Business Studies – 0450

1.1 – Business Activity

The word ‘business’ is very familiar to us. We are surrounded by businesses and we could not imagine
our life without the products we buy from them. So what is a business, or what is business studies?
Here’s the very posh definition for it: “the study of economics and management”
Not clear? Don’t worry, by the end of this chapter, you should be getting a clear picture of what a
business is.

The Economic Problem

Need: a good or service essential for living. Examples include water and food and shelter.
Want: a good or service that people would like to have, but is not required for living. Examples
include cars and watching movies.
Scarcity is the basic economic problem. It is a situation that exists when there are unlimited wants and
limited resources to produce the goods and services to satisfy those wants. For example, we have a
limited amount of money but there are a lot of things we would like to buy, using the money.

Opportunity cost
Opportunity cost is the next best alternative forgone by choosing another item. Due to scarcity, people
are often forced to make choices. When choices are made it leads to an opportunity cost
SCARCITY → CHOICE → OPPORTUNITY COST

Example: the government has a limited amount of money (scarcity) and must decide on whether to use
it to build a road, or construct a hospital (choice). The government chooses to construct the hospital
instead of the road. The opportunity cost here are the benefits from the road that they have sacrificed
(opportunity cost).

Factors of Production
Factors of Production are resources required to produce goods or services. They are classified into four
categories.
 Land: the natural resources that can be obtained from nature. This includes minerals, forests, oil and
gas. The reward for land is rent.
 Labour: the physical and mental efforts put in by the workers in the production process. The reward for
labour is wage/salary
 Capital: the finance, machinery and equipment needed for the production of goods and services. The
reward for capital is interest received on the capital
Enterprise: the risk taking ability of the person who brings the other factors of production together to
produce a good or service. The reward for enterprise is profit from the business.
Specialization
Specialization occurs when a person or organisation concentrates on a task at which they are best
at. Instead of everyone doing every job, the tasks are divided among people who are skilled and efficient
at them.

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 Advantages:
 Workers are trained to do a particular task and specialise in this, thus increasing efficiency
 Saves time and energy: production is faster by specialising
 Quicker to train labourers: workers only concentrate on a task, they do not have to be trained in all
aspects of the production process
 Skill development: workers can develop their skills as they do the same tasks repeatedly, mastering it.

Disadvantages:
 It can get monotonous/boring for workers, doing the same tasks repeatedly
 Higher labour turnover as the workers may demand for higher salaries and company is unable to keep
up with their demands
Over-dependency: if worker(s) responsible for a particular task is absent, the entire production process
may halt since nobody else may be able to do the task.

Purpose of Business Activity

So we’ve gone through factors of production, the problem of scarcity and specialization, but what is
business?
Business is any organization that uses all the factors of production (resources) to create goods
and services to satisfy human wants and needs.
Businesses attempt to solve the problem of scarcity, using scarce resources, to produce and sell those
goods and services that consumers need and want.

Added Value
Added value is the difference between the cost of materials bought in and the selling price of
the product.
Which is, the amount of value the business has added to the raw materials by turning it into
finished products. Every business wants to add value to their products so they may charge a
higher price for their products and gain more profits.
For example, logs of wood may not appeal to us as consumers and so we won’t buy it or would
pay a low price for it. But when a carpenter can use these logs to transform it into a chair we
can use, we will buy it at a higher cost because the carpenter has added value to those logs of
wood.

How to increase added value?

 Reducing the cost of production. Added value of a product is its price less the cost of production.
Reducing cost of production will increase the added value.
 Raising prices. By increasing prices they can raise added value, in the same way as described above.
But there will be problems that rise from both these measures. To lower cost of production, cheap
labour, raw materials etc. may have to be employed, which will create poor quality products and only
lowers the value of the product. People may not buy it. And when prices are raised, the high price may
result in customer loss, as they will turn to cheaper products.
In a practical sense, you can add value by:
 Branding
 Adding special features
 Provide premium services etc.

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 In a practical example, how would you add value to a jewellery store?
 Design an attractive package to put the jewellery items in.
 An attractive shop-window-display.
 Well-dressed and knowledgeable shop assistants.
All of this will help the jewellery store to raise prices above the additional costs involved.

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 1.2 – Classification of Businesses
Primary, Secondary and Tertiary Sector
Businesses can be classified into three sectors:

Primary sector: this involves the use/extraction of natural resources. Examples include agricultural
activities, mining, fishing, wood-cutting, oil drilling etc.

Secondary sector: this involves the manufacture of goods using the resources from the primary sector.
Examples include auto-mobile manufacturing, steel industries, cloth production etc.

Tertiary sector: this consist of all the services provided in an economy. This includes hotels, travel
agencies, hair salons, banks etc.

Up until the mid-18th century, the primary sector was the largest sector in the world, as agriculture was
the main profession. After the industrial revolution, more countries began to become more
industrialized and urban, leading to a rapid increase in the manufacturing sector (industrialization).

Nowadays, as countries are becoming more developed, the importance of tertiary sector is increasing,
while the primary sector is diminishing. The secondary sector is also slightly reducing in size (de-
industrialization) compared to the growth of the tertiary sector. This is due to the growing incomes of
consumers which raises their demand for more services like travel, hotels etc.

Private and Public Sector

Private sector: where private individuals own and run business ventures. Their aim is to make
a profit, and all costs and risks of the business is undertaken by the individual. Examples, Nike,
McDonald’s, Virgin Airlines etc.
Public sector: where the government owns and runs business ventures. Their aim is to provide
essential public goods and services (schools, hospitals, police etc.) in order to increase the
welfare of their citizens, they don’t work to earn a profit. It is funded by the taxpaying citizens’
money, so they work in the interest of these citizens to provide them with services.
Example: the Indian Railways is a public sector organization owned by the govt. of India.
In a mixed economy, both the public and private sector exists.

Activities that are usually in the public sector

 Health  Public transport (Mixed economy-recent changes from
book-pg.—15)
 Education  Water supply
 Defence  Electricity supply

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 1.3 – Enterprise, Business Growth and Size
Entrepreneurship
An entrepreneur is a person who organizes, operates and takes risks for a new business
venture. The entrepreneur brings together the various factors of production to produce goods
or services. Check below to see whether you have what it takes to be a successful
entrepreneur!
 Risk taker
 Creative
 Optimistic
 Self-confident
 Innovative
 Independent
 Effective communicator
 Hard working
Business plan
A business plan is a document containing the business objectives and important details about
the operations, finance and owners of the new business.
It provides a complete description of a business and its plans for the first few years; explains what the
business does, who will buy the product or service and why; provides financial forecasts demonstrating
overall viability; indicates the finance available and explains the financial requirements to start and
operate the business.
Some of the content of a regular business plan are:
 Executive summary: brief summary of the key features of the business and the business plan
 The owner: educational background and what any previous experience in doing previously
 The business: name and address of the business and detailed description of the product or service being
produced and sold; how and where it will be produced, who is likely to buy it, and in what quantities
 The market: describe the market research that has been carried out, what it has revealed and details of
prospective customers and competitors
 Advertising and promotion: how the business will be advertised to potential customers and details of
estimated costs of marketing
 Premises and equipment: details of planning regulations, costs of premises and the need for equipment
and buildings
 Business organisation: whether the enterprise will take the form of sole trader, partnership, company or
cooperative
 Costs: indication of the cost of producing the product or service, the prices it proposes to charge for the
products
 Finance: how much of the capital will come from savings and how much will come from borrowings
 Cash flow: forecast income (revenue) and outgoings (expenditures) over the first year
 Expansion: brief explanation of future plans
Making a business plan before actually starting the business can be very helpful. By documenting the
various details about the business, the owners will find it much easier to run it. There is a lesser chance
of losing sight of the mission and vision of the business as the objectives have been written down.
Moreover, having the objectives of the business set down clearly will help motivate the employees. A
new entrepreneur will find it easier to get a loan or overdraft from the bank if they have a business
plan.

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 Government support for business startups
According to startup.com, “a startup is a company typically in the early stages of its
development. These entrepreneurial ventures are typically started by 1-3 founders who focus
on capitalizing upon a perceived market demand by developing a viable product, service, or
platform”.
Why do governments want to help new start-ups?
 They provide employment to a lot of people
 They contribute to the growth of the economy
 They can also, if they grow to be successful, contribute to the exports of the country
 Start-ups often introduce fresh ideas and technologies into business and industry
How do governments support businesses?
 Organise advice: provide business advice to potential entrepreneurs, giving them information useful in
staring a venture, including legal and bureaucratic ones
 Provide low cost premises: provide land at low cost or low rent for new firms
 Provide loans at low interest rates
 Give grants for capital: provide financial aid to new firms for investment
 Give grants for training: provide financial aid for workforce training
 Give tax breaks/ holidays: high taxes are a disincentive for new firms to set up. Governments can thus
withdraw or lower taxation for new firms for a certain period of time
Measuring business size
Businesses come in many sizes. They can be owned by a single individual or have up to 50 shareholders.
They can employ thousands of workers or have a mere handful. But how can we classify a business as
big or small?
Business size can be measured in the following ways:
 Number of employees: larger firms have larger workforce employed
 Value of output: larger firms are likely to produce more than smaller ones
 Value of capital employed: larger businesses are likely to employ much more capital than smaller ones
However, these methods have their limitations and are not always accurate. Example: When using the
‘number of employees’ method to compare business size is not accurate as a capital intensive firm ( one
that employs a large amount of capital equipment) can produce large output by employing very little
labour (workers). Similarly, value of capital employed is not a reliable measure when comparing a
capital-intensive firm with a labour-intensive firm. Output value is also unreliable because some
different types of products are valued differently, and the size of the firm doesn’t depend on this.
Business growth
Businesses want to grow because growth helps reduce their average costs in the long-run, help develop
increased market share, and helps them produce and sell to them to new markets.
There are two ways in which a business can grow- internally and externally.
Internal growth
This occurs when a business expands its existing operations. For example, when a fast food chain opens
a new branch in another country. This is a slow means of growth but easier to manage than external
growth.
External growth
This is when a business takes over or merges with another business. It is sometimes
called integration as one firm is ‘integrated’ into the other.
A merger is when the owner of two businesses agree to join their firms together to make one business.

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A takeover occurs when one business buys out the owners of another business, which then becomes a
part of the ‘predator’ business.
External growth can largely be classified into three types:
 Horizontal merger/integration: This is when one firm merges with or takes over another one in the
same industry at the same stage of production. For example, when a firm that manufactures
furniture merges with another firm that also manufacturers furniture.
Benefits:
 Reduces number of competitors in the market, since two firms become one.
 Opportunities of economies of scale.
 Merging will allow the businesses to have a bigger share of the total market.

 Vertical merger/integration: This is when one firm merges with or takes over
another firm in the same industry but at a different stage of production. Therefore, vertical
integration can be of two types:
 Backward vertical integration: When one firm merges with or takes over another firm in the
same industry but at a stage of production that is behind the ‘predator’ firm. For example,
when a firm that manufactures furniture merges with a firm that supplies wood for
manufacturing furniture.
Benefits:
 Merger gives assured supply of essential components.
 The profit margin of the supplying firm is now absorbed by the expanded firm.
 The supplying firm can be prevented from supplying to competitors.
 Forward vertical integration: When one firm merges with or takes over another firm in the
same industry but at a stage of production that is ahead of the ‘predator’ firm. For example,
when a firm that manufactures furniture merges with a furniture retail store.
Benefits:
 Merger gives assured outlet for their product.
 The profit margin of the retailer is now absorbed by the expanded firm.
 The retailer can be prevented from selling the goods of competitors.
 Conglomerate merger/integration: This is when one firm merges with or takes over a firm in a
completely different industry. This is also known as ‘diversification’. For example, when a firm that
manufactures furniture merges with a firm that produces clothing.

 Benefits:
 Conglomerate integration allows businesses to have activities in more than one country.
This allows the firms to spread its risks.
 There could be a transfer of ideas between the two businesses even though they are in
different industries. This transfer of ideas could help improve the quality and demand for
the two products.

Drawbacks of growth
 Difficult to control staff: as a business grows, the business organisation in terms of departments and
divisions will grow, along with the number of employees, making it harder to control, co-ordinate
and communicate with everyone
 Lack of funds: growth requires a lot of capital.
 Lack of expertise: growth is a long and difficult process that will require people with expertise in the
field to manage and coordinate activities

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 Diseconomies of scale: this is the term used to describe how average costs of a firm tends to increase as
it grows beyond a point, reducing profitability. This is explored more deeply in a later section.

How to overcome
 Operate the business in small units-this a form of decentralization
 Expand more slowly –use profits from slowly expanding business to pay for further growth.
 Ensure sufficient long-term finance is available

Why businesses stay small

Not all businesses grow. Some stay small, employ a handful of workers and have little output. Here are
the reasons why.
 Type of industry: some firms remain small due to the industry they operate in. Examples of these are
hairdressers, car repairs, catering, etc., which give personal services and therefore cannot grow.
 Market size: if the firm operates in areas where the total number of customers is small, such as in rural
areas, there is no need for the firm to grow and thus stays small.
Owners’ objectives: not all owners want to increase the size of their firms and profits. Some of them
prefer keeping their businesses small and having a personal contact with all of their employees and
customers, having flexibility in controlling and running the business, having more control over decision-
making, and to keep it less stressful.

