business development unit - pearson schools - teaching resources

�Unit 8: BUsiness development

This unit contains four parts:

8.� The business idea

8.2 Resources and quality issues

8.3 Financial resources

8.4 Feasibility and evaluation

Business developmentUnit

8


2 GCe A2 level BUsiness for edexCel

IntroductionUnit

8

A business does not exist in a vacuum. Competitive businesses need to respond

to a variety of pressures, both internal and external, as well as needing to

innovate. This unit looks at how a small business can be established in response

to the needs for change, including the reasons for, and the likely outcomes of the

decisions taken.

While studying this unit you will need to focus on the assessment requirements.

You will be creating a fully developed business plan for the establishment of a new

small business operating as a sole trader or partnership. The plan will include your

aims and objectives, a marketing plan, resource issues and a financial analysis.

The plan will be presented as a viable business idea, suitable to support a request

for finance for the venture.

What you will learn in this unitWhat gives rise to a business idea

The role of small and medium-sized enterprises in the market

What is involved in setting up a business

How to carry out primary and secondary research into the needs of competitors and the power of competitors

The appropriate scale for a small enterprise

The resources required to set up a small enterprise and how they can be combined effectively

The importance of start-up finance

How to create an effective budget, profit and loss account and balance sheet

The importance of planning

How to evaluate business performance

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8.� The business ideaComing up with an original idea is only one part of coming up with a successful business idea.

What gives rise to a business idea?The inventor Sir Clive Sinclair is perhaps best known for the development of a good idea that didn’t sell. He was aware of the problems caused by petrol-guzzling large motor vehicles, as well as the difficulties of parking them and driving them in urban environments. So, in the 1980s he invented and launched the C5 battery-powered vehicle.

The idea was a celebrated failure. The product suffered from technical limitations and was hurt by marketing that appeared to position the product as a rival to cars rather than as a fun leisure ‘toy’.

Key term

Marketing. Providing the right product at the right price in the right place, profitably.

what is great to them is not necessarily great to other people’.

We can contrast the C5 with the development by James Dyson of his twin cyclone range of vacuum cleaners. In recent years these have revolutionised the way we clean our carpets and floors. Dyson developed his idea to replace old-fashioned vacuuming techniques by observing how industrial cyclone systems worked.

Dyson then produced and trialled hundreds of different prototypes to come up with a product that would appeal to them. Dyson products are now sold worldwide.

Another story of innovation is that of the birth of the iPod. The iPod originated with a business idea created by Tony Fadell, an independent contractor and hardware expert who had helped develop handheld devices. His idea was to take an MP3 player, build a Napster music sale service to complement it, and build a company around it.

Fadell took the idea around several major companies. All of them rejected it except Apple, the celebrated computer manufacturer. In early 2001 Apple assigned Faddel a team of 30 industrial designers – including designers,

Unit 8: BUsiness development 3

CASE STUDY

New Look has a clothing line called 915 which is aimed at 9 to 15-year-old girls. New Look carries out a lot of detailed market research to decide what exactly should go in the range. Girls typically start to take an interest in the range from 7 years old.

Value for moneyThe range is based on both what mothers want their children to dress in and what children want to wear. Items in the range include jeans and T-shirts as well as what is fashionable at the time. The items are designed to give value for money and some items, for example, come as cheap as £1.

Where’s the market?New Look has identified the 9–15 market as an important opportunity – market research has identified the ‘in betweenies’ as a significant market between children and the more adult market. It consists of lots of girls who relate to fashion.

Fashion statementDesigners of the range therefore pay careful attention to fashion trends and market research to generate new ideas that will appeal to this group. It is then a question of evaluating research information and selecting the best ideas, in order to plan a range of fashionable items for New Look 915.

Questions1IdentifyanddescribethemarketthatNewLookistargeting.2OutlinethebenefitsofNewLooktothistargetmarket.

33 3AnalysethekeystagesinturningtheNewLook915intoagoodbusinessproposition

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3

New Look 915

In later years Sir Clive Sinclair went on to admit that: ‘What inventors need to recognise is that


Enterprise cultureIn the UK we are said to have an ‘enterprise culture’. An enterprise culture is one in which people are prepared to take risks. When enterprise is combined with innovation (the ability to come up with and develop new ideas) then you have a dynamic enterprising economy. A survey carried out by NatWest in 2004 showed that 70 per cent of sixth formers would consider setting up a business when they have finished in full-time education. Being enterprising involves taking any type of risk and although it can relate to risking money – this does not have to be the case. In fact many business people risk other people’s money rather than their own.

In this country we do not have to go far to think of enterprising people. For example, there are people who set up great business enterprises like the Cadbury brothers, Michael Marks and Tom Spencer, Anita Roddick, Martha Lane Fox (who was a co-founder of lastminute.com), Tommy Singh and Richard Branson. There are great inventors like James Dyson who developed the bagless vacuum cleaner and Tim Berners Lee who was instrumental in creating the Internet, and Caption

Key termsprogrammers and hardware engineers. Faddel believed that the success of his product would convert Apple from being a computer business to a music business.

Apple’s iPod was developed in six months – quicker than any major product in the company’s history.

The Dyson and iPod stories show that coming up with a good idea is only one step in the process of business development. There are four main steps in the development of new business ideas:1 seeking and shaping opportunities2 generating new ideas3 evaluating and selecting ideas4 planning for implementation.

Market. The whole situation in which products and services are traded by buyers and sellers.

Market share. The sales of a product by a company expressed as a percentage of total sales in a market: if a company sells 20,000 products and the total number of those products sold overall is 200,000, the company has a market share of 10 per cent.

Target market. A group of consumers, sometimes called a segment, to which an organisation offers its products. An organisation often offers its products to several target markets simultaneously.


For most businesses, the business plan will be the main method of convincing prospective fund providers that the business proposal is viable. The business plan also shows that the proprietor has the commitment and determination to succeed. The business plan should be presented in a form that can be quickly and easily understood. The main part of a business plan normally needs no more than eight to ten pages supported, if necessary, with more detailed appendices. The plan will then be manageable. It needs to be a working document in which the owner and potential fund providers can find the management information they need.

A simple business plan should be clearly set out under the following headings (note that the table is cross-referenced to the various sections of this unit in the left-hand column):

HEADING CONTENTS

Contentspage This is useful in any kind of report that is more than two or three pages long.

Theowner(s) This section should give some information about the owner or owners, including their educational background and work experience. It should also contain the name and address of two referees.

Thebusinessandthe businessidea(8.1)

This should first contain the name and address of the business and then go on to give a detailed description of the product or service being offered, how and where it will be produced, who is likely to buy it and in what quantities.

Thelegalstatusofthe business(8.l)

This section will set out the legal position of the business, e.g. whether it is a soletrader, partnership or company.

Themarketandthelikely competitorsfortheproduct orservice(8.1)

This should set out the size of the market, the nature of competition in the market and the expected market share that your business expects to take. In this section you can outline some of the market research that you have carried out.

continued

Key terms

Business plan. A plan for the whole of a business covering a period of 1–3 years and setting out such aspects as financial plans, marketing plans, etc.

Forecast. Prediction of future events or figures based on some form of evidence, such as past results.

there are pop impresarios like Simon Cowell and Malcolm McLaren, who created the Sex Pistols.

All of these people were enterprising because they were able to think outside the box. Malcolm McLaren helped to create punk music, Martha Lane Fox helped to develop e-commerce and the Cadburys developed a range of famous chocolate products.

Creating a business planHaving a great business idea is only the start of developing a great business. What is then required is a lot of hard work and planning to make the business a success. In this unit we provide you with the support and structure to plan the development of an effective business.

Livewire is an organisation that has been created to help young people set up their own businesses in this country (see shell-www.livewire.org).

Livewire has defined a businessplan in the following way:

‘A business plan is a complete description of a business and its plans for the next one to three years. It explains what the business does (or will do if it’s a new business); it suggests who will buy the product or service and why, and it provides financial forecasts demonstrating overall viability, indicates the finance available and explains the financial requirements.’

� GCe A2 level BUsiness for edexCel

Table 8.1 Business plan structure

Promotionalstrategies(8.1) This should give information about how the business will be publicised to potential customers.

Themarketingmixforthe organisation(8.1)

This should give a brief outline of the key aspects of the blend of product, price, promotion and place.

Thequantitytobeproducedorlevelofservice (8.2)

This should give a brief summary of how many items or how many different types of items will be produced or of the service standards that will be provided.

Resourcesrequired(8.2) This should set out the:• physical resources required• human resources required.

Qualityissues(8.2) You should show how quality will be ensured within the business.

Thefinance(8.3) This should give details of how the finance for the business is going to be raised. How much will come from savings? How much will need to be borrowed?

Start-upbudget(8.3) You should create a budget for the first year of operation of the business.

Cashflowandbreak- even(8.3)

You should set out a predicted cash-flow statement for the first few months of trading. Set out a break-even chart to show the break-even point and when this will be achieved.

Profitandlossaccounts(8.3) You should create a projected profit and loss account for the first year of trading.

Startupbalancesheet(8.3) You should create a balance sheet to show the starting position of the business.

Evaluationofthebusiness positionattheendofayear(8.4)

Various tools can be used to evaluate the success of the business. For example, carry out a SWOT (strengths, weaknesses, opportunities and threats) analysis or examine various measures of success, such as profitability.

Afutureprojection(8.4) A projection can be carried out of what the business might look like in three years time.

Alternativeideas(8.4) This should supply alternative ways of developing the business in the future.

Key terms

Break-even point. The level of output at which total revenue equals total costs.

Budget. Plan for the future set out in numbers.

Partnership. A business owned by at least two partners, who share the responsibility for running and financing the business, as well as the risks.

Profit. The difference between revenue and costs.

Promotion. Techniques used by an organisation to communicate with others, e.g. advertising, flyers, etc.

Quality. Fitness for purpose.

Sole trader. A business owned by one person.


When you have finished studying this section you should be able to:

generate a range of possible ideas for a business

explain an appropriate legal status that you have chosen for your business

identify likely competitors for your product or service

outline suitable promotional strategies

establish an appropriate marketingmix for your product or service.

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shaving foam and two or three handy sized razors to see me through my holiday? A friend of mine came up with the idea of a toothbrush that plays nursery rhymes to encourage young children to clean their teeth.

You can see, therefore, that one way of coming up with a business idea is to generate a new and novel solution to a problem. This is what Akio Morita did when he developed the Sony Walkman – a music system that could be used on the move. This has led to more recent solutions, such as MP3 players and the iPod. Morita came up with the simple idea of creating a tape-based (cassette) system that could be carried, with a headset for listening to the music.

Another way of generating ideas is to go for a niche in the market. This is what the founders of Tie Rack did. They realised that people want attractive ties and neckwear but didn’t necessarily want to go to the hassle of looking round clothes shops. They therefore developed small outlets selling a range of high-quality ties in busy locations, such as between the train and tube station at (London) Kings Cross.

