Edexcel Advanced Subsidiary GCE in Economics & Business / Business Studies

(8EB01/8BS01)

Unit 1 - Developing New Business Ideas (6EB01/6BS01)

Revision guide
 Contents page
Page number

How to use this book 4

AS/A2 units 5

Exam top tips 6

1.3.1 – Characteristics of successful entrepreneurs 7

Characteristics of entrepreneurs 7-9

What motivates entrepreneurs? 9-11

Leadership styles 11-12

1.3.2 Identifying a business opportunity 13

What makes a market? What should firms supply? 13-16

Identifying what consumers want or need 17-20

1.3.3 – Evaluating a business opportunity 21

Researching demand for the business idea 21-23

Is there a market for the business idea? 24-26

Positioning the business idea 26-28

Product trial 28-30

Opportunity costs of developing one business idea as opposed to

another 30-31

1.3.4 – Current economic climate 32

Current economic climate 32-35

1.3.5 – Sources of finance 36

Sources of finance 36-40

1.3.6 – Measuring the potential success of a business idea 41

Estimation of sales levels, costs and profit 41-43

Break-even revenue level 43-45

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Measurement of profit 46-47

1.3.7 – Creation of a business plan 48

Creation of a business plan 48-49

© Ned Browne 2011. All rights reserved. No part of this book may be reproduced or
transmitted in any form or by any means, electronic or mechanical, including
photocopying, recording, or by any information storage and retrieval system without
the written permission of the author, except where permitted by law.

Please email ned.browne@southfields.wandsworth.sch.uk should you spot any

mistakes or omissions.

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 How to use this book

This guide should not be used in isolation. You also need to read around the subject
and go through practice exam papers. As a start point, use the resources listed below:

- For general business information: http://www.bbc.co.uk/news/business

- For all course-specific help (e.g. exam papers, syllabus, mark schemes etc.):
http://www.edexcel.com/quals/gce/gce08/eco-bus/Pages/default.aspx

- For definitions and diagrams: http://www.bized.co.uk/

- For higher level students: http://www.economist.com/

- A great all-round economics textbook: The Complete A-Z Economics and

Business Studies Handbook (Complete A-Z Handbooks) – Nancy Wall

- For a light-hearted introduction to economics - The Undercover Economist - Tim

Harford

There are also loads of useful teacher and student resources specifically for this Unit
(including practice exam papers) on http://www.geraldwood.com/

Assessment policy and methodology

How the exam board will assess you:

- You should be able to demonstrate knowledge and understanding of all topics.

- You should be able to apply your knowledge and understanding to economic

problems and issues arising from familiar and unfamiliar situations.

- You should be able to analyse economic problems and issues.

- You should be able to evaluate economic arguments and evidence and make
your own judgements.

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THE UNITS
There are four units to be studied overall, two units at AS Level and two units at A2
Level. This book covers Uni1 only.

AS Level
Name of unit % of total % of total A Nature of Exam
AS marks Level marks

Unit 1- Developing 50% 25% Part 1 – multiple

new business ideas choice/justification of choice
Part 2 – questions based on
stimulus material
1 hour and 15 minutes

Unit 2b – Business 50% 25% Part 1 – multiple

economics choice/justification of choice
Part 2 – questions based on
stimulus material
1 hour and 15 minutes

A2 Level
Name of unit % of total AS % of total A Nature of Exam
marks Level marks

Unit 3 – N/A 25% Questions based on stimulus

International material
business 1 hour and 30 minutes

Unit 4b – The N/A 25% This is a synoptic unit. In

wider economic other words, you can be
environment and examined on anything you’ve
business learned in the last two years.
However, the main focus will
be on unit 4 topics.

Questions based on pre-

release stimulus material and
additional stimulus material
1 hour and 30 minutes

Note: Centres doing Edexcel’s Business Studies A level (as opposed to their
Economics & Business A level) will study unit 2a (as oppose to 2b) and unit 4a (as
appose to 4b).

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 Exam top tips – unit 1

• Time wise you have about one minute for a mark. Do not spend too much
time on the first section. The law of diminishing returns… always attempt
every question.

• In the multiple choice section:

o Define any key words.
o State why the correct answer is right.
o Give an example or other extension
o Explain why two of the incorrect answers are wrong.
o Do not overwrite answers – aim for three or four sentences and c. 40
words

• Use the process of elimination to help you answer the multiple choice section.

• Always define all key terms that appear in the question.

• For the stimulus material based questions read the questions first: then
read/annotate the evidence.

• If a question asks for three reasons, you must have three paragraphs, starting,
“firstly, secondly and thirdly”, or something similar. Preferably with a line
between each paragraph.

• Marks are not awarded for additional reasons/explanations etc. For example,
if the question asks for two reasons, and you give three or more, the examiner
will only give marks for the first two reasons. The others will be crossed out
and not marked.

• Quote evidence in your answer (for example, “in evidence A it clearly states,
‘………………’”).

• Use diagrams where appropriate (they are worth up to 4 marks each). They
need to be fully labelled, and with a paragraph of explanation as to what’s
going on

• Do not get held up on questions you are struggling with… go back to them at
the end.

• Always write in full sentences.

• Check your answers at the end.

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 1.3.1 – Characteristics of successful entrepreneurs

Characteristics of entrepreneurs

What is an Entrepreneur?

An entrepreneur is anyone who starts a business. This includes all types of

enterprises big and small. For example, if you started a car washing business, you
would be an entrepreneur. The common misconception is that entrepreneurs are only
the famous people you read about in the newspapers, such as Roman Abramovich and
Duncan Bannatyne.
In addition, anyone who runs a business could be considered an entrepreneur,
especially were they to expand, modify or move into new markets. Such a leader
would be considered entrepreneurial.

Characteristics of Entrepreneurs

The backgrounds of entrepreneurs seem to be wide ranging - Richard Branson came

from an affluent family, whereas Richard Farleigh, of Dragons’ Den fame, was
brought up in care and various foster homes. However, entrepreneurs often possess
similar characteristics.

The six characteristics detailed in the syllabus are: being hard-working, resilient,
creative, self-confidence, willing to take calculated risks and possessing initiative.

Hard working
Entrepreneurs do not work 9-5; they often work extremely long hours including
evenings and weekends. Many owners of start-ups report working 80+ hours a week,
often for little initial reward. Indeed 60% of new businesses go bankrupt within five
years. So, the risks are high, but so are the potential returns.

Resilient
If you talk to entrepreneurs about failure they just don't get it. Failure is merely what
they need to go through on the road to success. If their business idea fails, it's that
ability to bounce back that’s the hallmark of an entrepreneur. Many entrepreneurs
experience failure before success. Resilience is the characteristic that’s needed to
carry on even when things are going badly wrong, such as losing an important client.

Creative
New ideas and innovation are the life-blood of many small businesses. Because they
find it hard to compete on price, their goods and services must usually be better or
have a distinctive Unique Selling Proposition (USP) in order for them to succeed.
A USP is what makes a company, product or service different or better than its rivals.
For example, when Tesco introduced Clubcard that provided it with a USP (as no-one
at that time ran a similar loyalty scheme). This concept closely links with the concept
of competitive advantage. This is what companies have that give them an advantage
over their competitors. These could include, for example, a well-regarded brand, a
good reputation, a lower cost-base or an extensive distribution network.

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Creativity is not a birthright; instead it’s often a matter of trying to look at things
differently. Entrepreneurs often see something that’s working elsewhere in the world
and then ‘import’ the idea and introduce it in their domestic market. For example, in
the early 1980s, Howard Schultz, while on a business trip in Italy, visited Milan’s
famous espresso bars. Impressed with their popularity, he saw their potential in
Seattle. This insight became Starbucks.
Others try to use new technology for a new purpose. There are numerous examples of
this occurring when the internet was launched – Jeff Bezos started selling books
online on amazon.com (which is now the world’s largest online retailer); Pierre
Omidyar founded ebay.com (an online auction website).
Many entrepreneurs don’t look at things as problems, but as opportunities. Satellite
Navigation systems solved one of the world’s oldest problems - people getting lost!
Finally, entrepreneurs will look for a ‘gap in the market’. This is when there is a
consumer want or need that’s not currently being satisfied by a company. For
example, when low-cost no-frills airlines emerged, they were satisfying a consumer
desire for cheap air travel.

Self-confident
All entrepreneurs have to believe in their own ability and that their idea will be a
success. Without this, they are unlikely to take the plunge into the world of
entrepreneurship. Confident people tend to be self-reliant, bold and undaunted.
Many people make big sacrifices in order to start business, for example, resigning
from well-paid jobs. They are unlikely to do this if they did not think they would
succeed. In addition, many entrepreneurs enjoy a challenge, and often dislike
working for big organisations where they can make little impact.

Take calculated risks

Entrepreneurs are willing to take risks if they can see the potential rewards. However,
good entrepreneurs will not gamble by taking ill-considered risks. Instead, the risks
are based on market knowledge and experience.
It’s possible to look at simple example calculations to demonstrate what taking a
calculated risk means: If an entrepreneur has £10,000 to invest; she may have a 70%
chance of doubling her money; but, she may have a 30% of losing the entire £10,000.
She would invest because she is willing to take calculated risks. On the other side of
the coin, ‘risk adverse’ people (who are unlikely to become entrepreneurs) would not
invest.
However, this is a simplification of reality, and does not take into account unknown
factors such as competitor activity.
It is also worth noting that the fear of failure is a key reason for many people not
starting their own enterprise.

Initiative
Initiative is the ability to act decisively, without prompting. In other words, you don’t
need someone to tell you what to do. No one tells an entrepreneur when to start work,
what needs to be done, or where to go for help. They have to motivate themselves.
This is why entrepreneurs are often described as ‘self starters’.

