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Business Studies IGCSE Notes C Huru
Business Studies IGCSE Notes C Huru
Business Studies
Notes
Edited by: C Huru
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Contents
1.4 – Types of Business Organizations ................................................................................................. 11
1.5 – Business Objectives and Stakeholder Objectives ....................................................................... 14
2.1 – Motivating Workers .................................................................................................................... 18
2.2 – Organization and Management .................................................................................................. 22
2.3 – Recruitment, Selection and Training of Workers ....................................................................... 26
2.4 – Internal and External Communication........................................................................................ 31
3.1 – Marketing, Competition and the Customer ............................................................................... 36
3.2 – Market Research ......................................................................................................................... 39
3.3 – Marketing Mix ............................................................................................................................. 44
Product ......................................................................................................................................... 44
Price .............................................................................................................................................. 47
Promotion ..................................................................................................................................... 49
Place .............................................................................................................................................. 50
Technology and the Marketing Mix ............................................................................................. 52
3.4 – Marketing Strategy...................................................................................................................... 54
4.1 – Production of Goods and Services .............................................................................................. 58
4.2 – Costs, Scale of Production and Break-even Analysis .................................................................. 65
4.3 – Achieving Quality Production ..................................................................................................... 69
4.4 – Location Decisions ....................................................................................................................... 71
5.1 – Business Finance: Needs and Sources ........................................................................................ 74
5.2 – Cash Flow Forecasting and Working Capital .............................................................................. 79
5.3 – Income Statements ..................................................................................................................... 83
5.4 – Balance Sheets............................................................................................................................. 86
5.5 – Analysis of Accounts.................................................................................................................... 88
Limitations of using accounts and ratio analysis......................................................................... 90
6.1 – Government Economic Policies and Objectives ......................................................................... 91
6.2 – Environmental and Ethical Issues ............................................................................................... 96
6.3 – Business and the International Economy ................................................................................... 99
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Chapter 1
Understanding Business activity
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4. Enterprise-The risk-taking ability of the person who brings the other factors
of production together to produce a good or service. The reward for
enterprise is profit from the business.
Specialization
Specialization occurs when a person or organisation concentrates on a task
at which they are best at. Instead of everyone doing every job, the tasks are
divided among people who are skilled and efficient at them.
Advantages
• Workers are trained to do a particular task and specialise in this-
thus increasing efficiency
• Saves time and energy- production is faster by specialising.
• Quicker to train labourers– Workers only concentrate on a task; they do
not have to be trained in all aspects of the production process.
• Skill development- workers can develop their skills as they do the same
tasks repeatedly, mastering it.
Disadvantages
Why Business?
So, we’ve gone through factors of production, the problem of scarcity and
specialization, but what is business?
Business is any organization that uses all the factors of production
(resources) to create goods and services to satisfy human wants and
needs.
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Added Value
Added value is the difference between the cost of materials bought in and
the selling price of the product.
Which is, the amount of value the business had added to the raw materials by
turning it into finished products. Every business wants to add value to their products
so they may charge a higher price for their products and gain more profits.
How to increase added value?
• Reducing the cost of production. Added value of a product is its price less
the cost of production. Reducing cost of production will increase the added
value.
• Raising prices. By increasing prices, they can raise added value, in the same
way as described above.
But there will be problems to both of this. To lower cost of production, cheap labour,
raw materials etc may have to be employed, which will create poor quality products
and only lowers the value of the product. People may not buy it. And when prices
are raised, the high price may result in customer loss, as they will turn to cheaper
products.
In a practical example, how would you add value to a jewellery store?
• Design an attractive package to put the jewellery items in.
• An attractive shop-window-display.
• Well-dressed and knowledgeable shop assistants.
All of this will help the jewellery store to raise prices above the additional costs
involved.
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1.2 – Classification of Businesses
Primary, Secondary and Tertiary Sector
Businesses can be classified into three sectors:
Primary sector: this involves the use/extraction of natural resources.
Examples include agricultural activities, mining, fishing, wood-cutting, oil drilling etc.
Secondary sector: this involves the manufacture of goods using the resources
from the primary sector. Examples include auto-mobile manufacturing, steel
industries, cloth production etc.
Tertiary sector: this consist of all the services provided in an economy. This
includes hotels, travel agencies, hair salons, banks etc.
Up until the mid-18th century, the primary sector was the largest sector in the
world, as agriculture was the main profession. After the industrial revolution, more
countries began to become more industrialized and urban, leading to a rapid
increase in the manufacturing sector (industrialization).
Nowadays, as countries are becoming more developed, the importance of tertiary
sector is increasing, while the primary sector is diminishing. The secondary sector is
also slightly reducing in size (de-industrialization) compared to the growth of the
tertiary sector. This is due to the growing incomes of consumers which raises their
demand for more services like travel, hotels etc.
Private and Public Sector
Private sector: where private individuals own and run business ventures.
Example: Nike is a private sector business.
Public sector: where the government owns and runs business ventures.
Example: the Indian Railways is a public sector organization owned by the govt. of
India.
In a mixed economy, both the public and private sector exists.
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1.3 – Enterprise, Business Growth and Size
Enterprise and entrepreneurship
An entrepreneur is a person who organizes, operates and takes risks for a
new business venture. The entrepreneur brings together the various factors of
production to produce goods or services. Check below to see whether you have what
it takes to be a successful entrepreneur!
• Risk taker
• Creative
• Optimistic
• Self-confident
• Innovative
• Independent
• Effective communicator
• Hard working
Business plan
A business plan is a document containing the business objectives and important
details about the operations, finance and owners of the new business.
Making a business plan before actually starting the business can be very helpful. By
documenting the various details about the business, the owners will find it much
easier to run it. There is a lesser chance of losing sight of the mission and
vision of the business as the objectives have been written down. Moreover, having
the objectives of the business set down clearly will help motivate the employees.
A new entrepreneur will find it easier to get a loan or overdraft from the bank if
they have a business plan.
Comparing business sizes
Businesses come in many shapes and sizes. They can be owned by a single
individual or have up to 50 shareholders. They can employ thousands of workers or
have a mere handful. But how can we classify a business as big or small?
Business size can be measured in the following ways:
• Number of employees
• Value of output
• Value of sales
• Value of capital employed
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• Profits
However, these methods have their limitations and are not always accurate.
Example: When using the ‘number of employees’ method to compare business size.
This method states that more workers employed means a bigger business. This is
not accurate as a capital-intensive firm (one that employs a large amount of capital
equipment) can produce large output by employing very little labour (workers).
Business growth
How can a business grow?
There are two ways in which a business can grow- internally and externally.
Internal growth
This occurs when a business expands its existing operations. For example,
when a fast food chain opens a new branch in another country. This is a slow means
of growth but easier to manage than external growth.
External growth
This is when a business takes over or merges with another business. It is
sometimes called integration as one firm is ‘integrated’ into the other.
A merger is when the owner of two businesses agree to join their firms together to
make one business.
A takeover occurs when one business buys out the owners of another business,
which then becomes a part of the ‘predator’ business.
External growth can largely be classified into three types:
•
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another firm in the same industry but at a different stage of
production. Therefore, vertical integration can be of two types:
• Backward vertical integration: When one firm merges with
or takes over another firm in the same industry but at a stage
of production that is behind the ‘predator’ firm. For
example, when a firm that manufactures furniture merges with
a firm that supplies wood for manufacturing furniture.
Benefits:
• Merger gives assured supply of essential components.
• The profit margin of the supplying firm is now absorbed
by the expanded firm.
• The supplying firm can be prevented from supplying to
competitors.
• Forward vertical integration: When one firm merges with or
takes over another firm in the same industry but at a stage of
production that is ahead of the ‘predator’ firm. For
example, when a firm that manufactures furniture merges with
a furniture retail store.
Benefits:
• Merger gives assured outlet for their product.
• The profit margin of the retailer is now absorbed by the
expanded firm.
• The retailer can be prevented from selling the goods of
competitors.
• Conglomerate merger/integration: This is when one firm merges with
or takes over a firm in a completely different industry. This is also
known as ‘diversification’. For example, when a firm that manufactures
furniture merges with a firm that produces clothing.
Benefits:
• Conglomerate integration allows businesses to have activities in more
than one country. This allows the firms to spread its risks.
• There could be a transfer of ideas between the two businesses even
though they are in different industries. This transfer of ideas could help
improve the quality and demand for the two products.
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Why businesses stay small
Not all businesses grow. Some stay small, employ a handful of workers and have
little output. Here are the reasons why.
• Type of industry: Some firms remain small due to the industry they operate
in. Examples of these are hairdressers, car repairs, catering, etc, which give
personal services and therefore cannot grow.
• Market size: If the firm operates in areas where the total number of
customers is small, such as in rural areas, there is no need for the firm to
grow and thus stays small.
• Owners’ objectives: Not all owners want to increase the size of their firms
and profits. Some of them prefer keeping their businesses small and having a
personal contact with all of their employees and customers.
Why businesses fail
For lack of a better way to start this paragraph. Not all businesses are successful.
For new firms especially, the rate of failure is rather high. The main reasons why
they fail are:
• Poor management: This is a common cause of business failure for new
firms. The main reason is lack of experience which could lead to bad decision
making. New entrepreneurs could make mistakes when choosing the location
of the firm, the raw materials to be used for production, etc, all resulting in
failure.