Why businesses fail

Not all businesses are successful. The main reasons why they fail are:
 Poor management: this is a common cause of business failure for new firms. The main reason is lack of
experience and planning which could lead to bad decision making. New entrepreneurs could make
mistakes when choosing the location of the firm, the raw materials to be used for production, etc., all
resulting in failure
 Over-expansion: this could lead to diseconomies of scale and greatly increase costs, if a firms expands
too quickly or over their optimum level
 Failure to plan for change: the demands of customers keep changing with change in tastes and fashion.
Due to this, firms must always be ready to change their products to meet the demand of their
customers. Failure to do so could result in losing customers and loss. They also won’t be ready to quickly
keep up with changes the competitors are making, and changes in laws and regulations
 Poor financial management: if the owner of the firm does not manage his finances properly, it could
result in cash shortages. This will mean that the employees cannot be paid and enough goods cannot be
produced. Poor cash flow can therefore also cause businesses to fail

Why new businesses are at a greater risk of failure

 Less experience: a lack of experience in the market or in business gets a lot of firms easily pushed out of
the market
 New to the market: they may still not understand the nuances and trends of the market, that existing
competitors will have mastered
 Don’t a lot of sales yet: only by increasing sales, can new firms grow and find their foothold in the
market. At a stage when they’re not selling much, they are at a greater risk of failing
 Don’t have a lot of money to support the business yet: financial issues can quickly get the better of new
firms if they aren’t very careful with their cash flows. It is only after they make considerable sales and
start making a profit, can they reinvest in the business and support it

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 1.4 – Types of Business Organizations
Sole Trader/Sole Proprietorship
A business organization owned and controlled by one person. Sole traders can employ other workers,
but only he/she invests and owns the business.
Advantages:
 Easy to set up: there are very few legal formalities involved in starting and running a sole proprietorship.
A less amount of capital is enough by sole traders to start the business. There is no need to publish
annual financial accounts.
 Full control: the sole trader has full control over the business. Decision-making is quick and easy, since
there are no other owners to discuss matters with.
 Sole trader receives all profit: Since there is only one owner, he/she will receive all of the profits the
company generates.
 Personal: since it is a small form of business, the owner can easily create and maintain contact with
customers, which will increase customer loyalty to the business and also let the owner know about
consumer wants and preferences.
Disadvantages:
 Unlimited liability: if the business has bills/debts left unpaid, legal actions will be taken against the
investors, where their even personal property can be seized, if their investments don’t meet the unpaid
amount. This is because the business and the investors are the legally not separate (unincorporated).
 Full responsibility: Since there is only one owner, the sole owner has to undertake all running activities.
He/she doesn’t have anyone to share his responsibilities with. This workload and risks are fully
concentrated on him/her.
 Lack of capital: As only one owner/investor is there, the amount of capital invested in the business will
be very low. This can restrict growth and expansion of the business. Their only sources of finance will be
personal savings or borrowing or bank loans (though banks will be reluctant to lend to sole traders since
it is risky).
 Lack of continuity: If the owner dies or retires, the business dies with him/her.
Partnerships
A partnership is a legal agreement between two or more (usually, up to twenty) people to own, finance
and run a business jointly and to share all profits.
Advantages:
 Easy to set up: Similar to sole traders, very few legal formalities are required to start a partnership
business. A partnership agreement/ partnership deed is a legal document that all partners have to sign,
which forms the partnership. There is no need to publish annual financial accounts.
 Partners can provide new skills and ideas: The partners may have some skills and ideas that can be used
by the business to improve business profits.
 More capital investments: Partners can invest more capital than what a sole trade only by himself
could.
Disadvantages:
 Conflicts: arguments may occur between partners while making decisions. This will delay decision-
making.
 Unlimited liability: similar to sole traders, partners too have unlimited liability- their personal items are
at risk if business goes bankrupt
 Lack of capital: smaller capital investments as compared to large companies.
 No continuity: if an owner retires or dies, the business also dies with them.

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 Joint-stock companies
These companies can sell shares, unlike partnerships and sole traders, to raise capital. Other people can
buy these shares (stocks) and become a shareholder (owner) of the company. Therefore they are jointly
owned by the people who have bought its stocks. These shareholders then receive dividends (part of
the profit; a return on investment).

The shareholders in companies have limited liabilities. That is, only their individual investments are at
risk if the business fails or leaves debts. If the company owes money, it can be sued and taken to court,
but its shareholders cannot. The companies have a separate legal identity from their owners, which is
why the owners have a limited liability. These companies are incorporated.
(When they’re unincorporated, shareholders have unlimited liability and don’t have a separate legal
identity from their business).

Companies also enjoys continuity, unlike partnerships and sole traders. That is, the business will
continue even if one of its owners retire or die.
Shareholders will elect a board of directors to manage and run the company in its day-to-day activities.
In small companies, the shareholders with the highest percentage of shares invested are directors, but
directors don’t have to be shareholders. The more shares a shareholder has, the more their voting
power.

These are two types of companies:

Private Limited Companies: One or more owners who can sell its’ shares to only the people known by
the existing shareholders (family and friends). Example: Ikea.
Advantages:
 Limited Liability: this is because, the company and the shareholders have separate legal identities.
 Raise huge amounts of capital: selling shares to other people (especially in Public Ltd. Co.), raises a huge
amount of capital, which is why companies are large.
 Public Ltd. Companies can advertise their shares, in the form of a prospectus, which tells interested
individuals about the business, its activities, profits, board of directors, shares on sale, share prices etc.
This will attract investors.

Disadvantages:
 Required to disclose financial information: Sometimes, private limited companies are required by law
to publish their financial statements annually, while for public limited companies, it is legally compulsory
to publish all accounts and reports. All the writing, printing and publishing of such details can prove to
be very expensive, and other competing companies could use it to learn the company secrets.
 Private Limited Companies cannot sell shares to the public. Their shares can only be sold to people
they know with the agreement of other shareholders. Transfer of shares is restricted here. This will raise
lesser capital than Public Ltd. Companies.
 Public Ltd. Companies require a lot of legal documents and investigations before it can be listed on the
stock exchange.
 Public and Private Limited Companies must also hold an Annual General Meeting (AGM), where all
shareholders are informed about the performance of the company and company decisions, vote on
strategic decisions and elect board of directors. This is very expensive to set up, especially if there are
thousands of shareholders.
 Public Ltd. Companies may have managerial problems: since they are very large, they become very
difficult to manage. Communication problems may occur which will slow down decision-making.

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 In Public Ltd. Companies, there may be a divorce of ownership and control: The shareholders can lose
control of the company when other large shareholders outvote them or when board of directors control
company decisions.
A summary of everything learned until now, in this section, in case you’re getting confused:

ADVANTAGES DISADVANTAGES

TO FRANCHISOR

Rapid, low cost method of business

expansion
Gets and income from franchisee
in the form of franchise fees and
royalties
Franchisee will better understand
the local tastes and so can
advertise and sell appropriately
Profits from the franchise needs to be
shared with the franchisee
Loss of control over running of business
If one franchise fails, it can affect the
reputation of the entire brand

Can access ideas and suggestions Franchisee may not be as skilled

from franchisee
Need to supply raw material/product
Franchisee will run the operations and provide support and training

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 TO FRANCHISEE

Cost of setting up business

No full control over business- need to
strictly follow franchisor’s standards and
rules

An established brand and trademark, so Profits have to be shared with franchisor

chance of business failing is low
Franchisor will give technical and Need to pay franchisor franchise fees
managerial support and royalties

Franchisor will supply the raw Need to advertise and promote the
materials/products business in the region themselves

Joint Ventures
Joint venture is an agreement between two or more businesses to work together on a project. The
foreign business will work with a domestic business in the same industry. Eg: Google Earth is a joint
venture/project between Google and NASA.
Advantages
 Reduces risks and cuts costs
 Each business brings different expertise to the joint venture
 The market potential for all the businesses in the joint venture is increased
 Market and product knowledge can be shared to the benefit of the businesses
Disadvantages
 Any mistakes made will reflect on all parties in the joint venture, which may damage their reputations
 The decision-making process may be ineffective due to different business culture or different styles of
leadership
Public Sector Corporation
Public sector corporations are businesses owned by the government and run by directors appointed by
the government. They usually provide essentials services like water, electricity, health services etc. The
government provides the capital to run these corporations in the form of subsidies (grants). The UK’s
National Health Service (NHS) is an example. Public corporations aim to:
 keep prices low so everybody can afford the service.
 keep people employed.
 offer a service to the public everywhere.
Advantages:
 Some businesses are considered too important to be owned by an individual. (electricity, water, airline)
 Other businesses, considered natural monopolies, are controlled by the government. (electricity, water)
 Reduces waste in an industry. (e.g. two railway lines in one city)
 Rescue important businesses when they are failing through nationalisation
 Provide essential services to the people

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 Drawbacks:
 Motivation might not be as high because profit is not an objective
 Subsidies lead to inefficiency. It is also considered unfair for private businesses
 There is normally no competition to public corporations, so there is no incentive to improve
 Businesses could be run for government popularity

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 1.5 – Business Objectives and
Stakeholder Objectives
Business objectives
Business objectives are the aims and targets that a business works towards to help it run
successfully. Although the setting of these objectives does not always guarantee the business success, it
has its benefits.
 Setting objectives increases motivation as employees and managers now have clear targets to work
towards.
 Decision making will be easier and less time consuming as there are set targets to base decisions on.
i.e., decisions will be taken in order to achieve business objectives.
 Setting objectives reduces conflicts and helps unite the business towards reaching the same goal.
 Managers can compare the business’ performance to its objectives and make any changes in its
activities if required.

Objectives vary with different businesses due to size, sector and many other factors. However, many
business in the private sector aim to achieve the following objectives.
 Survival: new or small firms usually have survival as a primary objective. Firms in a highly competitive
market will also be more concerned with survival rather than any other objective. To achieve this, firms
could decide to lower prices, which would mean forsaking other objectives such as profit maximization.
 Profit: this is the income of a business from its activities after deducting total costs. Private sector firms
usually have profit making as a primary objective. This is because profits are required for further
investment into the business as well as for the payment of return to the shareholders/owners of the
business.
 Growth: once a business has passed its survival stage it will aim for growth and expansion. This is usually
measured by value of sales or output. Aiming for business growth can be very beneficial. A larger
business can ensure greater job security and salaries for employees. The business can also benefit from
higher market share and economies of scale.
 Market share: this can be defined as the proportion of total market sales achieved by one business.
Increased market share can bring about many benefits to the business such as increased customer
loyalty, setting up of brand image, etc.
 Service to the society: some operations in the private sectors such as social enterprises do not aim for
profits and prefer to set more economical objectives. They aim to better the society by providing social,
environmental and financial aid. They help those in need, the underprivileged, the unemployed, the
economy and the government.
A business’ objectives do not remain the same forever. As market situations change and as the business
itself develops, its objectives will change to reflect its current market and economic position. For
example, a firm facing serious economic recession could change its objective from profit maximization
to short term survival.
Stakeholders
A stakeholder is any person or group that is interested in or directly affected by the performance or
activities of a business. These stakeholder groups can be external – groups that are outside the business
or they can be internal – those groups that work for or own the business.

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 Internal stakeholders:
 Shareholder/ Owners: these are the risk takers of the business. They invest capital into the business to
set up and expand it. These shareholders are liable to a share of the profits made by the business.
Objectives:
 Shareholders are entitled to a rate of return on the capital they have invested into the business
and will therefore have profit maximization as an objective.
 Business growth will also be an important objective as this will ensure that the value of the shares
will increase.

 Workers: these are the people that are employed by the business and are directly involved in its
activities.
Objectives:
 Contract of employment that states all the right and responsibilities to and of the employees.
 Regular payment for the work done by the employees.
 Workers will want to benefit from job satisfaction as well as motivation.
 The employees will want job security– the ability to be able to work without the fear of being
dismissed or made redundant.

 Managers: they are also employees but managers control the work of others. Managers are in charge
of making key business decisions.
Objectives:
 Like regular employees, managers too will aim towards a secure job.
 Higher salaries due to their jobs requiring more skill and effort.
 Managers will also wish for business growth as a bigger business means that managers can control a
bigger and well known business.

External Stakeholders:
 Customers: they are a very important part of every business. They purchase and consume the goods
and services that the business produces/ provides. Successful businesses use market research to find
out customer preferences before producing their goods.
Objectives:
 Price that reflects the quality of the good.
 The products must be reliable and safe. i.e., there must not be any false advertisement of the
products.
 The products must be well designed and of a perceived quality.

 Government: the role of the government is to protect the workers and customers from the business’
activities and safeguard their interests.
Objectives:
 The government will want the business to grow and survive as they will bring a lot of benefits to the
economy. A successful business will help increase the total output of the country, will improve
employment as well as increase government revenue through payment of taxes.
 They will expect the firms to stay within the rules and regulations set by the government.

 Banks: these banks provide financial help for the business’ operations’
Objectives:
 The banks will expect the business to be able to repay the amount that has been lent along with the
interest on it. The bank will thus have business liquidity as its objective.

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 Community: this consists of all the stakeholder groups, especially the third parties that are affected by
the business’ activities.
Objectives:
 The business must offer jobs and employ local employees.
 The production process of the business must in no way harm the environment.
 Products must be socially responsible and must not pose any harmful effects from consumption.

Public- sector businesses

Government owned and controlled businesses do not have the same objectives as those in the private
sector.
Objectives:
 Financial: although these businesses do not aim to maximize profits, they will have to meet the profit
target set by the government. This is so that it can be reinvested into the business for meeting the
needs of the society
 Service: the main aim of this organization is to provide a service to the community that must meet the
quality target set by the government
 Social: most of these social enterprises are set up in order to aid the community. This can be by
providing employment to citizens, providing good quality goods and services at an affordable rate, etc.
 They help the economy by contributing to GDP, decreasing unemployment rate and raising living
standards.
This is in total contrast to private sector aims like profit, growth, survival, market share etc.

Conflicts of stakeholders’ objectives

As all stakeholders have their own aims they would like to achieve, it is natural that conflicts of
stakeholders’ interests could occur. Therefore, if a business tries to satisfy the objectives of one
stakeholder, it might mean that another stakeholders’ objectives could go unfulfilled.

For example, workers will aim towards earning higher salaries. Shareholders might not want this to
happen as paying higher salaries could mean that less profit will be left over for payment of return to
the shareholders.

Similarly, the business might want to grow by expanding operations to build new factories. But this
might conflict with the community’s want for clean and pollution-free localities.

