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CONTENTS

Page

PART I

Basic questions for your business 1

Basic information needed to run the business 4

Rules of thumb 5

The business plan 6

Non-financial indicators 11

Glossary of terms 14

PART II: Doing it for yourself See separate booklet

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BASIC QUESTIONS FOR YOUR BUSINESS

This section contains fundamental questions that managers of any kind of business need to ask themselves.
Negative answers, or inability to answer because of lack of information, should serve as warning signals of likely
problems for management to review.

Your business
• What is your business? Why are you in business?
• What factors are critical for success? Do you analyse these factors?
• Who buys your products and why?
• Where do your profits come from?

Your strategy
• What are your business goals?
• How do you plan to achieve them?
• How do you intend to grow?
• What plans do you have for succession?

The market
• Who are your customers? Do you have sufficient information on them?
• What are their needs? How satisfied are they?
• Who are your competitors? Do you have information on them?
• What is your market share?
• What sets you apart from your competitors and makes you so special?
• How long will you be able to maintain this special market position?
• … and what happens when you lose this position?

The products
• What are your key products/services?
• What is your product (and process) life cycle?
• Is your product and process technology exclusive (patents), and how long is it defensible?
• Is the product range regularly updated in line with market needs?
• Who are your key suppliers? Do you know enough about them? What kind of relationships do you have with them
(e.g., co-design, partnership etc.)?
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Business plan

• What is your short-term business plan (of one to two years)?

• Does it have clear objectives which everyone in the business understands?

• Does the plan reflect your own ambitions, beliefs and assumptions (even if you have obtained help from your
financial advisers in drawing it up)?

• How does your plan identify your business opportunities and vulnerabilities, and where it is strong and weak?

• Are you also taking a longer-term approach (say three or more years)?

• How do you and your staff use the plan to guide the business? How regularly is it reviewed?

• Do you check performance against plan?

The business plan is described in greater detail in a later section.

Budgets

• Do you have a budget and does it link into the business plan?

• Is it an action plan (e.g., orders, capacity planning, resource balancing)?

• How good is your budgeting process? Do you have a good early indication of your results, or do they come as a
surprise to you?

• Is performance against budget checked regularly?

• And is action taken on variances?

• Do you realise that a first sign of trouble is when a business drifts off its cash targets even though it may still be
meeting its profit targets?

Performance reporting

• Do you rely only on the accounts you prepare for legal and tax reasons to tell you what is happening?

• Do you have a monthly financial reporting system?

• Does it provide information in the same form as the budget?

• Do your financial and non-financial indicators follow the performance of the business during the month? How
quickly are they produced? Do you use them?

• In case of declining results do you know which are the profit sensitive areas, which areas will affect cash and
sales, and where you can act fastest to reduce costs?

• How do costs run through your organisation, that is, your fixed and variable costs, your product costs, the stepped
costs caused by expansion when you exceed current capacity?

• How robust are the information systems? Are there any ‘private’ costing and information systems?

• Are you aware of the 80:20 rule in managing your information?

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Cash

• Cash is king: do you actively manage all aspects of your cash, from external financing, through working capital to
cash balances themselves?

• Do you understand the crucial difference between cash in hand (and the bank) and paper profits? And that you can
go bankrupt while seemingly making profits on paper?

• Do you use external finance? If so, do you know its cost?

• Do you realise that over-rapid business growth will put a strain on your cash resources?

• Do you also realise that excess cash may stem from a shrinkage in sales?

• Do you prepare regular cash flow forecasts (possibly with the help of your financial adviser)?

• How do you control cash collection from customers and overdue accounts?

