Characteristics of an Entrepreneur (Unit 1.

1)

• An entrepreneur is someone who makes a business idea happen either by their own
effort or by organizing other people to do the work.
• Successful entrepreneurs need:
⇒ Understanding of the market
ú Knowing what customers want and how well current businesses are
meeting them.
⇒ Initiative
ú Seizing opportunities, this requires confidence and the ability to be a
risk taker.
⇒ Creativity
ú The ability to come up with new and unique ideas.
⇒ Determination
ú Keep on going when the going gets tough.
⇒ Passion
ú The drive and enthusiasm to achieve something.
⇒ Persuasive abilities
⇒ Risk Taking

• Enterprise: is the set of skills and attitudes that help an individual turn an idea into
reality.
• People start a business for financial or non-financial reasons.
⇒ Financial:
ú Make profit
ú Financial security
ú Wealth
⇒ Non-financial:
ú Personal Satisfaction
ú Challenge
ú Working for yourself

• Leadership Styles:
⇒ MANAGERS: the five functions of managers are:
ú PLAN: Select organizational goals and set targets to achieve them.
ú COORDINATE: Coordinate resources and staff across departments,
especially when they must be shared.
ú DIRECT: Keep everyone connected to objectives and on track.
Communicate goals and instructions.
 ú CONTROL: Compare the actual results to targets set. Reward good
work and investigate failure to meet targets. Plan for problems and
introduce improvements.

⇒ Leadership Vs. Management:

ú Management involves getting things done through other people,
leadership means inspiring staff to achieve goals.

⇒ Leadership Styles: four main types:

ú Democratic:
§ Encourages participation in decision making
§ Strong coaching, listening and motivating skills
§ Teamwork and communication is important
§ Prepared to make final decision when agreement can't be
reached

⇒ Autocratic:
ú Full control of decision making
ú Employees have little or no input
ú Good in crisis situations
ú Motivation through rewards

⇒ Laissez-Faire:
ú Gives employees as much freedom as possible
ú Managers communicate goals to employees but allow them to choose
how to complete objectives, make decisions and resolve problems on
their own.

⇒ Bureaucratic:
ú Everything is done 'By the book' or by the policy
ú They enforce the rules
ú If it isn't covered by the book, the manager refers to the next level
above

⇒ Paternalistic:
ú A paternalist manager acts like a 'father'
ú They try to do what is best for their staff
 ú There will be consultation to find out the views of the employees, but
decisions are made by the manager
ú Paternalistic managers are interested in the security and social needs
of their staff but it is still an autocratic approach.

• Factors Effecting leadership Style:

⇒ Nature of the task
⇒ Personality
⇒ Time constraints
⇒ Skills of manager and workforce
⇒ Rate of change
⇒ Level of risk

• Douglas McGregor:
⇒ An American psychologist
⇒ Worked in the 1950s
⇒ Developed a theory about human behavior at work called “theory X and
theory Y”

⇒ Considerations:
ú Theory X and theory Y are extremes, it is likely that most managers
would fall somewhere in between.
ú A theory Y manager would create a more pleasant
workplace/environment.
ú A theory X manager may be better when dealing with casual workers
or at times of crisis.
Identifying a business opportunity 1.2

• What is a market?
“A place where buyers and sellers meet, in order to exchange goods and services for
money”

• Creating a Market:
⇒ A market can be held anywhere
o It doesn’t have to be a supermarket.
o It doesn’t even need a building.
⇒ Indeed one of the biggest markets in the world the meeting between buyers
and sellers is virtual.

• Supply:
“The amount of a product that suppliers (sellers) offer for sale at a given price”

• Why supply increases if prices increase:

⇒ Most firms want to make profit.
⇒ If the price of a product increases then:
o More profit will be made on each item sold
§ Assuming costs don’t change.
o Other firms may be encouraged to start making and selling the product.
§ As they see the opportunity to make a profit.
⇒ This direct relationship between the quantity supplied and price can be shown
on a supply curve.
• The supply Curve:

⇒ The supply curve shows how the quantity supplied changes as the price of the
good changes.
⇒ A fall in price (P1èP2) causes a fall in the quantity supplied (Q1èQ2).
⇒ A rise in price (P1èP3) causes an increase in the quantity supplied (Q1èQ3)

• Factors of Supply:
⇒ So any change in price results in a shift along the supply curve.
⇒ Other factors of supply:
o Costs of production
o Legislation a government policy
o Changes in production technology
o Weather
⇒ If any of these factors change the supply curve itself will shift.

