Cash Discount: This discount is allowed to the customers for making prompt payment. In
other words, cash discount is allowed only if the customer makes the payment within a fixed
period. Such discount motivates the customer to make the payment at the earliest. As the
discount is allowed at the time of making payment, so the entry for cash discount is recorded
alongwith the entry payment. Discount is a nominal account and as such, it is debited when it
is allowed to a customer and credited when it is received.

Difference between Trade Discount and Cash Discount

Basis of Difference Trade Discount Cash Discount

1. Meaning Trade discount is allowed at the Cash discount is allowed if the
time of sale to the customers or customer makes the payment
retailers at a fixed percentage on immediately or within a fixed
the printed price list. period.
2. Object Generally, it is allowed to the It is allowed to encourage quick
retailers to enable them to sell or prompt payment.
the goods to their customers at

126
 list price. The purpose is also to
increase the sales.
3. Recording in the It is not recorded in the books. It is recorded in the books.
books of accounts
4. Deduction from It is deducted from the invoice. It is not deducted from the
Invoice invoice.

Sometimes, a customer is allowed both the discounts, i.e., trade discount as well as cash discount. In
such a case, first trade discount is to be deducted from the price of the goods and then, cash discount
is to be calculated on the balance of the amount.

For example, if a trader sells goods of the list price of Rs. 2,00,000 at 10% trade discount and 2%
cash discount, the net amount will be calculated as under:

List Price Rs.

Less: Trade Discount @ 10% 2,00,000
20,000
1,80,000
Less: Cash Discount @ 2% 2 3,600
1,80,000 ×
100
1,76,400

It means that Rs. 1,76,400 will be paid if the payment is made in cash.

Compound Journal Entries

Sometimes, two or more transactions relating to one particular account take place on the same date.
In such cases, instead of passing separate entries for all such transactions, only one entry is passed.
Such a Journal entry is termed as Compound Journal Entry. For example, on 30th June Rs. 50,000 are
pade for salaries and Rs. 20,000 are paid for rent, the entry will be:

30th June Salary A/c Dr. 50,000

Rent A/c Dr. 20,000
To Cash A/c 70,000
(Expanses paid)

Such entries can be passed in either of the following three ways:

1. By debiting one account and crediting two or more accounts.
2. By crediting one account and debiting two or more accounts.
3. By debiting two or more accounts and crediting two or more accounts, such as the
‘Opening Entry’.

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ILLUSTRATION:

Record the following transactions in the Journal of Harish:

2009 Rs.
June 1 Paid cash to Santosh 96,000
and discount received from him 4,000
4 Received cash from Vipin 49,000
and discount allowed to him 1,000
10 Goods sold to Rajesh 3,00,000
12 Rajesh returned goods 20,000
14 Received cash from Rajesh Rs. 2,75,000 in
full settlement of his account.
20 Sold goods to Dinesh of the list price of Rs.
6,00,000 at 10% trade discount.
23 Purchased goods from Vinod of the list price
of Rs. 2,00,000 at 15% trade discount.

SOLUTION:
JOURNAL OF HARISH

Date Particulars L. Amount Amount

F. Dr. Cr.
2009 Rs. Rs.
June 1 Santosh 1,00,000
To Cash A/c 96,000
To Discount A/c 4,000
(Cash paid to Santosh and discount received)
June 4 Cash A/c 49,000
Discount A/c 1,000
To Vipin 50,000
(Cash received from Vipin and discount allowed)
June 10 Rajesh 3,00,000
To Sales A/c 3,00,000
(Goods sold to Rajesh)
June 12 Sales Return A/c 20,000
To Rajesh 20,000
(Goods returned by Rajesh)
June 14 Cash A/c 2,75,000
Discount A/c 5,000
To Rajesh 2,80,000
(Cash received from Rajesh and discount allowed to him)
June 20 Dinesh 5,40,000
To Sales A/c 5,40,000
(Goods of the list price of Rs. 6,00,000 sold at 10% trade
discount)
June 23 Purchase A/c 1,70,000
To Vinod 1,70,000
(Goods of the list price of Rs. 2,00,000 purchased at 15%
trade discount)
Total Rs. 14,60,000 14,60,00

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ILLUSTRATION:

Enter the following transactions in the Journal of Suresh:

2009
April 1 Purchased goods from Sanjay of the list price of Rs. 4,00,000 at 10% trade discounts.
April 2 Returned goods to Sanjay of the list price of Rs. 10,000.
April 6 Paid Cash to Sanjay Rs. 3,40,000 in full settlement of his account.

SOLUTION:
JOURNAL OF SURESH

Date Particulars L. Amount Amount

F. Dr. Cr.
2009 Rs. Rs.
April 1 Purchases A/c 3,60,000
To Sanjay 3,60,000
(Goods of the list price of Rs. 4,00,000 purchased at 10%
trade discount)
April 2 Sanjay 9,000
To Purchase Return A/c 9,000
(goods of the list price Rs. 10,000, returned to Sanjay;
Actual price being Rs. 10,000 less 10% trade discount)
April 6 Sanjay 3,51,000
To Cash A/c 3,40,000
To Discount A/c (See Note 1) 11,000
(Cash paid to Sanjay and discount received from him)
Total Rs. 7,20,000 7,20,000

Note 1. Discount received from Sanjay has been calculated as follows:

Rs.
Purchase 3,60,000
Less: Purchases Return 9,000
Net Amount due to Sanjay 3,51,000
Less: Amount paid in full settlement of his account 3,40,000
Discount received from his 11,000

ILLUSTRATION:

Enter the following transactions in the Journal of Gopesh.

2010
May 10 Sold goods to Jagdish of the list price of Rs. 10,00,000 at trade discount of 15%.
May 13 Jagidsh returned goods of the list price of Rs. 40,000.
May 18 Received from Jagdish the amount due from him, under a cash discount of 5%.

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SOLUTION:
JOURNAL OF SURESH

Date Particulars L. Amount Amount

F. Dr. Cr.
2010 Rs. Rs.
May 10 Jagdish Dr. 8,50,000
To Sale A/c 8,50,000
(Goods of the list price of Rs. 10,00,000 sold at
15% trade discount)
May 13 Sales Return A/c Dr. 34,000
To Jagdish 34,000
(Goods of the list price Rs. 40,000 returned by
Jagdish; Actual price being Rs. 40,000 less 15%
trade discount)
May 18 Cash A/c (See Note 1) Dr. 7,75,200
Discount A/c Dr. 40,800
To Jagdish 8,16,000
(Cash received from Jagdish and discount allowed
to him)
17,00,000 17,00,000

Note 1. Cash received from Jagdish has been calculated as follows:

Rs.
Sales 8,50,000
Less: Sales Return 34,000
Amount due from Jagdish 8,16,000
5
Discount allowed to him: 8,16,000 × 40,800
1000
Cash received from Jagdish 7,75,200

Recoding of Bank Transactions

S.No. Transaction Entry

1. When cash id deposited into the bank. Bank A/c Dr.
To Cash A/c
2. When cash is withdrawn from the bank. Cash A/c Dr.
To Bank A/c
3. When cheques, drafts etc. received from Bank A/c Dr.
the customers are deposited into the bank To Customer’s Personal A/c
on the same day.
4. When cheques, drafts etc. received from Cash A/c Dr.
the customers are not sent to bank on the To Customer’s Personal A/c
same day.
5. On the date when above cheques, drafts Bank A/c Dr.
etc. are sent to the bank. To Cash A/c
6. When a customer directly deposits the Bank A/c Dr.
amount in our bank account. To Customer’s Personal A/c
7. When a cheque previously deposited into Customer’s Personal A/c Dr.

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 the bank is dishonoured. To Bank A/c
8. A When a cheque is received from a customer Bank A/c Dr.
and discount is allowed to him, and if the Discount A/c Dr.
cheque is deposited into the bank on the To Customer’s Personal A/c
same day.
8. B In case the above cheque is dishonoured,
Customer’s Personal A/c Dr.
the discount allowed to the customer will To Bank A/c
also be withdrawn. To Discount A/c
9. When payment is made by issue of a Personal A/c Dr.
cheque. To Bank A/c
10. When expenses are paid by the issue of a
Expenses A/c Dr.
cheque. To Bank A/c
11. When cash is withdrawn from the bank for
Drawings A/c Dr.
the personal use of the proprietor. To Bank A/c
12. A When interest is charged by the bank. Interest A/c Dr.
To Bank A/c
12. B When interest is allowed by the bank. Bank A/c Dr.
To Interest A/c
13. When bank charges some amount for the Bank Charges A/c Dr.
services rendered by the bank. To Bank A/c

Opening Entry

Every firm starts its new books in the beginning of each year. Since the closing balances of last year
have to be carried forward to the next year, the first entry in each year’s Journal will be to record the
previous year’s closing balances of all the assets and liabilities. As it is the first entry, it is called the
opening entry. In this entry the accounts of all assets are debited because assets always show debit
balances and the accounts of liabilities and capital are credited because they always show credit
balances. If the balance of the capital account is not given in the question, it will be found out by
deducting the total of liabilities from the total of assets. On the contrary, if the total of liabilities
exceeds the total of assets, the difference will be treated as the amount of Goodwill and the same will
be debited in the opening entry.

For example, the following balances appeared in the books of Ranjeet on 1st January 2010:

Assets: Cash Rs. 80,000; Bank balance Rs. 2,00,000; Stock Rs. 5,40,000; Debtors Rs. 4,70,000
(Shyam Rs. 1,20,000, Abhishek Rs. 1,50,000, Rajendra Rs. 2,00,000); Machinery Rs. 6,00,000.

Liabilities: Creditors Rs. 2,00,000 (Suman Rs. 70,000; Hari Om Rs. 1,30,000), Capital Rs.
20,00,000. The Opening Entry will be:

Date Particulars L. Amount Amount

F. Dr. Cr.
2010 Rs. Rs.
Jan. 1 Cash A/c Dr. 80,000
Bank A/c Dr. 2,00,000
Stock A/c Dr. 5,40,000
Shyam Dr. 1,20,000
Abhishek Dr. 1,50,000
Rajendra Dr. 2,00,000
Machinery A/c Dr. 6,00,000
Goodwill A/c (Balancing Figure) Dr. 3,10,000

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 (i.e., Total of Liabilities Rs. 22,00,000
Less: Total of Assets Rs. 18,90,000
To Suman 70,000
To Hari Om 1,30,000
To Capital A/c 20,00,000
(Assets and liabilities brought forward)

Bad Debts

When the goods are sold to a customer on credit, and if the amount becomes irrecoverable due to his
insolvency or for some other reason, the amount not recovered is called bad debts. For recording it,
bad debts is debited and the customer’s account is credited.

For example: Rajan who owed us Rs. 1,00,000 is declared insolvent and Rs. 300 is received from
his estate. The journal entry will be:

Date Particulars L. Amount Amount

F. Dr. Cr.
Rs. Rs.
Cash A/c Dr. 30,000
Bad Debts A/c Dr. 70,000
To Rajan 1,00,000
(Rs. 300 received from Rajan on his insolvency)

ILLUSTRATION:

The following balances appeared in the books of Goyal Stores on 1st January, 2009:

Assets: Cash Rs. 1,50,000; Bank balance Rs. 50,000; Stock Rs. 4,00,000; Furniture Rs. 36,000;
Debtors Rs. 2,40,000 (X Rs. 60,000; Y Rs. 80,000 and Z Rs. 1,00,000).

Liabilities: Bank Loan Rs. 1,00,000; Creditors Rs. 1,25,000 (Aman Rs. 50,000, Sachin Rs. 75,000).

Following transactions took place during January 2009.

Jan. 2 Bught goods from Ajit for Rs. 2,00,000 at a trade discount of 10% and cash discount of
2%. Paid 60% amount immediately.
Jan. 4 Sold goods to X for Rs. 90,000.
Jan. 5 Received Rs. 1,48,000 from X in full settlement of his account.
Jan. 6 Cash deposited into bank Rs. 1,00,000.
Jan. 8 Cheque received from Y for Rs. 78,500 in full settlement of his account. This cheque was
immediately deposited into bank.
Jan. 10 Received a cheque from Z Rs. 20,000.
Jan. 12 Cheque received a from Z deposited into bank.
Jan. 15 Cheque received from Y dishonoured.
Jan. 16 Cash sales Rs. 1,50,000; Out of this amount Rs. 1,20,000 deposited into bank.
Jan. 16 Amount due to Aman paid by Cheque.
Jan. 18 Old newspapers sold Rs. 500.
Old furniture sold Rs. 7,500.
Jan. 20 Z became insolvent and Rs. 400 could be received from his estate.
Jan. 22 Purchased goods from Jagat and paid by cheque Rs. 80,000.

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Jan. 24 Sold half of the above goods to Subhakant at a profit of 30% on cost.
Jan. 25 Proprietor withdrew for private use Rs. 20,000 fro office and Rs. 30,000 from bank.
Jan. 31 Paid salary to Mohan by Cheque Rs, 20,000.
Jan. 31 Paid Rent by cheque Rs. 15,000.
Jan. 31 Paid trade expenses Rs. 5,000.

SOLUTION:
JOURNAL OF GOYAL STORES

Date Particulars L. Amount Amount

F. Dr. Cr.
2009 Rs. Rs.
Jan. 1 Cash A/c Dr. 1,50,000
Bank A/c Dr. 50,000
Stock A/c Dr. 4,00,000
Furniture A/c Dr. 36,000
X Dr. 60,000
Y Dr. 80,000
Z Dr. 1,00,000
To Loan from Bank 1,00,000
To Aman 50,000
To Sachin 75,000
To Capital (balancing figure) 6,51,000
(Assets and liabilities brought forward)
Jan. 2 Purchases A/c Dr. 1,80,000
To Cash A/c 1,05,840(1)
To Discount A/c 2,160
To Ajit 72,000
(Goods purchased and discount received)
Jan. 4 X Dr. 90,000
To Sales A/c 90,000
(Goods sold on credit)
Jan. 5 Cash A/c Dr. 1,48,000
Discount A/c Dr. 2,000
To X 1,50,000
(Cash received and discount allowed)
Jan. 6 Bank A/c Dr. 1,00,000
To Cash A/c 1,00,000
(Cash deposited into Bank)
Jan. 8 Bank A/c Dr. 78,500
Discount A/c Dr. 1,500
To Y 80,000
(Cheque received and deposited into bank)
Jan. 10 Cash A/c Dr. 20,000
To Z 20,000
(Cheque received)
Jan. 12 Bank A/c Dr. 20,000
To Cash A/c 20,000
(Cheque received from Z now deposited into
Bank)
Jan. 15 Y Dr. 80,000
To Bank A/c 78,500
To Discount A/c 1,500

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 (Cheque dishonoured, and discount withdrawn)
Jan. 16 Cash A/c Dr. 30,000
Bank A/c Dr. 1,20,000
To Sales A/c 1,50,000
(Cash sales)
Jan. 16 Aman Dr. 50,000
To Bank A/c 50,000
(Cheque given to Aman)
Jan. 18 Cash A/c Dr. 8,000
To Miscellaneous Income A/c 500
To Furniture A/c 7,500
(Old newspapers and old furniture sold)
Jan. 20 Cash A/c Dr. 32,000
Bad Debts A/c Dr. 48,000
To Z 80,000
(Cash received and bad-debts written off)
Jan. 22 Purchases A/c Dr. 80,000
To Bank A/c 80,000
(Goods purchased by cheque)
Jan. 24 Subhakant Dr. 52,000
To Sales A/c 52,000
(Goods sold on credit)
Jan. 25 Drawings A/c Dr. 50,000
To Cash A/c 20,000
To Bank A/c 30,000
(Amount withdrawn for private use)
Jan. 31 Salary A/c Dr. 20,000
Rent A/c Dr. 15,000
To Bank A/c 35,000
(Expenses paid by cheque)
Jan. 31 Trade Expenses A/c Dr. 5,000
To Cash A/c 5,000
(Expenses paid in cash)
Total Rs. 21,06,000 21,06,000

Note (1)

Rs.
Total Amount 2,00,000
Less 10% Trade Discount 20,000
1,80,000
Cash Purchase: 60% of Rs. 1,80,000 1,08,000
Less: Cash Discount (2% of 1,08,000) 2,160
Amount paid 1,05,840
Credit Purchase: 40% of Rs. 1,80,000 72,000

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Some Special Entries

1. Bad Debts Recovered: Sometimes, it so happens that the bad debts previously written off
are subsequently recovered. In such cases, the following entry is passed:

Cash A/c Dr.

To Bad Debts Recovered A/c

Care should be taken that the personal account of the debtor should not be credited because
the Debtor’s account must have been credited while passing the entry for bad debts.

2. Depreciation: It is the permanent and continuing decrease in the value of an asset on account
of wear and tear and passage of time. It is a business expense through it is not paid in cash.
Depreciation is a nominal account since it represents a loss and hence is debited. Asset
account will be credited as its value is reduced due to depreciation. Journal Entry will be:

Depreciation A/c Dr.

To Asset A/c

3. Interest on Capital: In order to ascertain the true efficiency of the business it is a normal
practice to charge business with interest on proprietor’s capital. Profits left after charging the
amount of such interest are the real profits earned by the business. Such interest is a loss from
the point of view of the business and therefore according to the rule of nominal accounts
Interest A/c is debited in the Journal entry. The amount of such interest is a gain from the
point of view of the proprietor. His capital is increased by the amount of interest and
therefore the capital account is credited in the Journal entry.

4. Interest on Drawings: If the firm allows interest on capital it should also charge interest on
drawings made by the proprietor. Such an interest is an expense for the proprietor and a gain
to the business. Hence an entry is made by debiting the drawings account and crediting
interest account.

ILLUSTRATION:

Pass Journal Entries for the following:

(1) Received Rs. 20,000 from Jatin, which were written off as bad-debts in the previous year.
(2) Provide 10% depreciation on furniture costing Rs. 50,000.
(3) Provide 12% interest on capital amounting to Rs. 10,00,000.
(4) Charge interest on drawings Rs. 8,000.

SOLUTION:
JOURNAL

Date Particulars L. Amount Amount

F. Dr. Cr.
Rs. Rs.
(1) Cash A/c Dr. 20,000
To Bad Debts Recovered A/c 20,000
(Cash received from Jatin, previously written
off as bad-debts.)

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 (2) Depreciation A/c Dr. 5,000
To Furniture A/c 5,000
(Depreciation provided on furniture)
(3) Interest on Capital A/c Dr. 1,20,000
To Capital A/c 1,20,000
(Interest provided on capital)
(4) Drawings A/c Dr. 8,000
To Interest on Drawings A/c 8,000
(Interest charged on drawings)
Total Rs. 1,53,000 1,53,000

Expenditure on the installation of Machinery and on the erection of Building: Machinery and
Building are the assets of the business. As such, any expenditure incurred on the carriage and
installation of machinery such as freight, transit expenses, installation expenses, wages paid for the
installation etc. is treated as capital expenditure and is debited to the Machinery Account. Similarly,
any expenditure incurred for the construction of a Building such as the purchase of materials and the
payment of wages are also treated as capital expenditure and as such debited to the Building
Account. However, repair charges incurred on an asset which is already appearing in the books are
debited to repairs account.

ILLUSTRATION:

Journalise the following items in the books of Raja Ram giving suitable narrations:

(i) Bought goods from Amit for Cash Rs. 50,000. also paid Rs. 1,000 for their carriage.
(ii) Purchased a machinery for Cash Rs. 3,00,000 and paid Rs. 25,000 in cash as wages on its
installation.
(iii) Bricks for Rs. 15,00,000 and timber for Rs. 10,00,000 purchased for the construction of
building. The payment was made by cheque.
(iv) Purchased an old machinery for Rs. 1,00,000 and spent Rs. 5,000 ion its carriage and Rs.
20,000 on its immediate repairs.
(v) Paid Rs. 2,500 for repairing the office furniture.

SOLUTION:
JOURNAL OF RAJA RAM

Date Particulars L. Amount Amount

F. Dr. Cr.
S.No. Rs. Rs.
(i) Purchases A/c Dr. 50,000
Carriage A/c Dr. 1,000
To Cash A/c 51,000
(Goods purchased for cash)
(ii) Machinery A/c Dr. 3,25,000
To Cash A/c 3,25,000
(Machinery purchased for Rs. 3,00,000 and
wages for Rs. 25,000 paid for its installation.)
(iii) Building A/c Dr. 25,00,000
To Bank A/c 25,00,000
(Bricks for Rs. 15,00,000 and timber for Rs.

136
 10,00,000 purchased for the construction of
building)
(iv) Machinery A/c Dr. 1,25,000
To Cash A/c 1,25,000
(Machinery purchased for Rs. 1,00,000 and
spent Rs. 5,000 on its carriage and Rs. 20,000
on its repairs)
(v) Repairs A/c Dr. 2,500
To Cash A/c 2,500
(Payment made for the repairs of old furniture)
Total Rs. 30,03,500 30,03,500

ILLUSTRATION:

Journalise the following transactions in the books of Harsh:

(i) Paid fire insurance premium on building by cheque Rs. 5,000 and Harsh’s life insurance
premium by cheque Rs. 1,00,000.
(ii) Paid for office cleaning Rs. 2,000.
(iii) Bank Changes Rs. 5,000.
(iv) Purchased goods for Rs. 10,00,000 from Naman and sold it to Aman for Rs. 12,00,000.
(v) Rajiv who owed us Rs. 15,000 is declared Insolvent and Rs. 650 is received as final dividend
from his estate.
(vi) Sold goods to Kitty list price Rs. 20,000, trade discount 10% and cash discount 5%. He paid
the amount on the same day and availed the cash discount.
(vii) Supplied goods costing Rs. 6,000 to Ritu, issued invoice at 10% above cost less 5% trade
discount.

SOLUTION:
JOURNAL OF HARSH

Date Particulars L. Amount Amount

F. Dr. Cr.
S.No. Rs. Rs.
(i) Insurance Charges A/c Dr. 50,000
Drawings A/c Dr. 1,00,000
To Bank A/c 1,50,000
(Payment of fire insurance and life insurance
premium)
(ii) Office Expenses A/c Dr. 2,000
To Cash A/c 2,000
(Expenditure on office cleaning)
(iii) Bank Charges A/c Dr. 5,000
To Bank A/c 5,000
(The recording of bank charges)
(iv) Purchases A/c Dr. 10,00,000
To Naman 10,00,000
(Goods purchased from Naman)
Aman 12,00,000 12,00,000
To Sales A/c
(Goods sold to Aman)
(v) Cash A/c Dr. 9,750

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 Bad-debts A/c Dr. 5,250
To Rajiv 15,000
(Cash received and Bad-debts written off)
(vi) Cash A/c Dr. 17,100
Discount A/c Dr. 900
To Sales A/c 18,000
(Goods of the list price of Rs. 20,000 sold at
10% trade discount and 5% cash discount)
(vii) Ritu Dr. 6,270(1)
To Sales A/c 6,270
(Goods sold to Ritu at 10% above cost and
allowed 5% trade discount)
Total Rs. 23,96,270 23,96,270

Note (1)

Rs.
Cost of Goods 6,000
Add: 10% of 6,000 600
6,600
5
Less: 6,600 × 330
1000
6,270

Special transactions relating to goods

1. Drawings in Goods: Sometimes the proprietor withdraws goods from the business for his
personal use. The entry for recording this transaction will be:

Drawings A/c Dr.

To Purchases A/c
(Goods taken for personal use)

Purchases account is credited because as a result of the transaction the net amount of
purchases of the business is reduced. Sales account should not be credited since the sale has
not taken place. Also when the goods go out of business at cost price, purchase account
should be credited and not Sales account.

2. Goods given away as charity: Charity is an expense of the business, as such charity account
will be debited. Goods are going out of the business at cost price, hence purchases are
reduced to that extent and as such, purchases account will be credited. The entry will be:

Charity A/c Dr.

To Purchases A/c
(Goods given away as charity)

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3. Goods distributed as free sample: Sometimes the goods are distributed as free samples to
the potential buyers in order to promote sales. As such, free samples can legitimately be
treated as an expense of business. The entry will be:

Free Samples A/c Dr.

To Purchases A/c
(Goods distributed as free samples)

4. Loss of goods by theft or loss by fire: The entry will be:

Loss by Theft A/c Dr.

Loss by Fire A/c Dr.
To Purchases A/c
(Goods lost by theft and goods destroyed by fire)

ILLUSTRATION:

Pass Journal Entries for the following:

(1) Proprietor withdrew for his personal use cash Rs. 20,000 and goods worth Rs. 10,000.
(2) Goods for Rs. 50,000 were given away as charity.
(3) Goods worth Rs. 25,000 were distributed as free samples.
(4) Goods worth Rs. 50,000 and cash Rs. 20,000 were stolen by an employee.
(5) goods worth Rs. 1,00,000 were destroyed by fire.

SOLUTION:

Date Particulars L. Amount Amount

F. Dr. Cr.
S.No. Rs. Rs.
(1) Drawings A/c Dr. 30,000
To Cash A/c 20,000
To Purchases A/c 10,000
(Cash and goods taken away for persona use)
(2) Charity A/c Dr. 50,000
To Purchases A/c 50,000
(Goods given away as charity)
(3) Free Samples A/c Dr. 25,000
To Purchases A/c 25,000
(Goods distributed as free samples)
(4) Loss by theft A/c Dr. 70,000
To Purchases A/c 50,000
To Cash A/c 20,000
(Goods and Cash stolen by an employee)
(5) Loss by Fire A/c Dr. 1,00,000
To Purchases A/c 1,00,000
(Goods destroyed by fire)
Total Rs. 2,75,000 2,75,000

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ILLUSTRATION:

Pass Journal Entries for the following:

1. Purchased on Iron Safe for business for Rs. 1,00,000.

2. Purchased filing cabinet for office use Rs. 40,000 and paid Rs. 200 as cartage on it.
3. Purchased a portable typewriter from Radha Kishan & Co. for Rs. 80,000.
4. Purchased an electric fan for Rs. 20,000.
5. Purchased a ‘Horse’ for business for Rs. 1,50,000.
6. Purchased Post Cards for Rs. 250; Envelopes for Rs. 500 and Stamps for Rs. 1,000.
7. Purchased office stationery for Rs. 4,000.
8. Gave a Charity – Cash Rs. 2,000 and Goods Rs. 4,000.