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 2.1 – Motivating Workers
Motivation
People work for several reasons:
 Have a better standard of living: by earning incomes they can satisfy their needs and wants
 Be secure: having a job means they can always maintain or grow that standard of living
 Gain experience and status: work allows people to get better at the job they do and earn a reputable
status in society
 Have job satisfaction: people also work for the satisfaction of having a job

Motivation is the reason why employees want to work hard and work effectively for the
business. Money is the main motivator, as explained above. Other factors that may motivate a person
to choose to do a particular job may include social needs (need to communicate and work with
others), esteem needs (to feel important, worthwhile), job satisfaction (to enjoy good
work), security (knowing that your job and pay are secure- that you will not lose your job).

Why motivate workers? Why do firms go to the pain of making sure their workers are
motivated? When workers are well-motivated, they become highly productive and effective in their
work, become absent less often, and less likely to leave the job, thus increasing the firm’s efficiency
and output, leading to higher profits. For example, in the service sector, if the employee is unhappy at
his work, he may act lazy and rude to customers, leading to low customer satisfaction, more complaints
and ultimately a bad reputation and low profits.

Motivation Theories
 F. W. Taylor: Taylor based his ideas on the assumption that workers were motivated by personal gains,
mainly money and that increasing pay would increase productivity (amount of output produced).
Therefore he proposed the piece-rate system, whereby workers get paid for the number of output they
produce. So in order, to gain more money, workers would produce more. He also suggested a scientific
management in production organisation, to break down labour (essentially division of labour) to
maximize output
However, this theory is not entirely true. There are various other motivators in the modern workplace,
some even more important than money. The piece rate system is not very practical in situations where
output cannot be measured (service industries) and also will lead to (high) output that doesn’t
guarantee high quality.

 Maslow’s Hierarchy: Abraham Maslow’s hierarchy of needs shows that employees are motivated by
each level of the hierarchy going from bottom to top. Mangers can identify which level their workers
are on and then take the necessary action to advance them onto the next level.

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 One limitation of this theory is that it doesn’t apply to every worker. For some employees, for example,
social needs aren’t important but they would be motivated by recognition and appreciation for their
work from seniors.

 Herzberg’s Two-Factor Theory: Frederick Herzberg’s two-factor theory, wherein he states that people
have two sets of needs:
Basic animal needs called ‘hygiene factors’:
 status
 security
 work conditions
 company policies and administration
 relationship with superiors
 relationship with subordinates
 salary
Needs that allow the human being to grow psychologically, called the ‘motivators’:
 achievement
 recognition
 personal growth/development
 promotion
 work itself
According to Herzberg, the hygiene factors need to be satisfied, if not they will act as de-motivators to
the workers. However hygiene factors don’t act as motivators as their effect quickly wear off.
Motivators will truly motivate workers to work more effectively.

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 Motivating Factors
Financial Motivators
 Wages: often paid weekly. They can be calculated in two ways:
 Time-Rate: pay based on the number of hours worked. Although output may increase, it doesn’t
mean that workers will work sincerely use the time to produce more- they may simply waste time
on very few output since their pay is based only on how long they work. The productive and
unproductive worker will get paid the same amount, irrespective of their output.
 Piece-Rate: pay based on the no. of output produced. Same as time-rate, this doesn’t ensure that
quality output is produced. Thus, efficient workers may feel demotivated as they’re getting the
same pay as inefficient workers, despite their efficiency.
 Salary: paid monthly or annually.
 Commission: paid to salesperson, based on a percentage of sales they’ve made. The higher the sales,
the more the pay. Although this will encourage salespersons to sell more products and increase profits,
it can be very stressful for them because no sales made means no pay at all.
 Bonus: additional amount paid to workers for good work
 Performance-related pay: paid based on performance. An appraisal (assessing the effectiveness of an
employee by senior management through interviews, observations, comments from colleagues etc.) is
used to measure this performance and a pay is given based on this.
 Profit-sharing: a scheme whereby a proportion of the company’s profits is distributed to workers.
Workers will be motivated to work better so that a higher profit is made.
 Share ownership: shares in the firm are given to employees so that they can become part owners of the
company. This will increase employees’ loyalty to the company, as they feel a sense of belonging.

Non-Financial Motivators
 Fringe benefits are non-financial rewards given to employees
 Company vehicle/car
 Free healthcare
 Children’s education fees paid for
 Free accommodation
 Free holidays/trips
 Discounts on the firm’s products

 Job Satisfaction: the enjoyment derived from the feeling that you’ve done a good job. Employees have
different ideas about what motivates them- it could be pay, promotional opportunities, team
involvement, relationship with superiors, level of responsibility, chances for training, the working hours,
status of the job etc. Responsibility, recognition and satisfaction are in particular very important.
So, how can companies ensure that they’re workers are satisfied with the job, other than the motivators
mentioned above?
 Job Rotation: involves workers swapping around jobs and doing each specific task for only a limited
time and then changing round again. This increases the variety in the work itself and will also make it
easier for managers to move around workers to do other jobs if somebody is ill or absent. The tasks
themselves are not made more interesting, but the switching of tasks may avoid boredom among
workers. This is very common in factories with a huge production line where workers will move from
retrieving products from the machine to labelling the products to packing the products to putting the
products into huge cartons.
 Job Enlargement: where extra tasks of similar level of work are added to a worker’s job description.
These extra tasks will not add greater responsibility or work for the employee, but make work more

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 interesting. E.g.: a worker hired to stock shelves will now, as a result of job enlargement, arrange stock
on shelves, label stock, fetch stock etc.
 Job Enrichment: involves adding tasks that require more skill and responsibility to a job. This gives
employees a sense of trust from senior management and motivate them to carry out the extra tasks
effectively. Some additional training may also be given to the employee to do so. E.g.: a receptionist
employed to welcome customers will now, as a result of job enrichment, deal with telephone enquiries,
word-process letters etc.
 Team-working: a group of workers is given responsibility for a particular process, product or
development. They can decide as a team how to organize and carry out the tasks. The workers take
part in decision making and take responsibility for the process. It gives them more control over their
work and thus a sense of commitment, increasing job satisfaction. Working as a group will also add to
morale, fulfill social needs and lead to job satisfaction.
 Opportunities for training: providing training will make workers feel that their work is being valued.
Training also provides them opportunities for personal growth and development, thereby attaining job
satisfaction
 Opportunities of promotion: providing opportunities for promotion will get workers to work more
efficiently and fill them with a sense of self-actualisation and job satisfaction

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 2.2 – Organization and Management
Organizational Structure

Organizational structure refers to the levels of management and division of responsibilities within a
business. They can be represented on organizational charts (left).
Advantages:
 All employees are aware of which communication channel is used to reach them with messages
 Everyone knows their position in the business. They know who they are accountable to and who they
are accountable for
 It shows the links and relationship between the different departments
 Gives everyone a sense of belonging as they appear on the organizational chart
The span of control is the number of subordinates working directly under a manager in the
organizational structure. In the above figure, the managing director’s span of control is four. The
marketing director’s span of control is the number of marketing managers working under him (it is not
specified how many, in the figure).
The chain of command is the structure of an organization that allows instructions to be passed on from
senior managers to lower levels of management. In the above figure, there is a short chain of command
since there are only four levels of management shown.

Now, if you look closely, there is a link between the span of control and chain of command. The wider
the span of control the shorter the chain of command since more people will appear horizontally
aligned on the chart than vertically. A short span of control often leads to long chain of command. (If
you don’t understand, try visualizing it on an organizational chart).

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 Advantages of a short chain of command (these are also the disadvantages of a long chain of command):
 Communication is quicker and more accurate
 Top managers are less remote from lower employees, so employees will be more motivated and top
managers can always stay in touch with the employees
 Spans of control will be wider, this means managers have more people to control this is beneficial
because it will encourage them to delegate responsibility (give work to subordinates) and so the
subordinates will be more motivated and feel trusted. However there is the risk that managers may lose
control over the tasks.

Line Managers have authority over people directly below them in the organizational structure.
Traditional marketing/operations/sales managers are good examples.
Staff Managers are specialists who provide support, information and assistance to line managers. The IT
department manager in most organisations act as staff managers.

Management
So, what role do manager really have in an organization? Here are their five primary roles:
 Planning: setting aims and targets for the organisations/department to achieve. It will give the
department and its employees a clear sense of purpose and direction. Managers should also plan for
resources required to achieve these targets – the number of people required, the finance needed etc.
 Organizing: managers should then organize the resources. This will include allocating responsibilities to
employees, possibly delegating.
 Coordinating: managers should ensure that each department is coordinating with one another to
achieve the organization’s aims. This will involve effective communication between departments and
managers and decision making. For example, the sales department will need to tell the operations dept.
how much they should produce in order to reach the target sales level. The operations dept. will in turn
tell the finance dept. how much money they need for production of those goods. They need to come
together regularly and make decisions that will help achieve each department’s aims as well as the
organization’s.
 Commanding: managers need to guide, lead and supervise their employees in the tasks they do and
make sure they are keeping to their deadlines and achieving targets.
 Controlling: managers must try to assess and evaluate the performance of each of their employees. If
some employees fail to achieve their target, the manager must see why it has occurred and what he can
do to correct it- maybe some training will be required or better equipment.

Delegation is giving a subordinate the authority to perform some tasks.

Advantages to managers:
 managers cannot do all work by themselves
 managers can measure the efficiency and effectiveness of their subordinates’ work
However, managers may be reluctant to delegate as they may lose their control over the work.

Advantages to subordinates:
 the work becomes more interesting and rewarding- increased job satisfaction
 employees feel more important and feel trusted– increasing loyalty to firm
 can act as a method of training and opportunities for promotions, if they do a good job.

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Leadership Styles
Leadership styles refer to the different approaches used when dealing with people when in a position
of authority. There are mainly three styles you need to learn: the autocratic, democratic and laissez-
faire styles.
Autocratic style is where the managers expects to be in charge of the business and have their orders
followed. They do all the decision-making, not involving employees at all. Communication is thus,
mainly one way- from top to bottom. This is standard in police and armed forces organizations.
Democratic style is where managers involve employees in the decision-making and communication is
two-way from top to bottom as well as bottom to top. Information about future plans is openly
communicated and discussed with employees and a final decision is made by the manager.
Laissez-faire (French phrase for ‘leave to do) style makes the broad objectives of the business known to
employees and leaves them to do their own decision-making and organize tasks. Communication is
rather difficult since a clear direction is not given. The manger has a very limited role to play.

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 Trade Unions
A trade union is a group of workers who have joined together to ensure their interest are protected.
They negotiate with the employer (firm) for better conditions and treatment and can threaten to take
industrial action if their requests are denied. Industrial action can include overtime ban (refusing to
work overtime), go slow (working at the slowest speed as is required by the employment contract),
strike (refusing to work at all and protesting instead) etc. Trade unions can also seek to put forward their
views to the media and influence government decisions relating to employment.

Benefits to workers of joining a trade union:

 strength in number- a sense of belonging and unity
 improved conditions of employment, for example, better pay, holidays, hours of work etc
 improved working conditions, foe example, health and safety
 improved benefits for workers who are not working, because they’re sick, retired or made redundant
(dismissed not because of any fault of their own)
 financial support if a member thinks he/she has been unfairly dismissed or treated
 benefits that have been negotiated for union member such as discounts on firm’s products, provision of
health services.

Disadvantages to workers of joining a trade unions:

 costs money to be member- a membership fee will be required
 may be asked to take industrial action even if they don’t agree with the union- they may not get paid
during a strike, for example.

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 2.3 – Recruitment, Selection and Training
of Workers
The Role of the H.R. (Human Resource) Department
 Recruitment and selection: attracting and selecting the best candidates for job posts
 Wages and salaries: set wages and salaries that attract and retain employees as well as motivate them
 Industrial relations: there must be effective communication between management and workforce to
solve complaints and disputes as well as discussing ideas and suggestions
 Training programmes: give employees training to increase their productivity and efficiency
 Health and safety: all laws on health and safety conditions in the workplace should be adhered to
 Redundancy and dismissal: the managers should dismiss any unsatisfactory/misbehaving employees
and make them redundant if they are no longer needed by the business.

Recruitment
Job Analysis, Description and Specification
Recruitment is the process from identifying that the business needs to employ someone up to the point
where applications have arrived at the business.

A vacancy arises when an employee resigns from a job or is dismissed by the management. When a
vacancy arises, a job analysis has to be prepared. A job analysis identifies and records the tasks and
responsibilities relating to the job. It will tell the managers what the job post is for.

Then a job description is prepared that outlines the responsibilities and duties to be carried out by
someone employed to do the job.

It will have information about the conditions of employment (salary, working hours, and pension
scheme), training offered, opportunities for promotion etc. This is given to all prospective candidates so
they know what exactly they will be required and expected to do.
Once this has been done, the H.R. department will draw up a job specification, a document that
outlines the requirements, qualifications, expertise, skills, physical/personal characteristics etc.
required by an employee to be able to take up the job.

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 Advertising the vacancy
Internal recruitment is when a vacancy is filled by an existing employee of the business.
Advantages:
 Saves time and money- no need for advertising and interviewing
 Person already known to business
 Person knows business’ ways of working
 Motivating for other employees to see their colleagues being promoted- urging them to work hard
Disadvantages:
 No new skills and experience coming into the business
 Jealousy among workers

External recruitment is when a vacancy is filled by someone who is not an existing employee and will
be new to the business. External recruitment needs to be advertised, unlike internal recruitment. This
can be done in local/national newspapers, specialist magazines and journals, job centres run by the
government (where job vacancies are posted and given to interested people; usually for unskilled or
semi-skilled jobs) or even recruitment agencies (who will recruit and send along candidates to the
company when they request it).

When advertising a job, the business needs to decide what should be included in the advertisement,
where it should be advertised, how much it will cost and whether it will be cost-effective.
When a person is interested in a job, they should apply for it by sending in a curriculum vitae (CV) or
resume, this will detail the person’s qualifications, experience, qualities and skills. The business will use
these to see which candidates match the job specification. It will also include statements of why the
candidate wants the job and why he/she feels they would be suitable for the job.