• Over-expansion: This could lead to diseconomies of scale and greatly
increase costs. this could happen if a firm expands too quickly or over their
optimum level.
• Failure to plan for change: The demands of customers keep changing with
change in tastes and fashion. Due to this, firms must always be ready to
change their products to meet the demand of their customers. Failure to do
so could result in losing customers and loss.
• Poor financial management: If the owner of the firm does not manage his
finances properly, it could result in cash shortages. This will mean that the
employees cannot be paid and enough goods cannot be produced. Poor cash
flow can therefore also cause businesses to fail.
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1.4 – Types of Business Organizations
Disadvantages:
1. Unlimited liability: if the business has bills/debts left unpaid, legal actions will
be taken against the investors, where their even personal property can be seized,
if their investments don’t meet the unpaid amount. This is because the business
and the investors are the legally not separate (unincorporated).
2. Full responsibility: Since there is only one owner, the sole owner has to
undertake all running activities. He/she doesn’t have anyone to share his
responsibilities with. This workload and risks are fully concentrated on him/her.
3. Lack of capital: As only one owner/investor is there, the amount of capital
invested in the business will be very low. This can restrict growth and expansion
of the business. Their only sources of finance will be personal savings or
borrowing or bank loans (though banks will be reluctant to lend to sole traders
since it is risky).
4. Lack of continuity: If the owner dies or retires, the business dies with him/her.
Partnerships
A partnership is a legal agreement between two or more (usually, up to twenty)
people to own, finance and run a business jointly and to share all profits.
Advantages:
1. Easy to set up: Similar to sole traders, very few legal formalities are required to
start a partnership business. A partnership agreement/ partnership deed is a
legal document that all partners have to sign, which forms the partnership. There
is no need to publish annual financial accounts.
2. Partners can provide new skills and ideas: The partners may have some
skills and ideas that can be used by the business to improve business profits.
3. More capital investments: Partners can invest more capital than what a sole
trade only by himself could.
Disadvantages:
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1. Conflicts: arguments may occur between partners while making decisions. This
will delay decision-making.
2. Unlimited liability: similar to sole traders, partners too have unlimited liability-
their personal items are at risk if business goes bankrupt
3. Lack of capital: smaller capital investments as compared to large companies.
4. No continuity: if an owner retires or dies, the business also dies with them.
Joint-stock companies
These companies can sell shares, unlike partnerships and sole traders, to raise
capital. Other people can buy these shares (stocks) and become
a shareholder (owner) of the company. Therefore, they are jointly owned by the
people who have bought its stocks. These shareholders then
receive dividends (part of the profit; a return on investment).
The shareholders in companies have limited liabilities. That is, only their
individual investments are at risk if the business fails or leaves debts. If the company
owes money, it can be sued and taken to court, but it’s shareholders cannot.
The companies have a separate legal identity from their owners, which is why
the owners have a limited liability. These companies are incorporated.
Companies also enjoys continuity, unlike partnerships and sole traders. That is, the
business will continue even if one of its owners retire or die.
Shareholders will elect a board of directors to manage and run the company in its
day-to-day activities. In small companies, the shareholders with the highest
percentage of shares invested are directors, but directors don’t have to be
shareholders. The more shares a shareholder has, the more their voting power.
Public Limited Companies: Two or more owners who can sell its’ shares to any
individual/organization in the general public through stock exchanges (see
Economics: topic 3.1 – Money and Finance). Example: Verizon Communications.
Advantages:
1. Limited Liability: this is because, the company and the shareholders have
separate legal identities.
2. Raise huge amounts of capital: selling shares to other people (especially in
Public Ltd. Co.’s), raises a huge amount of capital, which is why companies are
large.
3. Public Ltd. Companies can advertise their shares, in the form of
a prospectus, which tells interested individuals about the business, it’s activities,
profits, board of directors, shares on sale, share prices etc. This will attract
investors.
Disadvantages:
1. Required to disclose financial information: Sometimes, private limited
companies are required by law to publish their financial statements annually, while
for public limited companies, it is legally compulsory to publish all accounts and
reports. All the writing, printing and publishing of such details can prove to be
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very expensive, and other competing companies could use it to learn the company
secrets.
2. Private Limited Companies cannot sell shares to the public. Their shares
can only be sold to people they know with the agreement of other shareholders.
Transfer of shares is restricted here. This will raise lesser capital than Public Ltd.
Companies.
3. Public Ltd. Companies require a lot of legal documents and investigations
before it can be listed on the stock exchange.
4. Public and Private Limited Companies must also hold an Annual General
Meeting (AGM), where all shareholders are informed about the performance of
the company and company decisions, vote on strategic decisions and elect board
of directors. This is very expensive to set up, especially if there are thousands of
shareholders.
5. Public Ltd. Companies may have managerial problems: since they are very
large, they become very difficult to manage. Communication problems may occur
which will slow down decision-making.
6. In Public Ltd. Companies, there may be a divorce of ownership
and control: The shareholders can lose control of the company when other large
shareholders outvote them or when board of directors control company decisions.
A summary of everything learned until now, in this section, in case you’re getting
confused:
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1.5 – Business Objectives and Stakeholder Objectives
Business objectives:
Business objectives are the aims and targets that a business works towards to help it
run successfully. Although the setting of these objectives does not always
guarantee the business success, it has its benefits.
• Survival: New or small firms usually have survival as a primary objective. Firms
in a highly competitive market will also be more concerned with survival rather
than any other objective. To achieve this, firms could decide to lower prices, which
would mean forsaking other objectives such as profit maximization.
• Profit: This is the income of a business from its activities after deducting total
costs. Private sector firms usually have profit making as a primary objective. This
is because profits are required for further investment into the business as well
as for the payment of return to the shareholders/owners of the business.
• Growth: Once a business has passed its survival stage it will aim for growth and
expansion. This is usually measured by value of sales or output. Aiming for
business growth can be very beneficial. A larger business can ensure greater
job security and salaries for employees. The business can also benefit from
higher market share and economies of scale.
• Market share: This can be defined as the proportion of total market sales
achieved by one business. Increased market share can bring about many benefits
to the business such as increased customer loyalty, setting up of brand image,
etc.
• Service to the society: Some operations in the private sectors such as social
enterprises do not aim for profits and prefer to set more economical objectives.
They aim to better the society by providing social,
environmental and financial aid.
A business’ objectives do not remain the same forever. As market situations change
and as the business itself develops, its objectives will change to reflect its current
market and economic position. For example, a firm facing serious economic
recession could change its objective from profit maximization to short term survival.
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Stakeholder groups:
A stakeholder is any person or group that is interested in or directly
affected by the performance or activities of a business. These stakeholder
groups can be external – groups that are outside the business or they can be
internal – those groups that work for or own the business. Following are some of the
stakeholder’s groups and their objectives:
Shareholder/ Owners:
These are the risk takers of the business. They invest capital into the
business to set up and expand it. These shareholders are liable to a share of the
profits made by the business.
Objectives:
• Shareholders are entitled to a rate of return on the capital they have
invested into the business and will therefore have profit maximization as an
objective.
• Business growth will also be an important objective as this will ensure that the
value of the shares will increase.
Workers:
These are the people that are employed by the business and are directly
involved in its activities.
Objectives:
• Contract of employment that states all the right and responsibilities to and of
the employees.
• Regular payment for the work done by the employees.
• Workers will want to benefit from job satisfaction as well as motivation.
• The employees will want job security– the ability to be able to work without the
fear of being dismissed or made redundant.
Managers:
They are also employees but managers control the work of others. Managers
are in charge of making key business decisions.
Objectives:
• Like regular employees, managers too will aim towards a secure job.
• Higher salaries due to their jobs requiring more skill and effort.
• Managers will also wish for business growth as a bigger business means that
managers can control a bigger and well-known business.
Customers:
Customers are a very important part of every business. They purchase and
consume the goods and services that the business produces/ provides.
Successful businesses use market research to find out customer preferences
before producing their goods.
Objectives:
• Price that reflects the quality of the good.
• The products must be reliable and safe. i.e., there must not be any false
advertisement of the products.
• The products must be well designed and of a perceived quality.
Government:
The role of the government is to protect the workers and customers from the
business’ activities and safeguard their interests.
Objectives:
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• The government will want the business to grow and survive as they will bring a lot
of benefits to the economy. A successful business will help increase the total
output of the country, will improve employment as well as increase
government revenue through payment of taxes.
• They will expect the firms to stay within the rules and regulations set by the
government.
Banks:
These banks provide financial help for the business’ operations’
Objectives:
• The banks will expect the business to be able to repay the amount that has been
lent along with the interest on it. The bank will thus have business liquidity as its
objective.
Community:
This consists of all the stakeholder groups, especially the third parties that are
affected by the business’ activities.
Objectives:
• The business must offer jobs and employ local employees.
• The production process of the business must in no way harm the
environment.
• Products must be socially responsible and must not pose any harmful effects
from consumption.
Public- sector businesses:
Government owned and controlled businesses do not have the same objectives as
those in the private sector.
Objectives:
• Financial: Although these businesses do not aim to maximize profits, they will
have to meet the profit target set by the government. This is so that it can be
reinvested into the business for meeting the needs of the society.
• Service: The main aim of this organization is to provide a service to the
community that must meet the quality target set by the government.
• Social: Most of these social enterprises are set up in order to aid the community.
