5.

Fi
nanci
alI
nfor
mat
ionandDeci
sions
5.
1–BusinessFi
nance:
Needs
andSources
 Financei sthemoneyr equi r
edi nt he –Doesnotbecomedebtf ort hebusi ness,unl
ike
busi ness.Fi nancei sneededt osetup aloan.
thebusi ness,expandi tandi ncr ease D i
sadv ant ages:
wor kingcapi tal (theday -
to-dayr unning –S urp l
u s asset swillnotbeav ail
ablewi t
hnew
busi nesses
expenses) .
–Takest imet oselltheassetandt heexpect ed
 St art-upcapi tali st heiniti
al capi t
al amountmaynotbegai nedf ort heasset
usedi nthebusi nesst obuyf ixedand  Saleofi nvent ori
es: selloff i
nishedgoodsor
cur rentasset sbef oreitcanst art unwant edcomponent sini nventory.
tradi ng. Adv ant age:
 Wor kingCapi talf inanceneededbya –Reducescost sofinv entoryhol ding
busi nesst opayi tsday -
to-dayr unning D i
sa d va ntage:
expenses –I fnotenoughi nvent oryiskept ,
unexpect ed
i
ncr easedemandf or m cust omer scannotbe
 Capi talexpendi turei sthemoney
ful
f i
lled
spentonf i
xedasset s(asset st hatwill  Owner ’
ssav i
ngs: Forasol etraderand
l
astf ormor et hanay ear).Eg: vehicl
es, partner shi p,sincet hey’reuni ncorporated( owners
machi nery,buildingset c.Thesear e andbusi nessi snotsepar ate),anyf i
nancet he
l
ong- ter m capital needs. ownerdi rectl
yi nvestsf rom hi sownsav ingwillbe
 Rev enueExpendi ture,similarto i
nter nal fi
nance.
wor kingcapi tal,ist hemoneyspenton Adv ant ages:
day -
to- dayexpenseswhi chdoesnot –Wi llbeav ailabletot hef irm quickly
i
nv olvet hepur chaseofl ong- t
er m –N oi nt eresth as t
ob e paid.
asset s.Eg: wages, rent.Thesear e Disadv ant ages:
–I ncr easest her i
skt akenbyt heowner s.
shor t-
term capi tal needs.
Ext er nalf inancei sobt ainedf r
om sour ces
SourcesofFi nance out sideoft hebusi ness.
 I
ssueofshar
e:onl
yforl
i
mit
edcompani
es.
Int
ernalfi
nanceisobt
ainedf
rom wi
thi
nthe Adv
ant
age:
businessi
tsel
f.  Aper
manentsour
ceofcapi
tal
,noneedt
o
 Ret
ainedPr
ofi
t:pr
ofi
tkepti
nthebusi
nessaf
ter repaythemoneyt oshar
ehol
der
s
owner shav ebeengi vent hei rshar eoftheprofi
t. nointeresthast
obepaid
Firmscani nvestt hispr ofitbacki nthe Di
sadv
ant
ages:
busi nesses. 
Adv ant ages:  Di
vi
dendshavetobepaidtotheshar
eholder
s
–Doesnothav et ober epai d, unli
ke,aloan.  I
fmanysharesarebought
,theowner
shipof
–Noi nteresthast obepai d thebusinesswil
lchangehands.(
The
Disadv antages: ownershipisdeci
dedbywhohast hehighest
–Anewbusi nesswi l
l nothav er etai
nedprofit percent
ageofsharesinthecompany)
–Pr ofitsmaybet ool owt of inance  Bankloans: moneyborr
owedfrom banks
–Keepi ngmor epr ofi
tst obeusedascapi talwil
l Adv
ant
ages:
reduceowner ’sshar eofpr ofitandt heymay 
resistt hedeci sion.  Qui
cktoarr
angealoan
 Saleofexi stingasset s: asset st hatthebusiness  Canbeforvar
yingl
engt
hsofti
me
doesn’ tneedany mor e, forexampl e,unused  Lar
gecompaniescangetv
eryl
owrat
esof
buildingsorspar eequi pmentcanbesol dtorai
se i
nter
estont
hei
rloans
fi
nance Di
sadv
ant
ages:
Adv ant ages: 
–Makesbet teruseofcapi tal ti
edupi nthe  Needt
opayi
nter
estont
heloanper
iodi
cal
l
y
busi ness  I
thast
oberepai
daft
eraspeci
fi
edl
engthof
 t
ime Shor
t-t
ermf i
nancepr
ovidest
heworking
 Needt
ogi
vet
hebankacol
l
ater
alsecur
it
y(t
he capi
talabusi
nessneedsfori
tsday
-to-
day
bankwi llaskforsomev aluedasset ,usual l
y oper
ati
ons.
somepar tofthebusi ness,asasecur it
yt hey  Ov
erdr
aft
s:si
mil
art
oloans,
thebankcanar
range
canusei fatal lthebusi nesscannotr epayt he overdraf
tsbyall
owingbusinessest
ospendmor e
l
oani nthef uture.Forasol etrader,hishouse thanwhatisinthei
rbankaccount.Theover
draf
t
mi ghtbecol l
ater al
.Sot hereisar iskofl osing will
v ar
ywitheachmont h,
basedonhowmuch
highlyvaluableasset s) extr
amoneyt hebusinessneeds.
 Debent urei
ssues: debent ur
esar elong-terml oan Adv
ant
ages:
cert
if
icatesissuedbycompani es.Likeshar es, 
debent ur
eswi ll
bei ssued, peoplewi ll
buyt hem  Fl
exi
blef
orm ofbor
rowi
ngsi
nceov
erdr
awn
andthebusi nesscanr aisemoney .Butt his amount scanbevari
edeachmont h
fi
nanceact sasal oan-itwi l
lhavet ober epai d  Int
eresthastobepaidonl
yont heamount
aft
eraspeci fiedper iodoft i
meandi nterestwi l
l overdrawn
havetobepai dfori taswel l.  Overdraft
saregener
all
ycheaperthanl
oansi
n
Adv
ant
age: thelong-t
erm
 Di
sadv
ant
ages:
 Canbeusedt
orai
sev
eryl
ong-
ter
mfi
nance, 
f
orexampl
e,25y
ear
s  I
nter
estr
atescanv
aryper
iodi
cal
l
y,unl
i
ke
Di
sadv
ant
age: loanswhichhav eaf ixedi
nterestrat
e.
  Theba nkcanaskf ortheoverdraftt
obe
 I
nter
esthast
obepai
dandi
thast
ober
epai
d repai
datashor t-noti
ce.
 Debtf
act
ori
ng:
adebt
ori
saper
sonwhoowes  TradeCredit
s: t
hisiswhenabusi nessdelays
thebusinessmoneyf ort
hegoodst heyhave payingsuppli
ersforsomet i
me, i
mpr ovi
ngthei
r
boughtfrom thebusi
ness.Debtfactorsar
e cashpositi
on
special
i
stagentsthatcancoll
ectallthebusi
ness’ Adv
ant
age:
debtsfrom debtor
s. 
Adv
ant
ages:  Noi
nter
est
s,r
epay
ment
sinv
olv
ed
 Di
sadv
ant
age:
 I
mmedi at
ecashisavai
l
abletothebusi
ness 
 Busi
nessdoesn’
thav
et ohandl
ethedebt  I
fthepay
ment
sar
enotmadequi
ckl
y,
col
l
ect
ing suppl
ier
smayr ef
usetogiv
edi
scount
sint
he
Di
sadv
ant
age: fut
ureorref
usetosuppl
yatal
l
  DebtFactor
ing:(
seeabove)
 Thedebtf
act
orwi
l
lgetaper
centoft
hedebt
s
coll
ect
edasreward.Thus, t
hebusiness
doesn’
tgetal
loftheirdebts
 Gr
ant sandsubsi
dies:governmentagenciesand
ot
herexternal
sourcescangi v
ethebusinessa Long-termfinancei
sthef
inancet
hati
s
gr
antorsubsidy avai
lableformorethanayear
.
Adv
ant
age:  Loans: from banksorpr iv
ateindiv
idual
s.
  Debent ures
 Donothavet
ober
epai
d,i
sfr
ee  IssueofShar es
Di
sadv
ant
age:  HirePur chase: al
lowsthebusinesst obuyaf i
xed
 assetandpayf oritinmont hl
yinstal
mentst hat
 Ther
ear
eusual
l
ycer
tai
ncondi
ti
onst
oful
fi
lto i
ncl udeinterestcharges.Thisisnotamet hodt o
getagr ant.Exampl e,tolocateinapar t
icular raisecapi t
albutgivesthebusinesstimetor aise
under -
developedar ea. thecapi t
al.
 Micro-finance:speci ali
nst i
tut
esar esetupi n Adv
ant
age:
poorly-developedcount rieswher efinancial
ly- 
l
ackingpeopl elookingt ostartorexpandsmal l  Thef
ir
msdoesn’
tneedal
argesum ofcasht
o
businessescangetsmal lsumsofmoney .They acqui
ret
heasset
provideal lsortsoffinancialservi
ces Di
sadv
ant
age:
 Crowdf undi ng:rai
sescapi talbyaski ngsmal l 
fundsf rom al argepool ofpeople,e.g.via  Acashdeposithastobepaidinthebegi
nni
ng
Kickstarter.Thesefundsar evoluntary‘donations’  Cancar
rylar
gei nt
erestchar
ges.
anddon’ thavet ober et
ur norpaidadi vidend.  Leasi
ng:
thi
sal
l
owsabusi
nesst
ouseanasset
wi
thoutpurchasi
ngit
.Mont
hlyl
easingpayment
s
ar
einsteadmadet ot
heowneroftheasset
.The
 businesscandeci
det obuytheassetattheend thebusiness.Theyneedt odeci dewhet herthey
oftheleasi
ngperi
od.Somef ir
mssel lt
heirasset
s woul dri
skl osi
ngcontrol f
orbusi nessexpansi
on.
forcashandthenleasethem backfrom aleasi
ng  Risk-gearing:ifbusi
nesshasexi sti
ngloans,
company .Thi
siscall
edsaleandleaseback. borrowingmor ecapitalcani ncr easegeari
ng-ri
sk
Adv
ant
ages: ofthebusi ness-ashighint erestshav etobepaid
 evenwhent hereisnopr ofit,
loansand
 Thef
ir
m doesn’
tneedal
argesum ofmoney debenturesneedt ober epai det c.Banksand
t
ouset
heasset shareholderswi l
lberel
uct antt oinvestinri
sky
 Thecar
eandmai
ntenanceoft
heasseti
s businesses.
donebyt
hel
easi
ngcompany
Di
sadv
ant
age:

Fi
nancef r
om banksandshar
ehol
ders
 Thet
otal
cost
sofl
easi
ngt
heassetcoul
d
fi
nall
yendupbei
ngmoret
hant
hecostof
Chancesofabankwi ll
i
ngt
olendabusiness
purchasi
ngt
heasset
! fi
nanceishigherwhen:
 Acashf
lowf
orecasti
spr
esent
eddet
ail
i
ngwhy
f
inancei
sneededandhowi
twi
l
lbeused
 Ani
ncomest
atementf
rom t
hel
astt
radi
ngy
ear
Fact
orsthataf
fectchoi
ceofsour
ceof andt hef orecastincomest atementf orthenext
fi
nance year,toseehowmuchpr ofitthebusinessmakes
 Pur
pose:
ifaf
ixedasseti
stobebought
,hi
re andwi ll
make.
purchaseorl easi ngwi l
l beappropri
at e,buti
f  Detailsofexi stingl
oansandsour cesoff i
nance
fi
nancei sneededt opayof frentsandwages, beingused
debtfactor i
ng, ov erdraftswillbeused.  Evidencet hatasecur it
y/coll
ateralisavail
able
 Time-period: forl ong-term usesoff i
nance, l
oans, witht hebusi nesstoreducet hebank’sr i
skof
debentureandshar eissuesar eused, butfora l
endi ng
shortperiod, ov erdraftsaremor esui t
able.  Abus i
nesspl anispresentedt oexplai
ncl ear
ly
 Amountneeded: f orlargeamount s,loansand whatt hebusi nesshopestoachi eveinthef ut
ure
shareissuescanbeused.Forsmal leramount s, andwhyf i
nancei simportanttot heseplans
overdraf
ts, saleofasset s,debtfact
or i
ngwi l
lbe Chancesofashar
ehol
derwil
l
ingt
oinv
esti
n
used. abusinessi
shi
gherwhen:
 Legalform andsi ze: onlyal i
mitedcompanycan  t
hecompany
’sshar
epr
icesar
eincr
easi
ng-t
hisi
s
i
ssueshar esanddebent ures.Smallfirmshav e agoodi
ndi
cat
orofi
mpr
ovi
ngper
for
mance
l
imitedsour cedoff inancesav ail
abl
et ochoose  divi
dendsandpr
ofi
tsar
ehigh
fr
om  thecompanyhasagoodreput
ati
onsandf
utur
e
 Control:i
fl i
mi tedcompani esissuetoomany gr
owt
hpl
ans
shares,thecur r entowner smayl osecont rolof

5.
2–CashFlowForecast
ingand
WorkingCapit
al
Whyi scashimpor t
ant? i
nflowsandcashoutf
lowsoveraper
iodof
Ifafi
rm doesn’thaveanycasht opayi t
s ti
me.
workers,suppl
iers,l
andlordandgov er
nment, Cashinf
lowsarethesumsofmoneyr ecei
ved
thebusinesscouldgoi ntoli
qui
dation– bythebusi
nessoveraperi
odofti
me.E.g.:
sell
i
ngev eryt
hingitownst opayit
sdebt s.  sal
esrevenuefrom sal
eofpr
oduct
s
Thebusinessneedst ohav eanadequat e  paymentfrom debt
ors–debt
orsar
ecust
omer
s
amountofcasht obeabl etopayforalli
ts whohav ealr
eadypur chasedgoodsf rom t
he
short-
ter
m pay ments. businessbutdidn’tpayforthem att
hatti
me
 mone yborr
owedf rom ext
ernalsour
ces,l
ikeloans
CashFl
ow  themoneyf r
om t hesaleofbusinessassets
 i
nv est
orsputt
ingmor emoneyintothebusiness
Thecashf
lowofabusi
nessesi
sit
scash Cashout
fl
owsar
ethesumsofmoneypai
d
 outbyt
hebusi
nessov
eraper
iodoft
ime.Eg: Cashf l
owisnott hesameaspr of
it!Profi
tis
 pur
chasi
nggoodsandmater
ial
sforcash thesurpl
usamountaf tertot
al costshav e
 payi
ngwages,
sal
ari
esandotherexpensesi
n beendeductedfrom sales.I
tincludesal l
cash i
ncomeandpay mentsincurredi ntheyear,
 purchasi
ngfixedasset
s whetheral
readyreceiv
edorpai dort onotyet
 repayi
ngloans(cashisgoingoutofthebusi
ness)
recei
vedorpaidrespectful
ly
.Inacashf l
ow,
 bypa yi
ngcredit
orsofthebusi
ness-credi
tor
sare
onlyt
hoseelement spaidbycashar e
suppl
i
erswhosuppl
i
edit
emstothebusi
nessbut
werenotpai
datt
heti
meofsuppl
y. consi
dered.
Thecashf
lowcy
cle: CashFl
owFor
ecast
s
Acashflowforecasti
sanest i
mateoffutur
e
cashinf
lowsandout f
lowsofabusiness,
usual
lyonamont h-by-
monthbasis.Thi
sthen
showstheexpectedcashbalanceattheend
ofeachmonth.Itcanhelpt
ellthemanager:

 howmuchcashi
sav
ail
abl
eforpay
ingbi
l
ls,
purchasingfixedassetsorrepay i
ngl oans
 howmuc hcasht hebankwi l
l needtol endtothe
businesst oavoidinsol
vency(runningoutof
l
iquidcash)
 whe therthebusinesshastoomuchcasht hatcan
beputt oapr ofi
tableuseinthebusi ness
Exampleofacashf
lowf
orecastf
ort
hef
our
months:

Thecashinfl
owsar el
i
stedfir
standt
henthe amountofcashheldbythebusinessatt
he
cashoutf
lows.Thetot
alinf
lowsandoutf
lows st
artoft
hemont h
havetobecalcul
atedaft
ereachsect
ion. NetCashFlow=Tot alCashInf
low–Tot al
CashOutfl
ow
Theopeni
ngcash/
bankbal
ancei
sthe Thenetcashfl
owi saddedtoopeningcash
 balancetof indt
heclosingcash/ bank  Delaypay mentt osuppl iers:aski
ngf ormor eti
me
balance–t heamountofcashhel dbyt he top aysup pli
ersw il
lhelpd ecreasecas h outfl
ow s
businessatt heendoft hemont h.Remember , i
nt he short-
run.H ow ever,suppl
iersco ul
dr efuse
theclosi
ngcash/ bankbal ancef oronemont h tosupplyoncr editandmayr educedi scount sfor
l
atepay ment
i
st heopeni ngcash/bankbal ancef orthenext
 Askdebt or stopaymor equi ckl
y:ifdebt or
sar e
mont h!
askedt opayal lthedebt stheyhav etot hef i
rm
Thef i
guresi nbr
acketdenot eanegat i
ve quicker,t
hef ir
m’ scashi nfl
owswoul di ncreasei n
balance,i
.e.,anetcashout fl
ow( outf
lows> theshort-run.Thesedebt orswill
incl
udecr edit
i
nflows) customer s,whocanbeaskedt omakecashsal es
asopposedt ocreditsalesforpurchases(cash
Usesofcashf
lowf
orecast
s: willhavetobepaidont hespot,creditwil
lmean
 whenset
ti
ngupt
hebusi
nesst
hemanagerneeds theycanpayi nthefuture,t
husbecomi ng
toknowhowmuchcashi sr equi r
edt osetupt he debtors).However,
cust omersmaymov etoother
business.Thecashf l
owf orecasthel pscal culat
e businessesthatsti
l
l off
ersthem ti
met opay
thecashout fl
owssuchasr ent ,purchaseof  De l
ayorcancelpurchasesofcapi t
al
assets, adv erti
singet c. equipment :t
hiswil
lgreatl
yhelpreducecash
 As tatementofcashf l
owf or ecastisr equi r
edby outflowsintheshort-r
un,butatthecostofthe
bankmanager swhent hebusi nessappl iesf ora effi
ciencythefi
rmlosesoutonnotbuy ingnew
l
oan.Thebankmanagerwi l
l needt oknowhow technologyandstil
lusingoldequipment .
mucht ol endt ot hebusi nessf ori t
soper at i
ons, Inthelong-ter
m, t
oi mprovecashf l
ow,t
he
whent hel oani sneeded, forhowl ongi tisneeded businesswi l
lneedtoattractmor e
andwheni tcanber epaid. i
nvest ors,
cutcostsbyi ncreasi
ng
 Managi ngcashf l
ow–i fthecashf lowf or ecast eff
iciency,devel
opmor epr oductstoat
tract
givesanegat i
v ecashf l
owf oramont h(s) ,t
hen customer sandincreaseinflows.
thebusi nesswi l
lneedt opl anaheadandappl yf
or
anov er draftsot hatt henegat i
v ebalancei s Wor
kingCapi
tal
avoided( ascashcomei nandt hei nf
lowexceeds
theout flow) .Ifthereist oomuchcash, the Workingcapi t
al t
hecapitalr
equir
edbyt he
businessmaydeci det or epayl oans( sot hat businesstopayi tsshort
-ter
m day-t
o-day
i
nterestpay menti nthef uturewi l
lbelow)orpay expenses.Wor kingcapitali
salloftheliqui
d
offcredi tors/suppliers( t
omai ntainheal thy assetsoft hebusiness–t heasset
st hatcan
rel
ationshi pwi t
hsuppl iers). bequi ckl
yconv ert
edtocasht opayof ft
he
business’debts.Workingcapit
alcanbei nt
he
for
m of :
Howcancashf l
owprobl
emsbeov er
come?  cashneededtopayexpenses
Whenanegativ
ecashfl
owisforecast(l
ack  cashduefrom debt
ors–debtor
s/cr
edi
t
ofcash)t
hefol
lowi
ngmethodscanbeused customer scanbeaskedt oqui cklypayof fwhat
tocorr
ecti
t: theyowet ot
hebusinessinor derf orthebusiness
toraisecash
 cashi nthefor
m ofinvent
or y– Inv entoryof
 I
ncr
easebankl
oans:bankl
oanswi
l
linj
ectmor
e fi
nishedgoodscanbequi cklysoldof ftobuild
cashint
othebusi ness,
butthefi
rm wi
llhaveto cashi nfl
ows.Toomuchi nvent oryresult
si nhigh
payregul
arinter
estpaymentsont hel
oansandi t costs, t
oolowinvent
orymaycausepr oduct i
onto
wil
levent
uallyhavetoberepaid,
causi
ngf ut
ure stop.
cashoutfl
ows
 5.
3–I
ncomeSt
atement
s
Accountsarethefi
nancialr
ecor
dsofaf i
rm’s i
ncomeandpay mentsincurr
edint
heyear,
tr
ansact
ions. whetheral
readyrecei
vedorpaidortonotyet
Fi
nalAccountsarepreparedattheendofthe recei
vedorpaidrespectf
ull
y.I
nacashflow,
fi
nanci
alyearandgivedetai
lsoftheprof
itor onlyt
hoseelement spai
dincashimmediatel
y
l
ossmadeaswel l
ast heworthofthe areconsi
dered.
busi
ness. I
ncomeSt
atement
Pr
ofi
t
Anincomest atementisafinanci
aldocument
Profit= SalesRev enue–Totalcost ofthebusinesst hatr
ecordsalli
ncome
Whent het otal
cost sexceedt
hesales generatedbyt hebusi
nessaswel last he
revenue,thenal ossismade. costsincurr
edbyt hebusinessandt husthe
profi
torlossmadeov ert
hef i
nancialyear
.
Howt
oincr
easepr
ofi
t? Alsoknownaspr ofi
tandlossaccount .
 I
ncreasesal
esr
evenue
 Cutcosts
Whyi
spr
ofi
timpor
tantt
oabusi
ness?
 I
tisar
ewar
dforent
erpr
ise:ent
repr
eneur
sst
art
busi nessest omakeapr ofit
 Itisar ewar df orrisk-taking:entrepr eneurshasto
takeconsi der ableriskswhent heyinv estcapit
al
i
nav enture, andpr of i
tsar ea
compensat ion/ r
ewar dtot hem fort akingthese
risks( paidint hef orm ofpr ofi
tsordi v i
dends)
 Itisasour ceoff inance:af t
erpay ment sto
owner s,prof i
tsar er ei
nvest edbacki ntothe
busi nessf orf urtherexpansi on(thisiscal l
ed
retainedear nings) Asi
mpl
eIncomeSt
atement
 Itisani ndicat orofsuccess:mor epr ofi
ts
i
ndi catet oinv estor sthatt hebusi ness/ i
ndustr
yis SalesRev enue=t otalsales
wor t
ht heirtimeandmoney ,andt heywi lli
nvest CostofSal es=t otalvari
ablecostof
mor eei t
heri nthef irm ornewf irmsoft hei
rown, product
ion+( openi nginventor
yoff i
nished
i
nt hehopesofgai ninggoodr eturnsont hei
r goods– cl osingi nventoryoffi
nishedgoods)
i
nv est ment GrossProf it=Sal esRev enue–CostofSal es
Forsoci
al ent
erprises,profi
tisnotoneof Expenses: all
ov erheads/ f
ixedcosts
thei
rpri
mar yobjectives,butwel f
areofthe NetProfit=Gr ossPr ofi
t–Expenses
soci
etyis.Howev er,theywi l
lalsostr
iveto
makesomepr ofittoreinvestitbackintot
he Profi
tafterTax=NetPr ofit–Tax
busi
nessandhel pi tgrow. Divi
dends: shareofprofitgiv
ent o
shareholders;r
eturnonshar es
Profi
tisnotthesameascashf low!Prof
iti
s RetainedPr ofi
tfortheyear=Pr of
itaf
terTax
thesurpl
usamountaf tertot
al costshave –Di vi
dends.Thi sret
ainedear ni
ngsisthen
beendeductedfrom sales.I
tincludesall keptasidef oruseinthebusi ness.
 Onl
yav er
ysmal
lpor
ti
onofthesal
esr evenueendsupbei
ngt
her
etai
nedpr
ofi
t.Al
lcost
s,t
axesand
di
vi
dendshavet
obededuct
edfrom sales.

