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Foundation Business Studies (I)

Enterprise: What is meant by the terms "enterprise" and "entrepreneurs". What is meant by risk. What are the importance of risk and rewards such as profit. The motives for becoming an entrepreneur. Disadvantages of setting up your own business. The Qualities and Skills required by an Entrepreneur. * Why business activity is important to the economy. What are the government support for enterprise and entrepreneurs (Business Link)?

Generating and Protecting Business Ideas. What are the sources of business ideas, the identification of a product or market niche, franchises, copyright, patents and trademarks. The sources of ideas may include brain-storming, own personal experience and business experience. The generation of business ideas must be in relation to a small business with limited resources. Candidates should be familiar with the formation and operation of franchises and understand the benefits and pitfalls to franchisors or franchisees of operating a franchise as opposed to starting a new business.

Transforming Resources into Goods and Services: inputs, outputs and the nature of the transformation of resources into finished products, adding value within the context of the tertiary, secondary and primary industries.

Developing Business Plans. The purpose and contents of business plans, sources of information and guidance. The benefits and the problems of plans/planning for small businesses. The planning process involves decisions based on the resources to be used and factors providing competitive advantage. The sources of information should include: small business advisors, accountants, bank managers and government agencies.

Conducting Start-up Market Research: methods of primary and secondary market research, qualitative and quantitative research, size and types of samples. Factors influencing the choice of sampling methods. The relative value of different approaches to market research.

Methods of sampling: random, quota and stratified. The available finance, the nature of the product, the risk involved and the target market will influence the choice of sampling method and size of sample.

Understanding Markets: the nature and types of markets, the importance of demand, types of market segmentation, market size, growth and share. Markets take different forms, e.g. local, national, physical and electronic. Demand is affected by a range of factors including the price of the product, competitor actions, consumer incomes, success of businesses’ marketing and seasonal factors. The benefits and drawbacks of types of segmentation. Calculate market size, growth and share.

Choosing the Right Legal Structure for the Business: Sole traders, Partnerships, Private and Public limited companies and non-profit businesses. The benefits and drawbacks of legal structures and understand Plc’s as a means of comparison.

Raising Finance: Sources of finance available to start businesses. The difference between short-term and long-term finance, internal and external sources of finance. The different Sources of Finance. Sources of finance should include: ordinary share capital, loan capital (bank loans, overdrafts only), venture capital and personal sources. The advantages and disadvantages of these in specific contexts.

Locating the Business: factors influencing start-up location decisions. The factors should include: technology, costs, infrastructure, the market and qualitative factors. Their relative importance may vary according to the type of business.

Employing People: types of employees used in small businesses. How to use consultants and advisors. The types of employees: temporary, permanent, full-time and part-time. What are the reasons, drawbacks and difficulties of employing people and/or using consultants and advisors?

Entrepreneurs, Enterprise and Risk.

Entrepreneurs are people who bring new businesses and products/services into the market. They are usually creative, patient, determined, resilient and passionate about their ideas. They often receive Government grants to help and encourage them set up a business.

Enterprise refers to the skills needed to do this.

Risks are the chance of loss or damage; the probability that something goes wrong leading to a loss.

Entrepreneurs are important in the business world because they…

They make a major contribution to economic activity: Create jobs and opportunities. Job Creation: Thousands of jobs are created by new businesses that are set up every year and by the small businesses that prosper and take on more staff.

Are able to spot gaps in a market: Entrepreneurs encourage innovation through investment and risk taking. Many of the products and service you in your daily use have been developed through entrepreneurial activity.

Overall, entrepreneurs enable an economy to respond to changing global conditions. Businesses pay substantial taxes and encourages competition in markets; which further enhance the effects of employment and tax revenue.

There are a lot of motives or reasons for becoming an entrepreneur, including the following…

Were made redundant or retired

Spotted an opportunity

Wanted control over their working life

There are several issues that young people may experience when becoming an entrepreneur…

Difficult to get funding due to a lack of experience

Age discrimination – not being taken seriously

Businesses: A Business is a person or organisation that produces goods/ services for sale to customers in return for money.

Reason why people might set up a business:

Be the boss, make a living, gain more control over working life, escape an uninteresting job or career, pursue a career or hobby, satisfaction from building something, making a fortune, need for flexible working, change in personal circumstances – e.g. redundancy, bereavement.

