Where does the money come from?

Posted by Abd. Ghafar ARM

All businesses need money, or  finance, in order to operate. They need finance for: start-up  items such as premises, equipment and initial advertising; the ongoing running costs of the business, including raw materials, wages and salaries, administrative costs, maintaining and arising from a shortage of cash; expansion, including purchasing additional equipment, larger  premises, or even financing the takeover of other businesses.

Sources of finance

Finance can be generate either from within the business (internal sources), or outside (external sources). 

Internal sources of finance

1.     Profits and reserves

Most businesses retain part of their profits to buy new or replacement machinery and equipment. If the amount retained is not needed immediately, it can be kept as a reserve for future use, either for expansion or in an emergency.

2.     Selling assets

Many businesses have assets such as machinery, vehicles and property that they can sell. If a business needs to raise finance quickly, selling assets may be the best to do this, especially if the assets are surplus to requirements or under-utilized. Selling as asset to a finance house, and leasing it back can be a way of raising finance while retaining use of the asset.

3.     Owners’ capital

Small businesses are usually set up with finance provided by the owners. The advantage of this is that there are no interests or other charges. The disadvantage is that the owners risk losing the money they put into the business.

            External sources of finance

1.     Short-term, medium-term and long –term finance 
     Short-term finance is finance that is required for up to three years; medium-term finance is  required for between three and ten years; long-term finance is required for more than ten years.

2.      Friends and family

Small business owners may be able to borrow from friends and families. Such loans may well be given without security or charging interest. Normally, however, the amount raised will be small and may only be suitable for short-term finance.

3.       Banks

Banks provide two principal types of finance for business: overdrafts and loans.

And overdraft is an agreement whereby the business can draw on its bank account more than it has deposited. Interest charged on the amount overdrawn is usually higher than on finance from other sources, and overdrafts are only appropriate for short-term finance, for example to cover cash-flow problems.

Banks also provide loans, usually for a set period and purpose. Interest is charged on the amount of the loan. With medium- and long-term loans for larger amounts, security is often required so that if the business is unable to repay the loan the bank will be able to sell the item given as security and recover its money. When considering making a loan to a business, a bank will want to see a business plan including budgets, forecast and cast-flow forecast to ensure that the business will be able to repay the loan.

In many Muslim countries, banks are forbidden to charge interest on loans. Instead, Muslim banks may provide finance for business by providing capital in return for a share in the profits of the business.

4.     Hire purchase

Hire purchase is a form of credit arranged through a manufacturer or finance house (like a bank). An item such as a vehicle or large machine is bought and paid for in installments. Each installment includes an element of interest on the purchase price. Although the business making the purchase has use of the item throughout, it does not become the property of the business until the final payment is made.

5.     Trade credit

Most business purchase are made on the basis that payment will be made at a later date, usually within thirty days of purchase or by the end of the following month. This is called trade credit. If the customer has sufficient standing with the supplier, it may be possible to extend the period of credit. While this may give the purchasing business some additional finance for a short time, it is only appropriate for very short-time finance.

6.     Factoring

To overcome the cash-flow problems associated with supplying goods and services on credit and not being paid until some time later, some finance houses provide a factoring service. A factoring house will pay the business up to 80% of the value of its invoices each month immediately. The supplying business therefore business receives an immediate injection of cash without waiting for customers to pay their invoices. The remaining 20%, less the factoring house’s commission, will be received when invoices are paid to the factoring house.

7.     Leasing

An alternative to buying items such as property, machinery and vehicles is for a business to lease them from the supplier or a specialist leasing company. A lease is for a set period of time and while the business leasing the asset (the lessee) has full use of the asset during that time, the asset remains the property of the leasing company (the lessor). Leasing assets avoids paying large sums to purchase assets, enabling the money to be used for other purposes. The length of leases tends to make leasing appropriate as a source of medium- to long-term finance.

8.      Debentures or corporate bonds

Debentures or corporate bonds are long-term fixed-period loans to the business by Individuals or financial institutions. They are secured against the business and carry a fixed rate of interest throughout the period of the debenture. The rate of interest is lower than other types of loan.

