Chapter 18: Production of Goods and Services

Production is the effective management of resources in producing goods and services.

The operations department in a firm overlooks the production process. They must:

 Use the resources in a cost-effective and efficient manner

 Manage inventory effectively
 Produce the required output to meet customer demands
 Meet the quality standards expected by customers

Productivity
Productivity is a measure of the efficiency of inputs used in the production process over a
period of time. It is the output measured against the inputs used to produce it. The formula
is:

Businesses often measure the labour productivity to see how efficient their employees are in
producing output. The formula for it is:

Businesses look to increase productivity, as the output will increase per employee and so the
average costs of production will fall. This way, they will be able to sell more while also being
able to lower prices.
Ways to increase productivity:

 improving labour skills by training them so they work more productively and waste
lesser resources
 introducing automation (using machinery and IT equipment to control production) so
that production is faster and error-free
 improve employee motivation so that they will be willing to produce more and
efficiently so.

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  improved quality control and assurance systems to ensure that there are no wastage of
resources

Inventory Management
Firms can hold inventory (stock) of raw materials, goods that are not completed yet (a.k.a work-
in-progress) and finished unsold goods. Finished good stocks are kept so that any unexpected
rise in demand is fulfilled.

 When inventory gets to a certain point (reorder level), they will be reordered by the firm
to bring the level of inventory back up to the maximum level again. The business has to
reorder inventory before they go too low since the reorder supply will take time to arrive
at the firm
 The time it takes for the reorder supply to arrive is known as lead time.
 If too high inventory is held, the costs of holding and maintaining it will be very high.
 The buffer inventory level is the level of inventory the business should hold at the very
minimum to satisfy customer demand at all times. During the lead time the inventory will
have hit the buffer level and as reorder arrives, it will shoot back up to the maximum
level.

Lean Production
Lean production refers to the various techniques a firm can adopt to reduce wastage and increase
efficiency/productivity.
The seven types of wastage that can occur in a firm:

 Overproduction– producing goods before they have been ordered by customers. This
results in too much output and so high inventory costs
 Waiting– when goods are not being moved or processed in any way, then waste is
occurring
 Transportation-moving goods around unnecessarily is simply wasting time. They also
risk damage during movement
 Unnecessary inventory-too much inventory takes up valuable space and incurs cost

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  Motion-unnecessary moving about of employees and operation of machinery is a waste
of time and cost respectively.
 Over-processing-using complex machinery and equipment to perform simple tasks may
be unnecessary and is a waste of time, effort and money
 Defects– any fault in equipment can halt production and waste valuable time. Goods can
also turn out to be faulty and need to be fixed- taking up more money and time

By avoiding such wastage, a firm can benefit in many ways

 less storage of raw materials, components and finished goods- less money and time tied
up in inventory
 quicker production of goods and services
 no need to repair faulty goods- leads to good customer satisfaction
 ultimately, costs will lower, which helps reduce prices, making the business more
competitive and earn higher profits as well

Now, how to implement lean production? The different methods are:

 Kaizen: it’s a Japanese term meaning ‘continuous improvement’. It aims to increase

efficiency and reduce wastage by getting workers to get together in small groups and
discuss problems and suggest solutions. Since they’re the ones directly involved in
production they will know best to identify issues. When kaizen is implemented, the
factory floor, for example, is rearranged by re-positioning machinery and equipment
so that production can flow smoothly through the factory in the least possible time.

Benefits:

 increased productivity

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  reduced amount of space needed for production
 improved factory layout may allow some jobs to be combined, so
freeing up employees to do other jobs in the factory
 Just-in-Time inventory control: this techniques eliminates the need to hold any kind of
inventory by ensuring that supplies arrive just in time they are needed for production. The
making of any parts is done just in time to be used in the next stage of production and
finished goods are made just in time they are needed for delivery to the customer/shop.
The firm will need very reliable suppliers and an efficient system for reordering supplies.
Benefits:Reduces cost of holding inventory
 Warehouse space is not needed any more, so more space is available for other
uses
 Finished goods are immediately sold off, so cash flows in quickly
 Cell Production: the production line is divided into separate, self-contained units each
making a part of the finished good. This works because it improves worker morale when
they are put into teams and concentrate on one part alone.

Methods of Production

 Job Production: products are made specifically to order, customized for each customer.
Eg: wedding cakes, made-to-measure suits, films etc.
Advantages:Most suitable for one-off products and personal services
 The product meets the exact requirement of the customer
 Workers will have more varied jobs as each order is different, improving
morale
 very flexible method of production

Disadvantages:Skilled labour will often be required which is expensive
 Costs are higher for job production firms because they are usually labour-
intensive
 Production often takes a long time
 Since they are made to order, any errors may be expensive to fix
 Materials may have to be specially purchased for different orders, which is
expensive

 Batch Production: similar products are made in batches or blocks. A small quantity of
one product is made, then a small quantity of another. Eg: cookies, building houses of the
same design etc.
Advantages:Flexible way of working- production can be easily switched between
products
 Gives some variety to workers
 More variety means more consumer choice
 Even if one product’s machinery breaks down, other products can still be
made

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 
Disadvantages:Can be expensive since finished and semi-finished goods will need
moving about
 Machines have to be reset between production batches which delays
production
 Lots of raw materials will be needed for different product batches, which can
be expensive.

 Flow Production: large quantities of products are produced in a continuous process on

the production line. Eg: a soft drinks factory.
Advantages:There is a high output of standardized (identical) products
 Costs are low in the long run and so prices can be kept low
 Can benefit from economies of scale in purchasing
 Automated production lines can run 24×7
 Goods are produced quickly and cheaply
 Capital-intensive production, so reduced labour costs and increases efficiency

Disadvantages:A very boring system for the workers, leads to low job satisfaction and
motivation
 Lots of raw materials and finished goods need to be held in inventory- this is
expensive
 Capital cost of setting up the flow line is very high
 If one machinery breaks down, entire production will be affected

Factors that affect which production method to use:

 The nature of the product: Whether it is a personal, customized-to-order product, in

which case job production will be used. If it is a standard product, then flow production
will be used
 The size of the market: For a large market, flow production will be required. Small local
and niche markets may make use of batch and flow production. Goods that are highly
demanded but not in very large quantities, batch production is most suitable.
 The nature of demand: If there is a fair and steady demand for the product, it would be
more suitable to run a production line for the product. For less frequent demand, batch
and job will be appropriate.
 The size of the business: Small firms with little capital access will not produce using
large automated production lines, but will use batch and job production.

