Business development

This unit contains four parts: 8.1 The business idea

Unit

8.2 Resources and quality issues 8.3 Financial resources 8.4 Feasibility and evaluation

Unit 8: Business development

Unit

Introduction
business does not exist in a vacuum. Competitive businesses need to respond to a variety of pressures, both internal and external, as well as needing to

innovate. This unit looks at how a small business can be established in response to the needs for change, including the reasons for, and the likely outcomes of the decisions taken. While studying this unit you will need to focus on the assessment requirements. You will be creating a fully developed business plan for the establishment of a new small business operating as a sole trader or partnership. The plan will include your aims and objectives, a marketing plan, resource issues and a financial analysis. The plan will be presented as a viable business idea, suitable to support a request for finance for the venture.

What you will learn in this unit

What gives rise to a business idea The role of small and medium-sized enterprises in the market What is involved in setting up a business How to carry out primary and secondary research into the needs of competitors and the power of competitors The appropriate scale for a small enterprise The resources required to set up a small enterprise and how they can be combined effectively The importance of start-up finance How to create an effective budget, profit and loss account and balance sheet The importance of planning How to evaluate business performance

GCE A2 Level Business

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Edexcel

8.1 The business idea

Coming up with an original idea is only one part of coming up with a successful business idea.

What gives rise to a business idea?

The inventor Sir Clive Sinclair is perhaps best known for the development of a good idea that didnt sell. He was aware of the problems caused by petrol-guzzling large motor vehicles, as well as the difficulties of parking them and driving them in urban environments. So, in the 1980s he invented and launched the C5 battery-powered vehicle. The idea was a celebrated failure. The product suffered from technical limitations and was hurt by marketing that appeared to position the product as a rival to cars rather than as a fun leisure toy.

Key term
Marketing. Providing the right product at the right price in the right place, profitably. In later years Sir Clive Sinclair went on to admit that: What inventors need to recognise is that

what is great to them is not necessarily great to other people. We can contrast the C5 with the development by James Dyson of his twin cyclone range of vacuum cleaners. In recent years these have revolutionised the way we clean our carpets and floors. Dyson developed his idea to replace oldfashioned vacuuming techniques by observing how industrial cyclone systems worked. Dyson then produced and trialled hundreds of different prototypes to come up with a product that would appeal to them. Dyson products are now sold worldwide. Another story of innovation is that of the birth of the iPod. The iPod originated with a business idea created by Tony Fadell, an independent contractor and hardware expert who had helped develop handheld devices. His idea was to take an MP3 player, build a Napster music sale service to complement it, and build a company around it. Fadell took the idea around several major companies. All of them rejected it except Apple, the celebrated computer manufacturer. In early 2001 Apple assigned Faddel a team of 30 industrial designers including designers,

CASE STUDY

New Look 915

New Look has a clothing line called 915 which is aimed at 9 to 15-year-old girls. New Look carries out a lot of detailed market research to decide what exactly should go in the range. Girls typically start to take an interest in the range from 7 years old. The range is based on both what mothers want their children to dress in and what children want to wear. Items in the range include jeans and T-shirts as well as what is fashionable at the time. The items are designed to give value for money and some items, for example, come as cheap as 1.

Wheres the market?

Value for money

New Look has identified the 915 market as an important opportunity market research has identified the in betweenies as a significant market between children and the more adult market. It consists of lots of girls who relate to fashion.

Fashion statement

Designers of the range therefore pay careful attention to fashion trends and market research to generate new ideas that will appeal to this group. It is then a question of evaluating research information and selecting the best ideas, in order to plan a range of fashionable items for New Look 915.

Questions  Identify and describe the market that New Look is targeting. 3 1 Outline the benefits of New Look to this target market. 3 2  3 3 3 Analyse the key stages in turning the New Look 915 into a good business proposition

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programmers and hardware engineers. Faddel believed that the success of his product would convert Apple from being a computer business to a music business. Apples iPod was developed in six months quicker than any major product in the companys history. The Dyson and iPod stories show that coming up with a good idea is only one step in the process of business development. There are four main steps in the development of new business ideas: 1 seeking and shaping opportunities 2 generating new ideas 3 evaluating and selecting ideas 4 planning for implementation.

Key terms
Market. The whole situation in which products and services are traded by buyers and sellers. Market share. The sales of a product by a company expressed as a percentage of total sales in a market: if a company sells 20,000 products and the total number of those products sold overall is 200,000, the company has a market share of 10 per cent. Target market. A group of consumers, sometimes called a segment, to which an organisation offers its products. An organisation often offers its products to several target markets simultaneously.

Enterprise culture
In the UK we are said to have an enterprise culture. An enterprise culture is one in which people are prepared to take risks. When enterprise is combined with innovation (the ability to come up with and develop new ideas) then you have a dynamic enterprising economy. A survey carried out by NatWest in 2004 showed that 70 per cent of sixth formers would consider setting up a business when they have finished in full-time education. Being enterprising involves taking any type of risk and although it can relate to risking money this does not have to be the case. In fact many business people risk other peoples money rather than their own. In this country we do not have to go far to think of enterprising people. For example, there are people who set up great business enterprises like the Cadbury brothers, Michael Marks and Tom Spencer, Anita Roddick, Martha Lane Fox (who was a cofounder of lastminute.com), Tommy Singh and Richard Branson. There are great inventors like James Dyson who developed the bagless vacuum cleaner and Tim Berners Lee who was instrumental in creating the Internet, and
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Caption
 GCE A2 Level Business Edexcel

there are pop impresarios like Simon Cowell and Malcolm McLaren, who created the Sex Pistols. All of these people were enterprising because they were able to think outside the box. Malcolm McLaren helped to create punk music, Martha Lane Fox helped to develop e-commerce and the Cadburys developed a range of famous chocolate products.

Key terms
Business plan. A plan for the whole of a business covering a period of 13 years and setting out such aspects as financial plans, marketing plans, etc. Forecast. Prediction of future events or figures based on some form of evidence, such as past results.

Creating a business plan

Having a great business idea is only the start of developing a great business. What is then required is a lot of hard work and planning to make the business a success. In this unit we provide you with the support and structure to plan the development of an effective business. Livewire is an organisation that has been created to help young people set up their own businesses in this country (see shell-www.livewire.org). Livewire has defined a business plan in the following way: A business plan is a complete description of a  business and its plans for the next one to three years. It explains what the business does (or will do if its a new business); it suggests who will buy the product or service and why, and it provides financial forecasts demonstrating overall viability, indicates the finance available and explains the financial requirements. HEADING Contents page The owner(s) CONTENTS

For most businesses, the business plan will be the main method of convincing prospective fund providers that the business proposal is viable. The business plan also shows that the proprietor has the commitment and determination to succeed. The business plan should be presented in a form that can be quickly and easily understood. The main part of a business plan normally needs no more than eight to ten pages supported, if necessary, with more detailed appendices. The plan will then be manageable. It needs to be a working document in which the owner and potential fund providers can find the management information they need. A simple business plan should be clearly set out under the following headings (note that the table is cross-referenced to the various sections of this unit in the left-hand column):

This is useful in any kind of report that is more than two or three pages long. This section should give some information about the owner or owners, including their educational background and work experience. It should also contain the name and address of two referees. This should first contain the name and address of the business and then go on to give a detailed description of the product or service being offered, how and where it will be produced, who is likely to buy it and in what quantities. This section will set out the legal position of the business, e.g. whether it is a sole trader, partnership or company.

The business and the business idea (8.1)

The legal status of the business (8.l)

This should set out the size of the market, the nature of The market and the likely competitors for the product competition in the market and the expected market share that or service (8.1) your business expects to take. In this section you can outline some of the market research that you have carried out.
continued

Unit 8: Business

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Promotional strategies (8.1) This should give information about how the business will be publicised to potential customers. The marketing mix for the organisation (8.1) This should give a brief outline of the key aspects of the blend of product, price, promotion and place.

The quantity to be This should give a brief summary of how many items or how produced or level of service many different types of items will be produced or of the service (8.2) standards that will be provided. Resources required (8.2) This should set out the: physical resources required human resources required. You should show how quality will be ensured within the business. This should give details of how the finance for the business is going to be raised. How much will come from savings? How much will need to be borrowed? You should create a budget for the first year of operation of the business. You should set out a predicted cash-flow statement for the first few months of trading. Set out a break-even chart to show the break-even point and when this will be achieved.

Quality issues (8.2) The finance (8.3)

Start-up budget (8.3) Cash flow and breakeven (8.3)

Profit and loss accounts (8.3) You should create a projected profit and loss account for the first year of trading. Start up balance sheet (8.3) Evaluation of the business position at the end of a year (8.4) A future projection (8.4) Alternative ideas (8.4) You should create a balance sheet to show the starting position of the business. Various tools can be used to evaluate the success of the business. For example, carry out a SWOT (strengths, weaknesses, opportunities and threats) analysis or examine various measures of success, such as profitability. A projection can be carried out of what the business might look like in three years time. This should supply alternative ways of developing the business in the future.

Table 8.1 Business plan structure

Key terms
Break-even point. The level of output at which total revenue equals total costs. Budget. Plan for the future set out in numbers. Partnership. A business owned by at least two partners, who share the responsibility for running and financing the business, as well as the risks. Profit. The difference between revenue and costs. Promotion. Techniques used by an organisation to communicate with others, e.g. advertising, flyers, etc. Quality. Fitness for purpose. Sole trader. A business owned by one person.

GCE A2 Level Business

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Edexcel

Did you know?

One of the most important reasons for business failure, particularly for start-up businesses, is poor or no business planning. Sometimes the owners of new businesses have no idea of whether there is sufficient demand for their product, what prices competitors charge, the true cost of borrowing money, how to advertise and promote their business, or the importance of having a steady flow of new cash into the business.

When you have finished studying this section you should be able to:

generate a range of possible ideas for a business explain an appropriate legal status that you
have chosen for your business service

identify likely competitors for your product or outline suitable promotional strategies establish an appropriate marketing mix for
your product or service.

Key term
Marketing mix. The combination of product, price, place (sometimes called distribution), promotion and packaging offered by an organisation to potential consumers.

