Chapter two

2. Small business: vital components of the economy

2.1 Definition of small business
According to Small Business Administration, a small
business is one that does not dominate its industry has less
than $10 million in annual sales, and has fewer than 1000
employees. In the USA, the manufacturing firm is
officially a small business for government procurement
purposes, if it is not dominant in its field of operations and
if it has fewer than 500 employees, or if it is certified as
small by the Small Business Administration for purposes
fewer than 250 employees, depending on the size and the
standard set for different industries.
Small enterprises are well placed to have important
economic, social and political roles in employment
creation, resource utilization and income generation and in
helping to promote change in a general and specific
manner. Briefly, small enterprises comprise an important
part of today’s economy and their successful operations are
essential to the nation’s economic development.
Germany, Sweden, Norway, and Denmark: Units
employing up to 300 workers are considered to be small.
Sudan: Small industries are defined as those industries
which have a capital investment of less than $142,000 or
which employs less than 30 full time workers. Most

1
industries in this category are workshops, small oil mills,
perfumeries, ice factories, tanneries etc.
Ethiopia: Small enterprises are defined with an investment
capital of $2350 to $ 5880 (Birr 20,000 –Birr 50,000).
Micro enterprises are those with an investment paid up
capital not exceeding $ 2350 (Birr 20,000).
We can base ourselves on two criteria’s in defining small
businesses. They are:
1. Size criteria
Examples of criteria used to measure the size of small
businesses are
Number of Insurance in
employees force
Sales volume Volume of
Asset size deposits
2. Economic /control criteria
The economic/control definition covers:
All three of these characteristics must be satisfied if the
business is to rank as a small business.
1. Market Share: The characteristic of a small firm’s share
of the market is that it is not large enough to enable it to
influence the prices of national quantities of goods sold to
any significant extent.

2
2. Independence: means that the owner has control of the
business himself. It therefore rules out those small
subsidiaries, which, though in many ways fairly
autonomous, nevertheless have to refer major decisions
(e.g. on capital investment) to a higher level of authority.
3. Personalized Management: is the most characteristic
factor of all. It implies that the owner actively participates
in all aspects of the management of the business, and in all
major decision-making processes. There is little devolution
or delegation of authority. One person is involved when
anything material is concerned.
To provide a clear image of the small enterprise discussed
in this text, let us suggest the following general criteria for
defining the small business:
 One individual or a small group supplies Financial of
the business.
 Except for its marketing function, the firm’s
operations are geographically localized.
Typically, it operates in only one city or
community.

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 Compared to the biggest firms in the industry, the
business is small.
 The member of employees on the business is usually
fewer than 100.
Broadly speaking, then, small business enterprises include
family business engaging three or four family members and
cottage industries or independent workers in the non-
structured or informal sector of the economy. Additionally,
include non-manufacturing businesses such as small
building constructor’s maintenance and repair services,
trade and transport.
Importance of Small Business
1. Providing New Jobs
As the population and economy grow, small businesses
provide new job opportunities. It seems clear that small
businesses produce the “lion’s share” of the new jobs,
sometimes adding jobs while large corporations are
“downsizing” and lying off employees.
2. Introducing Innovation
New products that originate in the research laboratories of
big business make a valuable contribution to our standard

4
of living. There is question, however, as to the relative
importance of big business in achieving the truly significant
innovations. The record shows that many scientific
breakthroughs originated with independent inventors and
small organizations.
3. Stimulating Economic Competition
In a competitive business situation, individuals are driven
by self-interest to act in a socially desirable manner.
Competition acts as the regulator that transforms their
selfishness into service.
When producers consist of only a few big businesses,
however, the customer is at their mercy. They may set high
prices, withhold technological developments, exclude new
competitors or otherwise abuse their position of power. If
completion is to have a “cutting edge” there is need for
small firms.
4. Aiding Big Business
The face that some functions are more expertly preformed
by small business enables small firms to contribute to the
success of larger ones.