Of course, some people just copy existing ideas which they know have been successful elsewhere. This is why franchising is so popular. When you buy a franchise you buy the right to use a well-known name, such as McDonald’s, Dyno-Rod (plumbing), etc. and to use equipment and training supplied by the franchising organisation. Many successful business people copy good ideas from elsewhere. For example, on a visit to the US, you might spot an exciting retail opportunity that does not yet exist in this country and then develop it here.

Another way of generating ideas is to listen to what customers are saying about what they want. If young people write to the local paper complaining that there are no entertainment facilities for them in your town, then this might be an opportunity to set up a coffee shop or disco.

Of course, many people generate business ideas from doing things which they are good at. For example, Jamie Oliver is an excellent cook and he has built a restaurant business out of it.

Key term

Marketing mix. The combination of product, price, place (sometimes called distribution), promotion and packaging offered by an organisation to potential consumers.

Generating a business ideaHow do you generate a business idea?One way is to come up with a new idea which seems obvious but that nobody seems to have thought of. For example, often when I go on a short holiday I forget to bring my razors and shaving foam. This means I have to buy a pack of razor blades and a standard size shaving foam when I arrive at my destination. Wouldn’t it be a good idea for a company like Gillette or Bic to produce a small takeaway pack containing a mini-

Did you know?

One of the most important reasons for business failure, particularly for start-up businesses, is poor or no business planning. Sometimes the owners of new businesses have no idea of whether there is sufficient demand for their product, what prices competitors charge, the true cost of borrowing money, how to advertise and promote their business, or the importance of having a steady flow of new cash into the business.


Generating your idea

A niche marketA new andnovel idea

Doing somethingthat you

are good at

Copyinga good idea

See if you can generate a good business idea from one of the following suggestions.

See if you can create three ideas for each of the headings. When you have come up with your ideas, evaluate them to see which of them would be best for producing a workable business plan (following the model provided on page 6).

Figure 8.1 Generating ideas

Your legal statusMost businesses will be set up either as a sole trader, partnership or limited company. Sole traders and partnerships must inform the Inland Revenue within three months of starting, or face a fine. Sole traders or partners are classed as self-employed and are therefore responsible for paying their own income tax and national insurance. The directors of a limited company are responsible for making sure that the company produces accurate accounts that are audited by an external auditor who is able to state whether they are ‘true and fair’.

It is important to set out in your business plan what your legal status is. This affects the risk taken by those who are prepared to lend you money. They take more of a risk if you are a sole trader or partnership.

All sole traders and most partnerships have unlimitedliability. What this means is that the owners of the business are liable for its debts. Their liability is not restricted (limited) to what they put into the company – the liability extends

to the rest of their personal wealth. For example, they might have to sell their house and car to pay off business debts. Today there are some special types of large partnership, such as in accountancy, that can be classified as limited partnerships.

Key term

Limited liability. There is a restriction on how much a person is liable to the debts of a business.

Unlimited liability. There is no restriction on how much a person is liable to pay off the debts of the business.

A company is different from the partnership and sole trader in that the shareholders have limitedliability. Individual shareholders can only lose at a maximum the money they have invested in shares should the company run up debts – their shareholding is the limit of their liability.

Whatever form you choose, you should select a business name that will not cause problems to another business. Sole traders or partnerships trading under a name other than that of the owner(s) must display the owner’s name and address at business premises and on business stationery. Limited companies are required to display the registered name at their premises and on company publications.

Defining business sizeThere are various ways of defining small, medium and large enterprises – for example, according to the size of turnover. Another approach is according to the number of employees.

Key term

Turnover. The money value of sales made by a company (also referred to as sales revenue).

Learning activity

What legal status will your business take? Set this out in your business plan – explaining why you have chosen this particular form.

Learning activity


Official National Statistics define:

a small enterprise as having 0–49 employees

a medium enterprise as having 50–249 employees

a large enterprise as having over 250 employees.

Nearly all businesses in the UK are small, which shows the importance of this type of business to our economy:

99.2 per cent of business today (2005) are small

0.6 per cent are medium sized

0.2 per cent are large.

Small and medium-sized enterprises account for about 58 per cent of employment and just over 50 per cent of turnover.

There are about 3 million enterprises with no employees (about 70 per cent of all enterprises). Businesses with no employees are sole proprietors and partnerships made up of the self-employed owner-manager(s) and companies made up of only one director. There are about 2.5 million sole proprietors in the UK and about 500,000 partnerships. There are 960,000 companies.

Likely competitors for the products or serviceA market is made up of buyers and sellers of a good or service. Markets can be sub-divided into particular segments in which competitors are competing for the same or similar groups of customers. For example:

at one level we have the market for drinks

a category of this is the market for hot drinks

a component of this is the market for tea

a component of this is the market for tea bags

a component of this is the market for fruit-flavoured tea bags.

The producer of fruit-flavoured tea bags needs to understand that not only do they face competition from other producers of fruit teas, but also from other types of teas, from coffee and other hot drinks and from drinks in general.

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We use the term ‘direct competition’ to describe businesses that are competing head on for the same group of customers. ‘Indirect competition’ refers to competition which is less intense but still needs to be considered. The Coca-Cola Corporation, for example, believes that in order to sell more Coca-Cola across the globe they have to compete with alternatives, such as tea and coffee.

In examining a market in which you want to compete, you should try to estimate:

the size and value of the market, for example, how many customers make up that market and what the likely value of their purchases is in that market in a given period of time

the share of the market that you are likely to take.

For example, after conducting market research in your local town you might find that 2000 people buy sandwiches every day and that they spend on average £3 on sandwiches. The total value of the market is therefore:

2000 × £3 = £6000Based on your market research you find that one in ten sandwich purchasers will switch to buying from you. Using these figures you can then estimate that your daily sales will be:

£6000 ÷ 10 = £600Assuming that you operate for five days a week your weekly sales will be:

£600 × 5 = £3000Assuming that you operate for 50 weeks in the year, your expected annual sales revenue would be:

50 × £3000 = £150,000

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Key term

Revenue. The value of sales (in money terms) that the product is likely to achieve, or has achieved.

Learning activity

List three goods and services which you believe have little direct or indirect competition. Can you list another three that have lots of direct competition?

�0 GCe A2 level BUsiness for edexCel

However, in order to secure this revenue and your share of the market you need to carry out a detailed competitor analysis. To analyse the competition you need to identify the key ingredients that you compete on.

Key elements of competition for sandwiches, as revealed by market research are detailed in the table above.

ElEmENT Of COmpETITION DETAIlS

Price When given the choice of similar sandwiches, customers will go for the cheaper ones.

Bread Some people like white bread, some prefer brown and more exotic varieties such as wholemeal and stone-ground. A key consideration is the freshness of the bread.

Fillings The popular favourites are cheese, ham, egg, chicken, tuna, roast vegetables, prawns and then more exotic recipes.

Packaging Customers prefer packaging that seals in the flavour and is easy to open.

Place Customers prefer to buy from convenient locations, such as on their route to work.

Branding Customers prefer to buy sandwiches with a strong brand identity.

Culturalfactors Tastes are influenced by cultural factors such as religion and upbringing – for example, Muslims will only purchase meat that has been prepared by halal butchers.

Table 8.2 Customer considerations in purchasing sandwiches

position in the market. In contrast, no-frills outlets such as Aldi and Netto place themselves at the very low-price position in the market.

In creating a positionalmap it is important to consider where your current competitors have placed themselves, and where it is likely that new competitors will place themselves.

You need to decide where you want to position (place) your product in the market in which you operate. To do this you need to decide on the key dimensions to the competitiveness of the good or service.

For example, two common dimensions are price and quality. If we look at competition between food outlets, Marks & Spencer places itself at the high-quality, relatively high-price

Key term

Positional map. Setting out how a firm compares with rivals in its place in the market as illustrated by two or more dimensions.

In the map opposite, you can see a situation in which a business, Exotic Sandwiches, has decided to position itself in the high-price, high-novelty section of the market in a big city. Is this wise given the number of competitors already operating in this segment?

Note that the dots on the map represent existing competing firms.

Learning activity

Set out a table to show the key competitive elements for a business idea that you want to develop.

��Unit 8: BUsiness development

GCE A2 Business for Edexcel – Double AwardAW 013Tek-Art (MJH)

High price

Low price

High noveltyLow novelty

Figure 8.2 A positional map for local sandwich businesses

Promotional strategiesIn setting out a business plan it is important to set out a clear structure as to how you will promote your product. There is no point in having a brilliant product if nobody knows about it. The promotional strategy is the means that you will employ to get the right messages across about your business and product. It takes a lot of time to build brand awareness and customer recognition of a product. High-quality promotion is therefore very important.

The promotional tools that you will need to consider are:

advertising – communicating through mass media, e.g. television, radio, newspapers, billboards, flyers through people’s doors, etc.

salespromotion – providing customers with an incentive to buy products, e.g. by offering two for the price of one

personalselling – face-to-face communication aimed at persuading and informing customers

publicrelations(PR) – making sure that favourable impressions are communicated to the press and the buying public

sponsorship – improving the image of a business and/or product by funding unrelated activities.

A promotional strategy is a plan to use these tools in the most effective way to achieve your objectives.

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It will also be helpful in discussing the market to outline the key findings of any market research you have carried out, particularly in relation to the marketing mix.

What type of product or service do customers want?

What sorts of benefits are they looking for from the product or service?

What sort of price would they be prepared to pay?

Do they want to pay premium prices for premium products or low prices for standard products?

Where do they want to buy the product – i.e. what places are most suitable?

What sort of promotion would appeal to the target audience?

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Learning activity

Set out a positional map showing the position of a business that you would like to set up. Use the two dimensions that you consider to be most significant competitive factors. Show the rough positions of competitors on the map. Explain why you have chosen your position and how you are likely to beat the competition.


For example, your objective might be to make sure that at least 50 per cent of the people in your town are aware of your new sandwich business and what it offers. Your promotional strategy then might be to advertise in the local press and to produce public relations communications for the media to get the message across. In addition, you might post coupons through the doors of 1000 houses, offering half-price sandwiches for the first month after your opening.

In considering your marketing mix, think about the following elements.

Product. What exactly is the product or service you are offering? What are the key benefits that it offers customers? What are the distinctive features (e.g. design)? Are you offering a range of products? What packaging will you be using?

Price. What sort of pricing method will you use (e.g. a promotional price to launch the product, a premium price to give it distinctive quality, etc)?

Promotion. List the promotional activities that will be used.

Place. How will the product be distributed to consumers? What selling outlets will you use?

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Key term

Objective. A planned result to be achieved by an individual or organisation, e.g. the objective of increasing sales by 10 per cent this year.

