Achieving quality production

Quality means to produce a good or service which meets customer expectations. The
products should be free of faults or defects. Quality is important because it:
• establishes a brand image
• builds brand loyalty
• maintains good reputation
• increase sales
• attract new customers

If there is no quality, the firm will

• lose customers to other brands
• have to replace faulty products and repeat poor service, increasing costs
• bad reputation leading to low sales and profits
There are three methods a business can implement to achieve quality: quality control, quality
assurance and total quality management.

Quality Control

Quality control is the checking for quality at the end of the production process, whether
a good or a service.
Advantages:
• Eliminates the fault or defect before the customer receives it, so better customer
satisfaction
• Not much training required for conducting this quality check
Disadvantages:
• Still expensive to hire employees to check for quality
• Quality control may find faults and errors but doesn’t find out why the fault has
occurred, so it’s difficult to solve the problem
• if product has to be replaced and reworked, then it is very expensive for the firm
Quality Assurance

Quality assurance is the checking for quality throughout the production process of a
good or service.
Advantages:
• Eliminates the fault or defect before the customer receives it, so better customer
satisfaction
• Since each stage of production is checked for quality, faults and errors can be
easily identified and solved
• Products don’t have to be scrapped or reworked as often, so less expensive than
quality control
Disadvantages:
• Expensive to carry out since quality checks have to be carried throughout the entire
process, which will require manpower and appropriate technology at every stage.
• How well will employees follow quality standards? The firm will have to ensure that
every employee follows quality standards consistently and prudently, and knows how
to address quality issues.
Total Quality Management (TQM)
Total Quality Management or TQM is the continuous improvement of products and
production processes by focusing on quality at each stage of production. There is
great emphasis on ensuring that customers are satisfied. In TQM, customers just aren’t the
consumers of the final product. It is every worker at each stage of production. Workers at
one stage have to ensure the quality standards are met for the product in production at their
stage before they are passed onto the next stage and so on. Thus, quality is maintained
throughout production and products are error-free.
TQM also involves quality circles and like Kaizen, workers come together and discuss issues
and solutions, to reduce waste ensure zero defects.

Advantages:
• quality is built into every part of the production process and becomes central to the
workers principles
• eliminates all faults before the product gets to the final customer
• no customer complaints and so improved brand image
• products don’t have to be scrapped or reworked, so lesser costs
• waste is removed and efficiency is improved
Disadvantages:
• Expensive to train employees all employees
• Relies on all employees following TQM– how well are they motivated to follow the
procedures?

How can customers be assured of the quality of a product or service?

They can look for a quality mark on the product like ISO (International Organization for
Standardization). The business with these quality marks would have followed certain quality
procedures to keep the quality mark. For services, a good reputation and positive customer
reviews are good indicators of the service’s quality.
 Locating decisions
Owners need to decide a location for their firm to operate in, at the time of setting up, when it
needs to expand operations, and when the current location proves unsatisfactory for some
reason. Location is important because it can affect the firm’s costs, profits, efficiency, and
the market base it reaches out to.

Factors that affect the location decisions of a manufacturing firm:

• Production Method: when job production is used, the business will operate on a
small scale, so the nearness to components/raw materials won’t be that important.
For flow production, on the other hand, production will be on a large scale- there will
be a huge number of components and transport costs will be high- so components
need to be close by.
• Market: if the product is a consumer good and perishable, the factories need to be
close to the markets to sell out quickly before it perishes.
• Raw Materials/Components: the factories may need to be located close to where
raw materials can be acquired, especially if the raw material is to be processed while
still fresh, like fruits for fruit juice.
• External economies: the business may locate near other firms that support the
business by provide services- eg.: business that install and maintain factory
equipment.
• Availability of labour: Businesses will need to locate near areas where they can get
workers of the skills they need in the factory. If lots of unskilled workers are needed
in the factories firms locate in areas of high unemployment. Wage rates also vary by
location and firms will want to set up in locations where wage rates are low.
• Government Influence: the government sometimes gives incentives and grants to
firms that set up in low-development, rural and high-unemployment areas. There may
also be govt. rules and restrictions in setting up, e.g.: in some areas of great natural
beauty. The business needs to consider these.
• Transport & Communication infrastructure: the factories need to be located near
areas where there are good road/rail/port/air transport systems. If goods are to be
exported, it needs to be set up near ports.
• Power and water supply: factories need water and power to operate and a reliable
and steady supply of both should be ensured by setting up in areas where they are
available.
• Climate: not the most important factor but can influence certain sectors. Eg.: the dry
climate in Silicon Valley aids the manufacturing of silicon chips.
• Owner’s personal preferences
Factors that affect the location decisions of a service-sector firm:
• Customers: service-sector businesses that have direct contact with customers need
to locate in customer-accessible and convenient places. Eg.; restaurants,
hairdressers, post offices etc.
• Technology: today, with increasing use of IT to shop and make payments,
customers do not need direct access to services and proximity to the
market/customer is not a very important factor in location decisions. They locate
away from customers in places where there are low rent and wage rates. Eg.: banks
• Availability of labour: if large number of workers are required in the firm, then it will
need to locate close to residential areas. If they want certain types of worker skills,
they will need to locate in places where such skilled workers can be found. However,
with work-from-home and technology, this is not that big of a factor nowadays.
• Climate: tourism services need to be in places of good climate.
• Nearness to other business: some services serve the needs of large companies,
such as firm equipment servicing and so they need to be very close to such
businesses. Businesses may also set up where close competitors are to watch them
and snatch away their customers.
• Rent/taxes
• Owner’s personal preferences