• Shifting the supply curve could be caused by:

⇒ Changes in production costs
⇒ Changes in production taxes and/or subsidies
⇒ Changes in technology
⇒ The weather/climate (primary commodities)
⇒ The number of producers in the market
 ⇒ There is no change in price
⇒ However, firms are now willing to supply more
⇒ The quantity supplied therefore increases (Q1èQ2)

• Demand:
“The quantity of a good service that buyers (consumers) wish to purchase at a given
price.”
⇒ Most people want to buy for the lowest price
⇒ This is exactly how most consumers behave:
o When prices are high, demand will be low.
o When prices are low, demand will be high.

• Why demand decreases if prices increases:

⇒ Most consumers are looking to buy as cheaply as possible:
o Everyone likes a bargain
o Nobody likes to be “ripped off”
⇒ If the price of a product increases then:
o People won’t be able to afford to buy as many
• Assuming their income stays the same
o Instead people may look for cheaper alternatives
• E.g. buying margarine instead of butter.
⇒ This indirect (or inverse) relationship between the quantity demand and price
can be shown on a Demand curve.
• The demand Curve:

⇒ The demand curve shows how the quantity demanded changes the price of
the good changes.
⇒ A fall in price (p1èP2) causes an increase in the quantity demanded
(Q1èQ2).
⇒ A rise in price (P1èP3) causes a decrease in the quantity demand (Q1èQ3).

• The factors of demand:

⇒ Factors affecting demand:
o Income
o The price of other goods (competitor products/substitute products)
o Tastes and Customs
o Changes in populations
o Advertising
o The law
o Government policies
o Attitudes and information
⇒ If these factors change, the demand curve will shift.

• Shifting the demand curve:

⇒ Shifting in the demand curve can be caused by:
o Increases in consumer population
 o Increases income
o Consumer tastes shift toward the good in question.
o The price of substitutes rises.
o The price of a complementary good fails.
o The bank of England cuts interest rates.
⇒ There is no change in price.
⇒ However, consumer are now willing to buy more.
⇒ The quantity demanded therefore increases (Q1èQ2)

• Market equilibrium – Determining price

⇒ By combining supply and demand we can show how a market works.

⇒ The two curves should cross at one point
⇒ This point is called equilibrium.
⇒ Any change in price would, in theory, lead to a return of the equilibrium price.
• Product orientation and market orientation:

⇒ Product Orientation:
o When a business bases its marketing mix on what the business sees as
its internal strengths, the business’s marketing is said t be “product
orientated”.
o A product-orientated firm has its primary focus on its products and on
the skills, knowledge and systems that support the product.

⇒ Market orientation:
o A market orientated business is one that organizes its activities,
products and services around the wants and needs of its customers.
o The business bases its marketing mix on its perception of what the
market wants.

⇒ Advantages of product orientated Organizations:

o Firms can focus on internal quality:
§ Technological investments can be applied to a wide range of
products
§ Economies of scale can more easily occur
§ Allows outsourcing of production
§ The organization is essentially a design house
⇒ Disadvantages of product orientated organizations:
o changes in market structure will not be responded to
o fashion and taste are not accounted for in the public mix
o technology applied can be left behind

⇒ Advantages of Market orientation:

o The business should be flexible to changes in demand patterns
o The business, through market research, will have a strong
understanding of the needs of the customer
o New products should have a greater chance of success
⇒ Disadvantages of Market Orientation:
o High cost of market research
o Constant internal change as needs of the market are met
⇒ Market orientation gets the right product. Product orientation gets the
product right.

⇒ Tools of market orientation:

o Market research
o Market testing
o Customer focus

⇒ Tools of product Orientation:

o Product research
o Product testing
o Product focus
Evaluating a Business Opportunity 1.3

• In order to find out what customers want, firms will carry out MARKET RESEARCH
• Market research can be defined as:
“The systematic gathering, recording and analysis of data in order to better
understand the behavior of consumers.”

• The information collected can be used to:

⇒ Identify new business opportunities or ideas
⇒ Identify patterns in consumer behavior and forecast likely demand.
⇒ Identify the main competitors.

• Researching The Market:

Market research can be carried out in two main ways.
⇒ Primary Research:
o Sometimes called field research.
o This is new information that has been collected first hand.
o It could be:
§ Collected by the firm.
§ Collected by specialist research companies.

⇒ Secondary Research:
o Sometimes called desk research.
o This is information that’s already been collected.
o It could be information:
§ From within the firm.
§ Or outside the firm.

• Carrying out primary research:

⇒ Primary research will be carried out by asking a sample of people
o It would be impossible to ask every prospective customer.
⇒ Sampling involves selecting few people to interview
o So its important that they are representative of the whole market.
⇒ Sampling methods include:
o Probability Sampling.
o Non-Probability Sampling.