9.       Venture capital

Venture capitalists are specialists in providing finance mainly for smaller businesses usually in return for a shareholding in the business. There is thus an element of risk to the person or organization providing the capital. Venture capital is long term, and may be substantial.
10.   Issuing shares

A private or public limited company may raise finance by issuing additional shares, as long as the total number of shares issued is within the company’s authorized capital. In the case of a private limited company, additional shares can only be issued to the present shareholders, or new shareholders, whit the agreement of the current shareholders. Any person or organization such as a financial institution can purchase new shares in a public limited company. Public limited companies are able to obtain very large amounts of finance in this way. The principal advantage of raising finance by issuing shares is that the money raised does not have to be paid back.

11.   Public sector sources of finance

Grants and subsides for business can sometimes be obtained from local and national government or other public bodies. These normally do not have to be repaid, but are usually only available in particular circumstances, and with conditions attached. For example, a government trying to attack new businesses to locate in an area of high unemployment may offer a grant in respect of every new job created.

            How do businesses decide?

When seeking finance, businesses consider various criteria to ensure that the source they choose is appropriate to their needs. The main criteria businesses use are:

1.       How long is the finance required? A bank overdraft may be suitable for short-term finance, but is very costly in the long term, when a loan may be more suitable.

2.       What is the purpose of the finance? A small start-up business may look to finance from its owners in the first place, while an existing company wanting to ensure a regular cash flow could consider factoring.

3.       How much is required? A small amount may be covered by an overdraft, while a successful business seeking large sums in order to expand, perhaps by taking over another company, may seek funding from a venture capitalist, or issue shares.

4.       What risk is involved? All business activity involves some risk. However, a business taking out a loan or overdraft must pay interest. If the business is unsuccessful, the interest must still be paid and the loan repaid. The higher the risk involved, therefore, the more likely a business is to seek finance from issuing shares, venture capitalist or the owners of the business, since these sources do not bear interest or have to be repaid.

5.       Is the gearing too high? The gearing of business is the ratio of long-term loans to the capital employed. If loans amount to more than about 50% of capital employed, the business is said to be highly geared. This means that the business is relying on borrowed money, and has to pay substantial interest charges. A business that is already highly geared will try to avoid taking out further loans since this will only increase gearing.

What do providers of finance consider?

Providing finance to business always involves some risk for the provider. In order to reduce the risk, banks, shareholders, other financial institutions and other providers of finance will therefore consider the following questions:

1.       Will the business be able to make interest or other payments such as dividends? In deciding this, the provider of finance will consider the past financial record of the business, including the business’s accounts, and forecasts of future financial performance.

2.       Is the business too highly geared? The higher the gearing, the higher the risk of providing further finance, since a higher proportion of the capital of the business is in form of loans. If the business fails, it may not be able to repay all the money it owes.

3.       Is the business efficiently managed? Providers of finance will look carefully at the experience and skills of the people who direct or manage the business, te ensure that their money will be well used.

Summary

·         All businesses need money, or finance.

·         Short-term, medium-term or long-term finance can be obtained from internal or external sources.

·         Internal sources include: profits and resources; the sale of assets and owners’ capital.

·         External sources include: loans; hire purchase; trade credit; factoring; leasing; ventures capital and share issues.

·         Choosing a source of finance that is inappropriate to the needs of the business can be a costly mistake.

Glossary

Finance: the money a business needs to operate.

Internal sources of finance: sources of finance within the business or provided by its present owners.

External sources of finance: sources of finance from outside the business or its present owners.

Short-term: a period of up to three years.

Medium-term:  a period of between three and ten years.

Long-term: a period of more than ten years.

Capital: the money invested in a business by its owners.

Resource: Chris J. Nuttall, IGCSE Business Studies, Cambridge University 2002

Is there a best type of business?

Posted by Abd. Ghafar ARM

On e of the first decisions a person setting up in must make is which type of business organization is most appropriate. Choosing the right type of organization involves considering several factors about the business and the person setting it up. Later, as the business develops and grows, its needs, and the needs of its owners, are different, so that a different type of ownership may be more suitable.

Factor influencing the choice of type of business organization

Ownership

Ownership is perhaps the most obvious factor affecting the type of organization appropriate for business. In some cases this will be the factor that dictates the type of organization chosen.

