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CHAPTER TWO
SMALL BUSINESS MANAGEMENT
2.1 Definition and Importance of Small Business
2.1.1 Definitions
• Small businesses are the usual product of entrepreneurship.
• They are characterized by closely-held ownership, a primarily local area of
operations, and a small scale operation.
• Often run by the owners themselves, many small businesses are small by design
where the primary objective is employment for the owners.
.
There are a number of yardsticks being used for determining a business as small or big.
Some of the important yardsticks used for classifying businesses are the following:
 Total assets – the total cash, inventory, land and machinery, and other resources a
business holds
 Owner’s Equity – the total investment made by investors, often referred to as capital
 Annual Sales Revenues
 Number of Employees
Each yardstick has points in its favor, but “number of employees” yardstick has more than any
of the other yardsticks.

Let us look at some definitions of small business:

USA:- uses the term “small business” to refer to an owner-managed business that
employs a handful of people – usually not more than 20 or 25.

A white house conference defined a small business as one with 400 or fewer employees.

According to Gatewood, Taylor, and Ferrell (Management), “small business is defined as

any business that is not dominant in its competitive area and does not employ more than
500 people.”

According to Bateman and Snell ( Management, 6th ed), “small business is defined often
as having fewer than 100 employees, being independently owned and operated, not
dominant in its field, and not characterized by many innovative practices.”

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According to Griffin (Management, 5thed), “small business is defined as one that is

privately owned by one individual, or a small group of individuals; it has sales and
assets that are not large enough to influence its environment.”

According to Central Statistics Authority, Ethiopia, “small enterprises are those business
enterprises with a paid-up capital of above 20,000 and not exceeding 500,000 birr, and
excluding high technology consultancy firms and other high technology establishments.”
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Therefore,
Small business is a business which is independently owned and operated, not dominated in its
field of operation and meets certain standard of number of employee and capital.
- In short, it must be independently owned and managed.

Generally, there are two approaches to define small business enterprises:

 Size criteria
 Economic/ control criteria

I. Size criteria
Size refers to the scale of operation. Some of the criteria’s to measure the size are:
 Number of employees: - for example in Ethiopian case it is Less than 50 employees.
 Investment paid up capital: - for Ethiopia it is Less than 50000 birr.
 Volume of sales, production and deposits are also used to measure the size of business.

 Economic/control criteria
Size does not always reflect the true nature of an enterprise. In addition, qualitative
characteristics will be used to differentiate small business from other businesses. These
are
i. Market share
The characteristic of a small business market share is not large enough to enable it to
influence the price of national quantities of goods sold to any significant level.
ii. Independence
Independence means that an owner has control of the business himself.
iii. Personalized management

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Personalized management is the most characteristics of all. It implies that the owner
actively participate in all aspects of the management of the business, and in major decision
making process. There is little devolution or delegation of authority
iv. Technology
Small business is generally labor intensive
Geographical area of operation:-The area of operation of a small business is often local

2.1.2 The Importance of Small Business Enterprises

The following are some of the major vital roles of MSE
Greater value in building up a local production structure and in promoting economic
growth
As a means of creating employment opportunity, and achieving a fair distribution of
national resources, income, knowledge and power
A seed bed for development of local entrepreneurship
Promote rural industrialization
More appropriate technology is applied
Supplier of parts and accessories to bigger industries
Play prominent role in promoting the export market
The opportunity to: create your own destiny
reach your full potential
reap unlimited profits

2.2 Economic, social & political aspects of small business enterprise

Small business has to play a vital role in Ethiopian economy. They need a strong support on
socio-economic and political ground.
1. Socialistic idea (the equality argument )
Our goal is being the establishment a socialistic pattern of society. Our objectives are
equitable distribution of wealth and decentralization of economic power. According to this
argument unregulated growth of large scale industries results in concentration of economic
power in a few hands and consequently grosses inequities in the distribution of income and
wealth in the country. On the other hand, income generated in a large number of small
enterprises is dispersed more widely and its benefit is derived by a large population
2. Less capital and more labor

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The main problem is that we have vast manpower and inadequate capital, which has resulted
in increasing unemployment. This is unlike in a situation in western where man power is
limited but capital resources are enormous.
The small scale sector has the capacity to generate a much higher degree of employment than
the large scale sector. This argument is based on the assumption that small scale industry are
labor intensive and thus create more employment per unit of capital.