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BASIC INFORMATION NEEDED TO

RUN THE BUSINESS

Breakeven point

Analysis of costs
• Fixed costs
• Variable costs (what they vary with and to what extent)
• Overhead costs

Product costs
• Direct
• Indirect
• Gross margins

Monthly earnings

Actual revenue and expenditure compared with budget

Non-financial indicators
For example, quantities, number of employees, quality, service, complaints, defects, rework, scrap, amount of stock
(and location), its value and saleability, labour hours, sales volumes, number of credit notes

Performance by product (as applicable)

• Geographical area
• By business location
• By customer (group) if applicable
• By salesperson

Seasonal factors in sales, costs, purchases

Order book information

Key suppliers and customers

Amount owed and owing (and overdue accounts), how good the debt is

Borrowings (and repayment terms), cost of borrowing and what the loans are secured on

Investment in fixed assets

This a general list. While some indicators (such as the breakeven point) apply to all businesses, others (such as
many of the non-financial indicators) do not. Readers have to determine what information is relevant for them.
If, for instance, seasonal factors are important, they need to be aware of this so that they can include it in their
business information, plan for it, and benchmark with other similarly placed businesses.

All terms used are explained in the glossary.

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RULES OF THUMB

Key figures which should be updated regularly and be readily available:

• Amounts owed by third parties (reported on monthly)

• Accounts payable (reported monthly)

• Cash balance (and the forward position)

• Short-term investments

• Short-term borrowings compared with credit facilities

• Number of employees

• Order book

• Sales

• Market share

• Customer satisfaction data

Key ratios (as applicable to the business in question):

• Profitability ratios

• Debt/capital

• Debtor days

• Stock days

• Product and total margins

• Sales/net assets

• Turnover per employee ( and comparison with competitors if known)

• Liquidity ratio

• Current ratio

The methods of calculating these ratios are explained in the glossary.

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THE BUSINESS PLAN

1 INTRODUCTION
The business plan sets out how the owners/managers of a business intend to realise its objectives. Without such a plan
a business will drift. The plan serves six main purposes.

• It enables management to think through the business in a logical and structured way and to set out the stages in the
achievement of the business objectives.

• It enables management to plot progress against the plan.

• It ensures that both the resources needed to carry out the strategy and the time when they are required are
identified.

• It is a means for making all employees aware of the business’s direction.

• The document is available for discussion with prospective investors and lenders of finance (e.g., the bank).

• The plan links into the detailed, short-term, one-year budget. The purpose of a budget is:
• To monitor unit and managerial performance (the latter possibly linking into bonus arrangements)
• To forecast the out-turn of the period’s trading (through the use of flexed budgets and based on variance
analyses)
• To assist with cost control

A business plan has to be particular to the organisation in question, its situation and time. All that can be done here is
to set out generally regarded good practice. One thing is certain, however: a business plan is not just a document, to
be produced and filed. Planning is a continuous process. The business plan has to be a living document, constantly in
use to monitor, control and guide progress. That means it should be under regular review and will need to be amended
in line with changing circumstances.

2 THE BACKGROUND
Before preparing the plan management should

• review previous plans (if any) and their outcome

• be very clear as to their objectives – a business plan must have a purpose

• set out the key business assumptions on which their plans will be based (e.g., inflation, exchange rates, market
growth, competitive pressures, etc.)

• take a critical look at their business. The classical way is by means of the strengths-weaknesses-opportunities-
threats (SWOT) analysis, which identifies the business’s situation from four key angles. The strategies will be
based on the outcome of this analysis.

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3 THE BUDGET
A typical business plan looks up to three years forward and it is normal for the first year of the plan to be set out in
considerable detail. This one-year plan, or budget, will be prepared in such a way that progress can be regularly
monitored (usually monthly) by checking the variance between the actual performance and the budget, which will be
phased to take account of seasonal variations.

The budget will show financial figures (cash, profit/loss, working capital, etc.) and also non-financial items such as
personnel numbers, output, order book, etc. Budgets can be produced for units, departments, and products as well as
for the total organisation.

Budgets for the forthcoming period are usually produced before the end of the current period. While it is not usual for
budgets to be changed during the period to which they relate (apart from the most extraordinary circumstances) it is
common practice for revised forecasts to be produced during the year as circumstances change. A further refinement
is to flex the budgets, i.e., to show performance at different levels of business. This makes comparisons with actual
outcomes more meaningful in cases where activity levels differ from those included in the budget.

4 WHAT THE PROVIDERS OF FINANCE WANT TO SEE

Almost invariably bank managers and other providers of finance will want to see a business plan before advancing
finance. Not to have a business plan will be regarded as a bad sign. They will be looking not only at the plan, but at
the persons behind it.

