Unit 2: Entrepreneurship Practice

Module Two: - New Venture, Planning and Creation

MARKET RESEARCH
In this lesson, students should be able to:
1. Define the term market research
2. Discuss the purpose and benefits of market research
3. Explain the importance of conducting a market research
4. Differentiate between primary and secondary data
5. List the steps in conducting a market research
6. Discuss the key elements of market research

What is Market Research?

When was the last time you consumed a product (for example, your favourite meal) or enjoyed a
service (for example, an all-inclusive hotel) and were really satisfied?
If you have had that experience with any product or service, it was the result of good marketing
research.
According to ‘entrepreneurship.org’, market research is the ‘the process of gathering, analyzing
and interpreting information about a market, about a product or service to be offered for sale in
the market, and about the past, present and potential customers for the product or service.’
It involves the collection and analysing of information need to make business decisions
regarding potential customers and identifying their preferences.
Furthermore, market research is the process through which a firm engages its resources or hires
another firm to collect and analyse information about the firm’s customers, competitors and other
factors which might impact on its ability to satisfy customers.
Moreover, in conducting market research certain aspects of marketing such as market price,
distribution channels, and promotion among others will be researched. This sometimes leads to
the terms; market research and market research being used interchangeably. However, the terms
are distinct and should be treated as such. Consequently, marking research deals with
investigating how to best reach the customer, as such it deals with aspects of the marketing mix.
Market research involves the gathering and analysis of data that is relevant to your marketing.
For example, you might want to know:
 the size of the market – this can be measured in terms of the number of dollars spent in it
(the value of the market) or number of items purchased (the volume of the market).
 key market trends – for example, whether the market as a whole is growing, or whether
particular types of products are growing in popularity
 what customers value about the product, how much they are prepared to pay for it,
and what your product can do better than other products on the market
 key characteristics of customers (such as their age, lifestyle, attitudes and buying
patterns). A customer profile is an outline of the customer base.

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Market research can identify the fundamental reason for buying the product (for example,
because you are thirsty or hungry) and customer wants (which shows which product you would
like to buy). Having identified the need, the business will aim to make you want their products.
Market research provides a manager with information. This is important for effective decision-
making. Imagine you are wandering around in your home at midnight and none of the lights are
working. You stumble, move slowly, and make mistakes getting around: market research can
provide the lighting in the room that enables you to move quickly, efficiently and effectively, to
get to where you want.
By undertaking market research, managers should have a better idea of what people want and
how they behave. This should mean that the firm can meet their needs more effectively and
avoid wasteful marketing activities. Imagine that you are considering launching a new product.
If you can find out who your target market is, what they read, where they shop, what they watch
and listen to, then your marketing can be much more effective. For example, there is no point in
spending money on a big Saturday evening television campaign if you target audience is at a
nightclub.
Market research may be undertaken before the business is set up in order to decide whether or
not it is viable. It can also be undertaken once the business is up and running to decide what to
do next – for example, whether to change the price of a product or launch a new brand.
Typically, market research is used to:

Assesses the
Identifies
effectiveness of
market
different
opportunities
marketing actions

Market
Research

Assesses the
alternative options
open to the
businesses to meet
customer needs

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Purpose of Marketing Research
Entrepreneurs may perceive market research as a tedious process. However, it is important to
comprehend the usefulness of research and the benefits associated with market planning.
Market research provides avenues of insight for the entrepreneur into the demand for the product
and the challenges which may be encountered during the entrepreneurial process and increase of
sales. Market research can be conducted by the entrepreneur or researchers within the company.
Some businesses may decide to employ or contract company that specializes in market research.
The research should provide information about the level of demand, as well as the characteristics
and demographics of the potential target market and income levels. The entrepreneur would also
find competitors, their market share, about strengths and weaknesses. There would also be
information that would help in projecting sales and distribution.
Furthermore, market research can be used to monitor and evaluate the actions previously
implemented to assess the progress of strategy in achieving the objective. This information will
assist in developing an effective plan which for increasing revenue and distribution of the
product to consumers. In addition, it is also beneficial for an entrepreneur who is seeking an
investor for his business.
While there is no doubt that intuition plays a part in entrepreneurship, marketing decisions
should be done effective research and not on guesses. An entrepreneur who has extensive
experience in a particular market may be able to make a good decision based on that experience,
the likelihood of success in marketing the product. Entrepreneurs must also consider the positive
impact that sound market research will have on the business plan and obtaining financing.
Lenders and investors are more likely to support an entrepreneur who can demonstrate solid
decisions based on objective information. Sales forecasts are the bases for projected revenues
and profits. Therefore, forecasts that are based on research are likely to produce more valid
projections, and that makes it more valuable to an entrepreneur who is looking for financial
support.

Benefits of Conducting a Market Research

1. Allows you to understand the nature and needs of existing customers so that you can
continually devise strategies that will be effective in maintaining satisfaction.
2. Assists the business in identifying and understanding potential customers.
3. Reveals the current position of the firm in the marketplace. This will enable it to assess
how much of its goals it has achieved and plan the ‘way forward’ from that position.
4. Helps in the minimizing of business risks. It may ‘open your eyes’ to sides of a matter
being investigated that you never knew, causing you to be in the position to make a more
informed decision.
5. Identifies market trends. It can provide you with a lot of data that will enable to do an
analysis which will highlight trends that can be used to predict future performance.
6. Identifies new business opportunities. For instance, a talk with your customers about a
current product, may reveal another need that you never knew existed. You would now
be able to take advantage of that opportunity.
7. Allows the entrepreneur to investigate existing problems

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 8. Allows the entrepreneur to investigate existing.
9. Should ultimately lead to an increase in sales and profits.
10. Enables the business to set target targets that are SMART (Specific, Measurable,
Achievable, Realistic and Time-bond)
11. Helps the business to gain and maintain a competitive edge. It will bring to light
information about your competitors that you never knew, that will enable you to make
your offering more unique.

Importance of Conducting a Market Research

Marketing research is a very important tool used by businesses, especially in an increasingly
competitive market, for the following reasons, among others:
 Helps management to make informed decisions
 Marketing opportunities can be identified
 The needs of the target market can be ascertained
 The firm can gather information to assist it in pricing the product
 To assess the level of competition in the market
 To ascertain the features of a product that appeal to the target market
 To monitor the firm’s performance in the market
 Helps to prevent the firm from making uncalculated risks.

Market Research can help the entrepreneur to:

1. Identify problems
2. Understand the changing market
3. Focus or develop strategies to keep existing customers
4. Improve the quality of decision making

Primary and Secondary Market Research

Primary market research gathers data for the first time for a specific purpose. It can be
tailored precisely to your own needs but can be quite expensive and time consuming, compared
with using information already collected. The danger is that because of cost constraints or
because you are inexperienced you only ask a relatively small number of people, or specific
group that does not really represent the population. This means that your results may be biased
and misleading. It you ask your friends, for example, they may tell you it is a great idea even if
it isn’t because they do not want to upset you.
If you are going to undertake primary research you need to make sure that you:

 Don’t lead people into giving you the answer you want (for example, Why do you think
my idea is so good? Is a leading question)
 Ask a representative group of people (that you hope will represent your target group)
 Ask enough people for the findings to be significant. One person’s opinion may not
necessarily reflect the views of the population as a whole.

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Primary data – collection of new data for a specific purpose and target market. Primary data can
be gathered:
(a) Observation – this is where data is gathered by observing the people or process involve
in the research. For example, you may watch what is happening in the stores of your possible
competitors or count how many people walk by a potential location for your shop on a typical
day to calculate the ‘football.’ (In retailing, the football is an important indicator of the likely
number of customers. The more people that walk past the more customers you may get.)

(b) Survey – this is where information is gathered from a sample of a relatively large group
of people which is referred to as the ‘population’. These people are usually asked to answer a
series of questions pertaining to the problem being researched. A questionnaire or interview is
often used to gather such data. For example, you may have been stopped in the street and asked
your opinion about something. This a face-to-face survey and is one way of finding out what
people think. Firms also use telephone, mail or online surveys to find out the views of potential
customers. Surveys may give you an idea of what people think or whether or not to go ahead.

(c) Focus group – by asking a small group of people what they think.

(d) Test marketing – sometimes a business may try a product in a test market such as a
particular region for a while to see how it sells. If this goes well it might be rolled out to other
areas, if sales are poor changes could be made to the product or the way it is promoted to see
what happens then.

(e) Experiment – this information can be gathered by conducting laboratory research where
both variables are scientifically assessed.

The researcher can target specific groups and provide up to date information on the market.
Furthermore, business researchers in contemporary settings are utilizing more online methods of
collecting data. This involves researching journals and studies online (secondary) and
conducting focus groups, sending online questionnaires and surveys (primary).

(2) Secondary market research uses data that already exists. It is particularly useful for general
information on the economy, the market and on competitors.

While secondary data is usually quite quick to get hold of, it is not always in the right format for
your needs, or up to date. The research may have been done in the previous year when what you
want is this year’s figure. It may organise sales data according to the sales per country.
Nevertheless, secondary research is usually a good starting point. Once you have looked at
secondary sources you can identify what else you need to know, what information needs to be
gathered for the first time.

A secondary data source is where previously used data is gathered to be used in the current
research. Secondary data can therefore be defined as data that has been collected for previous
research. This data is not specific to the current research but can offer some guide as to how to
proceed. A rule of thumb is that secondary data should be consulted before the researcher

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collects primary data. Secondary data has the advantage of being cheaper to acquire than
primary data. It is also said to be obtained much more quickly than primary data. However, one
of its drawbacks is that it is not always readily available or, even if it is, sometimes it cannot be
used for the problem under review. Secondary data can be collected from a number of sources,
including but not limited to:
 Company reports – these can provide information on the company’s sales
 Government publications or statistical institutions, such as the Planning Institute of
Jamaica, the Central Statistical Office in Trinidad and Tobago and the Barbados
Statistical Service, among others. These publications would include statistics on
inflation, exchange rates and unemployment.
 Articles from credible local newspapers
 Local libraries
 Journals containing experts’ opinions

Market research focuses on the business environment, potential customers, and competitors. It is
crucial for the entrepreneur to be attentive to these areas as it would help in measuring the
market demand for the product and enabling customer satisfaction.
(a) Business Environment – the entrepreneur, should conduct a PESTLE analysis that would
assess the impact of the political, economic, social, technological, legal and
environmental factors that could impact the business.
(b) Customers – it is important to evaluate the customers’ needs and ensure there is a
demand for your product in order to ensure the venture’s sustainability.
(c) Competitor – market research allows the entrepreneur identify competitors.
Entrepreneurs/management are able to make strategic plans that are viable and would
contribute to increasing sales and market share.
The market research process will guide you in deciding if the venture is feasible and shows
profitability.

Conducting Market Research

Many entrepreneurs find it difficult to conduct market research. Effective research can make
heavy demands on resources; financial, personnel and time, but even small and micro
entrepreneurs can do effective research. In order to obtain the information that would allow the
development of appropriate marketing strategies, the entrepreneur must analyse the internal and
external factors which could impact the ability to compete and to satisfy customers. These
factors are sometimes classified as five Cs: company, customers, collaborators, competitors
and context. Research success is achieved through the use of a simple, systematic approach to
the research task, as summarized in the following steps:
1. Define the Research Question
For most new businesses this may be as simple as ‘What level of sales will we achieve
with this product?’

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 2. Develop an Appropriate Research Plan
Consideration must be given to the types and sources of information, the need for
primary research and the best techniques for gathering the information.
3. Implement the Research Plan
The actual research is done within the entrepreneur’s resource constraints
4. Analyse and Interpret the Data
Interpreting the analysis in an honest way and presenting your readers with your point of
view give a sense of completeness and closure. An effective conclusion should provide
closure for the paper, leaving the reader feeling satisfied that the arguments have been
fully explained.

Key Elements of Market Research

The research plan and research instrument must be designed to yield the kind of information that
is needed. The entrepreneur must have the information needed to make relevant decisions and
achieve customer satisfaction this includes:
I. Product Characteristics
According to Kotler (2003), ‘a product is anything that can be offered to a market to satisfy a
want or need.’ He describes products as, ‘physical goods, services, experiences, events, persons,
places, properties, organizations, information and ideas.’ The entrepreneur must have a clear
understanding of the product features in order to formulate the marketing strategy and meet the
customer needs. It is important to understand how the product is perceived on the market.
It must be clear what product features and characteristics are valued by customers. Product
characteristics are attributes or features that clearly describe the ability of the product to satisfy
the needs of consumers. These features should differentiate an enterprise’s product from other
products in the market. The product’s characteristics will be influenced by the nature and needs
of the target market. They might be used to determine the price that the product will be sold for
and how it will be promoted and made available to the customers.
The entrepreneur needs to also be aware of the distinction between a good or service. The good
is tangible and can be stored for future use whereas, a service is intangible and cannot be stored.
A service that is not used is lost. Key features of a service are: (a) Intangibility, where the
service cannot be seen or touched before actual buying; (b) Inseparability, where the service
cannot be separated from the service provider and activities are sued at the time of purchase;
(c)Perishability, where the service cannot be stored for future use and (d) Heterogeneity, in that
the service will vary with the service provider and the environmental circumstances at the time.
Each product is made up of both tangible and intangible features which help to define the
product. The marketer must communicate to the market, the benefits that will be derived from
the use of product rather mere tangible features.
Let us look at some of the basic benefits that a product may provide:
 Functionality – the product must fulfil its purpose. It should perform the task that it was
designed to perform.

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  Durability – the product must last for the stated time of use, maintaining its strength and
form throughout all types of pressure.
 Quality – Quality is a very important feature. It tells the value of the product.
Customers will match the quality with the price in order to make the decision to buy or
not buy.
 Usability – the usability of a product speaks to the extent to which and ease with which
a product can be used by the target market to effectively satisfy needs.
 Maintainability – maintainability looks at whether the product can be preserved with the
application of specified measures.
 Safety – the product must not pose a threat to humans and the environment when used
in the prescribed way. The business must ensure that the safety features and
preventative measures are highlighted.
The business must articulate the product’s characteristics in such a way that they are clear to
customers and potential customers and allow the product to be set apart and above its
competitors’ products. The entrepreneur must ensure that the business has a standard for its
services.
The market researcher should therefore be aware of what the target customer wants and ensure
that the product offering match the customer requirements. The market research should inform
as to who is the buyer; who will influence the buying decision and the trends in buying needs;
competition product offering and the target market size.

II. Definition of market

The size and nature of the market set the parameters within which the firm operates. It is
important to determine whether the product has mass appeal or serves a niche. Is it a local
phenomenon or something that might have global appeal?
According to Kotler (2003), a market is the set of all actual and potential buyers of a market
offer. The entrepreneur can utilize the following market definition in research and planning.
This is important in deciding on which market to measure in market research. The following
definitions are based on Kotler (2003), Marketing Management 11th Edition:
 Potential Market: the set of consumers who express a ‘sufficient level’ of interest in a
market offering.
 Available Market: the set of consumers who possess an interest, the income and access to
a particular market offer.
 Target Market or Served Market: the segment or part of the available market that
company decides to pursue.
 Penetrated Market: this consists of the set of consumers who are purchasing the firm’s
products.
The market size and share must be determined, and the marketer must be aware of the
opportunities for growth and potential threats.