SOLUTION:
JOURNAL

Date Particulars L. Amount Amount

F. Dr. Cr.
S.No. Rs. Rs.
(1) Office Equipment A/c Dr. 1,00,000
To Cash A/c 1,00,000
(Iron-safe purchased)
(2) Office Equipment A/c Dr. 40,200
To Cash A/c 40,200
(Filing cabinet purchased for Rs. 40,000 and
cartage paid on it Rs. 200)
(3) Office Equipment A/c Dr. 80,000
To Radha Kishan & Co. 80,000
(Portable typewriter purchased)
(4) Fixtures A/c Dr. 20,000
To Cash A/c 20,000
(Electric fan purchased)
(5) Live Stock A/c Dr. 1,50,000
To Cash A/c 1,50,000
(A horse purchased for business)
(6) Postage A/c Dr. 1,750
To Cash A/c 1,750
(Post Cards, envelopes and stamps purchased)
(7) Stationery A/c Dr. 4,000
To Cash A/c 4,000
(Stationery purchased for office use)
(8) Charity A/c Dr. 6,000
To Cash A/c 2,000
To Purchases A/c 4,000
(Cash and goods given as Charity)
Total Rs. 4,01,950 4,01,950

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 LESSON 5
LEDGER
Ms. Shikha Gupta

Meaning

Business transactions are fist entered in Journal or Special Purpose Subsidiary Books. The next step
is to transfer the entries to respective accounts in Ledger. In other word, all entries recorded in
Journal or Special Purpose Subsidiary Books are classified and in order to ascertain the position of a
particular account, all transactions relating to that particular account are collected at one place in the
Ledger. In short, a Ledger is a book which contains all accounts of the business enterprise whether
Personal, Real or Nominal.

Ledger is called the ‘Principal Book’. It is also called the book of final entry because the transactions
which are first entered in Journal or Subsidiary Books are finally incorporated in the Ledger.

Advantages of Ledger

1. All accounts are opened on separate pages in this books. Hence, all the transactions
pertaining to an account are collected at one place in the Ledger. As such, by looking at the
balance of that account one can understand the collective effect of all such transactions at any
point of time.

2. Any type of information relating to the business can be easily obtained from the Ledger, such
as (I) how much amount each customer owes to the firm; (II) how much amount the firm
owes to each creditor; (III) how much is the amount of purchase and sales during a particular
period; (IV) how much amount has been paid or received on account of various items, and
(V) what is the ultimate position of assets and capital.

3. A trail balance can be prepared with the help of ledger balances which helps in ascertaining
the arithmetical accuracy of the accounts.
4. A trading and profit and loss account can only be prepared with the help of ledger balances.

5. A balance sheet can also be prepared with the help of ledger balances which depicts the
financials position of the business.

Distinction between ‘Books of Original Entry’ and ‘Ledger’

The books in which the business transactions are recorded first of all are termed as ‘books of original
entry’ or Special Purpose subsidiary books. The Transactions from these books are then transferred
into the ledger accounts. As such, the Ledger is called the ‘Principal Book’ because all transactions
ultimately find their way into Ledger.

So far as cash book is concerned, it is also a book of original entry and a principal book as well.
Because all the cash transactions are recorded for the first time in the cash book, it is therefore a
book of original entry and it is also a principal book because when a cash book is maintained, a cash
account is not prepared in the Ledger.

141
 Journal or Books of Original Entry Ledger
1. As the name indicates, all the transactions All the transactions entered in Journal or
are first of all recorded in these books, i.e., Subsidiary Books are later transferred to
journal or subsidiary books such as the Ledger. As such, the Ledger is also
purchases book, sales book etc. As the called a book of final entry.
transactions are entered for the first time in
these books, they are also referred to as
books of primary entry.
2. In these books, transactions are entered in a In this book, transactions are recorded in
chronological order, as and when they take analytical order, i.e., all the transactions
place. As such the position of an account at pertaining to a particular account are
any point of time cannot be ascertained contained at one place in the Ledger. Thus,
from these books. position of an account can be easily
ascertained at any point of time.
3. Full details of a transaction (narrations) are Full details of a transaction are not recorded
recorded in these books. in the Ledger.
4. Final Account (trading, profit and loss Final accounts can be prepared with the
account and balance sheet) cannot be help of Ledger balances.
prepared with the help of books of original
entry.
5. These books are considered as more Ledger is considered as less authentic and
authentic and reliable in comparison to the reliable in comparison to books of original
ledger, since these are the books in which entry, since entries are recorded in the
the entry is recorded first of all. Ledger at a later stage.
6. The process of recording entries in the The process of recording entries in the
books of original entry is called Ledger is called ‘posting’.
‘journalising’.
7. page number of the Ledger, i.e., Ledger Page number of the Journal or subsidiary
Folio (L.F.) is written in these books. books, i.e., Journal Folio (J.F.) is written in
Ledger.
8. Accuracy of these books cannot be tested. Accuracy of the Ledger Accounts is tested
by preparing a Trial Balance.

Proforma of Ledger

Each Ledger account is divided into two equal parts. The left-hand side is known as the debit side
and the right-hand side as the credit side. As an account is in ‘T’ shape, therefore, sometimes it is
called ‘T’ account. The format of an account is as shown below:

Dr. NAME OF ACCOUNT Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. Rs.

As shown above, there are found columns on each side of an account:

1. Date: The date of the transaction is recorded in this column.

142
2. Particulars: Each transaction affects two accounts. The name of the other account which is
affected by the transaction is written in this column.
3. Journal Folio or J.F.: In this column, the page number of the Journal or Subsidiary Book from
which that particular entry is transferred, is entered.
4. Amount: The amount pertaining to this account is entered in this column.

Rules of Posting

Posting is the process of transferring entries from Journal or Subsidiary Books to the Ledger. The
following rules should be observed while posting entries in the Ledger:

1. All transactions relating to an account should be entered at one place. In other words, two
separate accounts should not be opened for posting transactions relating to the same account.
If there are two customers with similar names, their accounts should be distinguished by
writing their address against their names, say the Account of Ajay (of Moti Bagh) and the
Account of Ajay (of Karol Bagh).

2. The word ‘To’ is used before the accounts which appear on the debit side of an account.
Similarly, the word ‘By’ is used before the accounts which appear on the credit side of an
account.

3. If an account has been debited in the Journal entry, the posting in the Ledger should also be
made on the debit side of such account. In the Particulars column, the name of the other
account which has been credited in the Journal entry should be written for reference.

4. If an account has been credited in the Journal entry, the posting in the Ledger should also be
made on the credit side of such account. In the particulars column, the name of the other
account which has been debited in the Journal entry should be written for reference.

5. Similar amount which has been posted on the debit side of an account should also be posted
on the credit side of another account.

6. It is not necessary to write the word ‘A/c after the personal accounts.

Example: On 1st April, 2009, sold goods for cash Rs. 20,000. Pass Journal entry and post it into
Ledger.

Solution: Journal Entry:

2009
April 1 Cash A/c Dr. 20,000
To Sales A/c 20,000
(Cash sales)

The above entry will be posted into Ledger Accounts as follows:

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Dr. CASH ACCOUNT Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
2009 Rs. Rs.
April 1 To Sales A/c 20,000

Dr. SALES ACCOUNT Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. 2009 Rs.
April 1 By Cash A/c 20,000

Posting of Compound Journal Entries

When in a Journal entry, two or more accounts are debited and only one account is credited or vice
versa, the entry is termed as compound journal entry. In case of posting of a compound journal entry,
posting has to be made in all the accounts whether debited or credited in the entry. For example, if on
10th April 2009, cash received from Jatin & Co. is Rs. 1,48,000 and discount allowed to them is Rs.
2,000, the compound entry and the Ledger Accounts will be as follows:

2009
April 10 Cash A/c Dr. 1,48,000
Discount A/c Dr. 2,000
To Jatin & Co. A/c 1,50,000
(Cash received and discount allowed)

Dr. CASH ACCOUNT Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount
2009 Rs. Rs.
Apr. 10 To Jatin & Co. A/c 1,48,000

Dr. DISCOUNT ACCOUNT Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount
2009 Rs. Rs.
Apr. 10 To Jatin & Co. A/c 2,000

Dr. SALES ACCOUNT Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. 2009 Rs.
Apr. 10 By Cash A/c 1,48,000
Apr. 10 By Discount 2,000

ILLUSTRATION:

Pass Journal Entries for the following transactions and post them into Ledger:

2010 Rs.
April 1 Raja Ram commenced business with cash 20,00,000

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 3 Purchased office furniture for cash 2,00,000
5 Purchased goods for cash 5,00,000
8 Purchased goods from Jain Trading Co. 2,50,000
from Jindal Garments 1,60,000
10 Returned goods to Jain Trading Co. 50,000
14 Paid cash to Jain Trading Co. in full settlement of their account,
after deducting 5% cash discount.
15 Sold goods for cash 4,00,000
18 Sold goods to HCL Limited, less 10% Trade Discount 3,00,000
20 Raja Ram withdrew from business for his personal use-Cash 1,00,000
Goods 40,000
21 Paid to Jindal Garments 78,000
Discount received 2,000
22 Received from HCL Limited 88,500
Discount allowed 1,500
25 Sold goods to Hemraj Limited for cash 1,20,000
28 Purchased goods from Dhingra Brothers 2,40,000
30 Paid for Rent Rs. 20,000 and Salaries Rs. 40,000.

SOLUTION:
JOURNAL OF RAJA RAM

Date Particulars L. Amount Amount

F. Dr. Cr.
2010 Rs. Rs.
April 1 Cash A/c Dr. 20,00,000
To Capital A/c 20,00,000
(Raja Ram started business with cash)
3 Furniture A/c Dr. 2,00,000
To Cash A/c 2,00,000
(Furniture purchased for cash)
5 Purchases A/c Dr. 5,00,000
To Cash A/c 5,00,000
(Goods purchased for cash)
8 Purchases A/c Dr. 4,10,000
To Jain Trading Co. 2,50,000
To Jindal Garments 1,60,000
(Goods purchased on credit)
10 Jain Trading Co. Dr. 50,000
To Purchases Returns A/c 50,000
(Goods returned to Jain Trading Co.)
14 Jain Trading Co. Dr. 2,00,000
To Cash A/c 1,90,000
To Discount A/c 10,000
(Cash paid and discount received)
15 Cash A/c Dr. 4,00,000
To Sales A/c 4,00,000
(Goods sold for cash)
18 HCL Limited Dr. 2,70,000
To Sales A/c 2,70,000
(Goods wroth Rs. 3,00,000 sold at a trade
discount of 10%)
20 Drawing A/c Dr. 1,40,000

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 To Cash A/c 1,00,000
To Purchases A/c 40,000
(Cash and goods withdrew by proprietor for his
personal use)
21 Jindal Garments Dr. 80,000
To Cash A/c 78,000
To Discount A/c 2,000
(Cash paid and discount received)
22 Cash A/c Dr. 88,500
Discount A/c Dr. 1,500
To HCL Limited 90,000
(Cash received and discount allowed)
25 Cash A/c Dr. 1,20,000
To Sales A/c 1,20,000
(Goods sold for cash)
28 Purchases A/c Dr. 2,40,000
To Dhingra Brothers 2,40,000
(Goods purchased on credit)
30 Rent A/c Dr. 20,000
Salaries A/c Dr. 40,000
To Cash A/c 60,000
(Expenses paid in cash
Total Rs. 47,60,000 47,60,000

LEDGER OF RAJA RAM

Dr. CASH ACCOUNT Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.
Apr. 1 To Capital A/c 20,00,000 Apr. 3 By Furniture A/c 2,00,000
15 To Sales A/c 4,00,000 5 By Purchases A/c 5,00,000
22 To HCL Limited 88,500 14 By Jain Trading Co. 1,90,000
25 To Sales A/c 1,20,000 20 By Drawings A/c 1,00,000
21 By Jindal Garments 78,000
30 By Rent A/c 20,000
30 By Salaries A/c 40,000

CAPITAL ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. 2010 Rs.
Apr. 1 By Cash A/c 20,00,000

FURNITURE ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 3 To Cash A/c 2,00,000

PURCHASES ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.
Apr. 5 To Cash A/c 5,00,000 Apr. 8 By Drawing A/c 40,000

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 8 To Jain Trading Co. 2,50,000
8 To Jindal Garments 1,60,000
28 To Dhingra Brothers 2,40,000

JAIN TRADING CO.

Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.
Apr. 10 To Purchases Apr. 8 By Purchases A/c 2,50,000
Returns A/c 50,000
14 To Cash A/c 1,90,000
14 To Discount 10,000

JINDAL GARMENTS
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.
Apr. 21 To Cash A/c 78,000 Apr. 8 By Purchases A/c 1,60,000
21 To Discount 2,000

JAIN TRADING CO.

Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs.
Apr. 10 By Jain Trading
Co. 50,000

PURCHASES RETURNS ACCOUNT

Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. 2010 Rs.
Apr. 10 By Jain Trading
Co. 50,000

DISCOUNT (RECEIVED) ACCOUNT

Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. 2010 Rs.
Apr. 14 By Jain Trading 1,00,000
Co.
21 By Jindal 2,000
Garments

SALES ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. 2010 Rs.
Apr. 15 By Cash A/c 4,00,000
18 By HCL Limited 2,70,000
25 By Cash A/c 1,20,000

HCL LIMITED
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.

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Apr. 18 To Sales A/c 2,70,000 Apr. 22 By Cash A/c 88,500
22 By Discount A/c 1,500

DRAWINGS ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 20 To Cash A/c 1,00,000
20 To Purchases A/c 40,000

DISCOUNT (ALLOWED ACCOUNT)

Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 22 To HCL Limited 1,500

DHINGRA BROTHERS
Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. 2010 Rs.
Apr. 28 By Purchases A/c 2,40,000

RENT ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 30 To Cash A/c 20,000

SALARIES ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 30 To Cash A/c 40,000

Note: Two separate accounts for ‘Discount Received A/c’ and ‘Discount Allowed A/c’ have been
opened to enable the management to know separately how much amount was gained or lost on
discount.

Closing and Balancing of Accounts

At the end of the accounting period or whenever needed, a businessman will be interested in
knowing the position of various accounts. For this purpose the accounts are balanced. Balancing of
an account means that the debit and credit sides are totalled and the difference between the two sides
is inserted on the side which is shorter so as to make their totals equal. If the debit side exceeds the
credit, the balance is called a debit balance and on the other hand, if the credit side exceeds the
debits, the balance is called a credit balance.

As discussed earlier, all the accounts are classified into three categories according to their nature, i.e.
(1) Personal Accounts, (2) Real Accounts and (3) Nominal Accounts. There are different methods for
balancing of each of the three categories of accounts discussed as below:

1. Closing of Personal Accounts: From the balancing of these accounts we can ascertain as to
how much amount is owing from each individual customer and how much amount is owed to

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 each individual creditor. If a personal account shows a debit balance, it indicates the amount
owing from him. On the contrary, if a personal account shows a credit balance, it indicates
the amount owing to him.

In case the total of the debit side is in excess of the credit side, the difference between the two
is inserted on the credit side of the account in order to make their totals equal. The words ‘By
Balance c/d’, i.e., balance carried down are written against the amount of the difference. In
the next accounting period, the balance is brought down on the debit side by writing the
words ‘To Balance b/d’.

On the contrary, if the total of the credit side is in excess of the debit side, the difference
between the two is inserted on the debit side of the account in order to make their totals
equal. The words ‘To Balance c/d’ are written against the amount of the difference. In the
next accounting period, the balance is brought down on the credit side by writing the words
‘By Balance b/d’.

Personal Accounts as shown ‘Opened’ in Illustration will be closed in the following manner:

Dr. CAPITAL ACCOUNT Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.
Apr. 30 To Balance c/d 20,00,000 Apr. 1 By Cash A/c 20,00,000
May 1 By 20,00,000

JAIN TRADING CO.

Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.
Apr. 10 To Purchases Apr. 8 By Purchases A/c 2,50,000
Returns A/c 50,000
14 To Cash A/c 1,90,000
14 To Discount 10,000
2,50,000 2,50,000

JINDAL GARMENTS
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.
Apr. 21 To Cash A/c 78,000 Apr. 8 By Purchases A/c 1,60,000
21 To Discount 2,000
30 To Balance c/d 80,000
1,60,000 1,60,000

HCL LIMITED
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.
Apr. 18 To Sales A/c 2,70,000 Apr. 22 By Cash A/c 88,500
22 By Discount A/c 1,500
30 By Balance c/d 1,80,000
2,70,000 2,70,000
May 1 To Balance b/d 1,80,000

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 DRAWINGS ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.
Apr. 20 To Cash A/c 1,00,000 Apr. 30 By Balance c/d 1,40,000
20 To Purchases A/c 40,000
1,40,000 1,40,000
May 1 To Balance b/d 1,40,000

DHINGRA BROTHERS
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.
Apr. 30 To Balance c/d 2,40,000 Apr. 28 By Purchases A/c 2,40,000
May 1 By Balance b/d 2,40,000

2. Closing of Real Accounts: Real accounts include the accounts of cash in hand and the
accounts of all other assets such as Land, Building, Furniture, Investments etc. Account
relating to Goods are also included in real accounts. Method of closing the Cash A/c and the
accounts of all other assets in the same as that of personal accounts. When balanced, these
will always show debit balances.

Accounts relating to ‘Goods’ such as Purchases A/c, Sales A/c, Purchases Return A/c, Sales
Return A/c and Stock A/c, although real accounts by nature, are not balanced. These accounts
are closed by transferring them to Trading Account at the end of the year. (For details refer
to chapter on Final Accounts).

Real Accounts as shown opened in Illustration will be closed in the following manner:

Dr. CASH ACCOUNT Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.
Apr. 1 To Capital A/c 20,00,000 Apr. 3 By Furniture A/c 2,00,000
15 To Sales A/c 4,00,000 5 By Purchases A/c 5,00,000
22 To HCL Limited 88,500 14 By Jain Trading Co. 1,90,000
25 To Sales A/c 1,20,000 20 By Drawings A/c 1,00,000
21 By Jindal Garments 78,000
30 By Rent A/c 20,000
30 By Salaries A/c 40,000

26,08,500 26,08,500
May 1 To Balance b/d 14,80,500

FURNITURE ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.
Apr. 3 To Cash A/c 2,00,000 Apr. 30 By Balance c/d 2,00,000
May 1 To Balance b/d 2,00,000

PURCHASES ACCOUNT

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 Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. 2010 Rs.
Apr. 5 To Cash A/c 5,00,000 Apr. 8 By Drawing A/c 40,000
8 To Jain Trading Co. 2,50,000
8 To Jindal Garments 1,60,000
28 To Dhingra Brothers 2,40,000
11,50,00

PURCHASES RETURNS ACCOUNT

Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. 2010 Rs.
Apr. 10 By Jain Trading
Co. 50,000

SALES ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. 2010 Rs.
Apr. 15 By Cash A/c 4,00,000
18 By HCL Limited 2,70,000
25 By Cash A/c 1,20,000
7,90,000

3. Closing of Nominal Accounts: Nominal accounts include the accounts relating to the
expenses and incomes of the firm. These accounts do not require balancing. As the main
purpose of opening the nominal accounts is to ascertain the net profit or loss of the firm, all
such accounts are transferred to the trading and profit and loss account of the firm at the end
of the financial period. (For details refer to Chapter on Final Accounts).

Nominal Accounts as shown opened in Illustration will appear as follows:

DISCOUNT (RECEIVED) ACCOUNT

Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. 2010 Rs.
Apr. 14 By Jain Trading 1,00,000
Co.
21 By Jindal 2,000
Garments

DISCOUNT (ALLOWED ACCOUNT)

Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 22 To HCL Limited 1,500

RENT ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 30 To Cash A/c 20,000

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 SALARIES ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 30 To Cash A/c 40,000

Trail Balance

When posting of all the transactions into the Ledger is completed and the accounts are balanced off,
it becomes necessary to check the arithmetical accuracy of the accounting work. For this purpose, the
balance of each and every account in the Ledger is put on a list. The list so prepared is called a trial
balance.

Ledger account which shows a debit balance is put on the debit side of the trail balance and the
account which shows a credit balance is put on the credit side of the trail balance. Account which
shows no balance, i.e., whose debit and credit totals are equal, is not entered in the trail balance. If
the total of the debit side of trail balance equal to that of its credit side, it is proved that books are
atleast arithmetically correct and there are not errors in the posting and balancing the ledger
accounts.

If a trial balance is prepared for Illustration with the help of the above prepared ledger accounts, it
will appear as follows:

Particulars L.F. Dr. Cr.

Balances Balances
Rs. Rs.
Capital A/c 20,00,000
Jindal Garments 80,000
HCL Limited 1,80,000
Drawings A/c 1,40,000
Dhingra Brothers 2,40,000
Cash A/c 14,80,500
Furniture A/c 2,00,000
Purchases A/c 11,10,000
Purchases Return A/c 50,000
Sales A/c 7,90,000
Discount (Received) A/c 12,000
Discount (Allowed) A/c 1,500
Rent A/c 20,000
Salaries A/c 40,000
Total 31,72,000 31,72,000

Significance of various balances relating to Accounts

1. Debit balance of a Personal Account indicates the amount which is owing to the firm by a
person. In other words, he is the debtor of the firm.

2. Credit balance of a Personal Account indicates the amount which is owing to the person
concerned. In other words, he is the creditor of the firm.

152
3. Bank Account is a personal account and not a real account because bank account is the
account of some banking company which is an artificial person. If the bank account shows a
debit balance it would indicate the balance of Cash at bank. On the other hand, if it shows a
credit balance, it would indicate an overdraft balance.

4. Debit balance of a Real Account shows the value of an asset in the books of the firm.

5. Usually real accounts do not show credit balances.

6. Debit balance of a Nominal Account indicates loss or expense.

7. Credit balance of a Nominal Account indicates gain or income.

In brief, it can be said that:

(I) A debit balance is either an asset or an expense.

(II) A credit balance shows liability, capital or the income earned.

Posting of Opening Entry

We have seen that the first entry in each year’s Journal is to record the opening balances of various
assets and liabilities at the beginning of the new year. It is termed as the ‘Opening entry’.

As the accounts of all the assets will be debited in an opening entry, an account for each asset will be
opened in the Ledger and the posting will be made on the debit side by writing the words ‘To
Balance b/d’.

Similarly, as the accounts of the liabilities will be credited in an opening entry, an account for each
liability will be opened in the Ledger and the posting will be made on the credit side by writing the
words ‘By Balance b/d’.

Thus, by posting the opening entry completely, all the accounts pertaining to assets and liabilities in
the beginning will be opened in the Ledger.

ILLUSTRATION

The following balances appeared in the Ledger of M/s J.K. Traders on 1st April 2010:

Cash in hand 60,000; Cash at Bank 1,20,000; Bills Receivable 70,000; Lalit (Cr.) 30,000; Stock
(Goods) 54,000; Bills Payable 20,000; Paresh (Dr.) 97,000; Saurav (Dr.) 1,00,000.

SOLUTION:

JOURNAL OF M/S J.K. TRADERS

Date Particulars L. Amount Amount

F. Dr. Cr.
2010 Rs. Rs.
April 1 Cash A/c Dr. 60,000
Bank A/c Dr. 1,20,000
Bills Receivable A/c Dr. 70,000

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 Stock A/c Dr. 54,000
Paresh Dr. 97,000
Saurav Dr. 1,00,000
To Lalit 30,000
To Bills Payable A/c 20,000
To Capital A/c (Balancing figure) 4,51,000
(Opening entry recorded in journal, capital is
ascertained by deducting Cr. side from Dr. side
i.e. 5,01,000 – 50,000 = Rs. 4,51,000

LEDGER

Dr. CASH ACCOUNT Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 1 To Balance b/d 60,000

BANK ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 1 To Balance b/d 1,20,000

BILLS RECEIVABLE ACCOUNT

Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 1 To Balance b/d 70,000

STOCK ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 1 To Balance b/d 54,000

PARESH
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 1 To Balance b/d 97,000

SAURAV
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 Rs. Rs.
Apr. 1 To Balance b/d 1,00,000

LALIT
Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. 2010 Rs.
Apr. 1 By Balance b/d 30,000

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 BILLS PAYABLE ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. 2010 Rs.
Apr. 1 By Balance b/d 20,000

CAPITAL ACCOUNT
Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. 2010 Rs.
Apr. 1 By Balance b/d 4,51,000

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 LESSON 6
FINAL ACCOUNTS (FINAL STATEMENTS)
FROM INCOMPLETE RECORDS
(SINGLE ENTRY SYSTEM)
Ms. Shikha Gupta
MEANING AND TYPES

Meaning: Accounting records which have not been maintained strictly on the basis of double entry
book-keeping system––where every debit must have a corresponding credit––are often described as
incomplete records, popularly known as single entry system. In practice, the unqualified accountants
follow some type of mixed or hybrid system in which some transactions are recorded with proper
debits and credits whereas for some transactions only one entry is made. Still for some transactions
no entry may be such a procedure as a system of incomplete records fails to disclose a true and fair
view of the financial position and operating results of a business enterprise. A sole trader may not
require elaborate system of book-keeping since he may be interested only in such information as:

(i) What is his bank balance?

(ii) How much money is owing to him and by whom?
(iii) What does he owe for goods purchased on credit?
(iv) How much does he owe for important items like rent, wages etc.?

It is thus clear that he will keep only such books as are necessary to provide him the foregoing
information. He may keep an analytical cash book completed the regularly and accurately together
with neatly filed invoices and other relevant vouchers so that the accountant can compile some sort
of a statement of profit and a statement of assets and liabilities.

Types: A scrutiny of many procedures adopted in maintaining records under single entry system (or
incomplete records) brings forth the existence of following three types:

(i) Pure single entry, in which only personal accounts are maintained with the result that no
information is available in respect of cash and bank balances, sales and purchases etc. In view
of its failure to provide even the basic information regarding cash etc., this method exists
only on paper and has not practical application.

(ii) Simple single entry, under which only: (a) personal accounts, and (b) cash book are
maintained. Although these accounts are kept on the basis of double entry system, postings
from cash book are made only to personal accounts and no other account is to be found in the
ledger. Cash received from debtors or cash paid to creditors is simply noted on the bills
issued or received as the case may be.

(iii) Quasi single entry is a system in which (a) personal accounts, (b) cash book, and (c) some
subsidiary books are maintained. The main subsidiary books kept under this system are Sales
Book, Purchases Book and Bills Book. No separate record is maintained for the discounts
which are directly entered into the personal accounts. In addition, some scattered information
is also available in respect of few important items of expenses like wages, rent, rates etc. In
fact it is this method which is generally adopted as a substitute for double entry system.