Selection
Applicants who are shortlisted will be interviewed by the H.R. manager. They will also call up the
referee provided by the applicant (a referee could be the previous employer or colleagues who can give
a confidential opinion about the applicant’s reliability, honesty and suitability for the job). Interviews will
allow the manager to assess:

 the applicant’s ability to do the job

 personal qualities of the applicant
 character and personality of applicant

In addition to interviews, firms can conduct certain tests to select the best candidate. This could
include skills tests (ability to do the job), aptitude tests (candidate’s potential to gain additional skills),
personality tests (what kind of a personality the candidate has- will it be suitable for the job?), group
situation tests (how they manage and work in teams) etc.
When a successful candidate has been selected the others must be sent a letter of rejection.

The contract of employment: a legal agreement between the employer and the employee listing the
rights and responsibilities of workers. It will include:
 the name of employer and employee
 job title
 date when employment will begin

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 hours to work
 rate of pay and other benefits
 when payment is made
 holiday entitlement
 the amount of notice to be given to terminate the employment that the employer or employee must
give to end the employment etc.
Employment contracts can be part-time or full-time. Part-time employment is often considered to be
between 1 and 30-35 hours a week whereas full-time employment will usually work 35 hours or more a
week.

Advantages to employer of part-time employment (disadvantages of full-time employment to

employer):
 more flexible hours of work
 easier to ask employees just to work at busy times
 easier to extend business opening/operating hours by working evenings or at weekends
 works lesser hours so employee is willing to accept lower pay
 less expensive than employing and paying full-time workers.
Disadvantages to employer of part-time employment (advantages of full-time employment to
employers)
 less likely to be trained because the workers see the job as temporary
 takes longer to recruit two part-time workers than one full-time worker
 can be less committed to the business/ more likely to leave and go get another job
 less likely to be promoted because they will not have gained the skills and experience as full-time
employees
 more difficult to communicate with part-time workers when they are not in work- all work at different
times.

Training
Training is important to a business as it will improve the worker’s skills and knowledge and help the
business to be more efficient and productive, especially when new processes and products are
introduced. It will improve the workers’ chances at getting promoted and raise their morale.
The three types of training are:
 Induction training: an introduction given to a new employee, explaining the firm’s activities, customs
and procedures and introducing them to their fellow workers.
Advantages:
 Helps new employees to settle into their job quickly
 May be a legal requirement to give health and safety training before the start of work
 Less likely to make mistakes
Disadvantages:
 Time-consuming
 Wages still have to be paid during training, even though they aren’t working
 Delays the state of the employee starting the job
 On-the-job training: occurs by watching a more experienced worker doing the job
Advantages:
 It ensures there is some production from worker whilst they are training
 It usually costs less than off-the-job training
 It is training to the specific needs of the business

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 Disadvantages:
 The trainer will lose some production time as they are taking some time to teach the new employee
 The trainer may have bad habits that can be passed onto the trainee
 It may not necessarily be recognised training qualifications outside the business
 Off-the-job training: involves being trained away from the workplace, usually by specialist trainers
Advantages:
 A broad range of skills can be taught using these techniques
 Employees may be taught a variety of skills and they may become multi-skilled that can allow them
to do various jobs in the company when the need arises.
Disadvantages:
 Costs are high
 It means wages are paid but no work is being done by the worker
 The additional qualifications means it is easier for the employee to leave and find another job

Workforce Planning
Workforce Planning: the establishing of the workforce needed by the business for the foreseeable
future in terms of the number and skills of employees required.
They may have to downsize (reduce the no. of employees) the workforce because of:
 Introduction of automation
 Falling demand for their products
 Factory/shop/office closure
 Relocating factory abroad
 A business has merged or been taken over and some jobs are no longer needed.

They can downsize the workforce in two ways:

 Dismissal: where a worker is told to leave their job because their work or behaviour is unsatisfactory.
 Redundancy: when an employee is no longer needed and so loses their work, though not due to any
fault of theirs. They may be given some money as compensation for the redundancy.
Worker could also resign (they are leaving because they have found another job) and retire (they are
getting old and want to stop working).
Legal Controls over Employment Issues
There are lot so government laws that affect equal employment opportunities. These laws require
businesses to treat their employees equally in the workplace and when being recruited and selected-
there should be no discrimination based on age, gender, religion, race etc.
Employees are protected in many areas including
 against unfair discrimination
 health and safety at work (protection from dangerous machinery, safety clothing and equipment,
hygiene conditions, medical aid etc.)
 against unfair dismissal
 wage protection (through the contract of employment since it will have listed the pay and conditions).
Many countries have a legal minimum wage– the minimum wage an employer has to pay its employee.
This avoids employers from exploiting its employees, and encourages more people to find work, but
since costs are rising for the business, they may make many workers redundant- unemployment will
rise. An industrial tribunal is a legal meeting which considers workers’ complaints of unfair dismissal or
discrimination at work. This will hear both sides of the case and may give the worker compensation if
the dismissal was unfair.

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 2.4 – Internal and External Communication
Effective Communication
Communication is the transferring of a message from the sender to the receiver, who understands the
message.
Internal communication is between two members of the same organisations. Example: communication
between departments, notices and circulars to workers, signboards and labels inside factories and
offices etc.
External communication is between the organisation and other organisations or individuals. Example:
orders of goods to suppliers, advertising of products, sending customers messages about delivery, offers
etc.
Effective communication involves:
 A transmitter/sender of the message
 A medium of communication eg: letter, telephone conversation, text message
 A receiver of the message
 A feedback/response from the receiver to confirm that the message has been received and
acknowledged.
One-way communication involves a message which does not require a feedback. Example: signs saying
‘no smoking’ or an instruction saying ‘deliver these goods to a customer’
Two-way communication is when the receiver gives a response to the message received. Example: a
letter from one manager to another about an important matter that needs to be discussed. A two-way
communication ensures that the person receiving the message understands it and has acted up on it. It
also makes the receiver feel more a part of the process- could be a way of motivating employees.
Advertisements
Downward communication: messages from managers to subordinates i.e. from top to bottom of an
organization structure.
Upward communication: messages/feedback from subordinates to managers i.e. from bottom to top of
an organization structure
Horizontal communication occurs between people on the same level of an organization structure.
Communication Methods
Verbal methods (eg: telephone conversation, face-to-face conversation, video conferencing, meetings)
Advantages:
 Quick and efficient
 There is an opportunity for immediate feedback
 Speaker can reinforce the message- change his tone, body language etc. to influence the listeners.
Disadvantages:
 Can take long if there is feedback and therefore, discussions
 In a meeting, it cannot be guaranteed that everybody is listening or has understood the message
 No written record of the message can be kept for later reference.
Written methods (eg: letters, memos, text-messages, reports, e-mail, social media, faxes, notices,
signboards)
Advantages:
 There is evidence of the message for later reference.
 Can include details
 Can be copied and sent to many people, especially with e-mail
 E-mail and fax is quick and cheap

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 Disadvantages:
 Direct feedback may not always be possible
 Cannot ensure that message has been received and/or acknowledged
 Language could be difficult to understand.
 Long messages may cause disinterest in receivers
 No opportunity for body language to be used to reinforce messages

Visual Methods (eg: diagrams, charts, videos, presentations, photographs, cartoons, posters)
Advantages:
 Can present information in an appealing and attractive way
 Can be used along with written material (eg: reports with diagrams and charts)
Disadvantages:
 No feedback
 May not be understood/ interpreted properly.

Factors that affect the choice of an appropriate communication method:

 Speed: if the receiver has to get the information quickly, then a telephone call or text message has to be
sent. If speed isn’t important, a letter or e-mail will be more appropriate.
 Cost: if the company wishes to keep costs down, it may choose to use letters or face-to-face meetings as
a medium of communication. Otherwise, telephone, posters etc. will be used.
 Message details: if the message is very detailed, then written and visual methods will be used.
 Leadership style: a democratic style would use two-way communication methods such as verbal
mediums. An autocratic one would use notices and announcements.
 The receiver: if there is only receiver, then a personal face-to-face or telephone call will be more apt. If
all the staff is to be sent a message, a notice or e-mail will be sent.
 Importance of a written record: if the message is one that needs to have a written record like a legal
document or receipts of new customer orders, then written methods will be used.
 Importance of feedback: if feedback is important, like for a quick query, then a direct verbal or written
method will have to be used.
Formal communication is when messages are sent through established channels using professional
language. Eg: reports, emails, memos, official meetings.
Informal communication is when information is sent and received casually with the use of everyday
language. Eg: staff briefings. Managers can sometimes use the ‘grapevine’ (informal communication
among employees- usually where rumors and gossips spread!) to test out the reactions to new ideas (for
example, a new shift system at a factory) before officially deciding whether or not to make it official.

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Communication Barriers
Communication barriers are factors that stop effective communication of messages.

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 3.1 – Marketing, Competition and the Customer
A market consists of all buyers and sellers of a particular good.
What is marketing?
By definition, marketing is the management process responsible for identifying, anticipating and
satisfying consumers’ requirements profitably.
The role of marketing in a business is as follows:
 Identifying customer needs through market research
 Satisfying customer needs by producing and selling goods and services
 Maintaining customer loyalty: building customer relationships through a variety of methods that
encourage customers to keep buying one firm’s products instead of their rivals’. For example, loyalty
card schemes, discounts for continuous purchases, after-sales services, messages that inform past
customers of new products and offers etc.
 Gain information on customers: by understanding why customers buy their products, a firm can
develop and sell better products in the future
 Anticipate changes in customer needs: the business will need to keep looking for any changes in
customer spending patterns and see if they can produce goods that customers want that are not
currently available in the market.
Some objectives the marketing department in a firm may have:
 Raise awareness of their product(s)
 Increase sales revenue and profits
 Increase or maintain market share (this is the proportion of sales a company has in the overall market
sales. For example, if in a market, $1 million worth of toys were sold in a year and company A’s total
sales was $30,000 in that year, company A’s market share for the year is ($300,000/ $1000000) *100 =
30%)
 Enter new markets at home or abroad
 Develop new products or improve existing products.
Market Changes
Why customer spending patterns may change:
 change in their tastes and preferences
 change in technology: as new technology becomes available, the old versions of products become outdated and
people want more sophisticated features on products
 change in income: the higher the income, the more expensive goods consumers will buy and vice versa
 ageing population: in many countries, the proportion of older people is increasing and so demand for products for
seniors are increasing (such as anti-ageing creams, medical assistance etc.)
The power and importance of changing customer needs:
Firms need to always know what their consumers want (and they will need to undertake lots of research
and development to do so) in order to stay ahead of competitors and stay profitable. If they don’t
produce and sell what customers want, they will buy competitors’ products and the firm will fail to
survive.
Why some markets have become more competitive:
 Globalization: products are being sold in markets all over the world, so there are more competitors in
the market
 Improvement in transportation infrastructures: better transport systems means that it is easier and
cheaper to distribute and sell products everywhere
 Internet/E-Commerce: customers can now buy products over the internet form anywhere in the world,
making the market more competitive

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 How business can respond to changing spending patterns and increased competition:
A business has to ensure that it maintains its market share and remains competitive in the market. It can
ensure this by:

 maintaining good customer relationships: by ensuring that customers keep buying from their business
only, they can keep up their market share. By doing so, they can also get information about their
spending patterns and respond to their wants and needs to increase market share
 keep improving its existing products, so that sales is maintained.
 introduce new products to keep customers coming back, and drive them away from competitors’
products
keep costs low to maintain profitability: low costs means the firm can afford to charge low prices. And
low prices generally means more demand and sales, and thus market share.

Niche & Mass Marketing

Niche Marketing: identifying and exploiting a small segment of a larger market by developing products
to suit it. For example, Versace designs and Clique perfumes have niche markets- the rich, high-status
consumer group.
Advantages:
 Small firms can thrive in niche markets where large forms have not yet been established
 If there are no or very few competitors, firms can sell products at a high price and gain high profit
margins because customers will be willing be willing to pay more for exclusive products
 Firms can focus on the needs of just one customer group, thereby giving them an advantage over large
firms who only sell to the mass market
Limitations:
 Lack of economies of scale (can’t benefit from the lower costs that arise from a larger
operations/market)
 Risk of over-dependence on a single product or market: if the demand for the product falls, the firm
won’t have a mass product they can fall back on
 Likely to attract competition if successful

Mass Marketing: selling the same product to the whole market with no attempt to target groups with in
it. For example, the iPhone sold is the same everywhere, there are no variations in design over location
or income.
Advantages:
 Larger amount of sales when compared to a niche market
 Can benefit from economies of scale: a large volume of products are produced and so the average costs
will be low when compared to a niche market
 Risks are spread, unlike in a niche market. If the product isn’t successful in one market, it’s fine as there
are several other markets
 More chances for the business to grow since there is a large market. In niche markets, this is difficult as
the product is only targeted towards a particular group.
Limitations:
 They will have to face more competition
 Can’t charge a higher price than competition because they’re all selling similar products

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 Market Segmentation
A market segment is an identifiable sub-group of a larger market in which consumers have similar
characteristics and preferences
Market segmentation is the process of dividing a market of potential customers into groups, or
segments, based on different characteristics. For example, PepsiCo identified the health-conscious
market segment and targeted/marketed the Diet Coke towards them.
Markets can be segmented on the basis of socio-economic
groups (income), age, location, gender, lifestyle, use of the product (home/ work/ leisure/ business)
etc.
Each segment will require different methods of promotion and distribution. For example, products
aimed towards kids would be distributed through popular retail stores and products for businessmen
would be advertised in exclusive business magazines.
Advantages:
 Makes marketing cost-effective, as it only targets a specific segment and meets their needs.
 The above leads to higher sales and profitability
 Increased opportunities to increase sales

