CHAPTER 2

SMALL BUSINESS
 2.1 Definition of Small Business
 Defining small business is not an easy as it looks; we can have different
definitions depending on:-
o the size of the industry we are talking about,
o the purpose of the definition, and
o the country the definition is applicable to.

 In classifying and defining a business organization, the following

questions can be raised.
– What yardsticks are applied to determine business size?
– Is independent ownership a critical factor?
– Is either sales volume or number of employees a logical
guide in describing smallness?
– Can a business be described accurately as small in both
manufacturing and retailing sector etc.?
 The approaches writers use in defining small business include:
size criteria/quantitative & economic control/ qualitative
criteria.
1) By size criteria: even though size variables are not uniformly
used internationally and as a result vary from nation to nation, the
following could be used relatively to describe/define small business:

Number of workers involved in the business

Sales volume
Capital of start up
Asset size
Insurance in force
Volume of deposit
The specific number of employees, sales volume or asset size
and the amount of capital varies from nation to nation.



• Generally, there is no universally accepted definition of small
business.
• Micro and Small Enterprises (MSEs) has led to diverse definitions and
unresolved debates while the convergence in MSEs definitions is
certainly a welcome move for the standardization of data collection on
enterprises.
• Although the boundaries between micro, small, medium and large
enterprises are at best arbitrary, categorizing business enterprises by
scale of operation is important for functional and promotional
purposes to achieve the desired goals of development.
• Policy makers, researchers, and others involved in the promotion and
development of small business use different terms such as:
─ Micro enterprises,
─ Informal sectors,
─ Small business,
─ Small enterprises,
─ Small scale industries,
─ Small and medium sized enterprises, etc.
• Different governments and writers considerably differ in
defining MSEs because of the following two factors.
– The first factor is population and stage of a country’s economic
development.
– A definition of MSE in the developed world would differ from
how MSEs are defined in developing countries.

– The second factor is industry within which the MSE is operating

and competing.

• In recent times, there has been some degree of convergence in MSEs

definitions particularly in Europe. The European Commission defines
MSEs using a combination of
– employee numbers,
– annual turnover or balance sheet total and
– ownership.
• Although many countries around the globe seemed to be
using common factors in their definitions, the degree of
emphasis and measures used differ quite considerably.

• Their factors include:

– number of employees,
– volume of sales, and
– the capital value of the business.

• In most cases:
– number of employees,
– volume of sales turn over, and
– asset size are widely used as yardstick criteria to define.

• However, the above convergence does not in any way

suggest a common agreement of the specific numbers in
terms of these variables.
 When we come to MSEs definition in
Ethiopian context
• Two types of working definitions for Micro and Small
Enterprises (MSEs) were used in the past,
• one is by the Ministry of Trade and Industry (MOTI) and
• the other is Central Statistics Authority (CSA).

• According to MSE Development Strategy (MOTI,1997):

– Micro enterprises are those business enterprises in the formal and
informal sector, with a paid up capital of not exceeding birr
20,000 and excluding high tech-consultancy firms and other high
tech-establishments.

– Small enterprises are those business enterprises with a paid up

capital of above birr 20,000 and not exceeding birr 500,000 and
excluding high tech consultancy firms and other high tech
establishments.
Central Statistics Authority (CSA):
• For the purpose of compiling statistical information, Central Statistics
Authority (CSA) categorizes enterprises into different scales of
operations on the size of employment and the nature of equipment.
• According to Central Statistics Authority (CSA):
– Establishments employing less than ten persons and using motor
operated equipment are considered as small-scale manufacturing
enterprises.

– Enterprises in the micro enterprise category are subdivided into

informal sector operations and cottage industries:

• Cottage and handicraft industries are those establishments

performing their activities by hand and using non-power driven
machines.
• The informal sector is defined as household type establishments or
activities, which are non-registered enterprises or cooperatives
operating with less than 10 persons.
• This un-uniform definition was the issue because there is a need to
have agreed national definition for:

– consistency of legislation
– research purposes, and
– financial and enterprise promotion agencies

• There fore; ministry of trade and industry of the FDRE had provided the
following definitions in past years even though it was modified
currently.
– Micro enterprises: are business enterprises found in all sectors of
Ethiopian economy with a paid-up capital (fixed assets) of not more
than 500,000.