Technology and Production

 Automation: equipment used in the factory is controlled by computers to carry out

mechanical processes, such as spray painting a car body.
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  Mechanization: production is done by machines but is operated by people
 CAD (computer aided designing): a computer software that draws items being designed
more quickly and allows them to be rotated, zoomed in and viewed from all angles.
 CAM (computer aided manufacturing): computers monitor the production process and
controls machines and robots-similar to automation
 CIM (computer integrated manufacturing): the integration of CAD and CAM. The
computers that design the product using CAD is connected to the CAM software to
directly produce the physical design.
 EPOS (electronic point-of-sale): used at checkouts/tills where operator scans the bar-
code of each item bought by the customer individually. The item details and price appear
on screen and are printed in the receipt. They can also automatically update and reorder
stock as items are bought.
 EFTPOS (electronic funds transfer at point-of-sale): the electronic cash register at the till
will be connected to the retailer’s main computer and different banks. When the customer
swipes the debit card at the till, information is read by the scanner and an amount is
withdrawn from the customer’s bank account (after the PIN is entered).

Advantages of technology in production

 Greater productivity
 Greater job satisfaction among workers as boring, routine jobs are done by machines
 Better quality products
 Quicker communication and less paperwork
 More accurate demand levels are forecast since computer monitor inventory levels
 New products can be introduced as new production methods are introduced

Disadvantages of technology in production

 Unemployment rises as machines and computers replace human labour

 Expensive to set up
 New technology quickly becomes outdated and frequent updating of systems will be
needed- this is expensive and time-consuming.
 Employees may take time to adjust to new technology or even resist it as their work
practices change.

Chapter 19: Costs, Scale of Production and Break-even Analysis

Costs
Fixed Costs are costs that do not vary with output produced or sold in the short run. They are
incurred even when the output is 0 and will remain the same in the short run. In the long-run they
may change. Also known as overhead costs.
E.g.: rent, even if production has not started, the firm still has to pay the rent.
Variable Costs are costs that directly vary with the output produced or sold. E.g.: material
costs and wage rates that are only paid according to the output produced.
TOTAL COST = TOTAL FIXED COSTS + TOTAL VARIABLE COSTS

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TOTAL COST = AVERAGE COST * OUTPUT
AVERAGE COST (unit cost) = TOTAL COST/ TOTAL OUTPUT
A business can use these cost data to make different decisions. Some examples are: setting
prices (if the average cost of one unit is $3, then the price would be set at $4 to make a profit of
$1 on each unit), deciding whether to stop production (if the total cost exceeds the total
revenue, a loss is being made, and so the production might be stopped), deciding on the best
location (locations with the cheaper costs will be chosen) etc.
Scale of production
As output increases, a firm’s average cost decreases.
Economies of scale are the factors that lead to a reduction in average costs as a business
increases in size. The five economies of scale are:

 Purchasing economies: For large output, a large amount of components have to be

bought. This will give them some bulk-buying discounts that reduce costs
 Marketing economies: Larger businesses will be able to afford its own vehicles to
distribute goods and advertise on paper and TV. They can cut down on marketing labour
costs. The advertising rates costs also do not rise as much as the size of the advertisement
ordered by the business. Average costs will thus reduce.
 Financial economies: Bank managers will be more willing to lend money to large
businesses as they are more likely to be able to pay off the loan than small businesses.
Thus they will be charged a low rate of interest on their borrowings, reducing average
costs.
 Managerial economies: Large businesses may be able to afford to hire specialist
managers who are very efficient and can reduce the business’ costs.
 Technical economies: Large businesses can afford to buy large machinery such as a flow
production line that can produce a large output and reduce average costs.

Diseconomies of scale are the factors that lead to an increase the average costs of a business as it
grows beyond a certain size. They are:

 Poor communication: as a business grows large, more departments and managers and
employees will be added and communication can get difficult. Messages may be
inaccurate and slow to receive, leading to lower efficiency and higher average costs in the
business.
 Low morale: when there are lots of workers in the business and they have non-contact
with their senior managers, the workers may feel unimportant and not valued by
management. This would lead to inefficiency and higher average costs.
 Slow decision-making: As a business grows larger, its chain of command will get
longer. Communication will get very slow and so any decision-making will also take
time, since all employees and departments may need to be consulted with.

Businesses are now dividing themselves into small units that can control themselves and
communicate more effectively, to avoid any diseconomies from arising.

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Break-even
Break-even level of output is the output that needs to be produced and sold in order to start
making a profit. So, the break-even output is the output at which total revenue equals total
costs (neither a profit nor loss is made, all costs are covered).
A break-even chart can be drawn, that shows the costs and revenues of a business across
different levels of output and the output needed to break even.
Example:
In the chart below, costs and revenues are being calculated over the output of 2000 units.
The fixed costs is 5000 across all output (since it is fixed!).
The variable cost is $3 per unit so will be $0 at output is 0 and $6000 at output 2000- so you just
draw a straight line from $0 to $6000.
The total costs will then start from the point where fixed cost starts and be parallel to the
variable costs (since T.C.= F.C.+V.C. You can manually calculate the total cost at output 2000:
($6000+$5000=$11000).
The price per unit is $8 so the total revenue is $16000 at output 2000.
Now the break-even point can be calculated at the point where total revenue and total cost
equals– at an output of 1000. (In order to find the sales revenue at output 1000, just do
$8*1000= $8000. The business needs to make $8000 in sales revenue to start making a profit).

Advantages of break-even charts:

 Managers can look at the graph to find out the profit or loss at each level of output
 Managers can change the costs and revenues and redraw the graph to see how that would
affect profit and loss, for example, if the selling price is increased or variable cost is
reduced.

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  The break-even chart can also help calculate the safety margin- the amount by which
sales exceed break-even point. In the above graph, if the business decided to sell 2000
units, their margin of safety would be 1000 units. In sales terms, the margin of safety
would be 1000*8 = $8000. They are $8000 safe from making a loss.
Margin of Safety (units) = Units being produced and sold – Break-even output

Limitations of break-even charts:

 They are constructed assuming that all units being produced are sold. In practice, there
are always inventory of finished goods. Not everything produced is sold off.
 Fixed costs may not always be fixed if the scale of production changes. If more output
is to be produced, an additional factory or machinery may be needed that increases fixed
costs.
 Break-even charts assume that costs can always be drawn using straight lines. Costs
may increase or decrease due to various reasons. If more output is produced, workers
may be given an overtime wage that increases the variable cost per unit and cause the
variable cost line to steep upwards.

Break-even can also be calculated without drawing a chart. A formula can be used:
Break-even level of production =Total fixed costs/ Contribution per unit
Contribution = Selling price – Variable cost per unit (this is the value added/contributed to
the product when sold)
In the above example, the contribution is $8 -$3 =$5, so the break-even level is:
$5000/$5 = 1000 units!

Chapter 20: Achieving Quality Production

Quality means to produce a good or service which meets customer expectations. The products
should be free of faults or defects. Quality is important because it:

 establishes a brand image

 builds brand loyalty
 maintains good reputation
 increase sales
 attract new customers

If there is no quality, the firm will

 lose customers to other brands

 have to replace faulty products and repeat poor service, increasing costs
 bad reputation leading to low sales and profits

There are three methods a business can implement to achieve quality: quality control, quality
assurance and total quality management.