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 3.2 – Market Research
Product-oriented business: such firms produce the product first and then tries to find a market for it.
Their concentration is on the product – its quality and price. Firms producing electrical and digital goods
such as refrigerators and computers are examples of product-oriented businesses.
Market-oriented businesses: such firms will conduct market research to see what consumers want and
then produce goods and services to satisfy them. They will set a marketing budget and undertake the
different methods of researching consumer tastes and spending patterns, as well as market conditions.
Example, mobile phone markets.
Market research is the process of collecting, analysing and interpreting information about a product.
Why is market research important/needed?
Firms need to conduct market research in order to ensure that they are producing goods and services
that will sell successfully in the market and generate profits. If they don’t, they could lose a lot of money
and fail to survive. Market research will answer a lot of the business’s questions prior to product
development such as ‘will customers be willing to buy this product?’, ‘what is the biggest factor that
influences customers’ buying preferences- price or quality?’, ‘what is the competition in the market
like?’ and so on.
Market research data can be quantitative (numerical-what percentage of teenagers in the city have
internet access) or qualitative (opinion/ judgement- why do more women buy the company’s product
than men?)
Market research methods can be categorized into two: primary and secondary market research.
Primary Market Research (Field Research)
The collection of original data. It involves directly collecting information from existing or potential
customers. First-hand data is collected by people who want to use the data (i.e. the firm). Examples of
primary market research methods include questionnaires, focus groups, interviews, observation, and
online surveys and so on.
The process of primary research:
1. Establish the purpose of the market research
2. Decide on the most suitable market research method
3. Decide the size of the sample (customers to conduct research on) and identify the sample
4. Carry out the research
5. Collate and analyse the data
6. Produce a report of the findings
Sample is a subset of a population that is used to represent the entire group as a whole. When
doing research, it is often impractical to survey every member of a particular population because the
number of people is simply too large. Selecting a sample is called sampling. A random sampling occurs
when people are selected at random for research, while quota sampling is when people are selected on
the basis of certain characteristics (age, gender, location etc.) for research.
Methods of primary research
 Questionnaires: Can be done face-to-face, through telephone, post or the internet. Online surveys can
also be conducted whereby researchers will email the sample members to go onto a particular website
and fill out a questionnaire posted there. These questions need to be unbiased, clear and easy to answer
to ensure that reliable and accurate answers are logged in.
Advantages:
 Detailed information can be collected
 Customer’s opinions about the product can be obtained
 Online surveys will be cheaper and easier to collate and analyse

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  Can be linked to prize draws and prize draw websites to encourage customers to fill out surveys
Disadvantages:
 If questions are not clear or are misleading, then unreliable answers will be given
 Time-consuming and expensive to carry out research, collate and analyse them.
 Interviews: interviewer will have ready-made questions for the interviewee.
Advantages:
 Interviewer is able to explain questions that the interviewee doesn’t understand and can also ask
follow-up questions
 Can gather detailed responses and interpret body-language, allowing interviewer to come to
accurate conclusions about the customer’s opinions.
Disadvantages:
 The interviewer could lead and influence the interviewee to answer a certain way. For example, by
rephrasing a question such as ‘Would you buy this product’ to ‘But, you would definitely buy this
product, right?’ to which the customer in order to appear polite would say yes when in actuality
they wouldn’t buy the product.
 Time-consuming and expensive to interview everyone in the sample
 Focus Groups: A group of people representative of the target market (a focus group) agree to provide
information about a particular product or general spending patterns over time. They can also test the
company’s products and give opinions on them.
Advantage:
 They can provide detailed information about the consumer’s opinions
Disadvantages:
 Time-consuming
 Expensive
 Opinions could be influenced by others in the group.
 Observation: This can take the form of recording (eg: meters fitted to TV screens to see what channels
are being watched), watching (eg: counting how many people enter a shop), auditing (e.g.: counting of
stock in shops to see which products sold well).
Advantage:
 Inexpensive
Disadvantage:
 Only gives basic figures. Does not tell the firm why consumer buys them.
Secondary Market Research (Desk Research)
The collection of information that has already been made available by others. Second-hand data about
consumers and markets is collected from already published sources.
Internal sources of information:
 Sales department’s sales records, pricing data, customer records, sales reports
 Opinions of distributors and public relations officers
 Finance department
 Customer Services department
External sources of information:
 Government statistics: will have information about populations and age structures in the economy.
 Newspapers: articles about economic conditions and forecast spending patterns.
 Trade associations: if there is a trade association for a particular industry, it will have several reports on
that industry’s markets.
 Market research agencies: these agencies carry out market research on behalf of the company and
provide detailed reports.

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 Internet: will have a wide range of articles about companies, government statistics, newspapers and
blogs.
Accuracy of Market Research Data
The reliability and accuracy of market research depends upon a large number of factors:
 How carefully the sample was drawn up, its size, the types of people selected etc.
 How questions were phrased in questionnaires and surveys
 Who carried out the research: secondary research is likely to be less reliable since it was drawn up by
others for different purpose at an earlier time.
 Bias: newspaper articles are often biased and may leave out crucial information deliberately.
 Age of information: researched data shouldn’t be too outdated. Customer tastes, fashions, economic
conditions, technology all move fast and the old data will be of no use now.
Presentation of Data from Market Research
Different data handling methods can be used to present data from market research. This will include:
 Tally Tables: used to record data in its original form. The tally table below shows the number and type of
vehicles passing by a shop at different times of the day:

 Charts: show the total figures for each piece of data (bar/ column charts) or the proportion of each piece
of data in terms of the total number (pie charts). For example the above tally table data can be recorded
in a bar chart as shown below:

The pie chart above could show a company’s market share in different countries.

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 Graphs: used to show the relationship between two sets of data. For example how average temperature
varied across the year.

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 3.3 – Marketing Mix
Marketing mix refers to the different elements involved in the marketing of a good or service- the 4
P’s- Product, Price, Promotion and Place.

Product
Product is the good or service being produced and sold in the market. This includes all the features of
the product as well as its final packaging.
Types of products include: consumer goods, consumer services, producer goods, producer services.
What makes a successful product?
 It satisfies existing needs and wants of the customers
 It is able to stimulate new wants from the consumers
 Its design – performance, reliability, quality etc. should all be consistent with the product’s brand image
 It is distinctive from its competitors and stands out
 It is not too expensive to produce, and the price will be able to cover the costs
New Product Development: development of a new product by a business. The process:
1. Generate ideas: the firm brainstorms new product concepts, using customer suggestions, competitors’
products, employees’ ideas, sales department data and the information provided by the research and
development department
2. Select the best ideas for further research: the firm decides which ideas to abandon and which to
research further. If the product is too costly or may not sell well, it will be abandoned
3. Decide if the firm will be able to sell enough units for the product to be a success: this research
includes looking into forecast sales, size of market share, cost-benefit analysis etc. for each product idea,
undertaken by the marketing department
4. Develop a prototype: by making a prototype of the new product, the operations department can see
how the product can be manufactured, any problems arising from it and how to fix them. Computer
simulations are usually used to produce 3D prototypes on screen
5. Test launch: the developed product is sold to one section of the market to see how well it sells, before
producing more, and to identify what changes need to be made to increase sales. Today a lot of digital
products like apps and software run beta versions, which is basically a market test
6. Full launch of the product: the product is launched to the entire market
Advantages:
 Can create a Unique Selling Point (USP) by developing a new innovative product for the first time in the
market. This USP can be used to charge a high price for the product as well as be used in advertising.
 Charge higher prices for new products (price skimming as explained later)
 Increase potential sales, revenue and profit
 Helps spreads risks because having more products mean that even if one fails, the other will keep
generating a profit for the company
Disadvantages:
 Market research is expensive and time consuming
 Investment can be very expensive
Why is brand image important?
Brand image is an identity given to a product that differentiates it from competitors’ products.
Brand loyalty is the tendency of customers to keep buying the same brand continuously instead of
switching over to competitors’ products.
 Consumers recognize the firm’s product more easily when looking at similar products- helps
differentiate the company’s product from another.

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 Their product can be charged higher than less well-known brands – if there is an established high brand
image, then it is easier to charge high prices because customers will buy it nonetheless.
 Easier to launch new products into the market if the brand image is already established. Apple is one
such company- their brand image is so reputed that new products that they launch now become an
immediate success.
Why is packaging important?
 It protects the product
 It provide information about the product (its ingredients, price, manufacturing and expiry dates etc.)
 To help consumers recognize the product (the brand name and logo on the packaging will help identify
what product it is)
It keeps the product fresh
Product Life Cycle (PLC)
The product life cycle refers to the stages a product goes through from its introduction to its retirement
in terms of sales.

At these different stages, the product will need different marketing decisions/strategies in terms of the
4Ps.

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 Extension strategies: marketing techniques used to extend the maturity stage of a product (to keep the
product in the market):
 Finding new markets for the product
 Finding new uses for the product
 Redesigning the product or the packaging to improve its appeal to consumers
 Increasing advertising and other promotional activities
The effect on the PLC of a product of a successful extension strategy:

Price
Price is the amount of money producers are willing to sell or consumer are willing to buy the product
for.
Different methods of pricing:
 Market skimming: Setting a high price for a new product that is unique or very different from other
products on the market.
Advantages:
 Profit earned is very high
 Helps recover/compensate research and development costs
Disadvantage:
 It may backfire if competitors produce similar products at a lower price
 Penetration pricing: Setting a very low price to attract customers to buy a new product
Advantages:
 Attracts customers more quickly
 Can increase market share quickly
Disadvantages:
 Low revenue due to lower prices
 Cannot recover development costs quickly
 Competitive pricing: Setting a price similar to that of competitors’ products which are already available
in the market
Advantage:
 Business can compete on other matters such as service and quality
Disadvantage:
 Still need to find ways of competing to attract sales.
 Cost plus pricing: Setting price by adding a fixed amount to the cost of making the product
Advantages:
 Quick and easy to work out the price
 Makes sure that the price covers all of the costs
Disadvantage:
 Price might be set higher than competitors or more than customers are willing to pay, which
reduces sales and profits

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 Loss leader pricing/Promotional pricing: Setting the price of a few products at below cost to attract
customers into the shop in the hope that they will buy other products as well
Advantages:
 Helps to sell off unwanted stock before it becomes out of date
 A good way of increasing short term sales and market share
Disadvantage:
 Revenue on each item is lower so profits may also be lower

Factors that affect what pricing method should be used:

 Is it a new or existing product?
If it’s new, then price skimming or penetration pricing will be most suitable. If it’s an existing product,
competitive pricing or promotional pricing will be appropriate.
 Is the product unique?
If yes, then price skimming will be beneficial, otherwise competitive or promotional pricing.
 Is there a lot of competition in the market?
If yes, competitive pricing will need to be used.
 Does the business have a well-known brand image?
If yes, price skimming will be highly successful.
 What are the costs of producing and supplying the product?
If there are high costs, costs plus pricing will be needed to cover the costs. If costs are low, market
penetration and promotional pricing will be appropriate.
 What are the marketing objectives of the business?
If the business objective is to quickly gain a market share and customer base, then penetration pricing
could be used. If the objective is to simply maintain sales, competitive pricing will be appropriate.

Price Elasticity
The PED of a product refers to the responsiveness of the quantity demanded for it to changes in its
price.
PED (of a product) = % change in quantity demanded / % change in price

When the PED is >1, that is there is a higher % change in demand in response to a change in price, the
PED is said to be elastic.
When the PED is <1, that is there is a lower % change in demand in response to a change in price, the
PED is said to be inelastic.
Producers can calculate the PED of their product and take suitable action to make the product more
profitable.

If the product is found to have an elastic demand, the producer can lower prices to increase
profitability. The law of demand states that a fall in price increases the demand. And since it is an elastic
product (change in demand is higher than change in price), the demand of the product will increase
highly. The producers get more profit.
If the product is found to have an inelastic demand, the producer can raise prices to increase
profitability. Since quantity demanded wouldn’t fall much as it is inelastic, the high prices will make way
for higher revenue and thus higher profits.

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Place
Place refers to how the product is distributed from the producer to the final consumer. There are
different distribution channels that a product can be sold through.

Distribution
Channel Explanation Advantages Disadvantages

The product is sold – All of the – Delivery costs

to the consumer profit is earned may be high if there
straight from the by the producer are customers over a
manufacturer. A – The producer wide area
good example is a controls all parts – All storage costs
factory outlet of the marketing must be paid for by
where products mix the producer
directly arrive at – Quickest – All promotional
their own shop method of activities must be
from the factory getting the carried out and
Manufacturer and are sold to product to the financed by the
to Consumer customers. consumer producer

– The retailer
The manufacturer – The cost of takes some of
will sell its holding the profit away
products to a inventories of from the
retailer (who will the product is producer
have stocks of paid by the – The producer
products from retailer loses some
other – The retailer control of the
manufacturers as will pay for marketing mix
well) who will advertising – The producer
then sell them to and other must pay for
customers who promotional delivery of
visit the shop. For activities products to the
example, brands – Retailers retailers
like Sony, Canon are more – Retailers
Manufacturer and Panasonic sell conveniently usually sell
to Retailer their products to located for competitors’
to Consumer various retailers. consumers products as well

Page | 43
 –
Wholesal
ers will
advertise – Another
and middleman
promote is added so
the more profit
The manufacturer will sell large product to is taken
volumes of its products to a retailers away from
wholesaler (wholesalers will have – the producer
stocks from different Wholesal – The
manufacturers). Retailer will buy ers pay producer
small quantities of the product for loses even
Manufacturer from the wholesaler and sell it to transport more control
to Wholesaler the consumers. One good example and of the
to Retailer is the distribution of medicinal storage marketing
to Consumer drugs. costs mix

The manufacturer will sell their

products to an agent who has
specialized information about the
market and will know the best
wholesalers to sell them to. This is – Another
Manufacturer common when firms are exporting their middleman is
to Agent products to a foreign country. They will added so even
to Wholesaler need a knowledgeable agent to take care – The agent has more profit is taken
to Retailer of the products’ distribution in another specialised knowledge away from the
to Consumer country of the market producer

What affects place decisions?

 The type of product it is: if it’s sold to producers of other goods, distribution would either be direct
(specialist machinery) or wholesaler (nuts, bolts, screws etc.).
 The technicality of the product: as lots of technical information needs to be passed to the customer,
direct selling is usually preferred.
 How often the product is purchased: if the product is bought on a daily basis, it should be sold through
retail stores that customers can easily access.
 The price of the product: if the products is an expensive, luxury good, it would only be sold through a
few specialist, high-end outlets. For example, luxury watches and jewellery.
 The durability of the product: if it’s an easily perishable product like fruits, it will need to be sold
through a wide amount of retailers to be sold quickly.
 Location of customers: the products should be easily accessible by its customers. If customers are
located over the world, e-commerce (explained below) will be required.
 Where competitors sell their product: in order to directly compete with competitors, the products need
to be sold where competitors are selling too.

