Business Studies (Unit 1)

Entrepreneurs

- People who take existing businesses into a competitive market- People who take calculated risks to start a business because of their belief in the product or service

that they have developed- People who start a business and then use similar ideas or names to start another

Entrepreneurs are usually creative, patient, determined, resilient and passionate about their ideas. They often receive Government grants to help and encourage them set up a business.

Entrepreneurs are important in the business world because they…

- Create jobs and services- Are able to spot gaps in a market

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

- Couldn’t find a job- Needed money- Were made redundant or had an early retirement- Want to build on experience as an employee- Spotted an opportunity- Wanted control over their working life

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

- Lack of support from family and friends- Difficult to get funding- Age discrimination by suppliers- Not taken seriously by contacts

Enterprise

An enterprise is about running a business and the entrepreneurship that is needed for it to succeed. It is about taking risks, being creative and innovative, and using your initiative.

Opportunity Cost

An opportunity cost is the cost of missing out on the next best alternative. For example, if an entrepreneur has decided to open one shop in Meadowhall, the opportunity cost may have been the chance to open two or three smaller shops elsewhere.

Franchises

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

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

The franchisor usually controls the rules concerning the following…

- Décor and uniforms- Product range- Price marketing

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

- Staff recruitment and training- Stock ordering- Customer service

Advantages Disadvantages

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

There is not much freedom in decision-making

Franchises often have a national advertisement campaign available to the franchisee

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

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

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

Customers will recognise the brand easily You can only buy products from the franchisee

Protecting Ideas

An idea cannot be fully protected, but patents and copyrights are methods of preventing others from copying and distributing an invention or creative piece of work. The term used to describe these works is referred to as Intellectual Property.

There are different many types of IP – there are a few examples listed below…

- Music, Paintings and Writing- Engineering- Inventions

A Patent provides a certain amount of time (up to 20 years) for which an inventors work cannot be copied by anybody else. Patents can cost from £1,000 to £500,000+ and breaking a patent is not a criminal offence. Owners of patents can only claim damages through the civil courts.

A Trademark is any sign that can distinguish the goods or services from one trader to another. These can be…

- Logos and Pictures- Words- Sounds- Smells

These can be used to distinguish a product or brand from its competitors (eg: Coca Cola and Pepsi)

A Copyright applies to written work (for example: books and song lyrics).Unlike a patent, a copyright occurs automatically and there is no need to pay for it. Copyright is in the heart of computing - this is why Microsoft can charge premium prices for their Office software.

Adding Value

The process of adding value involves doing something to a product to higher its price. For example ready-grated cheese is more expensive than a block of cheese the same weight.Products that are protected by patents can also be used to add value as they’re the only one like it (APPLE!!)

Primary Sector Secondary Sector Tertiary Sector

This sector deals with growing, fishing, farming, extraction of

natural materials, etc.

This sector includes manufacturing and engineering. Raw materials

are turned into finished products

This sector includes services like retailing, teaching, healthcare,

wholesale and tourism

It is hard to add value to products here as they are often the same

This sector adds the most value (eg: Walkers v Tesco crisps)

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

Business Plans

A business plan sets out how a business idea will be financed, marketed and put into practice. It is likely to be essential in getting funding from a bank because they will need to see how well a business idea is though through and how financially viable it is.

It is a great idea to create a business plan because of the following…

- It helps clarify business objectives- It gives directions- It helps make decisions about resources that are needed- It helps to measure success

A good business plan should contain…

- How you are going to develop your business- When you are going to do it- How you will manage your finance

Any business plan is only as good as the information on which it is based. It is a good guide, but is only a plan of an idea which you have yet to trial and test.

