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Measurement of Business Size

Different Methods of Measuring the Size of the Business

Problems of measuring the size of the business:

• There are several different ways of measuring and comparing business size and they often give different comparative results
  • A firm might appear large by one measure but quite small by another
• There is no internationally agreed definition of what a small, medium or large business

Different Measures of Size:

• Number of Employees
  • Easy to understand
    • Obvious that a shop run by just the owner or their family is small and a firm employing many staff is likely to be large
  • Does not consider business that needs to employ only a few people due to expensive capital equipment
• Revenue: total value of sales made by a business in a given time period
  • Often used as a measure of size, especially when comparing firms in the same industry
  • Less effective when comparing firms in different industries:
    • Some might be engaged in ‘high-value’ production and others might be in ‘low-value’ production
  • Measure is needed to calculate market share
• Capital Employed: the total value of all long-term finance invested in the business
  • The larger the business enterprise, the greater the value of capital needed for long-term investment
  • Comparisons between firms in different industries may give a misleading picture
    • Two firms employing the same number of staff may have very different capital equipment needs
• Market Capitalisation: the total value of a company’s issued shares
  • Can be used only for businesses that have shares quoted on the stock exchange (public limited companies)
  • Calculated by the formula:

• As share prices tend to change every day, this form of comparison is not a very stable one
• Market Share: sales of the business as a proportion of total market sales
  • If a firm has a high market share, it must be among the leaders in the industry and comparatively large
    • However, when the size of the total market is small, a high market share will not indicate a very large firm
  • Calculated by the formula:

Significance of Small Businesses

Advantages and Disadvantages of Small Businesses

Advantages	Disadvantages
– Can be managed and controlled by the owner(s) – Often able to adapt quickly to meet changing customer needs – Offer personal service to customers – Find it easier to know each worker, and many staff prefer to work for a smaller, more ‘human’ businessIf family-owned, the business culture is often informal, employees well-motivated and family members perform multiple roles	– May have limited access to sources of finance – The owner/s has/have to carry a large burden of responsibility if unable to afford to employ specialist managers – May not be diversified, so there are greater risks of negative impact of external change – Few opportunities for economies of scale

Strengths and Weaknesses of Family-Owned Businesses

Strengths

Weaknesses

(1) Commitment: – Family owners show dedication in seeing the business grow, prosper and get passed on to future generations – Have the incentive to work harder and reinvest part of their profits into the business to allow it to grow in the long term (2) Reliability and Pride: – Name and reputation associated with their products therefore striving to increase the quality of their output and maintain a good relationship with their stakeholders (3) Knowledge Continuity: – Considered a priority to pass accumulated knowledge, experience and skills to next generation -Increases level of commitment and provide the necessary tools to run the family business

(1) Succession / Continuity Problem: – High rate of failure among family businesses can be explained by lack of skills and ability of later generations – Also, splitting of management responsibilities between several family members to give them all a role in it (2) Informality: – Less interest in setting clear and formal business practices and procedures – Can lead to inefficiencies and internal conflicts (3) Traditional: – A reluctance to change systems and procedures, continuing to operate as it was historically run – Leads to lack of innovation (4) Conflict: – Problems within the family may reflect on management of the business and make effective decisions less likely

The Importance of Small Businesses and Their Role in the Economy

• Many jobs are created by small firms
  • The small-business sector employs a very significant proportion of the working population in most countries
• Small businesses are often run by dynamic entrepreneurs, with new ideas for consumer goods and services
  • Helps create variety in the market and consumers will benefit from greater choice
• The large firms of the future are the small firms of today
  • As more smaller firms are encouraged to become established and expand, the greater the chances that an economy will benefit from large-scale organisations in the future
• Small firms may enjoy lower average costs than larger ones and this benefit could be passed on to the consumer
  • Costs could be lower because wage rates paid to staff may be less than the salaries paid in large organisations

The Role of Small Businesses as Part of the Industry Structure in Some Industries

• Small firms can create competition for larger businesses
  • Without competition, larger firms could exploit consumers with high prices and poor services
  • Example: the cost of air travel has been reduced due to the establishment of small airlines competing with large, established companies
• Small firms often supply specialist goods and services to important industries in a country
  • By being able to adapt quickly to the changing needs of large firms, small businesses increase the competitiveness of the larger organisations
  • Example: the global car industry is dominated by major manufacturers that depend on small specialist suppliers of (for example) on-board computers, high-quality audio equipment and headlights