For example, a small trader who intends to work on his or her own in a business, such as that of a dressmaker or plumber, will almost inevitably set up as a sole trader. A sole trader may, however, decide to take on a partner, perhaps to help them in an area of business where they do not feel they have sufficient skills, such as in finance and administration. Setting up a partnership rather than a sole trader business allows for a division of labour, with each partner specializing in one area of the business. Many professional firms are set up in this way.

Where more owners are involved, or where continuity of the business is needed, perhaps in a family business, it may be more appropriate to set up a private limited company. The owners will have a share in the business, which can be increased or transferred if necessary. The death or retirement of one of the shareholders will not affect the existence of the business, and shares can be passed from generation to generation.

Control

The type of organization appropriate for a business very much depends on the amount of control over the running of the business the owners want to keep for themselves. A sole trader has complete control over all decisions regarding the running of the business. Partners share control as set in the partnership agreement.

Control of a limited company is shared by the shareholders in proportion to the number of shares they own. In the case of a private limited company, the shareholders are normally closely involved with the day-to-day running of the company, and control is therefore largely kept within the company. Control of public limited company, on the other hand, passes to the shareholders, who are mainly outside the company itself. It is even possible for a public limited company to be taken over by another company. In this case control would pass to an entirely different company.

Source of finance

We have seen in previous units that more sources of finance are available to incorporated companies than to unincorporated businesses.  This is important if a business needs access to large amounts of finance. While a sole trader may able to finance the purchase of small premises and limited equipment from his or her own resources, a manufacturing business needing a factory and expensive machinery may need the additional sources of finance available to a limited company, including bank and venture capitalists (see unit 10). Businesses requiring really large amounts of capital may need to consider becoming public limited companies by offering shares to the general public, although this is not suitable for start-up businesses.

Use of profits

The owners of unincorporated businesses such as sole traders and partnerships have complete control over the use of any profits of the business. Such profits can be re-invested in the business, perhaps to buy new equipment or fund expansion, or kept by owners. The owners of unincorporated businesses pay normal income tax on the profits of the business as if those profits were their private income.

The profits of limited company, however, must be used, firstly to pay business tax to the government (see unit 12), and secondly to pay a dividend to shareholders as their reward for investing in the company. Only after these items have been paid can a decision be taken on how to use any remaining profits: to re-invest in the company, or perhaps distribute part to employees as a bonus in recognition of their efforts.

Size

The size of a business can be measured in several ways: by sales turnover; by number of employees; by number of outlets. One person can run a small business more easily than a large business, since there is less involved. Larger businesses have to employ specialists in various aspects of running the business, such financial management, administration, personnel and so on.

Generally speaking, therefore, sole traders tend to be the smallest type of businesses, followed by partnerships. Limited companies tend to be larger, with public limited companies the largest of all.

There are some notable exceptions to this, however. JCB is privately owned, although it rivals all but the largest of public limited companies. Similarly, some large firms of accountants, such as Ernst and Young and KPMG, are partnerships although they are as large as many private and public limited companies and operate.

Growth

As a business grows it may have different needs and these will determine which is the most suitable type of organization. A sole trader may need to take on a partner in order to cope with the additional work. If additional finance is required, perhaps to purchase a larger factory or office, or buy more machinery, the business may consider becoming a private or even a public limited company in order to gain access to more sources of finance.

Summary

·         Several factors affect the choice of type of organization for a business.

·        These include: type of ownership; the degree of control the owner requires; the amount of finance needed, how profits are to be used; the size of the business.

·         As the business develops, a different type of organization may be more suitable.

Glossary

Venture capitalist: people or groups willing to provide capital for a business, usually in return for a share in the business and any future profits the business makes.

Resource: Chris J. Nuttall, IGCSE Business Studies, Cambridge University 2002

Other Types of Business Organization

Posted by Abd. Ghafar ARM

Some types of business organizations are a result of co-operation between businesses, either as a joint venture or as one business operating in the name of and providing the products of another. These spread the risks involved between one or more businesses. In a co-operative, all members share the risks and the benefits of the business.

Franchises

A franchise is an agreement allowing one business to trade under the name of and sell the products or services of another. The business granting the franchise is called the franchiser; the business taking put the franchise is called the franchisee.

Taking out a franchise is a way of avoiding many of the risks involved with starting up a business. For the business granting the franchise, it is a way of developing the business and expanding without committing the resources of the business. Success of both franchiser and franchisee depends on close co-operation between both businesses.