• They will want details of the owner/managers of the business, their background and experience, other activities,
etc.

• They will be looking for management commitment, with enthusiasm tempered by realism.

• The plan must be thought through and not be a skimpy piece of work. A few figures on a spreadsheet are not
enough.

• The plan must be used to run the business and there must be a means for checking progress against the plan. An
information system must be in place to provide regular details of progress against plan. Bank managers are
particularly wary of businesses that are slow in producing internal performance figures.

• Lenders will want to guard against risk. In particular they will be looking for two assurances (sometimes known as
the two ‘exits’):
• That the business has the means of making regular payment of interest on the amount loaned.
• That if everything goes wrong the bank can still get its money back (i.e., by having a debenture over the
business’s assets).

• Forward-looking financial statements, particularly the cash flow forecast, are therefore of critical importance.

• The bank wants openness and no surprises. If something is going wrong it does not want this covered up, it wants
to be informed – quickly.

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5 THE DETAILS OF THE BUSINESS PLAN

5.1 The basics

• Management summary, in plain words

• The rationale behind the proposal

• The owner’s/management’s goals and objectives

• Key facts: figures, history, names, addresses, references

• The marketing imperative: why this business is different from all the others, and why it is better

• Assets, facilities, sensitivities, breakevens, vulnerabilities, SWOT

• Where the money will come from and how it will be repaid

• The financials: operating statement, balance sheet, cash flow, costings

5.2 The classical business plan

The checklist below is intended to cover as many eventualities as possible. Obviously, most plans will not be
set out in such detail, particularly for the smaller business. The following should therefore be used as a
checklist for the plan to be based on, with the structure respected, but without any of the detail that is not
applicable.

The title pages

• Title

• Summary: one page, in plain words

• Key facts at a glance: one page

• Contents page, with details such as partnership agreements set out in the appendices

• The appendices and attachments shown separately

Introduction

• Background to the business: previous years’ results if applicable (say three years)

• Background to the owner(s)/managers if it is a new business

• Key objectives

• Type of business: e.g., sole trader, partnership, private, public company

• Key assumptions behind the business plan

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The product/service

• Existing business

• Strengths, weaknesses, opportunities, and threats

• What makes it so special: unique features of the business

• Development

Marketing

• The present market

• Competitors and prospective competitors: products, prices, locations, likely developments

• Customers and prospective customers

• Key customers and how reliant the business is on them

• Future: prospective sales and market share

• Any other aspects, e.g., distribution

Legal aspects

• Legal form of the business

• Tax and liability implications for the owners

Premises, assets, facilities, and purchasing

• Premises, where situated, size, how owned, local taxes, planning permission, etc.

• Plant and equipment

• Purchasing arrangements if applicable

• Key suppliers and how dependent the business is on them

People

• Management: with details of the owners/key managers

• Employees and terms of employment

• Organisation chart if applicable

Protecting the business

• Security

• Insurance

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The financials

• Past accounts and key performance figures if applicable

• Budgeted profit and loss account for the current year, plus forward projections

• Cash flow forecast

• Projected balance sheets

• Ratios and comparisons, ideally internally, over periods of time, and externally

• Product/service costings if applicable

• Breakeven analysis

• Capital expenditure programme

• Funding

• Risk, particularly foreign exchange risk if there is foreign business

Safety net if it all goes wrong

• What is the fall back plan?

• … in particular, what will happen if there is a cash crisis?

• Long-term lines of credit

• Replacement of a key employee

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NON-FINANCIAL INDICATORS

Administration
• Number of credit notes per period (broken down by reason and amount)
• Number of invoices per period and average invoice amount
• Number of packing notes per period and average size of packing note
• Telephone logging: number of abortive calls, time before calls are answered
• Invoicing errors
• Reconciliations
• Accounting errors and rectifications

Customers/suppliers
• Top (say 20) customers
• Top (say 20) suppliers
• Inward quality failures
• Percentage of business accounted for by the top customers and by the top suppliers
• Market share
• Complaints (detailed by cause, unit, person, customer, etc.)
• New customers (and from which competitor)
• Lost customers (to which competitor and why)
• Returned goods (and why)
• Stock errors
• Lead times
• Warranty claims