3. Removing regional imbalances (the decentralization arguments)

Another problem is the continued shifting of people from rural to urban areas which causes
overcrowding in cities with slum conditions due to lack of social and medical amenities which
require heavy investments. This problem can be resolved by inducing people to set up small
scale industries in rural areas.
Large scale industries have the tendency to concentrate in big cities. As a result semi urban
and rural areas remain deprived of the benefit of industrialization like problems of pollution,
slums and shortage of civic facilities etc.
4. Creating self-employment opportunities
5. Ancillary functions
Many small scale industrial units supply parts and accessories to bigger industries. This
ancillary function involves specialization in a specific area and results greater profitability.
6. Export promotion
Small scale industries are now a day’s opening up fresh avenues in the export market in our
world. Realizing the importance of the small scale sectors in the economy the Ethiopian
government has adopted several measures to speed up the growth of small industries.

7. Supply of critical raw materials

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The government of Ethiopia has also liberalized the import policy to ensure regular supply of
raw materials to small sale units and devised a more efficient and consistent system of
distribution of critical raw materials.
2.3 Small Business Failure factors
Many small businesses fail due to various reasons. Presumably, most of the reasons are
artificial i.e. the majority of the reasons are created by faults and mistakes of human beings.
Some of the reasons include the following.
Managerial incompetence or inexperience
Neglect
Weak control system
Under capitalization

Failure to clearly define and understand your market, your customers, and your
customers' buying habits
Poor financial control
Over investment in fixed asset
Failure to plan current as well as future operation
Failure to adopt proper inventory control system
Improper Attitude ( The entrepreneur may not respect time, employees and may have
lazy lifestyle and dictatorial style of work)
Failure to develop a strategic plan
Inadequate marketing plan
Incorrect market identification
Poor distribution channel
Poor location
Weak marketing communication or promotion
Incorrect pricing

2.4. How to avoid the pitfalls/ difficulties of a small business

Know your business in depth: - Knowing your industry well can be one of the ways of
minimizing the failures of small businesses. Also knowing your business well by preparing
documented business mission, objective, strategies and policies is another method.

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Have a Good Relation with Stake Holders: personal contact with suppliers, customers, trade
association and even competitors is one of the ways to get knowledge.
Prepare business plan: -a well-written plan is a crucial ingredient for the success of small
business. Answering, “what business I am in?” leads to the establishment of goals and
objectives. In turn these serve as aids in creating strategies, policies, and procedures.
Managing financial resources: - the first step in managing financial resource is to have adequate
startup capital. The most valuable financial resource to small business is cash. You cannot
maintain control over a business unless you are not able to judge its financial health.
Understanding financial statement: - to understand what is truly going on in the business you
must have at least basic understanding of accounting and finance that would help to recognize
the financial position of your business from time to time.
Learn to manage people effectively: -every business depends on a foundation of well-trained
and motivated employees. You would only do this if you learn how to manage people more
effectively.
Keep in tune with yourself:-the success of your business will depend on your constant presence
and attention and so it is critical. As an entrepreneur, you must always physically and mentally
fit through adjusting yourself with time.
Take up short professional courses in management (entrepreneurship): to improve your
managerial skills.
Be sensitive to your customers: your best opportunity lies within your customers. If you lose
them, you will be hurt. So as an entrepreneur, don’t ever give yourself a chance to disappoint
them. The other is be wise in identifying the present and future needs of your customers through
the analysis of the changes in their interests.

2.5. Problems in Ethiopia Small Business

Small scale industries have not been able to contribute substantially as needed to the
economic development particularly because of financial, production and marketing problems.
These problems are still major handicaps to their development. Lack of adequate finance and
credit has always been a major problem in Ethiopian small business. Mostly they do not have
access to industrial sources of finance partly because of their size and because of the fact that
their surpluses which can be utilized to repay loans are negligible.

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Small businesses are also finds difficulties to get raw materials of good quality and at a
cheaper price in the field of production. Very often they do not get raw materials in time. As a
result these enterprises very often fail to produce goods in requisite quantities and of good
qualities at a lower cost. Furthermore the techniques of production these enterprises adopted
are usually out dated.
Besides, many small business enterprises are suffering with problem of marketing their
products.
2.6. Setting Small Business
Setting up new small enterprises is a very challenging and rewarding task. Several problems are
involved in the task. Right from the conception of the business idea up to the startup of
production, numerous decisions have to be taken.