This can be by providing employment to local citizens, providing good quality
goods and services at an affordable rate, etc.
Conflicts of stakeholders’ objectives:
As all stakeholders have their own aims they would like to achieve, it is natural that
conflicts of stakeholders’ interests could occur. Therefore, if a business tries to
satisfy the objectives of one stakeholder, it might mean that other stakeholders’
objectives could go unfulfilled.
For example, workers will aim towards earning higher salaries. Shareholders might
not want this to happen as paying higher salaries could mean that less profit will be
left over for payment of return to the shareholders.
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Chapter 2
People in Business
People work to earn money and fulfil their basic necessities and wants. But there are
several other reasons for work as well.
Motivation is the reason why employees want to work hard and work
effectively for the business. Money is the main motivator, as explained above.
Other factors that may motivate a person to choose to do a particular job may
include social needs (need to communicate and work with others), esteem needs (to
feel important, worthwhile), job satisfaction (to enjoy good work), security (knowing
that your job and pay are secure- that you will not lose your job).
Why motivate workers? Why do firms go to the pain of making sure their
workers are motivated? When workers are well-motivated, they become
highly productive and effective in their work and thus increases the firm’s
efficiency and output, leading to higher profits. For example, in the service
sector, if the employee is unhappy at his work, he may act lazy and rude to
customers, leading to low customer satisfaction, more complaints and ultimately a
bad reputation and low profits.
Motivation Theories
• F. W. Taylor: Taylor based his ideas on the assumption that workers were
motivated by personal gains, mainly money and that increasing pay would
increase productivity (amount of output produced). Therefore, he proposed
the piece-rate system, whereby workers get paid for the number of outputs
they produce. So, in order, to gain more money, workers would produce more.
However, this theory is not entirely true. There are various other motivators in the
modern workplace, some even more important than money. The piece rate
system is not very practical in situations where output cannot be measured
(service industries) and also will lead to (high) output that doesn’t guarantee high
quality.
• Maslow: Abraham Maslow’s hierarchy of needs shows that employees
are motivated by each level of the hierarchy going from bottom to top.
Mangers can identify which level their workers are on and then take the necessary
action to advance them onto the next level.
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One limitation of this theory is that it doesn’t apply to every worker. For some
employees, for example, social needs aren’t important but they would be
motivated by recognition and appreciation for their work from seniors.
• Herzberg: Frederick Herzberg’s two-factor theory, wherein he states that people
have two sets of needs- one basic animal needs called ‘hygiene factors’, the
other needs that allow the human being to grow psychologically, called
the ‘motivators’.
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According to Herzberg, the hygiene factors need to be satisfied, if not they will act
as de-motivators to the workers. However, hygiene factors don’t act as motivators
as their effect quickly wear off. Motivators will truly motivate workers to work
more effectively.
Motivating Factors
Financial Motivators
• Wages: often paid weekly. They can be calculated in two ways:
• Time-Rate: pay based on the number of hours worked. Although output
may increase, it doesn’t mean that workers will work sincerely use the time to
produce more- they may simply waste time on very few outputs since their
pay is based only on how long they work. The productive and unproductive
worker will get paid the same amount, irrespective of their output.
• Piece-Rate: pay based on the no. of output produced. Same as time-
rate, this doesn’t ensure that quality output is produced. Thus, efficient
workers may feel demotivated as they’re getting the same pay as inefficient
workers, despite their efficiency.
• Salary: paid monthly or annually.
• Commission: paid to salesperson, based on a percentage of sales they’ve made.
The higher the sales, the more the pay. Although this will encourage salespersons
to sell more products and increase profits, it can be very stressful for them
because no sales made means no pay at all.
• Bonus: additional amount paid to workers for good work
• Performance-related pay: paid based on performance. An appraisal (assessing
the effectiveness of an employee by senior management through interviews,
observations, comments from colleagues etc) is used to measure this performance
and a pay is given based on this.
• Profit-sharing: a scheme whereby a proportion of the company’s profits is
distributed to workers. Workers will be motivated to work better so that a higher
profit is made.
• Share ownership: shares in the firm are given to employees so that they can
become part owners of the company. This will increase employees’ loyalty to the
company, as they feel a sense of belongingness.
Non-Financial Motivators
Fringe benefits are non-financial rewards given to employees
• Company vehicle/car
• Free healthcare
• Children’s education fees paid for
• Free accommodation
• Free holidays/trips
• Discounts on the firm’s products
Job Satisfaction: the enjoyment derived from the feeling that you’ve done
a good job. Employees have different ideas about what motivates them- it could be
pay, promotional opportunities, team involvement, relationship with superiors, level
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of responsibility, chances for training, the working hours, status of the job etc.
Responsibility, recognition and satisfaction are in particular very important.
So, how can companies ensure that they’re workers are satisfied with the job, other
than the motivators mentioned above?
• Job Rotation: involves workers swapping around jobs and doing each
specific task for only a limited time and then changing round again. This increases
the variety in the work itself and will also make it easier for managers to move
around workers to do other jobs if somebody is ill or absent. The tasks themselves
are not made more interesting, but the switching of tasks may avoid boredom
among workers. This is very common in factories with a huge production line
where workers will move from retrieving products from the machine to labelling
the products to packing the products to putting the products into huge cartons.
• Job Enlargement: where extra tasks of similar level of work are added to
a worker’s job description. These extra tasks will not add greater responsibility or
work for the employee, but make work more interesting. E.g.: a worker hired to
stock shelves will now, as a result of job enlargement, arrange stock on shelves,
label stock, fetch stock etc.
• Job Enrichment: involves adding tasks that require more skill and
responsibility to a job. This gives employees a sense of trust from senior
management and motivate them to carry out the extra tasks effectively. Some
additional training may also be given to the employee to do so. E.g.: a receptionist
employed to welcome customers will now, as a result of job enrichment, deal with
telephone enquiries, word-process letters etc.
• Team-working: a group of workers is given responsibility for a particular
process, product or development. They can decide as a team how to organize
and carry out the tasks. The workers take part in decision making and take
responsibility for the process. It gives them more control over their work and thus
a sense of commitment, increasing job satisfaction. Working as a group will also
add to morale, fulfil social needs and lead to job satisfaction.
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2.2 – Organization and Management
Organizational Structure
Advantages:
• All employees are aware of which communication channel is used to reach
them with messages
• Everyone knows their position in the business. They know who they are
accountable to and who they are accountable for
• It shows the links and relationship between the different departments
• Gives everyone a sense of belonging as they appear on the organizational chart
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Advantages of a short chain of command (these are also the disadvantages of a long
chain of command):
• Communication is quicker and more accurate
• Top managers are less remote from lower employees, so employees will be
more motivated and top managers can always stay in touch with the employees
• Spans of control will be wider; this means managers have more people to control
This is beneficial because it will encourage them to delegate
responsibility (give work to subordinates) and so the subordinates will be more
motivated and feel trusted. However, there is the risk that managers may lose
control over the tasks.
Line Managers have authority over people directly below them in the
organizational structure. Traditional marketing/operations/sales managers are good
examples.
Staff Managers are specialists who provide support, information and assistance to
line managers. The IT department manager in most organisations act as staff
managers.
Management
So, what role do manager really have in an organization? Here are their five primary
roles:
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Advantages to managers:
• managers cannot do all work by themselves
• managers can measure the efficiency and effectiveness of their subordinates’ work
However, managers may be reluctant to delegate as they may lose their control over
the work.
Advantages to subordinates:
• the work becomes more interesting and rewarding- increased job satisfaction
• employees feel more important and feel trusted– increasing loyalty to firm
• can act as a method of training and opportunities for promotions, if they do a
good job.
Leadership Styles
Leaderships styles refer to the different approaches used when dealing with
people when in a position of authority. There are mainly three styles you need
to learn: the autocratic, democratic and laissez-faire styles.
Autocratic style is where the managers expects to be in charge of the business
and have their orders followed. They do all the decision-making, not involving
employees at all. Communication is thus, mainly one way- from top to bottom. This
is standard in police and armed forces organizations.
Democratic style is where managers involve employees in the decision-making
and communication is two-way from top to bottom as well as bottom to top.
Information about future plans is openly communicated and discussed with
employees and a final decision is made by the manager.
Laissez-faire (French phrase for ‘leave to do’) style makes the broad objectives of
the business known to employees and leaves them to do their own decision-
making and organize tasks. Communication is rather difficult since a clear direction
is not given. The manger has a very limited role to play.
Trade Unions
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A trade union is a group of workers who have joined together to ensure
their interest are protected. They negotiate with the employer (firm) for better
conditions and treatment and can threaten to take industrial action if their requests
are denied. Industrial action can include overtime ban (refusing to work overtime),
go slow (working at the slowest speed as is required by the employment contract),
strike (refusing to work at all and protesting instead) etc. Trade unions can also seek
to put forward their views to the media and influence government decisions relating
to employment.
Benefits to workers of joining a trade union:
• strength in number- a sense of belonging and unity
• improved conditions of employment, for example, better pay, holidays, hours
of work etc
• improved working conditions, for example, health and safety
• improved benefits for workers who are not working, because they’re sick, retired
or made redundant (dismissed not because of any fault of their own)
• financial support if a member thinks he/she has been unfairly dismissed or
treated
• benefits that have been negotiated for union member such as discounts on firm’s
products, provision of health services.