Distribution
• Delivery times
• Misroutings
• Returns
• Breakages
• Lost deliveries
• Wrong deliveries
• Pilferage
• Out of stock
• Delays
• Chasing suppliers and expediting

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Manufacturing
• Production/output
• Set up times
• Scrap
• Rework
• Breakdowns
• Downtime
• Cycle times
• Output/head
• Machine utilisation
• Process yield

Personnel
• Succession plans
• Training schedules and achievement
• Staff skill base and gaps against future requirements
• Staff turnover
• Absenteeism
• Staff sickness
• Staff feedback
• Results of exit interviews
• Third party opinion (from press comment)

Quality
• Incidence of non-quality, broken down into prevention, detection, and failure
• Incidence of failure
• Incidence of after-sales warranty service and repairs
• Timeliness in supply

Safety
• Number of incidents
• Accidents ( the accident, injury/loss of life, location, time, circumstances, etc.)

Service
• Customer surveys
• Repeat business
• Unsolicited praise
• Third party views (from press comment)
• JIT record
• Delinquency in supply
• Adherence to plan

Technology
• Number (and percentage) of new products being sold which were not in existence five (and three) years ago
• Percentage sales from new products
• Speed of getting new products/services to the market

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EXAMPLES OF INDUSTRY-SPECIFIC INDICATORS

Car hire
• Market share
• Number of rental days sold in the period
• Number of rental transactions closed/opened (closing ratio)
• Percentage vehicles at the ‘correct’ location
• Percentage utilisation per day
• Percentage chargeable utilisation
• Average length of car hire
• Complaints
• Unsolicited praise
• Repeat business: who, why, when, where
• Customers lost (to whom) and gained (from whom)
• Getting it right first time
• Breakdowns
• Faults found on internal checks
• Billing errors
• League tables comparing branches with each other

Courier
• Misroutings
• Mis-sorts
• Breakages
• Losses
• Pilferage
• Claims
• Reasons for failures
• Late consignments
• Number of consignments
• Revenue per consignment and per kilo
• Consignment weights
• Excess capacity

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GLOSSARY OF TERMS

CASH MANAGEMENT

Businessmen hardly need to be reminded that balance sheets and profit and loss accounts are all very well,
but that cash is the lifeblood of business. A business that can not pay its way is bankrupt. Cash has to be
planned for to ensure adequate funds are always readily available (either on hand or from the bank or other
outside parties) and to provide for any seasonal factors (such as a build up of stocks), or heavy special one-off
payments (such as tax or VAT or expenditure for fixed assets). The cash flow forecast is the document that
providers of finance, such as banks, place most emphasis on.

Cash flow forecast

The cash generated and spent in a given period is called the cash flow. Cash flow forecasts, linked to the bank balance
show the movement (receipts and payments) week by week or month by month for a period in the future. For a small
business it is usual to set out the forecast weekly for a period of three months say, after which the figures would
typically be shown monthly for the next nine months. In businesses where cash is critical it is not unusual to monitor
cash flows daily.

WORKING CAPITAL

Working capital is the capital available for conducting the day-to-day operations of the business. Working
capital has to be managed properly for the operations to be managed properly. Working capital is defined as
the excess of current assets over current liabilities (i.e. cash, plus amounts owed by debtors, plus stocks, less
amounts owing to creditors). It consists of short-term items all of which have a direct and immediate impact on
cash. Proper cash management therefore entails effective management of working capital.

The details below describe the main items of working capital and the main indicators used in its management.

Stocks (or inventories)

Goods held comprising:
• Goods or other assets purchased for resale
• Raw materials and components purchased for incorporation into products for sale
• Products and services in intermediate stages of completion (work-in-progress)

Only goods that can be and are expected to be sold are included, i.e., obsolete and defective stocks are excluded.

Stock holding period

The period during which stock is held in relation to sales. Normally the aim of a business is to reduce this period to
the minimum consistent with sales and continuing production.