Disadvantages of starting a business: Some common problems include

Having to acquire all the skills necessary to run a business such as book-keeping, knowledge of consumers and employment law

Having to take full responsibility for decision-making.

Having to work long hours, perhaps over the weekend, and taking few holidays.

Having to accept a much lower income, or even none at all, until the business begins to take up market share and make a profit.

Franchises

A franchisee is a person or company who has paid to become part of an established franchise like McDonalds. A franchise enables you to run your own business whilst using a successful formula created by the franchisor.

The Government suggests that 70% of new businesses fail before three years compared with 7% of franchises. This is usually because the idea for the business was not viable or because stronger competitors emerged.

The franchisor usually controls the rules concerning the following…

Décor

Product range

Staff uniforms

However; the franchisee is usually able to make their own decisions about the following…

Staff recruitment and training

Stock management

Advantages of Franchises

Disadvantages of Franchises

It is a good way of starting a business without having to do it from scratch

There is not much freedom in decision-making

Customers will recognise the brand easily

The franchisor takes a cut of the business income which can make it hard to make large profits

Due to the success of the franchise, banks can approve more loans and with less interest

Franchises may not be as good as they sound. It can be expensive to buy into with bad support

Protecting Ideas

An idea cannot be fully protected, but patents and copyrights are methods of preventing others from copying and distributing an invention or creative piece of work. This is called Intellectual Property.

A Patent provides a certain amount of time for which an invention or product cannot be copied by anybody else. Patents can cost from £1,000 to £500,000+ and breaking a patent is not a criminal offence. Owners of patents can only claim damages through the civil courts.

A Trademark is a sign that can distinguish one product, service or brand from one to another. These can be…

Logos and Pictures

Smells

Sounds

A Copyright applies to written work (for example: books and song lyrics). Unlike a patent, a copyright occurs automatically and there is no need to pay for it.

Adding Value

The process of adding value involves doing something to a product to increase its price. For example: ready-grated cheese is more expensive than a block of cheese. Products that are protected by patents can be used to add value. The adding of sugar into yogurt and toasted cornflakes were considered to have been one of the most successful and revolutionary business decision in the UK and US respectively.

Primary Sector

Secondary Sector

Tertiary Sector

It is hard to add value to products here as they are often the same (oil, coal, gas, etc)

This sector is manufacturing and adds the most value (eg: Walkers v Tesco Value)

Effective marketing can make products stand out here (eg: M&S)

The yogurt industry provides an excellent example of how adding value could be an excellent strategy towards business. In brief, the yogurt… added sugar to the common known medicine drinks – (sour and bitter) and makes it a fun drink for desserts or treat. In the following years following the Second World War where the majority of UK citizens were becoming wealthier and more inclined towards desserts, looking

The Kellogg’s brothers were also well known for their “adding value” strategy. The younger brother saw potential in the toasted cornflakes which were initially by-products of the corn separation production. However, the elder one still emphasized on his single goal of creating a healthy breakfast cereal and despites his brother’s idea of adding sugar to the product. After the younger one established his own company, added sugar to the drink, sales went up the roof in America, established a whole new idea of having a convenient cereal instead of conventional full meal as breakfast.

Business Plans

A business plan is a written document that describes a business, its objectives, its strategies, the market it is in and its financial forecast. In general, it sets out how a business idea will be financed, marketed and put into practice. It is likely to be essential in getting funding from a bank because they will need to see how well a business idea is thought through and how financially viable it is.

It is a great idea to create a business plan (or the purpose of it is) because of the following…

It provides a sense of directions by setting the objectives and defining responsibilities. Therefore, it helps make decisions about resources that are needed. By doing so, it helps to help control or manage the business. This reflective management helps provides something which can be used to measure actual performance.

It ensures viability even further by reducing the risks involved in starting your business because it encourages you to think about all the aspects of the business. By ensuring a two-way expansion, it raises finance - it makes it easier to persuade the bank to give you a loan to start your business.

A good business plan should contain…

The idea - a simple description of the proposed business

Where the idea came from and why it is a good one

Key targets for the business - sales, profit, growth (give a sense of direction for the business) ideally for the next 3-4 years.

Finance required - how much from the founder, how much to be loaned over how loan and from who

Market overview - main segments, market size (value, quantity) growth, market shares of main competitors (if known)

How the business will operate (in terms of location, premises, staff, distribution methods)

Cash flow forecast (very crucial) + trading forecast.