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 III. Expected Sales Trends
Market research provides the entrepreneur with information in understanding consumer spending
patterns and factors affecting demand. Understanding trends can help improve the accuracy of
forecasts and planning.
The market researcher should be aware of fluctuating sales trends as this may point to new trends
in the market. Further, sales trends point to issues in customer retention. The expected sales
trend analysis will underscore which customer segments are experiencing highest sales growth
or decline in monetary terms; or how strong is the growth or decline trend. Understanding sales
trends is important for sales forecasting. That is projecting expected customer demand for a
specific company’s good or service in a particular time period. This will inform the entrepreneur
of what products to pursue and how much to spend on marketing efforts and the development of
the marketing strategy. According to Kotler (2003), a sales forecast can be developed based on
past sales figures. This can be done by using:
 Time Series Analysis: this entails analyzing past time series. This would be done
according to elements such as trend, cycle, seasonal and erratic. The researcher will then
project the elements into the future.
 Exponential Smoothing: this deals with a projection of the sales for the next period.
This is achieved by using an average of past sales and most recent sales figure.
 Statistical Demand Analysis: This entails a measurement of the impact of factors (casual)
such as income and price on sales level.
Trends in sales can be identified when sales data for a number of years are carefully analysed.
The sales patterns that are discovered help to make predictions of how the product may perform
in the coming years. They also have implications for the expected cash inflow. Any short fall or
problem foreseen can be planned for. They will allow the firm to predict future patterns so that
production schedules can be properly planned. The marketer can also compare the sales trends
of the business with that of the competitors. Potential yearly sales are found by multiplying the
number of potential customers by the average amount expected to be spent.

IV. Customer Analysis

The entrepreneur must know who the customer is. Having a customer profile is essential to
developing appropriate marketing campaigns and continuing to seek ways to please the
customer. New strategies can be evolved for ways to improve customer satisfaction and reduce
wastage of resources and maximize the marketing plan.
The customer analysis will:
 Identify the target market
The target market must be identified. The business must know who its customers are. Is
the business selling its goods or services to other businesses or to consumers? Customers
must be placed in their respective market segments and customer profiles must be
prepared for each group. Market segmentation is the process of dividing the market
into smaller groups according to its varying needs. This allows the marketer to better
tailor marketing strategies to fit each need type.
Customers may be divided according to demographics (age, gender, marital status,

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 income, geographic location etc.) or psychographics (lifestyle, interests, buying habits,
opinions etc.). The marketer must be as specific as possible. It a story book about
princesses with an audio feature is being made, do not just say that the target market is
‘Girls’. You may need to say ‘Girls in Happy Country, between the ages of 3 to 10. A
marketer will also need to ascertain who the ‘user’ is as against the ‘buyer’. The person
buying, say cornflakes, may be the parents but they are really buying it for the children.
The strategies that are utilized to attract the customer must not therefore be geared solely
towards the parents, but rather, to a great extent, towards the children. So, the box would
be colourful and display pictures of current and popular cartoon characters. This is so
even though we are aware that the parents will consume the product too. Keep in mind,
that more than likely, it is the children who will walk into the supermarket with their
parents and ‘point out’ the product to their parents.

 Look at the needs of the customers

As said before, your efforts would be futile if you do not find out the needs of your
customers then seek to design your product to satisfy them. Afterwards, you are not
expected to be static. As need change, your offering, which relates to the elements of
marketing mix must change.

 Show how the customers’ needs are satisfied by the products and services that the
business is offering.
Are your customers’ needs being satisfied by the products and services that you offer?
Are there needs that are unmet? The marketer must investigate the extent of satisfaction
so that if need be, he or she can make appropriate adjustments to the marketing mix.

V. Promotional Strategy
The promotional strategy is devised to make the customers and prospective customers aware of
the products and services of a business. It will also be geared towards motivating them to buy.
The main aim is to attract and retain customers. Producing successful promotional strategies will
require an accurate knowledge of the target market and the promotional tools that are available
that will be effective. The marketer must have a good knowledge of his or her target market and
select the most effective tool to say for example, communicate the attributes of the product or
service to it. If the target market is ‘teenagers’ then social media is definitely the most suitable
tool that should be used to reach them. There is also the need for a tremendous level of creativity
on the part of the marketing team.
Social media is a powerful tool that can be used to attract customers. It allows for communities
to be developed and the numbers of persons within each have the ability to be multiplied at a
very fast rate over and over. The following are some common examples of Social and Media
Sharing Networks: Facebook, Twitter, LinkedIn, Google +, YouTube, Pinterest, Instagram and
Snapchat.
Other promotional tools include the use of Mass Media Advertising, Public Relations, Personal
Selling and Sales Promotion tactics such as Contests and Product Giveaways.

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VI. Nature and level of competition
The business does not exist in a vacuum but rather in competitive environment. The
entrepreneur should observe and become knowledgeable of competitors. This will assist the
organisation in decision making in developing sustainable business strategies. A competitor
analysis will provide information on the impact or influence the competitor may have on the
venture.
Information must be collected on the competitors. This will include information on the
competitors’ market share, products and services, marketing strategies and management team.
Using social media and various websites can be of assistance in informing you about what
persons are saying about your competitors.
The business needs to investigate:
 Who their competitors are
 The size of their market share
 Their strengths and weaknesses
 If they are likely to move into the firm’s market share
 If the industry is fragmented, concentrated or both
The business needs to know if it is facing direct competition or indirect competition. Direct
competition exists when two firms are producing similar products for the same target market.
For example, two companies that are producing soft drinks. On the other hand, indirect
competition occurs when two companies are producing different products but are competing for
the same dollar.
Having as correct as possible perspective of the position of the competitors at all times will help
the business in its attempts to gain and maintain a competitive edge. It is not good enough to
pretend that you are the only ‘heat’ in the market or to give your investors and other stakeholders
that impression.

Cost-benefit analysis approach to market research

In assessing the cost of market research to a venture the entrepreneur must consider the research
method to be used and the relative costs of each option available. The size of the sample
population should also be considered in costing market research. In considering a cost-benefit
analysis approach to market research the entrepreneur can look at examples of cost associated
with market research:

 Time spent by research staff and consultants on research activities

 Resources (of the firm) used in the process such as, electricity, accommodation
 Cost of each research location
 Cost per research participant
 Cost of delaying a product entry into the market as a result of market research
 Opportunity cost of market research in terms of using resources in another area

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 Possible benefits of conducting market research entails:
 Lower the risk of product failure on the market
 Create a better profile of customers and market
 Provide a more detailed and up-to-date understanding of the venture’s environments
 Identify opportunities in the market
 Can benefit the organization’s image of having a culture of research and learning

Moreover, the cost of a market research programme is dependent by the research method to be
used example focus group may be more expensive in terms of location, time, cost of participant
than a phone survey.
After, estimates on cost and benefits of the market research process are done, the venture can
calculate the return on investment. The return on investment quantifies or shows the dollar
worth of the project. Further, it can highlight additional advantages that may be more qualitative
in nature. Additionally, calculating the rate of return can lend support to the viability of a
project. The formula for calculating Return on Investment (ROI) is:
ROI = (Financial value - Project cost) / Project cost

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Revision Questions relating to Market Research
Answer the following questions to test your knowledge on the information covered.
Answer TRUE or FALSE
1. A market research should only be done at the start of a business

2. Collecting research data can guide an entrepreneur in selecting a target market

3. Market research does not tell you who your competitors are

4. Secondary data is given by potential competitors

5. Market research is only conducted when there is a problem

6. Market research

(a) Does not include global factors

(b) Increases sales

(c) Occurs at the start of a venture

(d) All of the above

7. The first stage before gathering data is

(a) Determine research methods

(b) Identify target market

(c) Obtain research resources

(d) Identify research objectives

8. _________________ is information that already exists somewhere, having been collected for
another purpose.

(a) Primary data

(b) External information

(c) Secondary data

(d) Experimental information

9. Primary research

(a) Involves a focus group

(b) Requires direct contact with people

(c) Must have a questionnaire

(d) Collected for a specific purpose

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10. The process of collecting, analysing and interpreting data in order to make an informed

decision about a product, customers, target market or industry best defines which of the
following?
a. Sampling
b. Market research
c. Marketing
d. Primary data

11. Which of the following is NOT a primary source of data?

a. Internet article
b. Experiment
c. Survey
d. Observation
12. Which of the following would NOT be an advantage of secondary data over primary data?
a. Usually cheaper to gather
b. Faster access from existing sources
c. Previously collected for other research
d. Guides the researcher before primary sources are consulted

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Unit 2: Entrepreneurship
MODULE 2: NEW VENTURE, PLANNING AND CREATION
Chapter 2: FEASIBILTY ANALYSIS
In this lesson, students should be able to:
7. Define the term feasibility analysis
8. Discuss the purpose and benefits of feasibility analysis
9. Explain the importance of conducting a feasibility analysis
10. Discuss the key elements of feasibility analysis

Feasibility analysis is the process of determining if a business idea is viable. A feasibility

analysis takes the guesswork (to a certain degree) out of a business launch and provides
an entrepreneur with a more secure notion that a business idea is feasible or viable. It is the
preliminary evaluation of a business idea, conducted for the purpose of determining whether the
idea is worth pursuing.

Feasibility analysis takes the guesswork (to certain degree) out of a business launch and provides
an entrepreneur with a more secure notion that a business idea is feasible or viable.

According to Coulter (2003), a feasibility study is a ‘systematic analysis of the various aspects of
a proposed entrepreneurial venture.’
A well-designed feasibility study should provide a historical background of the business or
project, a description of the product or service, accounting statements, details of the operations
and management, marketing research and policies, financial data, legal requirements and tax
obligations. Generally, feasibility studies precede technical development and project
implementation.

The focus of this chapter will be for students to develop a clear understanding of the purpose of
feasibility analysis and its benefits. The chapter will also profile the key elements of a feasibility
analysis such as personality feasibility or individual’s SWOT profile, management, operational,
financial, marketing, time, industry, and cultural feasibility.

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Purpose of a Feasibility Analysis

Feasibility analysis or a feasibility study; is a valuable tool and critical part of the screening and
planning process. It tests the idea and the potential of the proposed venture by evaluating several
key areas. In so doing, the entrepreneur takes a realistic look at what is required and the chances
of success. There are many opportunities to make adjustments which could mitigate any
negatives which are identified.

Knowing that the odds of failure are high, the entrepreneur should see this as a chance to
improve those odds. It also reflects positively when the entrepreneur can demonstrate that
thorough analysis was part of the venture planning process. There is also the benefit of being
even better prepared to face the tough questions when courting investors and lenders.

The purpose of the feasibility analysis to objectively and rationally uncover the strengths and
weaknesses of an existing business or proposed venture, opportunities and threats present in the
environment, the resources required to carry through, and ultimately the prospects for success. In
its simplest terms, the two criteria to judge feasibility are cost required and value to be attained.

Benefits of a Feasibility Analysis

1. It provides information that will allow you to see whether you should or should not
proceed with a business idea
2. While the feasibility analysis is being carried out, the entrepreneur may discover new
business opportunities
3. The feasibility study ‘narrow down’ the options that are available to the business. This
makes it easier to make a decision.
4. If the entrepreneur realizes that a business idea is not to be pursued as a result of the
findings of the feasibility study, he or she is in the position to save on resources such as
time and various costs that would have been incurred to set the business idea in motion.
5. The feasibility study can provide an opportunity for the entrepreneur to connect with
prospective investors.
6. Problems can be identified, and solutions provided during the period of analysis.
7. The study allows the business to see what resources are required and to assess the
business’ ability to provide these resources.
8. Information gathered during the study will help the business to set realistic timelines.
9. The feasibility study is the steppingstone for the preparation of the business plan.

A well-designed feasibility study should provide:

1. a historical background of the business or project,

2. a description of the product or service,

3. accounting statements,

4. details of the operations and management, marketing research and policies, financial data,
legal requirements and tax obligations.

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 When to Conduct a Feasibility Study or Feasibility Analysis

Timing of Feasibility Analysis - the proper time to conduct a feasibility analysis is early in
thinking through the prospects for a new business. The thought is to screen ideas before a lot of
resource are spend on them.

Key Elements of Feasibility Analysis

1. Personality Feasibility (an individual’s SWOT analysis)

Successful entrepreneurs possess certain characteristics such as follows:
(i) Innovative – the entrepreneur is able to translate obscure opportunity into profitable enterprise
was notes as a key trait of the entrepreneur.
(ii)Creative – this trait is similar but slightly different from innovation. Whereas innovation is a
response to opportunity or challenge, creativity is the ability to envision and make something
new. This draws on the dreamer within. It is the ability to come up with original ideas.
(iii) Calculated risk takers – Entrepreneurs are no daredevils. Although they have a higher
tendency to take risks than others do, they are not reckless nor are they gamblers. They
simply choose to take those risks which they reasonably expect to overcome in earning
profit.
(iv) A systematic planner – Someone coined the adage ‘Plan the work and work the
plan.’ Successful entrepreneurs recognize the importance of planning and they engage in
thoughtful analysis of the situation ahead of time.
(v) Visionary – after they have come up with an idea or a solution for a problem,
entrepreneurs engage in what we might call ‘visioning.’ They have their minds set on the
future of their product or
(vi) Achievement oriented – entrepreneurs set goals for themselves that become their
focus. It is not usually about fame or status. Rather, it is an internal drive to reach their
own standards. Seeing the dream of a new product or business become a reality can be the
motivation that keeps them going.
(vii) Persistent – successful entrepreneurs recognize that success is not always
immediate. They often have already gone through failures but do not allow those failures
to daunt them
(viii) Dynamic –Entrepreneurs lead teams and organizations. As a person, the
entrepreneur must be able to transfer the vision and passion behind the work. This person
must be able to face the challenges and failures yet rise above them. Terms like ‘high -
energy’ and ‘optimistic’ are often used to describe this trait.
(ix) Hard-working – being entrepreneurs is not an easy, glamorous thing. There is a
lot of work involved at every stage. People who prefer an easy route usually choose to stay
in a ‘safe’ job. The entrepreneur assumes a lot of responsibility and faces a lot of physical,
mental and emotional demands.
(x) Self – confident – Successful entrepreneurs believe in themselves and their ideas.
They know the importance of taking advice and working with others but they do not

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 depend on people’s acceptance of them or their ideas. They do not allow failure or
people’s opinions to sway them. Instead, they learn from mistakes and move on.
(xi) Feels a Sense of Ownership - taking responsibility for getting things done – and
doing them with care and attention – means to act like an owner. Rather than viewing a
problem as someone else’s, the entrepreneur sees it as his or her own and takes pride in
finding a solution, leaving things in a better shape than they were before encountering
them, and improving upon situations rather than leaving them unattended.
(xii) Able to Communicate - Entrepreneurs recognize that the most important part of
any business is the human element. Human resources – whether in the form of clients,
employees, or strategic partners – are what makes or breaks a business, and communication
is the key to successful relationships with people. The entrepreneur works to improve
communication skills, whether those are written, spoken, or non-verbal messages conveyed
through body language.
Above all, the entrepreneur develops a keen ability to listen and hear what others are
trying to say, because the best communicators got that way by first being the best listeners.
(xiii) Passionate about Learning - Entrepreneurs are often “autodidactic” learners,
which means that much of what they know they learned not in a formal classroom setting
but instead on their own by seeking out information, asking questions, and doing personal
reading and research. They also are quick to learn from their own mistakes, which means
they are less prone to keep repeating them due to arrogance, ego, or a blindness to one’s
own faults, shortcomings, or errors in judgement.
(xiv) Dedicated - Entrepreneurs dedicate themselves to the fulfilment of their plans,
visions, and dreams, and that tenacity of purpose generates electricity throughout the whole
organization.
(xv) Optimistic - A positive outlook is essential for the entrepreneur, who learns to see
setbacks as bargain priced tuition for the valuable business lessons gained through first-
hand experience.
(xvi) A Leader by Example - Entrepreneurs not only lead themselves through self-
motivation as self-starters who jump into tasks with enthusiasm, but they are also skilled at
leading others. They know the importance of teamwork, and they understand the need to
appreciate others, support them, and reward them accordingly. True leaders do not become
indispensable, otherwise things fall apart in their absence and they can never rise to the
highest level of entrepreneurial freedom and prosperity. Neither do they squander the
potential of those working under their guidance.
(xvii) Not Afraid of Risk or Success - Many people could be successful if they only took
chances. And many people who do take chances and become somewhat successful find the
realization of their dreams an overwhelming possibility, so they sabotage their continued
success by retreating into a comfort zone of smallness.
There are traits that may come naturally to the entrepreneur and others which may come with
time. Perhaps there are characteristics which the individual may never have. The first step is to
do an analysis and reflection.