• Probability Samples:
⇒ Simple random sampling:
 o Here, every single member of the population has an equal chance of
being chosen.
⇒ Systematic random sampling:
o With this method, every n  th member of the population is surveyed, for
example every 5th.
⇒ Stratified random sampling:
o This involves dividing the sample into market segments, based on
existing knowledge.
⇒ Cluster Sampling:
o This method splits the whole market into small areas, and sampling is
carried out in those areas believed to be typical.

• Non-Probability Samples:
⇒ Quota Sampling:
o A certain number of people with given characteristics will be
interviewed.
⇒ Convenience Sampling:
o Interviews everyone available.
⇒ Judgment Sampling:
o This allows the interviewer to select people who they judge to be
representative of the market.

• Secondary Data:
⇒ It can be obtained from two sources:
o Inside the business:
§ Existing research data
§ Past promotional data
§ Sales records
§ Stock records
§ Financial records
§ Customer database

o Outside the business:

§ Government statistics
§ Commercial firms. (E.g. Mintel)
§ International publications. (E.g. World Bank)
§ Competitors annual reports
 § The media

• Investigating the market:

⇒ In order to asses the demand for a product a business must consider:
o The size of the market
o Market niches (Gap in market)
o Existing market segments
o Potential Market growth

⇒ The size of the market:

o Firms will need to think about the size of the market:
§ A large market means lots of potential customers
§ A small market means potential profits would be limited.

⇒ In order to asses whether there is a market for the idea, it is important to

consider:
o The number of competitors.
o The potential market growth.

⇒ It is crucial to Consider:
o Market share
o Market growth.

• Calculating market share:

Market Share (%)= Value of Product Sales/Value of market sales x 100

• Calculating Market Growth:

⇒ Ideally a firm will want to enter a market that is growing
o This means more products are being sold
⇒ Market growth refers to an increase in the size of the market for a particular
product.
o If the market is shrinking then market growth will be negative.\

• Market share Vs. Market Growth:

⇒ Ideally a firm will want a big market share of a growing market
⇒ However, this is not always possible

• Market Segmentation:
 ⇒ Most businesses will break a market into smaller manageable chucks, called
segments.
⇒ This means consumers with similar characteristics together.

• Segmenting the market:

⇒ Geographic Segmentation:
o Based on Geographic Patterns
⇒ Demographic Segmentation:
o Age, Gender, income, etc.
⇒ Psychographic Segmentation:
o Social Class
⇒ Behaviorist Segmentation:
o Behavior Patterns

⇒ Geographic Segmentation:
o His is a simple form of segmentation based on geographic Patterns.
o This could compare:
§ Spending levels
§ Income levels
§ Employment levels
§ Buying Habits

⇒ Demographic Segmentation:
o This refers to ways of separating people according to their
characteristics.
o There are three main ways:
§ Age:
ú People of different ages buy different products.
§ Gender:
ú Men and women behave differently, and buy different
things.
§ Income:
ú People with different disposable income levels will
purchase different products, even with the same brand.

⇒ Psychographic Segmentation:
 o This separates households according to their social class, life-style
and/or personality.

⇒ Behavioristic Segmentation:
o This considers consumer behavior patterns including:
§ What people buy
§ How often people buy
§ How loyal customers are to certain brands
o The introduction and use of loyalty cards has made this much easier
for firms to do.

• Problems with Mass marketing:

⇒ It can carry high levels of fixed costs in the form of capital e.g. buildings, land
and machinery.
⇒ Vulnerability to changes in tastes and fashions, meaning chances of spare
capacity and therefore capacity under utilization.
⇒ Very difficult to appeal directly and satisfy needs of individual customers.
⇒ Regular market research however, can help to reduce the risks of mass
market failure.

• Product differentiation:
⇒ The extent to which the consumer views your product or service as being
different from those of your competitors.
⇒ By generating a clear difference in the eyes of the consumer, you can benefit
from:
o Increased sales volume
o Greater scope for charging higher prices.
⇒ Mass market firms use product proliferation (Changing something slightly) to
serve a variety of different consumer needs. However, the need for mass
production limits the number of different products that can be offered.

• Niche Marketing
⇒ This is when a business targets a product or service at a small segment of a
larger market. E.g. Cars, specialist clubs.

• Small firms and niche markets

⇒ Few large firms directly compete in niche markets.
⇒ Limited competitors because of small potential target market.
 ⇒ This allows firms to charge higher (premium) prices.
⇒ Little opportunity for economies of scale.
⇒ Lack of scope for large scale manufacturing.
⇒ Greater opportunity for understanding the specific needs of their customer
and changing accordingly.
⇒ More effective targeting of their customers base via promotions. Effective use
of their limited resources.

• Problems with niche marketing:

⇒ The small scale limits opportunities for large profits.
⇒ Unit costs tend to be higher due to purchasing items in small quantities.
⇒ Specialist firms are vulnerable to changes in tastes and fashions.
⇒ Larger firms might be attracted to a rapidly expanding niche market.