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Task: The specification suggests that students should evaluate their own
characteristics and whether they possess the right ones (as detailed above) to become
successful entrepreneurs. If they do not, they should consider how they could
develop/improve these skills.

Test yourself
- What is an entrepreneur?
- Name two entrepreneurs.
- What is a gap in the market?
- What does USP stand for?
- Explain the concept of competitive advantage.
- Write down the six characteristics of entrepreneurs.

What motivates entrepreneurs?

Non-profit motives
There are many reasons people might want to start their own business. The list below
is not exhaustive, rather is intended to stimulate thought beyond “they do it for the
money”.

The first reason is the desire to be your own boss. As an entrepreneur you call the
shots and no one is going to tell you what to do. This is a massive motivator for many
people.

The next reason is to prove yourself. Lots of people go through life (especially their
early lives) being told what they can’t do or that they won’t amount to anything. For
some, this makes them all the more determined to prove themselves right and their
doubters wrong.

Another reason is employment. Sometimes the only way to get a job is to start your
own business. This could be for a number of reasons – they could have been made
redundant, they may not have good enough qualifications to get a decent job or they
may have a criminal record. (It is interesting to note that almost half of all self-made
millionaires left school with no qualifications.)

For some, they just love the business world; doing deals, creating new products and
winning. Warren Buffett, once the world’s richest person, is a classic example of this.
He lives a frugal life and has given over $30 billion to charity, yet he is still working
well into his seventies. Mark Zuckerberg, the founder of Facebook and the world’s
youngest self-made billionaire, is another good example – he doesn’t even own a bed,
preferring to sleep on a sofa in a rented apartment. Their work provides them with
‘job satisfaction’.

Others value the independence that running their own business gives them. They are
not as reliant on other people and are in control of their own destiny. In addition, they
are able to make quick decisions and are not constrained by bureaucracy.

Finally, and this is particularly true of people with children, entrepreneurship is a

‘lifestyle choice’. They can get up when they want, they can work from home, they

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can decide to give themselves seven weeks off every year, and they can see their kids
every day.

Ethical stance
Some people want to start companies so they can ‘make a difference’. In other
words, in their own small way, make the world a better place.
A good example of this is Anita Roddick who started The Body Shop so she could
sell cosmetics that had not been tested on animals. It didn’t just stop there - her
husband, Gordon Roddick, co-founded The Big Issue magazine with John Bird. This
was to enable homeless people generate an income (effectively becoming self
employed sellers of the Big Issue Magazine).

The added bonus of having an ethical stance is that it can give a company competitive
advantage and a distinctive USP. This can help increase sales and enable the
company to create a unique promotional campaign. For some consumers this will be
a deciding factor when considering where to shop.

Hint: If you are struggling to understand what an ethical business would do, think the
opposite: what would they not do? For example, they would not employ child labour,
exploit their workforce, pollute the environment etc.

Task: Think of three other things an ethical company would not do.

Profit motives
Many entrepreneurs do not seek to make as much money as possible, as there are big
sacrifices that accompany being very successful. Rather they seek to make enough
money to have a good quality of life, but not any more. This type of entrepreneur is
known as a satificer.

Some, however, are the opposite and seek to gain as much profit as possible. They
are known as profit maximisers. The way to maximise profits is to increase sales
revenue whilst minimising costs. This does not mean that they will necessarily
neglect customers in a drive to reduce costs, as there is far more money to be made in
repeat purchases. Thus profit maximisers will often seek to provide outstanding
customer service.

Key words you need to know:

Start up costs = This is the money you have to spend to set up a business. In the case
of a restaurant it would be: cooker, fridge, tables, sign, cutlery, plates etc.
Running costs = This is the money you need to pay for day-to-day costs. In the case
of a restaurant it would be: wages, food, drinks and bills (e.g. gas, electricity
etc.).Sales revenue = Selling price X number of units sold.
Fixed costs = Costs that stay the same however many units you produce.
Variable costs = Costs that change with each additional unit you produce.
Total variable costs = Number of units X variable cost per unit.
Total costs = Fixed costs + total variable costs.
Gross profit = Sales revenue – total variable costs.
Operating Profit = Gross profit – fixed costs =Sales revenue - total costs.

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Work out the monthly profit
- A watch manufacturer has fixed costs of £2,700 per month. She makes 100 watches
a month, and the Variable Cost per unit is £22.30. They sell each watch for £85
- A rugby ball manufacturer has fixed costs of £1,788 per month. Their variable costs
are £4 per unit and they make 380 rugby balls each month. They sell each rugby ball
for £17

Most entrepreneurs have many mixed motives, both profit and non-profit, and would
probably cite a number of the reasons detailed above.
A useful exercise is to look at the list above and consider which ones would be most
important to you, were you to start your own enterprise.

Test yourself
- Write down the six things that often motivate entrepreneurs.
- Next to each one, explain why it might motivate an entrepreneur.

Leadership styles

Leadership (in this context) is the process of influencing others to work towards an
organisation’s goal. However, there are many ways of doing this. The method one
leader chooses may differ dramatically from another leader. Nonetheless, they could
both be very capable leaders. The different methods of managing people are known
as leadership styles. The main ones are detailed below:

Autocratic
Autocratic leaders take decisions without consulting colleagues who are lower down
the hierarchy. This leadership style is often associated with ruthless leaders such as
Adolf Hitler. Orders are passed from the top to the bottom (one-way
communication), and these orders are followed often due to the leader being feared.

Advantages – this is suitable when fast decisions need to be made, or when there is an
emergency to deal with.
Disadvantages – the ideas from subordinates don’t get heard, and it discourages staff
from taking initiative or from being proactive.

Democratic
Democratic leaders guide rather than dictate. They consult widely and encourage
everyone to participate in the decision-making process. There are two main types of
democratic leaders: paternalistic (who take a genuine interest in subordinates and
their needs, and act in a motherly/fatherly manner) and consultative (who ask
subordinates their opinions and then make decisions based on these).

Advantages – leaders are able to glean lots of new ideas from employees, and
employees may be encouraged to work harder as those further up the hierarchy
respect and value them.
Disadvantages – the decision-making process is lengthened, and it may be harder to
take disciplinary action if a subordinate has ‘become a friend’.

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Laissez-faire
Laissez-faire leaders leave decision-taking to subordinates, allowing them to be
creative. This leadership style is typical of serial entrepreneurs such as Stelios Haji-
Ioannou, who has founded numerous companies including easyJet, easyHotel and
easyCar. It would be impossible for him to run all these companies, so he has to leave
the day-to-day management to other people. This does not mean to say he uses this
leadership style when he is in the throes of setting up a new business. Good leaders
are able to adapt their leadership style to the situation at hand. Creative industries,
such as advertising, also tend to have laissez-faire leaders.

Advantages – empowers employees and encourages them to think for themselves,

thus growing them as individuals.
Disadvantages – not suited to all industry types, especially ones where clear
instructions are essential to prevent disasters occurring. For example, car
manufacturing, where several thousand components go into the manufacturing of each
vehicle.

Leadership qualities
Good leaders tend to possess similar qualities, which include: competence (have to be
good at what they do), analysis and synthesis skills (can quickly analyse events and
ideas and act upon them), social skills (are aware of how others are thinking and
feeling), communication skills/charisma (they are effective in gaining support, often
using fluent and persuasive language), self-belief (providing the confidence needed
for leadership) and energy and drive.

Theory X and Theory Y

Douglas McGregor (1906 - 1964), an American social psychologist, proposed his
famous X-Y theory in his 1960 book 'The Human Side of Enterprise’. He maintained
that there are two fundamental approaches to managing people:

Theory X (tends to lead to an 'authoritarian management' style)

This theory suggests that the average person dislikes work and will avoid it if he/she
can. Therefore most people must be forced with the threat of punishment to work
towards organisational objectives. The theory also states that the average person
prefers to be directed, to avoid responsibility, is relatively unambitious, and wants
security above all else.
Theory X is now widely regarded as less effective in most circumstances.

Theory Y (tends to lead to a 'participative management’ style)

This theory suggests that effort in work is as natural as play, and that people will
apply self-control and self-direction in the pursuit of organisational objectives,
without external control or the threat of punishment. Moreover they are usually
willing to accept and often seek responsibility.
The theory also states that the capacity to use a high degree of imagination, ingenuity
and creativity in solving organisational problems is widely, not narrowly, distributed
in the population, and that in industry the intellectual potential of the average person
is only partly utilised.
Theory Y is now regarded as the more enlightened and effective approach.

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 1.3.2 Identifying a business opportunity

What makes a market?

A market is any medium through which buyers and sellers can reach agreement to
trade at a price. Traditional markets where farmers and merchants traded their wares
gave rise to the word ‘market’. Today, a marketplace could range from an online
retailer to a fruit and vegetable market. Nowadays, almost anything imaginable is
traded: from information to rare earths, from potatoes to silicone chips, from smart
phones to stocks & shares.
In economics the word ‘market’ can also refer to an industry. For example,
economists may speak of the ‘software market’ or the ‘car market’.

So what gave rise to markets?

Humans have traded for thousands of years, but the real turning point in the United
Kingdom was the industrial revolution, which is widely regarded to have taken off
between 1760 and 1840. With the rise of factories fuelled by coal, the population
moved away from self sufficiency into salaried pay, giving them ‘purchasing power’.
By specialising, companies could produce in greater qualities at a lower cost per unit.
This has continued to this day, with very few people in the developed world being self
sufficient. Instead people specialise and trade. For example, a doctor plies her trade
in exchange for money, and with this money she can buy the goods and services she
wants or needs.
The concept of specialising should benefit all parties, as the total amount an economy
can produce greatly increases with specialisation.

Is there a market?
For a market to exist there must be effective demand for the good or service.
(“Effective demand” is demand back up by the ability to pay.) This is represented by
the demand line. The demand line is from the point of view of the consumer.
Consumers normally want low prices - the lower the price, the higher the demand.