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This can be done by conducting a personal SWOT Analysis – dealing personal strengths,
weaknesses, opportunities and threats.
SWOT analysis (alternatively SWOT Matrix) is an acronym for strengths, weaknesses,
opportunities, and threats and is a structured planning method that evaluates those four elements
of an organisation, project or business venture.

A SWOT analysis can be carried out for a company, product, place, industry, or person. It
involves specifying the objective of the business venture or project and identifying the internal
and external factors that are favourable and unfavourable to achieve that objective. The degree to
which the internal environment of the firm matches with the external environment is expressed
by the concept of strategic fit.

• Strengths: characteristics of the business or project that give it an advantage over others

• Weaknesses: characteristics of the business that place the business or project at a disadvantage
relative to others

• Opportunities: elements in the environment that the business or project could exploit to its
advantage

• Threats: elements in the environment that could cause trouble for the business or project

Identification of SWOTs is important because they can inform later steps in planning to achieve
the objective. First, decision-makers should consider whether the objective is attainable, given
the SWOTs. If the objective is not attainable, they must select a different objective and repeat the
process.

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Example

2. Management feasibility

Managing a business of any size is demanding but more so as the scale increases. It is often
better to have a good team at the core and not an individual. This would allow the entrepreneur
to make up for the deficits in his experience and skills set. The entrepreneur should look for
team members whose strengths, compensate for his or her weaknesses. The team must
collectively possess the experience, training, drive and management skills to achieve success.

3. Legal feasibility

Legal feasibility determines whether the proposed system conflicts with legal requirements, e.g.
a data processing system must comply with the local data protection regulations and if the
proposed venture is acceptable in accordance with the laws of the land.

4. Operational feasibility

The actual operation of the business would require a location, staffing, machinery, equipment
and fittings. It also involves the systems by which the firm would actually create its value-added
products. The entrepreneur must examine the willingness and ability of management,
employees, customers, suppliers etc. to use and support the proposed system. The entrepreneur
will determine whether the existing work practices of the firm, will support the new system.

5. Financial feasibility

Business is about profit generation and so evaluation of the business idea must include careful
consideration of the financials. It is important to demonstrate the source, size, and growth of

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expected profits, but other financial issues must be considered as well. The review must look at
the source, type, and timing of capital. How much equity or debt will be utilized and at what
stages in the life of the business? How much debt impact the cash flow or the business?
Questions about the size and timing of payments, and efficiency and return on investment are all
relevant in determining the financial feasibility of the business. It is important to show that the
needs of the business ae anticipated and that the capital and cash flow are adequate.

The financial feasibility will look at aspects such as the amount of start-up capital that is needed,
the sources of that capital, cost acquiring the capital (interest rate) and the expected return on
investment. The entrepreneur will also examine the earning potential of the product or service.

6. Marketing feasibility

This section is similar to what would have been covered in the marketing plan. The research into
the market factors would inform the evaluation of the likely success of the marketing efforts of
the business.
A marketing feasibility includes:

 An assessment of the industry in which the proposed business will operate

 An identification of the target market and the determination of its demography so that its
behaviour will be easily understood.
 The establishment of expected sales trends
 A determination of current and future market potential
 An analysis of the competitors and the level of competition
 An investigation into the most suitable pricing strategy for the target market
 An assessment of the most suitable ways to get the product or service to the customers.
 An evaluation of the effectiveness of selected promotional tools as seen through the
responses of the prospective customers.

7. Time feasibility
Getting a business started or a new product to market is demanding and time sensitive. It
is important to demonstrate through your feasibility analysis that the tasks and processes
that lead to the start-up of the business can be completed in the specific time required.
Getting patents, licences, staff, equipment and supplies are among the things that need to
be done.
All have to be completed to facilitate operationalization, and each one takes time.
Time is of the essence and a late start might find the entrepreneur left behind.

8. Industry feasibility
Being realistic and objective about an opportunity is critical to success. The entrepreneur
must assess the industry into which the business has entered. The characteristics of the
industry and the firms that make it up, trends in the related technology, and expectations
for the future are factors that could affect the success and sustainability of the enterprise.

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 Even in a promising industry, it is important that the management team has the kind of
knowledge, experience and networking skills that are necessary to be effective.

9. Cultural feasibility
This is an important look at how the proposed business could affect local culture or be
affected by the local culture. Will the business or product be received? Will there be
objections or even protests by the local community? These problems have arisen even
for established businesses, so new enterprises should not overlook them.

A Distinction between Market Research and Feasibility Analysis

A feasibility study as we have seen, is carried out to determine whether or not it is worthwhile to
invest resources into the pursuance of a business idea or perhaps a project. The market research
is a detailed investigation into various components such as the target market and the level of
competition. The feasibility study has a broader scope than the market research. It focuses on a
range of components, in fact, any aspect of the business can become a basis for a feasibility
study. It must also be noted that market research can be carried out in the form of the feasibility
study before the business is started but can be carried out at any time during the lifetime of the
business.

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UNIT 2: ENTREPRENEURSHIP PRACTICE

MODULE TWO: NEW VENTURE PLANNING AND CREATION

OBJECTIVES: Students will be able to

1. Explain the difference between equity and debt

2. Identify advantages and disadvantages of equity and debt
3. Identify sources of equity and debt funding
4. Identify various savings and investment options

Capital is especially important in the establishment and operation of a business. It is defined as

the money invested in a business venture which is used to purchase assets to facilitate trade. It
also refers to goods (plant, equipment and machinery) that are used in the production of other
goods and services. For example, a gardener needs to purchase a weed whacker or lawnmower,
among other tools, in order to carry out his work effectively. He will also need additional funds
to take care of other day-to-day expenses such as gasoline and lubricating oil.

Therefore, the choice of capital that is accessed depends on a number of factors. The
entrepreneurs must think about the amount of capital and the use to which it would be put. In
this way, the entrepreneur would best determine what source or combination of sources is
optimal. The decision is important because each source may have limits to what is available,
specific costs and benefits.

The type of capital must also match the purpose for which it is used in terms of timing – short
term capital for short term projects and similar matching for other durations. This is because the
firm should benefit from what it is paying for and should not be burdened with payments for any
unreasonable time after the benefit has ended.

Sources of funding are easily classified as equity financing (where financier takes a share in the
ownership and control of the business) or debt financing (where the financier must be repaid the
amount along with interest). In some instance, firms may benefit from other special funding in
the form of grants, subsidies, gifts and bequests. The sources of these funds are different yet
alike, in that no repayment is required.

Equity and Debt Financing

Debt and equity are tools which an entrepreneur may choose to use. Each has costs and benefits
which should be evaluated.

(1) Equity capital or equity financing is money or funding that is raised from the issuing of
shares. It is also seen as a personal investment in a business by its owner(s). The major
risk associated with equity capital is that the owner(s) stand(s) to lose all the money that
was invested in the business should it fail. A business wishing to access equity capital
must be willing to surrender some of its ownership, as a share represents ownership in the

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 issuing company. However, businesses using equity capital do not have to worry about
repayment since it is not a loan but an investment on the part of each shareholder. The
company will only pay dividend when it has made profit and it is feasible to do so. The
major sources of equity capital include sale on the stock exchange, personal savings,
partners, venture capitalist companies and friends and families (that is, where the funds
are not in the form of a loan).

(2) Debt capital or debt financing represents any money that is borrowed by the business
which must be repaid with interest. One of the main advantages of using debt capital is
that businesses do not have to surrender any of their ownership in order to source capital.
It is important to note, though, that, with debt capital, the funds must be repaid along with
interest, whether or not the company is profitable. This loan will have to be carried on the
business’s balance sheet as a liability until it is repaid. The major sources of debt capital
include commercial banks, building societies, trade credit, credit unions, bonds and other
financial institutions.

Advantages Disadvantages
Equity  It does not put pressure on the The company has to surrender
capital firm’s cashflow. some of its ownership to
 There is no need for collateral shareholders.
 The firm does not have to pay The business has to publish its
monthly amounts for principal accounts.
and interest
 Since the shareholders are part
owners of the company, they do
not have to be repaid if the
company fails

 The lender has no equity in the  Since this is money

Debt firm and so the owners do not
Capital lose any control
 The lender will only be paid the
agreed principal plus interest
and so there is no interest in or
claim on the profits of the firm
 The amounts for principal and
interest are usually known as
expenses. This means that they
can be planned for
 The company is not required to
publish its accounts on an
annual basis for shareholders to
borrowed by the firm, it
must be repaid
 The lender often
requires the firm to
submit its cash flow
statements and balance
sheet
 The company’s assets
may have to be used as
collateral for the loans
received
 The loan has to be
repaid regardless of the

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 see level profit or loss.

Sources of Equity Financing

There are multiple sources of equity financing to choose from, each with its own
characteristics and benefits. Since equity gives rights to the shareholders, there are legal
guidelines which must be considered. Once the entrepreneur makes a decision to share
ownership with others, it is very important to develop clear policies and agreements to
protect their mutual interests.

1. Friends and Family – the closest and easiest sources of equity for entrepreneurs in the
early stages of business growth are close friends and family. Entrepreneurs often find
business partners and investors among people they know personally, who offer their
encouragement. By choosing persons with the right skills, the entrepreneur could have
invaluable technical support as well. As stated earlier, equity means that someone else
has the rights of ownership and may seek to share in the controlling of the business.
While partnerships have very minimal legal requirements, limited companies require
detailed registration and annual filing of documents. In either case, it is important to
have clear, written agreements to guide the operations.
2. Private Placements – a private placement is the sale of shares among persons in the
entrepreneur’s network. Some countries have stricter guidelines than others, but it is
generally up to the entrepreneur to sell to persons of his choice. The major rule is that the
shares cannot be advertised or sold to the general public. These persons purchase equity
and have the usual rights of shareholders, but they are not able to resell shares to the
public. The benefit is that there is a larger number of persons to put in capital. The
problem is that decisions are made by a board of directors and not the entrepreneur. The
shareholders are entitled to reports and access to the business office.
3. Public Offerings – when a firm raises capital by selling shares to members of the general
public, it is said to make a public offering. The first such sale is called an Initial Public
Offering or IPO. The benefit here is that the pool of investors is almost infinite because
members of the population, as well as institutional investors, may choose to buy shares.
There would be a board of directors that would be responsible for policy and major
decisions in the business. This is even more demanding than the private company
because the state puts in greater requirements to protect the interests of the investors.
4. Angel Funding / Business Angels – Angel investors are usually the first investor of the
business. An individual who is willing to invest personal capital in return for equity in
the venture. These are informal investors who provide financial assistance or angel
funding to finance new ventures and entrepreneurs. The funding is usually equity-based
and the investors tend to spend more time directly assisting the business and the
entrepreneur.
The risk is high for angel investment as the business still has to prove itself in the market.

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 This is often an early stage in the growth of the business and may be followed by venture
capital or wider sale of shares. The angel investor buys equity in the entrepreneur’s firm
and gives support to develop the business until the next round of capital is obtained.
Kuratko(2009) identifies five basic types of angel investors: corporate angels,
entrepreneur angels, enthusiast angels, micromanagement angels and professional angels.

5. Venture Capitalist – are strongly influenced by a strong management team, a product

with a powerful competitive advantage and large market. Venture capitalist usually
provides a large amount of funding to start ups and innovative investment opportunities
which have the potential to yield a high rate of return on the investment if such
companies are successful.
This is a form of private equity investment in which the investor (venture capitalist) buys
into the business for a specific period and agrees to provide specific support to the
business. The equity comes from funds invested in the venture capital (VC) company for
the purpose of providing VC funding. Usually, venture capital firms provide assistance
in marketing, growing the business and general consultancy. During the period of the
investment, the venture capitalist helps improve the business so that the value of his
investment goes up. When the specified period is over, the VC firm sells the shares at the
new price and makes a profit because of capital appreciation. The shares may be
purchased by the entrepreneur or by the next group of investors.
6. Crowd Funding – this practice entails funding ventures at start-up or expansion by
raising monetary contributions from a large number of collective individuals.