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 Promotion
Promotion: marketing activities used to communicate with customers and potential customers to
inform and persuade them to buy a business’s products.
Aims of promotion:
 Inform customers about a new product
 Persuade customers to buy the product
 Create a brand image
 Increase sales and market share
Types of promotion
 Advertising: Paid-for communication with consumers which uses printed and visual media like
television, radio, newspapers, magazines, billboards, flyers, cinema etc. This can be informative (create
product awareness) or persuasive (persuade consumers to buy the product). The process of advertising:

 Sales Promotion: using techniques such as ‘buy one get one free’, occasional price reductions, free
after-sales services, gifts, competitions, point-of–sale displays (a special display stand for a product in a
shop), free samples etc. to encourage sales.
 Below-the-line promotion: promotion that is not paid for communication but uses incentives to
encourage consumers to buy. Incentives include money-off coupons or vouchers, loyalty reward
schemes, competitions and games with cash or other prizes.
 Personal selling: sales staff communicate directly with consumer to achieve a sale and form a long-term
relationship between the firm and consumer.
 Direct mail: also known as mailshots, printed materials like flyers, newsletters and brochures which are
sent directly to the addresses of customers.
 Sponsorship: payment by a business to have its name or products associated with a particular event. For
example Emirates is Spanish football club Real Madrid’s jersey sponsor- Emirates pays the club to be its
sponsor and gains a high customer awareness and brand image in return.
What affects promotional decisions?
 Stage of product on the PLC: different stages of the PLC will require different promotional strategies;
see above.
 The nature of the product: If it’s a consumer good, a firm could use persuasive advertising and use
billboards and TV commercials. Producer goods would have bulk-buy-discounts to encourage more
sales. The kind of product it is can affect the type of advertising, the media of advertising and the
method of sales promotion.
 The nature of the target market: a local market would only need small amounts of advertising while
national markets will need TV and billboard advertising. If the product is sold to a mass market,
extensive advertising would be needed. But niche market products such as water skis would only need
advertising in special sports and lifestyle magazines.
 Cost-effectiveness: the amount of money put into promotion (out of the total marketing budget) should
be not too much that it fails to bring in the sales revenue enough to cover those costs at least.
Promotional activities are highly dependent on the budget.

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Technology and the Marketing Mix
It is also worth noting that the internet/ e-commerce is now widely used to distribute products. E-
Commerce is the use of the internet and other technologies used by businesses to market and sell goods
and services to customers. Examples of e-commerce include online shopping, internet banking, online
ticket-booking, online hotel reservations etc.
Websites like Amazon and e-Bay act as online retailers.
Online selling is favoured by producers because it is cheaper in the long-run and they can sell products
to a larger customer base/ market. However there will be increased competition from lots of
producers.
Consumers prefer online shopping because there are wider choices of detailed products that are
also cheaper and they can buy things at their own convenience 24×7. However, there is no personal
communication with the producer and online security issues may occur.
However, e-commerce means an entire new type of marketing strategy is also required – online
promotions, new channel of distribution, new pricing strategies (since price competition in e-commerce
is very high and demand is very price elastic). It requires a lot of money to set up – online websites,
promotions, web developers and technicians to run and maintain the system etc.
The internet is also used for promotion and advertising of products in the form of paid social media
ads and sponsors, pop-ups, email newsletters etc. It helps reach target customers, is relatively
cheap and helps the firm respond to market changes quicker (since online ads can be easily
altered/updated rather than billboards and TV ads). But it can alienate and chase customers away if
they see it too frequently and find it annoying. There is also the risk of the adverts being publicized
negatively if it has annoying or offensive content that customers quickly criticize

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 3.4 – Marketing Strategy
Marketing Strategy
A marketing strategy is a plan to combine the right combination of the four elements of the marketing
mix for a product to achieve its marketing objectives. Marketing objectives could include maintaining
market shares, increasing sales in a niche market, increasing sale of an existing product by using
extension strategies etc.
Factors that affect the marketing strategy:

Legal Controls on Marketing

There are various laws that can affect marketing decisions on quality, price and the contents of
advertisements.
 laws that protect consumers from being sold faulty and dangerous goods
 laws that prevent the firms from using misleading information in advertising Example: Volkswagen
falsely advertised environmentally friendly diesel cars and were legally forced to pull all cars from the
market
 laws that protect consumers from being exploited in industries where there is little or no competition,
known as monopolizing.
Entering New Markets
Growing business in other countries can increase sales, revenue and profits. This is because the
business is now available to a wider group of people, which increases potential customers. If the home
markets have saturated (product is in maturity stage), firms take their products to international markets.

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 Trade barriers and restrictions have also reduced significantly over the years, along with new transport
infrastructures, so it is now cheaper and easier to export products to other countries.
Problems of entering foreign markets:
 Difference in language and culture: It may be difficult to communicate with people in other countries
because of language barriers and as for culture, different images, colors and symbols have different
meanings and importance in different places. For example, McDonald’s had to make its menu more
vegetarian in Indian markets
 Lack of market knowledge: The business won’t know much about the market it is entering and the
customers won’t be familiar with the new business brand, and so getting established in the market will
be difficult and expensive
 Economic differences: The cost and prices may be lower or higher in different countries so businesses
may not be able to sell the product at the price which will give them a profit
 High transport costs
 Social differences: Different people will have different needs and wants from people in other countries,
and so the product may not be successful in all countries
 Difference in legal controls to protect consumers: The business may have to spend more money on
producing the products in a way that complies with that country’s laws.
How to overcome such problems:
 Joint venture: an agreement between two or more businesses to work together on a project. The
foreign business will work with a domestic business in the same industry. Eg: Japan’s Suzuki Motor
Corporation created a joint venture with India’s Maruti Udyog Limited to form Maruti Suzuki, a highly
successful car manufacturing project in India.
Advantages:
 Reduces risks and cuts costs
 Each business brings different expertise to the joint venture
 The market potential for all the businesses in the joint venture is increased
 Market and product knowledge can be shared to the benefit of the businesses
Disadvantages:
 Any mistakes made will reflect on all parties in the joint venture, which may damage their
reputations
 The decision-making process may be ineffective due to different business culture or different styles
of leadership
 Franchise/License: the owner of a business (the franchisor) grants a licence to another person or
business (the franchisee) to use their business idea – often in a specific geographical area. Fast food
companies such as McDonald’s and Subway operate around the globe through lots of franchises in
different countries.

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 ADVANTAGES DISADVANTAGES

Rapid, low cost method of business Profits from the franchise needs to
expansion be shared with the franchisee
Gets an income from franchisee in the form Loss of control over running of
of franchise fees and royalties business

Franchisee will better understand the local If one franchise fails, it can affect
tastes and so can advertise and sell the reputation of the entire brand
appropriately
Franchisee may not be as skilled
Can access ideas and suggestions from
franchisee Need to supply raw
material/product and provide
TO Franchisee will run the operations support and training
FRANCHISOR

Working with an Cost of setting up business

established brand means No full control over business- need to strictly follow
chance of business failing franchisor’s standards and rules
is low
Franchisor will give
technical and managerial Profits have to be shared with franchisor
support
Need to pay franchisor franchise fees and royalties
Franchisor will supply
the raw Need to advertise and promote the business in the
TO materials/products region themselves
FRANCHISEE

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 4.1 – Production of Goods and Services
Production is the effective management of resources in producing goods and services.

The operations department in a firm overlooks the production process. They must:
 Use the resources in a cost-effective and efficient manner
 Manage inventory effectively
 Produce the required output to meet customer demands
 Meet the quality standards expected by customers
Productivity
Productivity is a measure of the efficiency of inputs used in the production process over a period of
time. It is the output measured against the inputs used to produce it. The formula is:

Businesses often measure the labour productivity to see how efficient their employees are in producing
output. The formula for it is:

Businesses look to increase productivity, as the output will increase per employee and so the average
costs of production will fall. This way, they will be able to sell more while also being able to lower
prices.

Ways to increase productivity:

 improving labour skills by training them so they work more productively and waste lesser resources
 introducing automation (using machinery and IT equipment to control production) so that production is
faster and error-free
 improve employee motivation so that they will be willing to produce more and efficiently so.
 improved quality control and assurance systems to ensure that there are no wastage of resources

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 Inventory Management
Firms can hold inventory (stock) of raw materials, goods that are not completed yet (a.k.a work-in-
progress) and finished unsold goods. Finished good stocks are kept so that any unexpected rise in
demand is fulfilled.
 When inventory gets to a certain point (reorder level), they will be reordered by the firm to bring the
level of inventory back up to the maximum level again. The business has to reorder inventory before
they go too low since the reorder supply will take time to arrive at the firm
 The time it takes for the reorder supply to arrive is known as lead time.
 If too high inventory is held, the costs of holding and maintaining it will be very high.
 The buffer inventory level is the level of inventory the business should hold at the very minimum to
satisfy customer demand at all times. During the lead time the inventory will have hit the buffer level
and as reorder arrives, it will shoot back up to the maximum level.

Lean Production
Lean production refers to the various techniques a firm can adopt to reduce wastage and increase
efficiency/productivity.
The seven types of wastage that can occur in a firm:
 Overproduction– producing goods before they have been ordered by customers. This results in too
much output and so high inventory costs
 Waiting– when goods are not being moved or processed in any way, then waste is occurring
 Transportation-moving goods around unnecessarily is simply wasting time. They also risk damage during
movement
 Unnecessary inventory-too much inventory takes up valuable space and incurs cost
 Motion-unnecessary moving about of employees and operation of machinery is a waste of time and cost
respectively.
 Over-processing-using complex machinery and equipment to perform simple tasks may be unnecessary
and is a waste of time, effort and money
 Defects– any fault in equipment can halt production and waste valuable time. Goods can also turn out
to be faulty and need to be fixed- taking up more money and time

By avoiding such wastage, a firm can benefit in many ways

 less storage of raw materials, components and finished goods- less money and time tied up in inventory
 quicker production of goods and services
 no need to repair faulty goods- leads to good customer satisfaction

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 ultimately, costs will lower, which helps reduce prices, making the business more competitive and earn
higher profits as well

Now, how to implement lean production? The different methods are:

 Kaizen: it’s a Japanese term meaning ‘continuous improvement’. It aims to increase efficiency and
reduce wastage by getting workers to get together in small groups and discuss problems and suggest
solutions. Since they’re the ones directly involved in production they will know best to identify issues.
When kaizen is implemented, the factory floor, for example, is rearranged by re-positioning machinery
and equipment so that production can flow smoothly through the factory in the least possible time.

Benefits:


 increased productivity
 reduced amount of space needed for production
 improved factory layout may allow some jobs to be combined, so freeing up employees to do
other jobs in the factory
 Just-in-Time inventory control: this techniques eliminates the need to hold any kind of inventory by
ensuring that supplies arrive just in time they are needed for production. The making of any parts is
done just in time to be used in the next stage of production and finished goods are made just in time
they are needed for delivery to the customer/shop. The firm will need very reliable suppliers and an
efficient system for reordering supplies.
Benefits: Reduces cost of holding inventory
 Warehouse space is not needed any more, so more space is available for other uses
 Finished goods are immediately sold off, so cash flows in quickly
 Cell Production: the production line is divided into separate, self-contained units each making a part of
the finished good. This works because it improves worker morale when they are put into teams and
concentrate on one part alone.

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 Methods of Production
 Job Production: products are made specifically to order, customized for each customer. Eg: wedding
cakes, made-to-measure suits, films etc.
Advantages:
 Most suitable for one-off products and personal services
 The product meets the exact requirement of the customer
 Workers will have more varied jobs as each order is different, improving morale
 very flexible method of production
Disadvantages:
 Skilled labour will often be required which is expensive
 Costs are higher for job production firms because they are usually labour-intensive
 Production often takes a long time
 Since they are made to order, any errors may be expensive to fix
 Materials may have to be specially purchased for different orders, which is expensive

 Batch Production: similar products are made in batches or blocks. A small quantity of one product is
made, then a small quantity of another. Eg: cookies, building houses of the same design etc.
Advantages:
 Flexible way of working- production can be easily switched between products
 Gives some variety to workers
 More variety means more consumer choice
 Even if one product’s machinery breaks down, other products can still be made
Disadvantages:
 Can be expensive since finished and semi-finished goods will need moving about
 Machines have to be reset between production batches which delays production
 Lots of raw materials will be needed for different product batches, which can be expensive.

 Flow Production: large quantities of products are produced in a continuous process on the production
line. Eg: a soft drinks factory.
Advantages:
 There is a high output of standardized (identical) products
 Costs are low in the long run and so prices can be kept low
 Can benefit from economies of scale in purchasing
 Automated production lines can run 24×7
 Goods are produced quickly and cheaply
 Capital-intensive production, so reduced labour costs and increases efficiency
Disadvantages:
 A very boring system for the workers, leads to low job satisfaction and motivation
 Lots of raw materials and finished goods need to be held in inventory- this is expensive
 Capital cost of setting up the flow line is very high
 If one machinery breaks down, entire production will be affected

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 Factors that affect which production method to use:
 The nature of the product: Whether it is a personal, customized-to-order product, in which case job
production will be used. If it is a standard product, then flow production will be used
 The size of the market: For a large market, flow production will be required. Small local and niche
markets may make use of batch and flow production. Goods that are highly demanded but not in very
large quantities, batch production is most suitable.
 The nature of demand: If there is a fair and steady demand for the product, it would be more suitable to
run a production line for the product. For less frequent demand, batch and job will be appropriate.
 The size of the business: Small firms with little capital access will not produce using large automated
production lines, but will use batch and job production.
Technology and Production
 Automation: equipment used in the factory is controlled by computers to carry out mechanical
processes, such as spray painting a car body.
 Mechanization: production is done by machines but is operated by people
 CAD (computer aided designing): a computer software that draws items being designed more quickly
and allows them to be rotated, zoomed in and viewed from all angles.
 CAM (computer aided manufacturing): computers monitor the production process and controls
machines and robots-similar to automation
 CIM (computer integrated manufacturing): the integration of CAD and CAM. The computers that design
the product using CAD is connected to the CAM software to directly produce the physical design.
 EPOS (electronic point-of-sale): used at checkouts/tills where operator scans the bar-code of each item
bought by the customer individually. The item details and price appear on screen and are printed in the
receipt. They can also automatically update and reorder stock as items are bought.
 EFTPOS (electronic funds transfer at point-of-sale): the electronic cash register at the till will be
connected to the retailer’s main computer and different banks. When the customer swipes the debit
card at the till, information is read by the scanner and an amount is withdrawn from the customer’s
bank account (after the PIN is entered).
Advantages of technology in production
 Greater productivity
 Greater job satisfaction among workers as boring, routine jobs are done by machines
 Better quality products
 Quicker communication and less paperwork
 More accurate demand levels are forecast since computer monitor inventory levels
 New products can be introduced as new production methods are introduced
Disadvantages of technology in production
 Unemployment rises as machines and computers replace human labour
 Expensive to set up
 New technology quickly becomes outdated and frequent updating of systems will be needed- this is
expensive and time-consuming.
 Employees may take time to adjust to new technology or even resist it as their work practices change.