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SPECIAL FEATURES OF SINGLE ENTRY SYSTEM

It is possible to enumerate special features of single entry system such as:

(i) It is an inaccurate, unscientific and unsystematic method of recording business transactions.

(ii) There is generally no record of real and personal accounts and, in most of the cases, a record
is kept for cash transactions and personal accounts.

(iii) Cash book mixes up business and personal transactions of the owners.

(iv) There is no uniformity in maintaining the records and the system may differ from firm to firm
depending on the requirements and convenience of each firm.
(v) Profit under this system is only an estimate and therefore true and correct profits cannot be
determined. The same is the case with the financial position in the absence of a proper
balance sheet.

(vi) this system is generally found in sole trading concerns or even in partnership firms to some
extent but never in the case of limited liability companies on account of legal requirements.

ADVANTAGES OF SINGLE ENTRY SYSTEM

Though there is nothing to commend about this system yet it is not out of place to state that the
following advantages:

(i) as the system is simple, it can be maintained by anyone without adequate or special
knowledge of accounting;

(ii) it is less costly because expenses for keeping the records are very nominal and

(iii) it is less time-consuming since the transactions are entered only in limited number of books.

DEFECTS OF SINGLE SYSTEM

The single entry system suffers from the following defects:

(i) As two-fold aspect of the transactions is not recorded on the basis of double entry system, it
is not possible to compile a trail balance from available information. Arithmetical accuracy of
the books therefore is always in doubt.

(ii) The complete record of the nominal accounts is not maintained. It is, therefore, not possible
to calculate accurately the results of business operations i.e., profit or loss.

(iii) Since real accounts are not kept separately, it is not possible to prepare the balance sheet. It
is, therefore, difficult to obtain an idea about true financial position of the business enterprise.

(iv) The double entry system is endowed with the automatic checks which are missing in the
single entry system. Hence committing of frauds is easier and their detection is difficult.

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(v) Profit or loss in single entry system is calculated in most of the cases by comparing the
capital at the end with the capital in the beginning. It does not provide useful information in
respect of causes or sources of profit or loss.

(vi) Errors are quite common and there is no procedure for detecting them.

(vii) It is not possible to attempt intra-firm or inter-firm comparisons since necessary statistical
information regarding depreciation, sale or purchase of assets etc., is not available.

(viii) In the absence of complete and classified information, the proprietor will definitely be in a fix
in the following situations:
(a) while selling his business since no method of determining its net worth is available;
(b) while valuing the goodwill;
(c) while filing claim with the insurance company for the loss of stock by fire etc.;
(d) while facing the income tax authorities for the reliability of his computed income;
(e) while arranging loans from the financial institutions as no satisfactory data are
available regarding the liquidity or profitability of the enterprise.

DIFFERENCE BETWEEN SINGLE ENTRY SYSTEM

AND DOUBLE ENTRY SYSTEM

Basis of Difference Single Entry System Double Entry System

(i) Both Aspects In some case both and in other case Both aspects i.e., Dr. and Cr. of a
only one aspect of a transaction is transaction are recorded.
recorded.

(ii) Accounts Only personal accounts and cash All personal, real and nominal
account are opened. accounts are opened.

(iii) Trial Balance Trial balance cannot be prepared. Trial balance is prepared.

(iv) Profit or Loss Trading and Profit and Loss Trading and Profit and Loss
Accounts are not prepared; hence Account is prepared; hence profit
Profit or Loss cannot be found out. or loss can be easily found out.

(v) Financial Position In the absence of a reliable Balance Balance Sheet is prepared; hence
Sheet, financial position cannot be financial position can be easily
found out easily. found out.

(vi) Utility This system is suitable for a small This system is suitable for all types
business. of businesses.

ASCERTAINMENT OF PROFIT (OR LOSS)

The bitter taste of maintaining incomplete records or adopting any type of single entry system is felt
when the income tax officer wants to know the evidence of annual income or when the sales tax or
VAT personnel seek information about the annual turnover; and also when the business enterprise
wants to determine its financial position and operating results at the end of the accounting period.
This creates some special problems for the accountants because in the absence of complete records, it
is not possible to prepare final accounts and produce a income statement for operating results and a

158
balance sheet for the financial position. However, the accounting profession employs one of the two
methods namely:
(i) Statement of Affairs Method and
(ii) Conversion Method depending on the available information to achieve the desired results.

STATMEMENT OF AFFAIRS METHOD

(Ascertainment of Profit by Capital Comparison)

This method is also known as Net Worth Method or Method of Capital Comparison. When pure
single entry has been adopted with no record of nominal and real accounts, the profit or loss for the
accounting period can be ascertained by preparing the following statements under this method: (i)
Statement of Affairs and (ii) Statement of Profit and Loss.

STATEMENT OF AFFAIRS

When the net worth or net assets (Capital) at the end of the given period is more than that o the
beginning (with necessary adjustments), the result is profit, and when it is the opposite, there is a
loss. It is, therefore, necessary to find out capital in the beginning and capital at the end of the
accounting period. Capital is the difference between Total Assets and Total Outside Liabilities on a
given date. In order to calculate capital in the beginning and at the end, a statement showing items of
different assets and liabilities has to be prepared. This statement is called Statement of Affairs which
is similar (though not the same) to Balance Sheet. The accountant utilises the following sources for
the purpose of finding out the assets and liabilities of a business enterprise:
(i) Cash Book for cash balance.
(ii) Bank Pass Book for bank balance.
(iii) Personal Ledger for Debtors and Creditors.
(iv) Stock by actual counting and valuation.
(v) As regards Fixed Assets, he prepares a list of them. The proprietor would help the accountant
by disclosing the original cost and date of purchase, all a matter of mere memory. After
deducting reasonable amount of depreciation, the written down or depreciated value would be
included in the Statement of Affairs.
(vi) Outstanding and prepared expenses and income would be ascertained from rough notings
here and there or mere memory.

Capital: The assets and liabilities are suitably arranged in the Statement of Affairs and the excess of
assets over liabilities is the capital (the balance figure).

Proforma Statement of Affairs as on……………..

Liabilities Rs. Assets Rs.

Creditors Building
Bills Payable Machinery
Outstanding Wages Cash
Income Received in Advance Bank
Capital (Balancing Figure) Stock
Prepaid Insurance etc., etc.

159
 STATEMENT OF PROFIT AND LOSS

The two statements of affairs one at the beginning of the accounting period (known as opening) and
the other at, the end of the accounting period (known as closing) would simply provide information
in respect of capital in the beginning and capital, at the end respectively. Now we are to find out the
profit or loss. An increase in the capital at the end over the capital in the beginning would apparently
mean profit and decrease a loss. But it should be appreciated that such increase or decrease in the
capital at the end may not necessarily be on account of profit or loss as the case may be. For
example, if the proprietor introduces additional capital during the year, there will be increase in
capital at the end (despite no profit) and similarly if any drawings (withdrawals in cash or kind) are
made, that would reduce the capital at the end. Hence necessary adjustments must be made before
the capital at the end is compared with the capital in the beginning for the purpose of ascertaining
correct profit or loss. Accordingly the following procedure must be adopted:

Proforma Statement of Profit and Loss (with Adjustment in Capital)

for the year ending on…………………..

Rs.
Capital at the end
Add: Drawings during the year (i)
Less: Additional capital introduced or invested during the year (ii)
Actual Capital that ought to be at the end
Less: Capital in the beginning
Profit or loss subject to adjustments (iii)

(i) In the absence of drawings, the capital at the end would have been more; hence drawings are
added back to the capital at the end.

(ii) In case additional capital were not introduced during the year, capital at the end would be
less. Thus additional capital is deducted from the capital at the end.

(iii) If the adjusted closing capital is more than the capital in the beginning, there is a profit and
if it is less than opening capital, there is a loss.

The profit or loss, thus arrived at, is subject to following adjustments:

(i) Interest on capital and drawings;
(ii) Salary to a partner;
(iii) Depreciation;
(iv) Provision for doubtful debts;
(v) Outstanding income and expenses;
(vi) Prepaid expenses and income etc.

These adjustments are made to profit or loss arrived at by comparing two capitals. Unadjusted
figure is like gross profit or loss.

Alternatively, the above stated adjustments may be made in the capital in beginning as well:

160

Capital in the beginning
Add: Additional capital introduced during the year
Less: Drawings during the year
Actual Capital that ought to be in the business
Less: Capital at the end
Profit or loss subject to adjustments (a)
(a) If the actual capital (opening capital with adjustments of additional capital and
drawings) is more than the capital at the end, the result is loss and profit if vice versa.
DIFFERENCE BETWEEN STATEMENT OF AFFAIRS AND
BALANCE SHEET
Although the statement of affairs is treated at par with the balance sheet yet there are significant
fundamental differences between the two as outlines below:
Points of Difference Statement of Affairs
1. Reliability It is prepared on the basis of
transactions partly recorded on the
basis of double entry book-keeping
and partly on the basis of single
entry. Most of the assets are
recorded on the basis of estimates,
assumptions, information gathered
from memory rather than records.
2. Trial Balance It is not possible to prepare trial
balance on the basis of available
information. Hence, it is not
possible to verify the arithmetical
accuracy of the various items.
3. Capital In this statement, capital is merely
a balancing figure being excess of
assets over capital. Hence assets
need not be equal to liabilities.
4. Omission Since this statement is prepared on
the basis of incomplete records, it
is very difficult, if not impossible,
to locate the assets and liabilities, if
they are omitted from the books.
5. Basis of The valuation of assets is generally
Valuation done in an arbitrary manner;
therefore no method of valuation is
disclosed.
161
Rs.
Balance Sheet
It is based on transactions recorded
strictly on the basis of double entry
book-keeping; each item in the balance
sheet can be verified from the relevant
subsidiary books and ledger. Hence the
balance sheet is not only reliable, but
also dependable.
Under double entry system, a trial
balance is prepared at the end of the
accounting period. It ensures the
arithmetical accuracy of the items
stated therein. And since the balance, it
can be safely taken as authentic
statement.
Capital is derived from the capital
account in the ledger and therefore the
total of assets side will always be equal
to the total of liabilities side.
There is no possibility of omission of
any item of asset and liability since all
items are properly recorded. Moreover,
it is easy to locate the missing items
since the balance sheet will not agree.
The valuation of assets is done on
scientific basis, that is original cost in
the case of new assets and depreciated
amount on the basis of cost minus
depreciation to date for used assets.
Any change in the method of valuation
 is properly disclosed.

6. Objects The object of preparing this The object of preparing the balance
statement is the calculation of sheet is to ascertain the financial
capital figures in the beginning and position on a particular date.
at the end of the accounting period
respectively.

ILLUSTRATION: (Capital at the end not given)

Sunny commenced business on January 1, 2009 with capital of Rs. 1,00,000. He immediately bought
furniture and fixtures for Rs. 20,000. On 30 June, 2009, he borrowed from his wife Rs. 50,000 @9%
p.a. (interest not yet paid) and introduced a further capital of his own amounting to Rs. 15,000. X
drew at the rate of Rs. 3,000 p.m. at the end of each month for household expenses. On 31 December
2009 his financial position was as under:

Rs. Rs.
Cash in hand 28,000 Bills Receivable 16,000
Sundry Debtors 48,000 Sundry Creditors 5,000
Stock 68,000 Owing for Rent 1,500

Calculate profit or loss X for 2009

SOLUTION:
SUNNY

(i) Sunny’s opening capital is Rs. 1,00,000 including Rs, 80,000 cash and Rs. 20,000 furniture.
(ii) He has introduced Rs. 15,000 as additional capital.
(iii) Loan from wife along with interest on loan is a liability on the business and not additional
capital.
(iv) He has withdrawn Rs. 36,000 during the year (i.e., at Rs. 3,000 for twelve months).
(v) His closing capital can be found either by preparing a Statement of Affairs as on 31.12.2009
or by using the formula:
Capital = Assets – Liabilities

Let us prepare the Statement of Affairs

Statement of Affairs as on 31.12.2009

Liabilities Rs. Assets Rs.
Sundry Creditors 5,000 Cash in hand 28,000
Outstanding Rent 1,500 Sundry Debtors 48,000
Loan from Wife 50,000 Stock 68,000
Interest on Loan from Mrs. Sunny 2,250 Bills Receivable 16,000
Sunny’s Capital (Balancing Figure) 1,23,250 Furniture and Fixtures 20,000
1,80,000 1,80,000

162
 Statement of Profit and Loss for 2009
Rs.
Capital as on 31.12.2009 1,21,250
Add: Drawings during the year 36,000
1,57,250
Less: Capital introduced during the year 15,000
1,42,250
Less: Capital as on 1.1.2009 1,00,000
Profit earned in 2009 42,250
ILLUSTRATION: (Capitals not known)

Mohan is a small cloth merchant who has not kept full double entry records. His position as on 1
January 2010 stood as follows: Cash ins hand Rs. 7,600; Balance at Bank Rs. 69,950; Stock Rs.
1,26,000; Sundry Debtors Rs. 45,000; furniture Rs. 20,000; Sundry Creditors Rs. 43,100. His
position at the end 2002 was as follows: Cash in hand Rs. 4,700; Balance at Bank as per Bank Pass
Book Rs. 59,300; Stock Rs. 1,67,000; Sundry Debtors Rs. 63,200; Furniture Rs. 20,000; Mobike Rs.
40,000; Sundry Creditors Rs. 53,000. During the year he had withdrawn Rs. 4,000 per month for his
personal expenses and purchased a new Mobike for his business use for Rs. 40,000. A cheque of Rs.
10,000 issued on 29.12.2010 was presented for payment on 12.1.2011. Prepare a statement showing
his trading result for the year ended 31 December 2010 and a Balance Sheet as on 31.12.2010 after,
(a) providing 10% depreciation on furniture and 20% depreciation on Mobike; (b) writing off Rs.
3,200 as actual bad debts; and (c) making a 5% provision for likely bad debts.

SOLUTION:

1. Opening capital can be ascertained by preparing Statement of Affairs as on 1.1.2010 as

follows:

MOHAN
Statement of Affairs as on 1.1.2010

Liabilities Rs. Assets Rs.

Sundry Creditors 43,100 Cash in hand 7,600
Mohan’s Capital 2,25,000 Cash at Bank 69,500
(Balance Figure) Sundry Debtors 45,000
Stock-in-Trade 1,26,000
Furniture 20,000
2,68,100 1,80,000

2. Capital at the end can be ascertained by preparing either a Statement of Affairs as on

31.12.2010 or by using the formula or accounting equation i.e. Capital = Assets – Liabilities.
Let us follows formula or accounting equation to find out his capital at the end:
Rs.
Assets (Before adjustments) 4,700
Cash in hand 49,300
Cash at Bank as per Cash Book (59,300 – 10,000) 63,200
Sundry Debtors 1,67,000
Stock-in-Trade 20,000
Furniture 40,000
Mobike 3,44,200
Less: Liabilities

163
Sundry Creditors 53,000
Capital = Assets – Liabilities (Balancing Figure) 2,91,200

3. Statement of Profit for the year ending on 31.12.2010

Rs.
Capital at the end (31.12.2010) 2,91,200
Add: Drawings during the year 48,000
3,39,200
Less: Capital in the beginning 2,25,000
Profit subject to adjustments or Gross Profit 1,14,200
Less: Actual bad debts 3,200
1,11,000

Less: Depreciation on:

Furniture : 2,000 (10% of Rs. 20,000)
Mobike : 8,000 (10% of Rs. 40,000) 10,000
1,01,000
Less: Provision for doubtful debts: 5% on Rs. 60,000 (63,200 – 3,200) 3,000
Net Profit 9,80,000

Statement of Affairs of Mr. Mohan as on 31.12.2010

Liabilities Rs. Assets Rs.

Sundry Creditors 53,000 Cash in hand 4,700
Capital (as on 1.1.2010) 2,25,000 Cash at Bank 49,300
Add: Profit 98,000 (As per Cash Book)
3,23,000 Sundry Debtors 63,200
Less: Drawings 48,000 2,75,000 Less: Bad Debts 3,200
60,000
Less: Provision for
Doubtful debts 3,000 57,000
Stock-in-Trade 1,67,000
Furniture 20,000
Less: Depreciation 2,000 18,000
Mobike 40,000
Less: Depreciation 8,000 32,000
3,28,000 3,28,000

ILLUSTRATION: (Bad Debts, Cheques Issued but not presented)

On 1-4-2009 Ragini started a business with a capital of Rs. 15,00,000 with which she opened a bank
account. On the same date she bought furniture for Rs. 2,04,000 and stock of goods for Rs. 5,94,000.
On 31 March 2010, the stock-in-hand was valued at 7,90,000 and fittings stood at Rs. 1,67,000.
Book debts amounted to Rs. 7,80,000 of which Rs. 15,000 was considered as bad. Her bank balance
as per cash book was Rs. 1,50,000. A cheque of Rs. 14,000 sent for deposit on 30 March 2010 was
realised on 5 April 2010, and a cheque of Rs. 7,000 issued on 15 March 2010 was not presented until
2 April 2010. Bank charges amounted to Rs. 400 but the same was not intimated to Ragini upto 31
March 2010. her drawings amounted Rs. 3,06,000. She had also taken for personal use goods

164
amounting to Rs. 1,20,000. Creditors stood at Rs. 2,52,000 at the end. Prepare a statement showing
profit or loss for the accounting period ending on 31 March 2010.

SOLUTION:

Calculation of Capital as on 31 March 2010

Assets Rs.
Cash at Ban as per Cash Book (1,50,000 – 400) 1,49,600
Stock 7,90,000
Furniture and Fittings 1,67,000
Book Debts (7,80,000 – 15,000) 7,65,000
18,71,600
Less: Creditors 2,52,000
Capital on 31 March 2009 16,19,600
Less: Capital on 1 April 2009 15,00,000
1,19,600
Add: Drawings (3,06,000 + 1,20,000) 4,26,000
Profit for the year 5,45,600

ILLUSTRATION:

Yashicca commenced business on 1 Jaunary, 2009, with a capital of Rs. 10,00,000 which she paid
into banking account opened for that purpose. On the same day she bought stock valued at Rs.
6,50,000 and shop fixtures which cost Rs. 2,00,000. Her books kept by single entry consisted of a
cash book and ledger and the whole of his receipt and payments both in connection with the business
and her private affairs was passed through his cash book. On 31.12.2009 stock was taken which,
amounted to Rs. 6,00,000. There were book debts in the ledger amounting to Rs. 3,50,000 of which
Rs. 10,000 was irrecoverable; creditors as per ledger amounted to Rs. 4,83,000 and the cash book
showed a balance Rs. 1,67,000 but according to the pass book the balance at Yashicca’s credit was
only Rs. 67,000 she having lent her Jatin Rs. 1,00,000 and omitted to enter it in the cash book.
Yashicca’s private expenses during the year amounted to Rs. 1,50,000 worth of goods from her shop
and Rs. 50,000 cash. The fixture were valued at Rs. 2,50,000 on 31.12.2009.

From the information, prepare a statement of Yashicca’s profit or loss in the business for the year
2010 assuming that she introduced additional capital of Rs. 2,00,000 during the year 2009.

SOLUTION:

Calculation of Capital on 31 December 2009

Assets on 31 December 2009 Rs.

Stock 6,00,000
Book Debts (3,50,000 – 10,000) 3,40,000
Cash at Bank 67,000
Loan to Jatin 1,00,000
Fixtures 2,50,000
13,57,000
Less: Creditors 4,83,000
Capital 8,74,000

165
 RAGINI
Statement of Profit (Loss) for the year ending 31 December 2010

Rs. Rs.
Capital on 31 December 2010 8,74,000
Add: Drawings 2,00,000
10,74,000
Less: Additional Capital 2,00,000
8,74,000
Less: Capital in the beginning (10,00,000)
Loss for the year 2010 (1,26,000)

ILLUSTRATION:

Ms. Nirmala had Rs. 40,00,000 in bank on 1 January 2009 when she started business. Her
incomplete records showed her position on follows:

31.03.2009 31.03.2010
Rs. Rs.
Cash in hand 2,00,000 3,20,000
Stock in Trade 5,10,000 6,50,000
Debtors 8,00,000 5,00,000
Creditors 4,50,000 3,30,000

On 1 February 2009, she began withdrawing Rs. 50,000 per month from the business for her
personal use. Her account in the bank showed the following entries:

Deposits Withdrawals
Rs. Rs.
1 January 2009 40,00,000 -
1 January 2009 to 31 March 2009 - 25,00,000
1 April 2009 to 31 March 2010 42,50,000 35,00,000

The above withdrawals included payments by cheques of Rs. 21,20,000 and Rs. 7,50,000
respectively during the period 1 January 2009 to 31 March 2009 and from 1 April 2009 to 31 March
2010 for purchase of machinery for the business. The deposits after 1 January 2009 consisted wholly
of sale price received from customers by cheque. Determine the profit / loss of Ms. Nirmala for the
year ended 31 March 2010.

SOLUTION:

NIRMALA
Statement of Affairs as on 31 March 2009

Rs. Rs.
Creditors Cash in hand 2,00,000
Capital (Balancing Figure) 4,50,000 Bank (40,00,000 – 25,00,000) 15,00,000
46,80,000 Debtors 8,00,000
Stock in hand 5,10,000
Machinery 21,20,000
51,30,000 51,30,000

166
 Statement of Affairs as on 31 March 2010

Rs. Rs.
Creditors 3,30,000 Cash in hand 3,20,000
Capital (Balancing Figure) 62,60,000 Stock in hand 6,50,000
Debtors 5,00,000
Bank 22,50,000
Machinery 28,70,000
65,90,000 65,90,000

Rs.
Capital on 31 March 2010 62,60,000
Add: Drawings (50,000 × 12) 6,00,000
68,60,000
Less: Opening Capital 46,80,000
Net Profit for the Year 21,80,000

Tutorial Note

Rs.
Cash at Bank on 31 March 2010 15,00,000
Opening Balance (1.4.2009) 42,50,000
Add: Deposits (from 1.4.2009 to 31.3.2010) 57,50,000
35,00,000
Less: Withdrawals (from 1.4.2009 to 31.3.2010) 22,50,000

ILLUSTRATION:

James keeps his books on single entry and following information is disclosed from his records:

As on 31.12.2009 As on 31.12.2010
Balance at Bank 21,000 (Cr.) 56,000 (Dr.)
Stock in Trade 1,50,000 2,00,000
Sundry Debtors 3,00,000 2,85,000
Furniture 50,000 50,000
Investments 50,000 50,000
Cash in Hand 1,000 4,000
Sundry Creditors 2,50,000 2,70,000
Bill Payable 10,000 5,000
Loan from Dev - 30,000

James transferred Rs. 2,500 each month during first half year and Rs. 2,000 each month for the
remaining period from the business to his private banking account by way of drawings. In addition,
he withdrew Rs. 50,000 for his daughter’s marriage and Rs. 10,000 for charitable purposes. He also
withdrew goods worth Rs. 10,000 for domestic purposes. In September, 2006, he had received a
lottery prize of Rs. 50,000, of which he invested into the business Rs. 40,000. He sold his private car
for Rs. 35,000 and proceeds were utilized for business. He wants his furniture to be depreciated at
10% and a Reserve for Doubtful Debts to be created at 5%. He had not paid two months’ salary to
his clear @ Rs. 1,500 p.m. and two months’ rent of shops was outstanding amounting to Rs. 2,000.
Commission earned but not yet received by him was Rs. 24,000. Prepare statement of profit for the
year ending 31.12.2010.

167
SOLUTION:

JAMES
Statement of Affairs as on 1 January 2010

Liabilities Rs. Assets Rs.

Bank overdraft 21,000 Cash in hand 1,000
Bill payable 10,000 Sundry debtors 3,00,000
Sundry creditors 2,50,000 Stock in trade 1,50,000
Capital as on 1.1.2010 2,70,000 Investments 50,000
Furniture 50,000
5,51,000 5,51,000

(Provisional) Statement of Affairs as on 31.12.2010

Liabilities Rs. Assets Rs.

Bills Payable 5,000 Cash in hand 4,000
Sundry Creditors 2,70,000 Cash at Bank 56,000
Loan from Dev 30,000 Sundry Debtors 2,85,000
Outstanding expenses: Less: R.D.D. 14,250 2,70,750
Rent 2,000 Stock in hand 2,00,000
Salary 3,000 5,000 Investments 50,000
Capital (Balance Figure) 3,39,750 Furniture 50,000
Less: Depreciation 5,000 45,000
Accrued Commission 24,000
6,49,750 6,49,750

Statement of Profit for the year ended 31.12.2010

Rs. Rs.
Capital on 31.12.2010 3,39,750
Add: Drawings:
Cash (2,500×60+2,000×60) 27,000
For Daughter’ marriage 50,000
For Charity 10,000
Goods for Personal Use 10,000 97,000
4,36,750
Less: Additional Capital
Proceeds of Lottery 40,000
Sale of Private Car 35,000 75,000
3,61,750
Less: Capital in the beginning 2,70,000
Profit for the year 91,750

168
 Tutorial Note

Capital at the end can be verified as follows

Rs.
Capital in the beginning 2,70,000
Add: Additional Capital 75,000
3,45,000
Less: Drawings 97,000
2,48,000
Add: Net Profits 91,750
3,39750

ILLUSTRATION:

The balance sheets of Pooja as on 31 March 2009 and 31 March 2010 are given below. She is unable
to understand what has happened to the profit of Rs. 15,00,000 as disclosed by balance sheet on 31
March 2010 as she does not find the same in her bank balance. Draw up a statement which may help
her solve the problem.