Sources of Debt Financing

1. Loans – this is one of the simplest forms of debt and probably the first thing that comes
to mind when you think of this kind of funding. The entrepreneur or firm is provided
with the funds repayment is made over a period of time at a specific rate of interest. The
loan has a specific life and is matched against the life of the asset for which it is being
sought. Current assets should be paid for with short-term loans while fixed assets are
paid for with medium or long-term loans.
2. Leases and Mortgages – firms may also finance major asset purchases through leases
and mortgages. These are finance options which use assets like machinery, buildings,
and real estate as collateral for long-term loans. The bank, leasing company or other
financial institutions would retain rights to the asset until the funds are repaid. This type
of arrangement is attractive for both parties because the financier has good collateral and
the firm spreads costs over the life of the asset.
3. Grants - There are lots of grants out there, and many of them are ideal for tech start-ups
looking for a funding boost, especially if your business is very innovative or specific.
This is free money – you do not have to pay a grant back – and the prestige. Grants are
especially good for businesses in niche industries, where there’s often less competition
for the money. However, grant proposals can take a long time to put together, there can

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 be quite a lot of competition, and the money has to be used for a specific purpose. It is
rare that a grant can fund the business alone – you will usually be expected to match at
least part of the funding with your own finance.
4. Bank Overdrafts – this is a form of short-term lending in which the firm’s bankers allow
more funds to be drawn from an account than the firm actually has. The excess is called
an overdraft and has to be repaid in the short term (usually 30 days) with interest. This
type of funding is ideal for buying the stock of goods or raw materials, as well as meeting
deficits in cash flow which are part of the firm’s regular financial cycle and would be
resolved within the same time frame.
5. Trade Credit is the deferment of payment for goods or services supplied to the business.
Firms may also use this credit facility offered by their suppliers. This is a way of
financing their working capital needs and can often be used without interest charges.
Many suppliers of goods and raw materials offer firms up to 90 days for payment. This
means the buyer has time to sell the goods or raise funds otherwise. This option may also
be available when buying machinery.
The longer the credit period, the more money the business will have in the short run. The
business will now have the opportunity of making revenues from the sale of these
products before payment becomes due.
The suppliers may offer a delayed payment period, use documentary credit or even
provide their own financing terms. This could allow the seller to repossess the goods and
sell them to another firm if the buyer defaults on payment.
6. Gifts – gifts can be described as the transfer of assets or valuables without any obligation
to reciprocate. These gifts help with the daily operations of the business and its
expansion. Many countries offer gifts or grants to small business owners as a means of
stimulating economic growth in the economy.
7. Bequests – Any gift that is received as a result of the reading of a Will, is called a
bequest. However, a bequest can be made by someone who is living. It may be cash, a
building, machinery or any other asset.

Savings and Investment Options

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The option of savings is used when one is interested in keeping his or her money safe over a
relatively short period. The aim is usually to meet a commitment such as university tuition for
your children or to ensure security on a ‘rainy day’. Investments on the other hand are made
when one wishes to grow his or her money, usually over a relatively long period of time.
Although the two are different concepts they are both needed by the entrepreneur.

Savings Investments
Low Risk Higher risk than savings options
Earns a lower interest rate than Gives higher returns. However, there is the risk
investments of losing some or all of the investment
Used for short term goals Used for long term goals

Savings Options
Saving is income not spent or deferred consumption. Methods of saving include putting money
aside in, for example, a deposit account, a pension account, an investment fund, or as cash.
Saving also involves reducing expenditures, such as recurring costs. In terms of personal finance,
saving generally specifies low-risk preservation of money, as in a deposit account, versus
investment wherein risk is a lot higher; in economics more broadly, it refers to any income not
used for immediate consumption.
(a) savings accounts – the entrepreneur may choose to open an account at a commercial bank,
building society or credit union. The procedure for opening an account at any of these
institutions may vary slightly and is fairly easy. For the normal savings account, the interest rate
is low, and earnings are taxable. However, the option of opening foreign currency savings
account at some institutions.
(a) Savings accounts offer easy access to funds and some institutions encourage regular savings
by setting mandatory savings amounts for each period.

(b) Certificate of Deposit or Fixed Deposits - A fixed deposit, or ‘FD’, is a type of bank account
that promises the investor a fixed rate of interest. In return, the investor agrees not to withdraw or
access their funds for a fixed period of time. In a fixed deposit, interest is only paid at the very
end of the investment period. Since the investment term and interest rate are fixed, you can easily
calculate the interest you will earn at the end of any fixed deposit investment. When you open a
fixed deposit account, you have the option to choose a tenure (also known as ‘term’). When you
select a tenure, you are deciding to put your money away and not touch it for a period of time
(one month, three months, six months, one year, etc.). These tenures can vary anywhere from
one month to five years.
The returns on Certificate of Deposit are higher than that provided by the normal savings
account.

Investment Options

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Investment generally results in acquiring an asset, also called an investment. If the asset is
available at a price worth investing, it is normally expected either to generate income or to
appreciate in value, so that it can be sold at a higher price (or both). Investors generally expect
higher returns from riskier investments. Financial assets range from low-risk, low-return
investments, such as high-grade government bonds, to those with higher risk and higher expected
commensurate reward, such as emerging markets stock investments.

(1) Stock
Stock show ownership in companies. Companies raise capital through the issue of
stocks. The holder of the stocks becomes a part owner in the issuing company. The level
of control that is exercised is dependent on the degree of ownership. Stockholders are
entitled to dividends (share of profits) when they are declared.
There are two main types of stocks – common stocks or (ordinary stocks) and
preference stocks or (preferred stocks).
Preference stocks carry a fixed rate of dividend and the dividends are paid before those
attached to common stocks. Although, the holder of common stock may stand to gain
‘big’ after the preference dividends are taken out of profits, there are times when they
may lose quite a lot. Therefore, they are considered to be the real risk-bearers of the
business.
(2) Bonds
Bonds are interest bearing instruments that are issued by the government and
corporations in their bid to raise funds. They are usually long-term. When a business
subscribes to a bond issue, it is lending money.
Bonds do not offer ownership rights, but the purchaser (bondholder) is entitled to interest
on a periodic basis until the bond is redeemed (principal is repaid). The bond has the
advantage of being able to be transferred to another business or individual before its
maturity date.
Bonds are less volatile than stocks. The interest that the investor will receive on the
bonds that he or she holds, it not dependent on the profits of the firm, as in the case of
dividends. The issuing company is obligated to pay the interest and it must be charged to
the income statement in each period. The non-payment of interest could result in the
business being forced into liquation.

(3) Treasury Bills, also known as T-bills are the short-term money market instrument,
issued by the central bank on behalf of the government to curb temporary liquidity
shortfalls. These do not yield any interest, but issued at a discount, at its redemption
price, and repaid at par when it gets matured. These bills are usually sold in
denominations of $1,000 while some can reach a maximum denomination of $5 million.
The longer the maturity date, the higher the interest rate that the T-Bill will pay to the
investor.

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 (4) Mutual funds
A mutual fund is an option which places money that has been invested by various
investors in various securities instead of just one. The mutual fund company will select
various instruments such as good stock and bonds to place the pooled funds into.
Diversification throughout different industries and in different types of instruments
lessens risk. This act is supported by the saying ‘Don’t put all your eggs in one basket’.
The investment is managed by an experienced funds manager who carefully selects the
instruments for each portfolio and monitors them.

(5) Annuities
Annuities are long term contracts that are made available by insurance companies.
Regular amounts or a fixed amount are or is paid over to the insurance company and a
specified time, normally retirement, a regular amount is paid over to the investor during
the remainder of his or her lifetime. This a Deferred Annuity. However, the investor can
receive payments almost immediately as in the case Immediate Annuities.

CHAPTER THREE

FINANCIAL STATEMENTS

OBJECTIVES: Students will be able to

1. List the steps of the accounting cycle

2. Explain the accounting concepts or principles
3. Discuss the elements of the different financial statements
4. Explain the statement of cashflow
5. Prepare a simple cash flow from a given question
6. Describe break-even analysis

Financial information is very important to entrepreneurs. It reveals whether entrepreneurs:

have profitable ventures

 Have enough money to pay bills for goods and services on credit and taxes on time
 Are able to manage the time it takes between selling goods on credit and colleting cash
from customers
 Are making the best use of funds they have invested in the business.

The above information is revealed to entrepreneurs through financial statements. This aspect of
providing information is called Financial Accounting. Financial accounting is defined as
recording, classifying and summarizing financial information in ways that will provide the

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entrepreneur with useful information to help him or her assess the performance, financial
position and historical cash flows of the venture and plan future activities.

Furthermore, it refers to the fundamental guidelines, policies, procedures and regulations

mandated by the General Accepted Accounting Principles (GAAP), which was established by
the Financial Standards Board (FASB) and/or government regulators. It provides information
designed to satisfy the needs of external users. This reporting is done in the form of financial
statements. These accounts are usually produced annually. They are based on historical
information and are rarely used internally. Financial accounts are used by external users for
several reasons. The external users of accounting information fall into six groups; each has
different interests in the business depending on how you are financially structure and thus will
want answers to unique questions.
(1) Owners and Prospective Owners. Has the business earned satisfactory income on its total
investment? Should an investment be made in this business? Should the present investment be
increased, decreased? Can the business install costly pollution control equipment and still be
profitable?
(2) Creditors and Lenders. Should a loan be granted to the business? Will the business be
able to pay its debts as they become due?

(3) Employees and their Unions. Does the business have the ability to pay increased wages?
Is the business financially able to provide long-term employment for its workforce?

(4) Customers. Does the business offer useful products at fair prices? Will the business survive
long enough to honour its product warranties?
(5) Governments. Is the business, such as a local public utility, charge a fair rate for its
services? How much tax does the business owe?

(6) The General Public. Is the business providing useful products and gainful employment for
the local citizens without causing serious environmental problems?

Management accounting allows the entrepreneur to plan future activities and to make decisions
to enable the venture to plan for profit (at start up stages and during its years of operation).
It refers to the processes and procedures implemented for internal decision making and
reporting within an organisation. It provides information that is useful in running a business by
internal users, usually accomplished through custom designed reports. These are produced as
often as a business wants them (usually monthly). They can be prepared using the business’s
own internal policies and bookkeeping/financial management system.
Internal users, Senior and Middle Management use accounting information to run a business.
Employees utilize accounting information to determine a business’s profitability and profit
sharing.

Management account information or reports should:

• Relate to the part of the business for which the manager is responsible. For example, a
Production Manager wants information on costs of production but not on advertising.

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 • Involve planning for the future. For instance, a budget would show financial plans for
the coming year.

• Meet two tests:

the accounting information must be useful and relevant; and
it must not cost more to gather and process than it is worth.

Accounting Principles /(Concepts)

The practices of financial accounting are guided by local regulatory laws, generally accepted
accounting principles (GAAP) and International Financial Reporting Standards (IFRS). These
are a combination of accounting conventions or concepts and standards and are used to
determine how the record and measure transactions and events and prepare financial statement or
end users.

The standards were developed by a universally recognized standard-setting body which includes
inputs from accountants in practice and accounting bodies (ACCA, CIMA) in a process of wide
consultation (due process). These rules were developed via ‘due process’ and were accepted and
practised universally.

An accounting concept is nothing but a basic assumption about the environment in which the
business operates and accounting functions. It is an assumption that is well recognized and
accepted by the accounting professionals. It, therefore, gains acceptability among the entire
accounting professionals. It is the building block on which the entire accounting structure rests.
They are general in nature and present a philosophy with regard to the manner business
transactions must be recorded.

Accounting Principles

(1) Separate Entity or Business Entity Principle

The business is considered as a unit or entity that is separate from all the people that are
related to it or transact with it either directly or indirectly. For example, capital
introduced by the owner of the business into the business increases the assets as well as
owings of the business to the owner. Although the business belongs to the owner, and the
total of his personal and business worth in terms of net assets owned by him remains the
same, yet he is able to analyse the growth of the business by recording them separately.

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 So, when the owner introduces his personal assets in the business, they are recorded as
business assets separately in the books of the business, and not in the name of the owner.
However, if the owner uses some of the business assets for his personal use, say payment
of his personal electricity bill from office cash, it is treated as drawings made by him
from the business. In this way, this concept enables the accountants to distinguish
between personal and business transactions.

(2) Going concern refers to the assumption that the life of business will be ongoing. It
suggests that the business is run with the objective of continuing it for a long number of
years, and it not intended to be closed in the near future. It assumes that the business has
an unlimited life, extending to an indefinite period until it is liquidated. It is important for
the interested parties to know that the business is run for a long period of time so that
they are induced to enter into various contracts with the enterprise. Such an assumption is
made by every interested party, even if the life of a business cannot be known with
certainty.
However, an enterprise is not considered to be a going concern if there is a clear
evidence or specific information about its end. For example, when the venture is for a
specific purpose, such as setting up of a stall in an exhibition or fair, the business comes
to an end on the completion of fair or exhibition.

(3) Money Measurement is considered as a common basis for recording business

transactions. According to this concept, only transactions alone that can be expressed in
terms of money should be included in the accounting records. In the absence of common
measuring unit (i.e. money) it is not possible to add or subtract various business events.

(4) Time Period as per going concern concept, the business is assumed to have an indefinite
life. However, the proprietor of the business cannot wait for such a long period for the
determination of income. Such a measurement of income at the end of the life of business
would render useless information as well as it will be too late to take corrective steps at
that time. Therefore, accountants choose some convenient period of time to measure the
income or to know the results of business transaction known as accounting period. Thus,
accounting period refers to the span of time at the end of which financial statements are
prepared to represent the results of the operations of the business during the relevant
period and financial position at the end of that relevant period. The accounting period
varies in time intervals such as a month, quarter, and year. However, the year is the most
common accounting period as a result of established business practices traditions and
government requirements.

(5) Historical Cost or Cost Principle

The cost concept requires that the assets should be recorded at the acquisition cost. Since
the original or acquisition cost relates to the past, it is also referred to as historical cost.
Historical cost is recognised as the appropriate valuation basis for recognition of all

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 goods and services, expenses cost, and equities. For the purposes of recording in
accounting, all business transactions are measured in terms of actual prices at the time of
occurrence of the transaction.
For example, if a business entity purchases a machine for $5,000,000 from a builder
friend. The actual worth of the machinery is $6,000,000. This asset would be recorded in
the books at $5,000,000 not at $6,000,000 because for the business entity actual cost of
the asset is $5,000,000 i.e. the price paid for it. The basis for all future transactions
relating to this building would be its cost that is $5,000,000. For example, the
depreciation will be charged at $5,000,000, not at $6,000,000. Further historical cost is
considered more relevant than any other value of asset that is market value.

(6) Matching Principle

The matching principle in financial accounting is the process of matching revenues with
expenses to a particular period for which the income is being determined. This concept
emphasizes which items of costs are expenses in a given accounting period. Costs are
reported as expenses in the accounting period in which the revenues associated with those
costs are reported. For example, when the sales value of some goods is reported as
revenue in a year, then the cost of those goods would be reported as an expense in the
same year. The matching concept needs to be fulfilled only after accrual concept has been
completed by the accountant. First, revenues are measured in accordance with the accrual
concept, and then costs are associated with these revenues.

(7) Realization of Income or Revenue Recognition

Business enterprises utilise resources to earn revenue by sale of goods or rendering of
services. Revenue is the gross inflow of cash receivables or other considerations arising
in the course of an enterprise from the sale of goods, from the rendering of services and
from holding of assets. Revenue is measured by the changes made to customers or clients
for goods supplied and services rendered to them and by the changes and rewards
arising from the provision of assets. It excludes amounts collected on behalf of third
parties such as certain taxes.
Thus, revenue is considered as being realized or earned on the date when the sale
process is complete, and transfer of title or ownership takes place.

(8) Dual Aspect or Double Entry Principle

In every type of business, there are numerous transactions. For example, purchase of
goods from several suppliers, sell to various customers for cash or on credit, payment to
suppliers, collection from customers, payment of salaries and wages, payment of rent and
taxes, etc. In each of the above transactions, there are two aspects to be recorded from
the point of view of the entity. For example – if there is the sale of goods – it involves two
aspects, one is the delivery of goods and other is the receipt of cash (in the case of cash
sale) or the acknowledgement of the debt from the customer (in the case of credit sale).
The recognition of two aspects for every transaction is known as dual aspect analysis.