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Quality Control
Quality control is the checking for quality at the end of the production process, whether a
good or a service.
Advantages:

 Eliminates the fault or defect before the customer receives it, so better customer
satisfaction
 Not much training required for conducting this quality check

Disadvantages:

 Still expensive to hire employees to check for quality

 Quality control may find faults and errors but doesn’t find out why the fault has
occurred, so the it’s difficult to solve the problem
 if product has to be replaced and reworked, then it is very expensive for the firm

Quality Assurance
Quality assurance is the checking for quality throughout the production process of a good or
service.
Advantages:

 Eliminates the fault or defect before the customer receives it, so better customer
satisfaction
 Since each stage of production is checked for quality, faults and errors can be easily
identified and solved
 Products don’t have to be scrapped or reworked as often, so less expensive than
quality control

Disadvantages:

 Expensive to carry out since quality checks have to be carried throughout the entire
process, which will require manpower and appropriate technology at every stage.
 How well will employees follow quality standards? The firm will have to ensure that
every employee follows quality standards consistently and prudently, and knows how to
address quality issues.

Total Quality Management (TQM)

Total Quality Management or TQM is the continuous improvement of products and
production processes by focusing on quality at each stage of production. There is great
emphasis on ensuring that customers are satisfied. In TQM, customers just aren’t the consumers
of the final product. It is every worker at each stage of production. Workers at one stage have to
ensure the quality standards are met for the product in production at their stage before they are
passed onto the next stage and so on. Thus, quality is maintained throughout production and
products are error-free.
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TQM also involves quality circles and like Kaizen, workers come together and discuss issues and
solutions, to reduce waste ensure zero defects.
Advantages:

 quality is built into every part of the production process and becomes central to the
workers principles
 eliminates all faults before the product gets to the final customer
 no customer complaints and so improved brand image
 products don’t have to be scrapped or reworked, so lesser costs
 waste is removed and efficiency is improved

Disadvantages:

 Expensive to train employees all employees

 Relies on all employees following TQM– how well are they motivated to follow the
procedures?

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

They can look for a quality mark on the product like ISO (International Organization for
Standardization). The business with these quality marks would have followed certain quality
procedures to keep the quality mark. For services, a good reputation and positive customer
reviews are good indicators of the service’s quality.

Chapter 21: Location Decisions

Owners need to decide a location for their firm to operate in, at the time of setting up, when it
needs to expand operations, and when the current location proves unsatisfactory for some reason.
Location is important because it can affect the firm’s costs, profits, efficiency and the market
base it reaches out to.
Factors that affect the location decisions of a manufacturing firm:

 Production Method: when job production is used, the business will operate on a small
scale, so the nearness to components/raw materials won’t be that important. For flow
production, on the other hand, production will be on a large scale- there will be a huge
amount of components and transport costs will be high- so components need to be close
by.
 Market: if the product is a consumer good and perishable, the factories need to be close
to the markets to sell out quickly before it perishes.
 Raw Materials/Components: the factories may need to be located close to where raw
materials can be acquired, especially if the raw material is to be processed while still
fresh, like fruits for fruit juice.
 External economies: the business may locate near other firms that support the business
by provide services- eg: business that install and maintain factory equipment.
 Availability of labour: Businesses will need to locate near areas where they can get
workers of the skills they need in the factory. If lots of unskilled workers are needed in

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 the factories firms locate in areas of high unemployment. Wage rates also vary by
location and firms will want to set up in locations where wage rates are low.
 Government Influence: the government sometimes gives incentives and grants to firms
that set up in low-development, rural and high-unemployment areas. There may also be
govt. rules and restrictions in setting up, e.g.: in some areas of great natural beauty. The
business needs to consider these.
 Transport & Communication infrastructure: the factories need to be located near
areas where there are good road/rail/port/air transport systems. If goods are to be
exported, it needs to be set up near ports.
 Power and water supply: factories need water and power to operate and a reliable and
steady supply of both should be ensured by setting up in areas where they are available.
 Climate: not the most important factor but can influence certain sectors. Eg: the dry
climate in Silicon Valley aids the manufacturing of silicon chips.
 Owner’s personal preferences

Factors that affect the location decisions of a service-sector firm:

 Customers: service-sector businesses that have direct contact with customers need to
locate in customer-accessible and convenient places. Eg; restaurants, hairdressers, post
offices etc.
 Technology: today, with increasing use of IT to shop and make payments, customers do
not need direct access to services and proximity to the market/customer is not a very
important factor in location decisions. They locate away from customers in places where
there are low rent and wage rates. Eg: banks
 Availability of labour: if large number of workers are required in the firm, then it will
need to locate close to residential areas. If they want certain types of worker skills, they
will need to locate in places where such skilled workers can be found. However, with
work-from-home and technology, this is not that big of a factor nowadays.
 Climate: tourism services need to be located in places of good climate.
 Nearness to other business: some services serve the needs of large companies, such as
firm equipment servicing and so they need to be very close to such businesses.
Businesses may also set up where close competitors are to watch them and snatch away
their customers.
 Rent/taxes
 Owner’s personal preferences

Factors that affect the location decisions of a retailing firm:

 Shoppers: retailers need to be located in areas where shoppers frequent, like malls, to
attract as many customers as possible.
 Nearby shops: being located to other shops that are visited regularly will also attract
attention of customers into the shop. Being near competitors also helps keep an eye on
competition and snatch away customers.

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  Customer parking availability: when parking is available nearby, more people will
find it convenient to shop in that area.
 Availability of suitable vacant premises: Obviously, there needs to be a vacant premise
available to set up the business. Vacant premises can also help the business expand their
premises in the future.
 Rent/taxes: rents and taxes on the locations need to be affordable.
 Access to delivery vehicles: if the retailer has home delivery services, then delivery
vehicles will be required.
 Security: high rates of crime and theft can happen in shops. Shopping complexes with
security guards will thus be preferred by firms.

Why businesses locate in different countries?

 New markets overseas.

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

The role of legal controls on location decisions

Governments influence location decisions:

 to encourage businesses to set up and expand in areas of high unemployment and under-
development. Grants and subsidies can be given to businesses that set up in such areas.
 to discourage firms from setting in areas of that are overcrowded or renowned for natural
beauty. Planning restrictions can be put into place to do so.