UsesofI
ncomeSt
atement
I
ncomestat
ement
sareusedbymanager
sto:

 knowtheprof
it
/lossmadebyt
hebusi
ness
 comparet
heirperfor
mancewi
tht
hatofpr
evi
ousy
ear
s’andwi
tht
hatofcompet
it
ors’
.I
fpr
ofi
tisl
owert
han
thatoflastyear’swhyisitfal
li
ngandwhatcant heydotocorrecttheissue?Ifi
tislowerthanthatof
compet i
tors’whatcantheydot obemor eprof
it
ableandbecompet i
ti
v einthemarket?
 knowt hepr ofi
tabi
li
tyofindivi
dualproductsbyprepari
ngseparateincomest at
ementf oreachproduct.
Theymaydeci detostopproduct i
onofproductsthataremakinglosses.
 helpdeci dewhatproductst olaunchbyprepari
ngf or
ecasti
ncomest at ementf
ort hefi
rstf
ewy ears.
Whichev erproducti
sforecasttohav eahigherprof
it,
thebusi
nesswi llchoosetolaunchthatproduct

5.
4–St
atementof
 Fi
nanci
alPosi
ti
on
Busi
nessSt es–04505.
udi 4–St
atementof debenturesetc.
)-theydonothav etoberepaid
Fi
nanci
alPosi
ti
on wit
hinay ear.
 Short
-term/curr
entl i
abil
it
ies(tr
adepayabl
es(to
Thebal ancesheet ,al
ongwi tht hei
ncome suppl
iers),
overdraftetc.
)-theseneedt
ober epai
d
stat
ementi spreparedattheendoft he wit
hinay ear.
fi
nancial y
ear .I
tshowst hev alueofa
business’ assetsandliabil
it
iesatapar ti
cul
ar CURRENTASSETS–CURRENTLI ABI LITIES
ti
me.I tisalsoknownas‘ st
at ementof =WORKI NGCAPI TAL
fi
nancialposi ti
on’
. Thisi
sbecauset hel iquidcashacompany
Assetsar et hosei
temsofv alueownedbyt he haswi t
ht hem wi llbet heliquid( shor t
-term)
busi
ness. assetstheyownl esst heshor t-term debt s
 Fi
xed/
non-
cur
rentasset
s(bui
l
dings,
vehi
cles, theyhav etopay .
equipmentet c.
)areasset sthatremai nint he  Shar eholder’sEqui tyist het otal
businessformor ethanay ear–theirv aluesfal
l amountofmoneyi nvest edint he
overtimeinapr ocesscal leddepreciationevery
companybyshar eholder s.Thi swi l
l
year.
 Short-t
erm/currentasset s(i
nventory,trade
i
ncludebot ht heshar ecapi t
al
receiv
ables(debtsfr om customers),cashet c)ar
e (i
nv esteddi r
ect lybyshar eholders)and
ownedonl yforav eryshor tti
me. reserves( retainedear ningsr eser ve,
 The r
ecanal sointangibl
e( cannotbet ouchedor gener alreserveet c.).
fel
t)non-currentassetsl i
kecopyrightsand Shar eholderscanseei ftheirst akei n
patentsthataddv aluetot hebusiness. thebusi nesshasr isenorf all
enby
Liabil
it
iesarethedebt
sowedbyt
hebusi
ness l
ooki ngatt het otalequi tyfigureont he
toitscredi
tors. balancesheet .
 Long-
ter
m/non-
cur
rentl
iabi
li
ti
es(
loans,

Checkwhet
hert
heequat
ionsont
her
ightar
esat
isf
iedi
nthi
sbal
ancesheet
!
 SHAREHOLDERSEQUI
TY=TOTALASSETS–TOTALLI
ABI
LITI
ES

TOTALASSETS=TOTALLI ABILI
TIES+SHAREHOLDERSEQUITY
CAPITALEMPLOYED=SHAREHOLDERSEQUI TY+NON-CURRENTLIABI
LITI
ES
Thi
sisbecausenon-cur
rentli
abil
i
tiesl
ikel
oansar
eal
sousedf
orper
manentinvest
menti
nthe
company.
Usesofastatementoffinanci
alposit
ion
 Whent
hecur
rentasset
ssubt
otal
iscompar
edt
othecur
rentl
i
abi
l
iti
essubt
otal
,i
nvest
orscanest
imat
e
whet heraf i
rm hasaccesst osuf fi
cientfundsint heshor ttermt opayof fi
tsshor t
-term obli
gations
i
.e.,whet heritisl i
quid
 Onec anal socompar ethet otal amountofdebt( l
iabil
it
ies)tothetotal amountofequi tylist
edont he
balancesheet ,toseei fther esultingdebt -
equityr ati
oindicatesadanger ouslyhighl evelofborrowi ng.This
i
nfor mat i
oni sespeci al
lyusef ulf orlendersandcr editors,(
especiall
ybanks)whowantt oknowi fthefirm
willbeabl etopaybacki tsdebt
 I
nv estorsl i
ketoex aminet heamountofcashont hebalancesheett oseei fther
ei senoughav ailabletopay
them adi vi
dend
 Ma nager scanexami neitsbal ancesheett oseei fthereareanyasset sthatcouldpot ential
lybesol d
offwi thoutharmi ngt heunder lyingbusi ness.Forexampl e,theycancompar etherepor tedinventoryasset s
tothesal estoder i
v eani nventor yturnoverlevel,whichcani ndicat
et hepresenceofexcessi nvent ory,so
theywi llsellof
ft heexcessi nvent orytoraisefinance
 5.
5–Anal
ysi
sofAccount
s
Busi
nessSt es–04505.
udi 5–Anal
ysi
sofAccount
s
Thedat acontai
nedinthefi
nancial beablet opayof fit
scur rentliabi
li
ti
es.Thetwo
statementsareusedtomakesomeusef ul l
iqui
dityrati
osshownbel ow, usethisconcept.
observati
onsabouttheperformanceand  Cur rentRatio:thisist hebasicliqui
dit
yrati
o
fi
nancialstr
engthofthebusiness.Thisi
sthe thatcalcul
ateshowmanycur r
entassetsare
thereinpropor t
iontoev erycurr
entli
abil
it
y,so
analysi
sofaccountsofabusi ness.Todoso,
thehigherthecur rentr ati
othebet t
er(avalue
rati
oanalysi
sisemployed.
abov e1isfav ourable).theformulais:
Rat
ioAnal
ysi
s
 Pr
ofi
tabi
li
tyRat
ios:
prof
it
abi
l
ityi
stheabi
li
tyofa
companyt ousei tsresourcest ogener ate
 Li
qui
dRat
io/Aci
dTestRat
io:t
hisi
sver
y
revenuesi nexcessofi tsexpenses.Theser atios
si
mi l
artocurrentr ati
obutt hi
srati
odoesn’ t
areusedt oseehowpr ofi
tablethebusi nesshas
consideri
nvent orytobeal iqui
dasset,sinceit
beenint hey earended.
wil
ltaketimef orittobesol dandmadei nto
 Re t
urnonCapi talEmpl oyed( ROCE) :t
his
cash.Ahighlev elofinventoryinabusiness
calculatest her et
urn(netpr ofi
t )intermsof
canthuscauseabi gdif
fer
encebet weeni t
s
thecapi talinvestedint hebusi ness
curr
entandl i
qui di
tyrati
os.Sot her
eisasl ight
(sharehol der’sequity+non- curr entli
abil
it
ies)
dif
ferenceinthef ormula:
i.
e.the%ofnetpr ofi
tearnedoneachuni tof
capitalempl oyed.Thehi ghertheROCEt he
betterthepr ofi
tabil
it
yis.Thef or mul ais:

Usesanduser
sofaccount
s
 Gr
ossPr
ofi
tMar
gin:t
hiscal
cul
atest
hegr
oss
 Manager
s:t
heywi
l
luset
heaccount
stohel
p
prof
it(
sales–costofproducti
on)intermsof
them keepcont rol overt heper f
ormanceofeach
thesal
es,orinot
herwords,the%ofgr oss
productoreachdi visionsi ncet heycanseewhi ch
prof
itmadeoneachunitofsalesrevenue.
productsar epr ofitablyper for mi ngandwhi char e
ThehighertheGPM,thebett
er.Theformulai
s:
not.
 Thi swi l
lallowt hem t ot akebet t
erdeci sions.
Ifforexampl e, productAhasagoodgr oss
profitmar gi nof35%buti t
snetpr ofitmar gi
n
isonl y5%, thismeanst hatt hebusi nesshas
 Netpr
ofi
tMar
gin:t
hiscal
cul
atest
henet veryhi ghexpensest hati scausi ngt hehuge
profi
t(grossprofit
-expenses)intermsoft
he diff
er encebet weent het wor ati
os.Theywi l
l
sales,
i.e.the%ofnetpr ofitgenerat
edon trytor educeexpensesi nt hecomi ngy ear.In
eachuni tofsalesrevenue.Thehighert
he thecaseofl i
qui dity
, ifbot hr ati
osar ev erylow,
NPM, thebet t
er.Thef or
mul ais: theywi lltryt opayof fcur rentl i
abili
tiest o
impr ovet her atios.
 Rat i
oscanbecompar edwi thot herf i
rmsi n
theindust ry /compet itor sandal sowi t
h
previousy ear st oseehowt hey’r
edoi ng.
 Li
qui
dit
yRat
ios:
li
qui
dit
yist
heabi
li
tyoft
he Businesseswi lldefinitelywantt oper form
companyt opaybackitsshort
-term debts.I
tifit bettert hant heirrivalst oat t
ractshar ehol ders
doesn’
thavethenecessaryworkingcapitalt
odo toinv estint heirbusi nessandt ost ay
so,i
twil
lgoill
iqui
d(f
orcedtopayof fitsdebtsby compet it
ivei nthemar ket .Businesseswi ll
sel
li
ngassets).I
ntheprevi
oustopic,wesai dthat alsot rytoi mpr ovet hei rpr ofit
abili
tyand
worki
ngcapital=cur
rentasset
s–cur r
ent li
quidi t
yposi tionseachy ear.
l
iabi
li
ti
es.Soabusinessneedscur r
entasset sto  Sharehol ders: sincet heyar et heowner sofa
l
imitedcompany ,i
tisal egal requi r
ementt hat
 theybepr esent edwi tht hef i
nanci alaccount sof  Wor
ker
sandt
radeuni
ons:
theywi
l
lwantt
oseei
f
thecompany .Fr om t hei ncomest atement sand thebusiness’fut
ureissecureornot .I
fthe
thepr ofi
t abi l
ityr at i
os, especi allyt heROCE, busi
nessi sconti
nuouslyrunni
ngal ossandi sin
existingshar ehol dersandpot ent i
al inv estor scan ri
skofinsolvency(notbei
ngl i
qui
d),itmayshut
seewhet hert heyshoul di nv esti nt he downoper ati
onsandwor kerswil
llosetheirjobs!
busi nessbybuy ingshar es.Ahi gherpr ofitabili
ty,  Otherbusinesses:managersofcompet i
ng
thehi ghert hechanceofget tingdi vidends.They compani esmaywantt ocompar etheir
willalsocompar ether at i
oswi thot her perf
ormancet ooormaywantt otakeov erthe
compani esandwi t
hpr ev iousy ear st ot aket he busi
nessandwant stoseeifthetakeoverwi l
lbe
mostpr of i
tabl edeci sion.Thebal ancesheetwi ll benefi
cial.
tel
l
mor
shar
eatt
ehol der
heendoft
swhet hert
hey
hebusi
eart hanatt
nesswaswor
hebegi nni
t
ng
h
Li
mit
ati
onsofusi
ngaccount
s
ofthey ear ,andt heliqui dityr atioswi llbeusedt o andr
ati
oanal
ysis
ascer tainhowr iskyi twi llbet oinv esti nt he
company -theywon’ twantt oi nv esti nbusi nesses  Rat
iosar
ebasedonpastaccount
ingdat
aand
withser iousl iqui dit
ypr obl ems. willnotindicatehowt hebusi nesswi l
l performin
 Credi tors: Thebal ancesheetandl i
qui dityr ati
os thef uture
willtellcr edi tor s( suppl iers)t hecashposi tionand  Ma nager swi l
lhav eallaccount s,buttheext ernal
debt soft hebusi ness.Theywi l
l onlyber eadyt o userswi llonlyhav ethosepubl ishedaccount s
suppl yt ot hebusi nessi ftheywi l
l beabl et opay thatcont ainonl ythedatar equiredbyl aw-t hey
them.I fther ear el i
quidi typr oblems, theywon’ t maynotgett he‘ f
ull
-pi
cture’aboutt hebusi ness’
suppl yt hebusi nessasi tisr iskyf ort hem. performance.
 Bank s:Si mi lart ohowsuppl i
er suseaccount s,  Compa r
ingaccount ingdataov ertheyear scan
theywi l
l lookathowr iskyi tist ol endt ot he l
eadt omi sleadingassumpt i
onssi ncet hedat a
busi ness.Theywi ll
onl yl endt opr ofitableand willbeaf fectedbyi nfl
ation( r
isingprices)
l
iquidf i
rms.  Diff
er entcompani esmayusedi ffer
ent
 Gov er nment : thegov er nmentandt axof ficialswill account ingmet hodsandsowi llhavedi f
ferent
l
ookatt hepr of i
tsoft hecompanyt of i
xat axr ate rati
or esults,maki ngcompar i
sonsbet ween
andt oseei ft hebusi nessi spr ofitabl eandl i
quid compani esunr eli
able.
enought ocont i
nueoper ationsandt husi ft he
wor ker ’
sj obswi llbepr ot ect ed.
 6.Ext
ernalI
nfl
uencesonBusi
nessAct
ivi
ty

6.
1–Economi
cIssues
HomeNot
esBusi
nessSt es–04506.
udi 1–Economi
cIssues

TheBusi
ness/Tr
adeCy
cle
Aneconomywi
l
lnotal
way
sgot
hroughaneconomi
cgr
owt
h;t
her
eisusual
l
yacy
cle,
asshown
bel
ow.

Growt h–whenGDPi srising,unempl oymentisf alli

ng
andt her
ear ehigherl ivi
ngst andar dsint hecount ry.Businesseswi l
llookt oexpandandpr oduce
mor eandwi ll
ear nhighpr ofi
ts.
Boom–whenGDPi sati tshighestandt hereistoomuchspendi ng, causingi nfl
ati
ont orapidlyrise.
Businesscost swi l
lriseandf i
rmswi l
l becomewor ri
edabouthowt heyar egoi ngtostaypr ofi
tabl e
i
nt henearf ut
ure.
Recession–whenGDPst artst ofalldueofhi ghpr i
ces,asdemandandspendi ngf al
l
s.Firmswi l
l
cutbackpr oductiont ost aypr ofi
tableandunempl oymentmayr iseasar esult.
Slump–whenGDPi ssol owt hatpr i
cesst arttofall(def
lati
on)andunempl oymentwi l
lreachv er y
highlevel
s.Manybusi nesseswi l
lclosedownast heycannotsur vi
vet hev erylowdemandl evel .
Theeconomywi l
l suffer.
(Whent hegov ernmentt akesmeasur est oincreasedemandandspendi ngi ntheeconomyt ot ake
i
tf r
om aslumpt ogr owt h,iti
scal ledast he‘recovery’peri
od).Thecy clerepeat s.

Economi
cObj
ect
ives
Here,we’
lll
ookatthedi
ff
erenteconomicobj
ect
ivesagover
nmentmi ghthav
eandhowt
hei
r
absence/
negli
gencewil
laf
fecttheeconomyaswellasbusi
nesses.