Sources of information for a business plan:

Banks – often provide free business planning ICT tools.

Accountants – which had become compulsory for business start-up by the UK government

The Prince’s Trust (entrepreneurs 18-30 years)

PRIME (entrepreneurs over 50 years)

Government agencies (e.g. Business Link, Local Enterprise Agencies, NFEA – National Federation of Enterprise Agencies)

Any business plan is only as good as the information on which it is based. It is a good guide, but is only a plan. In other words, “failing to plan” means “planning to fail”.

Benefits of Business Plans

Problems with Business Plans

It makes the entrepreneur consider every aspect of the start-up so they can try to eliminate failures and minimize risks and costs involved.

The BP is only a plan and does not guarantee success. For example: sales may be lower than estimated; external factors e.g. political and economic may not be predictable.

It makes the entrepreneur more aware of what skills they are missing so that they can have more knowledge of what kind of expert to hire.

If the plan is too rigid some problems may arise. It must be flexible (enough) to adapt to market changes

Venture capital may be available to the business if investors like the business plan.

High sales expectations may cause overspending in other areas such as stock and staffing

Legal Structures

The legal structure of a business is crucial in determining how seriously the owners will be financially impacted if things go wrong. It also has an effect on the taxation levels that the business and owners need to pay.

In Unlimited Liability, the owners of a business are fully responsible for any debts incurred, even if this requires them to sell their personal assets or possessions. There are two types of businesses that have unlimited liability…

Sole traders

Partnership

A Sole Trader is someone who owns and operates their own business. A sole trader can have employees, but they must take all the final decisions about running the business.

Advantages of Sole Traders

Disadvantages of Sole Traders

They make all the decisions and keep all the profit

The owner is the only one responsible if it fails

There are no administrative costs to pay

There are long hours of work involved

They are confidential as accounts aren’t published

Becoming ill causes problems running the business

A Partnership is where 2-20 people start their own business with the goal of making profit. Trust is vital.

Advantages of Partnerships

Disadvantages of Partnerships

There is additional skills and a shared workload

There is UL even when it is your partners fault

There is more capital available to invest into

There is a loss of control and profits are shared

There are no administrative costs to pay

There may be business disagreements

With Limited Liability, debts incurred by the business must stay within the business. The owner doesn’t have any personal liability and doesn’t need to sell personal possessions if the business fails.

A business must go through a legal process to gain limited liability. This process is called incorporation.

A small business can be started up as a sole trader, partnership or Private Limited Company (LTD). The start-up for an LTD can be as little as £100 and the company can be fully owned by the entrepreneur.

Shares cannot be floated on the Stock Market – this allows the owner to have full control over the business.

Putting LTD after a company name is a legal requirement and says that a business is small with limited liability.

Advantages of Limited liability

Disadvantages of Limited liability

It gives confidence to shareholders to invest

More annual costs (eg: audited accounts)

There is wider access to finance opportunities

Businesses must publish financial information

An LTD can become a Public Limited Company (PLC) when it has £50,000+ in share capital. The business may then be floated on the stock market where the public can buy shares. This provides finance for the business to expand. However, too much cash in a short amount of time can make a business grow too fast.

There may also be some other problems with PLCs…

It is hard to have any objectives other than profit

A small group of control can be unlikely due to the availability of shares on the market

There may be a lack of concern for the future of the business if the only goal is profit

Some other forms of businesses include non-profit organisations which focus on the interests of the members and not shareholders, and Co-operatives which are worker-owned.

Market Research

Market research is the process of gathering information about consumers, competitors and market trends. A target market is the chunk of the whole market that the product or service is aimed at.

It aims to identify consumers buying habits and attitudes to products and services. It can be quantitative (numerical) e.g. how many people buy the Daily Mail? or qualitative (why do these people buy the Daily Mail?)

Why conduct a market research?

Market research data can give start up business useful information about:

The nature of the market in terms of demand:

The likely size of the market

The likely trends in the market

How much money is spent

What Sales can be expected

The nature of the market in terms of demand:

What products do they normally purchase?

How much are they willing to spend

Are they likely to buy your products or services?