The marketing mix of the organisationThe marketing mix of a business consists of four major elements. These are referred to as the 4 Ps:

product

price

promotion

place.

The marketing mix that you choose needs to be appropriate to your business objectives. For example, if your objective is to grow steadily as an upmarket sandwich provider, then you will need to produce a high-quality (fresh and well-finished) product which sells at a premium price, involves promotional activity that reflects a quality product and is placed in fairly exclusive locations.

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Researching your business idea will be a time-consuming process. Be prepared to put a lot of time into this task:

research the feasibility of the product idea

research the market to find out what potential customers want

research the competition to find out the strengths and weaknesses of existing competitors

research a suitable promotional mix

create an appropriate marketing mix.

Primary(field)research can include face-to-face interviews and telephone or postal surveys. It is also worth speaking to distributors and retailers as well as your competition (simple information such as number of competitors in the area can be found in The Yellow Pages and other business directories). When carrying out primary research, handle data confidentially and in accordance with data protection law. You may want to conduct test marketing using prototype products to determine demand and what, if any, changes should be made.

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Learning activity

Design a promotional strategy for your business idea. This should include:

objectives for the promotional campaign (what you want to achieve)

a promotional strategy setting out the blend of promotional tools that you will use and why you plan to use them.

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Learning activity

In setting out your development plan, make sure to relate each of these elements of the 4 Ps to your business and/or product objectives.

�3Unit 8: BUsiness development

Deskresearch. Visit your local business library and look on the Internet for relevant data. Statistical information can be gleaned from a number of sources, such as the Office of National Statistics. It is also worth contacting trade association, newspapers and journals, as well as reading competitors’ literature.

8.2 Resources and quality issuesYou should now have established your business idea and its potential through the research you have carried out. Now you need to consider the scale of the operation by looking critically at:

the quantity of goods to be produced or level of service offered

the technology you will need to use

the production process, including timing

the physical resources required

the human resources required

how quality can be assured and controlled.

To do this you will need to consider how the necessary resources may be combined efficiently to achieve the desired outcomes. You will also need to consider any relevant legal, economic, technical and environmental constraints.

How much to produce?Producing the right quantity is a tricky decision. If you don’t produce enough then customers will be frustrated and will go to your competitors. If you produce too much then you will have stock lying around, deteriorating in condition and getting in people’s way.

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The amount to be produced depends on two principal factors:

thelevelofdemand: this depends on how much customers want to buy

howmuchcanbesupplied:this depends on how much you can supply through your existing processes, which depends on your equipment and the level of skill of your employees.

Economies of scaleWhen we refer to the scale of production – we mean the capacity of the firm to produce larger or smaller quantities of goods. Most firms in this country are sole traders and partnerships – typically they operate on a small scale. Huge companies like Shell, Cadburys and British Airways produce on a large scale.

If you operate on a larger scale you need more machinery and equipment, and you need to operate from a larger plant. Through operating on a large scale a business is able to benefit from what are known as economies of scale. Typical economies of scale relate to:

productioneconomies: being able to use better techniques of production, e.g. mass producing lots of identical items at a very low cost per unit

marketingeconomies: e.g. being able to advertise the same product across the globe using the same or a highly similar campaign

financialeconomies: being able to borrow money far more cheaply because of the scale of the business and being able to cut other financial costs, e.g. the setting-up cost of a large loan is proportionately much smaller than for a small loan, etc.

sellingeconomies: being able to reduce distribution and promotional costs.

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Key term

Loan. Finance provided by an individual, company, financial institution, government or some other provider. The loan must be repaid over a given period of time with additional interest payments.

Did you know?

Before the Rover car company went into liquidation, one of the jokes going around about the company was: ‘You can see two human features on the earth when you look at it from space. One is the great wall of China. The other is the stockpile of Rover cars outside the factory waiting to be sold.


Large companies benefit from economies of scale

Technology, production process and timingTechnologyUsing the right technology is very important in developing a competitive advantage. This is particularly true in the world of information and communications technology, where small companies using the latest computers and computer applications can gain a considerable advantage over companies working with less advanced systems – for example, in web page design.

Production processAnother important consideration is the process that you employ. Processes are systems and methods that you use to make a product. For example, sandwiches can be produced individually by hand. Alternatively, they could be produced in batches – e.g. a batch of ham and cheese sandwiches, followed by a batch of chicken sandwiches. Mechanical processes could also be used to process the sandwiches, e.g. electronic cutting, spreading and packaging devices.

Getting the processes right is a key aspect of competitive advantage.

CASE STUDY

CASE STUDY

New technology for making sandwiches

is being continually developed. This is illustrated by recent practice at Hazlewood Sandwiches, one of this countries best-known sandwich producers. Until recently cucumbers and tomatoes that go into sandwich making were sliced into containers and then placed on bread slices manually.

Slice linesHowever, Hazlewood has developed automatic machinery which places cucumber or tomatoes onto a moving slice of bread on the production line. The new method

Automatic sandwiches




involves taking out single items (e.g. slices of cucumber) from a bulk container and arranging them in patterns on a bread slice on a moving production line, while at the same time removing reject items.

Questions1Identifythebenefitsofthisapproachtothesandwichproducer.2Explainthekeybenefitstoconsumers.

33 3Justifytheuseofeconomiesofscaleinproductioninsandwichmaking.3334AssessthelikelyimpactonthesandwichmarketoflargeproducerssuchasHazlewood

sandwichesusingmass-productiontechnology.

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Timing and other constraintsIn setting out your plan, it is helpful to identify potential constraints to production capacity. For

example, in the case study below the business is limited in its ability to meet potential demand by lack of time and physical resources.

Unit 8: BUsiness development ��

A group of students has formed an enterprise to produce candles for the Christmas market. They meet for one afternoon a week to run this project. Market research indicates that they can sell up to 500 candles at a Christmas store. They have therefore created a production plan setting out responsibilities for the various processes and a time schedule for the 10-week period leading up to their Christmas fare. Although potential demand for candles is 500, with their existing production capacity they can only make 40 candles a week.

Making candles

�� GCe A2 level BUsiness for edexCel

Questions1Explainwhyitisimportanttoestablishtimingsandresponsibilitieswhencreatinga

productionschedule.33 2Analysetheimportanceofincludingqualitychecksintheprocess.33 3Respondtoaviewthatwasvoicedbyoneofthemembersofthestudentteamwhosaid

that,‘Itisnotimportanttoconcentrateonquality.Ouremphasisshouldbeonmakingandsellingasmanycandlesaspossible.’

3334Proposeanalternativeplanningscheduleforpreparingthecandlesforthemarketsoastobettermatchthesupplywiththedemandofthecandles.

3

Figure 8.XX Caption

Planning to provide servicesOf course most modern businesses are not concerned with producing a physical product. A large proportion of businesses involve providing a service, e.g. office cleaning, hairdressing, providing restaurant and café services, etc.

Learning activity

Identify the key processes involved in producing your product or providing your service. Set out these processes in a diagrammatic form (e.g. using a flow chart). An important consideration will be the timing required. Make sure that you leave yourself enough time to complete the processes.

Processes to be carried out Who is responsible Time schedule

Buy in candle making equipment and set up production line

Purchasing manager, production manager and production team

Week 1

Prepare wax and mix with colours

Prepare threads

Heat wax

Place wax in moulds

Leave moulds to cool

Extract candles from moulds

Check quality of finished articles

Break up reject (faulty) items

Store candles

Production manager and production team Week 2

Same as for week 2 Production manager and production team Week 3




Same as for week 2

Produce packaging materials

Production manager and production team and packaging department

Week 7

Same as for week 2 Production manager and production team and packaging department

Week 8

Same as for week 2 Production manager and production team and packaging department

Week 9

Prepare packaging for remaining candles

Carry out last-minute quality checks

Sell candles at Christmas fair

All enterprise members Week 10


In terms of production planning for a service, it is necessary to establish ‘levels of service’. For example, in a standard barber shop the level of service usually involves being able to read a tabloid newspaper and listen to the radio before having your haircut, while the barber discusses football with you or where you are going on your holidays. In contrast more upmarket unisex hairdressers give a much higher level of service, which may include:

glossy magazines

a cup of coffee while you wait

the opportunity to have your nails manicured

a free chocolate bar and other gifts, etc.

It is very important therefore to think carefully about the level of service you will offer. This should relate to:

what your customers want, as discovered by market research

what your competitors are offering

the extent to which you want to give your customers superior service.

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much it would cost to rent the floor space that you require.

2 Plantandfittings.What types of plant and fittings will you require? How much will it cost to lease and hire this equipment?

3 Vehicles.Provide details of vehicles required and the hire purchase requirements. You could get this information from a car dealership.

In this section you can also set out which suppliers you will use and the terms on which they will supply you with relevant materials and other supplies.

Human resources requiredIn setting out the human resource requirements of a business it is necessary to establish:

how many people are needed

what jobs they will have to do

what skills and capabilities they will need to have.

Job analysisJob analysis is the process of identifying the knowledge, skills and attitudes required to do particular jobs. It is therefore essential to carry out a job analysis so that you can be clear about what is required to run the human resource side of your business. A summary of the job analysis you have conducted should be presented in your business plan, together with an outline of the numbers of people that will initially be employed, along with what their jobs will entail. An outline of expected expansion of the business in the first year should also be provided, showing the number of extra people who will need to be employed and what they will be expected to do. A rough estimate of labour costs should also be included.

Quality issuesQuality can be defined as continually meeting agreed customer needs. Many people believe that quality is more important than price in determining demand for most goods and services.

In taking quality to new heights, it is generally recognised that there are three stages:

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Physical resources requiredIt is important to consider the physical resources required to run a business. For many businesses, key areas will be the premises, plant and fittings and vehicles. Presenting a detailed section on this enables potential investors and lenders to appreciate that you have thought carefully about what you need to set up and run your business. A useful structure to this section of your business plan could be as follows:

1 Premises(whetheryouwillbuyorrent).Set out the floor space area required, and the cost of the annual rent. This information can be gained by enquiring at an estate agent how

Learning activity

If you plan to offer a service, set out the levels of service you will provide and justify this level of service (e.g. in terms of the marketing mix, the target audience and the competition).

CASE STUDY


1 Qualitycontrol.This is an old idea. It is concerned with detecting and cutting out components or final products which fall below set standards. This process takes place after products have been produced.

2 Qualityassurance.Quality assurance occurs both during and after the event, and is concerned with trying to stop faults from happening in the first place. Quality assurance is concerned with making sure products are produced to predetermined standards. It is the responsibility of the workforce rather than an end-of-production line inspector.

3 TotalQualityManagement(TQM).This process goes further. It is concerned with creating a quality culture so that every employee will seek to delight customers. The customer is the centre of the production process. In a total quality system, TQM takes place at every stage of an organisation’s operations and is the responsibility of all employees. TQM encourages the organisation and everyone that is involved in it to concentrate on quality.

