Chapter 7, Size of a business

External growth: business expansion achieved by means of merging with or taking over
another business, from either the same or a different industry

When 2 businesses collide, it is more efficient because they share facilities and larger
economies of scale. save money on marketing and distribution cost

Merger: an agreement by shareholders and managers of two businesses to bring both firms
together under a common board of directors with shareholders in both businesses owning
shares in the newly merged business.

Takeover: when a company buys more than 50% of the shares of another company and
becomes the controlling owner of it – of en referred to as ‘acquisition’.

Synergy: literally means that ‘the whole is greater than the sum of parts’, so in integration it
is of en assumed that the new, larger business will be more successful than the two, formerly
separate, businesses were

it can fail because it is too big and difficult to control, little mutual benefit, and they may have
2 different ideologies.
22: The nature of operations

operations is concerned with the use of resources land labour and capital.peration managers
must be concerned with efficiency on production, quality and innovation.
The production process;
the inputs are converted into outputs.

Added value: the difference between the cost of purchasing raw materials and the price the
finished goods are sold for – this is the same as creating value.

the value added depend on the design on the product, the efficiency in which the inputa
resources are combined and managed and being able to convince ocnsumers to pay more
for the product than the cost of the inputs.
all operations need land labour and capital
Intellectual capital: intangible capital of a business that includes human capital (well-trained
and knowledgeable employees), structural capital (databases and information systems) and
relational capital (good links with suppliers and customers)
Production and productivity

Production: converting inputs into outputs.

Level of production: the number of units produced during a time period.
Productivity: the ratio of outputs to inputs during production, e.g. output per worker per time
period
Raising productivity levels
4 ways in which productivity levels can be increased
1. improve the training staff to raise skill levels
2. improve worker motivation
3. purchase more technological advanced equipment
4. more efficient management

increasing productivity does not guarantees a business to success. more worker effort may
increase wages.
Efficiency and effectiveness

23: operation planning

Operations planning: preparing input resources to supply products to meet expected

demand.

The decisions taken by operations managers can have a significant impact on the success
of businesses. These decisions are often influenced by:
■ marketing factors
■ availability of resources
■ technology
 1) The link with marketing
■ match output closely to the demand levels – this may require the holding of inventories
■ keep inventory levels to a minimum efficient level
■ reduce wastage of production, e.g. by perishable products being rejected due to being too
old
■ employ and keep busy a stable, appropriate number of staff
■ produce the right product mix, i.e. the range of products that are forecast to be demanded
2) The availability of resources
■ Location: A business might locate in a country or a region that has an abundant supply of
necessary raw materials.
■ Nature of production method: If the supply of suitable employees is good and wage costs
are low then a business might decide to operate a labor intensive production method.
■ Automation: If the cost of automated/robotic computer controlled equipment is falling then
a business could decide to change production methods in favor of IT-based systems.
3) Technology
CAD – computer aided design: the use of computer programs to create two- or
three-dimensional (2D or 3D) graphical representations of physical objects.
CAM – computer aided manufacturing: the use of computer software to control machine
tools and related machinery in the manufacturing of components or complete products.

The benefits of CAD include:

■ lower product development costs
■ increased productivity
■ improved product quality
■ faster time-to-market
■ good visualization of the final product and its constituent parts
■ great accuracy, so errors are reduced
■ easy re-use of design data for other product applications.

The limitations of CAD include:

■ complexity of the programs
■ need for extensive employee training
■ large amounts of computer processing power required and this can be expensive.

The benefits of CAM include:

■ precise manufacturing and reduced quality problems – compared to production methods
controlled by people
■ faster production and increased labor productivity
■ more flexible production allowing quick changeover from one product to another
■ integrating with CAD, CAM allows more design variants of a product to be produced, which
means that niche products can be produced as well as mainstream mass market products.
This increased customisation increases the competitiveness of businesses in both small and
large market segments.

The limitations of CAM include:

■ cost of hardware, programs and employee training – these costs may mean that smaller
businesses cannot access the benefits of CAM – although technology is becoming cheaper
■ hardware failure – breakdowns can and do occur and they can be complex and
time-consuming to solve

The need for flexibility and innovation

Operational flexibility: the ability of a business to vary both the level of production and the
range of products following changes in customer demand.
■ increase capacity by extending buildings and buying more equipment
■ hold high stocks
■ have a flexible and adaptable labor force
■ have flexible flow-line production equipment

Process innovation: the use of a new or much improved production method or service
delivery method.
■ Robots in manufacturing.
■ Faster machines to manufacture microchips for computers.
■ Computer tracking of inventories, e.g. by using barcodes and scanners, to reduce the
chances of customers finding businesses out of stock.
■ Using the Internet to track the exact location of parcels being delivered worldwide and
improve the speed of delivery

