UNIT 1: MEANING AND THE OVER-VIEW OF BUSINESS

Content
1.0 Objectives and Aims
1.1 Introduction
0 1.2 Definition of Business
1 1.3 Characteristics of Business
2 1.3.1. Dealing with Goods and Services
3 1.3.2. Sales, Transfer and Exchange of Values
4 1.3.3. Recurrence of Dealing
5 1.3.4. Profit Motive
6 1.3.5. Element of Risk
7 1.4. Classifications of Business
8 1.4.1. Industry
9 1.4.2. Commerce
1.5. Business Environment
10 1.5.1. Internal Factors
11 1.5.2. External Factors
12 1.6. Business Ethics and Social Responsibilities
13 1.6.1. Business Ethics
14 1.6.2. Social Responsibility
15 1.6.3. Ethics and Social Responsibility in Business
16 1.6.4. Views of Social Responsibilities
17 1.6.5. Determinants of Ethical Standards and Practices
18 1.7. Major points for the success of a modern Business
19 1.8. Qualities of a Good Business person
20 1.9 Summary

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 21 1.10 Answers for Check Your Progress Questions

1.0 AIMS AND OBJECTIVES

The main purpose of this lesson is to introduce students with the meaning and definition of
business. In this unit, you will study about the different characteristics, types and classification
of business. Further more, you will look at the general business environment that influences
the operation and success of any business organization. We also discuss the terms ethics and
social responsibilities that study how the standards of moral conduct among individuals are
classified and expressed behaviorally.
At the end of this unit you are expected to:
 clearly define business;
 know the main characteristics of business
 identify the major classification of business and commerce
 understand the business ethics and social responsibilities of a business;
 know the main parts that affect a business in a certain environment
 specify the important qualities of a business person.

1.1 INTRODUCTION

In order to survive themselves, all human beings can involve into two major activities;
economic activities and non-economic activities. The economic activities involve in the
production and distribution of material wealth for the purpose of making profit or earning
return in terms of money. On the other hand, the non-economic activities are activities that
are not involved in the production of material wealth and people do these activities for non-
profit purpose. Example, Religious organizations, Research institutes, Charity organizations etc.
These organizations engage in non-economic activities where their main priorities or motives
are to help others.

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All human beings have some basic needs: things that they must consume to survive. In
addition to these basic needs, there are many things that people wants to make their lives
more comfortable and satisfying. The work that every person performs is there fore, related
directly or indirectly to the satisfaction of these needs and wants.
Business is one of the economic activities where people engage in to benefit themselves and
others (customers) with the main purpose of generating profit or return. A business function is
the process of putting of different resources such as time, effort, skill, knowledge, capital, etc.
to produce goods or services. Therefore, a businessperson should know how to create a
business that could stay for long with the satisfaction of the need and want of customers.
1.2. DEFINITION OF BUSINESS
Business is an economic activity and a continuous process of identifying and satisfying the
demand (willing and able users) need and want of customers by providing goods and services
with the main aim of making profit.
So from the above definition we could take out the following basic points: -
-Business is an economic activity
-A Continuous process
- Satisfies needs and wants.
- Provides goods and services
-Its main goal is to make profit.
1.3 CHARACTERISTICS OF BUSINESS
As it was pointed out in the above definition, business has some unique characteristics of its
own.
It has five basic characteristics that are going to be discussed.
1.3.1 Providing (dealing) with goods and services
A business has to produce or give service to others by way of adding utility. Utility refers to the
characteristics of a good or service in terms of giving value (satisfaction) to customers.

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So business not only provides goods and services but it should provide something that satisfies
customers. Through the provision of a product or service a business deals in satisfying four
types of utilities.
0 Form utility-
utility- Changing of the shape and character of a raw material into a value
added product. Example cotton in to cloth, sugarcane in to sugar. Manufacturing companies
creates form utility.
1 Time utility-
utility- Making the product produced or the service to reach users at the
right time or when it is required by customers. Time utility answers the question of when
consumers obtain the product or service. Warehousing companies create time utility
2 Place utility- Providing of a good or service to the right place where customers
fount it /putting it where it is needed/. i.e making goods available to the place of the
consumers. Transporting company creates place utility.
3 Possession utility-
utility- it is the process of selling goods or services to front line users
(customers). It is an exchange process between buyers and sellers and involves in the transfer
of title from seller to the buyer.
To support the above, take a look at this example: Eat-Fruit Co. produces different types of
vegetables (form utility) and using its own transport it provides the fruit at the right time and
place i.e. to fruit eaters in Addis (time and place utility) and using its distribution methods (out
lets) it sells its product to customers (possession utility)
1.3.2 Sale, Transfer and Exchange of values
In any business there are two or more persons who exchange goods and services and they are
referred to as buyers and sellers. So making of ‘Doro Wot’ for personal consumption is not a
business activity unless soled to another person on a continuous base.
And when transferring and selling, a businessperson should identify the need and want of
customers so as to satisfy them.
. Need is a general desire. Eg. Hunger, thirst etc

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. Want is a specific need. Eg. Want for water or cock or alcoholic drink
1.3.3 Recurrence of Dealings-
Dealings- business is not a one-time activity; it should be a continuous
process. For example if I sell my watch to you, it is not a business activity since it has been
done only ones. Instead business is a regular and continuous activity whereby business people
do it on a repeated way. So selling of a car to a friend is not a business activity.
1.3.4 Profit motive-
motive- the main motive or purpose of business is to get profit since it is an
economic activity -NGO’s (Non-Governmental Organization), religious organizations or a
person drawing (pointing) pictures for his/her own satisfactions are involved in a non-
economic activities and hence are not regarded as business. But through this profit the activity
that the business does should be in harmony (balance) with customers and society i.e the
activates should be ethical and socially responsible.
1.3.5 Element of Risk-
Risk- to set up a business, one should invest either in cash or item. As an
investor, people should realize that there is a probability of losing this investment through
natural or artificial events.
A business might get bankrupt (loss), products might get damaged, burned etc. So a
businessperson should make a calculated risk in at least minimizing the unforeseen events that
may occur. For example one could insure (buy an insurance policy) for the fixed assets of the
company (business) in order to secure and get the damaged or lost items through the
insurance policy.
So as discussed above some of the major characteristics of business are: -
-it deals in the provision of goods and services
-it sales, transfers and exchanges goods and services that satisfy the need and
want of customers.
-it is a continuous process (business has a recurrence of dealing)
-the main purpose of business is getting profit by being ethical and socially
responsible

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 -any business has an element of risk.
1.4 CLASSIFICATIONS OF BUSINESS
In the previous discussions, we have seen the definition of business and its unique
characteristics. In the following discussion we will see the main classification of business.
Generally business could engage in the making or producing of goods and the distribution
(provision) of these goods and services to customers. Individuals or businesspersons who
produce or make goods (tangible products) are called producers (Manufacturers). And those
businesspersons who distribute the produced materials from the center of production to the
center of consumption are called commercial people.
1.4.1 Industry-
Industry- is a productive firm concerned with a particular business dealing with tangible
products or other service giving businesses. Under this context, we can also define industries
as part of a business activity, which concerns itself with the raising, producing, processing or
fabricating of products.
An industry may produce final products that are ready to be used by ultimate customers
(finished goods) such as shoes, automobiles etc. These goods are known as consumer goods.
Industrial goods are goods that are going to be used in the production of other goods. For
example Sulfuric Acid produced by ‘Awash Melkesa’ is used to process many industrial goods
such as textiles, plastics etc. And if products need further processing by another industry, the
type of industries that do this kind of activity are referred as intermediary good receiving
industries. For example iron (steel) or aluminum from steel industry could be processed by an
airplane industry to which materials are referred as intermediate goods. So to summarize the
difference between the three types of industrial goods;
4 Consumers goods- used by final consumers as they are
Eg. Soaps, bread, cloth, sugar, etc.
5 Industrial goods-need further production or are used in the production of other
goods.

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 Eg. Chemicals that are used as an input to produce another item such as, the different parts of
a car to be assembled together to have the final good (car)
6 Intermediate goods (semi-finished good) are goods that require further
processing or need to be converted to a finished goods.
Eg. Plastics or Aluminum that are further processed to come up with a value added good
Types of Industries
We have defined industry in a broad way above. We will also see the types or classifications of
industry based on the type of products (goods) they produce as follows.
Extractive Industry-
Industry- it is the discovery and utilization of natural resources from the earth, air
or water. It is also referred to as a primary activity under Geography study. Farming, mining,
fishing etc. are examples of extractive industry.
Genetic industry-
industry- this type of industry engages in producing and multiplying of certain animals
and plant species for profit. Plant and cattle breading, fish culturing, or cross breeding of cattle
of Ethiopia with European or Western cattle to have better productivity is an example of this
industry.
Construction industry-
industry- involves in the construction (building) of roads, dams, high ways etc.
They are erected, built or fabricated at a fixed site. For example a person building a ten-story
building might rent it to some one to get profit out of it. By this sense construction industry is
regarded as a business activity.
Manufacturing industry-
industry- concerns in the conversion or transformation of raw materials or
semi-finished goods into a finished product. Manufacturing industry takes an input, process
this input to come up with a value added output. For example raw cotton is taken as an input
by a textile industry and processed in the industry through different stages to come up with a
shirt skirt etc.
Based on the activities carried out, manufacturing industries divided into the following
categories.

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 A. Analytical industry-
industry- to analyze means to break down. This type of manufacturing industry
changes one product to different products. That is to say it takes out many products from one
starting material. Eg. Oil refinery through fractional distillation breaks down crud oil into
petrol, gasoline, kerosine etc. Milk could be processed into butter, cheese etc. These are good
examples of analytical industries.
B. Synthetic Industry. This is the reverse of analytical industry i.e. it gets one product from
different inputs. Eg. Mugger cement factory uses concrete, gypsum, and other inputs to
produce cement.
C. Processing industry-
industry- a certain raw material is processed at different stages to have a value
added good. Eg. Addis Tayer, Akaki Textile or Wonji sugar factories process Rubber, Cotton and
Sugarcane respectively.
D. Assembling industry-
industry- the different components of a certain good are assembled (put
together) in a physical way. Eg. Car, tractor, Television etc. factories buy their respective parts
from different producers and put them together to come up with respective goods. In Ethiopia
AMEC and Vestel Television are examples of assembly line industries. To summarize;
7 Analytical industry => one input into many eg. ‘Shola milk pasteurize’
8 Synthetic industry => Many into one eg.“Awash Melkasa’ or ‘Mugger’ cement
factory.
9 Processing industry => Processing of one major raw material
Eg. ‘Mojo’ Tannery or Akaki textile
10 Assembling industry => putting of different inputs in a physical way.
Eg. Nazret Tractor or Mesfen Engineering (or assembly)
1.4.2 Commerce
Once an industry produces a tangible products that needs to be delivered to customers. The
core duty of commercial people is to add time and place utility by providing the product
produced to where users available at the right time. Commerce engages in the exchange and

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distribution of goods and services. Commercial people use a well-organized system of
transport, insurance, warehouse etc. to facilitate the free and uninterrupted flow of goods and
services from center of production to the center of consumption.
Some of the major problems solved by commercial people are: -
0 - Finding of customers who have the capacity and willingness to buy the product
or services.
1 - Solving of problems of time, place and form of payment. They do this by
providing suitable way of making payment such as using of check, banks or credit system.
Using of the appropriate type of transportation. For example a flower to be exported to
Europe needs a fast transportation, like airplane since the product can be easily perishable
(spoiled). Problems related to packaging and proper delivery of goods could be performed
through specialized commercial people. Provision of proper storage, warehouse and after
sales service (e.g. Warranty, home delivery etc.)
COMPONENTS OF COMMERCE
As it has already defined commerce is a highly complex process, which involves the operation
of many activities that are directly related to buying and selling i.e exchange process. These
different activities may be described under two major categories. Under commercial activity,
there are groups who try to solve the core problems of commerce called traders and those
who solve the peripheral (revolving) problems of commerce are known as Aids to trade.
a. Trade.
Trade. Traders are those groups that solve the central problem of commerce by finding and
selling the product produced to willing and able buyers. Trade is the process of buying and
selling, exchanging or transferring of goods to customers.
customers
Wholesalers, retailers, agents, importers and exporters are examples of traders and they solve
the core problem of commerce by directly interacting with producers and customers.
b. Aids to trade.
trade. The word aid means support. And as the word tells us this commercial people
try to solve the various revolving problem of commerce. They don’t have a direct interaction

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with producers and customers in terms of providing the product produced but they solve
auxiliary or ancillary problem of commerce such as making payments, deposits etc through
banks or protection of assets by insurance companies. In the next part we will try to see some
of the elements included under aid to trade activities.
I. Banking-
Banking- they solve time, place and form of payment when transactions are made.
Banks as an independent unit engage in the following activities.
-Making of payments Eg. Mugger cement may write a check to its agent and this agent could
receive the money from the Bank of Mugger cement.
-Currency exchanges-different
exchanges-different countries have their own currencies and banks try to solve this
problem by providing exchange rates for different countries and making it easy for inter
country business. Eg. Changing of birr with U.S dollar.
-They make deposits; give loan, settlement of debt, selling and buying of currencies etc to
solve the peripheral problem of commerce.
II.
II. Transportation-
Transportation- provides place utility by carrying goods form producers to traders and
finally to consumers. Transport companies specializing in this area deliver products where
traders and users want them to be delivered. Eg. (Ethiopian Air Lines) gives this service to
different exporters by transporting animal products, Fruits and vegetables at the right time
and place before they are spoiled (lose their original form).
III. Insurance-
Insurance- One of the characteristics of business is risk. And the main duty of insurance
companies is to safeguard business assets through insurance policy. Whatever it is, a
production company or goods in transit need to have insurance to overcome the events of
unforeseen circumstances. Eg. The purchase of insurance policy by ‘Kombolcha’ textile factory
has enabled it to cover the lose that may happen by fire accident.
IV. Packaging-
Packaging- Packing is the process of putting things together in a proper container so that
breakage, leakage, shrinkage and spoilage can be avoided or minimized while goods are being
transported.

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V. Advertisement-
Advertisement- brings goods and services to the attention and knowledge of prospective
buyers. Through advertisement consumers can get better information about the availability,
usefulness, price, quality and other attributes of the products. Advertising agents try to
promote local or foreign products so that customers could purchase products.
1.5 BUSINESS ENVIRONMENT
Until now we have tried to see the definition and sub-divisions of business. In this part we will
try to explore the different factors that have impact on a certain business. A business does not
exist in a vacuum (empty space) it is affected by those forces near and far to it. Any business is
affected by internal factors such as strategy, goal of the organization, policy, structure etc.
Externally a business is affected by those forces that have a direct impact such as customers,
competitors, supplies and human recourse; and by indirect forces (PEST => political, Economic,
Socio-cultural and Technological factors).
1.5.1 Internal factors: - As mentioned earlier above the policies and objectives of a business
and the capability of the organization in terms of its financial and any other resources have
immediate impact on the performance of a business. If a company fails to use its different
resources properly, then it will have a direct implication (effect) on the performance of the
business. For example if management and employee do not have a smooth relation it will
affect the performance of the business directly.
1.5.2 External factors-
factors- these are forces that could act on two levels. There are external factors
with direct force on a business operation and factors with an indirect force on a business
performance. The next diagram briefly summarizes the factors that have impact on the
performance of business.

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 -Internal factors (organization. policy, objective, management,

-Employee, internal resources etc.)

Business environment

External Factors Direct force

(customers, competitors, suppliers
and human resources)

Political
Economic
Indirect force (PEST)
Socio-cultural
Technological
a. Direct external forces-
forces- these are forces that have a direct effect on the performance of a
business but beyond the boundaries of the business (the company).
i. Customers-
Customers- “Customer is a king”, as marketers put it. Customers are the front line users of a
certain business’s goods or services. They are the one who make a decision whether to buy or
use a product/service. So they have a direct effect on the performance of a business and the
company should have a good relation, with the understanding of the need and want of
customers.
ii.Competitors-
ii.Competitors- these are individuals or groups that produce the same or similar type of
products. A business should know the moves and counter moves of competitors (how they are
reacting) in order to satisfy customers in a better way than competitors. Market intelligence is
a key to determine the movement of competitors. Competition is not a one-way force

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(concept). A business may compete against the other firm with regard to customers,
employees, raw materials and other resources. Those competitors who produce the same or
similar type of products or services are known as intratype competitors. Eg. Bedele Beer,
Dashen Beer, Harar Beer and Meta Beer factories compete for the same resource such as
barely and for similar customers. Those competitors that are distinctly different but competing
for the same resources are known as intertype competitors. Example, the Commercial Bank of
Ethiopia and Telecommunication Corporation are competing for the same resources such as
human resource.
iii. Suppliers-
Suppliers- these are groups or individuals that provide different resources to a company.
So a business should be sure to choose a client (supplier), which is reliable and consistent in
terms of providing resources on time at a reasonable price. For example the supply of cement
is a critical (important) input for a certain person engaging in construction activity.
iv. Human resource-
resource- there is skilled and unskilled human resources to an organization. Human
resource is the most important part for the performance of a business and the business should
make sure that it has good supply of human resource. To do so an organization must attract
and keep good human resource input. Eg. By providing attractive salary, benefit, security etc.
b. Indirect external forces-
forces- these are forces that have a less degree of control than internal
and external direct forces. But a business at least should know what these indirect forces and
make the necessary adjustment using the controllable tools
Some of the indirect forces that have impact on a business are discussed as follows.
0 i. Political factors-
factors- A business should know the political situation of a country
before making investment or while in operation. Understanding and knowing of the rule,
regulations, laws, policies etc of a country is an important factor for the performance of a
business. The stability and predictability of a state is another issue that needs to be
understood by a business. For example, under Ethiopian law, foreign investors are not allowed

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to engage in financial business such as banks and insurances. So it is an opportunity for local
investors and a threat (negative thing) for investors from abroad.
1 ii. Economic factors-
factors- Different macro-economic indicators such as GDP (Gross
Domestic Product), PCI (Per-Capita Income), inflation, monitory value, employment rate etc.
give us different information as to the constraints and opportunities of a country. For example
the per-Capital income of Ethiopia is $100 while the PCI of Switzerland is between $ 30,000
and $35,000. This by itself gives information to a businessperson as to what type of
product/service to produce to individuals of Ethiopia or Switzerland. Therefore business
organizations should monitor changes in different macro-economic indicators to minimize
possible external threats and capitalize on opportunities.
2 iii. Cultural and social environment-
environment- culture is like a distinct identity of one
nation from the other. It indicate life style, value system, region, language etc. of one group of
people. For example pork meat (pig meet) is totally forbidden (not allowed to be eaten) by
Orthodox and Hindu religion followers do not eat Muslim countries or any animal product. So
a businessperson should identify what things are allowed in one country and what is not
allowed before making any decision as to what and how to market a product or service. Also
different countries have a number of social groups with different income level and way of life.
So a businessperson should know which social group(s) are his/her target groups to sell the
product.
3 iv.
iv. Technological factors-
factors- different countries have different level of technological
development and adaptation. For instance, using of a highly computerized technology in poor
country’s like Ethiopia might be a poor calculated investment and an existing business also
needs to update itself with changing technological developments. For instance, opening a
typewriter producing company (business) is an outdated (obsolete) type of activity. Therefore
any business must keep abreast of the latest developments in technology and incorporate
them as the situation demands so as to stay competitive in this volatile environment.

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So to summarize, a business can have different internal and external strengths, weaknesses,
opportunities and threats and the business should keep a good sense of the changing
environment and adopt itself to this changing environment accordingly.
Political

Customers

Business org.
(Internal factors)
Competitors
eg. Marketing
Economical mixes Human
Resource Technological

Suppliers

Socio-cultural

1.6 BUSINESS ETHICS AND SOCIAL RESPONSIBILITIES

We have seen that as long as a business exists in a certain environment, it should know and
take the necessary measure to have an opportunity and to solve the possible threats.
When a business exists in a certain environment it should have ethical standard towards those
which it is serving and be responsible in the society it exists.
1.6.1 Business Ethics

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Ethics is a word with a Greek root ‘ethos’ meaning standard, belief or character. Like wise a
business needs to have an ethical ground to the customers it is serving, create a fair
competition with competitors and guide itself under the legal frame work in which it exists.
Business Ethics is a micro-level issue that studies the principles and values, which guides a
business individual in making responsible choices in relation to the possibilities set out by
economics and business. In a rather simple expression, business ethics is about honesty, trust,
respect and fairness in all business dealings. For example selling of an expired product to
customers, giving of a wrong information in advertisement, not abiding one self in a legal
frame work and the like are some of the unethical activities done by business people.
1.6.2 Social Responsibility-
Responsibility- It is a macro level issue that goes one-step forward to think about
the well being of society or issues such as pollution, discrimination, poverty and
unemployment are the moral conducts expected from business individuals.
For example, a business person giving money or donation to poverty stricken individuals or
planting of trees to keep the environment or creating equal opportunity in the business or
affirmative action for minorities are examples of socially responsible activities.
1.6.3. Ethics and Social Responsibility in Business
The terms of ethics and social responsibility refer to value-oriented decisions and behavior. As
it has been explained earlier, the word ethics comes from the Greek root ‘ethos’ meaning
character guiding beliefs, standards, or ideals that pervade a group, a community, and people.
Today, ethics is the study of moral behavior, the study of how the standards of moral conduct
among individuals are classified and expressed behaviorally. Business ethics is the study of the
principles and values, which guide us in making responsible choices in relation to the
possibilities, set out by economics and business. In simple expression, Terms such as business
ethics, corporate ethics, medical ethics, or legal ethics are used to indicate the particular areas
of application. But to have meaning, the ethics involved in each must still refer to the value-
oriented decisions and behavior of individuals.

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Social responsibility is a relatively new term. It is the moral conduct that relates to such broad
issues as environmental pollution, discrimination, poverty, unemployment, inflation, increased
poverty of minority groups, and the like would be viewed as socially irresponsible-as not
fulfilling its responsibility to society. It can make general statements that are readily accepted
by the business community, such as: safety standards in air sea travel are important.
However, there is a tendency to think of social responsibility in terms of business organizations
and to think of ethics in terms of individuals, but this is not a useful distinction. In the final
analysis, decisions are made by people and, therefore, individual mangers at some level must
assume responsibility for every corporate decision. The executive who lies about a
competitor’s product, the manufacturer who markets a highly flammable article of clothing,
the individualist who dumps pollutants into stream-all behave in an ethically irresponsible
was. The most meaningful way to distinguish business ethics from social responsibility is in
term of a decision’s implications for society as whole. Within this frame of reference, business
ethics are concerned with micro-ethics (relating operating decisions with limited social
impact); social responsibility is concerned with macro-ethics (relating to decisions with broad
implications for a large segment of society). Even this distinction is hard to maintain
consistently. For convenience in communication, the term business ethics is sometimes used
in the broad sense to include both micro-ethics and macro-ethics as expressed in profit making
organizations.
1.6.4. Views of social responsibility
There are three views of social responsibility: (1) the classical view, (1) the accountability view,
and (3) the public view.
a) The Classical view
The classical view of corporate social responsibility prevailed during the nineteenth and early
twentieth centuries. In this view, the free enterprise economy as an invisible hand is

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continually at work for the good of the public. From this perspective, the concepts of social
responsibility in terms of an objective set of ethical standards or intensity of commitment to
the welfare of others makes no sense. It is the invisible hand-the competitive system itself-
that protects the society. This is expressed as the value of capitalism.
The values of capitalism originate in the belief that when a business selfishly pursues its profit
objective while competing with other businesses, the system forces it to be efficient and to
produce the best possible product at the lowest possible price. Competition further demands
that businesses produce what people need and that they deal fairly and honestly with the
public. To do otherwise results in a loss of customers to competing company. Competition for
labor and the need for a good public image require companies to be fair in dealing with their
employees, and free competition for jobs encourages employees to be efficient and
productive.
The critics argue that if the system is allowed to operate without constraints, free competition
will destroy itself and result in monopoly.
b) The accountability view.
A small step removed from the contemporary version of the classical view is the accountability
view of social responsibility. The accountability view recognizes the virtues of a free market
and seeks to preserve them. On the other hand, it accepts the fact that business is chartered
by society and should there be accountable to it. Business should not only fulfill its
responsibility to its stockholders but should also deal equitably with others upon whom its
success is dependent. These include employees, customers, suppliers, creditors, and the
community and larger economy in which the business functions.
The accountability view of social responsibility is best expressed as each business pays its own
way and treat each of its publics with fairness and consideration.
c) The Public view

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The public view of social responsibility, also called the quality of life, is beyond mere
accountability and portrays business as partner with government, education, and other
institutions in solving society’s problems and thereby improving the quality of life for
everyone. One goal of business is to make a profit, but business is not free to pursue only
selfish goals. Business actively works at solving public problems, such as poverty,
unemployment, inflation and crime.
The public view differs from the accountability view in that the obligation of business goes
beyond paying its own way. Because society has given business the right to function and has
provided an environment favorable to profit making, business is a servant of the public and is
not private in the classical sense. The public view can be best understood from the following
discussion as to the responsibilities of business to its environmental elements.
Responsibility to the nation: in general these obligations are in relation to the fulfillment of
national needs and aspirations and implementations of national plans, policies. Businesses
should be a useful and effective instrument for the economic growth. These business
organizations should be responsible for the following points and other related importance in
contributing to the good of the nation.
Producing according to national priority, which means production and supplying goods that
are needed in the given nation.
Aiming at import substitution schemes in order to help the nation to become self-reliant and
avoid dependency on other nations.
Showing their endeavor in increasing the foreign currency earning of a country by developing
export markets.
Participating in removing inequalities of opportunities and provide a good ground to all to
work and progress.
Contributing in training and developing skilled personnel for economic growth and
development.

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 Paying special attention to the disabled and weaker sections of the society.
Respecting the laws and regulations of the nation and pay taxes regularly and honestly.
Responsibility to the community: Here the emphasis will be to indicate some points as to the
responsibility of business organization in the community or specific area where they carry their
activates. Business, as most often refereed as trustees of a community, must discharge its
obligations and generally strive to enhance to goodwill community in which it operates. This is
usually manifested in one or all of the followings.
i. Contribute for improving the quality of life and welfare of the community in donating and
giving aid for improving schools, hospitals, parks, roads, and other facilities. Business also
helps the community in alleviating some social problems arising due to some problems such as
drought, flood, earthquake and other social problems.
ii. Contributing to the health and wellbeing of the community in
producing safe and non-hazardous products. Together with taking in part in voluntary
installation of anti-pollution equipment, keeping industrial wastes from being dumped in
water or released in to the air and controlling excessive noise pollution.
iii. Create opportunity for gainful employment for the citizens.
iv. To be responsible in the utilization of scarce resources economically.
0 Responsibility to the customers: As stated earlier, customer refers to person or business that
purchases the products of the company. Since customers are the foundations that determine
what business is, and keep it in existence, businesses must be responsible for the customers.
To mention some of them:
i. Supply goods and services of standard quality at the right time, right place and right time.
ii. Guard customers against the poor quality of goods, incorrect
measurements, poor after sales service, adulteration of goods, misleading advertisement and
lack of courtesy and the like.
iii. Protect the interest of customers out scarcity conditions.

20
 iv. The business should charge reasonable price.
D. Responsibility of employees or workers
Business activity is conducted through human beings that work as individual or groups. The
efficiency and success of the business heavily depends upon how the workers are managed
and handled to get their willing cooperation and to make them carry out their tasks with their
maximum ability and interest. To pinpoint some of the points.
i. Provide fair deal to employees at different levels in the from of fair
wages and other incentives.
ii. Give the opportunity for developing new skills and abilities and have
work climate in which they will grow mature and productive beings.
iii. Give an opportunity to participate in decision making.
iv. Provide job satisfaction by making the job interesting and challenging
and by reducing the unpleasantness of work.
Other than the above mentioned points, business organizations should have to be responsible
for suppliers, competitors, financial institutions, owners and other elements in the society.
1.6.5. Determinants of Ethical Standards and Practices
Unethical practices include misleading advertising, cheating customers, unfair credit practices,
overselling, failure to live up to contracts and prejudice in hiring and promotion. But there are
different views about ethical judgments among business managers. In this part of the paper,
we see different criteria to make ethical judgment.
Common practice.
practice. ‘Everybody does it’ is a common justification for questionable business
practices. This justification usually rests on a belief that failure to engage in certain practice-be
it bribery, espionage, or paying slave wages-is to place oneself at a competitive disadvantage
and thereby to court financial disaster. But since this approach has no foundation in an
absolute system of values, it often leads to unacceptable behavior and to external controls.

21
Legality.
Legality. When mangers behave in ways that society considers detrimental, laws are passed to
define correct of ethical behavior. There are many laws in many countries that regulate
business practices. But problems in implementation are also common in developing countries.
Businesses may deliberately break laws on the assumption (1) one may not get caught, (2)
one may not be convicted and (3) if one is caught and convicted, the financial gains will more
offset the losses. Therefore, the problem of reliance upon the law as a basis for ethics is that a
good part of the laws passed are not to be implemented, at least not systematically and
effectively.
Codes of ethics.
ethics. There is a need for objective standards, other than laws and government and
government regulation, to help managers make ethical decisions. When dependent solely on
the subjective standards of individual managers, ethical decisions are unpredictable and
subject to all forms of perceptual, defensive, and self-serving bias.
Most professions have dealt with the need for objective standards by developing codes of
ethics by which their members are expected to live. Notable among these are the ethical
codes of physicians, psychologist, lawyers, and certified public accountants.
Personal morality.
morality. There are many determinants of the ethical standards and practices of
managers, but single determinant is sufficient to protect individuals and society from the
consequences of unethical behavior. The one determinant most likely to lead to ethical
behavior is high personal standards of conduct-individual commitment to values respect
human rights and dignity. Managers with persona integrity and moral sensitivity are capable of
the understanding and motivation required to benefit from ethics and legal statements of
socially responsible conduct. Managers who are deficient in these qualities can be expected to
behave unethically in spite of external constraints.
Finally, the factors that influence ethical behavior are the business environment, the
organization and the individual as shown in summery under Table 1.1.
Table 1.1 Determinants of Ethical behavior

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 PERSONAL DETERMINANTS FROM DETERMINANTS FROM THE
DETERMINANTS OF WITHIN THE EXTERNAL ENVIRONMENT
ETHICAL BEHAVIOR ORGANIZATION
 Early home and community Statements of organizational Ethical climate in the
influence. philosophy. industry.
 Commitment to religious  Behavior of superiors Ethical climate in the
and/or other value within the company. government.
 systems.  Behavior of Values and ethical
 Beliefs about the role of organizational peers. expectations of the
business in society.  Nature and extent of society.
 Explicitness of personal code company.  Extent of relevant laws and
of business ethics.  Availability of a company other
 Extent of financial and other codes of ethics.  constraints.
personal needs.  Consequences of unethical Extent of prosecution and
 Maturity and resistance to an behavior. penalties for
unhealthy need to  Pressures to conform to lawbreaking.
 conform. organized norms.  Emphasis of news media on
 Excessive pressure to be unethical
productive.  behavior.

1.7 MAJOR POINTS FOR THE SUCCESS OF A MODERN BUSINESS.

As mentioned above environment is dynamic and comes with opportunities and threats. So
what are some of the requisites (conditions) to stay competitive in this volatile (fast)
environment?
In this part some of the steps that could make an organization successful are cussed.
1) Determination of objective- a business with no objective is like a ship with
no compass. Objectives give purpose and direction to a business. The objectives set by a

23
 business should be clear and achievable. Also they should be translated into short and long-
range objectives.
2) The application of the management process i.e. planning, organizing,
implementation and control.
* Planning –it gives a wise judgment of the future. As the saying goes ‘Failing to plan is
planning to fail.’ Planning is helpful to meet the unforeseen events of the future-Like objective
a business need to have short and long range plan that takes into account the resources it has
and its objective reality.
* Organization-
Organization- it is the process of co-coordinating internal recourses in an efficient and
effective way. Man, Machine and Materials should be properly combined or co-coordinated to
accomplish the task intended (to be effective) and to use recourses in an economical way (to
be efficient).
* Implementation-
Implementation- this is the practical aspect of the business where employees do the task,
which they are assigned. Motivation and good leadership are the keys to keep (move) the
work force to achieve what has been intended.
* Control- what has been planned and what has been produced at least should be compared.
Control helps to take the positive lessons and correct the mistakes done so as to be better
next time.
Quality and quantity control help to compare the capability of a business.
* Research-
Research- Research, which is a systematic search for new knowledge, helps a business to
understand the changing need and want of customers or the moves and counter moves of
competitors. One of the main reasons for many businesses to go out from market is due to
lack of adequate market research. And that is why we see duplication of effort in our country.
Hotel, taxi, Internet café, pastries are the common examples for this.
* Finance-
Finance- One of the most important asset of a company is finance. A business not only
should plan by taking into account its internal resources but it should have possible source of

24
finance. So a business must correctly estimate the financial requirement and managements for
securing its finance and sources.
* Proper location, layout and size-
size- a business should take sufficient care in the initial stage to
find out a suitable place, for locating a limit and to fix a proper size for it. For example when
setting or starting a certain beauty salon the business person should make sure that there are
enough number of customers in that area or who might use the service before starting the
business.
1.8 QUALITIES OF A GOOD BUSINESSPERSON
In the above discussion, we have tried to point out some of the important points needed to
make a business successful in general. In this part the qualities that a businessperson need to
have as an individual are going to be discussed.
* Ability to analyze situations accurately
This is the ability of a businessperson to use his/her intelligence to analyze situations. It also
includes the ability of collecting relevant and accurate information and to use them to forecast
what would happen. He/she should be able to analyze the test and feeling of customers, their
behavior to a given set of price, the impact of changes in the size of the firm are the qualities
expected from him/her in terms of analyzing situations.
* Initiative and capacity to take prompt (quick) decisions.
decisions.
“A poor decision made on time is better than a good decision made out of time.” As the
saying puts, it one of the qualities needed from a businessperson is the ability to make quick
decision on time and to be smarter than competitors.
Determination courage and perseverance
These are qualities of will, power and determination to succeed. A businessperson should keep
in mind that there is always risk in a business and he/she should think of a way to come from a
situation than trembling (panic) out of it.
* Intelligence and alertness

25
 A businessperson should be intelligent enough to make use of business opportunities when
and how they come. He/she also should be alert enough for new developments, opportunities
and threats.
* Quality of leadership and motivation
Communicating with employee of the business, creating a good relation between
management and personnel is a key quality that a businessperson needs to have. Motivating
of workers through an appropriate reward is the quality expected from a businessperson.
* Business morality and integrity
Honesty, fair dealing, good trust towards customers and moral are also the other quality of a
businessperson.
A businessperson not only should give priority to the money (profit) he/she is getting but to
honesty and integrity.
* Training and Education-
Education-
On the job training and education are important ways of developing the ability of a
businessperson. For example it is through training that a businessperson can acquaint him/her
self with computer and new technology.
* Sound practical experience-
experience-
Experience is the best teacher. A businessperson should put his/her experience of the past and
present in order to improve the future in a better way.
Check Your Progress
1. What is business for you?
_______________________________________________________________________________
2. What is an economic activity?
_______________________________________________________________________________
3. What makes business different from religious organizations?