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 4.2 – Costs, Scale of Production and Break-
even Analysis
Costs
Fixed Costs are costs that do not vary with output produced or sold in the short run. They are incurred
even when the output is 0 and will remain the same in the short run. In the long-run they may change.
Also known as overhead costs.
E.g.: rent, even if production has not started, the firm still has to pay the rent.
Variable Costs are costs that directly vary with the output produced or sold. E.g.: material costs and
wage rates that are only paid according to the output produced.
TOTAL COST = TOTAL FIXED COSTS + TOTAL VARIABLE COSTS
TOTAL COST = AVERAGE COST * OUTPUT
AVERAGE COST (unit cost) = TOTAL COST/ TOTAL OUTPUT
A business can use these cost data to make different decisions. Some examples are: setting prices (if the
average cost of one unit is $3, then the price would be set at $4 to make a profit of $1 on each
unit), deciding whether to stop production (if the total cost exceeds the total revenue, a loss is being
made, and so the production might be stopped), deciding on the best location (locations with the
cheaper costs will be chosen) etc.
Scale of production
As output increases, a firm’s average cost decreases.

Economies of scale are the factors that lead to a reduction in average costs as a business increases in
size. The five economies of scale are:
 Purchasing economies: For large output, a large amount of components have to be bought. This will give
them some bulk-buying discounts that reduce costs
 Marketing economies: Larger businesses will be able to afford its own vehicles to distribute goods and
advertise on paper and TV. They can cut down on marketing labour costs. The advertising rates costs
also do not rise as much as the size of the advertisement ordered by the business. Average costs will
thus reduce.
 Financial economies: Bank managers will be more willing to lend money to large businesses as they are
more likely to be able to pay off the loan than small businesses. Thus they will be charged a low rate of
interest on their borrowings, reducing average costs.
 Managerial economies: Large businesses may be able to afford to hire specialist managers who are very
efficient and can reduce the business’ costs.
 Technical economies: Large businesses can afford to buy large machinery such as a flow production line
that can produce a large output and reduce average costs.

Diseconomies of scale are the factors that lead to an increase the average costs of a business as it grows
beyond a certain size. They are:
 Poor communication: as a business grows large, more departments and managers and employees will
be added and communication can get difficult. Messages may be inaccurate and slow to receive, leading
to lower efficiency and higher average costs in the business.
 Low morale: when there are lots of workers in the business and they have non-contact with their senior
managers, the workers may feel unimportant and not valued by management. This would lead to
inefficiency and higher average costs.

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 Slow decision-making: As a business grows larger, its chain of command will get longer. Communication
will get very slow and so any decision-making will also take time, since all employees and departments
may need to be consulted with.
Businesses are now dividing themselves into small units that can control themselves and communicate
more effectively, to avoid any diseconomies from arising.
Break-even
Break-even level of output is the output that needs to be produced and sold in order to start making a
profit. So, the break-even output is the output at which total revenue equals total costs (neither a
profit nor loss is made, all costs are covered).
A break-even chart can be drawn, that shows the costs and revenues of a business across different levels
of output and the output needed to break even.
Example:
In the chart below, costs and revenues are being calculated over the output of 2000 units.
The fixed costs is 5000 across all output (since it is fixed!).
The variable cost is $3 per unit so will be $0 at output is 0 and $6000 at output 2000- so you just draw a
straight line from $0 to $6000.
The total costs will then start from the point where fixed cost starts and be parallel to the variable costs
(since T.C. = F.C. +V.C. You can manually calculate the total cost at output 2000: ($6000+$5000=$11000).
The price per unit is $8 so the total revenue is $16000 at output 2000.
Now the break-even point can be calculated at the point where total revenue and total cost equals– at
an output of 1000. (In order to find the sales revenue at output 1000, just do $8*1000= $8000. The
business needs to make $8000 in sales revenue to start making a profit).

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 Advantages of break-even charts:
 Managers can look at the graph to find out the profit or loss at each level of output
 Managers can change the costs and revenues and redraw the graph to see how that would affect profit
and loss, for example, if the selling price is increased or variable cost is reduced.
 The break-even chart can also help calculate the safety margin- the amount by which sales exceed
break-even point. In the above graph, if the business decided to sell 2000 units, their margin of safety
would be 1000 units. In sales terms, the margin of safety would be 1000*8 = $8000. They are $8000 safe
from making a loss.
Margin of Safety (units) = Units being produced and sold – Break-even output
Limitations of break-even charts:
 They are constructed assuming that all units being produced are sold. In practice, there are always
inventory of finished goods. Not everything produced is sold off.
 Fixed costs may not always be fixed if the scale of production changes. If more output is to be
produced, an additional factory or machinery may be needed that increases fixed costs.
Break-even charts assume that costs can always be drawn using straight lines. Costs may increase or
decrease due to various reasons. If more output is produced, workers may be given an overtime wage
that increases the variable cost per unit and cause the variable cost line to steep upwards.

Break-even can also be calculated without drawing a chart. A formula can be used:
Break-even level of production =Total fixed costs/ Contribution per unit
Contribution = Selling price – Variable cost per unit (this is the value added/contributed to the product
when sold)
In the above example, the contribution is $8 -$3=$5, so the break-even level is:
$5000/$5 = 1000 units!

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 4.3 – Achieving Quality Production
Quality means to produce a good or service which meets customer expectations. The products should
be free of faults or defects. Quality is important because it:
 establishes a brand image
 builds brand loyalty
 maintains good reputation
 increase sales
 attract new customers
If there is no quality, the firm will
 lose customers to other brands
 have to replace faulty products and repeat poor service, increasing costs
 bad reputation leading to low sales and profits
There are three methods a business can implement to achieve quality: quality control, quality assurance
and total quality management.
Quality Control
Quality control is the checking for quality at the end of the production process, whether a good or a
service.
Advantages:
 Eliminates the fault or defect before the customer receives it, so better customer satisfaction
 Not much training required for conducting this quality check
Disadvantages:
 Still expensive to hire employees to check for quality
 Quality control may find faults and errors but doesn’t find out why the fault has occurred, so the it’s
difficult to solve the problem
 if product has to be replaced and reworked, then it is very expensive for the firm
Quality Assurance
Quality assurance is the checking for quality throughout the production process of a good or service.
Advantages:
 Eliminates the fault or defect before the customer receives it, so better customer satisfaction
 Since each stage of production is checked for quality, faults and errors can be easily identified and
solved
 Products don’t have to be scrapped or reworked as often, so less expensive than quality control
Disadvantages:
 Expensive to carry out since quality checks have to be carried throughout the entire process, which will
require manpower and appropriate technology at every stage.
 How well will employees follow quality standards? The firm will have to ensure that every employee
follows quality standards consistently and prudently, and knows how to address quality issues.
Total Quality Management (TQM)
Total Quality Management or TQM is the continuous improvement of products and production
processes by focusing on quality at each stage of production. There is great emphasis on ensuring that
customers are satisfied. In TQM, customers just aren’t the consumers of the final product. It is every
worker at each stage of production. Workers at one stage have to ensure the quality standards are met
for the product in production at their stage before they are passed onto the next stage and so on. Thus,
quality is maintained throughout production and products are error-free.

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 TQM also involves quality circles and like Kaizen, workers come together and discuss issues and
solutions, to reduce waste ensure zero defects.
Advantages:
 quality is built into every part of the production process and becomes central to the workers principles
 eliminates all faults before the product gets to the final customer
 no customer complaints and so improved brand image
 products don’t have to be scrapped or reworked, so lesser costs
 waste is removed and efficiency is improved
Disadvantages:
 Expensive to train employees all employees
 Relies on all employees following TQM– how well are they motivated to follow the procedures?
How can customers be assured of the quality of a product or service?
They can look for a quality mark on the product like ISO (International Organization for Standardization).
The business with these quality marks would have followed certain quality procedures to keep the
quality mark. For services, a good reputation and positive customer reviews are good indicators of the
service’s quality.

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 4.4 – Location Decisions
Owners need to decide a location for their firm to operate in, at the time of setting up, when it needs to
expand operations, and when the current location proves unsatisfactory for some reason. Location is
important because it can affect the firm’s costs, profits, efficiency and the market base it reaches out to.
Factors that affect the location decisions of a manufacturing firm:
 Production Method: when job production is used, the business will operate on a small scale, so the
nearness to components/raw materials won’t be that important. For flow production, on the other
hand, production will be on a large scale- there will be a huge amount of components and transport
costs will be high- so components need to be close by.
 Market: if the product is a consumer good and perishable, the factories need to be close to the markets
to sell out quickly before it perishes.
 Raw Materials/Components: the factories may need to be located close to where raw materials can be
acquired, especially if the raw material is to be processed while still fresh, like fruits for fruit juice.
 External economies: the business may locate near other firms that support the business by provide
services- eg: business that install and maintain factory equipment.
 Availability of labour: Businesses will need to locate near areas where they can get workers of the skills
they need in the factory. If lots of unskilled workers are needed in the factories firms locate in areas of
high unemployment. Wage rates also vary by location and firms will want to set up in locations where
wage rates are low.
 Government Influence: the government sometimes gives incentives and grants to firms that set up in
low-development, rural and high-unemployment areas. There may also be govt. rules and restrictions in
setting up, e.g.: in some areas of great natural beauty. The business needs to consider these.
 Transport & Communication infrastructure: the factories need to be located near areas where there are
good road/rail/port/air transport systems. If goods are to be exported, it needs to be set up near ports.
 Power and water supply: factories need water and power to operate and a reliable and steady supply of
both should be ensured by setting up in areas where they are available.
 Climate: not the most important factor but can influence certain sectors. Eg: the dry climate in Silicon
Valley aids the manufacturing of silicon chips.
 Owner’s personal preferences

Factors that affect the location decisions of a service-sector firm:

 Customers: service-sector businesses that have direct contact with customers need to locate in
customer-accessible and convenient places. Eg; restaurants, hairdressers, post offices etc.
 Technology: today, with increasing use of IT to shop and make payments, customers do not need direct
access to services and proximity to the market/customer is not a very important factor in location
decisions. They locate away from customers in places where there are low rent and wage rates. Eg:
banks
 Availability of labour: if large number of workers are required in the firm, then it will need to locate
close to residential areas. If they want certain types of worker skills, they will need to locate in places
where such skilled workers can be found. However, with work-from-home and technology, this is not
that big of a factor nowadays.
 Climate: tourism services need to be located in places of good climate.
 Nearness to other business: some services serve the needs of large companies, such as firm equipment
servicing and so they need to be very close to such businesses. Businesses may also set up where close
competitors are to watch them and snatch away their customers.
 Rent/taxes
 Owner’s personal preferences

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 Factors that affect the location decisions of a retailing firm:
 Shoppers: retailers need to be located in areas where shoppers frequent, like malls, to attract as many
customers as possible.
 Nearby shops: being located to other shops that are visited regularly will also attract attention of
customers into the shop. Being near competitors also helps keep an eye on competition and snatch
away customers.
 Customer parking availability: when parking is available nearby, more people will find it convenient to
shop in that area.
 Availability of suitable vacant premises: Obviously, there needs to be a vacant premise available to set
up the business. Vacant premises can also help the business expand their premises in the future.
 Rent/taxes: rents and taxes on the locations need to be affordable.
 Access to delivery vehicles: if the retailer has home delivery services, then delivery vehicles will be
required.
 Security: high rates of crime and theft can happen in shops. Shopping complexes with security guards
will thus be preferred by firms.

Why businesses locate in different countries?

 New markets overseas.
 Cheaper or new raw materials available in other countries.
 Cheaper and/or skilled workers are available overseas.
 Rent/ taxes are lower...
 Availability of government grants and other incentives
 Avoid trade barriers and tariffs: when exporting goods to other countries, there will be some tariffs,
rules and regulations to get by. In order to avoid this, firms start operating in the country itself, since
there is no exporting/importing involved now.

The role of legal controls on location decisions

Governments influence location decisions:
 to encourage businesses to set up and expand in areas of high unemployment and under-
development. Grants and subsidies can be given to businesses that set up in such areas.
 to discourage firms from setting in areas of that are overcrowded or renowned for natural
beauty. Planning restrictions can be put into place to do so.

