Revision Business GCSE Instant

tutor2u
GCSE Business Studies

Key Study Notes for Exams in 2004

Authors: Dan Cottrell, Charlie Boddington
Cranleigh School

www.tutor2u.net

Online Learning Resource of the Year

Dan Cottrell, Charles Boddington 2004
INTRODUCTION

This Tutor2u GCSE Core Notes 2004 provides comprehensive study notes for the entire GCSE
specification of the main UK examination boards. It has been written to allow you to cover all the
key topics, in the right amount of detail. No more. No less.
What does Core Notes cover? Each examination board and indeed every traditional GCS
Business Studies textbook splits into to its own sections. We have split the courses into six main
sections, following the major sections of the boards, but your board might approach it in a slightly
different order. No problem.
How should you use the Core Notes? These notes have been designed to allow you to make
effective use of your revision time. The notes contain the things you need to know explained
clearly, and in a logical order. Work through each section carefully and go back again over the
areas you fight a bit difficult.
We also recommend that you add your own notes, questions and answers so the Core Notes
become personal to you. Weve left plenty of space to make your own adjustments, highlight the
key points or make references to your textbook. Remember - TAKE OWNERSHIP and ADD
VALUE!
We are happy to receive suggestions about this edition of GCSE Business Studies Core Notes
2004. Perhaps you have some suggestions about areas that you think should be included in the
next edition. Please email us at feedback@tutor2u.net.
We would like to thank Jim Riley, Managing Director of Tutor2u for his excellent support and
guidance and also to John Cottrell for his proof reading and learned advice.
Good luck with your studies and our best wishes to you in the exams!

Dan Cottrell & Charlie Boddington

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GCSE Business Studies Key Study Notes 2004
tutor2u 2004 Page 4 of 165

Contents
Marketing...................................................................................................................................................................................... 9
What is Marketing?....................................................................................................................... 9
Introduction ................................................................................................................................................................................................. 9
Kinds of Market........................................................................................................................................................................................... 9
Marketing Orientation ............................................................................................................................................................................10
Role of Marketing in a Business...........................................................................................................................................................11
Market Segmentation................................................................................................................. 12
Introduction ...............................................................................................................................................................................................12
Market Segments......................................................................................................................................................................................13
Mass and Niche Markets........................................................................................................................................................................14
Marketing Research ................................................................................................................... 15
Introduction to Marketing Research...................................................................................................................................................15
Primary Research......................................................................................................................................................................................15
Questionnaires...........................................................................................................................................................................................16
Advantages and Disadvantages of Primary Research ....................................................................................................................17
Secondary Research.................................................................................................................................................................................17
Uses of Marketing Research..................................................................................................................................................................18
Marketing Strategy, Objectives and Plans............................................................................... 19
Marketing Strategy..................................................................................................................................................................................19
Marketing Objectives...............................................................................................................................................................................19
Marketing Plans ........................................................................................................................................................................................19
SWOT Analysis...........................................................................................................................................................................................20
Marketing Mix...........................................................................................................................................................................................20
Products and Brands ................................................................................................................. 22
Introduction ...............................................................................................................................................................................................22
New Products.............................................................................................................................................................................................22
Services and Goods Marketing .............................................................................................................................................................23
Brands and Branding...............................................................................................................................................................................23
Packaging....................................................................................................................................................................................................24
Product Life Cycle.....................................................................................................................................................................................24
Product Portfolio & the Boston Matrix..............................................................................................................................................26
Pricing ......................................................................................................................................... 28
Introduction to Pricing............................................................................................................................................................................28
Pricing Strategies .....................................................................................................................................................................................28
Promotion ................................................................................................................................... 30
Introduction ...............................................................................................................................................................................................30
Advertising..................................................................................................................................................................................................30
Public Relations ........................................................................................................................................................................................31
Personal Selling.........................................................................................................................................................................................31
Direct Marketing.......................................................................................................................................................................................32
Sales Promotion........................................................................................................................................................................................32
Place (Distribution) .................................................................................................................... 34
Introduction ...............................................................................................................................................................................................34
Distribution Channels..............................................................................................................................................................................34
Overseas Markets......................................................................................................................................................................................34
E-Commerce...............................................................................................................................................................................................35

Production..............................................................................................................................................................................37
Production Process.................................................................................................................... 37
Stages of Production ................................................................................................................. 38
Primary Production ..................................................................................................................................................................................38
Secondary Production .............................................................................................................................................................................38
Tertiary Production...................................................................................................................................................................................38
Methods of Production .............................................................................................................. 40
Job Production...........................................................................................................................................................................................40
Batch Production......................................................................................................................................................................................40
Flow Production........................................................................................................................................................................................41
Production Efficiency................................................................................................................. 43
Introduction ...............................................................................................................................................................................................43
Efficiency ....................................................................................................................................................................................................43
Strategies to Improve Efficiency..........................................................................................................................................................44
Lean Production......................................................................................................................... 45
Introduction ...............................................................................................................................................................................................45
Cell Production..........................................................................................................................................................................................45
Kaizen (Continuous Improvement) ......................................................................................................................................................45
Just-in-time (JIT) Production.............................................................................................................................................................46
Economies of Scale ................................................................................................................... 47
Introduction ...............................................................................................................................................................................................47
Internal Economies of Scale..................................................................................................................................................................47
External Economies of Scale .................................................................................................................................................................48
Diseconomies of Scale.............................................................................................................................................................................48
Quality Management .................................................................................................................. 50
What is Quality? .......................................................................................................................................................................................50
Why is Quality Important?.....................................................................................................................................................................50
Quality Control..........................................................................................................................................................................................51
Total Quality Management....................................................................................................................................................................51
Business Location ..................................................................................................................... 53
Introduction ...............................................................................................................................................................................................53
Factors Affecting Location.....................................................................................................................................................................53
Stock Control .............................................................................................................................. 56
Introduction ...............................................................................................................................................................................................56
Stock Management..................................................................................................................................................................................56
Managing People......................................................................................................................................................58
Recruitment, Selection and Retention...................................................................................... 58
Introduction ...............................................................................................................................................................................................58
Recruitment Planning..............................................................................................................................................................................59
Methods of Recruitment ........................................................................................................................................................................59
Handling Applications.............................................................................................................................................................................61
Methods of Selection ..............................................................................................................................................................................61
Employee Retention.................................................................................................................................................................................62
Training ....................................................................................................................................... 64
Why is Training Necessary? ...................................................................................................................................................................64

Induction Training....................................................................................................................................................................................64
Methods of Training.................................................................................................................................................................................64
Government Training Schemes.............................................................................................................................................................65
Motivation ................................................................................................................................... 67
Importance of Motivation......................................................................................................................................................................67
Motivational Theory.................................................................................................................................................................................67
Management Styles.................................................................................................................... 71
Introduction ...............................................................................................................................................................................................71
Evaluation of Management Styles.......................................................................................................................................................72
McGregors Theory X and Y....................................................................................................................................................................73
Rewarding Employees............................................................................................................... 74
Introduction ...............................................................................................................................................................................................74
Financial Rewards.....................................................................................................................................................................................74
Non-financial Rewards ...........................................................................................................................................................................76
Groups at work........................................................................................................................... 78
Trade Unions ..............................................................................................................................................................................................78
Industrial Action.......................................................................................................................................................................................78
Changing Role of Trade Unions ............................................................................................................................................................79
Benefits of Trade Unions ........................................................................................................................................................................79
Other Groups in the Workplace............................................................................................................................................................80
Communication .......................................................................................................................... 81
Introduction ...............................................................................................................................................................................................81
Importance of Communication.............................................................................................................................................................81
Communication and Motivation..........................................................................................................................................................81
Methods of Communication..................................................................................................................................................................82
Effective Communication.......................................................................................................................................................................82
Barriers to Communication....................................................................................................................................................................83
Business Objectives...........................................................................................................................................85
Forms of Business Ownership and Operation........................................................................ 85
Introduction ...............................................................................................................................................................................................85
Sole Trader..................................................................................................................................................................................................85
Partnerships ...............................................................................................................................................................................................86
Limited Companies...................................................................................................................................................................................87
Co-operatives ............................................................................................................................................................................................89
Franchises ...................................................................................................................................................................................................89
Public Sector and Privatisation ............................................................................................................................................................91
Organisation of a Business....................................................................................................... 93
Introduction ...............................................................................................................................................................................................93
Span of Control and Hierarchies..........................................................................................................................................................93
Delegation ..................................................................................................................................................................................................95
Business Departments.............................................................................................................................................................................96
Nature of the Organisation of a Business .........................................................................................................................................97
Business Aims and Objectives ................................................................................................. 98
Introduction ...............................................................................................................................................................................................98
Business Objectives..................................................................................................................................................................................98
Alternative Aims and Objectives ..........................................................................................................................................................99
Changing Objectives................................................................................................................................................................................99

Stakeholders............................................................................................................................. 101
Introduction ............................................................................................................................................................................................ 101
Stakeholders versus Shareholders..................................................................................................................................................... 101
Social Responsibility............................................................................................................................................................................. 102
Ethics......................................................................................................................................................................................................... 102
Starting a Business.................................................................................................................. 103
Introduction ............................................................................................................................................................................................ 103
Entrepreneurs ......................................................................................................................................................................................... 103
Start Up Finance.................................................................................................................................................................................... 104
Business Plan.......................................................................................................................................................................................... 104
Advantages of Small Businesses ....................................................................................................................................................... 105
Growing a Business................................................................................................................. 106
Introduction ............................................................................................................................................................................................ 106
Mergers and Acquisitions.................................................................................................................................................................... 107
Constraints on Growth......................................................................................................................................................................... 107
Rationalisation....................................................................................................................................................................................... 108
International business and globalisation........................................................................................................................................ 108
External Environment and Business........................................................................................ 110
The Business Environment ..................................................................................................... 110
What is a Business? .............................................................................................................................................................................. 110
Business Activity.................................................................................................................................................................................... 110
Main Types of Business Activity........................................................................................................................................................ 111
Types of product .................................................................................................................................................................................... 111
Markets..................................................................................................................................................................................................... 112
Main Functions in a Business ............................................................................................................................................................ 112
Profit, Loss and the Entrepreneur ..................................................................................................................................................... 112
External Factors Affecting Business...................................................................................... 114
Introduction ............................................................................................................................................................................................ 114
Main Factors ........................................................................................................................................................................................... 114
Changing External Environment ....................................................................................................................................................... 114
Business and Competition................................................................................................................................................................... 115
Social Environment and Responsibility........................................................................................................................................... 115
Legislation ............................................................................................................................................................................................... 116
Ethics......................................................................................................................................................................................................... 117
Pressure Groups ..................................................................................................................................................................................... 118
Environmental Issues............................................................................................................................................................................ 118
Technological Change .......................................................................................................................................................................... 118
Economic Environment ...........................................................................................................122
Types of Business Activity................................................................................................................................................................... 122
How Business Activity is Changing.................................................................................................................................................. 122
Types of Economy.................................................................................................................................................................................. 123
Private and Public Sector Business................................................................................................................................................... 123
Government Economic Policy ............................................................................................................................................................ 124
Taxation.................................................................................................................................................................................................... 125
Government Spending.......................................................................................................................................................................... 125
Interest Rates.......................................................................................................................................................................................... 126
Labour Market ........................................................................................................................................................................................ 126
Gross Domestic Product (GDP) and Consumer Spending........................................................................................................... 127
Exchange Rates...................................................................................................................................................................................... 128

Business and the Global Economy.................................................................................................................................................... 129
Business and Europe............................................................................................................................................................................. 130
European Single Currency (Euro)................................................................................................................................................... 131
Social and External Costs.................................................................................................................................................................... 131
Accounting and Finance..........................................................................................................................133
Profit .......................................................................................................................................... 133
What is Profit and Why is it Important? ........................................................................................................................................ 133
Sources and Uses of Finance ................................................................................................. 135
Introduction ............................................................................................................................................................................................ 135
Choosing the Right Source of Finance............................................................................................................................................ 136
Short Term and Long Term Finance.................................................................................................................................................. 136
Internal and External Finance............................................................................................................................................................ 137
Sources of External Finance............................................................................................................................................................... 138
Debentures .............................................................................................................................................................................................. 139
Bank Loans and Overdrafts................................................................................................................................................................. 139
Leasing...................................................................................................................................................................................................... 140
Hire Purchase.......................................................................................................................................................................................... 140
Debt Factoring........................................................................................................................................................................................ 140
Government Finance............................................................................................................................................................................. 140
Trade Credit............................................................................................................................................................................................. 141
Retained Profits ..................................................................................................................................................................................... 141
Own Capital............................................................................................................................................................................................. 141
Working Capital ..................................................................................................................................................................................... 141
Sources of Finance for Public Sector Organisations.................................................................................................................... 141
Financial Accounting............................................................................................................... 143
Introduction ............................................................................................................................................................................................ 143
Financial Statements............................................................................................................................................................................ 143
Profit and Loss Account....................................................................................................................................................................... 144
Revenue and Capital Expenditure..................................................................................................................................................... 146
Balance Sheet......................................................................................................................................................................................... 147
Depreciation............................................................................................................................................................................................ 148
Cash flow statement............................................................................................................................................................................. 149
Legal Obligations ................................................................................................................................................................................... 149
Decision-making and Financial Accounts ...................................................................................................................................... 149
Analysing Financial Performance........................................................................................... 151
Introduction ............................................................................................................................................................................................ 151
Profit and Profitability ......................................................................................................................................................................... 151
Liquidity.................................................................................................................................................................................................... 153
Financial efficiency............................................................................................................................................................................... 153
Business Costs ........................................................................................................................ 158
Introduction ............................................................................................................................................................................................ 158
Fixed and Variable Costs ..................................................................................................................................................................... 158
Standard Costing and Variances ....................................................................................................................................................... 159
Break-even .............................................................................................................................................................................................. 159
Budgeting and Business Plans............................................................................................... 162
Introduction ............................................................................................................................................................................................ 162
Cash Flow Forecasting ......................................................................................................................................................................... 162
Business Plans ........................................................................................................................................................................................ 164

MARKETING
What is Marketing?
Introduction
What makes someone buy a product? Or more importantly, what makes them buy the product you are trying
to sell? In business, you need to persuade a customer to part with money in exchange for a good or a
service. You have decide on what the product is going to be like (e.g. shape, colour, size, features); at what
price are you going to sell it; where you are going to sell it (e.g. in a shop, over the Internet, by mail order);
and how you going to help the customer find out about the product (e.g. advertise in the local newspaper or
on the radio). Marketing is all of these things.
A market is a group of consumers, who could be individuals, businesses or governments who might buy this
type of product for example, the market for running shoes or the market for fresh flowers.
And marketing is often defined as:
The process of identifying, anticipating (predicting) and satisfying customer needs
profitably
What does it mean?
Identifying finding out by using marketing research about current products, the possibility of new
products, and about current markets and possible new markets.
Anticipating (predicting) analysing the data collected and using the managers skills to judge
what might happen in these markets and how the products might be suited or changed, adapted or
updated.
Satisfying customer needs making sure the person, business or government is happy with what
they are buying, will not complain and will be happy to buy again if appropriate.
Profitably adding value to the product so when sold, the price of the product is greater than cost
of the inputs.
All of these marketing activities take place in a market.
Kinds of Market
There are four main kinds of market:
Industrial markets: the market for manufactured products aimed at businesses, i.e. capital goods
e.g. engineering, construction.
Consumer markets: the market for goods and services that are sold to households e.g. clothing,
shampoo, holidays.
Commodity markets market for primary products or raw materials e.g. steel, coal, coffee.
Financial markets: the market for services that dealing with money e.g. banking, insurance,
accounting.
Much of your study of marketing will focus on consumer markets - since this relates to the kinds of products

and services that you, your friends and family buy.
Goods bought in consumer markets can be categorised in several further ways:
Fast-moving consumer goods ( FMCGs )
- These are high volume, low unit value, fast repurchase.
- Examples include: Ready meals; Baked Beans; Newspapers.
Consumer durables
- These have low volume but high unit value. Consumer durables are often further divided into
white goods (e.g. fridge-freezers; cookers; dishwashers; microwaves) and brown/black
goods (e.g. DVD players; games consoles; personal computers).
Soft goods
- Soft goods are similar to consumer durables, except that they wear out more quickly and therefore
have a shorter replacement cycle. Examples include clothes, shoes.
Services (e.g. hairdressing, dentists, childcare)
Not all markets are the same. Some are very large, some small. Some markets are focused on a particular
location; others operate around the world. We need a measure of a market most often we talk about
market size.
Market size means the number of customers in the market (either current or potential buyers) and the
amount (value or volume) that they buy.
One business rarely sells to all the customers in the market. They will have a share of the market with the
rest shared out amongst one or more competitors.
Market share by value: using sales in a specific period (usually one year).
Market share by volume: using units sold or bought as a measure of size.
Market share is an important idea. There is lots of evidence to show that businesses that enjoy a large share
of a market achieve higher profits than smaller competitors.
Marketing Orientation
Businesses can develop new products based on either a marketing orientated approach or a product
orientated approach.
A marketing orientated approach means a business reacts to what customers want. The
decisions taken are based around information about customers needs and wants, rather than what
the business thinks is right for the customer. Most successful businesses take a market-orientated
approach.
A product orientated approach means the business develops products based on what it is good at
making or doing, rather than what a customer wants. This approach is usually criticised because it
often leads to unsuccessful products - particularly in well-established markets.
Most markets are moving towards a more market-orientated approach because customers have
become more knowledgeable and require more variety and better quality. To compete, businesses need to
be more sensitive to their customers needs otherwise they will lose sales to their rivals.

On the other hand some products are argued to create a need or want in the customer, especially products
with a very high technological content. Mobile phones have moved from being a business accessory to being
a big consumer brand item, with many additional gadgets, such as pictures, video and Internet access.
Innovations create the need rather than the customer being able to second-guess how new technology is
going to develop.
Role of Marketing in a Business
Marketing is perhaps the most important activity in a business because it has a direct effect on profitability
and sales. Larger businesses will dedicate specific staff and departments for the purpose of marketing.
It is important to realise that marketing cannot be carried out in isolation from the rest of the business. For
example:
The marketing section of a business needs to work closely with operations, research and
development, finance and human resources to check their plans are possible.
Operations will need to use sales forecasts produced by the marketing department to plan their
production schedules.
Sales forecasts will also be an important part of the budgets produced by the finance department,
as well as the deployment of labour for the human resources department.
A research and development department will need to work very closely with the marketing
department to understand the needs of the customers and to test outputs of the R&D section.

Key Terms in this Section

Term Definition
Consumer
Markets
Markets for goods and services that are sold to households
Industrial markets Markets for goods and services sold to other businesses
Market A market is the demand for a particular product or service
Market share
The proportion of the overall market that is held by one particular business or product.
A market is shared amongst competitors
Market Size
The value or a market over a period of time (usually measured over one year).
Sometimes market size is also measured in terms of volume (e.g. the number of units
sold in the period)
Marketing
Orientation
A business that basis its marketing decisions on the needs and wants of customers


Market Segmentation
Introduction
A market for a product is made up of different types of consumer who buy the product, which can be
subdivided into segments.
Market segments are an important part of marketing because markets consist of customers with similar
needs. For example, consider the wide variety of markets that exist to meet the following customer needs:
Need Market Segments Created to Meet the Customer Need
To eat Restaurants; fast-food outlets; grocery supermarkets
To drink Coffee bars; wine & spirits production; milk production
To exercise Health & leisure clubs; sport equipment; walking holidays
To travel Airlines; railways; motor car industry; holiday industry
To
socialise
Introduction agencies; sporting events; pubs
As you can imagine, such markets (if they were not further divided) would be very broad and of little use to
someone wanting to make sensible marketing decisions.
Fortunately for those involved in marketing, customers in a market are not the same. Customers differ in
the:
Benefits they want
Amount they are able to or willing to pay
Media (e.g. television, newspapers, radio stations) they see
Quantities they buy
Time and place that they buy
It therefore makes sense for businesses to segment the overall market and to target specific segments of a
market so that they can design and deliver more relevant products and services
By splitting the market into segment it is easier to analyse who buys the product and then aim to target these
customers specifically. For instance if you know that it is mainly young men under 21 who buy your product
you might then advertise in magazines such as FHM or Loaded.

Market Segments
The main ways in which market can be segmented are into:
Socio-economic grouping see notes further below
Age of the customer for instance teenagers or old age pensioners
Gender male or female
Size and composition of customer households a household of say two unmarried adults, or a
single person living only or a family with 2 children and a per dog
Geographical location e.g. London, Scotland
Ethnicity and/or religion e.g. Islamic or Anglo-Italian
Educational background of customers e.g. graduates or school leavers
Segmentation that divides the market into groups based on factors such as age, gender and family size is
known as demographic segmentation .
Socio-economic segments are widely used in marketing.
The six standard socio-economic groupings in the UK are:
Group Description
A Higher managerial, administrative or professional e.g. surgeon or company director
B Intermediate managerial, administrative or professional e.g. teachers, solicitors
C1 Skilled non-manual e.g. sales assistants, shop floor supervisors
C2 Skilled manual e.g. electrician, plumber
D Semi skilled e.g. assembly line workers, cleaners
E Unskilled, pensioners and unemployed
Age is a particularly important grouping because:
Members of the same age group tend to be at the same stage of their family life cycle, e.g. new
parents, and thus to have similar wants.
Consumers of a similar age also have similar financial circumstances (e.g. retired people living on a
pension and savings will have a different income they can spend compared with students at
university).

Mass and Niche Markets
A mass market product is a product that appeals to a large number of different segments, such as Coca
Cola. Sales in a mass market are much greater than in a niche market, potentially leading to economies of
scale as well.
A niche market product appeals to a just a few segments or perhaps just one, a specialist product, e.g.
Railway Modeling magazine. There will be less competition and a chance to charge higher prices, but small
sales and not much opportunity for economies of scale.
A business will need to decide whether it wants to have a mass market product or a niche market product. It
can then adjust its marketing mix (see further). For example, a niche market product will have a higher price
probably than a mass market product and promotion will be different since different segments will need to be
targeted.


Term Definition
Demographic
segmentation
Defining a market segment in terms of factors such as age, gender and family
size
Geographic
segmentation
Defining a segment in terms of where customers are located
Market segment A group of customers with similar needs and wants
Mass market Goods and services that appeal to many customer segments
Niche market Goods and services that appeal to a narrow or small customer base
Socio-economic
segmentation
Defining a market segment in terms of income and occupation

Marketing Research
Introduction to Marketing Research
Marketing research means finding out about the product and its market place. It is an important part of
identifying and anticipating customers needs. Once the product has been bought, marketing research can be
used to see if the customer was satisfied.
A business might carry out marketing research to:
Find data and information that help a business understand what customers want now or in the
future.
Find out whether current products are satisfying customers.
Test new products by asking potential customers to try out the product.
Assess the results of its promotional strategy e.g. test the effectiveness of an advertising
campaign.
Understand the activities and strategies of competitors.
The two main kinds of marketing research are
Primary research
Secondary research
Primary Research
Primary research involves getting original data directly about the product and market. Primary research
data is data that did not exist before. It is designed to answer specific questions of interest to the business -
for example:
What proportion of customers believes the level of customer service provided by the business is
rated good or excellent?
What do customers think of a new version of a popular product?
To collect primary data a business must carry out field research. The main methods of field research are:
Face-to-face interviews interviewers ask people on the street or on their doorstep a series of
questions.
Telephone interviews - similar questions to face-to-face interviews, although often shorter.
Online surveys using email or the Internet. This is an increasingly popular way of obtaining
primary data and much less costly than face-to-face or telephone interviews.
Questionnaires sent in the post (for example a customer feedback form sent to people who have
recently bought a product or service).
Focus groups and consumer panels a small group of people meet together with a facilitator
who asks the panel to examine a product and then asked in depth questions. This method is often
used when a business is planning to introduce a new product or brand name.

In most cases it is not possible to ask all existing or potential customers the questions that the business
wants answering. So primary research makes use of surveys and sampling to obtain valid results.
Sampling is where a small section of the relevant population is asked a number of questions or is given the
opportunity to use a sample of the product to indicate what the whole population would think about the
product.
For example, for a recent advertising campaign 108 people were asked whether they would choose the new
MG ZT to drive over a Mercedes 3 series. 88 people said they would choose the MG ZT, enabling MG to say
that 8 out of 10 people prefer the MG (or over 80% of the driving population in the UK).
The four main types of sampling are:
Quota sampling asking people who share certain characteristics (e.g. aged between 18-25).
Random sampling everyone has an equal chance of being asked a question.
Stratified sampling population is segmented by a common characteristic.
Cluster sampling target population is divided into groups (normally by geographical region) and
random sample taken from these groups.
Questionnaires
Questionnaires are one the main tools in the use of field research. A questionnaire contains a series of
questions which gather primary marketing research data for the business.
Questionnaires need to be designed carefully. The design of the questionnaire depends on the following:
Objectives of the questionnaire what information is needed, at a minimum, from customers who
complete the questions?
The type of person who is going to be asked questions need be easy to understand and also
easy to answer depending on the person who is answering.
How the questionnaire is going to be taken? A face-to-face questionnaire might include
different questions to an emailed questionnaire. An interviewer will be filling in a face-to-face
questionnaire and the person may be able to ask for the question to be rephrased if they do not
understand it the first time.
The types of questions that can be asked can be split into three groups:
Simple yes/no answers e.g. have you seen the new advert for cornflakes
Multiple choice a number of options are available to the answer
Sliding scale a value is placed on an answer e.g. how do rate the performance of this product
less than satisfactory, satisfactory, excellent (or could use a scale of 1-10 with 10 being excellent
and 1 being dreadful!).
Once the questionnaires are complete, the data is collated and analysed.

Advantages and Disadvantages of Primary Research
The main advantages of primary research and data are that it is:
Up to date.
Specific to the purpose asks the questions the business wants answers to.
Collects data which no other business will have access to (the results are confidential).
In the case of online surveys and telephone interviews, the data can be obtained quite quickly (think
about how quickly political opinion polls come out).
The main disadvantages of primary research are that it:
Can be difficult to collect and/or take a long time to collect.
Is expensive to collect.
May provide mis-leading results if the sample is not large enough or chosen with care; or if the
questionnaire questions are not worded properly.
Secondary Research
Secondary research involves obtaining market information from existing information and material. This
information is known as secondary data.
The main sources of secondary data are:
Published financial information (e.g. accounts of competitors)
Government reports (e.g. data from the National Statistical Office)
Data from consumer groups (e.g. Which? magazine surveys of consumer products)
Reports from marketing research companies (e.g. Mintel, Keynote)
Internal business records e.g. sales reports
Press cuttings
Trade and industry associations
Typical information that might be found using secondary includes:
Size of the market and how fast it is growing.
Competitors how many; sales and profits; pricing strategies; product development.
Age and occupational profile of consumer in a region.
Key trends in the market e.g. how are customer needs and wants changing?
The main advantages of using secondary research are:
Provided the information exists, it is usually quicker and cheaper than primary research. It can
provide a perspective on the whole market, giving the business a feel for whether they should spend

more money on developing products for that market. For instance they could find out that there are not
enough potential customers for the product to break even.
The main disadvantages of using secondary research are:
It is out of date quickly.
It is available to all the other businesses, so does not provide many advantages against competitors.
The data may not exactly fit the purpose of the research.
A good example of using secondary research effectively is in the launch of a new product. Government
statistics could provide information on the size of the market, the socio-economic groups in a launch area.
Competitors brochures and websites could give information on pricing, product sizes and features of existing
products in the market.
Uses of Marketing Research
As we said earlier, it is vital that a marketing-orientated business understands as much as possible about its
customers and the way in which they are already being served by competitors.
Marketing research is particularly important in launching a new product. Marketing research is aimed at
reducing the risk of failure. It tries to find out how the customer will react to the new product. If they are
negative in their findings, then either the product is shelved, or adjustments are made.
The uses of marketing research are often to find out:
Answers to questions on whether the customer will buy the product and how often?
What they are willing to pay?
What type of customer is interested in the product?
Where it should be sold?
A small business would probably find large-scale primary research too expensive. Instead they often rely on
asking friends and family, or customers. However, small businesses increasingly have access to the
extensive amount of material available on the Internet.
A small business can also use the local business organizations such as the Department of Trade and
Industry (DTi), Training Enterprise Councils (TECs) and Chambers of Commerce.
Term Definition
Marketing
research
The gathering, recording and analysing of data about questions relating to a product
or service and its market
Primary research Marketing research data collected specifically for a marketing research project and
obtained directly from the relevant source.
Sampling Obtaining research results from a small group to represent the views of a larger group
Secondary
research
Marketing research data that has already been collected, analyses and used for other
purposes or published for general reference


Marketing Strategy, Objectives and Plans
Marketing Strategy
Marketing strategies explain how the marketing function fits in with the overall strategy for a business.
Examples of marketing strategies could be:
Business Strategy Example Marketing Strategies
Launch new products
Expand distribution (e.g. open more shops)
Grow sales
Start selling products into overseas markets
Increase selling prices Increase profits
Reduce the amount spent on television advertising
Implement a public relations programme Build customer
awareness
Invest more in advertising
Once a strategy has been identified, then the business must develop an action to turn the strategy into reality.
The starting point for this plan is the setting of marketing objectives.
Marketing Objectives
Marketing objectives are the specific targets for marketing set by the business to achieve their corporate
objectives.
Examples of marketing objectives might be:
Increase sales by 10%
Launch a new product by the end of the year
Achieve a 95% customer satisfaction rating
Increase the number of retail outlets selling our products by 250 within 12 months
It is important for a business to set marketing objectives because managers can then have targets for their
work. They can then measure more effectively the success or failure of their marketing strategies to achieve
these objectives.
Marketing Plans
The marketing plan is a detailed document that explains how all the different elements of the marketing mix
will be used to achieve the marketing objectives.
A marketing plan is usually prepared following a review of the current situation (sometimes called a
marketing audit) that looks at questions such as:
What are our existing products and brands?
Are the markets we do business in growing? If so, how fast?