The strength and activities of the competitors

Future product or service development

There are 2 main ways of collecting market research (Secondary and Primary research)

Secondary Research is data that already exists. Secondary research can be established using data/information that has already been collected, usually by another company, organisation or government body. For instance, the ONS that provides statistics about economic performance in specific regions. They can be internal or external.

Examples of Internal Sources includes: Company Accounts, Sales Records – which can identify trends in sales pattern, Customer records/ Retail data i.e. Loyalty cards, till data, etc.

Examples of External Sources includes: Google, Government sources, Trade associations, Trade press and magazines; Directories, Prices – comparison websites, Competitor Materials and Market research reports published from accounting firms.

Advantages of Secondary Research

Disadvantages of Secondary Research

It is easy to access

It may be outdated and not be to the specific needs of your business (collect for another purpose)

It is usually cheap or even free

It may not be accurate

It is saves time as the data already exists

The reliability and quality may be questioned

Primary Research is the process of gathering information fresh/new information/data (directly from people within your target market). It is first hand information and has not been collected by anyone else, and is sometimes called Field research.

This can be very expensive when carried out by specialist market research companies (e.g.Big Four) and there must be a lot of care taken into consideration to eliminate bias from your research!

Methods of Primary Research may include the following…

Observation/Experimentation

Surveys and Questionnaires: Set of predetermined questions to be answered by the respondent. (Postal, telephone, Face to face, online)

In-depth interview

Focus Groups

Test Marketing

Advantages of Primary Research

Disadvantages of Primary Research

The research will be up to date and tailored to your business (Specific to the purpose – asks the questions the business wants answer to)

It can be time-consuming

You can guarantee reliability and quality

It can be very expensive (most expensive method)

It is confidential to you and your business because it collects data which no other business will have access to

May be biased or skewed

Provide misleading results if the sample is not large enough (population validity), chosen with care (ethics) or if the questions are not worded properly.

Primary and Secondary data can be either quantitative or qualitative

Quantitative data/research asks questions which usually provide simple, numerical statistics-facts answers based on numbers. For example, ‘which pack do you prefer?’ or ‘how many newspapers did you buy last week?’

However, it can be hard to find valid data when using quantitative methods in small-scale research.

Qualitative data/research is in-depth research into the insights (motivations, feelings, ideas and opinions) behind consumers’ buying habits. It is used generally to investigate why people buy certain products. It does not produce statistics like ‘53% liked the chocolate’ but asks why they liked it instead. One form of this type of research could be interviews or short detailed answers in surveys.

However, it is hard to collect qualitative research in small-scale samples and bias may creep in.

Sampling

A Random sample is where everybody in the population has an equal chance of being chosen. Achieving a truly random sample requires careful thought because people may often be missing.

A Quota sample is where interviewees are selected in proportion to the consumer profile of the target market. For example: if the total amount of people at college was 1,000 with 40% males and 60% females, the male number would be 400 and the female number would be 600. These people can then be broken down into age groups, directorates, etc.

This method allows interviewers to interview anybody as long as they achieve the correct quota in the end. It can work out relatively cheap and effective and is used most often by market research companies.

A Stratified sample is when you interview people with specific characteristics (eg: 30-45 year olds). So within this section of the population individuals can be found at random or by setting a quota.

There are many factors which can potentially influence the choice of sampling methods

Cost

Time

Sample Size

After deciding which method to use the next consideration is how many interviews should be conducted. Some companies interview between 100 and 1,500 people and consider it large enough to reflect the views of 45 million people. This can be heavily argued.

A sample with at least 1,000 responses usually produces a high confidence level compared with 10 or 100.

However, it can be extremely expensive to conduct large amounts of research and sampling 1,000 people can cost £30,000. Surveys of 4 or 5 new products may cost £120,000+ on research alone.

When answering a question on market research or quantitative figures I MUST question the following…

Who produced the information?

How was it produced?

What was the sample size?

What is the confidence level of the research?

Types of Markets

A market can be anything from the amount of people that buy a specific product, the number of products in a category or how much is spent on one specific thing. They key elements to any market are…

Size (how much is spent every year)

The extent to which it can be divided (e.g. TV magazines, health magazines, clothing magazines, etc.)

Market share (e.g. the food market can be divided into breakfast cereals and Kellogg’s are the leader)

Local markets are small firms which don’t really care about the size of the national market. They are more concerned with the state of the local market (eg: local hairdressers and plumbers).