Generating a business idea

How do you generate a business idea?
One way is to come up with a new idea which seems obvious but that nobody seems to have thought of. For example, often when I go on a short holiday I forget to bring my razors and shaving foam. This means I have to buy a pack of razor blades and a standard size shaving foam when I arrive at my destination. Wouldnt it be a good idea for a company like Gillette or Bic to produce a small takeaway pack containing a mini-

shaving foam and two or three handy sized razors to see me through my holiday? A friend of mine came up with the idea of a toothbrush that plays nursery rhymes to encourage young children to clean their teeth. You can see, therefore, that one way of coming up with a business idea is to generate a new and novel solution to a problem. This is what Akio Morita did when he developed the Sony Walkman a music system that could be used on the move. This has led to more recent solutions, such as MP3 players and the iPod. Morita came up with the simple idea of creating a tape-based (cassette) system that could be carried, with a headset for listening to the music. Another way of generating ideas is to go for a niche in the market. This is what the founders of Tie Rack did. They realised that people want attractive ties and neckwear but didnt necessarily want to go to the hassle of looking round clothes shops. They therefore developed small outlets selling a range of high-quality ties in busy locations, such as between the train and tube station at (London) Kings Cross. Of course, some people just copy existing ideas which they know have been successful elsewhere. This is why franchising is so popular. When you buy a franchise you buy the right to use a well-known name, such as McDonalds, DynoRod (plumbing), etc. and to use equipment and training supplied by the franchising organisation. Many successful business people copy good ideas from elsewhere. For example, on a visit to the US, you might spot an exciting retail opportunity that does not yet exist in this country and then develop it here. Another way of generating ideas is to listen to what customers are saying about what they want. If young people write to the local paper complaining that there are no entertainment facilities for them in your town, then this might be an opportunity to set up a coffee shop or disco. Of course, many people generate business ideas from doing things which they are good at. For example, Jamie Oliver is an excellent cook and he has built a restaurant business out of it.

Unit 8: Business

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Learning activity
See if you can generate a good business idea from one of the following suggestions.
A new and novel idea A niche market

to the rest of their personal wealth. For example, they might have to sell their house and car to pay off business debts. Today there are some special types of large partnership, such as in accountancy, that can be classified as limited partnerships.

Key term
Generating your idea Limited liability. There is a restriction on how much a person is liable to the debts of a business.
Copying a good idea

Doing something that you are good at

Unlimited liability. There is no restriction on how much a person is liable to pay off the debts of the business. A company is different from the partnership and sole trader in that the shareholders have limited liability. Individual shareholders can only lose at a maximum the money they have invested in shares should the company run up debts their shareholding is the limit of their liability. Whatever form you choose, you should select a business name that will not cause problems to another business. Sole traders or partnerships trading under a name other than that of the owner(s) must display the owners name and address at business premises and on business stationery. Limited companies are required to display the registered name at their premises and on company publications.

Figure 8.1 Generating ideas

See if you can create three ideas for each of the headings. When you have come up with your ideas, evaluate them to see which of them would be best for producing a workable business plan (following the model provided on page 6).

Your legal status

Most businesses will be set up either as a sole trader, partnership or limited company. Sole traders and partnerships must inform the Inland Revenue within three months of starting, or face a fine. Sole traders or partners are classed as selfemployed and are therefore responsible for paying their own income tax and national insurance. The directors of a limited company are responsible for making sure that the company produces accurate accounts that are audited by an external auditor who is able to state whether they are true and fair. It is important to set out in your business plan what your legal status is. This affects the risk taken by those who are prepared to lend you money. They take more of a risk if you are a sole trader or partnership. All sole traders and most partnerships have unlimited liability. What this means is that the owners of the business are liable for its debts. Their liability is not restricted (limited) to what they put into the company the liability extends
 GCE A2 Level Business
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Learning activity
What legal status will your business take? Set this out in your business plan explaining why you have chosen this particular form.

Defining business size

There are various ways of defining small, medium and large enterprises for example, according to the size of turnover. Another approach is according to the number of employees.

Key term
Turnover. The money value of sales made by a company (also referred to as sales revenue).

Edexcel

Official National Statistics define:

a small enterprise as having 049 employees a medium enterprise as having 50249

employees

a large enterprise as having over 250

employees. Nearly all businesses in the UK are small, which shows the importance of this type of business to our economy:

We use the term direct competition to describe businesses that are competing head on for the same group of customers. Indirect competition refers to competition which is less intense but still needs to be considered. The Coca-Cola Corporation, for example, believes that in order to sell more Coca-Cola across the globe they have to compete with alternatives, such as tea and coffee.

99.2 per cent of business today (2005) are small 0.6 per cent are medium sized 0.2 per cent are large.
Small and medium-sized enterprises account for about 58 per cent of employment and just over 50 per cent of turnover. There are about 3 million enterprises with no employees (about 70 per cent of all enterprises). Businesses with no employees are sole proprietors and partnerships made up of the self-employed owner-manager(s) and companies made up of only one director. There are about 2.5 million sole proprietors in the UK and about 500,000 partnerships. There are 960,000 companies.

Learning activity
List three goods and services which you believe have little direct or indirect competition. Can you list another three that have lots of direct competition? In examining a market in which you want to compete, you should try to estimate:

the size and value of the market, for example,

how many customers make up that market and what the likely value of their purchases is in that market in a given period of time take.

the share of the market that you are likely to

For example, after conducting market research in your local town you might find that 2000 people buy sandwiches every day and that they spend on average 3 on sandwiches. The total value of the market is therefore: 2000 3 = 6000 Based on your market research you find that one in ten sandwich purchasers will switch to buying from you. Using these figures you can then estimate that your daily sales will be: 6000 10 = 600 Assuming that you operate for five days a week your weekly sales will be: 600 5 = 3000 Assuming that you operate for 50 weeks in the year, your expected annual sales revenue would be: 50 3000 = 150,000

Likely competitors for the products or service

A market is made up of buyers and sellers of a good or service. Markets can be sub-divided into particular segments in which competitors are competing for the same or similar groups of customers. For example:

at one level we have the market for drinks a category of this is the market for hot drinks a component of this is the market for tea a component of this is the market for tea bags a component of this is the market for fruitflavoured tea bags. The producer of fruit-flavoured tea bags needs to understand that not only do they face competition from other producers of fruit teas, but also from other types of teas, from coffee and other hot drinks and from drinks in general.

Key term
Revenue. The value of sales (in money terms) that the product is likely to achieve, or has achieved.

Unit 8: Business

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Element of competition Price Bread

Details When given the choice of similar sandwiches, customers will go for the cheaper ones. Some people like white bread, some prefer brown and more exotic varieties such as wholemeal and stone-ground. A key consideration is the freshness of the bread. The popular favourites are cheese, ham, egg, chicken, tuna, roast vegetables, prawns and then more exotic recipes. Customers prefer packaging that seals in the flavour and is easy to open. Customers prefer to buy from convenient locations, such as on their route to work. Customers prefer to buy sandwiches with a strong brand identity. Tastes are influenced by cultural factors such as religion and upbringing for example, Muslims will only purchase meat that has been prepared by halal butchers.

Fillings Packaging Place Branding Cultural factors

Table 8.2 Customer considerations in purchasing sandwiches

However, in order to secure this revenue and your share of the market you need to carry out a detailed competitor analysis. To analyse the competition you need to identify the key ingredients that you compete on. Key elements of competition for sandwiches, as revealed by market research are detailed in the table above.

position in the market. In contrast, no-frills outlets such as Aldi and Netto place themselves at the very low-price position in the market. In creating a positional map it is important to consider where your current competitors have placed themselves, and where it is likely that new competitors will place themselves.

Learning activity
Set out a table to show the key competitive elements for a business idea that you want to develop.

Key term
Positional map. Setting out how a firm compares with rivals in its place in the market as illustrated by two or more dimensions.

You need to decide where you want to position (place) your product in the market in which you operate. To do this you need to decide on the key dimensions to the competitiveness of the good or service. For example, two common dimensions are price and quality. If we look at competition between food outlets, Marks & Spencer places itself at the high-quality, relatively high-price

In the map opposite, you can see a situation in which a business, Exotic Sandwiches, has decided to position itself in the high-price, highnovelty section of the market in a big city. Is this wise given the number of competitors already operating in this segment? Note that the dots on the map represent existing competing firms.

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High price

Low novelty

High novelty

Low price

FIGURE A positional map for local sandwich businesses GCE A2 8.2 Business for Edexcel Double Award
AW 013 Tek-Art (MJH)

Learning activity
Set out a positional map showing the position of a business that you would like to set up. Use the two dimensions that you consider to be most significant competitive factors. Show the rough positions of competitors on the map. Explain why you have chosen your position and how you are likely to beat the competition.

Promotional strategies
In setting out a business plan it is important to set out a clear structure as to how you will promote your product. There is no point in having a brilliant product if nobody knows about it. The promotional strategy is the means that you will employ to get the right messages across about your business and product. It takes a lot of time to build brand awareness and customer recognition of a product. High-quality promotion is therefore very important. The promotional tools that you will need to consider are:

It will also be helpful in discussing the market to outline the key findings of any market research you have carried out, particularly in relation to the marketing mix.

advertising communicating through mass

What type of product or service do customers

want?

media, e.g. television, radio, newspapers, billboards, flyers through peoples doors, etc. an incentive to buy products, e.g. by offering two for the price of one aimed at persuading and informing customers favourable impressions are communicated to the press and the buying public business and/or product by funding unrelated activities.

What sorts of benefits are they looking for

from the product or service? pay?

sales promotion providing customers with

What sort of price would they be prepared to Do they want to pay premium prices for

personal selling face-to-face communication public relations (PR) making sure that

premium products or low prices for standard products? what places are most suitable? target audience?

Where do they want to buy the product i.e. What sort of promotion would appeal to the

sponsorship improving the image of a

A promotional strategy is a plan to use these tools in the most effective way to achieve your objectives.
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Key term
Objective. A planned result to be achieved by an individual or organisation, e.g. the objective of increasing sales by 10 per cent this year.

In considering your marketing mix, think about the following elements.

Product. What exactly is the product or service

For example, your objective might be to make sure that at least 50 per cent of the people in your town are aware of your new sandwich business and what it offers. Your promotional strategy then might be to advertise in the local press and to produce public relations communications for the media to get the message across. In addition, you might post coupons through the doors of 1000 houses, offering half-price sandwiches for the first month after your opening.

you are offering? What are the key benefits that it offers customers? What are the distinctive features (e.g. design)? Are you offering a range of products? What packaging will you be using? use (e.g. a promotional price to launch the product, a premium price to give it distinctive quality, etc)? will be used.

Price. What sort of pricing method will you

Promotion. List the promotional activities that Place. How will the product be distributed to

consumers? What selling outlets will you use?