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What should firms supply?
Assuming there is demand for a good or service companies will seek to satisfy this
demand by supplying that good or service. This is represented by the supply line.
The supply line is from the point of view of the producer. Producers normally want
high prices - the higher the price, the greater the quantity produced.

The relationship between price and supply

A rise in price will result in a greater quantity being produced (see diagram below):

It should be noted that the increased supply, in the long run, should result in prices
dropping as new entrants will enter the market, causing prices to drop.
The opposite is also true: if prices drop the amount supplied by producers will fall
(see diagram overleaf).

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Factors affecting supply
There are many factors other than price affecting supply, many of them beyond the
control of the producer. These are knows as the ‘non-price determinants of supply’:
- Climate/natural shocks – Some years the climate is ideal for growing certain
foodstuffs, such as bananas, coco beans and wheat. In these years supply will
increase and the price will drop accordingly. In years when there floods or droughts
supply can be severely depleted, and prices will rise.
- The cost of production – There may be demand for a good/service, but if the cost
of production is prohibitively high, it will not be supplied. A recent example is that of
hydrogen fuel cell cars, whose only emission is water. However, the unit cost is over
£200,000, so they are not commercially viable.
- Technology – Consumers may want products that are not yet possible to produce.
On the other hand, new innovations create brand new markets, such as the smart
phone market, the search engine market and the high-definition television market.
Often technology is developed for a different purpose than its eventual main use. For
example, the internet was developed by the American military, but was profitably
adopted by the commercial world.
- Expectations of producers – There may be demand for a product, but producers
could think that demand is likely to decrease. For example, Canon stopped making
analogue cameras when there was still considerable demand. They did this because
they believed that the future was digital cameras. As such, they reallocated their
resources (factors of production) accordingly. The same is true of niche markets that
may be unprofitable in the short term, but show potential in the long run. Companies
will often be willing to make a loss for some time in the hope of future profits. For
example, Amazon.com was founded in 1994, but did not make a profit until Q4 2002.
- Laws and social expectations – Sometimes businesses are stopped dead in their
tracks by new laws. Famously alcohol was banned in America during Prohibition
(1919 – 1933). Any company brewing alcohol had to close down or diversify;
although the ban was often flouted. In terms of social expectations, some products
have become socially unacceptable, such as fur products in the United Kingdom.
- Number of suppliers – If there are few suppliers, this may be seen as an
opportunity for rival firms to start supplying the same goods or services. The
opposite is also true – intense competition may discourage new entrants to the market.

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The impact of the ‘non-price determinants of supply’ can be seen below – the supply
line will shift. In this case, supply has increased:

Profit signalling mechanism

As we have discussed earlier, most entrepreneurs are at least partly motivated by
money. The profit signalling mechanism is a simple concept: if profits in one market
are high there should be lots of new entrants; if profits are declining, companies will
leave the market. The diagram above shows what would happen if large profits were
being made.

In the example below, supply has decreased. This would be the case when companies
leave a declining market:

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 Identifying what consumers want or need

Factors affecting demand

The factors affecting demand are known as the ‘non-price determinants of demand’.
However, although the list below is recognised as the main non-price determinants,
there are many other factors affecting the demand for goods and services:
- Advertising – Good advertising will normally increase demand for goods and
services. Conversely, poor advertising can damage a brand’s sales/reputation.
- Taste/fashion – Products, services and brands come in and out of fashion endlessly.
Any school’s playground will be testament to things that have come and gone, from
Cabbage Patch Dolls to Star Wars cards, from Tamagotchis to PSPs. Some items, for
a short period of time, are viewed as ‘must have’ whose sales are as much determined
by word-of-mouth publicity as they are by expensive marketing campaigns.
- Price of complements – Some goods and services go hand in hand with others. The
best example is that of a car and petrol; one without the other is useless. If the price
of cars goes up, the demand for petrol goes down. Vice versa is true. The price of
petrol will also affect the demand for cars.
- Price of substitutes – These are goods and services that have direct competition.
For example, if the price of a bar of Cadbury’s Dairy Milk increased by 10p, demand
for a similar bar of Galaxy chocolate would increase (assuming the price of Galaxy
chocolate did not rise as well).
- Income – As incomes in a country rise, so does demand for normal goods and
services. However, demand for some goods and services could decrease. For
example, in a less developed country people would not buy more and more rice if
their incomes rose; instead they would buy more vegetables and meat. This is
because rice is an inferior good. The distribution of income is also important. For
example, China has a low level of GDP per capita, yet there is high demand for luxury
goods as it has a large population, some of whom are very wealthy.
- Expectations – This one is of particular interest to investors and speculators. If, for
example, an investor thought the price of gold was going to rise, they would buy gold.
Thus the demand for gold would go up. The same is true of virtually any potentially
appreciating asset, such as property, land, copper, shares or fine wine.
- Number of buyers – The more buyers the higher demand and the higher the price.
Works of art often sell for millions of pounds because two or more very wealthy
buyers are desperate to own them. They bid against each other and the price rises and
rises. (If the work of art was a one-off, the limited supply will also play a big factor
in determining the eventual price.) But the importance of the number of buyers is not
just prevalent in the art market, it is also a significant factor influencing how much
companies can charge.

As mentioned above, this list is not exhaustive. For example, a health scare could
impact on demand for a product, as could research that showed potential health
benefits.

Task: think of three other factors that could increase or decrease the demand for a
good or service.

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As you can see from the diagrams above the first eight determinates of demand
(Advertising, Taste/fashion, Price of complements, Price of substitutes, Income,
Expectations and Number of buyers) all shift the demand line (either to the left or the
right). However, a change to the price will create a movement along the line (as
shown below).

In this instance, a reduction in price (from P1 to P2) has resulted in an increase in

demand from Q1 to Q2.

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Interaction of supply and demand
Up until now, we have just looked at diagrams with either supply lines or demand
lines. We are now going to examine what happens when you have both. In a supply
and demand diagram, the point where demand crosses supply is known as the
equilibrium point. This is the point where the price and quantity would tend to
settle.

Price

Supply

Equilibrium point

Demand

Quantity

If the price is set too low, there will be excess demand; conversely if the price is set
too high, there will be excess supply (see diagram below).

Benefits of market orientation

Some companies are product orientated, which means they focus on developing new
products without researching consumer wants/needs beforehand. This is sometimes
the case with technical companies who may stumble across a new innovation that
could be commercially viable. However, from the mid twentieth century onwards,

19
most companies have become market orientated. In other words, they research the
market and then try to produce goods and services to satisfy consumer wants and
needs.
The benefits of market orientation include:
- As companies are producing goods and services consumers have said they
want, this should result in successful product launches.
- There should be less wastage as companies are not producing products that
consumers don’t want. This, in turn, should lead to higher profit margins.
- Research and development should be more focused, which should also save
the company money.

Practice supply and demand questions

Draw/label/explain Supply & Demand diagrams for the relevant markets for the
following scenarios:

1. Walmart decides to open a chain of clothes shops in the UK.

2. Automation increases Nike’s T-shirt production by 25%.

3. The high demand for iPhones encourages more companies to make smart
phones.

4. Supply of rice increases due to favourable weather conditions.

5. Reduced demand for cars also affects the demand for raw materials.

6. New Look and Primark merge.

7. PC World’s January sale.

8. Christmas advertising campaign for John Lewis.

9. The effect of increased unemployment on wages.

10. All oil producing countries agree to restrict output.

11. Demand for shares in Lloyds TSB decreases due to economic instability.

12. Demand increases for a football match with only 25,000 seats available.

13. Why an increase in the price of petrol also increases the amount people spend
on the internet.

14. Shock weather events reduce the worldwide supply of bananas.

15. The price of oil drops.

Note – for some, you may be able to draw more than one diagram.

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 1.3.3 – Evaluating a business opportunity

Researching demand for the business idea

Market research
In this context, a market is usually where a group of similar goods and service
compete. For example, the car market, the mobile phone market or the clothes
market.
New entrants to any of these markets will conduct research to ascertain whether their
product will attract the necessary number of customers. There have been numerous
occasions when companies have not undertaken adequate market research and their
products have failed as a result.
Coca-Cola launched a brand of water in the UK, Dasani, and did not research the
advertising they had previously run in America. The UK adverts described Desani as
"bottled spunk" or featured the tagline "can't live without spunk". This unfortunate
mistake, coupled with the fact that the UK public were unhappy about the water being
treated tap water (as opposed to mineral water), led to the collapse of the Desani
brand in the UK.
It is worth noting that Coca-Cola are famous for their excellent marketing; so if they
can make a mistake of this magnitude, then entrepreneurs, often operating on
shoestring budgets, are even more likely to come unstuck if they do not complete
thorough market research. Good market research provides information that can
inform the decision making process, leading to better choices being made.

Some key questions entrepreneurs may have

- Is there a market or potential demand for the product?
- How much are people willing to pay?
- What are competitors charging?
- Does the business model provide a competitive advantage?
- Where should I set up?
- What media do my target audience read/listen to/view?
- What are the likely start-up/running costs?
- What laws will affect the business?
- How many staff will I need to employ?
- What skills will the employees need?

This is not a definitive list, but an example of the types of questions that would need
answering in advance of any business launch.
Task – Think of four more key questions entrepreneurs may have while researching
demand for a business idea.

Primary market research (field research)

Primary research is any research that is being undertaken for the first time. Types of
primary research include: interviews, focus groups, questionnaires and telephone/
online surveys. Different types of research will be used in different situations. If a
company requires quantitative information, it will probably use online/telephone
surveys or questionnaires. But should a company require qualitative data, it would be
more likely to use interviews and focus groups. These latter two types of research
also enable the facilitator to ask subsequent questions. (Although a detailed telephone
survey could also achieve the same results.)