However, some small businesses may still be focused on the national market (eg: selling their products through large supermarkets or by operating on the internet)

National markets cater for the nation but are also concerned about local competition (eg: H&M, New Look). Therefore, these businesses are located everywhere and use national media to advertise.

Electronic markets are markets that used to be physical. The stock exchange and exchange currency markets are now all on-screen and eBay and other auction markets are transforming how we make transactions. Electronic markets often have key characteristics…

They are very price competitive so the costs are kept down

They can operate from anywhere

The market is cheap to enter so new competitors can arrive anytime

Market Size, Growth and Share

Market Size is the amount of goods purchased or the amount spent on those goods.

By establishing Market Growth you can determine whether a market is growing or declining. The formula for calculating market growth is below…

New figure – old figure = Market Change

Market Change / the old figure * 100 = % in Market Change

Market share is the proportion of the total market that is owned by one company. It is essential for evaluating the success of a firm’s marketing activities. The formula for calculating market share is below…

Company revenue / whole market revenue * 100 = % of Market Share

There are many advantages of being a market leader…

High distribution without much effort

Able to charge higher prices

Able to get new products onto shelves as their name is widely recognised

Market Segmentation

Markets can be subdivided into several different ways. The magazine market is a good example and can be split up into gender, age and lifestyle. Businesses must know their target markets’ needs and wants.

Advantages

Disadvantages

Segmentation is acknowledgement that customers are not all the same and will not respond the same

Segmentation only works if the business can provide products and services that the market needs

With small adjustments, products can appeal to different target markets (eg: a club at night and day)

The size of the segmented market needs to be sufficient to be profitable for the business in question

The business can target their marketing efforts, therefore making more efficient use of the resources

Providing different products and services to different segments can cost more (lose economies of scale)

Demand

Demand is the desire to buy a product backed by the ability to do so. It is also known as effective demand.

Price can affect demand in the following ways…

The higher the price of the product the less of the product people can afford to buy

The price of other competitors products

The value that the consumers place on the brand can affect its demand

Income has grown in the last century. The demand for most products and services grows with the economy.

Normal goods

the demand for these grows broadly in line with economic growth (eg: petrol and food)

Luxury goods

the demand for these grows faster than the growth of the economy

Inferior goods

the demand for these falls as the economy grows. As we get wealthier we prefer to buy branded products instead of home-brand ones

Of course, if the economy is struggling luxury goods quickly vanish and inferior goods become more popular.

The Actions of competitors plays a big influence on demand. For example, the demand for a Ryanair flight to Dublin doesn’t just depend on the price of the flight or customers incomes but the prices of rival flights too.

A firm’s own Marketing objectives may also play a part in the demand for a product or service.

Seasonal factors are the biggest influence on demand for some businesses. For example: Ice cream sales will boom in the summer whereas the coat market will be more successful in the winter.

Location

One of the most important factors influencing the success of a business is its location. This makes good locations with good infrastructure very expensive, and small businesses often struggle to compete.

Factors affecting the choice of location…

The cost of land

a business whose products are price sensitive need to keep costs down so a cheap location may help

Space

is there room for expansion? This should be a consideration in case the business does well

Government grants

financial incentives that are offered by the government may influence the decision on location

Accessibility to the market

businesses that operate on the internet may not need to worry about this factor but hairdressers and such will benefit from being close to their target market

Accessibility of suppliers

businesses that use JIT will benefit from being close to suppliers due to shorter deliveries

Cost of labour in the location

locating in a high area of unemployment may help to keep costs down, but will the workforce have the required skills?

Infrastructure

the provisions available in a certain area, for example transport links and telecommunications. Online businesses such as Amazon and Play will need to be in areas with sufficient transport links.

Sources of Finance

A source of finance is the term used to describe where a business gets its money from. Almost all new businesses will need money to invest before it can start operating, including the following…

Capital investments such as machinery, equipment and property

Money for running the business (bills, wages, etc.)

Sources of Finance could be External or Internal; Short-Term or Long-Term.