Learning activity
Design a promotional strategy for your business idea. This should include:

Learning activity
In setting out your development plan, make sure to relate each of these elements of the 4 Ps to your business and/or product objectives.

objectives for the promotional campaign (what  you want to achieve)  promotional strategy setting out the blend a of promotional tools that you will use and why you plan to use them.

Researching your business idea will be a timeconsuming process. Be prepared to put a lot of time into this task:

research the feasibility of the product idea

The marketing mix of the organisation

The marketing mix of a business consists of four major elements. These are referred to as the 4 Ps:

research the market to find out what potential  customers want research the competition to find out the  strengths and weaknesses of existing competitors

product price promotion place.

The marketing mix that you choose needs to be appropriate to your business objectives. For example, if your objective is to grow steadily as an upmarket sandwich provider, then you will need to produce a high-quality (fresh and well-finished) product which sells at a premium price, involves promotional activity that reflects a quality product and is placed in fairly exclusive locations.
12 GCE A2 Level Business
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research a suitable promotional mix create an appropriate marketing mix.

Primary (field) research can include face-to-face interviews and telephone or postal surveys. It is also worth speaking to distributors and retailers as well as your competition (simple information such as number of competitors in the area can be found in The Yellow Pages and other business directories). When carrying out primary research, handle data confidentially and in accordance with data protection law. You may want to conduct test marketing using prototype products to determine demand and what, if any, changes should be made.

Edexcel

Desk research. Visit your local business library and look on the Internet for relevant data. Statistical information can be gleaned from a number of sources, such as the Office of National Statistics. It is also worth contacting trade association, newspapers and journals, as well as reading competitors literature.

The amount to be produced depends on two principal factors:

the level of demand: this depends on how

much customers want to buy

how much can be supplied: this depends

8.2 Resources and quality issues

You should now have established your business idea and its potential through the research you have carried out. Now you need to consider the scale of the operation by looking critically at:

on how much you can supply through your existing processes, which depends on your equipment and the level of skill of your employees.

Economies of scale
When we refer to the scale of production we mean the capacity of the firm to produce larger or smaller quantities of goods. Most firms in this country are sole traders and partnerships typically they operate on a small scale. Huge companies like Shell, Cadburys and British Airways produce on a large scale. If you operate on a larger scale you need more machinery and equipment, and you need to operate from a larger plant. Through operating on a large scale a business is able to benefit from what are known as economies of scale. Typical economies of scale relate to:

the quantity of goods to be produced or level

of service offered

the technology you will need to use the production process, including timing the physical resources required the human resources required how quality can be assured and controlled.
To do this you will need to consider how the necessary resources may be combined efficiently to achieve the desired outcomes. You will also need to consider any relevant legal, economic, technical and environmental constraints.

production economies: being able to use better

techniques of production, e.g. mass producing lots of identical items at a very low cost per unit advertise the same product across the globe using the same or a highly similar campaign money far more cheaply because of the scale of the business and being able to cut other financial costs, e.g. the setting-up cost of a large loan is proportionately much smaller than for a small loan, etc. distribution and promotional costs.

marketing economies: e.g. being able to

How much to produce?

Producing the right quantity is a tricky decision. If you dont produce enough then customers will be frustrated and will go to your competitors. If you produce too much then you will have stock lying around, deteriorating in condition and getting in peoples way.

financial economies: being able to borrow

Did you know?

Before the Rover car company went into liquidation, one of the jokes going around about the company was: You can see two human features on the earth when you look at it from space. One is the great wall of China. The other is the stockpile of Rover cars outside the factory waiting to be sold.

selling economies: being able to reduce

Key term
Loan. Finance provided by an individual, company, financial institution, government or some other provider. The loan must be repaid over a given period of time with additional interest payments.

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Large companies benefit from economies of scale

Technology, production process and timing

Technology
Using the right technology is very important in developing a competitive advantage. This is particularly true in the world of information and communications technology, where small companies using the latest computers and computer applications can gain a considerable advantage over companies working with less advanced systems for example, in web page design.

Production process
Another important consideration is the process that you employ. Processes are systems and methods that you use to make a product. For example, sandwiches can be produced individually by hand. Alternatively, they could be produced in batches e.g. a batch of ham and cheese sandwiches, followed by a batch of chicken sandwiches. Mechanical processes could also be used to process the sandwiches, e.g. electronic cutting, spreading and packaging devices. Getting the processes right is a key aspect of competitive advantage.

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CASE STUDY

Automatic sandwiches

ew technology for making sandwiches is being continually developed. This is illustrated by recent practice at Hazlewood Sandwiches, one of this countries best-known sandwich Slice lines GCE A2 GCE Business A2 GCE Business A2 forBusiness Edexcel for Edexcel for Double Edexcel Double Award Double AwardAward producers. Until recently cucumbers However, Hazlewood has developed AW 003 AW 003 AW 003 and tomatoes that go into sandwich Tek-Art Tek-Art (MJH) Tek-Art (MJH) (MJH) automatic machinery which places making were sliced into containers cucumber or tomatoes onto a and then placed on bread slices moving slice of bread on the manually. production line. The new method

involves taking out single items (e.g. slices of cucumber) from a bulk container and arranging them in patterns on a bread slice on a moving production line, while at the same time removing reject items.

Questions Identify the benefits of this approach to the sandwich producer. 3 1  3 2 Explain the key benefits to consumers. 3 3 3 Justify the use of economies of scale in production in sandwich making. 3 3 3 4 Assess the likely impact on the sandwich market of large producers such as Hazlewood sandwiches using mass-production technology.

Timing and other constraints

In setting out your plan, it is helpful to identify potential constraints to production capacity. For

example, in the case study below the business is limited in its ability to meet potential demand by lack of time and physical resources.

CASE STUDY

Making candles
A group of students has formed an enterprise to produce candles for the Christmas market. They meet for one afternoon a week to run this project. Market research indicates that they can sell up to 500 candles at a Christmas store. They have therefore created a production plan setting out responsibilities for the various processes and a time schedule for the 10-week period leading up to their Christmas fare. Although potential demand for candles is 500, with their existing production capacity they can only make 40 candles a week.

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Processes to be carried out

Buy in candle making equipment and set up production line Prepare wax and mix with colours Prepare threads Heat wax Place wax in moulds Leave moulds to cool Extract candles from moulds Check quality of finished articles Break up reject (faulty) items Store candles Same as for week 2 Same as for week 2 Same as for week 2 Same as for week 2 Same as for week 2 Produce packaging materials Same as for week 2 Same as for week 2 Prepare packaging for remaining candles Carry out last-minute quality checks Sell candles at Christmas fair

Who is responsible
Purchasing manager, production manager and production team Production manager and production team

Time schedule
Week 1 Week 2

Production manager and production team Production manager and production team Production manager and production team Production manager and production team Production manager and production team and packaging department Production manager and production team and packaging department Production manager and production team and packaging department All enterprise members

Week 3 Week 4 Week 5 Week 6 Week 7 Week 8 Week 9 Week 10

FiGURE 8.XX Caption Questions Explain why it is important to establish timings and responsibilities when creating a 3 1  production schedule. 3 3 2 Analyse the importance of including quality checks in the process. 3 3 3 Respond to a view that was voiced by one of the members of the student team who said that, It is not important to concentrate on quality. Our emphasis should be on making and selling as many candles as possible. 3 3 3 4 Propose an alternative planning schedule for preparing the candles for the market so as to better match the supply with the demand of the candles.

Learning activity
Identify the key processes involved in producing your product or providing your service. Set out these processes in a diagrammatic form (e.g. using a flow chart). An important consideration will be the timing required. Make sure that you leave yourself enough time to complete the processes.

Planning to provide services

Of course most modern businesses are not concerned with producing a physical product. A large proportion of businesses involve providing a service, e.g. office cleaning, hairdressing, providing restaurant and caf services, etc.

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In terms of production planning for a service, it is necessary to establish levels of service. For example, in a standard barber shop the level of service usually involves being able to read a tabloid newspaper and listen to the radio before having your haircut, while the barber discusses football with you or where you are going on your holidays. In contrast more upmarket unisex hairdressers give a much higher level of service, which may include:

much it would cost to rent the floor space that you require. 2  Plant and fittings. What types of plant and fittings will you require? How much will it cost to lease and hire this equipment? 3  Vehicles. Provide details of vehicles required and the hire purchase requirements. You could get this information from a car dealership. In this section you can also set out which suppliers you will use and the terms on which they will supply you with relevant materials and other supplies.

glossy magazines a cup of coffee while you wait the opportunity to have your nails manicured a free chocolate bar and other gifts, etc.
It is very important therefore to think carefully about the level of service you will offer. This should relate to:

Human resources required

In setting out the human resource requirements of a business it is necessary to establish:

how many people are needed what jobs they will have to do what skills and capabilities they will need to
have.

what your customers want, as discovered by

market research

what your competitors are offering the extent to which you want to give your
customers superior service.

Job analysis
Job analysis is the process of identifying the knowledge, skills and attitudes required to do particular jobs. It is therefore essential to carry out a job analysis so that you can be clear about what is required to run the human resource side of your business. A summary of the job analysis you have conducted should be presented in your business plan, together with an outline of the numbers of people that will initially be employed, along with what their jobs will entail. An outline of expected expansion of the business in the first year should also be provided, showing the number of extra people who will need to be employed and what they will be expected to do. A rough estimate of labour costs should also be included.

Learning activity
If you plan to offer a service, set out the levels of service you will provide and justify this level of service (e.g. in terms of the marketing mix, the target audience and the competition).

Physical resources required

It is important to consider the physical resources required to run a business. For many businesses, key areas will be the premises, plant and fittings and vehicles. Presenting a detailed section on this enables potential investors and lenders to appreciate that you have thought carefully about what you need to set up and run your business. A useful structure to this section of your business plan could be as follows: 1 P  remises (whether you will buy or rent). Set out the floor space area required, and the cost of the annual rent. This information can be gained by enquiring at an estate agent how

Quality issues
Quality can be defined as continually meeting agreed customer needs. Many people believe that quality is more important than price in determining demand for most goods and services. In taking quality to new heights, it is generally recognised that there are three stages:
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1 Q  uality control. This is an old idea. It is concerned with detecting and cutting out components or final products which fall below set standards. This process takes place after products have been produced. 2  Quality assurance. Quality assurance occurs both during and after the event, and is concerned with trying to stop faults from happening in the first place. Quality assurance is concerned with making sure products are produced to predetermined standards. It is the responsibility of the workforce rather than an end-of-production line inspector.

