CHAPTER FOUR

OPERATE AN ENTERPRISE
 To get financing for a new business, entrepreneurs must
explore every option available.
 Four basic questions must be answered during initial
financial planning.
 What types of capital do I need in my new
business?
 How can I estimate the amounts needed?

 Where can I obtain the required funds?

 What should my financing proposal include?

 Broadly speaking there are two main sources of

finance
 Equity, i.e., ownership capital

 Borrowed capital (debt)

 CONT….
 Equity financing
 Equity capital is money given for a share of ownership
of the company.
 The investor shares in the profits of the venture, as
well as any disposition of assets on a prorate basis.
 . Key factors favoring the use of one type of financing
over another are:
 availability of funds

 the assets of the venture and

 the prevailing interest rates.

 Equity capital is not therefore a continual drain from

the cash flow of a company, such as a loan, which needs
interest payment
SOURCE OF EQUITY FINANCING

 Personal savings
 The entrepreneur should contribute at least 50% of
the starting up capital.
 If an entrepreneur is not willing to risk his own
money potential investors are not likely to risk their
money in the business either.
 Friends and family members

 Friends and relatives who believe in you are more likely

to invest in your business than are strangers.
 Angels

 wealthy individuals, often entrepreneurs themselves,

who invest in business startups in exchange for equity
stocks in the companies.
CONT…
 The most common way to find them is through
networking through community.
 Partners

 Entrepreneurs can take on partners to expand the capital

foundation of business.
 entrepreneurs must consider the impact of giving up
some personal control over operations and sharing
profits.
 Debt financing

 Debt financing is a financing method involving an

interest-bearing instrument, usually a loan.
 The payment of which is only indirectly related to the
sales and profits of the venture.
CONT…
 Debt financing (also called asset-based financing)
requires that some asset (such as car, house, plant,
machine, or land) be used as collateral.
 Requires the entrepreneurs to pay back the amount of
funds borrowed, plus a fee expressed in terms of the
interest rate.
 The entrepreneur needs to be careful that the debt is
not so large.
 Sources of debt financing

 Commercial banks

 Banks focus on a company’s capacity to create positive

cash flow because they know that’s where the money
to repay their loan will come from.
CONT…
 None bank source
 none bank sources are the following:

 Asset-based lenders

 Inventory financing

 Trade credit

 Saving and loan association

 Insurance companies

 Venture capital

 Some people are endowed with good product ideas,

but lack the necessary funds to translate these ideas
in to production.
 CONT…
 The concept of venture capital was evolved to
help such persons.
 Venture capital is a form of equity financing of
projects with high risk and high return.
 It is meant for financing high technology
projects.
 provides finance for growth businesses, usually
through equity capital with some loan element.
 investment funds from a variety of sources,
including pension funds, insurance companies,
investment trusts, regional development
agencies, and private individuals through
Business Expansion Scheme (BES).
CONT…
 The structure of any particular investment will vary , but usually
involves any combination of three types of capital:
 Equity shares

 Preference shares, and

 Loans

 Points to consider in the financing proposal

The financial plan must consist
 Initial financial requirements;

 Profit-and-loss forecast;

 Cash-flow forecast;

 Break-even analysis;

 Projected source of funds;

 Projected balance sheet;

 Ownership interest;

 Risk and contingency plans

o Once you open the door of your business, you will begin to
wear two hats instead of one.
the entrepreneur.

A manager
o As a manager you will coordinate the people, processes, and

other resources of your operation on the day to day basis.

 This is to achieve your principal objectives- profitability
and survival.
 Main areas in managing a business

 Managing Cash Flow

 You should have enough cash to meet your obligations

when they come due.
CONT….

 Comparing forecasted cash flow with actual result is

important.
 measures you can take to make improvements in cash
flow.
 Tighten up your credits and collections.

 Take advantage of credit terms.

 Managing inventory carefully.

 Put cash surplus to work.

 Cut expenses.

 Managing Purchases

 Selecting the right quality, Buying the right quantity,

Timing your purchases, Choosing the right vendors,
Getting the right price, Follow up on purchase
CONT…

 Managing Inventory
 Finding the right level of inventory is necessary.

 It requires inventory planning.