Who are our competitors? What advantages (if any) do we have over them?
How effective has our marketing been in recent history? Are there ways in which we could achieve
the marketing objectives differently and more profitably?
SWOT Analysis
An important part of the planning process is looking at the existing position of the business and trying to
decide how factors external to the business may affect the business.
A business can perform a SWOT analysis as away of deciding which marketing strategy to use. The
business performs an audit on the internal and external nature of the business looking at the current and
future situation. An audit is a review of all the business activities.
Internal Explanation Strategy Implications
Strengths Reviews the business current strengths
such as a good brand or strong sales
performance
Can develop the strengths, perhaps in the
way they promote the product, or wish to
develop new products (Virgin have used
their strong brand name to launch several
products)
Weaknesses Reviews the business current
weaknesses such poor response times to
requests for information or late deliveries
Can implement strategies to eradicate these
weaknesses e.g. more resources put into a
better warehousing system for the despatch
of goods.
External
Opportunities Reviews the business future
opportunities e.g. new technology making
it easier to manufacturer certain goods or
new markets abroad
Can use strategies to take advantage of the
potential opportunities e.g. developing new
products to meet the potential increased
demand
Threats Reviews the business future threats,
mostly from increased competition from
other firms or from changes in the
economic situation.
Can employ strategies to ward off these
problems, e.g. setting lower prices or
increasing promotion
Marketing Mix
The marketing mix deals with the way in which a business uses price, product, distribution and promotion to
market and sell its product.
The marketing mix is often referred to as the Four Ps - since the most important elements of marketing are
concerned with:
Product - the product (or service) that the customer obtains.
Price - how much the customer pays for the product.
Place how the product is distributed to the customer.
Promotion - how the customer is found and persuaded to buy the product.
It is known as a mix because each ingredient affects the other and the mix must overall be suitable to the
target customer.

For instance:
High quality materials used in a product can mean that a higher price is obtainable.
An advertising campaign carried in one area of the country requires distribution of the product to be
in place in advance of the campaign to ensure there are no disappointed customers.
Promotion is needed to emphasise the new features of a product.
The marketing mix is the way in which the marketing strategy is put into action - in other words, the actions
arising from the marketing plan.
Term Definition
Marketing mix The marketing decisions taken about products, prices, promotion and place
(distribution)
Marketing
objectives
Specific, measurable, achievable objectives for the marketing function
Marketing plan
The action plan that describes in detail what marketing activities are to be carried out
Marketing
strategy
A description of the overall approach taken by a business towards marketing in order
to achieve the business objectives
SWOT analysis A method of assessing the current situation of the business focusing on the things
within its control (strengths and weaknesses) and outside of its control (opportunities
and threats)


Products and Brands
Introduction
What is a product? A product is anything that is capable of satisfying customer needs . This definition
therefore includes both:
Physical products e.g. cars, washing machines, DVD players, take-away pizzas.
Services e.g. dental treatment, accountancy, insurance.
Products are at the heart of marketing. The product needs to exist for the other elements of the mix to
happen.
Part of the marketing of the product is through product differentiation. This means making the product
different from its competitors. Product differentiation can be achieved through:
Distinctive design e.g. Dyson; Apple iPod.
Branding - e.g. Nike, Reebok.
Performance - e.g. Mercedes, BMW.
Most businesses sell more that one product. Often they will produce several similar products that appeal to
different customers. A collection of such products is known as a product group or product range .
Good examples of product groups include:
Dells range of desktop and laptop computers.
Sonys range of DVD players and televisions.
There are several advantages to having a product range rather than just one product:
Spread the risk a decline in one product may be offset by sales of other products.
Selling a single product may not generate enough returns for the business (e.g. the market segment
may be too small to earn a living).
A range can be sold to different segments of the market e.g. family holidays and activity holidays.
However a greater range of products can mean that the marketing resources (e.g. personnel and cash) are
spread more thinly. Recently Unilever, who make over two hundred well known brands such as Dove and
Flora margarine, decided sell some of their product names to concentrate their investment on fewer products
and brands.
New Products
To grow fast, businesses need to develop new products. But before a business can launch a new product, it
needs to go through several stages before it appears in the market place.
The main stages are:
Marketing research find out what customers want, who they are, and where the gaps are in the
marketplace.

Product development and testing make prototypes; experiment by allowing a sample of
potential customers to trial the product before it is launched.
Distribution of product to outlets the product cannot be sold unless it is in a position for
customers to buy it books will need to be in the bookshops and hammers in the hardware stores.
Promotional launch to inform customers features of new product this might be done locally,
nationally or internationally the customers need to know that the product is ready, available and
that it might be the sort of thing they want to buy.
At the first two stages (marketing research and product development/testing) many products are rejected
because the findings of research shows that it will not be successful or they cannot make a satisfactory
prototype. Product testing might show that customers react badly to the product.
The new product launch needs all the elements of the mix to be in place to be successful.
Services and Goods Marketing
Products can be split into two broad categories:
Goods physical products that you can touch and feel, e.g. food and clothing
Services products that are non-physical watching a film or going to school
Marketing services can be different to marketing goods.
Services, such as banking, are mainly marketed through product differentiation. Similar products are adjusted
to the target audience, for instance instant access account and long-term deposit accounts, or accounts for
children. Businesses then use heavy promotion to highlight these differences.
It differs from goods marketing, because goods have greater opportunity to use packaging and physical
product design.
Brands and Branding
A brand is a product with unique character, for instance in design or image. It is consistent and well
recognised.
The advantages of having a strong brand are:
Inspires customer loyalty leading to repeat sales and word-of mouth recommendation.
The brand owner can usually charge higher prices, especially if the brand is the market leader.
Retailers or service sellers want to stock top selling brands. With limited shelf space it is more likely
the top brands will be on the shelf than less well-known brands.
Some retailers use own-label brands, where they use their name of the product rather than the
manufacturers like Tescos Finest range of meals and foodstuffs. These tend to be cheaper than the
normal brands, but will give the retailer more profit than selling a normal brand.
Some brands are so strong that they have become global brands. This means that the product is sold in
many countries and the contents are very similar. Examples of global brands include: Microsoft, Coca Cola,
Disney, Mercedes and Hewlett Packard.
The strength of a brand can be exploited by a business to develop new products. This is known as brand
extension a product with some of the brands s characteristics. Examples include Dove soap and Dove

Shampoo (both contain moisturiser); Mars Bar and Mars Ice Cream.
Brand stretching is where the brand is used for a diverse range of products, not necessarily connected, e.g.
Virgin Airlines and Virgin Cola; Marks and Spencer clothes and food.
The logo on a product is an important part of the product. A logo is a symbol or picture that represents the
business. It is important because it is easy to recognise, establishes brand loyalty and can create a
favourable image.
Packaging
Packaging is sometimes known as the fifth P in the marketing mix. It is closely associated with product
because it is in what most goods are delivered to the customer.
The main purposes of packaging are to:
Protect the product on its journey from the manufacturer and warehouse to retailer and then to
customer (who might use the packaging for storage e.g. jam jar).
Promote the product by communicating information about the product.
Packaging also contains key details on usage/storage and safety (most products need to comply with
packaging legislation).
Product Life Cycle
The product life cycle is an important concept in marketing because it describes the stages a product goes
through from when it was first thought of until it finally is removed from the market. Not all products reach this
final stage. Some continue to grow and others rise and fall.
The main stages of the product life cycle are:
Introduction researching, developing and then launching the product.
Growth when sales are increasing at their fastest rate.
Maturity sales are near their highest, but the rate of growth is slowing down, e.g. new competitors
in market or saturation.
Decline final stage of the cycle, when sales begin to fall.
This can be illustrated by looking at the sales during the time period of the product.

A branded good can enjoy continuous growth, such as Microsoft, because the product is being constantly
improved and advertised, and maintains a strong brand loyalty.
Extension strategies extend the life of the product before it goes into decline. Again businesses use
marketing techniques to improve sales. Examples of the techniques are:
Advertising try to gain a new audience or remind the current audience, e.g. the recent Kelloggs
Cornflakes adverts.
Price reduction more attractive to customers.
Adding value add new features to the current product, e.g. video messaging on mobile phones.
Explore new markets try selling abroad, e.g. Robbie Williams trying to sell more records in the
US.
New packaging brightening up old packaging, or subtle changes such as putting crisps in foil
packets or Seventies music compilations.

Product Portfolio & the Boston Matrix
A business with a range of products has a portfolio of products. However, owning a product portfolio poses a
problem for a business. It must decide how to allocate investment (e.g. in product development, promotion)
across the portfolio.
A portfolio of products can be analysed using the Boston Group Consulting Matrix. This categorises the
products into one of four different areas, based on:
Market share does the product being sold have a low or high market share?
Market growth are the numbers of potential customers in the market growing or not?
How does the Boston Matrix work? The four categories can be described as follows:

Stars are high growth products competing in markets where they are strong compared with the
competition. Often Stars need heavy investment to sustain growth. Eventually growth will slow and,
assuming they keep their market share, Stars will become Cash Cows
Cash cows are low-growth products with a high market share. These are mature, successful
products with relatively little need for investment. They need to be managed for continued profit - so
that they continue to generate the strong cash flows that the company needs for its Stars
Question marks are products with low market share operating in high growth markets. This
suggests that they have potential, but may need substantial investment to grow market share at the
expense of larger competitors. Management have to think hard about Question Marks - which
ones should they invest in? Which ones should they allow to fail or shrink?

Unsurprisingly, the term dogs refers to products that have a low market share in unattractive,
low-growth markets. Dogs may generate enough cash to break-even, but they are rarely, if ever,
worth investing in. Dogs are usually sold or closed.
Ideally a business would prefer products in all categories (apart from Dogs!) to give it a balanced portfolio of
products.
Term Definition
Boston matrix Analysis of products into four categories based on market growth and market share
Brand A product with unique character, for instance in design or image. It is consistent and
well recognised.
Brand / product
extension
Making new products based on the original brands characteristics
Product A good or a service that is capable of satisfying customer needs
Product
differentiation
Making a product different from its close rivals, e.g. different colours, shape or
design features
Product life cycle
Describes the stages a product goes through from when it was first thought of until it
finally is removed from the market


Pricing
Introduction to Pricing
The law of demand states that, for nearly all products, the higher the price the lower the demand. In other
words, sales will fall if prices are put up. However higher prices can also mean higher profits. So how does a
business decide how to set a price for its products?
A business needs to set a price which maximises their sales revenue. Sales revenue is the total amount of
money made from sales and is the price of the product multiplied by the number of sales.
For a new business with a new product setting a price can be difficult to do because they have no experience
of what customers are prepared to pay.
Get the price too high and sales are lost, too low and people who are prepared to pay more are not going to.
Businesses use a variety of methods to work out what price they might set:
Past product data.
What competitors or similar markets have as prices?
Surveys and questionnaires.
They are several factors that the business will need to consider in setting the price:
The state of the market for the product if there is a high demand for the product, but a shortage
then the business can put prices up. Recently, when the US government decided to publish
guidelines on what to do in the event of war, following the terrorist attacks on their country, people
rushed out to buy masking tape. There was quickly a shortage and prices went up. Union Jack
flags during the Jubilee year were also subject to higher prices for the same reason.
The state of the economy some products are more sensitive to changes in unemployment and
workers wages than others. Makers of luxury products will need to drop prices especially when the
economy is in a downturn.
Pricing Strategies
There are several different pricing strategies available to a business:
Strategy Description
Cost-plus pricing Setting a price by adding a fixed amount or percentage to the cost of making the
product
Penetration pricing Setting a very low price to gain as many sales as possible
Price skimming Setting a high price before other competitors come into the market
Predatory pricing Setting a very low price to knock out all the other competition
Competitor pricing Setting a price based on competitors prices
Price discrimination Setting different prices for the same good, but to different markets e.g. peak and off
peak mobile phone calls
Psychological
pricing
Setting a price just below a large number to make it seem smaller e.g. 9.99 not
10

A new business that is entering the market might try the following strategies:
If they are first into the market then they might use price SKIMMING.
If they are trying to establish themselves in the market then PENETRATION pricing.
Sometimes a business may use a loss leader. This is a product where the price is so low that the retailer
may not make any profit or even a loss on the sale, but does attract shoppers to buy other full price products.
Orange juice has been used by businesses such as Rank Hovis McDougall to entice supermarkets to stock
more of their other products.
Price skimming has been used for the launch of high technology products, such as DVD players and
Personal Digital Assistants (PDAs) - which were far more expensive than they are now when they first
arrived in the market.

Term Definition
Price skimming Setting a high price when a new product first enters the market
Price penetration Setting a low a price so make lots of sales quickly

Promotion
Introduction
Promotion is the way in which a business makes their product known to the customers, current and potential
The three main methods of promotion are:
Advertising
Public relations
Merchandising
These main areas form a part of the promotional mix that includes direct mailing, personal selling and sales
promotion. A business will use a range of promotional activities for its product, depending on the marketing
strategy and the budget available.
The way in which promotion is targeted is split into two types:
Above the line promotion paid for communication in the independent media e.g. advertising on
TV or in the newspapers. Though it can be targeted, it could be seen by anyone outside the target
audience.
Below the line promotion promotional activities where the business has direct control e.g. direct
mailing and money off coupons. It is aimed directly at the target audience.
Advertising
Advertising presents or promotes the product to the target audience through media such as TV, radio,
billboards to encourage them to buy.
When deciding which type of advertising to use known as an advertising medium a business needs to
consider the following factors:
Reach of the media nationally or locally, the number of potential customers it could reach.
Nature of the product the media needs to reflect the image of the product; a recruitment ad
would be placed in a trade magazine or newspaper but a lipstick ad would be shown on TV or
womens magazines.
Position in product life cycle launch stage will need different advertising from extension
strategies.
Cost of medium radio cheaper than TV, but may want to consider cost per head if reaching a
larger audience.
In the printed media, advertising can take two forms:
A classified advert is normally put into a newspaper by an individual and is expressed solely in
words and numbers.
A display advert is where space is bought in the newspaper or magazine and can be filled with
words and/or pictures.

Display adverts have more impact, but are more expensive.
Advertising can also be split into two main types:
Persuasive advertising - this tries to entice the customer to buy the product by informing them of
the product benefit.
Informative advertising - this gives the customer information. Mostly done by the government
(e.g. health campaigns, new welfare benefits).
Sometimes a business will employ an advertising agency to deal with its needs. An agency plans,
organises and produces advertising campaigns for other businesses. The advantage of an agency
managing the campaign is that it has the expertise a business may not have, e.g. copywriters, designers and
media buyers.
Businesses need to be fully aware of the laws that govern advertising. The main law is the Trade
Descriptions Act goods advertised for sale must be as they are described. Also the advertising industry
has its own Code of Practice, and is regulated by the Advertising Standards Authority where complaints
about the nature of advertising can be dealt with.
Public Relations
Public relations is a broad series of activities involving a business managing its relationships with different
parts of the public, e.g. customers, the media and investors.
The main objectives of public relations are:
To achieve favourable publicity about the business at no cost.
To build the image and reputation of the business and its products, particularly amongst
customers.
To communicate effectively with customers.
Public relations (PR) has the following advantages over advertising in terms of promotion:
No direct charge is made for PR, though a business will need to pay for its own PR department or
external PR consultant.
PR is arguably more powerful because the message the business communicates through PR is often
more believable than paid for advertising.
However there is no guarantee that PR will reach its target audience (newspapers may fail to print the story)
whereas advertising must be printed since the space in the newspaper is paid for.
Personal Selling
Personal selling is where businesses use people to sell the product directly to the customer. The sellers
promote the product through their attitude, appearance and knowledge. They aim to inform and encourage
the customer to buy the product.
A good example of personal selling is found in department stores on the perfume and cosmetic counters. A
customer can get advice on how to apply the product and can try different products. It is worth noting that
this part of the department store is often the most profitable.

Direct Marketing
Direct marketing is aimed directly at the customer, so bringing the promotional activity straight to the target
audience e.g. direct mailing or door-to-door sellers.
Examples of business than rely on direct marketing are:
QVC (TV Selling)
Boden (clothes from catalogues)
Sunday Times Wine Direct (wine through flyers in newspapers)
Direct marketing has the following advantages and disadvantages:
Advantages Disadvantages
No intermediaries (e.g. retailers) to take part of
the profits
Costs of distribution of promotional material
Producer can control own marketing
Costs of making distributional material (e.g.
catalogues for Next)
Chance to reach customers who would not
have gone to the shops

Sales Promotion
Sales promotion is the process of persuading a potential customer to buy the product. It can be part of the
personal selling process.
The main methods of sales promotion are:
Money off coupons customers receive coupons, or cut coupons out of newspapers or a products
packaging that enables them to buy the product next time at a reduced price.
Competitions buying the product will allow the customer to take part in a chance to win a prize
(e.g. Coca Cola ring pulls).
Discount vouchers a voucher (like a money off coupon).
Free gifts a free product when buy another product.
Point of sales materials e.g. posters, display stands ways of presenting the product in its best
way or show the customer that the product is there.
Loyalty cards e.g. Nectar and Air Miles; where customers earn points for buying certain goods or
shopping at certain retailers that can later be exchanged for money, goods or other offers.
Examples of recent sales promotions are:
Tesco computers for schools
Cadburys sport in the community
Caf Nero free coffee card
Loyalty cards have recently become an important form of sales promotion. They encourage the customer to

return to the retailer by giving them discounts based on the spending from a previous visit.
Loyalty cards can offset the discounts they offer by making more sales and persuading the customer to come
back. They also provide information about the shopping habits of customers where do they shop, when
and what do they buy? This is very valuable marketing research and can be used in the planning process for
new and existing products.

Term Definition
Above the line
promotion
Paid for communication in the independent media
Below the line
promotion
Promotional activities where the business has direct control e.g. direct mailing and
money off coupons
Direct marketing Marketing which is aimed straight at the customer
Personal selling Using people to sell the product directly to the customer
Public relations
Managing relations with the outside world, mainly the media, but also the local and
wider community
Sales promotion Process of persuading customers to buy the product


Place (Distribution)
Introduction
Distribution is how the business gets its products to the customers. It does this through four main distribution
channels:
Wholesalers
Distributors / Sales Agents
Retailers
Direct
Distribution Channels
Wholesalers break bulk they buy in large quantities from manufacturers and then break them into
smaller quantities to sell to retailers. This reduces transport costs to the manufacturer (few journeys to
wholesaler rather than many journeys to retailers) and retailers can order in smaller amounts from
wholesalers.
Agents provide a link between sellers and buyers. They are not employed by the company but sell the
products or services for a commission. The best examples of an agent are a travel agent or an estate agent.
For instance the travel agent will sell travel companies holidays to potential holidaymakers and take a cut of
the sales revenue.
Some businesses miss out the wholesaler, especially large multiples such as supermarkets. They can order
directly from the producer and then use their own system of distribution. The advantage for a producer is that
they get greater control over the marketing of their product.
Other businesses use direct marketing as their key distribution channel. This is where they sell directly to
the customer. The most common channels for direct marketing are:
Direct mail
E-mails
Mail-order catalogues
Telephone sales
Overseas Markets
Many businesses sell into overseas markets. This is known as exporting . Exporting is not easy, for the
following reasons:
Exchanges rates can change, making the prices of goods coming into or going out of the country
sometimes more expensive, sometimes much cheaper.
Language barriers mean that it can be difficult to communicate with potential buyers.
Different cultures mean that products are not suitable for certain countries, e.g. on religious
grounds.

Trade barriers, such as quotas, tariffs and legislation exist which can make it difficult to actually
place the product in that country, or certainly make it more expensive to sell there.
The UKs membership of the Europe Union (EU) has reduced the effect of trade barriers for UK businesses.
The EU is a Single Market that has the freedom of movement of goods and services within the market. The
UK is part of the European Single Market which means it should not face any barriers to trade, e.g. quotas
and tariffs, which would add costs to their exports.
E-Commerce
E-commerce is the use of the Internet and email to buy, sell and market products. It has grown in use
considerably in the last five years, though it still makes up a surprisingly small part of the whole retail market
(less than 5% for most retail segments).
Businesses are increasingly under pressure to provide an e-commerce aspect to their business particularly
those that sell to consumers (known as B2C or Business to Consumer). This is normally in the form of a
website and certainly email.
A website can be used to provide information on the product/business, or provide a pace where sales can be
made. If sales are required then there needs to be a link to a warehouse for goods, so despatch can be
made.
Costs and benefits of using e-commerce
The main costs of using e-commerce for a business are:
Expense of setting up and maintaining the website staff will need to be trained to run the site
especially if it is to be used for online purchasing.
Businesses have become exposed to more fraud or hacking into their site.
The benefits for a business of using e-commerce are:
Using websites to advertise more widely.
Small business can access wider than local markets.
Can market directly to past customers via email.
Selling to larger markets.
Reduces cost of sales (especially through purchasing online).
Attracts new customers.
Businesses can therefore improve their productivity and competitive edge through the use of e-commerce.
However the business fundamentals must also be in place as e-commerce is only one element in the whole
business mix. These fundamentals are the key functions of the business working well e.g. a good production
and distribution network.
E-commerce issues
There are a number of issues that have arisen from the use of e-commerce:

Consumer protection giving information over the Internet by customers has led to potential
situations of abuse of the information. Customers have become reluctant to give out credit card
information, despite the protection offered by both the business involved and the credit card
company.
With greater reliance on e-commerce there is a danger that more traditional forms of shopping will
become obsolete, meaning loss of jobs and also a loss of culture. Traditional markets and High
Streets may be lost.
Spam email is becoming an intrusion into the household beyond the normal junk mail coming
through the letterbox. Emails and e-commerce are much harder to control by the law and therefore
unscrupulous companies may be able to take advantage of less knowledgeable and more easily
manipulated consumers (especially those of school age).
To counter these problems a business which is going to use e-commerce needs to:
Make sure it has a secure system which does not endanger the personal rights of its customers
Act in a socially responsible manner towards its customers


Term Definition
Agents People who sell the product on behalf of the business, but are employed by them
Breaking bulk
Splitting large amounts of product into smaller amounts which can then be shipped
to other outlets
Distribution
channels
Ways in which the product reaches the customer from the business
e-commerce Using the Internet and email to sell products
Wholesalers Buy in large quantities, break bulk and then sell this to retailers

PRODUCTION
Production Process
The way that businesses create products and services is known as the production process.
There are three main parts to the production process as can be seen in the diagram below:

A firm must purchase all the necessary inputs and then transform them into the product (outputs) that it
wishes to sell. For example a football shirt manufacturer must buy the fabric, pay someone for a design,
invest in machinery, rent a factory and employ workers in order for the football shirts to be made and then
sold.
How well-organised a firm is at undertaking this transformation process will determine its success. This is
known as the productive efficiency of a firm and it will want to be as efficient as possible in transforming its
inputs into outputs (i.e. using the minimum number of inputs as possible to achieve a set amount of output).
This will reduce the cost per unit of production and allow the firm to sell at a lower price.
Ultimately, the objective of the production process is to create goods and services that meet the needs
and wants of customers. The needs and wants of customers will be met if a business can produce the
correct number of products, in the shortest possible time, to the best quality and all at a competitive price.

Stages of Production
Production within an economy can be divided into three main stages: primary, secondary and tertiary.
Primary Production
Primary production involves the extraction of raw materials (e.g. coal, iron, agricultural commodities). Raw
materials can be:
Extracted e.g. coal, iron ore, oil, gas and stone
Harvested / collected e.g. fish
Grown e.g. timber, cereal crops
There is little value added in primary production. The aim is usually to produce the highest quantity at lowest
cost to a satisfactory standard.
Secondary Production
Secondary production involves transforming raw materials into goods. There are two main kinds of goods:
Consumer goods e.g. washing machines, DVD players. As the name implies, these are used by
consumers
Industrial / capital goods e.g. plant and machinery, complex information systems. Industrial and
capital goods are used by businesses themselves during the production process.
In the secondary production sector, value is added to the raw material inputs. For example, foodstuffs are
transformed into ready meals for sale in supermarkets; metals, fabrics, and plastics are transformed into
motor vehicles.
There are many different industry sectors in secondary production. For example:
Construction
Electronic instruments
Pharmaceuticals (drugs)
House-building
Tertiary Production
Tertiary production is associated with the provision of services (an intangible product). As with the secondary
sector, there are many tertiary production markets. Good examples include:
Hotels
Private healthcare and education
Accountants
Tourism


Term Definition
Added value The process of increasing the worth of resources by working on them
Primary
production
Production which involves the extraction of raw materials
Production
process
The process of transforming inputs (labour, raw materials, land) into outputs
(products)
Productive
efficiency
How efficient or competent a firm is at transforming inputs into outputs
Secondary
production
Production which involves transforming raw materials into goods
Tertiary
production
Production which is associated with supplying services


Methods of Production
Job, Batch and Flow production are the three main ways a firm could choose to make its product(s). Each
method varies greatly in how they actually handle the production process but the aim of each is the same: to
transform in puts into outputs in the most efficient way.
Job Production
Job production involves firms producing items that meet the specific requirements of the customer. Often
these are one-off, unique items such as those made by an architect or wedding dressmaker. For an
architect, each building or structure that he designs will be different and tailored to the needs of each
individual client.
With job production, a single worker or group of workers handles the complete task. Jobs can be on a small-
scale involving little or no technology. However, jobs can also be complex requiring lots of technology.
With low technology jobs, production is simple and it is relatively easy to get hold of the skills and equipment
required. Good examples of the job method include:
Hairdressers
Tailoring
Painting and decorating
Plumbing and heating repairs in the home
High technology jobs are much more complex and difficult. These jobs need to be very well project-managed
and require highly qualified and skilled workers. Examples of high technology / complex jobs include:
Film production
Large construction projects (e.g. the Millennium Dome)
Installing new transport systems (e.g. trams in Sheffield and Manchester)
Advantages
The advantage of job production is that each item can be altered for the specific customer and this provides
genuine marketing benefits. A business is likely to be able to add value to the products and possibly create
a unique selling point (USP), both of which should enable it to sell at high prices.
Disadvantages
Whether it is based on low or high technology, Job production is an expensive process as it is labour
intensive (uses more workers compared to machines). This raises costs to firms as the payment of wages
and salaries is more expensive than the costs of running machines.
Batch Production
As businesses grow and production volumes increase, the production process is often changed to a batch
method. Batch methods require that a group of items move through the production process together, a
stage at a time.
For example when a bakery bakes loaves of wholemeal bread, a large ball of wholemeal dough will be split
into several loaves which will be spread out together on a large baking tray. The loaves on the tray will then
together be cooked, wrapped and dispatched to shelves, before the bakery starts on a separate batch of, for

example, crusty white bread. Note that each loaf is identical within a batch but that loaves can vary from
batch to batch.
Batch production is a very common method of organising manufacture. Good examples include:
Production of electronic instruments
Fish and chip shops
Paint and wallpaper manufacturers
Cereal farming
Advantages
The batch method can be an advantage for businesses that produce a range of products. It is cheaper to
produce a number of each item in one go because machines can be used more effectively, the materials can
be bought in bulk and the workers can specialise in that task. There are two particular advantages of workers
being able to concentrate their skills.
They should become more expert at their tasks, which will in turn increase productivity (output per
worker). This will lower costs, as fewer workers are needed to produce a set amount.
Better quality products should be produced as workers are more familiar with the task and so can find
ways of improving it.
Disadvantages
Batch production requires very careful planning to decide what batch will be produced when. Once a batch is
in production it is difficult to change, as switching to another batch takes time and will mean a loss of output.
Batch methods can also result in the build up of significant work in progress or stocks (i.e. completed
batches waiting for their turn to be worked on in the next operation). This increases costs as it takes up
space and raises the chance of damage to stock.
Flow Production
Flow production involves a continuous movement of items through the production process. This means that
when one task is finished the next task must start immediately. Therefore, the time taken on each task must
be the same.
Flow production (often known as mass production) involves the use of production lines such as in a car
manufacturer where doors, engines, bonnets and wheels are added to a chassis as it moves along the
assembly line. It is appropriate when firms are looking to produce a high volume of similar items. Some of
the big brand names that have consistently high demand are most suitable for this type of production:
Heinz baked beans
Kelloggs corn flakes
Mars bars
Ford cars
Advantages
Flow production is capital intensive. This means it uses a high proportion of machinery in relation to workers,
as is the case on an assembly line. The advantage of this is that a high number of products can roll off
assembly lines at very low cost. This is because production can continue at night and over weekends and

also firms can benefit from economies of scale, which should lower the cost per unit of production.
Disadvantages
The main disadvantage is that with so much machinery it is very difficult to alter the production process. This
makes production inflexible and means that all products have to be very similar or standardised and cannot
be tailored to individual tastes. However some variety can be achieved by applying different finishes,
decorations etc at the end of the production line.
Summary of different types of production

Job Batch Flow
Low volume one-off items. Average volume- groups of
products produced together
High volume continuous
production
Very flexible production

Flexible between batches Inflexible production
Unique, tailor made products

Range of products Standardised products
Relatively high cost per unit Average efficiency- cost per unit
decreases
Very low cost per unit


Production Efficiency
Introduction
A business should constantly be trying to improve its efficiency. In many markets, a business needs to be at
least as efficient as its main competitors in order to be able to compete and survive in the long-term. A more
efficient business will produce lower cost goods than competitors and may generate more profit possibly at
lower prices
Increasing efficiency will boost the capacity of a business, assuming there is no change in the number of
inputs employed. The capacity of a firm refers to how much a business can produce during a specific period
of time.
Efficiency
Where a business has efficient production, it is operating at maximum output at minimum cost per unit of
output. Efficiency is, therefore, a measure of how well the production or transformation process is
performing. However, this is not always easy to assess.
There are several ways to measure efficiency
Productivity
This measures the relationship between inputs into the production process and the resultant outputs. The
most commonly used measure is labour productivity, which is measured by output per worker. For example,
assume a sofa manufacturer makes 100 sofas a month and employs 25 workers. The labour productivity is 4
sofas per person per month.
There are several other measures of productivity.
Output per hour / day / week
Output per machine
Unit costs
Unit cost (also referred to as cost per unit) divides total costs by the number of units produced. A falling ratio
would indicate that efficiency was improving.
Unit costs = Total Costs / Units of output
Stock levels
A business will have set itself a target stock level of finished goods that it should achieve. This is calculated to
satisfy the demand expected by the marketing department plans and based on what the production
department thinks they can produce. If the stock level falls below this level then the productive efficiency has
reduced since the output per worker has not met the planned requirements.
Non-productive ( idle ) resources
Which resources are not in constant use in the business? Are employees often left with nothing to do? Are
machines only used for part of available time? Too many idle resources are a common sign of inefficiency in
production.