Benefits Problems

It makes the entrepreneur consider every aspect of the start-up so they can try to eliminate failures

The BP is only a plan and does not guarantee success. For example: sales may be lower than predicted

It makes the entrepreneur aware of what skills they are missing so that they can hire an expert

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

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

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

It gives the chance for others to pick up and help with the business idea if the entrepreneur needs it

The entrepreneur may get too involved in creating a plan and forget about the businesses needs

Legal Structures

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

In Unlimited Liability the owners of a business are fully responsible for any debts incurred, even if this requires them to sell their personal assets or possessions and even become bankrupt.

There are two types of businesses that have unlimited liability…

- Sole traders- Partnerships

A Sole Trader is someone who owns and operates their own business. A sole trader can have employees, but they must take all the final decisions about running the business.This is the most common type of legal structure used in the UK; particularly in areas where little finance is required and there is a demand for personal service.

Advantages of Sole Traders Disadvantages of Sole Traders

They make all the decisions and keep all the profit The owner is the only one responsible if it fails

There are no formal rules to follow in establishment There are limited sources of finance available

There are no administrative costs to pay There are long hours of work involved

They are confidential as accounts aren’t published Becoming ill causes problems running the business

A Partnership is where 2-20 people start their own business with the goal of making profit. Unlimited liability applies just like ST’s. Trust is vital and this structure can often be found in medicine and law professions.

Advantages of Partnerships Disadvantages of Partnerships

There is additional skills and a shared workload There is UL even when it is your partners fault

There is more capital available to invest into There is a loss of control and profits are shared

There are no administrative costs to pay There may be business disagreements

With Limited Liability, debts incurred by the business must stay within the business. The owner doesn’t have any personal liability and doesn’t need to sell personal possessions if the business fails.A business must go through a legal process to gain limited liability. This process is called incorporation.

The Articles of Association outlines the internal management of the company. It includes the rights of the shareholders, the role of directors and the frequency of shareholder meetings.

The Memorandum of Association governs the relationship between the company and the outside world. It includes the company name, the object of the company, the limitation of liability and the share capital.

A small business can be started up as a sole trader, partnership or Private Limited Company (LTD). The start-up for an LTD can be as little as £100 and the company can be fully owned by the entrepreneur.The shares of an LTD cannot be bought and sold without the agreement of the other directors, and so an LTD cannot be listed on the stock market. This allows control over how the business is ran.

Putting LTD after a company’s name is a legal requirement and it indicates that a business is relatively small and has limited liability.

Advantages of Limited liability Disadvantages of Limited liability

It gives confidence to shareholders to invest Businesses must make financial information public

There is wider access to finance opportunities More annual costs (eg: audited accounts)

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

There may also be some other problems with PLCs…

- It is hard to have any objectives other than profit- A small group of control can be unlikely due to the availability of shares on the market- Shareholders are the owners of the PLC but they do not make day-to-day decisions – this is left to the

directors who are appointed shareholders- The directors can cause problems as they may only be concerned about their own interests rather

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

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

Market Research

Market research gathers information about consumers, competitors and distributors in a firms target market. A target market is the chunk of the whole market that the product or service is aimed at.It aims to identify consumers buying habits and attitudes to current and future products and services. It can be numerical (how many people buy the Daily Mail?) or psychological (why do these people buy the Daily Mail?)

Secondary Research is data that already exists. Secondary research can be found through the internet, Government produced data and market research companies. It can be used to examine market size, market growth and decline and market share.

Some of the benefits of secondary research are below…

- It’s easy to access- It is usually cheap or even free- It saves a lot of time

There are also some disadvantages…

- It may not have been produced to the specific needs of your business- It may not be accurate- The reliability and quality of the data may be questioned

Primary Research is the process of gathering information directly from people within your target market. This can be very expensive when carried out by specialist market research companies, but there is a lot of research that small start-up business can do.However, there must be a lot of care taken to eliminate bias from your research!

- Observationthese can be used to measure traffic flows (cars or people) in a location to see if the type of customer you want is around. This can be repeated in different locations.