Chapter 22: Business Finance: Needs and Sources

Finance is the money required in the business. Finance is needed to set up the business, expand
it and increase working capital (the day-to-day running expenses).
Start-up capital is the initial capital used in the business to buy fixed and current assets before it
can start trading.
Working Capital finance needed by a business to pay its day-to-day running expenses
Capital expenditure is the money spent on fixed assets (assets that will last for more than a
year). Eg: vehicles, machinery, buildings etc. These are long-term capital needs.
Revenue Expenditure, similar to working capital, is the money spent on day-to-day expenses
which does not involve the purchase of long-term assets. Eg: wages, rent. These are short-term
capital needs.
Sources of Finance
Internal finance is obtained from within the business itself.

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

External finance is obtained from sources outside of the business.

 Issue of share: only for limited companies.

Advantage:

 A permanent source of capital, no need to repay the money to shareholders

no interest has to be paid

Disadvantages:

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 Dividends have to be paid to the shareholders

If many shares are bought, the ownership of the business will change hands.

(The ownership is decided by who has the highest percentage of shares in the
company)
 Bank loans: money borrowed from banks

Advantages:

 Quick to arrange a loan

 Can be for varying lengths of time
 Large companies can get very low rates of interest on their loans

Disadvantages:

 Need to pay interest on the loan periodically

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

Advantage:

 Can be used to raise very long-term finance, for example, 25 years

Disadvantage:

 Interest has to be paid and it has to be repaid

 Debt factoring: a debtor is a person who owes the business money for the goods they
have bought from the business. Debt factors are specialist agents that can collect all the
business’ debts from debtors.

Advantages:

 Immediate cash is available to the business

 Business doesn’t have to handle the debt collecting

Disadvantage:

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  The debt factor will get a percent of the debts collected as reward. Thus, the
business doesn’t get all of their debts
 Grants and subsidies: government agencies and other external sources can give the
business a grant or subsidy

Advantage:

 Do not have to be repaid, is free

Disadvantage:

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

Short-term finance provides the working capital a business needs for its day-to-day operations.

 Overdrafts: similar to loans, the bank can arrange overdrafts by allowing businesses to
spend more than what is in their bank account. The overdraft will vary with each month,
based on how much extra money the business needs.

Advantages:

 Flexible form of borrowing since overdrawn amounts can be varied each

month
 Interest has to be paid only on the amount overdrawn
 Overdrafts are generally cheaper than loans in the long-term

Disadvantages:

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

Advantage:

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  No interests, repayments involved

Disadvantage:

If the payments are not made quickly, suppliers may refuse to give discounts
in the future or refuse to supply at all
 Debt Factoring: (see above)

Long-term finance is the finance that is available for more than a year.

 Loans: from banks or private individuals.

 Debentures
 Issue of Shares
 Hire Purchase: allows the business to buy a fixed asset and pay for it in monthly
instalments that include interest charges. This is not a method to raise capital but gives
the business time to raise the capital.

Advantage:

 The firms doesn’t need a large sum of cash to acquire the asset

Disadvantage:

 A cash deposit has to be paid in the beginning

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

Advantages:

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

Disadvantage:

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

Factors that affect choice of source of finance

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  Purpose: if a fixed asset is to be bought, hire purchase or leasing will be appropriate, but
if finance is needed to pay off rents and wages, debt factoring, overdrafts will be used.
 Time-period: for long-term uses of finance, loans, debenture and share issues are used,
but for a short period, overdrafts are more suitable.
 Amount needed: for large amounts, loans and share issues can be used. For smaller
amounts, overdrafts, sale of assets, debt factoring will be used.
 Legal form and size: only a limited company can issue shares and debentures. Small
firms have limited sourced of finances available to choose from
 Control: if limited companies issue too many shares, the current owners may lose control
of the business. They need to decide whether they would risk losing control for business
expansion.
 Risk- gearing: if business has existing loans, borrowing more capital can increase
gearing- risk of the business- as high interests have to be paid even when there is no
profit, loans and debentures need to be repaid etc. Banks and shareholders will be
reluctant to invest in risky businesses.

Finance from banks and shareholders

Chances of a bank willing to lend a business finance is higher when:

 A cash flow forecast is presented detailing why finance is needed and how it will be used
 An income statement from the last trading year and the forecast income statement for the
next year, to see how much profit the business makes and will make.
 Details of existing loans and sources of finance being used
 Evidence that a security/collateral is available with the business to reduce the bank’s risk
of lending
 A business plan is presented to explain clearly what the business hopes to achieve in the
future and why finance is important to these plans

Chances of a shareholder willing to invest in a business is higher when:

 the company’s share prices are increasing- this is a good indicator of improving
performance
 dividends and profits are high
 the company has a good reputations and future growth plans

Chapter 23: Cash Flow Forecasting and Working Capital

Why is cash important?
If a firm doesn’t have any cash to pay its workers, suppliers, landlord and government, the
business could go into liquidation– selling everything it owns to pay its debts. The business
needs to have an adequate amount of cash to be able to pay for all its short-term payments.
Cash Flow
The cash flow of a businesses is its cash inflows and cash outflows over a period of time.
Cash inflows are the sums of money received by the business over a period of time. E.g.:

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  sales revenue from sale of products
 payment from debtors– debtors are customers who have already purchased goods from
the business but didn’t pay for them at that time
 money borrowed from external sources, like loans
 the money from the sale of business assets
 investors putting more money into the business

Cash outflows are the sums of money paid out by the business over a period of time. Eg:

 purchasing goods and materials for cash

 paying wages, salaries and other expenses in cash
 purchasing fixed assets
 repaying loans (cash is going out of the business)
 by paying creditors of the business- creditors are suppliers who supplied items to the
business but were not paid at the time of supply.

The cash flow cycle:

Cash flow is not the same as profit! Profit is the surplus amount after total costs have been
deducted from sales. It includes all income and payments incurred in the year, whether already
received or paid or to not yet received or paid respectfully. In a cash flow, only those elements
paid by cash are considered.
Cash Flow Forecasts
A cash flow forecast is an estimate of future cash inflows and outflows of a business, usually on
a month-by-month basis. This then shows the expected cash balance at the end of each month. It
can help tell the manager:

 how much cash is available for paying bills, purchasing fixed assets or repaying loans
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  how much cash the bank will need to lend to the business to avoid insolvency (running
out of liquid cash)
 whether the business has too much cash that can be put to a profitable use in the business

Example of a cash flow forecast for the four months:

The cash inflows are listed first and then the cash outflows. The total inflows and outflows have
to be calculated after each section.
The opening cash/bank balance is the amount of cash held by the business at the start of the
month
Net Cash Flow = Total Cash Inflow – Total Cash Outflow
The net cash flow is added to opening cash balance to find the closing cash/bank balance– the
amount of cash held by the business at the end of the month. Remember, the closing cash/bank
balance for one month is the opening cash/bank balance for the next month!
The figures in bracket denote a negative balance, i.e., a net cash outflow (outflows > inflows)
Uses of cash flow forecasts:

 when setting up the business the manager needs to know how much cash is required to
set up the business. The cash flow forecast helps calculate the cash outflows such as rent,
purchase of assets, advertising etc.
 A statement of cash flow forecast is required by bank managers when the business
applies for a loan. The bank manager will need to know how much to lend to the
business for its operations, when the loan is needed, for how long it is needed and when it
can be repaid.
 Managing cash flow– if the cash flow forecast gives a negative cash flow for a month(s),
then the business will need to plan ahead and apply for an overdraft so that the negative
balance is avoided (as cash come in and the inflow exceeds the outflow). If there is too
much cash, the business may decide to repay loans (so that interest payment in the future
will be low) or pay off creditors/suppliers (to maintain healthy relationship with
suppliers).