Disadvantages to workers of joining a trade union:
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2.3 – Recruitment, Selection and Training of Workers
The Role of the H.R. (Human Resource) Department
• Recruitment and selection: attracting and selecting the best candidates for job
posts
• Wages and salaries: set wages and salaries that attract and retain employees
as well as motivate them
• Industrial relations: there must be effective communication between
management and workforce to solve complaints and disputes as well as discussing
ideas and suggestions
• Training programmes: give employees training to increase their productivity
and efficiency
• Health and safety: all laws on health and safety conditions in the workplace
should be adhered to
• Redundancy and dismissal: the managers should dismiss any
unsatisfactory/misbehaving employees and make them redundant if they are no
longer needed by the business.
Recruitment
Applicants who are shortlisted will be interviewed by the H.R. manager. They will
also call up the referee provided by the applicant (a referee could be the previous
employer or colleagues who can give a confidential opinion about the applicant’s
reliability, honesty and suitability for the job). Interviews will allow the manager to
assess:
• the applicant’s ability to do the job
• personal qualities of the applicant
• character and personality of applicant
In addition to interviews, firms can conduct certain tests to select the best
candidate. This could include skills tests (ability to do the job), aptitude tests
(candidate’s potential to gain additional skills), personality tests (what kind of a
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personality the candidate has- will it be suitable for the job?), group situation tests
(how they manage and work in teams) etc.
When a successful candidate has been selected the others must be sent a letter of
rejection.
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Induction training: an introduction given to a new employee, explaining the
firm’s activities, customs and procedures and introducing them to their fellow
workers.
Advantages:
Off-the-job training: involves being trained away from the workplace, usually
by specialist trainers
Advantages:
• A broad range of skills can be taught using these techniques
• Employees may be taught a variety of skills and they may become multi-skilled
that can allow them to do various jobs in the company when the need arises.
Disadvantages:
• Costs are high
• It means wages are paid but no work is being done by the worker
• The additional qualifications mean it is easier for the employee to leave and find
another job
Workforce Planning: the establishing of the workforce needed by the business for
the foreseeable future in terms of the number and skills of employees
required.
They may have to downsize (reduce the no. of employees) the workforce because
of:
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• Introduction of automation
• Falling demand for their products
• Factory/shop/office closure
• Relocating factory abroad
• A business has merged or been taken over and some jobs are no longer needed
They can downsize the workforce in two ways:
• Dismissal: where a worker is told to leave their job because their work or
behaviour is unsatisfactory.
• Redundancy: when an employee is no longer needed and so loses their work,
though not due to any fault of theirs. They may be given some money as
compensation for the redundancy.
Worker could also resign (they are leaving because they have found another job)
and retire (they are getting old and want to stop working).
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2.4 – Internal and External Communication
Effective Communication
Communication is the transferring of a message from the sender to the
receiver, who understands the message.
Internal communication is between two members of the same organisations.
Example: communication between departments, notices and circulars to workers,
signboards and labels inside factories and offices etc.
External communication is between the organisation and other organisations or
individuals. Example: orders of goods to suppliers, advertising of products, sending
customers messages about delivery, offers etc.
Effective communication involves:
• A transmitter/sender of the message
• A medium of communication e.g.: letter, telephone conversation, text
message
• A receiver of the message
• A feedback/response from the receiver to confirm that the message has been
received and acknowledged.
One-way communication involves a message which does not require a feedback.
Example: signs saying ‘no smoking’ or an instruction saying ‘deliver these goods to a
customer’
Two-way communication is when the receiver gives a response to the message
received. Example: a letter from one manager to another about an important matter
that needs to be discussed. A two-way communication ensures that the person
receiving the message understands it and has acted up on it. It also makes the
receiver feel more a part of the process- could be a way of motivating employees.
Downward communication: messages from managers to subordinates i.e. from
top to bottom of an organization structure.
Upward communication: messages/feedback from subordinates to managers i.e.
from bottom to top of an organization structure
Horizontal communication occurs between people on the same level of an
organization structure.
Communication Methods
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• Can take long if there is feedback and therefore, discussions
• In a meeting, it cannot be guaranteed that everybody is listening or has
understood the message
• No written record of the message can be kept for later reference.
• No feedback
• May not be understood/ interpreted properly.
• Speed: if the receiver has to get the information quickly, then a telephone call or
text message has to be sent. If speed isn’t important, a letter or e-mail will be
more appropriate.
• Cost: if the company wishes to keep costs down, it may choose to use letters or
face-to-face meetings as a medium of communication. Otherwise, telephone,
posters etc. will be used.
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• Message details: if the message is very detailed, then written and visual
methods will be used.
• Leadership style: a democratic style would use two-way communication
methods such as verbal mediums. An autocratic one would use notices and
announcements.
• The receiver: if there is only receiver, then a personal face-to-face or telephone
call will be more apt. If all the staff is to be sent a message, a notice or e-mail will
be sent.
• Importance of a written record: if the message is one that needs to have a
written record like a legal document or receipts of new customer orders, then
written methods will be used.
• Importance of feedback: if feedback is important, like for a quick query, then a
direct verbal or written method will have to be used.
Formal communication is when messages are sent through established channels
using professional language. E.g.: reports, emails, memos, official meetings.
Informal communication is when information is sent and received casually with
the use of everyday language. E.g.: staff briefings. Managers can sometimes use the
‘grapevine’ (informal communication among employees- usually where rumours and
gossips spread!) to test out the reactions to new ideas (for example, a new shift
system at a factory) before officially deciding whether or not to make it official.
Communication Barriers
Communication barriers are factors that stop effective communication of
messages.
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Chapter 3
Marketing
What is a market?
A market consists of all buyers and sellers of a particular good.
What is Marketing?
By definition, marketing is the management process responsible for identifying,
anticipating and satisfying consumers’ requirements profitably.
Marketing Changes
Why customer spending patterns may change:
• change in their tastes and fashions
• change in technology: as new technology becomes available, the old versions of
products become outdated and people want more sophisticated features on
products.
• change in income: the higher the income, the more expensive goods consumers
will buy; and vice versa.
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• ageing population: in many countries, the proportion of older people is increasing
and products that are required by them are increasing- such as anti-ageing
creams, medical assistance etc.
The power and importance of changing customer needs:
Firms need to always know what their consumers want (and they will need to
undertake lots of research and development to do so) in order to stay ahead of
competitors and stay profitable. If they don’t produce and sell what customers want,
they will buy competitors’ products and the firm will fail to survive.
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Advantages:
• Larger amount of sales, as compared to niche market.
• Can benefit from economies of scale: a large volume of products is produced and
so the average costs will be low, as compared to niche market.
• Risks are spread, unlike in niche market. If the product isn’t successful in one
market, it’s fine as there are several other markets.
• More chances for the business to grow since there is a large market. In niche
markets, this is difficult as the product is only targeted towards a particular group.
Market Segmentation
A market segment is an identifiable sub-group of a larger market in which
consumers have similar characteristics and preferences
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3.2 – Market Research
Product-oriented business: such firms produce the product first and then tries to
find a market for it. Their concentration is on the product – it’s quality and price. The
most common example are all basic necessities for living- foods and agricultural
tools.
Market-oriented businesses: such firms will conduct market research to see
what consumers want and then produce goods and services to satisfy them. They
will set a marketing budget and undertake the different methods of researching
consumer tastes and spending patterns, as well as market conditions. Example,
mobile phone markets.
Market Research
Market research is the process of collecting, analysing and interpreting information
about a product.
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The process of primary research:
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and can also ask follow-up questions
2. Can gather detailed responses, body-language also allowing interviewer to
come to accurate conclusions about the customer’s opinions.
Disadvantages:
1. The interviewer could lead and influence the interviewee to answer a certain
way. For example, by phrasing a question such as ‘Would you buy this product’ to
‘But, you would definitely buy this product, right?’ to which the customer in order
to appear polite would say yes when in actuality they wouldn’t buy the product.
2. Time-consuming and expensive to interview everyone in the sample.
• Observation: This can take the form of recording (e.g.: meters fitted to TV
screens to see what channels are being watched), watching (e.g.: counting how
many people enter a shop), auditing (e.g.: counting of stock in shops to see which
products sold well).
Advantage:
1. Inexpensive
Disadvantage:
1. Only gives basic figures. Does not tell the firm why consumer buys them.
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• Newspapers: articles about economic conditions and forecast spending patterns.
• Trade associations: if there is a trade association for a particular industry, it will
have several reports on that industry’s markets.
• Market research agencies: these agencies carry out market research on behalf
of the company and provide detailed reports.
• Internet: will have a wide range of articles about companies, government
statistics, newspapers and blogs.
• How carefully the sample was drawn up, the size, the types of people selected etc.
• How questions were phrased in questionnaires and surveys
• Who carried out the research: secondary research is likely to be less reliable since
it was drawn up by others for different purpose at an earlier time?
• Bias: newspaper articles are often biased and may leave out crucial information
deliberately.
• Age of information: researched data shouldn’t be too outdated. Customer tastes,
fashions, economic conditions, technology all move fast and the old data will be of
no use now.
• Tally Tables: used to record data in its original form. The tally table below shows
the number and type of vehicles passing by a shop at different times of the day:
• Charts: shows the total figures for each piece of data (bar/column charts) or the
proportion of each piece of data in terms of the total number (pie charts). For
example, the above tally table data can be recorded in a bar chart as shown
below:
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The pie chart above could show a company’s market share in different countries.