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Stock turn
The number of times stock is ‘turned over’ or utilised during a given period, generally a year, but adapted to
individual requirements for internal control purposes. Where individual product margins are small (as in sales of
canned foods for instance) the aim would be to turn over the stock very frequently. Where the stock cannot be turned
over so frequently (e.g., luxury clothes or automobiles) the objective will be to achieve substantial margins for each
individual item sold.

Stock days

Stock at the due date (i.e. period end)

× days in the period (i.e. 365)
Total cost of sales for the period (say a year)

It is also usual to show this in terms of months.

The significance of this statistic is that (in comparison with trends over time within the business or with other
businesses) it can indicate whether excessive levels of stock are being held, tying up cash unnecessarily.

Amounts owed by third parties (also called debtors, outstandings, and receivables)

Money owed to the business by its customers or others

These should be split up according to when payment is/has been due so as to identify those within the due period and
the overdues (30, 60, 90, etc., days overdue).

The significance of this split is that it shows the company where to focus the credit control, i.e., on the overdue
element, particularly the long overdues (e.g. 90 days or more).

Debtor days

These are calculated as follows:

Debtors (at the due date)

× days in the period
Sales (inc. VAT) in the period

The usual period taken is a year, thus a year’s sales would be taken and 365 days could be used. It is also usual to
show this ratio in terms of months or weeks.

The significance of this ratio is that it indicates the effectiveness of credit control procedures in general. The
figure of days outstanding should be compared with trends over time within the business, with the standard
terms of business, and with ratios achieved by competitors. The organisation cannot benefit from money tied
up unnecessarily in receivables.

Borrowings and repayment terms

These should be identified by: amount borrowed, terms, when due to be repaid.

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BUDGETS AND PLANNING

It goes without saying that without a plan a business merely drifts, without knowing where it is going. A plan
gives direction to a business. The short-term plan (the budget)
• enables the business to organise its resources for the period in question
• enables it to gauge the impact of unforeseen events during the period, and provides a framework for
dealing with them
• sets performance standards for subordinate managers and therefore can be a powerful means of
motivating them

Above all, a budget provides a safeguard against the businessman’s biggest dread, unpleasant surprises.

A business plan enables providers of finance to a business to evaluate it. They will usually not lend money
unless there is a viable plan.

Budget
A financial or qualitative statement of policy expressed in financial and non-financial terms and prepared and
approved by management prior to a defined period of time (usually the business’s financial year). It is normally
financially oriented and will show income, expenditure, sales, and profitability. Budgets are usually phased over the
months (or quarters) of the year in question, and it will be particularly important to do this where the business is
seasonal. While the budget has to be approved by top management it is important that it should be prepared by the
more junior managers who will have the responsibility for carrying it out.

Business plan
A plan which typically covers in both the long and short term:
• Customers
• Market analysis
• Resources (e.g., staff, finance)
• Service and distribution
• Selling and supplying
• Future strategy
• Product development
• Manufacture
• Stock holding and control
• Management and staff
• Finance

Business planning
The systematic review of business strategy and the development of a long-term plan to enable the business to achieve
its objectives

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BALANCE SHEET

This key document sets out the financial position of the business at a particular date in the past showing what
the business owns, what it owes, and the owner’s equity in it. Large organisations produce their balance
sheets as frequently as once a month, but smaller businesses will find it necessary to produce them much less
often, say only once a quarter. What is important to realise is that a balance sheet is a photograph of the
business at a particular point in time. In order to understand how the business has moved, and to
benchmark it against other, similar businesses, it will be necessary to view a series of balance sheets, and the
profit and loss accounts linking them.

The main components of a balance sheet are set out below.

Fixed assets
Any asset, tangible or intangible, acquired for retention by a business for the purpose of providing a service to the
business, and not held for resale in the normal course of trading.

Long-term liabilities and loan capital

Long-term liabilities: amounts payable to external creditors (how the business is financed and how the proceeds from
asset sales would be shared if the business were sold).

Loan capital: debentures, bonds and other long-term loans to a business; overdrafts, being theoretically repayable on
demand, are not usually shown in this category.

Long-term liabilities are items payable more than one year after the balance-sheet date. Short-term liabilities are
included under working capital.

Equity
The issued ordinary share capital plus reserves; these latter represent the investment in the business by the ordinary
shareholders (the owners).