 Mai
ntai
neconomi
cgr
owt
h:economi
cgr
owt
hoccur
swhenacount
ry’
sGr
ossDomest
icPr
oduct(
GDP)
i
ncreasei.
e.moregoodsandservicesareproducedt
haninthepr
evi
ousy
ear.Thi
swill
incr
easet
he
countr
y’si
ncomesandachievegreaterl
ivi
ngstandar
ds.
Eff
ectsofreduci
ngGDP(recessi
on):
 Asout putfal
l
s,f
ewerwor ker
swi l
lbeneededbyfir
ms,sounempl
oymentwil
lri
se
  Asgoodsandser
vicest
hatcanbeconsumedbyt
hepeopl
efal
l
s,t
hest
andar
dofl
i
vingi
ntheeconomy
wi
l
lal
sof
all
 Achi
evepr
icest
abi
li
ty:
inf
lat
ioni
sthei
ncr
easei
nav
eragepr
icesofgoodsandser
vicesov
ert
ime.(
Not
e
that, i
nf l
ation, int hereal wor l
d, alway sexi sts.I tisnat ur al forpr i
cest oi ncr easeast hey earsgoby .I
nt he
caset her ei saf all i
nthepr i
cel evel,iti scal ledadef lation)Mai ntainingal owi nf lati
onwi ll
hel ptheeconomy
todev elopandgr owbet ter.
Effectsofhi ghi nflati
on:
 Asc ostofl ivingwi ll haver i
senandpeopl es’ r
eal incomes( t
hev alueofi ncome)wi llhavef all
en( when
pricesi ncr easeandi ncomeshav en’ t
,thei ncomewi ll buyl essergoodsandser vi
ces-t hepur chasi ng
powerwi ll f
all).
 Pr icesofdomest icgoodswi llr
iseasopposedt of or eigngoodsi nt hemar ket .Thecount ry’
sexpor tswill
becomel esscompet iti
vei nthei nt ernat ional mar ket .Domest icwor ker smayl oset heirjobsi ftheir
product sandf ir
msdon’ tdowel l
.
 Whe npr i
cesr ise,demandwi llfall andal lcost swi l
l rise( aswages, mat erial costs, overheadswi llallr
ise)
-causi ngpr of itstof al l
.Thus, theywi l
lbeunwi lli
ngt oexpandandpr oducemor eint hef uture.
 Thel i
vingst andar ds( qualityofl ife)int hecount rymayf allwhencost sofl i
v i
ngr ise.
 Re duceunempl oy ment :unempl oymentexi stswhenpeopl ewhoar ewi llingandabl etowor kcannotf inda
j
ob.Al owunempl oymentmeanshi ghout put ,incomes, livingst andar dset c.
Effectsofhi ghunempl oy ment :
 Une mpl oy edpeopl edonotpr oduceany thingandso, thet otalout put / GDPi nt hecount rywi l
lfall
.Thi s
will i
nt urn, leadt oaf alli
neconomi cgr owt h.
 Une mpl oy edpeopl er eceivenoi ncomes, t
husi ncomei nequalitycanr isei nt heeconomyandl ivi
ng
standar dswi llfal
l.Ital someanst hatbusi nesseswi llfacel owdemandduet olowi ncomes.
 Thegov er nmentpay soutunempl oy mentbenef i
tst ot heunempl oy edandt hiswi llri
sedur inghi gh
unempl oy mentandgov ernmentwi l
lnotenoughmoneyl eftov ert ospendonot herser vicesl i
ke
educat i
onandheal th.
 Mai ntai nbal anceofpay ment sst abi li
t y:t
hi sr ecordst hedi fferencebet weenacount ry’
sexpor ts(goods
andser vicessol df r
om t hecount r
yt oanot her )andi mpor ts( goodsandser vi
cesboughti nbyt hecount ry
from anot hercount ry).Theexpor tsandi mpor tsneedst oequal eachot her ,thusbal anced.
Effectofadi sequi li
bri
um i nthebal anceofpay ment s:
 I fthei mpor tsofacount r
yexceedi tsexpor ts,itwill causedepr eci ationi nt heexchanger ate–t hev alue
oft hecount ry’scur rencywi llf
al lagai nstot herf oreigncur rencies( thi swi llbeexpl ainedi ndet ailhere).
 I ftheexpor tsexceedt heimpor tsi tindi catest hatt hecount r
yi ssel li
ngmor egoodst hani tis
consumi ng-t hecount r
yitselfdoesn’ tbenef i
tfrom anyhi ghout putconsumpt ion.
 Re ducei ncomeequal i
ty /achiev eef fect i
vei ncomer edi st r
ibut i
on: thedi ff erence/ gapbet weent hei ncomes
ofr i
chandpoorpeopl eshoul dnar rowdownf orincomeequal itytoi mpr ov e.Impr ovedi ncomeequal it
ywi ll
ensur ebet terl i
vingst andar dsandhel pt heeconomyt ogr owf asterandbecomemor edev eloped.
Effectsofpoori ncomeequal i
ty:
 I nequal distr i
but i
onofgoodsandser vices-t hepoorcannotbuyasmanygoodsast her i
ch-poorl i
v i
ng
standar dswi llari
se.
Gov
ernmentEconomi
cPol
i
cies
 Gover
nmentcani
nfl
uencet
heeconomi
ccondi
ti
onsi
nacount
rybyt
aki
ngav
ari
etyof
pol
i
cies.

 Fiscalpol i
cyisagov er
nmentpol i
cywhi chadjustsgov ernmentspendi ngandt axationto
i
nf l
uencet heeconomy .Itisthebudget arypol i
cy,becausei tmanagest hegov ernment
expenditureandr evenue.Gov ernmentai msf orabalancebudgetandt ri
est oachiev eit
usingfiscal pol i
cy.
 Increasinggov ernmentspendi ngandr educingt axeswi llencouragemor epr oductionand
i
ncr easeempl oyment ,dri
vingupGDPgr owth.Thi sisbecausegov er
nmentspendi ng
createsempl oy mentandi ncreaseseconomi cact i
vit
yi nt heeconomyandl owert axes
meanspeopl ehav emor emoneyt oconsumeandf ir
mshav etopayl essert axont heir
profit
s.Ont heot herhand, reducinggov ernmentspendi ngandi ncreasingt axeswi l
l
discouragepr oduct i
onandconsumpt i
on, andunempl oy mentandGDPwi llfall
.
 Monet arypol icyisagov er
nmentpol icyt hatadjuststhei nterestr
ateandf oreignexchange
ratestoi nfl
uencet hedemandandsuppl yofmoneyi nt heeconomy ,andthusdemandand
supply.Itisusual lyconduct edbyt hecount ry’
scent r
al bankandusual lyusedt omai nt
ain
 pricestabilit
y,lowunempl oymentandeconomi cgrowt h.
 Increasingi nterestrateswi l
ldiscourageinv
estmentsandconsumpt ion,
causing
empl oymentandGDPt ofall(asthecostofborr
owing-int
erestonloans–hasi ncreased,
andpeopl epref ertoearnmor ei nt
erestbysavi
ngratherthanspend).Simil
arl
y,reduci
ng
i
nt er
estr ateswi llboostinvestment,consumpti
on,empl oyment,andthusGDP.

Supply-
sidepol
ici
es:boththefi
scalandmonetar
ypol
ici
esdi
rect
lyaf
fectdemand,
butt
hepol
i
cies
thati
nfl
uencesupplyareverydi
ff
erent.I
tcani
ncl
ude:
 Pr
ivat
isat
ion:
sel
l
inggov
ernmentor
gani
zat
ionst
opr
ivat
eindi
vi
dual
s-t
hiswi
l
lincr
easeef
fi
ciencyand
pr
oduct
ivi
tyt
hati
ncr
easesuppl
yaswel
lencour
agecompet
it
orst
oent
erandf
urt
heri
ncr
easesuppl
y.
 I
mpr
ovet
rai
ningandeducat
ion:
gov
ernment
scanspendmor
eonschool
s,col
l
egesandt
rai
ningcent
resso
t
hatpeopl
eint
heeconomycanbecomebet
terski
l
ledandknowl
edgeabl
e,hel
pingi
ncr
easi
ngpr
oduct
ivi
ty.
 I
ncr
easedcompet
it
ion:
byact
ingagai
nstmonopol
i
es(
fi
rmst
hatr
est
ri
ctcompet
it
orst
oent
ert
hat
i
ndustry
/hav i
ngful
ldominanceinthemar
ket
-referxx
xformor
edet ai
l
s)andreduci
nggover
nmentrul
es
andregulat
ions(
oftenter
med‘ der
egul
ati
on’
),t
hecompeti
ti
veenv
ironmentcanbeimprov
edandthus
becomemor epr
oducti
ve.

*EXAM TI P:Remembert hateconomi ccondit

ionsandpol i
ciesareallinter
connect
ed;
onechange
wil
lleadt oanef f
ectwhichwi l
lleadtoanothereffectandsoon, l
ikeachai nr
eacti
oni
nmany
dif
ferentway s.I
ny ourexams, youshouldtakecar etoexpl ainthoseeffectst
hatarer
elev
antand
appropriatet
ot hebusinessoreconomyi nthequest i
on*
Howmi ghtbusinessesreacttopol i
cychanges?I twilldependv aryi
ngonhowmuchi mpactthe
poli
cychangewi l
lhaveont hepar t
icul
arbusiness/industry
/ economy .Hereareafewexamples:

6.
2–Env
ironment
aland
 Et
hical
Issues
HomeNot
esBusi
nessSt es–04506.
udi 2–Envi
ronment
alandEt
hicalI
ssues

Busi
ness’
Impactont
heEnv
ironment
Socialresponsibil
it
yiswhenabusi nessdecisionbenefi
tsstakeholder
sotherthansharehol
der
s
i
.e.worker s,communi t
y,suppli
ers,
bankset c.
Thisisv eryimport
antwhencomi ngtoenv i
ronment ali
ssues.Businessescanpollut
etheairby
rel
easingsmokeandpoi sonousgases,poll
utewat erbodi
esar ounditbyrel
easingwasteand
chemical sintot
hem, anddamaget henatur
al beautyofaplaceandsoon.
WHYBUSI
NESSESWANTTOBE WHYBUSINESSESDONOTWANTTO
ENVI
RONMENT-FRI
ENDLY BEENVI
RONMENT-FRI
ENDLY

Iti
sexpensi vetoreduceandr ecycle
Senseofsoci
alresponsibi
li
tythat wastef ort
hebusi ness.I
tmeanst hat
comesfrom t
hef actthatt
heir expensivemachi neryandskil
led
act
ivi
ti
esarecontri
butingt
oglobal l
abourwi ll
ber equir
edbyt he
warmingandpoll
ut i
on business–r educingprofi
ts.