The business is owned and run by the franchisee. However, the franchiser usually retains some control over the franchisee in matters of product design and brand name, advertising and service. Some franchisers, such as McDonald’s, control almost the whole of the franchise operation, supplying equipment, ingredients, staff uniforms, training, and setting menus, prices, portion sizes, cooking times and so on.

Where does the money come from?

Sole traders, partnerships or limited companies may own and run franchise, and the sources of finance to purchase the franchise are largely the same as for these types of business. The initial cost of a franchise varies according to the product, type of premises and other equipment required, and the company selling the franchise. Sometimes the franchisers may help with finance for the franchises.

Besides the original purchase price of the franchise, the franchisee has to pay an annual fee, usually based on percentage of sales. This must be paid even if the franchisee has made a loss. In this case the franchisee must apply to his or her bank for a loan or overdraft.

What happens if things go wrong?

The success of a franchise is the responsibility of the franchisee. If the franchisee is a sole trader or partnership they will have unlimited liability (see unit 6) which means they could lose everything if the business goes wrong and they are left with large debts.

However, the success and reputation of the franchiser depends on its franchisees succeeding. It is therefore in the interests of the franchiser to help the franchisee as much as possible.

What are the main advantages of a franchise?

By operating under the name and logo of a well-known company, a franchise business has a much greater chance of success. Apart from providing a proven product, the franchiser may well provide national and local advertising and training in business and other important areas.

Although they are small businesses, franchises operate as though they were part of a large business. This means that they are often able to benefit from bulk purchasing arrangements. Banks, too, are often prepared to make loans to franchisees on the basis that they carry less risk.

There are advantages, too, for the franchiser. By selling franchises, a business is abler to expand without committing its own resources. The risk is spread between businesses, and both benefit from the arrangement in that their success is in part dependent on the other. In addition, by franchising a part of its operation, a business is able to concentrate on its core activity.

What are the main disadvantages of a franchise?

There are also some disadvantages for both franchiser and franchisee. The franchiser is dependent on the franchisee for the success of the business. The franchisee, on the other hand, has less control of their own business than they would if they remained an independent sole trader or partnership. They are tied to the franchiser and their success depends on the success of the franchiser’s product. Franchisers have little control over areas such as product development. The franchisee also has to pay a continuing annual fee, regardless of any loss the business may make.

Co-operatives

Co-operatives are business enterprises that are owned jointly by members, who may be private individuals or other business organizations. They exist for the mutual benefit of members, who share equally in the decision-making and management of the co-operative. Finance is raised by the members, who generally receive a share in the profits of the co-operative.

There are four main types of co-operative:

• Retail co-operatives, which buy goods in bulk at an advantageous price and re-sell them to members as cheaply as possible;
• Trading co-operatives, which are formed to distribute and sell  the products or services of their members (members are usually small businesses, which join together as a co-operatives in order to gain the benefits normally associated with larger businesses – see unit 31) where economies of scale are discussed);
• Worker co-operatives, which are businesses owned and run by their employees;
• Housing co-operatives, which develop, maintain and manage low-cost housing on behalf of their members.

In some countries, where there are a large number of small businesses in an industry, such as farming and agriculture, the formation of co-operatives is encouraged. In India, for example, the government encourages growers in some agricultural industries such as sugar, jute and cotton, to form co-operatives to ensure the sharing of techniques and technology so as to improve efficiency and productivity in farming. However, they are expensive, and often quite beyond the reach of a small farmer. Several small farmers forming a co-operative, however, may well be able to afford one between them. Each farmer in the co-operative can then share use of the combine harvester.

Joint ventures

Increasingly, large projects are being undertaken as joint ventures. Joint ventures may be between two or more businesses in the private sector, or in the private sector and the public sector. For example, new hospital or railway may build as a joint venture between the government and private enterprise. Sometimes a joint venture, such as the development of a new aeroplane, may involve businesses in more than one country. In this way, each business only has to find part of the cost of the project, and the risk is spread between all the businesses in the joint venture.

Public sector organizations

Public sector organizations are owned and run by local or national government. They are mainly large organizations that are either expensive to run and need a considerable amount of capital investment, or are essential services considered too important to be left to private enterprise. In recent years there has been considerable debate over whether the government should be involved with running businesses or whether this is best left in the hands of private individuals.