26
_______________________________________________________________________________
Using an example of your own, try to explain the provision of different types of utilities.
_______________________________________________________________________________
Which of the following is involved in the business activity?
United Nation --------Yes/ No
Unity University College --------- Yes/ No
Buying of a computer set from a friend ---------Yes/No
4. Mention the main characteristics of business with example for each
_______________________________________________________________________________
Give an example of your own for the three types of goods produced by an industry:
_______________________________________________________________________________
What is the difference between manufacturing and construction industry?
_______________________________________________________________________________
Explain the different types of manufacturing industries
_______________________________________________________________________________
Eat fruit has its own distribution outlet of its products while Wenj sugar factory produces and
gives the responsibility of distribution to other commercial people. Which is advantageous?
Give your reason.
_______________________________________________________________________________
Mention the main divisions and sub-divisions of business.
_______________________________________________________________________________
Mention some other points that have internal influence on the business operation.
_______________________________________________________________________________
Why do multinational companies move from USA to Far eastern countries such as Vietnam
and China?

27
_______________________________________________________________________________
Mention the possible effect of one of the external factors.
_______________________________________________________________________________
How could a business have information about PEST Factors?
_______________________________________________________________________________
Give two examples for business ethics and social responsibility.
_______________________________________________________________________________
What is the difference between business ethics and social responsibility?
_______________________________________________________________________________
Mention the main types of social responsibilities.
_______________________________________________________________________________

1.9 SUMMARY

In this lesson, we have studied the meaning and definition of business and the general
classifications of human activities in to economic and non-economic activities. The economic
activities related to the production, exchange and distribution of material wealth, Non-
economic activities involve in other activities such as social, political cultural and religious
obligations. Business activity has special characteristics that differentiate it from other
activities. Business involves in dealing with goods and services for value, generating profit and
some elements of risk
Business is also classified into two broad categories: industry and commerce. Industry a part of
business activity, which concerns itself with raising, producing and processing or fabricating
tangible products. There are different types of industries such as extractive industry, Genetic
industry, construction industry and manufacturing industry. The manufacturing industry also
sub-divided into analytical industry, synthetic industry processing industry and assembly line
industries.

28
On the other hand, commerce is the other category of business, which is concerned with the
exchange, and distribution of goods and services. Trade and aids to trade are components of
business that facilitate the buying and selling process. Business operation is influenced buy
internal and external environments. External factors include customers, competitors,
suppliers, technology, economy, social and cultural environments.

Human Beings

Non-Economic Economic

Business

Industry Commerce

Trade Aid to trade

Genetic Manufacturing Construction Extractive

Processing Analytical Synthetic Assembly

1.10 ANSWER FOR CHECK YOUR PROGRESS

29
 (2) An economic activity is an activity where people engage them selves for the purpose of
getting something in returns profit in the case of business.
(3) Business aims in getting profit and it is an economic activity. A religious organization main
motive is not profiting but to help and teach others. It is a non- economic activity.
(5) I) No ii) Yes iii) No
(8) Manufacturing industry changes a certain input by adding, removing or modifying it to a
value added good in a certain specific site. Construction industry is on activity of building up
different infrastructures fuel or dam, highways etc.
(10) It depends on the cost, choice, ability and the nature of product produced by a company.
(See distribution channel in Chapter III
(11) See Summery
(12) Internal factors may also include organizational structure, detailed budgets and programs,
relation between employee and mgt. Etc. are some other internal environments of a business.
(13) Search for cheep human resource and inputs, which are expensive in the U.S
(15) By using different spastics, researches etc.
(17) Management tries to force the future in an educated way, co-ordinate resources in an
effective and efficient way, follow the preparing lamentation of tasks and controls them.

1.11 REFERENCE

 R.K SHARM AND SHASHI K. aupta: Business Organization and Management;

Management; 1988.
 SHARMA, M Business Management,
Management, RBSA, 1996
 BACERYEE, M. Business Organization and Management,
Management, Kalyania, Pub. 1984.
 management, 5th ed, 1997.
PRAKUSH JAGDISK, Business organization and management,
 policy, 5th ed. 1995.
Buchhoiz, R. Business environment and Public policy,
 Ethics, 96/97, 8th ed. Dushkin Pub, 1996
Richard son, J. Business Ethics,

30
UNIT 2: LEGAL FORMS OF OWNERSHIP OF BUSINESS
Contents
2.0. Aims and Objectives of the Block
2.1 Introduction
2.2 Characteristics of Ideal Forms of Business Organization
2.3 Sole proprietorship
2.3.1. Advantages of sole proprietorship
2.3.2 Disadvantages of sole proprietorship
2.4 Partnership
2.4.1. Features of partnership
2.4.2. Types of Partnership
2.4.3. Types of Partners
2.4.4. Advantages of partnership
2.4.5 Disadvantages of partnership
2.5 Private limited company
2.5.1 Definition and nature
2.5.2 Formation of Private Limited Company
2.5.3 Management of the Company
2.5.4 Dissolution
2.6 Corporation (Joint Stock Company)
2.6.1 Nature and Characteristics
2.6.2 Classification

31
 2.6.3 Corporate Structure
2.6.4 Advantages of Corporation
2.6.5 Disadvantages of Corporation
2.7 Summary
2.8 Reference
2.0 AIMS AND OBJECTIVES
There are various legal forms of ownership of business that the businesspersons can own.
These are sole proprietorship, partnership, Private Limited Company (Corporation). The major
objectives of this session are to introduce students with the choice of the different forms of
business ownership, the characteristics of a suitable form of organization, advantages and
disadvantages of each form of business organization.
Therefore, after reading this unit, the student will be able to:
 understand the specific features of individual enterprise;
 define the different forms of business ownership;
 evaluate the advantages and disadvantages and disadvantages of different business
organizations;
 distinguish between general partnership and limited partnership
 understand the role of general partners and limited partners in the limited partnership form
of business organization;
 describe how to organize and manage PLC.
 understand special characteristics of corporate form of business
organization;
 describe the duties and responsibilities of stockholders, board of directors
and officers of the corporation;
 distinguish the difference between preferred stocks and common stocks.
2.1 INTRODUCTION

32
 Ownership of business organization may take many different legal forms, each of which carries
specific duties and responsibilities. There are four most prevalent forms of ownership of
business-named sole proprietorship (individual ownership), partnership (joint ownership),
private limited company, and corporation (stockholders ownership). All business owners must
decide which form of legal organization will best satisfy their interest and requirement. There
are certain factors that deserve due considerations in choosing the suitable form of ownership
of business.

2.2 CHARACTERISTICS OF IDEAL (SUITABLE) FORM OF BUSINESS ORGANIZATION

 Simple to establish and dissolve - The desirable form of business is the one, which can be,
organized with the least difficulty least expense and which requires minimum effort to fulfill
legal requirement. Just like organization, the ideal form of business is that which requires
minimum effort to dissolve that business. Dissolution means termination of the operation of
that business.
 The requirement of capital - Sufficient amount of fund is necessary to finance the operation
of the business. If the amount of capital required is very large, the owners must ensure the
safety of their investment, fair return on investment and the transferability of their capital.
Owners always interested in the business that will pay them the best return on their
investment,
 Less Risk (limited liability) - The businesspersons will naturally prefer to have limited
liability. They choose the organization in which they are responsible to the extent of their
investment in that business i.e limited liability. This is a legal condition under which any
damages or liability attribute to the business will not be attached to the owner’s personal
property. That means if the business become insolvent or wind up, the owners will be
responsible only up to the amount they contribute to the business. In this case, the creditors
do not have the legal right to claim the personal property of the owners if the assets of the
business could not cover the liability of the business.

33
  Relation ship between ownership and management (control) - There is a situation where
ownership of the business and management of the business are separated. That means
owners may not manage or control the operation of business. Non-owner managers may
manage the business. But a good form of business is the one, which invites a direct
relationship between ownership and control because non-owner management may not
have a direct personal interest in maximizing profit through efficient operating.
 Flexibility of Operation - This is the amount of change and adjustment of the organization with
out difficulty as the need may be. That means a good form of organization is that which is
flexible and adaptable to the changing conditions.
 Continuity and Stability - This refers to the extent to which an organization enjoys
uninterrupted existence over a long period of time. The business should be able to formulate
plans for the future so that it attracts investors and pays return on investment for
considerable period of time. Continuity is also socially desirable because if the organization is
continuous and stable, it provides a continuous employment opportunity to the member of
the society.
 Maintenance of secrecy - A good form of business organization is the one, which retains the
vital business secrets with out being leaked out to the competitors. The businessperson has to
be careful to ensure the business chosen by him/her should allow to retain business
confidential.
 Less Government Control - Different forms of organization are to varying degrees of regulation
and control by the government. If there is strong government control, the business may entail
considerable amount of time, money, energy and effort to comply with legal formality and
instructions of the government.
 Less Tax Liability - Other things being equal, the ideal form of organization will be that which

incurred minimum amount of tax liability.

34
 2.3 SOLE PROPRIETORSHIP
The sole proprietorship can be defined as a form of business organization in which an
individual introduces his/her own capital, uses his/her own skill and intelligence, and is solely
responsible for the results of its operation. It is the oldest and most common form of business
organization in which one person assumes all risks and all profits. In this form of business
there is no distinction between the business and the individuals private affairs. That means the
law recognizes the business and the individual owner as one and the same.
A sole proprietor may receive help from others (family) in operating the business, but he/she
is usually the only boss. The capital needed to start and operate the business is not high and it
is normally provided by the owner from personal wealth or borrowed money. In such form of
ownership, prompt decision is very important and special consideration is given to the needs,
tasks and fashions of customers.
This form is also known as individual or single proprietorship, sole proprietorship, individual
enterprise or individual entrepreneurship. Examples are private colleges, restaurants, photo
studious, grocery, retail shop, private hospitals, clinics etc.
2.3.1. Advantages of Sole proprietorship
A sole proprietor is usually an active manager working in his/her business everyday, he/she
controls the operations, supervises the employees and makes decisions promptly. Some of the
advantages of the sole proprietorship are:
 Ownership of all Profits The single ownership allows the owner to receive all profits
generated by the business. The profit created by the business will not be shared with other
individuals.
 Simple and Low cost of Establishing and dissolution.
dissolution. It is very simple to start and operate a
sole proprietorship form of business. If an individual has a reasonable money to start the
profitable business the necessary thing is only to get license from the authorized office.
There is little legal procedure to be followed. Similarly if the business is not profitable and

35
 the owner would not be able to run that business, it is easy to dissolve such kind of business.
The necessary thing to be done is to pay debt if there is any and to return the license to the
theorized office.
 Independence and personal satisfaction.
satisfaction. The concept of being one’s own boss may be the
most important reason for an individual to establish one’s own business. As a sole
proprietor, one has the satisfaction of working for himself/herself. One can make his/her
own decision regarding the hours to work, the employees to hire, whether to expand the
business in to another line. In taking business decisions, the owner does not need to consult
other persons and he/she can take fast decisions to take advantage of business
opportunities. Therefore, co-ordination is not as such a problem and decision-making
becomes absolute and quick.
 Tax advantages. Special taxes that are levied against a corporation that causes double
taxation are not applicable in the sole proprietorship. Since the law recognizes the business
and the owner as one and the same, the business is levied a single tax.
 Retention of business secrecy.
secrecy. The sole proprietor is not legally required to publish its
financial condition nor it is required to make other confidential information public. That
means the sole proprietor does not have to disclose his/her performance or plans to the
public and since confidential information is a key to the success of a competitive business, it
is unlikely that the owner will leak the information. Thus, any change that the owner wants
to make concerning the business methods, policies and procedures can be done with out the
knowledge of others. This can help the sole proprietor to take advantage of business
opportunities.
 Social Acceptability. This form of owner ship of business is also socially desirable since every
body becomes the owner of business; it implies that wealth is distributed among the
majority of the members of the society. It is obvious that instead of working for others
business, every one of the member of the society wishes to have his/her own business or

36
 property. This may ensure equitable distribution of the wealth of the country among the
members of the society.
2.3.2 Limitation of Sole Proprietorship
As there are some advantages of owning this form of business, there are also some limitations.
The limitations include the following.
 Unlimited Liability. In this form of ownership business liabilities are personal liabilities. The
owner of the business is personally liable for all debts incurred by the business. Unlimited
liability makes the owner’s assets available to satisfy the claims of creditors of the business. It
means that the individual owner is legally liable for all debts of the business and if his/her
original investment will not cover the obligation of the business, the creditors have legal right
to claim the personal and legal property of the owner.
 Limited resources. That means there is a limitation of financial and human resource. Since the
individual is the sole owner of the business, he/she must rely on his/her own ability to borrow
money in order to finance the operation of the firm. Banks and other lending institutions may
hesitate to lend large sum of money to a single proprietor. Similarly creditors might be
unwilling to sell large quantities of items on credit to a single owner or to a business that is
run and supported by one individual.
 Difficulties of management. Because of the smallness of the firm, the individual owner must
assume the responsibility of a diversification of managerial tasks (hiring employees,
purchasing, selling, financing etc.). Most failures of the sole proprietorship directly attributed
to lack of such managerial capability.
 Lack of Continuity. Since the business and the owner are one and the same, the death,
insanity, imprisonment, retirement of the owner or bankruptcy of the business could
terminate the life of the business.
An individual may create a good business but because of physical incapability he/she may not
be able to continue work. This means that the life of the business depends up on the life of the

37
 owner and the profitability of the business. However the business can be recognized and
recover soon after the owner’s death if a successor has been trained to take over the business.
 Lack of Opportunity for employees’ status. Employees of the organization, by nature are
ambitious to grow up in the continuing status of their position in the organization hierarchy.
But the sole proprietorship, since, it may be small, may not satisfy this interest of the
employees. Therefore, ambitious employee may not stay in the business for a long period of
time where there is so limited opportunity to grow in their status. Therefore, the
proprietorship may be unable to keep highly qualified individuals for long even though it offers
good salaries and fringe benefits.

2.4 PARTNERSHIP

Partnership is legal association of two or more persons as co-owners of a business for profit.
The word ‘partner’ is derived from two words “part” and “owner”. This form of business
ownership represents the second stage in the evaluation of the form of business organization.
Partnerships are often the extensions of a business that began as a sole proprietorship. The
original owner may want to expand the business or the business may have grown too big for a
single person to manage it. It grew essentially to meet the requirements of expanding the
business, which calls for more capital and diversified managerial ability that were considered
as limitations of the sale proprietorship.
According to the commercial code of Ethiopia (1960) article No 211-partnership agreement is
defined as a contract where by two or more persons who intend top join together, make
contributions for the purpose of carrying out activity of all economic nature and of
participating in the profits and losses arising out there of, if any.
2.4.1 Features of Partnership
I. FORMATION
It requires the existence of two or more persons.

38
There must be a contractual agreement between the persons known as memorandum of
association or articles of partnership.
The memorandum of association is also known as article of co partnership. Since the
partnership is a voluntary association of individuals, each partner usually contributes capital,
labor, skill etc. to the firm. An agreement must be reached regarding such items as to the
investment to be made by each member, how to divide the future profits among the
themselves etc. Such an agreement may be oral, written, or implied by the actions of the
parties although it is preferable that the agreement be in writing to avoid misunderstandings.
If the partnership involves real property to be transferred to the firm, or if the length of
business transactions will be longer than one year from the date of the contract, then they
must prepare a written agreement.
According to the commercial code of Ethiopia (1960), the formation of any business
organization other than joint venture shall be of no effect unless it is made in writing and is
known to third parties. It sets fourth the exact relationship between the parties and includes
the following items.
 Date of the contract.
 Name of the business
 Names, nationality and address of each partner
 Location of the business (the head office and branches, if any)
 The purpose of the firm and the nature of the business
 Contribution of each partner, his or her value and methods of valuation.
 Duties, obligations and restrictions of partners.
 Distribution of profit and losses
 Duration of the firm
 Salaries and withdrawals of partners
 Procedures for dissolution of the partnership etc.

39
II. CONTRIBUTION
The contribution made to this form of ownership of business by each partner can be in the
form of cash (money), liability, fixed assets, other property or experience, knowledge, ability
etc. If it is not clearly stated on the memorandum of association and agreed up on by each
member, the contribution that has to be made for the business should be on an equal basis.
The money (capital) for the business may be raised by borrowing from outside financial
institutions depending on the strength of the business and the personal property of the
partners. Partners can use their personal property as collateral to borrow large amount of
money from outside financial institutions.
III. MANAGEMENT SITUATIONS
In this form of business, every partner has the right to actively participate in the management
of the firm and responsible for the performance of the organization. The partnership
agreement provides the assignment of duties and responsibilities of each partner, and how
the partners will manage the partnership based on their capital contribution, educational
background, knowledge and experience.
IV. DURATION OF THE PARTNERSHIP.
The partnership will be terminated if one of the partners withdraw, die, imprisoned, insane, or
if the business is bankrupt. That means the life of the business depends upon the life of the
partner. However, if the remaining partners agree to continue the business in the previous
form, style and name, the firm will not be dissolved.
In some situations, the partnership can also be dissolved if
 The purpose for which it is established is achieved
 It can not achieve the purpose or
 With the agreement of the partners before the expiry of the term.
V. OTHER LEGAL FEATURES.

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 Implied agency

This means each and every partner is liable for every fault and wrong he/she does while taking
part in the management activity. When acting on his/her given specified areas, every partner
has an authority to act on behalf of his/her fellow partners and the firm in the ordinary course
of the business. Thus, he/she is an agent of the firm and other partners. The relations
between partners are one of agency so that every partner binds the other partner by an act in
the name of the partner, by an act in the name of the partnership firm and in the ordinary
course of its business. This indicates that the firm is responsible for every mistake or fraud
committed by the partner in the course of business and his/her knowledge will be treated as
knowledge of the firm because he/she is an agent of the firm and other partners. Outside
parties, which enter into a contract with partners, are entitled to believe that the firm also
agrees to the contract.
 Utmost good faith

It means that there must be high standard of honesty among the partners. That means every
partner must disclose all facts that believed to be necessary and one should not get any
secret benefit behind the other. There must be mutual trust and confidence among the
partners.
 No separate legal entity

Just like the sole proprietorship form of ownership, the law recognizes partnership form of
business and the owners as one and the same. There is no distinction between the owners
and the business and the firm has no independent legal existence apart from a person who
constitutes it.
 Restriction on transfer of interest

In the partnership form of business, the partner cannot transfer his share or give his/her
ownership to other third part or outsides without the consent or agreement of other
partners.

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 Unanimity of consent

If change intended to be introduced to the business, it requires the agreement of all partners.
No partner can act out of the specified rules and regulations. If a partner makes major and
special decision, he/she requires the consent or agreement of all partners before the decision
will be implemented.
2.4.2 Types of Partnership
Partnerships are classified as either general or limited.
 General partnerships

General partnerships are the most common types of partnerships. Whenever the term
partnership appears by itself, the reference is always to the general partnership in which all
partners participate actively in the business and share all responsibilities, including unlimited
liability. A general partnership is really a sole proprietorship multiplied by the number of
partners. There is no legal limit to the number of partners.
The general partnership consists partners who are jointly, severally partially and fully liable as
between themselves and to the partnership undertaking and all partners have unlimited
liability i.e. if the business asset is not sufficient to cover the liability, debt coverage goes to
the extent of his/her personal assets.
 Limited Partnerships

Limited partnership must contain at least one general partner who must assume unlimited
liability for all business debts. The purpose of limited partnership is to allow a person to
provide capital, on which he/she expects a normal return, with out assuming liability for debts
beyond the amount of his/her investment. In this type of organization, one or more partners
may have limited liability as long as at least one other partner who has unlimited liability.
-The withdrawal, death or retirement of the limited partner does not dissolve the firm, but if the
general partner should withdraw, or die, the partnership would be terminated.

42
- Limited partners do not participate in the active management of the business. Limited partners
are attracted to this form of partnership because it offers them an opportunity to invest their
capital without being involved in active management. Limited partners do offer general
partners the possibility of raising additional capital with out giving up managerial control of
the business.
2.4.3 Types of partners
Partner’s duties and responsibilities may vary with respect to such factors and management
practice, sharing of profits, and extent of liability. General and limited partners may also be
secret, silent, dormant or nominal partners.
a) Secret partners are those partners who are active in the business, but are not known to the
general public.
b) Silent partners. Silent partners are known to the general public but are not active in
management of the business.
c) Dormant partners- Dormant partner is neither active in management nor known to the
public. This type of partner is often limited partner.
d) Nominal partner- Nominal partners invest no capital in a partnership and thus are not true
partners. Instead they often provide experience, special skills or other non-monetary factors of
value to the business.
2.4.4 Advantages of Partnership
 Ease of organization- although more difficult to organize than the sole proprietorship, all that

is essentially needed in the partnership is an agreement between the partners. While it is

desirable that article of co partnership be prepared in writing with legal assistance, it is not
mandatory and an oral contract would be acceptable. The dissolution of the partnership is also
a simple matter. But according to the commercial code of Ethiopia the agreement must be
made in writing.

43
 Capital availability. The partnership form of ownership has more than one owner, therefore,

providing more sources of fund than the sole proprietorship. Financial institutions are also
more willing to lend money when two or more people are responsible for the repayment of
the borrowed capital.
 Ease of expansion. Since there is the greater chance of getting large amount of capital, the

partnership could expand more easily than the sole proprietorship. Also the other point to be
considered is the fact that multiple owners can supervise more employees and larger facilities
than could a single individual.
 Management benefits. Since there are always at least two partners, no one individual is

forced to handle all the diversified activities. Each partner may control different functions of
the firm such as internal as well as external relation of the firm. This pooling of talent is of
tremendous value to the business as it enables the partnership to operate with a variety of
specialists.
 Highest credit standing. The partnership usually enjoys the highest credit standing as

compared with the sole proprietorship and the corporation. In case of the sole proprietorship
the personal assets of one owner may not be sufficient to satisfy the business debts. But in the
partnership there are two or more owners combining their personal assets and can borrow
large sum of money. In case of the corporation, the owners do not risk their personal wealth
to satisfy business obligation and therefore, do not warrant a high credit standing.
 Tax benefits.
benefits. Just as in the sole proprietorship the partners are taxed as individual and there is
no double taxation, as found in the corporate form of business.
2.4.5 Disadvantages of Partnership
 Unlimited liability. If the asset of the partnership is not sufficient to pay its
obligation, the creditors have the right to claim the personal property of any or all of the
partners to satisfy the debt. Not only are partners liable for debts incurred by joint decision,
they are also liable for any debts made by a partner when acting for the firm.

44
This incurs high cost for individual partner with large personal asset as he/she may find
himself/herself obligated to repay the entire debt of the partnership from his/her personal
assets.
 Delay in Decision Making. Under this form of business, the authority of
control and management of partnership is equally delegated to general partners. It is obvious
that decisions made by several partners are often better than those made by one. However,
having two, or more people deciding on some aspect of the business can also be difficult. The
partners will not always agree with each other, as every partner would try to assert his/her
positions and tries to promote his/her personal interest. As a result poor decision may be
made and important decision-making becomes more time consuming hindering the business
from seizing advantages of new business opportunities. If disagreement should occur on a vital
decision, the only solution to the problem maybe to dissolve the partnership.
 Lack of Continuity. The partnerships can be terminated by the agreement
of the partners themselves, by court order, or in the event of the death, insanity of any
partner or bankruptcy of the business. Therefore, it is obvious that the more people involved
in the firm, the greater the chance of dissolution causing the partnership to be the least
permanent form of business ownership.
 Investment withdrawal difficulty
A person who invests money in a partnership may have a hard time withdrawing the
investment. It is much easier to invest in a partnership than to withdraw. The money invested
is some times called frozen investment because it is tied up in the operation of the business.

2.5 PRIVATE LIMITED COMPANY

Private limited companies are formed from partnership or family business and become
incorporated business firm. These are under the control of small number of people or family
members who are both directors and majority shareholders. Private limited company shares
some characteristics from the partnership and some features from corporation.

45
 2.5.1 Definitions and Nature
According to the commercial code of Ethiopia (1960) private limited company is defined as a
company whose members are liable only to the extent of their contribution. The members of
the private limited company should not be less than two or more than fifty and the business is
always commercial in form. The company is prohibited to issue transferable securities in any
form. If the members reduced below the legal minimum number, the organization will be
dissolved.
The capital requirement for establishment of private limited company should not be less than
15,000 Birr. The company is required to issue shares and the value of each share will not be
less than 10 Birr. The company cannot be involved in the activity of banking, insurance or any
business of similar nature.
2.5.2 Formation of Private Limited Company
The company must have name, which is followed by private limited company. It is instituted in
the form of memorandum of association, and signed by all members or by persons acting on
their behalf and is authenticated. According to the commercial code of Ethiopia, the
memorandum of association should contain the following terms.
 the name, nationality and address of the members
 the company name, head office and branch, if any
 the amount of capital
 the value of contributions made by each member
 a statement that the capital is fully paid
 the number of shares held by each member
 the procedure for distribution of profits
 the number of managers, their powers and the agents, if any
 the period of time for which the company is established etc

46
When members make contribution in kind, the value should be accepted by the other
members and the method of valuation should be accepted by all members.
2.5.3 Management of the Company
One or more managers manage the private limited company. If there are more than twenty
members, the decision is passed at the meeting of the members and auditors appointed by
the members, but when there are twenty or less members, the decision may not require the
meeting of all members. In this form of business, managers other than members may be
appointed by the members or by the memorandum of association.
2.5.4 Dissolution of Private Limited Company
Just like other forms of business organizations, the private limited company is dissolved by the
court order at the request of any member where the term of the company has not been fixed.
The death of a member, bankruptcy, or insolvency of a member will not cause dissolution of a
company.
2.6 CORPORATIONS (JOINT STOCK COMPANY)
Corporation is one of the most important forms of business organization. Corporation offers
an easier way to finance itself by means of dividing its ownership into many small units that
can be sold to a wide economic range of customers. A corporation also offers a limited liability
to the person interested in the enterprise and has unlimited life span not affected by the
death of any particular owner or by the transfer of the shares of any particular owner.
2.6.1 Nature of the corporation
Corporation is an entirely different organizational structure from the sole proprietorship or
Partnership. Corporation is an artificial being, invisible, intangible and existing only in
contemplation of the law. In other words, the corporation is an artificial person having no
existence except in the eyes of the law. It is a legal person that is created by the governmental
action. This means that the property of the corporation is not owned by the persons who own
shares in corporation, but by the corporation itself.

47
 2.6.2 Characteristics of the corporation
Corporation has the following important characteristics.
 Separate legal entity.
entity. A corporation becomes a legal entity and is granted many of the same
rights as individuals. Like any person, the corporation has the right to manage its own affairs,
the right to produce and sell products to customers, the right to buy, own, and transfer
property, the right to make contracts, sue and to be sued. A corporation is formed by
obtaining approval of a certificate of incorporation, article of incorporation or charter from the
state.
 Limited Liability.
Liability. The liability of shareholder is generally limited. This means that the
shareholder is not personally responsible for the debts and liabilities of the corporation. Since
the corporation has separate legal entity, the debts of the corporation are the debts of this
artificial person and not of the people running the corporation or owning the shares of stock in
it. The capital contributed by the shareholders may be exhausted by the claims of the creditors
but if there is unpaid balance the personal property of the shareholder will not be affected.
 Corporation has unlimited life span.
span. The corporation has the power to continue as a unit
forever or for stated period of time regardless of changes in stock ownership. If no period is
fixed for its duration, the corporation will exist indefinitely unless it is legally dissolved. It can
be dissolved in only three ways.
i. By court order
ii. By the approval of the majority of the stockholders
iii. By the expiration of the corporate charter. The corporation is not affected or interrupted by
the death, withdrawal of any shareholder or director or by insolvency of the company.
 It is empowered by the government to carry on specific line of business.
business.
 Transferability of shares.
shares. The shareholders have the right to transfer or sale their shares to
others with out consent of other members.

48
 Separations of management from ownership. The shareholders or owners do not have the

opportunity to manage the day-to-day operation of the business. The corporation is managed
by paid individuals who have specialized capacity and experience.
 Common seal.
seal. A corporation is not a natural person and therefore cannot sign document by
itself. There should be a common seal designed in the name of the corporation (company) and
used as a substitute for its signature.
2.6.3 Classifications of Corporation
Corporations may be classified in terms of their relationship to the public and the nature of
their activities.
I. Public corporations
A public corporation is a company whose stock is widely held and available for sale to the
general public. These are businesses owned by large number of public investors. These
investors buy stock on the open market, thereby providing public corporations with large
amounts of permanent capital. In return, the shareholders receive the chance to share in the
profits if the corporation generates profit.
II. Private corporations (closely held corporation)
A private corporation is a business whose stock is held by small group of individuals and is not
available for sale to the general public. Private corporations withhold their stock from the
public sale, preferring to finance any expansion with out their own earning or to borrow from
some other source. Many such corporations are small firms, which in the past would have
operated as proprietorships or partnerships but are incorporated to obtain the advantages of
limited liability and other corporate benefits. Some times the controlling group may be a
family, employees or the management group.
III. Special service corporations.
corporations. These are corporations formed for transportation, banking,
insurance, savings and loan operations and similar specialized functions. The state laws and
the administrate agencies regulate on detail the manner in which business is conducted.

49
IV. Non- for profit corporations. Not all corporations are profit-making institutions. There are
many non-profit corporations as well. For instance corporations are organized for educational,
religious and charitable purposes. Any income resulting from the operations of the firm is used
for the specific purpose such as educational and religious purpose not distributed to its
owners.
2.6.4 Corporate Structure
From the practical point of view, the shareholder of the large public corporation cannot run
the corporation because they are too many to serve as an efficient managing body. Instead,
they elect a board of directors to represent them. The directors, in turn, select and monitor
the top officers who actually run the company. Therefore, there are three bodies that
constitute the corporate structure: the stockholders, the board of directors and the officers of
the corporation.
I. The Stockholders
- The stockholders are known as the owners of a corporation. They are individuals who buy
share of stock that show proof of ownership.
- They do not own property as the proprietor or partners do in the other form of business.
- They also do not possess title of the company property, but have direct claim on the property
in the event of liquidation after creditors and preferred stockholders.
Types of stocks
Corporations can raise money by selling shares to investors who are known as stockholders or
shareholders. Business profits are distributed among the stockholders in the form of
dividends. Corporate stocks may be preferred stocks or common stocks. Preferred stocks are
shares whose owners have first claim on the corporation’s assets and profits but who usually
have no voting right in the firm. Preferred stock guarantees those who own it a fixed dividend,
much like the interest payment earned in a saving account. Preferred stock holders have
priority or preference over common stock holders as to dividends and also to assets if a

50
business is liquidated after creditors or bond holders. In contrast, common stock usually pays
dividends only if the corporation makes a profit.
Common stocks are shares whose owners usually have last claims on the corporation’s assets
(after creditors and owners of preferred stocks) but who have voting right in the firm.
Dividends on common stock are paid on the per-share basis. Thus, stockholder with hundred
shares receives hundred times dividends paid per share. Preferred stockholders do not have
voting rights, but common stockholders always have voting right with each share of common
stock, which is usually issued by big corporations. Every corporation whether it is big or small
must issue common stock.
According to corporate charter each stockholder receives one vote for each share of stock
owned, Because of the large size of the corporation, usually hundreds of thousands of
stockholders have the right to vote, although most of them do not always attend annual
meetings. Therefore, corporations provide each absentee stockholder with special form
(document) known as proxy.
proxy. The proxy is the power of attorney that transfers to third party
the stockholder’s right to vote. It does not transfer the legal ownership of the share and is
usually valid only for specific meeting. In this manner, stockholders who are unable to attend
meeting are able to vote and make their wishes on issue of importance.
Since stockholders are the owners of the corporation, they have certain group as well as
individual rights.
Some of the group rights are the right
0 - to vote and amend the by-law.
by-law.
1 - to elect directors.
2 - to change the charter
3 - to vote on the disposal of corporate asset
4 - to dissolve the corporation
Individual rights are:

51
 5 - to buy, sell and transfer his/her stock
6 - to receive dividends in the proportion to the number of shares owned.
7 - to inspect and review company records.
8 - to vote at stockholders meeting
9 - to receive evidence of ownership (stock certificate).
10 - To share in the distribution of assets in the event of dissolution.
By electing the board of directors, the stokeholds delegate their authority and usually exercise
indirect control over the affairs of the business.
II. The Board of Directors.
Usually the numbers of board of directors in many companies are not less than three
members and not more than twelve members. Most states permit the number of directors to
be fixed by the by laws. Representing the shareholders, the boards of directors are the chief
governing body of the corporation. Since the board of directors are elected by the
shareholders, they are responsible for the following activities.
a. They choose the president (chief executive officer) and other officers and delegation of
authority/power to run the day-to-day activities of the business.
b. They decide on major issues and problems including expansion of the business closing up or
retraction of the unprofitable branch or change of product line.
c. They also are responsible for declaration of dividends. This involves such decisions as the
percentage of the earnings to be retained and the method of dividend payment.
III. Officers
The officers of the corporation are elected by the board of directors and are directly
responsible to them for the carrying out of business objectives. They act as agent of the firm
because they have the power to bind the corporation contract.