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There are many advantages of primary research:
- It is up-to-date.
- It can be tailored to the company’s exact requirements.
- It is not available for competitors to use.
However, there are some disadvantages too:
- It is often far more expensive than secondary research.
- It is more time consuming, which could lead to delays in decision making.
- It runs the risk of producing poor/inaccurate results if it is not well planned. For
example, it’s vital that a comprehensive set of insightful questions are posed during
any research.

Secondary market research

Secondary research is finding out any information that already exists. Secondary
sources include: company accounts, sales data (sometimes from loyalty cards),
government statistics, trade publications, newspapers, journals and commercial data
(from research companies such as Gallup and Mintel). The first two are internal data
(from the company’s own records); the rest are external data (most of which can be
obtained, sometimes for a fee, on the internet).
The main advantages of secondary research include:
- It is often free.
- It is easy to access, especially with the growth of the internet.
- There is a wealth of information available.
The main disadvantages are:
- It’s often out-of-date.
- Competitors often have access to the same information, which makes it less
valuable.
- It can be unreliable (especially information on the internet), so sources have to be
checked thoroughly.
- Commercial data/research can be expensive.

Market research planning cycle

Market research is not a one-off activity that new businesses undertake; rather it’s an
ongoing process that good businesses carry out week after week, month after month,
year after year. This is often referred to as the market research planning cycle, a
simplified version of which is detailed below. The reason it’s called a cycle is that
once a company has reached the end, it goes straight back to the beginning and
repeats the process.

An example market research planning cycle:

- Define the objectives and identify the information that it needs.
- Decide on the type of research.
- Consider how to collect the data.
- Analyse and interpret the data effectively.
- Make recommendations (and act upon them) based on the data.

How this could look in the real world (car example):

- Assess the viability of electric cars.
- Using interviews and secondary research (mainly from the internet).

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- Video interviews, write down the answers, and produce a summary of the internet
research.
- Use numerical data and correlate interview results – then, based on this information,
work out what the results mean.
- Make recommendations – should the company start producing electric cars?

Sampling
Before a company carries out market research it must establish who they want to
answer the questions they have. The company will consider such things as age,
gender, income and demographics (where they live). This is crucial as asking the
wrong people could render the results worthless. Consider this: if Ferrari researched
possible new designs using a focus group, but that focus group consisted of people
who could not afford to buy a Ferrari, the research would be invalid.

So, before a company undertakes any research, it will try to establish its approximate
target audience. (This target audience may change in light of the research, but it is an
important starting point.) There are many different ways to select an appropriate
sample, for example:
- Random sampling – when people are selected at random. If the sample is big
enough then you are likely to end up with a representative group of people. If the
product had broad, non-age and non-gender appeal, this method of sampling is viable.
- Quota sampling – when a certain amount of each ‘type’ of person is selected (for
example, 50 adult males and 50 adult females).
- Stratified sampling – when the population is divided down into different groups
(strata), and then people from just one group are selected – for example, males in their
30s.

Problems with sampling

Companies often outsource market research in an attempt to avoid such issues as
interview bias. It would easy for an enthusiastic entrepreneur to persuade
participants, using leading questions, that they would like the new product, instead of
conducting the research in a detached neutral manner.
Another cause of inaccurate results is using a small sample size. No well-run
company would make important decisions based on researching a handful of people.
The final cause of inaccurate results is when companies select the most convenient
people available. This is no different to research you would have carried out at
GCSE. The likelihood is that you mainly used your peers to fill in questionnaires etc.
This would have saved time, but would have created biased results.

Task – group work

Think of a new business idea to research. Then:
- Create a questionnaire, print them out and get them filled in.
- Run a focus group – discuss/debate your idea.
- Undertake secondary research on your business idea:
- Is there a gap in the market?
- Who is the business’ main competition?
- How big is the business’ potential market?
- Any other relevant information.
- Analyse your primary and secondary results.

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- Create a presentation in PowerPoint and get ready to present your findings and
conclusion to the rest of the class. Is this a viable business idea?
Note: do not forget to consider possible bias.

Is there a market for the business idea?

Almost any business idea will attract some customers. However, companies are
driven by the profit motive and will therefore always seek business ideas that will
attract enough customers to make a reasonable profit. The biggest issue to overcome
is whether there will be a viable market for the business idea.
Market research will play a big part in this, but companies can’t just take a blinkered
approach – if their advertising and products research really well it does not mean they
will definitely succeed. They also have to consider the wider market. For example,
Bing.com is widely regarded as an outstanding search engine, and researches
exceptionally well. However, it is struggling to unseat the market leader Google, who
are the established and default search engine.

Market size
Companies will try to establish how valuable the market they are entering is at that
time. For example, were a company to enter the search engine market, it would need
to work out how much revenue was generated by that industry. It could then try to
predict the percentage of the market it could ‘capture’ and from that establish
potential sales revenue (needed to establish the break even point). This percentage of
each market a company has is known as the market share (%), which is calculated as
follows: sales of the business, product or brand / total sales in that market.

Market Size is measured by either the total sales volume (units), or the value of all
sales (monetary).

Working out the potential market size is harder to undertake when launching
completely new products. When companies were first researching the viability of
games consoles they had no competitor data. Instead, they looked at the value of the
total leisure market (e.g. cinema, video, television, ice skating etc.), and then
projected how much of that market they thought they could capture. This highlights
the concept of market classification, which is how companies choose to define the
market they operate in (for example, does the Premier League operate in the football
market, the sports market or the leisure & entertainment market?).

Potential market growth

For certain markets it is fairly obvious that they are growing, for example, smart
phones, online shopping and satellite navigation systems. These products are
technologically superior to their predecessors and there’s a wealth of secondary
research to suggest that the markets are growing now and are set to grow in the future.
On the other hand, many products have become technologically obsolete after a
period of declining sales (for example, VHS players, printed encyclopaedias and
analogue cameras). However, for some markets things aren’t so clear cut, and
determining whether they are likely to grow or decline is complex. The factors
companies consider when establishing potential market growth include:
- How large is the target audience?

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- Is there enough demand?
- Is the product/service technologically up-to-date?
- How well has the product researched – will people buy it?
- Is there competition that could stifle growth?

Market segmentation analysis

Market segmentation is the process of dividing a market into groups, known as
segments, of customers with similar needs or characteristics who are likely to exhibit
similar behaviours.
There are many ways to segment a market, such as geographic (where they live),
demographic (e.g. age, gender, occupation, education, religion, race etc.), income,
social class, behavioural, psychological and socio-economic groupings. Most of these
are self explanatory, the latter three are explained below:

Behavioural segmentation – this includes such things as spending patterns (whether

they are a spender or a saver) and how brand loyal they are.
Psychological segmentation – this includes such things as lifestyle, personality and
core values.
There are six socio-economic groupings:
A – Higher management and professionals e.g. lawyers, CEOs and doctors.
B – Intermediate management and professionals e.g. middle managers, senior
executives and teachers.
C1 - Supervisory, clerical and junior managerial e.g. shop-floor supervisors, bank
clerks and salespeople.
C2 – Skilled manual e.g. plumbers, electricians and plasterers.
D - Semi-skilled and unskilled manual workers e.g. assembly line workers, refuse
collectors and postmen.
E – Unskilled manual and low-income groups e.g. labourers, students, pensioners and
the unemployed.

New companies will use often use several different types of market segmentation in
order to further refine and identify their target audience and their key triggers/
motivators. The important thing is this: the better a company understands its target
market the more able it will be to create desirable goods and services.

Identification of market niches

A niche market is a small sector of a larger market. For example, diabetic chocolate
is a niche market within the larger chocolate market.
Small companies often target niche markets as this enables them to avoid competing
head on with bigger more established businesses. An interesting example of a
company operating in a niche market is that of the organic grocer, ‘As Nature
Intended’, who operates stores close to much larger supermarkets such as Sainsbury’s.
Its competitive advantage (and USP) is that it only sells organic products. It can
survive because it operates within a niche and consumers are willing to pay higher
prices for the perceived health benefits organic food brings.
Entrepreneurs seek to identify opportunities such as these as it gives them a much
better chance of succeeding. In addition, once the target audience has been
established, they can employ niche marketing techniques that can drive down
promotional costs. For example, if a company sold a product that was targeted at the
Asian market, they could advertise on Sunrise Radio (an Asian radio station in the

25
UK). The cost of advertising would be cheaper and better targeted, so their marketing
budget would stretch a lot further.

Task: look at a market and in groups try to think of a niche within that market.
Test yourself. Explain the following concepts:
- Market size.
- Potential market growth.
- Market segmentation analysis.
- Identification of market niches.

Positioning the business idea

Once an entrepreneur has established the core business idea, they should try to
establish where to position themselves in the market. Lots of markets are catered for
by many companies. For example, the fashion market has luxury brands (e.g. Prada),
mid-range brands (e.g. Top Shop) and budget brands (e.g. Primark). Positioning a
business idea entails working out where one company fits in relation to its
competitors.

Strengths and weaknesses of existing suppliers

A worthwhile exercise, when positioning a new company, is to look at the
competition. If they are particularly strong in one area it’s probably not worth
competing head on (although it would be worth learning from them). However, if
competitors demonstrate a weakness in a certain area, then this is ripe for exploitation.
So, if an entrepreneur was setting up a taxi firm, he may discover his competitors are
often late for pick ups. This is an opportunity to provide better customer service. But
if he found that he could not undercut them on price (without making a loss), he
should not try to compete on price.

Task: Think of a small local business. What are their strengths and what are their
weaknesses? If you were setting up in competition, what would you focus on (that
could become your competitive advantage)?

How they (existing suppliers) differentiate themselves

If a company seeks to differentiate, it seeks to be different. Being different is
important: how else is a company going to stand out from the crowd?
There are many ways that companies can differentiate themselves, such as:
- Branding/advertising.
- Range of products.
- Customer service.