• Mass Marketing Outline:

⇒ Mass marketing involves targeting everyone within the market.
⇒ It tends to make use of mass media methods such as television, radio, cinema
and national newspaper.
⇒ It requires a large amount of money to operate effectively.
⇒ It is usually dominated by a few firms.
⇒ The mass market is also highly competitive.

• Benefits of Mass Markets:

⇒ Large scale production is possible.
⇒ Clear advantages from economies of scale.
⇒ Lower costs per unit via bulk purchasing etc.
⇒ Mass media marketing is used to reach as large a potential target market as
possible.
⇒ Can be dominated by the larger firms creating significant barriers to entry for
competitors.
⇒ Mass marketing helps increase brand awareness and to encourage consumers
to try other products.

• Trade Offs & Opportunity cost:

⇒ Scarcity:
o We don’t have unlimited resources
 o The main resources that we have a limited amount of are money and
time.
o At times, choices will have to be made as we don’t have enough
money/time to be able to do everything we want to do.
o Money and time can only be spent once.

⇒ Opportunity Cost:
“The opportunity Cost is the cost of missing out on the next best alternative.”

⇒ Opportunity Costs for a small business:

o Choosing to start up in business rather than earning a steady salary.
o Picking one business idea over another.
o Choosing to spend money on fixtures and fittings rather than staff
training.
o Spending too much Money on stock.

⇒ Deciding Between Business Investments:

o Estimations of potential returns
o Considering the cash outlay required for each idea (Bigger outlay or
expenditure = Bigger Risk)
o Is the timing right?
o Do you have the skills to make the business work?

• Trade-offs:
⇒ Trade-offs are what you have to give up in order to get what the most.
⇒ These things are not always quantifiable.

• Product trials:
⇒ What are product trials?:
o Products trails are when a product is tested in the market before a
launch to asses likely demand levels.
⇒ Why is Test marketing carried out?:
o Launching a new product is very risky.
o 5/6 new products fail.
o It is also hugely expensive
o Test marketing can prevent unviable products being rolled out to the
whole market at huge expense.
⇒ Types of product trials:
o Sales research:
§ Customers are given the chance to try the product.
o Controlled test marketing:
§ The product is only available in a few stores.
o Test marketing:
§ The product is launched in a limited area.

⇒ Benefits of Product trials:

o It can save millions and can save damage to a companies reputation if
trial uncovers a problem.
o It is a good way to get customers to try a product.
o It provides customers feedback which can be used to make
improvements.
o Can provide information for firms to help them produce more accurate
sales-forecasts.

⇒ The reasons product trials are declining:

o Firms are scared that competitors will find out about their new
products and produce a “copycat” product.
o Major supermarkets now use centralized distribution channels which
makes it difficult to get a product into a few shops.
o Better marketing research techniques now mean that product trials are
no longer necessary.
o Globalization now means that companies are using whole companies as
test markets.

⇒ Product trials are useful for new businesses who:

o Don’t have access to sophisticated market research information.
o Cant afford a national product launch.
o Want to avoid expensive mistakes.
o Can use the results as a bargaining tool to get supermarket shelf
space:
o HOWEVER:
Product trials slow down the time taken to get a product to marketing
and things could be crucial.

⇒ Test marketing:
 ⇒ If test marketing is used then the area chosen needs to be given careful
considerations.
⇒ The size of the market-economy V. accuracy.
⇒ Is it representative of the whole market? (distribution, income, population.)

• Product positioning:
⇒ Firms need to identify the segments that would be most suitable for their
product
⇒ Ideally a firm will want to enter a growing market, since this means more is
being sold to consumers.
⇒ A firm will also have to consider the competition:
o What are their strengths?
o What are their weaknesses?
o How are they different.

⇒ Identifying the competition: To analyze the competition they must first be

identified.

⇒ Identifying strengths and weaknesses:

o Once the competition has been identified, their strengths and
weaknesses can be considered.
o This can be used to identify ways of making your product different.

⇒ Market Mapping:
o Once a firm has knowledge of their competitors they can identify gaps
in the market.
o This is often done using “Market Mapping”
o This allows similar products in a market to be mapped using two
variables quality and price.

⇒ Gaining a competitive advantage:

o Methods of obtaining a competitive advantage:
§ Value for Money
§ Facilities
§ Brand Name
§ Taste
§ Customer Service: Delivery, After Sales service.
§ Images
 § Location

⇒ What is Value Added?

o It can be defined as:
“The increase in the benefits of a good or service which are created at
each stage of production”
o This means that value can be added simply by making a product more
appealing to customers
o Methods of adding value include:
o Changing raw materials
o Packaging
o Branding

⇒ Calculating Value Added:

Value added can be calculated using the formula:
Value added = Value of Output – Value of input

⇒ Added Value and Survival:

o It is by adding value that a business is able to make a profit.
o As such the method of adding Value used a less important than the
fact that value is added.
o A business that does not add value will not survive in the long-term

• Market Mapping:
• What is a market map:
• A market map is a tool used by business when they are considering entering a
new market or launching a new product.
• A market map allows the business to examine the existing
competitors/products in a market.
• They can see which areas of the market are overcrowded or spot potential
gaps.
• In order to construct a market map the company decided on 2 key factors of
the market.