- Small-scale questionnairesthese can be used to gain the opinions of your target audience

- Small-scale focus group

For large companies primary research may be used in new product development. Some methods include…

- Experimentationgetting people to try out their new product or service

- Questionnaires- Focus groups- Field trials

Some of the advantages of secondary market research are listed below…

- You can focus on subjects specific to your business- Accuracy can be guaranteed- The information is confidential and belongs to you

However, there are some disadvantages…

- It can be very time consuming- It can often cost a lot of money

Quantitative research asks questions which usually provide simple, numerical answers. For example, ‘which pack do you prefer?’ or ‘how many newspapers did you buy last week?’However it can be hard to find valid data when using quantitative methods in small-scale research.

Qualitative research is in-depth research into the motivations behind buying habits. It does not produce statistics like ‘53% liked the chocolate’ but asks why they liked it instead. One form of this research could be interviews. However, it is hard to collect qualitative research in small-scale samples and bias may creep in.

Sampling

If surveying the whole population is too expensive, a business may choose a sample instead. There are three main sampling methods…

A Random sample is where everybody in the population has an equal chance of being chosen. Achieving a truly random sample requires careful thought because people may often be missing. Research companies use the following method to try and achieve a random sample…

- They pick names at random from the electoral roll (every 50th name)- They then send an interviewer to the address given- If the person is out, they visit twice more

This method is often effective but it can be very slow and very expensive.

A Quota sample is where interviewees are selected in proportion to the consumer profile of the target market. For example: if the total amount of people at college was 4,000 with 40% males and 60% females, the male number would be 1,600 and the female number would be 2,400. These people can then be broken down into age groups, directorates, etc.

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

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

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

- Cost (a major consideration)- Time

Some other types of research may include…

- Postal surveysonly a small proportion are returned and they can end up being bias

- Telephonethese are cost effective and receive an immediate response but a lot of people aren’t interested

- Face to facethese can include open and closed questions but are expensive and time consuming

Sample Size

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

A sample with at least 1,000 responses usually produces a high confidence level compared with 10 or 100.However, it can be extremely expensive to conduct large amounts of research and sampling 1,000 people can cost £30,000. Surveys of 4 or 5 new products may cost £120,000+ on research alone.

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

- Who produced the information?- How was it produced?- What was the sample size?- What is the confidence level of the research?

Types of Markets

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

- Size (how much is spent every year)- The extent to which it can be divided (eg: TV magazines, health magazines, clothing magazines, etc.)- Market share (eg: the food market can be divided into breakfast cereals and Kellogg’s are the leader)

Local markets are small firms which don’t really care about the size of the national market. They are more concerned with the state of the local market (eg: local hairdressers and plumbers).However, some small businesses may still be focused on the national market (eg: selling their products through large supermarkets or by operating on the internet)

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

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

- They are very price competitive so the costs are kept down- They can operate from anywhere- The market is cheap to enter so new competitors can arrive anytime

Market Size, Growth and Share

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

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

New figure – old figure = Market ChangeMarket Change * 100 / the old figure = % in Market Change

For example: if the old figure is 400,000 and the new figure is 500,000 the market change would +25%

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

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

There are many advantages of being a market leader…

- High distribution without much effort- Able to charge higher prices- Able to get new products onto shelves as their name is widely recognised

Market Segmentation

Markets can be subdivided into several different ways. The magazine market is a good example and can be split up into gender, age and lifestyle.

The key to successful market segmentation is to…

- Know your market- Know your target market’s tastes and habits

Advantages Disadvantages

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

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

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

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

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

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

Demand

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

Price can affect demand in the following ways…

- The higher the price of the product the less of the product people can afford to buy- The price of other competitors products- The value that the consumers place on the brand can affect its demand

Income has grown in the last century. If the economy grows at 2.5% incomes should double every 3 years. The demand for most products and services grows as the economy grows…

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

- Luxury goodsthe demand for these grows faster than the growth of the economy

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

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

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

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

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

Location

One of the most important factors influencing the success of a business is its location. This makes good locations very expensive, and small businesses often struggle to compete with large ones.There are several factors affecting a business’s decision on location, but they can be split up into quantitative and qualitative factors.

