THE ASSOCIATION OF BUSINESS EXECUTIVES

CERTIFICATE
IM

Introduction to Business

morning 7 June 2006

1 Time allowed: 3 hours.

2 Answer any FOUR questions.

3 All questions carry 25 marks. Marks for subdivisions of questions are

shown in brackets.

4 No books, dictionaries, notes or any other written materials are

allowed in this examination.

5 Calculators are allowed providing they are not programmable and

cannot store or recall information. Electronic dictionaries and
personal organisers are NOT allowed.

6 Candidates who break ABE regulations, or commit any misconduct,

will be disqualified from the examinations.

7 Question papers must not be removed from the Examination Hall.

 Answer any FOUR questions

Q1 (a) Briefly describe the following marketing terms:

(i) Extension strategies

(ii) Skim pricing
(iii) Niche market (12 marks)

(b) How is the market for a product such as cars

segmented? (13 marks)
(Total 25 marks)

Q2 (a) Identify three main problems facing the owner of a

small business. (9 marks)

(b) Examine the reasons why a franchise is more likely to

survive in business than a sole trader. (16 marks)
(Total 25 marks)

Q3 (a) Using PEST analysis, discuss how external

constraints might influence a business. (16 marks)

(b) Examine how a business might react when faced with

a prolonged recession. (9 marks)
(Total 25 marks)

Q4 (a) What do you understand by the term ‘insurance’? (5 marks)

(b) Outline two services provided for a business by an

insurance company. (8 marks)

(c) Excluding insurance, outline three business services

offered to firms by banks. (12 marks)
(Total 25 marks)
Q5 (a) Using examples, identify the differences between:

(i) primary sector and secondary sector

(ii) inputs and outputs
(iii) shareholders and stakeholders (9 marks)

(b) Explain the role and importance of the following

functional departments in a business:

(i) Human Resources

(ii) Marketing
(iii) Research and Development (16 marks)
(Total 25 marks)

Q6 (a) What do you understand by the term ‘labour

turnover’? (5 marks)

(b) How might labour turnover be calculated? (4 marks)

(c) The workforce is often considered to be the most

important asset of a business. Compare the cost and
benefits of introducing a comprehensive training
programme in order to improve the workforce. (16 marks)
(Total 25 marks)

Q7 (a) Explain the importance of and give the equations for

the following:

(i) Current ratio

(ii) Return on capital employed
(iii) Gearing (15 marks)

(b) Define the term ‘working capital’ and state three

reasons why cash is so important to a business. (10 marks)
(Total 25 marks)
Q8 (a) What are the main features of the following forms of
production:

(i) job production

(ii) batch production? (9 marks)

(b) Explain two advantages and two disadvantages of

flow production for:

(i) the business

(ii) the employee (16 marks)
(Total 25 marks)
 Certificate

Introduction to Business

Examiner’s Suggested Answers

Question 1

(a) (i) Extension strategies – these are plans to lengthen the life cycle of a
product as it approaches and enters the maturity stage. These
strategies can range from redesigning the product, adding an extra
feature, changing the packaging, reducing the price and image to
completely repositioning the product in another market. A good
example is the repositioning of Baby Oil and Baby Powder to become
part of the skin care market for women as well as a product for the
babycare sector.

(ii) This is a pricing policy that aims to price a new product at a high level
so that it is only purchased by trend-setters, enthusiasts or the very
rich. ‘Skimming’ the market is usually an option used for innovative
products such as the recent launch of i-pods and third generation
mobile phones.

(iii) A ‘niche’ market is a relatively small and identifiable segment of a

larger market. This type of market appeals to small firms as it is often
overlooked by large-scale producers and is therefore less competitive.
This allows small firms to charge higher prices as the consumers are
willing to pay a premium for what they perceive to be a more unique
product or service. For example a ‘made to measure’ tailor can charge
much more for a suit than a large clothing firm offering ‘ready made’
suits.