• Choosing the right factors:

⇒ Each market will have different key features
o Examples would be:
 o High price/low price
o For the young/old
o Modern/traditional
o For men/women
o Trendy/classic
o Fashion/Functional
o Luxury/Everyday
o Light/Filling

⇒ Adding Value:
“Adding value means creating something that has a higher value to
customers than the bought value”

⇒ Ways to add value:

o The amount of value added is the difference between the materials and
the selling price.
o Value added can be increased either by reducing costs or by increasing
the price.
o To add more value firms usually add a feature to the product that
makes it more valuable to the customer which allows them to charge a
higher price.

⇒ Different ways to add value:

o Convenience And speed: In Britain most people will pay extra to
save their own time.
o God design: A beautifully designed dress might sell for $400, while
one using exactly the same quantity of material might sell for just $40.
o High quality manufacture or service: A Lexus sells at $100,000
because it is regarded as one of the best-made cars in the world; it
never breaks down and is like sitting in a huge leather armchair.
o Brand Name: A Nike swoosh add tens of pounds to the value of a
pair of trainers.
o USP: A features which is different from other similar products

⇒ The importance of value added:

o People starting businesses often forget about everyday costs. There
are obvious ones such as gas and electricity and phones, but others
 such as the cost of wastage (theft, damaged goods), of the cost of
recruiting and training staff.
o All these costs have to be paid for out of the value added. So there
needs to be a big enough difference between price and bought in costs
to allow internal costs to be paid for.
o Value added is necessity in business, not luxury.
Economic Considerations (1.4)

• Government and the economy:

⇒ There are 3 types of economy:
o Free market economy:
the government is not involved in business activity.
o Mixed economy:
A mixture of government control and private business organizations
o Central planned or command economy:
All decisions made by the government

⇒ Government Control Of Economy

o The sole function of the government is to enable citizens to
become wealthier and have better standard of living.

⇒ Government Objectives:
o Full employment
o Economic growth
o Low inflation
o A positive balance of payment
o A stable economy

⇒ Full employment
o People at work produce valuable goods and services
o Work provides people with incomes and they can support themselves
o When people spend they help keep other people employed
o Unemployed people have to be provided for by the state and taxes
need to be increased to pay for this

⇒ Economic Growth:
o Satisfies peoples needs and wants
o Raises standard of living
o More products to sell abroad and can earn money to buy imports
o More jobs are created and raises incomes and profits

⇒ Low inflation:
o Inflation is the rate at which the price of goods and services increases.
o High inflation will reduce exports and encourage cheaper imports.
Harmful to UK firms.
o People on low incomes unable to buy as much.
 o High inflation causes cash flow problems for firms.
o Encourages employees to ask for higher wages which in turn causes
inflation.

⇒ Positive balance of payment:

o Makes UK richer
o Helps to keep the value of the pound high which makes the price of
imports cheaper and this helps to keep inflation low.
o If the value of the pound is strong interest rates do not need to be
high to protect it.

⇒ A stable economy:
o Easier for businesses to plan for the future
o People will not be suddenly threatened with unemployment, higher
prices etc.
o People and businesses who borrow money will know exactly how much
this will cost.
o Foreign investors will be willing to invest in the UK.

⇒ Two prominent Economic policies used by governments are:

o FISCAL POLICY: adjusting the level of demand in the economy by
altering spending and taxation; lower taxes more money to
spend; greater expenditure in public sector create demand reduce
unemployment.
o MONETARY POLICY: Control the economy through interest rates and
the money supply. Target rate for inflation set by the government and
Monetary Policy Committee sets the level of interest rate and
supply of money to meet this target.

• Interest Rates:
⇒ the cost of borrowing money and the return for lending money (or reward for
saving).
⇒ Also represents an opportunity cost.

• How businesses are affected by interest rates:

⇒ Investment decisions and spending on capital goods
⇒ Debt burden on loans
⇒ Exports/imports (due to changes in the value of the pound)
 ⇒ Opportunity Cost of saving
⇒ Changes in the level of consumer spending
⇒ Business confidence

• Consumer demand:
⇒ Changes in the cost of borrowing for goods purchased on credit (usually larger
items)
⇒ Changes in mortgage repayments (implications on disposable income).
⇒ Consumer confidence.