• Graphs: used to show the relationship between two sets of data. For example,
how average temperature varied across the year.
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3.3 – Marketing Mix
Marketing mix refers to the different elements involved in the marketing of a good
or service- the 4 P’s- Product, Price, Promotion and Place.
Product
Product is the good or service being produced and sold in the market. This includes
all the features of the product as well as its final packaging.
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New Product Development: development of a new product by a business. The
process:
Advantages:
– Can create a Unique Selling Point (USP) by developing a new innovative
product for the first time in the market. This USP can be used to charge a high price
for the product as well as be used in advertising.
– Charge higher prices for new products (price skimming as explained later)
– Increase potential sales, revenue and profit
– Helps spreads risks because business: having more products mean that even if
one fails, the other will keep generating a profit for the company
Disadvantages:
– Market research to identify customer needs- expensive and time consuming
– Investment can be very expensive
Why is brand image important?
Brand image is an identity given to a product that differentiates itself from
competitors’ products.
Brand loyalty when customers keep buying the same brand again and again
instead of switching over to competitors’
• Consumers recognize their product more easily when looking at similar
products- helps differentiate one company’s product from another.
• Their product can be charged higher than less well-known brands – if there is
an established high brand image, then it is easier to charge high prices because
customers will buy it, nonetheless.
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• Easier to launch new products into the market if the brand image is already
established. Apple is one such company- their brand image is so reputed that new
products that they launch now become an immediate success.
Why is packaging important?
• Protect the product
• Provide information about the product (it’s ingredients, price, expiry dates etc)
• To help consumers recognize the product (the brand name and logo will help
identify what product it is)
• To keep product fresh
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Extension strategies: marketing techniques used to extend the maturity stage of
a product (keep the product in the market):
• Finding new markets for the product
• Finding new uses for the product
• Redesigning the product or the packaging to improve its appeal to consumers
• Increased advertising and other promotional activities
The effect on the PLC of a product of a successful extension strategy:
Price
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Price is the amount of money producers are willing to sell or consumer are willing to
buy for the product.
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• Is the product unique?
If yes, then price skimming will be beneficial, otherwise competitive or
promotional pricing.
• Is there a lot of competition in the market?
If yes, competitive pricing will need to be used.
• Does the business have a well-known brand image?
If yes, price skimming will be highly successful.
• What are the costs of producing and supplying the product?
If there are high costs, costs plus pricing will be needed to cover the costs. If
costs are low, market penetration and promotional pricing will be appropriate.
• What are the marketing objectives of the business?
If the business objective is to quickly gain a market share and customer base,
then penetration pricing could be used. If the objective is to simply maintain sales,
competitive pricing will be appropriate.
Price Elasticity
The PED of a product refers to the responsiveness of the quantity demanded
for it to changes in its price.
PED (of a product) = % change in quantity demanded / % change in price
When the PED is >1, that is there is a higher % change in demand in response to a
change in price, the PED is said to be elastic.
When the PED is <1, that is there is a lower % change in demand in response to a
change in price, the PED is said to be inelastic.
Producers can calculate the PED of their product and take a suitable action to make
the product more profitable.
If the product is found to have an elastic demand, the producer can lower
prices to increase profitability. The law of demand states that a price fall
increases the demand. And since, it is an elastic product (change in demand is
higher than change in price), the demand of the product will increase highly. The
producers get more profit.
If the product is found to have an inelastic demand, the producer can raise
prices to increase profitability. Since quantity demanded wouldn’t fall much, as
it is inelastic, the high prices will make way for higher revenue and thus higher
profits.
For a detailed explanation about PED, click here
Promotion
Aims of promotion:
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• Increase sales and market share
Types of promotion
• Advertising: Paid-for communication with consumers which uses printed and
visual media like television, radio, newspapers, magazines, billboards, flyers,
cinema etc. This can be informative (create product awareness) or persuasive
(persuade consumers to buy the product). The process of advertising:
• Sales Promotion: using techniques such as ‘buy one get one free’, occasional
price reductions, free after-sales services, gifts, competitions, point-of–sale
displays (a special display stand for a product in a shop), free samples etc to
encourage sales.
• Below-the-line promotion: promotion that is not paid for communication but
uses incentives to encourage consumers to buy. Incentives include money-off
coupons or vouchers, loyalty reward schemes, competitions and games with cash
or other prizes.
• Personal selling: sales staff communicate directly with consumer to achieve a
sale and form a long-term relationship between the firm and consumer.
• Direct mail: also known as mailshots, printed materials like flyers, newsletters
and brochures which are sent directly to the addresses of customers.
• Sponsorship: payment by a business to have its name or products associated
with a particular event. For example, Emirates is Spanish football club Real
Madrid’s jersey sponsor- Emirates pays the club to be its sponsor and gains a high
customer awareness and brand image in return.
What affects promotional decisions?
• Stage of product on the PLC: different stages of the PLC will require different
promotional strategies; see above.
• The nature of the product: If it’s a consumer good, it would use persuasive
advertising and use billboards and TV commercials. Producer goods would have
bulk-buy-discounts to encourage more sales. The kind of product it is can affect
the type of advertising, the media of advertising and the method of sales
promotion.
• The nature of the target market: a local market would only need small
amounts of advertising while national markets will need TV and billboard
advertising. If the product is sold to a mass market, extensive advertising would
be needed. But niche market products such as water skis would only need
advertising in special sports and lifestyle magazines.
Place
Place refers to how the product is distributed from the producer to the final
consumer. There are different distribution channels that a product can be sold
through.
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Distribution
Channel Explanation Advantages Disadvantages
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Distribution
Channel Explanation Advantages Disadvantages
It is also worth noting that the internet/ E-commerce is now widely used to
distribute products. E-Commerce is the use of the internet and other technologies
used by businesses to market and sell goods and services to customers. Examples of
e-commerce include online shopping, internet banking, online ticket-booking, online
hotel reservations etc.
Websites like Amazon and e-Bay act as online retailers.
Online selling is favoured by producers because it is cheaper in the long-run and
they can sell products to a larger customer base/ market. However, there will
be increased competition from lots of producers.
Consumers prefer online shopping because there are wider choices of detailed
products that are also cheaper and they can buy things at their
own convenience 24×7. However, there is no personal communication with the
producer and online security issues may occur.
The internet is also used for promotion and advertising of products in the form of
paid YouTube ads and sponsors, pop-ups, email newsletters etc.
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3.4 – Marketing Strategy
There are various laws that can affect marketing decisions on quality, price and the
contents of advertisements.
• laws that protect consumers from being sold faulty and dangerous goods
• laws that prevent the firms from using misleading information in advertising.
Example: Volkswagen falsely advertised environmentally friendly diesel cars.
• laws that protect consumers from being exploited in industries where there is little
or no competition, known as monopolising.
Entering New Markets
Growing in other countries can increase sales, revenue and profits. This is because
the business is now available to a wider group of people, which increases potential
customers. If the home markets have saturated (product is in maturity stage), firms
take their products to international markets. Trade barriers and restrictions have also
reduced significantly over the years, along with new transport infrastructures, so it is
now cheaper and easier to export products to other countries.
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Problems of entering foreign markets:
• Difference in language and culture: It may be difficult to communicate with
people in other countries because of language barriers and as for the culture,
different images, colours and symbols have different meanings and importance in
different places. For example, McDonald’s had to make its menu more vegetarian
in Indian markets.
• Lack of market knowledge: The business won’t know much about the market it
is entering and the customers won’t be familiar with the new business brand, and
so establishing in the market will be difficult and expensive.
• Economic differences: The cost and prices may be lower or higher in different
countries so businesses may not be able to sell the product at the price which will
give them a profit.
• High transport costs
• Social differences: Different people will have different needs and wants from
people in other countries, and so the product may not be successful in all
countries.
• Difference in legal controls to protect consumers: The business may have
to spend more money on producing the products in a way that complies with that
country’s laws.
How to overcome such problems:
• Joint venture: an agreement between two or more businesses to work
together on a project. The foreign business will work with a domestic business
in the same industry. E.g.: Japan’s Suzuki Motor Corporations created a joint
venture with India’s Maruti Udyog Limited to form Maruti Suzuki, a highly
successful car manufacturing project in India.
Advantages
– Reduces risks and cuts costs
– Each business brings different expertise to the joint venture
– The market potential for all the businesses in the joint venture is increased
– Market and product knowledge can be shared to the benefit of the businesses
Disadvantages
– Any mistakes made will reflect on all parties in the joint venture, which may
damage their reputations
– The decision-making process may be ineffective due to different business culture
or different styles of leadership
• Franchise: the owner of a business (the franchisor) grants a licence to
another person or business (the franchisee) to use their business idea –
often in a specific geographical area. Fast food companies such as McDonald’s and
Subway operate around the globe through lots of franchises in different countries.
ADVANTAGES DISADVANTAGES
· Rapid, low cost method of · Profits from the franchise
business expansion needs to be shared with the
· Gets and income from franchisee
franchisee in the form of franchise · Loss of control over running
fees and royalties of business
TO
FRANCHISOR
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· Franchisee will better · If one franchise fails, it can
understand the local tastes and so affect the reputation of the entire
can advertise and sell appropriately brand
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Chapter 4
Operations Management
Businesses often measure the labour productivity to see how efficient their
employees are in producing output. The formula for it is:
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Businesses look to increase productivity, as the output will increase per employee
and so the average costs of production will fall.