Task: In pairs, discuss two other ways a company could differentiate themselves.

As well as looking at strengths and weaknesses of existing suppliers, new companies

will also look at how the competition differentiates itself. This will help them ensure
they are different from their competition. It is not by chance that Coca-Cola’s cans
are red, whereas Pepsi Cola’s cans are blue.

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Market mapping
A market map shows the range of positions that a product or company can take in a
given market. This position is based on two important features of the product in
question.

Task: Create and label circles (the size depending on how large the company is) on
the grid below that show where different supermarkets sit within the UK supermarket
market:

Other dimensions could include:

Want Need
High-tech Low-tech
Healthy Unhealthy

Task: Think of two more possible dimensions.

It is also worth noting that companies will try to occupy as much of this grid as
possible. Tesco, for example, has multiple store formats (e.g. Express, Metro,
Superstore) and sub-brands (e.g. Tesco Finest and Tesco Value). This is to ensure
they have products and services that appeal to as many people as possible.

Competitive advantage of product or service idea in context

Definition of competitive advantage – how one company’s goods/services are better
than another’s. For example:
- What can a company do better than their competition?
- What can a company do differently than their competition?
- What will make one business stand out compared to the competition?

27
Real world examples include Nissan’s Leaf (whose competitive advantage is that it’s
electric), Dyson’s fan (which doesn’t have any blades) and Amazon (who, for
example, sell the widest range of books - over 34 million).

Task: Write down the names of three famous companies. For each one, explain their
competitive advantages.

Adding value
Added value is the difference between the value of the input costs and the final selling
price of the product. For example, if it cost £35,000 to make a Porsche and it was
sold for £40,000 the added value would be £5,000.
Added value is the concept on which all companies rely to make a profit. If
consumers were not willing to pay more than the price of the raw materials, the
company could not survive. Companies with competitive advantage can add more
value, as consumers are willing to pay more in this circumstance. Nike can charge
higher prices because of its strong brand. Apple can charge high prices because of its
innovative products.

Task: You are running a local café. What could you offer that would make customers
more willing to pay higher prices?

Test yourself. Explain the following concepts:

- Strengths and weaknesses of existing suppliers.
- How they differentiate themselves.
- Market mapping.
- Competitive advantage of product or service idea in context.
- Adding value.

Product trial

All new products go through a development stage, in which the firm undertakes
Research & Development (R&D) to ensure the new product will succeed in
satisfying the needs of the customer. There is often substantial investment made by
businesses at this stage, as expensive prototypes may be developed and tested through
market research. Many products will not make it past this stage. As there are no sales
during the R&D phase, the firm will be making a loss on that product.
As well as researching products and services, companies also test advertising and
other promotional campaigns. An interesting example of this is French Connexion’s
fcuk campaign: In April 1997, French Connection began branding their clothes
"fcuk". Though they insisted it was an acronym for French Connection United
Kingdom, its similarity to a swearword caused controversy. French Connection fully
exploited this and produced an extremely popular range of T-shirts with messages
such as "fcuk fashion”. The fcuk campaign was tested on a focus group before it was
launched throughout UK and the world. Approximately 50% of the people from the
focus group thought it was amazing and very original, but the other 50% thought it
was offensive and in poor taste. French Connexion realised that 50% of people loving
the advertisements was more than adequate to generate increased sales. A year after
the campaign broke their share price had increased 93%.

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Test marketing of a product to assess likely demand levels
This is a when a company tests a product on a small segment of the market before a
full-scale launch. The company seeks to evaluate the proposed marketing mix for a
product prior to its full launch. In the United Kingdom the Tyne Tees region is where
companies often trial new products before they are launched nationwide. The area is
chosen as it has a very varied demographic. Multinational companies will often test in
one country before launching globally.
If the test marketing is successful, the company is able to more accurately calculate
sales when it launches nationally (or globally). This will aid them when ascertaining
the resources (such as factories and raw materials) needed to meet the projected
demand. In addition, test marketing also allows companies to refine the marketing
mix: they could change the product, price, place or promotion based on evidence/data
gleaned from the test market.

The downside of such testing is that competitors become aware of the impending
launch. This could encourage them to develop rival products, or push forward the
launch of a rival product that was already in development. Apple do not use test
markets and attempt to keep all their products shrouded in secrecy until their launch.
Although, in the digital/information age, this has proved increasingly difficult.

A lovely example of a very small scale (but highly successful) product trial is that of
Innocent Smoothies: In 1998 the founders of the company bought £500 worth of fruit,
turned it into smoothies and sold them from a stall at a music festival in London.
They put up a big sign saying 'Do you think we should give up our jobs to make these
smoothies?' and put out a bin saying 'YES' and a bin saying 'NO' and asked people to
put the empty bottle in the correct bin. At the end of the weekend the 'YES' bin was
full… the next day they resigned from their current jobs. Innocent Smoothies have
been a major success – by early 2010 Coca-Cola had acquired a 58% of the company,
which should allow them to expand across the world.

Product trialling/test marketing isn’t just for new businesses. Any successful
company will continually trial new products with a view to improving their offering.

Main advantages of product trialling:

- Risks can be reduced.
- Invaluable customer feedback can be received.
- Changing any part of the marketing mix during the trialling period is much easier
and cheaper than after a nationwide launch.

Main disadvantages of product trialling:

- Testing can be very expensive.
- Takes a long time to release new products so trends could pass.
- Competitors could copy ideas.
- Step-change products and services.

So what are ‘step-change’ products? These are groundbreaking products that are so
different to anything that’s been seen before people struggle to understand them. As
such, they tend to research very badly. Imagine trying to explain the internet to
someone 40 years ago… it would have been a struggle! Another example happened
in 1978 when the Sony Walkman was almost abandoned before launch. Initial

29
product testing was far from positive - many people were very sceptical of releasing a
tape player that could not record. In addition, they could not imagine people walking
around with headphones in their ears listening to music! Akio Morita (a Sony
Executive) refused to be swayed by poor product testing results and staked his own
reputation on the success of the Walkman. History has proved him to be a visionary,
who was way ahead of his time.

Consideration of how to turn product trial into repeat purchases

Very few companies want consumers to purchase their products once – they want
them to buy them again and again. The frequency of the repeat purchase depends on
the product. Nestle would like their customers to buy a Kit-Kat every few days (if not
more), Nokia would like their customers to buy a new mobile phone every 18 months
and BMW want to sell their customers a new car every three years or so. The lifetime
value of a customer is what companies are interested in – consider this: a person who
buys one Kit-Kat every two days for 70 years will generate Nestle £6,300 in revenues
(at today’s prices) during the course of their life. Much better than a one-off 50p
purchase.
So, how do companies encourage repeat purchase? The list below is not definitive,
but gives an idea of some of the strategies:
- Offering products people like.
- Excellent customer service.
- Advertising (to remind people about the product).
- Loyalty schemes.
- Sales promotion (such as price reductions, competitions etc.).

Task: Write down the name of something you have bought again and again. Then,
write down two reasons you repeat purchased.
Now, from this list, choose two:
- A new soft drink company.
- A new restaurant.
- A new building firm.
- A new coach company.
For both businesses you have chosen, write down three things they need to get right in
order for customers to repeat purchase.

Opportunity costs of developing one business idea as opposed to another

Opportunity cost definition - an opportunity cost is the next best alternative foregone
(i.e. if you choose one thing over another; the thing you did NOT choose is the
opportunity cost). For example, if a company had the money to either buy a new
computer or a new photocopier, the opportunity cost would be the one they didn’t
choose to buy.

Trade-offs between opportunities

A trade-off is when you have to choose one thing over another - it is simply another
way of looking at opportunity cost. For example, a company may have to choose
between paying shareholders a dividend or re-investing money into the company
(retained profit). Companies are constantly faced with trade offs, as it is impossible to

30
do everything. The best companies will consistently make the correct decision.
Below is a list of possible trade offs:
- Advertise on the internet Vs. Advertise in the local newspaper.
- Premium pricing Vs. Competitor pricing.
- Profit maximisation Vs. Satisficing.
- Niche market Vs. Mass market.
- Market orientation Vs. Product orientation.
- Launch in a test market Vs. Launch nationally.
- One new business idea Vs. Another new business idea.

Many entrepreneurs (including the founders of Innocent Smoothies) are faced with a
big trade-off before they even begin their company: Start a business Vs. Continue to
work for someone else.

Task: Write down two more possible trade-offs. (Hint: think of the four Ps.)

Effects on stakeholders
A stakeholder is someone who has an interest in a business. Stakeholders include
customers, employees, suppliers, the government, the local community, pressure
groups, manager and owners (e.g. shareholders).
Every decision/trade off a company makes will affect different stakeholders in
different ways. There is only one constant – companies will not be able to keep all
stakeholders happy all the time.
For example, if a company started to impose strict environmental policies, this would
make green pressure groups happy, but could alienate investors (shareholders) who
may be concerned about the effect of increased costs on the company’s profitability.

Task: Write down six of your school’s/college’s stakeholders.

Task: Looking at the earlier example, (a company may have to choose between
paying shareholders a dividend or re-investing money into the company (retained
profit). Explain which stakeholders this decision could affect and how?

31
 1.3.4 – Current economic climate

Implications of government decisions for business

The government is not only the economy’s largest consumer, it also has the power to
affect businesses and how they act.
The first thing that could affect businesses is interest rates. In the United Kingdom,
the Bank of England’s Monetary Policy Committee sets interest rates. It has had
independence from the government since 1997. Its stated aim is to keep inflation at
2% per annum. This has not always proved easy, especially with rising commodity
prices which are affected by global demand, particularly from countries such as China
and India.