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

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

In the long-term, to improve cash flow, the business will need to attract more investors, cut
costs by increasing efficiency, develop more products to attract customers and increase inflows.
Working Capital
Working capital the capital required by the business to pay its short-term day-to-day expenses.
Working capital is all of the liquid assets of the business– the assets that can be quickly
converted to cash to pay off the business’ debts. Working capital can be in the form of:

 cash needed to pay expenses

 cash due from debtors – debtors/credit customers can be asked to quickly pay off what
they owe to the business in order for the business to raise cash
 cash in the form of inventory – Inventory of finished goods can be quickly sold off to
build cash inflows. Too much inventory results in high costs, too low inventory may
cause production to stop.

Chapter 24: Income Statements

Accounts are the financial records of a firm’s transactions.

Final Accounts are prepared at the end of the financial year and give details of the profit or loss
made as well as the worth of the business.
Profit
Profit = Sales Revenue – Total cost
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When the total costs exceed the sales revenue, then a loss is made.
How to increase profit?

 Increase sales revenue

 Cut costs

Why is profit important to a business?

 It is a reward for enterprise: entrepreneurs start businesses to make a profit

 It is a reward for risk-taking: entrepreneurs has to take considerable risks when they
invest capital in a venture, and profits are a compensation/reward to them for taking these
risks (paid in the form of profits or dividends)
 It is a source of finance: after payments to owners, profits are reinvested back into the
business for further expansion (this is called retained earnings)
 It is an indicator of success: more profits indicate to investors that the business/industry
is worth their time and money, and they will invest more either int he firm or new firms
of their own, in the hopes of gaining good returns on their investment

For social enterprises, profit is not one of their primary objectives, but welfare of the society is.
However, they will also strive to make some profit to reinvest it back into the business and help
it grow.
Profit is not the same as cash flow! Profit is the surplus amount after total costs have been
deducted from sales. It includes all income and payments incurred in the year, whether already
received or paid or to not yet received or paid respectfully. In a cash flow, only those elements
paid in cash immediately are considered.
Income Statement
An income statement is a financial document of the business that records all income generated
by the business as well as the costs incurred by the business and thus the profit or loss made
over the financial year. Also known as profit and loss account.

A simple Income Statement

Sales Revenue = total sales

Cost of Sales = total variable cost of production + (opening inventory of finished goods –

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closing inventory of finished goods)
Gross Profit = Sales Revenue – Cost of Sales
Expenses: all overheads/fixed costs
Net Profit = Gross Profit – Expenses

Profit after Tax = Net Profit – Tax

Dividends: share of profit given to shareholders; return on shares
Retained Profit for the year = Profit after Tax – Dividends. This retained earnings is then kept
aside for use in the business.

Only a
very small portion of the sales revenue ends up being the retained profit. All costs, taxes and dividends have to
be deducted from sales.

Uses of Income Statement

Income statements are used by managers to:

 know the profit/loss made by the business

 compare their performance with that of previous years’ and with that of competitors’.
If profit is lower than that of last year’s why is it falling and what can they do to correct
the issue? If it is lower than that of competitors’ what can they do to be more profitable
and be competitive in the market?
 know the profitability of individual products by preparing separate income statement
for each product. They may decide to stop production of products that are making losses.
 help decide what products to launch by preparing forecast income statement for the
first few years. Whichever product is forecast to have a higher profit, the business will
choose to launch that product.

Chapter 25: Statement of Financial Position

The balance sheet, along with the income statement is prepared at the end of the financial year.
It shows the value of a business’ assets and liabilities at a particular time. It is also known as
‘statement of financial position’.
Assets are those items of value owned by the business.

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  Fixed/non-current assets (buildings, vehicles, equipment etc.) are assets that remain in
the business for more than a year – their values fall over time in a process called
depreciation every year.
 Short-term/current assets (inventory, trade receivables (debts from customers), cash etc)
are owned only for a very short time.
 There can also intangible (cannot be touched or felt) non-current assets like copyrights
and patents that add value to the business.

Liabilities are the debts owed by the business to its creditors.

 Long-term/non-current liabilities (loans, debentures etc.)- they do not have to be repaid

within a year.
 Short-term/current liabilities (trade payables (to suppliers), overdraft etc.)- these need to
be repaid within a year.

CURRENT ASSETS – CURRENT LIABILITIES = WORKING CAPITAL

This is because the liquid cash a company has with them will be the liquid (short-term) assets
they own less the short-term debts they have to pay.
Shareholder’s Equity is the total amount of money invested in the company by shareholders.
This will include both the share capital (invested directly by shareholders) and reserves (retained
earnings reserve, general reserve etc.).
Shareholders can see if their stake in the business has risen or fallen by looking at the total equity
figure on the balance sheet.

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Check whether the equations on the right are satisfied in this balance sheet!

SHAREHOLDERS EQUITY = TOTAL ASSETS – TOTAL LIABILITIES

TOTAL ASSETS = TOTAL LIABILITIES + SHAREHOLDERS EQUITY

CAPITAL EMPLOYED = SHAREHOLDERS EQUITY + NON-CURRENT
LIABILITIES
This is because non-current liabilities like loans are also used for permanent investment in the
company.
Uses of a statement of financial position

 When the current assets subtotal is compared to the current liabilities subtotal, investors
can estimate whether a firm has access to sufficient funds in the short term to pay off its
short-term obligations i.e., whether it is liquid
 One can also compare the total amount of debt (liabilities) to the total amount of equity
listed on the balance sheet, to see if the resulting debt-equity ratio indicates a
dangerously high level of borrowing. This information is especially useful for lenders and
creditors, (especially banks) who want to know if the firm will be able to pay back its
debt

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  Investors like to examine the amount of cash on the balance sheet to see if there is
enough available to pay them a dividend
 Managers can examine its balance sheet to see if there are any assets that could
potentially be sold off without harming the underlying business. For example, they can
compare the reported inventory assets to the sales to derive an inventory turnover level,
which can indicate the presence of excess inventory, so they will sell off the excess
inventory to raise finance.
Chapter 26: Analysis of accounts
The data contained in the financial statements are used to make some useful observations
about the performance and financial strength of the business. This is the analysis of accounts
of a business. To do so, ratio analysis is employed.
Ratio Analysis