Businesses will also need to be able to raise money for other reasons such as expansion of premises, machinery and employees, to buy more produce for large orders, or for more external reasons such as a dip in the economy. The amount of finance available to a business will depend on:

The type of business

a sole trader is somewhat restricted to the amount they can put into a business from their own resources. A limited company will be able to raise share capital in addition to being able to borrow. A balance between equity (own money) and debt (loans) should be around 50:50

The stage of development of the business

new businesses will have a harder time raising finances than a business that is already established

The state of the economy

if the economy is booming there will be higher business confidence and therefore more money

Having sufficient funding will ensure that a business can meet its current and future needs. A distinction between short, medium and long-term objectives should be made and the appropriate type of funding used.

Short-term finance (less than a year) should not be used to finance long-term projects.

Internal finance

External finance

Stretching existing capital further (eg: cutting stock)

Bank loans and overdrafts

Retained profits (not suitable for start-ups)

Trade credit (extending time to pay suppliers)

Selling some of the businesses assets (eg: buildings)

Share capital and Venture capital

Description

Advantages

Disadvantages

Retained Profit

Keeping previous profits to invest in the future

It is free because it is an internal source!

Not available to start-up businesses

Sale of assets

Selling off items with value (eg: buildings and shares)

It can reduce or eliminate debt

You may have to pay TAX

Loans

Borrowing money (usually from a bank) with interest

May not have to pay interest if the financer is family or friends

You may have to pay large interest fees

Debentures

A loan or share paid back with interest

Interest is usually lower than bank loans

You still have to pay interest

Venture capital

When someone invests in a high-risk business

It can be very successful (Dragons Den)

It is very risky with a high failure rate

Share capital

Selling shares on the stock market (PLC only!)

You can make money to invest

Giving away ownership of the business

Overdrafts

Agreement with the bank to have a negative balance

They are usually easy to access

Interests are usually higher than loans

Leasing

Renting something you cannot afford to buy

It is yours to use whenever you want it

You do not own it and it isn’t an asset

Trade credit

You don’t have to pay for something immediately

It can be easier to pay for things

Money may not be available when due

Employees

An employee is somebody who works for an organisation; usually under a contract of employment in return for a salary or a wage.

At the start of a new business it is common for an entrepreneur to work on their own, taking on all jobs associated with running the business. However, as the business expands they may need help.

Types of employees include

Temporary and permanent part-time (less than 30 hours per week)

Temporary and permanent full-time

Advantages of part-time staff

Disadvantages of part-time staff

Flexible and able to respond to fluctuations

Recruitment costs

They’re cheaper because they aren’t in everyday

Training costs

They may improve the quality of the workforce (more motivation and higher productivity and a decrease in absenteeism and labour turnover

May miss out on vital information as they’re not 24/7

Advantages of temporary staff

Disadvantages of temporary staff

Flexible and able to respond to fluctuations

Recruitment costs

They are able to cover for permanent employees

Training costs

Specialists can be employed for short periods

May have a lack of commitment (as with PT staff)

An alternative to hiring staff on a temporary basis is to use an employment agency. Although the workers carry out work in your business, they are paid by the agency. This means that the business owner has a contract with the agency and not the employee.

The main benefit to using an employment agency is that all recruitment/administration is done by the agency.

Businesses may choose to recruit an advisor/consultant for a specific period of time. These individuals provide services such as accountancy, business strategy, IT, etc. They are paid a fee for their services.

Advantages of advisors/consultants

Disadvantages of advisors/consultants

Able to stand back and ask questions staff cannot see

Their ideas may not be trusted

They bring ideas from outside the business

They may not be ideal for the needs of the business

They can raise sensitive issues that staff may ignore

They can often cost a lot of money to hire

Budgets

A budget is a detailed plan of the income and expenses expected over a certain period of time. Businesses will be required to produce a Budget for Revenue and Profits in order to persuade banks to lend finance.

Advantages of budgets…

They can help ensure that a business does not spend more than expected

They can help measure manager’s performance

They can motivate all the staff in the section (delegating budget-power can be motivating)

An Income budget is the expected Revenue over a certain period of time.

An Expenditure budget is the expected Expenses over a certain period of time.

In a Profit budget is the expected difference between Revenue and Expenses (Income & Expenditure Budgets)

Setting budgets is not an easy job. How do you decide on the level of sales next month or next year? This is especially hard for new businesses with no previous trading experience. Here’s how start-ups do it…

They produce an estimate of sales in the first few months based on secondary and primary market research conducted for their business plan

The entrepreneur relies on their own instinct and experience in the industry

Most established firms will use last year’s figures as a guide to the next years with an adjustment for any known changes or objectives.