What types of organization does the government own?

The main types of organizations that the government owns are: centralized organizations that provide essential services, such as security, health and education; nationalized industries, such as steel or coal; and public corporations such as the Post Office.

Many countries are now pursuing policies of privatization (returning nationalized industries to private ownership). Privatized companies are responsible to shareholders, just like any other public limited company. In Brazil, for example, the government has been pursuing a policy of privatizing state-owned companies since the early 1990s. formerly state-owned companies that have now been privatized include the Companhia Vale do Rio Doce (a mining company), the Companhia Siderurgica Nacional (the national steel mill), Rede Ferroviaria Federal SA (the national railway line), and Mafersa ( a manufacturer of railroad  equipment).

Summary

·         Running a franchise operation removes some of the risk involved in a small business.

·         A franchise operates under the name of another company, using their business idea and selling their products or services.

·         Sole traders, partnerships or limited companies may own and run franchises.

·         Co-operatives are owned and run by members for their mutual benefits.

·       Joint ventures can enable businesses to pool resources and spread the risk involved in an enterprise.

·        Organizations owned by the government on behalf of the general public are in the public sector.

·        The government owns different kinds of organizations that are considered to provide essential services that would not be adequately provided if left to private sector businesses.

·       There is considerable debate over whether government should be involved with running businesses.

Glossary

Co-operative: a business organizations formed by members for their mutual benefits.

Joint ventures: an enterprise undertaken by two or more business organizations which pool resources.

Franchise: an agreement allowing one business to trade under the name of and sell the products or services of another.

Franchiser: a business granting a franchise.

Franchisee: a business taking out a franchise.

Resource: Chris J. Nuttall, IGCSE Business Studies, Cambridge University 2002

Limited Companies II

Posted by Abd. Ghafar ARM

What is the difference between a public limited company and a private limited company?

The principle difference between a public limited company and a private limited company is that public limited companies can sell their shares to general public. In this way, they have access to virtually limitless funds that they can use to develop the business.

Because their shares can be bought by anyone, large public limited companies, such as Shell and General Motors, are amongst the largest businesses in the world with millions of shares owned by several hundred thousand shareholders. In practice, large financial institutions such as insurance companies and pension funds buy the majority of shares in successful public limited companies. The owners of public limited companies usually, therefore, have little involvement with – or interest in – the running of the company they own. As a limited company grows, therefore, the divorce of ownership from control becomes greater.

In order to offer their shares to the general public, companies that intend to become public limited companies must issue a prospectus describing the company and its prospect, and detail the offer of shares. Subsequently, the PLC must send a copy of its accounts and chairperson’s report to every shareholder each year and lodge its accounts with the Registrar of Companies.

After shares in a public limited company have been sold initially by the company, they can be traded freely on the stock market of the country in which the company is registered, although the company itself will gain no further money from this. The value of the shares on the stock market will reflect how well the company is performing. If the company performs well, its shares are likely to be thought of as a good investment. They will be in demand, and their value will rise. The value of shares is published daily in newspapers, and also on the internet. Public limited companies whose shares are available on the stock market are vulnerable to takeovers, which may result in the present directors losing control.

Why go public?

Most companies who decide to go public (become public limited companies) do so because this gives them access to an almost limitless source of capital. In reality the amount a business can raise depends on how well it is expected to do. Many businesses are able to fund expensive development and expansion programmers in this way.

The major disadvantage is that control of the businesses is divorced from those with an interest in the business itself. Most shareholders of public limited companies are mainly interested in the value of their shareholding and the dividend they receive. The senior directors of the business may be voted in or out at the next shareholders’ AGM, and must act in accordance with the wishes of the shareholders rather than the business itself.

In addition, companies whose shares are freely available on the stock market are liable to takeover, in which case all decision-making on the running of the business will pass into the hands of another company.

Summary

·         Limited companies are incorporated businesses that exist quite separately from their owners.

·         The owners of limited companies are called shareholders and have limited liability.

·         Private limited companies are not allowed to sell their shares to the general public.

·         Public limited companies are among the largest businesses in the world.

·         Public limited companies can sell their shares to the general public, which gives them access to vast source of capital.

·         The owners of public limited companies usually have little involvement in the running of the company.