 Profitability Ratios: profitability is the ability of a company to use its resources to

generate revenues in excess of its expenses. These ratios are used to see how profitable
the business has been in the year ended.
 Return on Capital Employed (ROCE): this calculates the return (net profit)
in terms of the capital invested in the business (shareholder’s equity + non-
current liabilities) i.e. the % of net profit earned on each unit of capital
employed. The higher the ROCE the better the profitability is. The formula is:

 Gross Profit Margin: this calculates the gross profit (sales – cost of
production) in terms of the sales, or in other words, the % of gross profit made
on each unit of sales revenue. The higher the GPM, the better. The formula is:

 Net profit Margin: this calculates the net profit (gross profit-expenses) in
terms of the sales, i.e. the % of net profit generated on each unit of sales
revenue. The higher the NPM, the better. The formula is:

 Liquidity Ratios: liquidity is the ability of the company to pay back its short-term
debts. It if it doesn’t have the necessary working capital to do so, it will go illiquid
(forced to pay off its debts by selling assets). In the previous topic, we said that working
capital = current assets – current liabilities. So a business needs current assets to be able
to pay off its current liabilities. The two liquidity ratios shown below, use this concept.
 Current Ratio: this is the basic liquidity ratio that calculates how many
current assets are there in proportion to every current liability, so the higher

26
 the current ratio the better (a value above 1 is favourable). the formula is:

 Liquid Ratio/ Acid Test Ratio: this is very similar to current ratio but this
ratio doesn’t consider inventory to be a liquid asset, since it will take time for
it to be sold and made into cash. A high level of inventory in a business can
thus cause a big difference between its current and liquidity ratios. So there is
a slight difference in the formula:

Uses and users of accounts

 Managers: they will use the accounts to help them keep control over the performance of
each product or each division since they can see which products are profitably
performing and which are not.
 This will allow them to take better decisions. If for example, product A has a
good gross profit margin of 35% but its net profit margin is only 5%, this
means that the business has very high expenses that is causing the huge
difference between the two ratios. They will try to reduce expenses in the
coming year. In the case of liquidity, if both ratios are very low, they will try
to pay off current liabilities to improve the ratios.
 Ratios can be compared with other firms in the industry/competitors and
also with previous years to see how they’re doing. Businesses will definitely
want to perform better than their rivals to attract shareholders to invest in their
business and to stay competitive in the market. Businesses will also try to
improve their profitability and liquidity positions each year.
 Shareholders: since they are the owners of a limited company, it is a legal requirement
that they be presented with the financial accounts of the company. From the income
statements and the profitability ratios, especially the ROCE, existing shareholders and
potential investors can see whether they should invest in the business by buying shares.
A higher profitability, the higher the chance of getting dividends. They will also
compare the ratios with other companies and with previous years to take the most
profitable decision. The balance sheet will tell shareholders whether the business was
worth more at the end of the year than at the beginning of the year, and the liquidity
ratios will be used to ascertain how risky it will be to invest in the company- they won’t
want to invest in businesses with serious liquidity problems.
 Creditors: The balance sheet and liquidity ratios will tell creditors (suppliers) the cash
position and debts of the business. They will only be ready to supply to the business if
they will be able to pay them. If there are liquidity problems, they won’t supply the
business as it is risky for them.
 Banks: Similar to how suppliers use accounts, they will look at how risky it is to lend to
the business. They will only lend to profitable and liquid firms.

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  Government: the government and tax officials will look at the profits of the company to
fix a tax rate and to see if the business is profitable and liquid enough to continue
operations and thus if the worker’s jobs will be protected.
 Workers and trade unions: they will want to see if the business’ future is secure or
not. If the business is continuously running a loss and is in risk of insolvency (not being
liquid), it may shut down operations and workers will lose their jobs!
 Other businesses: managers of competing companies may want to compare their
performance too or may want to take over the business and wants to see if the takeover
will be beneficial.

Limitations of using accounts and ratio analysis

 Ratios are based on past accounting data and will not indicate how the business will
perform in the future
 Managers will have all accounts, but the external users will only have those published
accounts that contain only the data required by law- they may not get the ‘full-picture’
about the business’ performance.
 Comparing accounting data over the years can lead to misleading assumptions since the
data will be affected by inflation (rising prices)
 Different companies may use different accounting methods and so will have different
ratio results, making comparisons between companies unreliable.

Chapter 27: Economic issues

The Business/ Trade Cycle
An economy will not always go through an economic growth; there is usually a cycle, as shown
below.

Growth– when GDP is rising, unemployment is falling and there are higher living standards in
the country. Businesses will look to expand and produce more and will earn high profits.
Boom– when GDP is at its highest and there is too much spending, causing inflation to rapidly
rise. Business costs will rise and firms will become worried about how they are going to stay
profitable in the near future.

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Recession– when GDP starts to fall due of high prices, as demand and spending falls. Firms will
cut back production to stay profitable and unemployment may rise as a result.
Slump– when GDP is so low that prices start to fall (deflation) and unemployment will reach
very high levels. Many businesses will close down as they cannot survive the very low demand
level. The economy will suffer.
(When the government takes measures to increase demand and spending in the economy to take
it from a slump to growth, it is called as the ‘recovery’ period). The cycle repeats.
Economic Objectives
Here, we’ll look at the different economic objectives a government might have and how their
absence/negligence will affect the economy as well as businesses.

 Maintain economic growth: economic growth occurs when a country’s Gross Domestic
Product (GDP) increase i.e. more goods and services are produced than in the previous
year. This will increase the country’s incomes and achieve greater living standards.
Effects of reducing GDP (recession):
 As output falls, fewer workers will be needed by firms, so unemployment will
rise
 As goods and services that can be consumed by the people falls, the standard
of living in the economy will also fall
 Achieve price stability: inflation is the increase in average prices of goods and services
over time. (Note that, inflation, in the real world, always exists. It is natural for prices to
increase as the years go by. In the case there is a fall in the price level, it is called a
deflation) Maintaining a low inflation will help the economy to develop and grow better.
Effects of high inflation:
 As cost of living will have risen and peoples’ real incomes (the value of
income) will have fallen (when prices increase and incomes haven’t, the
income will buy lesser goods and services- the purchasing power will fall).
 Prices of domestic goods will rise as opposed to foreign goods in the market.
The country’s exports will become less competitive in the international
market. Domestic workers may lose their jobs if their products and firms don’t
do well.
 When prices rise, demand will fall and all costs will rise (as wages, material
costs, overheads will all rise)- causing profits to fall. Thus, they will be
unwilling to expand and produce more in the future.
 The living standards (quality of life) in the country may fall when costs of
living rise.
 Reduce unemployment: unemployment exists when people who are willing and able to
work cannot find a job. A low unemployment means high output, incomes, living
standards etc.
Effects of high unemployment:
 Unemployed people do not produce anything and so, the total output/GDP in
the country will fall. This will in turn, lead to a fall in economic growth.
 Unemployed people receive no incomes, thus income inequality can rise in the
economy and living standards will fall. It also means that businesses will face
low demand due to low incomes.