Factors that affect the location decisions of a retailing firm:

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

Why businesses locate in different countries?

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

• to encourage businesses to set up and expand in areas of high unemployment and

under-development. Grants and subsidies can be given to businesses that set up in
such areas.
• to discourage firms from setting in areas of that are overcrowded or renowned for
natural beauty. Planning restrictions can be put into place to do so.
 Business finance: needs and sources
Finance is the money required in the business. Finance is needed to set up the business,
expand it and increase working capital (the day-to-day running expenses).
Start-up capital is the initial capital used in the business to buy fixed and current assets
before it can start trading.
Working Capital finance needed by a business to pay its day-to-day running expenses
Capital expenditure is the money spent on fixed assets (assets that will last for more than a
year). Eg.: vehicles, machinery, buildings etc. These are long-term capital needs.
Revenue Expenditure, like working capital, is the money spent on day-to-day expenses
which does not involve the purchase of long-term assets. Eg.: wages, rent. These are short-
term capital needs.
Sources of Finance

Internal finance is obtained from within the business itself.

• Retained Profit: profit kept in the business after owners have been given their share
of the profit. Firms can invest this profit back in the businesses.
Advantages:
– Does not have to be repaid, unlike, a loan.
– No interest must be paid
Disadvantages:
– A new business will not have retained profit
– Profits may be too low to finance
– Keeping more profits to be used as capital will reduce owner’s share of profit and
they may resist the decision.
• Sale of existing assets: assets that the business doesn’t need anymore, for
example, unused buildings or spare equipment can be sold to raise finance
Advantages:
– Makes better use of capital tied up in the business
– Does not become debt for the business, unlike a loan.
Disadvantages:
– Surplus assets will not be available with new businesses
– Takes time to sell the asset and the expected amount may not be gained for the
asset
• Sale of inventories: sell of finished goods or unwanted components in inventory.
Advantage:
– Reduces costs of inventory holding
Disadvantage:
– If not enough inventory is kept, unexpected increase demand form customers
cannot be fulfilled
• Owner’s savings: For a sole trader and partnership, since they’re unincorporated
(owners and business is not separate), any finance the owner directly invests from
his own saving will be internal finance.
Advantages:
– Will be available to the firm quickly
– No interest must be paid.
Disadvantages:
– Increases the risk taken by the owners.
External finance is obtained from sources outside of the business.
• Issue of share: only for limited companies.

Advantage:
• A permanent source of capital, no need to repay the money to
shareholders
no interest must be paid
Disadvantages:
•
Dividends must be paid to the shareholders
•
If many shares are bought, the ownership of the business will change
hands. (The ownership is decided by who has the highest percentage of
shares in the company)
• Bank loans: money borrowed from banks

Advantages:
• Quick to arrange a loan
• Can be for varying lengths of time
• Large companies can get very low rates of interest on their loans

Disadvantages:
• Need to pay interest on the loan periodically
• It must be repaid after a specified length of time
• Need to give the bank a collateral security (the bank will ask for some
valued asset, usually some part of the business, as a security they can
use if at all the business cannot repay the loan in the future. For a sole
trader, his house might be collateral. So there is a risk of losing highly
valuable assets)
• Debenture issues: debentures are long-term loan certificates issued by companies.
Like shares, debentures will be issued, people will buy them and the business can
raise money. But this finance acts as a loan- it will have to be repaid after a specified
period of time and interest will have to be paid for it as well.

Advantage:
• Can be used to raise very long-term finance, for example, 25 years

Disadvantage:
• Interest must be paid and it has to be repaid
• Debt factoring: a debtor is a person who owes the business money for the goods
they have bought from the business. Debt factors are specialist agents that can
collect all the business’ debts from debtors.