(Provisional) Statement of Affairs as on 31.12.2010

Liabilities 2009 2010 Assets 2009 2010

Rs. Rs. Rs. Rs.
Capital (31.3.2009) 23,00,000 23,00,000 Cash at Bank 2,00,000 2,00,000
Add: Profit for 2009-10 15,00,000 Debtors 14,00,000 19,00,000
38,00,000 Stock 6,00,000 10,00,000
Less: Drawings in Motor Vehicle 7,00,000 7,60,000
2009-10 2,40,000 Plant (net) 16,00,000 12,00,000
35,60,000 Land and Building 19,00,000 21,00,000
Mortgage on Land
and Buildings 16,00,000 12,00,000
Creditors 20,00,000 18,00,000
Bills Payable 5,00,000 6,00,000
64,00,000 71,60,000 64,00,000 71,60,000

SOLUTION:

POOJA
Hints: (i) Increase in Assets or Decrease in Liabilities = Profit
(ii) Decrease in Assets or Increase in Liabilities = Loss

Liabilities 31.03.2009 31.03.2010 Increase Decrease

Rs. Rs. Rs. Rs.
Sundry debtors 14,00,000 19,00,000 5,00,000 --
Stock 6,00,000 10,00,000 4,00,000 --
Motor Vehicle 7,00,000 7,60,000 60,000 --
Plant (net) 16,00,000 12,00,000 -- 4,00,000
Land and Buildings 19,00,000 21,00,000 2,00,000 --
Mortgage on Land
and Buildings 16,00,000 12,00,000 4,00,000 --

169
Creditors 20,00,000 18,00,000 2,00,000 --
Bills Payable 5,00,000 6,00,000 -- 1,00,000
Net increase in Assets -- -- -- --
(or decrease in liabilities) -- -- -- --
12,60,000
17,60,000 17,60,000

Rs.
Net increase in assets and net decrease in liabilities 12,60,000
Add: Drawings 2,40,000
Profit for the year ending 31 March 2010 15,00,000

170
 UNIT - I
LESSON 1
ENTREPRENEUR AND ENREPRENEURSHIP
Vipin Kumar

INTRODUCTION
The concept of entrepreneurship has been around for a very long time. In the last two decades it has
resurged. The concept of entrepreneurship is an age-old phenomenon that relates to the vision of an
entrepreneur as well as its implementation by him. Entrepreneurship is a creative and innovative
response to the environment. It is also the process of setting up a new venture. Entrepreneurship is a
composite skill that is a mixture of many qualities and traits such as imagination, risk taking, ability to
harness factors of production, i.e., land, labour, technology and various intangible factors.

Usually any one who runs a business is called an entrepreneur. The more precise meaning of
entrepreneur is one who creates his own business, i.e., a person who organizes, operates and assumes the
risk of a business venture. An entrepreneur is a person who perceives a need and then bri9ngs together
manpower, material and capital required to meet that need.

Entrepreneurship implies a set of values, norms and traits that are conductive to the growth of a business
enterprise. It is the organisational culture that focuses on new opportunities and creation of an
organisation where these opportunities can be perused earnestly. An entrepreneur seeks the
opportunities, looks for ways and means to capitalize on the newer opportunities by organizing the
structure and the resources and gaining control on them. As against this, a manager is primarily
concerned with the resources under his control, the structure of his organisation and its relations to the
market. He is also concerned with matching the opportunities with organizational abilities. The
entrepreneurs are driven by the perception of opportunities. They seek changes in the political rules,
social values, consumer preferences, technology etc. On the other hand resources like money, manpower
and material they control, drive the managers.

ENTREPRENEUR AND ENTREPRENEURSHIP

An entrepreneur is a person who searches for change and responds to it by starting an enterprise. In the
words of Adam Smith, “Entrepreneur is an individual who undertakes the formation of an organisation
for commercial purposes by recognizing the potential demand for goods and services and thereby acts as
an economic agent and transforms demand and supply.”

Entrepreneurship is the process that involves all actions an entrepreneur undertakes to establish an
enterprise to give reality to his business ideas. According to John Kaso and Howard Stavenson,
“Entrepreneurship is the attempt to create value through recognition of business opportunity, the
management of risk-taking appropriate to the opportunity and through the communicative and
management skills to mobilize human, financial and material resources necessary to bring a project to
fruition,” This definition recognizes that entrepreneurship involves the fusion of capital, technology and
human talent to complete a project successfully and with reasonable degree of risk.

Entrepreneurship is also defined as the ability to create and build something from practically nothing. It
is a knack of sensing opportunity where others see chaos, contradiction and confusion. Entrepreneurship
is the attitude of mind seek opportunity, take calculated risks and derive benefits by setting up a venture.
Thus, it comprises of numerous activities involved in conception, creation and running an enterprise.

According to Higgins, “Entrepreneurship means the function of seeking investment and production
opportunity, organizing an enterprise to undertake a new production process, raising capital, hiring
labour, arranging the supply of raw materials, finding site, introducing a new technique, discovering new
sources of raw materials and selecting top managers for day-to-day operations of the enterprise.” This
definition highlights risk-taking, innovating and resource organizing aspects of entrepreneurship.

Entrepreneurship can be described as a creative and innovative response to the environment. Such
responses can take place in any field of social endeavour-business, agriculture, education, social work
and the like. The entrepreneur is an innovator, action-oriented and highly motivated, he visualizes
business opportunities, gathers the necessary resources to take advantage of the environment and
initiates appropriate action to ensure success.

The foregoing definition indicate that entrepreneurship is associated with the following activities or
functions:

(i) Perceiving opportunities for profitable investment;

(ii) Initiative in establishing a business;
(iii)Risk bearing;
(iv) Introduction of innovations;
(v) Provision of capital; and
(vi) Co-ordination of different factors of production.

2
 EXHIBIT-1: Definitions of Entrepreneur and Entrepreneurship

“Entrepreneur is the co-ordinator and organizer of resources to design a business enterprise.”

- J.B. Say
“Entrepreneur is an individual who undertakes the formation of an organisation for
commercial purposes by recognizing the potential demand for goods and services and
thereby acts as an economic agent and transforms demand and supply.”
-Adam Smith
“Entrepreneurs are innovators who use the process of shattering the status quo of the existing
products and services to set new products, new services. He describes entrepreneurs as
innovators.”
-Joseph Shumpeter
“Entrepreneurship is the attempt to create value through recognition of business opportunity,
the management of risk taking appropriate to the opportunity and through the communicative
and management skills to mobilize human, financial and material resources necessary to
bring a project to fruition.”
-John Kaso and Howard Stavenson
“Entrepreneur is one who is involved in gathering and using resources to make use of
opportunities to produce results.”
-Peter Drucker
“Entrepreneurship is a systematic innovation which consists of the purposeful and organized
search for changes and in a systematic analysis of the opportunities such changes might offer
for economic and social innovation.”
-Peter Drucker

To sum up, the term ‘entrepreneur’ has been defined in various ways-a risk taker, a resource assembler,
an organisation to builder, an innovator, and so on. Truly speaking, an entrepreneur is all combined into
one. He introduces new ideas, carries on new activities, co-ordinates the factors of production and
decides how the business should be run. He has vision, originally of thought and ability to take calculate
risks.

EXHIBIT-2: What is an Enterprise

An entrepreneur is a person who starts an enterprise. The process of creation is called

entrepreneurship. The entrepreneur is the actor and entrepreneurship is the act. The outcome
of the actor and the act is called the enterprise. An enterprise is a business orgnanisation that
is formed and which provides goods and services, creates jobs, contributes to national
income, exports and overall economic development.

3
Difference between Entrepreneur and Entrepreneurship

The term ‘entrepreneur’ is used to describe the people who establish and manager their own business.
The process involved is called entrepreneurship. Entrepreneurship is an abstraction whereas
entrepreneurs are living people.

Entrepreneurship is the outcome of complex socio-economic, psychological and other factors.

Entrepreneur is the key individual central to entrepreneurship who makes things happen. Entrepreneur is
the actor, entrepreneurship is the act. Entrepreneurship is the most effective way to bridging the gap
between scientific innovations and the market place by creating new enterprises. An entrepreneur is the
catalyst who brings about the change.

TYPES OF ENTREPRENEURS

Clarence Danhof, on the basis of his study of American Agriculture, Classified entrepreneurs in the
manner that at the initial stage of economic development entrepreneurs have less initiative and drive and
as economic development proceeds they become more innovating and enthusiastic. Basing on this, he
classified entrepreneurs into four categories:

(a) Innovating Entrepreneurs: An innovating entrepreneur is one who introduces new goods,
inaugurates new method of production, discovers new market and reorganizes the enterprise. It is
important to note that such entrepreneurs can work only when a certain level of development is
already achieved, and people look forward to change and improvement. Generally, they are
typical of developed countries.

(b) Imitative Entrepreneurs: These are characterized by readiness to adopt successful innovations
inaugurated by successful innovating entrepreneurs. They lap up innovations originate by
innovating entrepreneurs. Imitative entrepreneurs do not innovate the changes themselves, they
only imitate techniques and technology innovated by others. Such types of entrepreneurs are
particularly suitable for the underdeveloped regions for bringing a mushroom drive of imitation
of new combinations of factors of production already available in development regions.

(c) Fabian Entrepreneurs: Fabian entrepreneurs are characterized by very great caution and
skepticism in experimenting and change in their enterprise. They imitate only when it becomes
perfectly clear that failure to do so would result in a loss of the relative position in the
enterprises. They are lazy and shy and lack the will to adopt to new methods of production.

(d) Drone Entrepreneurs: Drone entrepreneurs are characterized by a refusal to adopt opportunities
to make changes in production formulate even at the cost of severely reduced returns relative to
other like producers. Such entrepreneurs may even suffer losses but they are not ready to make
changes in their existing production methods. They struggle to exist, not to grow. Thus, they are
laggards as they continue to operate in their traditional way and resist changes.

4
NATURE OF ENTREPRENEURSHIP

(a) Economic Activity: Entrepreneurship involves the creation and operation of an enterprise.
Therefore, it is essentially an economic activity concerned with of value or wealth.

(b) Creative Response to Environment: Entrepreneurship involves innovation or introduction of

something new. It is a creative response to the environment. An entrepreneur recognizes the need
for change and initiates it. He does things in new and better ways.

(c) Purposeful Activity: Entrepreneurship is the purposeful activity of an individual or a group of

individuals who seek to earn profits through the production and distribution of economic goods
and services.

(d) Dynamic Process: Entrepreneurs thrive on the changing environment which brings new
opportunities for business. Flexibility is the hallmark of a successful entrepreneur.

(e) Risk Element: Entrepreneurs make decisions in the face of uncertainty. Therefore, risk is an
inherent and inseparable element of entrepreneurship. Until the new venture idea becomes
popular amongst the customers, it runs a family high degree of risk of incurring losses.

(f) Creator or Organisation: An entrepreneur assembles and Co-ordinates other factors of

production, i.e., land, labour and capital. Managerial skills and leadership are other very
important facets of entrepreneurship.

(g) Gap Filling Function: It is the job an entrepreneur to fill the gaps between needs and goods and
services. He has to complete the inputs and provides the knowledge about the production
process.

(h) Optimum Use of Resources: An entrepreneur optimizes the use of resources by arriving at the
most productive combination that will provide the society the needed goods and services.

NEED OF ENTREPRENEURSHIP

(a) Entrepreneurship as Career Option: An educated person has broadly two career option. One
is called wage or salary employment, wherein people are employed in government service,
public and private sectors and get fixed wage or salary. The other career option is entrepreneurial
employment under which people set up their new ventures. Wage employment does not generate
resources and is organized which in the existing wealth. Wage employment is self-saturating.
Once availed, it blocks the employment opportunity to others for another 10 years. On the other
hand, the latter contributes towards national wealth and has a unique characteristic of self-
generation. This starts a chain of activities that create unending employment opportunities.
Entrepreneurship promotes small saving amongst middle class individuals for investment into
new ventures. It also provides an outlet that creates an urge among individuals to attain
excellence in product design and related innovation. Thus, entrepreneurship provides a lasting
solution to the acute problem of unemployment.

5
 Table

Wage Employment Entrepreneurial Employment

Nature Self Satuating Self Generating
Scope Limited Unlimited
Orientation • Routine Types • Creative
• Status Quo • Innovative
• Problem Avoiding • Problem Solving
• Dependent • Independent Decisions
Contribution Consumers National Wealth Generates National Wealth
Earning Fixed (Subsistence) Growing (Generating Surplus)

In the context of employment generation, the three terms, i.e., Income Generation, Self-
Employment and Entrepreneurship are often used interchangeably. Entrepreneurship refers to
identification of innovative ideas, setting up of a new enterprise. Whereas, self-employment
refers to full time involvement in ones own occupation. One may or may not be bearing the risk,
mobilizing inputs, organizing production and marketing the product or service. Income
generating activities, on the other hand, are part time, casual and practised with a view of raising
additional income. All entrepreneurs are self-employed and income generating persons. But all
self-employed and income generating persons may not be entrepreneurs.

Fig.: Income Generation, Self-employment and Entrepreneurship

The three, however, can be considered as initial, middle and final stages of Entrepreneurial
Growth Process.

(b) National Income: National Income consists of goods and services produced in the country and
imported. The goods and services produced are for consumption within the country as well as to
meet the demand of exports. The domestic demand increases with ever increasing population and
improving standard of living. The export demand also increases to meet the needs of growing

6
 import due to various reasons. An increasing number of entrepreneurs are required to meet this
increasing demand for goods and services. Thus, entrepreneurship increases the national income.

(c) Employment Generation: Growing unemployment, particularly educated unemployment is an

acute problem of the nation. The available employment opportunities can cater to only 5 to 10
per cent of the unemployed. If a hundred persons become entrepreneurs they not only create a
hundred jobs for themselves but also provide employment to many more. As the time passes
these enterprises growth providing direct and indirect employment to many more. Thus,
entrepreneurship is the best way to fight the evil of unemployment.

Entrepreneurship helps solving problems related to:

• Employment generation
• National production
• Dispersal of economic power
• Balance regional development
• Harnessing youth vigour
NIESBUD

(d) Balanced Regional Development: The growth of industry and business leads to a large number
of public benefits like road transport, health, education, entertainment etc. When the industries
are concentrated in selected cities, the development gets limited to these cities. Till late sixties,
50 per cent of industrial enterprises were located in only six cities of India. A rapid development
of entrepreneurship ensures a balanced regional development. When the new entrepreneurs grow
at a faster pace, in view of the increasing competition in and around the cities, they are forced to
set up their enterprises in the smaller towns away from big cities. This helps in the development
of the backward regions.

If a region does not throw up a sufficient number of entrepreneurs, the needs of the local
population for the goods and services remain unsatisfied. The entrepreneurs from other places
step in and set up enterprises to fulfil the pent up demand of the local people. These alien
entrepreneurs do not invest the major part of the profits in the areas in which the unit is located.
Usually, the profit is invested at a place, from where the entrepreneurs come from. Such
entrepreneurs invest their profits in constructing their houses etc., at the place of their origin.
Thus, the backward areas do not get full benefits of business or industrial profits. This drainage
of wealth results in further deterioration of the area. The practice of siphoning the profits earned
through entrepreneurial activities based on local resources by alien entrepreneurs has been
compared with the blood sucking process practised by leeches, and termed as ‘leech effect’ by
Dr. M.M.P. Akhori.

7
 Fig.: Siphoning of Profits through Entrepreneurship Activities
by Alien Entrepreneurs

(e) Dispersal of Economic Power: The world affairs have been dominated by power. There have
always been two types of power, i.e., muscle power and economic power. In the modern age, the
muscle power has lost its relevance and the world is ruled by the economic power. Economic
power is the natural outcome of industrial and business activity. Industrial development normally
can lead to concentration of economic power in few hands. This concentration of power in few
hands has its own evils in the form of monopolies. Developing a large number of entrepreneurs
helps in dispersing the economic power amongst the population. This in turn causes hindrance to
the growth of monopolies, which exist partly because of lack of sufficient number of
entrepreneurs. Setting up of a large number of enterprises for the goods helps in weakening the
harmful effects of monopoly.

When a society produces a small number of entrepreneurs, the enterprises due to lack of
competition grow into a few big business houses. This results in concentration of wealth in a few
families. This can have serious social and national implication. When the number of enterprises
is large national wealth is shared by a large number of entrepreneurs, thus, dispersing wealth.
This dispersal of wealth promotes the real socialism and makes the economy healthy.

ENTREPRENEURSHIP VS. MANAGEMENT

Quite often an entrepreneur and a manager are considered similar because of some overlapping in their
roles. In a small firm, the owner himself acts as the manager. But there are some important differences
between a entrepreneur and a manager which are discussed below:

(a) Venture Creation: An entrepreneur often sets up a new venture while a manager only runs an
existing venture.

(b) Innovation: An entrepreneur introduces new ideas to increase profits and is, therefore, an
innovator. On the other hand, a manager runs the business on established lines and often
maintains the status quo. An entrepreneur is a ‘change agent’ whereas a manager is the ‘product
of change’. Entrepreneurship involves combining to initiate changes in production whereas
management involves combining to produce.

(c) Risk Bearing: An entrepreneur assumes risk of economic uncertainties involved in the
enterprise. A paid manager, on the other hand undertakes no risk.

8
(d) Status: An entrepreneur is his own boss and enjoys an independent status. In contrast, a manager
is an employee and dependent on the owner.

(e) Reward: For bearing risk, an entrepreneur earns profits which may fluctuate widely from one
time period to another. But the reward of a manager is the salary which is relatively fixed and
regular.

(f) Continuity: Management refers to the ongoing coordination of the production process whereas
entrepreneurship is a discontinuous phenomenon appearing to initiate change in the production
process and then disappears until it reappears to initiate another change.

Overlapping Roles of Entrepreneur and Manager

Joseph Schumpeter made a distinction between entrepreneur and manager. According to him, a manager
is one who deals with day-to-day affairs of a going concern. But an entrepreneur attempts to change the
factor combinations and thus increases productivity and profits. An entrepreneur launches a new
enterprise whereas a manager operates an existing enterprise. The roles of entrepreneur and manager
may, however, overlap in many situations. Entrepreneurs who start enterprises must use managerial
skills to implement their innovative ideas successfully. Similarly, managers must use entrepreneurial
skills in order to manager change and innovation to effectively deal with uncertain external environment
of business.

Table: Entrepreneur vs. Manager

Basis Entrepreneur Manager

1. Venture An entrepreneurs sets up a new A manager only runs an existing
creation venture and runs it. unit.
2. Innovation Entrepreneurship is another name of A manager is an employee of the
innovation. He works to find new business organisation. He cannot
methods, products, etc. operate independently.
3. Risk-taking An entrepreneur starts and runs his A manger takes less risk at
venture independently. He is self- compared to an entrepreneur. He is
employed and is his own basis. less tolerant to uncertainty. He does
not share business risks.
4. Status An entrepreneur takes calculated A manager need not be an innovator.
risk. He may even jeopardize his He deals with the day-to-day affairs
own financial security. He is of a going concern.
responsible for failure and financial
loss.
5. Reward An entrepreneur is motivated by A manager is motivated by rewards
profits. He may even suffer a loss. or incentives. His salary cannot be
negative.
6. Change An entrepreneur is responsive to A manager may not very receptive to
external environments and is always change, unless he is enterprising.
prepared to change.

9
ROLE OF FUNCTIONS OF ENTREPRENEURSHIP
Role of Entrepreneurship In Economic Development

The entrepreneur is the key to the creation of new enterprises that energise the economy and rejuvenate
the established enterprises that make up the economic structure. Entrepreneurs initiate and sustain the
process of economic development in the following ways:

i. Capital formation: Entrepreneurs mobilize the idle savings of the public through the issues of
industrial securities. Investment of public savings in industry results in productive utilization of
national resources. Rate of capital formation increases which is essential for rapid economic
growth. Thus, an entrepreneur is the creater of wealth.

ii. Improvement in per capita income: Entrepreneurs locate and exploit opportunities. They
convert the latest and idle resources like land, labour and capital into national income and wealth
in the form of goods and services. They help to increase. Net National Product and per capita
income in the country, which are important yardsticks for measuring economic growth.

iii. Generation of employment: Entrepreneurs generate employment both directly and indirectly.
Directly, self-employment as an entrepreneur offers the best way for independent and honourable
life. Indirect, by setting up large and small scale business units they offer jobs to millions. Thus,
entrepreneurship helps to reduce the unemployment problem in the country.

iv. Balanced regional development: Entrepreneurs in the public and private sectors help to remove
regional disparities in economic development. They set up industries in backward areas to avail
of the various concessions and subsidies offered by the Central and State Governments. Public
sector steel plants, and private sector industries by Modis, Tatas, Birlas and other have put the
hitherto unknown places on the international map.

v. Improvement in living standards: Entrepreneurs set up industries which remove scarcity of

essential commodities and introduce new products. Production of good on mass scale and
manufacture of handicrafts, etc., in the small scale sector help to improve the standard of life of a
common man. These offer goods at lower costs and increase variety in consumption.

vi. Economic independence: Entrepreneurship is essential for national self-reliance. Industrialists

help to manufacture indigenous substitutes of hitherto imported products thereby reducing
dependence on foreign countries. Businessmen also export goods and services on a large scale
and thereby earn the scarce foreign exchange for the country. Such import sub-situation and
export promotion help to ensure the economic independence of the country without which
political independence has little meaning.

vii. Backward and forward linkages: An entrepreneur initiates change which has a chain reaction.
Setting up of an enterprise has several backward and forward linkages. For example, the
establishment of a steel plant generates several ancillary units and expands the demand for iron

10
 ore, coal, etc. these are backward linkages. By increasing the supply of steel, the plant facilitates
the growth of machine building, tube making, untensil manufacturing and such other units.

FUNCTIONS OF AN ENTREPRENEUR

There has been a great deal of confusion and contradiction in literature on entrepreneurial functions.
Classical economists considered the entrepreneur as the owner of the business enterprise to which he
supplied capital. No distinction was made between the entrepreneur and the capitalist and as a result
profits and interest were lumped together. But in the modern corporation ownership is separated from
control. Ownership of business lies with shareholders who bear risks but do not exercise control. Control
lies with a small group of insiders known as Board of Directors. This group bears little risk and receives
a large remuneration even when no dividend in paid to the shareholders, i.e., the nominal owners. Thus,
the classical theory of enterprise fails in a large public company. A new theory of firm is required which
should take into account the income of an entrepreneur when he is not the owner of business.

Peter Kilby identified thirteen functions of an entrepreneur, which included some of the managerial
functions also.

These functions are as follows:

• Perceiving market opportunities

• Gaining command over scarce resources
• Purchasing inputs
• Marketing of the products and responding to competition
• Dealing with the public bureaucracy (concessions, licences and taxes)
• Managing human relations within the firm
• Managing customer and supplier relations
• Managing finance
• Managing production (control by written records,, supervision, coordinating input flows with
orders, maintenance)
• Acquiring and overseeing assembly of the factory
• Industrial engineering (minimizing inputs with a given production process)
• Upgrading process and product quality, and
• Introducing new production techniques and products.

Kilby suggested that these functions may vary according to the size, type and setting of an enterprise and
could be augmented through training and education.

We may classify the functions of an entrepreneur into three broad categories:

(i) Innovation;
(ii) Risk-bearing; and
(iii) Organisation and management

(a) Innovation: According to Schumpeter, an entrepreneur is basically an innovator who introduces

new combinations of means of production. Entrepreneurship is a creative activity and the

11
 entrepreneur introduces something new in any branch of economic activity. The carrying out of a
new combination implies employment of productive means in a changed form. It is not necessary
that new combination is carried out by people who control the product or commercial process. A
new combination can be carried out by employing both unused and used means of production.
As an innovator, entrepreneur forsees the potentially profitable opportunity and tries to exploit it.
He is a problem solver and gets satisfaction by attacking problems.

Innovation is also different from invention: Invention implies the discovery of new ideas, new
articles and new methods. On the other hand, innovation refers to the application of inventions
and discovery to make new combinations and thereby produce satisfaction and profits.
Inventions may facilitate innovations but an invention in itself is of little benefit to mankind
unless it is marketable. The innovator provides this missing link. An invention becomes an
innovation only when it is embodied in a product or service that can be successfully sold in the
market.

Some people believe that innovations are carried out by big firms. The truth is that most of the
innovations are the handiwork of small firms. Large firms may have strong organisation
structures and management skills but they lack flexibility. Due to their intrinsic flexibility small
firms can react rapidly to new demands and easily exploit new ideas. A large firm working under
the constraints of size and competition tends to perfect existing lines of production in order to
increase profits. On the other hand, a small firm tries to exploit the gaps in the production
system. Unlike the giant, it is not obliged to engage in expensive conversion and can launch itself
on new, narrow or risky markets.

(b) Risk Taking: Risk taking or uncertainty bearing implies assuming the responsibility for loss that
may occur due to unforeseen contingencies of the future. An entrepreneur provides or invests
capital in order to establish and run the enterprise. He guarantees interest to lenders, wages to
employees, rent to the landlord. After making payment to these persons little or nothing may be
left for him. Economists like Cantillon, J.B. Say and others stressed risk-taking as the specific
function of the entrepreneur. An entrepreneur reduces uncertainty in his plan of investment,
diversification of production and expansion of the enterprise.

Business is a game of skill wherein risk and rewards both are great. Ability of the highest order
is required for success in entrepreneurship. An entrepreneur is an especially talented and
motivated person who undertakes the risks of business. He visualizes opportunities for
introducing new ideas and handles economic uncertainty. He is an enterprising individual willing
to assume the risks involved in innovations, new ventures and expansion of an existing venture.

(c) Organisation Building: Alfred Marshall recognized organisationa and management of the
enterprise as the main function of an entrepreneur. It implies bringing together the various
factors of production. The purpose is to allocate the productive resources in order to minimize
losses and reduce costs in production. An entrepreneur takes business decisions. In the initial
stage of the establishment of an enterprise the entrepreneur may take all decisions by himself.
But as the enterprise grows and the work of decision making becomes more complex, the
entrepreneur delegates authority to subordinate executives. However, the central function of the
entrepreneur remains the same. He alone determines what lines of business to expand into and

12
 how much capital to employ. He determines the expansion and contraction of the size of the total
business and its various branches. Being at the helm of affairs, the entrepreneur is the final judge
in the conduct of his business.

An entrepreneur formulates business plans and ensures their execution. He coordinates the
agents of production, organizes and sets up the enterprise and supervises its operations. He thus
takes the final responsibility for the business. He makes the final choice concerning the business
and shapes the long-term policies of the enterprise. He is a decision-maker and derives
satisfaction by attacking problems.

Entrepreneurship And Environment

Entrepreneurship does not emerge and grow spontaneously. Rather it is dependent upon several
economic, social, political and psychological factors. These environmental factors may have both
positive and negative influences on the growth of entrepreneurship. Positive influences imply facilitating
and conducive conditions whereas negative influences refer to factors inhibiting the emergence of
entrepreneurship. Various environmental factors influencing the emergence of entrepreneurship are
given below:

(a) Economic Conditions: Economic environment exercises perhaps the most direct and immediate
influence on entrepreneurship. Capital, labour, raw materials and markets are the main economic
factors.