The first and for most step in starting a small business is to find out a suitable business idea and
give a practical shape to the idea. The entrepreneur should be convinced that idea is “in fact a
sound one and likely to give reasonable return on his investment”.
The search for an appropriate business idea is a complicated exercise because the entrepreneur
comes across enumerable business opportunities. To choose a business idea, skill, foresight and
ingenuity are required on the part of entrepreneur.

2.6.1. What is a basic business idea

In practical situation it is seen that an entrepreneur find it rather convenient to think of product,
keeping in view the immediate further rather than the long term goals. Business atmosphere
being what it is with all its intendants, uncertainties, it is more likely to face a serious problem
either when he wants to expect or when the first product meets with a failure.
It is logical, therefore, to think of a goal for the unit in the long run rather than to look for the
immediate tomorrow. This long term thinking is called Basic Business Idea. The basic business
idea and the product through hierarchy can be represented as follows

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Basic
BasicBusiness
BusinessIdea
Idea

Product
Productline
line

product
productrange
range

prod
prod
uct
uct

Fig 2.1. Hierarchical presentation of business idea

Businessmen should think of long term goal and the profit when they start a business. The basic
business idea, which is at the top of the hierarchy, is to meet the broadest needs of the customers
and has a long life perhaps from 5-50 years. The basic business idea facilitates choice of product
under an overall plan.
The product line is relatively narrow and has a shorter life. The product line consists of different
families of products. A unit with a basic business idea of producing packaging can manufacture
groups of the product for example, glass bottle: plastic package, aluminum package, paper
package, metal package etc.
The product range on the other hand includes different sizes of the product within the product
line. In the example given above different sizes and shapes of glass bottle can be manufactured
The product is one item of the product range having different specifications like size, material
used and weight etc.
The basic business ideas, which facilitate a choice of a product at different stages of the project,
allows for diversification and expansion. But the basic business idea is not always the same.
In order to establish a business venture with an entrepreneurial system, an entrepreneur needs to
take the following steps:
1. Search for business idea
2. Process the idea

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3. Select the best idea

1. Search for business idea: - the task of promotion begins with the search of a suitable
business idea. The idea may relate to the starting of a new business or to take over of an
existing enterprise. The idea should be sound and workable so that it may be exploited.
The idea may be originate from various sources. Some of the more useful ones are
consumers, existing companies; distribution channels, the government and research and
development units.
2. Idea processing
a. Preliminary evaluation and testing of ideas:-once business idea are discovered
screening and testing of idea is done through its technical feasibility and commercial
feasibility.
b. Detailed analysis:-after preliminary evaluation of the idea, the promising idea is
subjected to a throughout analysis from all angles. Full analysis is carried out in the
technical feasibility and economical visibility of the proposed project. Financial and
managerial feasibility is tested. At this stage a lot of information is required. Consultation
with experts in varies area of the industry may be necessary to carry out the detailed
analysis. Due care is necessary at this stage because the idea is finally accepted or
rejected at this stage.
3. Selecting the best idea
The feasibility report is analyzed to finally choose the most promising idea.

2.6.2. The Startup Process of a Small Enterprise

 Steps in setting a small scale unit
The challenges of starting a new enterprise from the stage of its conception till functioning are
indeed stupendous or multidimensional as indeed its contribution to the society in various forms
such as employment, economic growth, balanced development, equitable distribution of wealth
etc. Success is a slave to those who only correctly perceive the nature and intensity of problems
that they are likely to encounter but also plan appropriate remedial actions. Starting a new
business requires the following steps:
STEP 1: Identification of New Venture Opportunities
STEP 2: Evaluation and selection of New Venture Opportunities
STEP 3: Technical, Marketing and Financial Feasibility of the Identified Project

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STEP 4: Assessment of Personal Requirements and Organizational Capabilities

STEP 5: Analysis of Competition
STEP 6: Developing Action Plans
STEP 7: Implementation and Evaluation

STEP 1: Identification of New Venture Opportunities

In the search for new ventures, entrepreneurs explore both (a) external and (b) internal resources.
The external resources include:-

1 Newspapers, trade journals, professional journals etc. which tell about trends in fashions,
customs and other social areas.
2 Professional magazines catering to particular interests such as electronics, computers, etc.
3 Trade fairs and exhibitions displaying new products and services.
4 Government agencies.
5 Ideas put forth by others.