Internal Growth

Why and How a Business Might Grow Internally

Internal Growth: expansion of a business by means of opening new branches, shops or factories (also known as organic growth)

• Reasons why owners and directors of companies seek growth for their business:
  • Increased profits
    • Expanding the business and achieving higher sales, making the business more profitable
  • Increased market share
    • Gives a business a higher market profile and greater bargaining power with both suppliers and retailers
  • Increased economies of scale
  • Increased power and status of the owners and directors
    • Example: opportunities to gain publicity or influence government policy will increase if the business is large and well known
  • Reduced risk of being a takeover target
    • A larger business may become too large a target for a potential ‘predator’ company
• Example of internal growth: retailing business opening more shops in towns and cities where previously it had none
  • Growth can be considered slow; only a few branches or shops opening each year
  • Can avoid problems of excessively fast growth – tends to lead to inadequate capital and management problems associated with bringing two businesses together that often have different attitudes and cultures

Reference: Stimpson, P., Farquharson, A., & Stimpson, P. (2015). Cambridge international As and A level business coursebook. Cambridge: Cambridge University Press.

Economic Sectors

Primary, Secondary and Tertiary Sector Businesses

Firms produce a vast rage of different goods and services, but it is possible to classify these into three broad types of business activity

• Primary Sector Business Activity:
  • Firms engaged in industries that extract natural resources so that they can be used and processed by other firms
  • Examples: farming, fishing, oil extraction
• Secondary Sector Business Activity:
  • Firms that manufacture and process products from natural resources
  • Examples: computers, brewing, baking, clothes-making and construction
• Tertiary Sector Business Activity
  • Firms that provide services to consumers and other businesses
  • Examples: retailing, transport, insurance, banking, hotels, tourism and telecommunications

Changes in business activity:

• The importance of each sector in an economy changes over time
• The relative importance of each sector is measured in terms either of employment levels or of output levels as a proportion of the whole economy
• Benefits and problems of the increasing importance of secondary sector activity (industrialisation is used to describe the growing importance of the secondary-sector manufacturing industries in developed countries):
  • Benefits:
    • Total national output (gross domestic product) increases and this raises average standards of living
    • Increasing output of goods can result in lower imports and higher exports of such products
    • Expanding manufacturing businesses will result in more jobs being created
    • Expanding and profitable firms will pay more tax to the government
    • Value is added to the countries’ output of raw materials, rather than just exporting these as basic, unprocessed products
  • Problems:
    • The chance of work in manufacturing can encourage a huge movement of people from the countryside to the towns, which leads to housing and social problems
    • Imports of raw materials and components are often needed, which can increase the country’s import costs
    • Much of the growth in manufacturing industry is due to the expansion of multinational companies
• Reasons for the decline in the importance of secondary-sector activity and an increase in the tertiary sector (deindustrialisation is used to describe the situation in developed economics):
  • Rising incomes associated with higher living standards have led consumers to spend much of their extra income on services rather than more goods
  • As the rest of the world industrialises, manufacturing businesses face more competition and these rivals tend to be more efficient and use cheaper labour
    • Rising imports of goods are taking the market away from the domestic secondary sector firms

The Public and Private Sectors

Public Sector: comprises organisations accountable to and controlled by central or local government (the state)

Private Sector: comprises businesses owned and controlled by individuals or groups of individuals

Mixed Economy: economic resources are owned and controlled by both private and public sectors

Free-Market Economy: economic resources are owned largely by the private sector with very little state intervention

Command Economy: economic resources are owned, planned and controlled by the state

• In most mixed economy countries, certain important goods and services are provided by state-run organisations as it is argued that they are too significant to be left to private businesses
  • Example: health and education services, defence and public law and order (police force)
• The existence of ‘public good’: goods and services that cannot be charged for, so private-sector businesses cannot make a profit from producing them

Legal Structures

Main features of Different Types of Legal Structure, Including Ability to Raise Finance

Main Types of Private Sector Businesses:

• Sole trader: a business in which one person provides the permanent finance, and in return, has full control of the business and is able to keep all of the profits
  • Firm is likely to remain small
  • All sole traders have unlimited liability
    • The owner’s personal possessions and property can be taken to pay off the debts of the business, should it fail
  • Sole traders remain small because the owner wishes to remain in control of their own business and the limitations they have in raising capital

Advantages

Disadvantages

1. Easy to set up – no legal formalities 2. Owner has complete control – not answerable to anybody else 3. Owner keeps all profits 4. Able to choose times and patterns of working 5. Able to establish close and personal relationships with staff (if any are employed) and customers 6. Business can be based on the interests or skills of the owner – rather than working as an employee for a larger firm

1. Unlimited liability – all of owner’s assets are potentially at risk 2. Often faces intense competition from bigger firms 3. Owner is unable to specialise in areas of the business that are most interesting – is responsible for all aspects of management 4. Difficult to raise additional capital 5. Long hours often necessary to make business pay 6. Lack of continuity – as the business does not have separate legal status, when the owner dies, the business ends

• Partnership: a business formed by two or more people to carry on a business together, with shared capital investment and, usually, shared responsibilities
  • Partnerships are formed in order to overcome some of the drawbacks of being a sole trader
  • Drawing up a formal Deed of Partnership between all partners
    • Provides agreement on issues such as voting rights, the distribution of profits, the management role of each partner and who has authority to sign contracts

Advantages	Disadvantages
1. Partners may specialise in different areas of business management 2. Shared decision-making 3. Additional capital injected by each partner 4. Business losses shared between the partners 5. Greater privacy and fewer legal formalities than corporate organisations (companies)	1. Unlimited liability for all partners 2. Profits are shared 3. No continuity and the partnership will have to be reformed in the event of the death of one of the partners 4. All partners bound by the decisions of any one of them 5. Not possible to raise capital from selling shares 6. A sole trader, taking on partners, will lose independence of decision-making

• Private limited company: a small to medium-sized business that is owned by shareholders who are often members of the same family
  • Shares will be owned by the original sole trade, relatives, friends and employees
  • Former sole trader often still has a controlling interest
  • New issues of shares cannot be sold on the open market and existing shareholders may sell their shares only with the agreement of the other shareholders

Advantages	Disadvantages
1. Shareholders have limited liability 2. Separate legal personality 3. Continuity in the event of the death of a shareholder 4. Original owner is still often able to retain control 5. Able to raise capital from sale of shares to family, friends and employees 6. Greater status than an unincorporated business	1. Legal formalities involved in establishing the business 2. Capital cannot be raised by sale of shares to the general public 3. Quite difficult for shareholders to sell shares 4. Less secrecy over financial affairs than sole trader or partnership (end-of-year accounts should be available for public inspection)

• Public Limited Company: a limited company, often a large business, with the legal right to sell shares to the general public
  • Can raise potentially very large sums from public issues of shares and existing shareholders may also quickly sell their shares if they wish to
    • This flexibility of share buying and selling encourages the public to purchase the shares in the first instance and thus invest in the business
  • Shareholders own the company – however, they appoint a board of directors who control the management and decision-making of the business
• Cooperatives: a business organisation that is owned and controlled by the people who use its products, supplies or services
  • All members can contribute to the running of the business, sharing the workload, responsibilities and decision-making
  • All members have one vote at important meetings
  • Profits are shared equally among members

Advantages	Disadvantages
1. Buying in bulk 2. Working together to solve problems and take decisions 3. Good motivation for all members to work hard as they will benefit from shared profits	1. Poor management skills 2. Capital shortages because no sale of shares to the non-member general public is allowed 3. Slow decision making if all members are to be consulted on important issues

• Franchise: a business that uses the name, logo and trading system of an existing successful business
  • The franchisee is allowed to use the name, logo and marketing methods of the franchiser
  • The franchisee can then, separately, decide which form of legal structure to adopt

Advantages	Disadvantages
1. Fewer chances of new business failing as an established brand and product are being used 2. Advice and training offered by the franchiser 3. National advertising paid for by franchiser 4. Supplies obtained from established and quality-checked suppliers 5. Franchiser agrees not to open another branch in the local area	1. Share of profits or revenue has to be paid to franchiser each yearInitial franchise licence fee can be expensive 2. Local promotions may still have to be paid for by franchisee 3. No choice of supplies or suppliers to be used 4. Strict rules over pricing and layout of the outlet reduces owner’s control over their own business