3 T  otal Quality Management (TQM). This process goes further. It is concerned with creating a quality culture so that every employee will seek to delight customers. The customer is the centre of the production process. In a total quality system, TQM takes place at every stage of an organisations operations and is the responsibility of all employees. TQM encourages the organisation and everyone that is involved in it to concentrate on quality.

Key term
Quality assurance. Guaranteeing high levels of quality.

CASE STUDY

Quality Standards created by the British Standards Institution M

any organisations apply quality standards which are established nationally and internationally by standards creating bodies. These standards relate to products and processes (i.e. how the products are made). Many businesses trade at local, national and international levels. To win customers confidence it is important to meet the highest quality standards. Standards awarding bodies like the British Standards Institution (BSI) create and monitor standards of best practice. Committees of specialist experts create standards relating to product, material, service, process or technology in a particular industry. Today most of these standards relate to services and systems, as well as production methods. Examples of new standards are those related to improvement of utility billing services (e.g. gas and electricity suppliers) and implementation of web design processes, to ensure characteristics like usability and readability. Small and medium-sized enterprises benefit from applying standards created by the BSI. One of the most important aspects of BSIs work is helping organisations to develop management systems to ISO 9001 standard. This involves setting up systems to ensure that processes are customer focused and that a company is continually seeking to improve its management of quality issues.

Questions 3 3 3 Justify the time and effort that a business Explain how a small or medium-sized 3 1  would have to put in to create the management enterprise can benefit from applying systems required to meet ISO 9001. standards established by the BSI. 3 3 3 4 Evaluate the likely success of rival firms, 3 3 2 Consider why customers are more one of which abides by expected standards, likely to have confidence in a small or and another which seeks to cut costs by medium-sized enterprise that adheres to seeking to avoid detection that it is flouting ISO 9001. standards.

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Kaizen
Kaizen is a term much used in the area of quality. It is a Japanese word that, when translated, simply means continuous improvement. The improvement is gained by slow and steady change, and once achieved it is maintained at that level until such time as the next improvement step takes place. Kaizen is one way in which employees may participate in issues that affect the workforce.

is happening in the legal environment. Some examples of legal constraints are outlined below.

Limitations on business names. You cannot

Learning activity
Describe the quality issues that particularly affect your business. Explain how you are going to create management systems to ensure quality. Carry out some research on the website of the BSI to find out any standards that may be relevant to your business idea. To find the site, enter British Standards Online into a search engine.

use the same name as one already registered, or a name that is too similar to an existing name (e.g. by adding an s as in Body Shops). You cannot use a name that is considered offensive, although some firms come very close to the border of what is acceptable (e.g. FCUK). You cannot use a name that makes you appear to be something to do with government. people must register with the Inland Revenue. Staff have many rights under employment legislation, such as the National Minimum Wage. Employers must take out Employers Liability Insurance to cover accidents and injury at work. safety of their staff and that of visitors to the business. If you have five or more employees you must produce a written health and safety policy.

Employing staff. All businesses that employ

Legal, economic, technical and environmental constraints

Legal constraints Economic constraints

Health and safety. Businesses must ensure the

Licences or registration. Some businesses

Business idea

need a licence to trade, e.g. body piercing and tattooing, acupuncture, care homes, money lenders and child minders.

Environmental constraints

Technical constraints

FiGURE 8.3 Constraints on business ideas

There are a number of constraints which can have a negative impact on a business idea. Typically they involve some element of cost and therefore need to be carefully considered. They may prevent a business idea from being developed into a successful business.

Legal constraints
Legal constraints are limitations placed on the business and business activity through laws and regulations. There are thousands of these so it is essential to keep up to date with what

Caption
Unit 8: Business 19

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 Intellectual property rights. Businesses should

be aware that there are laws to protect designs, trademarks and copyright. It may be a good idea to protect your own designs and logos. (1998) protects individuals with regard to their personal data being held and processed by the business. You should check to see if you are required to register under the act.

Data protection. The Data Protection Act

packaging. For example, companies can be fined heavily for using too much unnecessary packaging. The Landfill Tax is levied on each ton of waste created by a business and there are other environmental taxes, such as congestion charges, which place costs on businesses.

Learning activity
Either carry out some primary research into a business idea that is similar to your own to find out what the legal, economic, technical and environmental constraints are for that business. Or carry out secondary research into the legal, economic, technical and environmental constraints that impact directly on your business idea. The best way to search for secondary information is to do Internet searches using keywords related to aspects of your business idea and terms such as legal constraints, laws, etc.

Economic constraints
Economic constraints are those that are imposed by what is happening in the wider economy. Examples of economic constraints are:

changes in interest rates which raise the cost of

your borrowing and repayment of loans

changes in unemployment levels, e.g. a fall

in unemployment will push wages up (as employers compete for employees); again this would raise costs economy moves into a recession with the demand for goods starting to fall, this could have an adverse effect on demand for your product/service.

the rate of growth of the economy, e.g. if the

In your business plan you should show how legal, economic, and technical constraints impact on your business idea and the steps that you will take to overcome these constraints.

Technical constraints
Technical constraints relate to what is technically possible. Modern technology makes it possible to produce more efficiently. However, it is often very expensive to invest in new technology. As a result many small businesses are constrained by having to work with inefficient technology, while bigger rivals invest in the latest equipment. Having said this, many small businesses are successful because they use better technology than bigger companies.

8.3 Financial resources

Finance underpins the ability of any business to develop. You will need to consider:

sources of finance start-up budget and working capital

requirements

forecasts for cash flow and break-even projected profit and loss accounts start up balance sheets.

Environmental constraints
Environmental constraints are becoming increasingly significant. The Environmental Protection Act (1990) has important implications for businesses that produce waste and imposes a duty of care upon owners of such businesses. Under the Act, a director or manager may be personally prosecuted for offences committed. Further regulations apply for businesses that handle hazardous substances and produce
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Key term
Working capital. The financial resources that enable a firm to operate a business on a day-today basis (e.g. to purchase fresh stock and to pay wages and bills) calculated by taking away shortterm liabilities from short-term assets.

Edexcel

All businesses need to keep records (books) of receipts and outgoings from which to prepare annual trading accounts, to be verified by a professional accountant. The management of money is a crucial part of any small business. You need to know whether your operation is profitable, predict and manage cash flow, keep control of your costs, and set prices so that you are competitive. Dont forget that if you are working on a self-employed basis, you will also have to pay income tax and national insurance contributions.

Learning activity
Brainstorm the key sources of finance that might help you to set up a clothes shop. Identify the major headings for which you would need finance (e.g. advertising and promotion) and the sources of finance that would be relevant for each heading (e.g. bank loan). The following template should be useful to you in setting out the sources of finance required to set up your business: Source of finance Own resources Bank loans and other bank finance Other forms of private finance (state source) Government loan/grant Other public sector, e.g. Local authority, Local enterprise council Total finance required

Sources of finance
Businesses need finance for day-to-day financial needs, such as paying suppliers, and for longer-term requirements, such as finance for purchases of buildings and major items of capital equipment.

A starting point is to identify how much of your own savings or capital you can put into the business. A second major source will be a bank loan, or some other form of finance provided by a bank (e.g. a mortgage or overdraft).

Key terms
Capital. Money put into a firm by the owners of the business. Mortgage. A large loan for an extended period, normally given for the purchase of property. Overdraft. A banking facility that allows you to draw out more money than there is in your account, in return for a fee plus interest charges.

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Other forms of private finance may include loans or investments from family and friends, as well as other approaches, such as using a credit card to provide some of the finance. Be careful if you choose to finance a business through your credit card, though. Many businesses use this form of finance, but it is very expensive because of the high interest rates involved. In addition, there are loans and grants available for small enterprises provided by government, some of which are outlined below. Some of these are provided centrally, while others are provided by local authorities and Local Enterprise Councils.

Key terms
Grant. Finance provided to a business (e.g. by government) for a specific purpose. Local Enterprise Council. An independent body set up by government to co-ordinate enterprise activities in a particular area, including support for small business enterprise. Small enterprise. A business employing between 0 and 49 people. There are many ways of financing a business both when it is starting up and as part of ongoing development. These sources of finance are summarised below. 6

Private sector sources of finance

1 P  ersonal funds. In sole trader and partnership businesses, owners funds are very important. The sole trader or partner provides these funds from savings or earnings and, in effect, they are risking their own capital when they put these funds into the business. 2  Profit retention. An important source of funds when the business is up and running is profit retention. Profits can either be taken out of the business by owners or put back in to finance ongoing development (profit retention). 3  Bank loans. Loans are taken out for a fixed period, repayment being either instalments or in full at the end of the term. Interest charges are levied at a certain percentage over base rate (e.g. 2 per cent over base). In addition, there
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may be arrangement fees to pay for setting up the loan and a security (insurance) fee. Bank overdrafts. These are the most frequently  used form of short-term bank finance and help with cash flow. Arrangements are made between the customer and the bank to include an agreed limit on an account, beyond which the customer will not draw. Interest is calculated on the basis of how much is overdrawn each day. Hire purchase (HP). This allows a business to  use an asset without having to find the money immediately. A finance company (usually owned by the major banks) provides finance to purchase the asset. The business pays a deposit and then further payments to the provider of the finance as stipulated in the agreement. At the end of the agreement, ownership of the asset is passed on to the business. Leasing. Leasing an asset provides similar  benefits to hire purchase in that a leasing agreement with a finance house (lessor) allows the business (lessee) to use an asset without having to buy it outright. The real distinction between the two forms of finance is that leasing does not confer an automatic right to eventual ownership of the asset. Commercial mortgages. A mortgage is a loan  secured on land and buildings and can be used to finance the purchase of the property. It is a long-term financing arrangement of typically 1030 years. Suppliers. Just as the business may give credit  to its own customers, the firm may be able to negotiate credit terms with its suppliers.

Key terms
Asset. Something that a business owns or money owed to it. Leasing. Renting a capital item such as a photocopier or car.

Government support
In setting up a small or medium-sized enterprise, it is also important to consider government

Edexcel

support. The government is keen to support small business because it recognises the importance of this sector in creating an entrepreneurial economy.

Competitive Awards Schemes. The

Key term
Entrepreneur. A person who sets up and runs a business venture.

government offers awards and cash prizes to encourage small business, e.g. by offering export and research and development prizes for excellent achievement. encourage businesses to relocate from overseas to the UK.