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 5.1 – Business Finance: Needs and Sources
Finance is the money required in the business. Finance is needed to set up the business, expand
it and increase working capital (the day-to-day running expenses).
Start-up capital is the initial capital used in the business to buy fixed and current assets before
it can start trading.
Working Capital finance needed by a business to pay its day-to-day running expenses
Capital expenditure is the money spent on fixed assets (assets that will last for more than a
year). Eg: vehicles, machinery, buildings etc. These are long-term capital needs.
Revenue Expenditure, similar to working capital, is the money spent on day-to-day expenses
which does not involve the purchase of long-term assets. Eg: wages, rent. These are short-term
capital needs.
Sources of Finance
Internal finance is obtained from within the business itself.
 Retained Profit: profit kept in the business after owners have been given their share of the profit. Firms
can invest this profit back in the businesses.
Advantages:
– Does not have to be repaid, unlike, a loan.
– No interest has to be paid
Disadvantages:
– A new business will not have retained profit
– Profits may be too low to finance
– Keeping more profits to be used as capital will reduce owner’s share of profit and they may resist the
decision.
 Sale of existing assets: assets that the business doesn’t need anymore, for example, unused buildings or
spare equipment can be sold to raise finance
Advantages:
– Makes better use of capital tied up in the business
– Does not become debt for the business, unlike a loan.
Disadvantages:
– Surplus assets will not be available with new businesses
– Takes time to sell the asset and the expected amount may not be gained for the asset
 Sale of inventories: sell of finished goods or unwanted components in inventory.
Advantage:
– Reduces costs of inventory holding
Disadvantage:
– If not enough inventory is kept, unexpected increase demand form customers cannot be fulfilled
 Owner’s savings: For a sole trader and partnership, since they’re unincorporated (owners and business
is not separate), any finance the owner directly invests from his own saving will be internal finance.
Advantages:
– Will be available to the firm quickly
– No interest has to be paid.
Disadvantages:
– Increases the risk taken by the owners.
Advertisements

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 REPORT THIS AD

External finance is obtained from sources outside of the business.

 Issue of share: only for limited companies.
Advantage:
 A permanent source of capital, no need to repay the money to shareholders
no interest has to be paid
Disadvantages:
 Dividends have to be paid to the shareholders
 If many shares are bought, the ownership of the business will change hands. (The ownership is
decided by who has the highest percentage of shares in the company)
 Bank loans: money borrowed from banks
Advantages:
 Quick to arrange a loan
 Can be for varying lengths of time
 Large companies can get very low rates of interest on their loans
Disadvantages:
 Need to pay interest on the loan periodically
 It has to be repaid after a specified length of time
 Need to give the bank a collateral security (the bank will ask for some valued asset, usually some
part of the business, as a security they can use if at all the business cannot repay the loan in the
future. For a sole trader, his house might be collateral. So there is a risk of losing highly valuable
assets)
 Debenture issues: debentures are long-term loan certificates issued by companies. Like shares,
debentures will be issued, people will buy them and the business can raise money. But this finance acts
as a loan- it will have to be repaid after a specified period of time and interest will have to be paid for it
as well.
Advantage:
 Can be used to raise very long-term finance, for example, 25 years
Disadvantage:
 Interest has to be paid and it has to be repaid
 Debt factoring: a debtor is a person who owes the business money for the goods they have bought from
the business. Debt factors are specialist agents that can collect all the business’ debts from debtors.
Advantages:
 Immediate cash is available to the business
 Business doesn’t have to handle the debt collecting
Disadvantage:
 The debt factor will get a percent of the debts collected as reward. Thus, the business doesn’t get all
of their debts
 Grants and subsidies: government agencies and other external sources can give the business a grant or
subsidy
Advantage:
 Do not have to be repaid, is free
Disadvantage:
 There are usually certain conditions to fulfil to get a grant. Example, to locate in a particular under-
developed area.

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 Micro-finance: special institutes are set up in poorly-developed countries where financially-lacking
people looking to start or expand small businesses can get small sums of money. They provide all sorts
of financial services
 Crowd funding: raises capital by asking small funds from a large pool of people, e.g. via Kickstarter.
These funds are voluntary ‘donations’ and don’t have to be return or paid a dividend.

Short-term finance provides the working capital a business needs for its day-to-day operations.
 Overdrafts: similar to loans, the bank can arrange overdrafts by allowing businesses to spend more than
what is in their bank account. The overdraft will vary with each month, based on how much extra money
the business needs.
Advantages:
 Flexible form of borrowing since overdrawn amounts can be varied each month
 Interest has to be paid only on the amount overdrawn
 Overdrafts are generally cheaper than loans in the long-term
Disadvantages:
 Interest rates can vary periodically, unlike loans which have a fixed interest rate.
 The bank can ask for the overdraft to be repaid at a short-notice.
 Trade Credits: this is when a business delays paying suppliers for some time, improving their cash
position
Advantage:
 No interests, repayments involved
Disadvantage:
 If the payments are not made quickly, suppliers may refuse to give discounts in the future or refuse
to supply at all
 Debt Factoring: (see above)

Long-term finance is the finance that is available for more than a year.
 Loans: from banks or private individuals.
 Debentures
 Issue of Shares
 Hire Purchase: allows the business to buy a fixed asset and pay for it in monthly instalments that include
interest charges. This is not a method to raise capital but gives the business time to raise the capital.
Advantage:
 The firms doesn’t need a large sum of cash to acquire the asset
Disadvantage:
 A cash deposit has to be paid in the beginning
 Can carry large interest charges.
 Leasing: this allows a business to use an asset without purchasing it. Monthly leasing payments are
instead made to the owner of the asset. The business can decide to buy the asset at the end of the
leasing period. Some firms sell their assets for cash and then lease them back from a leasing company.
This is called sale and leaseback.
Advantages:
 The firm doesn’t need a large sum of money to use the asset
 The care and maintenance of the asset is done by the leasing company
Disadvantage:
 The total costs of leasing the asset could finally end up being more than the cost of purchasing the
asset!

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 Factors that affect choice of source of finance
 Purpose: if a fixed asset is to be bought, hire purchase or leasing will be appropriate, but if finance is
needed to pay off rents and wages, debt factoring, overdrafts will be used.
 Time-period: for long-term uses of finance, loans, debenture and share issues are used, but for a short
period, overdrafts are more suitable.
 Amount needed: for large amounts, loans and share issues can be used. For smaller amounts,
overdrafts, sale of assets, debt factoring will be used.
 Legal form and size: only a limited company can issue shares and debentures. Small firms have limited
sourced of finances available to choose from
 Control: if limited companies issue too many shares, the current owners may lose control of the
business. They need to decide whether they would risk losing control for business expansion.
Risk- gearing: if business has existing loans, borrowing more capital can increase gearing- risk of the
business- as high interests have to be paid even when there is no profit, loans and debentures need to
be repaid etc. Banks and shareholders will be reluctant to invest in risky businesses.

Finance from banks and shareholders

Chances of a bank willing to lend a business finance is higher when:
 A cash flow forecast is presented detailing why finance is needed and how it will be used
 An income statement from the last trading year and the forecast income statement for the next year, to
see how much profit the business makes and will make.
 Details of existing loans and sources of finance being used
 Evidence that a security/collateral is available with the business to reduce the bank’s risk of lending
 A business plan is presented to explain clearly what the business hopes to achieve in the future and why
finance is important to these plans

Chances of a shareholder willing to invest in a business is higher when:

 the company’s share prices are increasing- this is a good indicator of improving performance
 dividends and profits are high
 the company has a good reputations and future growth plans

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 5.2 – Cash Flow Forecasting and
Working Capital
Why is cash important?
If a firm doesn’t have any cash to pay its workers, suppliers, landlord and government, the business
could go into liquidation– selling everything it owns to pay its debts. The business needs to have an
adequate amount of cash to be able to pay for all its short-term payments.
Cash Flow
The cash flow of a businesses is its cash inflows and cash outflows over a period of time.
Cash inflows are the sums of money received by the business over a period of time. E.g.:
 sales revenue from sale of products
 payment from debtors– debtors are customers who have already purchased goods from the business
but didn’t pay for them at that time
 money borrowed from external sources, like loans
 the money from the sale of business assets
 investors putting more money into the business
Cash outflows are the sums of money paid out by the business over a period of time. Eg:
 purchasing goods and materials for cash
 paying wages, salaries and other expenses in cash
 purchasing fixed assets
 repaying loans (cash is going out of the business)
 by paying creditors of the business- creditors are suppliers who supplied items to the business but were
not paid at the time of supply.
The cash flow cycle:

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 Cash flow is not the same as profit! Profit is the surplus amount after total costs have been deducted
from sales. It includes all income and payments incurred in the year, whether already received or paid or
to not yet received or paid respectfully. In a cash flow, only those elements paid by cash are considered.
Cash Flow Forecasts
A cash flow forecast is an estimate of future cash inflows and outflows of a business, usually on a
month-by-month basis. This then shows the expected cash balance at the end of each month. It can help
tell the manager:
 how much cash is available for paying bills, purchasing fixed assets or repaying loans
 how much cash the bank will need to lend to the business to avoid insolvency (running out of liquid
cash)
 whether the business has too much cash that can be put to a profitable use in the business
Example of a cash flow forecast for the four months:

The cash inflows are listed first and then the cash outflows. The total inflows and outflows have to be
calculated after each section.
The opening cash/bank balance is the amount of cash held by the business at the start of the month
Net Cash Flow = Total Cash Inflow – Total Cash Outflow
The net cash flow is added to opening cash balance to find the closing cash/bank balance– the amount
of cash held by the business at the end of the month. Remember, the closing cash/bank balance for one
month is the opening cash/bank balance for the next month!
The figures in bracket denote a negative balance, i.e., a net cash outflow (outflows > inflows)

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 Uses of cash flow forecasts:
 When setting up the business the manager needs to know how much cash is required to set up the
business. The cash flow forecast helps calculate the cash outflows such as rent, purchase of assets,
advertising etc.
 A statement of cash flow forecast is required by bank managers when the business applies for a loan.
The bank manager will need to know how much to lend to the business for its operations, when the loan
is needed, for how long it is needed and when it can be repaid.
 Managing cash flow– if the cash flow forecast gives a negative cash flow for a month(s), then the
business will need to plan ahead and apply for an overdraft so that the negative balance is avoided (as
cash come in and the inflow exceeds the outflow). If there is too much cash, the business may decide to
repay loans (so that interest payment in the future will be low) or pay off creditors/suppliers (to
maintain healthy relationship with suppliers).

How can cash flow problems be overcome?

When a negative cash flow is forecast (lack of cash) the following methods can be used to correct it:
 Increase bank loans: bank loans will inject more cash into the business, but the firm will have to pay
regular interest payments on the loans and it will eventually have to be repaid, causing future cash
outflows
 Delay payment to suppliers: asking for more time to pay suppliers will help decrease cash outflows in
the short-run. However, suppliers could refuse to supply on credit and may reduce discounts for late
payment
 Ask debtors to pay more quickly: if debtors are asked to pay all the debts they have to the firm quicker,
the firm’s cash inflows would increase in the short-run. These debtors will include credit customers, who
can be asked to make cash sales as opposed to credit sales for purchases (cash will have to be paid on
the spot, credit will mean they can pay in the future, thus becoming debtors). However, customers may
move to other businesses that still offers them time to pay
 Delay or cancel purchases of capital equipment: this will greatly help reduce cash outflows in the short-
run, but at the cost of the efficiency the firm loses out on not buying new technology and still using old
equipment.
In the long-term, to improve cash flow, the business will need to attract more investors, cut costs by
increasing efficiency, develop more products to attract customers and increase inflows.
Working Capital
Working capital the capital required by the business to pay its short-term day-to-day expenses. Working
capital is all of the liquid assets of the business– the assets that can be quickly converted to cash to pay
off the business’ debts. Working capital can be in the form of:
 cash needed to pay expenses
 cash due from debtors – debtors/credit customers can be asked to quickly pay off what they owe to the
business in order for the business to raise cash
 cash in the form of inventory – Inventory of finished goods can be quickly sold off to build cash inflows.
Too much inventory results in high costs, too low inventory may cause production to stop.

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 5.3 – Income Statements
Accounts are the financial records of a firm’s transactions.
Final Accounts are prepared at the end of the financial year and give details of the profit or loss made as
well as the worth of the business.
Profit
Profit = Sales Revenue – Total cost
When the total costs exceed the sales revenue, then a loss is made.

How to increase profit?

 Increase sales revenue
 Cut costs
Why is profit important to a business?
 It is a reward for enterprise: entrepreneurs start businesses to make a profit
 It is a reward for risk-taking: entrepreneurs has to take considerable risks when they invest capital in a
venture, and profits are a compensation/reward to them for taking these risks (paid in the form of
profits or dividends)
 It is a source of finance: after payments to owners, profits are reinvested back into the business for
further expansion (this is called retained earnings)
 It is an indicator of success: more profits indicate to investors that the business/industry is worth their
time and money, and they will invest more either into the firm or new firms of their own, in the hopes of
gaining good returns on their investment
For social enterprises, profit is not one of their primary objectives, but welfare of the society is.
However, they will also strive to make some profit to reinvest it back into the business and help it grow.
Profit is not the same as cash flow! Profit is the surplus amount after total costs have been deducted
from sales. It includes all income and payments incurred in the year, whether already received or paid or
to not yet received or paid respectfully. In a cash flow, only those elements paid in cash immediately are
considered.
Income Statement
An income statement is a financial document of the business that records all income generated by the
business as well as the costs incurred by the business and thus the profit or loss made over the financial
year. Also known as profit and loss account.

A simple Income Statement

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 Sales Revenue = total sales
Cost of Sales = total variable cost of production + (opening inventory of finished goods-closing inventory
of finished goods)
Gross Profit = Sales Revenue – Cost of Sales
Expenses: all overheads/fixed costs
Net Profit = Gross Profit – Expenses
Profit after Tax = Net Profit – Tax
Dividends: share of profit given to shareholders; return on shares
Retained Profit for the year = Profit after Tax – Dividends. This retained earnings is then kept aside for
use in the business.

Only a very small portion of the sales revenue ends up being the retained profit. All costs, taxes and
dividends have to be deducted from sales.

Uses of Income Statement

Income statements are used by managers to:
 know the profit/loss made by the business
 compare their performance with that of previous years’ and with that of competitors’. If profit is lower
than that of last year’s why is it falling and what can they do to correct the issue? If it is lower than that
of competitors’ what can they do to be more profitable and be competitive in the market?
 know the profitability of individual products by preparing separate income statement for each product.
They may decide to stop production of products that are making losses.
 help decide what products to launch by preparing forecast income statement for the first few years.
Whichever product is forecast to have a higher profit, the business will choose to launch that product

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