Firms can hold inventory (stock) of raw materials, goods that are not completed yet
(a.k.a work-in-progress) and finished unsold goods. Finished good stocks are kept so
that any unexpected rise in demand is fulfilled.
• When inventory gets to a certain point (reorder level), they will be reordered by
the firm to bring the level of inventory back up to the maximum level again. The
business has to reorder inventory before they go too low since the reorder supply
will take time to arrive at the firm
• The time it takes for the reorder supply to arrive is known as lead time.
• If too high inventory is held, the costs of holding and maintaining it will be very
high.
• The buffer inventory level is the level of inventory the business should hold at
the very minimum to satisfy customer demand at all times. During the lead time
the inventory will have hit the buffer level and as reorder arrives, it will shoot back
up to the maximum level.
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Lean Production
Lean production refers to the various techniques a firm can adopt to reduce wastage
and increase efficiency/productivity.
• less storage of raw materials, components and finished goods- less money and
time tied up in inventory
• quicker production of goods and services
• no need to repair faulty goods- leads to good customer satisfaction
• ultimately, costs will lower, which helps reduce prices, making the business
more competitive and earn higher profits as well
Now, how to implement lean production? The different methods are:
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Benefits:
•
•
•increased productivity
•reduced amount of space needed for production
•improved factory layout may allow some jobs to be combined, so freeing
up employees to do other jobs in the factory
• Just-in-Time inventory control: this technique eliminates the need to hold any
kind of inventory by ensuring that supplies arrive just in time they are needed for
production. The making of any parts is done just in time to be used in the next
stage of production and finished goods are made just in time they are needed for
delivery to the customer/shop. The firm will need very reliable suppliers and an
efficient system for reordering supplies.
Benefits:
• Reduces cost of holding inventory
• Warehouse space is not needed any more, so more space is available for
other uses
• Finished goods are immediately sold off, so cash flows in quickly
• Cell Production: the production line is divided into separate, self-contained units
each making a part of the finished good. This works because it improves worker
morale when they are put into teams and concentrate on one part alone.
Methods of Production
• Job Production: products are made specifically to order, customized for each
customer. E.g.: wedding cakes, made-to-measure suits, films etc.
Advantages:
• Most suitable for one-off products and personal services
• The product meets the exact requirement of the customer
• Workers will have more varied jobs as each order is different, improving
morale
• very flexible method of production
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Disadvantages:
• Skilled labour will often be required which is expensive
• Costs are higher for job production firms because they are usually labour-
intensive
• Production often takes a long time
• Since they are made to order, any errors may be expensive to fix
• Materials may have to be specially purchased for different orders, which is
expensive
Disadvantages:
• Can be expensive since finished and semi-finished goods will need moving
about
• Machines have to be reset between production batches which delays
production
• Lots of raw materials will be needed for different product batches, which can
be expensive.
Disadvantages:
• A very boring system for the workers, leads to low job satisfaction and
motivation
• Lots of raw materials and finished goods need to be held in inventory- this is
expensive
• Capital cost of setting up the flow line is very high
• If one machinery breaks down, entire production will be affected
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Factors that affect which production method to use:
• The nature of the product: Whether it is a personal, customized-to-order
product, in which case job production will be used. If it is a standard product, then
flow production will be used
• The size of the market: For a large market, flow production will be required.
Small local and niche markets may make use of batch and flow production. Goods
that are highly demanded but not in very large quantities, batch production is
most suitable.
• The nature of demand: If there is a fair and steady demand for the product, it
would be more suitable to run a production line for the product. For less frequent
demand, batch and job will be appropriate.
• The size of the business: Small firms with little capital access will not produce
using large automated production lines, but will use batch and job production.
Technology and Production
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• Expensive to set up
• New technology quickly becomes outdated and frequent updating of systems will
be needed- this is expensive and time-consuming.
• Employees may take time to adjust to new technology or even resist it as their
work practices change.
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4.2 – Costs, Scale of Production and Break-even Analysis
Costs
Fixed Costs are costs that do not vary with output produced or sold in the short
run. They are incurred even when the output is 0 and will remain the same in the
short run. In the long-run they may change. Also known as overhead costs.
E.g.: rent, even if production has not started, the firm still has to pay the rent.
Variable Costs are costs that directly vary with the output produced or sold.
E.g.: material costs and wage rates that are only paid according to the output
produced.
TOTAL COST = TOTAL FIXED COSTS + TOTAL VARIABLE COSTS
TOTAL COST = AVERAGE COST * OUTPUT
AVERAGE COST (unit cost) = TOTAL COST/ TOTAL OUTPUT
A business can use these cost data to make different decisions. Some examples
are: setting prices (if the average cost of one unit is $3, then the price would be
set at $4 to make a profit of $1 on each unit), deciding whether to stop
production (if the total cost exceeds the total revenue, a loss is being made, and
so the production might be stopped), deciding on the best location (locations
with the cheaper costs will be chosen) etc.
Scale of production
Economies of scale are the factors that lead to a reduction in average costs as a
business increases in size. The five economies of scale are:
• Purchasing economies: For large output, a large number of components have to
be bought. This will give them some bulk-buying discounts that reduce costs
• Marketing economies: Larger businesses will be able to afford its own vehicles to
distribute goods and advertise on paper and TV. They can cut down on marketing
labour costs. The advertising rates costs also do not rise as much as the size of
the advertisement ordered by the business. Average costs will thus reduce.
• Financial economies: Bank managers will be more willing to lend money to large
businesses as they are more likely to be able to pay off the loan than small
businesses. Thus, they will be charged a low rate of interest on their borrowings,
reducing average costs.
• Managerial economies: Large businesses may be able to afford to hire specialist
managers who are very efficient and can reduce the business’ costs.
• Technical economies: Large businesses can afford to buy large machinery such
as a flow production line that can produce a large output and reduce average
costs.
Diseconomies of scale are the factors that lead to an increase the average costs
of a business as it grows beyond a certain size. They are:
• Poor communication: as a business grows large, more departments and
managers and employees will be added and communication can get difficult.
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Messages may be inaccurate and slow to receive, leading to lower efficiency and
higher average costs in the business.
• Low morale: when there are lots of workers in the business and they have non-
contact with their senior managers, the workers may feel unimportant and not
valued by management. This would lead to inefficiency and higher average costs.
• Slow decision-making: As a business grows larger, it’s chain of command will
get longer. Communication will get very slow and so any decision-making will also
take time, since all employees and departments may need to be consulted with.
Businesses are now dividing themselves into small units that can control themselves
and communicate more effectively, to avoid any diseconomies from arising.
Break-even
Break-even level of output is the output that needs to be produced and sold in order
to start making a profit. So, the break-even output is the output at which total
revenue equals total costs (neither a profit nor loss is made, all costs are
covered).
A break-even chart can be drawn, that shows the costs and revenues of a business
across different levels of output and the output needed to break even.
Example:
In the chart below, costs and revenues are being calculated over the output of 2000
units.
The fixed costs is 5000 across all output (since it is fixed!).
The variable cost is $3 per unit so will be $0 at output is 0 and $6000 at output
2000- so you just draw a straight line from $0 to $6000.
The total costs will then start from the point where fixed cost starts and be parallel
to the variable costs (since T.C.=F.C.+V.C. You can manually calculate the total cost
at output 2000: ($6000+$5000=$11000).
The price per unit is $8 so the total revenue is $16000 at output 2000.
Now the breakeven point can be calculated at the point where total revenue
and total cost equals– at an output of 1000. (In order to find the sales revenue at
output 1000, just do $8*1000= $8000. The business needs to make $8000 in sales
revenue to start making a profit).
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Advantages of break-even charts:
• Managers can look at the graph to find out the profit or loss at each level of
output
• Managers can change the costs and revenues and redraw the graph to see how
that would affect profit and loss, for example, if the selling price is increased or
variable cost is reduced.
• The break-even chart can also help calculate the safety margin- the amount by
which sales exceed break-even point. In the above graph, if the business decided
to sell 2000 units, their margin of safety would be 1000 units. In sales terms, the
margin of safety would be 1000*8 = $8000. They are $8000 safe from making a
loss.
Margin of Safety (units) = Units being produced and sold – Break-even
output
Limitations of break-even charts:
• They are constructed assuming that all units being produced are sold. In
practice, there are always inventory of finished goods. Not everything produced is
sold off.
• Fixed costs may not always be fixed if the scale of production changes. If
more output is to be produced, an additional factory or machinery may be needed
that increases fixed costs.
• Break-even charts assume that costs can always be drawn using straight
lines. Costs may increase or decrease due to various reasons. If more output is
produced, workers may be given an overtime wage that increases the variable
cost per unit and cause the variable cost line to steep upwards.
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Break-even can also be calculated without drawing a chart. A formula can be used:
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4.3 – Achieving Quality Production
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 the 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
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• Expensive to carry out
• How well will employees follow quality standards?
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?
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4.4 – Location 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.
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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. E.g.; 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. E.g.:
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 located 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
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• Avoid trade barriers and tariffs: when exporting goods to other countries, there
will be some tariffs, rules and regulations to get by. in order to avoid this, firms
start operating in the country itself, since there is no exporting/importing involved
now.