• Effect on exchange rate:

⇒ You should understand the:
o Importance of HOT MONEY FLOWS.
o FLOATING EXCHANGE RATE – based on demand and supply of
sterling.

• Imports and Exports:

⇒ If interest rates fall this will lead to a fall in the value of the pound
è Fall in export prices and rise in import prices.
⇒ Price Elastic = Price Effects Demand (if price is high, demand is low).

• Inflation:
⇒ What is inflation?:
o Most people know that inflation is about rising prices.
o But it is not simply about increases in the prices of individual goods or
services, as these rise and fall all the time in a market economy.
o Inflation is a more general phenomenon – it is a widespread rise in the
level of prices across the economy.

⇒ Measuring inflation - RPI:

o The retail price index:
§ This was the favored measure of inflation by the UK
government until 2003.
§ It measures changes in the value of the average basket of
goods.
§ Each good is given a weighted value to reflect its importance
and to show the proportion of income spent upon them by the
 average family.

⇒ Problems with RPI:

o The major problem with the RPI was that it was felt to only reflect the
average person.
o This meant that pensioners and other low income groups often
suffered lower than inflation rises in their pensions and benefits,
making them worse off.
o Higher fuel prices especially effected these groups badly.

⇒ Consumer price index:

o The CPI measures changes through time in the price level of consumer
goods and services purchased by households.
o From 2003 the UK now use the CPI t measure inflation.
o This tends to provide a lower measure in percentage terms of inflation
and hence the target has been readjusted to 2%.
o The CPI provides a more accurate indication of inflation with the
economy but fails to measure housing costs.

• Inflation(continue):
⇒ Causes of inflation:
o Cost Push inflation:
§ This occurs when there is an increase in the cost of production
(e.g. higher wages, raw materials, fuel, tax etc.)
§ This forces firms to raise their prices to protect their profit
margins.

o Demand Pull:
§ This occurs when prices rise due to excess demand within the
economy.
§ If consumers’ incomes rise but there is no rise in the supply will
become limited and high levels of demand will force prices to
rise to act as a rationing mechanism.

⇒ Inflation and Expectations:

o Consumer and business expectations about what they think will
happen with inflation are very important.
 o If these groups believe that inflation will rise then they are likely to
demand higher wage rises and increase prices respectively.
o This will create additional inflationary pressures and generate an
inflationary spiral.

⇒ Hampers Longer-term Planning:

o With high inflation and the association economic instability, firms find it
more difficult to plan ahead.
o And longer-term developments often have to give way to short-term
expenditure.
o Firms are discouraged from making longer-term investments and tend
to restrict capital spending to high-return projects or those allowing a
relatively quick payback, and to assets that of insulation from inflation.

⇒ Increases risks and borrowing costs:

o When inflation is high and unpredictable it adds substantially to
financial risks, so savers and lenders require some insurance against
the uncertainty of the future value of their money – i.e. a risk premium
in the form of a higher interest rate.

⇒ That means higher borrowing costs, which discourages investment.

⇒ Exchange rates:
o Exchange rates: are the price of one currency in terms of another.
o Bi-lateral exchange rates: compare one currency against another.
o Exchange rates are determined much like any other price in a free
market, via demand and supply.

⇒ Factors that influence the pound:

o Inflation: if inflation in the UK is lower than elsewhere, then UK
exports will become more competitive and there will be an increase in
demand for pounds. Also foreign goods will be less competitive and so
UK citizens will supply less pounds to buy foreign goods. Therefore the
rate of the pound will tend to increase.
o Interest Rates: If UK interest rates rise relative to elsewhere, it will
become more attractive to deposit money in the UK, therefore demand
for sterling will rise. This is known as “hot money flows” and is an
important short run determinant of the value of a currency.
 o Speculation: If speculators believe the sterling will rise in the future,
they will demand more now to be able to make profit. This increase in
demand will cause the value to rise.
Therefore, movements in the exchange rate do not always reflect
economic fundamentals, but are often driven by the sentiments of the
financial markets. For examples, if markets see news which makes an
interest rate increase more likely, the value of the pound will probably
rise in anticipation.
o Change in Competitiveness: if British goods become more attractive
and competitive this will also cause the value of the exchange rate to
rise. This is important for determining the long run value of the pound.
o Relative strength of other currencies: Between 1999 and 2001 the
pound appreciated because the euro was seen as weak currency.
o Balance of payments: If there are more imports than exports, the
value of the pound falls due to less goods being manufactured in the
home country. This leads to fewer exported goods, therefore having a
knock on effect on the value of the currency due to less demand.