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  The government pays out unemployment benefits to the unemployed and this
will rise during high unemployment and government will not enough money
left over to spend on other services like education and health.
 Maintain balance of payments stability: this records the difference between a country’s
exports (goods and services sold from the country to another) and imports (goods and
services bought in by the country from another country). The exports and imports needs
to equal each other, thus balanced.
Effect of a disequilibrium in the balance of payments:
 If the imports of a country exceed ( vượt quá) its exports, it will cause
depreciation in the exchange rate – the value of the country’s currency will
fall against other foreign currencies (this will be explained in detail here).
 If the exports exceed the imports it indicates that the country is selling more
goods than it is consuming- the country itself doesn’t benefit from any high
output consumption.
 Reduce income equality/achieve effective income redistribution: the difference/gap
between the incomes of rich and poor people should narrow down for income equality to
improve. Improved income equality will ensure better living standards and help the
economy to grow faster and become more developed.
Effects of poor income equality:
 Inequal distribution of goods and services- the poor cannot buy as many goods
as the rich- poor living standards will arise.

Government Economic Policies

Government can influence the economic conditions in a country by taking a variety of policies.
Fiscal policy is a government policy which adjusts government spending and taxation to
influence the economy. It is the budgetary policy, because it manages the government
expenditure and revenue. Government aims for a balance budget and tries to achieve it using
fiscal policy.
Increasing government spending and reducing taxes will encourage more production and
increase employment, driving up GDP growth. This is because government spending creates
employment and increases economic activity in the economy and lower taxes means people have
more money to consume and firms have to pay lesser tax on their profits. On the other hand,
reducing government spending and increasing taxes will discourage production and
consumption, and unemployment and GDP will fall.
Monetary policy is a government policy that adjusts the interest rate and foreign exchange rates
to influence the demand and supply of money in the economy, and thus demand and supply. It is
usually conducted by the country’s central bank and usually used to maintain price stability, low
unemployment and economic growth.
Increasing interest rates will discourage investments and consumption, causing
employment and GDP to fall (as the cost of borrowing-interest on loans – has increased, and
people prefer to earn more interest by saving rather than spend). Similarly, reducing interest rates
will boost investment, consumption, employment, and thus GDP.

Supply-side policies: both the fiscal and monetary policies directly affect demand, but the
policies that influence supply are very different. It can include:

30
  Privatisation: selling government organizations to private individuals- this will increase
efficiency and productivity that increase supply as well encourage competitors to enter
and further increase supply.
 Improve training and education: governments can spend more on schools, colleges and
training centres so that people in the economy can become better skilled and
knowledgeable, helping increasing productivity.
 Increased competition: by acting against monopolies (firms that restrict competitors to
enter that industry/having full dominance in the market- refer xxx for more details) and
reducing government rules and regulations (often termed ‘deregulation’), the
competitive environment can be improved and thus become more productive.

For more details on government policies, check out our Economics notes.
*EXAM TIP: Remember that economic conditions and policies are all interconnected; one
change will lead to an effect which will lead to another effect and so on, like a chain reaction in
many different ways. In your exams, you should take care to explain those effects that are
relevant and appropriate to the business or economy in the question*
How might businesses react to policy changes? It will depend varying on how much impact the
policy change will have on the particular business/industry/economy. Here are a few examples:

Chapter 28: Environmental and Ethical Issues

Business’ Impact on the Environment
Social responsibility is when a business decision benefits stakeholders other than shareholders
i.e. workers, community, suppliers, banks etc.

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This is very important when coming to environmental issues. Businesses can pollute the air by
releasing smoke and poisonous gases, pollute water bodies around it by releasing waste and
chemicals into them, and damage the natural beauty of a place and so on.

WHY BUSINESSES WANT TO BE WHY BUSINESSES DO NOT WANT TO

ENVIRONMENT- FRIENDLY BE ENVIRONMENT-FRIENDLY

Sense of social responsibility that comes It is expensive to reduce and recycle waste
from the fact that their activities are for the business. It means that expensive
contributing to global warming and machinery and skilled labour will be required
pollution by the business – reducing profits.

Using up scarce non-renewable resources Firms will have to increase prices to

(such as rainforest wood and coal) will compensate for the expensive environment-
raise their prices in the future, so friendly methods used in production- higher
businesses won’t use them now prices mean lower demand.

Consumers are becoming socially-aware

High prices can make firms less competitive
and are willing to buy only environment
in the market and they could lose sales
friendly products.

Governments, environmental organisations,

even the community could take action Businesses claim that it is the government’s
against the business if they do serious duty to clean up pollution
damage to the environment

Externalities
A business’ decisions and actions can have significant effects on its stakeholders. These effects
are termed ‘externalities’. Externalities can be categorized into six groups given below and we’ll
take examples from a scenario where a business builds a new production factory.
Private Costs: costs paid for by the business for an activity.
Examples: costs of building the factory, hiring extra employees, purchasing new machinery,
running a production unit etc.
Private Benefits: gains for the business resulting from an activity.
Example: the extra money made from the sale of the produced goods etc.

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External Costs: costs paid for by the rest of the society (other than the business) as a result of
the business’ activity.
Examples: machinery noise, air pollution that leads to health problems among near residents,
loss of land (it could have been a farm land before) etc.
External Benefits: gains enjoyed by the rest of the society as a result of a business activity.
Example: new jobs created for residents, government will get more tax from the business, other
firms may move into the area to support the firm-helping develop the region, new roads might be
built that can be enjoyed by residents etc.
Social Costs = Private Costs + External Costs
Social Benefits = Private Benefits + External Benefits
Governments use the cost-benefit-analysis (CBA) to decide whether to proceed with a scheme
or not and businesses have also adopted it. In CBA, the government weighs up all the social
costs and benefits that will arise if the scheme is put into effect and give them all monetary
values (this is not easy- what is the value of losing natural beauty?). They will only allow the
scheme to proceed if the social benefits exceed the social costs, if the costs exceed the benefits, it
is not allowed to proceed.