52
 The chief executive officer (C.E.O.) may also be the chairman of the board, the president of the
corporation or both. The chief executive officer and the board, usually appoint officers below-
top rank including most vice presidents.
We have seen that the corporation is formed by the approval of the certificate of
incorporation or charter by the government. This corporate charter is written by the law of the
company and it contains
 Name address and location of the corporation
 For what purpose it is going to be established
 The amount and kind of stock to be authorized (i.e. how much common stock or preferred
stock)
 Privileges and voting powers of each stock and duration of the corporation.
 After the charter is approved by the government three way contract may be created between
 the state and the stockholders
 the stockholders and the corporation
 the incorporators and the state
In cooperators are persons who make the application for the certificate of incorporation.
2.6.5 Advantages of Corporation
 Limited Liability: The creditors cannot look beyond the assets of the
corporation to settle their debts because the corporation is a separate entity. The stockholders
liability is limited to the extent of the face value of the share held by each of them and their
personal property cannot be affected.
 Capital formation. Since the corporation can divide its ownership in to
shares of small denomination, it can attract capital from thousands of individuals of varying
income. In addition to this, corporation can also easily borrow large some of money because
the amount needed gives interests to those agents that market securities. The company can

53
 raise a large amount of capital by issuing shares as long as investors are willing to purchase
additional shares of stock.
 Transfer of Ownership. In a matter of moments, stockholders are able to
buy or sell shares through brokers in organized market known as stock exchange/market.
 Continuity or stability. Since the corporations are not dissolved by
bankruptcy of the company or insanity, withdrawal, death of stockholders change of
management or dispute over the ownership, they possess perpetual life.
 Staffed with management specialists. Because the corporation is larger
than the proprietorship, partnership and private limited company, it can be staffed with skilled
and experienced specialists to a greater degree.
 Possibility of expansion. Since the corporation uses a large capital investment, it would be
possible to use latest equipment and machineries in order to carry out its operation at large
scale. This would decrease the cost of production and increase profit and leads to big reserve
that serves for expansion of the company.
 Diffused or spread of risk.
risk. Because there are a number of stockholders, the risk is spread or
divided over several members and is reduced for each member. This would attract more
investors to take risk of new opportunities.
2.6.6 Disadvantages of Corporation
 High cost of organization.
organization. The corporation must get government approval and legal assistance
in forming this type of ownership. The time interval for organizing the corporation is long
because it may take many months, even years before the firm is formally recognized. Also the
high cost of legal procedure and investment in time will not encourage small business to enter
in this form of ownership.
 Double taxation.
taxation. The corporate form of organization must pay tax in the same manner as
individual and result in double taxation of corporate income. Double taxation developed first
from the taxing of the net profits of the corporation i.e. the corporation, as a legal entity

54
 should pay profit tax. Second from the portion of the profits distributed to the stockholders as
they receive individual income from the corporation
 Lack of owner’s personal interest. Since corporations have thousands of owners who usually

own a very small part of the business, each one has little interest in the management of the
firm.
Normally their interest is in the amount of dividends they will receive and increase the value of
their stock. Paid individuals manage the corporations and directors who may not be expected
to have intense inters in the success of the business.
 Delay in decision-making. In the corporate form of business, there may not be flexibility and

promptness of decisions. Sometimes decisions on key issues requiring the general meeting of
stock holders may be delayed because of the time in terval between the meetings, difficulty of
getting the required number of members to pass the decisions and the presence of diverse
interest, which may lead to disagreement and time consuming.
 Lack of secrecy.
secrecy. The publication of the required financial reports of a corporation becomes a
matter of public record. Therefore the large corporation is unable to keep confidential on
certain areas that they do not wish to reveal (profits or losses, sales, salaries to individuals or
dividends paid to stockholders) allowing competitors to change their plans on the
corporation’s open book.
 Rule by few or oligarchic fraudulent management.
management. The power of managing the corporation
may concentrate in the lands of very small group known as oligarchy. That means some
dishonest managers may succeed by misleading and cheating the stockholders as they wish.
Progress Check Questions
1. What is sole proprietorship? Define it?
________________________________________________________________________________
2. List examples of the sole proprietorship form of organization.
________________________________________________________________________________

55
3. What are the advantages and disadvantages of owning the sole proprietorship of business
organization?
_______________________________________________________________________________
4. Why is a sole proprietorship form of organization socially desirable?
________________________________________________________________________________
5. Distinguish the various characteristics of partnership form of organization.
_______________________________________________________________________________
6. What differentiate partnership form of business from the sole proprietorship form of
business?
_______________________________________________________________________________
7. What is the difference between partners and partnership?
________________________________________________________________________
8. Describe the difference between general partnership and limited partnerships.
________________________________________________________________________________
9. What is the role of limited partners in the limited partnership form of organization?
_______________________________________________________________________________
10.List
10.List the advantages and disadvantages of partnership form of business organization.
_______________________________________________________________________
11.Explain
11.Explain the difference between limited liability and unlimited liability.
_________________________________________________________________________
12.Describe
12.Describe the content of memorandum of association.
___________________________________________________________________________
13.What
13.What differentiate private limited company from other form of ownership?
_______________________________________________________________________________
14.How
14.How much capital is required for establishing the PLC?
_____________________________________________________________.

56
15.How
15.How can PLC managed?
_______________________________________________________________.
16.Describe
16.Describe how PLC would be dissolved.
________________________________________________________________.
17.What
17.What differentiate corporation from the other forms of business organization?
_________________________________________________________________________
18.Identify
18.Identify the characteristics of corporation.
________________________________________________________________.
19.How
19.How can corporation be dissolved?
_______________________________________________________________.
20.List
20.List the different types of corporation.
_______________________________________________________________.
21.What
21.What is the difference between common stocks and preferred stocks?
_____________________________________________________________________________
22.Explain
22.Explain about the major groups that constitute corporate structure.
________________________________________________________________.
23.What
23.What is proxy? (Explain)
____________________________________________________________.
24.What
24.What are the responsibilities of the board of directors?
________________________________________________________________________

2.7 SUMMARY

In this unit, you have studied about the different forms of ownership of businesses. We have
been that there are four main forms of organization for a business unit. It may be organized by
an individual as sole proprietorship, by mutual agreement of two or more persons as
partnership, by agreement of a group of individuals or family members in the form of private
limited company and by a number of persons as a joint stock company or corporations.

57
 Sole proprietorship is business form in which an individual uses his/her own knowledge, skills,
capital and effort so that he/ she is responsible for the result of the operation of the business.
Establishing and operating form of ownership of business has a number advantage such as
ease and low cost of organization and dissolution, ownership of all profit earned by the
business, payment of single tax when compared with corporation, retention of business
secrets etc. It has also its own limitations such as unlimited liability, difficulty of management,
look of continuity, lack of opportunity for employees etc.
Partnership is another form of business organization in which two or more individuals join
together and contribute some amount of capital in order to carry out economic activity for the
purpose of generating profit. It is possible to establish general partnership or limited
partnership form of organization
Another form of business organization is private limited company, which is formed by two or
more persons but not more than fifty members. The minimum amount of capital for
organizing private limited company is birr 15, 000
Corporation is another form of business organization, which has separate legal personality
(entity) apart from its shareholders, officers and directors who are not as a general rule liable
for the corporation’s debt and obligations. Corporation is established for unlimited life span
unless it is legally dissolved by the state order.
There are different types of corporations such as public corporations, private corporations,
special corporations and non for profit corporations and their structure is constituted by three
groups known as stockholders, board of directors, and the officers of the firm.
Corporation can raise money by issuing of two types of stock sip referred stocks and common
stocks.
2.8 ANSWERS FOR CHECK YOUR PROGRESS QUESTIONS
1. Sole proprietorship is a business form, which is created and run by a single
individual.

58
2. Restaurant, Private College, hotel, Shop etc.
3. Advantages: Ownership of 100% profit, ease of organizations, single tax
payment, personal satisfaction, keeping business secret etc.
Disadvantages: Unlimited liability, limited financial resources, lack of continuity, difficulty of
management.
4. Because the wealth of the nation will not concentrate on a few hands.
5. Organization, contribution of capital, agreement between persons,
duration, implied agency, utmost good faith, no separate legal entity, unanimity of consent
etc.
6. Partnership is a business form, which is organized by the agreement of two
or more persons.
7. Partners are individual members whereas partnership is the business.
8. In the general partnership, all partners are active participants in the
management of the firm and responsible for the result of that firm. Only general partners form
general partnership. But more general partners and one can form limited partnership or more
limited partners.
9. The role of limited partners is to contribute capital for the firm without
participating in the management of the firm and without assuming liability.
10. Advantages: ease of organization, capital availability, management benefit,
highest credit standing, tax benefit etc.
Disadvantages: Unlimited liability, lack of continuity, delay in decision-making, etc.
11. Limited liability means the investor losses only what he/she invests in the
business but in the unlimited liability if the assets of the business do not cover its liability, then
the owner may pay from his/her personal property.
12. Memorandum of association is a document, which indicates the
agreement of two or more persons in the partnership association.

59
13. The limitation of the liability to the extent of the investment of the owner
to the firm.
14. 15, 000 Ethiopian Birr.
15. By one or all members of the company i.e. their agreement determines.
16. Just like other forms of ownership it will be dissolved by the court order
not to be terminated by the bankruptcy of the business or the death of the owner.
17. Separate legal entity
18. Limited liability, unlimited life span, separation of management from
ownership, separate legal entity, having common seal etc.
19. By court order, by approval of the majority of shareholders, by the expiry
of the corporate charter.
20. Public corporations, private corporations, special service corporation, non-
profit corporations.
21. Preferred stocks guarantee the owners the preferential right to claim the
profit and assets of the business but common stocks are shares whose owners have last claims
on the assets and profit of the business.
22. Stockholders, board of directors and officers.
23. Proxy is the power of attorney that transfers the decision making power of
the shareholder to the third party.
24. To declare dividends, to select managers and to decide on major issues
and problems of the organization.

2.9 REFERENCES

 R. KSHARM AND SHASHI K,Gupta: Business organization and Management,

Management, 1988.
 SHARMA, N Business Management, RBSA, 1996.
 Anderson (fox) Twomy, Business law Principles,
Principles, Cases, environment, 5th ed.
Cases, environment,
 Commercial code of the Empire Ethiopia of 1960.

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 Sp Iyengar – B/C Goyal Business law,
law, published by G.S sharmey, proprietor, Richard and Co.
 BACERTEE. M Business Organization and Management,
Management, Kalyania, Pub, 1984.

UNIT 3: MARKETING
Contents
3.0 Aims and Objective
3.1 Introduction
3.2 Definition
3.3 Basic Concepts
3.4 Marketing Management
3.4.1 Marketing Management Philosophies
3.5 Functions of Marketing
3.5.1 Exchange Functions
3.5.2 Physical Supply Function
3.5.3 Facilitating function
3.6 Marketing Environment
3.6.1 forces in Company’s Microenvironment
3.6.2 Forces in Company’s Macro-environment
3.7 Marketing Ethics
3.8 Market Segmentation

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 3.8.1 Political, Economic Socio-cultural and Technological
3.8.2 Geographic
3.8.3 Psychographics
3.8.4 Behavioral
3.9 Classifications of Market
3.10 Marketing Mixes
3.10.1 Product
3.10.2 Placement
3.10.3 Promotion
3.10.4 Price
3.11 Summary
3.12 Answers to Check Your Progress Questions
3.13 Reference
3.0 AIMS AND OBJECTIVES
When you read this unit, you would be able to:
 understand the definition and meaning of marketing;
 know the basic concepts in marketing;
 understand and define marketing management;
 clearly know the different marketing management concepts;
 know the basic functions of marketing;
 understand what market segmentation and the basic means or factors of segmenting a
market;
 clearly know the marketing mixes or the four Ps;
 describe the different types of promotional mixes and other marketing mixes.

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3.1 INTRODUCTION
In the previous units, we have tried to discuss about the general definition, division and sub-
divisions of business in unit one, and the common types or legal forms of ownership of
business in unit two. In this unit, we will also define marketing, discuss the core concepts of
marketing such as needs, wants, demands, products, consumer value and satisfaction,
transaction, exchange etc. Furthermore, we will discuss marketing functions, market
segmentations based on various factors and marketing mixes such as product pricing,
promotion, placement (distribution).
3.2 DEFINITION OF MARKETING

Marketing is a social and managerial process by which individuals and groups obtain what they
need and want through creating and exchanging products and value with others. Broadly
speaking it is the anticipation, management and satisfaction of demand through the exchange
process.
As the basic marketing saying puts it ‘customer is a king.’ And this is the duty of marketing; to
identify the need and want of customers and satisfy it. Marketing basically tries to manipulate
product, price, promotion and placement (the four Ps) so that it can attract and satisfy
customers with a certain need, want and demand.
In order to know more about marketing we will explain basic concepts & words in marketing.
3.3 BASIC CONCEPTS IN MARKETING
The following are some of the most important marketing terms that marketers use regularly.
Need- It is a general drive or felt deprivation that people require for survival. Need for cloth,
safety, food, social, belongingness etc are some of the basic needs that people require.
Want- It is a specific need shaped by individual culture and personality, or the deeper part of
need is want. Eg. If you need food, you may want to eat, bread or biscuit or ‘Doro wat’ or

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‘Kitfo’ etc. If you need drink, you may want to drink water or Ambo water or Coca or Merinda,
depending upon your internal feeling.
Demand.
Demand. It is the ability and willingness to buy a product. Demand is there when an individual
has both the capacity and willingness to buy the products or services. Demand depends upon
the financial capacity of individuals. As people get more money, they demand more goods or
services to satisfy their needs and wants. Therefore, businesspersons must measure not only
how many people want their product, but also how many would actually be willing and able to
buy it.
Product is any thing that can be offered to a market, which does have demand, by consumers.
People satisfy their needs and wants with product. It includes physical objects, service, person,
place, organization and idea.
Customer value-
value- it is the difference between the value the customer gains from owning and
using a product and the cost of obtaining that product. A customer makes a cost benefit
analysis and gives value to a product if the benefit is greater than the cost or gives no value to
a product if the cost of obtaining the product is greater than the benefit that the customer
gets.
Customer Satisfaction-
Satisfaction- A customer is satisfied when purchase or use of a product gives
positive felling to the user. And a customer is dissatisfied when purchase or use of a product
gives negative felling to the user.
To put it simply if
i) Product performance > expectation a customer is over satisfied
ii) Product performance = expectation a customer is satisfied
iii) Product performance < expectation a customer is dissatisfied
Exchange-
Exchange- It is the act of obtaining a desired object from someone by offering something in
return. For and exchange to take place, at least two parties should interact and they should

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have something of value to one another. And it is based on the free will (willingness) of the
two parties.
Transaction- a trade between two parties that involves at least two things of value, agreed
upon conditions, a time of agreement and a place of agreement.
Market- It is a set of actual and potential buyers of a product. And these individuals or groups
share a particular need or want that can be satisfied through exchange.
3.4 MARKETING MANAGEMENT
Marketing management is the analysis, planning, implementation and control of programs
designed to create, build and maintain beneficial exchanges with target buyers for the purpose
of achieving organizational objectives.
It is the process of applying the different approach of management; there are different
marketing management concepts that are followed by different organizations. Marketing
management can occur in an organization in connection with any of its markets. The next
discussion will look their concepts in brief.
3.4.1 Marketing Management Philosophies
Philosophy is a principle, which is guided by a logical reasoning. And the different Marketing
management philosophies have their own belief or principle to sell their products to
customers. There are five alternative concepts under which businesses and other
organizations can conduct their marketing activities.
I. The Production Concept-
Concept- This concept believes that consumers will prefer products that are
widely available and affordable. Distribution and production are given high priority under this
concept. This concept is applicable when demand is greater than supply. As long as there are
enough volunteers and capable buyers the organization is expected to concentrate on
production and distribution efficiency. A good example is petroleum Company, where its
demand is high and the only thing expected from petroleum refining company is to produce as
much as possible and to intensify its distribution channels.

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The production concept is also applicable for those consumers who are price sensitive (who
prefer low priced products). Chinese products (cloths and shoes) soled in Ethiopia are good
examples.
II. The product Concept-
Concept- This concept gives priority to quality, performance and innovation.
They assume that as long as a product has good quality there is some one who will buy it. i.e
buyers admire well-made products, can appraise product quality and performance, and are
willing to pay more for product.
Electronics companies such as Sony and Philips follow this approach.
III. The selling Concept-
Concept- This concept assumes that consumers will not buy enough of a certain
product unless a strong promotion is used.
In a perfect competitive market (where there are many buyers and sellers), for consumer
goods (soaps, food items etc.) or for unsought goods (where people do not think of much such
as insurance) are well marketed by this concept.
The basic concept of this approach is to sell what they produce rather than to make what the
market want. They use a push strategy (strong promotion such as advertisement). This
concept also assumes that selling is the end of marketing. It focuses on creating sales volume
and transaction than building long-term relation with customers.
IV. Marketing Concept-
Concept- This concept puts customers at its center; “Customer is a king”.
Marketing concept tries to identify the need and want of customers before producing/
delivering a product/ service. While selling concept starts from producing marketing concept
starts from the market. i.e target customers
And the corporate mission of this compares put customers at the center. For example,
Ethiopian Air Lines puts its promotional statement as “Going to great length to please you.”
V. Societal Marketing Concept-
Concept- In addition to serving the interest of customers, this concept
goes one step forward to think about the well being of the society in which it functions.
The main belief or stand of each concept or philosophy is summarized as follows.

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Mkt. Mgt. Philo. Concept
i. Production Concept
- Providing of goods in a Wide and affordable way
- Providing of quality, innovative and good performing products.
- Using of push strategy or strong promotion to increase sales.
- Identifying to the need and want of customer (customer centered)
-Use of pull strategy
- In addition to satisfying customers it thinks about the well being of society
3.5 FUNCTIONS OF MARKETING

Marketing as a concept puts customers at its center and in doing so it has the following basic
functions.
Marketing in general has two major duties identifying the need and want of customers and
satisfying of utilities /Form, Time, Place and Possession)
The function of marketing revolves in satisfying these basic utilities.
Marketing has three basic functions. There are
0 Exchange Function
1 Physical Supply and
2 Facilitating Function.
Each one will be discussed below
3.5.1. Exchange Function- The exchange function of marketing deals with the buying, selling
and assembling of goods and services.
Marketing as a department or body is responsible for the purchase of the proper quality and
quantity of goods, the assembling of this inputs in such a way that they would provide form
utility and sell the value added good to customers.

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 Buying-
Buying- Buying is the estimation of needs, finding the source of supply,
making business connections and negotiation of prices and other terms and conditions. During
the purchase of different supplies the marketing departments function, in this regard, is to
make sure that the supply bought should match with customer’s expectation, willingness and
ability.
 Assembling-
Assembling- This function of marketing is concerned with the collection
and concentration of goods of the same types from different sources of supply to central
location for economical transportation.
Assembling mainly gives emphasis to the value adding of goods in such a way that it would
be accepted by customers or to be in a better form than competitors offering.
 Selling-
Selling- It is the transfer of ownership from producers to consumers.
Selling as a function of marketing need to develop good product planning and development of
product line where by marketers make sure that a certain product meets the requirement of a
certain market. It is using this information that a product line is developed. For example
detergents such as OMO came to know that for a country like Ethiopia the product line should
design (pock) the product in small quantity since the buying ability of most of Ethiopian
population is low.
The next stage after developing a product line is creation of demand using different means of
promotional techniques such as personal selling, advertising, sales promotion and publicity. So
to summarize the above, modern selling involves in product line, demand creation, negotiation
and contractual argument to transfer title of a goods.
3.5.2 Physical Supply function- This is a function of marketing that is to favorable time and
place utility; i.e. the provision of a product/service at the right time and place.
Not, only the production of goods is enough, but the product should be distributed to where
customers are available. Basically this function has two part; transportation and warehouse.

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 Transportation-
Transportation- Land, water, air and rail wary are the favorable ways of delivering a product to
the place of customers. The provision of the appropriate type of transport and making sure
that the product has been delivered center customers, are the duties of a marketing body. For
example perishable (easily spoiled goods) such as fish or flowers need fast transportation even
if it is expensive to use like airplane.
Transportation involves delivering the product before it gets out of use.
Different types of transportation could be rated as follows using certain criteria’s.
 Storage and warehousing-
warehousing- Storage and warehouse is helpful to provide products (to make
them available) whenever the customer wants them. A marketing body should be sure that a
warehouse is well stocked and properly kept so that customers could get the stocks they want
it at the right time, place and at the right condition.
3.5.3 Facilitating function-
function- The other function of marketing is to make sure that the smooth
flow of business is well facilitated. Marketers should be sure to maintain the goods and
standard of goods /service or should be sure to collect relevant and necessary information to
maintain and facilitate the running of a business.
 Financing-
Financing- Market financing is the process of finding the sources of finance
in order to cover the cost of marketing functions. Market financing involves financing of the
business enterprise and the ultimate consumer. This means the business should be able to sell
its products and need to generate profit so that the cost of organization is maintained. And
marketing body should choose for possible financial sources to strengthen the backbone of the
business.
Some of the possible sources of finance are:
- Owned investment and borrowing (short or long term borrowing) from financial institutions
such as banks.
- Accounts receivable financing are enables a firm to get cash advances from financial
institutions.

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 Marketing risk- As the whole business has risk, a marketing body has the
responsibility of taking calculated risk in terms of clearly putting the need, want, attitude,
interest etc. of customers or the movement of competitors in terms of identifying their
response, would minimize the possible threat that may happen.
Marketing risks could result from
- Change of market condition, situation of demand (enough purchase of a product), suppose
political or economic change could come up with a marketing risk.
- Natural /man made disasters such as rain., wind, earth quakes etc. also have their own impact
on the performance of a business.
So, insuring of effects and clear understanding of a certain environment using accurate, timely
and relevant dates would help to minimize the above risks.
 Market information-
information- Market information includes all facts, estimates, opinions and other
information’s collected using market research and intelligence are used to make marketing
decisions.
 Standardization and Grading-
Grading- Standardization is the process of establishing agreement on a
uniform identification of definite on a uniform identification of definite characteristics of
quality, design performance, quantity, service etc. Standardization is used for quality
measurement. Standards reduce verities and create consistencies. Grading is the process of
ranking goods according to their quality it is dividing goods into groups, which have
approximate of the same characteristics.
In doing so the marketing body as a facilitated, should clearly define the problem to be solved,
collect relevant, accurate and timely date, and use this information to come to a solution.
3.6. MARKETING ENVIRONMENT
One of the major responsibilities of company marketer is to monitor and search the
environment for new opportunities, in bad as well as good years. It also spins out new threats-

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 such as energy crisis, a sharp rise in interest rates, a deep recession and firms find their
marketing collapsing.
Company marketers need to constantly monitor the changing scheme. By erecting early
warning system, they will be able to alert marketing strategists to meet new challenges and
opportunities in the environment. The marketing environment comprises two variables:
controllable and non-controllable factors and forces-in response to which organizations design
their marketing strategies. We can distinguish between the company’s microenvironment and
macro-environment within the external environment. However, the company’s internal
environment, which is considered as internal environment or marketing mix is also the other
focus of attention for the section.
3.6.1. Forces in Company’s Microenvironment:
Microenvironment: The microenvironment consists of the actors
in the company’s immediate environment that affects its ability to serve its customers. The
common variables are suppliers of the company, marketing intermediaries, customers,
competitors, and the publics.
 Suppliers:
Suppliers: Suppliers are business firms and individuals who provide
resources needed by the company to produce the particular goods and services. Development
in the suppliers environment can have substantial effect on the Company’s marketing
operations. Marketing managers need to watch price trends of their key inputs. Managers are
equally concerned with supply availability. Supply shortages, labour strikers, and other events
can interfere with the fulfillment of delivery promise to customers and lose sales in the short
run and damage customer goodwill in the long run.
The company:
company: The marketing department is responsible for developing marketing plans for all
existing products and brands as well as developing new products and brands. Marketing
management, in formulating marketing plans must take into account the other groups in the
company, such as top management, finance, accounting, etc. This can be considered as part of
the internal environment.

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 Top management sets the company’s objectives, broad strategies, and polices. The marketing
manager must make decision within the context set by top management. Further more, the
marketing proposals must be approved by top management before they can be implemented.
The marketing manager must also work closely with the functional departments. Financial
management is concerned with the availability of funds to carry out the marketing plans, the
efficient allocation of these funds to different products, brands, and marketing activates; the
likely rates of return that will be realized; and the level of risk in the sales forecast and
marketing plan. Accounting has to measure revenues and costs to help marketing know how
well it is achieving its profit objectives. Production department deals with conversion of the
input to output. The human resources department deals with manpower aspects of the
organization.
 Marketing Intermediaries:
Intermediaries: - Marketing intermediaries are firms that aid the company in
promoting, selling, and distribution of goods to the final buyers. They include middlemen,
physical distribution firms, marketing service agencies, and financial-intermediaries. The
middlemen also perform the basic functions of marketing.
 Customers:
Customers: Customers are group of people that purchase the product of a firm repeatedly.
They affect the sales volume of a firm through their changing preference and tastes.
 Competitors:
Competitors: - Competitors are firms, which sell or purchase similar products side by side with
other firms. They affect the firm through their pricing policy and others.
 The Public:
Public: - A public is any group that has an actual or potential interest or impact on an
organization’s ability to achieve its objectives. Public can facilitate or impede the ability of an
organization to accomplish its goals. It includes such as the media.
3.6.2. Forces in the company’s macro-Environment:
macro-Environment: The macro-environment consists of the
larger societal forces that affect both the micro environmental elements and the company to
serve the market that include such as demographic, economic, physical, technological,

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 political/legal, and social/cultural forces. Some of these factors are already discussed in
chapter two of this teaching material.
 Demographic:
Demographic: - The first environmental factor of interest to market is population because
people make-up markets. Marketers are highly interested in the size of the world’s population,
its geographic distribution, density, mobility trends, age distribution, birth, marriage and death
rates, racial, ethnic and religious structure.
 Physical Environment:
Environment: - Marketers should be aware of the threats and opportunities
associated with trends in the physical environment impending shortage of certain raw
materials, increased cost of energy, increased, level of pollution, and strong government
intervention in natural-resource management.
Marketing management needs to pay attention to the physical environment, in terms of
obtaining needed resources and also of avoiding damage to the physical environment.
 Technological environment:-
environment:- The most dramatic force shaping people’s
destiny is technology. Technology is the sum total of knowledge we have, of ways to do things
and includes inventions, techniques and vast store of knowledge. But its main influence is on
ways of doing things on how we design, produce, distribute and sell goods as well as services.
The impact of technology is seen on new products, new machines, new tools, etc. Every new
technology is a force for creative destruction. Transistors hurt the vacuum-tube industry and
chip that of transistors.
3.7 MARKETING ETHICS
The concept of ethics in this part of the teaching material is related to marketing and can serve
as supplementary reading of students to what has been discussed in unit one of this material.
Conscientious marketers face many moral dilemmas. For instance, the marketers should
perform their duties efficiently and effectively to their organizations. On the other hand,
marketers should be guided by broad ethical references. But references to Ethical
theories/decisions/ have been limited to the citation of simple ethical maxims as listed below.

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 The golden rule:
rule: Act in the way you would expect others to act toward
you.
 The utilitarian principle:
principle: Act in a way that results in the greatest good for
the greatest number.
 Kant’s categorical imperative:
imperative: Act in such a way that the action taken
under the circumstances could be a universal law or rule or behavior.
 The professional ethics:
ethics: Take only actions that would be viewed as
proper by a disinterested panel of professional colleagues.
 The TV test:
test: A manager should always ask, ‘ would I feel comfortable
explaining to a national TV audience why I took this actions’?
Yet, the best thing to do is often unclear. Because not all managers have fine moral sensitivity,
companies need to develop corporate marketing ethics policies-broad guidelines that
everyone in the organization must follow.
follow. These policies should cover distributor relations,
advertising standards, customer service, pricing, product development, and general ethical
standards.
But what principle should guide companies and marketing managers on issues of ethics and
social responsibility? One philosophy is that such issues are decided by the free market and
legal system. Under this principle, companies and their managers are not responsible for
making moral judgments. Companies can in good conscience do whatever the system allows.
A second philosophy puts responsibility not in the system, but in the hands of individual
companies and managers. This more enlightened philosophy suggests that a company should
have a ‘social conscience’ Companies and managers should apply high standards of ethics and
morality when making corporate decisions, regardless of’ what the system allow’. To give
practical example, the following code of Ethics is given.
 Responsibility of the Marketer

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 Marketers must accept responsibility for the consequences of their activities and makes every
effort to ensure that their decisions, recommendations, and actions, functions to identify,
serve, and satisfy all relevant publics, customers, organizations and society
Marketers’ professional conduct must be guided by:
1. The basic rule of professional ethics: not knowingly to do harm;
2. The adherence to all applicable saws and regulation.
3. The accurate representation of their education, training and experiences;
4. The active support, practice, and promotion of this code of Ethics.
 Honesty and fairness

Marketers shall uphold and advance the integrity, and dignity of the marketing profession by:
1 Being honest in serving consumers, clients, employees, suppliers, distributors, and public;
2. Not knowingly participating in conflict of interest without prior notice to al parties involved
and;
3. Establishing equitable fee schedules including the payment or receipt of usual, customary,
and/or legal compensation for marketing exchanges.
 Rights and Duties of Parties in the Marketing Exchange Process

Participant in the marketing exchange should be able to expect that:

1. Products and services offered are safe and fit for their intended use;
2. Communications about offered products and services are not deceptive;
3. All parties intend to discharge their obligations, financial and otherwise, in good faith; and
4. Appropriate internal methods exist for equitable adjustment and/or redress of grievances
concerning purchase.
It is understood that the above would include, but is not limited to the following
responsibilities of the marketer:
 Disclosure of all substantial risks associated with product or service usage;

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 Identification of any product component substitution that might
materially change the product or impact on the buyer’s purchase decision;
 Identification of extra cost-added features.
In the areas of promotions
0 Avoidance of false and misleading advertising;
1 Rejection of high pressure manipulations, or misleading sales tactics;
2 Avoidance of sales promotions that use deception or manipulation
In the Areas of Distribution
 Not manipulating the availability of a product for purpose of exploitations;
 Not using coercion in the marketing channel;
 Not exerting undue influence over the reseller’s choice to handle a product
In the areas of pricing
 Not engaging in price fixing;
 Not practicing predatory pricing;
 Disclosing the full price associated with any purchase.
In the areas of Marketing Research
0 Prohibiting selling or fundraising under the guise of conducting research;
1 Maintaining research integrity by avoiding misrepresentation of pertinent
research data;
2 Treating outside clients and supplies daily.
 Organizational Relationships

Marketers should be aware of how their behavior may influence or impact on the behavior of
others organizational relationships. They should not demand, encourage, or apply coercion to
obtain unethical behavior in their relationships with others, such as employees, suppliers, or
customers.

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1. Apply confidentiality and anonymity in professional relationships with regard to privileged
information;
2. Meet their obligations and responsibilities in contracts and mutual agreements in a timely
manner;
3. Avid taking the work of others, in whole, or in part, and represent this work as their own or
directly benefit from it without compensation or consent of the originator or owner;
4. Avoid manipulation to take advantage of situations to maximize persona welfare in a way that
unfairly deprives or damages the organization
3.8 MARKET SEGMENTATION
The basic function of marketing has been discussed in the above section. In satisfying different
utilities marketers should be sure to identity clearly which group/individuals they are serving.
Market segmentation is helpful in identifying those groups, which is going to be satisfied by
marketers.
marketers Market segmentation is the process of dividing the total market into several
homogenous groups, where any group can be selected as a target market that can be reached
with a distinct marketing mix.
Practically speaking, it is difficult for a certain business to satisfy a whole country or region by
offering a single product. People also have different interest, attitudes, personality, culture etc
that makes them to have a positive, natural or negative felling towards a certain
product/service. So a marketer should use different segmenting variables in order to identify,
provide and satisfy a certain product to a certain group of individuals with similar need and
want.
There are five commonly used bases for segmenting a certain consumer market.
3.8.1) PEST (Political, Economic, Socio-Cultural and Technological) factors are helpful ways,
mainly to have a general information about a certain country’s macro performance. For
example the buying ability of individuals could be known as the general term, by analyzing
different macro-economic indicators.