(b) The market for cars can be segregated according to:

(i) Purpose – Consumers want cars for different purposes. The average
buyer may want a car for everyday transport to and from work. For
this a mid-size saloon car is ideal. However, others might want a
small, economical runabout whereas an executive might want a large
luxurious car in order to impress clients. A young single person might
want a sports car that reflects their fast lifestyle.
(ii) Size of family – A large family with several children might want an
estate car or a ‘people carrier’ that can accommodate six or seven
passengers and luggage.
(iii) Economy – Some drivers are concerned about the running costs of a
car. The miles per litre and the servicing costs might decide the type of
car bought. Large-engine cars are expensive to run and might only
appeal to the more wealthy person.
(iv) Socio-economic status – A car is normally the second most expensive
purchase after a house. Wealthy people will want an expensive car to
reflect their earnings whereas a student might only be able to afford a
small economical car.
 (v) Impact upon the environment – There is an increasing number of
buyers who are concerned about the environmental impact of driving.
For these consumers eco-friendly cars that run on batteries or liquid
gas would be more suitable.
(vi) Design – Some consumers prefer stylish shapes with flowing lines and
a sleek body whereas others are more concerned about comfort,
gadgetry or leg space.
(vii) Engine size – For motorists who drive a lot of miles, especially as part
of their work, a large engine would be more suitable as it generally
provides a more comfortable ride. A small economical engine will be
favoured by those for whom cost is a major factor.

Question 2

(a) The majority of business failures are small firms. The main problems facing
them are:

Lack of capital – most small businesses are started with the owner’s own
savings. In times of recession or falling sales this is inadequate to continue
paying the business’ fixed costs.
Lack of expertise – small businesses employ only a few people, many of
whom are not specialists in areas such as accounting, marketing,
production or personnel. Inadequate control of such areas as credit can
lead to severe cash flow problems.
Lack of planning – many small businesses start with a simple idea that is
easy to establish and control such as a retail outlet. They are nearly always
started when the economy is buoyant and demand is high. Unfortunately
the owner has rarely planned ahead to take account of opportunities to
expand or for periods of low demand. When these occur the owner is taken
unawares and is forced into a hurried decision, often the wrong one for the
circumstances.

(b) A franchise is an agreement where one person (the franchisee) purchases

from another (the franchisor) the right to sell a patented product or service
using a well-established framework and method. The franchise is more
likely to survive than a small independent business because:

The product is already proven in the market place and is known to the
customer.
The franchisee will receive expert help from the franchisor before, during
and after set-up.
The franchisor will provide on-going training and advice to overcome the
franchisee’s lack of experience.
The franchisor will provide a standard procedure for administration, basic
bookkeeping, financial planning, stock control and personnel management.
The franchisor provides the advantages of bulk buying and mass
advertising in return for the franchise fee.

For these reasons a franchise is more likely to survive in the dynamic

commercial world.
Question 3

(a) The influence of external constraints on a business can be understood

using a PEST analysis. This approach divides the constraints into:

Political – Governments impose regulations on business that must be

adhered to. These cover health and safety issues, consumer protection,
advertising standards, employment conditions and environmental factors.
These will increase the costs of business. Governments also influence
business through the tax system. Indirect taxes make the goods more
expensive for the consumer while subsidies reduce the market price. Other
influences include items such as planning permission, incentives for
location or the promotion of exports.
Economic – The state of the economy is one of the most important
influences. Most economies exhibit a trade cycle of growth followed by a
slow down and possibly recession. This will affect the level of demand for
the firm’s products. At the same time the firm will also be affected by
changes in unemployment or interest rate changes. Growing
unemployment will reduce demand while rising interest rates will increase
business costs. The reverse is true for falling unemployment and cuts in
interest rates. In a similar way changes in the exchange rate will affect the
ability of firms to compete against foreign companies in their own markets
and to be competitive abroad.
Social – A business must be aware of changes in society. Demographic
changes will affect demand in different sectors. The ageing population in
Europe has led to greater demands for healthcare and nursing homes. As
societies grow wealthier the population spends a greater proportion on
leisure pursuits such as foreign holidays, sports and pastimes. Changes in
public attitudes can also affect a business. The public are more
environmentally aware and are not prepared to buy products and services
that are considered antisocial, e.g. aerosols that contain CFCs.
Technological – Technological changes affect not only the production
process but also the range of products that is possible. The microchip has
led to the miniaturisation of many products while the development of
plastics has revolutionised the style of products and their cost. The leisure
industry has witnessed vast changes with the advent of computer games
and miniaturised music systems. The quality of items has also been
affected. In agriculture science has developed disease resistant plants,
improved crop yields and created new hybrid specimens. A business must
be aware of changes otherwise it will lose market share to competitors that
are more technologically advanced.

NB. Answers dealing with legal or environmental issues are equally

acceptable.