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 The method of recording transactions on the basis of the concept of duality is known as
‘Double Entry Bookkeeping.' Every transaction is recorded under the following heads
under this double entry system of bookkeeping while holding the following equation true
at all times:
Assets = Liabilities + Capital
In accounting terminology, resources are referred to as assets, obligations towards the
owners are referred to as capital, and obligations towards the outsiders is referred to as
liabilities The total of assets, and the total of obligations to owners and outsiders must
agree. This equation holds good at any point of time because of double entry system of
bookkeeping. In double entry system for every transaction, two entries are made one
entry consists of a debit to one or more accounts, and another entry consists of credit to
one or more accounts. However, the total amount debited always equals the total amount
credited.

(9) Materiality
In order to make financial statements more meaningful and to minimize costs, the
accountant should report only the information which is material. Thus, accounting
should focus on material facts and resources should not be wasted in recording and
analysing immaterial and insignificant facts. Materiality is an implicit guide for the
accountant in deciding what should be disclosed in the financial statements. However, it
is difficult to define the term materiality. Most definitions of materiality stress the role of
accountants’ judgment in interpreting what is and what is not material at the same time
stressing its importance. According to American Accounting Association (AAA), “an
item should be regarded as material if there is a reason to believe that knowledge of it
would influence the decision of informed investor.”

(10) Conservatism / Prudence

Every business enterprise wants to play safe in the world of uncertainty. These are
following two principal rules that are related to the convention of prudence:
(i) The accountant should not anticipate profits and should provide for all losses.
(ii) When in doubt, the accountant must prefer that method of accounting which will not
lead to any overestimation of assets and/or income.
(iii) When applied to business income, this convention results in recognition of all losses
that have occurred or liable to occur and to admit the gains only when they have been
realised.

(11) Consistency
Uniformity in accounting methods and practices over a period of time is necessary in
order to enable the management to analyze the records and draw correct inferences about
the working of the enterprise. The comparison of financial statements of one accounting
period with that of the other cannot be made unless they are prepared on the basis of
consistent methods. For example, if the income statement for the current year shows

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 higher earnings than the preceding year, the user is entitled to assume that the business
operations have been more profitable provided there is no change in the accounting
procedure adopted by the enterprise. The rationale for this convention is that frequent
changes in accounting treatment would make the income statement and balance sheet
unreliable to end users; there are many examples in which a change in accounting method
may bring different results. For instance, different methods of charging depreciation will
result in different amounts of depreciation to be written off the fixed assets over the
useful life of the asset. A change of method of charging depreciation will affect the
depreciation amount and consequently the net profits of the enterprise. The figures of net
profit do not become comparable in that case. If there is inconsistency in the record
keeping, it may bring about considerable influence on the income reported as well as the
value of assets in the statement of financial position.

(12) Full Disclosure

This convention requires that the accounts must be honestly prepared, and all material
information must be disclosed therein. Accountants decided that there should be a full,
fair and adequate disclosure. Full disclosure means the complete and comprehensive
presentation of information i.e., nothing is omitted. Fair disclosure means that
accounting principles have been applied in a fair manner so as to report the true and fair
view of the results of the business.
Adequate disclosure means that anything which influences the decision of the user must
always be reported. Thus, disclosure should not be taken to imply that every small piece
of information must find a place in the financial statements, rather provides that there
must be adequate disclosure of material information to the interested parties that is
required by them and will influence their decision making. For example, a firm is
depreciating its assets on a straight-line basis for last two years. It changes the method to
written down value method with retrospective effect. The firm must disclose this fact as a
part of accounting policies as ‘Notes to Accounts’ forming part of financial statements.

Accounting Cycle

In Financial Accounting, past events and transactions are recorded in a chronological manner on
a quarterly or yearly basis. This is done using a process known as the Accounting Cycle. The
Accounting is used to develop the financial records of a business in stages on an ongoing basis.
The stages are shown in the diagram below:

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Let us have a look at the stages of the accounting cycle.

Step 1 - Collecting and analyzing data from source documents.

When a transaction occurs; a document is produced. Most of the time, these documents are
external to the business (e.g., purchase orders, sales slips, etc.). However, they can also be
internal documents, such as interoffice sales, cheques, bills from providers, etc.
These documents are referred to as source documents. Some additional examples of source
documents include:

 The receipt you get when you purchase something at the store.
 Interest you earned on your savings account which is documented in your monthly bank
statement.
 The monthly electric utility bill that comes in the mail.
 The telephone bill.
 Invoices from other service providers, contractors, etc.

Step 2 – Journalizing transactions.

The source documents are recorded in a Journal. This is also known as a book of first entry.

The journal records both sides of the transaction recorded in the source document. These write-
ups are known as Journal entries. The Journal entries are then transferred to a Ledger.

Step 3 – Post to the Ledgers.

The purpose of a Ledger is to bring together all of the transactions for a similar activity.
For example, if a business has one bank account, then all transactions that include cash would
then be maintained in the cash account in the ledger. This process of transferring the values is
known as a posting. Once the entries have all been posted, the ledger accounts are added up in a
process called Balancing. Balancing implies that the sum of all Debits equals the sum of all
Credits.

Step 4 – Unadjusted Trial Balance.

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A particular working document called an unadjusted trial balance is created. This lists all the
balances from all the accounts in the ledger. Notice that the values are not posted to the trial
balance, they are merely copied. At this point, accounting happens. The accountant produces a
number of adjustments, which make sure that the values comply with accounting principles.
These values (such as depreciation of equipment) are then passed through the accounting system
resulting in an adjusted trial balance. This process continues until the accountant is satisfied.

Steps 5 – Prepare adjustments.

Period-end adjustments (usually quarterly) are required to bring accounts to their proper
balances after considering transactions and/or events not yet recorded. Under accrual accounting,
revenue is recorded when earned and expenses when they are incurred. An entry may be required
at the end of the period to record revenue that has been earned but not yet recorded on the books.
Similarly, an adjustment may be required to record expense that may have been incurred but not
yet recorded.

Step 6 – Prepare an adjusted trial balance.

This step is similar to the preparation of the unadjusted trial balance, but this time the adjusting
entries are included. Correction of any errors must be made.

Step 7 - Prepare Financial Statements.

Financial statements are drawn from the trial balance and are presented in the following forms:
• Income statement: prepared from revenue, expenses, gains and losses

• Balance sheet: prepared from assets, liabilities and equity accounts

• Statement of retained earnings: prepared from net income and dividend information

• Cash flow statement: derived from the other financial statement using either the direct
or indirect method.

Step 8 – Closing entries.

Revenues and expenses are accumulated and reported by period, monthly, quarterly, or yearly.
To prevent them not being added to or co-mingled with revenues and expenses of another period,
they need to be closed out that is, given zero balances at the end of each period. Their net
balances, which represent the income or loss for the period, are transferred into owners’ equity.
Once revenue and expense accounts are closed, the only accounts that have balances are the
asset, liability, and owners’ equity accounts. These balances are carried forward to the next
period.

Step 9 – Prepare post-closing trial balance.

The purpose of this final step is two-fold: to determine that all revenue and expense accounts
have been closed properly and to test the equality of debit and credit balances of all the balance
sheet accounts, that is, assets, liabilities, and owners’ equity.

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Understanding the Key Financial Statements

Financial statements are written reports which describe a venture’s financial position,
performance and cashflows. The statements most commonly used by businesses are Statement
of Comprehensive Income, Statement of Financial Position and Statement of Cash Flow. The
statements are usually prepared in this order because some of the information flows from one
statement to the next.

1. Statement of Comprehensive Income

The statement of comprehensive income records all of a business’s revenues and expenses for a
period of time. This statement shows if the firm is making a profit or experiencing a loss. Most
statements are prepared in a particular yearly format, making it very easy for entrepreneurs to
spot trends.
The statement of comprehensive income, the broadest measure of performance, captures the
extent management increased net assets during a reporting period, other than transactions with
owners and accounting changes and restatements. Comprehensive income has two components:
net profit (loss) and other comprehensive income.
 Net profit (loss) is the accounting measure users of financial statements tend to place the
most reliance on when assessing performance.
 Other comprehensive income (OCI) is comprised of items standard setters have decided
not to include in net profits, primarily because these items are transient and result from
factors largely outside a company’s influence.

Under IFRS, income statements have two primary elements: income and expenses.
Under U.S. GAAP, revenues, gains, expenses, and losses are all considered primary elements of
income statements.

The table on the next page gives a brief explanation of the accounts used in the Statement of
Comprehensive Income.

Accounts Meanings and Examples

Service Revenue or Firms obtain revenue each time a business sells a
Sales Revenue product or performs a service.

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 Investment Income From interest received and dividends received
Cost of sales or This section reveals the cost of merchandise sold during
Cost of Goods Sold an accounting period.
Selling expenses These are expenses resulting from activities such as
selling, delivering and displaying a product or service
Administrative expenses These expenses are associated with running the firm.
Some examples are salaries for office staff, telephone
expenses and electricity expenses.
Taxes Payments required by local government based on a
business’s profit. Some taxes businesses may have to
pay are sales, income and other business taxes.

2. Statement of Financial Position (formerly Balance Sheet)

The primary purpose of a balance sheet is to report an organisation's assets and liabilities at a
particular point in time. It provides an entrepreneur with an estimate of its financial position on a
given date. Assets and liabilities of the Statement of Financial Position are divided into two
categories.
The format is quite simple. All assets are listed first—usually in order of permanence —followed
by the liabilities. A picture is provided of each future economic benefit owned or controlled by
the company (its assets) as well as its debts (liabilities).

These categories are identified with meaning and examples in the table below

Meaning and examples

ASSETS
Current Include cash items that can be converted easily to
cash. May include examples such as accounts
receivables, inventories, marketable securities, bank
and cash
Non-current (formerly fixed assets) Assets owned (used) over a longer period of time and

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 that provide economic benefits to a firm for more
than one year in the future. They are land, building,
motor vehicle, equipment and furniture and long-
term investment.
Other These are miscellaneous assets of value that are not
seen. For example, patents, copyrights and
trademarks. These assets will also be classified as
fixed.
LIABILITIES
Current These are obligations that are payable within one
year. They include accounts payable, accrued
(outstanding) expenses and the current portion of a
non-current liability (debt).
Non-current (formerly long term) These include notes or loans that are repayable after
one year or more. They include purchase of land and
equipment.
OWNER’S EQUITY or CAPITAL This is the equity invested in the business by its
owners, plus the profits retained by the business.

The statement of financial position or (balance sheet) is based on the fundamental

accounting equation: Assets = Liabilities + Owner’s Equity /(Capital)

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 3. Statement of Cash Flow

A Statement of Cash Flow is an analysis of sources of cash that flowed into the business together
with how cash was allocated, for the accounting period. The information is grouped by
functional department because cash can be freed up from anywhere (such as getting customers to
pay faster or paying suppliers more slowly), not just from Sales or the Finance Department.
A cash flows statement provides information beyond that available from other financial
statements such as the Income Statement and the Statement of Financial Position.
It is important information because cash flow is essential to the continued operation of a
business. The main purpose of the statement, according to the Financial Accounting Standard
Board (FASB) is to provide:
• Information about the changes of an entity cash or cash equivalents in the accounting
period.
• Information about a company borrowing and debts repayment activities.
• The company sale and repurchase of its ownership securities.
• Other factors affecting the company's liquidity and solvency.

Statement of Cash Flow summarize an entrepreneurial venture’s cash position for a specified
period of time (including details). In summary, it assesses and reveals how
 much cash is on hand
 the cash was acquired
 much cash was spent

Cash flow statements, when prepared, are divided into three separate activities as mandated by
the relevant standard IAS No. 7 (by the accounting professional body) (IAS). These activities
are shown in the following order in the statement:
 Operating

 Investing

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  Financing

The table below list each activity and explains the firm’s sources and use of cash.
ACTIVITIES EXPLANATION
Operating This section includes the cash generated from the main profit-
making activities of a firm. Net income (loss) taken from the
Statement of Comprehensive Income is adjusted for non-cash
expenses such as depreciation, and for changes in operating
current assets and operating current liabilities. This activity is
shown on the first line of the current period’s statement of cash
flow.

Investing In this section, ONLY the cash paid for the purchase, and cash
received from the sale of investment in non-current assets (fixed
assets), are shown (some examples may be land, building and
equipment and long-term investments).

Financing The financing activity section includes cash raised during the
period by borrowing money or selling shares or increasing capital.
In addition, it includes cash used during the period for paying
dividends or drawings and repurchasing outstanding stock and
loans.

Preparation of Statement of Cash Flow

Step 1:- Assemble the Statement of Financial Position and Statement of Comprehensive Income
for the present year’s operations and look for an increase or decrease except for bank and cash.

Step 2:- First, document the net income for the period from the Statement of Comprehensive
Income.

Step 3:- Add interest expense and decrease in accounts receivables, increase in accounts
payables, decrease in inventory and depreciation expense (also amortization expense) and
deduct interest and dividend received, increase in accounts receivables, decrease in accounts

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payables and increase in inventory.

Step 4:- Subtract the use of funds ( for example, plant and equipment purchase, payment of
dividends, repayment of debt) under the appropriate activities.

Step 5:- Find the difference for each section (that is between sources and the use of funds).
Step 6:- Reconcile with the cash at close.

Financial Statement Analysis

Financial statements reveal what has happened during a particular period of time. Users, both
internal and external, are concerned about what will happen to a business in the future. For
example, creditors are concerned with the company’s ability to reap its future debts.
Entrepreneurs are concerned with a venture’s continued existence and its ability to finance future
expansion. Although financial statements are historical documents, they provide valuable
information.

Financial statement analysis uses selected data from financial statements to help forecast the
financial health of a business. This is done by examining trends in the data, comparing data
across the venture and analysing by using key ratios. In this section, we will consider some of
the basic ratios used to predict the future and financial health of entrepreneurial ventures.

Measuring Liquidity
Suppliers want to repaid on time. Therefore, they focus on tracking a company’s cash flows and
working capital. Sources to measure liquidity are working capital, current (working capital)
ratio, acid test (quick ratio), accounts receivable, average collection period, inventory ratio and
average sales period.

(a) Working capital – is the excess of current assts over current liabilities. The amount of
working capital in a firm of considerable interest to suppliers and owners. The excess
assures that debts will be paid when due. Working capital is computed as follows:
Working capital = Current assets – Current liabilities

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(b) Current (working capital) ratio
This ratio determines if the venture can pay its short-term debts. Working capital is
computed as follows:
Current assets divided by current liabilities = working capital ratio
The rule of thumb for this ratio is 2:1. It is important to interpret the results with great
care. A declining ratio might be a sign of a deteriorating condition. An improving ratio
might be over trading of inventory or it might indicate an improving financial condition.