Capital: Capital is one of the most important prerequisites to establish an enterprise. Availability
of capital facilitates the entrepreneur to bring together the labour of one, machine of another and
raw material of yet another to combine them to produce goods. Capital is, therefore, regarded as
a lubricant to the process of production. As capital supply increases, entrepreneurship also
increases.

Labour: The quality and quantity of labour is another factor which influences the emergence of
entrepreneurship. It is noticed that cheap labour is often less mobile or even immobile. And, the
potential advantages of low-cost labour are negated by the deleterious effect of labour
immobility. The disadvantages of high-cost labour can be modified by introduction of labour-
saving innovations as was done in the USA. Thus, it appears that labour problems can be solved
more easily than capital can be created.

Raw Materials: The necessity of raw materials hardly needs any emphasis for establishing any
industrial activity and, therefore, its influence in the emergence of entrepreneurship. In the
absence of raw materials, neither any enterprise can be established nor an entrepreneur can
emerge.

Market: The fact remains that the potential of the market constitutes the major determinant of
probable rewards from entrepreneurial function. Frankly speaking, if the proof of pudding lies in
eating, the proof of all production lies in consumption/marketing. The size and composition of
market both influence entrepreneurship.

13
(b) Social Factors: Social environment in a country exercises a significant impact on the emergence
of entrepreneurship. The main components of social environment are as follows:

Legitimacy of Entrepreneurship: The social status of those playing entrepreneurial role has been
considered one of the most important contents of entrepreneurial legitimacy. To increase the
legitimacy of entrepreneurship, some scholars have proposed the need for a change in traditional
values, which are assumed to be opposed to entrepreneurship.

Entrepreneurship will be more likely to emerge in settings in which legitimacy is high.

Social Mobility: Social mobility involves the degree of mobility, both social and geographical, a
high degree of mobility is conducive to entrepreneurship.

Security: Several scholars have advocated entrepreneurial security as an important facilitator of

entrepreneurial behavior.

Security is a significant factor for entrepreneurship development. This is reasonable too because
if individuals are fearful of losing their economic assets or of being subjected to various negative
sanctions, they will not be inclined to increase their insecurity by behaving entrepreneurially.

(c) Psychological Factors: Many entrepreneurial theorists have propounded theories of

entrepreneurship that concentrate specifically upon psychological factors.

Entrepreneurial class develop because it provides them psychological satisfaction.

(d) Governmental Influence: The government by its actions or its failure to act does influence both
the economic and non-economic conditions for entrepreneurship. Any interested government in
economic development can help, through its clearly expressed Industrial policy, promote
entrepreneurship in one way or other. By creating basic facilities, utilities and services and by
providing incentives and concessions, the government can provide the prospective entrepreneurs
a facilitative socio-economic setting. Such conducive setting minimizes the risks which the
entrepreneurs are to encounter. Thus, the supportive actions of the government appear as the
most conducive to the entrepreneurial growth. This is true of the Indian entrepreneurship also.
Table: Factors Influencing Entrepreneurship

Facilitating Factors Barriers

1. Technical knowledge 1. Lack of technical skills
2. Entrepreneurial training 2. Lack of market knowledge
3. Market contacts 3. Lack of seed capital
4. Family business 4. Lack of business knowledge
5. Availability of capital 5. Social stigma
6. Successful rolemodels 6. Time pressures and distractions
7. Local manpower 7. Legal and bureaucratical constraints
8. Capable advisors and supporters 8. Patent inhibitions
9. Supplier assistance 9. Political instability
10. Governmental and institutional support 10. Non cooperative attitude of banks and
other institutions

14
Small Business As A Seedbed of Entrepreneurship

Small enterprises have low investment and simple technology. They use local resources and cater
largely to local demands through personal the same person may perform various roles simultaneously as
an owner, a capitalist, an organizer, a manager, a labourer and what not. We know that a person who
organizes, manages and takes risks involved in running a business or enterprise is commonly called an
‘entrepreneur’. This means there are as many entrepreneurs as are small enterprises. Thus, small-scale
enterprise precede entrepreneurs and vice-versa. The Government of India has given small enterprises an
important place in the framework of Indian economic planning for ideological as well as economic
reasons. As a result, small sector has achieved an impressive growth in the number of units, for example,
over the period.

In common sense, increasing number of small enterprises means increasing number of persons assuming
the entrepreneurial career. In other sense increase in the number of persons assuming entrepreneurial
career has exactly become sine quo non with increase in the number of small scale enterprises. In
pursuant of the Government of India’s new small enterprise policy titled policy measures for promoting
and strengthening small, tiny and village enterprises tabled in the Parliament on 6th August 1991 and
later passed, the small sector is sure to develop and expand in coming years also. It infers to inter alia
more chances for enterprising persons to assume the entrepreneurial career in future. Thus, small scale
enterprises serve as seedbed for the emergence of entrepreneurship in the country. To conclude, more
the small enterprise development, more will be opportunities for the entrepreneurial career and vice
versa. The Indian Punjab is a clearest example of how opportunities for entrepreneurial carrier
commensurate with the increasing number of small enterprises in the State.

Small enterprises serve as the seedbed of entrepreneurship due to their following peculiar features:
(i) Small units create more self-employment opportunities with comparatively less capital
investment.
(ii) Small scale industries are usually based on local resources.
(iii) These industries can be located any where.
(iv) These units give quick return and have a shorter gestation period.
(v) These units cause relatively less environmental pollution and disruption.
(vi) The firms are viewed favourably because these lead to equitable distribution of income and
wealth.
(vii) These units facilitate industrial dispersal and avoid problems of unplanned urbanization.
(viii) Small firms require simple technology and low managerial skills.
(ix) These units help in better utilization of local resources and skills which might otherwise remain
unutilized.
(x) These units help to maintain and retain traditional skills and handicrafts.
(xi) Small units assist large and medium industries by acting as ancillaries.

15
 LESSON 2

ENTREPRENEURIAL COMPETENCIES
Vipin Kumar

Entrepreneurial behavior requires certain knowledge, skill or personality profile. Generally, it is called
entrepreneurial competence or traits.

A competence may be defined as an underlying characteristics of a person which results in effective

and/or superior performance in a job. A job competence is an underlying characteristics of a person in
that it may be motive, traits, skills, aspect of one’s self-image or a body of knowledge which one uses.

Thus, success of an entrepreneur is governed by entrepreneurial competencies. If he has all these

competencies, he can be expected to achieve his entrepreneurial goals. Elements of entrepreneurial
competencies as follows:

(i) Body of Knowledge

(ii) Set of Skills
(iii) Cluster of Appropriate Motives/Traits.

(i) Body of Knowledge: Innovation is possible only through knowledge. The inventor or originator
of the idea that led to the knowledge or vision, of some thing new; the artist of creative
endeavour. Inventors include those who identify new technological processes, new forms of
plant life and new designs. Thus, inventions deal with new processes, or new technical
knowledge. In a simple way, knowledge means collections of information and retention of facts
that an individual stores in some parts of his brain.

Creative process provides imaginative people, geminate ideas, nurture them and develop them
successfully. This type of idea has a value. However, it must be proven useful or be marketable
and to achieve either status or achievement, must be developed. But innovation is the
development process which translates an idea into an application. It requires persistence in
analytically working out the details of product design or service, to develop marketing, obtain
finances and plan operations.

(ii) Set of Skills: Skill is the ability to demonstrate a system and sequence of behavior that are
functionally related to attaining a performance or goal. An entrepreneur is required to have
certain skills and these skills also constitute his leadership qualities. These skills are as follows.

(a) Anticipatory Skills––foresight into a constantly changing environment;

(b) Visioning Skills––the use of persuation and example to induce a group to act in
accordance with the leader’s purposes or the shared purposes of a larger group;
(c) Value Congruence Skills––the need to be in touch with employee’s economic, safety,
psychological, spiritual, sexual, aesthetic and physical needs in order to engage people on
the basis of shared motives, values and goals;
(d) Empowerment Skills––the willingness to share power and to do so effectively; and

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 (e) Self understanding Skills––introspective or self underskills as well as framework within
which leaders understand both their own needs and goals and those of their employees.

In practice, an entrepreneur who pursues the idea, planning its application, acquiring resources
and establishing its market through persistence, planning, organizing and leadership needs above
skills. With the help of these skills, entrepreneur is expected to perform well in his
entrepreneurial behavior.

(iii) Cluster of Motives and Traits: Motives deal with recurrent concern for a goal, state or
condition appearing in fantasy, which drives, directs and selects behavior of the
individual. Actually motive represents thought related to a particular goal, state.
McClellend opined that “need achievement” is social motive to excel that tends to
characterize successful entrepreneurs especially when reinforced by cultural factors.
According to Paul Wilken “entrepreneurship becomes the link between need achievement
and economic growth. Thus, need for achievement is guiding force behind
entrepreneurial activities. It is the desire to do well and it motivates the people to
undertake innovative activities.

The trait may be defined as a dispositional or characteristic way in which the person
responds to an equivalent set of stimuli. These responses represent intelligence, charisma
decisiveness, enthusiasm, strength, bravery, integrity and self-confidence. Thus, traits are
an individual’s personal characteristics. Traits are contents of leadership qualities. So an
effective leader is one who possesses intelligence, alertness to the needs of others,
understanding of the task, good communication skills, initiative and persistence in
dealing with the problems. It is important to note that personal elements that govern the
leadership ability are intelligence, self-confidence, the drive to accept responsibility,
good communication skills and education.

In this way, entrepreneur is required to have certain traits. These traits are necessary for
leadership qualities expected from an entrepreneur. An entrepreneur should be (i)
adaptable to situations, (ii) alert to social environment, (iii) ambitious and achievement
oriented, (iv) assertive, (v) cooperative. (vi) decisive, (vii) dependable, (viii) dominant
(desire to influence others), (ix) energetic (high activity level); persistent, (x) self-
confident, (xi) tolerant of stress and (xii) willing to assume responsibility.

Thus, for achieving success in his entrepreneurial behavior, entrepreneur is required to

have entrepreneurial competencies and these are consist of a set of knowledge, skills,
motives and traits.

Entrepreneurial Competencies Identified By The Edi

Entrepreneurship Development Institute of India (EDI) conducted a study under the guidance of David
C. McClelland, a reputed behavioural scientist, in three countries, namely, India Malawi and Equador. It
was found out that possession of certain competencies or abilities results in superior performance. An
entrepreneur may possess certain competencies and at the same time it is possible to develop these

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through training, experience and guidance. Various competencies required for superior performance by
the entrepreneurs (identified during the study) are:

(a) Initiative: It is an inner urge in an individual to do or initiate something. These is a popular

saying, ‘Well begun is half done’. It is the entrepreneur who takes the first move towards setting
up of an enterprise. Most of the innovators have got this urge to do something different.
Entrepreneur basically is an innovator who carries out new combinations to initiate and
accelerate the process of economic development.

(b) Looking for Opportunity: An entrepreneur is always on the look out or searching for
opportunity and is ready to exploit it in the best interests of his enterprise.

(c) Persistence: An entrepreneur is never disheartened by failures. He follows Try-Try Again for
overcoming the obstacles that come in the way of achieving goals.

(d) Information Seeker: A successful entrepreneur always keeps his eyes and ears open and is
receptive to new ideas which can help in realizing his goals. He is ready to consult expert for
getting their expert advice.

(e) Concern for High Quality: Successful entrepreneurs do not believe in moderate or average
performance. They set high quality standards for themselves and then put in their best for
achieving these standards. They believe in excellence, which is reflected in everything they do.

(f) Commitment: Top performers are prepared to make all sacrifices for honouring the
commitments they have made. Whatever they commit, they take it as a moral binding for
honouring their commitments, irrespective of the costs involved.

(g) Concern for Efficiency: Top performers are always keen to devise new methods aimed at
promoting efficiency. They are keen to evolve and try new methods aimed at making working
easier, simpler, better, and economical.

(h) Systematic Planning: Successful entrepreneurs evolve future course of action keeping in mind
the goals to be realized. They believe in developing relevant and realistic plans and ensure proper
execution of the same in their pursuit of attaining their goals.

(i) Problem Solving: A successful entrepreneur takes each problem as a challenge and put in best
for finding out the most appropriate solution for the same. He will first of all understand the
problem and then evolve appropriate strategy dealing with the same.

(j) Self-confidence: Entrepreneurs are not cowed down by difficulties as they believe in their own
abilities and strengths. They have full faith on their knowledge, skill and competence and are not
worried about future uncertainties.

(k) Assertiveness: An assertive person knows what to say, when to say, how to say and whom to
say. He believe in his abilities and ensures that others fall in line with his thinking, aimed at
promoting the interests of the organisation.

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(l) Persuativeness: A successful entrepreneur through his sound arguments and logical reasoning is
in position to convince others to do the work the way he wants them to do. It is not the physical,
but intellectual force he will use for convincing others.

(m) Effective Strategist: A successful entrepreneur possesses the ability to evolve relevant strategy,
aimed at safeguarding or promoting organisation’s interests. Strategy may be with respect to
facing future uncertainities or challenges posed by competitors.

(n) Effective Monitoring: Entrepreneurs ensure that every thing is carried out in their organizations
as per their wishes. They ensure regular monitoring of the working so that the goals of the
oganisation are achieved in best possible manner.

(o) Concern for Employees Welfare: Future of the organisation depends on its employees. If the
employees are dedicated, committed and loyal, the organisation is bound to perform well. A
successful entrepreneur tries to promote organisation’s interest through promotion of interests of
the workers. He takes personal interest in solving problems confronting works and generates the
feeling that there is interpendence of the interest of workers and the management.

Developing Entrepreneurial Competencies

Following steps are involved in developing entrepreneurial competencies:

(a) Recognising Process: Entrepreneurial behaviour starts with understanding and recognition of
the fact that in which area potential behavior is going to be noteworthy. Specific competencies
are meant for innovative behavior and that is why recognition process should give specific
competencies.

(b) Process of Self-Assessment: It deals with identifying the specific competencies among the
potential candidates for entrepreneurship. It is just like identifying a fact––does one possess a
given competence and if so how frequently one exhibit the same in one’s day-to-day operational
behaviour.

(c) Process of Practice: It covers the desired framework to what extent a potential candidate for
entrepreneurship lacks certain competencies. But being interested to undertake entrepreneurial
beahviour he would like to acquire these competencies and strengthen others. Entrepreneurial
development programmes provide help in strengthening this process.

(d) Feed Back Process: It relates with appraisal or seeking information about the newly acquired
behaviour. It also deals with introspection process to what extent new behaviour or act of
exhibiting a competence has been beneficial.

Thus, there are different types of competencies required for developing entrepreneurship. To become a
successful entrepreneur, it is must for his to have that competencies or leadership qualities like
innovative, initiative, risk assuming personality, sensitivity to environment, sense of work, commitment
and decisiveness.

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ENTREPRENEURIAL MOTIVATION, PERFORMANCE AND REWARDS

Motivation

Every individual acts in a distinct manner. Since people act differently, the basic question is ‘why they
do what they do’? The answer to this question lies considerably in the explanation of motivation. The
term, ‘motivation’ comes from the Latin word ‘movere’ which means ‘to move’. Motivation, as the
base-building block of human action has been studied extensively. Studies on motivation broadly refer
to two areas (a) motivating self, and (b) motivating others. Available literature suggests that it is
imperative to understand the underlying concept of motivation in order to formulate a theoretical base
for both the aspects. Motivational theories are based on the fact that behavior is essentially purposeful
and directed towards the attainment of a goal. Thus, the concept “motive” refers to the purpose
underlying all goal directed actions. All motives, however, may not be equally important to the context
of the goal. Some action arise from a biological or physiological need, over which people do not have
much control. Such motives are common to the entire animal kingdom. But there are certain crucial and
other higher order needs which are common to human beings. The distinctly human motives are largely
unrelated to biological and survival needs. These are related to feelings of self-esteem, competency,
social acceptance, etc.

Psychologists have described the term motivation as:

• The immediate influence on the direction, vigour and persistence of action;

• The process of arousing action, sustaining the activity in progress and regulating the pattern of
activity.
• An inner state that energises activities and directs or channels bahaviour towards goal;
• How behavior gets started, is energized, is sustained, is directed, is stopped and what kinds of
subjective reactions are present in the organism while all this is going on;
• Steering one’s action towards certain goals and to commit a certain part of one’s energies reacting to
them.

These descriptions help in answering any or all the following questions:

(i) What energises human behaviour?
(ii) What directs such behavior?
(iii) How is this behaviour maintained and sustained?

Significance Of Motivation

Motivation is an effective instrument in the hands of manager for inspiring the workforce and creating a
confidence in it. By motivating the workforce, management creates ‘will to work’ which is necessary for
the achievement of organizational goals. Motivation involves getting the members of the group to pull
weight effectively, to give their loyalty to the group, to carry out properly the purpose of the
organisation. The following results may be expected if the employees are properly motivated:
(i) The workforce will be better satisfied if management provides them with opportunities to fulfil
their physiological and psychological needs. The workers will cooperate voluntarily with the
management and will contribute their maximum towards the goals of the enterprise.

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(ii) Workers will tend to be an efficient as possible by improving upon their skills and knowledge so
that they are able to contribute to the progress of the organisation. This will also result in
increased productivity.

(iii) The rates of labour turnover and absenteeism among the workers will be low.

(iv) There will be good human relations in the organisation as friction among the workers themselves
and between the workers and the management will decrease.

(v) The number of complaints and grievances will come down. Accident rate will also be low.

(vi) There will be increase in the quantity and quality of products. Wastage and scrap will be less.
Better quality of products will also increase the public image of the business.

Maslow’s Need Hierarchy Mode

A.H. Maslow developed a conceptual framework for understanding human motivation which has been
widely acclaimed. He defined a person’s effectiveness as a function of matching man’s opportunity with
the appropriate position of hierarchy of needs. Process of motivation begins with an assumption that
behaviour, atleast in part, is directed towards the achievement of satisfaction of needs. Maslow proposed
that human needs can be arranged in a particular order from the lower to the higher as shown in below.
The need hierarchy is as follows:

Fig. Maslow’s Need Hierarchy

(a) Basic Physiological Needs: the needs that are taken as the starting point for motivation theory
are the so-called physiological needs. These needs relate to the survival and maintenance of
human life. They include such things a food, clothing, shelter, air, water and other necessities of
life.

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(b) Safety and Security Needs: After satisfying the physiological needs, people want the assurance
of maintain a given economic level. They want job security, personal bodily security, security of
source of income, provision for old age, insurance against risks, etc.

(c) Social Needs: Man is social being, He is, therefore, interested in conversation, sociability
exchange of feelings and grievances, companionship, recognition, belongingess, etc.

(d) Esteem and Status Needs: These needs embrace such things as self-confidence, independence,
achievement, competence, knowledge, and success. They are also known an egoistic needs. They
are concerned with prestige and status of the individual.

(e) Self-fulfilment Needs: The final step under the need priority model is the need for self-
fulfilment or the need to fulfil what a person considers to be his mission in life. It involves
realizing one’s potentialities for continued self-development and for being creative in the
broadest sense of the word. After his other needs are fulfilled, a man has the desire for personal
achievement. He wants to do something which is challenging and since this challenge gives him
enough dash and initiative to work, it is beneficial to him in particular and to the society in
general. These sense of achievement gives him psychological satisfaction.

Maslow proposed that the needs have a definite sequence of domination. Second need does not dominate
until first need is reasonably satisfied and third need does not dominate until first two needs have been
reasonably satisfied and so on. The other side of the need hierarchy is that man is wanting animal, he
continues to want something or the other. He is never fully satisfied. If one need is satisfied, the other
need arises. As said above (according to Maslow), needs arise in a certain order of preference and not
randomly. Thus, if one’s lower level needs (physiological and security needs) are unsatisfied, he can be
motivated only by satisfying his higher level needs. Another point to note is that once a need or a
certain order of needs is satisfied, it ceases to be a motivating force. Man lives for bread alone as long
as it is not available. In the absence of air one cannot live, it is plenty of air which ceases to be
motivating.

Factors For Entrepreneurial Motivation

A number of factors have been found to be responsible for the growth of entrepreneurship. These factors
can be grouped in three categories namely Entrepreneurial Ambitions, Competency Reasons and
Facilitating Factors.

(a) Entrepreneurial Ambition

(i) To make money
(ii) To gain social prestige
(iii) To secure self-employment or independent living

(b) Compelling Reasons

(i) Unemployment or dissatisfaction with existing job or occupation
(ii) To use technical or professional knowledge and skills
(iii) To put the idle funds of the entrepreneur to use

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(c) Facilitating Factors
(i) Previous knowledge, experience or association with same or similar of activity
(ii) Influence and encouragement by family member, friends and relatives
(iii) Imitation of successful entrepreneurs.

Internal And External Factors

R.A. Sharma has studied the factors that prompted new entrepreneurs to enter industry and has classified
them in two major categories: the factors that are internal to the entrepreneur and those external to the
entrepreneur. The internal factors make the personality of an entrepreneur and induce the person to
adopt entrepreneurship. Without the presence of internal factors entrepreneurial activity in a person
cannot start. However once the entrepreneurial tendencies germinate in a person, the external factors
start playing an important role in the person becoming an entrepreneur and starting his own business
venture.

Internal Factors
• Desire to work independently
• Occupational experience
• Technical/Trade/Qualification and knowledge

External Factors
• Supportive government policies
• Availability of financial assistance
• Ancillary support
• Availability of infrastructural facilities like industrial plot, electricity, technical facilities etc.

People become industrial entrepreneurs because of three main reasons:

1. Desire to do something independently in life.
2. Availability of technical/manufacturing or trade knowledge and skill with prospective entrepreneur.
3. Support from government and other agencies.

MANAGERIAL ROLE AND MANAGEMENT PROCESS IN SMALL BUSINESS

Introduction

Small business has its own distinctive features. The owner himself often acts as the chief executive and
looks after more than one functional area. Therefore, managerial strategies and practices used
successfully in large firms cannot be blindly applied to small scale units. Basic managerial functions in
the two types of business––large and small are the same. But the manner in which these functions should
be carried out can be different.

Managerial Responsibilities Of An Entrepreneur

The managerial responsibilities of an entrepreneur include the following:

(a) Management of self (entrepreneurial qualities and motivation)

(b) Management of enterprise.

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 Fig.: Managerial Responsibilities of an Entrepreneur

(a) Management of Self: The term ‘entrepreneur’ has been defined in various ways––a risk-taker,
a resources assembler, an organisation builder, an innovator, and so on. Truly speaking, an
entrepreneur is all combined into one. He introduces new ideas, carries on new activities,
coordinates the factors of production and decides how the business should be run. He has vision,
originality of thought and ability to take calculated risks.

Entrepreneurship refers to identifying and innovating ideas and services, mobilizing resources,
organizing production/services and finally marketing them with an effort to cover the risk and
constantly strive for growth and excellence. The person who performs all these functions is
called an entrepreneur. The term ‘entrepreneur’ may be used for individuals who incubate new
ideas, start enterprises based on those ideas and provide added value to society based on their
independent initiative. The entrepreneurs have a vision, commitment to constructive change,
persistence to gather necessary resources, and energy to achieve amazing results.

To perform the entrepreneurial role effectively, an entrepreneur has to be creative and

innovative. Innovation may pertain to new products or services, new methods of production,
adopting new sources of supply of raw material, adding new attributes to a product and
introducing new, multiple and optimum utilization of resources. It requires the use of
imagination and intuition for sensing opportunities.

It should also be noted that self-control self-determination and self-confidence are the
important attributes of successful entrepreneurs. They should feel that they can do the work
rather than being made to feel the same through outside forces. They should be capable of
moulding their destiny and destiny of their enterprise.

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(b) Enterprise Management: There is a difference between operating an enterprise and managing
and enterprise which must be clearly understood by the entrepreneurs. Operating and enterprise
often involves buying or making goods and services, pricing, selling, and services. Although
different products/services require different operations, yet, these operational functions are
governed by common management principles. However, management is not the same as
operation. Operating is physical while managing is mental. For managing an enterprise
effectively, the first generation managers must learn to perform the basic management functions
of planning, organizing, staffing, directing and controlling.

An entrepreneurs must acquire management skills to manage his enterprise successfully.

Significance of Management:

(i) Determination of objectives or goals.

(ii) Efficient utilization of resources.
(iii) Sound organisation.
(iv) Integration of efforts and providing order to endeavours.
(v) Meeting challenges.
(vi) Nation’s growth and prosperity.

Planning Process

Planning is the process of deciding the objectives of business and choosing the most appropriate course
of action to achieve the objective. Planning is a rational process because logical reasoning is used in
setting objectives and in choosing course of action. Planning involves thinking and judgment and is,
therefore, called an intellectual process. Planning is a continuous process as changes in plans have to be
made from time to time to take care of changing environment. Planning is forward looking because
plans are prepared for a future period o time. Planning is a basic function as it lays the foundation for
other management functions.

Quite often a haphazard approach is adopted to planning in small firms. There is a misconception that
small firms are simple and do not require planning. The small scale entrepreneur does not want to
involve his staff in the planning process due to the desire to keep the secretes with himself. Personal
responsibility for results, lack of planning skills and absence of specialized staff are other major hurdles
to planning in small firms. Generally small scale units tend to take a short range view or problems and
seldom develop long range strategic plans.

Planning is very important for small business. It helps to focus attention on objectives, provides
direction to decision making, assists in facing uncertainty and change, improves efficiency of operations
and facilitates coordination and control.

Systematic planning in any business consists of the following steps:

25
(a) Mission Statement: First of all the basic mission or overall philosophy of the enterprise is
clearly defined. Mission statement should reflect the interest of the owners, customers,
employees and the society as a whole.

(b) Analysis of External Environment: Such analysis should cover economic conditions,
government policies and regulations, technological changes, political conditions and social
situation. It will reveal opportunities and threats which the firm is likely to face. Special attention
needs to be paid to market conditions and competitive situation.

(c) Analysis of Internal Environment: Situation audit is undertaken to judge the current position
of the firm in terms of market share, capacity utilization, sales turnover, profit margin, etc.
Appraisal of the firm’s resources (resource analysis) should be carried out to identify its
strengths and weaknesses. Physical facilities financial position, managerial capabilities,
marketing competence, etc. are covered in resource analysis. Financial and non-financial ratios
are often used to judge the resource position.

Analysis external and internal environment together is called SWOT (strengths, weaknesses,
opportunities and threats) analysis.