• Joint venture: two or more businesses agree to work closely together on a particular project and create a separate business division to do so

Advantages

Disadvantages

1. Costs and risks of a new business venture are shared; this is a major consideration when the cost of developing new products is rising rapidly 2. Different companies might have different strengths and experiences and they therefore fit well together 3. They might have major markets in different countries and can be exploited with the new product more effectively than if they decided to ‘go it alone’

1. Styles of management and culture might be so different that the two teams do not blend well together 2. Errors and mistakes might lead to one blaming the other for mistakes 3. The business failure of one of the partners would put the whole project at risk

• Holding company: a business organisation that owns and controls a number of separate businesses, but does not unite them into one unified company
  • The separate businesses are in completely different markets and the holding company have diversified interests
  • Keeping the businesses separate means that they are independent of each other for major decisions or policy changes
    • However, there will always be the possibility of centralised control from the directors of the holding company over crucial issues
• Public corporations: a business enterprise owned and controlled by the state – usually central or local government
  • Do not often have profit as a major objective

Advantages	Disadvantages
1. Managed with social objectives rather than solely with profit objectives 2. Loss-making services might still be kept operating if the social benefit is great enough 3. Finance raised mainly from the government	1. Tendency towards inefficiency due to lack of strict profit targets 2. Subsidies from government can also encourage inefficiencies 3. Government may interfere in business decisions for political reasons

Concept of Limited Liability and its Importance

• Limited liability: the only liability – or potential loss – a shareholder has if the company fails is the amount investment in the company, not the total wealth of the shareholder
  • The ownership of companies is divided into small units called shares
    • Share: a certificate confirming part ownership of a company and entitling the shareholder owner to dividends and certain shareholder rights
  • People can buy these and become shareholders
    • Shareholder: a person or institution owning shares in a limited company
  • Individuals with large blocks of shares often become directors of the business
• Effects of Limited Liability:
  • People are prepared to provide finance to enable companies to expand
  • The greater risk of the company failing to pay its debts is now transferred from investors to creditors (those suppliers / lenders who have not been paid)

Problems Resulting from Changing from One Legal Structure to Another

• Sole Trader to Partnership
  • When planning to go into partnership, it is important to choose business partners carefully – the errors and poor decisions of any one partner are considered to be the responsibility of them all
    • Example: business debts incurred by one partner – there is unlimited liability for all partners should the business venture fail
  • The loss of independence of decision making
  • Profits are shared
• Private Limited Companies to Public Limited Companies
  • The original owners of the business are usually still able to retain a majority of shares and continue to exercise management control when it is a private limited company
    • However, with public limited companies, due to the sheer volume of shares issued and number of people and institutions as investors, this is most unlikely
  • In a public limited company, shareholders own the company but they appoint a board of directors who control the management and decision-making of the business
    • This clear distinction between ownership and control can lead to conflicts, over the objectives to be set and direction to be taken by the business

Reference: Stimpson, P., Farquharson, A., & Stimpson, P. (2015). Cambridge international As and A level business coursebook. Cambridge: Cambridge University Press.

The Nature of Business Activity

Purpose of Business Activity:

• Business: any organisation that uses resources to meet the needs of customers by providing a product or service that they demand
• Business activity: involves creating and adding value to resources (such as raw materials and semi-finished goods) and making them more desirable – and thus valued by – the final purchaser
  • Businesses identify the needs of consumers or other firms
  • They purchase the resources – or factors of production – in order to produce goods and services that satisfy these needs, with the aim of making a profit
    • Factors of Production: resources needed by business to produce goods or services
      • Land: encompasses all renewable and non-renewable resources of nature
      • Labour: manual and skilled labour that make up the workforce of the business
      • Capital: the finance needed to set up a business and pay for its continuing operations and the man-made resources used in production (capital goods)
      • Enterprise: the driving force, provided by risk-taking individuals, that combines all other factors of production into a unit capable of producing goods and services
• Business activity uses scarce resources to produce goods and services that allow us to enjoy a higher standard of living
• Business activity exists to produce consumer goods or services that meet the needs of customers
  • Consumer goods: the physical and tangible goods sold to the general public
    • Durable consumer goods: cars and washing machines
    • Non-durable consumer goods: food, drinks and sweets
  • Consumer services: non-tangible products sold to the general public (example: hotel accommodation, insurance services and train journeys)

