Chapter 1: The purpose of Business Activity

The economics problem: needs and wants.

Basically, all humans have needs and wants. Needs are things we can't live without, while wants are
simply our desires that we can live without. We all have unlimited wants, which is true, since all of
us want a new PC, a car, new graphics card, etc. that we actually do not need to live. Businesses
produce goods and services to satisfy needs and wants.

Although we have unlimited wants, there are not enough resources for everyone. Resources can be
split into 4 factors of production, which are:

- Land: All natural resources used to make a product or service.
- Labor: The effort of workers required to make a product or service.
- Capital: Finance, machinery and equipment required to make a product or service.
- Enterprise: Skill and risk-taking ability of the entrepreneur.

Entrepreneurs are people who combine these factors of production to make a product.

With these discussed, lets move on to the economic problem. The economic problem results from
limited resources and unlimited wants. This situation causes scarcity, when there are not enough
goods to satisfy the wants for everybody. Because of this, we will have to choose which wants we
will satisfy (that will be of more benefit to us) and which we will not when buying things. For any
choice, you will have to would have obtained if you didn't spend that money. For example, you
would have got a book if you didn't buy the pen, or you would have a burger if you didn't buy the
chips. Basically, item that you didn't buy is the opportunity cost. Make sure that the opportunity
cost isn't higher than what you bought!


"Opportunity cost: the next best alternative given up by choosing another item."
Here is a diagram showing the whole economic problem:

Division of labor/Specialization

Because there are limited resources, we need to use them the most efficient way possible. Therefore,
we now use production methods that are as fast as possible and as efficient (costs less, earns more) as
possible. The main production method that we are using nowadays is known as specialization, or
division of labor.


"Division of Labor/Specialization is when the production process is split up into different tasks and
each specialized worker/ machine performs one of these tasks."

Pros:
Specialized workers are good at one task and increases efficiency and output.
Less time is wasted switching jobs by the individual.
Machinery also helps all jobs and can be operated 24/7.
Cons
Boredom from doing the same job lowers efficiency.
No flexibility because workers can only do one job and cannot do others well if needed.
If one worker is absent and no-one can replace him, the production process stops.
Why is business activity needed? (Summary)
- Provides goods and services from limited resources to satisfy unlimited wants.
- Scarcity results from limited resources and unlimited wants.
- Choice is necessary for scarce resources. This leads to opportunity costs.
- Specialization is required to make the most out of resources.

Business activity:
1. Combine factors of production to create goods and services.
2. Goods and services satisfy peoples wants.
3. Employs people and pays them wages so they can consume other products.
Business Objectives:
All businesses have aims or objectives to achieve. Their aims can vary depending on their type of
business or these can change depending on situations. The most common objectives are:
1. Profit: Profit is what keeps a company going and is the main aim of most businesses.
Normally a business will try to obtain a satisfactory level of profits so they do not have to
work long hours or pay too much tax.
2. Increase added value: Value added is the difference between the price and material costs of
a product. E.g. If the price when selling a pen is $3 and it costs $1 in material, the value
added would be $2. However, this does not take into account overheads and taxes. Added
value could be increased by working on products so that they become more expensive
finished products. One easy example of this is a mobile phone with a camera would sell for
much more than one without it. Of course, you will need to pay for the extra camera but as
long as prices rise more than costs, you get more profit.
3. Growth: Growth can only be achieved when customers are satisfied with a business. When
businesses grow they create more jobs and make them more secure when a business is larger.
The status and salary of managers are increased. Growth also means that a business is able to
spread risks by moving to other markets, or it is gaining a larger market share. Bigger
businesses also gain cost advantages, called economies of scale.
4. Survival: If a business do not survive, its owners lose everything. Therefore, businesses need
to focus on this objective the most when they are: starting up, competing with other
businesses, or in an economic recession.
5. Service to the community: This is the primary goal for most government owned businesses.
They plan to produce essential products to everybody who need them.
These business objectives can conflict because different people in a business want different things at
different times.

Stakeholders:
Stakeholders are a person or a group which has interest in a business for various reasons and will be
directly affected by its decisions. Stakeholders also have different objectives and these also conflict
over time.

There are two 6 types of stakeholders, and these types can be classified into two groups with similar
interests.

Group 1: Profit/Money
Owners:
1. Profit, return on capital.
2. Growth, increase in value of business.
Workers
3. High salaries.
4. Job security.
5. Job satisfaction.
Managers
6. High salaries.
7. Job security.
8. Growth of business so they get more power, status, and salary.
Group 2: Value
Customers
1. Safe products.
2. High quality.
3. Value for money.
4. Reliability of service and maintenance.
Government
5. Employment.
6. Taxes.
7. National output/GDP increase.
Community
8. Employment.
9. Security.
10. Business does not pollute the environment.
11. Safe products that are socially responsible.

Chapter 2: Types of business activity
Levels of economic activity

In order for products to be made and sold to the people, it must undergo 3 different production
processes. Each process is done by a different business sector and they are:
Primary sector: The natural resources extraction sector. E.g. farming, forestry, mining...
(earns the least money)
Secondary sector: The manufacturing sector. E.g. construction, car manufacturing, baking...
(earns a medium amount of money)
Tertiary sector: The service sector. E.g. banks, transport, insurance... (earns the most
money)
Importance of a sector in a country:
No. of workers employed.
Value of output and sales.
Industrialization: a country is moving from the primary sector to the secondary sector.
De-industrialization: a country is moving from the secondary sector to the tertiary sector.
In both cases, these processes both earn the country more revenue.

Types of economies

Free market economy:
All businesses are owned by the private sector. No government intervention.

Pros:
Consumers have a lot of choice
High motivation for workers
Competition keeps prices low
Incentive for other businesses to set up and make profits
Cons:
Not all products will be available for everybody, especially the poor
No government intervention means uncontrollable economic booms or recessions
Monopolies could be set up limiting consumer choice and exploiting them
Command/Planned economy:
All businesses are owned by the public sector. Total government intervention. Fixed wages for
everyone. Private property is not allowed.
Pros:
Eliminates any waste from competition between businesses (e.g. advertising the same
product)
Employment for everybody
All needs are met (although no luxury goods)
Cons:
Little motivation for workers
The government might produce things people don't want to buy
Low incentive for firms (no profit) leads to low efficiency
Mixed economy:
Businesses belong to both the private and public sector. Government controls part of the economy.

Industries under government ownership:
health
education
defense
public transport
water & electricity
Privatization
Privatization involves the government selling national businesses to the private sector to increase
output and efficiency.

Pros:
New incentive (profit) encourages the business to be more efficient
Competition lowers prices
Individuals have more capital than the government
Business decisions are for efficiency, not government popularity
Privatization raises money for the government
Cons:
Essential businesses making losses will be closed
Workers could be made redundant for the sake of profit
Businesses could become monopolies, leading to higher price
Comparing the size of businesses
Businesses vary in size, and there are some ways to measure them. For some people, this information
could be very useful:
Investors - how safe it is to invest in businesses
Government - tax
Competitors - compare their firm with other firms
Workers - job security, how many people they will be working with
Banks - can they get a loan back from a business?
Ways of measuring the size of a business:
Number of employees. Does not work on capital intensive firms that use machinery.
Value of output. Does not take into account people employed. Does not take into account
sales revenue.
Value of sales. Does not take into account people employed.
Capital employed. Does not work on labor intensive firms. High capital but low output
means low efficacy.
You cannot measure a businesss size by its profit, because profit depends on too many factors not
just the size of the firm.