Poor quality
There are many measures of poor quality any of which could indicate a problem with efficiency:
Customer complaints
Rejected finished goods identified by the quality control department
Customer returns of defective goods
Strategies to Improve Efficiency
There are several ways a business can try to improve efficiency levels.
Train the workforce
Training the workforce in order to give them more skills or knowledge is clearly a cost to firms. They will often
have to pay experts to train employees and will also lose the productive time of employees whilst they are
training.
However this increase in cost should be more than offset in the long term by improvements in the workers
productivity levels. This is because training should enable workers to work more quickly and more accurately
(produce better quality products).
Improve motivation
A better-motivated workforce will work harder and take pride in their work. This should increase the speed of
production and also improve the quality of products that are being produced. There are many different
financial (e.g. bonuses) and non-financial ways (e.g. empowerment) for businesses to motivate their workers.
More capital equipment
Investment into new, higher technological machinery can have a number of advantages.
Longer hours can be worked
Increased speed of production (machine can perform repetitive and complicated tasks more quickly)
Increased accuracy and therefore less wastage
Use better quality raw materials
This can reduce the amount of time wasted on rejected or defective products. A business should ensure they
find the supplier who can supply the best quality resources, but at a competitive price and also with reliable
delivery.
Conclusion
Improvements in efficiency are not that easy to obtain. For instance managers may find workers resistant to
changes such as introducing new machinery or new working practices. This is because workers fear that
changes will lead to redundancies. It can also take a long time for any new strategies to feed through into the
form of increased efficiency. In addition, there can be a conflict between productivity and quality. Increasing
productivity by its nature implies increasing the speed of production, and if managers are not careful this can
mean that workers focus solely on quantity and not the quality of their work.

Lean Production
Introduction
There is much evidence to suggest that the traditional mass production methods, used widely for much of
20
th
century, can create problems, which leads to inefficiency. The main problems are:
Employee boredom and low morale particularly where employees undertake repetitive jobs
Equipment failure regular breakdowns of equipment that can cause hold-ups elsewhere in the
production process
Equipment obsolescence where a machine quickly becomes outdated, although there is little
incentive to replace it if the machine had cost a lot of money
As a result of these problems, businesses have increasingly looked to see if they can make their production
more efficient by becoming more flexible and lean .
Lean production is an approach which originated in Japan during the 1950s and 1960s and has recently
been increasing in popularity among UK firms. Its main objective is to eliminate all forms of waste in the
production process and so produce more by using fewer inputs. There are several forms of waste that
lean production aims to eliminate.
Waste from materials
Waste of workers time and effort
Waste of floor space
Waste from defective products (poor quality)
By reducing this waste the costs of firms will decrease and they will become more efficient and competitive.
The idea is to make the product right first time (not spend time checking and re-checking).
There are several popular management techniques that have been developed to help achieve lean
production. The three most popular are:
Cell production
Kaizen (continuous improvement)
Just-in-time (JIT) manufacturing
Cell Production
In traditional production, products were manufactured in separate areas (each with a responsibility for a
different part of the manufacturing process) and many workers would work on their own, as on a production
line. In cell production, workers are organised into multi-skilled teams. Each team is responsible for a
particular part of the production process including quality control and health and safety. Each cell is made up
of several teams who deliver finished items on to the next cell in the production process.
Cell production can lead to efficiency improvements due to increased motivation (team spirit and added
responsibility given to cells) and workers sharing their skills and expertise.
Kaizen (Continuous Improvement)

Kaizen is a Japanese word for an approach to work where workers are told they have two jobs to do:
Firstly to carry out their existing task; and
Secondly to come up with ways of improving the task
The concept known as continuous improvement therefore implies a process where the overall progress
and gains in productivity within a firm, come from small improvements by workers being made all the time.
For example, an employee may simply re-organise the lay out of his work area, which saves 2 minutes
looking for and filing paperwork each day. When added up the course of a week, 10 minutes extra productive
time is gained, which over a year equates to an extra days work. If other workers also adopt this, then a firm
can benefit from a significant increase in output per worker (productivity) over a year.
Just-in-time (JIT) Production
JIT means that stock arrives on the production line just as it is needed. This minimises the amount of stock
that has to be stored (reducing storage costs).
JIT has many benefits and may appear an obvious way to organizes production but it is a complicated
process which requires efficient handling. For example, JIT relies on sophisticated computer systems to
ensure that the quantities of stock ordered and delivered are correct. This process needs to be carried out
very accurately or production could come to a standstill.
Advantages of JIT Disadvantages of JIT
Reduces costs of holding stock e.g.
warehousing rent
Needs suppliers and employees to be reliable
No money tied up in stock, can be use better
elsewhere May find it difficult to meet sudden increase in demand
Term Definition
Cell production
Production process is broken down and re-organised around teams or units
Efficiency When the production process is operating at maximum output at minimum cost per
unit of output
Just-in-time
production
Stock arrives on the production line just as it is needed
Kaizen
A process whereby overall progress and gains in productivity within a firm, come
from small improvements by workers being made all the time
Lean production Philosophy of production that originated in Japan. The main objective is to eliminate
all forms of waste in the production process and so produce more by using less
inputs
Productivity Measure of the relationship between inputs into the production process and the
resultant outputs
Unit costs Total costs divided by output

Economies of Scale
Introduction
Economies of scale arise when the cost per unit falls as output increases. Economies of scale are the
main advantage of increasing the scale of production and becoming big.
Why are economies of scale important?
- Firstly, because a large business can pass on lower costs to customers through lower prices and increase
its share of a market. This poses a threat to smaller businesses that can be undercut by the competition
- Secondly, a business could choose to maintain its current price for its product and accept higher profit
margins. For example, a furniture-maker which could produce 1,000 cabinets at 250 each might expand
and be able to produce 2,000 cabinets at 200 each. The total production cost will have risen to 400,000
from 250,000, but the cost per unit has fallen from 250 to 200. Assuming the business sells the cabinets
for 350 each, the profit margin per cabinet rises from 100 to 150.
There are two main types of economies of scale: internal and external. Internal economies of scale have a
greater potential impact on the costs and profitability of a business.
Internal Economies of Scale
Internal economies of scale relate to the lower unit costs a single firm can obtain by growing in size itself.
There are five main types of internal economies of scale.
Bulk-buying economies
As businesses grow they need to order larger quantities of production inputs. For example, they will order
more raw materials. As the order value increases, a business obtains more bargaining power with suppliers.
It may be able to obtain discounts and lower prices for the raw materials.
Technical economies
Businesses with large-scale production can use more advanced machinery (or use existing machinery more
efficiently). This may include using mass production techniques, which are a more efficient form of
production. A larger firm can also afford to invest more in research and development.
Financial economies
Many small businesses find it hard to obtain finance and when they do obtain it, the cost of the finance is
often quite high. This is because small businesses are perceived as being riskier than larger businesses that
have developed a good track record. Larger firms therefore find it easier to find potential lenders and to raise
money at lower interest rates.
Marketing economies
Every part of marketing has a cost particularly promotional methods such as advertising and running a
sales force. Many of these marketing costs are fixed costs and so as a business gets larger, it is able to
spread the cost of marketing over a wider range of products and sales cutting the average marketing cost
per unit.

Managerial economies
As a firm grows, there is greater potential for managers to specialise in particular tasks (e.g. marketing,
human resource management, finance). Specialist managers are likely to be more efficient as they possess
a high level of expertise, experience and qualifications compared to one person in a smaller firm trying to
perform all of these roles.
External Economies of Scale
External economies of scale occur when a firm benefits from lower unit costs as a result of the whole
industry growing in size. The main types are:
Transport and communication links improve
As an industry establishes itself and grows in a particular region, it is likely that the government will provide
better transport and communication links to improve accessibility to the region. This will lower transport costs
for firms in the area as journey times are reduced and also attract more potential customers. For example,
an area of Scotland known as Silicon Glen has attracted many high-tech firms and as a result improved air
and road links have been built in the region.
Training and education becomes more focused on the industry
Universities and colleges will offer more courses suitable for a career in the industry which has become
dominant in a region or nationally. For example, there are many more IT courses at being offered at colleges
as the whole IT industry in the UK has developed recently. This means firms can benefit from having a larger
pool of appropriately skilled workers to recruit from.
Other industries grow to support this industry
A network of suppliers or support industries may grow in size and/or locate close to the main industry. This
means a firm has a greater chance of finding a high quality yet affordable supplier close to their site.
Diseconomies of Scale
Increasing the size of a business does not always result in lower costs per unit. Sometimes a business can
get too big!
Diseconomies of scale occur when a business grows so large that the costs per unit increase.
Diseconomies of scale occur for several reasons, but all as a result of the difficulties of managing a larger
workforce.
Poor communication
As the business expands communicating between different departments and along the chain of command
becomes more difficult. There are more layers in the hierarchy that can distort a message and wider spans
of control for managers. This may result in workers having less clear instructions from management about
what they are supposed to do when.
In addition, there may be more written forms of communication (e.g. newsletters, notice boards, e-mails) and
less face-to-face meetings, which can result in less feedback and therefore less effective communication.

Lack of motivation
Workers can often feel more isolated and less appreciated in a larger business and so their loyalty and
motivation may diminish. It is harder for managers to stay in day-to-day contact with workers and build up a
good team environment and sense of belonging. This can lead to lower employee motivation with damaging
consequences for output and quality. The main result of poor employee motivation is falling productivity
levels and an increase in average labour costs per unit.
What can a business do about this? Possible solutions include:
Delegation of decision-making (empowerment)
Making jobs more interesting (job enrichment)
Splitting employees into teams (teamworking)
There is also a close link between communication and motivation (which the motivational theorist Elton Mayo
recognized) and so as communication becomes harder, motivation will decline. This is particularly true as
managers are less able to take a personal interest in the workers.
We cover the important area of motivation in this section of the Key Notes.
Loss of direction and co-ordination
It is harder to ensure that all workers are working for the same overall goal as the business grows. It is more
difficult for managers to supervise their subordinates and check that everyone is working together effectively,
as the spans of control have widened. A manager may be forced to delegate more tasks, which while often
motivating for his subordinates, leaves the manager less in control.
Term Definition
Diseconomies of
scale
Occur when a business grows so large that the cost per unit increases
Economies of
scale
As a output increases the unit costs of production decrease
External
economies of
scale
Occur when a firm benefits from lower unit costs as a result of the whole industry
growing in size
Internal
economies of
scale
Relate to the lower unit costs a single firm can obtain by growing in size itself


Quality Management
What is Quality?
What do we mean by the quality of a product or service? A simple definition is:
A quality product needs to be fit for purpose. This means the product must meet or exceed the
customer requirements.
It should be noted that a good quality product does not therefore have to be an expensive product; it merely
has to fulfill its purpose within the eyes of the customer.
For example, a cheap biro or cheap pair of trainers can be good quality as long as they do at least what the
customer expects them to do.
It is important to remember that it is the customer who sets the quality standards in terms of their overall
expectations of quality. There are several ways that a customer may define quality:
Reliability
Fit for purpose
Design
Safety
Long-lasting
In some cases, government act to encourage minimum standards for certain products. For example, the
British Standards Institute in the UK operates a well-known Kitemark scheme.
The Kitemark is a certification mark that offers proof that a product or service complies with the relevant
publicly available specification. It symbolises quality and safety and is recognized by over 80% of the UK
population.
Why is Quality Important?
Quality is important for two main reasons: reputation and costs.
Reputation
For virtually all purchasing decisions, customers choose which product to buy based on price and/or quality,
and occasionally on other factors such as the delivery time. The reputation of a business therefore depends
on these factors and it is often quality which can have the longest lasting impression (think of the long-
standing jokes about the quality of the old Skoda cars).
Customers often complain about the poor quality of the products and services they buy. Conversely, a
positive recommendation by a customer (for example by recommending a product or service to a friend)
helps to develop a positive reputation for quality.
There are many situations in which quality can prove to be less than expected: for example:
Poor service at a restaurant
A flight that runs late or is cancelled

A washing machine that breaks down
Clothing that unexpectedly shrinks in the wash
A good quality product can therefore provide a competitive edge over rivals and can lead to significant
marketing advantages. For example, a business will benefit from more repeat purchases and a longer life
cycle for its product. It may also be able to charge a premium (higher) price and so boost revenue.
Costs
A poor quality product does not only harm reputation and therefore sales but also increases costs to
businesses. There are many costs of poor quality, including:
Cost of reworking or remaking the product
Costs of replacements or refunds
Wasted materials
Costs of employing more staff to detect and solve quality problems
These extra costs will decrease the competitiveness of a business, as it may have to raise prices to cover
them.
Quality Control
The objective of quality control is to ensure each finished product meets the standard set out by the business
for a quality product. The traditional method by which a firm tries to achieve this quality standard is by having
a separate Quality Control department whose inspectors check the finished items and reject defective or
substandard products.
This method therefore detects quality problems at the end of the production process before they reach the
final customer. The Quality Control department would then try and change an aspect of the production
process and procedure, in order to solve quality problems that seem to occur most often.
This approach hopefully stops defective products getting to the market place and harming a firms reputation
but evidence shows that it has limited success at reducing the number of sub standard products being
produced and therefore wasting a firms resources.
Total Quality Management
An alternative and increasingly popular method of ensuring quality is known as Total Quality
Management or TQM . TQM is best described as being an attitude in a business where everyone in the
business is committed to achieving quality not just the people in the Quality Control or production
departments. It means that quality is being checked at every stage of the production process, as all
employees are trained to check their own work (self-checking).
Two of the main aims of TQM are zero defects and total customer satisfaction. Zero defects refers
to the aim of producing goods and services with no faults or problems. To achieve this requires:
Strong teamwork
Open sharing of information about what quality problems are arising and how they are caused
Investment in improving and refining production processes

There are various advantages and disadvantages of introducing TQM:
Improves reputation- faults and problems are
spotted and sorted quicker (zero defects)
Initial introduction costs- training workers
and disrupting current production whilst being
implemented
Higher employee morale workers motivated
by extra responsibility, team work and involvement
in decisions of TQM
Benefits may not be seen for several years
Lower costs Decrease waste as fewer
defective products and no need for separate
Quality Control inspectors
Workers may be resistant to change may feel
less secure in jobs
There is no guarantee that TQM will be a success and there have been cases of firms abandoning their new
TQM initiatives. This is often because after several years the benefits have not yet been fully achieved and
have not offset the initial costs. The success of TQM will depend upon the attitudes of workers throughout
the business and how readily they accept the changes to their traditional working practices.

Term Definition
Kitemark A certification mark that offers proof that a product or service complies with the
relevant publicly available specification
Quality A quality product needs to be fit for purpose. This means it must meet or exceed the
customer requirements
Quality control Aims to ensure each finished product meets the standard set out by the business for a
quality product
Total quality
management
(TQM)
TQM is best described as being an attitude in a business where everyone in the
business is committed to achieving quality
Zero defects Aim of producing goods and services with no faults or problems


Business Location
Introduction
Every business has to be located somewhere. A sole trader who works as a window cleaner may operate
from home, where as a multinational car company will have factories, offices and outlets in many countries.
For both businesses however, where to locate may be the most important decision they make and can
determine their success. It is a very expensive decision to reverse.
Factors Affecting Location
There are many factors that determine where a business will locate:
Cost of site
Availability of labour
Proximity to raw materials
Proximity to market
Infrastructure
Government incentives
Cost of site
The amount, type and cost of land are all important factors in choosing a location. The cost of land will vary
greatly across regions and countries. For example the cost of a site in the South East of England will be
significantly higher than a similar site in the North East. Also the kind of land may be important (e.g. avoiding
areas of possible mining subsidence)
The ability to expand and to build new premises may be important. This would require the support of the
local authorities for planning permission.
Availability of Labour
The availability of workers, their skill level and wage rate they need to be paid is crucial in deciding the where
to locate. Some businesses may need skilled labour whereas others require a large supply of lower-cost,
unskilled labour.
Where labour skills are in short supply (e.g. in some high-tech industries) it often happens that similar
businesses locate themselves close to each other. They might also be close to colleges and other training
organisations that provide the main source of newly trained employees.
Businesses that require large numbers of unskilled workers might prefer to be located in areas of low labour
costs. These are also often areas of high unemployment where recruitment may be easier than in areas
where there are labour shortages. Many multi-national companies that require large amounts of unskilled
labour, such as Nike to make trainers, have located factories in SE Asia where the wage rate is very low and
there are many available workers.
Proximity to raw materials
Businesses that use substantial quantities of raw materials may find it cheaper to locate near to the source of

those inputs as this will reduce transport costs. Such businesses are often called bulk-reducing as the
weight or size of the finished product is less than the combined raw materials that went into making it. Good
examples include:
Steel-producers
Sawmills
Sugar factories
Oil refineries
Proximity to Market
By contrast, businesses that assemble components (bulk-increasing) often choose to locate closer to where
the customer markets are. This is because the cost of transporting the bulkier or heavier finished product is
greater than the cost of transporting the raw materials or components. Good examples include:
Breweries
Car manufacturers
Bakeries
In some cases moving the final product is not possible, such as for services like restaurants and high street
shops. In these cases the businesses will locate at the market itself.
Infrastructure
Infrastructure covers the modes of transport for people, materials and information. Businesses need to
ensure there is adequate infrastructure provision or costs can rise, such as extra transport costs. It is the
government that is largely responsible for providing and maintaining local infrastructure.
The key infrastructure considerations are:
Road/rail/sea and air links. The most appropriate mode will depend on the type of business and
product, but road is used by over 80% of business.
Communications network. For example is there mobile phone coverage and suitable telephone
lines (e.g. availability of broadband internet access).
Access to basic facilities such as water and electricity (and enough power).
Government Incentives
Government policy also influences business location. Governments often offer incentives to start new
businesses, or relocate existing ones, in areas that need economic development (regeneration). This has
led to certain areas being called enterprise zones or assisted areas where firms are offered grants or low
interest loans if they locate into these economically depressed regions.
Another example is Regional Development Agencies which were first set up by the current government in
1999. Their aim is to:
Encourage economic development and regeneration
Promote business efficiency, investment and competitiveness

Promote employment
Provide training to the labour force to assist in growing employment
Both the UK Government and the European Commission offer financial support to businesses willing to move
to areas of high unemployment. Businesses are also encouraged to redevelop Brownfield sites (e.g. old
farms, inner city wasteland) rather than build on Greenfield land on the outskirts of cities.

Stock Control
Introduction
There are three types of stock that a business can hold:
Stocks of raw materials (inputs brought from suppliers waiting to be used in the production
process)
Work in progress (incomplete products still in the process of being made)
Stocks of finished products (finished goods of acceptable quality waiting to be sold to customers)
The aim of stock control is to minimise the cost of holding these stocks whilst ensuring that there are
enough materials for production to continue and be able to meet customer demand. Obtaining the correct
balance is not easy and the stock control department will work closely with the purchasing and marketing
departments.
The marketing department should be able to provide sales forecasts for the coming weeks or
months (this can be difficult if demand is seasonal or prone to unexpected fluctuation) and so allow
stock control managers to judge the type, quantity and timing of stocks needed.
It is the purchasing departments responsibility to order the correct quantity and quality of these
inputs, at a competitive price and from a reliable supplier who will deliver on time.
As it is difficult to ensure that a business has exactly the correct amount of stock at any one time, the majority
of firms will hold buffer stock. This is the safe amount of stock that needs to be held to cover unforeseen
rises in demand or problems of reordering supplies.
Stock Management
Good stock management by a firm will lower costs, improve efficiency and ensure production can meet
fluctuations in customer demand. It will give the firm a competitive advantage as more efficient production
can feed through to lower prices and also customers should always be satisfied as products will be available
on demand.
However, poor stock control can lead to problems associated with overstocking or stock-outs.
If a business holds too much buffer stock (stock held in reserve) or overestimates the level of demand for its
products, then it will overstock. Overstocking increase costs for businesses as holding stocks are an
expense for firms for several reasons.
Increases warehouse space needed
Higher insurance costs needed
Higher security costs needed to prevent theft
Stocks may be damaged, become obsolete or perish (go out of date)
Money spent buying the stocks could have been better spent elsewhere
The opposite of an overstock is a stock-out. This occurs when a businesses runs out of stocks. This can
have severe consequences for the business:
Loss of production (with workers still having to be paid but no products being produced)

Potential loss of sales or missed orders. This can harm the reputation of the business.
In these circumstances a business may choose to increase the amount of stock they hold in reserve (buffer
stock). There are advantages and disadvantages of increasing the stock level.
Can meet sudden changes in demand Costs of storage rent and insurance
Less chance of loss of production time because of
stock outs
Money tied up in stocks not being used elsewhere
in the business
Can take advantage of bulk buying economies of
scale
Large stocks subject to deterioration and theft


MANAGING PEOPLE
Recruitment, Selection and Retention
Introduction
Recruitment and selection is the process of identifying the need for a job, defining the requirements of the
position and the job holder, advertising the position and choosing the most appropriate person for the job.
Retention means ensuring that once the best person has been recruited, they stay with the business and are
not poached by rival companies.
Undertaking this process is one of the main objectives of management. Indeed, the success of any business
depends to a large extent on the quality of its staff. Recruiting employees with the correct skills can add
value to a business and recruiting workers at a wage or salary that the business can afford, will reduce costs.
Employees should therefore be carefully selected, managed and retained, just like any other resource


Recruitment Planning
There are a number of possible reasons as to why a business may have to recruit more employees:
Business is expanding due to:
Increasing sales of existing products
Developing new products
Entering new markets
Existing employees leaving to work with competitors or other local employers
Existing employees leaving due to factors such as retirement, sick leave, maternity leave
Business needs employees with new skills
Business is relocating and not all the existing workforce wants to move to the new location
In each of these circumstances a business will normally carry out Workforce Planning to find out how many
workers and what types of workers are required. The workforce plan will establish what vacancies exist and
managers then need to draw up a job description and job specification for each post.
A job description is a detailed explanation of the roles and responsibilities of the post advertised. Most
applicants will ask for this before applying for the job. It refers to the post available rather than the person.
A job specification is drawn up by the business and sets out the kind of qualifications, skills, experience and
personal attributes a successful candidate should possess. It is a vital tool in assessing the suitability of job
applicants and refers to the person rather than the post.
These documents are an important part of the recruitment and selection process and provide the basis as to
where the job may be advertised and whether an applicant is suitable for the post. They also help provide a
framework for questions to be asked at an interview.
Methods of Recruitment
A manager can recruit in two different ways:
Internal recruitment is when the business looks to fill the vacancy from within its existing
workforce.
External recruitment is when the business looks to fill the vacancy from any suitable applicant
outside the business.

Cheaper and quicker to recruit Limits the number of potential applicants
People already familiar with the business and
how it operates
No new ideas can be introduced from
outside the business
Provides opportunities for promotion with in
the business can be motivating
May cause resentment amongst
candidates not appointed
Internal
Recruitment
Business already knows the
strengths and weaknesses of
candidates
Creates another vacancy which needs
to be filled
Outside people bring in new ideas Longer process
Larger pool of workers from which to find the
best candidate
More expensive process due to
advertisements and interviews required
External
Recruitment
People have a wider range of experience Selection process may not be
effective enough to reveal the best
candidate
The four most popular ways of recruiting externally are:
Job centres - These are paid for by the government and are responsible for helping the
unemployed find jobs or get training. They also provide a service for businesses needing to
advertise a vacancy and are generally free to use.
Job advertisements - Advertisements are the most common form of external recruitment. They
can be found in many places (local and national newspapers, notice boards, recruitment fairs) and
should include some important information relating to the job (job title, pay package, location, job
description, how to apply-either by CV or application form). Where a business chooses to advertise
will depend on the cost of advertising and the coverage needed (i.e. how far away people will
consider applying for the job
Recruitment agency - Provides employers with details of suitable candidates for a vacancy and
can sometimes be referred to as head-hunters. They work for a fee and often specialise in
particular employment areas e.g. nursing, financial services, teacher recruitment
Personal recommendation - Often referred to as word of mouth and can be a recommendation
from a colleague at work. A full assessment of the candidate is still needed however but potentially
it saves on advertising cost.

Handling Applications
For many jobs, a business will ask applicants to provide a curriculum vitae (CV). This is a document (often
on one or two sides of A4) that the applicant designs providing the details summarised below.
Personal details Name, address, date of birth, nationality
Educational history Including examination results, schools/universities attended, professional
qualifications
Previous employment
history
Names of employers, position held, main achievements, remuneration
package, reasons for leaving
Suitability and reasons for
applying for the job
A chance for applicants to sell themselves
Names of referees Often recent employer or people who know applicant well and are ideally
independent
In some circumstances however an applicant may be asked to fill in a firms own application form. This is
different from a CV in that the employer designs it and sends it to applicants, but it will still ask for much of the
same information. It has the benefit over a CV in that a business is able to tailor it to their exact needs and
ask specific questions.
Once a business has received all the applications, they need to be analysed and the most appropriate form of
selection decided upon. When analysing applications, a business will normally sieve the applications into
three categories.
Those to reject - Candidates may be rejected because they may not meet the standards set out in
the job specification such as wrong qualifications or insufficient experience or they may not have
completed the application form to a satisfactory standard.
Those to place on a short list. Often comprises 3-10 of the best candidates who are asked to
interview
Those to place on a long list - A business will not normally reject all other candidates immediately
but keep some on a long list in case those on the short list drop out or do not appear suitable during
interview. The business would not want to incur costs putting them through the selection process,
such as interviews, unless they have to.
Methods of Selection
Interviews
An interview is the most common form of selection as it is relatively cheap to undertake and is the chance
for an employer to meet the applicant face to face and so obtain much more information on what the person
is like and how suitable they are for the job. Examples of information that can only be learnt from interview
and not on paper from a CV or application form are:
Conversational ability- often known as people skills
Natural enthusiasm or manner of the applicant
See how applicant reacts under pressure
Queries on comments or details missing from CV or application form

Interviewers should also follow-up a candidates references, which can act as the final check that all the
information given by the candidate is correct. An honest reference from an independent source can also
reveal good or bad incidences from the candidates past or particular traits that may have been missed.
There are though other forms of selection tests that can be used in addition to an interview to help select the
best applicant. The basic interview can be unreliable as applicants can perform well at interview but not have
the qualities or skills needed for the job. Other selection tests can increase the chances of choosing the best
applicant and so minimise the high costs of recruiting the wrong people. Examples of these tests are aptitude
tests, intelligence tests and psychometric tests (to reveal the personality of a candidate).
Managers selecting candidates for a high level post in an organisation may even send applicants
to an assessment centre. In such centres candidates undergo a variety of tests, role-plays and simulations
for a number of days.
Once the best candidate has been selected and agreed to take up the post, the new employee must be given
an employment contract. This is an important legal document that describes the obligations of the
employee and employer to each other (terms and conditions) as well as the initial remuneration package and
a number of other important details.
Employee Retention
Employee retention is the ability of a firm to convince its employees to remain with the business. It is often
measured by the labour turnover of a business. This is defined as the proportion of a firms workforce that
leaves during the course of a year.
There are many reasons why a high labour turnover figure (poor employee retention) may cause problems for
a firm:
Increases recruitment costs (e.g. advertising for replacement staff; employing temporary staff whilst
the job vacancies are filled)
Reflects poor morale in workforce and so low productivity levels
Increases training costs of new workers
Loss of productivity while new worker settles in
However, there are some advantages of a firm experiencing labour turnover:
It gives the chance for new people to be brought into the business who may have fresh ideas and up
to date market knowledge.
Workers with specialist knowledge or expertise can be employed rather than having to train up
existing lower skilled employees.
A business can improve its employee retention by offering:
Financial incentives (e.g. bonus, salary rise)
Non-financial incentives (e.g. promotion, more decision making power)
See this section for more details on incentives at work
A business may also have to adopt more flexible working practices in order to retain staff and fit in with the
changing trend in UK employment and working patterns. For instance, there is a greater emphasis currently
being placed on flexible hours contracts and part-time working. This is mainly to allow for the growing

number of women joining the workforce who have to juggle childcare and their working lives.