The Concept of Creating Value:

• Creating value: increasing the difference between the cost of purchasing bough-in materials and the price the finished goods are sold for
  • If a customer is prepared to pay a price that is greater than the cost of materials used in making or providing a good or service, then the business has been successful in creating value
  • Without creating value, a business will not be able to survive as other costs have to be paid and a profit must be made to justify staying in operation
• Added value: the difference between the cost of purchasing bought-in materials and the price the finished goods are sold for

The Nature of Economic Activity, the Problem of Choice and Opportunity Cost

• Economic Problem: there are insufficient goods to satisfy all of our needs and wants at any one time
• Purpose of Economic Activity: to provide for as many of our wants as possible
• Problem of Choice:
  • The shortage of products – together with the resources needed to make them – lead to having to make choices
  • As we cannot satisfy all of our wants, then we must choose those which we will satisfy now and those which we will forgo
• Opportunity Cost: the benefit of the next most desired option which is given up
  • In deciding to purchase or obtain one item, we must give up other goods as they cannot all be purchased

Business Environment is Dynamic

• Setting up a new business is risky because the business environment is dynamic, or constantly changing
  • There is also the risk of change, which can make the original business idea much less successful
• New businesses may fail if any of the following changes occur which may turn the venture from a successful enterprise to a loss-making enterprise:
  • New competitors
  • Legal changes
  • Economic changes that leave customers with much less money to spend
  • Technological changes that make the methods used by new business old-fashioned and expensive

What a Business Needs to Succeed

• Identifying successful business opportunities
  • There is difficulty in leaping towards successful entrepreneurship because there is the inability to identify a market need that will offer sufficient demand for their product to allow the business to be profitable
  • Original ideas for most new businesses come from several sources:
    • Own skills or hobbies – these skills will enable an entrepreneur to offer them to friends and relatives and this could be the start of the business
    • Previous employment experience – allows a potential entrepreneur to see the working of such a business and judge whether they could set up a similar business themselves
    • Franchising conferences and exhibitions – offering a wide range of new business start-up ideas which also give the potential benefits of the support of a much larger franchiser business
    • Small-budget market research – can indicate gaps in local markets that could be profitably filled by the entrepreneur
• Sourcing capital (finance)
  • Once the entrepreneur has decided on a business idea, the next task is to raise the necessary capital
  • Obtaining finance is a major problem for entrepreneurs because:
    • Lack of sufficient own finance
    • Lack of awareness of the financial support and grants available
    • Lack of any trading record to present to banks as evidence of past business success – a trading record would tend to give a bank confidence when deciding to lend money or not for a new venture
    • A poorly produced business plan that fails to convince potential investors of the chances of a business’s success
• Determining a location
  • Choosing the location for a new business has the need to minimise fixed costs
  • When finance is limited, it is very important to keep the break-even level of output as low as possible
  • The cost and position of the location chosen can have a big impact on the business entrepreneur’s chance of success
• Competition
  • A newly created business will often experience competition from older, established businesses, with more resources and more market knowledge
• Building a customer base
  • A new firm must establish itself in the market and build up customer numbers as quickly as possible
  • The long-term strength of the business will depend on encouraging customers to return to purchase products again and again
    • Many small businesses try to encourage this by offering a better service than their larger and better-funded competitors

Why Many Businesses Fail Early On

• Lack of record keeping
  • Many entrepreneurs fail to pay sufficient attention to accurate records as either they believe that it is less important than meeting their customers’ needs, or they think they can remember everything
  • With the falling cost of computing power, most businesses, even newly formed ones, can keep records on computer
• Lack of cash and working capital
  • Capital is needed for day-to-day cash, for the holding of inventories and to allow the giving of trade credit to customers, who then become trade receivables
  • Without sufficient working capital, the business may be unable to buy more supplies, or pay suppliers offer credit to important customers
  • Serious working capital deficiencies can be avoided if several simple, but important, steps are taken as the business is being established:
    • Constructing a cash flow forecast so that the liquidity and working capital needs of the business can be assessed month by month
    • Inject sufficient capital into the business at start-up to last for the first few months of operation when cash flow from customers may be slow to build up
    • Establish good relations with the bank so that short-term problems may be overcome with an overdraft extension
    • Use effective credit control over customers’ accounts
• Poor management skills
  • Entrepreneurs may have not yet developed the skills needed at a management level (such as leadership skills, cash handling and cash management skills, decision-making skills, communication skills, planning and coordinating skills and market, promotion and selling skills)
  • Potential entrepreneurs are usually encouraged to attend training courses to gain some of these skills before putting their hard-earned capital at risk, or to first seek management experience through employment