Business Growth
All owners want their businesses to expand. They reap these benefits:
Higher profits
More status, power and salary for managers
Low average costs (economies of scale)
Higher market share
Types of expansion:
Internal Growth: Organic growth. Growth paid for by owners capital or retained profits.
External Growth: Growth by taking over or merging with another business.
Types of Mergers (and main benefits):

- Horizontal Merger: merging with a business in the same business sector.
Reduces no. of competitors in industry
Economies of scale
Increase market share
- Vertical merger:
Forward vertical merger:
Assured outlet for products
Profit made by retailer is absorbed by manufacturer
Prevent retailer from selling products of other businesses
Market research on customers transferred directly to the manufacturer
Backward vertical merger:
Constant supply of raw materials
Profit from primary sector business is absorbed by manufacturer
Prevent supplier from supplying other businesses
Controlled cost of raw materials
Conglomerate merger:
Spreads risks
Transfer of new ideas from one section of the business to another
Why some businesses stay small:
There are some reasons why some businesses stay small. They are:
Type of industry the business is in: Industries offering personal service or specialized
products. They cannot grow bigger because they will lose the personal service demanded by
customers. E.g. hairdressers, cleaning, convenience store, etc.
Market size: If the size of the market a business is selling to be too small, the
business cannot expand. E.g. luxury cars (Lamborghini), expensive fashion
clothing, etc.
Owners objectives: Owners might want to keep a personal touch with staff and customers.
They do not want the increased stress and worry of running a bigger business.















Chapter 3: Forms of business organization
Almost every country consists of two business sectors, the private sector and the public sector.
Private sector businesses are operated and run by individuals, while public sector businesses are
operated by the government. The types of businesses present in a sector can vary, so lets take a look
at them.

Private Sector

Sole Traders

Sole traders are the most common form of business in the world, and take up as much as 90% of all
businesses in a country. The business is owned and run by one person only. Even though he can
employ people, he is still the sole proprietor of the business. These businesses are so common since
there are so little legal requirements to set up:
The owner must register with and send annual accounts to the government Tax Office.
They must register their business names with the Registrar of Business Names.
They must obey all basic laws for trading and commerce.
There are advantages and disadvantages to everything, and here are ones for sold traders:

Pros:
There are so few legal formalities are required to operate the business.
The owner is his own boss, and has total control over the business.
The owner gets 100% of profits.
Motivation because he gets all the profits.
The owner has freedom to change working hours or whom to employ, etc.
He has personal contact with customers.
He does not have to share information with anyone but the tax office, thus he enjoys
complete secrecy.
Cons:
Nobody to discuss problems with.
Unlimited liability.
Limited finance/capital, business will remain small.
The owner normally spends long hours working.
Some parts of the business can be inefficient because of lack of specialists.
Does not benefit from economies of scale.
No continuity, no legal identity.

Sole traders are recommended for people who:
Are setting up a new business.
Do not require a lot of capital for their business.
Require direct contact for customer service.

Partnership

A partnership is a group consisting of 2 to 20 people who run and own a business together. They
require a Deed of Partnership or Partnership Agreement, which is a document that states that all
partners agree to work with each other, and issues such as who put the most capital into the business
or who is entitled to the most profit. Other legal regulations are similar to that of a sole trader.

Pros:
More capital than a sole trader.
Responsibilities are split.
Any losses are shared between partners.
Cons:
Unlimited liability.
No continuity, no legal identity.
Partners can disagree on decisions, slowing down decision making.
If one partner is inefficient or dishonest, everybody loses.
Limited capital, there is a limit of 20 people for any partnership.

Recommended to people who:
Want to make a bigger business but does not want legal complications.
Professionals, such as doctors or lawyers, cannot form a company, and can only form a
partnership.
Family, when they want a simple means of getting everybody into a business (Warning:
Nepotism is usually not recommended).
Note: In some countries including the UK there can be Limited Partnerships. This business has
limited liability but shares cannot be bought or sold. It is abbreviated as LLP.

Private Limited Companies

Private Limited Companies have separate legal identities to their owners, and thus their owners have
limited liability. The company has continuity, and can sell shares to friends or family, although with
the consent of all shareholders. This business can now make legal contracts. Abbreviated as Ltd
(UK), or Proprietary Limited, (Pty) Ltd.

Pros:
The sale of shares make raising finance a lot easier.
Shareholders have limited liability, therefore it is safer for people to invest but creditors
must be cautious because if the business fails they will not get their money back.
Original owners are still able to keep control of the business by restricting share distribution.
Cons:

Owners need to deal with many legal formalities before forming a private
limited company:
O The Articles of Association: This contains the rules on how the company will be managed. It states
the rights and duties of directors, the rules on the election of directors and holding an official
meeting, as well as the issuing of shares.
O The Memorandum of Association: This contains very important information about the company and
directors. The official name and addresses of the registered offices of the company must be stated.
The objectives of the company must be given and also the amount of share capital the owners intend
to raise. The number of shares to be bought by each of the directors must also be made clear.
O Certificate of Incorporation: the document issued by the Registrar of Companies that will allow the
Company to start trading.
Shares cannot be freely sold without the consent of all shareholders.
The accounts of the company are less secret than that of sole traders and partnerships. Public
information must be provided to the Registrar of Companies.
Capital is still limited as the company cannot sell shares to the public.
Public Limited Companies

Public limited companies are similar to private limited companies, but they are able to sell shares to
the public. A private limited company can be converted into a public limited company by:
1. A statement in the Memorandum of Association must be made so that it says this company
is a public limited company.
2. All accounts must be made public.
3. The company has to apply for a listing in the Stock Exchange.
A prospectus must be issued to advertise to customers to buy shares, and it has to state how the
capital raised from shares will be spent.

Pros:
Limited liability.
Continuity.
Potential to raise limitless capital.
No restrictions on transfer of shares.
High status will attract investors and customers.
Cons:
Many legal formalities required to form the business.
Many rules and regulations to protect shareholders, including the publishing of annual
accounts.
Selling shares is expensive, because of the commission paid to banks to aid in selling shares
and costs of printing the prospectus.
Difficult to control since it is so large.
Owners lose control, when the original owners hold less than 51% of shares.
Control and ownership in a public limited company:

The Annual General Meeting (AGM) is held every year and all shareholders are invited to attend
so that they can elect their Board of Directors. Normally, Director are majority shareholders who
has the power to do whatever they want. However, this is not the case for public limited companies
since there can be millions of shareholders. Anyway, when directors are elected, they have to power
to make important decisions. However, they must hire managers to attend to day to day decisions.
Therefore:
Shareholders own the company
Directors and managers control the company
This is called the divorce between ownership and control.
Because shareholders invested in the company, they expect dividends. The directors could do things
other than give shareholders dividends, such as trying to expand the company. However, they might
lose their status in the next AGM if shareholders are not happy with what they are doing. All in all,
both directors and shareholders have their own objectives.

Co-operatives

Cooperatives are a group of people who agree to work together and pool their money together to buy
"bulk". Their features are:
All members have equal rights, no matter how much capital they invested.
All workload and decision making is equally shared, a manager maybe appointed for bigger
cooperatives
Profits are shared equally.
The most common cooperatives are:
Producer co-operatives: just like any other business, but run by workers.
Retail co-operatives: provides members with high quality goods or services for a reasonable
price.
Other notable business organizations:

Close Corporations:

This type of business is present in countries such as South Africa. It is like a private limited company
but it is much quicker to set up:
Maximum limit of 10 people.
You only need a simple founding statement which is sent to the Registrar of Companies to
start the business.
All members are managers (no divorce of ownership and control).
A separate legal unit, has both limited liability and continuity.
Cons:
The size limit is not suitable for a large business.
Members may disagree just like in a partnership.
Joint ventures

Two businesses agree to start a new project together, sharing capital, risks and profits.