⇒ The Demand Curve for Sterling:

o The demand for the pound comes from demand for our exports from
abroad. We want to be paid in pounds, no matter where our customers
come from, and so people abroad have to purchase pounds on the
foreign exchange market.
o If demand for exports increases, then demand for the pound on
the foreign exchange market increases.
o Demand for the pound also comes from the demand for saving in UK
bank accounts – if the UK interest rate goes up compared to interest
rates abroad, then people abroad will want to save their money in UK
bank accounts. Because you can save only pounds (rather than dollars
or euros) in UK banks.
o Demand for the pound on the foreign exchange market will rise
if the interest rate rises. The stocks of funds that move around the
world in search of the best return I called hot money.
o Long term capital movements are also important. So, inwards
investment into the UK increases demand for the pound.

⇒ The supply curve for sterling:

 o Supply of the pound onto the foreign exchange market comes from our
demand for imports. People abroad want to be paid in their own
currency, so we take our pounds along to the foreign exchange market,
releasing them on to the market in return for other currencies.
o SO, supply of the pound on the foreign exchange market
increases if demand for imports increases.
o If the interest rates abroad increases relative to the interest rate in
the UK, then funds will move from the UK to overseas bank accounts,
increasing the supply of the pound on foreign exchange markets.
o If there is net outwards investment from the UK economy, then the
supply of pound will increase.

⇒ Depreciation:
o Depreciation means that the value of the pound, in terms of other
currencies goes down.
⇒ Appreciation:
o Appreciation means that the value of the pound, in terms of other
currencies goes up.

⇒ Advantages of a strong pound:

o It keeps inflation under control:
§ A high pound leads to lower import prices – this boosts the real
living standards of consumers at least in the short run.
§ When the sterling is strong, it is cheaper to import raw
materials, components and capital inputs – good news for
growing businesses that rely on imported components or who
are wishing to increase their investment of new technology
from counties overseas.
§ A strong exchange rate helps to control inflation – domestic
producers face stiff international competition from cheaper
imports and will look to cut their costs accordingly.
§ Cheaper prices of imported foodstuff etc. will also have a
negative effect on the rate of consumer price inflation.

⇒ Disadvantages of a strong pound:

o The balance of trade and goods:
§ Cheaper imports lead to rising imports penetration and larger
trade deficit. (Basically more imports than exports).
Sources of finance (1.5)

• Definition:
⇒ Finance: this is money.
⇒ Sources of finance: This I where you get finance from.

• Why do businesses need finance?:

⇒ Starting up:
o Buildings, machinery, raw materials and office equipment.
⇒ Everyday bill payments (working capital):
o Short-term finance required for the day-to-day running of a business.
⇒ Take over bid.
⇒ Replace machinery/equipment.
⇒ Internal growth.
⇒ Expansion.

• The purpose of finance:

⇒ “Different sources of finance have different implications for a business, so it is
important that the most appropriate method of finance is chosen for the
purpose that the business has in mind.”

• Sources of finance:
⇒ Internal:
o “Finance which is raised internally, does not increase the debts of the
business”
e.g. Retained profit, personal savings, sale of unwanted assets, sale
and lease back.
⇒ External:
o “Finance provided by people or institutions outside the business,
creates a debt that will require payment”
e.g. Loans, overdraft, shares, Debentures.
(A debenture is a document that acknowledges the debt, the company
is liable to pay a specified amount with interest.

⇒ Time periods for finance:

o Generally considered to be:
§ Short-term è Up to 3 years.
§ Medium-term è 3 – 10 years.
 § Long-term è Over 10 years.

⇒ Short term finance:

o It is needed for the day-to-day running of a business and is usually for
a period of up to 3 years.
o In order to understand short-term finance it is necessary to
understand the concept of cash flow.
⇒ Cash flow:
o A business needs sufficient inflows of cash finance, its day-to-day
outgoings.

⇒ Sources of short-term finance:

o All commercial banks offer various methods of short-term finance for
businesses:
§ Overdraft
§ Short-term loans

§ Hire purchase (external)

§ Trade credit (internal)

⇒ External short-term finance:

o Overdraft: the bank allows the business to draw more money from
their bank account than they actually have in it.

o Advantages:
§ Very quick to arrange
§ Only pay interest on amount overdrawn
§ A good short-term solution to a cash flow problem.
o Disadvantages:
§ Only suitable for smaller amounts
§ Has to be repaid within a short amount of time
§ Interest or charges are paid.

o Short-term loan: an amount of money is borrowed from the bank, then

repaid (with interest) over a set period of time (0 – 3 years).

⇒ Factors which influence a bank’s decision to lend:

o Past trading record.
 o Purpose of the finance.
o Business proposal.
o Current financial position.
o Financial projections.
o Nature of the market/sales forecast.

⇒ Banks use this information to:

o Determine who qualifies for a loan.
o Determine what interest rate they will lend at.

o Interest rates - Cost of borrowing money (reward for savings)

o What credit limit to set.
o Banks also use this information to determine which customers are
likely to bring in the most revenue.