(b) A prolonged recession is a period when economic growth is negative. This

usually results in a fall in demand, especially for consumer goods and
services goods. Faced with this prospect a business can adopt one or more
of the following strategies:

(i) Reduce prices to retain current sales levels and market share. This
will result in lower profit margins unless accompanied by cost cutting
measures.
 (ii) Review the marketing strategy to target new and less affected markets,
possibly in other countries.
(iii) Reduce spending on product development and research and
development. This will reduce cash outflow in the short run but might
damage sales when the economy recovers.
(iv) Downsize the business by shedding surplus or peripheral labour and
closing less profitable branches. This might involve redundancy
payments and lead to a deterioration in workforce relations and
motivation.

It is important that the firm has a consistent strategy and that employees
are consulted and kept informed at each stage so that goodwill is
maintained for when the economy recovers.

Question 4

(a) Insurance is a means of managing risk. Technically it is the provision of a

legal contract between an ‘insurer’ who promises to pay the ‘insured’ if a
particular event (known as the ‘peril’) happens and the insured suffers a
financial loss. For example a business may insure themselves against fire,
theft, or storm damage. In return for the insurance the insured pays a
‘premium’, usually by regular instalments to an insurance company.

(b) Two main services provided by an insurance company for businesses

concern fire and accidents.

Fire insurance is required to protect not only the buildings belonging to a

business but also the stock and equipment stored in it. It is possible to
obtain extra insurance in order to cover ‘consequential’ loss. This
compensates for the disruption of business caused by a fire and may cover
loss of profits and extra expenses incurred in restoring the business, such
as temporary accommodation.

Accident insurance covers a wide range of events. Employer’s liability

protects the business from claims made by employees for injuries suffered
at work. All businesses are required by law to have this form of insurance.
Public liability is a similar form of insurance except that it covers the
general public for injury caused by the business or its employees. For
example if part of the roof fell off and injured pedestrians or if a company
vehicle injured a cyclist then the ‘public’ would be compensated by the
insurer. Without this type of insurance the business may face extremely
high claims for compensation, which could cause the firm to cease trading.

(c) Clearing banks (also known as retail banks) offer businesses a wide range
of banking services but the most common are cheque accounts, lending
and business advice.

For everyday purposes banks provide business accounts where money can
be deposited and withdrawn, usually by cheque. This provides a safe and
easy way for a firm to pay its debts and to secure its takings.
 Clearing banks can also assist to finance a business through a range of
lending services that include overdraft facilities, short- and medium-term
loans, factoring of debtors and leasing arrangements.

In recent years banks have developed business consultancy services that a

firm can use when faced with larger or more long-term projects such as
entering a new market, expanding its business or negotiating a takeover.

Question 5

(a) (i) The primary sector is concerned with the extraction or creation of raw
materials. Examples include all forms of mining (such as gold, copper
and coal), agriculture, fishing and forestry. The secondary sector,
however, uses these raw materials to produce finished goods. For
example wood could be used in the production of furniture or copper
in the making of electrical cable.

(ii) ‘Inputs’ are the four factors of production (land, labour, capital and
managerial ability) that a firm requires in order to produce. The end
product of the production process is the ‘output’, for example a car,
sewing machine, stainless steel sheets etc.

(iii) A stakeholder is any individual or group that has an effect on or is

affected by a business or organisation. This might include groups
such as employees, owners, trade unions, customers, pressure groups
and competitors. A shareholder, however, is a part owner of a business
who has invested funds in the purchase of the firm’s shares.
Shareholders have a right to vote and to attend the annual general
meeting.

(b) (i) The human resource department’s role is to find, recruit, train and
manage an organisation’s personnel. They are responsible for
conducting a human resource audit to establish the needs of the
business and then either recruiting or training the desired personnel.
The department also handles welfare issues and disciplinary issues
associated with employees. The human resource function is extremely
important as the success of a business depends on having the right
employees in the right jobs with the right skills.

(ii) Marketing is the all-embracing function that links the firm with its
customers in order to get the right product to the right place at the
right time. It is the job of marketing to undertake adequate market
research, both qualitative and quantitative, in order to make decisions
about the most appropriate marketing mix for each product. At all
stages in the marketing process, the department must work closely
with the production and research and development departments to
ensure that what is promised is delivered.