Many organisations apply quality standards which

are established nationally and internationally by standards creating bodies. These standards relate to products and processes (i.e. how the products are made). Many businesses trade at local, national and international levels. To win customers’ confidence it is important to meet the highest quality standards. Standards awarding bodies like the British Standards Institution (BSI) create and monitor standards

of best practice. Committees of specialist experts create standards relating to product, material, service, process or technology in a particular industry. Today most of these standards relate to services and systems, as well as production methods.

Examples of new standards are those related to improvement of utility billing services (e.g. gas and electricity suppliers) and implementation of web design processes, to

ensure characteristics like usability and readability.

Small and medium-sized enterprises benefit from apply-ing standards created by the BSI. One of the most important aspects of BSI’s work is helping organisations to develop man-agement systems to ISO 9001 standard. This involves setting up systems to ensure that proc-esses are customer focused and that a company is continually seeking to improve its manage-ment of quality issues.

Questions1Explainhowasmallormedium-sized

enterprisecanbenefitfromapplyingstandardsestablishedbytheBSI.

33 2Considerwhycustomersaremorelikelytohaveconfidenceinasmallormedium-sizedenterprisethatadherestoISO9001.

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33 3JustifythetimeandeffortthatabusinesswouldhavetoputintocreatethemanagementsystemsrequiredtomeetISO9001.

3334Evaluatethelikelysuccessofrivalfirms,oneofwhichabidesbyexpectedstandards,andanotherwhichseekstocutcostsbyseekingtoavoiddetectionthatitisfloutingstandards.

Quality Standards created by the British Standards Institution

Key term

Quality assurance. Guaranteeing high levels of quality.


Businessidea

Economicconstraints

Legalconstraints

Environmentalconstraints

Technicalconstraints

KaizenKaizen is a term much used in the area of quality. It is a Japanese word that, when translated, simply means ‘continuous improvement’. The improvement is gained by slow and steady change, and once achieved it is maintained at that level until such time as the next improvement step takes place. Kaizen is one way in which employees may participate in issues that affect the workforce.

Legal, economic, technical and environmental constraints

There are a number of constraints which can have a negative impact on a business idea. Typically they involve some element of cost and therefore need to be carefully considered. They may prevent a business idea from being developed into a successful business.

Legal constraintsLegal constraints are limitations placed on the business and business activity through laws and regulations. There are thousands of these – so it is essential to keep up to date with what

is happening in the legal environment. Some examples of legal constraints are outlined below.

Limitationsonbusinessnames. You cannot use the same name as one already registered, or a name that is too similar to an existing name (e.g. by adding an ‘s’ as in Body Shops). You cannot use a name that is considered offensive, although some firms come very close to the border of what is acceptable (e.g. FCUK). You cannot use a name that makes you appear to be something to do with government.

Employingstaff. All businesses that employ people must register with the Inland Revenue. Staff have many rights under employment legislation, such as the National Minimum Wage. Employers must take out Employers’ Liability Insurance to cover accidents and injury at work.

Healthandsafety. Businesses must ensure the safety of their staff and that of visitors to the business. If you have five or more employees you must produce a written health and safety policy.

Licencesorregistration. Some businesses need a licence to trade, e.g. body piercing and tattooing, acupuncture, care homes, money lenders and child minders.

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Figure 8.3 Constraints on business ideas

Caption

Learning activity

Describe the quality issues that particularly affect your business. Explain how you are going to create management systems to ensure quality. Carry out some research on the website of the BSI to find out any standards that may be relevant to your business idea. To find the site, enter ‘British Standards Online’ into a search engine.


Intellectualpropertyrights. Businesses should be aware that there are laws to protect designs, trademarks and copyright. It may be a good idea to protect your own designs and logos.

Dataprotection. The Data Protection Act (1998) protects individuals with regard to their personal data being held and processed by the business. You should check to see if you are required to register under the act.

Economic constraintsEconomic constraints are those that are imposed by what is happening in the wider economy. Examples of economic constraints are:

changes in interest rates which raise the cost of your borrowing and repayment of loans

changes in unemployment levels, e.g. a fall in unemployment will push wages up (as employers compete for employees); again this would raise costs

the rate of growth of the economy, e.g. if the economy moves into a recession with the demand for goods starting to fall, this could have an adverse effect on demand for your product/service.

Technical constraintsTechnical constraints relate to what is technically possible. Modern technology makes it possible to produce more efficiently. However, it is often very expensive to invest in new technology. As a result many small businesses are constrained by having to work with inefficient technology, while bigger rivals invest in the latest equipment. Having said this, many small businesses are successful because they use better technology than bigger companies.

Environmental constraintsEnvironmental constraints are becoming increasingly significant. The Environmental Protection Act (1990) has important implications for businesses that produce waste and imposes a duty of care upon owners of such businesses. Under the Act, a director or manager may be personally prosecuted for offences committed. Further regulations apply for businesses that handle hazardous substances and produce

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packaging. For example, companies can be fined heavily for using too much unnecessary packaging. The Landfill Tax is levied on each ton of waste created by a business and there are other environmental taxes, such as congestion charges, which place costs on businesses.

In your business plan you should show how legal, economic, and technical constraints impact on your business idea and the steps that you will take to overcome these constraints.

8.3 Financial resourcesFinance underpins the ability of any business to develop. You will need to consider:

sources of finance

start-up budget and workingcapital requirements

forecasts for cash flow and break-even

projected profit and loss accounts

start up balance sheets.

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Key term

Working capital. The financial resources that enable a firm to operate a business on a day-to-day basis (e.g. to purchase fresh stock and to pay wages and bills) calculated by taking away short-term liabilities from short-term assets.

Learning activity

Either carry out some primary research into a business idea that is similar to your own to find out what the legal, economic, technical and environmental constraints are for that business. Or carry out secondary research into the legal, economic, technical and environmental constraints that impact directly on your business idea. The best way to search for secondary information is to do Internet searches using keywords related to aspects of your business idea and terms such as ‘legal constraints’, ‘laws’, etc.

2�Unit 8: BUsiness development

All businesses need to keep records (books) of receipts and outgoings from which to prepare annual trading accounts, to be verified by a professional accountant. The management of money is a crucial part of any small business. You need to know whether your operation is profitable, predict and manage cash flow, keep control of your costs, and set prices so that you are competitive. Don’t forget that if you are working on a self-employed basis, you will also have to pay income tax and national insurance contributions.

Sources of financeBusinesses need finance for day-to-day financial needs, such as paying suppliers, and for longer-term requirements, such as finance for purchases of buildings and major items of capital equipment.

Caption

A starting point is to identify how much of your own savings or capital you can put into the business. A second major source will be a bank loan, or some other form of finance provided by a bank (e.g. a mortgage or overdraft).

Key terms

Capital. Money put into a firm by the owners of the business.

Mortgage. A large loan for an extended period, normally given for the purchase of property.

Overdraft. A banking facility that allows you to draw out more money than there is in your account, in return for a fee plus interest charges.

Learning activity

SOurCE Of fINANCE £

Own resources

Bank loans and other bank finance

Other forms of private finance (state source)

Government loan/grant

Other public sector, e.g. Local authority, Local enterprise council

Totalfinancerequired

Brainstorm the key sources of finance that might help you to set up a clothes shop. Identify the major headings for which you would need finance (e.g. advertising and promotion) and the sources of finance that would be relevant for each heading (e.g. bank loan).

The following template should be useful to you in setting out the sources of finance required to set up your business:


Other forms of private finance may include loans or investments from family and friends, as well as other approaches, such as using a credit card to provide some of the finance. Be careful if you choose to finance a business through your credit card, though. Many businesses use this form of finance, but it is very expensive because of the high interest rates involved.

In addition, there are loans and grants available for smallenterprises provided by government, some of which are outlined below. Some of these are provided centrally, while others are provided by local authorities and LocalEnterpriseCouncils.

may be arrangement fees to pay for setting up the loan and a security (insurance) fee.

4 Bankoverdrafts. These are the most frequently used form of short-term bank finance and help with cash flow. Arrangements are made between the customer and the bank to include an agreed limit on an account, beyond which the customer will not draw. Interest is calculated on the basis of how much is overdrawn each day.

5 Hirepurchase(HP). This allows a business to use an asset without having to find the money immediately. A finance company (usually owned by the major banks) provides finance to purchase the asset. The business pays a deposit and then further payments to the provider of the finance as stipulated in the agreement. At the end of the agreement, ownership of the asset is passed on to the business.

6 Leasing. Leasing an asset provides similar benefits to hire purchase in that a leasing agreement with a finance house (lessor) allows the business (lessee) to use an asset without having to buy it outright. The real distinction between the two forms of finance is that leasing does not confer an automatic right to eventual ownership of the asset.

7 Commercialmortgages. A mortgage is a loan secured on land and buildings and can be used to finance the purchase of the property. It is a long-term financing arrangement of typically 10–30 years.

8 Suppliers. Just as the business may give credit to its own customers, the firm may be able to negotiate credit terms with its suppliers.

There are many ways of financing a business – both when it is starting up and as part of ongoing development. These sources of finance are summarised below.

Private sector sources of finance1 Personalfunds. In sole trader and partnership

businesses, owners’ funds are very important. The sole trader or partner provides these funds from savings or earnings and, in effect, they are risking their own capital when they put these funds into the business.

2 Profitretention. An important source of funds when the business is up and running is profit retention. Profits can either be taken out of the business by owners or put back in to finance ongoing development (profit retention).

3 Bankloans. Loans are taken out for a fixed period, repayment being either instalments or in full at the end of the term. Interest charges are levied at a certain percentage over base rate (e.g. 2 per cent over base). In addition, there

Key terms

Grant. Finance provided to a business (e.g. by government) for a specific purpose.

Local Enterprise Council. An independent body set up by government to co-ordinate enterprise activities in a particular area, including support for small business enterprise.

Small enterprise. A business employing between 0 and 49 people.

Key terms

Asset. Something that a business owns or money owed to it.

Leasing. Renting a capital item such as a photocopier or car.

Government supportIn setting up a small or medium-sized enterprise, it is also important to consider government

23Unit 8: BUsiness development

support. The government is keen to support small business because it recognises the importance of this sector in creating an entrepreneurialeconomy.

CompetitiveAwardsSchemes. The government offers awards and cash prizes to encourage small business, e.g. by offering export and research and development prizes for excellent achievement.

Relocationgrants. There are grants to encourage businesses to relocate from overseas to the UK.

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Directgrant. This is a cash payment, which may be offered for activities such as training, employment, recruitment or export development. Nowadays businesses can rarely get 100 per cent grant funding for an activity. Most schemes require the receiver of the grant to put up a proportion of the cost, often around 50 per cent.

Repayablegrant. This is where cash funding is offered for a project with the intention that the sums are repaid out of future revenues. The grant is not repayable in the event of the project failing.