Term Definition
Curriculum vitae
(CV)
A document (often on one or two sides of A4) that a job applicant designs
themselves and gives their main details, such as previous employment,
qualifications, interests etc
Employee
retention
The ability of a firm to convince its employees to remain with the business
External
recruitment
The business looks to fill the vacancy from any suitable applicant outside the
business
Internal
recruitment
The business looks to fill the vacancy from within its existing workforce
Job description
A detailed explanation of the roles and responsibilities of the post advertised
Job specification A document which sets out the kind of qualifications, skills, experience and personal
attributes a successful job applicant should possess
Labour turnover The proportion of a firms workforce that leaves during the course of a year
Recruitment &
selection
The process of identifying the need for a job, defining the requirements of the
position and the job holder, advertising the position and choosing the most
appropriate person for the job
Short list When 3-10 of the best applicants are placed on a short list and then asked to
interview
Workforce plan Managers draw up a workforce plan to predict the number of staff required in the
future and what type of skill level they will need


Training
Why is Training Necessary?
Training is a process whereby an individual acquires job-related skills and knowledge. It is a cost to firms
to pay for the training and also to suffer the loss of working hours whilst an employee is being trained.
However, the potential gains from employee training are significant. The main benefits of training are
improved productivity and motivation of staff and also better quality products being made.
Some of the specific reasons as to why a business should train its employees are:
Introduce new employees to the business (this is known as induction training) see below
Help provide the skills the business needs (in particular making the workforce more flexible or being
trained on new higher technology machinery)
Provide employees with better knowledge about the business and the market it operates in
Provide support for jobs that are complex and for which the required skills and knowledge are often
changing (e.g. a firm of lawyers training staff about new legislation)
Support the introduction of new working methods, such as a firm introducing new lean production
techniques
Reduce the need for supervision and therefore free up valuable manager time
Help achieve a good health and safety record
Help improve quality of a product or service and lower customer complaints
Increase employee motivation and loyalty to the business
Induction Training
Induction training is important as it enables a new recruit to become productive as quickly as possible. It
can avoid costly mistakes by recruits not knowing the procedures or techniques of their new jobs. The length
of induction training will vary from job to job and will depend on the complexity of the job, the size of the
business and the level or position of the job within the business.
The following areas may be included in induction training:
Learning about the duties of the job
Meeting new colleagues
Seeing the layout the premises
Learning the values and aims of the business
Learning about the internal workings and policies of the business
Methods of Training
There are two main methods of training:

On-the-job training
On the job training occurs when workers pick up skills whilst working along side experienced workers at their
place of work. For example this could be the actual assembly line or offices where the employee works.
New workers may simply shadow or observe fellow employees to begin with and are often given
instruction manuals or interactive training programmes to work through.
Off-the-job training
This occurs when workers are taken away from their place of work to be trained. This may take place at
training agency or local college, although many larger firms also have their own training centres. Training
can take the form of lectures or self-study and can be used to develop more general skills and knowledge
that can be used in a variety of situations, e.g. management skills programme.
The respective advantages of on-the-job and off-the-job training are summarised below:
On-the-Job Training Off-the-Job Training
Cheaper to carry out
Learn from specialists in that area of work who
can provide more in-depth study
Training is very relevant and practical dealing
with day to day requirements of job
Can more easily deal with groups of workers at
the same time
Workers not taken away from jobs so can still
be productive
Employees respond better when taken away
from pressures of working environment
Employees who are new to a job role become
productive as quickly as possible
Workers may be able to obtain qualifications or
certificates
Government Training Schemes
The government recognises the importance of training to the individual worker, firms and the economy as a
whole. This is because a well-trained workforce will be better motivated, improve the productivity levels in the
country and make firms more efficient. As a result the UK will be able to compete better against other
countries
The Department for Education and Skills is the government department responsible for training and it
funds and overseas training schemes at a national and local level, mainly through 78 Training and Enterprise
Councils (TECs) across England and Wales. The TECs particularly focus on schemes that promote training
for existing workers.
The government also emphasises the need to increase training and education for young people. Much of
their current thinking focuses on encouraging young people to continue into further education and study for
NVQs and other qualifications. This has been criticised by some who believe many individuals would benefit
more from work related training or apprenticeships. The government does run a Modern Apprenticeship
scheme for this purpose.
In addition, there are other schemes and new initiatives that the government is responsible for:
Adult literacy initiatives - responsible for driving forward a national strategy to improve literacy, language and
numeracy skills (remember the conquer your gremlins adverts on TV)
The New Deal
The New Deal is aimed at people aged between 18 and 24 and out of work for more than 6 months. After
being assessed an individual will either be given help finding a job (which may include paying a business a

subsidy to employ them), be given training and education on new skills for up to a year or be encouraged to
gain work experience on voluntary schemes aimed at benefiting the local community.
Investors in People
Investors in People (IIP) is aimed at encouraging businesses to make training a priority. Businesses, which
meet the requirements for training employees, are entitled to use a logo identifying them as having met this
particular standard. This can enhance their reputation when recruiting or dealing with customers.

Term Definition
Induction
training
Introduces new employees to the business as whole and their particular job
Off-the-job
training
When workers are taken away from their place of work to be trained
On-the-job
training
When workers pick up skills whilst working along side experienced workers at their
place of work
Productivity The amount a worker produces in a set period of time
Training A process whereby an individual acquires job-related skills and knowledge


Motivation
Importance of Motivation
Motivation is the will to work. This comes from the enjoyment of the work itself and/or from the desire to
achieve certain goals e.g. earn more money or achieve promotion.
Managers spend considerable time working out how best to motivate their workers and there are a number of
different opinions about how this can be best done. A well-motivated workforce can provide the following
advantages:
Better productivity (amount produced per employee). This can lead to lower unit costs of production
and so enable a firm to sell its product at a lower price
Lower levels of absenteeism as the employees are content with their working lives
Lower levels of staff turnover (the number of employees leaving the business). This can lead to
lower training and recruitment costs
Improved industrial relations with trade unions
Contented workers give the firm a good reputation as an employer so making it easier to recruit the
best workers
Motivated employees are likely to improve product quality or the customer service associated with a
product
Motivational Theory
There are a number of different views as to what motivates workers. The most commonly held views or
theories are discussed below and have been developed over the last 100 years or so. Unfortunately these
theories do not all reach the same conclusions!
Taylor
Frederick Winslow Taylor (1856 1917) put forward the idea that workers are motivated mainly by pay. His
Theory of Scientific Management argued the following:
Workers do not naturally enjoy work and so need close supervision and control
Therefore managers should break down production into a series of small tasks
Workers should then be given appropriate training and tools so they can work as efficiently as
possible on one set task.
Workers are then paid according to the number of items they produce in a set period of time- piece-
rate pay.
As a result workers are encouraged to work hard and maximise their productivity.
Taylors methods were widely adopted as businesses saw the benefits of increased productivity levels and
lower unit costs. The most notably advocate was Henry Ford who used them to design the first ever
production line, making Ford cars. This was the start of the era of mass production.
Taylors approach has close links with the concept of an autocratic management style (managers take all the

decisions and simply give orders to those below them) and Macgregors Theory X approach to workers
(workers are viewed as lazy and wish to avoid responsibility).
However workers soon came to dislike Taylors approach as they were only given boring, repetitive tasks to
carry out and were being treated little better than human machines. Firms could also afford to lay off workers
as productivity levels increased. This led to an increase in strikes and other forms of industrial action by dis-
satisfied workers.
Mayo
Elton Mayo (1880 1949) believed that workers are not just concerned with money but could be better
motivated by having their social needs met whilst at work (something that Taylor ignored). He introduced the
Human Relation School of thought, which focused on managers taking more of an interest in the workers,
treating them as people who have worthwhile opinions and realising that workers enjoy interacting together.
Mayo conducted a series of experiments at the Hawthorne factory of the Western Electric Company in
Chicago
He isolated two groups of women workers and studied the effect on their productivity levels of changing
factors such as lighting and working conditions.
He expected to see productivity levels decline as lighting or other conditions became progressively worse
What he actually discovered surprised him: whatever the change in lighting or working conditions, the
productivity levels of the workers improved or remained the same.
From this Mayo concluded that workers are best motivated by:
Better communication between managers and workers (Hawthorne workers were consulted over
the experiments and also had the opportunity to give feedback)
Greater manager involvement in employees working lives (Hawthorne workers responded to the
increased level of attention they were receiving)
Working in groups or teams. (Hawthorne workers did not previously regularly work in teams)
In practice therefore businesses should re-organise production to encourage greater use of team working and
introduce personnel departments to encourage greater manager involvement in looking after employees
interests. His theory most closely fits in with a paternalistic style of management.
Maslow
Abraham Maslow (1908 1970) along with Frederick Herzberg (1923-) introduced the Neo-Human Relations
School in the 1950s, which focused on the psychological needs of employees. Maslow put forward a theory
that there are five levels of human needs which employees need to have fulfilled at work.
All of the needs are structured into a hierarchy (see below) and only once a lower level of need has been fully
met, would a worker be motivated by the opportunity of having the next need up in the hierarchy satisfied.
For example a person who is dying of hunger will be motivated to achieve a basic wage in order to buy food
before worrying about having a secure job contract or the respect of others.
A business should therefore offer different incentives to workers in order to help them fulfill each need in turn
and progress up the hierarchy (see below). Managers should also recognise that workers are not all
motivated in the same way and do not all move up the hierarchy at the same pace. They may therefore have
to offer a slightly different set of incentives from worker to worker.

Herzberg
Frederick Herzberg (1923-) had close links with Maslow and believed in a two-factor theory of motivation. He
argued that there were certain factors that a business could introduce that would directly motivate employees
to work harder (Motivators). However there were also factors that would de-motivate an employee if not
present but would not in themselves actually motivate employees to work harder (Hygiene factors)
Motivators are more concerned with the actual job itself. For instance how interesting the work is and how
much opportunity it gives for extra responsibility, recognition and promotion. Hygiene factors are factors
which surround the job rather than the job itself. For example a worker will only turn up to work if a business
has provided a reasonable level of pay and safe working conditions but these factors will not make him work
harder at his job once he is there. Importantly Herzberg viewed pay as a hygiene factor which is in direct
contrast to Taylor who viewed pay, and piece-rate in particular
Herzberg believed that businesses should motivate employees by adopting a democratic approach to
management and by improving the nature and content of the actual job through certain methods. Some of
the methods managers could use to achieve this are:
Job enlargement workers being given a greater variety of tasks to perform (not necessarily more
challenging) which should make the work more interesting.
Job enrichment - involves workers being given a wider range of more complex, interesting and
challenging tasks surrounding a complete unit of work. This should give a greater sense of
achievement.
Empowerment means delegating more power to employees to make their own decisions over
areas of their working life.

Summary of Motivation theory
Theorist Conclusions
Herzberg
Two factor
theory
Workers motivated to work harder by motivators e.g. more responsibility, more interesting
work, more praise for good work
Workers can become demotivated if hygiene factors are not met e.g. pay, working
conditions, relationships with colleagues
Maslow
Hierarchy of
needs
Workers motivated by having each level of need met in order as they move up the
hierarchy Levels of needs are: Physical, Security, Social, Self-esteem, Self-fulfillment
Workers must have lower level of needs fully met by firm before being motivated by next
level
Mayo
Human
Relations
School of
thought
Workers motivated by having social needs met
Workers should work in teams
Managers should have greater involvement in employees working life
More two-way communication between managers and workers
Taylor Workers given one repetitive task so they can learn to master it
Theory of
Scientific
Management
Managers should give orders and closely control workers
Workers should be paid per item they produced piece rate


Management Styles
Introduction
What makes a good leader or manager? For many it is someone who can inspire and get the most from their
staff.
There are many qualities that are needed to be a good leader or manager.
Be able to think creatively to provide a vision for the company and solve problems
Be calm under pressure and make clear decisions
Possess excellent two-way communication skills
Have the desire to achieve great things
Be well informed and knowledgeable about matters relating to the business
Possess an air of authority
Do you have to be born with the correct qualities or can you be taught to be a good leader? It is most likely
that well-known leaders or managers (Winston Churchill, Richard Branson or Alex Ferguson?) are successful
due to a combination of personal characteristics and good training.
Managers deal with their employees in different ways. Some are strict with their staff and like to be in
complete control, whilst others are more relaxed and allow workers the freedom to run their own working lives
(just like the different approaches you may see in teachers!). Whatever approach is predominately used it
will be vital to the success of the business. An organisation is only as good as the person running it.
There are three main categories of leadership styles: autocratic, paternalistic and democratic.
Autocratic (or authoritarian) managers like to make all the important decisions and closely supervise and
control workers. Managers do not trust workers and simply give orders (one-way communication) that they
expect to be obeyed. This approach derives from the views of Taylor as to how to motivate workers and
relates to McGregors theory X view of workers. This approach has limitations (as highlighted by other
motivational theorists such as Mayo and Herzberg) but it can be effective in certain situations. For example:
When quick decisions are needed in a company (e.g. in a time of crises)
When controlling large numbers of low skilled workers.
Paternalistic managers give more attention to the social needs and views of their workers. Managers are
interested in how happy workers feel and in many ways they act as a father figure (pater means father in
Latin). They consult employees over issues and listen to their feedback or opinions. The manager will
however make the actual decisions (in the best interests of the workers) as they believe the staff still need
direction and in this way it is still somewhat of an autocratic approach. The style is closely linked with Mayos
Human Relation view of motivation and also the social needs of Maslow.
A democratic style of management will put trust in employees and encourage them to make decisions. They
will delegate to them the authority to do this (empowerment) and listen to their advice. This requires good
two-way communication and often involves democratic discussion groups, which can offer useful suggestions
and ideas. Managers must be willing to encourage leadership skills in subordinates.
The ultimate democratic system occurs when decisions are made based on the majority view of all workers.
However, this is not feasible for the majority of decisions taken by a business- indeed one of the criticisms of
this style is that it can take longer to reach a decision. This style has close links with Herzbergs motivators

and Maslows higher order skills and also applies to McGregors theory Y view of workers.
Summary of management styles
Description Advantages Disadvantages
Autocratic Senior managers take
all the important
decisions with no
involvement from
workers
Quick decision making
Effective when employing
many low skilled workers
No two-way communication so
can be de-motivating
Creates them and us attitude
between managers and
workers
Paternalistic Managers make
decisions in best
interests of workers after
consultation
More two-way communication
so motivating
Workers feel their
social needs are being
met
Slows down decision making
Still quite a dictatorial or
autocratic style of
management
Democratic Workers allowed to
make own decisions.
Some businesses run
on the basis of majority
decisions
Authority is delegated to
workers which is motivating
Useful when complex
decisions are required
that need specialist skills
Mistakes or errors can be
made if workers are
not skilled or experienced
enough
Evaluation of Management Styles
It is impossible to say that one style is better for a business than another as it depends on a number of
different factors:
The skills and experience of the workers
How genuinely motivated the workers are
How quickly decisions are needed
The importance of the task or decision
The personality of the manager
The best managers are those that are versatile and can call upon the right style at the right time.
There has been a move towards a more democratic style of management in the UK in recent years. This is
due to:
Workers becoming better trained and able to take on more responsibility
Workers expecting the opportunity to quickly take on new tasks and roles as they want to move
rapidly up the career ladder
An increase in lean production techniques, such as total quality management and kaizen, which
require more employee involvement and a need to have increased control over their area of work.

McGregors Theory X and Y
Douglas McGregor published a book The Human Side of Enterprise in 1964 in which he argued that
managers have two very different views of workers in terms of their attitudes to work and motivation. Theory
X managers distrust their workers and believe workers will avoid work if they can, whereas Theory Y
managers believe workers like to work and want to be given more responsibility.
Although McGregor fully supported a Theory Y approach from managers which would undoubtedly be more
pleasant and interesting to work for, he also recognised that a Theory X view can be the most effective form
of management in certain circumstances- just like an autocratic management style or Taylorite view of
motivation. This might be when controlling a large number of part-time, student or low skilled workers who
are simply focused on collecting a pay packet at the end of the day and therefore need constant direction and
supervising to ensure they do not slack off.

Term Definition
Absenteeism Working days missed due to health or other reasons
Autocratic Managers who like to make all the important decisions and closely supervise and control
workers
Democratic Managers allow workers allowed to make own decisions
Hygiene factor A factor that when not present will de-motivate someone, but cannot directly motivate
someone to work harder
Motivation The will to work due to the enjoyment of the work itself and/or from the desire to achieve
certain goals e.g. earn more money or achieve promotion
Motivator A factor which will encourage someone to work harder
Paternalistic Managers who make decisions in the best interests of their workers after consultation
Piece-rate Pay according to the number of items produced
Theory X Theory X managers distrust their workers and believe workers will avoid work if they can
Theory Y Theory Y managers believe workers like to work and want to be given more
responsibility


Rewarding Employees
Introduction
Managers need to reward employees in order to motivate them to work harder. The methods of reward
largely fall into two categories: financial or non-financial incentives. Theorists such as Taylor support
financial rewards as the best method, but others such as Mayo and Herzberg promote non-financial rewards,
such as teamworking or job enrichment.
An alternative approach is to make a list of reasons why people go into work each morning and then consider
the rewards which may satisfy each. Some of the reasons may be to:
Earn money
Feel a sense of achievement or job satisfaction
Feel a sense of belonging to a group
Achieve a sense of security
Obtain a feeling of self-worth
Financial incentives can be used to meet the first of these and possibly would give someone more security
but the others need to be met by non-financial rewards.
Financial Rewards
In reality, despite the views of Herzberg that monetary methods of motivation have little value, firms still use
money as a major incentive. There are a variety of payment systems that a business could use to motivate its
employees.
Wages and Salaries
Wages are normally paid per hour worked and workers receive money at the end of the week. Overtime is
paid for any additional hours worked during the week. However salaries are annual (based on a years work)
and are paid at the end of each month.
Advantage Disadvantage
Simple and easy to use for businesses
Workers may resent being paid the same as a
colleague who they feel is not so productive
Piece-rate
Piece-rate is paying a worker per item they produce in a certain period of time. It was recommended by the
motivation theorist Taylor and had close links with working on production lines.
Increases speed of work and therefore
productivity
Workers do not concentrate on quality of work as
emphasis on speed of work
Often workers not entitled to sick pay or holiday
pay which reduces cost
Workers may ignore company rules, such as Health
and safety issues, in they try to speed up output

Fringe Benefits
These are often known as perks and are items an employee receives in addition to their normal wage or
salary e.g. company car, private health insurance, free meals.
Encourages loyalty to a company so employees
may stay for longer
Widespread use to a majority of employees will
increase costs sharply
Helps meet a workers human and social needs
Performance-related pay
This is paid to those employees who meet certain targets. The targets are often evaluated and reviewed in
regular appraisals with managers. It is system that is being increasingly used in businesses in the UK.
Easier for managers to monitor and control their
staff
It can be difficult to measure the performance of
employees in service based industries
Reduces the amount of time spent on industrial
relations (negotiations with trade unions)
It does not promote teamwork and can lead to
workers feeling they are treated unfairly if
colleagues are awarded more
Profit sharing
This is a system whereby employees receive a proportion of the companys profits. This means staff are in
the same position as shareholders.
Should improve loyalty to the company and
break down the them and us barrier if all staff
given same amount
The share given to employees is often too
small to provide a worthwhile incentive
Workers are more likely to accept changes to
their working practices if they can see that it may
decrease costs and so increase profit
Workers may feel that however hard they
work it will not have a noticeable effect on the
companys profit level, so therefore no incentive
Share ownership
This is a common incentive for senior managers who are given shares in the company rather than a
straightforward bonus or membership of a profit sharing scheme. It means that some staff are also
shareholders.

Employees will work harder as they have a stake in
the company, just like a shareholder has
Often only available to senior managers so can
cause resentment among other staff.
Workers are less likely to leave the firm


Non-financial Rewards
Job enrichment
Job enrichment means giving workers more interesting, challenging and complex tasks. Workers should also
be given the opportunity to complete a whole unit of work rather than individual separate tasks.
This is motivating for several reasons:
It gives workers the chance to test themselves and use their full range of ability
It is more motivating than job enlargement or job rotation (see below) as it increases the complexity
or challenge involved in the task, rather than just simply providing more variety to the work.
Workers should obtain a greater sense of achievement and possibly more praise or recognition of
their work when they have successfully completed a tougher task
Workers respond better as managers have shown trust in the fact that they possess the ability to
handle the increasing complexity and pressures of the work.
The managers need to judge carefully however what an appropriate task is for a worker to handle- if it is too
complex for the workers or they do not posses the correct skill level, then expensive mistakes could be made.
Job enlargement
Job enlargement means simply giving workers more tasks to do of a similar nature or complexity. This will
reduce the monotony or repetition involved in a persons work but over time this will not increase a persons
satisfaction or sense of achievement.
Job rotation is a part of this and involves having a wider variety of tasks to do, perhaps rotating jobs with
other members in your team, but not increasing the challenge of the job.
Teamworking
Teamworking is where employees work in groups or teams. This can meet a workers social needs as a
person can more easily build friendships and feel a sense of belonging to a unit or group and hopefully to the
business as a whole. This applies in much the same way as being a member of a sports team or any other
team representing a school or college.
A business can create a number of different types of team; examples include production teams (often known
as cells), quality circles and management teams.
Teamworking has other advantages to a firm over and above improving motivation. It can lead to greater
flexibility of production, as employees are likely to be multi-skilled (able to do more than one persons job) as
they have learnt from other team members or undertaken formal job rotation. This means they can cover
any absences and can quickly adapt to a new production technique.
Empowerment
Empowerment is like delegation. It is when power or authority is given to employees so they can make their
own decisions regarding their working life. For instance workers have control over how to use their time and
deciding the priority of tasks that need to be done. They are encouraged to consider problems they face and
come up with some solutions.
For empowerment to be successful, workers must have adequate training and/or good skill levels in order to

be trusted to make the correct decisions. If they do not, then expensive mistakes can be made that could
affect the whole business. It is the managers job to judge whether a subordinate can cope with more
authority and decision-making power. It should be noted however, that even if managers pass down authority
to their subordinates, they are still responsible for the work that is done by them.

Term Definition
Empowerment /
Delegation
When power or authority is given to employees so they can make their own
decisions regarding their working life
Fringe benefits
These are often known as perks and are items an employee receives in addition to
their normal wage or salary e.g. company car, private health insurance, free meals
Job enlargement
Involves simply giving workers more tasks to do of a similar nature or complexity
Job enrichment Giving workers more interesting, challenging and complex tasks
Job rotation Involves giving a worker a wider variety of tasks to do, perhaps rotating jobs with
other members in a team, but not increasing the challenge of the job
Performance-
related pay
Paid to those employees who meet certain targets. Targets are regularly reviewed
in appraisals
Profit sharing A system whereby employees receive a proportion of the companys profits
Share ownership
A common incentive for senior managers who are given shares in the
company


Groups at work
Trade Unions
A trade union is an organisation that employees can join in order to have their interests and goals better
represented. A worker will pay an annual subscription and in return will have their interests more powerfully
represented than if they had to negotiate with employers on their own.
Workers acting together in a trade union can counterbalance the power of large firms. This is due to
collective bargaining where all trade union members are balloted (given the opportunity to vote) on issues
and a trade union representative then negotiates with the employer on their behalf. The negotiations and
relationship between a trade union and an employer is known as industrial relations.
Traditionally trade unions used to focus their attention on obtaining a good standard of pay for their members
but more recently unions are concentrating on protecting the individual rights of their members. This may
mean providing legal and financial support and advice for members who feel their employer has discriminated
against them or dismissed them unfairly.
There are four main types of trade union as outlined in the table below:
Type of Union Description / Example
Craft of skills union To represent skilled workers e.g. Musicians Union (MU)
Industrial unions To represent the members of one particular industry e.g. Fire Brigades Union
(FBU)
General unions Unions which recruit workers from all types of industries and with any level or
range of skills e.g. Amicus the Manufacturing Science and Finance Union (MSF)
White-collar unions Represent office workers e.g. National Union of Teachers (NUT)
In addition there is the Trade Unions Congress (TUC) who represent all British trade unions at a national
and international level. In particular the TUC tries to influence government decision-making in the best
interests of unions and workers and to coordinate with trade union movements in other EU countries.
Industrial Action
The majority of worker-to-manager and therefore union-to-employer problems are worked out peacefully
through negotiation. However occasionally an issues arises where no agreement or solution can be reached.
This is when a trade union may conduct some form of industrial action in order to force the employer to back
down.
There are several different types of industrial action that could be taken:
Strike Workers select a day(s) on which they will not come into work.
Work to rule Workers apply the firms rules and procedures to the letter with the objective of
slowing down production. For example a machine worker may be told to ensure his machine is
clean and safe before starting work and so he will be deliberately nit-picking and spend hours doing
exactly this.
Go slow Employees carry on working but at the minimum pace possible in order to slow down
production but avoid disciplinary action.
Picketing Workers may stand at the entrance to the employers factory or place of work and
demonstrate with banners or slogans.

Overtime ban Workers simply refuse to work overtime as they are not obliged to. This can
prevent a firm being able to produce quickly enough to meet demand and they may lose orders.
If unions and employers continue in dispute then either side can bring in ACAS to help resolve the
disagreement. ACAS is the Advisory, Conciliation and Arbitration Service and is an independent body
financed by the government. It is responsible for giving advice to both sides, sitting in and helping with
negotiations and ultimately it can provide an individual, or arbitrator, who can judge the right outcome of the
dispute.
Changing Role of Trade Unions
The power of trade union has been gradually eroded over the last 20 years. This is due to a number of
reasons:
Laws passed by Conservative government during 1980s and 1990s which have weakened the
power of trade unions
Decline in trade union membership
Change in structure of industry from heavily unionised manufacturing industry towards service
sector businesses. Also more women and part-time workers who are less inclined to join unions.
Change in philosophy from conflicts due to collective bargaining to individual bargaining between
firms and employees
One of the new laws that was introduced stated that employers did not have to recognise any trade union if
they did not want to, regardless of how many of their workers belonged to it. This meant that trade unions
could play no part in negotiations and could not represent their workers at all. However, in 2000 a new EU
employment Law came into being which stated that an employer must legally recognise and negotiate with a
trade union if more than 50% of its workers belong to it.
Benefits of Trade Unions
In practice many firms choose to deal with trade unions as they can benefit not only the employee but also
the employer. This is shown below:
Benefits to an Employee Benefits to an Employer
More powerful voice when bargaining as a group
(e.g. for pay rises) as can threaten industrial
action such as strikes
Cheaper and quicker to bargain with one trade union
representative than individual workers
Workers will have their individual rights better
protected e.g. if dismissed unfairly or
discriminated against
Workers are better motivated if they feel their interests
are being looked after by trade unions
Trade unions increasingly wish to be seen as working with employers to create a better and more competitive
economy and not as organisations that stand in the way of change and increase costs for firms. They believe
that both parties have mutual interests. This has led to more and more single union agreements (where an
employer agrees to deal with only one union) but in return can often expect a no-strike deal from the union
(where unions agree never to strike if a dispute cannot be settled).