Usingupscar cenon-r
enewabl e Fi
rmswi ll
havetoincr
easepricesto
resources(suchasrainfor
estwood compensatefortheexpensi
ve
andcoal )wil
lrai
setheirpr
icesinthe envir
onment-f
ri
endlymethodsusedin
futur
e,sobusinesseswon’tuset hem product
ion-hi
gherpri
cesmeanl ower
now demand.

Consumersarebecomi ngsoci
all
y- Highpr
icescanmakefi
rmsless
awareandarewill
ingtobuyonly competi
ti
veinthemar
ketandthey
envi
ronmentfr
iendlypr
oducts. coul
dlosesales

Government s,envi
ronmental
organisat
ions,eventhecommunity
couldtakeact i
onagainstt
he Businessescl
aimthati
tist
he
businessiftheydoseriousdamage government’
sdutytocl
eanup
totheenv i
ronment pol
luti
on

Ext
ernal
i
ties
Abusiness’
decisionsandacti
onscanhav esi
gnif
icanteffect
sonit
sstakeholder
s.Theseef
fects
areter
med‘externali
ti
es’
.Ext
ernal
i
tiescanbecategorizedint
osi
xgroupsgivenbelowandwe’ll
takeexamplesfr
om ascenariowher eabusi
nessbuildsanewproducti
onfactory.

 PrivateCosts:costspaidforbyt
hebusi
nessforanact
ivi
ty.
Exampl es:
costsofbuildingthef
act
ory,
hir
ingext
raemployees,
pur
chasi
ngnewmachi
ner
y,
runningaproductionunitetc.
  Pr ivat eBenef it
s:gainsf orthebusi nessr esul t
ingf rom anact i
vity.
Exampl e: theext r
amoneymadef rom thesal eoft hepr oducedgoodset c.
 Ext er nalCost s:costspai df orbyt her estoft hesoci ety(othert hant hebusiness)asar esult
ofthebusi ness’activi
ty.
Exampl es: machi nerynoi se, airpollut
iont hatl eadst oheal thprobl emsamongnear
resi
dent s,lossofl and( itcoul dhav ebeenaf ar ml andbef ore)et c.
 Ext er nalBenef it
s:gainsenj oy edbyt her estoft hesoci etyasar esultofabusi nessacti
vit
y.
Exampl e: newj obscr eatedf orr esidents, gover nmentwi l
lgetmor etaxfrom thebusiness,
otherf irmsmaymov ei ntot hear eat osuppor tthef irm-helpingdev el
opt heregion,new
roadsmi ghtbebui l
tthatcanbeenj oyedbyr esident setc.
SocialCost s=Pr ivateCosts+Ext ernalCost s
SocialBenef i
ts=Pr i
vateBenef i
ts+Ext ernalBenef i
ts
Gov er
nment suset hecost-benef it
-anal ysis(CBA)t odeci dewhet hertopr oceedwi t
haschemeor
notandbusi nesseshav ealsoadopt edit.InCBA, thegov ernmentwei ghsupal lthesocialcost
s
andbenef i
tst hatwi l
lari
seiftheschemei sputi nt
oef fectandgi vet hem al lmonetaryv al
ues(thi
s
i
snoteasy -whati sthev al
ueofl osingnat ur
al beaut y?).Theywi llonlyal lowt heschemet o
proceedift hesoci albenefitsexceedt hesoci alcost s, i
fthecost sexceedt hebenefit
s, i
tisnot
al
lowedt opr oceed.

Sust
ainabl
eDev
elopment
Sustai
nabledevel
opmenti sdev
elopmentt hatdoesnotputatr
iskt
helivi
ngstandar
dsoffut
ure
generat
ions.Itmeanst
ryingtoachieveeconomicgr owt
hinawaythatdoesnotharmfut
ure
generat
ions.Fewexamplesofasust ai
nabledevelopmentar
e:
 usingr enewabl
eener
gy-sothatr
esourcesar
econservedforthefut
ure
 recyclewaste
 usef ewerresour
ces
 developnewenv ir
onment-
fr
iendl
yproduct
sandprocesses-reduceheal
thandcl
i
mat
icpr
obl
emsf
orf
utur
e
gener ati
ons
Env
ironment
alPr
essur
es
 Pressur egr oupsar eor ganisations/ groupsofpeopl ewhochangebusi ness( and
gov ernment )deci sions.I fabusi nessisseent obehav einasoci allyir
responsibleway ,they
canconductconsumerboy cotts( encour ageconsumer stostopbuy i
ngt heirproducts)and
takeot heract ions.
 Theyar eoftenv erypower f
ul becauset heyhav epubl icsuppor tandmedi acov erageandar e
well-f
inancedandequi ppedbyt hepubl ic.Ifapr essur egroupi spower f
ul i
tcanr esulti
na
badr eputationf ort hebusi nesst hatcanaf fectitinf utureendeav ours,sot hebusi nesswill
giveint othepr essur egr oups’ demands.Exampl e: Greenpeace
 Thegov ernmentcanal sopassl awst hatcanr estrictbusinessdeci sionssuchasnot
permi tt
ingfact or i
est ol ocat einpl acesofnat ural beaut y.
 Ther ecanal sobepenal tiesseti npl acet hatwi llpenal i
zefir
mst hatexcessi vel
y
pollute.Pollutionper mi tsar eli
censest opol l
uteupt oacer tainlimit.Thesear ev ery
expensi vetoacqui re,sof ir
mswi lltr
ytoav oidbuy ingt hepolluti
onper mi tandwi llhaveto
reducepol lutionl ev el
st odoso.
 Firmst hatpol lutel esscansel ltheirpolluti
onper mi tstomor epol luti
ngf i
rmst oear nmoney .
Taxescanal sobel eviedonpol l
ut inggoodsandser vi
ces.
Et
hicalDeci
sions
 Et
hical
deci
sionsarebasedonamoralcode.
 I
tmeans‘doi
ngt heri
ghtthi
ng’
.Busi
nessescoul
dbef
acedwi
thdeci
sionsr
egar
ding,
for
 exampl e,employmentofchi ldr
en, takingorofferingbribes,associ
atewith
people/organi
sationswi thabadr eput ati
onetc.Int hesecases,eveniftheyar
elegal,they
needt otakeadeci sionthattheyf eelisri
ght.
 Takingethical
/’r
ight’decisi
onscanmaket hebusi ness’ pr
oductspopularamongcust omers,
encouraget hegov ernmenttof avourt hem inanyf utur
edisputes/demandsandav oid
pressuregroupthr eats.Howev er
, thesecanendupbei ngexpensiveasthebusinesswi l
l
l
oseoutonusi ngcheaperunet hical opportuni
ties.

6.3–Businessandthe
Inter
nat
ionalEconomy
Busi
nessSt es–04506.
udi 3–Busi
nessandt
heI
nter
nat
ionalEconomy

Gl
obal
izat
ion

 Global
izat
ionisaterm usedtodescr i
betheincr
easesinworldwi
detradeandmovementof
peopleandcapitalbetweencount r
ies.Thesamegoodsandser v
icesaresol
dacr
ossthe
gl
obe; worker
sarefindi
ngiteasiertofindworkbygoingabr
oadforwork;moneyi
ssent
fr
om andt ocountri
eseverywhere.
Somer easonshowgl obali
zati
onhasoccur redare:
 I
ncr
easi
ngnumberoff
reet
radeagr
eement
s–t
hesear
eagr
eement
sbet
weencount
ri
est
hatal
l
owst
hem t
o
i
mpor
tandexpor
tgoodsandser
viceswi
thnot
ari
ff
sorquot
as.
 I
mpr ovedandcheapertr
anspor
t(water,
land,
air
)andcommunicat
ions(
int
ernet)infr
astr
uctur
e
 Developi
ngandemer gi
ngcount
riessuchasChinaandIndi
aar
ebecomingrapidlyindust
ri
ali
zedandsocan
exportl
argevolumesofgoodsandservi
ces.Thi
shascausedani
ncr
easei
ntheout
putandoppor
tuni
ti
esi
n
i
nternat
ional
trade,al
l
owingforgl
obal
i
sation

Adv
ant
agesofgl
obal
isat
ion

 Al
l
owsbusinessest
ostar
tsel
li
nginnewfor
eignmarkets,i
ncreasi
ngsalesandprofi
ts
 Canopenf
actori
esandpr
oduct
ionuni
tsi
nothercountr
ies,possi
blyatacheaperr
ate(cheapermat
eri
als
andlabourcanbeav ail
ableinothercountr
ies)
 I
mpor tpr
oductsfr
om ot hercountr
iesandselli
ttocust
omer si
nthedomest
icmarket-thiscoul
dbemor
e
prof
it
ableandproducingandsel l
i
ngt hegoodthemselv
es
 I
mpor tmater
ial
sandcomponent sforproducti
onfr
om for
eigncount
ri
esatacheaperrate.