Retained earnings
Included in equity, retained earnings are the amounts set aside (usually apportioned out of profit) for continued
investment in the business.

Working capital
Working capital consists of short-term assets and liabilities, namely:
• current assets: cash or any assets likely to be converted into cash or consumed in the normal course of business
within the normal operating cycle (usually one year), i.e., cash, stocks, good debtors (receivables);
• current liabilities: amounts owed that are expected to be repaid within one year, i.e., bank overdrafts (in the UK),
dividends, tax, amounts owing to trade creditors.

See earlier section on working capital.

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PROFIT AND LOSS ACCOUNT

The profit and loss account is the second key document essential for the management of a business. It sets
out how the business has performed over a period of time (a month and/or a quarter, and/or a year), the
beginning and end of the period being marked by balance sheets. It can be seen as the movement from one
balance sheet to another in operating terms. In particular the profit and loss account will show how well the
business is doing and whether it is paying its way. A business that consistently fails to make a profit cannot
survive.

An operating statement is a shortened form of profit and loss account which excludes the non-trading items
such as interest payable, rents receivable (where there are non-trading items), etc.

The key items in a profit and loss account are as follows:

Sales revenue or turnover

Shown net of VAT

Cost of sales
Usually includes only those costs that would be allocated to stocks, i.e., costs incurred in manufacture – materials,
direct wages, power, etc. In a service business the cost of sales would cover the payment to third parties for items
included in the service provided by the business.

Operating expenses
Expenses, other than cost of goods sold, incurred in the normal operation of the business (typically administration,
distribution, and selling expenses)

Gross margin
The difference between sales revenue and cost of sales

Contribution
Sales value less the variable cost of sales; it may be expressed as total contribution or as a percentage of sales.
Contribution is a central term in marginal costing where the contribution per unit is expressed as the difference
between the selling price and its marginal cost.

Profit
Gross profit: excess of sales revenue over cost of sales

Net profit: profit after all expenses (which can be before or after tax and/or interest, provided this is made clear).

FINANCIAL RATIOS

Business managers need to be aware of the more important ratios used by outsiders (such as banks) to
evaluate the financial strength and the profitability of businesses.

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Gearing
The ratio of fixed-interest capital and long-term borrowing to equity capital. It is calculated as follows:

Fixed dividend capital + long-term loans

Equity funds

The significance of this ratio is that outsiders are usually unwilling to lend to a business with an unfavourable
balance between the owners’ investment and borrowing from outside. Businesses in this situation which are
able to attract outside lending will find themselves paying a heavy price for such loans. A ratio of up to 1:2
between fixed-rate capital and equity capital, is usually regarded as satisfactory. This ratio also shows the
scope for further borrowing should it be necessary.

Current ratio
This is the ratio of current assets to current liabilities. Current assets are stocks, amounts owing and due to be received
within a year, and cash. Current liabilities are amounts owed and due to be repaid within a year.

The significance of this ratio is that it indicates the cushion available to short-term creditors against a possible
shortfall in the realised value of current assets. The ‘rule of thumb’ often quoted is that the ratio should be
about 2:1, though the averages in some industry sectors tend to be lower.

A ratio in excess of 2:1 may indicate excess stocks, inadequate credit control, or under-utilised cash.

Liquidity ratio (also known as the acid test ratio)

This shows the ratio of liquid assets to current liabilities. Liquid assets are debtors (amounts owed) plus cash; current
liabilities are debts the business has to repay within a year.

The significance of this ratio is that it relates short-term obligations to funds likely to be available to meet them.
The ‘rule of thumb’ is that the ratio should be about 1:1 though some sector averages tend to be lower. Ratios
below 1:1 however, may indicate financial stress. A ratio much in excess of 1:1 may indicate inadequate credit
control or under-utilised cash.

Profitability ratios
The most commonly used profitability ratios are profit on net assets (or return on capital employed – ROCE), and
Return on Investment (ROI) showing the return on the total investment in the business.

These show how well the business has used its investment in capital and has turned it into profit.

Two ratios combine to give the main ROCE ratio.