Other Groups in the Workplace
Employers Association (Trade Association)
These are organisations that represent the views and interests of companies within a certain industry. They
act like a pressure group on the government and also negotiate with trade unions.
Examples:
Universities and Colleges Employers Association
Engineering Employers Federation
Confederation of British Industry (CBI)
The CBI was established in 1965 and represents the interests of British businesses on a wide range of
issues. It has similar objectives to an Employers Association except that the CBI represents all UK
companies and not just those within one industry. It again acts as a pressure group and aims to create and
sustain conditions in the economy that allow UK firms to compete and prosper.

Term Definition
ACAS The Advisory, Conciliation and Arbitration Service and is an independent body
financed by the government aimed at resolving disputes between trade unions and
employers
Collective
bargaining
When workers gain strength from combining together (often in the form of a trade
union) in order to negotiate with an employer
Industrial Relations The negotiations and relationship between a trade union and an employer
No-strike
agreement
Trade unions sign a document agreeing never to strike if a dispute between an
employer and themselves cannot be settled
Single Union
Agreement
This occurs when an employer agrees to deal with only one trade union
Trade union An organisation that employees can join in order to have their interests and goals
better represented
Trade Unions
Congress (TUC)
An organisation that represent all British trade unions at a national and international
level


Communication
Introduction
Communication is the process by which a message or information is exchanged from a sender to a receiver.
For example a production manager (sender) may send a message to a sales manager (receiver) asking for
sales forecasts for the next 6 months so they can plan production levels. The sales manager would then reply
(feedback) to the production manager with the appropriate figures.
This is an example of internal communication, i.e. when communications occur between employees of a
business. Communication therefore links together all the different activities involved in a business and
ensures all employees are working towards the same goal and know exactly what they should be doing and
by when. Effective communication is therefore fundamental to the success of a business.
A business will of course need to communicate with people or organisations outside of the business. This is
known as external communication. For example a marketing manager will need to tell customers of a new
special pricing offers or the finance director may need to ask banks for a loan.
Receivers of Messages
Internal External
Workers
Directors
Managers
Customers
Local community
Suppliers
Shareholders
Government
Banks
Importance of Communication
Good communication has many advantages for a business: strong communication:
Motivates employees helps them feel part of the business (see below)
Easier to control and coordinate business activity prevents different parts of the business going
in opposite directions
Makes successful decision making easier for managers decisions are based on more complete
and accurate information
Better communication with customers will increase sales
Improve relationships with suppliers and possibly lead to more reliable delivery
Improves chances of obtaining finance e.g. keeping the bank up-to-date about how the business
is doing
Communication and Motivation
There is an integral link between communication and the motivation of employees and several motivational
theorists recognised this. Mayo especially emphasised the importance of communication between managers
and workers in meeting employees social needs. Maslow and Herzberg stressed the significance of
recognising employees achievements and self-esteem needs and these can only be done via clear and

effective communication.
Other reasons why there is such a close relationship between communication and motivation are:
Ensures that everyone is working towards the same company goals
Enables employees to be involved in decision-making
Employees can offer feedback and give suggestions
People are motivated by having clear targets set for them
Methods of Communication
There are many different methods or mediums of communication.
[insert diagram showing methods of communication]
There are several factors that will determine what the best or most appropriate method of communication:
Content of the message (e.g. is it confidential or lengthy)
Speed required
Amount of feedback wanted
Type of feedback required e.g. is a decision required from the person to whom the communication
is sent
Cost
The advancement of information technology has altered the way that many businesses communicate. For
example, fax was a popular form of communication for businesses in the 1980s. Whilst it still has its uses,
people now largely use e-mail instead. The internet is a key tool for many firms now to communicate with
many different groups, such as advertising to customers and finding suppliers. Investing in the new
technology is costly however and potentially it can become outdated within a few years. There is also the
need to train many staff on how to use the technology effectively and even then some employees may be
reluctant to change from their traditional methods.
Formal communication occurs when channels of communication are used which have been established by
the firm. This may be when workers communicate with managers via works councils or trade union
representatives. Informal communication is often known as communication through the grapevine and it
can be useful for a manager as they can hear some useful and interesting information which they would not
from official channels. This can often be akin to gossiping and it can transmit information quickly but not
always accurately (just think how rumours and gossip spread through a school!).
Effective Communication
Businesses need to have in place appropriate structures or technology in order to aid communication (e.g. e-
mail facilities for all employees) but on an every day level it is down to individual managers and employees to
ensure that they communicate their messages or information effectively. Not all managers for instance will
naturally have good communication skills and there is an obvious need for training in this case to ensure they
are able to choose the most appropriate communication method to get their message across clearly.
To be effective the message must be clearly understood by the receivers and also the receivers should be
able to supply some feedback. When feedback occurs it is known as two-way communication and is seen
as the most effective form of communication. The best example of this is direct face-to-face communication

as the sender can get an immediate reaction in terms of the oral reply and also importantly from the receivers
body language.
One-way communication occurs when there is no feedback given on a message, for example putting a
notice on a notice board. This is suitable in some circumstances, if for instance someone is announcing a
change of time for a meeting and little feedback is required, but generally employees should try to maximise
methods that encourage two-way communication and feedback.
Two-way feedback is becoming relevant in firms for two main reasons.
Many firms are introducing new techniques and initiatives, such as kaizen or total quality
management, which rely on employee participation and feedback. In addition two-way
communication is a pre-requisite for a democratic management style, which is becoming
increasingly popular in businesses.
For many firms one of their main objectives is to grow in size (gaining market share or entering new
markets) as this is seen as the way to boost profits. As a firm expands one of the major problems
they will face will be to continue to communicate effectively with their increasing workforce and so
maintain motivation levels
Barriers to Communication
There are various barriers to communication that need to be overcome for communication to be effective.
Some of the more common are:
Too many intermediaries. There may be too many layers in the hierarchy through which the
message has to be passed and it can get distorted on the way (like a game of Chinese whispers).
This may encourage a business to undertake delayering (removing a layer of management from the
hierarchy)
Geographical distance. Distance between a firms offices, production plants or outlets can limit
the methods of communication that can be used and so decrease the feedback possible.
Communication overload. Too much information being passed can cause problems e.g. slow
down decision-making. For example when surfing for something on the internet you van be
inundated with material, most of which is of little use!
Jargon. It may be that the sender uses too much technical jargon in the message that others may
not understand. Or the sender may simply not explain themselves clearly enough.



Term Definition
Effective
communication
When the message has been clearly understood by the receiver
External
communication
Communication with people or organisations outside of the business
Feedback Receiver gives a response on a message back to the sender
Formal
communication
Channels of communication are used which have been established by the
firm
Informal
communication
Unofficial channels of communication - often known as the grapevine
Internal
communication
Communication between employees of a business
Two-way
communication
When feedback is given on a message


BUSINESS OBJECTIVES
Forms of Business Ownership and Operation
Introduction
A business is always owned by someone. This can just be one person, or thousands. So a business can
have a number of different types of ownership, and this depends on the aims and objectives of the owners.
Most businesses aim to make profit for their owners. Profits may not be the major objective, but in order to
survive a business will need make a profit in the long term.
Some organisations however will be not-for-profit, such as charities or government-run corporations.
The main types of business ownership are:
Sole trader
Partnerships
Limited companies
Co-operative
Franchises
Public sector and privatisation
Each organisation has different rules and regulations dealing with ownership and the way that profits and
losses are dealt with.
Sole Trader
A sole trader is a business that is owned by one person. It may have one or more employees. It is the
most common form of ownership in the UK.
The main advantages of setting up as a sole trader are:
Total control of the business by the owner.
Cheap and easy to start up few forms to fill in and to start trading the sole trader does not need to
employ any specialist services, other than setting up a bank account and informing the tax offices.
Keep all the profit as the owner, all the profit belongs to the sole trader.
Business affairs are private competitors cannot see what you are earning, so will know less about
how the business works and how it succeeds.
The reasons why sole traders are often successful are:
Can offer specialist services to customers e.g. appliance repair specialists.
Can be sensitive to the needs of customers since they are closer to the customer and will react
more quickly, because they are the decision makers too.

Can cater for the needs of local people a small business in a local area can build up a following
in the community due to trust if people can see the owner they feel more comfortable than if the
owner is in some far off town, not able to hear the views of the local community.
The legal requirements of a sole trader are to:
Keep proper business accounts and records for the Inland Revenue (who collect the tax on
profits) and if necessary VAT accounts
Comply with legal requirements that concern protection of the customer (e.g. Sale of Goods Act)
The main disadvantages of being a sole trader are:
Unlimited liability see below.
Can be difficult to raise finance, because they are small, banks will not lend them large sums and they
will not be able to use any other form of long-term finance unless they change their ownership status.
Can be difficult to enjoy economies of scale, i.e. lower costs per unit due to higher levels of
production. A sole trader, for instance, may not be able to buy in bulk and enjoy the same discounts as
larger businesses.
There is a problem of continuity if the sole trader retires or dies what happens to the business next?
The reasons for being a sole trader are often a balance between business and personal costs and benefits.
Many will prefer the satisfaction of running a business with little paper work against the risks, pressure and
probably long working hours.
A sole trader is liable for any debts that the business incurs. This means that any money that the owner has
put into the business could be lost, BUT IMPORTANTLY, if the business continues to incur further costs then
the owner has to pay these as well. In some cases they may have sell some of their own possessions to pay
creditors.
Such a risk often puts potential sole traders off setting up businesses, but also makes them consider the
other forms of business structure.
Partnerships
A partnership is a business where there are two or more owners of the enterprise. Most partnerships are
between two and twenty members though there are examples like John Lewis and some of the major world
accountancy firms where there are hundreds of partners.
A partner is normally set up using a Deed of Partnership. This contains:
Amount of capital each partner should provide (i.e. starting cash).
How profits or losses should be divided.
How many votes each partner has (usually based on proportion of capital provided).
Rules on how to take on new partners.
How the partnership is brought to an end, or how a partner leaves.
The advantages of a sole trader becoming a partnership are:

Spreads the risk across more people, so if the business gets into difficulty then there are more people
to share the burden of debt
Partner may bring money and resources to the business (e.g. better premises to work from)
Partner may bring other skills and ideas to the business, complementing the work already done by the
original partner
Increased credibility with potential customers and suppliers who may see dealing with the business
as less risky than trading with just a sole trader
For example, a builder, working originally as a sole trader, may team up with an architect or carpenter to form
a partnership. Either would bring added expertise, but also might bring added capital and/or contacts. Of
course the builder could team up with another builder as well sharing the risk, and potentially the workload.
The main disadvantages of becoming a partnership are:
Have to share the profits.
Less control of the business for the individual.
Disputes over workload.
Problems if partners disagree over of direction of business.
The next step for a partnership is to move towards becoming a private limited company. However some
partnerships do not want to move to this stage. The advantages of remaining a partnership rather than
becoming a private limited company are:
Costs money to set up limited company (may need to employ a solicitor to set up the paper work).
Company accounts are filed so the public can view them (and competitors).
May need to spend money on an auditor to check the accounts before they are filed.
When a partnership finishes then, depending on how the Deed of Partnership is set up, each partner has an
agreed slice of the business.
Limited Companies
A limited company is a business that is owned by its shareholders, run by directors and most importantly
whose liability is limited.
Limited liability means that the investors can only lose the money they have invested and no more. This
encourages people to finance the company, and/or set up such a business, knowing that they can only lose
what they put in, if the company fails.
For people or businesses who have a claim against the company, limited liability means that they can only
recover money from the existing assets of the business. They cannot claim the personal assets of the
shareholders to recover amounts owed by the company.
To set up as a limited company, a company has to register with Companies House and is issued with a
Certificate of Incorporation. It also needs to have a Memorandum of Association which sets out what the
company has been formed to do, and Articles of Association which are internal rules over including what
the directors can do and voting rights of the shareholders.
Limited companies can either be private limited companies or public limited companies.

The difference between the two are:
Shares in a public limited company (plc) can be traded on the Stock Exchange and can be
bought by members of the general public. Shares in a private limited company are not available to
the general public; and
The issued share capital of a plc (the initial value of the shares put on sale) must be greater than
50,000 in a plc. A private limited company may have a smaller share capital
A private limited company might want to become a plc because:
Shares in a private limited company cannot be offered for sale to the general public, so restricting
availability of finance, especially if the business wants to expand. Therefore, it is attractive to
change status
It is also easier to raise money through other sources of finance e.g. from banks
[Note: becoming a plc does not necessarily mean that the company is quoted on the Stock Exchange. To
do that, the company must do a flotation (see below)]
The disadvantages of a being a public limited company (plc) are:
Costly and complicated to set up as a plc need to employee specialist bankers and lawyers to help
organise the converting to the plc.
Certain financial information must be made available for everyone, competitors and customers
included (would you want them to know how much profit you are making?)
Shareholders in public companies expect a steady stream of income from dividends, which might
mean that the business has to concentrate on short term objectives of creating a profit, whereas it might
be better to work on longer term objectives, such as growth and investment.
Threat of takeover, because another company can buy up a large number of shares because they are
traded publicly (can be sold to anyone). If they buy enough, they can then persuade other shareholders
to join with them to vote in a new management team.
Shareholders own the company. They buy shares because:
Shares normally pay dividends, which is a share of the profits at the end of the year. Companies on
the Stock Exchange usually pay dividends twice each year.
Over time the value of the share may increase and so can be sold for a profit this is known as a
capital gain. Of course, the price of shares can go down as well as up, so investing in shares can
be very risky.
If they have enough shares they can influence the management of the company. A good example is
a venture capitalist that will often buy up to 80% of the shares of a company and insist on
choosing some of the directors.
Flotation
A company may float on the stock market. This means selling all or part of the business to outside investors,
who can then buy and sell the shares on the Stick Exchange. Flotation generates additional funds for the
business and can be a major form of fund raising. When shares in a plc are first offered for sale to the
general public, the company is given a listing on the Stock Exchange.

Divorce of ownership and control
As a business becomes larger, the ownership and control of the business may become separated. This is
because the shareholders may have the money, but not the time or the management skills to run the
company. Therefore, the day-to-day running of the business is entrusted to the directors, who are employed
for their skills, by the shareholders.
The shareholders are therefore divorced from the running the business for 364 days of the year. They will
have their say at the Annual General Meeting (AGM) of the company, where the directors present the
accounts and results. Very recently a couple of businesses have had very strong shareholder unrest leading
the company to tone down a number of their decisions.
In practice directors tend to have at least a modest shareholding in the company. This provides the director
with an incentive to achieve good dividends and capital growth for the share (an increase in the share price).
Co-operatives
A co-operative is where a number of individuals or businesses work together to achieve a common purpose.
They are normally formed so individuals and small businesses can benefit from being part of a larger group,
meaning they have more power to buy or bargain.
There are three main types of co-operatives:
Retail co-operatives
Marketing or trader co-operatives
Worker co-operatives
A retail co-operative is probably the most familiar co-op. The Co-Op shops and Leo Hypermarkets are a
regular sight in the high street.
The objectives of a co-op tend to set them apart from other businesses. The objectives are normally more
focused on the members of the co-operative, the local community and the world community. Though profits
are required to enable them to reinvest in their business, they will not be a primary objective.
Though co-operatives exist to overcome some of the trading difficulties faced by small businesses, they can
still face of number of problems in their operation:
The system of one member one vote in some societies means a long, drawn out decision-making
process
Co-operatives may find it difficult to raise finance since banks are not so willing to lend them money
because their main aim is not to make a profit
Idealistic and ethical aims may not be agreeable with all members, so creating unrest and disharmony
The aims held by many co-operatives may not lead to profits in the long run (though many co-op shops
will continue to exist at a loss because the owners feel they are providing an important service to the
community.)
Franchises
A franchise is where a business sells a sole proprietor the right to set up a business using their name.
Examples of major franchises are:

McDonalds
Clarks Shoes
Pizza Hut
Holiday Inn
The franchisor is the business whose sells the right to another business to operate a franchise they may
run a number of their own businesses, but also may want to let others run the business in other parts of the
country.
A franchise is bought by the franchisee once they have purchased the franchise they have to pay a
proportion of their profits to the franchiser on a regular basis. Depending on the business involved, the
franchiser may provide training, management expertise and national marketing campaigns. They may also
supply the raw materials and equipment.
The advantages of being a franchisor:
Large companies see it as a means of rapid expansion with the franchisee providing most of the
finance.
If the franchise model works, then there are large profits to made from
- selling franchises
- royalty payments
- selling raw materials and equipment.
The advantages of setting up as a franchisee are:
The franchisee is given support by the franchiser. This includes marketing and staff training. So
starting a business in this way requires less expertise and is less lonely!
The franchisee may benefit from national advertising and being part of a well-known organisation
with an established name, format and product
Less investment is required at the start-up stage since the franchise business idea has already
been developed
A franchise allows people to start and run their own business with less risk. The chance of failure
among new franchises is lower as their product is a proven success and has a secure place in the
market
The disadvantages of setting up as a franchisee are:
Cost to buy franchise can be very expensive (hundreds of thousands of pounds).
Have to pay a percentage of your revenue to the business you have bought the franchiser from.
Have to follow the franchise model, so less flexible. You would probably be told what prices to set,
what advertising to use and what type of staff to employ.
In conclusion, a buying a franchise a good way of an individual setting up a business because:
They do not have to establish themselves in the same as a sole trader might have to.

They will have the support of a tried and tested business model, often with a national marketing
campaign behind them.
Public Sector and Privatisation
Businesses that are owned by the government are part of the public sector.
From 1945 to the mid 80s many industries were stated owned. However the Conservative government in the
1980s decided (along with many other governments around the world) that they would privatise a great many
of these industries. This means that they changed ownership from government to private shareholders.
They also changed their objectives, making them become more profit orientated.
The public sector of government exists and existed because the government needs and needed to:
Provide essential services not fully provided by the private sector (because those services
were not profitable e.g. rural bus services)
Prevent exploitation of customers large business would not charge too higher a price for their
services and also make sure that more needy households could afford essential services
Avoid duplication of resources it is sometimes unnecessary for two companies to be caring out
expensive research on the same product which would benefit the economy e.g. a new, more
efficient, petrol engine
Protect jobs and maintain key industries many public sector industries were very labour-
intensive and so if they went out of business there would be a substantial increase in UK
unemployment. Also it was felt that the UK needed to continue to have a strong industrial base in
areas such as coal and steel, vital to running the economy, especially if there was potential of a war
The move from public sector to private sector ownership has been justified because:
State run firms are inefficient - there is no incentive to cut costs or provide high quality services
because there is no competition
State run firms can be a financial burden on the government, using up tax revenue which could be
utilized elsewhere
Selling them off raises valuable money for the government, which can be used elsewhere in public
spending, e.g. on health or education
The possible disadvantages to society of privatization of public owned businesses are:
Private companies may put prices up, meaning that those who can least afford it, have to pay more
for their services (e.g. higher prices for water or electricity).
Cuts jobs, therefore increasing unemployment.
Reduces services that are not profitable, to the disadvantage of the needy.
Sole trader
Partnerships
Limited companies
Co-operative

Franchises

Term Definition
Co-operative A number of people or businesses working together to achieve a common purpose.
Divorce of
ownership and
control
Where the shareholders give the managers the authority to control the business
Flotation Selling shares for the first time on the Stock Exchange
Franchises A business that is sold to someone, giving them the right to use their name
Limited companies
Businesses which have limited liability, owned by the shareholders and run by
directors
Limited liability Where an investor can only lose what they put into the business
Partnerships A business where there are two or more owners
PLC A public limited company can sell shares on the Stock Exchange
Privatisation Selling publicly owned businesses to the private sector
Public sector Businesses and organizations that are owned and run by the government
Shares
Certificates of ownership of a business, a share representing part ownership of the
business
Sole trader A business owned by one person

Organisation of a Business
Introduction
A sole trader has to fulfill many roles. He or she is the sales person, accountant, marketing manager and
operations manager all rolled into one. As soon as the business takes on another person, then the business
starts to form some sort of organisation. This may be informal at the start of a business, but as it grows there
needs to be some type of formal organisation with a clearly defined organisational structure. This
organisation determines who is responsible for what job and who is responsible to whom.
For example lets us say a shopkeeper takes on an assistant. A formal organisation could mean that the
shopkeeper would be in charge of accounts, marketing and business strategy, whilst the assistant would do
the more mundane tasks of staking shelves, checking and re ordering stock.
This section will look at the different ways in which a business organises itself and the way managers interact
within that organisation.
Span of Control and Hierarchies
In a business of more than one person, unless the business has equal partners, then there are managers and
subordinates. Subordinates are workers controlled by the manager.
A hierarchy describes the structure of the management of the business, from the top of the company the
managing director, through to the shop floor worker, who reports to their foreman, in a manufacturing
business.
The hierarchy of a business is usually best understood by drawing an organisation chart showing which
levels of management and employees report to whom.
An example of a hierarchy is shown in the diagram below


A span of control is the number of people who report to one manager in a hierarchy. The more people
under the control of one manager - the wider the span of control. Less means a narrower span of control.
An example of a narrow span of control is shown in the diagram below:

The advantages of a narrow span of control are:
A narrow span of control allows a manager to communicate quickly with the employees under them
and control them more easily
Feedback of ideas from the workers will be more effective
It requires a higher level of management skill to control a greater number of employees, so there is
less management skill required
An example of a wide span of control is shown in the diagram below:

The advantages of wide span of control are:

There are less layers of management to pass a message through, so the message reaches more
employees faster
It costs less money to run a wider span of control because a business does not need to employ as
many managers
The width of the span of control depends on:
The type of product being made products which are easy to make or deliver will need less
supervision and so can have a wider span of control
Skills of managers and workers a more skilful workforce can operate with a wider span of
control because they will need less supervision. A more skilful manager can control a greater
number of staff
A tall organisation has a larger number of managers with a narrow span of control whilst a flat organisation
has few managers with a wide span of control.
A tall organisation can suffer from having too many managers (a huge expense) and decisions can
take a long time to reach the bottom of the hierarchy
BUT, a tall organisation can provide good opportunities for promotion and the manager does not
have to spend so much time managing the staff
Chain of command is the line on which orders and decisions are passed down from top to bottom of the
hierarchy. In a hierarchy the chain of command means that a production manager may be higher up the
hierarchy, but will not be able to tell a marketing person what to do.
The advantages of hierarchies are:
Helps create a clear communication line between the top and bottom of the business this improves
co-ordination and motivation since employees know what is expected of them and when.
Hierarchies create departments and departments form teams. There are motivational advantages of
working in teams.
The disadvantages of hierarchies are:
The formation of departments can mean that:
- Departments work for themselves and not the greater good of the business.
- Departments do not see the whole picture in making decisions.
Hierarchies can be inflexible and difficult to adjust, especially when businesses need to adapt to
changing markets remember employees do not tend to react well to change.
Delegation
Delegation is giving the authority for certain decisions to those below the manager. E.g. a manager may
authorise a subordinate to decide on what stock to buy for the business.
The two main advantages of delegation are:
Gives the manager more time to work on other aspects of the business.
Motivates the workers who are given the responsibility (link to motivation).

However there are difficulties in effective delegation:
Managers find it hard to hand over responsibility because they do not think other workers can
complete the task to the right standard.
There is a difficult balance between trust and control, where the manager might exercise too much
control over the subordinate, reducing the effectiveness of the benefits of the delegation.
Business Departments
When a business reaches a certain size then it might split into different departments. These departments will
specialise, employing people with expertise in these areas.
The main departments in a business might be:
Department Role
Accounts Provides a detailed record of the money coming in and going out of the business
and prepares accounts as a basis for financial decisions
Human Resources
or Personnel
Deals with all the recruitment, training, health and safety and pay negotiations with
unions/workers
Production Makes sure that the production plans are met on time and products of the right
quality are produced
Purchasing Buys all the raw materials and goods required for production
Sales and
marketing
Sales function deals with all aspects of selling to customers; the marketing function
carries out marketing research, organises advertising and product promotion


Nature of the Organisation of a Business
A business is normally organised by its functions, e.g. marketing department, accounts department and so on
(see organisational charts above). This is because being grouped together allows the functions to benefit
from specialisation and division of labour. This leads to lower unit costs and a greater efficiency. However it
can mean that there is departmental rivalry (see explanation above).
Larger businesses might have a number of businesses within the whole company. This would be
coordinated by a Head Office, where all the major decisions are made.
Other ways of organising the business could be more appropriate for different types of businesses:
Product the functions are organised around the product so at a business like ICI, who are the
UKs leading chemical manufacturer, a product manager would have a team of functions who would
answer to them, like accounting, marketing and production
Geographical a hierarchy might be split according to different places that the product is sold into
for instance a business may have a Far Eastern division of its business, which would take into
account the different cultural and supply differences of the region
Market the organisation is based on market segments so an airline business like British Airways
could concentrate on long haul, short haul, holiday makers, business clients and freight
A business whose decision-making comes from one place only is known as a centralised organisation.
Normally Head Office will decide on the major elements of strategy, no matter where the manufacturing
plants and sales teams are positioned around the country or globe. This means that there are good
opportunities for economies of scale.
Other businesses, especially multinationals (see below) will opt for a more decentralised organisation
where the individual businesses within the whole company group, make decisions for themselves. This
means that there is more opportunity to react to the changing marketplace (one of the advantages of a small
firm). However there is a possibility that these businesses (who may well be in different parts of the world)
might be duplicating research or not bargaining in such as strong position as a bigger overall company.

Term Definition
Centralised and
decentralised
A centralized organisation is controlled from one head office, and a decentralized
organisation is controlled wherever the business has an office.
Chain of command The line on which orders and decisions are passed
Delegation Giving authority and responsibility to a subordinate
Hierarchies The structure of a business indicating who is in charge of who
Span of control The number of subordinates under a manager


Business Aims and Objectives
Introduction
When a sole trader sets up they may have some unstated aims or objectives - for example to survive for the
first year. Other businesses may wish to state exactly what they are aiming to do, such as Amazon, the
Internet CD and bookseller, who wants to make history and have fun.
An aim is where the business wants to go in the future, its goals. It is a statement of purpose, e.g. we want
to grow the business into Europe.
Business objectives are the stated, measurable targets of how to achieve business aims. For
instance, we want to achieve sales of 10 million in European markets in 2004.
A mission statement sets out the business vision and values that enables employees, managers, customers
and even suppliers to understand the underlying basis for the actions of the business.
Business Objectives
Objectives give the business a clearly defined target. Plans can then be made to achieve these targets.
This can motivate the employees. It also enables the business to measure the progress towards to its stated
aims.
The most effective business objectives meet the following criteria:
S Specific objectives are aimed at what the business does, e.g. a hotel might have an objective
of filling 60% of its beds a night during October, an objective specific to that business.
M - Measurable the business can put a value to the objective, e.g. 10,000 in sales in the next
half year of trading.
A - Agreed by all those concerned in trying to achieve the objective.
R - Realistic the objective should be challenging, but it should also be able to be achieved by the
resources available.
T- Time specific they have a time limit of when the objective should be achieved, e.g. by the end
of the year.
The main objectives that a business might have are:
Survival a short term objective, probably for small business just starting out, or when a new firm
enters the market or at a time of crisis.
Profit maximisation try to make the most profit possible most like to be the aim of the owners
and shareholders.
Profit satisficing try to make enough profit to keep the owners comfortable probably the aim of
smaller businesses whose owners do not want to work longer hours.
Sales growth where the business tries to make as many sales as possible. This may be
because the managers believe that the survival of the business depends on being large. Large
businesses can also benefit from economies of scale.
A business may find that some of their objectives conflict with one and other:

Growth versus profit: for example, achieving higher sales in the short term (e.g. by cutting prices)
will reduce short-term profit.
Short-term versus long-term: for example, a business may decide to accept lower cash flows in the
short-term whilst it invests heavily in new products or plant and equipment.
Large investors in the Stock Exchange are often accused of looking too much at short-term objectives and
company performance rather than investing in a business for the long-term.
Alternative Aims and Objectives
Not all businesses seek profit or growth. Some organisations have alternative objectives.
Examples of other objectives:
Ethical and socially responsible objectives organisations like the Co-op or the Body Shop
have objectives which are based on their beliefs on how one should treat the environment and
people who are less fortunate.
Public sector corporations are run to not only generate a profit but provide a service to the public.
This service will need to meet the needs of the less well off in society or help improve the ability of
the economy to function: e.g. cheap and accessible transport service.
Public sector organisations that monitor or control private sector activities have objectives that
are to ensure that the business they are monitoring comply with the laws laid down.
Health care and education establishments their objectives are to provide a service most
private schools for instance have charitable status. Their aim is the enhancement of their pupils
through education.
Charities and voluntary organisations their aims and objectives are led by the beliefs they
stand for.
Changing Objectives
A business may change its objectives over time due to the following reasons:
A business may achieve an objective and will need to move onto another one (e.g. survival in the
first year may lead to an objective of increasing profit in the second year).
The competitive environment might change, with the launch of new products from competitors.
Technology might change product designs, so sales and production targets might need to change.


