Lesson 3

Introduction to Business 2019-2020
Lesson 3. Functional Areas of

Business
3.1. Operations
3.2. Marketing
3.3. Finance
3.1 OPERATIONS
Role within the firm

•Value creating activities that transform
inputs into finished goods and services
Environment
Inputs
Basic Outputs
Creative Transformation
Goods
process
Managerial Services
By-products
Feedback
Eduardo González Fidalgo © 1

Some examples
Type of Inputs Processes Outputs

Business
Doctors, nurses,
Medical procedures,
operating rooms, Health
therapy, professional care
Hospital ambulances, services,
of patients, service
equipment, waste…
delivery…
patients…
Food preparation
Flour, sugar, Cakes, pies,
according to recipes,
Bakery equipment (ovens), bread,
machine setup, mix,
energy, bakers… waste…
mould, bake, pack…
Coal- Conversion of the chemical

burning Coal, boiler, turbine, energy stored in coal into
Electricity,
electric transmission lines, thermal energy,
CO2…
generating water, employees… mechanical energy and,
plant finally, electrical energy…
PARTS OF THE PRODUCTION PROCESS
1. Transformation process
• Process that converts inputs into outputs. In a broad sense this
is the production technology
Elements of the transformation process

• Tasks: actions performed on raw materials, intermediate or
finished products. They can be manual, mechanized or
automated (mechanization vs. automation)
• Flows: movement of materials and information from one
location to another
• Storage: keeping of materials and information in good
conditions for later use or transfer. There is no task and no
movement of materials or information

2. Resources or inputs
• Everything that is used to obtain the final output
Types of inputs
• Basic: raw materials, components, information,
energy, labor, capital
• Creative: design of products and processes (related
to R&D)
• Managerial: planning, organizing & monitoring the
production process for a good functioning
3. Outputs
• Products, services and by-products obtained at the end of the
production process. Some by-products are undesirable (e.g.
pollution)
4. Feedback
• Information gathered throughout the process that is compared
with the initial planning to adjust the system for better
functioning.
• Another source of feedback comes from the environment that
exerts a big influence on the adjustment of the production
process (customer complaints, environmental regulations,
prices of inputs, etc.)

GOALS OF THE PRODUCTION PROCESS
1. Efficiency (cost)
• Produce at the minimum cost that is possible
or at least at a similar cost as competitors
2. Quality
• Internal view: the products conform to the
technical specifications
• External view: customers are satisfied with the
product (compared with competitors)
GOALS OF THE PRODUCTION PROCESS
3. Lead time (delivery time)

• Time elapsed between receiving the order of
production and placing the product on the hands
of the customer (production cycle)
4. Flexibility
• Ability to adjust the production process to
produce new products, to change from one
product to another, or to modify production
volume

TRADITIONAL PRODUCTION SYSTEMS
Project
High
Product Diversity (Flexibility)
production
Jobbing
production
Medium
Batch
production
Mass
production
Continuous
Low
production
Very low Low Medium High Very high

Manufacturing Volume
TYPES OF PRODUCTION SYSTEMS
1. PROJECT PRODUCTION
• Examples: building (bridges, skyscrapers, ships) and
services (decoration)
• Product: unique for each client
• Unit cost: high (no economies of scale)
• Labor: highly skilled (adaptable to different tasks)
• Machinery and equipment: versatile, general use
• Plant layout: fixed position (the product does not
move during transformation. Workers move to
where the product is located to perform operations)

2. JOB-SHOP AND BATCH PRODUCTION

• Examples: repair shops (j), bakery (b), pottery
(j/b), clothing (b), wedding dressmaker (j)
• Product: small volumes, high variety
• Unit cost: high
• Labor: highly skilled
• Machinery and equipment: versatile, general use,
hand tools (flexibility)
• Plant layout: process (the product visits the area
where the operation is to be performed)
Jobbing Batch
production production
Lathes Milling
T T T Drills
T T F F F F t t
Functional layout
Inspection E E Assembling
(process)
Painting
Materials
Products
warehouse P
warehouse P
Reception Shipping
Examples: repair shops (jobbing), bakery

(batch), pottery (jobbing/batching), wedding
Product A
dressmaker (jobbing) Product B
Product C 12