Softloans. This is a loan where the terms and conditions of repayment are more generous than others offering commercial terms.

Freeorsubsidisedconsultancy. This is very helpful in providing advice to those starting up a new enterprise for the first time.

Accesstoresources. This is helpful to small businesses that may not have access to certain resources, such as testing facilities for new products and projects. For example, small businesses can have access to Ministry of Defence research facilities.

Technologytransfer. There are a number of schemes whereby larger businesses help small firms by showing them how to develop new technologies, given government support.

Subsidies. The government subsidises some activities, e.g. some farming activities receive government cash support.

Adviceandinformation. Government bodies provide advice and information, particularly through online resources to small business, e.g. the Small Firms Service.

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Key term

Entrepreneur. A person who sets up and runs a business venture.

Key terms

Consultancy. Providing advice to businesses (usually for a fee).

Soft loan. A loan to a business that only needs to be paid back on relatively easy terms.

Start-up budget and working capital requirementsA budget is simply a plan that is set out in numbers. It is usual to set out a budget for the first 6 or 12 months when you set up your small business. The budget gives you a plan to work to. With a budget you will have a clearer idea of the money coming in to and going out of the business and the key items of expenditure and when they fall. With a budget in place you are then able to regularly monitor your business to check that you are sticking to the budget.

Any difference between what you budget and what actually happens is called a variance. Checking for variances helps you to solve problems before they get out of control. Budgeting prepares for the future and foresees problems before they occur.

Learning activity

What are the main forms of start-up finance available to your business? What types of finance would you expect to draw on during the first year of running your business? What additional sources of finance would you be likely to draw on in your first three years? Explain why.

Key term

Variance. Difference between what actually happens and what was budgeted to happen.


CASE STUDY

Super SandwichesWhen Karen Williams set up her sandwich-making business in Manchester, she created a budget which set out:• the amount of money required to start up the business• where that money came from (e.g. savings, family, loans, credit card)• what her production and other variable costs would be each month• where the income would come from to cover those costs• what her main capital items of expenditure would be and when they would fall• any additional inflows of funds (e.g. loans) that would need to come into the business to cover capital expenditure.

sales. A less detailed budget can also be created to cover the first three years of trading.

Budget for first 12 months of tradingWe have set out a simple budget for Superior Sandwiches below. Note that it is broken into four main sections:

Income (a breakdown of all sources of incomes and income generated from them)

Outgoings (a breakdown of all outgoings from the business)

Income – Outgoings

The balance which is carried forward each month

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Questions1ExplainwhyitmighthelpKarentocreateacapitalbudgettocoverthepurchaseofcapital

itemsforthebusiness.2IdentifythefinancialflowsanditemsthatKarenwouldwanttocheckonaregularbasis.

33 3DiscussthebenefitsthatKarenwouldreceivefromcreatingabudgetforherbusiness.3334Criticisetheviewthat‘budgetingwastesvaluabletimeandhencevaluableresourcesand

timespentonitshouldbekepttoaminimum’.

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You may want to create a budget for setting up your business. This should include all the expenditures you need to incur before you start trading. It should show how these expenditures are matched with relevant funding. For example, to set up a sandwich-making business you might create the following set up budget.

In creating the start-up budget above, the owner has a clear idea of how much it will cost simply to set up, what the main expenditures will be, and how these expenditures can be covered through funding.

It is also important to create a budget to cover the first year of trading, setting out expected incomings and outgoings. This will include both capital expenditure and income generated from


Table 8.3 Business expenditures

ExpENDITurES £

Rent of premises for three months 1200

Purchase of equipment 2000

Fixtures and fittings 1000

Advertising and promotion 1000

Purchase of supplies to start trading

1000

Pre-start up admin costs and salaries

2800

Totalstartupexpenditures 9000

Covered by:

Owner’s capital 5000

Bank loan 4000

Note that while the business is able to match incomes with outgoings in the first month – it rapidly runs into a position where it is not generating enough income in following months. This is where the small business will rely on its overdraft or credit card to see itself through this difficult period.

You can see from these figures that the business is increasingly having to draw on its overdraft to cover the negative balance from operating. This is while it waits for custom to pick up. You can see that by June the rate of increase of the negative balance is starting to slow down – partly because sales are picking up.

January February March April May June

Income

Owner’s capital 5000

Bank loan 4000

Sales 1000 1000 1000 1500 1500 2000

Totalincome 10000 1000 1000 1500 1500 2000

Outgoings

Supplies 1000 1500 1500 1500 1500 1500

Rent 1200 1200

Equipment 2000

Fixtures & fittings 1000

Advertising 1000

Admin 2800

Wages 600 1000 1000 1000 1000 1000

Totaloutgoings 9600 2500 2500 3700 2500 2500

Income–outgoings 400 (1500) (1500) (2200) (1000) (500)

Balancecarriedforward

400 (1100) (2600) (4800) (5800) (6300)

Note that negative figures are shown in brackets.

Table 8.4 Budget for first six months of trading (£)

Key term

Balance. The sum remaining when outgoings have been deducted from a previous balance and income.

2� GCe A2 level BUsiness for edexCel

You can see that by the end of the 12-month period the business is planned to be moving into a position where the negative balance is starting to disappear. The next turning point will be when break-even is achieved, and then the business will move into a profitable phase. That is the plan – as set out in the budget.

Variance analysisCreating a budget enables the business owner to get much greater control over the development of their business. The tool to do this is variance analysis. A variance is the difference between the planned (budgeted) figures and the figures that actually materialise.

To do this you would set out a chart with two columns for each month. In the first month you

July August September October November December

Income

Owners capital

Bank loan

Sales 2000 2500 3000 3500 4000 4000

Totalincome 2000 2500 3000 3500 4000 4000

Outgoings

Supplies 1600 1700 1800 1900 2000 2000

Rent 1200 1200

Equipment

Fixtures

Advertising

Admin

Wages

Totaloutgoing 2800 1700 1800 3100 2000 2000

Incomings–outgoings

(800) 800 1200 (400) 2000 2000


(7100) (6300) (5100) (5500) (3500) (1500)

Table 8.5 Budget for second six months of trading (£)

Learning activity

Create a budget anticipating the finance required and the expenditure involved in setting up your business. Then create a budget for the first 12 months that your business is in operation. The important thing is to make sure that your budget is realistic. You therefore need to create a set of supporting notes to justify the figures that you have created. For example, you can demonstrate that the figures for rent have been calculated by working out the square footage required for your business and then finding out the rental cost from an estate agent. You can justify your sales figures by carrying out market research to get a figure for the demand for your product. Equipment costs can be calculated by researching businesses of a similar size or type and the costs involved, and by doing Internet searches to find out capital equipment costs, etc.


Table 8.6 Budgeted and actual figures

JAN (buDGETED fIGurE) JAN (ACTuAl fIGurE) % vArIANCE

Income

Owner’s capital 5000 5000 0

Bank loan 4000 4000 0

Sales 1000 500 –50%

Totalincome 10000 9500 –5%

Outgoings

Supplies 1000 1000 0

Rent 1200 1200 0

Equipment 2000 1800 +10%

Fixtures and fittings 1000 1200 –20%

Advertising 1000 1000 0

Admin 2800 2800 0

Wages 600 600 0

Totaloutgoings 9600 9600 0

Incomings–outgoings 400 (100)


400 (100)

would put the budgeted figures. In the second column you would put the actual figures. You could then add a third column to show percentage variance. Where there are high percentage variances it is important for managers to take

loan for the first three months after the loan is taken out.)

You can see that the variance analysis indicates a problem in that sales in January are not as high as expected – in fact the actual figure is only 50 per cent of the budgeted one. Clearly, this could be a problem if it continues into succeeding periods. Management may need to take action to deal with this, such as spending more money on advertising and promotion. In terms of outgoings, equipment has been less costly than expected. However, this is balanced by a higher than

actions to stop the variances getting out of control.For example, if we take the budget for January for

Super Sandwiches – it could be set out as follows:(Note that we are assuming that the business does not have to make any repayments on the

expected charge for fittings. Management would need to note this but not necessarily take any action at this stage.

Working capitalAll businesses need to have workingcapital. Working capital is the difference between the income that will flow into the business in the short term and the pressing debts that will need to be paid in the short term.

For example, a business like Super Sandwiches will have pressing short-term liabilities that it


has to pay, such as bills to suppliers for bread and other ingredients (which it may buy on credit terms). To meet these pressing liabilities the business will have short-term assets which it can turn into cash. For example, it will have cash in its tills and it will be owed money by debtors, for example, where it has carried out catering contracts for business and other functions.

are likely to be short of cash. If you run out of cash completely the business will not be able to operate.

Break-even.It is important to be able to forecast when the business will be able to cover its costs with its revenues – the break-even point. The sooner that this is reached the more likely you are to be able to borrow money, because once you have reached this point you can start to make a profit.

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It is important to have this working capital, and you need to calculate how much working capital you need each month to enable the business to survive and develop.

Many small business people tend to think of their overdraft facility and credit card to be part of their working capital. However, you need to be careful because, although using a credit card gives you access to funds, you are also building up a corresponding liability (with interest on top).

Forecasts for cash flow and break-evenWhen you forecast, you are making a statement of what you expect to happen based on some sort of research to support your forecasts. Two important financial areas to forecast are described below.

Thecashflowinandoutofthebusiness.All businesses need cash – it is the oil that keeps the wheels of business turning. You need to know when cash is coming in and when you

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Did you know?

A number of businesses have suffered from cash flow crises. Good examples are transport companies that have run out of cash and not been able to put fuel into their vehicles – leading to a loss of confidence in the business. Other examples are football and other sports clubs which have run out of cash so that they are unable to pay their players’ wages.

Cash flow forecastWhen you construct a cash flow chart it is important to remember that the cash flow relates to actual cash coming in and out of a business. This flow therefore needs to be forecast for when the cash is received. For example, if you make a sale in January but are only paid for it in March – then the cash flow should be recorded in March.

The cashflowforecast shows how much cash is being generated in a particular month and the cumulative cash generation over time.

Key terms

Current assets. Things that a business owns that can be turned into cash in the short term, such as stock or debtors.

Current liabilities. Things that the business owes in the short term, such as goods bought and not paid for, or loans borrowed that must be paid back.

Working capital. Current assets of the business minus current liabilities.

Key term

Cash flow forecast. A technique for estimating the future bank balance of a company and anticipating overdraft requirements.

We can illustrate this by setting out a simple cash flow forecast for a small business engaged in a retailing activity. The forecast opposite shows the first three months of trading.