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Chapter 5
Financial Information and Decisions.
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). E.g.: vehicles, machinery, buildings etc.
Revenue Expenditure, similar to working capital, is the money spent on day-to-
day expenses which does not involve the purchase of long-term assets. E.g.: wages,
rent
Sources of Finance
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• 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 has to be paid.
Disadvantages:
– Increases the risk taken by the owners.
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– 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.
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.
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• 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!
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• dividends and profits are high
• the company has a good reputations and future growth plans
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5.2 – Cash Flow Forecasting and Working Capital
Cash Flow
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:
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• 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 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
balance– the amount of cash held by the business at the end of the month
Uses of cash flow forecasts:
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• 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).
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:
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• 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.
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5.3 – Income Statements
For social enterprises, profit is not one of their primary objectives, but welfare of the
society is. However, they will also strive to make some profit to reinvest it back into
the business and help it grow.
Income Statement
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This is a summarized
Income statement
Sales Revenue = total sales
Cost of Sales = total variable cost of production + (opening inventory of finished
goods – closing inventory of finished goods)
Gross Profit = Sales Revenue – Cost of Sales
Expenses: all overheads/fixed costs
Net Profit = Gross Profit – Expenses
Only a very small portion of the sales revenue ends up being the retained profit. All
costs, taxes and dividends have to be deducted from sales.
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Uses of Income Statement
Income statements are used by managers to:
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5.4 – Balance Sheets
The balance sheet, along with the income statement is prepared at the end of the
financial year. It shows the value of a business’ assets and liabilities at a
particular time. It is also known as ‘statement of financial position’.
Assets are those items of value owned by the business.
Fixed/non-current assets (buildings, vehicles, equipment etc) are assets that
remain in the business for more than a year – their values fall over time in a process
called depreciation every year.
Short-term/current assets (inventory, trade receivables (debts from customers),
cash etc) are owned only for a very short time.
There can also intangible (cannot be touched or felt) non-current assets like
copyrights and patents that add value to the business.
Liabilities are the debts owed by the business to its creditors.
Long-term/non-current liabilities (loans, debentures etc)- they do not have to be
repaid within a year.
Short-term/current liabilities (trade payables (to suppliers), overdraft etc)- these
need to be repaid within a year.
CURRENT ASSETS – CURRENT LIABILITIES = WORKING CAPITAL
This is because the liquid cash a company has with them will be the liquid (short-
term) assets they own less the short-term debts they have to pay.
Shareholder’s Equity is the total amount of money invested in the company by
shareholders. This will include both the share capital (invested directly by
shareholders) and reserves (retained earnings reserve, general reserve etc).
Shareholders can see if their stake in the business has risen or fallen by looking at
the total equity figure on the balance sheet.
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Check to see if
the equations mentioned on the right are satisfied on this balance sheet
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5.5 – Analysis of Accounts
The data contained in the financial statements are used to make some useful
observations about the performance and financial strength of the business.
This is the analysis of accounts of a business. To do so, ratio analysis is employed.
Ratio Analysis
• Profitability Ratios: these ratios are used to see how profitable the business
has been in the year ended.
• Return on Capital Employed (ROCE): this calculates the return (net profit) in
terms of the capital invested in the business (shareholder’s equity+non-
current liabilities) i.e. the % of net profit earned on each unit of capital
employed. The higher the ROCE the better the profitability is. The formula is:
• Gross Profit Margin: this calculates the gross profit (sales – cost of production)
in terms of the sales, or in other words, the % of gross profit made on each
unit of sales revenue. The higher the GPM, the better. The formula is:
• Net profit Margin: this calculates the net profit (gross profit-expenses) in
terms of the sales, i.e. the % of net profit generated on each unit of sales
revenue. The higher the NPM, the better. The formula is:
• Liquidity Ratios: liquidity is the ability of the company to pay back its short-term
debts. It if it doesn’t have the necessary working capital to do so, it will go illiquid
(forced to pay off its debts by selling assets). In the previous topic, we said that,
working capital = current assets – current liabilities. So, a business needs current
assets to be able to pay off its current liabilities. The two liquidity ratios shown
below, use this concept.
• Current Ratio: this is the basic liquidity ratio that calculates how many current
assets are there in proportion to every current liability, so the higher the
current ratio the better (a value above 1 is favourable). the formula is:
• Liquid Ratio/ Acid Test Ratio: this is very similar to current ratio but this ratio
doesn’t consider inventory to be a liquid asset, since it will take time for it to
be sold and made into cash. A high level of inventory in a business can thus
cause a big difference between its current and liquidity ratios. So, there is a
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slight difference in the formula:
• Managers: they will use the accounts to help them keep control over the
performance of each product or each division since they can see which products
are profitably performing and which are not.
• This will allow them to take better decisions. If for example, product A has
a good gross profit margin of 35% but its net profit margin is only 5%, this
means that the business has very high expenses that is causing the huge
difference between the two ratios. They will try to reduce expenses in the
coming year. In the case of liquidity, if both ratios are very low, they will try to
pay off current liabilities to improve the ratios.
• Ratios can be compared with other firms in the industry/competitors and
also with previous years to see how they’re doing. Businesses will definitely
want to perform better than their rivals to attract shareholders to invest in
their business and to stay competitive in the market. Businesses will also try to
improve their profitability and liquidity positions each year.
• Shareholders: since they are the owners of a limited company, it is a legal
requirement that they be presented with the financial accounts of the company.
From the income statements and the profitability ratios, especially the ROCE,
existing shareholders and potential investors can see whether they should
invest in the business by buying shares. A higher profitability, the higher the
chance of getting dividends. They will also compare the ratios with other
companies and with previous years to take the most profitable decision. The
balance sheet will tell shareholders whether the business was worth more at the
end of the year than at the beginning of the year, and the liquidity ratios will be
used to ascertain how risky it will be to invest in the company- they won’t want to
invest in businesses with serious liquidity problems.
• Creditors: The balance sheet and liquidity ratios will tell creditors (suppliers) the
cash position and debts of the business. They will only be ready to supply to the
business if they will be able to pay them If there are liquidity problems, they
won’t supply the business as it is risky for them.
• Banks: Similar to how suppliers use accounts, they will look at how risky it is to
lend to the business. They will only lend to profitable and liquid firms.
• Government: the government and tax officials will look at the profits of the
company to fix a tax rate and to see if the business is profitable and liquid enough
to continue operations and thus if the worker’s jobs will be protected.
• Workers and trade unions: they will want to see if the business’ future is
secure or not. If the business is continuously running a loss and is in risk of
insolvency (not being liquid), it may shut down operations and workers will lose
their jobs!
• Other businesses: managers of competing companies may want to compare
their performance too or may want to take over the business and wants to see if
the takeover will be beneficial.
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Limitations of using accounts and ratio analysis
• Ratios are based on past accounting data and will not indicate how the
business will perform in the future
• Managers will have all accounts, but the external users will only have those
published accounts that contain only the data required by law- they may not get
the ‘full-picture’ about the business’ performance.
• Comparing accounting data over the years can lead to misleading assumptions
since the data will be affected by inflation (rising prices)
• Different companies may use different accounting methods and so will
have different ratio results, making comparisons between companies unreliable.
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Chapter 6
Economic Objectives
Here, we’ll look at the different economic objectives a government might have and
how their absence/negligence will affect the economy as well as businesses.
• Maintain low inflation: inflation is the increase in average prices of goods and
services over time. (Note that, inflation, in the real world, always exists. It is
natural for prices to increase as the years go by. In the case there is a fall in the
price level, it is called a deflation) Maintaining a low inflation will help the economy
to develop and grow better.
Effects of high inflation:
• As cost of living will have risen and peoples’ real incomes (the value of
income) will have fallen (when prices increase and incomes haven’t, the
income will buy lesser goods and services- the purchasing power will fall).
• Prices of domestic goods will rise as opposed to foreign goods in the market.
The country’s exports will become less competitive in the international market.
Domestic workers may lose their jobs if their products and firms don’t do well.
• When prices rise, demand will fall and all costs will rise (as wages, material
costs, overheads will all rise)- causing profits to fall. Thus, they will be
unwilling to expand and produce more in the future.
• The living standards (quality of life) in the country may fall when costs of
living rise.
• Low unemployment: unemployment exists when people who are willing and
able to work cannot find a job. A low unemployment means high output, incomes,
living standards etc.
Effects of high unemployment:
• Unemployed people do not produce anything and so, the total output/GDP in
the country will fall. This will in turn, lead to a fall in economic growth.
• Unemployed people receive no incomes, thus income inequality can rise in the
economy and living standards will fall. It also means that businesses will face
low demand due to low incomes.
• The government pays out unemployment benefits to the unemployed and this
will rise during high unemployment and government will not enough money
left over to spend on other services like education and health.
• Economic growth: economic growth occurs when a country’s Gross Domestic
Product (GDP) increase i.e. more goods and services are produced than in the
previous year. This will increase the country’s incomes and achieve greater living
standards.
Effects of reducing GDP (recession):
• As output falls, fewer workers will be needed by firms, so unemployment will
rise
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• As goods and services that can be consumed by the people falls, the standard
of living in the economy will also fall
• Balance of Payments: this records the difference between a
country’s exports (goods and services sold from the country to another)
and imports (goods and services bought in by the country from another country).