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If small business were suddenly removed from the
contemporary scene, big businesses would find themselves
in difficulties.
 Two functions that small businesses can often perform
more efficiently than big businesses are the
distribution and the supply function.
5. Producing Goods and Services Efficiently
Common sense tells us that the efficient size of business
varies with the industry. We can easily recognize, for
example, that big business is better in manufacturing
automobiles but that small business is better in repairing
them.
The continued existence of small business in a competitive
economic system is in itself evidence of efficient small-
business operation. If small firms were hopelessly
inefficient, and making no useful contribution, they would
be forced out of business quickly by stronger competitors.
Advantages of Going into Small Business
1. Independence: Most small business owners enjoy being
their own boss; they like the freedom to do things their
way. Although often a great deal of responsibility is

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 associated with this independence, they are willing to
assume it.
2. Financial Opportunities: Another major reason for
going into business for oneself is financial opportunity.
Many small business owners make more money running
their own company than they would be working for
someone, else.
3. Community Service: Sometimes an individual will
realize that a particular good or service is not available. If
the person has reason to believe the public will pay for such
output, he or she will start a company to provide it.
4. Job Security: When one owns a business, job security is
ensured. The individual can work as long as he or she
wants, no mandatory retirement exists.
5. Family Employment: Another advantage is the
opportunity to provide family members with a place of
employment. This has several benefits, First, many owner
managers want to perpetuate their business, and how better
to do so than to get children or relatives to take it over?
Second, higher moral and trust usually occur more in
family-run business than in others. Third, in times of

7
severe economic downturn, small business owners can
provide employment for family members.
6. Challenge: Many small business owners are lured by the
challenge that accompanies going into business for oneself.
Research reveals that most successful small business
owners like to feel they have a chance to succeed (they
want to know success is possible) and a chance to fail
(success is not a sure thing). But one thing is certain: The
final outcome depends heavily on them. They want to win
or lose on their own abilities. This challenge gives them
psychological satisfaction.
Disadvantages of Going into Small Business
It should be recognized that some drawbacks to owning a
small business exist. Without proper preparation an
individual may find the career path of business ownership
frustrating. The major disadvantages of going into business
include the following:
Disadvantages
1. Sales Fluctuations
Working for a large firm that pays regularly allows the
employee to budget food expenditures, plan vacations, and

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buy clothing. The owner-manager, however, often faces
sales fluctuations. In some months sales are very high,
while in others they drop off dramatically. The individual
must balance cash inflows with cash outflows so that
enough money to meet expenses always exists. Sometimes
this will require the owner to take a short-term loan (30 to
90 days) to help the business get through a slack period.
And virtually every small business has sales fluctuations.
2. Competition
A second disadvantage of owning a business is the risk of
competition. In particular, an individual may start a
business and prosper for three or four years before meeting
insurmountable competition. Or changes in market demand
may occur, and the owner will find that this new demand is
being satisfied by large competitors. For example, small
restaurants and diners may find that they have lost
customers to fast-food chains.
3. Increased Responsibilities
Small businesses face many responsibilities, especially as
their operations get larger. For example, owners not only
have to make more decisions on major matters but also

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have to become knowledgeable in many different areas. A
successful owner is often a bookkeeper, accountant,
salesperson, personnel manager, and janitor all rolled into
one.
4. Financial Losses
When the owner makes all major decisions, inevitably
some of them will be wrong. On occasion, inventory will
be too high (or low); a product line developed at great
expense will not sell; a price reduction will not increase
product demand, with a resulting decline in total revenue;
an advertising campaign will not pay for itself; or an
increase in the sales force will prove to be a mistake, and
excess personnel will have to be laid off.
5. Employee Relations
The small business owner also needs to be concerned with
employee relations. If the workers are not content, sales
will suffer. For example, in many retail stores employees
are not allowed to talk or socialize on the job. Workers are
expected to remain at their sales counters and stay alert for
customers who need assistance.