Term Definition
Aim Long term direction and purpose of business
Mission statement The stated vision and values of a business
Objectives Specific measurable targets for the business
Profit maximization An objective of try to achieve the most profit over a specified time period
Survival objective
Try to make enough profit in the short term to make it worthwhile being in the
business

Stakeholders
Introduction
A stakeholder is any individual or organisation that is affected by the activities of a business. They may have
a direct or indirect interest in the business, and may be in contact with the business on a daily basis, or may
just occasionally.
The main stakeholders are:
Shareholders (not for a sole trader or partnership though) they will be interested in their
dividends and capital growth of their shares.
Management and employees they may also be shareholders they will be interested in their job
security, prospects and pay.
Customers and suppliers.
Banks and other financial organisations lending money to the business.
Government especially the Inland Revenue and the Customs and Excise who will be collecting
tax from them.
Trade Unions who will represent the interests of the workers.
Pressure Groups who are interested in whether the business is acting appropriately towards
their area of interest.
Stakeholders versus Shareholders
It is important to distinguish between a STAKEHOLDER and a SHAREHOLDER. They sound the same
but the difference is crucial!
Shareholders hold shares in the company that is they own part of it.
Stakeholders have an interest in the company but do not own it (unless they are shareholders).
Often the aims and objectives of the stakeholders are not the same as shareholders and they come into
conflict.
The conflict often arises because while shareholders want short-term profits, the other stakeholders desires
tend to cost money and reduce profits. The owners often have to balance their own wishes against those of
the other stakeholders or risk losing their ability to generate future profits (e.g. the workers may go on strike
or the customers refuse to buy the companys products).

Social Responsibility
Social responsibility is the duty and obligation of a business to other stakeholders.
Stakeholder Example of responsibility to that stakeholder
Shareholder Good return on investment
Employee Fair pay and working conditions
Supplier Regular business and prompt payment
Customer Fair price and safe product
Local community Jobs and minimum disruption
Government Employment for local community
Environment Less pollution
Social responsibility for one group can conflict with other groups, especially between shareholders and
stakeholders.
Ethics
Ethics refers to the moral rights and wrongs of any decision a business makes. It is a value judgement
that may differ in importance and meaning between different individuals.
Businesses may adopt ethical policies because they believe in them or they believe that by showing they are
ethical, they improve their sales.
Two good examples of businesses that have strong ethical policies are The Body Shop and Co-Op.
Some examples of ethical policies are:
Reduce pollution by using non-fossil fuels.
Disposal of waste safely and in an environmentally friendly manner.
Sponsoring local charity events.
Trading fairly with developing countries.


Term Definition
Ethics The moral rights and wrongs of any decision a business makes
Social responsibility The duty and obligation of the business to other stakeholders
Stakeholder An individual or organization affected by the activities of the business

Starting a Business
Introduction
An entrepreneur is defined as someone who has the ability to take risks and organise the factors of
production. When starting a new business the entrepreneur faces a number of problems before they can
start up. They need an idea and a will to succeed, but these are not enough on their own to be successful.
A business needs:
Finance to fund the other elements listed below: finance is usually the hardest thing to obtain in a
start-up business.
Labour to help develop a product or service and then to produce/deliver it.
Customers without them, the business will fail. Obtaining customers means the business must
undertake marketing.
Suppliers provide many of the inputs, such as raw materials.
Premises and equipment maybe a simple office, or possibly a large, modern factory; depending
on what the business activity is.
Management organisation & structure this is often very simple at the start-up stage (e.g. a sole
trader!).
Designed, researched and tested product or service a successful business is about more than
just having a good idea the product needs to be brought to the marketplace in its best format.
Dyson spent many years completing his first vacuum cleaner before being able to sell it.
A business may also need to protect its idea or products.
It can do this through:
Copyright and patents make it illegal for other firms to copy directly the business idea or invention.
Keep new products and services secret until they are ready for launch.
Focus on retaining key staff that would be otherwise valuable for competitors to poach!
Entrepreneurs
An entrepreneur needs several skills to succeed:
Have ideas
Ability to take risks
Ability to persuade others to join the business or lend the business money
Energy to keep the business going under tough circumstances it is often said that the best
entrepreneurs are the most persistent

Start Up Finance
The entrepreneur will need to finance to the business. This means they will need to find money to pay for:
The purchase of plant & machinery, office equipment etc
Renting or buying premises and offices (e.g. the first 3 months rent may need to be paid in
advance)
Essential business services such as insurance
The purchase of stocks of raw materials and components to allow production to start
The wages and salaries of the first employees to join the business (who may be needed before
any goods or services are actually sold)
To provide financial cover whilst the business waits for customers to pay
The main ways in which an entrepreneur can find finance for a new business are:
Own money
Bank loans
Bank overdraft
Money from friends
Grant assistance from government bodies
These types of finance can be split into INTERNAL and EXTERNAL sources of finance. Internal sources of
finance are generated from the business itself (e.g. cash from sales) and external sources of finance from
outside the business (e.g. a bank loan).
The business can also split the types of finance into categories relating to length of time the money is needed
for
Short-term: bank overdraft
Medium term: bank loan; lease; hire purchase; government grants
Long term: bank loan; mortgage; share issue (for limited companies); debenture
Business Plan
A business plan sets out how a business is going to achieve its aims and objectives. It is extremely useful for
a new business to use a plan because it can be used to show potential investors how their money is going to
be spent.
A business plan will probably contain the following elements:
Statement of aims and objectives
Description of market the business is selling to
Main competitors (how will they respond to a new competitor?)

Production and sales forecasts
Equipment needed
Distribution plan for how to get product to customers
In the plan, great care should be taken to estimate and forecast how the cash will come into and leave the
business in the early weeks and months.
This is because in the early days of setting up a business, finance is hardest to manage. It is uncertain how
easy it will be to find customers and will they buy the product or service at the price that is being asked?
The business will be incurring significant start-up costs which will eat into the available funds.
Advantages of Small Businesses
Not all businesses that start out need to grow to be large businesses. It is also true to say that small
businesses can also compete very effectively against large businesses.
Small business can offer the following advantages:
Reason Explanation
Personal
service
A small business can be more personal, so a customer feels they are talking more directly
to the person who makes and supports the product.
Closer to the
market
A small business can react more quickly to small changes in the market place because
the chain of command is much shorter.
Flexible A small business can change its product to suit the customers needs because it does not
have to fit in with large production runs. For instance, wedding cakes and tailored clothes.

Term Definition
Business plan Setting out of how a business is going to achieve its aims and objectives
Copyrights and
patents
Means of protecting ideas, products and concepts from being copied by other
businesses
Entrepreneur
A person who is the main risk taker and organizer of all the elements of the
business.
Internal and
external finance
Internal finance is money raised from inside the business whilst external finance
requires the business to seek other sources which are not directly part of the day to
day running of the business

Growing a Business
Introduction
The growth of a business is when it expands in size. The size of a business can be measured by the
following means:
Sales turnover (or sales revenue)
Number of employees
Share capital (the number of shares times the price of each share)
Market share the sales of the business of a particular product as a proportion of all sales of that
type of product. A 5% market share would mean that 1 in 20 of all products sold are sold by that
business.
Number of outlets (e.g. shops)
They may mean to grow in size or sometimes it just happens without the business making a conscientious
effort to do so. Businesses either grow organically or by acquisition and mergers.
Organic growth means the business grows by expanding its sales or their operations and is
financed through its own profits.
Acquisitions and mergers are when the business joins or buys other businesses, not necessary
of the same type.
Businesses may wish to expand for the following reasons:
Benefit from economies of scale lower unit costs due to an increase in size
A larger market share (selling more products than before) means they can charge higher prices
and gain more profit
As means of survival if they wish to compete with other growing businesses
Some businesses start selling or acquiring businesses that are not in the same market as the markets they
are presently selling in. This is known as diversification.
Businesses may wish to diversify because:
Helps spread the risks across a number of products. If one product fails due to market
conditions then other products in different markets should not be affected.
Good way of expanding if present market seems already full.
Gives the business fresh objectives and may act to motivate managers and staff.
A business can grow organically in the following ways:
Lower price - People will buy more at lower prices.
Increase advertising - Customers are made more aware of the attraction of the products.
Sell in different location - Selling to a new set of customers, more potential.

Sell on credit - Customers are attracted by the ability to buy now pay later.
Mergers and Acquisitions
A merger is where two or more businesses AGREE to join together to become one larger firm. An acquisition
is when one firm BUYS another firm.
When a one business buys another it is possible that the acquisition or merger integrates the new product
with the existing product. This integration can either be vertical or horizontal integration.
Mergers and acquisitions are an important option for larger businesses that wish to grow rapidly. However,
they are a high risk strategy it is easy to buy the wrong business, at the wrong price for the wrong reasons!
The advantages of mergers and acquisitions are:
Economies of scale, which reduces unit costs.
Greater market share for horizontal integration, which means the business can often charge higher
prices.
Spreads risks if products different.
Reduces competition if a rival is taken over.
Other businesses can bring new skills and specialist departments to the business.
It is easier to raise money if a larger business.
The disadvantages of mergers and acquisitions are:
Diseconomies of scale if business becomes too large, which leads to higher unit costs.
Clashes of culture between different types of businesses can occur, reducing the effectiveness of the
integration.
May need to make some workers redundant, especially at management levels this may have an
effect on motivation.
May be a conflict of objectives between different businesses, meaning decisions are more difficult to
make and causing disruption in the running of the business.
Constraints on Growth
Though a business may wish to grow in size, there may be reasons why it cannot do this:
Financial limitations a business may not be able to raise the necessary finance to grow any
bigger perhaps it has not made enough profits to generate the cash or the bank is not keen to
lend it more money at the moment.
Size of the market there is often a limit to number of people who are willing to buy the type of
product that the business is producing e.g. a printing press manufacturer will know that there are
only a small number of publishers in the UK who will be able to buy the product.
Government controls means that a business cannot necessarily have more than 25% of the
market share. This often arises when one business joins with another. If the government thinks it

is not in the public interest to have such a large business, then the joining together may not take
place.
Human resources are limited in terms of the skills available. Especially in more specialised areas
it may be difficult to find enough qualified staff in the area to expand the business. In the South
East of England, where unemployment is very low for some types of jobs, businesses have
struggled to expand for this very reason.
Rationalisation
Some businesses decide to reduce in size. This is known as rationalisation. This is where factories or
offices are closed down or sold to other businesses, or jobs are cut.
Sometimes this takes place because the business wants to concentrate on its core products. Other times it is
because the business is suffering from diseconomies of scale. This is where the business is so large that
communication is more difficult from the top management to the other parts of the business, reducing the
effectiveness of control, and potentially leading to de-motivation.
International business and globalisation
A business may wish to grow internationally as well as nationally.
A multinational company (MNC) is a business which has manufacturing plants in different countries, but a
Head Office in one country. The advantages of having manufacturing plants in different countries are:
Costs of production may be lower in these countries (especially wages)
May avoid having to pay import duties on the goods produced in this country
Reduces transport costs
Can also adjust the product to meet the local needs of the population of that country
A transnational company has no country as its base, but has regional Head Offices in many countries and is
owned by people from many different nationalities. Unilever is an example of such a business they make
such products as tea, deodorants and soap powder.
Globalisation is the ability of businesses to sell their products in many different countries and also to
manufacture in many different countries. Coca Cola, McDonalds and Microsoft are examples of companies
who are able to have global products which, with few adjustments, can be sold in many different countries.


Term Definition
Acquisitions and
mergers
Growing a business by either buying other firms (acquisitions) or joining together
with other firms (mergers)
Globalisation
The ability of businesses to sell and produce their products in many different
countries
Multinational
company (MNC)
A business with manufacturing plants and offices in different countries, but a Head
Office in one country
Organic growth The size of business grows due to finance from its own profits
Rationalisation Reducing the size of the operation of the business
Transnational
company (TNC)
A business which outlets/plants/offices in many countries and has Head Offices in
many countries and is owned by people from different countries


EXTERNAL ENVIRONMENT AND BUSINESS
The Business Environment
What is a Business?
A business is any organisation that is involved in the production of a good or the provision of a
service.
Businesses exist because people, firms and government have needs and wants for goods and services. A
business aims to satisfy these needs and wants, thus making a profit itself, paying the workers and rewarding
its owners.
The difference between a need and a want:
A need basic requirement for living e.g. food, water, warmth, security, shelter and clothing.
A want a desire beyond our needs. Once a want has been satisfied, something more is then
wanted, e.g. a better watch or faster computer.
Business Activity
Business activity is a three-stage process

INPUTS the main types (also known as the factors of production)
- Land and natural resources the area where production takes place and the raw materials
that are used (e.g. wood, fuel).
- Labour the people who transform the inputs (e.g. machine operators, bar staff).
- Capital the man made means of production (e.g. plant, machinery, computers, and vans).

- Entrepreneurship the people who are prepared to invest in and manage a business they
are the risk takers.
OUTPUTS - goods and services see types of products.
The transformation process ADDS VALUE to inputs. This means that the value of the outputs is greater than
the value of the original inputs.
ADDED VALUE is therefore the difference between the price of the output and the cost of inputs. This is the
way that a business makes a profit.
Two examples of the transformation process:
A builder uses bricks and mortar (inputs are raw materials and labour) to build a wall (the output).
The use of the builders skill and his time TRANSFORMS the inputs into output.
A piece of paper and ink (inputs and value of these items only a few pence). David Beckham with a
pen uses the paper and ink to sign his name the transformation process. The output is a valuable
autograph value added is at least 5 if not a lot more!
Main Types of Business Activity
The main types of business are:
Extractive primary industry
Manufacturing and construction secondary industry
Services - tertiary industry
Types of product
A product satisfies the needs and wants of customers.
There are two main types of product:
A good something tangible, something you can touch and use (e.g. a television).
A service usually intangible, something other people do for you (e.g. entertainment from a film
you watch).
Goods can be split into two types of good:
Consumer goods consumed by households. They cannot be used to produce more goods,
though they may give a flow of services. A consumer durable is a good that is not used up quickly,
but gives a flow of services over a period of time (e.g. a private car or a mobile phone). Non-
durables are used up in a short space of time such as food or fuel.
Producer (also known as industrial or capital) goods used in the production process
sometimes to make consumer goods, sometimes to make other producer goods. Examples are
printing presses, sewing machines, and computers.

Markets
A market is where products are bought and sold, and is therefore where the business operates. Market can
be classified in a number of different ways, e.g. local, national and international markets; by customer needs
e.g. for fast food or fashion shoes.
A product can be in more than one market, which means that it can have a number of different potential
buyers.
There are a number of different marketplaces (places where products are bought and sold):
Shops
Stalls in a weekly market
Mail order
Internet
Auction houses (e.g. Sotherbys)
Main Functions in a Business
A business has four main functions:
Marketing and sales
Accounts and finance
Production and operations
Human resource management
They each have an important role to play in helping to make a business operate effectively to achieve its
aims.
They are known as the internal functions of the business. There are all interrelated, so if a change happens
to one area, it will have some impact on all the other areas.
Profit, Loss and the Entrepreneur
A business exists to provide for wants and needs, but it needs someone to start and maintain that business.
These people are known as entrepreneurs.
An entrepreneur is someone who:
Has a business idea or spots a gap in the market.
Is willing to risk their time and money to develop this business idea.
Is able to organise the factors of production.
The reward for an entrepreneur is profit. Profit is the difference between total revenues (or sales) of a
business and its total costs.
PROFIT = REVENUE COSTS

Profit provides the incentive for people to start businesses. If profits for a business are extremely high, then
other businesses may start to compete in the same market (and make some of the profits for themselves).
A loss is when costs are greater than revenue.
A loss does not always mean that the business will cease to trade.
It may continue trading in the short term if it thinks that it will eventually return to profit.
It may be able to raise cash from another source.
However it may decide to stop trading and pay off all the money it owes.
Some businesses take a long time to make their first profit, like Amazon, the Internet CD and bookseller.
However in the long run it must make a profit to pay back the investors and those who lent the business
money (otherwise it will have to close down).

Term Definition
A business Any organisation involved in the production of a good or service
Adding value The difference between the cost of the inputs and the price of the output
Good A tangible item production of something you can touch and use
Market A place where goods and services are sold
Need Basic requirement of living
Primary production Extracting raw materials
Secondary
production
Manufacturing and construction
Service An intangible item something other people do for you.
Tertiary production Service industry
Transformation
process
Turning inputs (natural resources/raw materials, labour and capital) into outputs
(goods and services)
Want
Desires beyond our needs once one want has been satisfied, another want
appears

External Factors Affecting Business
Introduction
A business does not function in a vacuum. It has to act and react to what happens outside the factory and
office walls. These factors that happen outside the business are known as external factors or influences.
These will affect the main internal functions of the business and possibly the objectives of the business and
its strategies.
Main Factors
The main factor that affects most business is the degree of competition how fiercely other businesses
compete with the products that another business makes.
The other factors that can affect the business are:
Social how consumers, households and communities behave and their beliefs. For instance,
changes in attitude towards health, or a greater number of pensioners in a population.
Legal the way in which legislation in society affects the business. E.g. changes in employment
laws on working hours.
Economic how the economy affects a business in terms of taxation, government spending,
general demand, interest rates, exchange rates and European and global economic factors.
Political how changes in government policy might affect the business e.g. a decision to subsidise
building new houses in an area could be good for a local brick works.
Technological how the rapid pace of change in production processes and product innovation
affect a business.
Ethical what is regarded as morally right or wrong for a business to do. For instance should it
trade with countries which have a poor record on human rights.
Changing External Environment
Markets are changing all the time. It does depend on the type of product the business produces, however a
business needs to react or lose customers.
Some of the main reasons why markets change rapidly:
Customers develop new needs and wants.
New competitors enter a market.
New technologies mean that new products can be made.
A world or countrywide event happens e.g. Gulf War or foot and mouth disease.
Government introduces new legislation e.g. increases minimum wage.

Business and Competition
Though a business does not want competition from other businesses, inevitably most will face a degree of
competition.
The amount and type of competition depends on the market the business operates in:
Many small rival businesses e.g. a shopping mall or city centre arcade close rivalry.
A few large rival firms e.g. washing powder or Coke and Pepsi.
A rapidly changing market e.g. where the technology is being developed very quickly the
mobile phone market.
A business could react to an increase in competition (e.g. a launch of rival product) in the following ways:
Cut prices (but can reduce profits)
Improve quality (but increases costs)
Spend more on promotion (e.g. do more advertising, increase brand loyalty; but costs money)
Cut costs, e.g. use cheaper materials, make some workers redundant
Social Environment and Responsibility
Social change is when the people in the community adjust their attitudes to way they live. Businesses will
need to adjust their products to meet these changes, e.g. taking sugar out of childrens drinks, because
parents feel their children are having too much sugar in their diets.
The business also needs to be aware of their social responsibilities. These are the way they act towards the
different parts of society that they come into contact with.
Legislation covers a number of the areas of responsibility that a business has with its customers, employees
and other businesses.
It is also important to consider the effects a business can have on the local community. These are known as
the social benefits and social costs.
A social benefit is where a business action leads to benefits above and beyond the direct benefits to the
business and/or customer. For example, the building of an attractive new factory provides employment
opportunities to the local community.
A social cost is where the action has the reverse effect there are costs imposed on the rest of society, for
instance pollution.
These extra benefits and costs are distinguished from the private benefits and costs directly attributable to
the business. These extra cost and benefits are known as externalities external costs and benefits.
Governments encourage social benefits through the use of subsidies and grants (e.g. regional assistance for
undeveloped areas). They also discourage social costs with fines, taxes and legislation.
Pressure groups (see below) will also discourage social costs.

Legislation
The way in which a business can operate is controlled by legislation. Laws can be imposed by the UK or
European Union courts and government. Legislation mainly acts as a constraint on business.
The main areas of legislation that affect businesses are:
Employment law
Consumer protection
Competition law
Employment law
This is aimed at protecting the health, safety and rights of employees
The main employment laws that a business needs to consider are:
Health and Safety at Work Act 1974
Employers must provide safe premises and machinery. They must ensure that workers health is not affected
by their work.
The key costs and benefits of the Health and Safety at Work Act for a business are:
- Adds to costs to businesses that need to train staff and spend money maintaining the standards set
out.
- BUT may reduce cost in the long term because of a reduction in staff absences and not having to
pay compensation for injuries.
- Good health and safety record is a good way of encouraging recruitment of good workers.
Equal Pay Act 1970
Employees who do equal work or work of equal value must receive the same pay as workers of the other sex.
Sex Discrimination Act 1975
Employees cannot be sexually discriminated in employment, training or recruitment.
Race Relations Act 1976
It is illegal to discriminate against someone on the basis of race, ethnic group or colour.
Employment Protection Act 1978
Employees must be given a written contract of employment. It protects against unfair dismissal (without good
cause) and says that redundancy pay must be paid if the worker has served more than two years and their
job is to be abolished.
Employment law imposes additional costs to the business because they have to spend additional money on
training, recruitment and pay. Like the Health and Safety Act there are also benefits if the workers feel they
are treated fairly and there is more security, they will be more motivated.

Consumer Protection
This is aimed at making sure that businesses act fairly towards their consumers especially since consumers
are sometimes in a much weaker financial position. The main consumer protection legislation is:
Sale and Supply of Goods Act (this states that goods must be of satisfactory quality)
Trade Description Act (goods and services must perform in the way advertised by the business)
Consumer Credit Act (this protects the consumer when borrowing money or buying on credit)
Consumer protection imposes additional costs to businesses since they have to comply with the laws. If they
do not comply they risk fines and ultimately being put out of business by the courts of law.
Competition law
Competition law aims to ensure that fair competition takes place in each industry. Governments believe that
greater competition leads to lower prices, better quality goods and a wider variety of products.
Competition Commission (CC) and the Office of Fair Trading (OFT) investigate any business
that has more than 25% of the market share, especially if it merges with another business. They
may feel that the business has too much power and can set high prices and provide poor quality
products. The CC and OFT has the power between them either to fine these businesses, or
prevent the merger taking place.
The OFT can also fine businesses who fix prices or prevent other businesses from trading in their
market. Most recently they investigated the car industry and warranties offered by leading electrical
retailers.
Ethics
Ethics in business are views on moral rights and wrongs. They are difficult to define because certain people
hold different views.
Examples of ethical views
Use of child labour businesses like Nike have been under pressure since it is believed they use
child labour to produce their expensive trainers. Not only do people believe that children should not
work, but also their working conditions are unacceptable. Others argue that at least Nike are
providing jobs in better conditions than the workers would normally be able to obtain.
Third World trading the European Union has protected a number of industries (especially
farming) by putting additional costs on imports into the EU. This has adversely affected Third World
businesses. The Co-Op, amongst others, has been at the forefront of promoting Fair Trade .
Environment (GM foods) - genetically modified foods have brought greater yield and cheaper
produce for farmers, especially in the US and a number of Third World countries. However GM are
not felt to be acceptable by a number of people in the UK.
A business that operates an ethical policy may find that it:
Attracts more customers because they want to buy products with an ethical background since it
fits in with their beliefs.

Attracts better employees who want to work with an ethical company.
Avoids bad publicity Nike has attracted a lot of bad publicity due to its child labour accusations.
However an ethical position may have some downsides: it can:
Increase costs because they may have to use more expensive yet ethical suppliers or change
their methods of production.
Cause disagreements and conflicts in the business some members of the business may have
strong views that are not held by others. This happens often since there is often a conflict between
ethics and profits.
Pressure Groups
Business may feel obliged to act ethically or environmentally due to pressure groups.
Pressure groups are organisations formed by people who have a common aim to influence the decisions of
businesses and governments. They can campaign on a local level, for instance the building of a new factory
or on a national and international level, like Friends of the Earth.
Businesses especially may need to react if the pressure groups influence might reduce sales in the short or
long term. Shell, the oil extractors, had to change its plan to dispose of a disused oil rig out at sea because
of pressure group action.
Environmental Issues
With increased awareness of environmental issues, mainly through media and education, businesses need to
consider the environmental effects of their actions.
This adds costs to the business because they have may have to change their production techniques, or
change the way they market their products.
Businesses may react environmentally in the following ways:
Recycling
Energy efficiency
Using environmentally friendly fuels
Like acting in a socially responsible manner, they are advantages to the business of acting in an
environmentally way:
Customers react positively towards these types of businesses (note that many products make a
feature of being packed in recycled paper).
Local communities are more well-disposed towards these types of businesses the local community
is often a vital source of customers, employees and support businesses.
Technological Change
Technological change refers to the changes in production techniques and production equipment. It could be
a change in the machinery used to make a product or the computers to design a product.
More recently it is the use of the computers and information technology (IT) to improve the efficiency and

competitiveness of businesses that has led to technological change. Since technological is so rapid, there
are important implications for businesses.
A business can be affected by the following technological change:
In production
In provision of services
In the office
Technological change in production
Technological change leads to improved production of goods and services due to:
Computer-aided manufacturing (CAM) this reduces labour costs, is more accurate and faster and
can work at any hour of the day. The computer controls the machinery.
Computer-integrated manufacturing (CIM) here, computers control the whole production line.
Best example is in car production where robots undertake much of the work, reducing the need for
labour to perform boring, routine tasks.
Computer-aided design (CAD) Computers are used to help design products using computer
generated models and 3D drawings. Reduces the need to build physical models to test certain
conditions, known as prototypes. This can be expensive to produce just for testing purposes (e.g.
aircraft or new cars.
Therefore new production technology can increase the speed of production, improve the quality of the
product and reduce costs per unit of production.
Technological change can be seen in the shops and the provision of other services such as banking or
repairs.
Electronic point of sale (EPOS) and Electronic Funds Transfer at Point of Sale (EFTPOS) speed up
transactions in shops and give vital information for businesses so can sort out their stock levels.
EFTPOS means that shoppers can pay for goods and services using credit and debit cards.
Banks can use hole in the wall machines to deliver cash or take deposits therefore remain open
all hours.
Repair people can use handheld computers to work out what is wrong with the machinery they are
examining.
Technological change in the office helps speed up the movement of information and improves the analysis of
information:
Communication is improved through the use of the intranet and Internet. The intranet is an internal
system of computer communication while the internet can be used to communicate with customers,
suppliers amongst others in the outside world (through websites and email).
Workers can work away from the office using mobile technology such as phones, laptops and
modems.
Computers can be used to process, analyse and store vast amounts of data to give the business
more quality information.

E-commerce is the ability of businesses to trade with the world via websites. This means that there is a
larger market and the business is now open 24 hours a day. This has provided opportunities for businesses
that could only trade locally to now expand the size of the market (e.g. Amazon as world wide book and CD
sellers). Customers can also shop around for the best deals for new products.
The Internet can also be useful for recruitment purposes. Job vacancies can be advertised and targeted to
the right audience, often costing less than print alternatives. E.g. e-teach sends free emails every week
detailing teachers posts to subscribers.
Technological change can be very expensive: technology involves the following additional costs:
Purchasing the equipment
Installation
Training staff
Maintenance
Replacement/upgrading
There is legislation associated with the use of technology e.g. computer screens, noise levels.
In summary technological change can bring the following benefits to a business:
Reduced running costs
Improved productivity
Improved competitiveness
Lower costs per unit of product
Improved quality of service (e.g. speed of service)
Reduced wastage
If the benefits of the above outweigh the costs, then a business should be investing in new technology.
However it may need to consider the social costs of new technology:
Job losses
Motivation of workers worried about machines taking over their jobs (though extra training to work
with machines may provide some increased motivation)
Loss of traditional skills



Term Definition
Ethics Moral rights and wrongs of decisions
Legislation Laws made by the government to protect consumers, workers and other businesses
Pressure groups
A body who has a common aim to pursue a cause, and try to influence businesses
in pursuit of this cause
Social benefits
All the benefits of an action taken by a business including those not paid for by the
business
Social costs
All the costs of an action taken by a business including those not paid by the
business (e.g. production of a chemical includes the possible environmental
damage caused)
Technological
change
Where plant, machinery and IT have improved over the years due to the
advancement of our society


Economic Environment
Types of Business Activity
Business activity is the process of transforming inputs into outputs by adding value. There are three main
sectors of business activity:
Primary sector Involves the extraction and production of raw materials, such as coal, wood and
steel. A coal miner and a fisherman would be workers in the primary sector.
Secondary sector Involves the transformation of raw materials into goods e.g. manufacturing steel
into cars. A builder and a dressmaker would be workers in the secondary sector.
Tertiary sector Involves the provision of services to consumers and businesses, such as cinema
and banking. A shopkeeper and an accountant would be workers in the tertiary sector.
Goods move through a chain of production . The chain of production follows the construction of a good
from its extraction as a raw material through to its final sale to the consumer. So a piece of wood is cut from
a felled tree (primary sector), made into a table by a carpenter (secondary) and finally sold in a shop
(tertiary).
Some businesses have elements of all sectors in their chain of production. Others businesses choose to
specialise. Specialisation occurs when a producer concentrates on making a small number of products, or
on providing a narrowly defined service.
Examples of specialisation:
Baker only baking bread
Machinery that only cuts sheet metal
Lawyer dealing only with criminal law
Advantages of specialisation
Producer becomes more efficient because they learn the best way (all the short cuts) to produce at
the lowest cost
A producer may be able to charge a higher price from a customer the customer is prepared to pay
more for expert/specialist knowledge (e.g. a cosmetic surgeon)
How Business Activity is Changing
In the UK the tertiary industry has grown in importance due to:
Changes in household behaviour
Changes in business behaviour
The main changes in household behaviour are:
Higher incomes - this has meant that households demand more services such as more holidays
and eating out in restaurants, because they can afford to do so
More leisure time and so more time to spend on services, such as cinemas.