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3.8.2) Geographic Segmentation-
Segmentation- This is the process of dividing an overall market into
homogenous (similar) groups on the base of population location, topography, climate and
other geographical variables. For example in Sahara region when the climate is hot a
businessperson could sell light clothes that could have no demand in a dry cold climatic region
Geographic segmentation is used in order to know regional variations in consumer tastes and
also to determine and supply goods appropriate to a certain geographical region or climatic
change.
3.8.3) Demographic Segmentation – It is the dividing of an overall market into homogenous
group based on population characteristics such as age, sex, and income level, occupation,
education, stage in family lifecycle and etc.
Demographic indicators are usually used since they are easy to identify and are associated
with the sale of a product and service.
For example Johnson and Johnson, a body shop, company used to sell body lotion to bodies in
the U.S. but because, of the demographic change i.e. since the population in U.S. starts having
small or no children at all, the company was forced to shift its market to Africa and Asia where
the birth rate is high. So given different demographic indicators, information to marketers as
to what to sell and not to sell.
3.8.4) Psychographics segmentation-
segmentation- This type of segmentation tries to use behavioral profiles
developed from the analysis of activities, interest and life-styles of consumers. It is simply the
understanding of personality and psychology of consumer behavior in order to know what to
offer to a certain market. Preference of the purchase of a certain product could be known
through the study of life style. Understanding of the need, interest, feeling, attitude etc of
customers is a psychographics segmentation variable to identify group of customers with
similar needs and wants.
3.8.5) Behavioral Segmentation-
Segmentation- This type of segmentation tries to understand the purchasing
behavior of customers and to know its trend. Product usage rate, volume of usage, price

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sensitivity etc are used as a way of segmenting and satisfying a certain market. Using this
variable, users and non-users could be identified. And those that use a certain product could
be further divided as heavy, moderate and light users.
So by using the above segmentation variables an appropriate type of marketing mix is used for
a certain specific segment.
The next topic will discuss how to satisfy a certain market by using the controllable tools of a
marketing body (the 4 P’s or marketing mixes).
3.9 CLASSIFICATION OF MARKETS
3.9.1 On the basis of free intercourse
Markets have been classified as perfect and imperfect markets on the basis of free
intercourse. A market is said to be perfect market when all potential buyers and sellers are
promptly aware of the prices at which transactions take place and all the offers made by other
sellers and buyers and where any buyer can purchase from any seller
Under such conditions, the prices of materials would be the same all over the market. A
market is imperfect when some buyers and sellers or both are not aware of the offers being
made by others. Perfect competition in the market is found very rarely in the real world. The
modern competition and market is an example of perfect market.
3.9.2 On the basis of time Classification
Very short period market-
market- this is applicable to highly perishable articles like vegetables, milk
and fruits.
Short Period markets-
markets- time is given to adjust the supply to meet the demand. The time given
is not enough and influence of demand is greater than that of supply.
Long period markets-
markets- sufficient time is given for the changes in supply to adjust them to the
change in demand. Under these circumstances supply influences demand.
3.9.3 On the basis of the position of sellers

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Primary Markets:
Markets: In this market the primary producers sell all farm products to wholesales in
the village itself. This market deals in sales of fruits vegetables etc.
Secondary Market:
Market: -Here wholesalers supply their good to the retailers for selling them to
consumers.
Terminal Markets:
Markets: -The goods are finally disposed of directly to consumers. i.e retailer finally
sell these goods to the ultimate customers.
3.9.4 On the basis of the characteristics of the customer
Markets are broadly classified as consumer or industrial markets. These classifications are
based on the characteristics of the individual and organization within each market.
Consumer markets consist of purchases and/or individual household members who intend to
consume or benefit from the purchased products and who do not buy products to make
profits.
Industrial markets, also called business-to-business markets, are grouped broadly into
producer, reseller, governmental, and institutional categories. These markets purchase specific
kinds of products for use in making other products, for resale, or for day to day operations.
Producer markets consist of individuals and business organizations that buy certain products
to use in the manufacture of other products. Reseller markets consist of intermediaries such
as wholesalers and retailers that buy finished products and sell them for a profit.
Governmental markets consist of federal, state, country, and local governments. They buy
goods and services to maintain internal operations and to provide citizens with such products
as highways, education, water, energy, and national defense. Institutional markets include
churches, not for profit private schools and hospitals, civic clubs, fraternities and sororities,
charitable organizations, and foundations. Their goals are different from such typical business
whose goals are profit, market share, or return or return on investment.
3.10 MARKETING MIXES

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 Marketing mix is the set of marketing tools that the firm uses to pursue its marketing
objectives in the target market. There are a number of marketing mix tools. These tools are
known as 4P’s such as product, placement, (distribution), promotion and pricing.
Marketing mixes can also be defined as the mixture of controllable variables that can be
manipulated by the management of an organization.
Each marketing mix is discussed as follows.
3.10.1 Product: it includes a bundle of physical, service and symbolic attributes designed to
produce consumer want satisfaction. Product provides form utility to those individuals who
would purchase the product.
Products can be classified in different ways.
 One approach is to distinguish between goods and services.
Goods are basically objects that can be touched, stored, transported and mass-produced. Service
is any activity or benefit that one party can offer to another and is essentially intangible and
not result in ownership of any thing.
- Goods are tangible objects that can be perceived with sense. They
can be depicted in advertising. But services are often intangible involving actions and opposed
to objects.
- Goods can be stored. If demand is weak, the producer can hold items in inventory until they
sold. But services are perishable. The provider must match supply to demand since unused
capability cannot be saved until later.
- Goods can be transferred from producer to seller and can pass through the hands of
intermediaries. But services cannot be transported through intermediaries. The provider must
interact directly with the buyer.
 The other approach is to classify products into consumer products and industrial products.
- Consumer products are products bought by final consumers for personal consumption. There
are different types of consumer products.

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I. Convenient products.
These are consumer products and services that consumer buys frequently, immediately and with
a minimum comparison and buying efforts. They are low priced products and are readily
available when consumers need them. Examples, soap, sugar, candle, newspapers, batch box
etc.
II. Shopping products
- They are less-frequently purchased consumer products and services that consumers compare
carefully on suitability, quality price and style. Here consumers spend relatively much time and
effort in gathering information and making comparison. Examples, Furniture, clothing, hotel
services, medical services, etc.
III. Specialty goods
These are products and services with unique characteristics or brand identifications for which a
significant group of buyers are willing to make special purchase effort. Eg. Luxury items like
special brand cars, high priced photographic equipment, special watches etc.
IV. Unsought goods
There are consumer goods that the consumer either does not know or does not think of buying.
Example- a new product like the digital audiotape player is unsought until the consumers
become aware of it through advertising, encyclopedias etc. By their nature unsought goods
require a lot of advertising, personal selling and other marketing effort.
Industrial goods are those products purchased for further processing or for use in conducting a
business. Industrials products are grouped as raw materials and parts, capital items and
supplies and services.
Consumers and producers identify one product from the other using brands. To identify their
products from others marketers create, maintain and products from others marketers create
maintain and protect brands of their product and services. Brand is any name, term, symbol,

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signs design or a unifying combination of these that identifies and distinguishes one product
from the other.
A brand name is the verbal part of the brand consisting of words or letters that contains the
name used to identify the firm’s product from other competitors.
A brand mark is a non-verbal of symbol or sign part of the brand.
Trademark is a legally protected brand name or brand mark. The owners of the trademarks
have exclusive rights to their use.
Branding enables consumers to identity and distinguishes the product they like form the ones
they do not like.
Product Life Cycle
A product, like a human being, passes through different stages. At each stage of a product life
cycle a markets should use different strategies in the introduction, growth, maturity and
decline.

Maturity

Growth Decline

Introduction

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 Product Life Cycle
Each stage of the product life cycle is discussed below.
1) Introduction Stage-
Stage- in this stage the product is new to a certain market and the main duty
of the business is to stimulate demand. Promotional campaign should give information about
the new product.
The basic features of this stage are listed below: -
 Customers are hesitant in buying the product
 Productivity is low since demand is low
 Sales volume is low.
 High amount of money for promotion i.e high expense
 It is the least profitable stage.
So during this stage a company should try as much as possible to promote its product and get
known by customers.

Growth stage-
stage- Sales volume increases in this stage as new customers make purchase (use the
product) of a certain business. A product, which gets an acceptance by customers, is lucky
enough if it reaches this stage.
The basic characteristics of this stage are: -
 high growth rate in sales and profit
 customers are aware of the product/service
 competitors might enter to the market to share the profit gained by the growing business.
Promotion is still high in this stage but a reminding type of advertisement should be used.

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 So the company should capitalize this stage by increasing its distribution channels and provide
the product on time for customers who are showing a positive response to the product or
service.
Maturity Stage-
Stage- This is a stage where sales and profit reach climax (the maximum) level. This
stage is characterized by: -
 large number of competitors in a market
 available products exceed customer demand
 sales and profits are at their highest growth.
 Reduction in price may occur so as not to slip to a declining stage.
At this stage promotion should be used but the advertisement shown should be a reminding
type of advertisement. The company should develop a strategy to maintain sales and profit of
the business before it goes down to a declining stage.
Decline Stage-
Stage- Consumers shift to other products and sales and profit show a negative trend.
The characteristics of this stage are: -
 Sales is low,
 Profit is declining and could be negative
 There should be a differentiation of a product (modification) or a total change of model or
product.
So depending on the different life cycle of a product, a marketer should be alert enough to
take the appropriate measure in order to maintain the acceptability of the product,
satisfaction of customers and the profitability of the business.
The product life cycle assumes that profit and sales go in a certain pattern. The length of the
life cycle is different for different products.
While a new fashion may have a total life span of one calendar year, with an introductory
stage of two months but the automobile has been in maturity stage for more than twenty
years.

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 3.10.2) Placement (distribution)
The second marketing mix that solves the problem of supply with transportation and
warehouse by providing a product at the right time and place is distribution.
There are a number of possible ways of distribution channels. These channels help to deliver a
product from center of production to customers. The common channels of distribution are the
following:
1) Producer Customer: - a producer may sell its product directly to customers with out any
intermediaries.
2) Producer Retailer Consumer: - there is one intermediary (middle person) in order to
provide the product produced to customers.
3) Producer Wholesaler Retailer Consumer: - the marketing of many products is used
under this channel. For example Wonji sugar factory may sell (auction) its sugar to wholesalers
who may bring it to ‘Merkato’ or bulk. And this whole seller would sale to retailers who would
provide the sugar in local shops and stores to customers.
4) Producer Agent (Broker) Wholesaler retailer consumer
Here agent entered the distribution channel. The different between agents and wholesalers is
that
i) The agent does not take the title of the product while the wholesaler does
ii) Agents take commission from the produces while wholesalers generate profit of their own.
Retailer is a businessperson who sales to the ultimate (final) consumer.
Whole seller is a businessperson who by products for resale purpose to other whole sellers or
retailers but not to final users.
Factors that affect choice of channels of distribution
In choosing intermediaries a business should make sure that intermediaries are capable of
taking the responsibility of delivering the good to consumers.

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 Physical distribution is a key in terms of delivering a product to consumers at the right time
and at the right place. So the following key issues should be taken into account in choosing
choice of channel.
 Product consideration-
consideration- the type (nature) of a product determines whether to have a long or
short channel of distribution. For example fast transport and short channel of distribution is
essential for a perishable product to avoid delays and too much handling
Company Consideration-A
Consideration-A companies strength in financial capabilities would determine
whether to narrow elongate, increase or decrease its distribution channel & out lets. A
company’s product mix influences its channel pattern. The wider the companies’ products mix
the greater the ability of the company to deal with its customers directly. A Toyota car
producing company, for example has a long
 channel of distribution that goes to the extent of providing after sales service such as

maintenance, and this is because of the fact that it is producing (product mix), the different
brand cars.
 Middle person consideration-
consideration- choosing of a middle person that could work on behalf of the
company and just like the company is another factor that affects choice of channel. A company
would be forced by political factor, For example, not to have an outlet in a certain country. In
this case it should find an agent who would market its product in that region or country. For
instance Glorious is an agent chosen by Sony to distribute its product in Ethiopia.
 Cost is another factor that has effect in choosing a suitable distribution channel. Internal cost

of a company, competitors cost on channel of distribution, environmental conditions such as

legal and economic factors have impact on choice of distribution of channel.
So, depending on the estuation a company could use selective distribution channel (extensive)
or more distribution channel.
3.10.3) Promotion

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 Promotion is a persuasive communication designed to sale products services or ideas to actual
or potential customers. It is a part of marketing mix concerned with selecting appropriate
technique or tool for selling a product to a customer.
Promotion as a communication tool and a marketing mix has its own sub. Promotional mixes.
Those are Advertisement, Sales promotion, Personal selling and publicity. Each one will be
discussed below:
 Advertisement

Advertisement is the process of using written, visual, and oral or the combination of the above
in order to inform or remind customers about a product or service using a certain medias.
The main objectives of advertisement are: -
0 To provide information- when a product is new to a market (at the introduction
stage of the product life cycle)
1 To increase demand
To differentiate a product- by telling the unique features of a certain product
2 To maintain current sales volume
3 To counteract competitor’s promotion- when competitors show an
advertisement to sale a product similar to the business. The business should develop new
advertisement system to counteract to neutrals the effect of competitor.
To remind customers. Mainly when a product is on the growth and maturity stage of the
product life cycle.

Advertisement could use different medias of channels of communication to transmit its

message. Some of the possible ways of sending information to customers are: - newspapers,
magazines, television, radio; Internet, billboard, banners etc. But the main point is to use a
channel that is accessible by front line customers. For example advertising of soap for rural

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 population using television in Ethiopian might not get the customers intended. So the
appropriate type of channel accessible by customers should be used.
 Personal Selling

A promotional technique involving use of person to person to communication to sell the

product. In the case of advertisement, it advantage is the marketers can interact with a large
number of audiences at a single instance. But the communication is one way (not interactive).
In the case of personal selling the customer and the seller are face to face and they can
exchange information on an immediate, two way and interactive manner. The disadvantage of
personal selling is that it is the most expensive form of promotional mix.
Steps in personal selling
1. Prospecting- identification of potential customers.
- Distinguishing of those customers that are true buyers and those who do not.
2. Approach- Contact with sales person and potential customers.
- Finding of possible information about customers.
0 3. Presentation- describing of a products feature to a customer.
- Presentation should be clear, short and positive.
4. Demonstration- showing how the product operates functions etc. If it is an electronic item,
for example show by planning it or using who operates it.
5. Objection- receiving the opinion, answer of the customer about the product being
demonstrated.
6. Closing- initiating of purchase order. This is a stage where the sales person influences the
customer to buy or use the product shown.
Follow up- After the goods are to customers, soled the sales person should make sure that the
customer will make repeated purchase by providing after sales service or by giving gifts etc.
since ‘selling is not the end of marketing but rather it is the beginning.’
 Sales Promotion

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 Is a promotional technique involving short-term incentives to encourage purchase goods and
services. Sales promotion is very important mix because it increases the chance that the
customer will try the product. It also enhanced the recognition of the product. Examples of
sales promotions.
Giving of free samples, sale discount, showing of trade series, giving of warranty, after sales
service, lottery (like the one done by coke, Pepsi and beer Companies on the corky) etc. are
examples of sales promotion. While advertisement and personal selling provide reasons to buy
a product or service, sales promotion offers reasons to buy now, For example a company may
give a free Compact Disk (CD) for a customer who buys the CD player or TV.
 Publicity:
Publicity: - Offers several unique quality which is very believable, more
real news story to consumers than advertising. This promotional technique is unpaid media
coverage of news and a source of free advertisement. But the message transmitted is not the
control of the organization. Example ‘Siket programe’ transmitted in Ethiopian Television.
These are activities done by the public relation officer in order to provide information about
the performance, nature and overall performance of a business to a public.
It aims on building good relation with customers and public, creating of good image and
handling of unfavorable rumors (word of mouths), stories and events are the duty of the
public relation officer. The major functions of public relation are press relations, product
publicity, public affairs relation, and development of good image.
So in general promotional mixes are way of contacting with customers in order to promote the
purchase / use of the deferent promotional mixes, the appropriate choosing of media, timing
and related issue are some of the factors that need to be considered well during promotional
activities.
3.10.4 Pricing-
Pricing- Price is the only marketing mix element that generate revenue while the rest
(product, placement and promotion) are costs. Price is the value given to a product or service.
It may go by many names; rent of a house, tuition for education, fee for dentist or doctor, taxi

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 fair etc. are all values attached to the use / purchase of a service / product. It is simply the
amount of money charged to a product or service.
Price is not only a revenue-generating item but it is the most flexible marketing mix. Since it is
flexible and the only revenue generating item during setting of a certain price to a product or
service different factors should be taken in to account.
 Factors to be considered when setting prices

There are internal factors (within the company) and external factors (beyond the business)
that affect the pricing decision of a certain firm.
1) Internal factors.
factors. These are factors in the company itself that include cost of the
organization, objective of the business or marketing mix strategy
i) Marketing objectives- companies have different objectives
depending on their position and interest. Survival, current profit maximization, market share
leadership product quality leadership are the possible marketing objectives that a firm could
have.
Some companies want to get a reasonable profit and wish to stay long in a market so they will
set an average or reasonable price while others want to set a high price and take what they
could take in short period of time. So depending on the objective of a firm price could change
as well.
ii) Cost- Cost set the floor or lower limit for the price that the
company can charge for its product or service. For a business to stay competitively, at least it
needs to cover its fixed and variable costs. A business charges a price higher than its cost to
stay competitive in a market. And this is why cost is internal factor in setting price.
iii) Organizational Consideration- management decides who within
an organization should set price. Depending on the size of a company, price could be set at
differential levels. Sales or marketing department might set price in loyal companies while

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price is also find by top level management in small companies still in very large companies
pricing design is given to divisional or product line managers.
2) External factors-
factors- these are factors, which are outside the boundaries of the organization
market demands, competition, macro-environmental issues, customer perceptions of value
etc are some of the common factors that could set upper price limits.
i) Market and demand- while cost selects the lower limit, demand (market) sets the upper limit
of price. If a market is willing and able to buyer use a product, then the price of that item
would be higher as well. The supplier as to sets scarce items like petroleum, with high demand
by how much price they would be soled. Whereas goods with little demand will have low price
as well.
ii) Competitors Price- a marketing intelligence is needed to know about the cost and pricing
strategy of competitors. Mainly for a new product entering the market, it necessary to
evaluate the existing price of competitors than setting new price. For example, when Shewps
entered to the soft drink producing marketing Ethiopia, it followed in Ethiopia its had followed
the already existing price of coca and Pepsi, so as to avoid any price user. So the pricing
strategy of competitors is another factor that should be examined carefully before selecting a
certain price.
iii) Consumer Value and Perception- consumers are the final people that use a product. So
they decide at what price they should by an item. A marketer should make a research to know
how consumers regard this service/product and set a parallel price.
The company should also consider consumers perception of price and how their perceptions
affect consumer’s buying decisions.
iv) The political & economic situation of a country is also important in selling a product. For
example co co is being sold at a price of eight to ten Birr in Europe and North America while it
is soled at less than two Birr in Ethiopia. The economic condition of a country has effect on a
pricing strategy as it has seen in the above example.

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 Imported products are usually discouraged by government by imposing high tax (tariff) on
them & this will how a direct relation on the price set by a company.
Therefore, different internal and external factors should be considered before setting a certain
specific price.
In the coming part different pricing strategies that could be used by business will be discussed.
 Approaches in Pricing

There are three major approaches for setting price after taking into account the differed
internal and external factors of pricing. These are cost based, buyer based and competing-
based pricing.
I. Cost Based Pricing
Cost plus pricing-
pricing- it is a way of marking up or adding a certain values on the unit cost of a
company
Break-even analysis & target profit pricing-Setting
pricing-Setting price to a break even on the cost of making
selling a product. Break-even point is a point in a graph were total cost is equal with revenue.
I.e. the company is just on the point of covering its unit and variable cost. As long as the
company longer it does this, it could sustain for a certain period of time.
II. Value based pricing-
pricing- this method takes into consideration the perception, value and
orientation of customers to a certain goods/services to set price. This method starts from the
market to get information as to by how much would the customers want to purchase the
product/service.
III. Competitors based pricing-
pricing- in this case; consumers compare the price of one product with
another and make decision to by that produce. In this case a firm should know the pricing
strategy of competitors and its pricing strategy accordingly.
Depending on the intensity of competition, there could be two common methods of pricing
using competition, going rate and sealed-bid pricing.

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 Going-Rate pricing-
pricing- a firm bases its price largely on competitors price, with less attention paid
to its own costs or to demand. Firm might charge the same, more or less price than it s
competitors depending on its strategy.
Sealed-Bid pricing- computation based pricing is also used when firms bid for jobs. Using
sealed-bid pricing a firm may fix its price on how it thinks competitors will price other than on
its own cost and demand. The bid is based on offering the lowest price that competitors.
IV. New Product Pricing
When marketers (business) center to a market, they might set different type of prices (higher
or lower) depending on internal & external factors.
Market-Skimming Pricing-
Pricing- if a company sets a higher price in the introduction stage of its
product life cycle it is known as price skimming. In this case the company may make very few
sales but it is more profitable sales since products are old with high price more profitable sale.
This kind of strategy is done for skimming products (expensive) goods.
Market Penetration Pricing-
Pricing- it focuses on setting lower price for a new product to attract a
large number of customers & market share. Higher sales volumes result in filing costs and even
a decline in price.
Progress Check Questions
1. Define marketing.
_____________________________________________________________________________
2. Explain how marketing management is a process
_____________________________________________________________________________
3. Explain the difference between need and want.
_____________________________________________________________________________
4. Which marketing management would you choose? Why?
_____________________________________________________________________________
5. Discuss the physical distribution function of marketing.

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 _____________________________________________________________________________
6. Briefly discuss how topography is used as a geographic segmentation variable?
____________________________________________________________________________
7. What makes a product to move from growth stage to maturity?
_____________________________________________________________________________
8. What is the advantage of advertisement?
____________________________________________________________________________
9. How is personal selling better than advertisement?
_____________________________________________________________________________
10. What is the difference between P.R. and publicity?
_____________________________________________________________________________
_____________
11. What does it mean when we say price is the most flexible marketing mix?
_____________________________________________________________________________
_____________
12. Discuss the internal factors that affect pricing strategy.
_____________________________________________________________________________

3.11 SUMMARY

Marketing is one of the most important part of a business which makes a direct interaction
with customers in terms of understanding the need and want to guide a product /service.
Marketing basically is the identification of need, want and demand; and satisfaction of utility
(form, time, place and possession)
The major functions of marketing are exchange, physical distribution and facilitation.

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 According to the different believes, there are five different marketing management
philosophies: these are production, product, and selling, marketing and social marketing
concepts.
Market segmentation is a way of identifying a group of consumers with similar interest and
behavior. Geographic, psychographics, behavioral and demographic factors are helpful to
identify a homogeneous groups (consumer)
Marketing mixes are the controllable tools of a marketing body that help to provide and win
customers by manipulating them. Marketing mixes are consider as 4 P’s:
Product Personal selling
Price Advertisement
Place Sales Promotion
Promotion Public relation
3.12 ANSWER TO CHECK YOUR PROGRESS
(2) It is a managerial process since the activities done under marketing should be properly
planned, organized, Implemented and controlled. Resources are scares and they should be
properly used by applying management.
(3) Need is a general drive while want is a specific need.
(6) Topography is the geographical characteristics of a country whether it is mountainous,
plateau, land locked etc which have their implication of individuals behavior, way of life and
transportation to be used.
(7) A product goes from growth to maturity because of these reasons: -
Situation of market. i.e. Consumers have bought enough of a product or market had enough
of it.

Take over by competitors- the increase in sales and profit of the growth stage will tract
competitors to take the share of the existing market moving from growth to peck (maturity).

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(9) Personal selling is better than advertisement since it has an immediate two-way
communication with customers.
(11) It means we can easily increase, decrease or manipulate it in a better way than the other P’s
(marketing mixes).

3.13 REFERENCES

 Management, 11th ed, Kitab, Muha, 1997

C.B MAMORIA, Marketing Management,
 Management, 5th edition, prentice hally 1984.
Kotler, P. Marketing Management,
 Management, 9th ed, printice. Hall, 1998.
Kotler, Philip, Marketing Management,
 R.K MALHATYRO, Marketing Management 18th ed, Anmol, Pub. 1997.
 DIWAM, P. Marketing Management,
Management, Printice. Hall, 1998.
 marketing, 10th edition.
William J. Stanton, Fundamentals of marketing,
Unit 4: Local or Home Trade
Contents
4.0 Aims and Objectives
4.1 Introduction
4.2 Types of Local trade
4.2.1 Wholesale Trade
4.2.2 Retail Trade
4.3 Local Trade Transactions
4.4 Documents Required for Transactions
4.5 Summary
4.6 Answers for Progress Check Questions
4.7 References

4.0 AIMS AND OBJECTIVES

The main purpose of this session is to make students clearly understand the different types of
local trade and the various groups involved in the local trade transactions. It also aimed at

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 making students familiar with the important documents that are to be used as evidence during
the transaction process.
Therefore, after working through this study session, students would be able to:
 prepare purchase order;
 understand the various forms of payment for the purchase of goods on credit;
 know how to make payment through post office;
 identify important documents that are to be attached with the purchase order.

4.1 INTRODUCTION
Trade is one of the business activities, which is concerned with the sale, transfer, or exchange
of goods and services. It is a core part of business activity that includes transportation,
banking, advertising, insurance, warehousing etc.
Local trade or home trade implies the buying of goods within the boundaries of a country. The
payment for goods sold and bought is made in national currency either in cash or through the
banking system. This unit deals with the types of home trade, transactions and documents
used for transactions.

4.2 TYPES OF HOME TRADE

There are two types of internal (home) trade
4.2.1 Wholesale Trade
It refers to the purchase and sale of goods in bulk i.e, in large quantities directly from the
producer and sells them to retailers
4.2.2 Retail Trade
It involves the sale of goods to the ultimate consumers. The retailer can buy products from the
wholesaler or from the manufacturer and sells them to the final consumers.

4.3 LOCAL TRADE TRANSACTIONS

Transactions consist of a trade of values between two parties: one party gives something to
another party and gets another thing in return. The transactions involve agreement of

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 conditions, place and time. All business transactions are under taken by four groups of people.
These are:
1. Manufacturers or Producers
2. Distributors or Agents, Merchants
3. Dealers, Stockiest or Retailers
4. Consumers or Final users
Manufacturers are those who manufacture a product of their own. Buying from manufacturers
is generally cheaper and more dependable concerning delivery and repair or service facilities
than buying from wholesalers and retailers. For regular and large volume requirements
contracts arrangements with manufacturers would be advantageous.
Wholesalers are those who have the distributing rights of products manufactured by other
firms. Certain manufacturers sell their products only through the wholesalers or agent.
Retailers are those who stock and sell the product of others. They buy from the manufacturers
or wholesalers and finally sell them to consumers. Their prices are often higher from those of
the producers and the wholesalers because retailers have to add the carrying cost as well as
profit to the prices at which, they obtain products from the producers or wholesalers.
Consumers are those who buy products for their own personal consumptions.
4.4 DOCUMENTS REQUIRED FOR TRANSACTIONS
Business transaction requires some important documents for evidence. These documents are
important for facilitating exchange of goods and services. They are:
A. The proforma invoice
B. The quotation
C. The purchase order
D.The invoice
E. The document of payment for the goods
A. The Proforma Invoice: It is a form or document sent by the buyer to the seller, requesting
information about the price of the supplier's product compare it with the price of other
suppliers' product. That means it is a Quotation: is an offer made by the seller to buy certain
goods at specific price under certain conditions that are clearly stated. The conditions may
include the quantity, quality, price, terms of delivery and payment including the sample of the
product. The quotation should be numbered and sealed and a copy of it must be kept on file.

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B. The Purchase Order: the order is a written authorization to the supplier to supply the
particular material. It is evidence of contract between the buyer and the seller that binds both
the buyer and the seller to the terms under which the order is placed. Moreover, it is a
document, which gives the authority to the receiving unit to receive the materials ordered and
to the account unit to accept the bill from the supplier for payment. The purchase order can
be prepared in a number of copies to satisfy both the internal and external communication
need.
C. The request for information and should state the types of goods, quality, quantity and prices.
D. invoice: this document is prepared by the seller to the buyer after the
order is received and when goods are ready to be delivered to the buyer or after delivery of
goods.
Steps for preparation of an invoice is as follows:
1. As orders are received, they are stamped with the date of the receipt.
2. Then these orders are sent to the credit department for approval.
3. They are also sent to the invoicing department where invoices are
prepared which consist the following information’s
a. The invoice for the customer
b. An office copy from which the customer’s ledger account is
prepared.
c. A warehouse order copy instructing the warehouse to prepare and
pack the goods ready for immediate dispatch.
In some firms when there is a credit transaction, invoices are prepared after goods are
delivered to the buyer and “goods received memo is received by the buyer from the seller”
This “goods received memo” must be attached to the invoice to show the evidence of the
receipt of materials.

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 E. Payment: The finance or the account division will first of all check whether
the items supplied are on the basis of the purchase order. They compare the various reports
such as receiving, inspection and stores with the purchase order and finally make payment.
Payment will be made in different forms:
1. Payment in Cash - it is a form of payment for small amount when the
buyer handed over the money to the seller in person. I.e. as soon as goods/services are
received by the buyer, then the seller receives the cash.
2. Payment by Cheques - a cheque is a written order given by a customer of a
bank (drawer) requiring the bank (drawee) to pay on demand a specified some of money to a
person (payee) or to the bearer.
Types of cheques
There are two types of cheques namely order cheque an bearer cheque
a. Order cheque - on this type of cheque, the words “or order” are written after the name of the
payee. A payee is a person to who a cheque is to be paid.
These words imply that the payee may take the money himself/herself or may order the bank to
pay some body else.
b. Bearer cheque - on this bearer cheque, the words “or bear” appear after the name of the
payee. This kind of cheque may be drawn (cashed) by any one who bears (presents) it at a
bank on which it is drawn. Although bearer checks are legal, they are not in use in Ethiopia.
Any cheque must contain;
1. an unconditional order to pay a sum certain in money.
2. the name of the person (bank) who is to pay (drawee).
3. the place of the payment
4. the signature of the person who order the bank (drawer)
Characteristics of Cheques

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(a) Endorsement:
Endorsement: - an endorsement is the signature of the
payee put on the back of the cheque with or without a specific order. It transfers the right of
the payee to the person written on the cheque.
(b) Crossing the cheque: - it is an act of drawing two lines
vertically across its face. It means that the sum of the cheque will not be paid in cash but must
be transferred into an account.
(c) Dishonored cheques:
cheques: - when a bank refuses the payment of
checque, the cheque is said to be dishonored.
dishonored. There are some reasons that make cheques to
be dishonored. These are:
5. when the drawer has no account or has closed his/ her account with the bank.
6. when the cheque is post dated.
7. when there is insufficient money in the drawer’s account.
3. Payment by Credit Transfer:-
Transfer:- in this case, slip is prepared in duplicate,
showing the payees name, the amount to be paid, the payee’s bank and his/her account
number. This slip is presented to the bank with payment in cash or cheque. The first copy of
the slip is passed through the banking system to the payee’s bank, which will credit the
customer’s (payee’s) account and advises the customer of the payment.
Such credit transfers may take place by ordinary mail or by telegraph according to sender’s
wish. If the payee does not have a bank account, the bank still arranges payment to him/her to
come to the bank and collect payment.
4. The Postal Order (P.O): - this is a document ordering a post office to pay a
certain sum of money. The person who wishes to send the money buys the order of the
desired value from a post office and fills in the name of payee and the name of the post office
most convenient to the payee.
The postal order has two parts
I. The order itself that contains name of payee and the post office.