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Management believes that if the employees begin talking to
one another, they will lose potential sales. On the other
hand, research reveals that if employees feel isolated or
alone, their attitudes toward the job will decline. This, in
turn, will affect their sales ability.
6. Laws and Regulations
Small businesses are subject to a multitude of laws and
regulations. For example law may require the owner to pay
Social Security taxes for all employees as well as to with
hold taxes from each person’s pay and remit these funds to
the government. At the state or regional level, in addition
to employee taxes, often a state sales tax may need to be
collected and sent to the proper sate agency.
7. Risk of Failure
The ultimate risk the small business owner-manager faces
is failure, usually with a loss of most, if not all, of the
money invested in the enterprise. All owners face this risk,
and despite experience and business knowledge, many fail
because of factors beyond their control.
2.2 Economic, social and political aspects of small
business enterprise

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Small businesses (enterprises) have to play a vital role in
Ethiopian economy. They need a strong support on socio-
economic and political grounds.
1. Equitable income distribution or improved
standard of living
The main objectives are equitable distribution of wealth
and decentralization of economic power. The benefits of
industrial growth should be shared by as many people as
possible and should improve the general standard of living.
The benefits of economic growth should be shared by as
many people as possible and should also provide better
quality life by enhancing the general standard living
standards of people. Our country is focused on small scale
industries/businesses because; they better with regard to
improving the general standard of living of people.
2. Inadequate financial resources and vast human
resources
The lack of incredible growth in Ethiopian economy is
because the nation is lacking adequate financial resources
but at the same time having much manpower without work.

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This lack of finance/capital has led to a state where there is
high unemployment and which is increasing day by day.
A better alternative to mitigate this situation is to encourage
the establishment of small and micro enterprises. Small
enterprises require less capital to establish and at the same
time they generate more employment according to the
capital invested.
3. Rectifying regional imbalance/ rectifying rural/urban
divide
A country would be having some regions, mostly
urban regions, which are far very much developed
than other areas, especially rural areas. This leads to
disparity among these regions and in turn these well
developed regions face problems like high migration
led problems. This high migration puts a severe stress
on the existing infrastructure and would lead to poor
performance in supplying civic services adequately to
people. So as to stop migration of people and avoiding
stress on civic systems, the establishment of small
enterprises in rural areas, particularly agro industries
will reduce people’s migration by providing

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 employment within their regions. This rural agro
industries will also help in increasing the people’s
income in those areas and thereby improving the
country’s economy also. On political grounds, there is
a need to encourage small enterprises, and that too in
rural areas so as to create employment opportunities
and for income generation for its users.
4. Generation of foreign (hard) currency
 The imports of Ethiopia are greater than its exports.
 With regard to exports, majority of Ethiopian exports
are of either small or micro enterprises origin.
 From several developed and developing countries
experience, it could be said that small enterprises play
a big role in exports than large exporters.
 So with strong support measures from Ethiopian
government the small enterprises can also play a very
big role in reducing the negative discrepancy between
imports and exports.
 These strong export measures could take the form of
removal of bureaucratic hurdles, easy finance

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 availability, ensure easy availability of machinery and
raw materials, removal or reduction of taxes, etc.
2.3 Small Business Failure Factors
Every year many small business firms cease operations.
The most frequent cause is failure to pay debts, in which
case it is common for the owners to declare bankruptcy and
to seek to accommodate the creditors, such as paying them
25 cents on the birr.
In other instances, businesses go out of existence because
the owners realize that, although currently they are solvent,
if they continue operations they will incur debts they
cannot meet. In these instances, business failure can be
defined as a halt of operations.
2.3.1 Some specific causes of failure
Year after year, the major reason that businesses fail is
incompetence. The owners simply do not know how to run
the enterprise. They make major mistakes an experienced,
well-trained entrepreneur would see quickly and easily side
step.
The second most common reason business fails is
unbalanced experience. This means owners do not have

15
well-rounded experience in the major activities of the
business, such as finance, purchasing, selling, and
production. Because the owner lacks experience in one or
more of these critical areas, the enterprise gradually fails.
A third common cause of business failure is lack of
managerial experience. The owners simply do not know
how to manage people.
A fourth common reason is lack of experience in the line;
that is, the owner has entered a business field in which he
or she has very little knowledge.
Other common causes of business failure include neglect,
fraud, and disaster.
Neglect:- occur whenever an owner does not pay sufficient
attention to the enterprise. The owner who has someone
else manage the business while he or she goes fishing often
finds the business failing because of neglect.
Fraud:- involves intentional misrepresentation or
deception. If one of the people responsible for keeping the
business’s books begins purchasing materials or goods for
himself or herself with the company’s money, the business
might find itself bankrupt before too long.