Internal resources basically consist of storehouse of knowledge build up by an individual over

the years. An entrepreneur draws upon it and undertakes the following exercise:-
O Analysis of concepts in the light of existing problems and their capacity to solve them.
O Search of memories to find similarities and elements related to the concept and its problems.
O Recombining the elements found in new and useful ways.

STEP 2: Evaluation and selection of New Venture Opportunities

Once the business ideas are lacerated, study, screening, and testing of these ideas are done based
on the entrepreneur’s own experience or with the help of experts in the field. While evaluating
the major points to be considered are:
i. Technical feasibility that is the possibility of production with the available skill &
technology
ii. Commercial viability of the idea based on cost and profitability. It evaluates the
tradeoff between cost and income to judge the attractiveness of a business idea
STEP 3: Technical, Marketing and Financial Feasibility of the Identified Project
A. Technical Feasibility
It covers the following

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1. Identification of critical technical specifications comprising

a) The functional design of the product.
b) Adaptability to the new customer demand.
c) Durability
d) Reliability of performance.
e) Safety
f) Reasonable utility (i.e. acceptable level of obsolescence)
g) Standardization (i.e. elimination of unnecessary variety)
2. Examination of product quality-cost relationship
In making this investigation, the entrepreneur must understand that there are tradeoffs between
technical excellence and associated cost i.e. a positive relationship exists between technical
quality and costs. It is possible through an increase in the technical excellence of a product to
that level at which marginal product quality equals marginal cost. This level is reached where
slope of product quality and product cost curves are equal. Quality enhancement should not be
carried beyond a particular point because it would cause cost increase and lead to decrease in
total market demand (except where the product has a snob value). Thus entrepreneur should
avoid unnecessary gold plating when market situation does not justifies it.
3. Product testing, which includes:
a) Engineering studies relating to machines, tools, instruments work flow etc.
b) Product development through blueprint, models, prototypes.
c) Product testing through laboratory testing and field-testing.

B. Market Feasibility
The following process may be adopted to assure the market opportunities of a product.
1. Identifying the Market Potential
It involves an estimation of both the current demand of the product and projection of future
market trends. The prospective entrepreneur will do well to identify:
 Specific end users,
 Major market segments, and
 Potential volume of purchases within each market segment.

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Some statistical yardstick may be of quite help in accomplishing this work. To illustrate, a
potential manufacturer of helmets may find out the annual production of two wheelers,
percentage of helmet users and proportion of demand already met.
2. Estimating Cost-volume Relationship to ascertain how various price levels may affect
total sales volume. The price must reflect the value of the product. The entrepreneur may
not adopt a uniform price structure to take care of the sensitivity of the buyer to price
changes. The cost-volume analysis would also facilitate the determination of appropriate
economies of scales i.e. optimum size of enterprise, which has lowest average per unit
cost of production and distribution.
3. Sources of Market Information.
Relevant data for market analysis can be gathered from two main sources viz (a) primary sources
such as interviews, mailed questionnaire, survey etc and (b) secondary sources like government
agencies, trade unions, chambers of commerce etc. Whereas the former is costly, the latter may
not meet the requirements of the entrepreneur.
The following kind of data matrix may be quite helpful:
 Data relating to general economic trends as revealed by various indicators such as new
orders, house activity, inventories consumer spending.
 Market data relating to demand pattern, seasonal variation etc.
 Pricing data i.e. range of prices for same, complementary and substitute products; base
price; discount structure etc.
 Channels of distribution both wholesale and retail.
 Data relating to competitors.
To obtain this data, the entrepreneur may either conduct his own survey or approach a
consultant.