Sustainable Development
Sustainable development is development that does not put at risk the living standards of
future generations. It means trying to achieve economic growth in a way that does not harm
future generations. Few examples of a sustainable development are:

 using renewable energy- so that resources are conserved for the future
 recycle waste
 use fewer resources
 develop new environment-friendly products and processes- reduce health and climatic
problems for future generations

Environmental Pressures
Pressure groups are organisations/groups of people who change business (and government)
decisions. If a business is seen to behave in a socially irresponsible way, they can conduct
consumer boycotts (encourage consumers to stop buying their products) and take other actions.
They are often very powerful because they have public support and media coverage and are well-
financed and equipped by the public. If a pressure group is powerful it can result in a bad
reputation for the business that can affect it in future endeavours, so the business will give in to
the pressure groups’ demands. Example: Greenpeace
The government can also pass laws that can restrict business decisions such as not permitting
factories to locate in places of natural beauty.
There can also be penalties set in place that will penalize firms that excessively pollute.
Pollution permits are licenses to pollute up to a certain limit. These are very expensive to
acquire, so firms will try to avoid buying the pollution permit and will have to reduce pollution
levels to do so. Firms that pollute less can sell their pollution permits to more polluting firms to

earn oney. Taxes can also be levied on polluting goods and services.

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Ethical Decisions
Ethical decisions are based on a moral code. It means ‘doing the right thing’. Businesses could
be faced with decisions regarding, for example, employment of children, taking or offering
bribes, associate with people/organisations with a bad reputation etc. In these cases, even if they
are legal, they need to take a decision that they feel is right.
Taking ethical/’right’ decisions can make the business’ products popular among customers,
encourage the government to favour them in any future disputes/demands and avoid pressure
group threats. However, these can end up being expensive as the business will lose out on using
cheaper unethical opportunities.
Chapter 29-Business and the International Economy
Globalization
Globalization is a term used to describe the increases in worldwide trade and movement of
people and capital between countries. The same goods and services are sold across the globe;
workers are finding it easier to find work by going abroad for work; money is sent from and to
countries everywhere.
Some reasons how globalization has occurred are:

 Increasing number of free trade agreements– these are agreements between countries
that allow them to import and export goods and services with no tariffs or quotas.
 Improved and cheaper transport (water, land, air) and communications (internet)
infrastructure
 Developing and emerging countries such as China and India are becoming rapidly
industrialized and so can export large volumes of goods and services. This has caused an
increase in the output and opportunities in international trade, allowing for globalization

Advantages of globalization

 Allows businesses to start selling in new foreign markets, increasing sales and profits
 Can open factories and production units in other countries, possibly at a cheaper rate
(cheaper materials and labour can be available in other countries)
 Import products from other countries and sell it to customers in the domestic market- this
could be more profitable and producing and selling the good themselves
 Import materials and components for production from foreign countries at a cheaper
rate.

Disadvantages of globalization

 Increasing imports into the country

 from foreign competitors- now that foreign firms can compete in other countries, it puts
up much competition for domestic firms. If these domestic firms cannot compete with
the foreign goods’ cheap prices and high quality, they may be forced to close down
operations.

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  Increasing investment by multinationals in home country- this could further add to
competition in the domestic market (although small local firms can become suppliers to
the large multinational firms)
 Employees may leave domestic firms if they don’t pay as well as the foreign
multinationals in the country- businesses will have to increase pay and conditions to
recruit and retain employees.

When looking at an economy’s point of view, globalisation brings consumers more choice
and lower prices and forces domestic firms to be more efficient (in order to remain
competitive). However, competition from foreign producers can force domestic firms to close
down and jobs will be lost.
Protectionism
Protectionism refers to when governments protect domestic firms from foreign competition
using trade barriers such as tariffs and quotas; i.e. the opposite of free trade.
Import quota is a restriction on the quantity of goods that can be imported into the country.
Tariffs are taxes on imports.
Imposing these two measures will reduce the number of foreign goods in the domestic
market and make them expensive to buy, respectively. This will reduce the competitiveness of
the foreign goods and make it easy for domestic firms to produce and sell their goods. However,
it reduces free trade and globalization.
Free trade supporters say that it is better to allow consumers to buy imported goods and domestic
firms should produce and export goods and services that they have a competitive advantage in. In
this way, living standards across the globe will improve.

Multinational Companies (MNCs)

Multinational businesses are firms with operations (production/service) in more than one
country. Also known as transnational businesses. Examples: Shell, McDonald’s, Nissan etc.
Why do firms become multinationals?

 To produce goods with lower costs– cheaper material and labour may be available in
other countries
 To extract raw materials for production, available in a few other countries. For
example: crude oil in the Middle East
 To produce goods nearer to the markets to avoid transport costs.
 To avoid trade barriers on imports. If they produce the goods in foreign countries, the
firms will not have to pay import tariffs or be faced with a quota restriction
 To expand into different markets and spread their risks
 To remain competitive with rival firms which may also be expanding abroad

Advantages to a country of a multinational setting up in their country:

 More jobs created by multinationals

 Increases GDP of the country
 The technology that the multinational brings in can bring in new ideas and methods into
the country

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  As more goods are being produced in the country, the imports will be reduced and
some output can even be exported
 Multinationals will also pay taxes, thereby increasing the government’s tax revenue
 More product choice for consumers

Disadvantages to a country of a multinational setting up in their country:

 The jobs created are often for unskilled tasks. The more skilled jobs will be done by
workers that come from the firm’s home country. The unskilled workers may also be
exploited with very low wages and unhygienic working conditions.
 Since multinationals benefit from economies of scale, local firms may be forced out of
business, unable to survive the competition
 Multinationals can use up the scarce, non-renewable resources in the country
 Repatriation of profit can occur. The profits earned by the multinational could be sent
back to their home country and the government will not be able to levy tax on it.
 As multinationals are large, they can influence the government and economy. They
could threaten the government that they will close down and make workers unemployed
if they are not given financial grants and so on.

Exchange Rates
The exchange rate is the price of one currency in terms of another currency.
For example, €1= $1.2. To buy one euro, you’ll need 1.2 dollars. The demand and supply of
the currencies determine their exchange rate. In the above example, if the €’s demand was
greater than the $’s, or if the supply of € reduced more than the $, then the €’s price in terms of $
will increase. It could now be €1= $1.5. Each € now buys more $.
A currency appreciates when its value rises. The example above is an appreciation of the
Euro. A European exporting firm will find an appreciation disadvantageous as their American
consumers will now have to pay more $ to buy a €1 good (exports become expensive). Their
competitiveness has reduced. A European importing firm will find an appreciation of benefit.
They can buy American products for lesser Euros (imports become cheaper).
A currency depreciates when its value falls. In the example above, the Dollar depreciated. An
American exporting firm will find a depreciation advantageous as their European consumers will
now have to pay less € to buy a $1 good (exports become cheaper). Their competitiveness has
increased. An American importing firm will find a depreciation disadvantageous. They will have
to buy European products for more dollars (imports become expensive).
In summary, an appreciations is good for importers, bad for exporters; a depreciation is
good for exporters, bad for importers; given that the goods are price elastic (if the price didn’t
matter much to consumers, sales and revenue would not be affected by price- so no worries for
producers).

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