16
Disaster:- refers to some unforeseen happening or ‘ act of
God’. If a hurricane hits the area and destroys materials
sitting in the company’s yard, the loss may require the firm
to declare bankruptcy. The same is true for fires,
burglaries, robberies, or extended strikes.
2.4 Problems in Ethiopian small business
Small-scale industries have not been able to contribute
substantially as needed to the economic development
because of;
 financial,
 Production and marketing problems.
These problems are still major handicaps to development.
Small scale units do not have easy access to the capital
market because they mostly organized on proprietary
partnership basis and are very small size.
 Because of their size and their limited profit, they
search funds for investment purposes. Consequently,
they approach money-lenders who charge high rate of
interest. Hence small enterprises continue to be
financially weak.

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  A small-scale enterprise faces difficulty to get raw
materials of good quality and at cheaper rates in the
field of production. Very often they do not get raw
material in time. As a result, these enterprises very
often fail to produce goods in requisite quantities and
of good quality of a low cost.
 Furthermore, the techniques of production, which
these enterprises have adopted, are usually outdated.
Because of their poor financial position they are not
able to buy new equipment consequently their
productivity suffers. Besides, many small business
enterprises are suffering with the problem of
marketing their products.
2.5 Setting up a Small business
2.5.1 What is a basic business idea?
An entrepreneur should keep in view of future long term
goals. The long term thinking is called basic business idea.
An entrepreneur perceives an opportunity for marketing a
product or service. Then he establishes a business unit on
the basis of his perception. Finally, he manages his

18
enterprise expanding, growing or diversifying over a period
of time.
The basic business idea, which facilitates a choice of the
products at different stages of the project, allows for
diversification and expansion. The entrepreneur should
monitor the dynamic business environment and select basic
business idea that;
 generate quick returns
 Permits changes in the products.
The general business atmosphere guides the choice of basic
business idea. A basic business idea results from the
identification of business opportunities in the market. To be
successful in business, the entrepreneur should carry out
SWOT analysis, be sensitive to the market changes,
monitor the demand and supply, study consumer behavior
and choose the basic business idea.
2.5.2 What project an entrepreneur should have?
According to the Encyclopedia of Management, “a project
is an organized unit dedicated to the attainment of a goal-
the successful completion of development project on time,

19
within budget, in conformance with predetermined program
specifications.
According to Project Management Institute, USA, “a
project is a system involving the co-ordination of a number
of separate department entities through the organization,
and which must be completed within prescribed schedules
and time constraints

2.5.2.1 Project classification

1. Quantifiable and non-quantifiable projects
Little and Mirrelees divide the project into two broad
categories: quantifiable and non-quantifiable projects.
Quantifiable projects are those in which a plausible
quantitative assessment of benefits can be made. Non-
quantifiable projects are those where such an assessment is
not possible. Projects concerned with industrial
development, power generation, and mineral development
are forming part of quantifiable projects. The non-
quantifiable projects category comprises health, education,
and defense.

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2. Sectoral projects
According to Planning Commission, a project may fall in
the following sectors;
a) Agriculture and d) Transport and
allied/related sectors communication sector
b) Irrigation and allied e) Social services sector
sectors f) Miscellaneous sector
c) Industry and mining
sector
3. Techno-Economic projects
Techno-economic projects classification includes;
a) Factor-intensity oriented
The factor intensity is used as base for classification of
projects such as capital intensive or labour incentive which
depends upon the large scale investment in plant and
machinery or human resources.
b) Causation oriented classification
The causation-oriented projects are determined based on its
causes namely demand based projects. The non-availability
of certain goods or services and consequent demand for
such goods or services or the availability of certain raw

21
materials, skills or other inputs is the dominant reason for
starting the project.
c) Magnitude oriented classification
The size of investment forms the basis for magnitude-
oriented projects. Projects may thus be classified based on
its investment such as large-scale, medium-scale, and
small-scale projects.
4. Financial institutions classification
The projects are classified according to their age and
experience and the purpose for which the project is being
taken up. They are as follows;
1. new projects 4. diversification
2. expansion projects projects
3. modernization
projects
The projects listed above are generally profit-oriented and
the services oriented projects are classified as under;
 welfare projects  research and
 service projects development projects
 educational project