Production methods
Job production: producing a one-of item specially designed for the customer.
Batch production: producing a limited number of identical products – each item in the batch
passes through one stage of production before passing on to the next stage.
Flow production: producing items in a continually moving process.
Mass customisation: the use of flexible computer aided production systems to produce items
to meet individual customers’ requirements at mass-production cost levels.
 Problems of changing production methods
Job to batch:
■ Cost of equipment needed to handle large numbers in each batch.
■ Additional working capital needed to finance stocks and work in progress.
■ Staff demotivation – less emphasis placed on an individual’s craft skills.

Job or batch to flow:

■ Cost of capital equipment needed for flow production.
■ Staff training to be flexible and multi skilled – if this approach is not adopted, then workers
may end up on one boring repetitive task, which could be demotivating.
■ Accurate estimates of future demand to ensure that output matches demand.

Production methods – making the choice

■ Size of the market:
■ The amount of capital available
■ Availability of other resources
■ Market demand exists for products adapted to specific customer requirements
 Location decisions
Optimal location: a business location that gives the best combination of quantitative and
qualitative factors.
Deciding on the best location for a new business – or relocating/expanding an existing one –
is of en crucial to its success
Benefits of an optimal location
■ strategic in nature – as they are long-term and have an impact on the whole business
■ difficult to reverse if an error of judgment is made – due to the costs of relocation
■ taken at the highest management levels – they are not delegated to subordinates.

So an optimal location is likely to be a compromise that:

■ balances high fixed costs of the site and buildings with convenience for customers and
potential sales revenue
■ balances the low costs of a remote site with limited supply of suitably qualified labor
■ balances quantitative factors with qualitative ones (see below)
■ balances the opportunities of receiving government grants in areas of high unemployment
with the risks of low sales as average incomes in the area may be low.

Factors influencing location decisions: quantitative factors

Quantitative factors: these are measurable in financial terms and will have a direct impact on
either the costs of a site or the revenues from it and its profitability.

1) Labour costs
2) Transport costs
3) Sales revenue potential
4) Government grants

1) Profit estimates > By comparing the estimated revenues and costs of each location,
the site with the highest annual potential profit may be identified.
 2) Investment appraisal > Location decisions often involve a substantial capital
investment. Investment appraisal methods can be used to identify locations with the
highest potential returns over a number of years
3) Break-even analysis > The lower this break-even level of output, the better that site
is, other things being equal.

Qualitative factors
Qualitative factors: non-measurable factors that may influence business decisions.
1) Safety
2) Room for further expansion
3) Managers’ preferences
4) Ethical considerations
5) Environmental concerns
6) Infrastructure

Advantages and disadvantages of multi-site locations

International location decisions

Offshoring: the relocation of a business process done in one country to the same or another
company in another country.
Multinational: a business with operations or production bases in more than one country.
Reasons for international location decisions
1) To reduce costs
2) To access global (world) markets
3) To avoid protectionist trade barriers ( Tariff, quota, embargos)
Barriers
1) Language and other communication barriers
2) Cultural differences
3) Level-of-service concerns
4) Supply-chain concerns
5) Ethical considerations
 SCALE OF Operation
Scale of operation: the maximum output that can be achieved using the available inputs
(resources) – this scale can only be increased in the long term by employing more of all
inputs.

■ owners’ objectives
■ capital available
■ size of the market the firm operates in
■ number of competitors
■ scope for scale economies

Increasing the scale of operations> ECONOMIES OF SCALE

Economies of scale: reductions in a firm’s unit (average) costs of production that result from
an increase in the scale of operations.
1) Purchasing economies
2) Technical economies
3) Financial economies
4) Marketing economies
5) Managerial economies

Diseconomies of scale – big can be inefficient too

Diseconomies of scale: factors that cause average costs of production to rise when the scale
of operation is increased.
1) Communication problems
2) Alienation of the workforce
3) Poor coordination
 Avoid diseconomies of scale

1) Management by objectives
2) Decentralisation
3) Reduce diversification
Enterprise resource planning: the use of a single computer application to plan the purchase
and use of resources in an organization to improve the efficiency of operations.
Supply chain: all of the stages in the production process from obtaining raw materials to
selling to the consumer – from point of origin to point of consumption.
24: Inventory management

Inventory (stock): materials and goods required to allow for the production and supply of
products to the customer.