Pros:
Shared costs are good for tackling expensive projects. (e.g. aircraft)
Pooled knowledge. (e.g. foreign and local business)
Risks are shared.
Cons:
Profits have to be shared.
Disagreements might occur.
The two partners might run the joint venture differently.
Franchising

The franchisor is a business with a successful brand name that recruits franchisees (individual
businesses) to sell for them. (E.g. McDonald, Burger King)

Pros for the franchisor:
The franchisee has to pay to use the brand name.
Expansion is much faster because the franchisor does not have to finance all new outlets.
The franchisee manages outlets
All products sold must be bought from the franchisor.
Cons for the franchisor:
The failure of one franchise could lead to a bad reputation of the whole business.
The franchisee keeps the profits.
Pros for the franchisee:
The chance of failure is much reduced due to the well know brand image.
The franchisor pays for advertising.
All supplies can be obtained from the franchisor.
Many business decisions will be made by the franchisor (prices, store layout, products).
Training for staff and management is provide by the franchisor.
Banks are more willing to lend to franchisees because of lower risks.
Cons for the franchisee:
Less independence
May be unable to make decisions that would suit the local area.
License fee must be paid annually and a percentage of the turnover must be paid.
Public Sector

Public corporations:

A business owned by the government and run by Directors appointed by the government. These
businesses usually include the water supply, electricity supply, etc. The government give the
directors a set of objectives that they will have to follow:
To keep prices low so everybody can afford the service.
To keep people employed.
To offer a service to the public everywhere.
These objectives are expensive to follow, and are paid for by government subsidies. However, at one
point the government would realize they cannot keep doing this, so they will set different objectives:
To reduce costs, even if it means making a few people redundant.
To increase efficiency like a private company.
To close loss-making services, even if this mean some consumers are no longer provided
with the service.
Pros:
Some businesses are considered too important to be owned by an individual. (electricity,
water, airline)
Other businesses, considered natural monopolies, are controlled by the government.
(electricity, water)
Reduces waste in an industry. (e.g. two railway lines in one city)
Rescue important businesses when they are failing.
Provide essential services to the people (e.g. the BBC)
Cons:
Motivation might not be as high because profit is not an objective.
Subsidies lead to inefficiency. It is also considered unfair for private businesses.
There is normally no competition to public corporations, so there is no incentive to improve.
Businesses could be run for government popularity.
Municipal enterprises

These businesses are run by local government authorities which might be free to the user and
financed by local taxes. (e.g., street lighting, schools, local library, rubbish collection). If these
businesses make a loss, usually a government subsidy is provided. However, to reduce the burden on
taxpayers, many municipal enterprises are being privatized.

Chapter 4: Government and economic influences on business
The impact of business activity on society

All business activity has benefits and undesirable effects on society. These reasons are why governments want to have some
control over business activity:

Possible benefits:
Production of useful goods to satisfy customer wants.
Create employment/increases workers living standards.
Introduction of new products or processes that reduces costs and widen product range.
Taxes help finance public services.
Businesses earn foreign currency in exports and this could be spent on imports.
Possible undesirable effects:
Business might ruin cheap but beautiful areas.
Low wages and unsafe working conditions for workers because businesses want to lower costs.
Pollution
Production of dangerous goods.
Monopolies
Advertising can mislead customers.
Governments tend to pass laws that restrict undesirable activities while supporting desirable activities.

Governments and the economy

Government economic objectives:

Governments all have aims for their country, and this is what they are:
Low inflation.
Low unemployment.
Economic growth.
Balance of payments.
Low inflation:

Inflation occurs when prices rise. When prices rise rapidly many bad thing could happen:
Workers wages buy less than before. Therefore their real income (how much you can buy with so much money) falls.
Workers will be unhappy and demand for higher wages.
Prices of local goods will rise more than that of other countries with lower inflation. People may start buying foreign
goods instead.
It would cost more for businesses to start or expand and therefore it does not employ as many people.
Some people might be made redundant so that the business can cut costs.
Standards of living will fall.
This is obviously why governments want to keep inflation as low as possible.

Low levels of unemployment:

When people are unemployed, they want to work but cannot find a job. This causes many problems:
Unemployed people do not work. Therefore national output will be lower than it should be.
The government will have to pay for unemployment benefits. This is expensive and money cannot be used for other
purposes.
If the level up unemployment is low, it will increase national output and improve standards of living for workers.

Economic growth

A country is said to grow when its GDP (Gross Domestic Product) is increasing. This is the total value of goods produced in one
year. The standards of living tends to increase with economic growth. Problems arise when a country's GDP fall:
The country's output is falling, fewer workers are needed and unemployment occurs.
Standards of living will fall.
Businesses will not expand because they have less money to invest.
Economic growth is not achieved every year. There are years where the GDP falls and the trade cycle explains the pattern of
rises and falls in national GDP.

http://4.bp.blogspot.com/-UHm-ul-PqIU/TYW2Dy-
BNhI/AAAAAAAAACA/ljBXFwRRVIk/s1600/trade+cycle.jpg
The trade cycle has 4 main stages:
Growth: This is when GDP is rising, unemployment is falling, and the country has higher standards of living.
Businesses tend to do well in this period.
Boom: Caused by overspending. Prices rise rapidly and there is a shortage of skilled workers. Business costs will be
rising and they are uncertain about the future.
Recession: Because overspending caused the boom, people now spend too little. GDP will fall and businesses will lose
demand and profits. Workers may lose their jobs.
Slump: A long drawn out recession. Unemployment will peak and prices will fall. Many firms will go out of business.
After all of this happens the economy recovers and begins to grow again. Governments want to avoid a boom so that it will not
lead to a recession and a slump. Currently, the government of China is spending a lot of money so that their economy would
continue to grow and avoid a boom.

Balance of payments

Exports earn foreign currency, while imports are paid for by foreign currency (or vice versa). The difference between the
value of exports and imports of a country is called balance of payments. Governments try to achieve a balance in imports and
exports to avoid a trade deficit, when exports are higher than imports. Of course, the government will lose money and their
reservoir of foreign currency will fall. This results in:
If the country wants to import more, they will have to borrow foreign currency to buy goods.
The country's currency will now worth less compared to others and can buy less goods. This is called exchange rate
depreciation.
Government economic policies

Governments want to influence the national economy so that it would achieve their aforementioned objectives. They have a lot
of power over business activity and can pass laws to try to achieve their goals. The main ways in which governments can
influence business activity are called economic policies. They are:
Fiscal Policy: taxes and public spending.
Monetary policy: controlling the amount of money in the economy through interest rates.
Supply side policies: aimed at increasing efficiency.
Fiscal policy

Government spending could benefit some firms such as:
Construction firms (road building)
Defense industries (Iraq war)
Bus manufacturers (public transport)
Governments raise money from taxes. There are Direct taxes on income and Indirect taxes on spending. There are four
common taxes:
Income tax
Profits tax
VAT (Value Added Tax)
Import tariffs
Income tax

Income tax is based on a percentage of your income. Income tax is usually progressive, meaning that the percentage of tax you
have to pay rises with your income. Effects on business and individuals if there was a rise of income tax:
People will have less disposable income.
Sales fall because people have less money to spend.
Managers will cut costs for more profit. Workers might be made redundant.
Businesses producing luxury goods will lose the most, while others producing everyday needs will get less affected.
Profits tax or corporation tax

This is a percentage of the profit a business makes. A rise in it would mean:
Managers will have less retained profit, making it harder for the business to expand.
Owners will get less return on capital employed. Potential owners will be reluctant to start their own business if the
profit margin is too low.
Indirect taxes

These taxes are a percentage on the price of goods, making them more expensive. Governments want to avoid putting them on
essential goods such as foods. A rise it it would mean:
The effect would be almost the same as that of an increase in income tax. People would buy less but they would still
spend money on essential goods.
Again, real incomes fall. Costs will rise when workers demand higher wages.
Import tariffs and quotas

Governments put tariffs on imports to make local goods look more competitive and also to reduce imports. When governments
put import tariffs on imports:
Sales of local goods become cheaper than imports, leading to increased sales.
Businesses who import raw materials will suffer higher costs.
Other countries will retaliate by putting tariffs on the country's exports, making it less competitive.
Quotas maybe used to limit the amount of imports coming in.
Monetary policy and interest rates