Inflation is the rise in general prices and the reduction in value of money. It is usually
measured by the Consumer Price Index (CPI). (The CPI calculates the average
price increase as a percentage of a “basket” of 600 different goods and services. It
collects information on prices from 120,000 different retailing outlets.)
There are two main types: creeping inflation and hyper inflation. Creeping is gradual
inflation at a low rate. Hyper is fast inflation at a high rate (and, although no exact
figure defines hyper, 100%+ per annum would be considered hyper inflation).

Monetary policy
This is the policy on money supply and interest rates. Loose monetary policy is
when interest rates are low and the supply of money high. This encourages people
and businesses to spend, which will increase aggregate demand (the total demand for
goods and services within an economy). There are two reasons for this: firstly, there
is more money in the economy (interest payments on existing loans are reduced and
people/ businesses are more likely to borrow more money), and secondly, the
incentive to save is diminished, so people spend rather than save. This links back to
the concept of opportunity costs, as the opportunity cost of spending is saving (and
saving is no longer as attractive).
Increased spending should encourage economic growth. Economic growth is usually
measured via Gross Domestic Product (GDP), which examines the total value of
goods and services produced within a country’s geographical boarders. It can be
calculated as follows: GDP = C + I + G + (X – M). C = consumer spending, I =
investment, G = government spending, X = exports and M = imports. As you can see,
loose monetary policy can help increase at least three components of GDP.
Tight monetary policy is the opposite (interest rates are raised and the supply of
money is reduced), and has the opposite effect. Business and consumer spending will
reduce.

Quantitative easing
This is when the Bank of England buys assets, usually financial assets such as
government and corporate bonds, using money it has simply created out of thin air.
The institutions selling those assets (e.g. commercial banks) will then have "new"
money in their accounts, which then boosts the money supply in the economy. This is
all done electronically, so the Bank does not actually print new money. The first time
quantitative easing was used in the UK was in 2010.

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Fiscal policy
Fiscal policy is the government’s policy on spending and taxation. Loose fiscal
policy is when the government increases spending and reduces taxation; this will
increase the amount of money in the economy. Tight fiscal policy is when the
government decreases spending and increases taxation; this will decrease the amount
of money in the economy.
Many taxes directly affect consumers, such as income tax and VAT. By increasing
taxes such as these, the government can reduce aggregate demand. The government
could also cut benefits as another way of reducing demand.

The Bank of England and the government use monetary policy and fiscal policy to
control the amount of money in the economy. If it wants to reduce inflation and slow
down economic growth it will use tight fiscal and monetary policy. However, if
inflation is not a concern and they want to encourage economic growth they will
employ a strategy of loose fiscal and monetary policy.

Recession
A technical recession is when a country experiences two consecutive quarters of
negative growth. The year is split into four quarters: Q1 = January to March, Q2 =
April to June etc. If two adjoining quarters have negative growth the country is said
to be in a recession (and effectively getting poorer). This is typified by rising
unemployment, falling consumer confidence, as well as the fall in the components of
GDP such as consumer spending and investment. At this stage, the government will
try to stimulate economic growth.

GDP

Slump
Boom

Recession
Recovery

Time

How monetary policy and fiscal policy affects businesses

Most businesses benefit from economic growth, so few would favour tight fiscal and
monetary policies. However, businesses also fear inflation, so they have to accept
that sometimes tighter policies need to be employed.

Task: In groups, discuss how fiscal policy and monetary policy could affect an
entrepreneur’s decision to start a new business?

33
Causes of inflation
Cost push inflation: This occurs when the cost of production increases and firms put
up prices to maintain profits. Cost increases may happen because wages have gone up
or because raw material prices have increased.
Demand pull inflation: This occurs when aggregate demand exceeds aggregate
supply. If there is an excess level of demand in the economy, this will tend to cause
prices to rise. Demand pull inflation is essentially "too much money chasing too few
goods”.

Consequences for business of inflation

There are many issues associated with inflation; the main ones are listed below:
• Creates uncertainty – what are costs/revenues going to be?
• Makes exports more expensive and thus less competitive (assuming main
trading partners have lower inflation).
• Erodes the value of money (i.e. devalues money).
• Lender uncertainty which creates a reluctance to lend at a fixed rate as
inflation may eat into profits.
• Shoe-leather costs – the cost in time associated with walking from shop to
shop looking for the best price.
• Menu costs – the cost of updating price lists etc.

Task: Go onto the internet and find out the current rate of inflation, and how this has
changed over time.

Consequences for business of unemployment

Rising unemployment threatens businesses for two main reasons. Firstly, people who
lose their jobs will have less money to spend on goods and services. Secondly, with
increasing unemployment, people who are still employed may be worried about job
security. This damages consumer confidence, resulting in people saving more
money and spending less.
One upside of rising unemployment is that it will be easier for companies to recruit
staff without increasing salaries (which could lead to cost push inflation and a lack of
competitiveness). It is thought that, when unemployment drops to less than 5% and
heads towards full employment, there tends to be upward pressure on wages. And,
although the government would never admit it was true, some unemployment
definitely helps the economy.

Task: Go onto the internet and find out the current rate of unemployment, and how
this has changed over time. Make sure you know the percentage figures and the raw
figures.

Consequences for business of changes in exchange rates

As globalisation has spread across the world, exchange rates have increasingly
impacted on almost every company. You only have to walk down the aisles of your
local supermarket to realise how much, as a nation, we import.
Changing exchange rates affect businesses in a number of ways. Firstly, they could
affect the cost of supplies. Even an independent coffee shop requires its main product
(coffee) to be imported. Secondly, exchange fluctuations affect exporters and
importers of finished products. The example below illustrates this (the figures are not
real, but help explain the point):

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If in 2010 £1 = $2, then a £10,000 car made in the UK would sell for $20,000 in the
USA. If, however, in 2011 the value of the pound dropped – £1 = $1.50, then a
£10,000 car made in the UK would sell for $15,000 in the USA. One of the
‘determinants of demand’ is price. As such, in 2011 the company would sell more
cars (as the price has dropped to $15,000). The car manufacturer has not done
anything different; it is just that the fall of the value of the pound has positively
affected them. However, it they import lots of components from America, this could
drive their costs up.

Exchange rate falls Exchange rate rises

Exporters benefit. More goods sold Exporters have problems with the effect
abroad. Possibility of business expansion, of price increase in other countries.
increased sales, more employment and Possibility of sales falling, redundancies
rising profits. and business closure if problems persist.
Importers have problems due to increase Importers benefit. The cost of imports will
in the price of imported goods. As a result fall as fewer pounds are needed to pay for
sales might fall. them. This will mean that sales and profits
might rise.

Task: Go onto the internet and find out the value of the £ (sterling) compared to the $
(USA) and the € (Euro), and how these values have changed over time.

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 1.3.5 – Sources of finance

Why borrow money?

Richard Branson famously stated, “borrowing money is a necessary evil”. In other
words, very few entrepreneurs like to borrow money, but they often have to. There
are significant start-up costs associated with launching most new businesses. Even a
basic business, such as taxi firm, requires money for cars, advertising, telephone lines
etc. Setting up a new business takes time too, and during that time there are many
costs but no sales revenue. In addition, when the doors open for business most
companies are unlikely to have a stream of customers from day one. Instead, sales
will probably be very slow in the early months and years; and there is no guarantee
they will ever be enough revenue to break even.
Many entrepreneurs will use a range of sources of finance, almost always including
their own money. External investors will be reluctant to invest money unless the
entrepreneur is willing to risk their money too.

Influences on choice of finance

There are many sources of finance available to businesses, which can be subdivided in
many ways, for example:

1. The length of the finance is required

Short term – when the money is needed for less than a year.
Medium term – when the money needed for between one year and five years.
Long term – when the money is needed for more than five years.

2. Internal/external sources of finance

Sometimes the company will be able to raise money without having to go to an
external provider (such as a bank or a venture capitalist). External sources of finance
are when money is obtained from an external provider. Internal sources of finance
come from within the business.

3. Reason for the finance

Different sources of finance have been created for different purposes, from mortgages
to buy property, to overdrafts to help overcome cash-flow issues.

4. The type of company

Sole traders, partnerships, Private Limited Companies (Ltd) and Public Limited
Companies (PLCs) have different types of finance available to them. This is partly
affected by the issue of limited and unlimited liability. Unincorporated firms (sole
traders and partnerships) have unlimited liability, whereas incorporated companies
have limited liability. The owners of unlimited liability companies are personally
liable for all debts that company may have. As such, were the company to fail, they
risk losing their personal possessions (e.g. their house and car) as well as any money
they may have invested to pay the company’s debts. Whereas the owners of
companies with limited liability (i.e. shareholders) can only lose what they invested.
For example, if a private individual bought £20,000 of shares in British Airways, she
could only lose that amount and no more were British Airways to file for insolvency.

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Internal sources of finance
Retained profit – For incorporated companies, this financial year runs from any date
of their choosing; for unincorporated companies it runs from April 6 to April 5. This
is when companies work out their profits and what they are going to do with them –
they could give employees or shareholders bonuses. However, the company could
also choose to reinvest the money. This is known as retained profit. Retained profit
may be used to help finance many things, including equipment, premises or a research
and development programme. There is no cost involved as the business is using its
own money. However, there is an opportunity cost involved, as once the profit has
been used it cannot be used for anything else. Retained profit is used by all business
types. This is a medium to long term source of finance, and is internal.

Task: Write down one advantage and one disadvantage of using retained profits.

Sale of assets – This is when company sells something the business owns, such as a
building or a lorry. This is not the same as selling stock; the money it makes from
selling assets is in addition to its day-to-day revenue. The assets that are sold may no
longer be needed by the business. There are no costs involved other than the
opportunity cost of not being able to use the asset again. Sale of assets is used by all
business types. This is a medium term source of finance, and is internal.

Task: Some companies sell property only to lease it back immediately. In pairs,
discuss the logic behind this.