– Small enterprises: are business enterprises with a paid up capital of

more than 500,000 but not more than birr 2,000,000.

• The above definitions are given in accordance with the provisions of the
Federal Micro and Small Enterprises Agency.
 However, since Feb.2011, Ethiopian Ministry of Trade and Industry
(MOTI) has adopted official definition of Micro and a Small Enterprise
which is different from previous years.
 The current definition of MSEs in Ethiopia focused on:
 The number of employees that the enterprises hire,
 The size of the capital they own , and
 Their category as industry and service sector.

 According to this definition:

 Micro-enterprise is the business enterprise found in all sectors of the
Ethiopian economy hiring up to five man power and 100,000 birr capital for
industry and up to five man power and capital of 50,000 birr for service
sector.
 In small scale enterprise category, the industry sector includes 6-30 man
power and maximum of 1.5 million Birr capital and the service sector
involves 6-30 man power and capital of 500,000 birr.
 Under the industry sector there are Manufacturing, Construction, and
Mining and under the service includes Retail, Transport, Hotel and
Tourism, Recreation, Information Technology and Maintenance are
included.
 To provide a clearer image of the MSES, the following
general criteria in defining small business are suggested.
 Financing the business is supplied by an individual/small group
rarely more than 15-20 owners.
 Except for its marketing function, the firm’s operation is
geographically localized.
 Compared to the biggest firms in the industry, the business is small.
 The number of employees in the business is usually fewer than 100.

• Though the definition of small, micro and medium enterprises with

respect to size criteria varies from country to country the relatively
acceptable divisions are:
• Up to 19 workers – micro or very small enterprises
• 20-100 workers – small enterprises
• 101-500 workers – medium enterprises
• > 500 workers – Large enterprises
2.1.1 Characteristics of Small Scale Industries
 Capital investment is small.
 Most have fewer than 10 owners
 Generally engaged in the production of light consumer goods,
processing etc.
 Located in rural and semi-urban areas
 Most of these firms are privately owned and are organized as
sole proprietorship.
 Fixed assets form the largest component of small units.
 Most of the funds come from the entrepreneur’s savings,
 Small scale industrial activity has been growing at a faster rate
even than large scale enterprises.
 Very few of the small scale industries have grown up to
medium and large scale industries.
 Small scale industries activity is beehive of entrepreneurship.
 Exploitation of natural resources is another characteristic of
small scale industries.
 Small scale industries are quality conscious.
 2.2 Special Contribution of Small Business:
The special features that make small businesses superior
over large ones include the following:
1. Providing Job Opportunities: the number of new jobs created by small
business are significantly higher than created by large business.
2. Introducing Innovation: records show that many scientific
breakthroughs were originated with independent inventors and small
organizations.
3. Stimulating Economic Competition: small business by definition is
one that does not dominate its industry, and competition will be closer to
perfection.
4. Aiding big business: small businesses contribute to the success of
larger ones. Especially there are two types of business activities, which are
performed by small businesses more economically and effectively.
 Supply function: most small businesses act as suppliers, and sub-
contractor for large firms.
 The distribution function: few large manufacturers of in expensive
consumer products find it desirable to own wholesale and retail outlets.
5. Producing Goods and Services: we all depend highly on small
businesses for the provision of most goods and services we need in our lives.
Small businesses also offer certain benefits to the
individual entrepreneur. These include:
 Small business requires less time, energy, and financial
resource to establish.
 They also provide the entrepreneur with greater autonomy, and
independency.
 Small businesses help the entrepreneur develop his skill in
running his organizations as it has different kinds of activities
concerning the business.
 Like
 Business planning,
 Investment and finance,
 Customer relation,
 Personnel & HRM,
 Cash control and bookkeeping,
 Inventory control & purchasing,
 Marketing & sales, and leadership.
 Merits and Demerits of Small Business