Governments usually have to power to change interest rates through the central bank. Interest rates affect people who borrow
from the bank. When interest rates rise:
Businesses who owe to bank will have to pay more, resulting in less retained profit.
People are more reluctant to start new businesses or expand.
Consumers who took out loans such as mortgages will now have less disposable income. They will spend less on
other goods.
Demand will fall for businesses who produces luxury or expensive goods such as cars because people are less willing
to borrow.
Higher interest rates will encourage other countries to deposit money into local banks and earn higher profits. They
will change their money into the local currency, increasing its demand and causing exchange rate appreciation.
Supply side policies

These policies aim to make the countrys economy more efficient so that they can produce more goods and compete in the
international economy. In doing so their GDP will rise. Here are some policies:
Privatization: Its aim is to use profit as an incentive to increase efficiency.
Improve training and education: This obviously increases efficiency. This is crucial to countries with a big computer
software industry.
Increase competition: Competition causes companies to be more efficient to survive. Governments need to remove
any monopolies.
Government controls over business activity

Government also influence major areas of business activity:
what goods can be produced
responsibilities to employees and working conditions
responsibilities to consumers
responsibilities to the natural environment
location decisions
Undesirable effects created by business activity make governments want to control business activity:
Business might ruin cheap but beautiful areas.
Monopolies.
Advertising can mislead customers.
Why government control business activity

Production of certain goods and services:

Governments can pass laws to restrict and ban certain dangerous goods such as:
Weapons like guns and explosives.
Drugs
Goods that harm the environment
Consumer protection:

Consumers are easily misled by advertising. It is because consumers lack the technical knowledge and advertising can be very
persuasive. In the UK, these laws are passed to protect customers from being exploited by businesses:
Weights and Measures Act: to stop underweight goods being sold to customers.
Trade Descriptions Act: all advertisements must be truthful.
Consumer Credit Act: makes it illegal to not give customers their copy of the credit agreement to check how much
money they really have.
Sale of Goods Act: Makes it illegal to sell:
- Goods which have serious flaws or problems.
- Products that are not fit for the purpose intended by the consumer.
- Products that do not function as described on their label or by the retailer.
Consumer Protection Act: Make false pricing claims illegal. Consumers can now sue producers or retailers if their
products cause harm to them.
Competition policy: Control of monopolies

Monopolies could cause a lot of harm to an economy because there are nobody to compete against them:
They exploit consumers with high prices.
They prevent new firms from starting up.
Monopolies are not encouraged to be efficient because there are no competitors.
In some countries, monopolies are banned and must be broken up into smaller firms. In the UK, monopolies can be investigated
by the Competition Commission. This government body reports two main types of problems:
Business decisions that are against consumer interests, such as trying to eliminate all competitors.
Proposed mergers or takeovers that will result in a monopoly.
Protecting employees:

Employees need protection in the following areas:
Unfair discrimination
Health and safety at work
Unfair dismissal
Wage protection
Protection against unfair discrimination:

Often workers are discriminated in a job because of various reasons. There are laws that protect the employee from such reasons
to be discriminated against:
Sex Discrimination Act: people of different genders must have equal opportunities.
Race Relations Act: people of all races and religions mush have equal opportunities.
Disability Discrimination Act: it must be made suitable for disabled people to work in businesses.
Equal Opportunities Policy: That is what everything is all about.
The UK is currently working on an age discrimination act.

Health and Safety at work:

Laws protect workers from:
Protect workers from dangerous machinery.
Provide safety equipment and clothing.
Maintain reasonable workplace temperatures.
Provide hygienic conditions and washing facilities.
Do not insist on excessively long shifts and provide breaks in the work timetable.
Managers not only provide safety for their employees only because laws say so. Some believe that keeping employees safe and
happy improves their motivation and keeps them in the business. Others do it because it is present in their moral code. They are
then considered making an ethical decision. However, in many countries, workers are still exploited by employers.

Protection against unfair dismissal

Employees need protection from being dismissed unfairly. The following reasons for the employee to be dismissed is
unreasonable:
For joining a trade union.
For being pregnant.
When no warnings were given beforehand.
Workers who thing they have been dismissed unfairly can take their case to the Industrial Tribunal to be judged and he/she
might receive compensation if the case is in his/her favor.

Wage Protection

Employers must pay employees the same amount that has been stated on the contract of employment, which states:
Hours of work.
Nature of the job.
The wage rate to be paid.
How frequently wages will be paid.
What deduction will be made from wages, e.g. income tax?
A minimum wage rate is present in many Western countries and the USA. There are pros and cons of the minimum wage:

Pros:
Prevents strong employees to exploit unskilled workers who could not easily find work.
Encourages employers to train unskilled employees to increase efficiency.
Encourages more people to seek work.
Low-paid workers can now spend more.
Cons:
Increases costs, increases prices.
Owners who cannot afford these wages might make employees redundant instead.
Higher paid workers want higher wages to keep on the same level difference as the lower paid workers. Costs will rise.
Location of Industry

How governments want to locate businesses:
They encourage businesses to move to areas with a high level of unemployment, or called development areas.
They discourage firms from locating in overcrowded cites or sites noted for their natural beauty.
How governments will influence the decisions of firms to locate:
Businesses will be refused planning permission (permit to build in a place) if they wish to locate in overcrowded cities
or beautiful areas. Building in these areas might be banned altogether.
Governments can provide regional assistance, such as grants and subsidies to encourage firms to locate in
undeveloped areas.
Governments can help businesses too

Governments can help businesses to:
To encourage businesses to locate in poorer regions.
To encourage enterprise by helping small businesses set up and survive.
To encourage businesses to export.
Regional Assistance:
Governments want development to be spread evenly over the whole country.
Grants and subsidies can be used to attract firms to an area.
Small firms

Small firms are important for and economy because:
They provide most of the employment because they are usually labor intensive.
Small firms operate in rural areas where unemployment tends to be high.
They can grow into very important businesses employing thousands of workers and producing output worth millions of
dollars.
Provides more choice for customers. They compete against bigger companies.
They are often managed in a very flexible way, and is quicker to adapt to changing demands.
Governments help them by:
Lower rates of profits tax, so they can have more retained profit.
Giving grants and cheap loans.
Providing advice and information centers to small firms.
Exporting goods and services

Why governments want businesses to export:
Exports earn foreign currency, which can be used to buy imports.
More exports means more people needed to produce them, increasing employment and standards of living.
Successful exporters earn more money and have to pay more profits tax.
Governments can support exporters by:
Encourage banks to lend to exporting businesses at lower interest rates.
Offering subsidies or lower taxes to firms. However, other countries would retaliate and there would be no overall
advantage.
Trying to keep the local currency as stable as possible to make it easier for businesses to know how much they are
going to make from exports.
Organizing trade fairs abroad to encourage foreign businesses to buy the country's exports.
Offering credit facilities. This means that if a foreign customers refuses to pay for goods, the company could be
compensated by the government.
Businesses in the economic and legal environment

Businesses could not ignore the power of the government in controlling business activity. Multinationals are an exception
although normally businesses cannot afford to move to other countries. Government decisions create the environment in which
businesses will have to operate and adapt to. The environment created by legal and economic controls are one of the
constraints to managers when making decisions.