Table 8.7 Cash flow forecast

JANuAry fEbruAry mArCH

Openingbalance 0 1070 1550

Income

Cash sales 800 1000 1000

Received from debtors 100 300 300

Loans 3500

Totalincome 4400 1300 1300

Outgoings

Wages 25 25 25

Insurance 20 20 20

Materials 100 100 100

Repairs 15 15 15

Telephone 40 30 –

Drawings 600 600 600

National insurance 30 30 30

Capital expenditure 2500

Totaloutgoings 3330 820 790

Netcashflowi.e.Incomings–outgoings

1070 480 510

Closingcashbalance 1070 1550 2060

point for your business idea. Ideally you will need to justify a forecast which goes well beyond the break-even point (at least in the second and third year of trading). Break-evenanalysis shows how a business will cover costs or make a profit/loss at different levels of operation.

Breaking evenAny business that fails to cover its cost will find itself going down a slippery slope. Breakingeven is therefore an important business objective, and one that ensures survival at least in the short term. You will need to calculate the break-even

Learning activity

Create a cash flow chart for your business idea for the first 12 months of trading. Base your cash flow forecasts on appropriate research, e.g. insurance costs from an insurance company, national insurance from official figures (i.e. a percentage calculation), etc.

Key terms

Break-even analysis. Comparison of a firm’s revenue and its fixed and variable costs, to identify the minimum sales level needed to break even; it can be shown on a break-even chart.

Breaking even. Making sure costs are covered.


Let’s look at this by examining how a fictional business (Exotic Sandwiches) can break even. Exotic Sandwiches sells one main type of luxury jumbo sandwich, which costs £2 to produce. The costs that go directly into making each luxury sandwich include:

raw materials – wholemeal bread, mango, chives and spices

staff wages – which are based on how many sandwiches each employee sells.

The sandwiches are sold for £3 each. On the face of it, it seems that the business is making a profit of £1 on each sandwich sold (£3 – £2).

However, we haven’t accounted for all the costs yet. So far we have only accounted for what we call variablecosts – how much it costs directly to produce each sandwich. These are called variable costs because they vary directly with the numbers of items produced or sold:

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However, we haven’t included the overhead or fixedcosts, which are the costs of running the business, regardless of how many sandwiches we produce.

These overheads include the rent on the shop, local business taxes, fuel bills, insurance, the manager’s salary, and so on. That window smashed last Friday night has to be paid for somehow! Let’s say these overheads or fixed costs add up to exactly £20,000 per year. The business

Figure 8.4 Calculating contribution

Key terms

Fixed cost. A business cost that does not vary with the level of output or sales.

Variable cost. A cost that increases with the level of output or sales, e.g. the cost of ingredients in producing chocolate bars.

Key terms

Contribution. The financial contribution that each unit of an item sold makes towards paying off the fixed costs of a business. For example, if the variable cost of producing a chocolate bar is 10p and the chocolate bar is sold for 40p, each bar is contributing 30p (revenue – variable cost = 40 – 10 = 30).

Overheads. Costs that do not change when the firm sells more, and are not incurred by a specific department of the company, e.g. rent.

vArIAblE COST

1 sandwich £2

2 sandwiches £4

3 sandwiches £6

has to sell enough sandwiches to cover these fixed costs too, or it will make a loss.

As we saw above, every luxury sandwich sold brings in (or contributes) £1 towards covering the overheads. This £1 contribution comes from the sale price of £3 less the variable cost per sandwich of £2.

Sale price per sandwich £3

Variable cost per sandwich £2

Contribution per sandwich £1


The business therefore has to sell 20,000 sandwiches per year to cover all of its fixed costs (£20,000 ÷ 1 = 20,000 sandwiches).

If the business is open for 50 weeks in the year (being closed for two weeks’ holiday) this means that 400 sandwiches will need to be sold each week (20,000 ÷ 50 weeks). As long as Exotic Sandwiches sells 400 sandwiches on average each week, it will be safe!Break-even analysis can be converted into a formula or rule that goes like this:

Break-even sales = fixed cost ÷ contributionAnother way of expressing this is:

Break-even sales = overhead ÷ contribution

In this case: Break-even = £20,000 ÷ (£3 – £2 =£1) = 20,000 sandwiches

Let’s try these calculations again with a different business example. Imagine you run a hairdressing salon and charge £15 on average for each haircut. If the cost per haircut in terms of staff wages and materials is £5 and annual overheads are £50,000, how many haircuts do you need to do each year in order to cover your total costs and break even?

Answer:Overheads ÷ contribution = £50,000 ÷ £10 = 5000 per year

If we assume again that your business operates for 50 weeks a year, then you need to provide 5000 ÷ 50 = 100 haircuts each week (on average) to break even.

buSINESS AvErAGE CHArGE Or SAlE prICE

COST pEr uNIT fIxED COST brEAk-EvEN SAlES lEvEl

Taxi driver £10 £5 £25.000

Beauty salon £12.50 £5 £100,000

Recording studio £25 £7.50 £50,000

Table 8.12 Price, costs and break-even

Use the break-even formula to work out the weekly break-even sales for the following examples, assuming each business operates for 50 weeks per year. You may need to use a calculator. There are three key pieces of information we will be using: fixed costs, variable costs per unit and sale price per unit.

1 A taxi driver charges an average of £10 per trip, with a cost per trip of £5 and has fixed costs of £25,000 per year.

2 A beauty salon charges an average of £12.50 per visit, with a cost per visit of £5 and has fixed costs of £100,000 per year.

3 A recording studio charges £25 per studio hour, with a variable cost of £7.50 per studio hour and fixed costs of £50,000 per year.

This information can be summarised in the following table:

Break-even analysis can also be shown on a chart produced either manually or on a computer using a program like Microsoft Excel. We can do this manually by using a sheet of graph paper and

plotting sales on the horizontal axis, and costs and revenues on the vertical axis. The numbers to plot can be illustrated by the table below for Exotic Sandwiches.

Learning activity


We need to plot sales per week up to 800 on the horizontal axis and cost/revenue figures up to £120,000 per year on the vertical axis (see Figure 8.5). This will allow us to draw the following line graphs against weekly sales of 100–800 sandwiches:D:Annual fixed costE: Annual total costs = C + DG:Annual total revenue = A × 3 × 50You can draw all these lines by mapping the figures in each column against the right sales level.

Let’s start with annual fixed costs (line D). We know that these are £20,000, however many sandwiches are made and sold. We can therefore plot these as a straight line at £20,000.

Now we can plot annual total cost (line E). Total cost is made up of two parts – total fixed cost (which we have already drawn) and total variable cost. The variable cost is £2 per sandwich. We can therefore plot the total costs as a diagonal line starting at £20,000 and rising at £10,000 for every 100 sandwiches sold each week. For 100 sandwiches, total cost = £20,000 of fixed costs + £10,000 of variable costs (100 sandwiches × £2 × 50 weeks).

Now let’s take line G (sales revenue). Where sales = 100, plot revenue of £15,000 and mark a small × on the graph paper. Where sales = 200, plot revenue of £30,000. Keep going for the rest of the revenue figures compared to sales and then join all the points up to create a line graph.

We can now illustrate profit or loss at any level of sales. This is simply G (total sales revenue) –

E (total costs) at any level of sales.Once you have drawn all the lines you can see:

that the most profitable level of sales is 800 per week

that the break-even sales level which must be met to avoid making a loss is 400 per week

the way in which total costs and total revenue change as sales rise

the profit-making zone, where the total revenue line is higher than the total costs line (this is where sales are higher than 400 per week)

the loss-making zone, where the total revenue line is below the total costs line (this is where sales are less than 400 per week).

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Learning activity

Create a break-even chart for your business idea. You will need to calculate sales revenue at different levels of output based on the price that you expect to charge. You will then need to calculate and illustrate variable costs and fixed costs based on figures that you collect from researching costs of operating your business. You can then use Microsoft Excel to create a spreadsheet which illustrates all of these figures and enables you to calculate break-even. When do you expect to break even? How much do you need to sell to break-even?

A B C D E F G HSales output in sandwiches per week

Variable costs per week at £2 per sandwich

Annual total variable cost (per 50 week year)

Annual fixed costs at £20,000 regardless of sales

Annual total costs (=total variable costs + fixed costs)

Sales revenue per week at a price of £3 per sandwich)

Annual total revenue (= weekly revenue × 50)

Annual profit or loss (annual total revenue minus annual total cost)

100 £200 £10000 £20000 £30000 £300 £15000 –£15000

200 £400 £20000 £20000 £40000 £600 £30000 –£10000

300 £600 £30000 £20000 £50000 £900 £45000 –£5000

400 £800 £40000 £20000 £60000 £1200 £60000 £0

500 £1000 £50000 £20000 £70000 £1500 £75000 £5000

600 £1200 £60000 £20000 £80000 £1800 £90000 £10000

700 £1400 £70000 £20000 £90000 £2100 £105000 £15000

800 £1600 £80000 £20000 £100000 £2400 £120000 £20000

Table 8.9 Costs and revenues



Output in sandwiches per week

Cost

s an

d re

venu

es

0

£10,000

£20,000

£30,000

£40,000

£50,000

£60,000

£70,000

£80,000

£90,000

£100,000

£110,000

£120,000

£130,000

0 100 200 300 400 500 600 700 800

Annualfixed cost

(G) Sales revenue

Break-even level ofsales = 400 per week (A)

E) Annual total cost

(D)

Loss-making zone

Figure 8.5 Break-even chart

Projected profit and loss accountsThe calculations that you have built into your break-even chart should provide invaluable information for setting up projected profit and loss accounts for the first year of trading. You can also consider how the business will look in three years time by forecasting what you expect to happen to costs and revenues during this period. For example, will you be likely to alter your pricing structure in the second and third years and what extra costs will you incur? If you increase the scale of your production will variable costs fall because of economies of scale?

A forecast profit and loss account enables you to estimate the sales revenues that will flow into your business and the costs directly associated with this activity. For example, if you sell a sandwich for £3 and it costs you £2 in direct materials and direct labour to produce it then that sandwich will make a £1 contribution to paying off expenses such as loan repayments, electricity bills, etc.

Using the outline shown on page 34, it is possible to set out a projected profit and loss account. Target figures for revenues and costs can be placed in each month. Do this for your business over a 12-month period using a spreadsheet.


To create your profit and loss account, follow the steps below.1 Calculate your forecast sales revenue:

price charged × number of items expected to be sold.

2 From this, deduct your cost of sales. Your cost of sales are the costs which can be directly calculated for each item prepared for sale. For example, if you are producing sandwiches then the cost of buying in the bread and filling will be the cost of sale.

3 Calculate the gross profit: sales revenue – cost of sale.

4 From the gross profit, deduct the expenses. The expenses you incur depend on the type of business you are in, but typically include such things as interest on loans, rent and rates, etc.

5 Calculate the operating profit: gross profit – expenses.

6 From the operating profit (or loss), deduct taxes.

Start-up balance sheetsA balancesheet is a list of all the assets (what the firm owns or is owed by others) and liabilities (what the firm owes).