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II. The counter part, which contains summary of the order, which is
kept by the sender.
5. The money order (M.O): - this is an order to the post office to pay a sum of
money is known as money order. In this case, the sender fills an application showing the name
and address of the sender, the name and address of the payee, the name of the paying post
office and the sum of the money. The post office charges commission for such an order.
CHECK YOUR PROGRESS QUESTIONS
1. Explain the classification of home or internal trade.
………………………………………………………………………………………………………………………………………………
2. What are the parties that involve in the business transactions? Explain.
………………………………………………………………………………………………………………………………………………
3. What different types of documents are required for business transactions?
………………………………………………………………………………………………………………………………………………
4. Who prepare preforma invoice?
……………………………………………………………………………………………………………………………………………
5. What are the different ways of payment for business transactions?
………………………………………………………………………………………………………………………………………………
6. Describe the different types of cheques.
………………………………………………………………………………………………………………………………
7. What do you understand by the term “endorsement”?
………………………………………………………………………………………………………………………………………………
8. When would cheques become dishonest?
……………………………………………………………………………………………………………………………………………
9. Describe the different parts of postal?
………………………………………………………………………………………………………………………………………………

4.5 Summary

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In this study session you have looked at the classification of internal or home trade such as
wholesale trade and retail trade. You have worked to describe the different groups that
involved in the local trade transactions:
 the manufactures
 the distributors
 dealers and
 consumers
 You also studied the important documents that facilitate the exchange of goods and
service in internal trade transactions.
 The proforma invoices
 The quotation
 The purchase order
 The invoice
 The different forms of payment
4.6 Answers for progress check questions
1. a) whole sale trade b) retail trade
2. Manufacturers
Distributors
Dealers or retailers
Consumers
3. Proforama invoice
- The quotation
- The invoice
- Cheques
- Credit slips
4. The purchaser
5. Cash payment

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 - Payment by cheque
- Payment through post office
- Payment by credit transfer
6. Order cheque
- Bearer cheque
7. Putting ones own signature on the book of the cheque with or with out specific order
8. When;
- the drawer has no account or closed account
- the cheque is post dated
- there is insufficient fund
9. The order that contains the name of payee and post office
- The other part, which contains summary of the order, which is kept by the sender

4.8 REFERENCES

 management, 3rd ed.

Churchill Ford Walker, Sales force management,
 Richard R. Stiff, Edward W. cundiff, Moreman A.P Govanni, -Sales management, Decisions,
Strategies and cases 5th ed.
 Van Week, A.J, Purchasing Management,
Management, Chapman and Hall, 1994.
 Ballot Robert, Materials Management Tanaporevala.]
 Principles, 7th ed. 1994.
Pitman, Purchasing Principles,

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 Unit 6: Risk Management and Insurance

Contents
6.0. Aims and objectives
6.1. Introduction
6.2. Definition of risk
6.2.1. Types of business risk
6.2.2. Major Hazards and perils of risk
6.2.3. The process of risk management
6.3. Insurance: Basic concepts and its management
6.3.1. Definition of insurance
6.3.2. Insurable and non – insurable risks
6.3.3. Fundamental and legal principles of insurance
6.4. Summary
6.5. Answers for progress check questions
6.6. References

6.0 AIMS AND OBJECTIVES

The major objective of this unit is to introduce students with the various types and cause of
unexpected business risks and the way how to handle these risks. The unit enables the
students to know the steps to be followed in risk management. Further more, it helps the
students to clearly understand the different principles of insurance. Therefore, after reading
this unit students will be able to:
 understand the different types of business risks that the businessperson may
encounter.
 identify the difference between hazards and perils of these risks.
 understand and the process of risk a handling/risk management.
 explain the basic concepts of risk and principles of insurance.
6.1 INTRODUCTION

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 Risk is a danger of loss in the business activity due to unanticipated circumstances. Though
business aims at profit losses are quite possible and common. Risk or uncertainty arises
because the future is unknown and business has practically no control over several factors
affecting profits. In the business world as there is a chance of getting profit, there is also a
chance of loss or uncertainty of return on investment which is known as risk. This session deals
with the different types of risks, insurable and non-insurable risks, the process of risk
management and basic concepts of insurance.
6.2 DEFINITION OF RISK
Many scholars agree that there is no single universally accepted comprehensive definition of
risk. Different scholars such as psychologists, economists, statisticians, and engineers have
their own perception and definition of risk. Some of them defined risk as uncertainty
concerning the occurance of a loss. Others defined risk as a conditon in which there is a
possibility of adverse devation from what is expected. But the operational definition, which is
common to all, is that, risk is the probability of exposure to bad/adverse consequences such as
loss of property due to unexpected changes in the future.
6.2.1. Types of business Risks
The probabilities of exposure to adverse/bad consequences are numeriuous. The various types
of business risks that any businessperson may face can be classified into the following major
categories.
a. Property centerd risks: any business, whether it is big or small owns
properties or assets of different kinds such as buildings, machineries, materials etc. These
assets may be fully or partially damaged, destroyed, lost due to fire, earthquake, lightning,
windstorm etc. Such risks, which lead to physical damage, destruction or theft of property, are
known as property centered risks. Property centered risk cause direct financial loss which is
equal to the value of the property destroyed or indirect consequential loss which refers to
extra expenses or loss of income in the future as a result of such risk.
b. Market centered risk: any businessperson cannot be separable from the
environment that affects the business operation. The businessperson may interact with
different elements of the external environment such as customers, suppliers, labour market,
competitors and so on. The action and reaction between the business and the external
environmental changes may sometimes lead to undesirable consequences (risks) to the
business. These risks are known as market centered risks. These risks include:

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  business recession or economic decline in general
 undesirable price fluctuation
 production process and/or product obsolescence i.e. the company’s production process or
products may become obsolete if competitors introduce improved production technology or
product.
 bad-debt or risk of uncollictable accounts receivable if a customer who bought products on
account will die or disappear or will not be able to pay in any way.
 liability risk, which refers to losses or any other bad consequences such as bodily or property
damage to the third party due to the harmful nature of the products of the firm.
For example, product liability suit may be filed if a customer is injured, sick or sustained
property damage as a result of using the company’s product.
c. Employee centered Risks:
Risks: These risks are directly or indirectly related to
employee circumstances or the organization such as:
 work – place accidents and professional hazards, which may lead to employee – injury, partial
or total disability.
 employee frauds such as forgery, over – stating or understanding checks and other illegal acts
of an employee.
 employee strike which may cause considerable trouble and loss of income.
 loss of key employees or managers who have valuable specialized skill and experience which
can not be easily replaced. A company may loss key employees who are very important for the
success of the business due to sickness, death, resignation etc.
Based on their ultimate or final effect, the above different types of business risks are classified
in to two broad categories.
i. Pure risks which refer to the risks, which produce the possibilities of
adverse consequences (loss) or no loss situation. In this case, the possible ultimate effects are

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 loss if risk occurs or no loss if risk does not occur. E.g. the above-mentioned property centered
and personal risks fall under this category.
ii. Speculative risks which refer to risks, which produce the possibilities of
adverse consequences (loss) or favorable situations (profit). In this case, the ultimate effects
are ether profit or loss. E.g. Market entered risks are classified under this category.
6.2.2. Major Hazards and Perils of Risk
It is very important to distinguish between a hazard, which refers to a condition, which creates
and/or increases the probability of occurrence and severity of a particular risk and the peril
which is the main cause of a particular risk.
Example-defective electric wiring is the hazard or the condition that aggravates the probability
and severity of fire risk while fire is a peril (the cause) for property damage.
 If we take the risk of flood damage, flood is the cause of the loss and the fact that one of the
houses was on the bank of the river influences the outcome. In this case flood is the peril and
the proximity of the house to the river is the hazard.
There are three major types of hazards;
Physical hazards which refers to a physical condition, which increases the chance of risk such
as:
 Icy road which aggravates auto accident
 Defective wiring which aggravates fire risk
 Defective door – lock which aggravates theft
b. Moral hazard refers to dishonesty, fraudulent claims or deliberate defective character of an
individual, which increases the frequency, and severity of risk such as
 Intentionally burning unsold merchandise
 Intentionally inflating insurance claims
c. Moral Hazard, which refers to individual carelessness, negligence or indifference to risk or
loss because of the existence of insurance such as
 Smoking around the gasoline stations

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 Leaving ignition key in the car and increasing the chance of loss
 Leaving doors unlocked and increasing the chance of burglary
6.2.3 The process of Risk management
Risk management is defined as “a systematic process for the identification and evaluation of
pure loss exposure faced by an organization or individual and for the selection and
implementation of the most appropriate techniques for treating such exposures” (G.Rejda:
1995:38). As clearly indicated in the definition, risk management requires the performance of
sequential activities known as process /steps of risk management. The following are the steps
to be followed by the risk manager.
1. Analyzing the situation and identifying potential risks. The first
step in the process of risk management is conducting environmental examination i.e. past,
current or present and prospective future situation analysis with special reference to the
possibilities of exposures to adverse or undesirable consequences. In general, risk exposures
based on their analysis, anticipating and identifying the types of risks that the businessmen
may face in the future and also their possible causes.
2. Evaluating and determining the frequency of accurate and
severity or magnitude of possible losses due to anticipated risks.
3. Based on step 2, selecting the appropriate risk handling
mechanism (strategy) for handling anticipated risks.
Based on the frequency and severity of loss exposure (s) or anticipated risks, the risk manager
need to select the most appropriate strategy or combination of strategies for handling
anticipated risks.
The most common risk handling strategies, which are further divided into specific techniques
and appropriate situations fro each technique, are discussed as follows;
a. Risk control techniques (minimizing or avoiding losses through risk prevention or avoidance).
These are two situations.
i. Risk prevention (control): taking risk preventive measures to reduce
the frequency and severity of loss.

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 Example: quality control
Installing fire extinguisher, burglary alarm
Strict adherence to safety rules etc
This technique is appropriate when risk frequency is high and severity is low.
ii. Risk avoidance: Abandoning activities, which have high risk frequency and severity.
Example; avoiding construction in rift valley or flood area, avoid skiing over the ice etc
This technique is appropriate when frequency and severity are high.
b. Risk financing techniques (paying for the loss if risk happens)
Again there are two situations for this technique
i. Risk retention (self insurance): This means allocate money and pay for or recover the loss if
risk happens. This technique is appropriate when loss is predictable and when frequency and
severity of risk are low.
ii. Insurance (Transfer): This is simply purchase insurance policy and transfer the risk to the
insurance company. This method is appropriate when severity is high and frequency is low.
4. Implementing the chosen or selected risk-handling strategy.
Based on the situation, the risk manager may choose either any one of these or the
combination of the above-mentioned techniques. The selected technique should be
implemented or put into action.
5. Monitoring and evaluating and implementation of the selected
risk management strategy. The last step in the process of risk management is monitoring the
implementation process to make sure that the selected strategy is implemented as planned.
Monitoring requires periodic review of the implementation process, comparing actual
performance with planned and taking corrective action if there is any devation between actual
and planned performance. Finally, conducting impact assesspcent or evaluating at the end of
the planning period is essential in order to identify the efficiency and effectiveness of the
chosen strategy.

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 6.3 INSURANCE: BASIC CONCEPTS AND ITS MANAGEMENT
Many people confuse the concept of risk or risk management and insurance or insurance
management. But there is a clear distinction between these two concepts. In the previous
sections, it is indicated that insurance is only one of the four alternative strategies of
handling risk. In the following section an attempt will be mode to discuss an over view of the
basic concept of insurance
6.3.1. Definition of Insurance
Even though, there are various definitions of the term insurance, many writers focus one more
comprehensive definition. That is insurance is defined as a legal contract whereby one party
called the insurer or insurance company agrees to reimburse, recover or indemnify another
party called the insured (an individual, group or organization) if the insured suffers specific
monetary loss. As we can see in the definition insurance is a contract between the insurer and
insured whereby the insured transfers his/her potential risk to the insurance company.
However, in order for a particular insurance contract to be legal documents, it should be
written and supported by appropriate insurance policy document The insurance policy
document contains the following major elements.
- Statements, which provide information about the name, address,
sex, age and other attributes of the insured.
- Identification and location of property, period of protection, amount
of premiumr, and other relevant information.
- Definition of key terms and phrases in the policy.
- Summary of the major promises of the insurer and the insured and
the conditions under which the payment will be made.
- Conditions or provisions that qualify or place limitation on the
insurer’s promise.

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- The manner of relationships between the insurer and insured and
the third party etc.
6.3.2. Insurable and Non-Insurable Risks
Basically all risks may not be insured. Depending up on the nature of the property, type of risk
perils and hazards, while some risks are insurable others are uninsurable. Insurable risks fulfill
the following requirements;

a. There must be large number of exposure unit: since insurance companies operate under the
law of large numbers, there must be a large number of exposure unit subject to similar peril.
b. The expected loss need to be calculable, determinable and measurable: That means the loss
must be definite to a particular peril, time, place and amount.
c. The loss need to be accidental unintentional i.e. insurers do not pay for the losses intentionally
caused by the insured.
d. Calculable chance of loss: i.e. the insurer must be able to calculate the average frequency and
the severity of anticipated future loss.
e. The expected loss must be financially serious and the premium need to be economically
feasible to the insured.
f. The loss need not be catastrophic in a sense that large
portion of the exposure units (insured) should not incurr losses at the same time. That means
the risk must not affect all insured simultaneously. In addition to the above,
The following are also included in the uninsurable risks;

a. perils such as nuclear radiation

b. loses such as losses due to negligence
c. property such as animals and birds incase of home insurance.
6.3.3. Fundamental and Legal Principles of Insurance
In the insurance contract, the two parties, (the insured and the insurer) must be governed by
the following legal principles.

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1. The principle of utmost good faith: This principle states that high standard of honesty must
exist between the two parties to the contract. That means both parties to the contract must
make full and fair disclosure of all material factsrelated to the contract. Neither party shall try
to take advantage behind the other party’s lack of information. There should not be
misrepresentation and/or concealation of material facts either innocently or deliberately.
2. The principle of Indemnity: This principle states that the insured should not collect more than
the actual loss in the event of risk or damage. That means, the insured should not profit from a
coverd loss but restores (indeminified) to the same financial position that existed perior to the
occurance of the loss.
3. The principle of insurable interest. This principle refers to the financial interest of the insured
towards the subjects insured. That means the insured must lose financially or must suffer
some other kind of harm if loss occurs in the event of risk. The insured is said to have financial
interest if she/he benefits from the existence and suffers from the destruction or loss of the
subject insured.
4. The principle of subrogation: This principle states that the insurer who indeminifed
(compensated) the insured’s loss is entitled to be recovered from any liable third party
(parties) responsible for the loss. In insurance, the principle of subrogation substitute the
insurer in place of the insured for the purpose of claiming compensation (indeminity) for a loss
covered by the insurer from a liable third person. There fore, any businessperson is required to
know, understand and act in accordance with the stated fundamental legal principles of risk
and insurance.

6.4. SUMMARY
All businesses in one way or another involve some element of risk and uncertainty that might
happen due to various factors. While the business is in operation, there might be a danger of
loss from unforeseen circumstances such as fire accident, flood deterioration, theft, bad debt

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 and general finical problems, which are outside the control of the owner of the business. Risks
can be classified as:
 Property centered risks which are the loss or damage of the properties of the businesses.
 Market centered risks which occurred as a result of price fluctuation and due to the element of
external environment such as customers, suppliers, labor market, competitors etc.
 Employee centered risks such as work place accidents, employee frauds, death of key
employee etc. It is possible to classify risks into two broad categories: pure risks and
speculative risks. Pure risks are risks, which produce the possibilities of loss or no loss
situations. Speculation risks are risks which produce the possibilities of adverse consequence
(loss) or favorable consequence (profit).
Many of the risks arising due to various unexpected circumstances can be minimized by the
use of insurance. Insurance is an agreement between the insurer and the insured thereby the
insured transfers the potential risk to the insurance company. Both the insurer and the insured
should understand the legal principles of insurance such as the principles of indemnity,
insurable interest, subrogation and utmost good faith.
Check Your Progress Exercise
1.What is risk? Define it.
………………………………………………………………………………………………………………………………………………
2. Explain the different types of business risks.
……………………………………………………………………………………………………………………………………………
3. Give example for pure risks and speculative risks.
………………………………………………………………………………………………………………………………………………
4. Explain the different between perils and hazard.
……………………………………………………………………………………………………………………………
5. List the different types of hazards.
………………………………………………………………………………………………………………………………………………
6. Write the steps of risk management.
………………………………………………………………………………………………………………………………………………

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7. What are the different types of risk handling techniques. List
them.
………………………………………………………………………………………………………………………………………………
8. What is insurance? Define.
……………………………………………………………………………………………………………………………………
9. Explain the requirements for insurable and uninsurable risks.
………………………………………………………………………………………………………………………………………

10. What are the different principles of risks?

………………………………………………………………………………………………………………………………………………
6.5 ANSWERS TO CHECK YOUR PROGRESS EXERCISE
1. Risk is the probability of exposure to bad/adugse consequence such as loss of property due to
some unexpected accidents.
2. Property centerd risks, market centered risks and employee centered risks.
3. Example of pure risks are property centered risks such as fire, earth quake, lightning winds
tormovtce
Examples of speculative risks are market centered risks like price fluctuation, bad debts,
liability risk etc.
4. Perils are the main cause for a particular risks where as hazards are conditions that increase
the probability of occurrence and severity of a particular risk.
5. Physical hazard
Moval Hazard
Moral Hazard
a. Analyzing the situation and identifying potential risks.
b. Evaluating and determining the frequency of risks
c. Select the appropriate risk handling techniques
d. Implement the selected risk handling strategy
e. Ronitoring and evaluating the emplementaion

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6. Risk control techniques such as
 Risk prevention (control)
 Risk avoidance
Risk financing techniques like
 Risk retention (self insurance)
 Insurance (transfar)
7. Insurance is a contract between the insurer and the insured these by the insured transfers the
potential loss to the insurance company.
8. These must be large number of exposuse units
 The expected loss must be calculable, determinable and measurable.
 The loss must be accidental and un international
 Calculable chance of loss
 The loss must not be catastrophic
 The expected loss needs to be financially serious.
9. The principles of utmost good faith, insurable interest, subrogation and
indemnity.

6.6 REFERENCES
 C. Arthur Williams, Jr. and Richard M. Heins, Risk Management and Insurance 5th ed. 1993
 Jons, Richard E.
E. Risk based Management,
Management,
 Goplakrishnan, Insurance principle and practices
 Hailu felek, Risk Management and insurance;
insurance; Addis Ababa
University.

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 UNIT 7: BUDGET PREPARATION – ETHIOPIAN CONTEXT
Contents
- Aims and Objectives
- Introduction
- Banking and Monetary Policy
- The Context of Budget Reform
o Decentralization
o Fiscal Federalism
o Expenditure Assignment
- Budget Administration
- Budget Preparation Process
o Budgeting at the Federal Level
 Recurrent Budget
 Capital Budget
o Budgeting at the Regional Level
 Recurrent Budget
 Capital Budget
- Summary
- Answer to Check Your Progress

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 Aims and Objectives

After studying this unit, you will be able to explain:

- what budget reform is
- the budget preparation process at federal level, and
- the budget preparation process at regional level.

INTRODUCTION
The working definition made by the World Bank, Governance refers to the process whereby
elements in society wield power and authority, and influence and enact policies and decisions
concerning public life, economic and social development (World Bank, 1999). For being
effective, fiscal policy implementation requires coordination of political, functional and
financial factors. Politically, the institution requires coordination of political, functional and
financial factors. Politically, the institutional incentive structure should promote accountability
and incentives. Functionally, policies should clearly delineate the responsibilities of each type
of government and the private sector in the implementation process. Financially, policies
should be based on a sustainable strategy that relies on long-lasing sources of revenues. If
these three factors coordinated, one can say there is good governance in that particular
country. Decisions about raising fiscal revenues, and planning and implementing public
expenditures take place in the context of a political and incentive framework influenced by
several actors intervening through the process: Ministers, government institutions and staff,
donors providing budgetary support, and civil society, to the extent that they participate or are
given the opportunity to participate in the decision making forum. Fiscal performance and
budget management effectiveness are determined by how this framework is established. For
that reason, before going to evaluate the IPRSP done by our country, first it is better to look
the non-execution factors that led for the transformation of government budgets. With the
ending of the internal arm conflict in the country, public expenditure was re-oriented towards

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social and economic development. Importantly, the share of government recurrent
expenditure on education was raised from 11.9 percent in 1998/90 to 17.9 percent in
1996/97, and that of health from 3.5 percent to 5.8 percent. Moreover, emphasis was placed
on primary education and health care, to help tackle poverty at its root.

BANKING AND MONETARY POLICY

The 1974 revolution brought major changes to the banking system. Prior to the emergence of
the Marxist government, Ethiopia had several state-owned banking institutions and private
financial institutions. The National Bank of Ethiopia (the country's central bank and financial
adviser), the Commercial Bank of Ethiopia (which handled commercial operations), the
Agricultural and Industrial Development Bank (established largely to finance state-owned
enterprises), the Savings and Mortgage Corporation of Ethiopia, and the Imperial Savings and
Home Ownership Public Association (which provided savings and loan services) were the
major state-owned banks. Major private commercial institutions, many of which were foreign
owned, included the Addis Ababa Bank, the Banco di Napoli, and the Banco di Roma. In
addition, there were several insurance companies.
In January and February 1975, the government nationalized and subsequently reorganized
private banks and insurance companies. By the early 1980s, the country's banking system
included the National Bank of Ethiopia; the Addis Ababa Bank, which was formed by merging
the three commercial banks that existed prior to the revolution; the Ethiopian Insurance
Corporation, which incorporated all of the nationalized insurance companies; and the new
Housing and Savings Bank, which was responsible for making loans for new housing and home
improvement. The government placed all banks and financial institutions under the National
Bank of Ethiopia's control and supervision. The National Bank of Ethiopia regulated currency,
controlled credit and monetary policy, and administrated foreign-currency transactions and
the official foreign-exchange reserves. A majority of the banking services sere concentrated in

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 major urban areas, although there were efforts to establish more rural bank branches
throughout the country. However, the lending strategies of the banks showed that the
productive sectors were not given priority. In 1988, for example, about 55 percent of all
commercial bank credit financed imports and domestic trade and services. Agriculture and
industry received only 6 and 13 percent of the commercial credit, respectively.
To combat inflation and reduce the deficit, the government adopted a conservative fiscal
management policy in the 1980s. The government limited the budget deficit to an average of
about 14 percent of GDP in the five years ending in EFY 1988/89 by borrowing from local
sources. For instance, in EFY 1987/88 domestic borrowing financed about 38 percent of the
deficit. Addis Ababa also imposed measures to cut back capital expenditures and to lower
inflation. However, price controls, official overvaluing of the birr, and a freeze on the wages of
senior government staff have failed to control inflation. By 1988 inflation was averaging 7.1
percent annually, but it turned sharply upward during 1990 as war expenditures increased and
was estimated at 45 percent by mid 1991.
The Government of Ethiopia under the civil service reform plan has prepared a manual to
describe, analyze and make recommendations for the preparation of recurrent and capital
budgets at the federal and regional level. The manual is intended to be a living document and
it is expected that future various will add to and amend earlier versions. The manual is
intended to serve several purposes as described below.
1. Provide a context and detailed assessment of the budget process for making procedural
recommendations for implementation under the civil service reform.
2. Serve as an operational guide to budgeting.
3. Serve as a training resources, and
4. Provide a detailed information source for the partial development of the requirements
documents for the automated financial information system to be implemented under civil
service reform.

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 THE CONTEXT OF THE BUDGET REFORM
The central context of budget reform is Ethiopian's ambitious decentralization. Administrative
responsibility has been devoted to regions and within regions administrative responsibility is
being devolved to zones and woredas.
To understand financial administration in Ethiopia one must understand three frame works:
1. decentralization as devolution
2. the functions of public finance especially the allocation role and fiscal federalism, and
3. the assignment of expenditure functions under fiscal federalism.
Decentralization
There are three types of decentralization; deconcentration, devolution and privatization.
Deconcentration is the distribution of administrative functions within a single administrative
hierarchy. For example, a Ministry of Agriculture with region level branch offices reporting to
the ministry headquarters is an example of deconcentration. Devolution is the assignment of
administrative functions to autonomous or semi autonomous administrative hierarchies.
Ethiopia's regional states are an example of devolution. Finally, privatization is the assignment
of public tasks to private or quasi-private agencies. Privatizing the provision of health or
education would be an example of this decentralization.
While the pattern of decentralization in Ethiopia context is complex, varied and uneven
devolution is the dominant type. Devolved decentralization has the following attributes.
 The fundamental characteristic of devolved administrative systems is an evolving partnership
between administrative levels; federal to regions, region to sub regions.
 Partnership is build both by the reform processes and products, which promote discretion by
local authorities.
 Effective discretion requires capacity and accountability.
 The goal of devolution is increased discretion, which requires the capacity to exercise
discretion and political and administrative accountability.

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 Implementation dilemma: how to make progress in building the partnership in a reasonable
time frame while paying attention to both process and product etc.
Fiscal Federalism
Placing the decentralization framework into a financial framework raises the three functions of
public finance: stabilization, distribution and allocation. Public finance holds that the
stabilization function (managing monetary aggregates) should be centralized. The distribution
function which is to promote equity in resources has traditionally been viewed as a centralized
financial function though in recent years strong arguments have been raised that this function
can be decentralized. The use of formulas to assign subsidies between sub regional levels in
Ethiopia supports the argument that the distribution function can be decentralized. The
allocation function of public finance is the distribution of goods and services and it is broadly.
The body of financial theory explaining the decentralized allocation function is called Fiscal
Federalism. Fiscal federalism is the financial framework of decentralization.
Fiscal Federalism has five principles.
1. Local management of resources responds better to local preferences.
2. It may be more efficient to assign expenditures to the lowest level of
government consistent with efficient performance.
3. Administrative levels are accountable to local tax payers and accountable
to the administrative levels above which transferred the funds.
4. Fiscal equalization
5. Increases the stake in the process by local institutions and individuals.
The essence of fiscal federalism is improved management of resources through decentralizing
discretion to the lowest level where it can reflect preferences and be held accountable. The
central design issue of fiscal federalism is where to assign expenditure authority

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 Expenditure Assignment
The central task of fiscal federalism is the assignment of discretion over expenditure. A
framework for assigning expenditure functions is therefore needed. In budgets there are two
areas of discretion: how allocations are made and how costs are determined.
1. Allocations: there are types of allocations. Allocating a budget ceiling and
allocating from a budge ceiling. A ceiling is an overall sum from which allocations are made. In
some cases one level allocates a ceiling to another level and in other cases one level specifies
detailed expenditure items to another level.
Both these types of allocation decision may be:
a) arbitrary and subject to negotiation
b) governed by norms, standards, or formulate and therefore not arbitrary
c) based on last year's allocation.
The allocation criteria need to be specified and analyzed to determine whether they are
reflected in the budget and later in expenditures.
2. Costs: although allocation decision may be made at a given levels, these
may be constrained. They may be constrained by legislation, regulations and by other types of
policy. They are also constrained by the degree to which at any given level there exists choice
about costs. The "top" may set in place direct constrains (laws, regulations etc) and indirect
constraints (the fixing of cots, e.g., national salary scale). Thus, although there may be some
discretion over allocation, there may be less discretion over costs.
3. Policy: A budget is a financial expression of a policy. An annual budget
reflects the planning of expenditures for that year. Allocations therefore are /should be
based on the achievement of a given policies (e.g., increased enrollment, improved quality).

BUDGET ADMINISTRATION
PROCLAMATION NO. 358/2003
FEDERAL GOVERNMENT BUDGET PROCLAMATION

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 WHEREAS, it has become necessary to approve and disburse on time the budgetary
appropriation for undertakings by the Federal Government during the 1996 (E.C) Fiscal Year.
WHEREAS, the subsidy budget that may be appropriated to the Regions has to be decided on
the basis of the formula developed by the House of Federation;
NOW, THEREFORE, in accordance with Article 55(1) and (10) of the Constitution of the Federal
Democratic Republic of Ethiopia, it is hereby proclaimed as follows:
PART I
General
Article 1: This Proclamation may be cited as the "1996 Fiscal Year Budget Proclamation No.
358/2003."
Article 2: The Federal Budget is hereby appropriated for the fiscal year commencing on Hamle
1,1995 E.C and ending on Sene 30, 1996 E.C. from Federal Government revenues and other
funds for the undertakings set forth in the Schedule hereto:
(a) Fore Recurrent Expenditure Birr 7,885,500,000
(b) For Capital Expenditure Birr 5,404,911,028
(c) For Subsidy Appropriation to regions Birr 5,969,800,000
Grand Total Birr 19,260,211,028
(Nineteen Billion Two Hundred Sixty Million Two Hundred Eleven Thousand Twenty Eight Birr).
Article 3: The Ministry of Finance and Economic Development is hereby authorized to grant
advance of salary to permanent Federal Civil Servants for necessary cases in accordance with
directives issued thereon, and to fix the period of repayment thereof, and to collect interest
thereon, at the rate fixed by the directives to be issued by the Minister of Finance.
PART II
BUDGET ADMINISTRATION
Article 4: Powers of the Federal Government Organs

125
1) The Minister of Finance and Economic Development is hereby authorized
and directed, upon the request of the heads of the concerned Federal Government organs,
to disburse out of the Federal Government revenues and other funds the amounts
appropriated herein for undertakings of their respective organs.
2) The Minister of Finance and Economic Development is hereby authorized to allow Federal
Government Hospitals, to retain and expend within their total budgetary appropriations,
receipts from the current fiscal year up to an amount not exceeding 50% (Fifty percent) of
their receipt for the previous fiscal year.
3) Public bodies are hereby authorized to record on their appropriate budgetary head,
subhead, project, or program, as the case may be, and undertake all acts necessary for the
utilization of any additional loan or aid in kind and/or cash obtained from foreign or local
sources for carrying out capital project or recurrent programs, and report to the Minister of
Finance and Economic Development within one month from the end of the budget year.
4) The Ethiopian Customs Authority shall assess and record duties and taxes payable on goods
imported by public bodies, purchased with the proceeds of loans, or grants and
appropriated from the treasury or acquired in kind, and allow such goods to enter into the
country. The Authority shall notify the assessment, thus recorded to the public body
concerned.
5) If the agreement signed between the consultant and the project executing public body
stipulates that the income tax and the service sales tax payable by the public body, the same
shall inform the Federal Inland Revenue Authority. The federal Inland Revenue authority
shall on the basis of information it obtained from the public body keeps record of such
taxes. The authority shall also notify the public body of such record.
6) The Public Body, which received the notification, mentioned under sub-Article 4 and 5 above
shall record the amount of taxes and duties under its heading; sub-heading, program,
project and shall, within one month from the end of the budget year, communicate to the

126
 Ministry of Finance and Economic Development the Taxes and duties payable on goods for
which budget from the payment of the tax not already been appropriated.
7) The Ministry of Finance and Economic Development is further authorized and directed to
record as supplementary appropriation the additional loan or aid in kind and/or in cash
recorded pursuant to Sub-Article (3) and (6) of this Article.
8) The Minister of Finance and Economic Development is hereby authorized to set-up special
fund to be financed out of the proceeds of foreign loans and assistance obtained for the
reconstruction of infrastructures and other properties destroyed in the course of Ethio-
Eritrean conflict and to demobilize a portion of the defence force in order to reduce its size
to peace time requirements and to rehabilitate the demobilized members of the force in a
special program.
9) The Minister of Finance and Economic Development shall issue directive outlining conditions
under which the fund setup in accordance with Sub-Article 8 shall be administered.
Article 5: Budget Transfer
Without prejudice to the provisions of Article 17-20 of the Federal Government of Ethiopia
Financial Administration Proclamation No. 57/1996 budget transfer shall be executed as
follows:
1) Where a budget is required to finance pending obligations of a project approved in previous
years, such budget shall be allocated in the following manner:
a. If the budget can be covered by transfer from the capital budget of the public body, such
transfer may be authorized by the Ministry of Economic Development and Co-operation.
b. If the budget can be covered within the overall capital budget ceiling by transfer of capital
budget of one public body to the other, such transfer may be authorized by the Council of
Ministers on the basis of the recommendations submitted by the Ministry of Economic
Development and Co-operation.

127
 2) Transfer of recurrent budget from one public body to the other can be made upon
authorization of the Council of Ministers.

FEDERAL GOVERNMENT
SUMMARY OF REVENUE, EXTERNAL FUNDS AND DOMESTIC LOAN SUMMAR
(A) Domestic Revenue Birr
Tax Revenue 8,588,305,263
Non-Tax Revenue 1,945,304,152
Capital Revenue 359,673,355
Domestic Revenue Total 10,893,282,770
(B) External Assistance
Multilateral Institution 746,945,350
Bilateral Assistance 579,269,170
Counter Part Fund Assistance 2,474,850,263
HIPC Relief Assistance 819,063,431
External Assistance Total 4,620,128,214
(C) External Loan
Multilateral Institutions 2,142,696,544
Bilateral Loan -
Counter Part Fund Loan 240,103,500

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 External Loan Total 2,382,800,044
(D) Domestic Loan 1,364,000,000
Total 19,260,211,028
Budget Preparation Process
Budgeting at the Federal Level
The recurrent budget is not defined in the financial law or the financial regulations. The
financial law does provide a definition of the capital budget thereby residually defining the
recurrent budget. There is considerable uncertainty amongst budget staff as to what
expenditures should be placed in the recurrent or capital budget. The financial law defines the
items of expenditure for the capital budget as fixed assets or consultancy services.
Analysis of recurrent budgets though show that fixed assets which are not associated with an
external assistance project are frequently budgeted in the recurrent budget. It is also not clear
how to budget those externally financed projects which build capacity (training, technical
assistance) as opposed to those that install or build fixed assets.
There are a variety of criteria that can be used in defining recurrent and thus capital budgets.
The three most common are source of finance (domestic, external), status of expenditure
(project versus program), and object of expenditure (fixed asset, consultancy service, etc). The
financial law has defined the budget through the object of expenditure making the recurrent
budget residual to the definition of the capital budget.
The recurrent budget at the federal level, which consolidates and coordinates the recurrent
budgets of all Federal Public spending bodies, is prepared by the budget department of the
ministry of finance.
The Ministry of Finance are authorized by the Federal Government during the 1996 (G.C) fiscal
year under the proclamation No 358/2003. Some of the authority issued to MOF are quite
illuminating and worth discussing.
Article 3 of proclamation no 358/2003 states that: The Ministry of Finance and Economic and
development is here by authorized to grant advance of salary to permanent federal civil

129
servants for necessary cases in accordance with directives issued thereon, and to fix the period
of repayment thereof, and to collect interest thereon, at the rate fixed by the directives to be
issued by the Ministry of Finance.