Marketing is important, as it is the link between the customer and the

firm. Effective marketing will allow the business to understand the
needs of its clients and to supply those needs profitably.
 (iii) The role of the research and development (R&D) department is to
continually search for ways of either improving existing products or
creating new products using science and technology. R&D attempts to
convert theoretical knowledge into practical products that will provide
the firm with enhanced or new products. The department is important
because without a continuing development of its product range a firm
will lose ground to its competitors. The aim is always to be ‘first to
market’ with products that consumers desire.

Question 6

(a) Labour turnover is the rate at which employees leave a business. A high
rate of turnover is often caused by one or a combination of low wages, low
morale or poor working conditions. This in turn will increase the costs of
the business as it is forced to recruit and train replacements.

(b) In its simplest form labour turnover can be calculated using the equation:

Number of employees leaving/Total workforce * 100%

(c) The cost of training employees is not just the direct charge for a course.
While the employee is being trained the firm is losing the production that
the worker would have contributed. Where training is provided internally
there is also the overhead cost of the training area as well as the running
costs of the training department including salaries and training materials.
In cases leading to external qualifications there might also be examination
and resource material costs.

The benefits of training, however, often outweigh the financial costs.

Training should mean that the workforce is more skilled, more flexible and
can adjust faster to changes required by customers. This in itself should
provide a firm with a competitive advantage. Training also has a
motivational impact. A well-trained labour force often has a lower labour
turnover, which reduces recruitment and induction costs. Productivity is
also affected in that better trained personnel can achieve higher outputs
per period thus reducing overall unit costs. Investment in human capital is
as important as investment in new machinery.

Question 7

(a) (i) Current ratio = Current assets/Current liabilities

The current ratio is a measure of a firm’s ability to meet its short-term

debts. It is a main test of liquidity, the ability to settle debts as they
fall due by having available the necessary cash. The ratio should be
between 1.5 and 2, signifying sufficient liquid assets to meet its
obligations. Insufficient liquid assets could result in the closure of the
business.

(ii) Return on capital employed =

Operating profit/Total capital employed * 100%
 This ratio is often referred to as the prime ratio as it measures the
ability of the firm to generate profits from the long-term capital
employed in the business. A firm’s return on capital employed enables
a judgement to be made on the financial effectiveness of the current
policies of management.

(iii) Gearing measures the proportion of capital employed that is provided

by long-term lenders. The gearing ratio is given by the equation:

Gearing = Long-term liabilities/Total capital employed *100

(b) Working capital is the day-to-day finance required to run a business. It is

the finance required to pay for raw materials, running costs, labour and to
finance credit offered to customers.

Cash flow management is one of the most important functions of the

finance department. One reason why cash is so important is to meet daily
bills as they become due. If a company delays paying its suppliers they may
be reluctant to continue supplying the firm or to offer cost saving
discounts. In a similar way employees would not like any delay in receiving
their wages.

A second reason for good control of cash is to satisfy major creditors

especially banks who might have issued loans to the business or extended
overdraft facilities. Difficulties in meeting regular repayments could lead to
the firm’s closure.

A third reason for having adequate cash is for unforeseen events. These
could be such events as special deals on raw materials that might be
offered for cash-only settlement or to compensate for debtors lengthening
the period of repayment. In either case cash will be needed.

Question 8

(a) (i) Job production – This is for one-off, special orders that are custom-
built to the client’s specifications. Materials and parts are bought in
especially for the one order. Highly skilled workers are required to
interpret and construct the specialist design. General-purpose
machinery and tools are required as each order is different. There are
few opportunities for economies of scale as there is little chance of any
repeat orders.

(ii) Batch production – This involves the making of a large number of

identical items. More division of labour occurs so there is some
opportunity for the use of specialist machinery as well as general-
purpose machinery. The labour, therefore, need not be as skilled.
Advanced planning and procurement are possible with large batch
sizes.

(b) (i) The business – Advantages include increased output, the availability
of economies of scale, greater scope for standardisation, lower labour
costs, increased productivity, more assured quality and most
 important lower unit costs. Disadvantages include the high initial cost
of investment, the need for a large constant demand and the higher
impact on production of any breakdown in machinery.

(ii) The employee – An employee does not require sophisticated training as

the system is highly mechanised. There is less for the employee to
worry about or to be responsible for. The skills are transferable to
other production lines. The main disadvantage is that the tasks can be
very repetitive and boring. Production line work is often done on a
shift basis resulting in the working of unsociable hours. The operative
remains low skilled.