Infrastructure describes the provision of services in the area including transport links, telecommunications, health services and educational institutions. However, areas with good infrastructure will be costly.

Quantitative factors are based on financial data…

- The cost of landa business who’s products are price sensitive need to keep costs down so a cheap location may help

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

- Government interventionfinancial incentives that are offered by the government may influence the decision on location

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

- Accessibility of suppliesbusinesses that use JIT will benefit from being close to suppliers due to shorter deliveries

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

In addition to quantitative factors, some business owners may choose their location based on Qualitative Reasons. This can include certain areas with a high quality of life or because similar businesses are also located in that area. Some will also locate where an area has a reputation for certain industries.

- Labour intensivecall centres tend to be located in areas with cheap labour (eg: overseas) but this may affect quality

- Internet firmsonline businesses such as Amazon and Play will need to be in areas with efficient transport links

- Public servicesfor example Starbucks will need to be close to where their target market gather

- Manufacturingfirms like Toyota will need to be in areas near to suppliers and have room for expansion if they grow

Sources of Finance

A source of finance is the term used to describe where a business gets its money from.

Almost all new businesses will need money to invest before it can start operating, including the following…

- Capital investments such as machinery, equipment and property- Money for running the business (bills, wages, etc.)

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

The amount of finance available to a business will depend on:

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

- The stage of development of the businessnew businesses will have a harder time raising finances than a business that is already established, as they will have a record of successful loans and some assets to offer as collateral

- The state of the economyif the economy is booming there will be higher business confidence and therefore more money in the market available

Having sufficient funding will ensure that a business can meet its current and future needs. A distinction between short, medium and long-term objectives should be made and the appropriate type of funding used.Short-term finance (less than a year) should not be used to finance long-term projects.

Internal finance External finance

Stretching existing capital further (eg: cutting stock) Bank loans and overdrafts

Retained profits (not suitable for start-ups) Trade credit (extending time to pay suppliers)

Selling some of the businesses assets (eg: buildings) Share capital and Venture capital

Description Advantages Disadvantages

Retained Profit Keeping previous profits to invest in the future It is free because it is an internal source! Not available to start-up businesses

Sale of assets Selling off items with value (eg: buildings and shares) It can reduce or eliminate debt You may have to pay TAX

Loans Borrowing money (usually from a bank) with interest May not have to pay interest if the financer is family or friends

You may have to pay large interest fees

Debentures A loan or share paid back with interest Interest is usually lower than bank loans You still have to pay interest

Venture capital When someone invests in a high-risk business It can be very successful (Dragons Den) It is very risky with a high failure rate

Share capital Selling shares on the stock market (PLC only!) You can make money to invest Giving away ownership of the business

Overdrafts Agreement with the bank to have a negative balance They are usually easy to access Interests are usually higher than loans

Leasing Renting something you cannot afford to buy It is yours to use whenever you want it You do not own it and it isn’t an asset

Trade credit You don’t have to pay for something immediately It can be easier to pay for things Money may not be available when due

Employees

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

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

Recruitment can be expensive so before a business takes new staff it must go through the following process…

1. Identify the skills required in the businesswhat qualities will the employees need to have in order to move the business forward?