Recurrent Budget
FEDERAL GOVERNMENT
RECURRENT BUDGET
Description Recurrent Budget
1 2
TOTAL 7,885,500,000.00
ADM. & GEN. SERVICE 3,755,926,900.00
Organs of State 76,548,300.00
Justice and Public Order 223,982,800.00
National Defence 3,000,000,000.00
General Services 455,395,800.00
ECONOMIC SERVICE 396,071,700.00
Agric. And Natural Resources 110,093,600.00
Water Recourses 29,521,300.00
Industry and Trade 73,655,700.00
Mining and Energy 31,550,600.00
Transport and Communication 120,535,700.00
Construction 30,714,800.00
SOCIAL SERVICE 740,080,400.00
Education Trading 586,671,200.00
Culture and Sport 27,887,800.00
Health 74,642,900.00
Labor and Social Affairs 26,644,800.00

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Prevention and Rehabilitation 24,233,700.00
OTHER PAYMENTS 2,993,421,000.00
Transfer 10,507,600.00
Regional Subsidy
Public Debts 2,411,000,000.00
Provisions 369,200,000.00
Others 202,713,400.00

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 The budget preparation process is as enumerated below:
Preparation of Recurrent Budget in the MOF

Preparation of the macro framework

Allocating public expenditure between the federal and

regional governments

Allocating between recurrent and capital budget at federal

level

Budget call and ceiling notification by ministry of finance

Submission of the budget proposal to the ministry of

finance

Budget hearing with the ministry of finance

Review and recommendation by ministry of finance

Submission to the council of ministers

Submission to the council of peoples' representatives

Notation and publication

Allotment

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Preparation of the Macro Framework
This is an assessment of the economic situation and establishment of fiscal balance (GDP,
growth rate, etc). This stage includes two steps:
collecting and analyzing information regarding the performance of the economy in the previous
fiscal years,
economic protection such as growth, revenue estimating for the next year which is done by the
coordinating ministries (ministry of economic development and cooperation and ministry of
finance) with consultation with the National Bank of Ethiopia, the central statistics authority
and other relevant institutions. The macro framework is reviewed and approved by the prime
minister's office.
Allocating Public Expenditures Between the Federal and Regional Government
This step determines the amount of subsidy to regional governments. After preparing the
revenue estimation of total government expenditure (fiscal plan) a decision usually is made by
prime minister's office for allocating the shares to the federal and regional governments. The
distribution among regions is done by the Federation council with consultation of the Prime
Minister's office, Ministry of Economic Development and Cooperation, and Ministry of
Finance. Allocation between regions is based principally upon a formula, such as population,
level of development, revenue generation capacity. The price minister's office reviews the split
and then presents to the federation council.
Allocating Between Recurrent and Capital Budget at Federal Level
Depending on various factors, the PMO with consulation of ministry of economic development
and cooperation and the ministry of finance determines how much is to be allocated to
recurrent and capital expenditure. The decision is based on the following factors:
government prioritized sectors
non-discretionary expenditures

133
on going projects, and
institutional capacity
Budget Call and Ceiling Notification by the Ministry of Finance
The ministry of finance provided each spending public body a recurrent ceiling in the budget
call.
The ministry of finance prepares a proposal for the total recurrent budget and allocations to
spending public bodies.
The prime minister's office reviews the ministry of finance's proposal and makes adjustment.
The ministry of finance releases the budget ceiling to the line ministries in a budget call.
The budget call provides each ministry the following information: the macro economic
environment, an aggregate recurrent budget ceiling, and priorities to budget.
Submission of the Budget Proposal to the Ministry of Finance
Prior to a formal budget hearing, spending public bodies submit their budget proposals to the
ministry of finance. The budget submission is given to the budget department of the ministry
of finance for study. The ministry of finance prepares an issue paper on the major issues at
each head level in the proposed budget. Spending public bodies can submit above the ceiling
but have to have a compelling justification for a higher ceiling such as new priority activity.
Budget hearing with the Ministry of Finance
Spending public bodies defend their budget submission in a formal hearing with the ministry
of finance. The budget hearing includes ministers and/or vice ministers, heads of public bodies
and relevant department heads and budget experts from the spending public bodies and their
ministry of finance.
Spending public bodies can challenge the ceiling at the budget hearing. The heading focuses
on policies, programs, and cost issues.
Review and Recommendation by the Ministry of Finance

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 The budget committee of the ministry of finance reviews the discussion and make a
recommendation. If there is an increase in the spending public body's ceiling this has to go to
the prime minister's office for approval. Usually the ministry of finance recommends the
budget to the council of ministers.
Submission to the Council of Ministers
The recommended budget is submitted to the Deputy prime ministers in economic affairs
summon individuals from each ministry as required. Once reviewed, the budget is then
presented to the prime minister along with a brief. The prime minister may or may not make
amendments and then the budget is sent to the council of ministers for discussion.
Submission to the Council of Peoples' Representatives
Once approved by the council of ministers, the prime minister presents both the capital and
recurrent budgets to the council of peoples' representatives. The budget committee of the
council reviews and makes recommendations to the council.
Notification and Publication
The budget is appropriated by the council of peoples' representatives and is published in the
Negaret Gazeta. Spending public bodies are formally notified of their budget for the next
financial year by the release of Form 3/1 from the ministry of finance. Until Form 3/1 is
received, spending public bodies are authorized to spend one-twelfth of the previous years
budget with no provision for new expenditures (e.g., new staff posts). Form 3/1 is sent to the
Treasury Department of the ministry of finance which disburses funds to spending public
bodies.
Allotment
The public bodies are required to prepare salary allotment, work plan and cash flow and
submit to the ministry of finance. The allotment is verified by the ministry of finance and then
sent to the treasury department along with Form 6 which authorizes the disbursement.

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Capital Budget
Ethiopia has a dual budget system with capital and recurrent budgets prepared separately by
planning and finance institutions respectively. The budget preparation process calendars of
recurrent and capital budgets are different. The process of budgeting begins with the federal
coordinating ministries (ministry of finance and ministry of economic development and
cooperation), which determines the budget ceiling for federal spending public bodies and the
grants to the regions. The ministry of economic development and cooperation prepares the
grant formula, which the prime minister's office uses to issue the regional grants. The ministry
of economic development and cooperation also issue the capital budget ceiling for the federal
spending public bodies. The ministry of finance issues the recurrent budget ceiling to the
federal spending public bodies.
A capital budget is broadly describes as an outlay on projects that results in the acquisition of
fixed assets and the provision of development services. The financial law defines capital
expenditure as the "outlay of the acquisition of or improvements to fixed assets, and includes
expenditures made for consultancy services." Such outlays include: expenditure on physical
and social infrastructure, machinery and equipment, research studies and design,
management, supervision and direct labor costs, transfer payments like taxes related to
projects. The concept of a capital budget has therefore a wider coverage than simple outlays
in fixed investments, since it includes expenditure on development services like agricultural
research and transfer payments related to a project.
The capital budget is presented in two ways: by economic category and by appropriating
agency by code of expenditure. Individual projects are detailed under such sectors as
"agriculture development", "road construction" and the like. Project activities are further
codified by items of expenditure.
Currently the composition of capital expenditure in Ethiopia tends to increasingly shift towards
expenditure on physical infrastructure, which is an element of the economic development

136
category and the social infrastructure, which is included in the social development category.
This allocation is mainly due to the low level of the existing infrastructure development which
cannot be left to the private sector.
Preparation of the capital budget involves seven distinct stages with some reiteration
whenever there is a need.
FEDERAL GOVERNMENT
CAPITAL BUDGET
Description Capital Budget
1 2
TOTAL 5,404,911,028.00
ADM. & GEN. SERVICE 188,063,500.00
Organs of State
Justice and Public Order 68,861,800.00
National Defence 24,783,200.00
General Services 94,418,500.00
ECONOMIC SERVICE 3,401,311,638.00
Agric. And Natural Resources 637,869,387.00
Water Recourses 159,914,750.00
Industry and Trade 29,815,575.00
Mining and Energy 105,911,926.00
Transport and Communication 32,087,000.00
Construction 2,435,713,000.00
SOCIAL SERVICE 808,321,790.00
Education Trading 761.632,140.00
Culture and Sport 14,965,400.00
Health 30,518,000.00
Labor and Social Affairs 98,000.00
Prevention and Rehabilitation 1,108,250.00
OTHER PAYMENTS 2,993,421,000.00
Transfer 1,007,214,100.00
Regional Subsidy
Public Debts
Provisions
Others

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The brief description of the federal capital budget preparation procedures are as illustrated
below:
Preparation of the Capital Budget

Preparation of the macro framework

Allocating public expenditures between

the federal and regional government

Allocating between recurrent and capital

budget at federal level

Capital budget call

Capital budget review

Capital budget hearing and defense

Submission to the council of ministers

Submission to the draft capital budget to

the council of peoples' representatives

Notification and publication of the capital

budget

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1. Preparation of the Macro Framework
This is an assessment of the economic situation and establishment of fiscal balance (GDP,
growth rate, etc). This stage includes two steps: collecting and analyzing information regarding
the performance of the economy in the previous fiscal years, economic protection such as
growth, revenue estimating for the next year which is done by the coordinating ministries
(ministry of economic development and cooperation and ministry of finance) with
consultation with the National Bank of Ethiopia, the central statistics authority and other
relevant institutions. The macro framework is reviewed and approved by the prime minister's
office.
2. Allocating Public Expenditures Between the Federal and Regional Government
This step determines the amount of subsidy to regional governments. After preparing the
revenue estimation of total government expenditure (fiscal plan) a decision usually is made by
prime minister's office for allocating the shares to the federal and regional governments. The
distribution among regions is done by the Federation council with consultation of the prime
minister's office, ministry of economic development and cooperation, and ministry of finance.
Allocation between regions is based principally upon a formula, such as population, level of
development, revenue generation capacity. The price minister's office reviews the split and
then presents to the federation council.
3. Allocating Between Recurrent and Capital Budget at Federal Level
Depending on various factors, the PMO with consultation of ministry of economic
development and cooperation and the ministry of finance determines how much is to be
allocated to recurrent and capital expenditure. The decision is based on the following factors:
a) government prioritized sectors
b) non-discretionary expenditures
c) ongoing projects, and
d) institutional capacity

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4. Capital Budget Call
Each year the ministry of economic development and cooperation issues detailed capital
budget preparation guidelines to the federal government spending public bodies along with
the ceiling provided to each line institution. The overall national ceiling is decided by the prime
minister's office (with a background proposal from ministry of economic development and
cooperation).
Sectoral ceiling are usually issued immediately following the decision on national ceiling. The
objective of the budget call is to receive a capital budget proposal at a fixed date from
spending public bodies. Federal spending public bodies submit a budget proposal by code of
expenditure and source of finance each year.
5. Capital Budget Review
The sector departments of the ministry of economic development and cooperation review the
capital budget requests from different public bodies. At this stage projects are screened. If
there exists a discrepancy between the respective sector department and the public body, a
series of discussions are held to reach agreement. The various departments of the ministry
submit their first round recommendation to the development finance and budget department
of the ministry. The information capital budget steering committee (members drawn from
prime minister's office and the ministry of economic development) receives the consolidated
federal capital budget through development finance and budget.
6. Capital Budget Hearing and Defense
Federal spending bodies are called to defend their projects to a budget hearing convened by
the prime minister's office which is chaired by the prime minister or the deputy prime minister
or their economic advisor. The hearing customarily include a review of the following:
i. status of projects
ii. implementation capacity of the institution involved

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iii. compatibility with the country's development strategy
and policy
iv. cost structure
v. regional distribution.
A project description is presented at the hearing, which includes the following: objectives of
the project; main activities of the project; status of the project, total costs, past performance
of the project, structure of finance, whether the project is accepted or rejected by the sector.
The budget hearing focuses on whether to accept or reject a project during the up coming
fiscal year.
7. Submission to the Council of Ministers
The ministry of economic development and cooperation receives the capital budget
requirement of each institution, which is finally recommended by sector departments.
A brief analysis of the federal capital budget is prepared by the ministry along with a
consolidated federal capital budget is submitted to a meeting of the council of ministers called
by the prime minister. The ministry defends the budget to the council. The council of ministers
may make some adjustments and finally the draft capital budget passes the first stage of
approval.
8. Submission of the Draft Capital Budget to the Council of Peoples'
Representatives
The final draft federal capital budget is submitted through the council of ministers to the
council of peoples' representatives for discussion and final approval.
9. Notification and Publication of the Capital Budget
The final stage in capital budget preparation is notifying the line budgetary institutions of their
approved capital budget by items of expenditure through the ministry of economic
development and cooperation. The legal status of the capital budget is established through
publication in the "Negarit Gazeta".

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 Budgeting at the Region and Sub-region Levels
To reduce regional disparities among regions, government provides an incentive package
scheme to investors to encourage them to invest in the backward regions. Thereby
economic development will be fostered. In addition to this, government appropriately
allocate budget subsidies to all regions depending upon their infrastructure need: schools,
road, electricity, hospitals, etc.
The factors necessary to allocate funds to regions are worth discussions.
 The Objective of Budget Subsidy
To ensure rapid economic development, authority has to be decentralized at region and sub
region level in order to encourage them to determine their budget requirement. Accordingly,
the federal government will provide a general purpose grant and specific purpose grant.
Therefore, the main purpose of the General Grant is:
1. To assist regions and sub regions expenditures on which case they are
unable to cover.
2. To assist regions and sub regions on laying an infrastructure in order to
normalize the regional disparities.
3. The purpose of the general grant is indicative. On one hand, it works in
normalizing the horizontal fiscal imbalance and to maintain efficiency in allocation.
1. Type of Grant and Fiscal Transfer: when revenue is unable to cover the
expenditure, it may jeopardize the activities of the regions. In such instances, grant without a
question is necessary. In this case, either specific purpose grant or general purpose grant will
be a mandate.
2. General Purpose Grant: will provide full authority to the user as to allocate
the grants based up on their expenditures priority.

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3. Specific Purpose Grant: in this grant, expenditures are predetermined.
Whereby the regional government or the federal government will impose on regions to see to
it that they are implemented as per plan.

B. Expenditure and Revenue Equalization

The regions in order to meet their expenditure assignment they should have a financial
strength (Revenue or Financial Resource). In order to have a clear picture as to surplus and
deficit, the regions must laid an equalization system in order to monitor their performances.
Indicators of Budget Size
To determine the budget requirements of the regions and sub regions, certain factors needed
be considered. The following factors are quite illuminating:
1. Population
Every economic plan should be based up on the population. The planner must center the total
number of population. The planner must center the total number of population, the birth rate,
economic concentration, housing etc while planning, this variable must be considered, and
accordingly the budget need will be determined.
2. Expenditure Requirements
While determining their expenditure requirements, region and sub regions must compare
their regions with others in view of the economic development. That is, backward regions
must assess the budget size requirement according to the activities that they are intending to
take.
3. Agriculture
Agriculture is the backbone of the regional economy. In assessing of the budget size, the
agricultural development of the region is indicator while assessing the development, the
following factors needed to be considered:
i. workforce(development agent)
ii. number of a household in extension package program

143
iii. number of veterinary clinics
4. Health
Health sector development program must consider the primary health care – curative as well
as preventive. While trying to foster the health economy, the planner must look on to the
following variables.
A. Number of Health Center
 Number of health center/ thousands of population
 Number of clinics/ thousand population etc
B. Health Professionals
 Number of Doctors/ thousand population
 Number of Nurses/ thousand population
 Number of Laboratory Technicians/ thousand population
5. Education
The other factor to be consider while budget is the education center. The regions must
compare the level of education compared to the other regions before determining the
budgets. The factors to be work under this is:
A. Number of primary schools
B. Correlation between students and teachers
C. Class size of the primary school etc
6. Water
Water supply is one of the basic need that a human being requires to live. To avoid water
cause diseases, regions must work in supplying pure water to their fellow citizens. Accordingly,
they must work on the need assessment of water supply etc.
Federal Government Subsidies to Regions
Tigray Region 458,150,000
Afar Region 224,990,000

144
Amhara Region 1,335,050,000
Oromia Region 1,846,610,000
Somale Region 372,040,000
Benshangul-Gumuz Region 175,510,000
SNNP Region 1,138,920,000
Gambella People Region 130,580,000
Harari People Region 77,520,000
Addis Ababa City Administration 122,520,000
Dire Dawa Administration Council 85,910,000
Total 5,969,800,000
Source: Federal Government Budget Proclamation No. 358/2003
Regions and sub regions will have to take the various factors discussed above, while
submitting their budget proposal. According to their economic development, and the budget
requirement, the federal government may endorse the amount of subsidies granted to them.

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Procedures to Prepare Budget at Region and Sub-region Level
The procedures followed to prepare the budget at region and sub-region levels follow the
series of steps which are as follows.

Preceiling budgeting by woredas

Review of woreda pre-ceiling budges by

zones

Review of zone pre-ceiling budgets by

regions

Determination of the regional expenditure

envelop

Allocation of the regional between capital

and recurrent expenditure

Allocation to bureaus and zones

Allocation to zone sector department

Allocation to woreda

1. Pre-ceiling Budgeting by Woredas

The woredas prepares a budget with no indicative or final ceiling from the zone or the region.
There is no ceiling yet from the zone or the region because the federal government has not yet
notified them of their grant, which covers approximately 85% of ther regional expenditure.

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 The woreda sector office prepares a budget. The woreda executive committee forms a budget
committee to review the budget submission.
2. Review of Woreda Pre-ceiling Budgets by Zones
The woreda budgets are sent to the zone through two channels. The woreda executive
committee submits to the zone executive committee and the woreda sectoral offices send to
the zone sectoral departments. The executive committee will set up a budget committee
which reviews the woreda and one sectoral budget submissions.
3. Review Zone Pre-ceiling Budgets by Regions
The zone budgets are sent to the region through two channels. The zone executive committee
submits to the region sectoral bureaus. The sectoral bureaus then prepare a budget
submission to the region plan bureau. The sectoral bureau can change the budget submission
from the zone. The submission is the combined budget of the sectoral bureaus, departments
and offices.
4. Determination of the Regional Expenditure Envelop
The region is notified of the federal grant between March and May. The total regional public
expenditure envelope is then determined based on the federal grant, local revenue and local
borrowing.
5. Allocation of the Region Envelop Between Capital and Recurrent
Expenditure
The region allocates the expenditure envelop between capita and recurrent. The allocation
begins with recurrent expenditure specifically non-discretionary expenditure expenditures
(debt, legal liabilities, pension, salary). The largest share of recurrent expenditure is for salary
and the region can determine this total because all staff are managed from the region level.
The balance of the envelop or the upper bound residual of he expenditure envelop is reserved
for capital expenditures. The trend shows that government emphasizes capital expenditure.
6. Allocation to Bureaus and Zones

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 The capital envelope is allocated to the region bureaus by increment. First, the share of
ongoing projects, inter-regional projects and those projects administrated by bureaus at zone
and woreda level and included first.
7. Allocation to Zone sector Departments
In this step, the lump sum zone allocation is distributed by sector to the corresponding zone
and woreda departments and offices. Once the sahre of the zonal allocation is known the
sectoral budget allocation is made by the following criteria: ongoing projects, new priority
projects, the 5-year plan and inter-zonal projects.
8. Allocation to Woredas
The woreda's are allocated on a sectoral basis from the zone. Allocation is done through
discussion by the woreda council with the assistance of two planning officers who are assigned
to the council and experts from the zone who will make allocations to sectroal offices.
Check Your Progress Exercise
1. What is a budget reform? Explain.
………………………………………………………………………………………………………………………………………………
2. What is recurrent budget? Discuss.
………………………………………………………………………………………………………………………………………………
3. Discuss the process involved in budget preparation at the federal
level?
………………………………………………………………………………………………………………………………………………
4. Discuss the process involved in budget preparation at the regional
level?
………………………………………………………………………………………………………………………………………………

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 FEDERAL GOVERNMENT
CAPITAL BUDGET

Description Recurrent Budget Capital Budget Subsides Total

1 2 3 4 5
TOTAL 7,885,500,000.00 5,404,911,028.00
5,969,800,000.00 19,260,211,028.00
ADM. & GEN. SERVICE 3,755,926,900.00 188,063,500.00 - 3,943,990,400.00
Organs of State 76,548,300.00 68,861,800.00 145,410,100.00
Justice and Public Order 223,982,800.00 24,783,200.00 248,766,000.00
National Defence 3,000,000,000.00 3,000,000,000.00
General Services 455,395,800.00 94,418,500.00 549,814,300.00

ECONOMIC SERVICE 396,071,700.00 3,401,311,638.00 - 3,797,383,338.00

Agric. And Natural 110,093,600.00 637,869,387.00 747,962,987.00
Resources 29,521,300.00 159,914,750.00 189,436,050.00
Water Recourses 73,655,700.00 29,815,575.00 103,471,275.00
Industry and Trade 31,550,600.00 105,911,926.00 137,462,526.00
Mining and Energy 120,535,700.00 32,087,000.00 152,622,700.00
Transport and 30,714,800.00 2,435,713,000.00 2,466,427,800.00
Communication
Construction 740,080,400.00 808,321,790.00 - 1,548,402,190.00
SOCIAL SERVICE
Education Trading 586,671,200.00 761.632,140.00 1,348,303,340.00
Culture and Sport 27,887,800.00 14,965,400.00 42,853,200.00
Health 74,642,900.00 30,518,000.00 105,160,900.00
Labor and Social Affairs 26,644,800.00 98,000.00 26,742,800.00
Prevention and 24,233,700.00 1,108,250.00 25,341,959.00
Rehabilitation
OTHER PAYMENTS 2,993,421,000.00 1,007,214,100.00 5,969,800,000.00 9,970,435,100.00
Transfer 10,507,600.00 1,007,214,100.00 1,017,721,700.00
Regional Subsidy 5,969,800,000.00 5,969,800,000.00
Public Debts 2,411,000,000.00 2,411,000,000.00
Provisions 369,200,000.00 369,200,000.00
Others 202,713,400.00 202,713,400.00
Summary

Policies should clearly delineate the responsibilities of each type of government and the
private sector in the implementation process.
The central context of budget reform is ambitious decentralization.
"Decentralization is an outcome of the adoption of a federal system of government in
Ethiopia. With the devolution of power to the regional governments, implementation of

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economic policies and development programs have to a large measure, been shifted from the
center to the regions. The application of fiscal federalism ensures a single system of taxation,
allows some revenue collection by the regions and some revenue sharing with the federal
government while putting the majority of the revenue under the central authority, provides
budgetary subvention the regions, and grants the regions full autonomy in budgetary
expenditures.
The recurrent budget at the federal level, which consolidates and coordinates the recurrent
budgets of all budgets of all federal public spending bodies, is prepared by the budget
department of the ministry of finance.
A capital budget is broadly describes an outlay on projects that results in the acquisition of
fixed assets and the provision of development services. The capital budget is presented in two
ways: by economic category and by appropriating agency by code of expenditure. Individual
projects are detailed under such sectors as "agricultural development", "road construction",
and the line. Project activities are further codified by items of expenditure.

ANSWER TO CHECK YOUR PROGRESS EXERCISE

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 UNIT 6: GOVERNMENT AND PUBLIC SECTOR BUDGETING

Contents
- Aims and Objectives
- Introduction
- Public Finance
- Fiscal Policy and Public Development
- The Structure of Government Budget
o Revenue Budget
o Expenditure Budget
- Budget Policy
- Systematic Budget Preparation
- Summary
- Answer to Check Your Progress Exercise
Aims and Objectives
After studying this unit, you will be able to explain:
- what public finance is
- what fiscal policy is, and
- the structure of government budget.
Introduction
When we resort to fiscal policy to combat unemployment or inflation, we are deliberately
tampering with the federal budget. That is what discretionary fiscal policy really is budget
policy.
The federal budget is a statement of the federal government's planned expenditures and
anticipated receipts for the coming year. Whenever unemployment exists (whenever the
unemployment rate is above the natural rate), the federal government should plan a deficit
budget. That is it should plan to spend more than it expects to collect in taxes. By taking this

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action, the government infect the economy with additional spending or aggregate demand,
that should help drive it toward full employment. Inflationary times call for the opposite
approach, a surplus budget, which expresses the government's intention to spend less that it
expects to collect in taxes. A surplus budget help reduce the amount of aggregate demand in
the economy and thereby moderates inflationary pressures. A balanced budget – a plan to
match government expenditures and tax revenues – is appropriate only when the economy is
operating at full employment, when it has achieved a satisfactory and needs neither stimulus
nor restrains.
Public Finance
One of the most important policy of the government is fiscal policy, which deals with the
government through tax and non-tax sources and its expenditure. Detailed treatment is given
on this policy. An attempt is also made to explore all possible ways to account for the different
sources that constitute the government revenue. Due consideration is also given to the
component of government expenditure. These expenditures may consist of the government
expenditure. These expenditures may consist of the government spending on public goods and
social services that are usually provided by the government.
The government budget is a financial plan of activities to be performed sometime in the
future. However, in the process of delivering these public goods and social services, the
government may face budgetary deficits when expenditures exceed government revenue, it
looks for ways and means to finance these deficits.
Regardless of the type of economic system that a country follows there is always a
government. However, it may take different forms depending on the political, social and
economic factors. Some economies may have highly centralized government systems while
others may have a decentralized body of governments. Some of the forms of the government
include federal government, regional government and local government.

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 The duties and responsibilities of the local government may be different from the regional
government and again may be different from that of the federal government. Regardless of
the type and form they take, government usually have some common goal and objectives by
and large. These goals and objectives include the following.
1. The maintenance of law and order, so that the property rights can be secured and economic,
social, and political activities can be facilitated.
2. The achievement of macroeconomic stability, such as: controlling inflation, reducing
unemployment, avoidance of regional imbalances, fair or equitable income distribution, and
promoting economic growth.
3. Adoption of sound economic and social policies, and
4. Provision of public goods (defense and police force, the judiciary, highways, and other
economic infrastructures) and the basic social services (primary education and the health care
services and other social infrastructures).
This involvement become strong and necessary, particularly in the case of the existing
situations of developing countries where the majority of the population is poor and where the
private sector plays relatively minimal role.

FISCAL POLICY AND PUBLIC DEVELOPMENT

Fiscal policy involves managing the economy through the generation of revenues to discharge
the responsibility of the government by financing expenditures. The role and functions of fiscal
policy in the economy can be outlined in the following ways:
1. The allocation of resources into the production of public and private goods
2. The distribution of income in order to reduce gross inequality; and
3. The promotion of economic growth, and stabilization of economy by reducing fluctuation in
the level of price, output, and employment.
Source of government revenue are divided into tax and non-tax revenue. The principal source
of government revenue is tax revenue. Tax revenue can be further decomposed into direct,

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indirect and foreign trade taxes. Direct taxes are taxes levied directly on persons or legal
person entitles in the form of personal income taxes, property taxes, corporate income and
profit taxes and others. Indirect taxes are taxes levied on goods and services. Consumer pay
these taxes indirectly when they buy goods and services. The third category of taxes
constitutes the foreign trade taxes that are levied on imports and exports.
The non-tax revenue can be composed of collection of charges such as capital charges and
residual profits, fees, fines, sale of government properties and others.
The expenditure side of public finance may include recurrent and capital expenditure. The
recurrent expenditures include expenditures of wages and salaries of government employees,
pension payments, debt service payments, operating expenses of the government ministries
and other expenses of repeated nature. Capital expenditures contribute to economic growth
and they are targeted towards adding the capital stock of the country. Expenditures of this
type include investment on social and economic infrastructures such as roads and construction
of school and health care faculties.

THE STRUCTURE OF GOVERNMENT BUDGET

The structure of government budget constitutes the formats in which the budget data are
organized and classified for different purposes. Not only the intentions of the government will
be revealed but also the responsibility of implementing agencies will be clearly indicated in
these formats. The classification of government budget is divided into revenue and
expenditure budget.
Revenue Budget
Revenue budget consists of the annual forecast of government budget from tax and non-tax
sources. In Ethiopia, the annual revenue budget is structured into ordinary revenue, external
assistance and capital revenue.
The direct tax of the ordinary revenue consist of personal income tax, rental income tax,
business income tax, agricultural income tax, tax on dividend and chance winning, land use fee

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 and lease. The indirect tax is consisting of the excise and sales tax on locally manufactured
goods, service sales tax, stamps on duty. Tax on foreign trade includes customs duty and
excise tax on imported goods, sales tax on imported goods and export tax on coffee. The
revenue budget for the federal government of Ethiopia is prepared by the ministry of finance
(MOF) and for these regional governments by the respective regional finances bureaus.
Table 1
Federal Government Expenditure and its Financing
Revenue Budget (Financing)
(A) Domestic Revenue
Tax Revenue 8,588,305,263
Non-Tax Revenue 1,945,304,152
Capital Revenue 359,673,355
Domestic Revenue Total 10,893,282,770
(B) External Assistance
Multilateral Institutions 746,945,350
Bilateral Assistance 579,269,170
Counter Part Fund Assistance 2,474,850,263
HIPC Relief Assistance 819,063,431
External Assistance Total 4,620,128,214
(C) Loans and Credits
Multilateral Institutions 2,142,696,544
Bilateral Loan 0
Counter Part Fund Loan 240,103,500
Loans and Credit Total 2,382,800,044
(D) Domestic Borrowing 1,364,000,000
Total Revenue, Assistance and Borrowing 19,260,211,028

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Expenditure Budget
The recurrent budget is mostly financed from the domestic revenue source, that is from tax
and non-tax revenues. The capital budget is usually financed by external borrowing and grants.

Expenditure Budget

Recurrent Capital
Budget Budget

Administrative Economic Other expenditures Economic General Developments

Service Developments
& general
service

Social services Social Developments

The recurrent budget expenditure consists of expenses that are repeated in nature like salaries
of civil servants. The recurrent budget is structured in Ethiopia under four functional
categories: Administrative and general services, economic services, social services, and other
expenditures. All government bodies fall under either of these categories. For instances,
administrative and general services include such activities as political organs of the state such
as council of representatives and ministers, ministries, defense and so on. The economic
services include such activities under the agricultural, industrial and service sectors. The social
services include such activities as health, education and culture. Other expenditure include
pension payments, repayment of public debts, provision of unforeseen expenses and similar
items. Capital budget expenditure is usually made on the acquisition and improvements to
fixed assets and includes the expenses for consultancy services. The capital budget is grouped

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 under three headings: economic development, social development, and general development.
Economic development includes production activities in the agricultural and industrial sectors,
economic infrastructure in mining, road, and energy, commerce and communication. Social
development includes such activities like education, health, urban development, and welfare.
Table 2
Federal Government Expenditure and its Financing
Expenditure Budget
(A) Recurrent Expenditure Birr
Administration and General Service 3,755,926,900
Economic Service 396,071,700
Social Services 740,080,400
Other Expenditure 8,963,221,000
Domestic Revenue Total 13,855,300,000
(B) Capital Expenditure
General Development 746,945,350
Economic Development 579,269,170
Social Development 2,474,850,263
Other Expenditures 1,007,214,100
Capital Expenditure Total 5,404,911,02
Recurrent & Capital Expenditure Total 19,260,211,028

BUDGET POLICY

It is the policy of the federal government to have effective budgets that comply with the
financial law/regulations/directives, that comprehensively manage public expenditure, that
link public expenditure to government policy, that limit expenditure to revenue and debt
targets, that promote a balance of capital and recurrent expenditure, that transparently

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present items and activities of expenditure, that are prepared systematically according to an
authorized calendar, that are fully funded and promptly disbursed, and that are prepared and
implemented by staff trained in the regulations, principles and practice of budgeting.
Compliance with the financial law, regulations and directives. Budgets will be prepared and
implemented in compliance with the financial law, regulations and directives.
i) Comprehensive management of public expenditure
Proclamation No. 57/1996 "Financial Administration proclamation of the Federal Government
of Ethiopia" stipulates that the budget will comprehensively manage public revenues and
expenditure. The proclamation requires that all public money except those allowed by law by
placed in the consolidated fund and that all disbursement from the consolidated fund be
approved by the council of peoples representatives through an appropriation. Appropriations
will be implemented through the annual budget and through supplementary budgets as
necessary. No expenditure or commitment of expenditure can be incurred from an
appropriation without the approval of the ministry of finance.
ii) Linking public expenditure to government policy
Council of minister's regulation no 17/1997 stipulates that the priorities of the public
investment programs will set the priorities of the capital budget and no capital expenditure
shall be included in the capital budget if it has not been approved by the public investment
program. The civil service reform will expand the public investment program into a public
expenditure program which will comprehensively plan for three years both capital and
recurrent expenditure. The public expenditure program will set the priorities of the capital and
recurrent budget.
iii) Limiting Expenditure to Revenue and Debt Targets
The ministry of finance will establish the revenue projection for the annual budget.
Expenditure ceiling will be established based on this forecast taking into account policy largest
and external agreements establishing financing limits.