(d) Formulation of Objectives: On the basis of information collected through SWOT analysis, the
goals which the firm wants to achieve in future are decided. Goals should be challenging but
attainable. Goals should also reflect the mission of the firm. Goals are laid down both for short
period (next year) as well as long term (e.g. next five years).

(e) Development of Action Plans: Action plans refer to the future course of action to be adopted to
attain the objective. Action plans include the following:
(i) Priorities of different goals
(ii) Alternatives selected to exploit opportunities and to face threats in the environment
(iii) Timing of different courses of action
(iv) Action programmes for different functional areas of business.

Plans should be formalized in the form of working documents. Such formalization is necessary
for effective communication and implementation of plans.

(f) Execution and Review of Plans: Plans and action programmes are implemented. The plans are
reviewed on a continuous basis. Whenever necessary revision in the adopted plans and
programmes should be carried out. Such updating is essential to take care of changes in the
environment and capabilities of the enterprise.

Organising Process

Organising is an important function of management by which management brings together human and
material resources. This function must be performed when an activity involves two or more persons.
Organising involves determining the activities to be done, grouping the activities, assigning the grouped
activities to individuals, and creating a structure of authority and responsibility among the people to
achieve the objectives of the enterprise.

26
Urwick defined organizing as determining what activities are necessary to achieve and purpose and
arranging them in groups which may be necessary to assign to the individuals. The process of
organisation involves the determination of authority and responsibility relations in the organisation. An
important function of every manager is to determine the nature of the activities required to attain the
group goals, the grouping of these activities and the assignment of the activities to the individuals with
necessary delegation of authority.

The process of organisation involves the following steps:

(a) Determination of objectives;
(b) Identification and grouping of activities;
(c) Assignment of duties to individuals; and
(d) Development of relationships.

Types Of Organisation Structure

There are four main types of formal orgnaisation which are as follows:

(a) Line Organisation: In this form of organisation, a straight line command exists from the highest
to the lowest position. The authority and responsibility of every position is clearly defined. Each
subordinate is accountable to only one superior. But there is no specialization. Line organization
is considered to be most suitable for small scale units.

Chief Executive

Fig.: Line Organisation

(b) Line and Staff Organisation: As an enterprise grows management requires the services of staff
experts. These experts advise line managers but the final authority for taking decisions and issues
orders remains with true executives. Line and staff organisation provides the benefits of
specialization and unity of command. But there is danger of conflicts between line officers and
staff experts.

27
 Chief Executive

Fig.: Line & Staff Organisation

(c) Project Organisation: In this type of organisation, a separate team is created for every major
project. The team provides expert and focused efforts for timely completion of the project.

Fig.: Project Organisation

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(d) Matrix Organisation: This structure is a combination of functional and project responsibilities.
In addition to the permanent functional departments, project team are created temporarily. The
staff for projects is largely deputed from functional department. On the completion of a project
the staff returns back to their respective departments. A small scale firm may adopt project
structure when several projects are carried out simultaneously and each project requires high
degree of coordination among several technical experts.

Fig.: Matrix Organisation

Principles of Sound Organisation:

(a) Division of Work: The work to be performed should be divided into meaningful tasks and one
employee should as far as possible concentrate on one type of work only.

(b) Unity of Command: Each employee should report and be accountable to only one superior.
Orders and instruction should come from a single boss.

(c) Parity Between Authority and Responsibility: The authority of every employee should be
commensurate with his responsibility. The authority and responsibility of every position should
be clearly specified in the form of job descriptions and organisation charts.

(d) Scalar Chain: The chain of command from the top position to the lowest position must be direct
and clear.

(e) Departmentalisation: Similar tasks should be grouped into the same department on an
appropriate basis.

(f) Balance Between Centralisation and Decentralisation: Proper delegation of authority should
be made to ensure that there is the right degree of decentralisation.

(g) Appropriate Span: Span of control means the number of subordinates reporting directly to one
superior. The span should be appropriate in view of the nature of work, ability of the superior,
competence of subordinates, degree of coordination required, etc. Generally, small enterprises
prefer a wide span as they cannot afford the cost of additional layers in the organisation.

29
(h) Human Use of Human Resources: The requirements of work should integrated with the
capabilities and aspirations of employees.

(i) Flexibility: The organisation structure should be able to adapt to changes in the internal and
external environment.

Staffing

After organizing the various activities to be performed, management is in a position to know the
manpower requirements of the enterprise at different levels in the organisation structure. After
determining the number and types of personnel to be selected to fill different jobs, management
proceeds with recruiting, selecting and training the people to fulfil the requirements of the enterprise. In
a running enterprise, staffing is a continuous process because new jobs are created in the enterprise and
existing employees leave the enterprise.

Staffing comprises of those activities which are essential to keep manned the positions created by the
organisation structure. It includes the task of determining positions created by the organisation structure.
In includes the tasks of determining the requirements with regard to number and types of people for the
jobs to be done, laying down qualifications for various jobs and recruiting, selecting and training people
to perform those jobs efficiently.

Staffing is concerned with both manages and non-managers. It is a function performed by managers at
all levels. Earlier, staffing was considered a part of organising. But with the recognition of the
importance of the human factor in industry and business, it began to be considered as a separate
function. Staffi9ng usually includes the following activities:
(i) Human resource planning.
(ii) Deciding sources of recruitment.
(iii) Receiving applications.
(iv) Testing and interviewing.
(v) Final selection and appointment letter.
(vi) Orientation and placement.
(vii) Training and development.

Directing

Direction is the process of guiding, supervising, leading and motivating the subordinates to work in a
way that is beneficial to the enterprise. The manager not only shows the right path but also leads the
subordinates to achieve the objectives of the enterprise. He creates a sense of belongingness, faith and
loyalty among the subordinates.

The direction function involves the following four elements:

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(a) Leadership: Leadership is the process by which a manager guides and influences the work of
others in choosing and attaining specified goals. According to Chester Barnard, leadership is the
quality of the behaviour of the individuals whereby they guide people towards the
accomplishment of some common goal.

(b) Communication: A manager has to tell the workers what they are required to do, how to do and
when to do it. It has to create an understanding in the minds of the subordinates of work to be
done. This is done by the process of communication.

(c) Motivation: It is the function of a manager to motivate the people working under him to perform
the work assigned. A successful manager has to make proper use of motivation to enthuse the
people to work harmoniously for the attainment of desired objectives.

(d) Supervision: Supervision is the process by which conformity between planned and actual results
is maintained. Effective supervision ensures greater output of high quality. It teaches the
subordinates the way their tasks are to be performed.

Controlling

According to Fayol, “In an undertaking, control consists of verifying whether everything occurs in
conformity with the plan adopted, the instructions issued and the principles established.” Controlling is
that management activity whereby the managers compare actual performance against the planned one,
find out the deviations, take corrective action to remove the deviations, incorporate positive deviations
in the plans and help ensure the realization of the specific goals.

In a running concern, planning and control go together because planning seeks to set consistent,
integrated and articulated goals or programmes, while control seeks to compel events conform to plans.
The most notable feature of the process of control is that it is forward-looking. A manager cannot
control the past but can avoid the problems in future by taking actions in the light of past experiences.
The control process consists of the following steps:
(i) Setting up of standards
(ii) Measuring performance.
(iii) Comparing performance with standards.
(iv) Taking corrective action.

Decision-Making

Decision-making is a process of selection from a set of alternative courses of action which is

thought to fulfil the objectives of the decision problem more satisfactorily than other. A decision a
course of action which is consciously chosen for achieving a desired result. It is something that takes
place prior to the actual performance of a course of action that has been chosen. To state this in terms of
managerial decision-making, it is an act of choice wherein a manager selects a particular course of
action from the available alternatives in a given situation. Managerial decision-making involves the
entire process of establishing goals, defining tasks, searching for alternatives and developing plans in
order to find the best answer to the decision problem.

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Characteristics of Decision-Making

The basic characteristics of decision-making are enumerated below:

(a) It is a process of choosing a course of action from among the alternative courses of action.
(b) It is a human process involving to a great extent the application of intellectual abilities.
(c) It is the end process preceded by deliberation and reasoning.
(d) It is always related to the environment. A manager may take one decision in a particular set of
circumstances and another in a different set of circumstances.
(e) It involves a time dimension and a time lag.
(f) It always has a purpose. Keeping this in view, there may just be a decision not to decide.
(g) It involves all actions like defining the problem and probing and analyzing the various
alternatives which take place before a final choice is made.

Significance of Decision-making

No business can survive without effective decision-making. Decision-making is an essential part of

every function of management. In the words of Peter F. Drucker, “Whatever a manager does, he does
through decision-making.” Decision-making lies deeply embedded in the process of management.
Decision-making spreads over all the managerial functions and covers all the areas of the enterprise.
Management and decision-making are bound up and go side by side. Whether knowingly or
unknowingly, every manager makes decisions constantly.

Decision-making and planning are deeply interlinked. The determination of objectives, policies,
programmes, strategies, etc. involves decision-making. The managers also take decisions on the
organizational design, staffing, directing and leading the employees in work situations and on regulating
performance in tune with pre-determined standards. In other words, all managerial functions are
preceded by certain managerial decisions.

The most outstanding quality of a successful entrepreneur is his ability to make sound decisions. A
manager has to make up his mind quickly on certain matters. It is not correct to say that he has to make
spur of the moment decisions all the time. While taking many decisions, he gets enough time for careful
fact finding, analysis of alternatives and choice of the best alternative. Decision-making is a human
process. When a manager decides, he chooses a course which he thinks is the best.

Steps in Decision-making

(i) Defining the problem.

(ii) Analysing the problem.
(iii) Collection of data.
(iv) Developing alternatives.
(v) Review of key factors.
(vi) Selecting the best alternative.
(vii) Implementing the decision.
(viii) Follow up.

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 Fig.: Decision-making

Management Of Time

Time is a very valuable resource especially for a small scale entrepreneur who is often burdened with
multiple roles in his business. The entrepreneur can achieve considerable improvements in his firm’s
performance through more efficient us of time. Management of time involves the following steps:

(a) Time Use Analysis: First of all a systematic analysis is made to find out the proportion of total
time spent by the employer and his staff on different activities.

(b) Setting Priorities: Critical or vital activities should receive greater time. Activities taking more
than the justified time need to be identified. Irrelevant or time wasting activities should be
eliminated.

(c) Time Allocation: A work-cum-time schedule should be prepared. Proper time should be
allocated to each activity. The tasks one wants to do but for which he does not have time should
be noted.

(d) Adhere to Time Schedule: The most difficult part of time management is to complete each
activity within the prescribed time period. For this purposes, it is necessary to delegate tasks to
subordinates, to organize every workday and to continuously evaluate the time management
system.

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 LESSON 3
PLANT LOCATION AND LAYOUT
Vipin Kumar
Plant Location

Location of an enterprise is an important entrepreneurial decision as it affects the operational as well as

financial performance. So entrepreneur is required to identify that location at which the enterprise will
have easy access to physical, economic and social endowments. The general objective in selecting a
location is to minimize total cost of production and distribution. The selected location should be in a
position to help in generating maximum revenue and provide an opportunity for further growth and
expansion. An entrepreneur is expected to evaluate his targets in terms of time and cost variable and try
to select a proper location and seek possession of the site before the zero date. Generally, financial
institutions are also interested to inspect the location or site of the plant before sanctioning any loan to
the enterprise concerned. Efforts should also be made by the entrepreneur to remove all uncertainties
associated with the site before the zero date. Entrepreneur should also know that any change in location
or site at a later date not only targets will be missed but even the viability of the project may also be lost.
Thus, ideal location site helps in smooth and efficient functioning of an enterprise. It ensures a reduction
in costs as well as improves productivity and financial viability of the enterprise.

Need for Enterprise Location

The need for location or site is generally government by the following circumstances:

(i) To promote the establishment of a new enterprise.

(ii) To undertake expansion, decentralisation and diversification necessary for meeting
(iii) To manage the situations arising due to non-renewal of existing lease of an establishment
demand of products.
(iv) To develop new location if existing location has been declared as undesirable or unsuitable.
(v) To arrange a new location by shifting from existing location due to change in market pattern,
depletion of raw materials, change in production processes and transport facilities, etc.
(vi) To open new branch or production facility at new places for increasing the volume of production
and distribution activities.

Importance of Enterprise Location

Selection of plant location or site is quite important due to the following reasons:

(i) It enables the enterprise to operate smoothly, efficiently and with the minimum cost.
(ii) It controls wastages in efforts and talents at the entrepreneurs.
(iii) It reduces uncertainty in results.
(iv) It encourages effective mobilization of raw-materials, labour and potential customers.
(v) it develops the area by attracting other potential entrepreneurs and endowments like physical,
economic and social variables.

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Steps in Enterprise Location

Following steps are important in selecting a particular location or site for the plant:
(i) Selection of the region.
(ii) Selection of the locality or community.
(iii) Selection of the exact site and
(iv) Selection of an optimum site.

Generally, entrepreneur is free to select and location or site for the plant development. However,
regulatory provisions of the government also affect the choice of plant location or site.

Location, Localisation and Planned Location of Industries

Location is concerned with a particular site where entrepreneur is interested to establish his enterprise or
plant having lowest cost objective. If a particular industry is concentrated mainly in one areas is called
as localisation of industries. For example, Kolkata and Mumbai are known for jute and textiles industry
respectively. Planned location of industries is a systematic approach by which location of industries is
planned to give each region or area or place a variety of industries to promote dispersal of industries. For
example, in Ludhiana, different types of industries have been developed and no particular industry is
concentrated in that particular area.

Factors Influencing the selection of the Location of an Enterprise or Plant or Project

Following are the important factors which are normally to be considered when selecting the location of
an enterprise or project:

(a) Availability of Land: Land should be large enough to meet out present requirement with
provision for further expansion. Land should be for industrial use (land usage pattern to be
adhered to) and proper layout of plant and equipment must be possible as per the technical
feasibility study. Drainage level of land, soil testing report (should be suitable for the
construction of the factory) should be favourable to the project requirements.

(b) Availability of Raw Materials: Availability of required quantity and quality of raw materials at
a reasonable cost. Cost of materials generally constitutes a major chunk of total cost of
production and thus, the impact of raw materials on location depends upon their nature and the
source of their deposits.

(c) Supply of Manpower: Every enterprise requires an adequate supply of manpower with
appropriate skills. Availability of skilled manpower, cost of labour, labour expectations, local
culture affect the supply of manpower to the enterprise. Sometimes, it becomes difficult to obtain
high skilled people to work at very remote places with big town facilities. Alfred Weber rightly
remarked that that “an industrial site will deviate from the point of minimum transportation cost
to the cheaper labour centre if the additional cost of transportation at the new centre is more than
compensated by the savings in labour cost.” However, this situation has been changed. Labour is
mobile and there is a level of minimum wages fixed by the Government from time to time.
Moreover certain industries are capital intensive and they require less labour.

35
(d) Transport and Communication Facilities: Transport services are required for assembling of
materials and distribution of products. At the time of selection of a particular efforts should be
made to ensure that transportation facilities are easily available at reasonable rates. Site should
be well connected by road and rail or nearer to national highways, major railway yard etc.,
Transportation of equipment, material, product and personnel is an important requirement and it
should be ensured in time and in efficient manner.

(e) Proximity to the Market: Availability of consumer market also affects the viability of the
enterprise. An entrepreneur can improve his customer relations if they are available in nearby
areas and easily render rapid services to them. Enterprises engaged in the production of
perishable commodities and those producing for a local market are also interested to develop
their plants in potential consumer’s area as it would ensure a reduction in transportation cost
involved in distributing the finished products. Actually, an enterprise tends to disperse only if
they find a new consumer market.

(f) Water, Power and Fuel: Uninterrupted operations of an enterprise is the result of sufficient
supply of water, power and fuel etc. In this context, efforts are required to assess local sources of
water. Besides, required water supply to be assessed in terms of water conditions or sub-soil
water etc. Availability of power in the region is to be evaluated in terms of actual requirements.
Some industries consume lot power (aluminium) or water (Paper industry) and these variables
are a very important factor for them. Nowadays, industries are facing the problem of power
shortages and they are shifting to the fuel option––coal. For example, coal is the major source of
fuel for the iron and steel industry and these industries are located near the coal mines.

(g) Regional Development: In our country, government is pursuing the policy of balanced regional
development to solve the problems like slum, disparity of income and wealth and optimum use
of resources. In order to ensure balanced regional development, government has declared certain
areas as backward areas and zero industry areas. Government gives certain benefits like tax
benefits but it is necessary to evaluate the process to what extent they would outweigh the
disadvantages.

(h) External Economies: In some cases, an enterprise prefers to be located in those centres where
other industrial units are already located. There are certain facilities like transportation,
warehousing, banking, insurance, communication and factoring services etc. which are easily
available and industrial units tend to be concentrated in these areas. Besides, raw materials are
also available at cheaper prices and in large quantity. For example, by product of one enterprise
may be used as raw material by another enterprise. Enterprises working as distilleries are
generally located in nearby areas of Sugar mills because they supply molasses as raw materials
to distilleries.

(i) Personal Factors: Personal preferences and prejudices of an entrepreneur also effect the
selection of location. Entrepreneurial preferences are also affected by law and order, political
stability and safety etc. Thus, entrepreneurs prefer to locate their enterprises in those areas which
are safe and free from law and order problems.

36
(j) Local Laws and Regulations: In certain cases local laws and regulations impose restrictions on
the development of industrial units in special areas. For example, consent of various agencies
like local Panchayat, municipality, government, state planning bodies is mandatory for the
entrepreneurs otherwise they cannot run their enterprises in municipal or local areas. Similarly,
high rate of income-tax, sale-tax, octroi, etc. discourage entrepreneur to develop their plant in a
particular area or state. But facility of tax holidays encourages them otherwise to develop their
units in a particular area or state.

(k) Ecological and Environmental Factors: Certain industrial units are required to be governed by
the ecological and environmental provisions of Pollution Control Act. Industrial units are
required to follow the norms of Pollution Control Board. They have to make efforts for the
disposal of effluents are directed by the pollution control authorities. They have to arrange the
nearest source where effluent (after treatment) could be discharged.

Government Locational Policy

Industrial location has received closer attention of the government and policy planners in recent times.
Actually, location policy is an extension of the policy of development backward areas and industrial
disposal. It deals with negative aspect and positive thrust. The negative aspect is concerned with
preventive measures for developing new units in the already advanced areas and urban, metropolitan
centres with the dictates of then government from time to time. But positive thrust deals with
instruments like concessional finance, investment tax incentives subsidies etc. which are being used by
the government to develop new units in backward and zero industries districts of different states. With
the help of positive strategy, government is trying to ensure effective dispersal of industrial units to
backward areas. The government has already formulated a policy that “The new unit should not be
located within the standard urban area limit of a large metropolitan city having a population of more
than prescribed limit determined by government.

The location of industrial units is further regulated by the local zoning and land-use regulations as also
the environmental regulations. Hence, even if the requirement of the locational policy as stated above is
fulfilled, but the local zoning and land-use regulations of a State government, or the regulations of the
Ministry of Environment do not permit setting up of an industry at a location, then the entrepreneur
would be required to abide by that decision.

Thus, selection of location of an enterprise is an important decision and entrepreneur should try to assess
the implication of the above factors. These factors affect the survival and viability of the enterprise in
the long run.

One study of locational considerations from small-scale units revealed that the native place or
homelands (personal factor) of the entrepreneur was the most important factor. Heavy preference to
homeland suggests that small-scale enterprise is not freely mobile. Low preference for Government
incentives suggests that concessions and incentives cannot compensate for poor infrastructure.

Table given below also suggests that the locational choice undergo change with differences in the levels
of development across the regions (hills and plains).

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 Table: Factors Affecting Location Decision

Entrepreneur’s Response
Considerations Hills Plains Total
No. % No. % No. %
Homeland 15 67 11 39 26 52
Government
3 14 1 4 4 8
Incentives
Availability of
0 0 1 4 1 2
Raw material
Availability of
2 9 0 0 2 4
labour
Availability of
0 0 5 18 5 10
market
Availability of
infrastructure 1 5 9 32 10 20
facilities
Others 1 5 1 4 2 4
Total 22 100 28 100 50 100

Layout

Layout involves determining the space requirement for the facilities and arranging them in a manner to
ensure steady flow of operations with minimum overall cost. In order words, a layout is a floor plan for
arranging the desired facilities, machinery, equipment in an optimum locations so as to permit the
quickest flow of materials and manpower at the lowest cost and with the least amount of in process
handling from receipt of raw material to shipment of finished products.

Since, a layout once made cannot be changed/modified easily and without incurring considerable cost on
one hand and disrupting the operations on the other hand, layout decisions are strategic decisions.
Hence, layout has to be considered at the time of planning a new venture. A good layout should result in
comfort, convenience, better appearance, safety, efficiency and profits. A poorly planned layout causes
congestion, disruption in flow of man and/or materials, accidents, delays, rejections leading to
frustration and inefficiency. In a production unit layout includes factory design, that is layout of
workshop, raw material stock yards, finished goods stores, generator, compressor room etc. In hospitals
it involves fixing the location of wards, operation theater, out-patient departments, canteen, doctors and
nurses duty rooms etc. At another level layout planning involves layout of different machines, work
stations etc., in the shop floor and patient’s beds, drug store, doctors and nurses seats and other facilities
in a hospital ward.

Considerations of Plant Layout

• Maximum use of the available space.

• Compatibility with the production technology and product mix.
• Minimum movement of materials as well as men.
• Provision of proper space for maintenance.

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• Arrangement of proper in-transit storage and stacking space.
• Promotes effective supervision.
• Proper lighting and ventilation.
• Provision of maximum flexibility.
• Safety of operators and other staff.
• Minimum handling of materials.
• Provision for future expansion.
• Security against fire, theft, detoriation etc.
• Maximum flexibility to accommodate changes in production volume and product mix.
• Should meet the specific requirement of the production process viz., air conditioning, air cooling,
dust control, humidity control and may be required.

Advantages of Proper Plant Layout

1. Increase in Productivity
2. Maximum utilization of Space
3. Effective Supervision and Control
4. Economy in Material
5. Improved Safety and Handling
6. Improved Working Environment and Morale
7. Better Quality Control.

Types Of Layout

As discussed so far the plant layout facilitates the arrangement of machines, equipment and other
physical facilities in a planned manner within the factory premises. An entrepreneur must possess an
expertise to lay down a proper layout for new or existing plants. It differs from plant to plant, from
location to location and from industry to industry. But the basic principles governing plant layout are
more or less same.

As far as small business is concerned, it requires a smaller area of space and can be located in any kind
of building as long as the space is available and it is convenient. Plant layout for Small Scale business is
closely linked with the factory building and built up area.

From the point of view of plant layout, we can classify small business or unit into three categories:

I. Manufacturing units
II. Traders
III. Service Establishments

I. Manufacturing Units

In case of manufacturing unit, plant layout may be of four types:

39
(a) Product or line layout
(b) Process or functional layout
(c) Fixed position or location layout
(d) Combined or group layout

(a) Product or Line Layout:

Under this, machines and equipments are arranged in one line depending upon the sequence of
operations required for the product. The materials move from one workstation to another sequentially
without any backtracking or deviation. Under this, machines are grouped in one sequence. Therefore
materials are fed into the first machine and finished goods travel automatically from machine to
machine, the output of one machine becoming input of the next, e.g. in a paper mill, bamboos are fed
into the machine at one end and paper comes out at the other end. The raw material moves very fast
from one workstation to other stations with a minimum work in progress storage and material handling.

The grouping of machines should be done keeping in mind the following general principles.

(i) All the machine tools or other items of equipments must be placed at the point demanded by the
sequence of operations.
(ii) There should no points where one line crossed another line.
(iii) Materials may be fed where they are required for assembly but not necessarily at one point.
(iv) All the operations including assembly, testing packing must be included in the line.

A line layout for two products is given below;

Advantages: Product layout provides the following benefits:

(i) Low cost of material handling, due to straight and short route and absence of backtracking.
(ii) Smooth and uninterrupted operations.
(iii) Continuous flow of work.
(iv) Lesser investment in inventory and work in progress.
(v) Optimum use of floor space.
(vi) Shorter processing time or quicker output.
(vii) Less congestion of work in the process.
(viii) Simple and effective inspection of work and simplified production control.
(ix) Lower cost of manufacturing per unit.

40
Disadvantages: Product layout suffers from following drawbacks:

(i) High initial capital investment in special purpose machine.

(ii) Heavy overhead charges.
(iii) Breakdown of one machine will hamper the whole production process.
(iv) Lesser flexibility as specially laid out for particular product.

Suitability: Product layout is useful under following conditions:

(i) Mass production of standardized products.

(ii) Simple and repetitive manufacturing process.
(iii) Operation time for different process is more or less equal.
(iv) Reasonably stable demand for the product.
(v) Continuous supply of materials.

Therefore, the manufacturing units involving continuous manufacturing process, producing few
standardized products continuously on the firm’s own specifications and in anticipation of sales would
prefer product layout e.g. chemicals, sugar, paper, rubber, refineries, cement, automobiles, food
processing and electronics etc.

(b) Process Layout:

In this type of layout machines of a similar type are arranged together at one place. E.g. machines
performing drilling operations are arranged in the drilling department, machines performing casting
operations be grouped in the casting department. Therefore the machines are installed in the plants,
which follows the process layout.

Hence, such layouts typically have drilling departments, milling department, welding department,
heating department and painting department etc. the process or functional layout is followed from
historical period. It evolved from the handicraft method of production. The work has to be allocated to
each department in such a way that no machines are chosen to do as many different job as possible i.e.
the emphasis is on general purpose machine.

The work, which has to be done, is allocated to the machines according to loading schedules with the
object of ensuring that each machine is fully loaded. Process layout is shown in the following diagram.

41
Process layout showing movement of two products:

The grouping of machines according to the process has to be done keeping in mind the following
principles.

(i) The distance between departments should be as short as possible for avoiding long
distance movement of material.
(ii) The departments should be in sequence of operations
(iii) The arrangement should be convenient for inspection and supervision.

Advantages: Process layout provides the following benefits:

(i) Lower initial capital investment in machines and equipments. There is high degree of machine
utilization, as a machine is not blocked for a single product.
(ii) The overhead costs are relatively low.
(iii) Change in output design and volume can be more easily adapted to the output of variety of
products.
(iv) Breakdown of one machine does not result in complete work stoppage.
(v) Supervision can be more effective and specialised.
(vi) There is a greater flexibility of scope for expansion.