(c) Acid test ratio or (Quick Ratio)

This ratio also tests a company’s ability to pay its debt but in a much more rigorous way.
For the latter, inventories and prepaid expenses are deducted from current assets (leaving
the more liquid assets to be used in the calculation). Acid test ratio is computed as
follows:
Cash + receivables divided by current liabilities = acid test ratio

(d) Accounts receivable turnover

The accounts receivable turnover is a rough measure of how many times a company’s
accounts receivables have been turned into cash during the year. Accounts receivables
turnover is computed as follows:
Sales on account divided by average accounts receivable balance
= accounts receivable turnover
(e) Average collection period
The accounts turnover ratio figure is divided into 365 days to determine the average
number of days taken to collect an account. The days to collect an account is good or bad
depending on the credit terms.
The average collection period is computed as follows:
365 days divided by accounts receivables turnover = average collection period

(f) Inventory turnover

The inventory turnover ratio measures how many times a company’s inventory has been
sold and replaced during the year.
It is computed by:
Cost of goods sold divided by average inventory balance = inventory turnover

(g) Average sales period

Inventory turnover ratio figure is used to determine the number of days to sell the entire
inventory one time. It is computed as follows:
365 days divided by inventory turnover = average sales period

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Profitability

These ratios determine a venture’s ability to make a profit. The ratios commonly used give
valuable information on a business’s performance. Ratios include gross percentage ratio, net
profit percentage ratios, return on capital employed and inventory turnover.

(a) Gross Profit (Margin) Percentage

This ratio is calculated as follows:
Gross profit divided by Sales x 100 = Gross profit percentage on sales

This ratio measures how effectively a company has controlled its cost of goods sold at the right
price to give maximum gross profit. A change of ratios from one period may caused by one of
the following:
wastage or theft of goods
cost of goods may have increased, resulting in lower gross profit
selling price of goods may have been reduced in order to sell more

(b) Net profit (margin) percentage

This ratio takes into account the expenses incurred and shows the amount of profit
remaining. This ratio is calculated as follows:
Net Profit divided by Sales x 100 = Net profit percentage on sales

A change of ratios from one period may be caused by the following:

gross profit / sales percentage changing
the expenses changing (to make a reasonable profit, the expenses need to minimised)

(c) Return on Capital Employed (ROCE)

This ratio shows how well capital has been employed to make a profit. The ratio is
calculated as follows:
Net Profit divided by (opening capital + closing capital)/2 x 100

Break even Analysis

Breakeven analysis is a very important toll that is used by businesses in decision making. It
involves the study of the relationship between cost, volume, and profit. The breakeven point is
the point where neither a profit nor a loss is made. It is that point where your sales revenue
equals your total cost. If the firm makes and sells an additional unit, a profit will be made. If it
had made and sold one unit less, a loss would have been made.

Breakeven analysis is a method of determining the level of sales at which the company will
break even (have no profit or loss).

The following information is used in calculating the breakeven point: fixed costs, variable costs,
and contribution margin per unit.

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  Fixed costs are costs that do not change when the amount of goods sold changes. For
example, rent is a fixed cost.
 Variable costs are costs that vary, in total, as the quantity of goods sold changes but stay
constant on a per-unit basis. For example, sales commissions paid based on unit sales are
a variable cost.
 Contribution margin per unit is the excess revenue per unit over the variable cost per unit.
Contribution = Sales – Variable cost Contribution per unit = selling price – variable cost
per unit
 The breakeven point in units is calculated with this formula: fixed costs divided by
contribution margin per unit (selling price per unit less variable cost per unit).

A break-even analysis determines at which point your revenues from sales equal your costs.
It also tells you the amount of revenue your business needs to generate and the number of
units it must sell to break even before your business can become profitable.

Determining Costs

The first step is to determine the costs to manufacture your product or offer your service.
Once you know your costs, you can calculate your breakeven point.

Definition of Fixed and Variable Costs

 Variable costs are the expenses that vary with the amount of services rendered or
goods produced. They depend on the operations of the business. They include costs of
raw materials used for production, wages, and utilities. For example, the cost of
labourers to offload a container of goods may vary with the volume of goods in the
container or the number of loaded. In this case cost of labour depends on the volume
of operations of the business.
 Fixed Costs - costs that remain constant despite increases or decreases in sales or
volumes of production. Fixed costs include the cost of rent of office premises or
operating licenses for the year.
 A unit is a quantity used as a standard measurement of “output” for a product or
service. Units are used to measure volume, costs, or price. They include kilograms,
boxes, or units of a currency like dollars.

Formula for Calculating Break-Even Units

To determine how many units must be produced and sold to break even, use the
following formula:

Fixed costs (FC)

Selling Price (SP) - Variable cost per unit (VC) = Number of units needed to break even

Results of the break-even analysis can help you to:

1. Establish the profitability of your business.

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 2. Establish your firm’s capacity to meet the demand for its products and make a profit.

3. Establish whether there is sufficient market for this quantity of service or products.

4. Test whether the marketing plan can support the firm to sell the quantity needed to
break-even at the selling price established.

5. determine profit or loss at various levels of production or sales. This will enable the
business to see which products are profitable and which are not.

6. predict the effect of changes in the selling price.

7. determine cost and revenue at various levels of output. It aids in cost control

8. Determine how long it will take your business to make a profit. If you lose money for a
year or two, will you eventually make a profit? If not, you are in the wrong

9. Set realistic targets

10. communicate the feasibility of the business idea to prospective investors and creditors.

It is found in the business plan.

Benefits of using breakeven analysis includes:

1. It highlights the minimum quantity to be sold to prevent losses

2. It shows the relationship among costs, price and sales volume

3. Help in goal determination and can help the start up venture understand what output is
required for profits

4. Help in understanding if a venture proposition is viable

Limitations of using breakeven analysis includes:

1. Not a suitable means of analysis for more than one product at a time

2. May not reflect price changes at different output levels

UNIT 2:
MODULE TWO: BUSINESS MODEL

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OBJECTIVES: Students will be able to
1. Explain what a business model is
2. List the components of a business model
3. Describe the components of a business model

Description of A Business Model

Suppose you were about to open a pizza business. You would have to define how you would
acquire resources, produce pizzas and deliver value to consumers in a competitive environment.
The business model is the approach you take to do that. Ask yourself if all pizza businesses are
the same. While some operate on similar business models, there are different models. Some
operate as independent small businesses while other are chain stores. There are pizza businesses
which cater to the mass market while others are more focused and serve a specific niche. A very
different model is the frozen pizza business, which sells its product through supermarkets.
Business models can be approached from two perspectives. A general perspective defines
a business model as any type of conceptual framework explaining how to organise and evolve a
business venture. On the other hand, specific circumstances guide business modelling. For
instance, industries such as tourism and banking in the services sector, or automobile or shoe
manufacturing demand specific models that consider critical variables found within the industry's
specific environment.
According to Osterwalder, Pigneur, Tucci (2005), ‘A business model describes the value of an
organization offers its customers and illustrates the capabilities and resources required to create,
market and deliver this value and to generate profitable, sustainable revenue streams.’
The business model canvas was created by Osterwalder and Pigneur (2010); it is a strategic tool
that helps entrepreneurs focus their thoughts on the core business activities. In addition, it guides
them to identify the most important features their business by concentrating on four specific
areas of a business:
 Structure: In this section, the entrepreneur identifies the key activities of the business, as
well as the key resources and formulation of any partnerships or alliances.
 Offering: In this section the entrepreneur focusses on the value proposition of the
company. The value proposition highlights how the product or service benefits the
customer and how they differ from the competition.
 Customers: In this section, the entrepreneur identifies the target niche based on
demographics of the potential customer base, the customer relationship and the
distribution channels for reaching the customers.
 Finance: In this section, the entrepreneur concentrates on the information regarding the
revenue and expenses of the company. The entrepreneur describes the varying revenue
streams and cost structures.

COMPONENTS OF THE BUSINESS MODEL

The business model comprises of:-
1. Value Proposition
2. Beneficiaries

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3. Operations
4. Product Differentiation
5. Income Generation
6. Growth

(1) VALUE PROPOSITION (how do you create value?)

It is important to show how you, the entrepreneur will create value. This is central to the
business model. It must reveal the customers’ needs in each market segment and the products
and services that are being used to satisfy them.
Furthermore, the value proposition must be determined before making other business decisions.
The value proposition informs the business model of how the business will generate money, the
nature of main operations, how the business will acquire customers.
This proposition can lead to a competitive advantage when consumers pick that product or
service over other competitors because they receive greater value.
The value proposition entails:
 Product Offering: the actual good, service or combination of goods and services which
the entrepreneur will be selling to meet the needs of the target customers. The
entrepreneur must be confident that something of value is being offered.
Goods or services may be sold individually or in a bundle. Each product in a product
bundle cheaper than the price that is paid when each is sold individually.
The entrepreneur needs to detail the important characteristics or traits of the product. A
description should be given about what the product does and the distinct features it possesses.
The benefits provided by the product to the target customer should be discussed.
Other considerations may include:
 Whether the product will be mass produced to provide a standardized product or
customized product to meet the individual needs of each customer.
A company may wish to have one set of characteristics for its product or service despite the
different characteristics of the markets that it is being offered to. A ‘one size fits all’ approach is
used – standardized products and services
The benefits of the standardized products and services are as follows:
(a) it allows the firm to reap the benefits of economies of scale. The cost per unit lowers as
larger production runs take place.
(b) customer mobility relies on standardization. When customers are loyal to a product in one
country, they love to know that it has not changed when they relocate and seek to buy it in a
foreign country. When the company standardizes a product or service it can expect continued
loyalty.
Furthermore, the entrepreneur may choose to vary its product or service to fit its varying
market types – customized products or services.
However, the core competencies or values of the product or service are held constant.
Customization is more ideal for high margin products or services which have limited buyers.
The benefits of customized products or services are as follows:
(a) customization seeks to satisfy the needs of varying markets on a personalized level.

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Customers achieve customer satisfaction which leads to increased profitability for the enterprise.
(b) customization serves changing customers’ tastes. Consumers are changing and so must the
offerings of the business.
(c) a foreign government’s legislation may demand a change in the features of a standard product
as a requirement for acceptance.
(d) climate differences between countries or their states may warrant adjustments to product
features.
The final decision would depend on whether it adds value and could be delivered profitably.
For example:- Mobile-phone maker Nokia went a step further in localizing its phones to
different markets. The company uses local designers to create mobile phone handset models that
are specifically appropriate for each country. For example, the handsets designed in India are
dust resistant and have a built-in flashlight. The models designed in China have a touch screen,
stylus, and Chinese character recognition.
 Making a connection with the target group – direct distribution or indirect distribution
The type of communication channels that will be used such as, personal contact, mass
media (television, radio, social media, smart phones). The communication channels
should be assessed to determine strengths and weaknesses and cost factors. Additionally,
sales channels must be determined. This would include direct channels such as in person
or indirect channels with the use of an intermediary.
Intermediaries include sales agents, wholesalers and retailers.
When there is Direct Distribution, there is no use intermediaries when getting the product
from the manufacturer to the consumer. However, with Indirect Distribution, there several
channels that the product can pass through to get to the consumer.

Direct Distribution Indirect Distribution

Results in lower prices for the customer as Employs specialists that is ‘middlemen’ to
the costs of middlemen are eliminated. deal with consumers, leading to higher costs
for customers.
Allows the business to clearly see sales Partnering with an established intermediary
patterns, which positively contributes to the will allow the company to enter the market
planning process. quickly.
There is more control where ensuring the The business can focus on what it can do best
customer receives goods in the best fashion is and leave what they cannot do well to the
concerned. specialists.
Moreover, the entrepreneur should consider the cost of choosing the channel and its geographic
spread. Logistics in terms of the physical delivery of the products or services to the customer is
important in terms of the type of product. Example Microsoft can deliver some of its products
over the internet while some products have to be produced close to the target market.
 Internal manufacturing or outsourcing
Depending on a venture’s SWOT analysis, it may be better to do all the work or to contract some
of it to local or even foreign firms.
A venture may decide to manufacture what it sells or buy the goods that it will sell. However, it

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may decide to combine the two; manufacturing parts of its product but outsourcing a component
or some components.
A business may also buy its products, make changes to them, and then sell them or even license
another company to make and sell its products. The route that the business decides upon must be
one that optimizes customer satisfaction at the least cost.
Insourcing is the commencement of performing a business function that could be contracted out
internally: either with the help of a third-party provider who performs the task on-site or by
conducting said task independently. Insourcing is also defined as bringing a third-party
outsourcer to work inside a company's facility.
An example of an insourcing is where an IT outsourcing provider may be hired to service a
company's IT department while working inside the company's facilities.
Outsourcing involves the contracting out of a business process (e.g., payroll processing, claims
processing) and operational, and/or non-core functions (e.g. manufacturing, facility management,
call centre support) to another party.
An example of an outsourcing of white-collar work has grown rapidly since the early 21st
century. The digital workforce of countries like India and China are only paid a fraction of what
would be a minimum wage in the US. Outsourcing has also expanded to include many different
countries; Costa Rica has become a big source for outsourcing work as it offers the advantage of
a highly educated labour force, a large bilingual population, stable democratic government,
shares similar time zones with the United States, and it takes only a few hours to travel between
Costa Rica and the US. Companies such as Intel, Procter Gamble, HP, Gensler, Amazon, and
Bank of America have big operations in Costa Rica.
A business may outsource part of its operations for the following reasons:
(i) companies primarily outsource to reduce certain costs such as peripheral
or "non-core" business expenses,
(ii) high taxes,
(iii) high energy costs,
(iv) excessive government regulation or mandates, production
(v) and/or labour costs.
Finally, the benefits of value proposition include the following:
(a) a strong differentiation between the company and its competitors,
(b) increase in quantity,
© better operations efficiency and (d) increase in revenue.
Also creating a more personal and honest relationship with consumers through the value
proposition also gives them another reason to choose you.

(2) BENEFICIARY (for whom do you create value?)

Every business must have a target market. The entrepreneur may have started with a product
idea or a very general sense of what the business is about, but, once the research is done, and
before the business can start, it must be clear who the customers are and that all promotional
activities will be geared towards them.