Relocation grants. There are grants to

Key terms

Direct grant. This is a cash payment,

which may be offered for activities such as training, employment, recruitment or export development. Nowadays businesses can rarely get 100 per cent grant funding for an activity. Most schemes require the receiver of the grant to put up a proportion of the cost, often around 50 per cent. is offered for a project with the intention that the sums are repaid out of future revenues. The grant is not repayable in the event of the project failing. conditions of repayment are more generous than others offering commercial terms.

Consultancy. Providing advice to businesses (usually for a fee). Soft loan. A loan to a business that only needs to be paid back on relatively easy terms.

Learning activity
What are the main forms of start-up finance available to your business? What types of finance would you expect to draw on during the first year of running your business? What additional sources of finance would you be likely to draw on in your first three years? Explain why.

Repayable grant. This is where cash funding

Soft loans. This is a loan where the terms and

Free or subsidised consultancy. This is very

Start-up budget and working capital requirements

A budget is simply a plan that is set out in numbers. It is usual to set out a budget for the first 6 or 12 months when you set up your small business. The budget gives you a plan to work to. With a budget you will have a clearer idea of the money coming in to and going out of the business and the key items of expenditure and when they fall. With a budget in place you are then able to regularly monitor your business to check that you are sticking to the budget. Any difference between what you budget and what actually happens is called a variance. Checking for variances helps you to solve problems before they get out of control. Budgeting prepares for the future and foresees problems before they occur.

helpful in providing advice to those starting up a new enterprise for the first time. businesses that may not have access to certain resources, such as testing facilities for new products and projects. For example, small businesses can have access to Ministry of Defence research facilities. schemes whereby larger businesses help small firms by showing them how to develop new technologies, given government support. activities, e.g. some farming activities receive government cash support. provide advice and information, particularly through online resources to small business, e.g. the Small Firms Service.

Access to resources. This is helpful to small

Technology transfer. There are a number of

Subsidies. The government subsidises some

Advice and information. Government bodies

Key term
Variance. Difference between what actually happens and what was budgeted to happen.

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CASE STUDY

Super Sandwiches
When Karen Williams set up her sandwich-making business in Manchester, she created a budget which set out: the amount of money required to start up the business where that money came from (e.g.  savings, family, loans, credit card) what her production and other  variable costs would be each month where the income would come from  to cover those costs what her main capital items of  expenditure would be and when they would fall any additional inflows of funds  (e.g. loans) that would need to come into the business to cover capital expenditure.

Questions Explain why it might help Karen to create a capital budget to cover the purchase of capital 3 1  items for the business. Identify the financial flows and items that Karen would want to check on a regular basis. 3 2  3 3 3 Discuss the benefits that Karen would receive from creating a budget for her business. 3 3 3 4 Criticise the view that budgeting wastes valuable time and hence valuable resources and time spent on it should be kept to a minimum.

You may want to create a budget for setting up your business. This should include all the expenditures you need to incur before you start trading. It should show how these expenditures are matched with relevant funding. For example, to set up a sandwich-making business you might create the following set up budget. In creating the start-up budget above, the owner has a clear idea of how much it will cost simply to set up, what the main expenditures will be, and how these expenditures can be covered through funding. It is also important to create a budget to cover the first year of trading, setting out expected incomings and outgoings. This will include both capital expenditure and income generated from
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sales. A less detailed budget can also be created to cover the first three years of trading.

Budget for first 12 months of trading

We have set out a simple budget for Superior Sandwiches below. Note that it is broken into four main sections:

Income (a breakdown of all sources of incomes

and income generated from them) the business)

Outgoings (a breakdown of all outgoings from Income Outgoings The balance which is carried forward each month

Edexcel

Expenditures Rent of premises for three months Purchase of equipment Fixtures and fittings Advertising and promotion Purchase of supplies to start trading Pre-start up admin costs and salaries Total start up expenditures Covered by: Owners capital Bank loan
Table 8.3 Business expenditures

1200 2000 1000 1000 1000 2800 9000 5000 4000

Note that while the business is able to match incomes with outgoings in the first month it rapidly runs into a position where it is not generating enough income in following months. This is where the small business will rely on its overdraft or credit card to see itself through this difficult period. You can see from these figures that the business is increasingly having to draw on its overdraft to cover the negative balance from operating. This is while it waits for custom to pick up. You can see that by June the rate of increase of the negative balance is starting to slow down partly because sales are picking up.

Key term
Balance. The sum remaining when outgoings have been deducted from a previous balance and income.

January Income Owners capital Bank loan Sales Total income Outgoings Supplies Rent Equipment Fixtures & fittings Advertising Admin Wages Total outgoings Income outgoings Balance carried forward 1000 1200 2000 1000 1000 2800 600 9600 400 400 5000 4000 1000 10000

February

March

April

May

June

1000 1000

1000 1000

1500 1500

1500 1500

2000 2000

1500

1500

1500 1200

1500

1500

1000 2500 (1500) (1100)

1000 2500 (1500) (2600)

1000 3700 (2200) (4800)

1000 2500 (1000) (5800)

1000 2500 (500) (6300)

Note that negative figures are shown in brackets.

Table 8.4 Budget for first six months of trading ()

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July Income Owners capital Bank loan Sales Total income Outgoings Supplies Rent Equipment Fixtures Advertising Admin Wages Total outgoing Incomings outgoings Balance carried forward 2800 (800) (7100) 1600 1200 2000 2000

August

September

October

November

December

2500 2500

3000 3000

3500 3500

4000 4000

4000 4000

1700

1800

1900 1200

2000

2000

1700 800 (6300)

1800 1200 (5100)

3100 (400) (5500)

2000 2000 (3500)

2000 2000 (1500)

Table 8.5 Budget for second six months of trading ()

Learning activity
Create a budget anticipating the finance required and the expenditure involved in setting up your business. Then create a budget for the first 12 months that your business is in operation. The important thing is to make sure that your budget is realistic. You therefore need to create a set of supporting notes to justify the figures that you have created. For example, you can demonstrate that the figures for rent have been calculated by working out the square footage required for your business and then finding out the rental cost from an estate agent. You can justify your sales figures by carrying out market research to get a figure for the demand for your product. Equipment costs can be calculated by researching businesses of a similar size or type and the costs involved, and by doing Internet searches to find out capital equipment costs, etc.

You can see that by the end of the 12-month period the business is planned to be moving into a position where the negative balance is starting to disappear. The next turning point will be when break-even is achieved, and then the business will move into a profitable phase. That is the plan as set out in the budget.

Variance analysis
Creating a budget enables the business owner to get much greater control over the development of their business. The tool to do this is variance analysis. A variance is the difference between the planned (budgeted) figures and the figures that actually materialise. To do this you would set out a chart with two columns for each month. In the first month you

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would put the budgeted figures. In the second column you would put the actual figures. You could then add a third column to show percentage variance. Where there are high percentage variances it is important for managers to take

actions to stop the variances getting out of control. For example, if we take the budget for January for Super Sandwiches it could be set out as follows: (Note that we are assuming that the business does not have to make any repayments on the

Jan (budgeted figure) Income Owners capital Bank loan Sales Total income Outgoings Supplies Rent Equipment Fixtures and fittings Advertising Admin Wages Total outgoings Incomings outgoings Balance carried forward
Table 8.6 Budgeted and actual figures

Jan (actual figure) 5000 4000 500 9500

% variance 0 0 50% 5%

5000 4000 1000 10000

1000 1200 2000 1000 1000 2800 600 9600 400 400

1000 1200 1800 1200 1000 2800 600 9600 (100) (100)

0 0 +10% 20% 0 0 0 0

loan for the first three months after the loan is taken out.) You can see that the variance analysis indicates a problem in that sales in January are not as high as expected in fact the actual figure is only 50 per cent of the budgeted one. Clearly, this could be a problem if it continues into succeeding periods. Management may need to take action to deal with this, such as spending more money on advertising and promotion. In terms of outgoings, equipment has been less costly than expected. However, this is balanced by a higher than

expected charge for fittings. Management would need to note this but not necessarily take any action at this stage.

Working capital
All businesses need to have working capital. Working capital is the difference between the income that will flow into the business in the short term and the pressing debts that will need to be paid in the short term. For example, a business like Super Sandwiches will have pressing short-term liabilities that it
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has to pay, such as bills to suppliers for bread and other ingredients (which it may buy on credit terms). To meet these pressing liabilities the business will have short-term assets which it can turn into cash. For example, it will have cash in its tills and it will be owed money by debtors, for example, where it has carried out catering contracts for business and other functions.

are likely to be short of cash. If you run out of cash completely the business will not be able to operate.

Break-even. It is important to be able to

forecast when the business will be able to cover its costs with its revenues the break-even point. The sooner that this is reached the more likely you are to be able to borrow money, because once you have reached this point you can start to make a profit.

Key terms
Current assets. Things that a business owns that can be turned into cash in the short term, such as stock or debtors. Current liabilities. Things that the business owes in the short term, such as goods bought and not paid for, or loans borrowed that must be paid back. Working capital. Current assets of the business minus current liabilities.

Did you know?

A number of businesses have suffered from cash flow crises. Good examples are transport companies that have run out of cash and not been able to put fuel into their vehicles leading to a loss of confidence in the business. Other examples are football and other sports clubs which have run out of cash so that they are unable to pay their players wages.

Cash flow forecast

It is important to have this working capital, and you need to calculate how much working capital you need each month to enable the business to survive and develop. Many small business people tend to think of their overdraft facility and credit card to be part of their working capital. However, you need to be careful because, although using a credit card gives you access to funds, you are also building up a corresponding liability (with interest on top). When you construct a cash flow chart it is important to remember that the cash flow relates to actual cash coming in and out of a business. This flow therefore needs to be forecast for when the cash is received. For example, if you make a sale in January but are only paid for it in March then the cash flow should be recorded in March. The cash flow forecast shows how much cash is being generated in a particular month and the cumulative cash generation over time.

Forecasts for cash flow and breakeven

When you forecast, you are making a statement of what you expect to happen based on some sort of research to support your forecasts. Two important financial areas to forecast are described below.

Key term
Cash flow forecast. A technique for estimating the future bank balance of a company and anticipating overdraft requirements.

The cash flow in and out of the business. All

businesses need cash it is the oil that keeps the wheels of business turning. You need to know when cash is coming in and when you
for

We can illustrate this by setting out a simple cash flow forecast for a small business engaged in a retailing activity. The forecast opposite shows the first three months of trading.