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2.5.3 Definition of small industry
The term “small scale industries” has been defined in three
ways. The conventional definition includes cottage and
handicraft industries which employ traditional products,
largely in village households. The handloom textile
industry is an example.
The operational definition for policy purposes includes all
those undertakings having an investment in fixed assets, in
plant and machinery, whether held on ownership terms or
by lease or hire-purchase, not exceeding Birr 1200000.
Ancillary units and tiny units also come under the
umbrella of small scale industries.
A tiny unit is one whose investment in fixed assets in plant
and machinery does not exceed Birr 100000.
An ancillary undertaking is one whose investment in plant
and machinery does not exceed Birr 1500000 and is
engaged in the;
a. Manufacture of parts, component sub-assemblies,
tooling's or intermediate or

23
b. Rendering of services of supplying 1/3 percent of their
total service or production.
The third definition of small scale industries relates to
national income accounting. This includes all
manufacturing and processing activities, including
maintenance and repair services, undertaken by both
household and non-household small-scale manufacturing
units, which are not registered under the Factories Act.
A small industry is defined as “a unit engaged in
manufacturing, servicing, repairing, processing and
preservation of goods having investment in plant and
machinery, at an original cost not exceeding Birr 1200000.
Characteristics of small scale industries
1. Capital investment is 4. Located in rural and
small. semi-urban areas
2. Most have fewer than 5. All of these firms are
10 workers privately owned and
3. Generally engaged in are organized as sole
the production of light proprietorship.
consumer goods,
processing etc.

24
 6. Fixed assets form the and large scale
largest component of industries.
small units. 10. Small scale
7. Most of the funds industries activity is
come from the beehive of
entrepreneur’s entrepreneurship.
savings 11. Exploitation of
8. Small scale industrial natural resources is
activity has been another characteristic
growing at a faster of small scale
rate even than large industries.
scale enterprises. 12. Small scale
9. Very few of the small industries are quality
scale industries have conscious.
grown up to medium
2.5.4 Steps in setting a small scale unit
In order to establish an entrepreneurial system, an
entrepreneur needs to take the following steps:
1. Search for business 3. Select the best idea
ideas
2. Process the ideas

25
 4. Assemble the 5. Establish the
necessary input enterprise.
resources
1. Search for business idea
The task of promotion begins with the search for a suitable
business idea or opportunity. The idea may generate from
various sources e.g. success story of a friend or relative,
demand for certain projects, chances of producing a
substitute for an imported article, visits to trade fairs and
exhibitions, study of project profiles and industrial potential
surveys, meeting with government agencies etc. The idea
may relate to the starting of a new business or to take over
of an existing enterprise. The idea should be sound and
workable. It should yield a reasonable return on investment.
The promoter has to be imaginative and foresighted to
discover a business idea.
2. Idea processing
Once business ideas are discovered, screening and testing
of these ideas is done. The following considerations are
significant in the evaluation and testing of business ideas.
a) Technical feasibility

26
It refers to the possibility of producing the product.
Technical feasibility of an idea is judged in terms of
availability` of necessary technology, machinery and
equipment, labour skills and raw materials. The advice and
assistance of technical experts may be necessary to judge
the technical feasibility of various business ideas.
b) Commercial viability
A cost-benefit analysis is required to ascertain the
profitability of the ideas. An elaborate study of market
conditions and prevailing situation is made to assess the
viability and prospects of the proposed project. This is
known as feasibility study of the project. A number of
calculations have to made about the likely demand,
expected sales volume, selling price, cost of production,
breakeven point etc. The services of market analysts and
financial experts may be necessary for this purpose. In
order to judge the workability and profitability of the
proposed business, feasibility analysis has to be conducted.
After preliminary evaluation of the idea, the promising idea
is subjected to a thorough analysis. Full investigation is
carried out in the technical feasibility and economic