⇒ Security:
o Something that acts as assurance to a lender that will get its money
back if a business is unable to pay back money it has “borrowed” .
o If the business fails to repay the loan, the bank – as holder of the
deeds – is legally entitled to sell the factory and office in order to
recover any amount outstanding on the loan.

⇒ Internal short-term finance:

o Trade credit: items are bought from suppliers on a “buy now pay later”
basis.

o Advantages:
§ Gives businesses more cash to use in immediate future.
§ Does not incur interest charges.
o Disadvantages:
§ Can only be used to buy certain goods.
§ Bills usually have to be settled within 30, 60 or 90 days.

⇒ Sources of medium-term finance:

o Various different forms of medium-term finance are available to a
business:
§ Medium-term loan
§ Hire purchase
 § Leasing

⇒ External medium-term finance:

o The rate of interest payable on a medium-term loan depends on:
§ How much is borrowed
§ How long the money is needed for
§ The security that is provided.

o Businesses have the option to chose either a variable rate or a fixed

rate loan.

o VARIABLE: interest varies with whatever decision the bank of England

make with regard to interest rates.
o FIXED RATE: interest is fixed for the duration of the loan.

o Hire purchase: can also be medium-term.

o Leasing: Pay installments over a set period of time to rent an item –
businesses never actually own the item.

⇒ Long-term finance:
o Usually thought of as being for periods in excess of 10 years.
o This finance is for securing the resourcing for long-term growth.

⇒ Sources of long-term finance:

o For the long-term, a business essentially has the choice of raising
finance by borrowing or through the issue of shares.

§ Long term loans (external)

§ Issue of shares (external)

§ Sale and leaseback (internal)

§ Retained profit (internal)

⇒ External long-term finance:

o Long-term loan: an amount of money is borrowed from the bank, then
repaid (with interest) over a set period of time (10+ years).

o Used for expensive pieces of machinery

 o Loans for buildings – mortgages
o Variable rate or Fixed rate
o Fixed rate – not fixed for whole length of the loan.

o Issues of shares – A share in the business is sold to an individual or

another business – also known as equity finance. This money is then
used to purchase new assets.
è Shareholders are entitled to a dividend (share of company profits).

o Rights issue - when a company issues more shares.

⇒ Internal long-term finance:

o Sale and leaseback – asset is sold but then leaseback – usually for a
long period of time.

o Advantages:
§ Large sum of money is created.
§ Business can operate as normal after the sale.
§ Leasing company is responsible for maintenance of the item.
o Disadvantages:
§ High interest is often charged
§ Item does not belong to the business anymore
§ No guarantee that lease will be renewed

o Retained profit – profit retained for purpose of using in the future.

⇒ Other sources of finance:

o Government assistance
o Venture capital
o Business angles

⇒ A business’s choice of finance:

o Depends on many factors:
§ The type of business – sole traders and partnerships cannot
issue trades.
§ The amount of control desired – becoming a partnership or
company can weaken control.
 § Security – a lack of security may mean that banks are unwilling
to grant a loan.
§ Existing levels of debt – if high banks, they will think twice
about lending.

• Break-even Revenue:

⇒ Break-Even Analysis:
o Once a firm knows the total costs and revenue it can calculate the
break even point.
o This is defined as:
“Break even occurs when Total Costs are equal to Total
Revenue. In effect the business is Neither making Profit or
Loss.”

Which means = Total Revenue – Total Costs = 0

⇒ Is the Break-Even point achievable?

-Yes?
+Then there are no worries and carry on…

-No?:
o Then a number of actions must be taken:
§ Cut costs:
ú Can cheaper raw materials be used?
ú Can cheaper premises be found?
ú Do we need all the stuff we have budgeted for?
§ Raise prices:
ú Is this practical.
ú Are the customers willing to pay higher prices?
ú What are your competitors charging?
§ Broaden the product range:
ú Can complementary products be sold to boost sales?

⇒ Margin of safety”
o The margin of safety can be used t asses how close to its break-even
point a firm is.
 o Defined:
“The amount by which demand can fall before a firm incurs
losses i.e. how close the firm is to break-even level of output.”
o And is calculated using this formula:
Margin of safety = Total output – Break-Even output.

⇒ Why bother?
o It is useful when deciding whether a new product is going to be viable.
o Can the required quantity be realistically produced and sold?
o It can be used to see how changes to any one of the variables will
effect the break-even point:
§ Price – if price is increased will profits increase?
§ Costs - if costs increase how is profit effected?
§ Output – How does this effect both selling price and costs?
o It can allow a business to calculate the level of output needed to
achieve a given level of profit.
i.e. How many units must be sold to make $100,000 profit?