Chapter 5: Other influences on business
External constraints and constraints on business activity

Businesses cannot survive by neglecting the "real world", which includes influences that forces a
business to make certain decisions or constraints that limits or controls actions. External
constraints are things that businesses cannot control, these are:
Technological change: New products.
Technological change: New production processes.
Increased competition.
Environmental issues.
Here is a table from the book giving examples and the possible impacts on business activity:
Technological changes
Technological change bring about constant changes in consumer products and production
processes. By using R&D to develop new products, companies could open up new markets and
make huge amounts of money. Such companies include Microsoft, Sony and Apple. However, new
products quickly replace old ones just like how machines are replacing workers in production
processes.
There are two general things a firm could do when facing technological change:
Ignore the changes and operate in the "traditional and old fashioned way". However, they
can only sell to a small and limited market.
Compete by welcoming changes and have an access to huge mass markets.
Here are some pros and cons of technological change:

Pros:
New products encourage customers to buy more.
If a business comes up with a new product first, they gain a huge competitive advantage.
"High-tech" production methods make production more efficient.
Fewer workers are required.
New production methods can be adapted very quickly which gives businesses more
flexibility in meeting consumer wants.
E-commerce opens up new markets and the Internet is a medium of advertising.
Cons:
R&D is expensive, without guaranteed success.
Businesses that do not develop new products will fail, leaving workers unemployed.
New production methods and machines are expensive.
Workers will need retraining which is expensive. They might be reluctant to learn or fear that
they will not do well. This could lead to a fall in motivation.
E-commerce lacks personal customer service.
Smaller businesses cannot afford these things.
Introducing technological change successfully

Workers and managers may fear change. Workers might think:
Will I be able to operate the new machines?
Will I lose my job because the machines are more efficient?
Older workers are especially afraid of losing out to younger and better trained workers.
Managers also fear change, since recruiting technology experts will make them look more inferior
in some way.

To make these changes work better, workers need to be involved in the changes. Workers might be
told why the new machines are necessary and how they will be trained to use them, as well as letting
them suggest ways to make work more efficient with the machines. It leads to more opportunities
for trained and skilled staff and can lead to new ideas and products.

Competition

Most businesses have competitors. Most business decisions are based on:
What competitors are doing?
How they might react?
When you develop a successful product, other businesses will undoubtedly copy you. Therefore, you
will need to research and develop even more products, keeping ahead of them. Competition is a
major influence on business activity.

Environmental constraints on business activity

There are two general opinions on caring about the environment:

- Opinion A: Keeping the environment clean is too expensive. We want to keep prices low and this
is what consumers want too.
Protecting the environment is too expensive and reduce profits.
Increased prices mean increased costs.
Firms could become less competitive compared to others who are not environmentally
friendly.
Governments should pay to clean it up.
- Opinion B: Consumers are now starting to prefer businesses with social responsibility. Cleaner
and more efficient machinery benefit the business in the long-run.
Environmental issues affect us all and businesses have a social responsibility to deal with
them.
Using up scarce resources leaves less for future generations and raise prices.
Consumers are becoming more socially aware. More now prefer firms that are
environmentally friendly which could become a marketing advantage.
If a business damages the environment, pressure groups could protest and damage its image
and reputation.
Ways to make a business more environmentally friendly

Governments make these business activities illegal:
Locating in environmentally sensitive areas.
Dumping waste products into waterways.
Making products that cannot be easily recycled.
Manufacturers often complain that these laws raise prices. Therefore, some governments usually do
not make these laws strict with the hope of increasing output and in turn employment.

Financing penalties, including pollution permits

Pollution permits are licenses given to a business to pollute up to a certain level. If "dirty"
businesses pollute over the permitted level, they either have to buy permits from "cleaner firms" or
pay heavy fines. This encourages firms to be cleaner and sell their permits to dirtier companies for
more money. Other penalties include additional taxes.

Consumer action and pressure groups

Consumers are becoming more socially aware, and many of them will stop buying goods from
companies which pollute the environment, harming a business' reputation and image. Bad publicity
means lower sales. If they want to keep their sales revenue up firms would have to adapt to more
environmentally friendly production processes again.

Pressure groups are becoming very powerful nowadays. They can severely damage businesses that
are not socially responsible.

These are their powers:
Consumer boycotts
Protests
Blocking waste pipes.
These are times when they are likely to take action:
They have popular public support and has a lot of media coverage.
The group is well organized and financed.
These are times when they are less likely to take action:
What a company is doing is unpopular but not illegal. (e.g. testing drugs on rats)
The cost of making the company cleaner is more than losses that could be made by losing
image and sales.
The firm supplies other firms and not customers, public support will be less effective.
Environmental issues and cost-benefit analysis

Governments are increasingly concerned about the social and environmental effects of business
activity. They have started to use a new type of analysis on businesses and government proposals
which will not only take into account financial costs but also external costs.

Cost-benefit analysis requires and awareness of external costs (costs to the rest of society) and
external benefits (gains to the rest of society). Here are some examples.

Decision: A new chemical plant will be built.

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p.blogspot.com/-
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Social costs are worked out from private costs and external costs.
Social benefits are worked out from private benefits and external benefits.

In other words:
Social costs = private costs + external costs.
Social benefits = private benefits + external benefits.

Chapter 6: Business costs and revenue
Business costs

All business activity involves some kind of cost. Managers need to think about them because:
Whether costs are lower than revenues or not. Whether a business will make a profit or not.
To compare costs at different locations.
To help set prices.
There are two main types of costs, fixed and variable costs. Here are some types of costs:
Fixed costs = stay the same regardless of the amount of output. They are there regardless of whether a
business has made a profit or not. Also known as overheads.
Variable costs = varies with the amount of goods produced. They can be classified as direct costs (directly
related to a product).
Total costs = fixed + variable costs
Break-even charts, comparing costs with revenue
Drawing a break-even chart

Uses of break-even charts
There are other benefits from the break-even chart other than identifying the breakeven point and the
maximum profit. However, they are not all reliable so there are some disadvantages as well:
Pros:
The expected profit or loss can be calculated at any level of output.
The impacts of business decisions can be seen by redrawing the graph.
The breakeven chart show the safety margin which is the amount by which sales exceed the breakeven
point.
Cons:
The graph assumes that all goods produced are sold.
Fixed costs will change if the scale of production is changed.
Only focuses on the breakeven point. Completely ignores other aspects of production.
Does not take into account discounts or increased wages, etc. and other things that vary with time.
Break-even point: the calculation method.
It is possible to calculate the breakeven point with ought having to draw the graph. We need two formulas
to achieve this:
Selling Price - Variable Costs = Contribution
Break-even point = Total fixed costs/Contribution
Business costs: other definitions
There are other types of costs to be analysed that is split from fixed and variable costs:
Direct costs: costs that are directly related to the production of a particular product.
Marginal costs: how much costs will increase when a business decides to produce one more unit.
Indirect costs: costs not directly related to the product. They are often termed overheads.
Average cost per unit: total cost of production/total output
Economies and Diseconomies of scale:
Economies of scale are factors that lead to a reduction in average costs that are obtained by growth of a
business. There are five economies of scale:
Purchasing economies: Larger capital means you get discounts when buying bulk.
Marketing: More money for advertising and own transportation, cutting costs.
Financial: Easier to borrow money from Align Left banks with lower interest rates.
Managerial: Larger businesses can now afford specialist managers in all departments, increasing
efficiency.
Technical: They can now buy specialised and latest equipment to cut overall production costs.
However, there are diseconomies of scale which increases average costs when a business grows:
Poor communication: It is more difficult to communicate in larger firms since there are so many people a
message has to pass through. The managers might lose contact to customers and make wrong decisions.
Low morale: People work in large businesses with thousands of workers do not get much attention. They
feel they are not needed this decreases morale and in turn efficiency.
Slower decision making: More people have to agree with a decision and communication difficulties also
make decision making slower as well.
Budgets and forecasts: looking ahead
Business also needs to think ahead about the problems and opportunities that may arise in the future.
There are things to try to forecast such as:
Sales or consumer demands.
Exchange rates appreciation or depreciation.
Wage increases.
There are some forecasting methods:
Past sales could be used to calculate the trend, which could then be extended into the future.
Create a line of best fit for past sales and extend it for the future.
Panel consensus: asking a panel of experts for their opinion on what is going to happen in the future.
Market research.
Budgets

"Budgets are plans for the future containing numerical and financial targets". Better managers will create
many budgets for costs, planned revenue and profit and combine them into one single plan called the
master budget.