Businesses offer more after sale services e.g. help lines offered through telephone call centres,
since customers demand it
In terms of changes in business behaviour:
New and existing businesses need more sophisticated forms of support
Money and finance cash is needed for expansion. Banks and other lenders offer many different
ways for businesses to borrow money that best suit their needs. E.g. an overdraft for a short
period, a loan for a longer period.
Telecommunications the ability to communicate internally and externally is vital for business
success. Speed, cost and flexibility are all factors in determining the use of the type of wiring a
business may need. A number of businesses are now using wireless networks.
Local services businesses will need the support of local amenities and shops to service their
workers and their day-to-day needs (e.g. food for canteens).
Types of Economy
Businesses and households make up an economy. The type of economy affects the way that trade takes
place, how goods are produced and products are bought and sold.
There are two extreme types of economy:
Free market economies where there is no government intervention in the production of any sort
of good or service; businesses act own their own behalf.
Centrally planned economy where the government controls all forms of production.
Most economies are somewhere between these two extremes and are known as mixed economies, a
mixture of government owned corporations and privately own businesses.
Private and Public Sector Business
In a mixed economy most businesses can be classified as operating in either the private sector or public
sector.
Private sector
In the private sector, private individuals and organisations own the businesses. Any profits or surpluses are
rewards for this ownership and are either reinvested back into the business or given to the owners.
Public sector
In the public sector, organisations are owned and controlled by the government. These include central
government, local government and public corporations. Surpluses are either reinvested or used to reduce
taxes. The taxpayer pays for any losses made. The Royal Mail, National Health Service and the BBC are
examples of public organizations.
Private sector businesses tend to have different objectives from the public sector.
Private sector objectives might be:
Survival
Making a profit

Expansion
Satisfying shareholders
Public sector objectives are more definite. They are the provision of
An equitable level of goods and services that is low price, affordable and available for those who
need the products.
Products and services not provided by private business, such as free health care and defence.
Since 1980 the UK has reduced the number of public sector corporations dramatically with only a few
remaining. The sale of public sector corporations is known as privatisation. This is where the ownership
changes from government to private ownership, normally through the sale of shares. British Airways (BA),
British Steel and British Telecom (BT) were all privatised.
Government Economic Policy
The governments main economic aims are:
Economic growth more goods and services produced in the economy.
Low inflation prices that are not rising too fast.
Low unemployment as many people employed as possible.
Fair distribution of income
The main policies used by government to achieve these aims are:
Fiscal policy government spending and taxation. Government spending is also known as public
expenditure.
Monetary policy interest rates (the cost of borrowing money and rewards for saving).
Legislation laws that affect the way that a person or business can act.
The UK Government spends over 400bn a year and takes about the same in taxes. It also passes
legislation. These affect the way business can act, e.g. what it can produce, how much it costs and who it
can employ. It also affects the way that consumers spend their money.

Taxation
Taxation comes in two forms:
Direct taxation taxation on income and profits (income tax, National Insurance and corporation
tax).
Indirect taxation taxation on spending (VAT, excise duty).
Some examples of UK taxation are shown in the table below:
Example Type of tax/how it works Effects on business if the tax rises
Income tax A percentage of an individuals income is
taken in tax.
A reduction in disposable income (money
available to spend after tax); therefore
households will not be able to spend as
much, reducing sales.
VAT A percentage (17.5% currently in the UK)
is added to the price of the item. It does
not apply to all goods, e.g. childrens
clothes.
Increases the cost of the product, leading
to fewer sales.
Tax on beer
(excise
duty)
An amount is added to the cost of beer. Increases the cost of the product, leading
to fewer sales.
Corporation
tax
A tax on profits made by businesses. Reduces the amount of profit available at
the end of the year to be either distributed
to the shareholders or to pay for more
investment.
National
insurance
A tax on incomes (like income tax).
BUT also a tax on businesses who have to
pay a portion of the tax on behalf of the
worker
The same as income tax and corporation
tax but added to together.
Government Spending
The UK government spends approximately 400bn a year. Over a third of this money goes in welfare
benefits such as pensions, unemployment benefit and other forms of income support. The rest is spent on
health, education, defence, roads, law and order and on supporting businesses and local communities.
Businesses can benefit direct or indirectly from the rest of the spending.
Governments provide money in the form of grants, subsides and tax breaks (paying less tax than you should)
to encourage businesses in certain areas of the economy. A business that is starting out, or is going to
provide employment in a depressed area may be able to benefit from such help.
Examples of government assistance are:
Regional selective assistance that gives help to businesses wanting to set up in areas of high
unemployment.
Enterprise zones aim to attract businesses to inner city areas.
Governments also provide support through advisory bodies coordinated by the Department of Trade and

Industry, especially for small businesses.
Other bodies also provide information and support such as the Chambers of Commerce. This organisation
represents businesses in a local community, acting as a source of advice from the experiences of other
businesses and exploiting the connections within these businesses.
Businesses can also benefit indirectly because of the huge spending that governments undertake. For
instance the increases in health spending will benefit businesses that produce medical products or services
to hospital (e.g. cleaning).
Interest Rates
Interest rates are the cost of money. If you borrow money then you may have to pay back the original
amount PLUS a charge for borrowing the money. That charge is known as interest. It is a percentage of the
original amount. You may have to pay the interest weekly, monthly or annually. It is also the reward for
saving you receive a percentage of the original amount.
There is never just one interest rate. There are many rates based on whether you are a borrower or saver,
the type of borrowing you are making and your personal or business circumstances. However the rates will
tend to move up and down with the BASE RATE, which is a central rate, set by the Monetary Policy
Committee of the Bank of England.
The following types of borrowing and saving often have an interest rate attached:
Bank loans
Mortgages (borrowing to purchase a property)
Debentures
Deposit accounts
Bank current accounts
Credit cards
A change in interest rates affects businesses in the following ways:
If the business has loans then an increase in interest rates will mean higher repayments, reducing
profits.
If the business wants to borrow money to say build new premises, then they are less likely to go
ahead with the project when interest rates increase.
Customers are going to find that they are more attracted to saving than to spending if interest rates
go up and less likely to borrow money to spend as well. This may reduce sales for the business.
Labour Market
The labour market is where businesses hire workers. A business needs people to help the day to day
running of the operation. The amount of labour needed depends on whether the business is a labour
intensive or capital intensive.
A business that needs more people and less machinery is known a labour-intensive business.
Hairdressing, house building, teaching and the fashion industry are examples of labour intensive industries.
A capital-intensive industry is where a business relies heavily on machinery and technology in its

transformation of inputs into outputs. Good examples include the car industry, steel production and the rail
industry.
Unemployment is where there are people you are willing and able to work but cannot find employment at the
going wage rate. For example a machine worker who cannot get a job because there are no jobs for
machine workers in the area. High unemployment, though it can be bad for local sales, can provide a
business with a good source of cheap labour.
On the other hand a shortage of labour might cause difficulties for a business:
It may be more difficult to recruit new people - which might prevent the business from growing as
fast as it wishes
Existing workers may demand higher wages because they know that the business will be reluctant
to release them.
Competitors may try harder to poach the best staff.
The business may have to invest further in staff training and development rather than rely on
recruiting new skills into the business.
Recruitment of personnel can also depend on the mobility of labour in the labour market.
Mobility of labour means the speed with which a person can move into a different job. There are two main
types:
Geographical mobility
Can they physically move to that place of work? This depends on the transport links as well as peoples
desire to move house to get a job.
Occupational mobility
Do they have the skills to do the new job? This depends on the education and training that people have.
Even with GCSEs and A levels students will need more training to do many jobs.
The state of the regional labour market will be a major influence on location decisions for businesses. In the
South East, especially near London, there is low unemployment, so it will be difficult to find cheap labour,
though there is good pool of skilled labour. This is because a business may be able to attract good workers
from other businesses, at higher wages though. In the North East there are pockets of high unemployment,
with skilled workers without jobs, because some of the more traditional industries have declined.
Gross Domestic Product (GDP) and Consumer Spending
GDP stands for Gross Domestic Product. It is the sum of the all spending by households, firms and the
government in the economy over a period of time on goods and services. It also includes the balance of
exports (foreign spending on UK goods) and imports (our spending on foreign goods). In the UK GDP is over
1,000bn a year that is nearly 17,000 on average for every man, woman and child. Consumer spending
makes up over two thirds of all spending in the economy. Consumer spending is spending by households on
goods and services.
An increase in either figure (they both follow each other pretty closely) means that businesses, though not all,
will have benefited from an increase in sales.
A forecast increase (say for the future year ahead), provides a business with important information from
which it could make the following decisions:

Production schedules (such as when to order new stock).
Human resource management (whether to recruit new workers).
Cash flow forecasting (when to spend).
Marketing strategy (when to promote or increase prices).
Remember that some goods and services are unaffected by changes in GDP/consumer spending, for
instance sales of salt.
Exchange Rates
An exchange rate is the value of one currency expressed in terms of another. So 1 may be worth $1.55 and
1.33.
A currency that is getting stronger or appreciating is a currency that is going up in value against
another. So 1:$1.5 moving to 1:$1.8 means the pound is getting stronger
A currency that is becoming weaker or depreciating is a currency that is going down in value against
another. So 1:$1.8 moving to 1:$1.5 means the pound is getting weaker
Currencies change in value against each other all the time. This is because most currencies are based on
flexible exchange rates. The notable difference is in the Euro zone (see below).
Currencies change in value because there is a change in demand for holding that currency. Households,
governments and businesses need other countries currencies to buy their goods and services (e.g. holiday
makers for purchasing wine or a business buying spare parts for machinery from France will need Euros).
A change in exchange rates might affect a business in the following ways:
Exchange rates changes can increase or lower the price of a product sold abroad
The price of imported raw materials may change
The price of competitors products may change in the home market
For example an increase in the exchange rate will mean that price abroad goes up, lowering sales; price of
imported raw materials falls, either leading to a fall in price and more sales, or an increase in profits;
competitors prices fall, meaning lower sales.
Exchange rate French car (15,000) UK car (12,000) French raw materials (4
per kilo)
Originally 1:1.5 10,000 in the UK 18,000 in France 2.67 to UK businesses
appreciates
1:1.8
8,333 21,600 2.22
depreciates
1:1.2
12,500 14,400 3.33


Business and the Global Economy
Some businesses will concentrate on selling to the local market, but larger businesses might consider selling
abroad (exporting).
The advantages of exporting abroad are:
Larger markets.
May be less competition.
UK goods may be cheaper due to favourable exchange rates (a weak pound).
Some countries may demand less compliance with regulations, therefore making the goods cheaper
to manufacture.
The problems of trading abroad are:
Changes in exchange rates can make goods more expensive abroad.
Some countries protect their home markets by putting tariffs on incoming products. This is a tax on
imports, making foreign goods more expensive.
Protection can also be in the form of quotas, which limit the amount of products allowed into the
country, or strict laws on the types of products that can be sold in this country. A business will have to
comply with these laws, but it will increase the costs and so increase the price they sell the product for.
Globalisation is the sale and manufacture of products all around the world. Companies such as Coke and
MacDonalds have outlets and manufacturing plants across most of the world. Many companies have taken
advantage of the improvements in communication and transport links to set up in different parts of the world.
Manufacturing in different countries has the following advantages:
Closer to the market place so cheaper to transport the products.
Closer to the customers, so the business can make adjustments to the different cultures in that
country.
May be able to take advantage of cheaper labour or sources of raw materials.
May be able to avoid any trade restrictions that are imposed by country, by manufacturing inside the
country.

Examples of possible markets that businesses may wish to trade in:
Country Advantages Disadvantages
Ireland Part of EU (less export administration
costs)
Same language
Close by (fewer transport costs)
Small market
Euro
Germany or
France
Part of EU
Relatively close
Large market
Relatively rich
Different language
Different culture
USA Same language
Similar culture
Large market
Rich
Not in EU
Distance
Japan Very rich Distance
Very different language and culture
Business and Europe
The UK is part of the Single European Market, the European Union (EU). This means that it can trade one of
fourteen other countries in that market without facing any barriers to trade. It also means there is no
restriction in the employment of anyone in the EU or the ability to set a business in the EU.
The benefits of EU membership to businesses are:
Increase in market size (a greater number of potential customers) as a result of the freedom of
movement of goods and services. UK business can now sell to any of the other fourteen countries
without facing extra costs or restrictions on the types of products they can sell.
Greater access to cheap factors of production e.g. raw materials, technology and labour. A
business can employ individuals from any part of Europe. Football clubs have certainly benefited
from this! The National Health Service has found this a good source of skilled doctors and nurses
when they have had shortages of medical staff.
Access to EU government contracts, not just UK government contracts, benefiting businesses
who sell goods and services to government departments (e.g. road builders could be contracted to
provide roads in Spain).
Lower administration costs to trade, meaning that businesses do not have to pay to extra money
to send their goods abroad, other than normal transport costs.
The costs of EU membership to UK businesses are:
Greater competition from other EU businesses.
Increased costs due to compliance with EU regulations e.g. common technical standards.

Enlargement of the EU is likely to happen in the next few years with a number of Eastern European nations
joining the EU. This will provide a further increase in the market size BUT the customers will have a lower
average income and also be able to compete at lower prices with UK businesses.
European Single Currency (Euro)
At present the UK is outside the Euro zone. The Euro zone comprises 12 countries (Belgium, Austria,
France, Finland, Luxembourg, Italy, Netherlands, Germany, Portugal, Ireland, Greece and Spain) who share
one currency - the euro.
The advantages to businesses of being inside the Single Currency zone are:
No uncertainty over pricing and costs when exporting or importing, because they all share the same
currency
No costs of changing currency
European Union provides a number of subsidies and grants to help businesses in the UK set up, provide new
employment opportunities to long term and young unemployed, and develop rural and declining industrial
areas:
European Regional Development Fund (ERDF)
European Social Fund
Loans from the European Investment Bank
Social and External Costs
Social costs are the costs faced by all the community from the action of a business or individual.
An external cost is the cost that the business or individual does not incur when taking that action.
E.g. when a business pollutes in its production process a river, it does not incur the cost of clearing up the
damage further down the river. This cost is the externality or external cost.
The social cost is the external cost PLUS the costs to the business of production (a private cost to the
business.



Term Definition
Economic growth An increase in the number of goods and service produced in a year. A rise in GDP
European Single
Currency (Euro)
The common currency shared between 12 European states (excluding the UK)
European Union
15 countries in Europe who have no barriers to trade between them, but barriers to
other countries outside the EU
Exchange rates The value of one currency in terms of another currency
Fiscal policy The use of taxation and government spending to help control the economy
Free market, mixed
and command
economies
A free market economy has no government intervention and the market decides
what is produced and at what price. A command economy has total government
control over production. A mixed economy is between the two.
Gross domestic
product (GDP)
The total value of output of goods and services in the economy
Inflation A sustained increase in average prices in an economy over a year
Monetary policy The use of interest rates and the control of lending to help direct the economy
Private and public
sectors
The private sector is privately owned whereas the public sector is government
owned
Taxation
Either money taken by the government from income (direct tax) or money taken
when goods and services are bought (indirect tax)
Unemployment
The number of people willing and able to work but unable to find work at the going
wage rate


ACCOUNTING AND FINANCE
Profit
What is Profit and Why is it Important?
Profit is the difference between the income of the business and all its costs/expenses. It is normally
measured over a period of time.
They are four main types of profit quoted by a business:
Gross profit
This is the difference between sales income and the direct costs of making those products. Gross profit is
used as a performance indicator to help the business make decisions over its pricing policies and use of
materials.
Net profit
Net profit represents gross profit less all expenses associated with the normal running of the business. Net
profit shows how well the business performs under its normal trading circumstances. It is used to calculate
the primary efficiency ratio.
Net profit after interest and taxation
This is the profit available for the shareholders. Net profit after interest and taxation is all due to the owners
of the business. They can choose to take out, in the form of dividends, all, some or none of this.
Retained profit
Retained profit is the profit left over after the shareholders have been paid their dividends. Retained profit is
normally reinvested in the business.
Profit is important to a business because:
It is a reward to the owners of the business. They have taken risks with their money and time. If
there was no profit, then there would be little point in starting up or putting more money into the
business, they might as well put the money into a bank or building society
Profits are an important source of investment funds. Profit can be used to buy more stock,
improve technology or expand the premises
A business than does not make a profit will fail, potentially affecting employees, suppliers and the
local community
Many businesses do not face a dilemma or problem over the amount of profit they make, because they are
just happy to make a profit in the first place.
However there are situations where businesses can exploit the customers because there is not much
competition from other businesses. A business will need to an ethical view (what is morally right) on how
much to charge and whether they believe their profits to be excessive.
It needs to be remembered that profits are used to reinvest, which leads to better products for their
customers, better wages and working conditions for their workers or to help the local community.


Term Definition
Gross profit Revenue less cost of sales
Net profit or
operating profit
Profit generated by the business from its normal operations
Profit The difference between the revenues and costs to a business over a period of time
Retained profit
Profit due to the owners of the business. Net profit after taxes and interest
payments

Sources and Uses of Finance
Introduction
Finance is the money available to spend on business needs.
Right from the moment someone thinks of a business idea, there needs to be cash. As the business grows
there are inevitably greater calls for more money to finance expansion. The day to day running of the
business also needs money.
The main reasons a business needs finance are to:
Start a business
Depending on the type of business, it will need to finance the purchase of assets, materials and employing
people. There will also need to be money to cover the running costs. It may be some time before the
business generates enough cash from sales to pay for these costs. Link to cash flow forecasting.
Finance expansions to production capacity
As a business grows, it needs higher capacity and new technology to cut unit costs and keep up with
competitors. New technology can be relatively expensive to the business and is seen as a long term
investment, because the costs will outweigh the money saved or generated for a considerable period of time.
And remember new technology is not just dealing with computer systems, but also new machinery and tools
to perform processes quicker, more efficiently and with greater quality.
To develop and market new products
In fast moving markets, where competitors are constantly updating their products, a business needs to spend
money on developing and marketing new products e.g. to do marketing research and test new products in
pilot markets. These costs are not normally covered by sales of the products for some time (if at all), so
money needs to be raised to pay for the research.
To enter new markets
When a business seeks to expand it may look to sell their products into new markets. These can be new
geographical areas to sell to (e.g. export markets) or new types of customers. This costs money in terms of
research and marketing e.g. advertising campaigns and setting up retail outlets.
Take-over or acquisition
When a business buys another business, it will need to find money to pay for the acquisition (acquisitions
involve significant investment). This money will be used to pay owners of the business which is being
bought.
Moving to new premises
Finance is needed to pay for simple expenses such as the cost of renting of removal vans, through to
relocation packages for employees and the installation of machinery.
To pay for the day to day running of business
A business has many calls on its cash on a day to day basis, from paying a supplier for raw materials, paying
the wages through to buying a new printer cartridge.

Choosing the Right Source of Finance
A business needs to assess the different types of finance based on the following criteria:
Amount of money required a large amount of money is not available through some sources and
the other sources of finance may not offer enough flexibility for a smaller amount.
How quickly the money is needed the longer a business can spend trying to raise the money,
normally the cheaper it is. However it may need the money very quickly (say if had to pay a big
wage bill which if not paid would mean the factory would close down). The business would then
have to accept a higher cost.
The cheapest option available the cost of finance is normally measured in terms of the extra
money that needs to be paid to secure the initial amount the typical cost is the interest that has to
be paid on the borrowed amount. The cheapest form of money to a business comes from its
trading profits.
The amount of risk involved in the reason for the cash a project which has less chance of
leading to a profit is deemed more risky than one that does. Potential sources of finance (especially
external sources) take this into account and may not lend money to higher risk business projects,
unless there is some sort of guarantee that their money will be returned.
The length of time of the requirement for finance - a good entrepreneur will judge whether the
finance needed is for a long-term project or short term and therefore decide what type of finance
they wish to use.
Short Term and Long Term Finance
Short-term finance is needed to cover the day to day running of the business. It will be paid back in a short
period of time, so less risky for lenders.
Long-term finance tends to be spent on large projects that will pay back over a longer period of time. More
risky so lenders tend to ask for some form of insurance or security if the company is unable to repay the loan.
A mortgage is an example of secured long-term finance.
The main types of short-term finance are:
Overdraft
Suppliers credit
Working capital
The main types of long-term finance that are available for to a business are:
Mortgages
Bank loans
Share issue
Debentures
Retained profits
Hire purchase

Internal and External Finance
Internal finance comes from the trading of the business.
External finance comes from individuals or organisations that do not trade directly with the business e.g.
banks.
Internal finance tends to be the cheapest form of finance since a business does not need to pay interest on
the money. However it may not be able to generate the sums of money the business is looking for, especially
for larger uses of finance.
Examples of internal finance are:
Day to day cash from sales to customers.
Money loaned from trade suppliers through extended credit.
Reductions in the amount of stock held by the business.
Disposal (sale) of any surplus assets no longer needed (e.g. selling a company car).
Examples of external finance are:
An overdraft from the bank.
A loan from a bank or building society.
The sale of new shares through a share issue.
The table below summarises the main types of finance that are suitable for businesses at various stages of
development and/or ownership:
Type of Business Source of Finance
Small business start
up
Own cash is the cheapest form of finance since it carries no obligation to pay
any interest or give control of the business to any other party. Otherwise a bank
loan or a government grant.
Established sole trader
or partnership
Bank loans; bank overdraft; trade credit; retained profits; taking on a new
partner; government grant.
Limited company Bank loans; bank overdraft; trade credit; retained profits; share issue.
Purchasing fixed
assets
Owners funds, retained profits; bank loans; hire purchase; leasing.
Day to day running of
the business
Overdraft; extending trade credit; improving working capital.


Sources of External Finance
Equity finance
Equity finance is the money provided by the owners of the business.
SOLE TRADERS AND PARTNERSHIPS
A sole trader will provide money from his or her own savings.
A sole trader may find it difficult to raise much money from this source and therefore may take on a
partner who brings money into the business.
LIMITED COMPANIES
A limited company can sell shares, which represent how much of the business the shareholder owns.
There are two types of limited company that define the way that money can be raised through shares.
A private limited company can sell shares only to designated people and there is a limit how
much capital they can raise through this method.
A public limited company can issue shares to the public. This means anyone can have a share in
the company.
It is important to note that once a share is issued, it only raises money for the company the first time it is sold.
After that the proceeds any sale of that share goes to the owner of the share. It is like a second hand car.
When a BMW is sold second hand, then the money goes to the owner of the car and not BMW.
A company may wish to issue shares because:
A large amount of money can be raised through a share issue.
Unlike a loan the money does not have to be repaid over a fixed period of time.
A company may issue two types of shares:
Ordinary shares
- Ordinary shareholders can vote at company meeting.
- The amount of the dividend received varies.
Preference shares
- Preference shareholders do not have a vote at company meetings.
- The dividend is usually fixed (e.g. 5% of the value of shares held paid as dividend each year).
- Preference shareholders receive their dividend before ordinary shareholders.
Shares are bought because they provide a return to the shareholder. There are two parts to the returns
earned by shareholders:
Dividends paid out on each share held by the company (e.g. companies on the Stock Exchange
usually pay out two dividends each year).

Increases in the value of each share as the company itself grows in value (this is often known as
a capital gain).
In conclusion:
A business will issue shares to raise large sums of money. By doing this they are diluting the ownership
which means that the control of the business is spread amongst more people. However they only have to
pay dividends and dont have to pay out dividends at all, especially if they make a loss. But a shareholder
has the right to vote off a board of directors, if they can gain 50.1% of support of the rest of the shareholders.
Debentures
A debenture is a long term loan which is usually secured against a specific asset (e.g. the factory) or the
overall assets of a business. A debenture is repayable at a fixed date and has a fixed rate of interest.
Debentures are different from ordinary shares because:
The lender has no voting rights in the company.
The loan attracts interests whereas holders of ordinary shares get dividends.
The providers of loans are paid out before ordinary shareholders in the event that the business fails
(assuming there is some cash left).
Bank Loans and Overdrafts
A bank overdraft is a limit on borrowing on a bank current account. With an overdraft the amount
of borrowing may vary on a daily basis.
A bank loan is a fixed amount for a fixed term with regular fixed repayments. The interest on a loan
tends to be lower than an overdraft.
Example of a loan:
A business borrows 12,000 from a bank over 3 years at an interest rate of 5%. The approximate
repayments on this loan would be 392 a month for 36 months (14,112).
A fixed term means how many months or years before the loan has to be repaid in full.
Normally a fixed term loan will be for a greater amount than an overdraft.
Overdrafts Loans
Advantages Flexibility can change the amount
borrowed within limits
Interest is only paid on amounts
borrowed
Larger amounts can be borrowed
Lower interest rates than overdrafts
Regular repayments help plan cash flow
Disadvantages Cannot be used for large borrowing
Rates of interest higher than loans
Bank can change limit at any time or
ask for money to be paid back sooner
than expected
Less flexible than an overdraft
Have to pay back in stated time or risk
further financial problems

Leasing
Leasing is like renting a piece of equipment or machinery. The business pays a regular amount for a period
of time, but the item belongs to the leasing company.
Most company cars are leased to businesses. The business pays a monthly fee for the car and at the end of
the period (normally about two years), the business swaps the car for a newer model.
The advantages of leasing are:
Cheaper in the short run than buying a piece of equipment outright.
If technology is changing quickly or equipment wears out quickly it can be regularly updated or
replaced.
Cash flow management easier because of regular payments.
The disadvantages of leasing are:
More expensive in the long run, because the leasing company charges fees which make the total cost
greater than the original cost.
Hire Purchase
Business hires the equipment for a period of time making fixed regular payments. Once payments have
finished it then owns the piece of equipment. Hire purchase is different to leasing in that the business owns
the equipment when it has finished making payments. With an equipment lease, the equipment is handed
back to the leasing provider.
Debt Factoring
A business sells its outstanding customer accounts (those who have not paid their debts to the business) to a
debt factoring company.
The factoring company pays the business - say 80-90% of face value of the debts - and then collects the full
amount of the debts. Once it has done this it will pay the remaining amount to the business less a charge.
It is a good way of raising cash quickly, without the hassle of chasing payments. BUT it is not so good for
profits since it reduces the total revenue received from those sales.
Government Finance
The government and the European Union provide help to businesses for the following reasons:
Protect jobs in failing/declining industries.
Help create jobs in areas of high unemployment.
Help start up new businesses.
Help businesses relocate to areas of high unemployment.
Some of the main sources of funds are:
European Structural Fund
Assisted Areas

Regional Selective Assistance
Small Loans Guarantee Scheme
Trade Credit
A business does not always have to pay their bills as soon as they receive them. They are given period of
credit, normally around 30-60 days. By trying to extend this period they can improve their short-term finance
position.
Small businesses now have some protection under law that prevents larger firms exploiting their credit terms.
Trade credit is an important source of finance for nearly all businesses since it is effectively a free source of
finance.
Retained Profits
The cheapest form of finance is the business own profits. In the UK over 80% of retained profits are
reinvested back into the business. Since it is not being borrowed from anyone, it does not cost money to use.
Own Capital
For sole traders and partnerships a common source of finance, especially for start up is money from the
individuals who are forming the business. They may also borrow money from family and friends. Own capital
is a costless form of finance, but carries the risk of the money being lost.
Working Capital
Working capital is the amount of money available for the day to day running of the business. It is the
difference between current assets and current liabilities. See below for more details of how working capital
can be used.
Sources of Finance for Public Sector Organisations
Public sector organisations receive from both the normal sources that most businesses receive money, but
also from tax revenues. Most public sector organisations, such as schools and hospitals obtain more straight
from the government - who have previously collected the money from tax payers.
Other organisations gain money from sales, e.g. stamps for the Post Office, and licences for the BBC.