Manufacturing Business will hold stock in…

1) Raw materials and components
2) Work in progress
3) Finished goods

Inventory-holding costs
■ Opportunity cost: Working capital tied up in goods in storage could be put to another use.
It might be used to pay off loans, buy new equipment or pay off suppliers early to gain an
early-payment discount.
■ Storage costs: Inventories have to be held in secure warehouses. They often require
special conditions, such as refrigeration. Employees will be needed to guard and transport
the goods.
■ Risk of wastage and obsolescence: If inventories are not used or sold as rapidly as
expected, then there is an increasing danger of goods deteriorating or becoming outdated.

Costs of not holding enough inventories

● Lost sales: If a firm is unable to supply customers from goods held in storage, then
sales could be lost to firms that hold higher inventory levels.
● Idle production resources: If inventories of raw materials and components run out,
then production will have to stop.
● Special orders could be expensive: If an urgent order is given to a supplier to deliver
additional materials due to shortages, then extra costs might be incurred in
administration of the order and in special delivery charges.
● Small order quantities: Keeping low inventory levels may mean only ordering goods
and supplies in small quantities. The larger the size of each delivery, the higher will
be the average level of inventories held.
Economic order quantity: the optimum or least-cost quantity of stock to re-order taking into
account delivery costs and stock-holding costs.

Controlling inventory levels – a graphical approach

Buffer inventories: the minimum inventory level that should be held to ensure that production
could still take place should a delay in delivery occur or should production rates increase.
Reorder quantity: the number of units ordered each time.
Lead time: the normal time taken between ordering new stocks and their delivery.

Just-in-time (JIT) inventory control

Just-in-time: this inventory-control method aims to avoid holding inventories by requiring
supplies to arrive just as they are needed in production and completed products are
produced to order.

■ Relationships with suppliers have to be excellent:

■ Production staff must be multiskilled and prepared to change jobs at short notice
■ Equipment and machinery must be flexible
■ Accurate demand forecasts will make JIT a much more successful policy
■ The latest IT equipment will allow JIT to be more successful
■ Excellent employee–employer relationships are essential for JIT to operate smoothly
■ Quality must be everyone’s priority

JIT may not be suitable for all firms at all times:

■ There may be limits to the application of JIT if the costs resulting from production being
halted when supplies do not arrive far exceed the costs of holding buffer inventories of key
components.
■ Small firms could argue that the expensive IT systems needed to operate JET effectively
cannot be justified by the potential cost savings.
chapter 28 business finance

Start-up capital: the capital needed by an entrepreneur to set up a business.

Working capital: the capital needed to pay for raw materials, day-to-day running costs and
credit offered to customers. In accounting terms working capital = current assets – current
liabilities.
Capital expenditure: the purchase of assets that are expected to last for more than one year,
such as building and machinery.
Revenue expenditure: spending on all costs and assets other than fixed assets and includes
wages and salaries and materials bought for stock.
Liquidity: the ability of a firm to be able to pay its short term debts.
Liquidation: when a firm ceases trading and its assets are sold for cash to pay suppliers and
other creditors.

How much working capital is needed?

Sufficient working capital is essential to prevent a business from becoming illiquid and
unable to pay its debts. Too high a level of working capital is a disadvantage; the opportunity
cost of too much capital tied up in inventories, accounts receivable and idle cash is the
return that money could earn elsewhere in the business – invested in fixed assets, perhaps

Where does finance come from?

■ internal money raised from the business’s own assets or from profits left in the business
(plowed-back or retained earnings)
■ external money raised from sources outside the business.
 Internal sources of finance

Profits retained in the business

If any profit remains, this is kept (retained) in the business and becomes a source of finance
for future activities. Clearly, a newly formed company or one trading at a loss will not have
access to this source of finance. For other companies, retained earnings – if in a liquid form
– are a very significant source of funds for expansion.

Sale of assets
Established companies often find that they have assets that are no longer fully employed.
These could be sold to raise cash.

Reductions in working capital

When businesses increase stock levels or sell goods on credit to customers (trade
receivables), they use a source of finance. When companies reduce these assets – by
reducing their working capital – capital is released, which acts as a source of finance for
other uses.

External sources of finance

Short-term sources
■ bank overdrafts
■ trade credit
■ Debt factoring.
Overdraft : bank agrees to a business borrowing up to an agreed limit as and when required.
Factoring: selling of claims over trade receivables to a debt factor in exchange for immediate
liquidity – only a proportion of the value of the debts will be received as cash.

Bank overdraft
This means that the amount raised can vary from day to day, depending on the particular
needs of the business. The bank allows the business to ‘overdraw’ on its account at the bank
by writing cheques or making payments to a greater value than the balance in the account.