3. MASS AND CONTINUOUS PRODUCTION

• Examples: industrial manufacturing ... Ford
automobiles (m), milk processing (c)
• Product: standardized, low variety, high volume
• Unit cost: low and very low
• Labor: low skilled
• Machinery and equipment: specialized, automation
• Plant layout: product (the product flows through
the physical locations where tasks are to be
performed in strict sequential order). Mechanized
materials handling
Mass Continuous
production production
Product layout (assembly line) is used when all products

undergo the same operations in the same sequence.
Reception
Shipping
Final assembly line
Examples: Cars (mass), milk bottling (cont.), petrochemicals (cont.)…

14

Flexibility
Project
+ range / variety
- volume
Job shop
Flexible
Batch
Mass
Rigid Efficiency
Continuous
- range / variety
+ volume
Just in Time Flexibility and efficency
4. JUST IN TIME (JIT) / LEAN

• Examples: automobile manufacturing, Dell
computers…
• Product: high variety, large volume in small
batches
• Unit cost: low
• Labor: skilled multifunctional workers
• Machinery and equipment: general purpose,
flexible
• Plant layout: U-shaped or cellular layout (the
same worker or group of workers can perform
several different operations on the product)
• Suppliers: long term relationships (supplies
must come just in time whenever needed; no
stocks; reduce waste; pull system)

3.2 MARKETING

• Manage the relationships with customers
• Get to know customer needs and satisfy them at a profit
Strategic marketing
• Analyze customer needs and develop marketing strategies
through:
• Market segmentation: identify different types of customers
and divide the market accordingly
• Positioning: managing how the firm is perceived by customers
Tactical marketing
• Manage the marketing-mix variables: Product, Price, Place and
Promotion (the 4 Ps)

MARKETING MIX
PRODUCT
• Something offered in the market to satisfy
consumer needs
• The product can be understood as a bundle of
attributes (tangible and intangible)
• Consumer goods (milk, bread, cars) vs. industrial
goods (vans, working tools)
• Goods: can be stored, long life, mostly tangible
• Services: cannot be stored, consumed and
produced at the same time, one use
Product
Consumer versus industrial or business products
Marketing implications
20

MARKETING MIX
MAIN ATTRIBUTES OF A PRODUCT
•Quality
•Design
•Packaging
•Size and quantity
•Added services (warranty, transportation)
•Image (brand name, reputation)
PRODUCT LIFE CYCLE
€ Introduction Growth Maturity Decline
Sales
0
time...
Profit

MARKETING MIX
PLACE (Distribution)
• This variable relates to the delivery of the product
• The product should be available in the quantity,
moment and place that is convenient for the
customer
• Different distribution channels can be used
• Direct channels: the firm sells directly to the final
customer (Catalogue, Internet)
• Indirect channels: representatives, wholesalers,
retailers
Place
Number of Channel Levels

Place
How Channel Members Add Value
Place
 A manufacturer may use multiple channels

• To reach different market segments
– When the same product is sold to
consumers and businesses
• To increase sales or capture a larger
market share

MARKETING MIX
PRICE
• Amount of money that is paid for the product
• Summarizes the commercial policy of the firm
• Should reflect the value of the product for the
customer (as a bundle of attributes), with respect to
competing firms
• A higher price results in higher margins but lower
sales. These two effects should be optimally balanced
• Methods to establish prices: mark-up on cost,
demand-based pricing, comparison with competitors
MARKETING MIX
PROMOTION (Communication)
•Communicate with customers to get them informed about
our products and persuade them to buy
•Advertising: unilateral and impersonal communication using
mass media (unseen customers)
•Sales promotion: actions oriented to increase demand in a
limited period of time (discounts, gifts, food sampling, etc.)
•Public relations: actions oriented to build a favorable public
image of the firm (press releases, sponsorships, annual
reports)
•Direct marketing: personal communication with customers
(direct mail, telemarketing, door to door)

3.3 FINANCE

• Raise funds to support the activities of the firm and
decide which investment projects are worthwhile
• Ultimate goal: help maximize firm value
Financing
• How to raise funds
• Debt, stock, bonds
Investment
• Allocate funds to projects that increase firm value
FINANCE
FINANCING
•Firms need to raise funds to finance
investment projects and activities (assets)
•The combination of different sources of
finance determines the firm’s financial
structure (owners’ equity & liabilities)
•Sources of funding: internal vs. external
•Cost of financial resources: minimize