Here are the advantages of budgets:
They set objectives for managers and workers to work towards, increasing their motivation.
They can be used to see how well a business is doing by comparing the budget with the result in the
process of variance analysis. The variance is the difference between the budget and the result.
If workers get a say in choosing the objectives for a budget, the objectives would be more realistic since
they are the ones that are going to do it and it also gives them better motivation.
Helps control the business and its allocation of resources/money.
All in all, budgeting in useful for:
Reviewing past activities.
Controlling current business activity - following objectives.
Planning for the future.

Chapter 7: Business Accounting

What are accounts a why are they necessary?

Accounts are financial records of a firm's transactions that is kept up to date by the accountants,
who are qualified professionals responsible for keeping accurate accounts and producing the final
accounts.

Every end of the year, a final accounts must be produced which gives details of:
Profits and losses made.
Current value of the business.
Other financial results.
Limited companies are bound by law to publish these accounts, but not other businesses.

Financial documents involved in buying and selling.

Accountants use various documents that are used for buying and selling over the year for their final
accounts. They can help the accountant to:
Keep records of what the firm bought and from which supplier.
Keep records of what the firm sold and to which customer.
These documents are:
Purchase orders: requests for buying products. It contains the quantity, type and total cost of
goods. Here is an example.
Delivery notes: These are sent by the firm when it has received its goods. It must
be signed when the goods are delivered.
Invoices: These are sent by the supplier to request for payment from the firm.
Credit notes: Only issued if a mistake has been made. It states what kind of mistake has
been made.
Statements of account: Issued by the supplier to his customers which contains
the value of deliveries made each month, value of any credit notes issued and any payments made by
the customer. Here is an example.
Remittance advice slips: usually sent with the statement of accounts. It indicates which
invoices the firm is paying for so that the supplier will not make a mistake about payments.
Receipts: Issued after an invoice has been paid. It is proof that the firm has paid for their
goods.
Methods of making payment

There are several ways goods can be paid for:
Cash: The traditional payment method. However, many businesses do not prefer to use cash
for a number of security reasons. When cash is paid, a petty cash voucher is issued by the person in
charge of the firm's money who also signs it to authorise the payment. The person making the
purchase signs it too to show that the money has been received.
Cheque: It is an instruction to the bank to transfer money from a bank account to a named
person. In order to do this the bank needs cheque guarantee card, saying that they have enough
money in their account to support this payment.
Credit card: Lets the consumer obtain their goods now and pay later. If the payment is
delayed over a set period then the consumer will have to pay interest.
Debit card: Transfers money directly from user's account to that of the seller.
Recording accounting transactions

Businesses usually use computers to store their transactions so that they can be easily accessed,
calculated and printed quickly.

Who uses the financial accounts of a business?
Shareholders: They will want to know about the profit or losses made during the year and
whether the business is worth more at the end of the year or not.
Creditors: They want to see whether the company can afford to pay their loans back or not.
Government: Again, they want to check to see if correct taxes are paid. They also want to
see how well the business is doing so that it can keep employing people.
Other companies: Other companies want to compare their performance with a business or
see if it is a good idea to take it over.
What do final accounts contain?

The trading account

This account shows how the gross profit of a business is calculated. Obviously, it will contain this
formula:

Gross profit = Sales revenue - Cost of goods sold

Note that:
Gross profit does not take to account overheads.
Only calculate the cost of goods sold, and forget the inventory.
In a manufacturing business, direct labour and manufacturing costs are also deducted to
obtain gross profit.
The profit and loss account

The profit and loss account shows how net profit is calculated. It starts off with gross profit acquired
from the trading account and by deducting all other costs it comes up with net profit.

Depreciation is the fall in value of a fixed asset over time. It is also counted as an indirect cost to
businesses.

As for limited companies, there are a few differences with the normal profits and loss account:
Profits tax will be shown.
It needs to have an appropriation account at the end of the profits and loss account. This
shows what the company has done with its net profits, in other words, how much retained profit has
been put back into the company.
Results from the previous year are also included.
Balance sheet

The balance sheet shows you a business's assets and liabilities at a particular time. The balance sheet
records the value of a business at the end of the financial year. This is what it contains:
Fixed assets: land, vehicles, and buildings that are likely to be with the business for more
than one year. They depreciate over time.
Current assets: stocks, inventory, ash and debtors that are only there for a short time.
Long-term liabilities: long-term borrowings that does not have to be paid in one year.
Short-term liabilities: short-term borrowings that has to be paid in less than one year.
If your total assets are higher than your total liabilities, then you are said to own wealth. In a
normal business, wealth belongs to the owners, while in a limited company, it belongs to
the shareholders. Hence the equation:

Total assets - total liabilities = Owners'/Shareholders' wealth

Here are some terms found in balance sheets:
Working capital: is used to pay short-term debts and known as net current assets. If a
business do not have enough working capital then it might be forced to go out of business. The
formula:
Working capital = Current assets - Current liabilities
Net assets: Shows the net value of all assets owned by the company. These assets must be
paid for or finance by shareholders' funds or long term liabilities. The formula:
Net assets = Fixed assets + Working capital
Shareholders' funds: The total sum invested into the business by its owners. This money is
invested in two ways:
- Share capital: Money from newly issued shares.
- Profit and loss reserves: Profit that is owned by shareholders but not distributed to them but
kept as part of shareholders' funds.
Capital employed: Long-term and permanent capital of a business that has been used to pay
for all the assets. Therefore:
Capital employed = net assets
Capital employed = Shareholders' funds + long-term liabilities

Analysis of published accounts

Without analysis, financial accounts tell us next to nothing about the performance and financial
strength of a company. In order to do this we need to compare two figures with each other. This is
called ratio analysis.

Ratio analysis of accounts

The most common ratios used are for comparing the performance and liquidity of a business. Here
are five of the most commonly used ratios.

Ratios used for analysing performance:
Return on capital employed: This result could show the efficiency of a business. If the
result rises, the managers are becoming more successful.
Return on capital employed (%) = Operating profit/Capital employed * 100
Gross profit margin: If this rises, it could mean that either they are increasing added value
or costs have fallen.
Gross profit margin = Gross profit/Sales revenue * 100
Net profit margin: The higher the result, the more successful the managers are. This could
be compared with other businesses too.
Net profit margin = Net profit before tax/Sales revenue * 100

Note: Net profit does not include tax.

Ratios used for analysing liquidity: This is too see how much cash a business has to pay off all of
its short-term debts.
Current ratio: This ratio assumes that all current assets could be converted into cash
quickly, but this is not always true since stock/inventory could not be all sold in a short time.
Generally, a result of 1.5 to 2 would be preferable, so that a business could pay all of its short-term
debts and still have half of its money left.
Current ratio = Current assets/Current liabilities

Acid test or liquid ratio: This type of analysis neglects stocks, but it is similar to the current
ratio analysis.
Acid test ratio = (Current assets - Stocks)/Current liabilities

These ratios can be used to:
Compare with other years.
Compare with other businesses.
It must be remembered that a ratio on its own will give you nothing, but when it is compared with
ratios from the past and other businesses it will tell you a lot of things.

However, there are still some disadvantages of ratio analysis:
Only shows past results, does not show anything about the future.
Comparisons between years may be misleading because of inflation.
Comparisons between businesses could be difficult since each has its own accounting
methods.

Chapter 8: Cash flow planning
What is meant by cash flow?

Cash is a liquid asset, meaning that is can be spent on goods and services any time. Many business
experience cash flow problems, meaning that they do not have enough cash to do what they want to do.
Cash flow means "the flow of money in and out of a business". These are ways cash flow can occur:

Cash inflows:
Sale of goods for cash.
Payment from debtors.
Borrowing from a source (but will inevitably lead to cash outflow in the future).
Sale of unwanted assets.
Investment from investors: shareholders and owners
Cash outflows:
Purchasing goods for cash.
Payment of wages, salaries and others in cash.
Purchasing fixed assets.
Repaying loans.
Repaying creditors.
Cash flow cycle

A cash flow cycle explains the stages that are involved in the process of cash out and finally into the
business. This is what happens:


The longer it takes for cash to get back to the business, the more they will need working capital to pay off
their short-term debts. This cycle also helps us understand the importance of cash flow planning. This is
what happens when a company is short on cash:
Not enough to pay for materials, therefore sales will fall.
The company will want to insist customers on paying in cash, but they might lose them to competitors
who let them pay in credit.
There could be a liquidity crisis when it does not have enough cash to pay for overheads (bills, rent, etc.)
and the business might be forced to close down by its creditors.
Managers need to plan their cash flow so that they do not end up in these positions.