Common Advantages Some of the Demerits

1) Independency
1). Competition

2) Financial Opportunity 2). Sales Fluctuation

3) Job Security 3). Increased Responsibilities

4). Risk of Failure

4) Community Service
5). Employee relations
5) To Practice Challenge
 2.3. Risks and causes of failure associated with small business
Although many new small businesses are established in most countries, the
success rate is minimal. This can be attributing to many factors, which can
generally be classified in to two categories: external and personal (internal)
factors of failure.
External factors Personal (internal) factors
• Inexperience
• Economic business cycles, • Arrogance
• Fluctuating interest rate, • Mismanagement:
• Interrupted supplies, – Over Investment on Fixed
Assets:
• Labor market,
– Poor Inventory Control:
• Inflation, – Poor Financial Control:
• Government regulations, and – Poor Business Philosophy:
• Unstable financial markets – Lack of Planning:

 Although all businesses/small/big are subject to this risk, their effect on

small businesses is far more serious than any other businesses. This is
because the resources a small business owner controls are very limited
which makes it very difficult to deal with these situation.
Problems that can be attributed to personal weakness of the
entrepreneur..... Cont’d
• Inexperience: too often, entrepreneurs launch their enterprises without
having sufficient experiences to succeed. Inexperience can be translated
to mean a lack of technical or management insight.

• Arrogance: many small businesspersons – particularly inventors and

innovative entrepreneurs with new products become egocentrically
engrossed in their ventures. Their arrogance will not allow them to take
advice from others.

• Mismanagement: humble entrepreneurs steeped in experience can still

go under simply mismanagement of resources; they simply make
bad decisions in critical situations. These may include:
– Over Investment on Fixed Assets: when starting and expanding a
business, everyone likes to own assets rather than lease or subcontract, but
greater investment on fixed assets means less flexibility to adjust to
adverse conditions.
 Cont’d
– Poor Inventory Control: purchasing too much inventory increases the risk
of low turnover and obsolescence. Having too little inventory undermines
customer satisfaction and sales. Buying and holding the wrong inventory, at
the wrong time, evaporates cash.

– Poor Financial Control: results from poor control over credit sales, poor
bookkeeping, and advances and regular payment for inventory
purchase, loan payments, lease payments, utility cost, and payroll
expenses.

– Poor Business Philosophy: an unfortunate aspect of many business

failures is that too often-individual owner’s priorities get out of the way
of sound business practices.

– Lack of Planning: most entrepreneurs frequently underestimate the

importance of planning in the business success. However, not planning
means not anticipating future problems and challenges and not being
prepared for them in advance.
 2.4. Types of Small Business
• Most books on entrepreneurship and small business written by
westerners list the following as a small business.
• Manufacturing; - machine shops, bakeries
• Mining: - coal mines, sand and gravel companies
• Services: - beauty shops , travel agencies
• While other authors categorize small business as follows:
– Family Enterprises: they are locally owned and operated, often by one
person called sole proprietors. Proprietors may have started their business
in an effort to supplement or replace family income.
– Personal Service Firms: such business rely crucially on unique skills of
their founder or key employees in most instance, the business is the
person, and succession is unlikely unless a son or daughter develops
comparable skills.
– Franchises: It is a form of a business created by contract. An individual
receives specific help and advantages in exchange for a franchise fee and,
usually a percentage of sales. The franchisee may receive financial help.
Some scholars consider franchise as distribution system.
2.6 Problems in Ethiopian Small Business
According to World Bank report the following problems are
still major handicaps to small business:-.
 Lack of adequate finance and credit has always been a major problem in
Ethiopian small businesses. They do not have access to industrial sources of
finance partly because of their size and partly because of the fact that their
surpluses that can be utilized to repay loans are negligible.

 Because of their size and partly because of their limited profit, they search for
funds for investment purpose.
 Consequently, they approach money lenders who charge high rate of interest
and hence small enterprises continue to be financially weak.
 Small-scale units do not have easy access to the market because they
mostly are organized on proprietary partnership basis and are of very small
size. Besides, many small business enterprises are suffering with the problem
of marketing their products.
 Small-scale enterprises find it difficult to get raw materials of good quality and
cheaper rates in the field of production.
 Furthermore, the techniques of production, which these enterprises have
adopted, are usually out dated.
 2.7 Setting Small Businesses
2.7.1 What is a basic business idea?
• An entrepreneur should keep in view of future long term goals from the
opportunity he/she perceived and identified and this long term
thinking is called basic business idea.
• The entrepreneur should monitor and being flexible to the dynamic
business environment and select basic business idea that would:
– Generate quick returns
– Permit changes in the product.
• The general business atmosphere guides the choice of basic business
idea. A basic business idea results from the identification of business
opportunities in the market. To be successful in business, the entrepreneur
should carry out SWOT analysis, be sensitive to the market changes,
monitor the demand and supply, study consumer behavior and choose the
basic business idea.
1.7.2 What project an entrepreneur should have?