Advantages:
• Immediate cash is available to the business
• Business doesn’t have to handle the debt collecting

Disadvantage:
• The debt factor will get a percent of the debts collected as reward. Thus,
the business doesn’t get all of their debts
• Grants and subsidies: government agencies and other external sources can give
the business a grant or subsidy
Advantage:
• Do not have to be repaid, is free

Disadvantage:
• There are usually certain conditions to fulfil to get a grant. Example, to
locate in a particular under-developed area.
• Micro-finance: special institutes are set up in poorly-developed countries where
financially-lacking people looking to start or expand small businesses can get small
sums of money. They provide all sorts of financial services
• Crowdfunding: raises capital by asking small funds from a large pool of people, e.g.
via Kickstarter. These funds are voluntary ‘donations’ and don’t have to be return or
paid a dividend.

Short-term finance provides the working capital a business needs for its day-to-day
operations.
• Overdrafts: similar to loans, the bank can arrange overdrafts by allowing businesses
to spend more than what is in their bank account. The overdraft will vary with each
month, based on how much extra money the business needs.

Advantages:
• Flexible form of borrowing since overdrawn amounts can be varied each
month
• Interest has to be paid only on the amount overdrawn
• Overdrafts are generally cheaper than loans in the long-term

Disadvantages:
• Interest rates can vary periodically, unlike loans which have a fixed
interest rate.
• The bank can ask for the overdraft to be repaid at a short-notice.
• Trade Credits: this is when a business delays paying suppliers for some time,
improving their cash position

Advantage:
• No interests, repayments involved

Disadvantage:
•If the payments are not made quickly, suppliers may refuse to give
discounts in the future or refuse to supply at all
• Debt Factoring: (see above)
Long-term finance is the finance that is available for more than a year.
• Loans: from banks or private individuals.
• Debentures
• Issue of Shares
• Hire Purchase: allows the business to buy a fixed asset and pay for it in monthly
instalments that include interest charges. This is not a method to raise capital but
gives the business time to raise the capital.

Advantage:
• The firms don’t need a large sum of cash to acquire the asset

Disadvantage:
• A cash deposit has to be paid in the beginning
• Can carry large interest charges.
• Leasing: this allows a business to use an asset without purchasing it. Monthly
leasing payments are instead made to the owner of the asset. The business can
decide to buy the asset at the end of the leasing period. Some firms sell their assets
for cash and then lease them back from a leasing company. This is called sale and
leaseback.

Advantages:
• The firm doesn’t need a large sum of money to use the asset
• The care and maintenance of the asset is done by the leasing company

Disadvantage:
• The total costs of leasing the asset could finally end up being more than
the cost of purchasing the asset!

Factors that affect choice of source of finance

• Purpose: if a fixed asset is to be bought, hire purchase or leasing will be appropriate,
but if finance is needed to pay off rents and wages, debt factoring, overdrafts will be
used.
• Time-period: for long-term uses of finance, loans, debenture, and share issues are
used, but for a short period, overdrafts are more suitable.
• Amount needed: for large amounts, loans and share issues can be used. For
smaller amounts, overdrafts, sale of assets, debt factoring will be used.
• Legal form and size: only a limited company can issue shares and debentures.
Small firms have limited sourced of finances available to choose from
• Control: if limited companies issue too many shares, the current owners may lose
control of the business. They need to decide whether they would risk losing control
for business expansion.
• Risk- gearing: if business has existing loans, borrowing more capital can increase
gearing- risk of the business- as high interests have to be paid even when there is no
profit, loans and debentures need to be repaid etc. Banks and shareholders will be
reluctant to invest in risky businesses.
Finance from banks and shareholders
Chances of a bank willing to lend a business finance is higher when:
• A cash flow forecast is presented detailing why finance is needed and how it will be
used
• An income statement from the last trading year and the forecast income statement
for the next year, to see how much profit the business makes and will make.
• Details of existing loans and sources of finance being used
• Evidence that a security/collateral is available with the business to reduce the bank’s
risk of lending
• A business plan is presented to explain clearly what the business hopes to achieve
in the future and why finance is important to these plans
Chances of a shareholder willing to invest in a business is higher when:
• the company’s share prices are increasing- this is a good indicator of improving
performance
• dividends and profits are high
• the company has a good reputations and future growth plans
 Cash flow forecasting and working capital

Why is cash important?