Cash in bank - Money owned by the business and built up over time following
successful trading. This type of finance is usually used to fund the day–to-day
operation of the business. There is no cost involved other than the opportunity cost.
This is a short term source of finance, and is internal. Cash in bank is used by all
business types.

Task: Find out how much interest is paid on business bank accounts. This will help
you establish the opportunity cost.

Owner’s investment - The existing owner of the business may invest more money
into the business, or an entrepreneur might start a business using their savings.
Usually owners will invest when they foresee a return on their investment. As such,
they may invest in new technology, a new business idea or money-generating assets.
This is a long term source of finance, and is internal.

Task: In pairs, discuss possible advantages and disadvantages of owners investing

their own money.

Friends and family – A very common way for new entrepreneurs to raise money is
to borrow money from friends and family. The old adage states that no one should
mix business with pleasure, and there are obviously some drawbacks with raising
money this way. But there are some advantages too: there will probably be no interest
payments and you do not risk an external party assuming control of the business,
should you run into financial trouble. This is a long term source of finance, and is
external.

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Task: Write down the names of two people who might lend you money to start a
business. Be prepared to explain why you think they would.

External sources of finance

Overdraft - This is an arrangement with a bank where a business is able to withdraw
more money from its bank account than it actually has. The amount of the overdraft
may vary on a daily basis as money is paid into and taken out of the account. The
bank will charge the company interest on the money it owes. It is usually used to
overcome short-term cash-flow issues. This is a short term source of finance, and is
external (as the money is coming from the bank). Public Limited Companies would
rarely use this source of finance. It is a common source of finance for all other
business types.

Task: Think of a company type that may have cash-flow issues at certain time of the
year.

Trade credit – This is when a business sells goods to another business and allows
that business to defer payment, usually for 30 days. The period of credit is usually
interest-free. Effectively, they can ‘buy now, pay later’. This source of finance
allows the business buying the goods to sell them on before payment is made to the
supplier. This helps businesses that may have a temporary shortage of funds, or cash-
flow issues. However, the goods must be paid for even if they do not sell. This is a
short term source of finance, and is external (as the interest free period is financed by
the supplier). Trade credit is used by all business types. However, it is particularly
appealing to new entrepreneurs, who may not have much money.

Task: Explain how would a person running a café might use trade credit.

Bank loan – This is an amount of money borrowed from a bank, usually for a stated
purpose. The loan is normally for fixed period of time, and interest is charge on the
money. Bank loans may be used to help finance some form of business development
or the purchase of new equipment. It may also be used to help finance a new business.
This is a medium to long term source of finance, and is external (as the money is
coming from the bank). Public Limited Companies would rarely use this source of
finance. It is a common source of finance for all other business types.

Task: In pairs discuss why you think this is the most common source of external
finance.

Lease – This is a method of obtaining items for a stated period of time. At the end of
the lease the items are usually returned to the owner. Effectively, this is the same as
renting something. Leasing is ideally suited for items that have relatively short lives
because of the amount of use, or developments in technology, or where the items are
very expensive. For example, company cars, computer equipment and photocopiers.
Many shops also operate from leased premises. Monthly or annual payments have to
be made for the right to use the equipment/ property. The monthly amount payable
for technological goods will reflect the depreciation the lessor will incur. Leasing is
used by all business types. This is a medium to long term source of finance, and is
external.

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Task: Find out how much a small retail unit near to the school would cost to lease.

Hire purchase – This is when companies pay for an item over a number of months.
For example, they could pay 36 monthly payments to buy a van (an initial deposit
may also be required). This is generally an expensive source of finance, as the total
amount paid will be well above the outright purchase cost. The van does not become
the property of the user until the final payment has been made. Hire purchase is used
for similar items to leasing (except property). This is a medium to long term source
of finance, and is external. Public Limited Companies would rarely use this source of
finance. It is a common source of finance for all other business types.

Task: In pairs, discuss why some companies may prefer to use hire purchase over
leasing.

Grants - An amount of money usually made available for a specific purpose by the
government and/or local councils. Examples include grants available to young
entrepreneurs and to companies setting up in deprived areas. For example, the
government’s New Enterprise Allowance (NEA), which is a package of up to £2,000
available to unemployed people wanting to set up their own businesses. Normally,
grants do not usually need to be repaid. However, the process for obtaining a grant
can be frustrating and bureaucratic. This is a medium term source of finance, and is
external. Grants are used by all business types.

Task: Google “grants available to start a business”.

Venture capital – This is available from venture capitalists who invest in businesses
usually in exchange for an equity share. The panellists on Dragons’ Den are venture
capitalists. Companies who require large amounts of investment, often for an
innovative high-risk idea (e.g. amazon.com in 1994), would use this source of
finance. This is a long term source of finance, and is external. Venture capital is used
by business start ups.

Task: Watch an episode of Dragons’ Den.

Debenture – If companies want to borrow money, they can issue debentures. An

investor would give the company money in exchange for a debenture. The debenture
acknowledges the debt. Interest is paid by the company to the investor. Debentures
allow companies to set their own rate of interest. This is a medium to long term
source of finance, and is external. Debentures are normally used by Public Limited
Companies.

Task: In Google Images search for “debenture certificate”.

Mortgage – This is usually used to purchase a property, such as an office, factory or

retail unit. The property is normally used as security; if the borrower fails to repay
the mortgage, the lender assumes ownership of the property. Because the lender is
effectively in a ‘win-win situation’ the interest payable on a mortgage is normally
much lower than other sources of finance, such as conventional bank loans. This is a
long term source of finance, and is external. It is a common source of finance for all
business types.

39
Task: Find out how much a small retail unit near to the school would cost to buy.

Taking on a new partner – As its name suggests, this form of finance is used by
partnerships. To become an equity partner in an existing partnership a payment
would need to be made to the existing partners. This helps the partnership raise new
money. The cost to the existing partners is some loss of control (as the deed of
partnership would now include the new partner, who would have voting rights) and
the possible loss of profit (as the new partner would be entitled to a percentage of the
profits, as set out by the new deed of partnership). This is a long term source of
finance, and is external.

Task: On the internet, research the cost of buying into a partnership.

Share issue (ordinary share capital) – This is a source of finance used by limited
companies to raise finance in return for a “share” in the business. The shares of
Private Limited Companies are traded privately; whereas shares of Public Limited
Companies are traded on the stock market. Finance raised from a share issued may be
used to fund a major business development, such as a takeover or an expansion
abroad. There are few upfront costs, but the existing shareholders lose some control
of the business and dividends may have to be paid annually to the shareholders.
Shareholders are also allowed to attend Annual General Meetings (AGMs) and hold
voting rights which allows them to have a say in how the company is run. This is a
long term source of finance, and is external.

Task: On the BBC’s website find out the share price of HSBC and Barclays.

Practical work 1
You are a partner in a partnership of two people producing sausage rolls, and you
want to expand. To do this you need to:
• Extend your factory (cost £90,000)
• Buy new machinery (cost £60,000)
• Purchase extra ingredients
Evaluate suitable methods of finance for the partnership.
Hint: consider type of business, length of finance, internal/external finance and why
the finance is needed.

Practical work 2
You are a new entrepreneur starting a restaurant, and you need money for the
following things:
• A premises
• Ingredients
• Tables and chairs
• Kitchen appliances
Evaluate suitable methods of finance for the entrepreneur.

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 1.3.6 – Measuring the potential success of a business idea

Estimation of sales levels, costs and profits

As discussed in 1.3.3, most businesses will undertake market research in order to
establish probable demand for goods and services. However, entrepreneurs have to be
careful not to confuse consumer aspirations with likely sales – demand for a good or
service must be backed up by the ability to pay.
Most new businesses do not focus on making a profit; instead they focus on brand
development/recognition, repeat purchase and customer services. If they get these
things right, profit should follow. Facebook, for example, did not initially have any
advertising on their website; Twitter still does not have advertising. Instead they
initially focused on building a loyal customer base.

Identification of pricing strategy to be used

There are many ways to price goods and services. The pricing strategy a company
chooses will depend on many variables, such as the number of competitors. Most
companies will use a range of pricing strategies.
The pricing strategies in the syllabus are:

• Demand-based pricing - This is when companies set the price where supply
meets demand (i.e. at the equilibrium point).

• Competitor pricing - This is when companies price their products at a similar

level to their competitors’ products. E.g. Twix costs about the same as Double
Decker.
• Psychological pricing – Companies will price their goods at £9.99 rather than
at £10 because consumers will seem to think it is cheaper. In addition, it
makes it possible to claim, for example, that it costs “less than £10”.
• Skimming - This is when companies charge a very high price when the
product is first launched so “rich early adopters” buy the product. The price is

41
 then gradually reduced over a period of time. E.g. High tech products such as
iPhones and blu ray players.
• Cost-plus pricing - Companies add up the cost of designing, manufacturing,
distributing and selling the product etc., and then add a small amount onto
that. E.g. It costs 45p to make a product, it is sold for 50p.
Pricing strategies not in your syllabus:
• Penetration pricing – When companies launch a product at a low price, gain
market share, and then raise their price. E.g. Their nearest competitor charges
35p, their launch price is 25p.
• Differential pricing - This is when different people are charged different
amounts for the same thing. E.g. Train/bus tickets – OAPs, students and
working adults all pay different amounts for the same journey.
• Promotional pricing – This is when a reduction in price is used to either
attract customers or to sell off surplus products. E.g. Buy one get one free.
• Premium pricing – This is used when selling expensive high quality
products. A strong brand also helps companies charge premium prices. E.g.
The latest Rolls Royce car retails for £250,000.
• Destroyer/predatory pricing – This is when a company set their price so low
it puts their competitors out of business. Often companies can do this by
subsidising their price using profits from other parts of the business. The
Times used destroyer pricing against the Independent in the 1990s, slashing
their price to just 20p. In the UK, this pricing strategy is illegal.
Although these pricing strategies are not in the syllabus, they are useful to know and
you will gain marks should you use them in the exam.