Disadvantages: Process layout suffers from following drawbacks:

(i) Material handling costs are high due to backtracking.

(ii) More skilled labour is required resulting in higher cost.
(iii) Time gap or lag in production is higher.
(iv) Work in progress inventory is high needing greater storage space.
(v) More frequent inspection is needed which results in costly supervision.

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Suitability: Process layout is adopted when

(i) Products are not standardized.

(ii) Quantity produced is small.
(iii) There are frequent changes in design and style of product.
(iv) Job shop type of work is done.
(v) Machines are very expensive.

Thus, process layout or functional layout is suitable for job order production involving non-repetitive
processes and customer specifications and non-standardised products, e.g. tailoring, light and heavy
engineering products, made to order furniture industries, jewelry.

(c) Fixed Position or Location Layout:

In this type of layout, the major product being produced is fixed at one location. Equipment labour and
components are moved to that location. All facilities are brought and arranged around one work center.
This type of layout is not relevant for small scale entrepreneur. The following figure shows a fixed
position layout regarding shipbuilding.

Advantages: Fixed position layout provides the following benefits:

(i) It saves time and cost involved on the movement of work from one workstation to
another.
(ii) The layout is flexible as change in job design and operation sequence can be easily
incorporated.
(iii) It is more economical when several orders in different stages of progress are being
executed simultaneously.
(iv) Adjustments can be made to meet shortage of materials of absence of workers by changing the
sequence of operations.

Disadvantages: Fixed position layout has the following drawbacks:

(i) Production period being very long, capital investment is very heavy.
(ii) Very large space is required for storage of material and equipment near the product.
(iii) As several operations are often carried out simultaneously, there is possibility of confusion and
conflicts among different workgroups.

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Suitability: The fixed position layout is followed in following conditions:

(i) Manufacture of bulky and heavy products such as locomotives, ships, boilers, generators, wagon
building, aircraft manufacturing, etc.
(ii) Construction of building, flyovers, dams.
(iii) Hospital, the medicines, doctors and nurses are taken to the patient (product).

(d) Combined Layout:

Certain manufacturing units may require all three processes namely intermittent process (job shops), the
continuous process (mass production shops) and the representative process combined process [i.e.
miscellaneous shops].

In most of industries, only a product layout or process layout or fixed location layout does not exist.
Thus, in manufacturing concerns where several products are produced in repeated numbers with no
likelihood of continuous production, combined layout is followed. Generally, a combination of the
product and process layout or other combination are found, in practice, e.g. for industries involving the
fabrication of parts and assembly, fabrication tends to employ the process layout, while the assembly
areas often employ the product layout. In soap, manufacturing plant, the machinery manufacturing soap
is arrange don the product line principle, but ancillary services such as heating, the manufacturing of
glycerin, the power house, the water treatment plant etc. are arranged on a functional basis.

II. Traders

When two outlets carry almost same merchandise, customers usually buy in the one that is more
appealing to them. Thus, customers are attracted and kept by good layout i.e. good lighting, attractive
colours, good ventilation, air conditioning, modern design and arrangement and even music. All of these
things mean customer convenience appeal and greater business volume.

The customer is always impressed by service, efficiency and quality. Hence, the layout is essential for
handling merchandise, which is arranged as per the space available and the type and magnitude of goods
to be sold keeping in mind the convenience of customers.

There are three kinds of layouts in retail operations today.

(a) Self service or modified self service layout.

(b) Full service layout.
(c) Special layouts.

The self-service layouts, cuts down on sales clerk’s time and allow customers to select merchandise for
themselves. Customers should be led through the store in a way that will expose them to as much
display area as possible, e.g. Grocery Stores or department stores. In those stores, necessities or
convenience goods should be placed at the rear of the store. The use of colour and lighting is very
important to direct attention to interior displays and to make the most of the stores layout.

44
All operations are not self-service. Certain specialty enterprises sell to fewer number of customers or
higher priced product, e.g. Apparel, office machines, sporting goods, fashion items, hardware, good
quality shoes, jewelry, luggage and accessories, furniture and appliances are all examples of products
that require time and personal attention to be sold. These full service layouts provide area and equipment
necessary in such cases.

Some layouts depend strictly on the type of special store to be set up, e.g. TV repair shop, soft ice cream
store, and drive-in soft drink stores are all examples of business requiring special design. Thus, good
retail layout should be the one, which saves rent, time and labour.

3. Services Centers and Establishment

Services establishments such as motels, hotels, restaurants, must give due attention to client
convenience, quality of service, efficiency in delivering services and pleasing office ambience. In
today’s environment, the clients look for ease in approaching different departments of a service
organisation and hence the layout should be designed in a fashion, which allows clients quick and
convenient access to the facilities offered by a service establishment.

Applicability Of Plant Layout

Plant layout is applicable to all types of industries or plants. Certain plants require special arrangements
which, when incorporated make the layout look distinct from the types already discussed above.
Applicability of plant layout in manufacturing and service industries is discussed below.

In case of the manufacturing of ‘detergent powder’, a multi-storey building is specially constructed to

house the boiler. Materials are stored and poured into the boiler at different stages on different floors.
Other facilities are also provided around the boiler at different stations.

Another applicability of this layout is the manufacture of ‘talcum powder’. Here machinery is arranged
vertically i.e. from top to bottom. Thus, material is poured into the first machine at the top and powder
comes out at the bottom of the machinery located on the ground floor.

Yet another applicability of this layout is the ‘newspaper plant’, where the time element is of supreme
importance, the accomplishment being gapped in seconds. Here plant layout must be simple and direct
so as to eliminate distance, delay and confusion. There must be a perfect coordination of all departments
and machinery or equipments, as materials must never fail.

Plant layout is also applicable to ‘five star hotels’ as well. Here lodging, bar, restaurant, kitchen, stores,
swimming pool, laundry, shaving saloons, shopping arcades, conference hall, parking areas etc. should
all find an appropriate place in the layout. Here importance must be given to cleanliness, elegant
appearance, convenience and compact looks, which attract customers.

Similarly plant layout is applicable to a ‘cinema hall’, where emphasis is on comfort, and convenience
of the cinemagoers. The projector, screen, sound box, fire-fighting equipment, ambience etc. should be
of utmost importance.

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A plant layout applies besides the grouping of machinery, to an arrangement for other facilities as well.
Such facilities include receiving and dispatching points, inspection facilities, employee facilities, storage
etc.

Generally, the receiving and the dispatching departments should be at eight end of the plant. The
storeroom should be located close to the production, receiving and dispatching centers in order to
minimize handling costs. The inspection should be right next to other dispatch department as inspections
are done finally, before dispatch.

The maintenance department consisting of lighting, safety devices, fire protection, collection and
disposal of garbage, scrap etc. should be located in a place which is easily accessible to all the other
departments in the plant. The other employee facilities like toilet facilities, drinking water facilities, first
aid room, cafeteria etc. can be a little away from other departments but should be within easy reach of
the employees. Hence, there are the other industries or plants to which plant layout is applicable.

46
 LESSON 4
OPERATIONS PRODUCTION PLANNING AND CONTROL
Vipin Kumar
Introduction

Production and operations management play a crucial role in the success of small enterprises.

It helps the enterprise to produce quality and standardized and medium products at minimum cost. The
management process also helps in time management and scheduling of production and it control.

Production is the basic activity of all industrial units. All other activities revolve around this activity.
The end-product of the production activity is the creation of goods and services for the satisfaction of
human wants. The production activity is nothing but the step-by-step conversion of one form of
materials into another, either chemically or mechanically. This is done in factories which house
manufacturing processes. The basic inputs of the production processes are men, machines, plant,
services and methods. The products of the mine, farm, sea and forest are used as raw materials on which
the processing id done to create not always furnish a ready-made product for the ultimate consumption.
In a chain of manufacturing activities, the finished product of the processor sometimes becomes the raw
material (or component) for the other manufacturing firms falling next in the sequence.

“Production” involves the step-by-step conversion of one form of materials into another through
chemical or mechanical processing to create or enhance the utility of the products or services. According
to economists, production is an activity through which the form utility is either created or enhanced; e.g.,
a piece of wood has no doubt, some utility. However, when it is converted into a chair with some
mechanical processing, the utility of the material (i.e., a piece of wood) would enhance substantially.
According to E.S. Buffa, “production is process by which goods and services are created.

These days therefore both manufacturing and service organizations fall into the scope of production
management. Thus, production management which was formerly considered as manufacturing
management only, now after inclusion of services into its scope, is broadly known as operations
management. Many non-manufacturing organizations providing services like hospitals, banks,
transportation, farming, warehousing etc., are now covered by operations management.

Operations by formal definition is a process of changing inputs into outputs, with creation or adding of
value to some entity. The process of alteration or transportation of storage or inspection or any
combination thereof to add value to an entity is rightly called operations.

Operations in the services organizations has some unique features, different from those which has
manufacturing base. These are:
(i) Non-inventoriable output of service, since generally no stock is produced.
(ii) Variable demand.
(iii) Labour-intensive operations mostly.
(iv) Location of service is dictated by the location of the users.

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Objective Of Production Management

Production is an organized activity in a manufacturing organisation. Each organized activity must spell
out its objectives so that its existence can be justified on the basis of the degree of the attainment of
these objectives. Moreover, such identification of the objectives increases the consciousness of the
personnel working in the respective organistions in checking their efforts by verifying whether they are
in conformity with the stated objective of the organisation. The objectives of the production function are
classified as under: (I) Ultimate objectives, and (II) Intermediate objectives.

(I) Primary Objectives: The primary responsibility of the manufacturing activity is to produce a
product or products at (a) pre-established cost, (b) according to the specified quality, and (c)
within the stipulated time schedule.

(II) Secondary Objectives: Production is the result of various types of inputs, like men, materials,
machines and manufacturing services. The secondary objectives strive to attain the optimum
utilization of these various types of inputs. It should be noted that the output resulting out of the
inputs is measured in terms of the cost, quality and time which relate to the prescription of
aforesaid primary objectives.

Production Management

Production system is a system whose function is to convert a set of inputs into a set of desired outputs.
Production system is depicted under with help of chart.

Fig.: Production System

Production management involves the managerial decisions regarding design of the product and design of
the production system i.e. determination of production processes and production planning and control.

Production Design

In the development of the product, the design stage is the most crucial. Detailed specifications are listed
for a product at this stage. These specifications ultimately results in product quality. The product’s
design is translated in quantitative terms here. Compiling specification is not an easy task. It requires a

48
great deal of time. The profitability and competitiveness of the product depend upon its design which in
turn depends upon specifications. And so specifications should be carefully developed. Properly
formulated specification have the potential of controlling costs at the design stage. The task of setting
specifications is done in the face of sometimes conflicting views of different departments like sales,
engineering and production. We cannot over-specify as well as under specify. We have also to ensure
smoothness of the production line. Specifications are therefore clear and explicit, and preferably written.
Generally, specifications are prepared by a multidimensional committee (consisting of the design
engineers, the purchase officer, the marketing executive, the quality control executive etc.). Only after
the approval of the committee, the design in finalised. In case of most widely used and highly
competitive products, standard specifications are available.

Fig.: Product Design Process

Product development process is a continuous activity in an organisation.

Steps Of Production Planning And Control

Production Planning and Control (PPC) is a process that comprises the performance of some critical;
functions on either side, viz., planning as well as control.

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 Fig.: PPC Process

Production planning: Production planning may be defined as the technique of foreseeing every step in
a long series of separate operations, each step to be taken at the right time and in the right place and each
operations to be performed in maximum efficiency. It helps entrepreneur to work out the quantity of
material manpower, machine and money requires for producing predetermined level of output in given
period of time.

Routing: Under this, the operations, their path and sequence are established. To perform these
operations the proper class of machines and personnel required are also worked out. The main aim of
routing is to determine the best and cheapest sequence of operations and to ensure that this sequence is
strictly followed. In small enterprises, this job is usually done by entrepreneur himself in a rather adhoc
manner. Routing procedure involves following different activities.

(i) An analysis of the article to determine what to make and what to buy.
(ii) To determine the quality and type of material.
(iii) Determining the manufacturing operations and their sequence.
(iv) A determination of lot sizes.
(v) Determination of scrap factors.
(vi) An analysis of cost of the article.
(vii) Organisation of production control forms.

Scheduling: It means working out of time that should be required to perform each operation and also
the time necessary to perform the entire series as route, making allowances for all factors concerned. It

50
mainly concerns with time element and priorities of a job. The pattern of scheduling differs from one job
to another which is explained as below:

Production Schedule: The main aim is to schedule that amount of work which can easily be handled by
plant and equipment without interference. It’s not independent decision as it takes into account
following factors.

(i) Physical plant facilities of the type required to process the material being scheduled.
(ii) Personnel who possess the desired skills and experience to operate the equipment and perform
the type of work involved.
(iii) Necessary materials and purchased parts.

Master Schedule: Scheduling usually starts with preparation of master schedule which is weekly or
monthly break-down of the production requirement for each product for a definite time period, by
having this as a running record of total production requirements the entrepreneur is in better position to
shift the production from one product to another as per the changed production requirements. This forms
a base for all subsequent scheduling acclivities. A master schedule is followed by operator schedule
which fixes total time required to do a piece of work with a given machine or which shows the time
required to do each detailed operation of a given job with a given machine or process.

Manufacturing Schedule: it is prepared on the basis of type of manufacturing process involved. It is

very useful where single or few products are manufactured repeatedly at regular intervals. Thus it would
show the required quality of each product and sequence in which the same to be operated.

Scheduling of Job Order Manufacturing: Scheduling acquires greater importance in job order
manufacturing. This will enable the speedy execution of job at each center point.

As far as small scale industry is concerned scheduling is of utmost importance as it brings out efficiency
in the operations and reduces cost price. The small entrepreneur should maintain four types of schedules
to have a close scrutiny of all stages namely an enquiry schedule, a production schedule, a shop schedule
and an arrears schedule out of above four, a shop schedule is the most important most suited to the needs
of small scale industry as it enables a foreman to see at a glance.

(i) The total load on any section.

(ii) t/he operational sequence.
(iii) The stage, which any job has reached.

Loading: The next step is the execution of the schedule plan as per the route chalked out it includes the
assignment of the work to the operators at their machines or work places. So loading determines who
will do the work as routing determines where and scheduling determines when it shall be done. Gantt
Charts are most commonly used in small industries in order to determine the existing load and also to
foresee how fast a job can be done. The usefulness of their technique lies in the fact that they compare
what has been done and what out to have been done.

Most of a small scale enterprise fail due to non-adherence to delivery schedules therefore they can be
successful if they have ability to meet delivery order in time which no doubt depends upon production of

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quality goods in right time. It makes all the more important for entrepreneur to judge ahead of time what
should be done, where and when thus to leave nothing to chance once the work has begun.

Production Control: Production control is the process of planning production in advance of operations,
establishing the extract route of each individual item part or assembly, setting, starting and finishing for
each important item, assembly or the finishing production and releasing the necessary orders as well as
initiating the necessary follow-up to have the smooth function of the enterprise. The production control
is of complicated nature in small industries. The production planning and control department can
function at its best in small scale unit only when the work manger, the purchase manager, the personnel
manager and the financial controller assist in planning production activities. The production controller
directly reports to the works manager but in small scale unit, all the three functions namely material
control, planning and control are often performed by the entrepreneur himself production control starts
with dispatching and ends up with corrective actions.

Dispatching: Dispatching involves issue of production orders for starting the operations. Necessary
authority and conformation is given for:
(i) Movement of materials to different workstations.
(ii) Movement of tools and fixtures necessary for each operation.
(iii) Beginning of work on each operation.
(iv) Recording of time and cost involved in each operation.
(v) Movement of work from one operation to another in accordance with the route sheet.
(vi) Inspecting or supervision of work.

Dispatching is an important step as it translates production plans into production.

Follow-up: Every production programme involves determination of the progress of work, removing
bottlenecks in the flow of work and ensuring that the productive operations are taking place in
accordance with the plans. It spots delays or deviations from the production plans. It helps to reveal
detects in routing and scheduling, misunderstanding of orders and instruction, under loading or
overloading of work etc. All problems or deviations are investigated and remedial measures are
undertaken to ensure the completion of work by the planed date.

Inspection: This is mainly to ensure the quality of goods. It can be required as effective agency of
production control.

Corrective Measures: Corrective action may involve any of those activities of adjusting the route,
rescheduling of work changing the workloads, repairs and maintenance of machinery or equipment,
control over inventories of the cause of deviation is the poor performance of the employees. Certain
personnel decisions like training, transfer, demotion etc. may have to be taken. Alternate methods may
be suggested to handle peak loads.

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 LESSON 5
QUALITY, PRODUCTIVITY AND ENVIRONMENT
Vipin Kumar

Quality Control

The introduction of quality control techniques in the small scale business is one of the most significant
factors in the rapid development of the economy of the country, for it has brought about improvements
in the quality of product without any additional capital investment. Several countries in the world,
particularly those which suffered a setback to their economy after the Second World War, have
recovered their economy and established firm foreign markets by improving the quality of their
products. The application of quality control techniques also brings considerable savings at various stages
production. For this purpose, standardization plays a fundamental role in the assessment, specification
and measurement of the quality of a product. With the help of standardization, it is possible to lay down
basic procedures for ensuring quality control.

It is obvious that for a proper quality control in small scale industry is essential to have suitable raw
materials of specified quality to produce quality products. It is also necessary to enforce quality control
in industry at all stages of manufacture because, with the complex integrated industrial system in the
modern world, unless control is effected at all levels, It may be difficult to ensure the quality of the end
product. At the same time, the cost factor should be considered to be of equal importance, for it is the
cost of a product which determines its saleability. In a sheltered or seller’s market, the cost factor and
even the quality aspect are often neglected; but when industrial recession sets in and competition in the
export market becomes keen, adequate attention to quality and cost is essential. India has of late been
facing improving quality and reducing the cost of production.

Quality control is one of the important responsibilities of the production department. It minimizes
wastage, reduces cost, builds up goodwill for product in the market, facilities advertising sales, and
brings increasing satisfaction to its users.

Meaning: Quality is a related concept, related to certain predetermined characteristics such as shape,
dimensions, composition, strength, workmanship, finish, colour, time, weight, etc. According to Alford
and Beaty, “quality control is the mechanism by which products are made to measure up to the
specifications determined from the customer’s demands and transformed into sales, engineering and
manufacturing requirements. It is concerned with making things right rather than discovering and
rejecting those made wrong. Quality control is a technique by means of which products of uniform
acceptable quality are manufactured.” In other words, it is the systematic control of those variables
which are encountered in the manufacturing process and which affect the excellence of the finished
product.

Importance: Quality control has distinct advantages:

(a) It facilitates distribution, increases the sales and builds up goodwill and the brand in the market.
(b) It leads to all-round efficiency in the organisation.
(c) It helps the entrepreneur (manufacturer) in determining the responsibility of individual workers
and of the production units.

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(d) It minimises the cost by reducing wastages, increasing efficiency, standardizing procedures,
machines, tools, materials and working conditions.
(e) It enables the entrepreneur to know the cost of a product in advance, so that he may determine
competitive price.
(f) The entrepreneur ca conform to the standards set by the Government (if any.

Quality standards are set only after carefully analysing the consumer’s requirements and the cost of the
product (if the quality standards are set very high and maintained effectively, they may involve a higher
cost which may be beyond the expected range of the consumers).

Benefits Of Quality Management

For Employees:

• Empowerment
• Job satisfaction
• Improved working environment
• High morale

For Company:

• ROI
• Sustained Growth
• Good Image
• Risk Mitigation

For Customers:

• High quality products

• Good available of products
• Responsible pricing
• Quick complaint redressal

For Suppliers:

• Better understanding
• Larger role
• Regular business

Control over Production: The variations in quality are caused by variations in the materials used, in
men, machines, tools, and equipment and in methods and procedures of production and inspection.
These variables need to be controlled if quality products are to be manufactured.

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Methods of Quality Control

(a) Inspection: Inspection is one of the very important steps in quality control.

There are three important aspects of inspection:

(i) Production Inspection: It is to ensure that the goods sent into the market for sale are free
of defects and conform to the set standards of quality.

(ii) Process Inspection: It is designed to check raw material, machines, etc. it saves time and
wastage of material, and prevents process bottlenecks.

(iii) Inspection Analysis: A careful analysis of inspection results enables an entrepreneur to

locate these points in the manufacturing process at which control is breaking down.

(b) Statistical Analysis: Statistical Quality control (SQC) is a special type of technique to control
the quality of a product. In this method, statistical techniques are used to gather and analyse data
with a view to determining ad controlling quality. It is based on sampling, probability and
statistical inference, i.e., it judges an entire lot by the characteristics of sample. It is divided into
three parts: the analysis of samples, the use of control and taking corrective action.

Statistical quality control is a diagnostic and preventive device of quality control. It is widely
used in process control of continuous process industries and in industries producing goods on a
mass scale.

Quality Control in Small Scale Business

Quality control in the small scale sector is as necessary, or even more necessary than, in the large scale
sector because of the greater use of manpower in the former during the manufacturing processes. But is
application raises certain problems because of several limitations, including, financial, technical and
managerial. For a successful application of quality control, small scale units must take case of quality
right from the choice of raw materials, selection of machinery and equipment, tooling, designing,
manufacturing processes, testing, marketing and after-sales service. To ensure its success, the small unit
has to be suitably assisted by Government organisations, associations and institutions, which will have
to provide technical, financial management assistance and training to the small industrialist and create
quality consciousness in him.

With the combined efforts of the Development Commissioners, Small-scale Industrial Organisation,
Indian Standard Institution and State Government agencies, the small units have successfully adopted
quality control measures in various fields. Amongst the other measures, their quality control is based on:

(i) Indian Standards specifications;

(ii) Quality marketing schemes;
(iii) Company Standards ( in case of ancillary units);
(iv) Any other standard specifications prescribed by the Government or other purchasing agencies.

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The Indian Standards Specifications have been of valuable guidance to small scale units and have
persuaded them to adhere to the quality of the product. Several units have obtained the ISI mark to
establish the quality of their product. The quality of the small scale industries products, however,
depends upon many other factors, one of the biggest factors being the availability of suitable standard
raw materials. In this connection, several standard specifications for raw materials have been laid down
which have greatly helped the producers in the manufacture of suitable raw materials. On quality control
itself, the following Indian Standards have been published:

(i) Methods of statistical quality control during production by the use of a control chart;
(ii) Manual on basic principles of lot sampling; and
(iii) Sampling inspection tables.

Several State Governments have been operating quality marketing schemes and standards for various
products. Small-scale units manufacture the items in accordance with these standards; and the Quality
Marketing Centres of the Government stamp the “Q” mark on their products which assures customers
that the items have been made to certain quality standards. Several light engineering items, sports goods,
textiles are covered under this scheme. The specifications laid down under this scheme may or may not
conform to the Indian Standards, but they are acceptable to State Governments, probably because they
have been found to be suitable for one purpose or the other. The Quality Marketing Centres sometimes
inspect the goods on behalf of the ISI, Export Inspection Council and the Defence Department. State
Governments have set up a number of common facility centres and testing laboratories to assist the units
to manufacture goods to prescribed standards.

The quality of the products manufactured by ancillary units is prescribed by the large unit either as per
the national standards or company standards; sometimes the large units provide detailed specifications,
drawings, samples, analysis of materials to be used, inspection procedures, and for storage of materials
to small ancillary units. They also help them to manufacture items are inspected by these large units
even during the course of manufacture to ensure that they are fabricated in accordance with the
standards laid down by them. This helps the ancillary units to adhere to the required quality, which may
otherwise adversely affect the sale of their end product.

For the purchases of the Central Government through the Director-General of Supplies and Disposal, the
standards for the quality of the products are laid down by the department itself. These standards may
also be national standards. Inspection in carried out by the department before purchases are made from
small scale and other units. Similarly, standards are laid down for purchases by the Defence Department
for its requirements. For consumer use, some standards are prescribed by the Civil Supplies and Weights
and Measures Departments or by similar agencies.

Productivity

Productivity refers to the physical relation between the quality produced (output) and the quantity of
resource used in the course of production (input)

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Output implies production while input means land, labour, capital, management etc., Productivity
measures the efficiency of the production system. Higher productivity means producing more from a
given amount of input or producing a given amount with minimum level of inputs.

In other words the more the output from one worker or one machine (or a piece of equipment) per day
per shift, the higher is the productivity. Higher productivity is not to be taken in sense of higher
workloads or faster machines alone but it is always elimination of waste of all type of labour (time and
skill) machine time, capital and material management etc.

Productivity = Output per unit of input

Productivity and production are two different terms. Productivity is a relative term indicating the ratio
between total output and the total inputs used therein on the other hand production is an absolute
concept, which refers to the volume of output. The volume of production may increase but productivity
may decline due to inefficient use of resource. Efficient use of input may increase productivity but the
volume of production may not increase. Production refers to the end result of production system whereas
productivity reflects its efficiency.

Significance

Benefits derived from higher productivity are as follows:

(i) It helps to cut down cost per unit and thereby improve the profits.
(ii) Gains from productivity can be transferred to the consumers in from of lower priced products or
better quality products.
(iii) These gains can also be shared with workers or employees by paying them at higher rate.
(iv) A more productive entrepreneur can have better chances to exploit export opportunities.
(v) It would generate more employment opportunities.

Measurement of Productivity

Productivity may be measured either on aggregate bases or on individual basis, which are called total
and partial productivity respectively.

This index measures the efficiency in the use of all the resources.

Partial productivity indices, depending upon factors used, it measures the efficacy of individual factor of
production. Following are productivity indices for individual inputs.

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Factors Influencing Productivity

Productivity is outcome of several interrelated factors, which may broadly be divided into two
categories- human factors and technological factors.

(a) Human Factors: Human nature and human behaviour are the most significant determinants of
productivity. Human factors include both their ability as well as their willingness:

(i) Ability to work: Productivity of an organisation depends upon the competence and caliber
of its people-both workers and managers. Ability to work is governed by education,
training, experience, aptitude, etc. of the employees.

(ii) Willingness to work: Motivation and morale of people are very important factors that
determine productivity. These are affected by wage incentive schemes, labour
participation in management, communication systems, informal group relations,
promotion policy, union management relations, quality of leadership, working hours,
sanitation, ventilation, subsidized canteen company transport, etc.