Trade credit
By delaying the payment of bills for goods or services received, a business is, in effect,
obtaining finance.
 Debt factoring

When a business sells goods on credit, it creates trade receivables. The longer the time
allowed to pay up, the more finance the business has to find to carry on trading

Sources of medium-term finance

■ hire purchase and leasing >
■ medium-term bank loan.

Hire purchase and leasing

Hire purchase: an asset is sold to a company that agrees to pay fixed repayments over an
agreed time period – the asset belongs to the company.
Leasing: obtaining the use of equipment or vehicles and paying a rental or leasing charge
over a fixed period, this avoids the need for the business to raise long-term capital to buy the
asset; ownership remains with the leasing company.

Long-term finance
■ long-term loans from banks
■ debentures (also known as loan stock or corporate bonds).

Equity finance: permanent finance raised by companies through the sale of shares.
Long-term loans: loans that do not have to be repaid for at least one year.

Long-term loans from banks

These may be offered at either a variable or a fixed interest rate. Fixed rates provide more
certainty, but they can turn out to be expensive if the loan is agreed at a time of high interest
rates. Companies borrowing from banks will have to provide security or collateral for the
loan; this means the right to sell an asset is given to the bank if the company cannot repay
the debt.

Long-term bonds or debentures

Long-term bonds or debentures: bonds issued by companies to raise debt finance, often with
a fixed rate of interest.

Venture capital: risk capital invested in business start-ups or expanding small businesses
that have good profit potential but do not find it easy to gain finance from other sources

Microfinance
Microfinance: providing financial services for poor and low-income customers who do not
have access to banking services, such as loans and overdrafts offered by traditional
commercial banks
Crowdfunding: the use of small amounts of capital from a large number of individuals to
finance a new business venture.

Business plan: a detailed document giving evidence about a new or existing business, and
that aims to convince external lenders and investors to extend finance to the business.
29 costs

Direct costs: these costs can be clearly identified with each unit of production and can be
allocated to a cost center.
Indirect costs: costs that cannot be identified with a unit of production or allocated accurately
to a cost center.
Fixed costs: costs that do not vary with output in the short run.
Variable costs: costs that vary with output.
Marginal costs: the extra cost of producing one more unit of output.
Break-even point of production: the level of output at which total costs equal total revenue,
neither a profit nor a loss is made

Margin of safety: the amount by which the sales level exceeds the break-even level of
output.
Production over break-even point = = 200 / 400 = 50 0. %

break-even level of output = fixed cost / contribution per unit

Contribution per unit: selling price less variable cost per unit.

31 forecasting and managing cash flow

Cash flow: the sum of cash payments to a business (inflows) less the sum of cash payments
(outflows).
Liquidation: when a firm ceases trading and its assets are sold for cash to pay suppliers and
other creditors.
Insolvent: when a business cannot meet its short-term debts.
Cash inflows: payments in cash received by a business, such as those from customers
(trade receivables) or from the bank, e.g. receiving a loan.
Cash outflows: payments in cash made by a business, such as those to suppliers and
workers.

How to forecast cash flow?

INFLOWS
■ Owner’s own capital injection: This will be easy to forecast as this is under Mohammed’s
direct control.
■ Bank loan payments: These will be easy to forecast if they have been agreed with the
bank in advance, both in terms of amount and timing.
■ Customers’ cash purchases: These will be difficult to forecast as they depend on sales, so
a sales forecast will be necessary – but how accurate might this be?
■ Trade receivables payments: These will be difficult to forecast as these depend on two
unknowns.

OUTFLOWS
■ Lease payment for premises – easy to forecast as this will be in the estate agent’s details
of the property.
■ Annual rent payment – easy to forecast as this will be fixed and agreed for a certain time
period. The landlord may increase the rent after this period, however.
■ Electricity, gas, water and telephone bills

Cash-flow forecast: estimate of a firm’s future cash inflows and outflows.

Net monthly cash flow: estimated difference between monthly cash inflows and cash
outflows.
Opening cash balance: cash held by the business at the start of the month.
Closing cash balance: cash held at the end of the month becomes next month’s opening
balance.

The causes of cash-flow problems

1) Lack of planning
2) Poor credit control
3) Allowing customers too long to pay debts
4) Expanding too rapidly
5) Unexpected events
Credit control: monitoring of debts to ensure that credit periods are not exceeded.
Bad debt: unpaid customers’ bills that are now very unlikely to ever be paid.
Overtrading: expanding a business rapidly without obtaining all of the necessary finance so
that a cash-flow shortage develops.
Creditors: suppliers who have agreed to supply products on credit and who have not yet
been paid.