27
viability of the proposed project. Financial and managerial
feasibility of the idea are tested. After the evaluation of a
business idea is completed, the findings are presented in the
form of a report known as ‘feasibility report’ or project
report. This report helps in the final selection of the
project. It is also useful for procuring licenses, finance etc
from governmental agencies.
3. Idea selection
The feasibility report is analyzed to finally choose the most
promising idea. The following considerations influence the
selection of idea for a product or service;
a) Products whose inputs are banned or restricted by the
government
b) Products which can be exported easily and profitably
c) Products whose demand exceeds their supply so that
there exists ready demand.
d) Products on which the entrepreneur has manufacturing
and/or marketing experience.
e) Parent ancillary relationship i.e. the product is to be
manufactured for a parent company.
f) Products which showed high profitability

28
 g) Products based on the expansion or diversification
plans of existing firms
h) h. Products which ensured specific advantages- scale
of the industry or the location of the factory or
technology of manufacture.
i) Products favoured by the country’s industrial/licensing
policy.
j) Products for which incentives and subsidies are
available.
While considering these various factors- market, own
experience, policy and incentives,- an entrepreneur would
generally come across a mix of some encouraging and
some discouraging factors with reference to every product.
4. Assemble the necessary input requirements
Once the promoter is convinced of the feasibility and
profitability of the project, he assembles the necessary
resources to launch the enterprise. He has to choose
partners/collaborators, collect the required finance and
acquire land and buildings, plant and machinery, furniture
and fixtures, patents, employees etc. Decisions have to be
made about the size, location, layout etc of the enterprise.

29
The form of ownership organization has to be selected. The
main inputs required for launching an enterprise are as
follows;
A) Information and intelligence
In the turbulent business environment, information and
intelligence have become the key input in entrepreneurial
success. An entrepreneur requires relevant data on the
following aspects:
1. Size and nature of 6. Number and type of
demand for the product personnel required and
or service their resources
2. Volume and sources of 7. Amount and sources of
supply funds required for the
3. Price cost volume enterprise
relationship 8. Nature and degree of
4. Sources of raw competition
materials 9. Government policies
5. Type and suppliers of and regulations
technology, machinery concerning the industry
and equipment

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10. Export import
conditions for the
product/service.
B) Finance
A business enterprise requires finance for fixed assets
(fixed capital) as well as for current assets (working
capital). Once the amount of funds required are established,
the entrepreneur has to identify the sources from which the
funds are to be raised. He has also to decide the relative
proportion between the funds raised from different sources
(e.g. shares, debentures, loans etc). This decision is known
as the capital structure. It is a very crucial decision because
it influences the real worth of the enterprise and the return
of the owners. After deciding the capital structure, the
funds are raised. Systems are created for the efficient
management and control of working capital and earnings.
C) Personnel
People are the most valuable asset of an enterprise and an
entrepreneur has to make the following decisions
concerning the personnel:

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1. Number of personnel required for management, technical
and other positions in the enterprise.
2. Qualifications and experience required in the personnel
to perform the jobs effectively
3. Sources of recruitment
4. Procedure and methods of selecting the best candidates
5. Methods of orientation and training.
6. Criteria for evaluating the performance of employees.
7. Policies for the transfer and promotion of staff.
8. Policies and methods of remunerating the personnel.
9. Facilities to be provided for the safety, health, welfare of
the staff.
10. Participation of personnel in the management of the
enterprise.
5. Establish the enterprise
The form of ownership is to be decided upon and the
company formed and registered. Following this, action is
directed towards obtaining finance, necessary licenses, and
necessary infrastructure is to be taken. This would involve
dealing with various government bodies and other
institutions like:

32
  Financial institutions- for finance
 Sales tax, Income tax authorities- for respective
registration
 Licensing authority- for obtaining industrial license
and licenses for raw material procurement.
 Municipal Authorities and Electricity- for requisite
utilities.
 Directorate of Industries, Municipal Authorities etc-
for land, factory and shed etc
Once all the required authorizations and sanctions have
been obtained, action is to be taken for the following;
A.Ordering machineries E. Arranging for
from suppliers distribution of the
B.Obtaining utilities like product
power and water F. The plant is ready for
connections commissioning. Trial
C.Recruitment of staff run may be made at
D.Arranging supplies of this stage.
materials
Promotion efforts may be made to pave the way for
introducing the product. When the first few batches of the

33
product are introduced in the market, information regarding
its acceptance is to be gathered. On the basis of feedback
obtained, the process/product has to be modified until
acceptable output is obtained. Then the unit is ready for
commercial production.

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