The Role of the Entrepreneur

Qualities an Entrepreneur is Likely to Need for Success

• Innovation
  • The ability to carve a new niche in the market, attract customers in innovative ways and present their business as being different from others in the same market
  • Requires original ideas and an ability to do things differently
• Commitment and Self-Motivation
  • Requires the willingness to work hard, keen ambition to succeed, energy and focus
• Multiskilled
  • An entrepreneur will have to make the product (or provide the service) promote it, sell it and keep accounts
  • Requires a person who has many different qualities: being keen to learn technical skills, being able to get on with people and being good at handling money and keeping accounting records
• Leadership skills
  • Requires the entrepreneur to lead by example and must have a personality that encourages people in the business to follow them and be motivated by them
• Self-confidence and the ability to bounce back
  • Requires the entrepreneur to have such belief in themselves and their business idea that they would bounce back from any setbacks
• Risk taking
  • Must be willing to take risks in order to see results

The Role of Business Enterprise in the Development of a Business and a Country

• New business start-ups can be found in nearly all industries, yet it is true to say that there are some industries and sectors of industry where there is a much greater likelihood of new entrepreneurs entering
• Common types of entrepreneurial businesses:
  • Primary sector: firms engaged in extracting natural resources so that they can be used and processed by other firms
  • Secondary sector: firms that manufacture and process products from natural resources
  • Tertiary / Service sector: firms that provide services to consumers and other businesses
• Claimed benefits to the economy of a business enterprise
  • Employment creation:
    • In creating such employment, the national level of unemployment will fall
    • If the business survives and expands, then there may be additional jobs created in the businesses that supply them
  • Economic growth:
    • Any increase in output of goods or services from a start-up business will increase the gross domestic product of a country
    • If enough small businesses are created, economic growth will lead to increased living standards for the population
    • Increased output and consumption will also lead to increased tax revenues for the government
  • Firms’ survival and growth:
    • The survival of new firms will expand and become important businesses
      • These will employ large numbers of workers, add considerably to economic growth and will take the place of declining businesses that may be forced to close due to changing consumer tastes or technology
  • Innovation and technological change:
    • New businesses tend to be innovative and this creativity adds dynamism to an economy
      • This creativity can rub off on to other businesses and help to make the nation’s business sector more competitive
  • Exports
    • Firms will expand their operations to the export market and this will increase the value of a nation’s exports and improve its international competitiveness
  • Personal development
    • Starting and managing a successful business can aid in the development of useful skills and help an individual towards self-actualisation
      • This creates an example for others to follow and lead to further successful new enterprises that will boost the economy
  • Increased social cohesion
    • By creating jobs and career opportunities and by setting a good example for others to follow, entrepreneurship can help to achieve social cohesion in the country

Social Enterprises

The Range and Aims of Social Enterprises

• Social enterprise: a business with mainly social objectives that reinvests most of its profits into benefitting society rather than maximising returns to owners
  • Social enterprises compete with other businesses in the same market or industry, using business principles to achieve social objectives
• Common features of social enterprises:
  • They directly produce goods or provide services
  • They have social aims and use ethical ways of achieving them
  • They need to make a surplus or profit to survive as they cannot rely on donations as charities do

Triple Bottom Line – Economic (Financial), Social and Environmental Targets

• Triple Bottom Line: the three objectives of social enterprises
  • Economic: make a profit to reinvest back into the business and provide some return to owners
  • Social: provide jobs or support for local, often disadvantaged, communities
  • Environmental: to protect the environment and to manage the business in an environmentally sustainable way

Reference: Stimpson, P., Farquharson, A., & Stimpson, P. (2015). Cambridge international As and A level business coursebook. Cambridge: Cambridge University Press.