For a small business that is starting up, these assets will typically be fixed assets and current assets.

Learning activity

Create a forecast profit and loss account for the first year of trading for your business. Also produce a forecast profit and loss account for the first three years of trading. Explain the assumptions you make about such things as the sales you expect to make (show how they are based on market research). Show how you have calculated costs. Use literature available from the Inland Revenue to calculate the tax that will need to be paid on profits.

Jan£

Feb£

Mar£

Apr£

May£

Jun£

Jul£

Aug£

Sep£

Oct£

Nov£

Dec£

Sales

– Cost of sales

Grossprofit

Less:expenses

Electricity

Stationery

Business rates

Loan interest repaid

Depreciation

Marketing expenses

Training

Advertising

Other expenses

Operatingprofitorloss

– Tax

Operatingprofitaftertax

Table 8.10 Forecast profit and loss account


Fixedassets include land and buildings, plant and machinery, fixtures and fittings. These assets help the business to create wealth. Typically you will not sell your fixed assets – you will use them to generate earnings for you.

Currentassets are assets that the business will convert into cash in the short period. For example, current assets include items waiting to be sold, money owed to you for items sold on credit or for services rendered and, of course, cash itself.

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These assets appear in the top half of your balance sheet.

The bottom part of the balance sheet shows the liabilities of the business (what the business owes) and the owner’s capital (what is owed to the owner(s) of the business).

Assets– what the business owns or is owed.

Liabilities – what the business owes to outsiders

Owners’capital – what the business owes to the owners

Liabilities are typically broken down into short-term liabilities and long-term liabilities.

Short-termliabilities(currentliabilities) are liabilities that need to be paid back in under one year, e.g. repayments to those that have supplied you on credit, your overdraft, etc.

Long-termliabilities are liabilities that need to be paid back, but in over a year, e.g. mortgages and loans.

You could set out the start-up balance sheet of your business as shown below. There are three columns to help you do your calculations. However, you do not have to use three columns. You could set out your balance sheet using two or even one column.

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The overall structure of the balance sheet therefore is:

Balance sheet of my business as at … … … … … [put starting date here]

(£) (£) (£)Fixed assetsBuildings 100000Furniture 20000Fixtures and fittings 10000

_______130000

Current assetsStock 5000Debtors 500Cash 1500

_______7000

Current liabilitiesOverdraft 1000Working capital 6000

_______136000

Less long-term liabilities 56000Owners’ capital 80000

______________

Figure 8.6 Balance sheet template

Key term

Balance sheet. Account setting out the assets and liabilities of a business at a particular moment in time as well as the owners’ capital.


Learning activity

To create the balance sheet outlined on page 35, we first set out the fixed assets of the business. We put this figure in the first column.

We then calculated the current assets (stock + debtors + cash). We put this figure in the middle column as a sub-total.

We then worked out the short-term liabilities of the business. This consisted of a £1000 overdraft and again we put this in the middle column as a sub-total.

We then worked out the working capital of the business.

The working capital is the current assets minus current liabilities. This showed the money that would come into the business within the short period and the money that would flow out. It is important to have working capital to meet pressing

Create a start-up balance sheet for your business. Justify the realism of the figures that you have chosen. You can use the template set out below:

demands such as to pay wages and bills.We put the figure for working capital (£6000)

in the end column – a total column because it is such an important figure.

We then needed to deduct long-term liabilities of £56,000 so again we put them in the right-hand column.

The final figure is the sum of money that the owners have put into the business (£80,000).

A balance sheet will always balance because of the simple accounting equation:

assets = liabilities + owners’ capitalIt makes sense when you think about it – you can only buy assets with the money that you, the owners, have put into the business and any other debts that you have built up, such as in loans and overdrafts.

Balance sheet for ……………………………………………………… as at …………………

(£) (£) (£)Fixed assetsBuildingsEquipmentFixtures and fittings

Current assetsStocksDebtorsCash

Current liabilitiesOverdraftTrade creditCurrent liabilities

Working capital

Less long-term liabilitiesBank loanOther

Owners’ capital


8.4 Feasibility and evaluationToo many business ideas fail because of poor planning, lack of foresight and poor cash flow management, not just because they were bad ideas in the first place.

External scrutinisersPeople who have

or who are likely tolend the business

money

The Business Plan

Internal scrutinisersThe owners of thebusiness, the soletrader or partners

‘what if’ scenarios based on the information already gathered

a projected position for three years’ time based on the scenarios chosen

alternative ideas.

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Key term

Scenario. A ‘what if’ situation. A situation that can be imagined to happen.

There is a need to plan well, and a need to look at how things could change if plans are not successful or if other factors change. You will need to consider:

evaluation of the business plan at the end of the year

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Business plans need to be scrutinised by two groups of people:

Figure 8.7 Who needs to evaluate the plan?

Did you know?

When the authors of this book carried out research into problems faced by young people setting up their own businesses, they found that typical difficulties included:

failure to create a business plan

failure to research the market

running out of cash to pay ongoing bills

trying to expand too quickly

not understanding that they would have to pay certain costs, e.g. business rates.

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Businesses fail due to poor planning


To make it easy for the business plan to be analysed and evaluated, it needs to have the following characteristics.

Clearlysetoutandattractivetotheeye. A modern business plan should look good and the reader should be able to find his or her way around the various sections of the plan with ease. The plan, therefore, needs to use state-of-the-art desktop publishing techniques, including spreadsheets, tables and charts.

Systematicallyorganised. The plan should be set out in clear sections that include all the relevant information. There should be a table of contents at the start of the work, and related pieces of information should be grouped together, e.g. financial information, marketing information, etc.

Nottoolong. Readers of a business plan want to find their way round quickly, and check that the relevant information is set out in a convincing way. The reader who cannot quickly track down the market research information, the cash flow projection, profit projections, etc. will become frustrated and may even begin to wonder if the sheer volume of information may be masking real weaknesses in the business.

People who lend businesses money or who become involved as part owners, tend to take a pretty hard-nosed view of whether to get involved with a specific business or not. Some of the questions they will be seeking the answers to when they invest in or lend money to a business are set out below.

Will the business use my capital in an efficient way – so that there is a good rate of return on it relative to alternative investment opportunities?

Will the business make a healthy profitmargin indicating the business plan is sound?

Will the business reward us adequately for the risk we are taking in tying up funds with it – as well as be able to repay the initial investment if the need arises?

How large a share of the market will the organisation be able to command? The larger

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the market share, the more opportunity the organisation may have to develop competitive advantage over its rivals.

Key term

Profit margin. The difference between revenue and costs expressed as a percentage of the total revenue.

Of course, anyone lending money to or putting money into a business should be aware of the risks involved. A business plan is simply that – a plan. A well-thought-out plan enables a business to step out with confidence. It does not, and can never, guarantee business success.

Evaluation of the business position at the end of a yearIn setting up a business plan for a new business, it is important from the outset to be able to consider how effective the plan has been and how effectively the business ran. In other words, you need to identify ways in which you will evaluate the business position at the end of the year, and even three years ahead. You therefore need to establish expected targets to work towards. You can then evaluate the success of the business in meeting these targets.

For example, you will need targets relating to such things as:

when you expect to break even

monthly and yearly sales targets

marketing targets, e.g. percentage of market share

profit targets (profit margin targets)

targets for how much return you would like on your investment (return on capital employed)

cash flow targets.

This section encourages you to think about the targets that you can set for your business which can be used to evaluate performance at the end of the first (and third) year.

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CASE STUDY


The Wind Surf School

yEAr 1

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Fixed cost

Variable cost

Sales revenue

Profit/ loss

yEAr 2Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Fixed cost

Variable cost

Sales revenue

Profit/ loss

Jane and Julian wanted to try something adventurous when they left university. So they

set up a windsurf school to teach people wind surfing in Lanzarote (in the Canary Islands). They chose Lanzarote because it offered lots of custom from holiday makers. In addition, because of the good weather, it would enable them to operate almost all year round. They calculated that the fixed cost of setting up the windsurf school and other fixed costs for the first year would be about £50,000, including all the equipment they wanted to buy and the fixed costs involved with choosing appropriate premises.

They carried out market research to find out how much customers would be prepared to pay, as well as looking at prices charged by competitors in the resort where they had chosen to set up. They found that they could charge about £20 per hour. They calculated that, in a typical month, the overall market size in their resort would be 4000 rental hours. (in other words

4000 one-hour lessons). They calculated that they would be able to take 10 per cent of this market in the first year, and 20 per cent of the market in the second year, when they were better known, had developed better marketing and word of mouth had spread about their superior service. They calculated that variable costs per hour, including the cost of instruction would be £10 per hour. In the second year of operating the business, they would incur an extra £5000 of fixed costs when new equipment was purchased in January.

QuestionsUsethefollowingtemplatetoworkout:

theexpectedbreak-evenpoint(whenthiswouldoccur)anyprofitsthatthebusinesswouldexpecttomake,andwhentheywouldoccur.

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Some important aspects of evaluating business performance at the end of the first year are set out below.

How effective was the market research? Did it provide an accurate picture of what consumers were looking for?

Did we capture the share of the market that we expected?

Was the promotional mix appropriate and effective?

Did we get the marketing mix right? Are there new aspects of the marketing mix that we could develop, e.g. new products, new distribution channels, etc.?

Did we manage to break even as anticipated, are we near the break-even point?

How accurate was our budgeting?

What is our cash flow position? Do we have enough cash?

What are our prospects for making profits?

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Return on capital employedThere are various ways of using quantitative measures to judge the success of your business, including:

the figure for capital employed is usually taken at the start of the year, as this is the capital that generated the profit in the yearthe capital invested in a business is the owners capital + external capital invested in the business, e.g. loans.

There are two methods that you can use for calculating capital employed:

1 Thesourcesoffinanceapproach:Owners capital+ finance creditors, e.g. loans, overdraft, etc.– cash

2 ThenetassetsapproachFixed assets+ stock+ debtors

The best way to think about the percentage return on capital is to compare it with other investments.

If I invest £100 in a building society and earn £10 in interest in the year, the return on capital is 10 per cent.

If I put £100 into my own business producing biscuits and earn £11 profit in a year, then the return on my capital is 11 per cent.

In setting out a business plan, therefore, you need to convince potential backers (and yourself) that the return on capital will be relatively more attractive than alternative investment opportunities. Of course, another ingredient is the reliability of the return. If people reading your business plan feel your figures are just ‘pie in the sky’, they will not risk their money with you.

Return on capital employed (ROCE) can be measured using the following formula: Profits before interest and taxROCE = ___________________________ × 100 Capital employed

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Learning activity

Prepare a framework for evaluating your business idea at the end of the first year. Set out a list of questions to ask and a set of criteria for judging its effectiveness. For example, if you wanted to find out what percentage of the market you had gained at the end of the first year, you should decide what percentage of the market would be acceptable. What would be good and bad performance?