If a firm doesn’t have any cash to pay its workers, suppliers, landlord and government, the
business could go into liquidation– selling everything it owns to pay its debts. The business
needs to have an adequate amount of cash to be able to pay for all its short-term payments.
Cash Flow

The cash flow of a businesses is its cash inflows and cash outflows over a period of time.
Cash inflows are the sums of money received by the business over a period of time. E.g.:
• sales revenue from sale of products
• payment from debtors– debtors are customers who have already purchased goods
from the business but didn’t pay for them at that time
• money borrowed from external sources, like loans
• the money from the sale of business assets
• investors putting more money into the business
Cash outflows are the sums of money paid out by the business over a period of time. Eg.:
• purchasing goods and materials for cash
• paying wages, salaries, and other expenses in cash
• purchasing fixed assets
• repaying loans (cash is going out of the business)
• by paying creditors of the business- creditors are suppliers who supplied items to
the business but were not paid at the time of supply.
The cash flow cycle:

Cash flow is not the same as profit! Profit is the surplus amount after total costs have
been deducted from sales. It includes all income and payments incurred in the year, whether
already received or paid or to not yet received or paid respectfully. In a cash flow, only those
elements paid by cash are considered.
Cash Flow Forecasts

A cash flow forecast is an estimate of future cash inflows and outflows of a business, usually
on a month-by-month basis. This then shows the expected cash balance at the end of each
month. It can help tell the manager:
• how much cash is available for paying bills, purchasing fixed assets, or repaying
loans
• how much cash the bank will need to lend to the business to avoid insolvency
(running out of liquid cash)
• whether the business has too much cash that can be put to a profitable use in the
business
Example of a cash flow forecast for the four months:

The cash inflows are listed first and then the cash outflows. The total inflows and outflows
have to be calculated after each section.

The opening cash/bank balance is the amount of cash held by the business at the start of
the month
Net Cash Flow = Total Cash Inflow – Total Cash Outflow
The net cash flow is added to opening cash balance to find the closing cash/bank
balance– the amount of cash held by the business at the end of the month. Remember, the
closing cash/bank balance for one month is the opening cash/bank balance for the next
month!
The figures in bracket denote a negative balance, i.e., a net cash outflow (outflows > inflows)
Uses of cash flow forecasts:
• when setting up the business the manager needs to know how much cash is
required to set up the business. The cash flow forecast helps calculate the cash
outflows such as rent, purchase of assets, advertising etc.
• A statement of cash flow forecast is required by bank managers when the
business applies for a loan. The bank manager will need to know how much to
lend to the business for its operations, when the loan is needed, for how long it is
needed and when it can be repaid.
• Managing cash flow– if the cash flow forecast gives a negative cash flow for a
month(s), then the business will need to plan ahead and apply for an overdraft so
that the negative balance is avoided (as cash come in and the inflow exceeds the
outflow). If there is too much cash, the business may decide to repay loans (so that
interest payment in the future will be low) or pay off creditors/suppliers (to maintain
healthy relationship with suppliers).

How can cash flow problems be overcome?

When a negative cash flow is forecast (lack of cash) the following methods can be used to
correct it:

• Increase bank loans: bank loans will inject more cash into the business, but the firm
will have to pay regular interest payments on the loans and it will eventually have to
be repaid, causing future cash outflows
• Delay payment to suppliers: asking for more time to pay suppliers will help
decrease cash outflows in the short-run. However, suppliers could refuse to supply
on credit and may reduce discounts for late payment
• Ask debtors to pay more quickly: if debtors are asked to pay all the debts they
have to the firm quicker, the firm’s cash inflows would increase in the short-run.
These debtors will include credit customers, who can be asked to make cash sales
as opposed to credit sales for purchases (cash will have to be paid on the spot, credit
will mean they can pay in the future, thus becoming debtors). However, customers
may move to other businesses that still offers them time to pay
• Delay or cancel purchases of capital equipment: this will greatly help reduce cash
outflows in the short-run, but at the cost of the efficiency the firm loses out on not
buying new technology and still using old equipment.
In the long-term, to improve cash flow, the business will need to attract more investors, cut
costs by increasing efficiency, develop more products to attract customers and increase
inflows.
Working Capital

Working capital the capital required by the business to pay its short-term day-to-day
expenses. Working capital is all of the liquid assets of the business– the assets that can
be quickly converted to cash to pay off the business’ debts. Working capital can be in the
form of:
• cash needed to pay expenses
• cash due from debtors – debtors/credit customers can be asked to quickly pay off
what they owe to the business in order for the business to raise cash
• cash in the form of inventory – Inventory of finished goods can be quickly sold off to
build cash inflows. Too much inventory results in high costs, too low inventory may
cause production to stop.