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January Opening balance Income Cash sales Received from debtors Loans Total income Outgoings Wages Insurance Materials Repairs Telephone Drawings National insurance Capital expenditure Total outgoings Net cash flow i.e. Incomings outgoings Closing cash balance
Table 8.7 Cash flow forecast

February 1070 1000 300 1300

March 1550 1000 300 1300

0 800 100 3500 4400

25 20 100 15 40 600 30 2500 3330 1070 1070

25 20 100 15 30 600 30 820 480 1550

25 20 100 15 600 30 790 510 2060

Learning activity
Create a cash flow chart for your business idea for the first 12 months of trading. Base your cash flow forecasts on appropriate research, e.g. insurance costs from an insurance company, national insurance from official figures (i.e. a percentage calculation), etc.

point for your business idea. Ideally you will need to justify a forecast which goes well beyond the break-even point (at least in the second and third year of trading). Break-even analysis shows how a business will cover costs or make a profit/loss at different levels of operation.

Key terms

Breaking even
Any business that fails to cover its cost will find itself going down a slippery slope. Breaking even is therefore an important business objective, and one that ensures survival at least in the short term. You will need to calculate the break-even

Break-even analysis. Comparison of a firms revenue and its fixed and variable costs, to identify the minimum sales level needed to break even; it can be shown on a break-even chart. Breaking even. Making sure costs are covered.

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Lets look at this by examining how a fictional business (Exotic Sandwiches) can break even. Exotic Sandwiches sells one main type of luxury jumbo sandwich, which costs 2 to produce. The costs that go directly into making each luxury sandwich include:

raw materials wholemeal bread, mango,

chives and spices

has to sell enough sandwiches to cover these fixed costs too, or it will make a loss. As we saw above, every luxury sandwich sold brings in (or contributes) 1 towards covering the overheads. This 1 contribution comes from the sale price of 3 less the variable cost per sandwich of 2.

staff wages which are based on how many

sandwiches each employee sells. The sandwiches are sold for 3 each. On the face of it, it seems that the business is making a profit of 1 on each sandwich sold (3 2). However, we havent accounted for all the costs yet. So far we have only accounted for what we call variable costs how much it costs directly to produce each sandwich. These are called variable costs because they vary directly with the numbers of items produced or sold: Variable cost 1 sandwich 2 sandwiches 3 sandwiches 2 4 6
FiGURE 8.4 Calculating contribution

However, we havent included the overhead or fixed costs, which are the costs of running the business, regardless of how many sandwiches we produce.

Key terms
Contribution. The financial contribution that each unit of an item sold makes towards paying off the fixed costs of a business. For example, if the variable cost of producing a chocolate bar is 10p and the chocolate bar is sold for 40p, each bar is contributing 30p (revenue variable cost = 40 10 = 30). Overheads. Costs that do not change when the firm sells more, and are not incurred by a specific department of the company, e.g. rent.

Key terms
Fixed cost. A business cost that does not vary with the level of output or sales. Variable cost. A cost that increases with the level of output or sales, e.g. the cost of ingredients in producing chocolate bars.

These overheads include the rent on the shop, local business taxes, fuel bills, insurance, the managers salary, and so on. That window smashed last Friday night has to be paid for somehow! Lets say these overheads or fixed costs add up to exactly 20,000 per year. The business
30 GCE A2 Level Business
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Sale price per sandwich Variable cost per sandwich Contribution per sandwich

3 2 1

Edexcel

The business therefore has to sell 20,000 sandwiches per year to cover all of its fixed costs (20,000 1 = 20,000 sandwiches). If the business is open for 50 weeks in the year (being closed for two weeks holiday) this means that 400 sandwiches will need to be sold each week (20,000 50 weeks). As long as Exotic Sandwiches sells 400 sandwiches on average each week, it will be safe! Break-even analysis can be converted into a formula or rule that goes like this: Break-even sales = fixed cost contribution Another way of expressing this is: Break-even sales = overhead contribution In this case: Break-even = 20,000 (3 2 =1) = 20,000  sandwiches

Lets try these calculations again with a different business example. Imagine you run a hairdressing salon and charge 15 on average for each haircut. If the cost per haircut in terms of staff wages and materials is 5 and annual overheads are 50,000, how many haircuts do you need to do each year in order to cover your total costs and break even?  nswer: Overheads contribution A = 50,000 10 = 5000 per year If we assume again that your business operates for 50 weeks a year, then you need to provide 5000 50 = 100 haircuts each week (on average) to break even.

Learning activity
Use the break-even formula to work out the weekly break-even sales for the following examples, assuming each business operates for 50 weeks per year. You may need to use a calculator. There are three key pieces of information we will be using: fixed costs, variable costs per unit and sale price per unit. 1 A taxi driver charges an average of 10 per trip, with a cost per trip of 5 and has fixed costs of 25,000 per year. 2 A beauty salon charges an average of 12.50 per visit, with a cost per visit of 5 and has fixed costs of 100,000 per year. 3 A recording studio charges 25 per studio hour, with a variable cost of 7.50 per studio hour and fixed costs of 50,000 per year. This information can be summarised in the following table: Business Taxi driver Beauty salon Recording studio Average charge or sale price 10 12.50 25 Cost per unit 5 5 7.50 Fixed cost 25.000 100,000 50,000 Break-even sales level

Table 8.12 Price, costs and break-even

Break-even analysis can also be shown on a chart produced either manually or on a computer using a program like Microsoft Excel. We can do this manually by using a sheet of graph paper and

plotting sales on the horizontal axis, and costs and revenues on the vertical axis. The numbers to plot can be illustrated by the table below for Exotic Sandwiches.
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A Sales output in sandwiches per week

B Variable costs per week at 2 per sandwich

C Annual total variable cost (per 50 week year)

D Annual fixed costs at 20,000 regardless of sales

E Annual total costs (=total variable costs + fixed costs)

F Sales revenue per week at a price of 3 per sandwich)

G Annual total revenue (= weekly revenue 50)

100 200 300 400 500 600 700 800

200 400 600 800 1000 1200 1400 1600

10000 20000 30000 40000 50000 60000 70000 80000

20000 20000 20000 20000 20000 20000 20000 20000

30000 40000 50000 60000 70000 80000 90000 100000

300 600 900 1200 1500 1800 2100 2400

15000 30000 45000 60000 75000 90000 105000 120000

H Annual profit or loss (annual total revenue minus annual total cost) 15000 10000 5000 0 5000 10000 15000 20000

Table 8.9 Costs and revenues

We need to plot sales per week up to 800 on the horizontal axis and cost/revenue figures up to 120,000 per year on the vertical axis (see Figure 8.5). This will allow us to draw the following line graphs against weekly sales of 100800 sandwiches: D: Annual fixed cost E: Annual total costs = C + D G: Annual total revenue = A 3 50 You can draw all these lines by mapping the figures in each column against the right sales level. Lets start with annual fixed costs (line D). We know that these are 20,000, however many sandwiches are made and sold. We can therefore plot these as a straight line at 20,000. Now we can plot annual total cost (line E). Total cost is made up of two parts total fixed cost (which we have already drawn) and total variable cost. The variable cost is 2 per sandwich. We can therefore plot the total costs as a diagonal line starting at 20,000 and rising at 10,000 for every 100 sandwiches sold each week. For 100 sandwiches, total cost = 20,000 of fixed costs + 10,000 of variable costs (100 sandwiches 2 50 weeks). Now lets take line G (sales revenue). Where sales = 100, plot revenue of 15,000 and mark a small on the graph paper. Where sales = 200, plot revenue of 30,000. Keep going for the rest of the revenue figures compared to sales and then join all the points up to create a line graph. We can now illustrate profit or loss at any level of sales. This is simply G (total sales revenue)
32 GCE A2 Level Business
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E (total costs) at any level of sales. Once you have drawn all the lines you can see:

that the most profitable level of sales is 800 per

week

that the break-even sales level which must be

met to avoid making a loss is 400 per week change as sales rise

the way in which total costs and total revenue the profit-making zone, where the total

revenue line is higher than the total costs line (this is where sales are higher than 400 per week) line is below the total costs line (this is where sales are less than 400 per week).

the loss-making zone, where the total revenue

Learning activity
Create a break-even chart for your business idea. You will need to calculate sales revenue at different levels of output based on the price that you expect to charge. You will then need to calculate and illustrate variable costs and fixed costs based on figures that you collect from researching costs of operating your business. You can then use Microsoft Excel to create a spreadsheet which illustrates all of these figures and enables you to calculate break-even. When do you expect to break even? How much do you need to sell to break-even?

Edexcel

130,000 120,000 110,000 100,000 90,000 80,000 70,000 60,000 50,000 Loss-making zone 40,000 30,000 20,000 10,000 0 (D) Annual fixed cost Break-even level of sales = 400 per week 0 100 200 300 400 500 600 700 E) Annual total cost (G) Sales revenue

Costs and revenues

(A) 800

Output in sandwiches per week GCE A2 Business for Edexcel chart Double Award FiGURE 8.5 Break-even AW 007 Tek-Art (MJH)

Projected profit and loss accounts

The calculations that you have built into your break-even chart should provide invaluable information for setting up projected profit and loss accounts for the first year of trading. You can also consider how the business will look in three years time by forecasting what you expect to happen to costs and revenues during this period. For example, will you be likely to alter your pricing structure in the second and third years and what extra costs will you incur? If you increase the scale of your production will variable costs fall because of economies of scale?

A forecast profit and loss account enables you to estimate the sales revenues that will flow into your business and the costs directly associated with this activity. For example, if you sell a sandwich for 3 and it costs you 2 in direct materials and direct labour to produce it then that sandwich will make a 1 contribution to paying off expenses such as loan repayments, electricity bills, etc. Using the outline shown on page 34, it is possible to set out a projected profit and loss account. Target figures for revenues and costs can be placed in each month. Do this for your business over a 12-month period using a spreadsheet.
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Jan Sales Cost of sales Gross profit Less: expenses Electricity Stationery Business rates Loan interest repaid Depreciation Marketing expenses Training Advertising Other expenses Operating profit or loss Tax Operating profit after tax

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Table 8.10 Forecast profit and loss account

To create your profit and loss account, follow the steps below. 1  Calculate your forecast sales revenue: price charged number of items expected to be sold. 2  From this, deduct your cost of sales. Your cost of sales are the costs which can be directly calculated for each item prepared for sale. For example, if you are producing sandwiches then the cost of buying in the bread and filling will be the cost of sale. 3  Calculate the gross profit: sales revenue cost of sale. 4  From the gross profit, deduct the expenses. The expenses you incur depend on the type of business you are in, but typically include such things as interest on loans, rent and rates, etc. 5  Calculate the operating profit: gross profit expenses. 6  From the operating profit (or loss), deduct taxes.
34 GCE A2 Level Business
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Learning activity
Create a forecast profit and loss account for the first year of trading for your business. Also produce a forecast profit and loss account for the first three years of trading. Explain the assumptions you make about such things as the sales you expect to make (show how they are based on market research). Show how you have calculated costs. Use literature available from the Inland Revenue to calculate the tax that will need to be paid on profits.