Find out more

Find out more about starting your own business from one of the following:

Department for Trade and Industry (DTI) www.dti.go.uk/bestpractice

Business Gateway www.businessgateway.com

Business Link www.businesslink.gov.uk

Shell LiveWIRE www.shell-livewire.org

Smallbusiness.co.uk www.smalbusiness.co.uk

Startups.co.uk www.startup.co.uk

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CASE STUDY


Key term

ROCE. Return on capital employed. Profit measured as a percentage of the capital ploughed into a business by owners and in the form of loans and other types of capital injections.

Profits at TescoThe following figures show a summary of key financial indicators for Tesco from 2000 to 2004.

Profit margins Profits is a key indicator when judging business performance. It is the first point of reference for many lenders. It is all very well saying sales have risen, productivity is soaring and the organisation is growing. However, providers of finance will always want to know the answer to the question: ‘But have you made a profit?’

In creating a business plan, the entrepreneur should set out a projected profit and loss account. This account will set out a number of profitability targets as shown in Table 8.11.

Useful ways of calculating profit are gross profit and operating profit margins. In the Table 8.11, you can see the person who created the business plan anticipated gross profit percentages would rise from 33 per cent to 60 per cent over the first three years, while operating profit margins would rise from 0 per cent to 40 per cent over the same period.

Year ended February 2000 (£m) 2001 (£m) 2002 (£m) 2003 (£m) 2004 (£m)

UK turnover 16808 18203 19821 21309 24760

Operating profit (UK) 993 1100 1213 1297 1526Source: Tesco Website, Financial Information

Questions1CalculatetheoperatingprofitpercentageforTescoineachofthefiveyearsshown.2SuggestwaysinwhichfinancialmanagersatTescocouldseektoimprovethisperformance.

333 3Evaluatethetrend.Isitgoodorbad?333 4ProposeasetofideasforacompanythatisarivaltoTesco,whichmightenableittosteal

marketsharefromTesco.

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Learning activity

When you initially create your business idea calculate the ROCE. Explain the assumptions behind this calculation, i.e. show how you worked out the capital employed and the basis on which your profit calculations are estimated. If you run a business for a year at the end of it you will need to show how ROCE was calculated. Did it meet expectations? If so, explain your workings. If not, explain what went wrong.

You can see that both turnover and operating profit have increased. However, a more useful indicator is operating profit percentage, i.e. operating profit as a percentage of sales. When you do this calculation you will be able to see the

operating profit for each £1 of sales made in the five years.Operating profit percentage is calculated by: Operating profit 100 ______________ × ___ Turnover 1


SWOT analysisAnother useful tool to evaluate your business at the end of the first year is to do a SWOTanalysis.

StrengthsandWeaknesses are internal to the business. They typically relate to the resources of the business (e.g. finance, people, management). Strengths also relate to the quality of the planning and the strengths of the products (goods and services) that the business provides. Another strength or weakness is the position that the business holds in the market, e.g. is it the market leader or just a small insignificant player?

OpportunitiesandThreats typically relate to the market (e.g. is it growing) and to the competition (e.g. do they offer superior products?). Opportunities and threats also relate to some external environmental factors, such as new government laws, development of new technologies, etc.

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However, the reality for most businesses is that, for the first few months of running a business, losses will be made because:

it takes time to publicise a business and its products to generate sales

the start-up costs of a business usually outweigh early sales.

The gross profit margin shows the gross profit made on sales: Gross profitGross profit margin = ______________ × 100 Turnover (sales)

In evaluating whether 5, 10, 15 or 20 per cent would be a suitable gross profit margin, you would need to compare it to returns made on similar start-up businesses.

The operating profit margin shows the operating profit expressed as a percentage of turnover. It is a measure of the business owners’ ability to control indirect costs, and operating profit equals gross profit minus overheads: Net profitNet profit margin = __________ × 100 Turnover

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2007 2008 2009

Turnover 3000 4000 5000

Cost of sales 2000 2000 2000

Gross profit 1000 2000 3000

Grossprofit% 33 50 60

Expenses 1000 1000 1000

Operating profit 0 1000 2000

Operatingprofit% 0 25 40

Table 8.21 Calculating profit margins

Learning activity

Before you start off a business activity you should forecast gross profit margins and operating profit margins at the end of the first year. If you run your business for a year, you can then compare actual performance with forecasted/budgeted performance. What went right and what went wrong? Use your figures to answer this question.

Key term

SWOT analysis. Analysis of an organisation and its external environment to assess its internal strengths and weaknesses, and the opportunities and threats that exist in its operating environment.


CASE STUDY

Example SWOT analysisJulia set up as a fitness trainer last year. She hires out the local leisure centre to run aerobics and other classes. At the end of the first year she set out a SWOT analysis to evaluate how her business was progressing. On the basis of her SWOT she created an action plan to build on the strengths, reduce the weaknesses, take advantages of opportunities and combat threats.

ActionplanThese are the key areas that Julie included in her action plan:

1 Investigate possibility of taking on a part-time partner

2 Invest in new sound equipment

Strengths

Good capital base to set up the business

Lots of regular clients

High percentage gained of intended market

Good locations to operate from

Carried out detailed research to find out musical requirements of clientele

Classes always fully booked

Good promotional activity

Exceeded targets for profitability and return on capital employed

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Weaknesses

Had to cancel some classes because of double-bookings to leisure centres

Poor-quality sound systems

Had to cancel classes due to illness in December

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Opportunities

New leisure centre facility opening up early next year

Possibility of providing some classes at local college

Growth in the market of 10 per cent per year

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Threats

Two new rival competitors setting up in the new year offering a wider range of classes

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3 Increase promotional activity to differentiate product from competitors

4 Develop loyalty schemes to retain existing customers

5 Investigate possibility of winning contracts with new leisure facility


A projected position for three years’ time based on the scenarios chosenIt is difficult for businesses to plan in detail for more than a year ahead. Large businesses do it in the form of strategic (business) plans which are for three, five and even more years ahead. In a small business that is starting up this is particularly difficult. Any plans that you make for the future should therefore be tinged with caution. However, using scenarios that you build (realistic, pessimistic and optimistic ones) you can make some form of projection about what your business will look like three years ahead. For example, what position will it have in its market (e.g. market leader, small player, etc)? What sorts of sales revenue will it make? What about profits – will they rise steadily over the three years? Will the business be likely to diversify into new lines?

You should be able to identify at least three positions from the scenarios developed:

1 Themostlikelysituation. This should be based on your market, production and financial research. From these you should be able to predict the most likely situation and

Learning activity

Create a SWOT analysis to evaluate the performance of your business after one year or after a period of trading. Produce an accompanying action plan related to it.

‘What if’ scenariosThe actual running of a business frequently turns out to be different to what is planned. There are all sorts of things that can happen that would move the business off plan. For example:

sales could be higher or lower than expected

costs could turn out to be higher or lower than anticipated

the competition could prove to be stronger or weaker than expected.

In setting up a business, therefore, it is important to anticipate a range of ‘what if’ situations, and to plan for them. For example, what if a new competitor undercuts my prices? What is the implication for my business and what should I do about it?

The giant oil company Shell developed an approach from the 1970s onwards known as ‘scenario planning’. This involves imagining a range of scenarios for the oil industry – e.g. there is a long cold winter, there is a war in a sensitive part of the world, the government creates tougher environmental laws, etc. Shell is then able to make what are termed ‘contingency plans’ to prepare for a range of eventualities so that it isn’t taken by surprise.

In carrying out your research you will gather information. For example:

market research (information about the market)

competitor research (information about competitors)

cost research (information about supply conditions).

Carrying out this research should make it clear that you cannot predict future events with absolute certainty. For example, consumers say

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they are likely to buy a given number of your product at a certain price. However, you don’t know that they will – until they have actually made the purchase. You should, therefore, create some ‘what if’ scenarios – e.g. what if sales are 10 per cent less than expected? What if costs are 10 per cent higher than expected?

Learning activity

Create some ‘what if’ budgets for your business based on assumptions about demand and cost conditions being different from what you have expected. For example, ‘what if demand is 10 per cent lower and costs 10 per cent higher than expected?’ You should be able to work out the implications for break-even and profits. Given these ‘what if’ scenarios you should be able to identify alternative courses of action to take.


you will have already created budgets, cash flow statements, profit and loss accounts and balance sheets for this situation.

2 Apessimisticscenario. This is a situation in which the competition proves to be tougher than expected, and the market more difficult to penetrate. Costs will be higher than expected. Using these pessimistic predictions, calculate a break-even point and show what the profit and loss account will look like in three years time. Explain the pessimistic assumptions that you have made for this scenario.

3 Anoptimisticscenario. This is a situation in which sales revenue is higher than expected and your business wins more market share than anticipated. Calculate the break-even point and show what the profit and loss account will look like in three years time. Explain the optimistic assumptions that you have made for this scenario.

You should anticipate possible changes that might take place in the business environment and explain these. Possible changes could be changes in the market and economic conditions and new legal or environmental requirements coming into force.

Alternative ideasIf you follow up the ideas and learning activities in this unit you will be well placed to create an effective business plan for a business idea and to create systems to monitor and control the business over time.

Did you know?

The soft drink 7Up was launched on six previous occasions. Each time it failed – until the seventh time, when they chose the name 7Up–and the rest is history.

Learning activity

Set out some alternative ideas:

1 for tackling problems which are causing a business plan to go off track

2 for new business ideas that could be developed should an original business idea fail.

What do you do if the business plan fails? You need to show that you have alternative ideas to deal with this situation. You need to have ideas about what you can do if you are falling short of your plan. For example, to raise sales revenue, you could take actions such as:

reducing or raising price

spending more money on advertising and promotion

offering better terms and service to customers.

To lower costs, you could take actions such as:

moving your business to a lower-cost location

buying stock from a cheaper supplier

cutting down on waste.

If the business is a failure, then you need to have other ideas, such as producing a new good or service.

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UnIT ASSESSmEnT

If you carry out the tasks set out in the learning activities in this unit and follow the suggestions provided you will be well on your way to completing your unit assessment.

What you are required to (individually) produceA fully developed business plan for the establishment of a new small business operating as a sole trader or partnership to cover:

aims and objectives

a marketing plan

resource issues

financial analysis and planning.

The plan will be presented as a viable business idea, suitable to support a request for finance for the venture.

What you need to include in your work to score higher marksDetailed and original ideas with fully supported and justified evidence and proposals

Detailed and original information on competition

A comprehensive presentation of resource and quality issues with fully supported and detailed evidence

A detailed and professionally presented finance plan, with accurate and detailed financial forecasts, including break-even calculations, cash flow, budgets, profit and loss accounts and balance sheets

A detailed analysis and evaluation of the current and projected future position of the business with detailed and original recommendations and justifications of your conclusions

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business development unit - pearson schools - teaching resources

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