Glossary

Private limited company: a limited company whose share cannot be sold to the general public.

Public limited companies (plc): a limited company whose shares can be freely bought and sold by members of the public.

Stock market: the market for shares in public limited companies.

Divorce of ownership from control: the delegation of direct control of a limited company from its owners (shareholders) to directors.   

Creditors: people or organization to whom money is owed.

Takeover: the purchase of one company by another: public limited companies are susceptible of this.

Resource: Chris J. Nuttall, IGCSE Business Studies, Cambridge University 2002

 

Limited Companies I

Posted by Abd. Ghafar ARM

Limited companies are incorporated businesses, or corporations – that is they are set up as legal entities in their own right and exist quite separately from their owners.

The owners of limited companies are called shareholders, because they own a part, or share of the company. As a legal entity a limited company is responsible for its own affairs and debts. The owners or shareholders of the business have limited liability for the debts of the business. A limited company can own property and equipment, employ people and borrow money. It also pays business taxes on its profits.
Types of Limited Companies

There are broadly two types of limited companies: private limited companies and public limited companies. Private limited companies are normally smaller businesses. the number of shareholders of private limited company may be restricted; shares cannot be offered for sale to the general public or transferred without the agreement of all the shareholders. Public limited companies are generally larger than private limited companies.  Shares in public limited companies can be offered for sale to the general public and may be  freely bough and sold on the stock market of the country in which the company has been  registered.                                  

While the general principles of private and public limited companies are similar throughout the world, specific legislation concerning the establishment and running of limited companies does vary. In Bermuda, for example, companies are classified as “local”, “permit”, or “excepted”. At least 60% of the shareholders of local companies must be Bermudian. Permit companies may be incorporated outside Bermuda, but are permitted to trade within the country. Excepted companies are exempt from the 60% rule, but may not normally compare with local companies within Bermuda. In South Africa, a special type of corporation known as a “closed corporation” exists with up to ten members who “contribute” to the capital of the corporation, rather than buy shares in it.

Similarly, the titles used in different countries vary. Many countries have adopted the term ‘limited’, or ‘Ltd’, after the name of the company, as in JCB Ltd, the British-based company that produces and sells heavy earth-moving machinery throughout the world. To distinguish between private and public limited companies, some English-speaking countries have adopted the initials ‘plc’ after the company’s name to denote a public limited company.

In other countries, such as Australia and South Africa, private limited companies are known as ‘proprietary’ limited companies, which are abbreviated to ‘Pty Ltd’ after the company’s name. French and Spanish speaking countries, such as Argentina and Brazil, use ‘SA’ (French: Société Anonyme; Spanish; Sociedad Anomina) to identify public limited companies. Japan has joint stock companies (KK), which are similar to public limited companies in most respects, and limited liability companies.

How do you set up a limited company?

It is more difficult to set up a limited company than a sole trader business or a partnership. The company must be registered with the registrar of Companies (in some countries the Commercial Registry, Inspectorate of Corporations or other body responsible for registering limited companies limited companies and corporations) and have a Memorandum and Articles of Association. These are drawn up by a solicitor.

The Memorandum must give: the name of the company and address of its registered office; the purpose for which the company has been set up; the amount of share capital to be issued and the number of shares; a statement that the liability of shareholders will be limited; the names and addresses of at least one director and the company secretary.

The Articles of Association cover: who manages the company; shareholders’ rights; procedures and frequency of shareholders’ meetings; how the profits of the company are to be distributed. The Articles of Association can be altered later as long as they do not conflict with the Memorandum.

A Certificate of Incorporation is issued before the company can commence trading. All companies must lodge their accounts, including balance sheet, note to the accounts, and reports from the directors and auditor, with the Registrar of Companies or other appointed body. These can be inspected by the public.

Sole Traders and Partnerships

Posted by Abd. Ghafar ARM

In unit 4 we saw that businesses in the private sector are owned by private individuals. There are two forms of private sector businesses:

1. Unincorporated businesses, which do not exist separately from their owners.

2. Incorporated businesses, which are legally established as separate entities.

The owners of unincorporated businesses mainly have unlimited liability. This means that they are personally responsible for the affairs of the business – including the whole of any debts the business may have. The owners of incorporated businesses are not personally responsible for the affairs of the business, since the business exist as a legal entity in its own right. However, if an incorporated business fails, the owners may loss all the money they put into the business.