Start-up balance sheets

A balance sheet is a list of all the assets (what the firm owns or is owed by others) and liabilities (what the firm owes). For a small business that is starting up, these assets will typically be fixed assets and current assets.

Edexcel

 Fixed assets include land and buildings, plant

and machinery, fixtures and fittings. These assets help the business to create wealth. Typically you will not sell your fixed assets you will use them to generate earnings for you.

The overall structure of the balance sheet therefore is: Assets what the business owns or is owed. Liabilities what the business owes to outsiders Owners capital what the business owes to the owners Liabilities are typically broken down into shortterm liabilities and long-term liabilities.

Current assets are assets that the business

will convert into cash in the short period. For example, current assets include items waiting to be sold, money owed to you for items sold on credit or for services rendered and, of course, cash itself.

Short-term liabilities (current liabilities) are

Key term
Balance sheet. Account setting out the assets and liabilities of a business at a particular moment in time as well as the owners capital. liabilities that need to be paid back in under one year, e.g. repayments to those that have supplied you on credit, your overdraft, etc.

Long-term liabilities are liabilities that need to

be paid back, but in over a year, e.g. mortgages and loans.

These assets appear in the top half of your balance sheet. The bottom part of the balance sheet shows the liabilities of the business (what the business owes) and the owners capital (what is owed to the owner(s) of the business).

You could set out the start-up balance sheet of your business as shown below. There are three columns to help you do your calculations. However, you do not have to use three columns. You could set out your balance sheet using two or even one column.

Balance sheet of my business as at [put starting date here] () Fixed assets Buildings Furniture Fixtures and fittings Current assets Stock Debtors Cash Current liabilities Overdraft Working capital Less long-term liabilities Owners capital 100000 20000 10000 _______ 130000 5000 500 1500 _______ 7000 1000 6000 _______ 136000 56000 80000 _______ _______ () ()

Figure 8.6 Balance sheet template

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To create the balance sheet outlined on page 35, we first set out the fixed assets of the business. We put this figure in the first column. We then calculated the current assets (stock + debtors + cash). We put this figure in the middle column as a sub-total. We then worked out the short-term liabilities of the business. This consisted of a 1000 overdraft and again we put this in the middle column as a sub-total. We then worked out the working capital of the business. The working capital is the current assets minus current liabilities. This showed the money that would come into the business within the short period and the money that would flow out. It is important to have working capital to meet pressing

demands such as to pay wages and bills. We put the figure for working capital (6000) in the end column a total column because it is such an important figure. We then needed to deduct long-term liabilities of 56,000 so again we put them in the right-hand column. The final figure is the sum of money that the owners have put into the business (80,000). A balance sheet will always balance because of the simple accounting equation: assets = liabilities + owners capital It makes sense when you think about it you can only buy assets with the money that you, the owners, have put into the business and any other debts that you have built up, such as in loans and overdrafts.

Learning activity
Create a start-up balance sheet for your business. Justify the realism of the figures that you have chosen. You can use the template set out below:
Balance sheet for as at () Fixed assets Buildings Equipment Fixtures and fittings () ()

Current assets Stocks Debtors Cash

Current liabilities Overdraft Trade credit Current liabilities Working capital

Less long-term liabilities Bank loan Other Owners capital

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8.4 Feasibility and evaluation

what if scenarios based on the information

already gathered

Too many business ideas fail because of poor planning, lack of foresight and poor cash flow management, not just because they were bad ideas in the first place.

a projected position for three years time based

on the scenarios chosen

alternative ideas.
Key term
Scenario. A what if situation. A situation that can be imagined to happen.

Did you know?

When the authors of this book carried out research into problems faced by young people setting up their own businesses, they found that typical difficulties included:

failure to create a business plan failure to research the market running out of cash to pay ongoing bills trying to expand too quickly  ot understanding that they would have to n pay certain costs, e.g. business rates.

Business plans need to be scrutinised by two groups of people: The Business Plan

There is a need to plan well, and a need to look at how things could change if plans are not successful or if other factors change. You will need to consider:

Internal scrutinisers The owners of the business, the sole trader or partners

External scrutinisers People who have or who are likely to lend the business money

evaluation of the business plan at the end of

the year

Figure 8.7 Who needs to evaluate the plan?

Businesses fail due to poor planning

Unit 8: Business 37

development

To make it easy for the business plan to be analysed and evaluated, it needs to have the following characteristics.

the market share, the more opportunity the organisation may have to develop competitive advantage over its rivals.

Clearly set out and attractive to the eye. A

modern business plan should look good and the reader should be able to find his or her way around the various sections of the plan with ease. The plan, therefore, needs to use state-of-the-art desktop publishing techniques, including spreadsheets, tables and charts. be set out in clear sections that include all the relevant information. There should be a table of contents at the start of the work, and related pieces of information should be grouped together, e.g. financial information, marketing information, etc. want to find their way round quickly, and check that the relevant information is set out in a convincing way. The reader who cannot quickly track down the market research information, the cash flow projection, profit projections, etc. will become frustrated and may even begin to wonder if the sheer volume of information may be masking real weaknesses in the business.

Key term
Profit margin. The difference between revenue and costs expressed as a percentage of the total revenue.

Systematically organised. The plan should

Of course, anyone lending money to or putting money into a business should be aware of the risks involved. A business plan is simply that a plan. A well-thought-out plan enables a business to step out with confidence. It does not, and can never, guarantee business success.

Not too long. Readers of a business plan

Evaluation of the business position at the end of a year

In setting up a business plan for a new business, it is important from the outset to be able to consider how effective the plan has been and how effectively the business ran. In other words, you need to identify ways in which you will evaluate the business position at the end of the year, and even three years ahead. You therefore need to establish expected targets to work towards. You can then evaluate the success of the business in meeting these targets. For example, you will need targets relating to such things as:

People who lend businesses money or who become involved as part owners, tend to take a pretty hard-nosed view of whether to get involved with a specific business or not. Some of the questions they will be seeking the answers to when they invest in or lend money to a business are set out below.

when you expect to break even monthly and yearly sales targets marketing targets, e.g. percentage of market
share

Will the business use my capital in an

efficient way so that there is a good rate of return on it relative to alternative investment opportunities? indicating the business plan is sound?

profit targets (profit margin targets) targets for how much return you would like on
your investment (return on capital employed)

Will the business make a healthy profit margin Will the business reward us adequately for

cash flow targets.

This section encourages you to think about the targets that you can set for your business which can be used to evaluate performance at the end of the first (and third) year.

the risk we are taking in tying up funds with it as well as be able to repay the initial investment if the need arises? organisation be able to command? The larger
for

How large a share of the market will the

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CASE STUDY

The Wind Surf School J

ane and Julian wanted to try something adventurous when they left university. So they set up a windsurf school to teach people wind surfing in Lanzarote (in the Canary Islands). They chose Lanzarote because it offered lots of custom from holiday makers. In addition, because of the good weather, it would enable them to operate almost all year round. They calculated that the fixed cost of setting up the windsurf school and other fixed costs for the first year would be about 50,000, including all the equipment they wanted to buy and the fixed costs involved with choosing appropriate premises. They carried out market research to find out how much customers would be prepared to pay, as well as looking at prices charged by competitors in the resort where they had chosen to set up. They found that they could charge about 20 per hour. They calculated that, in a typical month, the overall market size in their resort would be 4000 rental hours. (in other words

4000 one-hour lessons). They calculated that they would be able to take 10 per cent of this market in the first year, and 20 per cent of the market in the second year, when they were better known, had developed better marketing and word of mouth had spread about their superior service. They calculated that variable costs per hour, including the cost of instruction would be 10 per hour. In the second year of operating the business, they would incur an extra 5000 of fixed costs when new equipment was purchased in January.

Questions Use the following template to work out: the expected break-even point (when this would occur) any profits that the business would expect to make, and when they would occur.
YEAR 1 Jan Fixed cost Variable cost Sales revenue Profit/ loss Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Jan Fixed cost Variable cost Sales revenue Profit/ loss

Feb

Mar

Apr

YEAR 2 May Jun

Jul

Aug

Sep

Oct

Nov

Dec

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Some important aspects of evaluating business performance at the end of the first year are set out below.

Return on capital employed

There are various ways of using quantitative measures to judge the success of your business, including:

How effective was the market research? Did it

provide an accurate picture of what consumers were looking for? expected? effective?

the figure for capital employed is usually taken

at the start of the year, as this is the capital that generated the profit in the year capital + external capital invested in the business, e.g. loans.

Did we capture the share of the market that we Was the promotional mix appropriate and Did we get the marketing mix right? Are

the capital invested in a business is the owners

there new aspects of the marketing mix that we could develop, e.g. new products, new distribution channels, etc.? are we near the break-even point?

There are two methods that you can use for calculating capital employed: 1 The sources of finance approach: Owners capital + finance creditors, e.g. loans, overdraft, etc. cash 2 The net assets approach Fixed assets + stock + debtors The best way to think about the percentage return on capital is to compare it with other investments.

Did we manage to break even as anticipated, How accurate was our budgeting? What is our cash flow position? Do we have
enough cash?

What are our prospects for making profits?

Learning activity
Prepare a framework for evaluating your business idea at the end of the first year. Set out a list of questions to ask and a set of criteria for judging its effectiveness. For example, if you wanted to find out what percentage of the market you had gained at the end of the first year, you should decide what percentage of the market would be acceptable. What would be good and bad performance?

If I invest 100 in a building society and earn

10 in interest in the year, the return on capital is 10 per cent. biscuits and earn 11 profit in a year, then the return on my capital is 11 per cent.

If I put 100 into my own business producing

Find out more

Find out more about starting your own business from one of the following:

Department for Trade and Industry (DTI)

www.dti.go.uk/bestpractice Business Gateway www.businessgateway.com Business Link www.businesslink.gov.uk Shell LiveWIRE www.shell-livewire.org Smallbusiness.co.uk www.smalbusiness.co.uk Startups.co.uk www.startup.co.uk

In setting out a business plan, therefore, you need to convince potential backers (and yourself) that the return on capital will be relatively more attractive than alternative investment opportunities. Of course, another ingredient is the reliability of the return. If people reading your business plan feel your figures are just pie in the sky, they will not risk their money with you. Return on capital employed (ROCE) can be measured using the following formula: Profits before interest and tax ROCE = ___________________________ 100 Capital employed

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CASE STUDY

The following figures show a summary of key financial indicators for Tesco from 2000 to 2004.