The exports and imports need to equal each other, thus balanced.
Effect of a disequilibrium in the balance of payments:
• If the imports of a country exceed its exports, it will cause depreciation in
the exchange rate– the value of the country’s currency will fall against other
foreign currencies (this will be explained in detail here).
• If the exports exceed the imports it indicates that the country is selling more
goods than it is consuming- the country itself doesn’t benefit from any high
output consumption.
• Income equality: the difference/gap between the incomes of rich and poor
people should narrow down for income equality to improve. Improved income
equality will ensure better living standards and help the economy to grow faster
become more developed.
Effects of poor income equality:
• Inequal distribution of goods and services- the poor cannot buy as many
goods as the rich- poor living standards will arise.
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Slump– when GDP is so low that prices start to fall (deflation) and unemployment
will reach very high levels. Many businesses will close down as they cannot survive
the very low demand level. The economy will suffer.
(When the government takes measures to increase demand and spending in the
economy to take it from a slump to growth, it is called as the ‘recovery’ period). The
cycle repeats.
FISCAL POLICY
Using taxes and government spending to influence the demand conditions in the
economy.
• GOVERNMENT SPENDING
Governments can change their spending on education, health, defence, law and
order, transport and communications infrastructure etc. to influence demand.
Higher spending on these services can boost demand in the economy as jobs and
GDP increase. Reducing government spending will reduce demand.
• TAXES
• Direct Taxes are paid directly from incomes. There are different types of
direct taxes.
• Income tax: paid from an individual’s income. Disposable income is the
income left after deducting income tax from it. When income tax rise,
there is little disposable income to spend on goods and services, firms will
face lower demand and sales and will cut production, increasing
unemployment. Lower income taxes will encourage more spending and
thus higher production.
• Corporation Tax: tax paid on a company’s profits. When the corporation
tax rate is increased, businesses will have lower profits left over to put
back into the business and will thus find it hard to expand and produce
more. It will also cause shareholders/owners to receive lower
dividends/returns for their investments. This will discourage people from
investing in businesses and economic growth could slow down. Reducing
corporation tax will encourage more production and investment.
• Indirect Taxes are added to the prices of goods and services and it is paid
while purchasing the good or service. Some examples are:
• GST/VAT: these are included in the price of goods and services.
Increasing these indirect taxes will increase the prices of goods and
services and reduce demand and in turn profits. Reducing these taxes will
increase demand.
• Import tariffs and quotas: an import tariff is a tax on imported goods
and services; an import quota is the physical limit to the quantity of a
product that can be imported into a country. Increasing tariffs will reduce
demand for foreign products and imposing quotas will mean there are
lesser foreign goods in the market to be sold and so demand is reduced.
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MONETARY POLICY
Using interest rates (as well as money supply and the exchange rate) to influence
the demand conditions in the economy.
The interest rate is the cost of borrowing money. When a person borrows
money from a bank, he has to pay an interest (monthly or annually) calculated on
the amount he borrowed. Interest can also be earned by depositing money in the
bank.
A higher interest rate will thus discourage borrowing (as more interest will have to
be paid to the bank) and encourage saving (people will get more interest from
saving) – thus, investing and spending will fall respectively- demand in the economy
will fall. A lower interest rate will increase demand.
From a business’ point of view, a higher interest rate means more interest has to be
paid on existing loans, reducing profits; as well as suffer low demand levels. They
may have to delay expansion plans that involve borrowing from the bank. A lower
interest rate will be more favourable to a business.
SUPPLY-SIDE POLICIES
Both the fiscal and monetary policies directly affect demand, but the policies that
influence supply are very different. It can include:
• Privatisation: selling government organizations to private individuals- this will
increase efficiency and productivity that increase supply as well encourage
competitors to enter and further increase supply.
• Improve training and education: governments can spend more on schools,
colleges and training centres so that people in the economy can become better
skilled and knowledgeable, helping increasing productivity.
• Increased competition: by acting against monopolies (firms that restrict
competitors to enter that industry/having full dominance in the market- refer xxx
for more details) and reducing government rules and regulations (often termed
‘deregulation’), the competitive environment can be improved and thus become
more productive.
*EXAM TIP: Remember that economic conditions and policies are all
interconnected; one change will lead to an effect which will lead to another effect
and so on, like a chain reaction in many different ways. In your exams, you should
take care to explain those effects that are relevant and appropriate to the business
or economy in the question*
How might businesses react to policy changes? It will depend varying on how much
impact the policy change will have on the particular business/industry/economy.
Here are a few examples:
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6.2 – Environmental and Ethical Issues
A business’ decisions and actions can have significant effects on its stakeholders.
These effects are termed ‘externalities. Externalities can be categorized into six
groups given below and we’ll take examples from a scenario where a business builds
a new production factory.
Sustainable development is development that does not put at risk the living
standards of future generations. It means trying to achieve economic growth in
a way that does not harm future generations. Few examples of a sustainable
development are:
• using renewable energy- so that resources are conserved for the future
• recycle waste
• use fewer resources
• develop new environment-friendly products and processes- reduce health and
climatic problems for future generations
Environmental Pressures
Ethical decisions are based on a moral code. It means ‘doing the right thing’.
Businesses could be faced with decisions regarding, for example, employment of
children, taking or offering bribes, associate with people/organisations with a bad
reputation etc. In these cases, even if they are legal, they need to take a decision
that they feel is right.
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Taking ethical/’right’ decisions can make the business’ products popular among
customers, encourage the government to favour them in any future
disputes/demands and avoid pressure group threats. However, these can end up
being expensive as the business will lose out on using cheaper unethical
opportunities.
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6.3 – Business and the International Economy
Globalization
• Allows businesses to start selling in new foreign markets, increasing sales and
profits
• Can open factories and production units in other countries, possibly at a cheaper
rate (cheaper materials and labour can be available in other countries)
• Import products from other countries and sell it to customers in the domestic
market- this could be more profitable and producing and selling the good
themselves
• Import materials and components for production from foreign countries at a
cheaper rate.
Disadvantages of globalisation
• Increasing imports into country from foreign competitors- now that foreign firms
can compete in other countries, it puts up much competition for domestic firms. If
these domestic firms cannot compete with the foreign goods’ cheap
prices and high quality, they may be forced to close down operations.
• Increasing investment by multinationals in home country- this could further add to
competition in the domestic market (although small local firms can become
suppliers to the large multinational firms)
• Employees may leave domestic firms if they don’t pay as well as the
foreign multinationals in the country- businesses will have to increase pay and
conditions to recruit and retain employees.
When looking at an economy’s point of view, globalisation brings consumers
more choice and lower prices and forces domestic firms to be more efficient (in
order to remain competitive). However, competition from foreign producers can
force domestic firms to close down and jobs will be lost.
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Protectionism
Multinationals
• To produce goods with lower costs– cheaper material and labour may be
available in other countries
• To extract raw materials for production, available in a few other countries.
For example: crude oil in the Middle East
• To produce goods nearer to the markets to avoid transport costs.
• To avoid trade barriers on imports. If they produce the goods in foreign
countries, the firms will not have to pay import tariffs or be faced with a quota
restriction
• To expand into different markets and spread their risks
• To remain competitive with rival firms which may also be expanding abroad
Advantages to a country of a multinational setting up in their country:
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• The jobs created are often for unskilled tasks. The more skilled jobs will be
done by workers that come from the firm’s home country. The unskilled workers
may also be exploited with very low wages and unhygienic working conditions.
• Since multinationals benefit from economies of scale, local firms may be forced
out of business, unable to survive the competition
• Multinationals can use up the scarce, non-renewable resources in the
country
• Repatriation of profit can occur. The profits earned by the multinational could
be sent back to their home country and the government will not be able to levy
tax on it.
• As multinationals are large, they can influence the government and
economy. They could threaten the government that they will close down and
make workers unemployed if they are not given financial grants and so on.
Exchange Rates
The exchange rate is the price of one currency in terms of another currency.
For example, €1=$1.2. To buy one euro, you’ll need 1.2 dollars. The demand and
supply of the currencies determine their exchange rate. In the above
example, if the €’s demand was greater than the $’s, or if the supply of € reduced
more than the $, then the €’s price in terms of $ will increase. It could now be €1=
$1.5. Each € now buys more $.
A currency appreciates when its value rises. The example above is an
appreciation of the Euro. A European exporting firm will find an appreciation
disadvantageous as their American consumers will now have to pay more $ to buy a
€1 good (exports become expensive). Their competitiveness has reduced. A
European importing firm will find an appreciation of benefit. They can buy American
products for lesser Euros (imports become cheaper).
A currency depreciates when its value falls. In the example above, the Dollar
depreciated. An American exporting firm will find a depreciation advantageous as
their European consumers will now have to pay less € to buy a $1 good (exports
become cheaper). Their competitiveness has increased. An American importing
firm will find a depreciation disadvantageous. They will have to buy European
products for more dollars (imports become expensive).
In summary, an appreciation is good for importers, bad for exporters; a
depreciation is good for exporters, bad for importers; given that the goods
are price elastic (if the price didn’t matter much to consumers, sales and revenue
would not be affected by price- so no worries for producers).
Confused? Don’t worry, it is a confusing topic. Check out our more
detailed Economics notes on exchange rates (scroll down!).
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