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The venture may decide to sell to business (business to business) or consumers (business to
consumers) or both. It must also identify whether the customer may be found upstream or
downstream in the value chain.
(i) Business to Business (B2B) – this entails the transactions between a business and its
suppliers or other business entities
(ii) Business-to-Consumer (B2C) – this entails the business retailing products and services
to the final consumers.
(iii) The business could be involved with both business to business (B2B) and business to
consumer (B2C) types of transactions.
(iv) Niche Market is a well-defined segment of a larger market.
An enterprise may develop marking strategies that are geared toward a small but
profitable part of a general market. This group is referred to as a niche market.
Niche marketing is advantageous to a business as the market is normally an ‘unserved’
one that the business can take and maintain. Prospective consumers want to know that
they are seen and that someone cares about them so much that they took the time to
develop strategies that are aimed at satisfying their needs. When a business can be
perceived as being that alert and thoughtful, it will hold a very powerful tool in its hands
that will go a long way in providing healthy income streams.
The downside of niche marketing is that it reduces your potential customer base.
(v) General Market
The general market has the following characteristics:
(a) It is sizeable enough to be profitable given your operating cost.
Only a tiny fraction of the consumers in China can afford to buy cars. However, because the
country’s population is so large (nearly 1.5 billion people), more cars are sold in China than in
Europe (and in the United States, depending on the month). Three billion people in the world
own cell phones. But that still leaves three billion who do not.
(b) It is growing - for example, the middle class of India is growing rapidly, making it a
very attractive market for consumer products companies. People under thirty make up
the majority of the Indian population, fueling the demand for “Bollywood” (Indian-
made) films.
© It is not already swamped by competitors, or you have found a way to stand out
in a crowd - IBM used to make PCs. However, after the marketplace became crowded with
competitors, IBM sold the product line to a Chinese company called Lenovo.
(d) Either it is accessible, or you can find a way to reach it.
Accessibility, or the lack of it, could include geographic accessibility, political and legal
barriers, technological barriers, or social barriers. For example, to overcome geographic barriers,
the consumer products company Unilever hires women in third-world countries to distribute the
company’s products to rural consumers who lack access to stores.
e. You have the resources to compete in it.
You might have a great idea to compete in the wind-power market. However, it is a
business that is capital intensive. What this means is that you will either need a lot of money or

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must be able to raise it. You might also have to compete with the likes of T. Boone Pickens, an
oil tycoon who is attempting to develop and profit from the wind-power market.
(f) It “fits in” with your firm’s objectives and mission.
Consider TerraCycle, which has made its mark by selling organic products in recycled packages.
Fertilizer made from worm excrement and sold in discarded plastic beverage bottles is just one
of its products. It wouldn’t be a good idea for TerraCycle to open up a polluting, coal-fired
power plant,no matter how profitable the market for the service might be.

It must also identify whether the customer may be found upstream or downstream in the value
chain.
(vi) Local, Regional or International Markets
Businesses may supply goods to the local market, the regional market, the international
market, or any combination of those markets. These are geographic locations.
The local marketers are concerned with customers that tend to be clustered tightly around
the marketer. The marketer can learn a great deal about the customer and make necessary
changes quickly. Naturally, the total potential market is limited. There is also the possibility that
a new competitor or environmental factor will put a local marketer out of business.
National marketers distribute their product throughout a country. This may involve
multiple manufacturing plants, a distribution system, including warehouses and privately owned
delivery vehicles, and different versions of the marketing "mix" or overall strategy. This type of
marketing offers tremendous profit potential but also exposes the marketer to new, aggressive
competitors.
Regional marketers cover a larger geographic area that may necessitate multiple
production plants and a more complex distribution network. While regional marketers tend to
serve adjoining cities, parts of states or entire states, dramatic differences in demand may still
exist, requiring extensive adjustments in marketing strategy.
International marketers operate in more than one country whereby massive adjustments
are normally made in the marketing mix in the different countries. The entrepreneur should
ensure that he or she has a good knowledge of the overseas markets and that all products meet
international standards. As the US market becomes more and more saturated with US-made
products, the continued expansion into foreign markets appears inevitable.
In the case of Honda Motors, for example, it builds manufacturing plants in the US,
hiring local employees, using local distribution systems, and advertising agencies, and
reinvesting a large percentage of the profits back into the United States.

(3) OPERATIONS (what is your internal sources of advantage?)

This component addresses the internal capabilities of the business or the business’s core
competencies. A firm’s core competencies are manifested in its unique values that gives it its
competitive advantage. They set the business apart from others, are not easy to replicate by
competitors and result in the leveraging of the products that are offered to the market.

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Core competencies are expressed through the unique skills of personnel, types of cutting-edge
technologies that are used, key resources that are available to the business, well-selected
channels etc. The selection of appropriate channels addresses the following question: What is
the most cost-effective channel or group channels that will be used to reach each customer
segment and be seen as superior value to them?
Also consider:
 Internal capabilities of a business arising out of organizational structure and or
culture
 Unique skills derived from previous experience, training, or strategic hiring
 Benefits from existing patents and developing products which can be patented
 Resources which the firm might be able to acquire to its advantage
 Technologies which allow the firm to be more efficient or effective
 Location advantages and disadvantages such as, proximity to target customers,
accessible transportation routes, zoning policies, access to low labour costs and
materials.
 Capacity planning and equipment requirements: details on the physical facility or
plant layout and whether plant is leased or purchased. The costs should be stated.
Equipment needs must also be assessed along with costs and timing factors.

(4) PRODUCT DIFFERENTIATION

Product Differentiation focuses on the question: How does the business set its products and
services apart from its competitors? This feature is vital if the business wants to be a ‘cut above
the rest.’ Since competitors may quickly seek to copy or surpass your product offerings, the
process of differentiating your product must be continuous.
(i) Operational excellence: it speaks to a sustainable achievement of customer
satisfaction through the combined and optimal efforts of all the personnel of an organization
who interact with efficient systems on a daily basis.
(ii) Product quality: the entrepreneur must ensure that his or her products and services
cause consumers ‘mouths to salivate.’ This can only happen when the quality of the products
is unparalleled. Consumers must not just reach for any product. They must reach for that
which is offered by that entrepreneur’s business. Like a magnet, the customers who are being
targeted and each product that is offered must connect.
The product quality delivered must be a better product that customers value is good for
business.

(iii) Innovative leadership: this a factor that can distinguish a firm. Innovative leadership
fosters increased innovation in the organization. It influences the type, quality and
uniqueness of the products that are being offered to the target market. The innovative leader
does not have to crease an idea but must be able to have the vision to carry it out.
Some traits of innovative leaders include:

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 (a) display excellent strategic vision
(b) possess strong customer focus
(c) foster an organizational climate of trust where innovations thrive
(d) inspire and motivate
(e) candid in their communication
(f) excel at Goal Stretching
(g) have a powerful imagination
(h) possess thorough knowledge of their products
(i) have the ability to manage risks
For example: - Steve Jobs who was the CEO of Apple Inc. is a perfect example.
He demonstrated great innovative leadership in bringing out new Apple products.
(iv) Cost: - being efficient and keeping costs down means the firm can pass on savings to
its customers.
The cost of the product to consumers should reflect its value. This cost paid by the
consumer, may be over, under or the same as the competitors’ price. Generally speaking,
consumers are willing to pay a price that is commensurate with the value that they perceive
that they are receiving. The business may have a product that is of a very high value but if it
sets a low price, consumers may simply refuse to buy. They will perceive the product as
being of inferior quality to the competitors’ and do not even try it. The entrepreneur’s
understanding of who his or her target customers are, will play a crucial role in price-setting.
(v) Networks: A business must understand how to strategically network to ensure
business growth. The entrepreneur should endeavour to set up systems that will ensure the
sharing of information amongst customers and prospective customers. Suppliers can be
included in a similar system. The way in which the customer relates to the business is very
important. The business must investigate the type of relationship that each customer segment
expects it to establish and maintain between them. The costs that are attached to these
relationships must be known and an examination done to see how the rest of the business
model is affected.
Detergents with bleach or softeners added and products carried exclusively by chain stores
are examples.

(5) INCOME GENERATION (How does the entrepreneur intend to make money?)
Businesses are income generating machines. How does the entrepreneur intend to make
money?
This would entail:
(i) Access to funding for the business such as, owner’s equity, source of funding.

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 (ii) Outline sales volumes and profit margins
A venture may be characterized by high margin (profit) and low volume (units produced or sold)
or it may be a low margin and high-volume operation. The business may also operate in between
the two extremes with a medium volume. A real estate business owner would be quite
unrealistic if he or she believes that his business’ rate of sales of homes would be comparable to
the rate of sales of a business that sells ice cream cones. Yet, both businesses may have the
ability to make ‘billions’ per year. How could that be? The real estate business although having
a much lower turnover rate than the ice cream business, depends on its high margins on each sale
to make great earnings while the ice cream business cannot change much for its products but
relies on high inventory turnovers to make great profits.
(iii) Outline credit policies and profit projections
(iv)Determine the operating leverage in terms of fixed and variable costs.
Operating leverage looks at the total fixed cost as a percentage of total cost. It examines degree
to which fixed costs and variable costs are incurred by the business.
A business will be able to calculate its break-even point as a result. Th entrepreneur will be able
to see what profit will be made given each of several projected sales figures. If a large
percentage of a firm’s total cost is fixed cost, then it is said that there is high operating leverage.
After the fixed costs are covered, for each additional sale, more profit is made. However, when a
large proportion of the company’s sales must be paid out in variable cost, then the company will
be experiencing low operating leverage. There will be variable costs attached to each additional
unit that is sold. This means that variable costs will be incurred only if there is a sale.

Degree of Operating Leverage

The degree of operating leverage shows how the firm’s operating profit changes in respect to
change in sales.
Degree of operating leverage = % change in operating income
% change in sales

For example: - Lee Ltd.’s operating income increased by 20% and its sales increased by 25%
over a one year period. Calculate its degree of operating leverage

Degree of operating leverage = 20% / 25% = 1.25

The key points of operating leverage are as follows:

 As operating leverage increases, more sales are needed to cover the increased
fixed costs.
 High levels of fixed costs increase business risk, which is the inherent uncertainty in the
operation of the business.
 Operating leverage also increases forecasting risk. Therefore, even a small error made in
forecasting sales can be magnified into a major error in forecasting cash flows.
(v)Pricing: Firms use different pricing strategies. The business model would describe the
approach that the firm will take. Pricing must be competitive and must be properly

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communicated to the customer. There may be a fixed pricing policy or one that is flexible.
Fixed pricing means that the price of a product or service is not subject to bargaining. The term
commonly indicates that an external agent, such as a merchant of the government, has set a price
level, which may not be changed for individual sales.
Flexible pricing may be seen when businesses offer different prices for a particular product, to
different market segments Whichever pricing strategy is chosen, must be chosen after much
deliberation.
It is possible that if flexible pricing, as in the case of a request of a special order is awarded to a
customer, it may affect other customers who are paying a higher and fixed price. However, if
not detrimental, the flexible pricing strategy may bring in funds that would not have otherwise
been gained.

(vi)Revenue Sources
Revenue sources examine the value that customers are willing to pay for. It looks at how
customers are currently paying and how they wish to pay. It also looks at the contribution that
each product type makes to its own revenue stream and to the company’s overall revenue
stream.
Revenue Streams
A revenue stream is an amount of money coming into a business or organisation from a
particular source. Businesses continually seek new ways of generating revenues, thus new
revenue streams. Finding a new revenue stream has gradually taken on a distinct and
specialized meaning in certain contexts to mean a new, novel, undiscovered, potentially
lucrative, innovative, and creative means of generating income or exploiting a potential.
This approach can especially be applied to new technology and internet businesses which find
extremely innovative ways of generating revenues, often ways which seemed not to be
possible. As a result, technology-based businesses are constantly updating their revenue
models to remain competitive.

(6) GROWTH (Investment Model of the Business)

The question that is asked under growth is: “What are the time scope and ambitions of the
venture?”
The growth aspect has implications for the venture’s strategy, economic performance, and
resource management for instance. It is important for a business model to the time, scope, and
size ambitions of the venture or what is the aim of investing in the business. Models of
venture ambitions include:

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 (i) Subsistence model: This is where an entrepreneur is entering into business strictly for
the purpose of personal survival. No growth vision is involved. The venture’s aim is
to basically survive and make enough income to cover its expenses such as paying
workers, paying creditors.

(ii) Income Model: In this approach, the entrepreneur invests in the venture so that it is
able generate a steady and consistent revenue stream of income to its lenders and
investors.
The venture is a means through which the entrepreneur is able to replace an existing
income or establish a desired one. The growth of the venture is not a major concern.

(iii) Growth model: the entrepreneur invests significantly at the start and there is
reinvestment in the venture with the aim to increase and grow the value of the venture.
operating under this model, gains profits and reinvest to fuel growth and to provide a
good return for its providers for capital.
The entrepreneur is focused on a long-term vision for the business and develops a
growth plan that includes milestones from the short-term into the long-term.

(iv) Speculative model: the time frame for the venture is shorter and the entrepreneur must
show the venture’s potential for success before selling the business.
Under this model, the venture seeks to make a gain and then ‘sell out’ as quickly as
possible.

OBJECTIVES: Students will be able to

1. Define the term business plan
2. Explain the purposes of a business plan
3. Discuss the benefits of a business plan
4. Describe what constitutes a good business plan
5. Describe the elements of a business plan

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 A BUSINESS PLAN is a formal statement of business goals, reasons they are attainable,
and plans for reaching them. It may also contain background information about the organisation
or team attempting to reach those goals.
A business plan is more extensive and detailed than the business model. In fact, the
business model would be described in the business plan. A business plan is a document which
outlines the various elements of the proposed business and demonstrates how it will operate as
well as how resources would be used, and profits generated.
A business plan is a written summary of an entrepreneur’s proposed business venture, its
operational and financial details, its marketing opportunities and strategy and its managers’ skills
and abilities.
PURPOSES OF BUSINESS PLAN
The business plan is a plan or blueprint for the company, and it is an indispensable tool in
attracting investors, obtaining loans, or both. Remember, too, that the value of your business plan
is not limited to the planning stages of your business and the process of finding start-up money.
Once you have acquired start-up capital, do not just stuff your plan in a drawer. Treat it as an
ongoing guide to your business and its operations, as well as a yardstick by which you can
measure your performance. Keep it handy, update it periodically, and use it to assess your
progress. The most common use of a business plan is persuading investors, lenders, or both, to
provide financing. These two groups look for different things.
(1) Investors are particularly interested in the quality of your business concept and the
ability of management to make your venture successful.
(2) Bankers and other lenders are primarily concerned with your company’s ability to
generate cash to repay loans.
To persuade investors and lenders to support your business, you need a professional, well-written
business plan that paints a clear picture of your proposed business.
The business plan serves several purposes to the enterprise.
For new enterprises:
 Puts into perspective the nature of the business opportunity or idea
 Details how the entrepreneur will bring the ideas to life
 Identifies the success factors of the business
General purposes of the Business Plan
 Convinces internal and external stakeholders that the business will be profitable
 Details the goals of the business for key areas and shows how these will be achieved

BENEFITS OF THE BUSINESS PLAN

The business plan:
 Enables the entrepreneur to monitor his or her business performance
 Allows the entrepreneur to identify the risks that are evident. Planning allows him or her
to understand such risks and reduce them where possible.
 Enables the entrepreneur to be familiar with his or her competitors and understand their
position in relation to his or her enterprise.

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  Enables the entrepreneur to pay close attention to the market
 Helps in predicting the future
 Gets the attention of potential investors
 Allows the entrepreneur to access loans
 Functions like a road map. It provides guidance to the entrepreneur towards the
achievement of objectives.
 Informs the entrepreneur of the instances where there are deviations from that which was
planned.
 Provides details on areas of the business model
 Motivates the workers in the business

WHAT CONSTITUTES A GOOD BUSINESS PLAN

 A Business Plan that stems from thorough research
A business plan that stems from thorough research will present an accurate picture of the
nature of the industry that a business currently exists in, the state of that industry, the
external factors that are currently influencing the industry, nature and movements of
competitors etc. this fact-based information will influence the enterprise’s choice of
strategies that will allow it to compete effectively in the market place.

 A Business Plan that is understandable

Expert help or advice allows for a plan that is clear and free from inconsistencies. This
promotes usefulness.