 Market Testing
It is an important method of establishing the overall feasibility of a new venture, significant
market testing methods include:
 Displaying the product at trade fairs,
 Test marketing to analyze the receptivity of the product, and

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 Sample sales.
C. Financial Feasibility
It covers the following:
 Determination of total financial requirements
It can be done by preparing a financial statement in the following way:
Financial Requirement Statement:
Initial Expense Period 1 Period 2
Expense in product development _________ _________
Legal expense _________ _________
Product testing expenditure _________ _________
Marketing and technical feasibility _________ _________
Expenditure
Fixed investments
Building _________ _________
Equipment and machinery _________ _________
Patents _________ _________
Other equipments _________ _________
Operational expenditure
Material _________ _________
Wages _________ _________
Sales promotion, distribution _________ _________
Rent, interest, insurance, taxes _________ _________
Contingency _________ _________
TOTAL
------------- -------------

In making the above estimation, provision must be made for cost escalation that is inevitable due
to price changes. Besides, appropriate sales forecasts should also be made to have a clear picture
of expenditure. The projection could be weekly or monthly.
 Financial resources and other costs
Financial resources could be categorized on the basis of periodicity into:
Short term resources: (those payable in a year). Trade credit supplies, short term loans from
banks or other lending institutions, sales of account receivable etc. belong to this category.
Medium term Loans: Intermediate term loans are those available for one to three (sometimes
five) years. It includes terms loans from banks, lease finance, financial assistance from
institutions etc.

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Long-term loans are those from banks, equity capital and investments of earnings.

 Cash Flow Analysis

If the projected sales associated financial requirements and available financial resources are
known, the anticipated cash flow can easily be determined.
Cash Flow (projected)
Cash flow and financial transactions Period 1 Period 2

1) Cash flow
Initial expense
Fixed investment
Operating expense
Total cash outflow
2) Cash inflow
Cash sales
Account receivables
Total operating inflow
3) Net cash flow (2-1)

 Anticipated return on investment

Financial feasibility is judged on the basis of satisfactory yield on investment. It can be
calculated by relating the average earnings expected over a given period to either the total
amount of investment or net worth of organization (Return on equity). Both are compared with
potential yield from alternative investment opportunities to ascertain the acceptability or
otherwise of a new venture.

STEP 4: Assessment of Personal Requirements and Organizational Capabilities

Human beings provide the motive force to an enterprise. For this purpose, it is necessary to
consider the available talent and skills consonants with the organization structure. An inventory
must be made of the skills needed for effective implementation of new venture. The steps in
undertaking the exercise relating to determination of personal requirements and designing the
initial organizational structure are described below:
A) Ascertaining the anticipated workflow and the various activities (called activity analysis). At
this stage, the total range of activities and level of skills are identified.
B) Grouping the activities into set of tasks that individuals can handle effectively.
C) Categorization of various tasks to form the basis of structure of organization.

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D) Determination of interrelationship between different positions and designing of organizational

hierarchy.
STEP 5: Analysis of Competition
In order to ensure the survival and growth of enterprise, it is essential to make competition
analysis.
Generally, every organization faces two types of competition:
i. Direct competition from similar products.
ii. Indirect competition from substitutes.
Competition analysis must seek to identify potential competitors, the strategies adopted by
them and their impact on proposed enterprise, specific advantages enjoyed by the purpose
venture and formalization of strategy in consonance with these advantages. The entrepreneur
must guard against being content with neutralization competitors strategic advantages. The
aim should be to have superior strategies at least during the initial stages.

STEP 6: Developing Action Plans

No strategic plan is complete until it is put in to action. To make the plan workable, the business
owner should divide the plan into projects, carefully defining each one of the following:
i. Purpose: What is the project designed to accomplish?
ii. Scope: Which areas of the company will be involved in the project?
iii. Contribution: How does the project relate to other projects & to the overall strategic
plan?
iv. Resource requirements: What human & financial resources are needed to complete the
project successfully?
v. Timing: Which schedules & deadlines will ensure project completion?
Under this particular step, how strategies are going to be undertaken is specified. Who does it?
Why it is done? When it is done? How it is going to done? is answered. For instance in
answering the how and who questions, an entrepreneur tries to focus on the ways of obtaining
finances, licenses, raw materials, equipments, recruiting staff, distribution network, construction
of plant etc.
STEP 7: Implementation and Evaluation
Now it is the time of reality. When action plans are materialized according to the action plan
which is composed of various projects, business plans are considered to be implemented. After,

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implementation follows evaluation. Evaluation is mainly concerning towards making sure the
achievement of mission, objectives etc.
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