 The purpose of inventory management is to find and

maintain inventory levels that are neither too small
nor too large.
 Analyze Your Finances

 enables you gain understanding of your financial

situations.
 Finances can be analyzed through

 comparing trends of financial statements

 analyzing ratios
CONT…
 Managing People
 The quality of an organization depends on the quality of
people it hires and keeps.
 Getting and keeping competent and motivated
employees is critical to the success of the organization.
 treating people appropriately by giving the tools,
training, and incentives they need to do their jobs.
 Information System

 How will owner and other organization members get

information?
 The system technology for information system may be
manual or computer based.
CONT…
 Growing Business
 Your business will not remain small for longer if you are
entrepreneur.
 Organizational growth is any increase in the level,
amount, or type of the organization’s operation and
outputs.
 An organization may be considered growing when there
is a permanent increase in its sales, assets, volume of
output, etc.
 A number of variables have been used in measuring
organizational growth.
 The most common measures are financial including:

 Increases in sales or revenue

 Increases in capital
CONT…
 Increases in profitability
 Increases in other financial measures

 Growth has also been measured by:

 The number of customers- number of customers served.

 The number of products- types of products offered.

 The number of locations- number of outlets opened.

 The number of employees

 Need for growth

o The important motives which drive business firms

towards growth are

 Survival

 Sever competition forces a firm to grow and gain

competitive strength.
CONT…
 By diversifying the range of its products and
markets, a firm can meet competition in the market
and minimize its risks.
 Economies of scale

 A large firm enjoys the advantages of bulk purchase

of materials, strong bargaining power, spreading of
overheads, well organized promotion campaigns,
cheaper finance, automation, expert management, etc
 These economies result in reduction in per unit cost
of operations and increase in profits.
 Expansion of market

 Business firms grow to cater to larger markets and to

meet the increasing demand.
CONT…
 Owner’s mandate
 The owner of a company gets the ultimate benefit of
growth in the form of higher dividends and rise in the
market value of shareholding.
 they may direct the management to ensure the growth
of the company through continuous investing of
profits instead of distributing the entire earnings.
 Technology

 Business firms also grow in order to reap the benefits

of modern technology.
 Many firms invest in research and development to
develop new products and new techniques.
CONT…
 Self-sufficiency
 Some firms grow to become independent in terms of
marketing of raw materials or marketing of products.
 They acquire other firms to gain control over the
supply of materials and marketing of finished
products.
 Growth Strategies

 Growth strategy may be defined as a strategic plan

formulated and implemented to expand the operation
of a business firm.
 Different firms may adopt different strategies in
order to grow.
CONT…
 First approach to pursue growth
1. Product-customer exploitation strategy (Market
penetration strategy)
 This strategy describes attempts to increase the sales
of current products to current customers.
2. Product development strategy
 This strategy describes attempts to increase sales to
current customers by developing new or improved
products.
3. Customer development strategy (Market Development
strategy)
 In this strategy, the business attempts to sell current
products to new customers by taking its products to
new location(s).
CONT…
4. Product-customer expansion
 Under this strategy the business attempts to expand
the business through new product and new customer.
 Second Approach to Expand a Business

 Integration

 business can grow either vertically or horizontally.

 Vertical Integration

 is a growth strategy that involves buying either one’s

suppliers and/or distributors.
 There are two strategies under vertical integration:

 Backward integration

 attempt to gain control of the supplier you use to

produce your product.
CONT….
 Forward Integration
 attempt to gain control of the distribution system for
your products. You can do this in two ways:
 First, you can eliminate intermediaries by selling
directly to your customers.
 Second, you can gain ownership of the distributors of
your business.
 Horizontal Integration

 involves buying up one’s competitor business in order

increase market share.
CONT…

 Diversification Growth Strategies

 is investing in products or businesses that are
different from the product you sell or the business
you own.
 Synergetic Diversification

 involves seeking products or businesses that are

technologically compatible with one’s existing product
or business.
 Horizontal Diversification

 a growth strategy in which a business owner seeks

products that are salable to his or her present
customers but technologically unrelated to those
products.
CONT…
 Example, Bell Sports, which manufactures bicycle helmets,
has begun selling clothing with the bell logo.
 Conglomerate Diversification

 It is a growth strategy in which a business owner looks to

acquire products or businesses that are totally unrelated
to its existing business both in terms of technology or
markets.
 Joint Venture and Merger

 They are an external growth strategies.

 Joint venture

 two or more independent firms establish a new enterprise.

 a temporary partnership between two or more companies

for a specified purpose.
CONT…

 Merger
 means a combination of two or more firms in to one.

 It may occur in two ways:

 takeover or acquisition of one company by another,

 creation of new company by complete consolidation of

two or more units.
 Subcontracting

 hiring another firm to perform some process of the

business.