2. Identify what the current skills arewho does what and where are we at the moment?

3. Identify the gaps between step one and twodoes the business now need financial or marketing skills?

4. Put a plan together to fill in the gaps

The business also needs to assess the length of time that they may need these skills, as this will influence the employment options which are as follows:

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

Advantages of part-time staff Disadvantages of part-time staff

They are flexible and able to respond to fluctuations Additional costs in recruitment and administration

Keep costs down (only pay them when they’re in) Additional costs of training new staff

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

absenteeism and labour turnover (% of staff leaving in a year C/W with the total amount of workers) as

they’re not stuck at work all week

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

May not feel the same belonging as full-time staff

Advantages of temporary staff Disadvantages of temporary staff

Flexible and able to respond to fluctuations May have a lack of commitment (as with PT staff)

They are able to cover for permanent employees Additional costs in recruitment and administration

Specialists can be employed for short periods Additional costs of training new staff

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

Agency workers are usually used to cover short term sickness or in industries that have a high labour turnover such as hotels, catering, security guards and cleaners.

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

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

Advantages of advisors/consultants Disadvantages of advisors/consultants

Able to stand back and ask questions staff cannot see Their ideas may not be trusted

They bring ideas from outside the business They may not be ideal for the needs of the business

They can raise sensitive issues that staff may ignore Ideas may not be suitable for the ‘real world’

They may be trusted more by external financers They can often cost a lot of money to hire

All employees must be given a contract of employment and a statement of the terms and conditions of their employment. Part-timers must also have the same pro-rata terms and conditions including wages, holidays, sick pay, maternity pay, etc.

Businesses must pay the minimum wage and national insurance contributions.

Failure to treat staff correctly may result in the business being taken to an employment tribunal where they could be forced to pay compensation to the employee.

Budgets

A budget is a detailed plan of the income and expenses expected over a certain period of time.

In a business start-up budgets for spending on various items should be set so the business owners can go to the bank for finance. A budget for the expected revenue and profits is also required to persuade the bank.

Budgets are not only needed for start-ups. When established businesses set up budgets they will need to…

- Try to ensure that no section of the business spends more than expected- Provide a benchmark for which managers’ success can be measured- Enable spending power to be delegated to local managers (this should improve the speed of decision-

making and could motivate the budget holder as they will have more control and responsibility)- Motivate all the staff in the section (budgets are a clear way of assessing performance)

An Income budget sets the target revenue to be gained over a period of time. This is usually the first budget to be produced as it ‘drives’ all other budgets.

An Expenditure budget is the name for various different budgets. These are driven by Sales budgets.

In a Profit budget the higher the revenue and the lower the expenditure, the higher the profit. Care is needed as quality and returning customers must be taken into account.

Setting budgets is not an easy job. How do you decide on the level of sales next month or year? This is especially hard for new businesses with no previous trading experience.

For start-up businesses setting budgets are difficult, but here’s how they do it…

- They produce a guesstimate of likely sales in the first few months based on secondary and primary market research conducted for the business plan

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

Most established firms will use last year’s figures as a guide to the next years with an adjustment for any known changes or objectives/goals (eg: increase sales by 10% in the first quarter).

Zero Based Budgeting is an alternative approach to expenditure budgets. This starts each sections budget at zero instead of last year’s figures. This helps budgets to stop rising every year.However, there may be some problems with this type of budgeting because managers may lack the experience in knowing what things really cost.

The best way to set budgets is to…

- Relate the budget directly with the businesses objectives (what it is trying to achieve)- To involve as many as possible during the process; budgets should then be agreed and realistic- Make budgets realistic and meaningful to the staff who have to work with them

However, there could be some issues…

- Senior managers might not want to delegate budget decisions because it may take too long to discuss and they could feel a loss of power and responsibility

- One set by managers, others may feel that it is not their job to be flexible with a budget so they could miss out on opportunities

Cash Flows

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

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

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

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

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

Below is an example of a cash flow forecast…

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

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

When studying cash flow forecasts I must question the validity of the figures and the possibility of bias. Also look for any trends in the figures.

Remember cash flow forecasts are estimations not certainty!

Calculating Revenue, Costs and Profit

The revenue received by a business as a result of its trading activities is a critical factor for its success.