Term Definition
Bank loans Long term lending by a bank over a fixed period
Debentures Fixed interest loans normally based on the purchase and security of an asset
Debt factoring
Raising money by getting another firm to buy the unpaid invoices due to the
business
Hire purchase
Renting a piece of equipment for a fixed period, after which the business takes
ownership
Internal and
external finance
Internal finance comes from the normal operations of the business (e.g. profit
generated) whereas external finance comes from outside sources
Leasing Renting a piece of equipment from another business for a fixed period of time
Mortgages Lending by a bank for the purchase of buildings
Overdrafts Lending by a bank on a short term basis
Shares A part ownership of the business which can earn a dividend
Short term and long
term finance
Short term finance covers the day to day running of the business. Long-term
finance is aimed at costly projects which will pay back in a period greater than a
year.
Suppliers credit A period of time before the business has to pay its bill
Working capital
Short-term finance available for the day to day running of the business. Current
assets minus current liabilities


Financial Accounting
Introduction
Financial accounts are the records of the financial dealings of the business, their every day transactions.
The main role of financial accounting is to:
Record financial transactions; e.g. collecting money from sales, paying suppliers, salaries and
wages.
Help the managers to manage the business more efficiently by preparing regular financial
information e.g. monthly management accounts showing sales, costs and profits against budgets,
forecasting cash flows, cost investigations.
Provide other stakeholders with legal/vital information (financial accounts: trading account,
profit and loss, and balance sheet).
- Shareholders how their investment is doing.
- Suppliers can they give the business trade credit.
- Banks and lenders can the business meet repayments of loans and risks of loaning the business
money.
- Inland revenue tax returns.
The main accounting records kept by the business are records for keeping the details of transactions:
Sales ledger: shows how much is owed by customers who have bought on credit.
Purchase ledger: shows how much is owed by the business to suppliers who have provided goods
and services on credit.
Cash book and bank statements: shows all transactions involving cash (e.g. receipts from
customers, payments to suppliers, employee wages).
Nominal (or General ) ledger: used to categorise the transactions of a business under headings
e.g. sales of widgets, raw materials, electricity, and postage.
These records are used to maintain the information that is used to make up the main financial statements.
Financial Statements
Financial accounting produces the following key documents:
Profit and loss account showing how the business has traded for a specific period.
Balance sheet a statement of the assets and liabilities of a business at a particular time, and how
those assets and liabilities have been financed.
Cash flow statement a statement showing how cash has come into the business and what it has
been spent on.

Profit and Loss Account
The purpose of the profit and loss account is to:
Show whether a business has made a PROFIT or LOSS over a financial year.
Describe how the profit or loss arose e.g. categorising costs between cost of sales and
operating costs.
A profit and loss account starts with the TRADING ACCOUNT and then takes into account all the other
expenses associated with the business.
Trading account
The trading account shows the income from sales and the direct costs of making those sales. It includes the
balance of stocks at the start and end of the year.
An example of the trading account of a business would look this:
Trading account for XYZ plc for the year ended 31
st
March 2003
Category
Sales 1,200,000
Opening Stock 150,000
Purchases 400,000
less Closing Stock (220,000)
Cost of Sales 330,000 (330,000)
Other Costs (70,000)
Gross Profit 800,000
Note that the closing stock figure would appear in the balance sheet under Stock.
Profit and loss account
The trading account now has all the other expenses now deducted.
It would look like the table on the following page:

Trading, profit and loss account for XYZ plc for the year ended 31
st
March 2003
000 Examples
Turnover
(sales)
revenue
1,200 The amount of money
generated by sales
e.g. 400 cars at 3,000 each
Cost of sales (400) The cost of making the
goods or buying them
Raw materials
Cost of labour working directly on each
product
Cost of running the machines/equipment
Gross profit 800 Turnover minus cost of sales
Overheads or
expenses
(320) Costs not directly involved
in the production process
(indirect costs)
Cost of premises e.g. rent, insurance,
repairs
Office costs e.g. stationery, postage,
computer maintenance, staff salaries
and wages
Sales and marketing costs e.g. salaries
of salesmen, advertising
Finance costs e.g. bank charges,
interest
on bank loans
Operating
profit
480 Gross profit minus overheads
Also known as NET PROFIT

Interest and
taxation
payable
(200) The money that is due to be paid in interest on loans and to the Inland
Revenue as tax
Net profit after
tax and
interest
280 The money available to be distributed to shareholders
Dividends (170) Money paid to shareholders as a reward for holding shares
Retained
profit
90 The money left for the business to reinvest
The business has to pay tax at the rate determined by the government and interest at the rates determined
by the lenders.
A business can influence its gross and net profits.
A business can improve its gross profit by:
Changing to cheaper raw material suppliers.
Redesigning the product to use fewer or cheaper materials.
Increasing selling prices.
Offer fewer discounts to customers.

A business can improve its operating or net profit by reducing its overheads.
It can cut its overheads by:
Reducing advertising expenditure.
Move to cheaper premises.
Combine jobs done by administrative staff to reduce employee numbers.
Renegotiate the cost of overheads such as legal and accounting fees.
Revenue and Capital Expenditure
Not all costs are put straight into the profit and loss account. Some items bought by the business will be used
for many years, so it makes sense to charge the cost of purchase over the years of their useful life (see
depreciation).
There are therefore two types of expenditure:
Revenue expenditure is money spent on goods and services which have been or will be
consumed
Capital expenditure is money spent on long term assets which are used over and over again
Examples:
Revenue expenditure Capital expenditure
Wages Buildings
Raw materials Machinery
Computer Software Computer systems (hardware)
Capital expenditure appears on the profit and loss account in the expenses and overheads section under the
term depreciation. (see depreciation) It appears in the balance sheet under fixed assets.

Balance Sheet
Balance sheets provide a snap shot of the assets and liabilities of a business at a point of time.
It shows what the business owns, is owed and owes:
Owns assets such as buildings, stock and cash.
Is owed money from debtors.
Owes money to creditors and the bank.
Owes to the investors and owners of the business (they own the profit).
A typical balance sheet would look like this:
Balance sheet for XYZ plc as at 31
st
March 2003
000 Notes
Fixed assets 1,800
Likely to find sub-totals for buildings, equipment and
vehicles
Current assets
Stock 300

Debtors 250

Cash 150

Total current assets 700 Stock + debtors + cash
Current liabilities (400)

Net Current Assets 300
Current assets current liabilities; also known as working
capital
Net assets employed 2,100 Fixed assets + net current assets
Financed by:
Long term liabilities 700 e.g. loans from banks
Share capital 1,000
Amounts invested by shareholders
Profit and loss
reserves
400
The profit accumulated that has been retained by the
business
Capital employed 2,100 Long term liabilities + share capital + profit and loss reserves
Note that net assets employed = capital employed. This is always the case, because the capital employed
is the amount of long-term money put into the business and the net assets employed how it is used.
Fixed assets
Fixed assets are:
Assets that provide a benefit for the business in the long-term (normally for at least a year), e.g.
buildings and machinery

Assets that the business intends to keep
Note that fixed assets are depreciated over their useful life (see depreciation).
Current assets
Current assets are assets that will be used up or sold in the next year + the cash balances kept in the
business. The main categories are:
Stocks finished goods, work in progress and raw materials (note: you may also see stocks called
inventories).
Debtors people who owe the business money (customers who owe money are known as trade
debtors).
Cash in the bank and in the cash box.
Current liabilities
Current liabilities are what the business owes in the short run. The main categories are:
Creditors money owed by the business in the short term (suppliers who are owed money by the
business are known as trade creditors).
Bank overdraft amounts due within the next 12 months.
The total of current assets minus current liabilities is known as working capital. This is amount of money
available for the day to day running of the business. A negative figure can be a problem for some businesses
that may need to pay for outstanding debts, but do not have enough spare cash to do so.
Long-term liabilities are the monies the business has borrowed for a period of more than a year
mainly bank loans.
Share capital is the money invested in the business by the owners.
Profit and loss reserves are the profits due to the owners that have not already been paid out in
dividends. This money is not necessarily held in cash (see the current assets), but may have been
used to buy more stock or fixed assets.
Shareholder funds are the share capital and reserves added together.
Capital is the amount of long-term money put into the business to buy assets. Main forms of
capital: owners money (share capital) and long term bank loans.
Depreciation
A fixed asset reduces in value over its useful life due to wear and tear and (when it is no longer useful)
obsolescence. Depreciation is the tool used by accountants to record the reduction in the original value of an
asset. Depreciation is charged every year of a fixed assets useful life to the profit and loss account. In the
balance sheet the original cost of the fixed asset is reduced by the amount of depreciation.
There are two main methods of depreciation:
Straight line depreciation this is where the same amount is charged every year using the
following formula to calculate it:

Original Cost of the Fixed Asset / Useful Life of the Asset
For example; a machine bought for 20,000 has a useful life of ten years. Management decide to charge
depreciation on a straight line basis. So the annual depreciation cost is 20,000 / 10 = 2,000
Reducing balance depreciation the same percentage of an assets value is taken off every
year, e.g. 20%.
Most businesses use straight line depreciation, but it is possible to argue that reducing method is better
because it reflects the fact that most assets lose most of their value in the first years of use.
Depreciation appears in the profit and loss account under expenses it reduces the profit for that year
because some of the asset was used up in that time period.
It appears in the balance sheet by reducing the value of the fixed assets. This means that the balance sheet
reflects a true and fair value of the assets.
Cash flow statement
The cash flow statement is an historical accounting statement that shows how the business has generated
and spent its cash. The cash flow statement is split into two parts:
Sources of funds where the cash has come from (e.g. profits, increase in trade credit).
Uses of funds - how it was used (e.g. purchase of assets, repayments on bank loans).
Note: a cash flow statement is different from a cash flow forecast which looks at the future movement of
cash.
Legal Obligations
The Companies Act requires limited companies to produce the following accounting statements and publish
them in the Annual Report and Accounts:
Profit and loss account
Balance sheet
Cash flow statement
Decision-making and Financial Accounts
A business will use the financial accounts to help assess the following areas:
How well they are doing.
What decisions worked well and which did not.
To decide what to do in the future.
For a business, the financial accounts will provide a key source of data to make decisions over its strategy.
Analysis of performance is covered in the next chapter.


Term Definition
Balance sheet
A statement of assets and liabilities of a business at a particular time and how those
assets have been financed
Capital expenditure Money spent on long term assets which are used over and over again
Cash flow
statement
A statement showing how cash has come into the business and what it has been
spent on
Current assets Short term assets which will be used up within a year
Current liabilities What the business owes in the short run
Depreciation Reduction in the value of an asset over its useful life time
Financial accounts A record of the financial dealings of the business
Fixed assets Long term assets which will be used for more than a year by the business
Overheads Costs not directly involved in the production process
Profit and loss
account
Shows how the business has traded over a specific period
Revenue
expenditure
Money spent on goods and services which have been or will be consumed


Analysing Financial Performance
Introduction
Analysing financial performance is about judging the successes and failures of a business by considering a
number of financial measures. Most of these measures are known as ratios.
A ratio is a measure of one piece of information in terms of another. A non-financial ratio might be the
numbers of boys to girls in a class, or the number of GCSE passes in business studies as a percentage of all
the GCSE passes in the school.
Ratios are normally compared with the previous years figures or with figures from competitors to see whether
the business has improved or not and whether it is better or worse than a rival.
The main areas that ratios look at are:
Profitability
Financial efficiency
Liquidity
It is not just ratios that are analysed. Forecasts of profit and sales are extremely useful, as well as a record of
profits made in previous years.
The main users of this financial information are:
Owners/shareholders
Employees
Managers
Creditors and banks
Competitors
Government (e.g. the Inland Revenue who calculate how much tax is due by a business)
Profit and Profitability
A business needs to make more money from sales than it costs to produce the products and maintain the
business for the following possible reasons:
To repay the owners of the business for investing.
To expand the business in the future.
A loss would eventually mean the business would have to close down.
The difference between profit and profitability is summarised below:
Profit is an absolute measure it equals sales revenue less costs
Profitability is a relative measure it shows the amount of profit relative to what created the
profit

In order to compare the performance of a business against previous years and other businesses it is useful to
calculate profitability ratios. The business can then analyse and spot favourable and unfavourable trends.
The main three profitability ratios are:
ROCE return on capital employed
Gross profit margin
Net profit margin
Return on Capital Employed (ROCE)
The main measure of business performance is ROCE. ROCE is also known as the primary efficiency ratio
because it is a better indicator than profit alone of how well a business is using the money invested. It shows
how much profit is being generated from the investment compared with alternative investments in similar
businesses or with interest from bank deposits. A higher figure is better. Any figure over 10% is a good
level, but it depends on how risky the business is thought to be.
A business could increase its ROCE by:
Increasing net profits without increasing or introducing new investment.
Reducing the amount invested in the business by selling assets that do not contribute to the profit
earned.
Gross profit margin
The gross profit margin of the business shows the ability of business to add value to the costs of directly
making the product. A higher figure is better.
A business could increase its gross profit margin by:
An increase in the selling price of existing products.
Introduction of new products which achieve a higher gross profit margin.
Reducing the cost of sales e.g. a fall in raw material prices.
Net profit margin
The net profit margin is the amount of profit generated per pound of sales.
It is useful to compare it against the gross profit margin and previous years to see how well the business
manages its expenses or overheads.
Importance of profit and cash
A business may be profitable but still go bankrupt even if it is profitable.
A business can make a profit but have a negative cash flow. Without enough cash to pay employees,
suppliers, banks and taxes the business will go bankrupt.
A business makes a profit when sales exceed costs. Positive cash flow arises when payments from
customers exceed payments to suppliers and employees. Cash may not be due from customers until next
month, but bills and employees may have to be paid today.

This situation can give rise to negative cash flow, even though the value of sales is greater than costs. Poor
cash flow is one of the main reasons why new businesses fail.
Liquidity
Liquidity means the ability of the business to meet its short-term debts. In practice this means having the
cash to pay any bills that need to be paid.
Liquid assets are those assets that are held in cash form or can be turned into cash very quickly.
There are two main tests of liquidity, the current ratio and the acid test.
Current ratio
The current ratio is usually defined as current assets divided by creditors falling due within one year.
The ratio is designed to assess the solvency of a business in the short term. If the current ratio exceeds one,
then the value of current assets is greater than the value of the short term creditors, indicating that the
company is able to pay its short term debts as they fall due. Note that this interpretation is fairly simplistic.
Acid test ratio
This is a tougher test of liquidity. Stock takes longer to turn into cash, so it is excluded from the current
assets in the calculation.
A ratio of 1 means that the short debts can be covered by the short-term liquid current assets. In a business
that receives a lot of cash on a day to day basis, e.g. a market stall trader or supermarket, they can have a
lower ratio, because they can probably raise the cash to pay a bill in the next few days. Some retailers, like a
car sales dealership, might find this more difficult to achieve and would need a higher ratio. This is because
they may have to wait more time to receive the cash, especially if someone is paying on credit.
A business could improve its liquidity ratios by:
Increasing the value of profitable sales.
Turning its overdraft into a long-term loan (reduces short-term liabilities and increases capital).
Financial efficiency
There are three main financial efficiency ratios:
Stock turnover
Debtor days
Creditor days
Stock turnover
Stock turnover is the number of times stock is turned into sales. The higher the figure, the more quickly stock
has been sold or turned over. A fruit stall will have a higher stock turnover than a car dealership.
Businesses want to have a higher stock turnover figure because this means that stock is not hanging around
on the shelves or storage. In this time it could become obsolete, get damaged or go out of date. It also costs
money to hold stock.

A business may increase its stock turnover by having:
Lower stock levels.
Disposal of slow moving or obsolete stock.
Reduction in range of products stocked.
Debtor days
The debtor days figure shows the number of days it takes for a business to collect money from customers
who have bought products on credit.
Businesses want to have as low a debtor days figure as possible. The larger the figure, the longer it takes to
collect the money, money needed to pay bills.
A business can encourage customers to pay their debts more quickly and so reduce the debtor day ratio in
the following ways:
Offer discounts for early payment.
Threaten to take the customer to court.
Refuse to supply more products or hold back part of an order until payment has been made.
Creditor days
Creditor days are a measure of how long it takes for the business to pay creditors. The larger the figure the
longer it takes the business to pay. A supplier would be interested to know how well a business does in
paying its bills.

Summary of Accounting Ratio Calculations
The table below provides some example data we can use to demonstrate how the main accounting ratios are
calculated. Work through the examples to make sure you can understand where the numbers come from.
Profit and Loss Account 2002
000
2003
000
Sales 1,500 2,000
Cost of Sales (750) (900)
Gross Profit 750 1,100
Overheads 500 650
Net profit 250 450

Balance Sheet at End of Financial Year
Fixed Assets 2,000 2,250
Current Assets:
Stocks 300 350
Debtors 250 300
Cash 500 500
Total Current Assets 1,050 1,250
Current liabilities (750) (650)
Net Current Assets 300 600
NET ASSETS 2,300 2,750

Financed by:
Share capital 100 100
Retained profits 2,200 2,650
CAPITAL EMPLOYED 2,300 2,750

Calculation of Gross Profit Margin:
Formula:
Gross Profit / Sales Expressed as a percentage
Calculation using example:
000
2003
000
Sales 1,500 2,000
Gross Profit 750 1,100
Gross Profit Margin 50% 55%


Calculation of Net Profit Margin:
Formula:
Net Profit / Sales Expressed as a percentage
000
2003
000
Sales 1,500 2,000
Net Profit 250 450
Net Profit Margin 16.7% 22.5%

Calculation of ROCE (Return on Capital Employed):
Formula:
Net Profit / Capital Employed Expressed as a percentage
Data from the Profit and Loss Account and the
Balance Sheet
2002
000
2003
000
Net Profit 250 450
Capital Employed 2,300 2,750
Return on Capital Employed 10.7% 16.4%

Calculation of Current Ratio:
Formula:
Current Assets / Current Liabilities
Data from Balance Sheet 2002
000
2003
000
Current Assets 1,050 1,250
Current Liabilities 750 650
Current Ratio 1.4 1.9


Calculation of Acid Test Ratio:
Formula:
Current Assets (excluding stocks) / Current Liabilities
Data from Balance Sheet 2002
000
2003
000
Current Assets (excluding stocks) 750 900
Current Liabilities 750 650
Current Ratio 1.0 1.4

Term Definition
Current ratio
A measure of liquidity that compares the value of current assets (i.e. assets that
can be turned into cash) against current liabilities (how much the business owes in
the short term)
Gross profit margin
The gross profit margin of the business shows the ability of business to add value to
the costs of directly making the product
Liquidity
The ability of the business to cover its short term debts with cash, the money it is
owed and stock
Net profit margin The net profit margin is the amount of profit generated per pound of sales
Profitability
A relative measure that shows how much profit has been generated by each
pound of sales
Ratios A way of comparing financial data to aid the decision making process
Return on capital
employed (ROCE)
The primary efficiency ratio, showing the return a business makes on the money
invested into it

Business Costs
Introduction
A business has many different costs, from paying for raw materials through to paying the rent or the heating
bill. By careful classification of these costs a business can analyse its performance and make better-
informed decisions.
The main ways in which a business needs to manage its costs are as follows:
Classification of costs into fixed and variable, direct and indirect.
Variance analysis to see if the business is keeping control of its costs.
Break even analysis which tells a business what it needs to sell to cover its costs.
An opportunity cost is the financial benefit forgone of the next best alternative use of money. A business
can measure the outcome of a decision by comparing it with the benefits (probably measured in profits or
revenue) it could have had if it had taken the next best option. The opportunity cost of buying a new piece of
machinery might be compared with the benefits of spending the money on a new advertising campaign.
Fixed and Variable Costs
Variable costs change in proportion to the amount of output produced.
Fixed costs remain the same, no matter how much the business produces.
The main kinds of costs are:
Variable costs Fixed costs
Raw materials Rent
Workers wages Salaries of head office workers
Energy/fuel for machines Heating and lighting
Insurance
Interest on loans
Semi-fixed costs are costs which only change when there is a large change in output. For example, costs
associated with buying a new machine to cope with increased production.
Also telephones and electricity for instance have a fixed and variable element: a standard line rental and then
a charge for each call/unit of electricity after that.
Direct costs are costs which can be identified directly with the production of a good or service; e.g.
raw materials.
Indirect costs are costs which cannot be matched against each product because they need to be
paid whether or not the production of good or services takes place; e.g. rent on the premises.
Classification of costs help allocate costs to right parts of the profit and loss account and also helps analysis
of the break even point of the business.

Standard Costing and Variances
A standard cost is the cost per unit of production when the product is made with the correct quantity and
quality of materials, and in the exact time allowed for its production.
A variance is when the ACTUAL cost is either greater or less than the standard cost.
Where actual costs are more than the standard, this is known as an adverse variance .
Where actual costs are less than the standard, this is known as a positive variance .
A variance (difference) from the standard may indicate what course of action to take to correct something that
is going wrong. A greater cost than standard (adverse variance) might lead to an investigation into how
inputs were being used e.g. too much waste of raw materials, incorrect operation of machinery.
Example:
Costs for January 2003 Budgeted () Actual () Variance ()
Wages 2,000 1,950 50 Positive
Materials 6,500 7,500 1,000 Adverse
Fuel 350 375 25 Adverse
Break-even
A business can work out how what volume of sales it needs to achieve to cover its costs. This is known as
the break even point.
The key to break even is to work out the contribution made from the sale of each unit.
The amount of money each unit sold contributes to pay for the fixed and indirect costs of the business.
Contribution = selling price less variable cost per unit
E.g. a product sells for 15 and has variable costs per unit of 11. Each unit sale therefore makes a
contribution of 4 towards the fixed costs of the business. If the business had fixed costs of 20,000, then it
would need to sell 5,000 units (4 x 5,000 = 20,000 contribution) in order to break even.
The margin of safety is the difference between the number of units of planned or actual sales and the number
of units of sales at break even point.
If, using the example above, planned sales were thought to be 6,000 units, then the margin of safety would
be 6,000 units break even 5,000 units = 1,000 units. The business would be able to sell 1,000 less than
planned before they were in danger of making a loss.
A break-even chart plots the sales revenue, different costs and helps identify the break even point and
margin of safety.

Drawing break-even charts
To draw a chart the following steps need to be followed:
1. Label the vertical axis sales and costs in pounds.
2. Label the horizontal axis sales/production (units).
3. On another piece of paper sketch the scales that you want to use given the data, then use this plan
on the chart.
4. Plot any two points from the sales revenue data for the sales revenue line and then draw a straight
line for sales revenue (assumes that the price per unit does not change) if the information is not
given for sales revenue, then work out two points, e.g. for 1000 units sold and 1500 units sold. The
start of the line should be through the origin (where the axes meet).
5. Draw a horizontal line for total fixed costs starting at the point on the vertical axis at the level of costs.
6. At the same starting point it is possible to draw the total costs line. Total costs are fixed costs plus
variable costs. Work out what the total costs are for say 1000 units and 1500 units. Then draw the
straight line starting at the same point as the fixed costs started and then through the two plotted
points.
7. Where the sales revenue crosses the total costs line is the break even point. Read off the units of
sales to give the break even level of sales.
8. The gap between the total costs line and sales revenue line after the break even point represents the
level of profit.

It is important for a business to understand its break-even point because the contribution from every unit sold
above the break-even point adds to profit. The break-even point provides a focus for the business, but also
helps it work out whether the forecast sales will be enough to produce a profit and whether further investment
in the product is worthwhile.
The limitations of break-even charts are:

Do not take into account possible changes in costs over the time period.
Do not allow for changes in the selling price.
Analysis only as good as the quality of information.
Do not allow for changes in market conditions in the time period e.g. entry of new competitor.

Term Definition
Break-even
analysis
Working out the level of production and sales a business needs to achieve to make
sure that revenues cover costs
Contribution
The amount of money that is generated from a sale which can go towards paying
for the fixed costs. The difference between selling price and variable cost per unit.
Direct and indirect
costs
Direct costs can be identified directly with production whereas indirect costs cannot
be matched against production, and need to be paid whether production takes place
or not
Fixed and variable
costs
A fixed cost does not vary with output, whereas a variable cost varies in proportion
to the amount of output
Margin of safety The difference between the break-even output and the expected sales.
Variance analysis
Analysis of whether actual costs have varied from the expected cost (standard
cost).


Budgeting and Business Plans
Introduction
Business managers need to look ahead at what lies in the future. An important part of this process is the use
of budgeting, which sets out what can be spent and how, and the use of business plans, which set out the
direction of the business and the strategies to achieve that direction.
A budget is an agreed plan for future expenditure and income from sales based on the objectives of the
business.
A budget helps managers to measure whether they are achieving what they set out to achieve. If they are
under or over budget they can take steps to correct the position.
A budget also helps managers allocate resources at the start of a period e.g. in which areas is the business
going to invest? How much will be spent on advertising this year?
Budgets also provide a way of allocating responsibility among employees.
The main types of budget are:
Sales budget probably a month by month breakdown of how many products the business aims to
sell, and how much revenue it will get from those sales.
Marketing budget describes how the business intends to achieve the budgeted sales (e.g. how
much advertising, sales promotion).
Production budget numbers to be produced and costs of production used to help schedule
work and order raw materials.
Departmental budgets sets out how much each department can spend during a year.
Cash flow budget ties all the other budgets together helps understand what money is coming
in (sales) and what money is going out (production and departmental).
A budget can play a role in motivating employees in the following way:
As a non-money motivator a budget provides a focus and a sense of achievement when it is
reached.
Rewards in the form of bonuses can be linked to the achievement of budgets, encouraging
employees to contribute more towards the overall profitability of the business.
Cash Flow Forecasting
A cash flow forecast or budget is used to anticipate when it can pay bills and plan when it might need to make
provision for any cash flow problems (e.g. arrange for there to be some finance available in the form of an
overdraft or loan).
The key elements of a cash flow budget are:
Opening balance How much cash the business has at the start of the time period.
Cash inflow How much cash is coming into the business from product sales, sales of assets, loans
from the bank, grants from the government, and other sources of finance.

Cash outflow How much cash is going out of the business, such as expenses, wages, raw
materials, buying new machinery, tax payments and dividends.
Closing balance How much money is left at the end of the month.
Opening balance carried forward The next time period brings forward the closing balance from
the previous time period.
A worked example of a cash flow forecast is provided below:
Jan () Feb () Mar ()
A
Opening balance (I from last
month)
3,000 5,750 8,550
B Cash inflow
C Sales 6,000 5,500 6,750
D Total 6,000 5,500 6,750
E Cash outflow
F Materials 1,500 1,200 1,800
G Wages 1,750 1,500 1,950
H Total (F+G) 3,250 2,700 3,750
I Closing balance (A+D-H) 5,750 8,550 11,550
There are some limitations to cash flow forecasts:
The longer they predict, the more likely they may not foresee changes in the market place e.g. a
new competitor may force down the prices of products sold.
It relies on estimates of future costs, which may difficult to predict.
A business can improve its cash flow in the following ways:
Agree an overdraft or increase an existing overdraft from the bank.
Extend the length of time taken to pay suppliers.
Reduce the price of some products to get quick sales.
Sell to customers for cash rather than offer trade credit.
Sell some equipment.
Reduce stock levels.
Buy cheaper raw materials.
Allow debtors discounts for early payment.
Operate tighter customer credit controls.
Use debt factoring.


Business Plans
A business plan describes the main aims, objectives and strategy of a business. Several supporting
documents (budgets) show how these objectives are to be achieved. If the business follows this plan then, if
nothing unexpected happens, it should achieve its objectives.
If there are variances from a budget, then managers will need to make adjustments. For example, a
positive or favourable variance, such as more sales than planned, means that the production budget will need
to be adjusted to make products to meet the extra demand.
Banks are especially keen to see a business plan before they lend a business any amount of money.
It will want to know if it will get the money back. A business plan serves several purposes in this case: it
Explains a business idea so the bank can see whether it is likely to work financially.
Shows the bank whether future profits will cover the interest on the loan.
Shows the bank when it can expect to be repaid.
Shows where the information comes from and whether it is reliable.
A business plan must be presented in such a way as to convince the bank that the intentions of the business
are serious and achievable.
For example:
A bank thinking of lending money to a business would be interested in the following information:
Acid test ratio or current ratio (see below) these show the liquidity of the business, the ability to pay back
the money it owes in the short term. A ratio of less than one may mean that the business could find it difficult
to cover their liabilities and so the bank may be reluctant to extend or continue lending.
Profit forecasts a successful business will be able to pay back its loans.
Cash forecasts future cash flows will be needed to pay interest and repay loans.
Fixed assets a business can use assets as security for loans.
Example of better management of overheads
Overheads are the expenses that not directly involved in the production and selling of the goods and
services.
A way to reduce these overheads is to move to cheaper premises, reduce the number of staff in the head
office or cut the marketing budget. However all of these changes may not necessarily benefit the business in
the long run.

Term Definition
Budgeting
Setting out how much will be spent in an area over a period of time and where it will
be spent
Business plan
Describes the main objectives and strategy of the business and how it is going to
achieve them
Cash flow
forecasting
Shows the expected cash inflow and outflow over a period of time to help anticipate
possible cash flow problems in the future
Cash inflows
Cash that comes into the business e.g. payments from customers, sales of fixed
assets
Cash outflows
Cash that goes out of the business e.g. payments to suppliers, payments to buy
fixed assets, payment of tax to the government, payment of wages and salaries to
employees
Marketing budget
The activities and costs associated with the ways that the business intends to
achieve its targeted sales
Production budget
Details of the expected production output of the business and what it is expected
to cost to achieve this

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