Zero Based Budgeting is an alternative approach to Expenditure budgets. This starts each budget at zero instead of last year’s figures. This helps to stop budgets from rising every year.

However, there may be some problems with this type of budgeting because managers may lack the experience of knowing what things really cost.

The best way to set budgets is to…

Relate the budget directly with the businesses objectives (what it is trying to achieve)

To involve as many as possible during the process; budgets should then be agreed and realistic

Make budgets realistic and meaningful to the staff who have to work with them

Cash Flows

A cash flow is the flow of money in and out of a business over a given period of time. Cash flow forecasting is estimating the flow of money in and out of the business. Remember that cash does not always mean profit!

Managing cash flow is one of the most important aspects of financial management. Without the cash to pay bills, all businesses will fall.

Cash flow problems are the most common reason for business failures. Cash flow forecasts are vital in business start-ups because they help get finance and will also show the finance provider when they will be paid back.

All businesses need to manage their cash position carefully and will need to predict their cash position in the forecast for at least the next six months. This will help enable them to take action if cash becomes short.

To prepare a cash flow forecast, businesses need to try and estimate all the money coming into and out of the business. These flows are then set in a grid showing the cash movements each month. Cash Flow example…

In order to prepare cash flow forecasts, businesses need to make estimations, just like in budgets, so the estimations are only as good as the research used to carry it out. It is much easier for an established business to create a forecast but all companies must build their forecast in contingencies.

When conducting a forecast; businesses must anticipate disasters like cash shortages. By creating a worst-case forecast, companies will be able to arrange financial cover for these events before they happen.

Calculating Revenue, Costs and Profit

The revenue received by a business can be a crucial factor of its success. When a business starts up they should expect low revenues because…

Their company or product is unknown

They are unable to buy large amounts of stock to supply big orders

It’s difficult to charge premium prices as they aren’t yet established

Entrepreneurs start their financial planning by assessing what revenue they might receive in their first financial year. Revenue is calculated by using the following formula…

Quantity of goods sold * Selling Price = Sales Revenue

A business that plans to increase its revenue may benefit more from selling a large quantity of products at a low price rather than a small quantity of products at a high price.

The Cost of Production is important for a manager to know because it will…

Assess whether it is possible to trade

Find out how actual costs and predicted costs match

Makes judgements on cost efficiency

Fixed Costs are those that do not vary with the level of output (eg: salaries, rent, utilities, interest charges).

Variable Costs are those that do vary with the level of output (eg: materials, piece-rate labour).

The formula for calculating Total Costs is:

Fixed costs + Variable costs = Total costs

Profit is the difference between revenue and expenditure and is main motive for many businesses. However, some businesses are not established with the aim of making a profit. Profit can be calculated by using the following formula:

Total revenue – Total costs = Profit (Remember that revenue does not always mean profit!!)

Managers usually refer to Net/Operating Profit as the amount left once all fixed and variable costs have been deducted from revenue. However, this is before TAX has been paid.

After working out the total profit after TAX, it can be used to…

Pay shareholders

Reinvest in the company (retained profits)

Profits are important for most businesses because…

They provide a measure for business success

They are the best source of new finance for a business (retained profits)

Forecasting costs and revenues can be difficult new businesses as they don’t have any past figures give them ideas. It is possible that entrepreneurs will underestimate fixed and variable costs and overestimate revenues.

A business will want to compare its profitability over time. This is called the Net Profit margin and the higher the margin the better! The Net Profit Margin can be calculated with the following formula…

Net Profit x 100 / Total revenue = Net profit margin

Calculating Break-Even

The breakeven analysis compares a company’s total revenue with its total costs to find out the minimum level of sales required to cover its costs. This is usually shown on a graph called a breakeven chart. In order to calculate the breakeven point a business will need to know the following:

The selling price of the product/unit

Their fixed costs

The variable costs per unit

The breakeven point can be calculated by using the following formula…

Fixed costs / (Selling price per unit – Variable costs per unit) = Breakeven Output

Contribution is the difference between sales revenue and variable costs. It pays for a business’s fixed costs and the remaining money is then counted as profit. Contribution can be calculated by using the following formula…

Selling price per unit – Variable costs per unit = Contribution PER UNIT

Total revenue – Total variable costs = Contribution

(Contribution PER UNIT is effectively just the second part of the breakeven formula)

Contribution can be reduced by lowering variable costs and increasing selling prices. Lowering fixed costs can then also produce more profit as they are paid for by contribution.