Task: For each pricing strategy listed above, identify a good or service that uses this
strategy.

Calculating potential profit

Working out sales revenue/volume is never as straightforward as companies would
hope. There are many factors making the calculation hard. For example, competitor
activity, converting potential sales into actual sales and the external economic
environment (interest rates, unemployment, economic growth etc.).
Calculating costs should be easier provided the entrepreneur has a detailed/researched
business plan. However, all costs are subject to external factors too, such as the rate
of inflation and the availability of skilled workers.

Task: Billy makes sandwiches and sells them in offices around Liverpool. His
monthly fixed costs are £500. His variable cost per sandwich is £1.50, and he sells
each one of £2.50. How many sandwiches would he need to sell each day (assuming
there are 20 office days each month) to make £1,000 profit in a month?

Break-even revenue level

Very few new businesses turn in a profit in their first year of trading. Their ambitions
tend to be more modest. Before making a profit a new company’s initial goal will be
to break even. Breaking even is achieved when a company’s sales revenue is at the
same level as their total costs. Simplistically: Sales revenue = £5,000; Total costs =
£5,000; profit = £0.00.

42
We might ask what the point is of running a business that is only breaking even. The
owner may be drawing a salary (included in the total costs) – and merely surviving is
no mean feat for many new businesses.

Key words
Break-even point = sales revenue = total costs. The business is neither making a profit
nor a loss.

Identification of the contribution from a potential range of products or services

Most companies try not to rely on one product/service to generate their income and
diversify to increase sales revenue and spread the risk. For example, Google started
as a search engine, but now has Google Chrome (a web browser), Android (a mobile
phone operating system), You Tube (which it bought in 2006) and Google Energy (a
renewable energy project in North Dakota). Some of these projects may lose money,
but between them they generate substantial profits.

Key words:
Contribution = selling price – variable cost
Break-even point = Fixed costs
Contribution

Identification of break-even revenue

Companies will always try to work out how many units they need to sell to break
even. On the example below, they needed to sell approximately 90 units.

Task: Use the information below to construct two break-even charts (on graph paper)
and calculate the break even point. Check your answer using the break-even formula.

Question 1

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Question 2

Assessment of whether the break-even revenue level is achievable

Unfortunately most new companies don’t find out whether or not the break-even
revenue is achievable until they have been trading for a while. Nonetheless, applying
common sense can prevent catastrophes. For example, if a businesswoman was
planning on launching a 60-seat restaurant and discovered she would need to serve 70
people each night to break even she would need to go back to the drawing-board.
There are two things she would need to consider:
- How to reduce her costs?
- How to increase her sales revenue? Higher prices or more sittings/seats?

The diagram overleaf shows what would happen were she to increase her prices.
(Needless to say, the increased prices could reduce her number of customers.)

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Desired margin of safety
The margin of safety is the difference between the number of units currently being
sold and the number of units needed to be sold to break even. It is illustrated on the
diagram below:

The concept of ‘margin of safety’ allows companies to look at what would happen
were sales revenue to drop. For example, could they survive a recession?
In 2010, the European Union conducted ‘stress tests’ on all 92 European banks to see
if they could survive ‘future economic shocks’ – seven failed!

45
 Measurement of profit

Basic profit and loss

Profit and loss forecasts are used to estimate annual revenues and expenditures. See
example below:

At the end of the financial year companies will produce a profit and loss statement
based on their actual costs and revenues. This allows companies to check the quality
of their profit and loss forecast and this should help them create more accurate
forecasts in the future.

Key words:
Cost of sales (i.e. variable costs) = These are the costs directly associated with
production. For example, in the manufacture of wooden tables the direct costs could
include: timber, nails, screws, glue etc. Wages are not usually included in cost of
sales, unless they can be directly attributed to that good/service (for example, a
worker being paid piece rate or commission).
Gross profit = Sales revenue – cost of sales.
Operating costs (i.e. fixed costs) = Costs not directly associated with production.
For example, electricity bill, gas bill, water rates, salaries, stationery, business rates,
rent etc.
Operating profit = Gross profit – operating costs.

Gross profit margin = Gross profit x 100

Sales revenue

The gross profit margin allows companies to see if they need to reduce their cost of
sales or increase their sales revenue. It is an incomplete measure of profits as it does
not taking into account most costs. For example, it does not normally include
wages/salaries (most companies’ biggest costs).

Operating profit margin = Operating profit x 100

Sales revenue

The operating profit margin is a more accurate measure of profits, as it presents a

fuller picture as it includes most costs (the exceptions being things such as dividend
payments, tax and interest payments).

46
Some companies operate on wafer-thin profit margins, but are selling significant
quantities which acts as a counterbalance. For example, 3% of £2 billion is still a
significant amount. Smaller businesses have to have higher profit margins due to
lower levels of sales revenue.

Note: Both gross profit margin and operating profit margin are normally expressed as
percentages as it allows companies to compare figures more easily. For example,
how one company’s profit margins compare to another company’s (or how they
compare to previous years).

Other items in profit and loss statements

• Exceptional items – One-off costs e.g. Redundancies (which will not happen
every year).
• Net interest – The difference between the interest which the company paid on
loans and the interest which the company received on savings.
• Corporation tax – The tax which companies pay to the Government. A
percentage of the profit a company makes. The level varies, but is normally in
the region of 30%.
• Dividends – Payments made to shareholders every year.

Task: Using the profit and loss example above, work out the gross profit margin and
operating profit margin.

Task: Identify three ways a company could improve their profits.

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 1.3.7 – Creation of a business plan

A business plan is a document that sets out a proposal for a new business. Some
entrepreneurs create very detailed business plans, others don’t. For example, Duncan
Bannatyne famously dismisses them as a waste of time. However, most people
setting up in business for the first time will create a business plan.

Purpose of a business plan

The main purposes of a business plan are that it:
- Helps with planning (and focusing on what needs to be done). Whilst entrepreneurs
are writing the business plan, it often throws up new ideas and areas to be addressed.
- Helps entrepreneurs raise capital (e.g. a bank loan). Banks and venture capitalists
will normally insist of seeing a business plan before lending any money. Sometimes
they will read it prior to any meeting taking place. More often that not, new
entrepreneurs will have to make numerous changes to the plan before any financing is
agreed.

Key feature of a business plan

No two business plans will follow the same format, as different business types require
different business plans. The following sections are the ones detailed in the syllabus:

Product or service to be produced – this might sound obvious, but it’s surprising
how many business plans do not include basic product/service information, such as
functionality, design, features and USP. As a rule of thumb, the more detail the
better, especially anything that demonstrates a competitive advantage, as this is what
investors will want to know.

Marketing plan – All marketing plans will include, as a minimum, the four Ps.
These will then be broken down into more details:
- Product – as above.
- Price – such as the prices of main competitors, pricing strategies to be employed,
profit margins and contribution per unit.
- Promotion – such as types of advertising, public relations, sales promotion and
sponsorship to be used. This section will need to contain full costs, and likely return
on investment.
- Place – such as where the product/service will be sold, distribution deals struck (or
to be struck), warehousing and cost of transportation.

Production plan – This would need to include how the product would be made,
where it would be made and the associated costs. Many UK companies have
production facilities overseas in order to take advantage of lower costs (or they
outsource production to an overseas company). If this was the case, the business plan
would need to include the impact of this on costs and timescales. It takes a long time
to ship goods from, for example, China to the UK. Any possible technical difficulties
should also be explained and addressed in this section.

Premises and equipment needed – This would vary massively from business to
business. For example, a restaurant would need: premises near to potential
consumers, ovens, fridges, freezers, cutlery, tables, plates, signs, menus etc. The

48
business would need to establish costs for everything they need, and include estimates
and price lists within the plan (as evidence they had carried out thorough research).

Human resources involved in implementing the business idea – The plan would
need to detail all the people the company would employ and what skills they would
need to possess. Not everyone would need to be employed full time – companies may
employ consultants, part time staff or outsource certain functions (for example,
cleaning, IT or production). Everyone involved in the venture would need to be
detailed alongside their estimated wages. Full in-depth Curriculum Vitaes of the
entrepreneur/entrepreneurs need to be included, detailing past successes (both
academic and business). It is often said that banks/venture capitalists invest in people
not ideas, as it is the people who can make the ideas a reality. So this is a crucial
section.

Sources of finance – Needless to say, a business plan is a tool to secure finance.

However, investors would look to see how ‘creative’ the entrepreneur has been in
terms of financing the business. For example, a plumber setting up his own business
could use a range of different types of finance such as:
- Buy materials (such as copper pipes) using trade credit.
- Lease a van.
- Obtain a grant from the government to cover other start-up costs.
Most businesses will not rely on one source of funding but will instead use a range of
methods.

Profit and loss forecast – Investors are only in the business to make money, so they
will want to see a return on their capital. Put simply, profit = sales revenue – total
costs. The business plan will need to detail likely sales, selling price and all costs
(fixed, variable, start-up, running etc.). Many business plans will also include break-
even analysis, including the margin of safety, to help investors made a decision.

Cash flow forecast – Many small businesses go bankrupt due to lack of cash. This
does not mean they are not potentially profitable businesses, but it does mean then are
unable to pay their debts at a given time. A cash flow forecasts attempts to predict all
the inflows and all the outflows of money month by month (usually on a 12 monthly
revolving cycle). This can help highlight when the company will be unable to pay its
bills. With this information to hand, companies are then able to plan to minimise the
impact of this – for example, they could arrange an overdraft with the bank or they
could use trade credit to delay payments to suppliers. This will help them stay in
business.

Task: Choose a new business idea. Then, using the headings above, create a detailed
business plan.

49