Cash flow is not profit!

First we need to examine the formula for cash flow:

Cash flow = Cash inflow - Cash outflow

However, when calculating profit, we also take into account credit that debtors owe us. Therefore, a
company might make $20,000 in profit but only $10,000 is received in cash because half of it is played by
credit card.

This creates something known as insolvency:
Profitable business could run out of cash because of various reasons. This is called insolvency and it is
one main reason why businesses fail.
This can be because of several reasons:
Allowing customers too long to pay back, so that they will not have paid off the debts yet by the time the
business has run out of cash.
Purchasing too many assets at once.
Producing or purchasing too much stock/inventory when expanding too quickly. This is called
overtrading.
Here is an example of a cash flow statement:

As you can see, the closing bank balance in February is negative, which means that it has become
overdrawn.

Cash flow forecasts

Because of the aforementioned problems, it is important for the manager to get an idea of how much cash
will be available for which months. A cash flow forecast can tell the manager:
How much cash is available for paying bills, loans and other fixed assets?
How much the bank might need to lend to avoid insolvency?
Whether the business has too much cash which could be more useful if used.
Uses of cash flow forecasts:
Starting up a business: In the first months of a business, a lot of capital will be needed to set it up
properly. The problem is, not everybody realises that the amount of money they needed is much more
than they had expected. Therefore, a cash flow forecast will give them a better idea of how much money
will be needed.
Keeping the bank manager informed: It needs to be shown to the bank to inform it of the size of the
needed loan/overdraft, when it is needed, how long it is needed and when it could be repaid. Only then
will the bank give you a chance to get a loan.
Running an existing business: It is important to know the cash flow of a business so that loans could be
arranged in advance in order to get the least interest possible. If a firm has cash flow problems and goes to
the bank for a loan for the next day, it will charge high interests because it knows that the business has no
choice. Also, if a business exceeds the overdraft limit without informing the bank, it could be asked to
repay the overdraft immediately and could result in closure of the business.
Managing cash flow: If a business has too much cash, it should put the cash to some good use quickly.
Some examples of this is: repaying all loans for less interest, paying creditors immediately to get
discounts.
How can cash flow problems be solved?

Here are some steps to solve cash flow problems:
Arrange for future loans with the bank when you anticipate negative cash flow.
Reduce or delay planned expenses until cash is available, e.g. ask to pay in credit.
Increasing forecasted cash inflow, e.g. by getting a part-time job.
For more information on the importance of cash flow visit page 132 in the book. This case study will give
you a lot of information.





Chapter 9: Financing business activity
Why do businesses need finance?


Businesses need finance, or money, to pay for their overhead costs as well as their day to day and variable
expenses. Here are three situations when businesses need finance the most:

Starting a business: Huge amounts of finance is needed to start a business which requires buying fixed
assets, paying rent and other overheads as well as producing or buying the first products to sell. The
finance required to start up a business is called start-up capital.
Expanding a business: When expanding, a lot of capital is needed in order to buy more fixed assets or
fund a takeover. Internal growth by developing new products also requires a notable amount of finance
for R&D.
A business in difficulties: For example, for loss making businesses money is needed to buy more efficient
machinery, or money is needed to cover negative cash flow. However, it is usually difficult for these
firms to get loans.
All all cases, businesses need finance for either capital expenditure or revenue expenditure:
Capital expenditure: Money spent on fixed assets.
Revenue expenditure: Money spent on day-to-day expenses.

Sources of finance

There are many ways to obtain finance, and they can be grouped in these ways.
Internal or external.
Short-term, medium-term or long-term.
Internal finance:

This is finance that can be taken from within the business itself. There are advantages and disadvantages
to each of them:
Retained profit: Profit reinvested into a business after part of the net profit has been distributed to its
owners.
+ Retained profit does not have to be repaid unlike a loan.
- New businesses do not have much retained profit.
- Retained profit from small firms are not enough for expansion.
- Reduces payment to owners/shareholders.
Sale of existing assets: Firms can get rid of their unwanted assets for cash.
+ Makes better use of capital that is not used for anything.
- Takes time to sell all of these assets.
- New businesses do not have these assets to sell.
Running down stocks: Sell everything in the current existing inventory.
+ Reduces opportunity cost and storage costs of having inventory.
- Risks disappointing customers if there are not enough stock left.
Owners' savings: Only applies to businesses that do not have limited liability. Since the legal identity of
the business and owners are the same, this method is considered to be internal.
+ Available quickly.
+ No interest paid.
- Limited capital.
- Increases risks for owners.
External finance:

This is money raised from individuals or organisations outside a business. It is the most common way to
raise finance.
Issue of shares: Same as owners' savings, but only available to limited companies.
+ A permanent source of capital that does not have to be repaid.
+ No interest paid.
- Dividends will have to be paid.
- Ownership of the company could change hands to the majority shareholder.
Bank loans: money borrowed from the bank.
+ Quick to arrange.
+ Variable lengths of time.
+ Lower rates offered if a large company borrows large sums.
- Must be repaid with interest.
- Collateral is needed to secure a loan and may be lost.
Selling debentures: These are long-term loan certificates issued by limited companies.
+ These can be used to raise long-term finance, e.g. 25 years.
+ No collateral is required, just the trustworthiness of a big company.
- Must be repaid with interest.
Factoring of debts: Some businesses (debt factors) "buy" debts of a firm's debtors (e.g. customers) and
pay the firm cash in return. The firm now does not worry about worrying about whether their customers
will pay or not and 100% of all the debts goes to the factor. Factoring debt is very difficult for me to
understand and explain, so explore http://business-debt.cleardebts.co.uk/factoring.html for more
information.
+ Immediate cash is obtained.
+ Risk of collecting debt becomes the factors.
- The firm does not receive 100% value of the debt.
Grants and subsidies: can be obtained from outside agencies like the government.
+ Do not have to be repaid.
- They have conditions that you have to fulfil (e.g. locating in poor areas).
Short-term finance:

This is working capital required to pay current liabilities that is needed up to three years. There are three
main ways of acquiring short-term finance:
Overdrafts: Allows you do draw more from your bank account than you have.
+ Overdrafts can vary every month, making it flexible.
+ Interest only needs to be paid only to the amount overdrawn.
+ They can turn out cheaper than loans.
- Interest rates are variable, and often higher than loans.
- The bank can ask for the overdraft back immediately anytime.
Trade credits: Delaying payment to your creditors, which leaves the company with better cash flow for
that month.
+ It is almost a short-term interest free loan.
- The supplier could refuse to give discounts or to supply you at all if your payments are delayed too
much.
Factoring of debts
Medium-term finance:

Finance available for 3 to 10 years that is used to buy fixed assets such as machinery and vehicles.
Bank loans
Hire purchase: This allows firm to pay for assets over time in monthly payments which has interest.
+ The firm does not have to come up with a lot of cash quickly.
- A deposit has to be paid at the start of the period of payment.
- Interest paid can be very high.
Leasing: Hiring something. Businesses could use the asset but will have to pay monthly. The business
may choose to buy the asset at the end of the leasing period. Some businesses sell their fixed assets to a
leasing company who lease them back so that they could obtain cash. This is called sale and leaseback.
+ The firm does not have to come up with a lot of cash quickly.
+ The leasing firm takes care of the assets.
- The total leasing costs will be higher than if the business has purchased it.
Long-term finance:

This kind of finance is available for more than 10 years. The money is used for long-term fixed assets or
the takeover of another company.
Issue of shares: Shares are sometimes called equities, therefore issuing shares is called equity finance.
New issues, or shares sold by public limited companies can raise near limitless finance. However, a
business will want to give the right issue of shares so that the amount bought by shareholders will not
upset the balance of ownership.
+ A permanent source of capital that does not have to be repaid.
+ No interests paid.
- Dividends will have to be paid. And they have to be paid after tax (so taxes become higher), while
interest on loans are paid before taxes.
- Ownership of the company could change hands to the majority shareholder.
Long-term loans or debt finance: Loans from a bank, and this is how they are different from issuing
shares:
Interest is paid before taxes, it is counted as an expense.
Interest has to be paid every year but dividends only need to be paid if the firm has made profit.
They are not permanent capital.
They need collateral.
Debentures
How the choice of finance is made in a business

These are the factors that managers consider when choosing the type of finance they need.