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iv) A balance of capital and recurrent expenditure
It is government policy that public expenditures be sustainable. Capital expenditure will have
adequate complimentary recurred expenditure. To promote this balance of capital and
recurrent expenditure, the planning and budgeting reforms of the civil service reform will
improve the linkage between the planning and budgeting of capital and recurrent expenditure.
One reform will be the introduction of cost center budgeting, which will link expenditures
within and between the recurrent and capital budgets to common activity. A second reform
will be the introduction of the public expenditure program that will link capital and recurrent
expenditures and frame the priorities of both the capital and recurrent budgets. A third reform
will be the development of budget norms which link an activity's capital, non-wage recurrent
and salary costs.
v) Transparent Presentation of items and activities of expenditure
It is government policy to strengthen the line item budget and their introduce cost center
budgeting to promote responsibility for inputs and their outputs. Five steps are being taken to
implement these reforms. Once step is to develop a consistent coding of the chart of accounts.
The charts of accounts are the major budget headings used to present the budget.
A second step is to promote consistency in budget categories. Consistent formats should be
used to the extent possible by both the capital and recurrent budgets.
A third step is to link where possible capital and recurrent expenditures on a cost center basis.
Cost centers will allow managers in public bodies to know the total cost of an activity or an
administrative unit and can guide budgeting decisions.
A fourth step is to improve the list of the items of expenditure. Line item budgets are based on
items of expenditure and are designed to control the inputs of expenditure. (Strengthening
line items budgets require improving the item of expenditure codes so they are consistent,
detailed and transparent.)

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 A fifth step in improving the budget will be the introduction of work plans for the cost center.
The work plans will link inputs to outputs and will form the bases of a public body's request for
a budget.

SYSTEMATIC BUDGET PREPARATION

Budgets will be prepared according to an authoritative calendar. The calendar will schedule
the seven phases of budgeting:
1. call
2. request
3. recommendation
4. approval
5. notification
6. operation and
7. execution.
The first phase, call is when the coordinating ministries of finance and planning ask each public
body to prepare a budget request and would provide the budget ceiling for the public body.
The second phase request is when public bodies submit their request for requirement and
capital expenditure to the ministry of finance and the ministry of economic development and
cooperation respectively. The third phase, recommendation, in a review by the ministry of
finance and the ministry of economic development and cooperation of the agency requests
and then a recommendation for each agency based on a recommended ceiling for the total
capital and recurrent budget. The fourth phase, approval, has two stages: Approval by the
council of ministers and approved by the parliament. Phase five is notification where the
ministry of finance and the ministry of economic development and cooperation, notify the
agencies of their approved estimates of revenue and expenditure by class of account and line
item. The six phase of budgeting is operation, which has three tasks:

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(1) Preparation of action plans for the financial and physical implication
which are submitted to the ministry of finance, the ministry of economic development and
cooperation and the prime minister's office.
(2) The elaboration of these action plans for internal use to implement
the budget, and
(3) The establishment of an operating budget linked to accounts for
financial control. The seventh phase of budgeting is execution which has three tasks: 1)
request and adjustments for transfer and supplementary allocations, 2) preparation of a
monthly report on the financial and physical action plans to the ministry of finance, the
ministry of economic development and cooperation, and the prime minister's office, and 3)
identification of savings and transfer.
Except for emergencies that require reallocation or delay of appropriated disbursements, or
shortfalls in revenue collection, budgets will be fully funded from the consolidated fund and
promptly disbursed.
Effective implementation of budget procedure required staff who are trained in the
regulations, practice and principles of budgeting. Government has recently trained trainers to
instruct staff in the financial law and regulations. Government is also developing a training
program based on a partnership of federal and regional training institutions that will instruct
staff in current practice and budget principles as well as the new budget procedures of the civil
service reform. Instruction is basic job skills will be delivered by finance and planning bodies at
the federal and regional level. The institutional approach to training reflected in this strategy
of building a partnership between federal and regional training institution will promote
continuity in the instruction of staff and strengthen the capacity of training institutions to
deliver instruction to a large number of federal and regional staff.

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Check Your Progress Exercise?
Summary
The government budget is a financial plan of activities to be performed sometimes in the
future. However in the process of delivering these public goods and social services, the
government may face budgetary deficits when expenditures exceed government revenue, it
looks for ways and means to finance these deficits.
Fiscal policy involves managing the economy through the generation of revenues to discharge
the responsibility of the government by financing expenditures.
Source of government revenue are divided into tax and non-tax revenue. Tax revenue can be
further decomposed into direct, indirect and foreign trade taxes. The non-tax revenue can be
composed of collection of charges such as capital changes and residual profits, fees, furies,
sale of government properties and others.
The expenditure side of public finance may include recurrent and capital expenditure. The
recurrent expenditures include expenditures of wages and salaries, pension payments, etc.
Capital expenditures contribute to economic growth and they are targeted towards adding the
capital stock of the country.
Answer to Check your progress exercise
Unit 8: Legal Issues, Risk and Insurance Management

Contents
8.0 Aims and Objectives
8.1 Introduction
8.2 Legal Issues
8.2.1 Legal forms of Business Ownership
8.2.2 Intellectual Properties
8.3 Risk Management
8.3.1 Risk-Basic Concepts

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 8.3.2 Classification of Risk
8.3.3 The Process /Steps/ of Risk Management
8.4 Insurance Management
8.4.1 Insurance: Basic Concepts
8.4.2 Fundamental Legal Principles of Insurance
8.5 Summary
8.6 Answers to Check Your Progress Questions

8.0 AIMS AND OBJECTIVES

At the end of this unit you are expected to

 understand the legal requirements of owning a business

 understand the issues of legal forms of business ownership

 identify the different types of forms of ownership

 understand the issues of intellectual properties and types

 understand the issue of risk, types of risk and the mechanism of their management

 understand the issue of insurance

8.1 INTRODUCTION

As an entrepreneur establish his own business, he has to consider certain issues such as legal
forms of ownership, intellectual properties, risk and insurance management. Hence, this unit is
designed in such a way that all these issues are to be discussed. First we will see the legal
forms of business ownership then we will discuss about intellectual properties finally we will
discuss about risk and insurance management processes.

8.2 LEGAL ISSUES

Entrepreneurs, after they identify their business ideas and developing a business plan, are
expected to think about certain legal issues. They have to legalize their business and they have
to be registered for it. They have to determine the legal forms of business ownership that
he/she will establish. Besides she/he should get legal protection to their inventions or

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creations. Hence, they have to get a legal property right from the concerned body. The Science
the Technology Commission in Ethiopia.
8.2.1 LEGAL FORMS OF BUSINESS OWNERSHIP
Nothing, in the over regulated word of today, is ever simple. Before a new business is
launched thought should give some to the legal problems that need to be dealt with. The first
issue is the legal form for the business. The four most popular are: the sole proprietorship,
partnership, limited liability company and share company.
A. SOLE PROPRIETORSHIP
This is the business owned by one individual. The individual is the business, and the business is
the individual. The two are inseparable. A sole trader is the simplest form of business to start –
all that is needed is the first customer. It faces fewer regulations than a limited company and
there are no major requirements about accounts and audits, although the individual will pay
personal taxes which will be calculated based upon the profits made by the business.
There are two important limitations, however. The first is that a sole trader will find it more
difficult to borrow large amounts of money than a limited company because lending
institutions prefer the assets of the business to be placed within the legal framework of a
company, because of the restrictions then placed upon the business. It is, however, quite
common for a business to start life as a sole trader and incorporate later in life as more capital
is needed.
The second disadvantage is that the sole trader is personally liable for all the debts of the
business, no matter how large. That means creditors may look both to the business assets and
the proprietor’s assets to satisfy their debts. However, this disadvantage should not be over
emphasized because of the widely adopted practice of placing some family assets in the name
of the spouse or another relative and because, even as a limited company, a bank is likely to
ask for a personal guarantee from the proprietor before giving a loan.

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B. PARTNERSHIPS
Some professions such as doctors and accountants, are required by law to conduct business as
partnerships. Partnerships are just groups of sole traders who come together, formally or
informally, to do business. As such it allows them to pool their resources, some to contribute
capital, other their skills. Partnerships, therefore, face all the advantages of sole traders plus
some additional disadvantages.

The first of these disadvantages is that each partner has unlimited liability for the debts of the
partnership, whether they incurred them personally or not. Clearly partnerships require a lot
of trust. The second disadvantage is that the partnership is held to cease every time one
partner leaves or a new one joins, which means dividing up the assets and liabilities in some
way, even if other partners end up buying them and the business never actually ceases
trading.
Generally, if you are considering a partnership you would be well-advised to draw up a formal
partnership agreement. It is very easy to get into an informal partnership with a friend, but if
you cannot work together, or times get hard, you may regret it. Partnership agreements cover
such issues as capital contributions, division of profit and interest on capital, power to draw
money or take remuneration from the business, preparation of accounts and procedures when
the partnership is held to cease. Solicitors can provide a model agreement which can be
adapted to suit particular circumstances.
C. Limited Companies (Private limited and share company)
A company registered in accordance with the provisions of the Companies Acts is a separate
legal entity distinct from its owners or shareholders, and its directors or managers. It can enter
into contracts and sue or be sued in its own right. It is taxed separately through Corporation
Tax. There is a divorce between management and ownership, with a board of directors elected
by the shareholders to control the day-to-day running of the business. There need be only two
shareholders and one director, and shareholders can also be directors.

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The advantage of this form of business is that the liability of the shareholders is limited by the
amount of capital they put into the business. What is more, a company has unlimited life and
can be sold on to other shareholders. Indeed there is no limit to the number of shareholders.
Therefore a limited company can attract additional risk capital from backers who may not wish
to be involved in the day-to-day running of the business. Also, because of the regulation they
face, bankers prefer to lead to companies rather then sole traders, although they may still
require personal guarantees. Clearly this is the best form for a growth business that will
require capital and will face risks as it grows.
Nevertheless there are some disadvantages to this form of business. Under the companies
acts, a company must keep certain books of account and appoint an auditor. It must file an
annual return with companies’ house which includes accounts and details of directors and
shareholders. This takes time and money and means that competitors might have access to
information that they would not otherwise.
EXHIBIT 8.1
Advantages and disadvantages of different forms of business
Sole trade Partnership Limited company
Advantages Easy to form Easy to form Limited liability
 Minimum of  Minimum of regulation  Easier to borrow money
regulation Can raise risk capital
through additional
shareholders
 Can be sold-on
 Pays Corporation Tax
Disadvantages Unlimited Unlimited personal Must comply with
personal liability liability for debts of Companies Acts
 More difficult to whole partnership Greater regulation
borrow money  More difficult to borrow  Greater disclosure of
Pay personal tax  ‘Cease trading’ whenever
 Pay personal tax

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 D. FRANCHISE
These are not so much a legal form of business as a way of doing business. They are
increasingly popular, particularly with individuals who are less entrepreneurial but wish to run
their own business. A franchise is a business in which the owner of the name or method of
doing business (the franchiser) allows a local operator (the franchisee) to set up a business
under that name. The local operator may be a sole trader or a limited company.
In exchange for an initial fee (anything from a few thousand to hundreds of thousands of
pounds) and a loyalty on sales, the franchiser lays down a blueprint of how the business is to
be run; content and nature of product or service, price and performance standards, type, size
and layout of shop or business, training and other support or controls. Since the franchise is
usually a tried and tested and other support or controls. Since the franchise is usually a tried
and tested idea, well known by potential customers, the franchisee should have a ready
market and a better chance of a successful start-up.
EXHIBIT 8.2
Advantages and disadvantages of Franchise
Franchisee Franchiser
Advantages Business format proved Less risk failure of  Way of expanding business quickly
 Easier to obtain finance than own start-up.  Financing costs shared with Franchisees
Established format. Start-up should be quicker  Franchisees usually highly motivated
since their livelihood depends on success
Training and support available from franchiser.
National branding should help sales.
 Economies of scale may apply.
Disadvantages Not really your own idea and Creation. The rules Take time and money to comply with.
 Lack of real independence. Franchiser makes the rules. Loss of some control to franchisees
 Franchisees can influence the business Failure of franchisee can reflect on franchise
 Buying into franchise can be expensive  May be obligations to franchisee in the franchise
 Royalties can be high agreement.

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 Goodwill you build up dependent upon continuing franchise
agreement. This may cause problem if you wish to sell
Franchiser can damage brand

8.2.2 INTELLECTUAL PROPERTIES

There are three forms of intellectual property rights an entrepreneur should think about as he
creates something different and better.
1. Patents
A patent is a grant of a property right by the government to an inventor. It is issued through
the Ethiopian science and Technology. The most common type of patent is called a utility
patent and it is granted for years. All patents, however, have the distinction of being assets
with commercial value because they provide exclusive rights of ownership to patent holders,
their heirs and assigns. (An “assign” is anyone who might be assigned ownership or rights
through sales or license of a patent.
Patents are exclusive property rights that can be sold, transferred, willed, licensed or used as
collateral much like other valuable assets. In fact, most independent inventors do not
commercialize their inventions or create new products from their ideas. Instead they sell or
license their patents to others who have the resources to develop products and commercial
markets.
Patent law stipulates broad categories of what can and cannot be patented and in the words
of the statue any person who invents or discovers any new and useful improvements thereof
may obtain a patent. There are several crucial words and phrases in the statute have specific
meaning to determine what can be patented and what must be included in a patent
application.
Tests of “New” and “Useful”
Anything that is patentable must be new and useful. Many applications fall one of these two
criteria. Patents are filed and later turned down. For example because ideas behind them have
previously been registered or because they have become public knowledge.

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Exhibit 8-3 what can be patented
Processes Methods of protection, research, testing, analysis and other technologies with new
applications.
Machines Products, instruments, machines, and other physical objects that have proved useful
and unique.
Manufactures Combinations of physical matter not found in nature fabricated in unique
and useful applications
Compositions of matter Chemical compounds, medicine and botanical compositions that do
not exist in nature in an uncultivated state nor those that could evolve in nature, that are new
and useful.
The process of using radar was patented. In each instance, there was not a specific product
(no physical object identified by the patent) but each process was documented and
subsequently demonstrated as being workable, new and useful.
The word machine in the patent law means that the patent applications is for a specific
physical item. Most of us think of patents for physical products and this is the stereotype of all
patents. Once again it has to be new and useful not merely a work of art or some curiously. A
prototype of the product had to be developed and in many instances the patent office
inspected the prototype to validate its function and usefulness. Prototypes are unnecessary
today but there are very specific requirements for technical drawings that accompany patent
applications.
The word manufacturer refers to physical items that have been fabricated through new
combinations of materials or technical applications. In most instances the application must
explain how the product is made including materials, manufacturing processes and any
additional modifications that the investor wants to include for protection under the patent
grant.
The law also permits patenting compositions of matter. This category in patent law relates to
chemical compounds such as synthetic materials, medicines, cosmetics, fertilizing agents, and
biogenetic catalysts. Simply having a mixture of ingredients however, does not constitute a
patent able composition. It follows that a great many medicines and other mixtures of known
ingredients do not have patents. The composition must have a new ingredient, often itself
patentable, or be synthetic creation such as polyacrylamide, one of the synthetically created
base materials used in plastics.
1.1 Types of Patents
The patent law provides the categories of patents as: utility patents, design patents, and plant
patents. There are no other proper names or categories of patents however one often hears
an inventor speak of obtaining a product patent or a process patent. Both of these are
normally called utility patents. In some instances they will be design patents, and for botanical

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creations they are issued as plant patents. These are described in the following paragraphs
and in Exhibit 6-2 as an introduction to patent requirements.
a) Unities Patents
A utility patent is granted for new products, process, machines, methods of manufacturing,
and compositions of matter. This category excludes most botanical creations related to plant
and agricultural use process described later in the unit focuses on utility patents. Similar
patents can be filed in more than 80 countries, and there are joint utility patent protection
rights that can be obtained for international regions such as the European Economic
Community (EEC).

Exhibit 8-4 Types of Patents

Utility patentsGranted for new processes, machines, manufactures, and compositions not
including botanical creations, with a protected for specific period.
Design patents Granted for any original ornamental design for an article of manufacture
with protected specific period.
Plant patents Grand for botanical creations that have been a sexually reproduced and do
not exist in nature with a protected for specific period.
b) Design patents
Design patents are granted for any new or original ornamental design for an article of
manufacture. A design patent protects and appearance of the article, not the article itself. An
inventory could easily register both a utility patent and a design patent, but the design patent
has a limited life. For example design patents can be obtained for 31/2.7. or 14 years.
Entrepreneurs can select the period of time for protection in order to commercialize designs
and to realize the benefits of their ingenuity. The benefit of a design patent is that the
ornamental nature of the patent may be a distinguishing feature that allows an individual to
have exclusive use of visual imagery thus enhancing sales or creating brand identification. For
example, a new golf putter will not be granted a utility patent because golf putters have been
around for two centuries. Yet a new design that changes the physical appearance of the golf
club may be granted a design patent.
c) Plant Patents
In botanical terms, any new variety of plant that has been asexually reproduced can be
granted a plant patent. The new plant must not exist in nature or in an uncultivated state.
Therefore, new plants, mutants, hybrids, the seedlings may be patented. Provided the
inventor can satisfy the patent office that the new plant did not evolve from nature. This is a
rather narrow definition, yet hundreds of patents have been granted for unusual hybrid roses,
ornamental trees, shrubs, food grains, and an assortment of special-purpose grasses, herbs
and vegetable plants. A plant provides the same protection as a utility patent for specific
period.

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 1.2 Process of patenting
a) Document Disclosures
An important service provided by the science and technology is limited protection through the
invention disclosure program. As first step in seeking protection from the commission, most
inventors file a document disclosure statement. This is simply a statement made by an
inventor to register an ideas with the commission. It will be retained for certain period, then
destroyed unless a reference is made to the disclosure in a patent application.
A disclosure is made by writing a letter setting forth the idea. The inventor should explain what
the item is that is new and useful, how it is to be used and generally how it is expected to be
made. The letter should have an accompanying photograph of the inventor that is expected to
be made. The letter should have accompanying photograph of the inventor that is his or her
idea. The drawings need not be formally drafted blueprints. In fact, the patent office prefers
simple illustrations that can be photocopied and folded to dimensions not to exceed legal-
sized paper. The inventor must enclose a self-addressed envelope and a fee of certain amount
(See Appendix 1-6). Fees change periodically. But the cost of the disclosure is unimportant.
The fact that the inventor has been able to officially register his or her idea is important.
The commission takes absolutely no position as to be patentiability of an item registered
under the disclosure program but the documents will be stamped with a date and file number.
This procedure provides evidence for an inventor to bring to court against a conflicting claim
or against a person trying to infringe on the idea. It also provides a legal priority of claim for an
invention and allows an inventor some measure of security while the idea is developed well
enough for a patent application.
Who May Apply for a Patent
According to patent law, only an inventor may apply for a patent. But this rule has several
refinements. If an inventor dies before making and application, the executor or legal
administrator of the estate can file for a patent on behalf of the deceased to protect the
interests of heirs. If a person is insane or incapable, a guardian may file for the inventor. When
two or more persons have a joint interest, the patent must be filed in all names of parties as
joint inventors. There have also been instances when an inventor has refused to file, or has
disappeared, and a joint inventor has filed in both names.
Anyone filing for a patent must swear by oath or make a formal declaration that he or she has
a proprietary interest in the invention. Merely having an investment in another person’s
invention is insufficient. Individuals must have been involved in creating the item being
patented. Anyone filling for a patent who is not the inventor is subject to criminal penalties.
b) The Patent Search
A patent search is required to determine whether and inventor’s creation already exists and
remains actively protected under the law. Most inventors will retain a patent attorney
experienced with the search process. The attorney will do all legal work from search to

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finalization of the patent. However, the search process is the same whether done by an
attorney or an individual. In each location there is a Search Room that contains patent
information: however the extent of information in each library varies. Some will have all
patents issued all still others maintain only recent patent information with cross-reference
indexing. These regional libraries are called Patent Depositary Libraries and those in major
cities will summarize most information maintained in commission, where formal records and
original documents are maintained.
Preliminary Search. The first step is to complete a preliminary search that scans patent
summaries for prior claims or inventions. Inventors, or their patent attorney access patent
records, try to be diligent to unearth prior patents (or patents with similarities to the
invention). Then make a judgment call whether to proceed with an application. A preliminary
search may not uncover all prior claims and a patent may be denied later by an examiner who
does make a thorough investigation. The preliminary search may also miss something because
few individuals actually search the main records. In most instances, the search is done through
an on-line computer data bank using key words to sift through classifications. Consequently,
an inventor of a new dental instrument may put “dental instrument” into the computer and
get several thousand patents to review but miss dental instruments called “probes” that exist
in another classification. However, searching on “prob” is likely to get everything from space
satellites to acupuncture needles. Some adroitness at word searching is necessary.
Collecting Search Documents. Anyone can obtain hard photocopies of patents of photo
facsimiles of summary sheets, drawings, data on microfilm, abstracts, and information
Document Patent Patent
Patent Patent
disclosure application examination
search grant

Initial filling of Inventor files Patent office

Preliminary Patent office
creation with formal written makes through
search of patent documents
patent office to application with search and
records by new patent
establish drawings, patent
inventor or legal grant and
record of idea claims examination,
agent to uncover allowed
declarations, and specifies
prior claims and claims for
and required claims allowed
patents, if any recordation
or problems to
Record of Creation
idea with Opinion by given status Final patent
official file legal agent as of “patent Creation records recorded
number to the filed” with as “patent and “letters
patentability file number pending” patent” sent
of invention subject to third to inventor.
party objections
or counter
Figure 8-5 The Patent Process

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 Maintained in scientific and technical journals. The patent charges a small fee to these
services, but the convenience is remarkable. Nearly all major sources of information within the
patent office system can be accessed through one of the regional depository libraries.
c) Making the Patent Application
An application is made after the preliminary search and it is to the commissioner of patents
and trademarks. There are three main parts to the application. The first is a written document
that comprises a description of the invention, its specifications, and “claims”. A claim is a
specific description of the item and how it works. Some inventions have literally hundreds of
claims about what they can do or how they can work. When a patent is issued, it may have
some of these claims rejected. In any event, the inventor will want to provide complete
information about what the invention is to do and how it is to be used. The second part of the
application is a set of drawings. When an application is made, these drawings can be rather
crude, but they must be accurate, drawn on flexible material (i.e. foldable while paper as
opposed to fiber hood is a formal oath or plastic film). And able to be photocopied. The third
part of the application is a formal oath or declaration by the inventor. These items are bundled
together and accompanied with an application by the inventor. These items are bundled
together and accompanied with an application fee. When the patent office records the
transaction as being a complete application, a file number is assigned and the inventor
notified.
The Written Document. Patent office maintain standard application forms and typically use
legal – or standard- size paper for describing the invention. Individuals can write their own
applications, but they must conform to patent office guidelines. This document will be at least
several pages along and contain at least five sections:
A formal declaration that identifies the inventor what type of patent is being applied for a
summary of prior application (if any), and a statement that the inventor is claiming that the
idea is original.
A brief history that describes how the invention evolved the background of its development,
evidence of testing of certification, and how it was devised.
An abstract the describes what the item is and how it works. An abstract can be very brief,
perhaps only several lines or other paragraph.
A thought description that carefully itemizes the invention’s working parts, how they are
made, and how the item is used. A description usually refers to associated drawings with
extremely detailed information about parts, materials, specifications and methods of
manufacture.
A description of claims that individually lists each modification, use, or alternative, material,
method of manufacture, or feature that is being claimed for patent protection by the inventor.
An inventor must specify at least one claim because a patent will be based on the claims

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 requested, not on a general description. A complicated device, however, may have hundreds
of claims in order to protect an inventor who wants the latitude to substitute materials, parts
or processes, and who may find new uses with further development.
The written document may have several other sections. For example, if a patent attorney or
patent agent is involved, then the inventor must give the attorney or agent a power of
attorney to act on behalf of the inventor with the Patent Office. Without a power of attorney,
a patent lawyer or agent cannot access the inventor’s records or conduct any business with
the Patent office pertaining to the application.
In many instances a patent application will have an assignment whereby the inventor assigns
title and rights to a third party. For example, an individual may file an application on an
invention made through his or her company. The assignment would be to the company for
which the inventor works. Assignments can be made to any legal entity, and the effect of an
assignment is to have letters patent granted directly to the assignee when a patent is
successful.
Drawings. The application need only contain simple, but accurate, hand drawings of the
invention. These can be done by the inventor, and there is seldom a need for extensive
engineering blueprints. Later in the patenting process, the Patent Officer will require formal
drawings. And the inventor will most likely have to contract the drafting work to someone who
completely understands complex specifications for a final set of illustrations.
Oaths of Declarations. The Patent Office will provide standard forms of oaths and
declarations, and while most patent attorney’s have their own forms the law only requires
that inventors make an oath or declaration that they believe they are the original and first
inventors of the item. The Patent Office has additional rules for oaths and declarations to
reveal prior claims foreign patent applications and allegations about claims (e.g. what the
invention is supposed to do). The inventor must sign the application together with joint
inventors, and although standard forms usually have provisions for a notary, the declaration
does not have to be notarized to be legal.
1.3 Patent Filing Fees
Currently, the basic filing fee for a patent application is $340. but there are additional fees that
vary substantially with the complexity and number of patent claims. Realistically, filling fees
can approach some amount of money, however, there is financial relief for inventors classified
as “small entities”. A small entity is a sole inventor, a small business or a nonprofit institution,
but to qualify, the applicant must file a verification form that has to be approved by the
commissioner of patent and trademarks. If qualified a small entry pays only half the normal
filing fee.
Patent filing fees do not include patent attorney fees or other costs of patent search, patent
agency work, preparing drawings and so on. For a simple invention the total cost of an
application might well exceed.
2. Trademark

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 The registration of trademarks must conform to the Trademark however, trademarks are
protected by common law so that an individual does not have to register a trademark formally
to establish the validity of ownership. It is important to note that registration with a patent
and Trademark Office establishes legal documentation that can be used in court. Without
registration the privilege of ownership is subject to contention in a civil action between the
parties. It follows that registration is a reasonable course of action.
a) Defining Trademarks and Service Marks
A trademark “includes any word, name, symbol, or distinguishing device, or nay combination
thereof adopted and used by a manufacturer or merchant to identify his goods and distinguish
them from those manufactured or sold by others.” Trademarks can be names in commerce,
such as Coke, clearly trademarked by Coca-Cola Corporation. A trademark can be a symbol,
such as Apple Computer Corporation’s unusual apple with a bite in the side. Distinguishing
devices can be artistic renderings of corporate products such as the wild mustang horse for
the Ford automobile, the intricate shield and eagle design used on beer cans by Anheuser-
Buseh. Inc. or insignia designed for NFL football teams.
An important qualification for a trademark is that the mark, name, or insignia must be used
commercially. Consequently, a logo not actually used in trade may be denied registration and
one that was registered out of use for an extended period of time may loss registration
protection. Also, a company name cannot be registered as a trade mark but it can be
registered as a service mark. To be eligible for registration, a distinguishing mark must be used
in commerce on a continuous basis. For example, the trade marked name “Coke” has been in
continuous use since its inception.
A service mark is similar to and can be registered in the same way with the same protection. A
service mark can be a name, wording used in advertising symbols, or artistic figures that create
a distinctive service concept. Therefore, the unique lettering of the abbreviation “IBM” for
International Business Machines coupled with a design and a specific blue color cannot be
replicated by another firm.
b) Steps of Filing for a Trade Mark
i. Written Application. Using a Patent Office standard form (or simply writing the application
on legal-size white paper), an applicant provides conventional information such as name,
address, citizenship, identification of patents, and corporate name. Also, the applicant must
make a declaration clearly stating the individual or company that claims proprietary
ownership. In addition, the application, the applicant must declare that a mark has been
adopted and explain how it is being used commercially.
There are several dozen categories of trademarks. These are called classes of trademarks and
the applicant must select the appropriate class for filling. For example, a trademark for laundry
soap is in Class 3, and a photographic trademark is Class 9. Coffee is in Class 30, and
entertainment marks fall into Class 41. It is not uncommon to have a trademark registered in

175
several classes (but to do so costs additional filling fees). A photographic trademark, for
example, might be used in camera manufacturing, television movies, and games. Disney, Inc.,
has nearly everything the company creates trademarked in multiple classifications
(entertainment characters as manufactured toys, clothing, games, candies, glassware,
photographs, and so on).

Applicant Filling

Written Drawings Specimen

prepared prepared
application

Using standard form Formal drawing Image, photograph,

facsimile, or artist
or plan paper, the on white paper
rendering in flexible
trademark is using black ink for file
described and
classified with

Patent Office Action

Trademark Trademark
examination
issue

Patent Office Trademark is registered,

searches records copies are sent to
and examines the applicant, and the
trademark for trademark is published
lawful recording in the Official Gazette

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 Exhibit 8.6 Filling for a Trademark
The application must establish a date on which the trademark was first used commercially.
This defines the beginning of the term of protection in the event of any modifications or
disputes claims. The applicant must make an oath or formal declaration that he or she (or the
organization for which the trademark will be issued) is the originator and therefore has the
right to use the trademark in commerce. Then the application is signed by the individual,
corporate officers, partners, owners of firms, or association officers, and it is notarized.
ii. Drawings. A formal drawing of each trademark must be
submitted on plain white paper (such as a good-quality bond) and permanent black India ink
used to pen the lines. The drawing cannot have erasures or “whiteout” or multiple colors.
Standard-size typing applicant, and dates of commercial use. This procedure does not require
engineering credentials or special skills other than to provide an accurate rendering of the
mark one wishes to protect.
iii. Specimens. Five specimens of actual trademarks or facsimiles must be submitted with the
application, but it is not necessary to submit specimens of all commercial uses or all intended
uses. (Imagine what a task that would be for Disney, labels for designer jeans and the
Academy Awards Oscar figurine, for example, are registered through validated photographs.
Facsimiles can be artistic renderings. Reproductions, or photographs. Specimens and facsimiles
must be capable of photocopying and fit onto a legal size format.
iv. Obtaining and Verifying Trademarks
Once an application is successful, the Patent Office will register a trademark, send three copies
of the registration to the applicant, and the trademark for tracking the 20-year protection
limitation. That’s it. The entire process can usually be accomplished inexpensively and rather
quickly (a matter of a few months in most cases). The patent Office Official Gazette contains a
trademark section that lists trademark registrations on a weekly basis. Clearly, there can be
complicated trademark registrations, and the search, application, and verification process can
assume enormous proportions, particularly if one is applying for foreign trademark rights or
filling for multiple classifications of a single trademark.
3. The Essence of Copyrights
A copyright is distinct from patents and trademarks in that intellectual property is protected
for the life of the originator. This protection affords an extraordinary property right and a
substantial estate. Copyrights are granted by the Copyright Office, an extension of the Library
of Congress, and application is made after intellectual property is published but before it is
made available to the public. This unusual practice is derived from common law doctrine that
requires property to be final published from before it is copyrighted. Therefore, a printed
copyright statement will appear on material before registration occurs. (however, in Ethiopia
all these rights are granted by the Ethiopian Science and Technology Commission.)

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A copyright extends protection to authors, composers, and artists, and it relates to the form of
expression rather than the subject matter. This distinction is important because most
intellectual property has proprietary information in terms of subject or using the original
material. This prohibition does not prevent another person from using the “subject matter”
and then rewriting the material. For example, the concept of an electronic spreadsheet
(subject matter) is not protected: however, the software program devised to create the
spreadsheet (form of expensive) is protected by copyright. This subject has become extremely
controversial for computer software programs, which are usually copyrighted but not
patented. Computer software is a special topic that will be addressed under separate heading.
Visual materials under copyright protection are photographs, paintings, sculptures, poems,
articles, stories, books, music, sound recordings, motion pictures audiovisual works,
periodicals, computer punch cards, microfilm, pantomimes, and choreographic works. These
can be accurately differentiated from similar works. Copyright law extends to literary and
dramatic efforts, so that performances and recording rights also can be protected. In some
instances, new copyrights can be obtained for old material, if the new use represents a new
form of expression. This point is illustrated in the accompanying profile of Thorn EMI, the
recording company that handle the Beatles.
a) Materials Exempted from a copyright
The first step in establishing a copyright is that the material must be copyrighted by an
unequivocal statement before the published material is offered for sale or made public.
Consequently, if an author writes a story, publishes it, and offers it for sale, then seeks a
copyright, it will be denied. In fact, no one can copyright the story at that point: it has passed
into “public domain”, and anyone can have access to use or copy the story. Also, a “blank
form” or an “idea” cannot be copyrighted. As a general rule, anything that lacks creative
authorship cannot be copyrighted. Thus slogans, colors, variations on lettering titles, formulas,
measurements, or translations of existing materials have too little creative value to qualify.
Mathematical formulas are exempt because they express a “state of nature”, not a creative
human endeavor.
b) Fair Use and Limitations of Copyright Protection
Through court interpretations, a concept of fair use has been established so that copyright
material can be used and copied within limitations. For example, most scientific papers and
textbooks build on previously published and copyrighted work. Educational researchers and
teachers are expected to make extensive use of previously published materials, either building
on prior knowledge to extend their own research or disseminating information to students. As
a result, the law allows use of copyrighted information for education within certain stipulated
guidelines. If more than 10 present of a short copyrighted article is quoted or copied, for
example, written permission usually is needed from the copyright owner. For longer works
such as a textbook, permission may be required for 50-word quotations, and the copyright
owners may require payment and attribution for granting that permission. Reproduction of a

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copyrighted work for criticism, comment, scholarship, research, and classroom teaching is
considered fair use, not an infringement of copyright.
The doctrine of fair use was established to encourage dissemination of intellectual property.
To that end, scholars are encouraged to draw on published information without undue
restrictions. Authors are expected to extend past knowledge into future essays. Teachers are
given a great deal of latitude to copy materials for classroom use. These uses are considered
essential to “diffuse” knowledge for the benefit of society. When these efforts are not for
commercial gain, the doctrine of fair use will be extremely liberal. When a user can realize a
commercial gain, the doctrine is interpreted more closely to protect the copyright owner’s
interests.
c) Obtaining a copyright
Once a copyright declaration has been printed on material, a formal filling process will proceed
as illustrated in figure 6-3. however, a copyright does not have to be

Declaration Application

Print copyright Make application to Issue

declaration by the the Copyright Office, Obtain
owner on property pay required fees verification
caution: Owner must of copyright
declare in published and registered
from but not sell or Deposit number from
distribute copyright Library of
item before it is Forward Congress
registered concurrently with
application copies
of material or
excerpts required
for deposit with the
Library of Congress

Exhibit 8.7
Copyright Procedure

field to be valid. By printing a copyright statement on material, it is “copyrighted”, provided

there is no infringement on someone else’s material. Merely writing a declaration statement,
however, does not constitute a valid claim that can be used in court. Under copyright law,
there is a specific requirement that a copyright be registered with the Copyright Office for it to
be accepted in court as evidence. To be clear about this matter, courts cannot accept an
unregistered claim as evidence, nor can a court act on a copyright infringement when the
copyright is unregistered.