When a business starts up they should expect low revenues because…

- Their company or product is unknown- They are unable to buy large amounts of stock to supply big orders- It’s difficult to charge premium prices as they aren’t yet established

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

Quantity of goods sold * selling price = Sales Revenue

A business that plans to increase its revenue can plan to sell more products at a low price rather than a smaller amount of products at a high price.

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

- Assess whether it is possible to trade- Find out how actual costs and predicted costs match- Makes judgements on cost efficiency

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

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

The formula for calculating Total Costs is:

Fixed costs + Variable costs = Total costs

Profit is a comparison of revenues and costs and it is also the main motive for many businesses. However, some businesses are not established with the aim of making a profit. Profit can be calculated by using the following formula:

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

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

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

- Pay shareholders- Reinvest in the company (retained profits)

Profits are important for most businesses because…

- They provide a measure for business success- They are the best source of new finance for a business (retained profits)

It is common for a new business to fail to make profits in its first few months. Cash is like water and profits are like food. You can survive without food for two weeks but only a few days without water! (ie: you can survive without profit but once cash runs out, the business will fall)

Forecasting costs and revenues can be difficult when starting a new business. As they don’t have any past records to give them ideas, it is possible that entrepreneurs will underestimate fixed and variable costs and overestimate revenues.

A business will want to compare its profitability over time. This is called the Net Profit margin and the higher the margin the better!

The Net Profit Margin can be calculated with the following formula…

Net Profit x 100 / Total revenue = Net profit margin

Calculating Break-Even

The breakeven analysis compares a company’s total revenue with its total costs to find out the minimum level of sales required to cover its costs. This is usually shown on a graph called a breakeven chart.

In order to calculate the breakeven point a business will need to know the following:

- The selling price of the product/unit- Their fixed costs- Its variable costs per unit

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

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

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

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

Total revenue – Total variable costs = Contribution

(Contribution per unit is effectively just the second part of the breakeven formula)

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

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

The breakeven point is achieved when the contributions made by each product have produced enough funds to cover the fixed costs. For example:if fixed costs are £120,000 and the contribution per unit is £1.50 the breakeven point would be 80,000 units (£120,000/£1.50)

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

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

Number of units sold – Breakeven point = MOS

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

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

Key Terms

Term Definition

Adding Value Doing something to a product in order to increase its price

Advisor/consultant Somebody who provides businesses with help and advice

Bank Loan Borrowing a fixed amount from a bank with interest

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

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

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

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

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

Business Objective A goal that a business wishes to achieve

Cash Flow The incomings and outgoings of a business

Cash Flow Forecast A forecast predicting the incomings and outgoings of a business

Contribution The difference between total revenue and total variable costs

Contribution Per Unit The difference between the selling price per unit and variable costs per unit

Costs Amounts incurred by a business during trading operations

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

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

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

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

Enterprise Where new businesses are formed to offer products or services

Entrepreneur Somebody who takes calculated risks to start up a business

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

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

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

Full-time Employee Somebody who works 30+ hours a week under a contract

Income Budget The budget which sets out estimates of revenue

Input The resources that go into producing goods and services

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

Location The place where a company is located or does business

Margin of Safety The difference between the output sold and the breakeven point

Market The place where buyers and sellers come together to do business

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

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

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

Market Share The percentage of an market that particular business or product owns

Market Size The total demand or value in a specific market

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

Opportunity Cost The cost of missing out on the next-best alternative

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

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

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

Profit The difference between total sales and total costs

Qualitative Research Detailed research like beliefs, values and opinions

Quantitative Research Non-detailed numerical research like sales figures

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

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

Risk The probability or change that wanted outcomes will not occur

Sample A subset of a population usually chosen for market research

Share Capital Finance invested into a business by shareholders

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

Sole Trader A one-person business with unlimited liability

Supplier A business that provides goods or services to other firms

Total Costs A businesses total variable and fixed costs added together

Trade Credit When a business does not have to pay for something immediately

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

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

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

Variable Costs Costs that change with the level of output

Venture Capital Someone who invests in a new start-up business

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