 A Business Plan that is continually updated

A business plan that is written with its users in mind will promote understandability and
will be likely to pull the desired responses from them.

 A Business Plan that is influenced by and stems from the perspective of the
entrepreneur.
A good business plan will accurately reflect the business idea of the entrepreneur, how he
or she sees the external and internal environments and the approaches that he or she plans
to take. Therefore, it is important that the entrepreneur be intimately involved in the
preparation of the plan and not leave it entirely up to a third party.
 A Business Plan that has realistic and achievable goals and objectives
The entrepreneur must ensure that the goals that are set are ones which are achievable
and realistic or he or she would be on a ‘fool’s errand.’ That would prove to be quite
costly.
 A Business Plan that is presentable
A Business Plan should be properly presented so as to enable its users to easily read and
follow its contents. The plan must be properly formatted. Seek advice on the preferrable
font size, format, style etc.

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KEY SECTIONS OF A BUSINESS PLAN
(i) Executive Summary: This section comes first but is actually done after the writing of
the plan is completed. It provides a summary or overview of all the other elements.
It is intended to bring across a clear picture of the nature of the proposed project or business
opportunity and the ‘good’ that it has to offer. It is what the reader looks at first, and if it does
not capture the reader’s attention, it might be the only thing that he or she looks at. It should,
therefore, emphasize the key points of the plan and get the reader excited about the prospects of
the business.
The executive summary appears at the Contents
 Description of the business opportunity
 Explanation of the business concept
 Industry overview
 Description of the target market
 Explanation of the areas where competitive advantage is expected
 Description of the management team with emphasis being placed on each
member’s qualifications and experience in the respective assigned area(s).
 Financing expected and intended purpose
 Highlights such as sales and profit projections, rate of return on investment
and the repayment dates for loans
An effective approach in writing the executive summary is to paraphrase key
sentences from each section of the business plan. This process will ensure that
the key information of each section is included in the executive summary.
(ii) Description of (Proposed) Business or Business Description
It is a brief description of the company and tell the reader why you are starting your
business, what benefits it provides, and why it will be successful.
The business description section provided introductory details such as:
o Name, type and location of business
o Legal structure (sole proprietorship, partnership etc.)
o Goals and objectives of the business
o Brief history of the business
o Current state of the industry that the business is in and its future prospects.
o Vision and mission statement
o Current stage of development of the business
o Value proposition

The business description will also briefly express the business concept. The business
concept will explain the value that the business is offering (product or and service) and to whom
(beneficiaries or target market). The uniqueness of the business’ product offerings must be
highlighted when they are being described. The business concept communicates to the reader,
who the target market customers are and the problem that will be solved or the need that will be
satisfied.
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The value proposition should clearly give the benefits that will be derived by customers through
the use of the product or service. It must be clearly articulated and must seek to place the
business in a more favourable light than that which the competitors find themselves. The
customer will seek to compare the value proposition of the business with those being offered by
the competitors. A listing of benefits may include statements such as:
 No mess
 Lower costs
 Easy use
 Convenient location
 Better after service
 Speed
The value proposition will also describe the distribution channel. This tells how the good or
service will get to customers; directly (manufacturer to consumer) or indirectly, through the use
of intermediaries.

(iii) Management
Making a great plan is one thing but if the business does noy have the persons with the
expertise to manage the business so as to make everything ‘happen’ then one can expect the
plan to fail. There must be a team that is well-equipped in every way so as to bring the plan
to realization. A description of this team must be given. The reason for the inclusion of this
element in the business plan is to portray the strength and integrity of the business and solicit
trust from proposed investors, creditors, and other users.
Owners
Make sure to give names of the owners and the percentage and type of ownership that they
have in the business. Also state whether or not they will be involved in the day-to-day
management of the business and the extent of management if they will.

Other Levels of Management

Each member (directors and middle management) should be given their due consideration.
State their current responsibilities or those they will assume. Their experience (proven track
record) and qualifications that are relevant to the position and to making the business realize
its profits potential must be the focus. Some companies include a resume for each key
management personnel in the appendix of the business plan and make reference to them in
this section.
Although the aim is to convey strengths, instances where any member of the management
team has failed in the past may be mentioned, if that failure led to future success. This will
show the resilience of that member and win the favour of wise creditors.
Note well that in addition to the management section of the business plan, some businesses
include a section that shows the organizational structure.

(iv) Marketing

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 The main aim of most businesses in the private sector is to make profits. This will not be
possible without a need and a market. One can imagine that there is a gap between the
business and the market. The business has to identify a need and undertake the job of
creating just the right product or service that will fulfil this need. It also has to match that
need with a target market and get the product to it in the most convenient way. All these
activities and more are a part of the function ‘marketing’. In return for this expending of
energy, the business receives revenue.
The marketing section of the business plan has at its core, the function of outlining to users,
how the revenue potential of the firm will be maximised. The entrepreneur will look at the price
that the ideal customer will pay and the systems that will allow him or her to receive the good or
service in the most efficient manner. It addresses the marketing strategies that will be used to
attract and maintain customers which should result in the earning of maximum revenue. The
competitors will be examined, and the entrepreneur will seek to determine in what ways the
business is different and better than theirs.
In order to determine the revenue potential, the enterprise will need to know the current and
expected future size of its market. Bear in mind that a market may grown or it may be at a stage
in its cycle where it is about to decline.

Benefits of the Marketing Plan

The Marketing Plan:
 Provides a basis for comparing planned performance and actual performance
 Contains strategies that both employees and management can implement to achieve
specified goals.
 Makes the marketing manager aware of the opportunities and risks that the business is
open to and the strengths and weaknesses that are inherent.
 May be used as a reference toll for future planning.

Elements of the Marketing Section of the Business Plan

 Marketing objectives
 Situation analysis
 Description of the target market
 Description of competitors
 Actions to be taken or the decision made under each of the 4P’s
 Marketing budget

(1) Marketing Objectives

The marketing objectives must be in line with the mission and goals of the business.

(2) The Situation Analysis

The situation analysis is undertaken by a firm to get an understanding of its capabilities.
In so doing, it enables an examination of the internal and external environment of an

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 enterprise as they relate to the target market and the industry at large. A SWOT Analysis
forms a part of the Situational Analysis. The size of the industry will be looked at as well
as its history, growth patterns and future prospects.

(3) Description of the Target Market

The target market is the factor that the whole marketing plan is hinged upon. All
activities must be directed towards it. It means therefore, that it should be carefully
defined by the entrepreneur. In order to help in this definition, the marketing manager
must determine its characteristics and behaviour. These are based on the following:

- geographic location – according to region, city, density (urban, suburban, rural) etc.
- demographic make-up – according to age, sex, religion, income, education etc.
- psychographic breakdown – according to social class, personality, and lifestyle.

(4) Description of Competitors

The marketing manager must do an analysis of its major components. He or she must
understand the competition and be able to properly articulate each one’s position. Some
of the questions that must be answered are:
(a) Who are the major competitors?
(b) What product or service do the competitors offer?
(c) How do the competitors’ offerings compare to the business’ offerings?
(d) How do the customers of the competitors perceive the product offerings?
(e ) What are the strengths and weaknesses of the competitors’ offerings?
(f) In what area (s) does or do the competitors have the competitive edge?
Only when the competition is fully understood, will the business know how to position its
product in a more superior light.
The Four P’s
The marketing mix is a set of tools that a business may use to achieve its marketing objectives.
It comprises four variables that are altogether known as the Four Ps of marketing. The Four Ps
are: Product, Place, Price and Promotion. The business will use these variables to arrive at
certain decisions that will allow the business to meet its objectives.
a. Product – the product is anything that is offered to the market to satisfy a need or want.
The product can be a good (tangible) or a service (intangible) or it can be a combination
of the two. The marketing manager will include in the plan, details of the design,
packaging, quality, features, after-sales service and customer service for the product that
is being offered.
When customers consider a product, their focus is usually on the benefits that can be
derived from it and not the product itself. The manager must therefore ensure that a
needs analysis is done before even preparing the marketing plan.
The Three Levels of a Product
The product consists of three levels. The innermost level is called the Core Product.
The next level is the Actual Product, and the outermost level is the Augmented Product.

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 The Core Product is the benefit that is being derived as spoken of above. It is not
tangible. The Actual Product is the physical product. It is what you see and feel. It
consists of the various physical features such as colour, branding and style. The
Augmented Product consists of all the other non-physical features that are added. So
warranty, after-sales service, financing, delivery and installation are some offerings that
you will find on this level.
b. Place
Place speaks to how the customers will access the product or service. Remember, if a
product is not seen it may not be bought. It is therefore, the onus of the firm to ensure
that the product is easily seen and accessible by the customer, in the form and amounts or
numbers required when needed. Location, channels of distribution and methods of
delivery that suit different products and their target customers must be discussed.
Other consideration will include:
- shipping requirements
- delivery terms
- online locations and services
- demographics of market (age, size, income, etc.)
Businesses that provide personalized services such as hair salons, and those that offer
retailing services must pay close attention to location. Manufacturing concerns who will
deliver to wholesalers do not have to be too choosy but at the same time, locating near to
their raw materials sources and near well-developed roadways are essential if costs are to
be kept at a minimum.
The business must research the various chains that it will utilize and justify each in the
plan. The various tiers are as follows:
Selling directly to customers

Producer Customers

Selling through retailers

Producer Retailers Customers

Selling through wholesalers

Producer Wholesalers Retailers Customers

Remember, the business should base its choice of channel for each product line on ease
of customers’ accessibility, customers’ quantity demands, level of durability and the
intention to keep costs at the lowest figures possible.
c. Price
Price is the amount that is paid for each unit of a good or service. Price brings in
revenue. It is this revenue that will determine the volume of sales and hence the
profitability of the business. The business must carefully communicate its pricing
strategies to users of the business plan.
Although there is a ‘rule of thumb’ that the price that is set must exceed the costs that are

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 incurred to put the product in a saleable condition, there many other factors that may be
considered when a business is deciding which pricing policy it should adopt. Bear in
mind that the price must be seen as attractive by the target market. It is therefore
imperative that the manager finds out what price makes the target market ‘tick.’ Having
an intimate knowledge of the intended buyers will help in this regard.

Some factors that influence Price-Setting

- Competitors’ Prices – these may be used with a highly price sensitive market.
- Market Demand – the business watches the ‘invisible hand’ that is demand and supply,
to determine price. If demand is less than supply, a lower price is necessary for a normal
good or vice versa.
- Brand Strategy – firms that align their prices to their brand strategy, have to satisfy the
expectations of their customers. If the business portrays a low-price image, then it needs
to be consistent with a low-price strategy.
- Production Cost – the costs of inputs such as raw materials and labour will greatly
impact the price that is set.
- Economic Factors – there are a host of economic factors that will impact prices. These
may include interest rates, unemployment rates, price paid by the government for crucial
imports such as oil and tax rates.
- Availability – goods that are in high demand but which are scarce or made from one or
more scarce resources will attract high prices.
- Distribution Chain – a good may be priced differently depending on where it is in the
distribution chain. The manufacture cannot set high prices for goods when the good will
be passing through wholesalers and retailers to get to customers. High prices will turn
away the middlemen. Each unit desires to make a profit and at the same time attract
buyers.
d. Promotion
The marketing manager must discuss the various methods that the busines will utilize to
attract customers or promote each product, its service and its brand. Advertising is one
method of promotion that is commonly spoken about. However, there are other methods
that the business can utilize. The business must carefully select the tools that are
necessary to bring awareness of the existence of its offerings to target market. The tools
should get prospective customers to try the proposed product and get them hooked on it
and any future offerings. Promotion allows the business to inform, persuade, and remind.
Some Tools of Promotion
- Sales promotion – these include short term techniques (give-aways, contests, samples or free
trials) that are used to get customers to buy the business’ products.
- Public Relations – this is a deliberate and sustained attempt on the part of a company to
engage the public in such a way that helps in the building of a good image. Press conferences,
print media, sponsorship of members of the community and the social media are just few of the
tools that may be used to facilitate communication.
- Advertising – advertising is a tool that utilizes the mass media with the aim of communicating

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information to buyers and prospective buyers of goods and services. It may be used to bring
awareness of a new product, inform the market of a change in location, remind the target market
of the existence of a product etc.
- Personal Selling – this involves ‘face to face’ contact. If is best used for highly
priced goods. It allows for the building of lasting relationships between the firm and
the customers.
Promotion is usually seen as the fun part of marketing. However, if keen attention is not paid to
sufficiently researching this are to find a ‘best fit’ for business’s products and services, millions
of dollars may be wasted. Promotion for a product or service, must result in increased sales for
that product or service and in such a way that far surpasses the cost of that promotion.
Media
* Print Media
* Radio
* Television
* Internet
* Direct Mail
* Social Media
The Marketing Budget – a budget is required for the marketing plan. This budget details
the projected costs and revenues that are associated with the marketing aspect of the business
plan.
(v) Operations
The element operations speak to the aspect of production. It looks at the resources that are
required to enable the production of goods or service. An ideally located facility or group of
facilities that is outfitted with the right machinery and equipment and operated by persons with
the requisite skills crucial for the expanding firm. Up-to-date production techniques are detailed
as well as considerations for materials sourcing, inventory control and quality control.
Activities needed:
- explain the production process
- state how hazardous materials will be stored and disposed of
- state the industry (local and international) standards that have been adhered to
- explain how nay risk that may be encountered in production may be mitigated
- give details of the supply chain and contingency plan
- explain the quality control methods
- give the type, size and location of the manufacturing plant
- outline lease arrangements of the manufacturing plant
- explain the type of raw materials and how they will be sourced
- give the financing arrangements of equipment
- give the special needs (such as power) of the business
- describe the inventory control system
- give research and testing details of products
(vi) Financials

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The entrepreneur must consider whether the business is a viable one for all stakeholders. If it is
not, then he or she needs to go back to the ‘drawing board’. It therefore goes without saying that
the financial section of the business plan is crucial.
The financial section is a projection of the financial standing of a business for a specified period.
Many businesses fail to treat this section with the care and attention that is needed and therefore
it is usually poorly done. Many business owners do not understand the areas accounting and
finance. In this case, the entrepreneur must be willing to spend a ‘tidy sum’ to get this section
properly done. A fantastic marketing and production plan are meaningless to a prospective
investor or creditors, if they are not backed by realistic figures.
The financials consist of the following statements:
a. Income Statement or Statement of Comprehensive Income
b. Statement of Financial Position (formerly known as the Balance Sheet)
c. Cash Flow Statement
d. Cash Budgets

Break even analysis is a must in this section. A business must know that the break-even point is
for each of its products and services. Ratio analysis is also another area that is featured.
(vii) Loan or Investment Proposal
In this section, the entrepreneur will state the amount requested and the purpose. He
or she will also describe how the amounts that have been borrowed, will be repaid
(rate and repayment schedule) and give the exit strategy of the business.
(viii) Sales Plan
Although many firms discuss the aspect of sales in their marketing plan, there is a
segment called the sales plan that is suited for that purpose.
Business Model vs Business Plan
The business plan contains all the elements that will communicate the feasibility of prospective
business while the business model shows the element that make an existing business create value
for its shareholders.

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