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For artistic materials, recordings, audiovisual works, computer programs, and most other
copyright deposits, there are more complicated requirements. To register software, for
example, a partial reproduction of the first and the last computer program code is needed
exactly how much code must be reproduced and deposited is somewhat arbitrary and vies
with the length and complexity of the software program. Requirements for books, articles,
periodicals, sheet music, and similar materials are that two copies of the published items be
deposited. The deposit can be made concurrently with the copyright filling, and the Copyright
Office will document the material, register it, and give the applicant written verification.
Registration is simple in most instances, but occasionally it becomes complicated. For
example, when the creators of the electronic toy rear. Taddesse, tried to register it, they
submitted a videotape to establish the unusual toy movements. This was rejected by the
Copyright office, but after several months of legal intervention, Tadesse was copyrighted as a
“compilation of data” the story is expanded in the adjacent profile.
Validating Property Rights
With all the ceremony attached to registering patents, trademarks, and copyrights, one would
think that an individual has ironclad protection. That is not the case, in fact, there is no
presumption that any form of protection is valid until it has been tested in a court of record. A
“court of record” is a higher court whose rulings are recorded and open for public reference.
The court can act on criminal infringement cases, render judgments on patent disputes,
however, are resolved through civil court actions (between parties) rather than through
criminal proceedings.
The revelation can be quite disturbing to an inventor with patent in hand who thought his or
her invention was backed by the federal government, patent documents, trademark
registrations, copyrights, and department of commerce are nothing to do with individual
cases. They do not resolve disputes or validate property rights, and they cannot help defend a
claimant. Nevertheless, registration provides very strong legal documentation for presenting
evidence in favor of ownership rights.
When there is dispute over ownership, the holder of a registered property right (patent,
copyright, or trademark) brings suit against an alleged infringement is a criminal violation:
copyright or trademark infringement is not “on the surface” a criminal violation. Therefore, a
person who violates patent law can be criminally charged and then sued again in a civil court
for personal damages. A person who violates a trademark or copyright is typically sued in a
civil action and enjoyed to stop using the protected materials, and the violator can be held for
any personal damages suffered by the registered owner. Copyright or trademark violators also
can be subject to criminal charges under circumstances that relate to fraud and willful
infringement.
8.3 RISK AND INSURANCE MANAGEMENT (RISK MANAGEMENT)

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 Because every business has got an element of risk, another important legal aspect that an
entrepreneur to look into and critically analyze are:
A. The various types of business risks that an entrepreneur may encounter
B. The major hazards and causes/perils of these risks
C. The process/steps of risk handling/management
D. Basic concepts and principles of risk and insurance
In the following section, an attempt will be made to briefly discuss the basic concepts, types,
causes, steps and principles related to business risk and insurance.
8.3.1 Risk; Basic Concepts and its Management
Definition of Risk: As many scholars agreed, so for, no single and comprehensive definition of
risk exists. Economists, behavioral scientists, statisticians, etc have their own perception and
definition of risk. Some scholars defined it as uncertainty concerning the occurrence of a loss
(Rejda, 1995). Others defined it as a condition in which there is a possibility of an adverse
deviation from what is expected (Unity University College, 1998). However, for the sake of
common understanding, it could be important to give operational definition for our discussion.
That is, Risk is the probability of exposure to bad/adverse consequences (such as loss, loss of
property, etc) due to unexpected changes in the future.
8.3.2 Classification of Risk
The probabilities of exposure to adverse/bad consequences are multi facet. The various types
of business risks that an entrepreneur may face can be classified into four major groups as
indicated below.
Property Cantered Risks: Entrepreneur’s, big or small, own properties or assets of different
kinds such as buildings, machinery, materials, etc. These assets may be fully or partially
damaged, destroyed, lost or theft due to fire, earth quake, lightening tornado, windstorm, etc.
Such risks which lead to physical damage, destruction or theft of property are termed as
property-centered risks. Property centered risk cause direct financial loss which is equal to the
value of the property destroyed and/or indirect/consequential loss which refers to extra
expenses or loss of income in the future as a result of such risks.
Employee Centered Risks: These risks are directly or indirectly related to employee
circumstances of the entrepreneur such as:
- Work-place accidents and professional hazards which may lead to employee injury, partial or
total disabilities.
- Employee strike which may cause considerable trouble and loss of income
- Employee frauds such as forgery, over-stating or under-stating checks and other illegal acts of
an employee(s).

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- Loss of key employees/executive who have valuable specialized skill and experience which
cannot be easily replaced. An entrepreneur may loss his/her key employees who are vital for
the success of his/her business due to sickness, death, resignation, etc.
Market-Centered Risk: An entrepreneur is not an island. He/she interacts which different
elements of the external environment such as customers, suppliers, the labor market,
competitors, etc. The actions and reactions between the entrepreneur and the external
environment coupled with other environmental changes may sometimes lead to undesirable
consequences /risks/ to the entrepreneur. These risks are termed as market centered risks.
Such types of risks include:
- Business recession or economic decline in general.
- Undesirable price fluctuation
- Production process and/or product obsolescence i.e. an entrepreneur’s production process
and/or products may become obsolete if competitors introduce improved production
technology and/or product.
- Bad debt or risk or risk of uncollectible accounts receivable if a customer who bought on
accounts dies or disappears.
- Liability risk which refers t losses or any other bad consequences such as bodily or property
damage to the party (some one else) due to the action or the product of an entrepreneur. For
example, product liability suit may be filed if a customer is injured, sick or sustained property
damage as a result of using an entrepreneur’s product.
Personal/Individual Centered Risks: These are risks which directly affect personal
circumstances of the entrepreneur and lead to complete loss or reduction of earned income,
depletion of financial assets, and/or extra expenses.
Examples of such risks are:
- Risk of premature death
- Risk of old age
- Risk of poor health
- Risk of unemployment, etc.
Based on their ultimate effect, the above mentioned types of business risks are grouped into
two broad categories are:
a. Pure Risks which refer to the risks which produce the possibilities of adverse consequences
(loss) or natural (no loss) situation. In this. In this case, the possible ultimate effects are loss if
risk occurs or no loss if risk doesn’t occur. The above mentioned property-centered and
personal risks fall under this category.
b. Speculative Risks which refer to risks which produce the possibilities of adverse consequences
(loss) or favorable situation (profit). In this case, the ultimate effects are either profit or loss.
Market centered risks are good examples of this category.
c. Risk, Peril and Hazard: An entrepreneur need to clearly distinguish between what is called the
peril which is the main cause of a particular risk and a hazard which refers to a condition which

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 creates and/or increases the probability of occurrence and severity of a particular risk. For
example, while fire is a peril/ (the cause) for property damage, defective electric wiring is the
hazard or the condition that aggravates the probability and severity of fire risk.
The three major types of hazard are:
Physical Hazard which refer to a physical condition which increases the chance or risk such as:
 Icy road which aggravates auto accident
 Defective wiring which aggravates fire risk
 Defective door-lock which aggravates theft.
Moral Hazard refers to dishonesty, fraudulent claims or deliberate character defects of an
individual which increase the frequency and severity of risk such as:
Intentionally burning unsold merchandize
Intentionally inflating insurance claims, etc.
Morale Hazard which refers to inadvertent carelessness, negligence or indifference to risk/loss
because of the existence of insurance such as:
 Leaving ignition ken in the car and increasing the chance of loss
 Leaving doors unlocked and increasing the chance of burglary.
Therefore, an entrepreneur is required to know the various types as well as causes of risk and
critically analyze the frequency and severity of possible risks that he/she may encounter in the
future. Based on this analysis, risk-handling strategy/strategies need to be designed. In the
following section, the process /steps/ of risk management will be briefly discussed.
8.3.3 The Process/Steps/ of Risk Management
Risk management is defined as “a systematic process for the identification and evaluation of
pure loss exposure faced by an organization or individual and for the selection and
implementation of the most appropriate techniques for treating such exposures” (G. Rejda,
1995: 38) As clearly indicated in the definition, risk management requires the performance of
sequential activities known as the process/steps of risk management. These steps are briefly
discussed below.
1. Analyzing the situation and identifying potential risks. The first step in the process of or risk
management is conducting environmental scanning i.e. retrospective or past, current or
present and prospective future situation analysis with special reference to the probabilities of
exposures to adverse or undesirable consequences; in short, risk exposures and based on this
analysis, anticipating and identifying the type(s) of risk(s) that businessmen may face in the
future and also its/their possible causes (discussed before)
2. Evaluating and determining the frequency of occurrence and severity or
magnitude of possible losses due to anticipated risks.
3. Based on step 2, selecting the appropriate risk handling strategy for handling anticipated
risk(s).

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 Based on the frequency and severity of loss exposure(s) or anticipated risks, the risk manager
need to select the most appropriate strategy or combination of strategies for handling
anticipated risk(s). The chosen strategy will be risk management strategy of the entrepreneur.
The most common risk handling strategies, which are further divided into two specific
techniques (risk control and risk financing tools) and appropriate situation(s) for each
technique are indicated in the table below.

Risk control techniques (minimizing or avoiding

Risk financing
lossestechniques (paying for the loss if risk happens)
through
risk presentation or avoidances)
Risk Prevention Risk avoidance Risk Retention Insurance/
(control) (self-insurance) transfer
- Taking risk Abandoning - Allocate money and Buy insurance policy
preventive measures activities which have pay and transfer
to reduce the high risk - for or recover the the risk to specialized
frequency and severity frequency and severity. loss insurance
of loss eg. Quality Eg. - if risk happens. companies. This
control Avoiding method is
- Installing fire construction in rift valley- This technique is appropriate when
extinguisher, burglary or flood area - appropriate when loss severity is
alarm Thus technique is is high and frequency is
- Driver exam appropriate when - predictable, low.
- Strict adherence frequency and frequency and
to safety rules severity are high. severity or risks are * to be discussed next
- This technique is low.
appropriate when
Risk frequency is high
and severity
is low.
4. Implementing the chosen/selected risk handling strategy: based on the situation, an
entrepreneur may choose either may one or combination of the above mentioned
technique(s). The chosen technique(s) need to be implemented or put into action.
5. Monitoring and evaluating the implementation of the chosen risk
management strategy. The last step in the process of risk management is monitoring the

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 implementation process to make sure that the selected strategy is implemented as planned.
Monitoring requires periodic review of the implementation process, comparing actual with
planned performance and taking corrective action if there is any deviation between actual and
planned performances. Finally, conducting impact assessment or evaluating, unusually at the
end of the planning period, is essential in order to identify the efficiency and effectiveness of
the chosen strategy.

8.4 INSURANCE MANAGEMENT

8.4.1 Insurance: Basic Concepts and its Management
Though so many people confuse the concepts of risk or risk management and insurance or
insurance management, there is vivid distinction between these concepts. As it is indicated in
the previous section, insurance is only one of the four alternative strategies of handling risk. In
this section, an attempt will be made to provide an overview of the basic concepts of
insurance.
A. Definition of Insurance:
Notwithstanding the various definitions of the term insurance, the author preferred to focus
only on one more comprehensive and operational definition. That is, insurance is defined as a
legal contract whereby one party, called the insurer or insurance company agrees to
reimburse, recover or indemnify another party, called the insured (an individual, a group,
organization, etc) if the latter (the insured) suffers a specified monetary loss. As it is clearly
indicated in the definition, insurance is a contract between the insurer and the insured
whereby the insured transfer his/her potential risk(s) to the insurance company. However, in
order for a particular insurance contract to be legal document, it should be written and
supported by appropriate insurance policy-document. The insurance policy-document among
other things, need to contain the following elements:
1. Declarations: Statements which provide information about:
- the name, address, sex, age, etc for a person
- identification and location of the property, period of protection, amount of premium and
other relevant information’s.
2. Definition of key works and phrases in the policy document
3. Insurance agreements which summarize the major promises of the insurer and the insured as
well as the conditions under which assets are to be paid.
4. Exclusive such as:
- Excluded periods such as unclear radiation
- Excluded losses such as losses due to negligence
- Excluded property such as animals and birds in case of home insurance.
5. Conditions or provisions that quality or place limitation on the insurer’s promise

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 6. Other miscellaneous provisions such as, for example, the manner of relationships between the
insurer and insured, the insured/insurer and the third party, etc.
B. Insurable and Uninsurable Risks
Not all risks are insurable. Depending upon the nature of the property, type of risk, perils and
hazards; while some risks are insurable, others are uninsurable.
Generally, insurable risks need to meet the following requirements.
1. There must be a large number of exposure units: As insurance companies operate under the
low of large numbers, ideally, they need a large number of exposure units subject to similar
peril.
2. The expected loss need to be calculable, determinable and measurable: which means, the loss
must be de definite to a particular peril, time, place and amount.
3. The loss need to be accidental and un international. I.e., insurers do not pay for the losses
intentionally caused by the insured.
4. Calculable chance of loss: i.e. the insurer must be able to calculate the average frequency and
severity of anticipated future losses.
5. The expected loss must be financially serious and the premium needs to be economically
feasible to the insured.
6. The loss need not be catastrophic in a sense that a larger portion of exposure units (insured)
should not incur losses at the same time. The peril must not be likely to affect all insured
simultaneously.
Therefore, insurability or uninsurability of a particular risk depends upon whether it meets the
above mentioned requirements or not.
8.4.2 Fundamental Legal Principles of Insurance
The two parties to the insurance contract (the insurer and the insured) are governed by the
following legal principles:
1. The Principles of Indemnity: This principles states that the insured should
not collect more than the actual loss in the event of risk/ damage. That is, the insured should
not profit from a covered loss; but restored (indemnified) to the same financial position that
existed prior to the occurrence of the loss. However, there are some exceptions to this
principle. Some of these are:
 Valued policy
 Replacement cost insurance
 Life insurance – the word indemnity is not applicable for life insurance
2. The Principle of Insurable Interest: This principle refers to the financial
interest of the insured towards the subject insured. That is, the insured must lose financially or
must suffer some other kind of harm if loss occurs in the event of risk. The insured is said to
have financial interest if he/she benefits from the existence and suffer from the
destruction/loss of the subject insured.

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 3.The Principle of Subrogation: The principle states that the insurer who
indemnified/compensated/ the insured’s loss is entitled to be recovered from any liable third
party/ parties responsible for the loss. In insurance, the principle of subrogation substitutes
the insurer in place of the insured for the purposes of claiming compensation /indemnity/ for
a loss covered by the insurer from a liable third person. The aim is to prevent the insured from
collecting money from the third party (the one who made the loss) and his/her insurer.
4.The Principle of Utmost Good Faith: This principle states that high degree of honesty is
imposed on both parties to the insurance contract. That is, both parties to the contract must
make full and fair disclosure of all material facts related to the contract. Neither party shall try
to take advantage of the other party’s lack of information. Which means:
 There should be no misrepresentation and/or cancellation of material fact either deliberately
or innocently.
 Both parties to the contract need to live up to their promises/warranty indicate in the
contract.
5.The Principle of Contributions
This one supports the principle of indemnity. It is applied to a situation where a person or firm,
for some reason, purchase insurance from two or more insurers to cover the same subject
matter against loss or damage. Under such circumstance, the insured cannot collect
compensation from each insurer. If this happen, insurance becomes a profit making
mechanism. So, the insured is paid only to the extent of the loss suffered. But, each insurer will
make contribution to settle the claim.
Therefore, an entrepreneur is required to clearly know, understand and act is accordance with
the above mentioned fundamental legal principles of risk and insurance.

8.5 SUMMARY
Before a new business is launched though should be given to some legal issues associated with
the establishment of a new business. Such issues are the legal forms of business ownership
(sole proprietorship, partnership and limited companies (both private and share companies);
risks associated with the establishment of a new business and the methods of handling risks-
insurance.
Check Your Progress Questions
1. Discuss the difference between sole proprietorship and partnerships
……………………………………………………………………………………………………………………………
2. What is the difference and similarities between private and share companies? Discuss
……………………………………………………………………………………………………………………………
3. What is Risk? Define
……………………………………………………………………………………………
4. Discuss the types of risks

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 ……………………………………………………………………………………………………………………………
5. What is Insurance management
……………………………………………………………………………………………………………………………
6. Discuss the principles of insurance.
…………………………………………………………………………………………………………………………

8.6 ANSWER TO CHECK YOUR PROGRESS

1. Refer section 7.2.1 (A & B) 5. Refer section 7.4.1

2. Refer section 7.2.1 (C) 6. Refer section 7.4.2
3. Refer section 7.3.1
4. Refer section 7.3.2
Unit Budget Preparation – Ethiopian Context
Introduction
The working definition made by the World Bank, Governance refers to the process whereby
elements in society wield power and authority, and influence and enact policies and decisions
concerning public life, economic and social development (World Bank, 1999). For being
effective, fiscal policy implementation requires coordination of political, functional and
financial factors. Politically, the institution requires coordination of political, functional and
financial factors. Politically, the institutional incentive structure should promote accountability
and incentives. Functionally, policies should clearly delineate the responsibilities of each type
of government and the private sector in the implementation process. Financially, policies
should be based on a sustainable strategy that relies on long-lasing sources of revenues. If
these three factors coordinated, one can say there is good governance in that particular
country. Decisions about raising fiscal revenues, and planning and implementing public
expenditures take place in the context of a political and incentive framework influenced by
several actors intervening through the process: Ministers, government institutions and staff,
donors providing budgetary support, and civil society, to the extent that they participate or are
given the opportunity to participate in the decision making forum. Fiscal performance and
budget management effectiveness are determined by how this framework is established. For
that reason, before going to evaluate the IPRSP done by our country, first it is better to look
the non-execution factors that led for the transformation of government budgets. With the
ending of the internal arm conflict in the country, public expenditure was re-oriented towards
social and economic development. Importantly, the share of government recurrent
expenditure on education was raised from 11.9 percent in 1998/90 to 17.9 percent in
1996/97, and that of health from 3.5 percent to 5.8 percent. Moreover, emphasis was placed

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 on primary education and health care, to help tackle poverty at its root. However, during the
last three years, government expenditures are shifted to some other non-development
activities. These are:
- the war between Ethiopia and Eritrea on border conflict
- the drought. Before the drought used to occur in every 10 years and now it is changing and
beocome in every 5 years.
- the fall in coffee prices and the rise of petroleum, and
- the depreciation of the Birr.
The previous two years of 1998/99 and 1999/2000 were exceptional years due to conflict with
Eritrea. Defense expenditure rose sharply from below 3 percent of GDP in previous years to an
average of 10.7 percent during these years. Consequently the gap on the fiscal and balance of
payments fronts widened markedly with deficits of 8.8 and 8.7 percent of GDP respectively,
and money supply increased at an average rate of 10.4 percent. The external imbalance was
additionally aggravated by adverse terms of trade following the fall in coffee prices and the
rise in prices of petroleum, while economic growth was further hampered by crop harvest
failures due to drought which led to threat of famine. During these two years, the growth rate
of GDP declined to 5.6 percent, far less than what was initially feared, but the rater of inflation
increased to 4.3 percent by 1999/2000 (as per Addis Ababa retail price), and the Birr
depreciated by 16.5 percent within the two years.
The situation of poverty in Ethiopia has been an issue of concern to all sectors. With a
population of 62.8 million Ethiopia is the second largest country in Sub-Saharan Africa and
among the least developed countries. It has a poverty situation that puts it at the bottom of all
countries. The per capita income of Ethiopia which is USD 100, is the second lowest among
least developed countries. Poverty in Ethiopia is mainly a rural manifestation; 47.5% of the
populations in rural areas live below the poverty line. In urban areas the figure is 33.2%. By
designing poverty reduction strategies (bearing in mind debt relief strategies as well),
countries can address the core issues of poverty and enabling a sustainable flow of resources.
This helps to strengthen poverty reduction programs: releasing resources for investment in
basic services such as health, education, infrastructure, etc. The PRSP aims include identifying
the root causes of poverty and the strategies to reduce it. All stages follow from identifying to
strategizing; only if done in particular manners will PRSP be successful. "The strategy of
drawing a common PRSP would be a framework for accelerating poverty reduction by
including medium-term budgetary provisions, poverty-focused public spending priorities,
sector plans, and mechanisms for strengthening engagement with all actors of development
on a long term basis" (CRDA, April 18, 2001).
The Ethiopian Interim PRSP touches on and deals with governance and its fiscal policy with
reduction of poverty on at the core of the agenda of the country's development, through four
building blocks, namely, ADLI (Agricultural Development Led Industrialization), judiciary and
civil service reform, decentralization and empowerment, and capacity building in public and

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private sectors. The main contents of these building blocks, their inter-relations and how they
may, in combination, lead to poverty reduction over the long term are examined briefly by the
IPRSP. ADLI foresees that agricultural growth should improve the conditions of food security in
the country. The strategy according to the IPRSP for this will come predominantly from within
agriculture, the medium to long-term target is to reduce the absolute size of the food insecure
population substantially as to exit from food aid, and rely on fiscal transfer of resource to
support a residual of relatively small numbers of food-deficit households. Industrialization is
the other arm of the ADLI strategy, which is inter-woven with the development of the private
sector
There are three types of measures that will be undertaken to encourage private investment.
First, to make the existing policies work better, by removing regulatory impediments and
improving implementation capacities on the side of government. Second, to encourage public-
private sector partnership through establishment of platforms of dialogue. Third, to make the
business environment and the incentive structure attractive for manufacturing in particular, as
it is relatively disadvantaged compared to other activities due to relative lack of experience in
this line of business, and the possibility of higher enforcement of taxes.
For the Judiciary and Civil Service Reform, the IPRSP strategy is to use the budget of the
government as follows: First, the expenditure management and control component includes
reform of procurement, auditing and internal controls. Second, the human resource
management component seeks to reform performance appraisal and job classifications, and
improve the incentive system. Third, the service delivery component is designed to improve
the quality of services handling mechanism. Fourth, the top management systems component
is meant to improve the selection and performance of senior government officials. Fifth, the
ethics component, which will aim to introduce code of conduct and prevent corruption. The
judicial reform will on the other hand overhaul the legislative framework to reflect the 1994
constitution and strengthen the judiciary.
For the decentralization and empowerment, the IPRSP states the strategy as follows:
"Decentralization is an outcome of the adoption of a federal system of government in
Ethiopia. With the devolution of power to the regional governments, implementation of
economic policies and development programs have to a large measure, been shifted from the
center to the regions. The application of fiscal federalism ensures a single system of taxation,
allows some revenue collection by the regions and some revenue sharing with the federal
government while putting the majority of the revenue under the central authority, provides
budgetary subvention the regions, and grants the regions full autonomy in budgetary
expenditures. Consequently, considerable space has been created for effective
decentralization and empowerment, which in turn creates room for tacking poverty directly at
the grass root level." (IPRSP, September 2000).
Finally, regarding Capacity Building, the strategy and program framework of capacity building
that has been formulated is designed to feed into ADLI, judiciary and civil service reform, and

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decentralization and empowerment, thus it fits properly the country's poverty reduction
strategy as expressed by the IPRSP. However, the IPRSP has its own shortcoming towards
governance and the budget. The IPRSP doesn't give emphasis on pastoralist development and
lack gender sensitivity. Without considering the pastoralist that consists of the majority of the
population, how can we alleviate poverty in the country, including the gender aspect? The
interim also lack transparency to be judged or evaluated by other civil societies, however, the
Britton Wood Institutions need the participation of Civil Societies. Hopefully, this will take in to
consideration in preparing the final PRSP document. The steps that has to be taken, I
personally fill that increase the likelihood of effective use of public financial resources in favor
of the poor are the followings: policy reform and budget allocation on increased public
expenditure on Health, Education and on Capacity Building.
When we see the health condition in our country, at current growth rate, Ethiopia's population
will almost triple to 145 million by 2025, yet approximately one-fourth of Ethiopia's children
currently die before their fifth birthday, and the maternal mortality rate is estimated to be one
of the highest in the world. Preventive and primary health care and health care financing, the
expansion of integrated health and family planning services, including HIV/AIDS prevention
programs in urban areas should be given the priority in the fiscal policy. Here, as I stated above
the IPRSP should include the backward regions of pastoralist areas.
When we come to the educational background, less than 35% of Ethiopia's elementary school
age population is enrolled in primary school, with even lower enrollment rates for girls and
rural children. Therefore, government, to increase primary enrollments should directed at
strengthening the system's financing and administrative capacity, increasing public investment
in primary education, improving teacher training and the quality of educational materials, and
increasing community involvement in school management and support. And finally,
government should focus on the development of an independent judiciary, of course it is
focusing, the strengthening of Ethiopian NGOs and the decentralization of government
functions, including strengthening the capacity of regional governments, especially the
backwards, to manage the delivery of health, family planning and educational services.
The Budgetary Process
During the imperial period, the government initiated the budget cycle each year on the first
day of Tikimt (October 11) by issuing a "call for budget proposals". Supposedly, the various
ministries and agencies adhered to deadlines in completing the budgetary process. These
organizations submitted current and capital budget proposals to the Ministry of Finance: the
Council of Ministers reviewed all requests. The ultimate power for approval rested with the
emperor.
After the revolution, the government developed new guidelines on budget preparation and
approval. Addis Ababa issued annual budget "calls" in July or August, with preliminary
information and guidance. The new guidelines required ministries and agencies to complete
their proposals by January, when budget hearings would begin. The hearings included

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discussions with ministries in which requests would be aligned with allocations, and
justifications for requests would be evaluated. After the ministries submitted their current
budget proposals to the Ministry of Finance for review, with a copy to the ONCCP, the ONCCP
executive committee would approve, disapprove, or change the requests. Conversely,
ministries would send capital budget proposals to the ONCCP with a copy to the Ministry of
Finance. The ONCCP would conclude a similar process of budget hearings, which would include
a review of adherence to guidelines, justifications for requests, and conformity to investment
priorities identified in the national plan. Thus, under the new system, the Ministry of Finance
developed the current budget, and the ONCCP developed the capital budget. Draft current and
capital budgets prepared by the Ministry of Finance and the ONCCP, respectively, would then
be reconciled with estimates of revenues, domestic resources, and other sources of findings
such as loans and aid. The consolidated current and capital budgets then would go to the
Council of Ministers for review and recommendations. The final approval was the head of
state's prerogative (See Banking and Monetary Policy, this ch.).
DATA AS OF 1991
Revenue and Expenditures
Resources were allocated among the various sectors of the economy differently in the imperial
and revolutionary periods. Under the emperor, the government dedicated about 36 percent of
the annual budget to national defense and maintenance of internal order.
Toward the end of the imperial period, the budgets of the various ministries increased steadily
while tax yields stagnated. With a majority of the population living at a substance level, there
was limited opportunity to increase taxes on personal or agricultural income. Consequently,
the imperial government relied on indirect taxes (customs, excise, and sales) to generate
revenues. For instance, in the early 1970s taxes on foreign trade accounted for close to two
fifths of the tax revenues and about one-third of all government revenues, excluding foreign
grants. At the same time, direct taxes accounted for less than one-third of tax revenues.
The revolutionary government changed the tax structure in 1976, replacing taxes on
agricultural income and rural land with a rural land-use fee and a new tax on income from
agricultural activities. The government partially alleviated the tax collection problem that
existed during the imperial period by delegating the responsibility for collecting the fee and
tax on agriculture to peasant associations, which received a small percentage of revenues as
payment. Whereas total revenue increased significantly, to about 24 percent of GDP in EFY
1988/89, tax revenues remained stagnant at around 15 percent of GDP. In EFY 1974/75, total
revenue and tax revenue had been 13 and 11 percent of GDP, respectively. Despite the 1976
changes in the tax structure, the government believed that the agricultural income tax was
being underpaid, largely because of underassessment by peasant associations.
The government levied taxes on exports and imports. In 1987 Addis Ababa taxed all exports at
2 percent and levied an additional export duty and a surtax on coffee. Import taxes included
customs duties and a 19 percent general import transaction tax. Because of a policy of

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encouraging new capital investment, the government exempted capital goods from all import
taxes. Among imports, intermediate goods were taxed on a scale ranging from 0 to 35 percent,
consumer goods on a scale of 0 to 100 percent, and luxuries at a flat rate of 200 percent. High
taxes on certain consumer goods and luxury items contributed to a flourishing underground
economy in which the smuggling of some imports, particularly liquor and electronic goods,
played an important part.
Although tax collection procedures proved somewhat ineffective, the government maintained
close control of current and capital expenditures. The Ministry of Finance oversaw
procurements and audited ministers to ensure that expenditures conformed to budget
authorizations.
Current expenditures as a proportion of GDP grew from 13.2 percent in EFY 1974/75 to 26.1
percent in EFY 1987/88. This growth was largely the result of the increase in expenditures for
defense and general services following the 1974 revolution. During the 1977-78 Ogaden War,
for example, when the Somali counteroffensive was under way, defense took close to 60
percent of the budget. That percentage declined after 1979, although it remained relatively
higher than the figure for the pre-Revolutionary period. Between 1974 and 1988, about 40 to
50 percent of the budget was dedicated to defense and government services.
Economic and social services received less than 30 percent of government funds until EFY
1972/73, when a rise in educational outlays pushed them to around 40 percent. Under the
Mengisut regime, economic and social service expenditures remained at pre-Revolutionary
levels: agriculture's share was 2 percent, while education and health received an average of 14
and 4 percent, respectively.
Banking and Monetary Policy
Te 1974 revolution brought major changes to the banking system. Prior to the emergence of
the Marxist government, Ethiopia had several state-owned banking institutions and private
financial institutions. The National Bank of Ethiopia (the country's central bank and financial
adviser), the Commercial Bank of Ethiopia (which handled commercial operations), the
Agricultural and Industrial Development Bank (established largely to finance state-owned
enterprises), the Savings and Mortgage Corporation of Ethiopia, and the Imperial Savings and
Home Ownership Public Association (which provided savings and loan services) were the
major state-owned banks. Major private commercial institutions, many of which were foreign
owned, included the Addis Ababa Bank, the Banco di Napoli, and the Banco di Roma. In
addition, there were several insurance companies.
In January and February 1975, the government nationalized and subsequently reorganized
private banks and insurance companies. By the early 1980s, the country's banking system
included the National Bank of Ethiopia; the Addis Ababa Bank, which was formed by merging
the three commercial banks that existed prior to the revolution; the Ethiopian Insurance
Corporation, which incorporated all of the nationalized insurance companies; and the new
Housing and Savings Bank, which was responsible for making loans for new housing and home

193
improvement. The government placed all banks and financial institutions under the National
Bank of Ethiopia's control and supervision. The National Bank of Ethiopia regulated currency,
controlled credit and monetary policy, and administrated foreign-currency transactions and
the official foreign-exchange reserves. A majority of the banking services sere concentrated in
major urban areas, although there were efforts to establish more rural bank branches
throughout the country. However, the lending strategies of the banks showed that the
productive sectors were not given priority. In 1988, for example, about 55 percent of all
commercial bank credit financed imports and domestic trade and services. Agriculture and
industry received only 6 and 13 percent of the commercial credit, respectively.
To combat inflation and reduce the deficit, the government adopted a conservative fiscal
management policy in the 1980s. The government limited the budget deficit to an average of
about 14 percent of GDP in the five years ending in EFY 1988/89 by borrowing from local
sources. For instance, in EFY 1987/88 domestic borrowing financed about 38 percent of the
deficit. Addis Ababa also imposed measures to cut back capital expenditures and to lower
inflation. However, price controls, official overvaluing of the birr, and a freeze on the wages of
senior government staff have failed to control inflation. By 1988 inflation was averaging 7.1
percent annually, but it turned sharply upward during 1990 as war expenditures increased and
was estimated at 45 percent by mid 1991.

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