(b) Technological Factors: Technological factors exert significant influence on the level of
productivity. These include the following:

(i) Size and capacity of plant

(ii) Product design and standardization
(iii) Timely supply of materials and fuel
(iv) Rationalisation and automation measures
(v) Repairs and maintenance
(vi) Production planning and control
(vii) Plant layout and location
(viii) Materials handling system
(ix) Inspection and quality control
(x) Machinery and equipment used
(xi) Research and development
(xii) Inventory control

(c) Managerial Factors: The competence and attitudes of managers have an important bearing on
productivity. In many organisations, productivity is low despite latest technology and trained
manpower. This is due to inefficient and indifferent management. Competent and dedicated

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 managers can obtain extraordinary results from ordinary people. Job performance of employees
depends on their ability and willingness to work. Management is the catalyst to create both.
Advanced technology requires knowledgeable workers who in turn work productively under
professionally qualified managers. No ideology can win a greater output with less effort. It is
only through sound management that optimum utilization of human and technical resources can
be secured.

(d) Natural Factors: Natural factors such as physical, geographical and climate conditions exert
considerable influence on productivity, particularly in extreme climates (too cold or too hot)
tends to be comparatively low, Natural resources like water, fuel and minerals influence
productivity.

(e) Sociological Factors: Social customs, traditions and institutions influence attitudes towards
work and job. For instance, bias on the basis of caste, religion, etc., inhibited the growth of
modern industry in some countries. The joint family system affected incentive to work hard in
India. Close ties with land and native place hampered stability and discipline among industrial
labour.

(f) Political Factors: Law and order, stability of Government, harmony between States, etc. are
essential for high productivity in industries Taxation policies of the Government influence
willingness to work, capital formation, modernization and expansion of plants etc. Industrial
policy affects the size, and capacity of plants. Tariff policies influence competition. Elimination
of sick and inefficient units also helps to improve productivity.

(g) Economic Factors: Size of the market, banking and credit facilities, transport and
communication systems, etc. is important factors influencing productivity.

Environmental Analysis

Business environment may be defined as all those conditions and forces external to a business unit under
which it operates. These forces include customers, creditors, competitors, suppliers, government, social-
cultural organisations, political parties, international organisations, etc. Some of these forces may have
direct influence over the business firm while others may operate indirectly.

Opportunities In The Environment

Entrepreneurship does not emerge and grow spontaneously. Rather it is dependent upon several
economic, social, politic legal and other factors. An entrepreneur should understand the behaviour of
key environmental forces that have an implication on the enterprise and understand and get a grasp of
the techniques available for environmental scanning.

Sensing of environmental opportunities involves the following steps:

(a) Environmental scanning.

(b) Generation of ideas
(c) Identification of goods and services to the produced and sold.

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An overview of these steps is given below:

(a) Scanning of Environment: The word ‘scan’ means––to examine closely especially in search of
something. Scanning of environment means processes by which entrepreneurs monitor their
relevant environment to identify opportunities and threats affecting them. It also develops an
understanding of socio-culture, economic, political and other developmental factors in order to
ensure that perceived entrepreneurial opportunity is compatible with them. It helps in knowing
treads, issues and expectation from the environment changes.

(b) Generation of Ideas: While scanning of environment, an entrepreneur can take up thorough
study of different sources of business ideas to explore it. These ideas can come from talking to
friend and other, customers, brainstorming, visiting shops etc. it is mainly a conscious effort to
gather ideas from several sources with the purpose of finding a creative solution to a problem or
need of the society.

(c) Identification of Product or Service: After evaluating the various ideas received from different
sources, an entrepreneur can select the products or services for launching an entrepreneurial
venture.

The benefits of understanding the relevant environment of business are described below:

(a) Identification of Opportunities to Get First Mover Advantage: By keeping in touch with the
changes in the external environment, an enterprise can identify opportunities and find strategies
to capitalize on the opportunities at the earliest. For example if there is a change in the syllabus
for a particular class, a publishing company may bring out the revised edition at the earliest to
reap the first mover advantage.

(b) Formulation of Strategies and Policies: Environmental analysis helps in identifying threats and
opportunities in the market. These can serve as the basis of formulation of strategies to counter
threats and capitalize on opportunities in the market. Leading companies like Infosis, TCS, HUL,
Airtel, Hero Honda and ITC have engaged the services of experts to monitor trends in the
external environment. The inputs provided by the experts are used in making strategies.

(c) Tapping Useful Resources: A business gets various resources or inputs from the environment
and converts into desired goods and services for transfer to the customers. If the management of
a firm has a thorough knowledge of the external environment, it ca tap raw materials, technology
and even financial resources from the market at economical prices and at the right time.

(d) Better Performance: Proper understanding of the various elements of the external environment
is necessary to take timely action to deal with the threats and avail opportunities for the purpose
of improvement in performance of the firm.

(e) Sensitisation of Entrepreneurs to Cope up with Rapid Changes: A keen watch on the trends
in environment would help to sensitise the entrepreneur to the changing technology, competition,
government policies and changing needs of the customers. For example, Reliance Industries has

60
 always kept pace with the external environment and formulated strategies to avail opportunities
in emerging hi-tech areas.

(f) Image Building: If a firm is sensitive to the external environment, it will come out with new
products and services to meet the requirements of the customers. This would build the image or
reputation of the firm in the eyes of the customers and the general public. Because of sensitivity
to India consumers’ requirements, Samsung has been able to enhance its brand image in the
Indian market in a short span of time.

Analysis Of Environment

Environment analysis is the process of monitoring the economic and non-economic environment to
determine the opportunities for and threats to an enterprise. Such an analysis involves data collection,
information processing and forecasting to provide a rational basis for developing goals and strategic of
business can set his future direction only when he has visualized and perceived the opportunities and
constraints that lie ahead. Environmental analysis would enables the entrepreneur to predict future
developments and take timely actions to make a constructive use of these developments.

Environment scanning is crucial for spotting a business opportunity, identification of product or service
to the produced and in raising resources for launching the project. There is an interface between spotting
an opportunity and translating it into a sustainable and profitable project as shown below:

Fig.: Opportunity Project Interface

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Environmental Factors (Elements Of Environment)

Entrepreneurship environment refers to the various forces within which various small, medium and large
enterprises operate.

EXHIBIT: Business Environment at a Glance

1. Economic Nature of economic system, structural anatomy of economy, role of

government policies, the nature of factor endowment and markets.

2. Social-cultural Changing role of consumers, conduct of business, marketers and

social-cultural behaviour.

3. Political-Legal Stability of government, laws, judiciary and politics, consumer and

environmental protection.

4. Technological Technology and Ecology, Information Technology, Inventions, etc.

5. Physical/Natural Environmental concerns, natural resources, effect of improper

handling of natural resources and environment, Ecology and
Technology.

6. Historical Historical heritage.

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 Fig.: Environmental Forces Affecting Entrepreneurship

Economic Environment

Economic environment refers to the nature of economy (capitalist, socialist or mixed), economic
policies of the government, markets for material, labour, capital, etc., business firms and institutions
such as banks, insurance companies, transport companies, etc., and level of income of the people.

The economic environment is greatly influenced by the government through fiscal policies, economic
controls, industrial policy and import-export policy. For instance, if the government announces a cut in
the excise duty on the sales of business firms manufacturing air conditioners will go up. Similarly, if the
government allows liberal finance to export-oriented units at concessional rates, such units will get a
boost.

Politico-Legal Environment

(a) Political Environment: The viability of a business depends upon the ability with which it can
meet the challenges arising out of the political environment. The political environment of a
country is influenced by political parties, political stability, Government’s intervention in
business, constitutional provisions affecting business, foreign policy, etc. All these factors have a
bearing on business.

(b) Legal-Regulatory Environment: Legal regulatory environment of business is determined by

the constitutional provisions, economic laws, commercial laws, industrial and labour laws,
government regulations under various laws and court decisions. These help the government in
the regulation of economic is centrally planned and controlled, the business enterprises are
required to operate within the framework of legal-regulatory environment.

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Technological Environment

Technological environment refers to the state of technology in the areas of manufacturing, mining,
construction, materials handling, transportation, etc. and also information technology. Advancement in
technology leads to greater productivity, higher quality and lower cost of production for the business.

Historical Environment

The historical heritage of the country also influences the current environment of business. The business
environment in a number of newly independent nations has been largely determined by the colonial
status which those countries enjoyed earlier. The French Revolution had much to do with the emergence
of capitalist spirit of business and investment. World War I and the Soviet Revolution provided a
perspective to realize the ambition of a State-owned and controlled business system.

Physical Environment

Physical and geographical factors can play a predominant role in constituting the non-economic
environment and thereby affecting the business. The application of modern technology in industry leads
to rapid economic growth at a huge social cost––deterioration of the physical environment arounds us,
i.e. air pollution, noise pollution, water pollution, so on and so forth. The nature of such costs is being
assessed by biologists, ecologists, sociologists and conservationists. In the light of this, much talk is
there about the social responsibilities of business. Business now has to calculate social net profitability
(social benefit minus social cost) of its ventures. In this calculation, business must consider the physical
environmental factors such as the quantity and quality of existing forest wealth, possibility of artificial
rain, the exploitation of seas products like fish, the health hazards out of pollution, etc.

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 LESSON 6
MANAGING BUSINESS GROWTH
Vipin Kumar

Meaning Of Business Growth

Generally, the term ‘business growth’ is used to convey various thing such as rise in the total sales
volume per annum, an increase in the production capacity, an increase in physical output, an increase in
capital employed, an increase in employment and an increase in raw materials and power used. These
factors are in fact, indicators of growth. They do not provide a specific meaning of growth. Business
growth means an increase in scale of operations and resources of a firm usually accompanied by
increase in its size.

Some people use the terms ‘growth’ and ‘size’ interchangeably. But these terms are not identical.
Increase in size does not always mean growth. In fact, size is ones of the outcomes of growth. For
example, if an industrial firm with 1000 employees adds another 100 employees to its work-force, it
does not mean that the firm has necessarily grown. There may not be any increase in production because
of decrease in the productivity of the workers due to certain reasons. However, if the new employees are
placed in some new types of operations on new machinery and equipment resulting in higher production,
it can be concluded that some growth has occurred. It may be noted that it is easy to measure the size of
a business firm. The indicators of size may also be used as indicators of growth after careful analysis of
the given facts and figures about the change in the scale of operations and resources of a firm.

Stages of Growth

Business is an organ of growth. Every entrepreneur likes to see his enterprise grow in terms of sale and
revenue. This exemplified by the Four State Growth Model which highlight the stages under which an
entrepreneur has to move in order to grow and develop. These stages are:
(i) Pre-start up stage.
(ii) Start up stage.
(iii) Early growth stage.
(iv) Later growth stage.

An entrepreneur may make a humble beginning with a comparatively small enterprise. Small enterprises
are, however, vulnerable to even mild changes in the environment, change in people’s tastes, in
government policies, in fashions and in style of living-anything can affect a small and fledging
enterprise. Even well-managed units, in due course, may hit a crisis point and even face closure. Scarcity
of raw materials availability of substitutes in the market, obsolete technology or sheer lack of vision––
any of these may pose a threat to an enterprise. Sustainability, therefore, becomes a crucial managerial
function for an entrepreneur.

The analogy of birth of a child can be used to explain the problems involved in launching or floating a
new business enterprise. The person who has a business idea and takes steps to implement it is known as
an entrepreneur or a promoter. The entrepreneur has to act both as a mother and mid-wife because it is
he who faces various difficulties to bring the new enterprise into existence and brings it up into a
successful venture. That is why, business is also called a venture. The entrepreneur assembles and

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coordinates various factors of production, namely, human resources, machines, capital and materials to
start a new enterprise and keep in running. The ultimate success of a business depends upon the
entrepreneur’s skills to manage various problems with which he is confronted while starting a new
enterprise.

During the early growth stage, an entrepreneur concentrate on increasing the production and sale of
existing products. He will try to achieve efficiency, reduce cost of production and take steps to win new
customers and enter new markets. But at the later growth stage, the entrepreneur may go in for
modernization, expansion and diversification. Creativity and innovation will play a key role in growth
and expansion.

After the entrepreneur reaches the take off stage, where will he starts-earning reasonable profits, he will
like to consolidate the gains and maintain momentum for a period of 3 to 5 years. Consolidation stage is
very crucial as environment like changes in government policies, and tastes and preferences of
consumers, rise in the price of materials and rise in competition in the market. However, the stage of
consolidation cannot continue indefinitely. If it does, other entrepreneur in the field will increase the
competition and it may prove disastrous. So, after consolidating the enterprise, continuous efforts should
be made in increase the momentum to achieve growth. This stage of growth and development is
characterised by extending the range or replacing models and seeking new market opportunities.
Creativity and innovation play a key role throughout and strategies for expansion will rely on the
creative inputs that the entrepreneur can generate.

Need For Growth

As we have already said that business enterprise is like a human being, growth is a necessary stimulant
to most of the business firms. As a matter of fact, growth is precondition for the survival of a business
firm. An enterprise that does not grow may, in course of time have to be closed down because of its
obsolete products. The market is full of examples of very popular products disappearing from the scene
for lack of growth plans. For example, pagers vanished from the market because better technology
product i.e. cell phone were introduced. The reasons which drive business enterprises toward growth are
described below:

(a) Survival: In a competitive market no single enterprise can have monopoly. The competition can
be direct or indirect. Direct competition comes from other firms manufacturing the same product.
For example, there are many brands of shampoos available in the market. To survive the
competition the manufacturer of each brand of shampoo has to continuously bring new versions
of basic product to maintain an edge over his competitors. Indirect competition may come from
availability of cheaper substitutes. For example, the khadi industry faced a problem when
polyester emerged. Severe competition forces a firm to grow and gain competitive strength. Any
business firm that fails to grow can’t survive for long. A growing concern will be an innovator
and can easily face the risk of competition. Thus growth is means of survival in a competitive
and challenging environment.

(b) Economics of Scale: Growth of a firm may provide several economies in production,
purchasing, marketing, finance, management etc. A growing firm enjoys the advantages of bulk
purchase of materials, increased bargaining power, spreading of overheads, expert management

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 etc. this leads to low cost of production and higher margin of profit. This also ensures full
utilisation of plant capacity.

(c) Owner Mandate: The owners of a company get the ultimate benefit of growth in the form of
higher profits. They may direct the management to reinvest a substantial portion of the earnings
in the business rather than paying them out. Capable management may on its own like to take
carefully calculated risk and expand the size of the company.

(d) Expansion of the Market: Increase in demand for goods and services leads business firms to
increase the supply also. Population explosion and transportation led to increase in the size of
markets which in turn resulted in mass production. Business firms grow to meet the increasing
demand. Expanding market provide opportunity for business growth.

(e) Latest Technology: Some business firms invest in research and development activities to create
new products and new techniques, while other try to acquire latest technology from the market.
Rationalisation and automation results in more efficient use of resources and a firm may grow to
obtain them.

(f) Prestige and Power: The more the size of the business firm increase the more is the prestige and
power of the firm. Businessmen satisfy their urge for power by increasing the size of their
business firm.

(g) Government Policy: In a planned economy like India, business firms operate under a large
number of rules and restrictions. A big firm is in a better position to carry out the various legal
formalities required to obtain licenses and quotas. Business firms may plan for growth to make
use of the incentives provided by the government. The government provides certain subsidies
and tax concessions to the new industrial units in the backward areas and those producing goods
for export only.

(h) Self-sufficiency: Some firms grow the become self-sufficient in terms of marketing of raw
material or marketing of products. Growth in either or both of these forms reduces the
dependency of the firm over other firms.

Advantages of Growth

Business firms try to achieve growth in order to obtain the following advantages:

(i) For obtaining the economies of scale.

(ii) For exploitation of business opportunities.
(iii) For facing competition in the market by diversifying the product line.
(iv) For providing protection against adverse business conditions eg. Depression.
(v) For gaining economic and market power.
(vi) For raising profits and creating resources for further reinvestment into business.
(vii) For making optimum utilisation of resources.
(viii) For securing subsidies, tax concessions and other incentives offered by the government.

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Limitation of Growth

Business firms cannot grow indefinitely. Growth has its own limitations which are:

(a) Finance: Growth, especially external growth, requires additional capital investment which is
sometimes difficult for a small firm to arrange.

(b) Market: Growth can be achieved to the extent that the size of market permits. If a firm grows
faster than increase in the size of the market, it is likely to face failure.

(c) Human Relations Problems: In a big firm, management loses personal touch with employees
and customers. Motivation and morale tend to be low resulting in inefficiency.

(d) Management: Growth increases the functions and complexities of operations. As the number of
functions and departments increase, coordination and control become very difficult. If the
organisation and management structure is not capable of accommodating them, growth may be
harmful.

(e) Lack of Knowledge: Under conglomerate growth, a firm enters new industries and new markets
about which the managers know little. Managers find it difficult to find and develop manages
who can quickly handle new units and improve their earning potential against heavy odds. Many
growing firms could not succeed because their manages felt that they could manage anything
anywhere.

(f) Social Problems: From social point of view also big firms may be undesirable as they may lead
to concentration of economic power and creation of monopolies which may exploit consumers.
In their desire for growth firms indulge in combative advertising. The quickening growth creates
a cultural gap when society finds it difficult to cope with technological change.

Forms of Growth

One an entrepreneur understand some of the factors that influence growth and development, he can
choose a suitable way for achieving it. Business growth can take place in many ways. Broadly, various
types of growth can be divided into two broad categories – organic and inorganic growth.

Organic Growth: It can also be termed as internal growth. It is growth from within. It is planned and
slow increase in the size and resources of the firm. A firm can grow internally by ploughing back of its
profits into the business every year. This leads to the growth of production and sales turnover of the
business. Internal growth may take place either through increase in the sales of existing products or by
adding new products. Internal growth is slow and involves comparatively little change in the existing
organisation structure. It can be planned and managed easily as it is slow. The ways used by the
management for internal growth include: (i) intensification; (ii) diversification and (iii) modernization.

Inorganic Growth: It can also be termed as external growth. It involves a merger of two or more
business firms. A firm may acquire another firm or firms may combine together to improve their
competitive strength. External growth has been attempted by the business houses through the two

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strategies (a) mergers and acquisitions and (b) joint ventures. Merger again can be of two types: (i) a
firm merges with other firm in the same industry having similar or related products. This type of merger
leads to coordination problem between the two firms (ii) a firm merges with another firm in altogether
different lines of business and have little common in their products or processes such a merger is known
as conglomerate merger.

Inorganic growth is fast and allows immediate utilization of acquired assets. There is no risk of
overproduction as the capacity of the industry as whole remains unchanged. Merger leads to
combination of independent units to control competition, to gain economics of scale and also sometimes,
to modernize production facilities. But merger also leads to social problem of monopoly, problem of
coordination, strain on capital structure, etc. Thus, external growth involves problem of reorganization.

Growth Strategy

Under growth strategy, an enterprise is expected to increase its level of business operations than its
immediate past. Actually, in this strategy, a firm increases its expected performance in terms of market
share, sales revenue, earnings etc. “A growth strategy is one that an enterprise pursues when it increases
its level of objectives upward in a significant level.” The basic purpose of this strategy is to achieve
higher growth by initiating growth mechanism. These mechanisms are entering new market, capturing
large share of the markets by improved product, developing products, acquiring latest technology,
acquiring better resources and inculcating professionalism in management.

Growth Strategies

Intensive Expansion Integration Merger Diversification

i) Market Penetration i) Backward Integration i) Horizontal i) Merger &
ii) Market Development ii) Forward Integration ii) Vertical Acquisition
iii) Product Development iii) Product Development iii) Conglomerate ii) Joint Venture
iv) Concentric

Features of Growth Strategy: Growth strategy entails the following features:

(i) Strategy which involves holding the relative position of the firm in a high-growth product market
areas.
(ii) Increase market share in high growth market.
(iii) Increase market share in slow growth (matured markets).
(iv) Hold strong relative position in slow growth market: use excess cash flow, funds capability and
other resources to support penetration of multi-national markets with existing product line.
(v) Hold strong relative position in a maturing market: use excess cash flow, external funds
capability and other resources to support penetration of new product market areas domestically.
(vi) Hold strong relative position in multi-national markets with present product line, use excess cash
flow, funds capability, and other resources to diversify products.
(vii) Hold strong position in diversified product line domestically, use excess cash flow, funds
capability and other resources to diversify markets.

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Rationale of Growth Strategies: Following rationale are used in favour of growth strategies:

(i) Growth company holds better public image and ables to attract professional managers.
(ii) Growth firm easily adjusts itself with the changing scenario specially in terms of opportunities
available, technological changes etc.
(iii) Growth firm motivates management for high performance by initiating higher compensation
packages and satisfying power and recognition needs.

Approaches to Growth Strategy: Following approaches are used for growth strategy:

(a) Intensive Expansion: It deals with protection and development of product market line of the
firm. It helps the firm to expand its share of market, sales volume and profit volume. Intensive
expansion is possible in three ways: (i) Markets penetration, (ii) Market development, and (iii)
Product development.

(i) Market Penetration: In this process, company assesses the scope of its present product
in the market. If it is possible for the company to increase its volumes of sales and profits
by initiating aggressive marketing efforts then it will try to improve the product quality
and design. Because, these steps enable the company to increase its following steps: (1)
including customers through mass media to buy its products more frequently and in
larger quantities, (2) attracting existing customers by providing better service and
improving brand image of the product, (3) initiating price reduction and offensive
advertising programmes to convert potential customers into real customers.

(ii) Market Development: It deals with launching of existing products in new market.
Generally, it is possible through the appointment of sales agents and dealers,
development of new channels of distribution, franchising etc. Thus, in market
development process, the firm tries to move into new geographical areas with its existing
products. However, the firm should try to incorporate some minor modifications if any in
existing products the local conditions of that particular geographical area.

(iii) Product Development: It incorporates improvements in the quality and standard of the
existing product as well as launching of new product in the market. Product development
is made possible through (1) launching of new product through research and
development, (2) product innovation, (3) increase in product brand range.

(b) Integration: A company tries to expand externally. It is a growth strategy “wherein new
products or services are added which are complementary to the existing product or service line. It
is characterised by the extension of the firm’s business definition in two possible directions from
the present backward and forward. It is generally motivated by taking into account the growth
and survival possibilities. It is of two types:

(i) Backward Integration: It is the creation of facilities for production of raw materials and
components to ensure smooth current production behaviour. It is setting up of facilities

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 for the production of raw materials and components required for the current operation of
the firm.

(ii) Forward Integration: It is the creation of facilities for manufacturing products for which
current products as inputs for manufacture of another product of the same organisation.

(c) Merger: A merger is a combination of two or more business in which one acquires the assets
and liabilities of the other in exchange for cash, stock or both are companies dissolved and assets
and liabilities are combined and new equity shares are issued. According to Prof. L.H. Haney, it
is a form of business organisation which is established by outright purchase of the properties of
constituents, organisations and the merger is the result of forming new company by
amalgamating two or more existing companies or by absorbing one business enterprise by
another unit.

Types of Mergers: Major types of mergers are as follows:

(i) Horizontal Merger: It involves merger of two firms operating and competing in the same kind
of business activity. Its main intension is to avail benefit of economies of scale.

(ii) Vertical Merger: It occurs between firms who are in different stages of production operation.
This type of merger takes place when two or more firms are engaged in complementary
production bases. The rationale rests primarily on the costliness of market exchange and
contracting.

(iii) Conglomerate Merger: It involves firms engaged in unrelated type of business activities.
Conglomerate mergers are possible mainly on three lines: (1) Product-extension mergers broaden
the product lines of firms; these are mergers between firms in related business activities and may
also be called concentric mergers. (2) A geographic market extension merger involves two firms
whose operations have been conducted in non-overlapping geographic areas. (c) The other
conglomerate mergers which are often referred to as pure conglomerate mergers involve
unrelated business activities.

(iv) Concentric Merger: It involves combination of two or more firms which are related to each
other in terms of customer functions, customer groups or technology. For example, combination
of shoe company with a hosiery firm engaged in production of socks.

d) Diversification: It is a mode of business expansion. It involves addition of units that produce

different products that can be distributed through the same channel. Under this process a firm
switches over to new products and markets rather than continuing with the existing ones only.
Diversification can be achieved in there different ways.

(i) A firm can diversify internally by using standard organisation or new venture
organisation.
(ii) It can diversify through ventures or by forming mergers or amalgamation with other
business enterprises.
(iii) It can be achieved by forming a conglomeration.

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(i) Merger and Acquisition Process: It involves external diversification when a firm is
interested to take over another firm working in other new field or allied areas. Actually,
these are the areas where production units are adopting strategies to enter the field. These
fields are generally treated as sunrise industries. Mergers and acquisitions are the best
methods to achieve the target. Actually, it is possible for the firm to use securities in
obtaining other companies whereas it might not be able to finance the acquisition of
equivalent assets and capabilities internally.

(ii) Joint Venture: It involves mutual cooperation of two independent firms who are
interested to participate in a business venture. “Joint ventures are a special case of
consolidation where two or more companies form a temporary partnership for a specified
purpose.” In practice, and also allows to defend the strategic posture jointly against forces
which could be difficult to defend individually.

Basically, in joint venture, participants continue to exist as separate firms with a joint
venture representing a newly created business enterprise. The joint ventures are usually
described as having the following characteristics: (1) contribution by partners of money,
property, effort, knowledge, skill or other asset, to a common undertaking, (2) joint
property interest in the subject-matter of the ventures, (3) right of mutual control or
management of the enterprise, (4) expectation of profit or presence of adventure, (5) right
to share in profit, (6) usual limitation of the objective to a single undertaking or adhoc
enterprise.

Rationale for Joint ventures: Following are the main rationale for joint ventures:
(1) To augment insufficient financial or technical ability to enter a particular line of
business.
(2) To share technology and/or generic management services in organisation planning
and control.
(3) To diversify risk.
(4) To obtain distribution channel or raw material supply.
(5) To achieve economies of scale.
(6) To extend activities with similar investment that is done independently.
(7) To take advantage of favourable tax treatment or political incentives (particularly
in foreign ventures).

(iii) Conglomeration: It is another technique to diversity in other areas. Diversification

activities related with product extension and market extension are included in
conglomerate diversification process. The motivation on the part of the diversifying or
acquiring firm is in expectation that it has or will have excess capacity of general
managerial capabilities in relation to its existing product, market activities or
technological capabilities. It may also enable the firm to develop industry specific
managerial experience and firm specific organisation capital over time.

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