BALANCE SHEET
ASSETS EQUITY AND LIABILITIES
Cash Accounts payable
Short term investments Notes payable (short term, incl. loans)
Accounts receivable CURRENT LIABILITIES
Inventory
TOTAL CURRENT ASSETS Notes payable (long term, incl. loans)
Bonds and debentures
Long term investments LONG TERM LIABILITIES
Plant and Equipment (tangible)
Patents and Licences (intangible) Capital stock
(Accumulated Depreciation) Retained earnings
TOTAL FIXED ASSETS TOTAL STOCKHOLDERS EQUITY
TOTAL ASSETS TOTAL OWNER’S EQUITY AND LIABILITIES
BALANCE SHEET
FIRM
time
A balance sheet is often described as a "snapshot” of a firm's

financial condition. It represents the assets, liabilities and
ownership equity of the firm at a given point in time.
32

SOURCES OF FUNDING
INTERNAL FUNDS
• Self financing: funds generated from
the operations of the firm and ready
to be reinvested
• Maintenance: cash available to
replace assets (depreciation)
• Growth: retained earnings
(dividend policy)
SOURCES OF FUNDING
EXTERNAL FUNDS
• Funds raised from investors and creditors
• Equity financing: the money raised from investors
in exchange of ownership rights is called
shareholders’ equity. Does not generate interest
expenses and does not have to be paid back.
• Initial capital (+ retained earnings)
• New stock issues (easier for floated companies)
• Debt financing (liabilities): the money raised from
borrowing is called debt or leverage. Has to be
repaid with an agreed-upon interest

SOURCES OF FUNDING
SOURCES OF DEBT FINANCING

•Trade credit (S/T)
•Bank loan (S/T) and (L/T)
•Bank overdraft (line of credit) (S/T)
•Bill of exchange/promissory note (S/T)
•Factoring and invoice discounting (S/T)
•Bonds and debentures (L/T)
•Leasing (L/T)
SOURCES OF FUNDING
COST OF CAPITAL
•Cost of equity
•Not to be paid back but has cost
•Opportunity cost for shareholders’ cash
•Ke= risk free return + risk premium
•Cost of debt
•Interests paid
•Ki= interest expenses/total liabilities

SOURCES OF FUNDING
WEIGHTED COST OF CAPITAL
E D
K Ke  Ki
ED ED
E  Equity
D  Debt (total Liabilities )
FINANCE
INVESTMENT
•Allocate financial resources (funds raised)
to investment projects that create value
•A project creates value if its return is
higher than the weighted cost of capital
•If the return is not enough to cover the
cost of capital, the project destroys value

FINANCE
Variables of an investment project
•Initial investment (C0) (negative)

•Time horizon (n)
•Inflows (It)
•Outflows (Ot)
•Net cash flows (Ct=It-Ot)
DYNAMIC CRITERIA
Dynamic investments must consider the time value of money, i.e. a dollar received
today is worth more than a dollar received in the future because the sooner you
receive a sum of money, the sooner you can put that money to work
Net Present Value Internal Rate of

(NPV) Return (IRR)
40

DYNAMIC CRITERIA
Time value of money

(i=discount rate=cost of capital)
Future Value – how much a given
amount of cash received today will
be worth in a future period, given
the time value of money
Cn  C0 (1  i ) n
capitalising
Co Cn t
Present Value – how much a

given amount of cash received
Cn
C0  in a future period is worth today,
(1  i) n given the time value of money
discounting
Co Cn
t
41
FINANCE
NET PRESENT VALUE
C1 C2 Cn
NPV  C0    
1  i (1  i ) 2
(1  i ) n
n
 C0  C1   2C2     nCn    t Ct
t 0
i  discount rate ( cost of capital )

1  i  capitaliza tion factor
1
  discount factor
1 i

FINANCE
INTERNAL RATE OF RETURN (IRR)
C1 C2 Cn
C0    0
1  irr (1  irr ) 2
(1  irr ) n
FINANCE
EFFECTS ON FIRM VALUE
NPV IRR Effect

>0 >i Adds value
=0 =i Neutral
<0 <i Destroys value

NPV & IRR: Example
WHICH OF THESE PROJECTS WOULD YOU RECOMMEND?
Project C0 C1 C2 SUM
A -23000 4500 25000 6500
B -23000 18000 11000 6000
C -45000 3000 48000 6000
PROFITABILITY
PROFITABILITY RATIOS
• Relates profit to some relevant variable
• Return on Sales (ROS)
• Return on Assets (ROA)
• Return on Equity (ROE)

RETURN ON SALES
• Indicates how sales contribute to profit. It is a
measure of the gross profit margin per €1 in sales
EBIT
ROS 
S
EBIT  Earnings Before Interests and Taxes

S  Sales
RETURN ON ASSETS
•Indicates how investment (assets) generates profit. What is
the profit each €1 invested in the company is generating?
EBIT
ROA  ; A  Assets
A
After tax version... .