In this unit, we will examine unincorporated businesses – sole traders and partnerships. We will look at incorporated businesses, private and public limited companies, in unit 7.

Is size important?

Posted by Abd. Ghafar ARM

Businesses come in all sizes. Some are small, owned and run by just one person, while at the other end of scale are giant companies, familiar to us all, which operate all over the world, businesses grow in different ways, and for different reasons.

How is business organized?

Posted by Abd. Ghafar ARM

Some businesses are owned by private individuals, while others are owned by the state. Businesses owned by private individuals are in the private sector. Businesses owned by the state are in the public sector.

What part does the state play?

Posted by Abd. Ghafar ARM

Governments try to influence the economy of a country for several reasons:

1. To make sure that essential goods and services are produced and made available to those sections of the community who need them.

2. To prohibit or control the production of goods and services considered undesirable or harmful to society, such as drugs.

What is business all about?

Posted by Abd. Ghafar ARM

Many different groups of people are interested in the activities of a business. These are called the stakeholders of the business. Each group of stakeholders may have its own objectives for the business. The purpose of a business organization is to meet the objectives of its stakeholders through the production of goods or the provision of services that are wanted by people in society. The success of business is measured by the extent to which it achieves these objectives.

Who are the stakeholders?

Stakeholders are individuals and groups involved with a business or with an interest in the activities of business. They include: consumers, employees, managers, owners, financiers, the community as a whole, the government.

Some stakeholders, such as employees and managers are internal (inside the business) while others, such as consumers and financiers (people and business that provide finance or loans for the business), are external (outside the business). Each group of stakeholders has its own objectives and exerts influence over the business in order to achieve these:

• Consumers – the main areas of interest for consumers are quality of product and value for money; they have influence over a business because they can take their custom elsewhere.

• Employees – the main areas of interest for employees are working conditions and pay; they have influence over a business because they can produce poor work, strike, or leave to find employment elsewhere.

• Managers – the main areas of interest for managers are the success of the business, power and payment for themselves; they have influence over a business because they are responsible for planning the activities of the business and for its day-to-day running.

• Owners – the main areas of interest for the owners of a business are the success of the business and the amount of profit the business makes: the higher the profit of a business, the more the owners receive; they have influence over the business because they have the final power to take decisions on the activities of the business.

• Financiers – the main areas of interest for those with a financial interest in a business are how secure is the money they have invested in or loaned to the business, and the return they are receiving; they have influence over the business because they can withdraw their financial support, causing the business to curtail its activities, and possibly even close down.

• The community as a whole – the main areas of interest for the community are social and environment matters such as pollution, noise and destruction of the environment; they have influence because they can organize pressure groups to lobby the business itself, other groups of stakeholders, and the government.

• The government – the main areas of interest for the government are the well-being of all sections of society, including employees, consumers, the community as a whole, and environmental issues; it has influence over the business because it can legislate on matters of concern, restricting the activities of business or compelling them to behave in certain ways. The government also has an interest in the success of business in the country, and may support business through grants and subsidies, by promoting export abroad and by restricting imports.

Stakeholders can increase their power by forming alliances. For example, suppose a textile company disposes of its waste in a local river. This pollutes the river and kills fish, but is an effective and cheap way to get rid of the waste. The community objects of the damage to the environment and wants the textile company to stop the pollution. Since the final customers of the cloth produced by the textile company are members of the community, the company’s own customers, such as clothing and fabric manufacturers, are concerned that their own business might suffer if they are seen as supporting a business whose activities damage the environment. They therefore threaten to take away their custom. The owners of the textile company are afraid that the company will lose customers and support the other stakeholders in changing the company’s policies on the disposal of waste.

Sometimes the objectives of different stakeholder group conflict. For example, traditional farming method are increasingly being changed is response to new technology. Machinery can now enable one person to do the work that was previously done by several. This has reduced the cost of farming, leading to lower prices for customers while maintaining the farmer’s profits. Obviously, this benefits both the farmers and their customers. However, it conflicts with the interests of farm workers, who may lose their jobs.