Di
sadv
ant
agesofgl
obal
i
sat
ion

 I
ncr
easi
ngi
mpor
tsi
ntocount
ryf
rom f
orei
gncompet
it
ors-nowt
hatf
orei
gnf
ir
mscancompet
einot
her
countri
es,itputsupmuchcompet i
tionfordomesticfir
ms.Ifthesedomest icfir
mscannotcompet ewith
theforeigngoods’ cheappri
cesandhi ghquali
ty,theymaybef orcedtoclosedownoper at
ions.
 Incr
easinginvestmentbymul t
inati
onalsinhomecount ry-t
hiscouldfur
theraddt ocompet i
tioninthe
domest icmarket(alt
houghsmal l
localfi
rmscanbecomesuppl ier
stothelar gemul ti
nati
onal f
ir
ms)
 Empl oyeesmayl eavedomest i
cfirmsiftheydon’tpayaswel lastheforeignmul tinat
ionalsinthecountr
y-
businesseswi l
lhavetoincr
easepayandcondi ti
onst orecr
uitandretai
nempl oyees.
Whenl
ookingataneconomy
’spointofv
iew,gl
obal
isat
ionbringsconsumer
smor echoi
ceand
l
owerpr
icesandfor
cesdomesti
cf i
rmstobemoreeffi
cient(
inordert
oremaincompeti
ti
ve)
.
 However
,compet
it
ionf
rom f
orei
gnpr
oducer
scanf
orcedomest
icf
ir
mst
ocl
osedownandj
obs
wi
llbel
ost.
Pr
otect
ioni
sm

 Protect i
onism ref
erstowhengov ernmentsprotectdomest i
cf i
rmsf rom foreign
compet it
ionusingtradebarrierssuchast ari
ffsandquotas;i.
e.theopposi t
eoff reet
rade.
 Impor tquot aisarestri
cti
onont hequant i
tyofgoodsthatcanbei mpor tedint
ot hecountry
.
Tari
f fsaret axesonimpor t
s.
 Imposi ngt hesetwomeasur eswi llreducethenumberoff oreigngoodsi nthedomest i
c
mar ketandmaket hem expensi vetobuy ,
respecti
vel
y.Thiswillreducet he
compet i
tivenessoftheforei
gngoodsandmakei teasyfordomest icfirmst oproduceand
sell
t heirgoods.Howev er,i
tr educesf r
eetradeandglobali
sati
on.
 Freet radesuppor t
erssaythati ti
sbet tert
oallowconsumer stobuyi mpor t
edgoodsand
domest i
cf ir
msshoul dproduceandexpor tgoodsandser vi
cest hattheyhav eacompet i
ti
ve
advant agei n.I
nthisway,li
vingst andardsacrosstheglobewilli
mpr ov e.

Mul
ti
nat
ionalCompani
es(
MNCs)

Multi
nati
onalbusi
nessesarefi
rmswithoper
ati
ons( pr
oduct
ion/ser
vice)i
nmor et
hanone
countr
y.Alsoknownast r
ansnat
ional
busi
nesses.Exampl
es:Shell
,McDonald’
s,Ni
ssanet
c.

Whydof
ir
msbecomemul
ti
nat
ional
s?

 Toproducegoodswi
thl
owercosts–cheapermateri
alandl
abourmaybeav ai
labl
einot
hercount
ri
es
 Toextr
actrawmater
ial
sforpr
oducti
on,avai
labl
einafewothercount
ri
es.Forexampl
e:cr
udeoili
nthe
Middl
eEast
 Toproducegoodsnear ertot hemar ketstoavoidt r
ansportcost
s.
 Toavoidtradebarri
ersoni mpor t
s.Iftheyproducet hegoodsinforei
gncount
ri
es,
thef
ir
mswi
l
lnothav
eto
payimporttari
ff
sorbef acedwi thaquot arest
ricti
on
 Toexpandi nt
odiff
erentmar ketsandspr eadtheirri
sks
 Toremaincompet it
ivewithrivalfi
rmswhi chmayal sobeexpandingabr
oad

Adv
ant
agest
oacount
ryofamul
ti
nat
ional
set
ti
ngupi
nthei
rcount
ry:

 Morejobscreat
edbymul ti
nat i
onals
 I
ncreasesGDPoft hecountry
 Thetechnol
ogythatthemultinati
onalbri
ngsincanbr i
nginnewideasandmet hodsi
ntot
hecount
ry
 Asmor egoodsarebeingproducedi nthecountr
y,theimport
swillbereducedandsomeoutputcanev
en
beexported
 Multi
nati
onal
swillal
sopayt axes,ther
ebyincr
easingthegovernment’
staxr ev
enue
 Moreproductchoiceforconsumer s

Di
sadv
ant
agest
oacount
ryofamul
ti
nat
ional
set
ti
ngupi
nthei
rcount
ry:

 Thej
obscr
eat
edar
eof
tenf
orunski
ll
edt
asks.Themor
eski
l
ledj
obswi
l
lbedonebywor
ker
sthatcome
fr
om t hefir
m’shomecount ry.Theunskil
ledwor ker
smayal sobeexpl oit
edwi t
hveryl
owwagesand
unhygienicworkingcondi t
ions.
 Sincemul ti
nati
onalsbenef i
tf rom economiesofscale,l
ocalfirmsmaybef orcedoutofbusiness, unableto
survi
v ethecompet i
tion
 Mul t
inati
onalscanuseupt hescar ce,
non-renewableresourcesi nthecount
ry
 Repat r
iati
onofpr ofitcanoccur .Theprofit
searnedbyt hemul t
inati
onalcoul
dbesentbackt ot heirhome
count r
yandt hegov ernmentwi l
lnotbeabletolevytaxonit.
 Asmul t
inat
ional
sar elarge,theycani nfl
uencethegov ernmentandeconomy .Theycouldt
hr eatent he
governmentt hattheywi l
lclosedownandmakewor kersunempl oyedift
heyarenotgiv
enfinanci algrant
s
andsoon.

ExchangeRat
es

 Theexchanger atei sthepr i

ceofonecur rencyi nt ermsofanot hercur rency .
Forexampl e,€1=$1. 2.Tobuyoneeur o,you’ llneed1. 2dol l
ars.Thedemandandsuppl yof
thecur renci esdet ermi net heirexchanger ate.Int heabov eexampl e, i
fthe€’ sdemandwas
greatert hant he$’ s,ori fthesuppl yof€r educedmor et hant he$, thent he€’ spr i
ceint erms
of$wi lli
ncr ease.Itcoul dnowbe€1=$1. 5.Each€nowbuy smor e$.
 Acur rencyappr eciateswheni t
sv aluer i
ses.Theexampl eabov eisanappr eciati
onoft he
Euro.AEur opeanexpor ti
ngf ir
m wi ll
findanappr eciationdi sadv antageousast heir
Amer icanconsumer swi l
lnowhav et opaymor e$t obuya€1good( expor t
sbecome
expensi ve) .Theircompet iti
venesshasr educed.AEur opeani mpor tingf irm willfi
ndan
appreci ationofbenef i
t.TheycanbuyAmer icanpr oduct sforl esserEur os( i
mpor t
sbecome
cheaper )
.
 Acur rencydepr eciateswheni t
sv aluef all
s.I ntheexampl eabov e, theDol l
ardepr eciated.
AnAmer icanexpor ti
ngf i
rm wi l
lfi
ndadepr eciationadv antageousast heirEur opean
consumer swi l
lnowhav et opayl ess€t obuya$1good( expor t
sbecomecheaper )
.Thei r
compet it
ivenesshasi ncreased.AnAmer i
cani mpor t
ingf i
rm wi l
lfi
ndadepr eciati
on
disadv antageous.Theywi l
lhavet obuyEur opeanpr oduct sformor edol lars(impor t
s
becomeexpensi v
e) .
 Insummar y,anappr eciationsisgoodf ori mpor ters,badf orexpor ter s;adepr eci
ationi s
goodf orexpor ters, badf orimpor ters; givent hatt hegoodsar epriceel ast i
c( i
fthepr ice
didn’
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