Profits at Tesco
2000 (m) 16808 993 2001 (m) 18203 1100 2002 (m) 19821 1213

Year ended February UK turnover Operating profit (UK)

2003 (m) 21309 1297

2004 (m) 24760 1526

Source: Tesco Website, Financial Information

You can see that both turnover and operating profit have increased. However, a more useful indicator is operating profit percentage, i.e. operating profit as a percentage of sales. When you do this calculation you will be able to see the

operating profit for each 1 of sales made in the five years. Operating profit percentage is calculated by: ______________ Operating profit ___ 100 Turnover 1

Questions Calculate the operating profit percentage for Tesco in each of the five years shown. 3 1  Suggest ways in which financial managers at Tesco could seek to improve this performance. 3 2  3 3 3 3 Evaluate the trend. Is it good or bad? 3 3 3 4 Propose a set of ideas for a company that is a rival to Tesco, which might enable it to steal market share from Tesco.

Key term
ROCE. Return on capital employed. Profit measured as a percentage of the capital ploughed into a business by owners and in the form of loans and other types of capital injections.

Profit margins
Profits is a key indicator when judging business performance. It is the first point of reference for many lenders. It is all very well saying sales have risen, productivity is soaring and the organisation is growing. However, providers of finance will always want to know the answer to the question: But have you made a profit? In creating a business plan, the entrepreneur should set out a projected profit and loss account. This account will set out a number of profitability targets as shown in Table 8.11. Useful ways of calculating profit are gross profit and operating profit margins. In the Table 8.11, you can see the person who created the business plan anticipated gross profit percentages would rise from 33 per cent to 60 per cent over the first three years, while operating profit margins would rise from 0 per cent to 40 per cent over the same period.
Unit 8: Business 41

Learning activity
When you initially create your business idea calculate the ROCE. Explain the assumptions behind this calculation, i.e. show how you worked out the capital employed and the basis on which your profit calculations are estimated. If you run a business for a year at the end of it you will need to show how ROCE was calculated. Did it meet expectations? If so, explain your workings. If not, explain what went wrong.

development

2007 Turnover Cost of sales Gross profit Gross profit % Expenses Operating profit Operating profit % 3000 2000 1000 33 1000 0 0

2008 4000 2000 2000 50 1000 1000 25

2009 5000 2000 3000 60 1000 2000 40

Learning activity
Before you start off a business activity you should forecast gross profit margins and operating profit margins at the end of the first year. If you run your business for a year, you can then compare actual performance with forecasted/budgeted performance. What went right and what went wrong? Use your figures to answer this question.

SWOT analysis
Another useful tool to evaluate your business at the end of the first year is to do a SWOT analysis.

Table 8.21 Calculating profit margins

Strengths and Weaknesses are internal to

However, the reality for most businesses is that, for the first few months of running a business, losses will be made because:

it takes time to publicise a business and its

products to generate sales outweigh early sales.

the business. They typically relate to the resources of the business (e.g. finance, people, management). Strengths also relate to the quality of the planning and the strengths of the products (goods and services) that the business provides. Another strength or weakness is the position that the business holds in the market, e.g. is it the market leader or just a small insignificant player? to the market (e.g. is it growing) and to the competition (e.g. do they offer superior products?). Opportunities and threats also relate to some external environmental factors, such as new government laws, development of new technologies, etc.

the start-up costs of a business usually

The gross profit margin shows the gross profit made on sales: Gross profit Gross profit margin = ______________ 100 Turnover (sales) In evaluating whether 5, 10, 15 or 20 per cent would be a suitable gross profit margin, you would need to compare it to returns made on similar start-up businesses. The operating profit margin shows the operating profit expressed as a percentage of turnover. It is a measure of the business owners ability to control indirect costs, and operating profit equals gross profit minus overheads: Net profit Net profit margin = __________ 100 Turnover

Opportunities and Threats typically relate

Key term
SWOT analysis. Analysis of an organisation and its external environment to assess its internal strengths and weaknesses, and the opportunities and threats that exist in its operating environment.

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CASE STUDY Example SWOT analysis

Julia set up as a fitness trainer last year. She hires out the local leisure centre to run aerobics and other classes. At the end of the first year she set out a SWOT analysis to evaluate how her business was progressing. On the basis of her SWOT she created an action plan to build on the strengths, reduce the weaknesses, take advantages of opportunities and combat threats.

Strengths

Weaknesses

Good capital base to set up the business Lots of regular clients High percentage gained of intended market  Good locations to operate from  arried out detailed research to find out musical C requirements of clientele Classes always fully booked Good promotional activity  xceeded targets for profitability and return on E capital employed

 ad to cancel some classes because H of double-bookings to leisure centres Poor-quality sound systems  ad to cancel classes due to illness in H December

Opportunities

Threats

 ew leisure centre facility opening up early next N year  ossibility of providing some classes at local P college Growth in the market of 10 per cent per year 

 wo new rival competitors setting T up in the new year offering a wider range of classes

Action plan These are the key areas that Julie included in her action plan: 1  Investigate possibility of taking on a parttime partner 2 Invest in new sound equipment

3  Increase promotional activity to differentiate product from competitors 4  Develop loyalty schemes to retain existing customers 5  Investigate possibility of winning contracts with new leisure facility

Unit 8: Business

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Learning activity
Create a SWOT analysis to evaluate the performance of your business after one year or after a period of trading. Produce an accompanying action plan related to it.

they are likely to buy a given number of your product at a certain price. However, you dont know that they will until they have actually made the purchase. You should, therefore, create some what if scenarios e.g. what if sales are 10 per cent less than expected? What if costs are 10 per cent higher than expected?

What if scenarios
The actual running of a business frequently turns out to be different to what is planned. There are all sorts of things that can happen that would move the business off plan. For example:

Learning activity
Create some what if budgets for your business based on assumptions about demand and cost conditions being different from what you have expected. For example, what if demand is 10 per cent lower and costs 10 per cent higher than expected? You should be able to work out the implications for break-even and profits. Given these what if scenarios you should be able to identify alternative courses of action to take.

sales could be higher or lower than expected costs could turn out to be higher or lower than
anticipated

the competition could prove to be stronger or

weaker than expected. In setting up a business, therefore, it is important to anticipate a range of what if situations, and to plan for them. For example, what if a new competitor undercuts my prices? What is the implication for my business and what should I do about it? The giant oil company Shell developed an approach from the 1970s onwards known as scenario planning. This involves imagining a range of scenarios for the oil industry e.g. there is a long cold winter, there is a war in a sensitive part of the world, the government creates tougher environmental laws, etc. Shell is then able to make what are termed contingency plans to prepare for a range of eventualities so that it isnt taken by surprise. In carrying out your research you will gather information. For example:

A projected position for three years time based on the scenarios chosen
It is difficult for businesses to plan in detail for more than a year ahead. Large businesses do it in the form of strategic (business) plans which are for three, five and even more years ahead. In a small business that is starting up this is particularly difficult. Any plans that you make for the future should therefore be tinged with caution. However, using scenarios that you build (realistic, pessimistic and optimistic ones) you can make some form of projection about what your business will look like three years ahead. For example, what position will it have in its market (e.g. market leader, small player, etc)? What sorts of sales revenue will it make? What about profits will they rise steadily over the three years? Will the business be likely to diversify into new lines? You should be able to identify at least three positions from the scenarios developed: 1 T  he most likely situation. This should be based on your market, production and financial research. From these you should be able to predict the most likely situation and

market research (information about the

market)

competitor research (information about

competitors) conditions).

cost research (information about supply

Carrying out this research should make it clear that you cannot predict future events with absolute certainty. For example, consumers say
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you will have already created budgets, cash flow statements, profit and loss accounts and balance sheets for this situation. 2  A pessimistic scenario. This is a situation in which the competition proves to be tougher than expected, and the market more difficult to penetrate. Costs will be higher than expected. Using these pessimistic predictions, calculate a break-even point and show what the profit and loss account will look like in three years time. Explain the pessimistic assumptions that you have made for this scenario. 3  An optimistic scenario. This is a situation in which sales revenue is higher than expected and your business wins more market share than anticipated. Calculate the break-even point and show what the profit and loss account will look like in three years time. Explain the optimistic assumptions that you have made for this scenario. You should anticipate possible changes that might take place in the business environment and explain these. Possible changes could be changes in the market and economic conditions and new legal or environmental requirements coming into force.

What do you do if the business plan fails? You need to show that you have alternative ideas to deal with this situation. You need to have ideas about what you can do if you are falling short of your plan. For example, to raise sales revenue, you could take actions such as:

reducing or raising price spending more money on advertising and

promotion

offering better terms and service to customers.

To lower costs, you could take actions such as:

moving your business to a lower-cost location buying stock from a cheaper supplier cutting down on waste.
If the business is a failure, then you need to have other ideas, such as producing a new good or service.

Learning activity
Set out some alternative ideas: 1 for tackling problems which are causing a business plan to go off track 2 for new business ideas that could be developed should an original business idea fail.

Alternative ideas
If you follow up the ideas and learning activities in this unit you will be well placed to create an effective business plan for a business idea and to create systems to monitor and control the business over time.

Did you know?

The soft drink 7Up was launched on six previous occasions. Each time it failed until the seventh time, when they chose the name 7Upand the rest is history.

Unit 8: Business

development

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Unit assessment
If you carry out the tasks set out in the learning activities in this unit and follow the suggestions provided you will be well on your way to completing your unit assessment.

What you are required to (individually) produce

A fully developed business plan for the establishment of a new small business operating as a sole trader or partnership to cover: aims and objectives a marketing plan resource issues financial analysis and planning. The plan will be presented as a viable business idea, suitable to support a request for finance for the venture.

What you need to include in your work to score higher marks

Detailed and original ideas with fully supported and justified evidence and proposals Detailed and original information on competition A comprehensive presentation of resource and quality issues with fully supported and detailed evidence A detailed and professionally presented finance plan, with accurate and detailed financial forecasts, including break-even calculations, cash flow, budgets, profit and loss accounts and balance sheets A detailed analysis and evaluation of the current and projected future position of the business with detailed and original recommendations and justifications of your conclusions

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GCE A2 Level Business

for

Edexcel