The widespread use of cash dispensers had led to a reduction in employment in banking resulting in reduced personnel cost and increased profits for the bank. This is to advantage of the bank’s shareholders who see their dividends increasing. However, is conflict with the interest of bank employees who may lose their jobs.

Where are the objectives of different stakeholder groups conflict, a compromise must be reached.

What is the purpose of business?

The purpose or objectives of a business largely depend on whether the business is a private enterprise established to make a profit for its owners, a non-profit-making organization such as a charity or voluntary organization, or a public enterprise set up to provide a service to the community. In some circumstances the objectives of a business may conflict or change over time.

Private enterprise
Making a profit

One of the main objectives of private enterprise (business owned by private individuals) is to make a profit. All business activity costs money, and business must pay their costs out of the income they receive from selling their goods and services. The profit a business makes is the amount by which its income exceeds its costs. Part of the profit of a business must be paid to the government in business or corporation tax. The remaining profit may be:

• Kept by the owners of the business as a return on the money they have invested in the business

• Distributed among the employees of the business, perhaps as a bonus in recognition of their efforts

• Retained within the business to pay for new equipment, fund expansion, or just to meet future emergencies

• Used to pay back loans

Increase sales revenue

The sales revenue of a business is the amount it receives from selling its goods and services. As we have seen, the excess of sales revenue over costs is profit. By increasing sales revenue without a corresponding increase in costs, a business can generate a higher profit.

Gaining and enlarging market share

The market for a product consists of the total value of sales of that product. Market can be regional, national or international in scope. Obviously, to be successful, a business must gain a share of the market in which it operates. The larger the share of the market that a business has the better, since a larger share of the market means more sales and greater profits. A prime objective of many businesses is therefore to gain and enlarge their market share.

Growth

As businesses grow they are able to enjoy economies of scale. This means that they able to produce their goods or services for a lower average cost, increasing sales, leading to increased production, taking on more employees, and perhaps even opening new factories or sales outlets, or by taking over or merging with another business, so that the combined business produces more goods and sell them at a more competitive price to more customers than either of the original businesses.

Provide employment

Small businesses are often set up in order to provide employment for their owners. This may then be a main objective for many small businesses.

In larger businesses the owners may not be employed in the business. No business can survive without employees to produce the goods or services, and to run the business, however. All businesses, whatever their size or product, must provide employment.

Public enterprise

Public service organizations provide services, such as education, health and national security, which are considered essential to the welfare of society. Some public services, such as museums, may not be provided if people had to buy the service individually. Other public services, such as national defence, must be provided to everybody in a society, or not at all – it is impossible to provide an army to defend some people and not others. The government usually takes over the provision of public services, which are paid for out of tax revenues.

Non-profit-making organization

Non-profit-making organizations include charities and voluntary organization. They may be national, such as Voluntary Action Network India, or international in scope, such as the Red Cross. Charities and voluntary organizations are set up to fulfill a perceived social need or to provide help to a specific section of the community.

Funds are raised through donations from the general public, other business organization and governments. Any surplus, after the running costs of the organization have been deducted, is used to support the charity’s cause or reason for existence. Charities and voluntary organizations do not make a profit.

Changing and conflicting objectives

Sometimes the different objectives of a business may conflict. For example, a major concern is conservation of the environment. Most businesses share this concern and try to behave in an environmentally friendly way. A cement factory may therefore decide to burn a fuel that does not pollute the atmosphere rather than a chemical fuel that does cause pollution, even though the chemical fuel is cheaper and more efficient. While this helps the cement factory to achieve its objective of being environmentally friendly, however, the additional cost of the fuel, and the poorer performance of the factory hinders the factory from achieving its objective of maximizing profit. The objectives conflict and the factory must make a business decision about the action it should take on burning fuel.

Summary
• Stakeholders are people and groups who are interested in the activities of businesses.

• Stakeholders try to influence the behavior of businesses in order to achieve their own objectives.

• Businesses have objectives they are seeking to achieve.
• The objectives of a business may change and conflict over time.

The Nature and Purpose of Economy Activity

Posted by Abd. Ghafar ARM

Businesses produce goods and services:

• Goods are things you can touch and use, or consume, such as clothes, food and books.

• Services are things that other people do for you, such as cutting your hair or selling your goods  in a shop.

To produce goods and services businesses use resources or other goods that are made from resources that are naturally occurring on or in the earth.