EBIT  Taxes
ROA 
A

DECOMPOSING RETURN ON ASSETS

• Is return on sales multiplied by assets turnover
EBIT EBIT S
ROA   ·  ROS ·AT
A S A
AT  Assets Turnover
RETURN ON EQUITY
• Indicates how investment made by firm owners (equity)
converts into profit. What is the profit each €1 invested by the
owners is generating?
EBT
ROE 
E
E  Equity ; EBT  Earnings Before Tax
NP
After tax version... . ROE 
E
NP  Net Profit

UNDERSTANDING THE RATIOS
Equity EBT
EBIT Assets
Debt I
DECOMPOSING RETURN ON EQUITY
EBT EBIT  I ROA·A  ki ·D

ROE    
E E E
ROA·( D  E )  ki ·D D D
  ROA·  ROA  ki 
E E E
D
 ROA  ( ROA  ki )  ROA  FL
E
D  Debt ; Ki  Average cost of debt ; FL Financial Leverage

ADE

Example
A firm makes €1 EBIT for each €10 in sales, generating €2 in sales

for each €1 in assets. The firm’s financial structure is evenly split,
50% debt and 50% equity. The average cost of debt is 16%.
Compute ROA and ROE and explain the difference between them
Exercise
Maxitrends Inc. made EBIT=€450 this year, with

ROA=0.18. Considering that the firm had to pay
€150 on interest expenses and that the gearing
ratio (D/E) is equal to 3, calculate ROE and
explain the difference with respect to ROA.

Lesson 3

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Introduction to Business 2019-2020

Lesson 3. Functional Areas of

Role within the firm

Eduardo González Fidalgo © 1

Type of Inputs Processes Outputs

Coal- Conversion of the chemical

PARTS OF THE PRODUCTION PROCESS

Elements of the transformation process

Eduardo González Fidalgo © 2

PARTS OF THE PRODUCTION PROCESS

PARTS OF THE PRODUCTION PROCESS

Eduardo González Fidalgo © 3

GOALS OF THE PRODUCTION PROCESS

GOALS OF THE PRODUCTION PROCESS

3. Lead time (delivery time)

Eduardo González Fidalgo © 4

TRADITIONAL PRODUCTION SYSTEMS

Very low Low Medium High Very high

TYPES OF PRODUCTION SYSTEMS

Eduardo González Fidalgo © 5

TYPES OF PRODUCTION SYSTEMS

2. JOB-SHOP AND BATCH PRODUCTION

Examples: repair shops (jobbing), bakery

Eduardo González Fidalgo © 6

TYPES OF PRODUCTION SYSTEMS

3. MASS AND CONTINUOUS PRODUCTION

Product layout (assembly line) is used when all products

Final assembly line

Examples: Cars (mass), milk bottling (cont.), petrochemicals (cont.)…

Eduardo González Fidalgo © 7

TYPES OF PRODUCTION SYSTEMS

Just in Time Flexibility and efficency

4. JUST IN TIME (JIT) / LEAN

Eduardo González Fidalgo © 8

Role within the firm

Eduardo González Fidalgo © 9

Consumer versus industrial or business products

Eduardo González Fidalgo © 10

MAIN ATTRIBUTES OF A PRODUCT

PRODUCT LIFE CYCLE

€ Introduction Growth Maturity Decline

Eduardo González Fidalgo © 11

Number of Channel Levels

Eduardo González Fidalgo © 12

How Channel Members Add Value

 A manufacturer may use multiple channels

Eduardo González Fidalgo © 13

Eduardo González Fidalgo © 14

Role within the firm

Eduardo González Fidalgo © 15

ASSETS EQUITY AND LIABILITIES

Cash Accounts payable

Short term investments Notes payable (short term, incl. loans)

Accounts receivable CURRENT LIABILITIES

TOTAL CURRENT ASSETS Notes payable (long term, incl. loans)

Bonds and debentures

Long term investments LONG TERM LIABILITIES

Plant and Equipment (tangible)

Patents and Licences (intangible) Capital stock

(Accumulated Depreciation) Retained earnings

TOTAL FIXED ASSETS TOTAL STOCKHOLDERS EQUITY

TOTAL ASSETS TOTAL OWNER’S EQUITY AND LIABILITIES