• Profit/sales: indicating margins achieved and expressed as a percentage of sales
• Sales/net assets: indicating efficiency in the use of assets and expressed as the rate of turnover of net assets in
relation to sales

Each of these has a group of subsidiary ratios, the purpose of which is to indicate
• the order in which improvements in performance should be sought
• the maintenance or improvement of performance (by observing trends)
• the effect of improvement in each area on the main ratio, profit/net assets
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COSTS AND COSTING

There is a whole series of internal indicators used by businesses as appropriate, to guide them in their financial
management.

Breakeven point
The level of activity at which contribution (i.e. sales revenue less variable costs) covers all fixed costs so that there is
neither profit or loss. It may be calculated by the use of a breakeven chart or by the use of formulas. For example:

Total fixed cost

= number of units to be sold to break even
Contribution per unit

Breakeven chart
A chart which indicates the approximate profit and loss at different levels of sales volumes within a limited range.

The breakeven point is critical to the understanding of the business, for example:
• Where profits begin to be made in a period
• Where there is scope for marginal pricing
• The cost/volume relationship

Costs

An understanding of the nature of the costs running through the business is essential to proper business
management (such as the definition of the breakeven point) and to cost management.

• Fixed costs: Costs that do not vary with the level of business but remain constant over a period of time and that,
within certain operational limits, tend to be unaffected by fluctuations in the level of activity. Examples are: rent,
business rates, insurance.

• Variable costs: Costs that vary with the level of business.

• Direct costs: Costs that can be economically identified with a specific product or saleable service, e.g., employees,
material, etc.

• Indirect costs: Costs that can not be related directly to a specific product or service, e.g., managers covering
several areas, power, floor space in general use, general stores, etc.

• Overhead costs: General expenses that can not be related to products and services, typically head office costs.

• Marginal costs: The amount, at any given volume of business, by which aggregate costs are changed if the volume
of business is increased or decreased by one unit; in other words the extra cost of one further unit or the cost that
would be avoided if the unit was not produced or provided. In this context, a unit is either a single article or a
standard measure such as a litre or kilogram, but may in certain circumstances be an operation, process, or even
part of an organisation.

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METHODOLOGIES
Benchmarking
The assessment of how well a business is doing against competitors and similar firms and the analysis of what must
be done to improve performance to be as good as, and do better than, the industry leaders. Benchmarking covers non-
financial as well as financial figures. It goes without saying that for benchmarking to be carried out properly, the
business has to prepare figures (financial as well as non-financial) that can be compared with other businesses.

Factoring
The sale of debts (normally only ‘clean’ debts, however) to a third party (the factor) at a discount in return for prompt
cash. The factor in effect takes over the running of the sales ledger.

Invoice discounting
As with factoring, debts are sold to the factor but here the business continues to operate its own sales ledger and deals
with customers when collecting outstanding debts.

Just-in-time (JIT)
A technique for the organisation of work flows, to allow rapid, high quality, flexible production while minimising
manufacturing waste and stock levels. This is usually done in conjunction with suppliers who supply the products
exactly when (and only when) they are needed. The management of supermarkets is an excellent example of the use
of this technique.

Just-in-time production
A system which is driven by demand for finished products whereby each component on a production line is produced
only when needed for the next stage.

Just-in-time purchasing
Matching the receipt of material closely with usage so that raw material inventories are reduced to near zero levels.

SWOT analysis
A critical assessment of the business’s strengths, weaknesses, opportunities, and threats (SWOT), in relation to the
internal and environmental factors affecting the business, in order to establish its condition prior to the preparation of
a strategic review or a long-term plan.

Total quality management (TQM)

The continuous improvement in quality, productivity, and effectiveness obtained by establishing management
responsibility for processes as well as output.

Key suppliers and customers

The 80/20 rule is useful here, i.e., the 20% or so of the customers/suppliers that account for 80% or so of the
business/management time/activity/problems. It is remarkable how constant this rule is and how widespread its
application, for example: the 20% of employees who take up 80% of the management’s time, the 20% of the fleet
vehicles that cause 80% of the problems, etc.

Turnover per employee

It is very common to view the trends and relate this ratio to competitors and to industry averages.

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