• What is Project?
– It is an organized unit dedicated to the attainment of a
goal- the successful completion of development project on
time, within budget, in conformance with predetermined
program specifications.
– It is a system involving the co-ordination of a number of
separate department entities through the organization, and
which must be completed within prescribed schedules and
time constraints.
 Project classification
1. Quantifiable and non-quantifiable projects
– Quantifiable projects are those in which a plausible quantitative
assessment of benefits can be made. Projects concerned with industrial
development, power generation, and mineral development are forming part
of quantifiable projects.
– Non-quantifiable projects are those where such an assessment is not
possible. The non-quantifiable projects category comprises health,
education, and defense.
2. Sectoral projects
– According to sectoral classification, a project may fall in the following
sectors;
a) Agriculture and allied sectors.
b) Manufacturing and mining sector.
c) Transport and communication sector.
d) Social services sector.
e) Miscellaneous sector.
– This sector classification of projects is quite useful for resource allocation
at macro levels.
3. Techno-Economic projects: Techno-economic projects
classification includes;
a) Factor-intensity oriented
• The factor intensity is used as base for classification of projects such as
capital intensive or labor incentive which depends upon the large
scale investment in plant and machinery or human resources.

b) Causation oriented classification

• The causation-oriented projects are determined based on its causes
namely demand based projects. The non-availability of certain goods or
services and consequent demand for such goods or services or the
availability of certain raw materials, skills or other inputs is the dominant
reason for starting the project.

c) Magnitude oriented classification

• The size of investment forms the basis for magnitude-oriented projects.
Projects may thus be classified based on its investment such as large-
scale, medium-scale, and small-scale projects.
4. Financial institutions classification
• The projects are classified according to their age and experience and
the purpose for which the project is being taken up. They are as
follows;
a) New projects.

b) Expansion projects.

c) Modernization projects.

d) Diversification projects
5. The projects listed above are generally profit-oriented and the services
oriented projects are classified as under;
a) Welfare projects.

b) Service projects.

c) Research and development projects.

d) Educational projects.
 Definition of industry and small scale industry
• An industry
– is an institution where raw materials is purchased from suppliers,
converted in to a finished product using machinery and labor and
sold to the buyer. Conversion of raw materials means changing
the size shape, chemical properties and assembling different parts,
etc.
– is able to carry out the function of buying, manufacturing and
selling its product with the use of an organization: an organization
being a collection of people with of different skills, who coordinate
the various functions involved. Industry can be classified as
manufacturing, process, conversion and service.

• Small scale industries

– can be defined as industrial unites engaged in
manufacturing/preservation activities or repairing/servicing
operations including such actions as quarrying.
2.7.3 STEPS IN SETTING UP BUSINESSES
 In order to establish an entrepreneurial system, an
entrepreneur needs to take the following steps:

1. Search for business ideas.

2. Process the ideas.

3. Select the best idea.

4. Assemble the necessary input resources.

5. Establish the enterprise.

 1). Search for Business Idea
• The task of promotion begins with the search for a suitable
business idea or opportunity. The promoter has to be imaginative
and foresighted to discover a business idea.
• The idea may be generated from various sources such as:
• Work Experience: success story of a friend or relative,
• Hobbies:
• Deliberate Search: study of project profiles and industrial potential surveys,
• Observing the Market:
• Customers:- Demand for certain projects,
• Government organizations
• Distribution channels
• Trade fair and exhibitions
• Mass medias
• •
The idea may relate to the starting of a new business or to take over
of
an existing enterprise. The idea should be sound and workable. It
should yield a reasonable return on investment.
 2) Idea Processing/Screening
• Business ideas/opportunities need to be screened and
assessed for the viability once they have been identified
and generated.
• Process of screening business ideas
i. List down all the business ideas you have identified
Here, write down at least ten business ideas on
your observation on what people would like to
buy.
ii. Down screening ideas into three
Make selection of three business ideas from the
least of ten business ideas developed in the first
step.
To screen business ideas there are criteria. Some of
criteria include:

a) Marketability/demand

b) Profitability of the idea f) Financial feasibility

c) Availability of raw materials g) Risk exposure

d) Personal goals and h) Government support
competencies of the and incentives
entrepreneur
i) Technical feasibility

e) Ease of implementation j) Commercial viability

 3) Idea Selection
 The feasibility report is analyzed to finally choose the most promising idea.
The following considerations influence the selection of idea for a product or
service;
a) Products whose inputs are not banned or restricted by the
government
b)Products which can be exported easily and profitably
c) Products whose demand exceeds their supply so that there exists
ready demand.
d)Products on which the entrepreneur has manufacturing and/or
marketing experience.
e) Parent ancillary relationship i.e. the product is to be manufactured for
a parent company.
f) Products which showed high profitability
g)Products based on the expansion or diversification plans of existing
firms
h) Products which ensured specific advantages- scale of the industry or
the location of the factory or technology of manufacture.
i) Products favored by the country’s industrial/licensing policy.
j) Products for which incentives and subsidies are available.
4) Assemble the necessary input requirements

• Once the promoter is convinced of the feasibility and profitability of

the project, he assembles the necessary resources to launch the
enterprise.

• He has to choose partners/collaborators, collect the required

finance and acquire land and buildings, plant and machinery,
furniture and fixtures, patents, employees etc.

• Decisions have to be made about the size, location, layout etc. of

the enterprise. The form of ownership organization has to be
selected.

• The main inputs required for launching an enterprise are as

follows;
a)Information and intelligence
b) Finance
c)Personnel
 a) Information and intelligence
• In the turbulent business environment, information and intelligence have
become the key input in entrepreneurial success. An entrepreneur
requires relevant data on the following aspects:

1. Size and nature of demand for the product or service

2. Volume and sources of supply
3. Price cost volume relationship
4. Sources of raw materials
5. Type and suppliers of technology, machinery and equipment
6. Number and type of personnel required and their resources
7. Amount and sources of funds required for the enterprise
8. Nature and degree of competition
9. Government policies and regulations concerning the industry
10.Export import conditions for the product/service.
b) Finance C) Personnel
o People are the most valuable asset of an
A business enterprise enterprise and an entrepreneur has to
requires finance for: make the following decisions concerning
 fixed assets (fixed the personnel:
capital) &  Number of personnel required for
 current assets (working management, technical and other positions in
capital). the enterprise.
 Qualifications and experience required in the
personnel to perform the jobs effectively
 Funds could be raised from  Sources of recruitment
different sources (e.g.  Procedure and methods of selecting the best
shares, debentures, loans candidates
 Methods of orientation and training.
etc.) This decision is known  Criteria for evaluating the performance of
as the capital structure. employees.
 Policies for the transfer and promotion of staff.
 Systems are required for  Policies and methods of remunerating the
personnel.
the efficient management  Facilities to be provided for the safety, health,
and control of working welfare of the staff.
capital and earnings.  Participation of personnel in the management
of the enterprise.
 5) Establish The Enterprise
 The form of ownership is to be decided upon and the
company formed and registered.
 Following this, action is directed towards obtaining
finance, necessary licenses, and necessary
infrastructure is to be taken.
 This would involve dealing with various government bodies
and other institutions like:
– Financial institutions- for finance
– Sales tax, Income tax authorities- for respective registration
– Licensing authority- for obtaining industrial license and licenses for
raw material procurement.
– Municipal Authorities and Electricity- for requisite utilities.
– Directorate of Industries, Municipal Authorities etc.- for land, factory
and shed etc.
 Cont’d
• Once all the required authorizations and sanctions have been obtained,
action is to be taken for the following;
• Ordering machineries from suppliers
• Obtaining utilities like power and water connections
• Recruitment of staff
• Arranging supplies of materials
• Arranging for distribution of the product

• And then the plant is ready for commissioning. Trial run may be made at
this stage. Promotion efforts may be made to pave the way for introducing
the product.

• When the first few batches of the product are introduced in the market,
information regarding its acceptance is to be gathered.

• On the basis of feedback obtained, the process/product has to be modified

until acceptable output is obtained. Then the unit is ready for commercial
production.