If sales revenues exceed the variable costs, the product will be making a positive contribution. Contribution should rise as output increases, covering fixed costs and then increasing profits.

Once you have calculated the breakeven point on a graph you can then work out the Safety Margin. This is the amount of sales a business can lose before it starts to lose profits (the difference in units between the breakeven point and the quantity of units sold)

You can work out the Margin of Safety using this formula…

Number of units sold – Breakeven point = MOS

You can also work out the Margin of Safety in £ by:

MOS in units * Selling price per unit = MOS in £

Key Terms

Term

Definition

Adding Value

Doing something to a product in order to increase its price

Advisor/consultant

Somebody who provides businesses with help and advice

Bank Loan

Borrowing a fixed amount from a bank with interest

Bank Overdraft

An agreement with a bank to go into a negative balance – high interest

Breakeven Point

The point at where a business’s revenue covers its total costs

Budget

A plan of income and expenses expected over a period of time

Business Angel

Someone who invests in a high-risk business and provides help/support

Business Plan

Sets out how a business idea will be financed, marketed and put into practice

Business Objective

A goal that a business wishes to achieve

Cash Flow

The incomings and outgoings of a business

Cash Flow Forecast

A forecast predicting the incomings and outgoings of a business

Contribution

The difference between total revenue and total variable costs

Contribution Per Unit

The difference between the selling price per unit and variable costs per unit

Costs

Amounts incurred by a business during trading operations

Demand

The amount or price of a product that customers are willing to pay

Demographic

Defining a market in terms of segmentation (eg: age, income)

Elasticity of Demand

The responsiveness of demand to a change in price or customers incomes

Electronic Market

A market where sellers and customers do not meet (eg: Play, Amazon)

Enterprise

Where new businesses are formed to offer products or services

Entrepreneur

Somebody who takes calculated risks to start up a business

Expenditure Budget

The budget that sets out the total costs (usually split into categories)

Fixed Costs

Costs that do not change with output (eg: rent, salaries, utilities)

Franchisor

Someone/a business who rents their business to other people/businesses

Full-time Employee

Somebody who works 30+ hours a week under a contract

Income Budget

The budget which sets out estimates of revenue

Input

The resources that go into producing goods and services

Limited Liability

Business owners/shareholders that are not fully responsible for a business fail

Location

The place where a company is located or does business

Margin of Safety

The difference between the output sold and the breakeven point

Market

The place where buyers and sellers come together to do business

Market Growth

The percentage of growth of a market over a time-period

Market Research

The process of collecting and analysing data to help make marketing decisions

Market Segmentation

Segmenting a market into difference sections (eg: age, gender)

Market Share

The percentage of an market that particular business or product owns

Market Size

The total demand or value in a specific market

Niche Market

A small part of a large market where customers have specific needs

Opportunity Cost

The cost of missing out on the next-best alternative

Patent

The right to be the only producer of a specific product or service

Permanent Employee

Someone who works for a business with no set-out ending period

Primary Research

Research which is carried out by a company for its own needs

Profit

The difference between total sales and total costs

Qualitative Research

Detailed research like beliefs, values and opinions

Quantitative Research

Non-detailed numerical research like sales figures

Returns

The rewards to a business (eg: profit, customer satisfaction)

Revenue

The income of sales (selling price per unit * total units sold)

Risk

The probability or change that wanted outcomes will not occur

Sample

A subset of a population usually chosen for market research

Share Capital

Finance invested into a business by shareholders

Social Enterprise

A business that has objectives other than making profits (eg: charities)

Sole Trader

A one-person business with unlimited liability

Supplier

A business that provides goods or services to other firms

Total Costs

A businesses total variable and fixed costs added together

Trade Credit

When a business does not have to pay for something immediately

Trademark

A sign that can distinguish the goods or services from one trader to another

Unlimited Liability

Owners of a company that are completely liable if a business fails

USP

A unique selling point of a product or service that makes it stand out

Variable Costs

Costs that change with the level of output

Venture Capital

Someone who invests in a new start-up business

Working Capital

The amount of money that a business has available for day-to-day activities