Purpose and time period: Managers need to match the source of finance to its purpose. It is quite simple,
short-term finance is used to buy current assets and things like that, while long-term finance for fixed
assets and similar things.
Amount needed: Different types of finance depends on how much is needed.
Status and size: Bigger companies have more choices of finance. They pay less interest to banks.
Control: owners lose control if they own less than 51% of shares in their company.
Risk and gearing: loans raise the gearing of a business, meaning that their risk is increased. Gearing is can
be obtained by calculating the percentage of long-term loans compared to total capital. If long-term loans
take up more than 50% of total capital, then the business would be called highly geared. This is very risky
because the business will have to pay back a lot of its loans and has to succeed to do so. Banks are less
willing to lend to these businesses, so they will have to find other types of finance.
Will banks lend and will shareholders invest?

Loans will be available to businesses but information about the business is required:
The firms trading records.
Forecasts about the future.
Forecasts have to show that the firms are solvent, i.e. able to repay the loan and the interest back.
Banks will also consider:
Experience of the people running a business.
Gearing ratio of a business.
This is what shareholders will consider if they want to invest:
The future prospects of the company.
How much dividends are given out compared to other companies.
Trend of share prices.
Gearing ratio.

Business plans

Banks will want to see a business plan if they are to lend to most businesses, especially a newly created
one. A business plan contains:
Objectives.
How the business will be operated.
How the business will be financed.
By creating a business plan owners will have to think carefully ahead about their business to ensure the
best plan possible. These are things they will need to consider:
Target market and consumers.
Profits, costs and break-even point.
Location of the business.
Machinery and workers required.
Without a detailed plan which works, bank managers will be reluctant to lend any money to businesses
because their owners have not shown that they are serious enough about their business.

Here is an example of a business plan from the book, it shows the things you need to put in a business
plan:



Chapter 10: Organisational Structure
What is organisational structure?


Organisational structure refers to the levels of management and division of responsibilities within a
business, which could be presented in an organisational chart.


For simpler businesses in which the owner employs only himself, there is no need for an
organisational structure. However, if the business expands and employs other people, an
organisational structure is needed. When employing people, everybody needs a job description.
These are its main advantages:

People who apply can see what they are expected to do.
People who are already employed will know exactly what to do.
Here is an example of a Job Description taken from the book:

When there are more than one person in a small business and they all do different things, it means
that they are specialising in different jobs.

Delegation

Delegation refers to giving a subordinate the responsibility and authority to do a given task.
However, the final responsibility still lies with the person who delegated the job to the subordinate.
Here are the advantages of delegation for managers and employees, as well as why some managers
choose not to delegate.

Pros for the manager:
By letting subordinate do smaller tasks, managers have more time to do more important
tasks.
Managers are less likely to make mistakes if tasks are done by specialist employees.
Managers can measure the success of their task more easily.
Pros for the subordinates:
Work becomes more interesting and rewarding.
Employees feel important and trusted.
Helps train workers, giving them better career opportunities.
Why some managers don't want to delegate:
Managers are afraid that their employees will fail.
Managers want total control.
Managers are scared that the subordinate will do tasks better than them, making them
feel insecure.
Delegation must mean:
A reduction in direct control by managers or supervisors.
An increase in trust of workers by managers or supervisors.
Organisational charts

Eventually, when a business grows larger and employs many people, they will have to create
an organisational chart to work out a clear structure for their company. Here is another example of
an organisational chart from the book:
http://3.bp.blogspot.com/-i_SovL30MwM/TZx-4mcD63I/AAAAAAAAADY/hSre1_-
Yztw/s1600/orgchart3.jpg

Here are the most important features of the chart:
It is a hierarchy. There are different levels in the business which has different degrees of
authority. People on the same level have the same degree of authority.
It is organised into departments, which has their own function.
It shows the chain of command, which is how power and authority is passed down from the
top of the hierarchy, and span of control, meaning how many subordinates one person controls, of
the business.
Advantages of an organisational chart:
The charts shows how everybody is linked together. Makes employees aware of
the communication channel that will be used for messages to reach them.
Employees can see their position and power, and who they take orders from.
It shows the relationship between departments.
Gives people a sense of belonging since they are always in one particular department.
Chain of command and span of control:
http://2.bp.blogspot.com/-oF6l6ordicc/TZx9wvAsIQI/AAAAAAAAADI/-
E4uzizVxr4/s1600/chain%2526span.jpg


Here are two organisations, one having a long chain of command and the other a wide span of
control. Therefore, the longer the chain of command, the taller the business hierarchy and the
narrower the span of control. When it is short, the business will have a wider span of control.


In recent years, people have begun to prefer to have their business have a wider span of control and
shorter chain of command. In some cases, whole levels of management were removed. This is
called de-layering. This is because short chains of commands have these advantages:
Communication is faster and more accurate. The message has to pass through less people.
Managers are closer to all employees so that they can understand the business better.
Spans of control will be wider, meaning that the manager would have to take care of more
subordinates, this makes:
The manager delegate more, and we already know the advantages of delegation.
Workers gain more job satisfaction and feel trusted because of delegation.
However, if the span of control is too wide, managers could lose control. If the subordinates are
poorly trained, many mistakes would be made.

Functional departments

Here is an example of an organisational chart from a larger business from the book:

http://3.bp.blogspot.com/-oqa05cIgOn4/TZx9Vavc-
YI/AAAAAAAAADE/fSWXUGp9qGY/s1600/orgchart1.jpg
Here are the key features of this graph:
The business is divided into functional departments. They use specialists for each job and
this creates more efficiency. However, workers are more loyal to their department than to the
organisation as a whole. Therefore, conflict can occur between different departments. Managers
working in these departments are called line managers, who have direct authority and the power to
put their decisions into effect over their department.
Not only are there departments, there are also other regional divisions that take care of
outlets that are situated in other countries. They use the local knowledge to their advantage.
There are some departments which do not have a distinctive function but still
employs specialists and report directly to the CEO/Board of Directors. These departments are
the IT department, and the Economic Forecasting department. Some say the HR department fits
in this category. These departments give specialist advice and support to the board of Directors
and line managers, and the managers of these departments are called staff managers. They are often
very highly qualified personnel who specialises in only their area.
Here are the pros and cons of employing staff managers:

Pros:
Staff managers help and provide advice for line managers on things such as computer
systems.
Helps line managers concentrate on their main tasks.
Cons:
There may be conflict between the two groups on important decisions and views.
Line employees may be confused and do not know who to take orders form, line or staff
managers.
Decentralisation

Decentralisation refers to a business delegating important decisions to lower divisions in the
business. In a centralised structure important decisions are taken at the centre, or higher levels of
management.

Advantages of a decentralised structure:
Decisions are made by managers who are "closer to the action".
Managers feel more trusted and get more job satisfaction due to delegation.
Decisions can be made much more quickly.
The business can adapt to change much more quickly.
Decentralisation means that:
Less central control.
More delegation.
Decisions taken "lower down" in the organisation.
Authority given to departments/regions
Different forms of decentralisation:
Functional decentralisation: Specialist departments are given the authority to
make decisions. The most common of these are:
Human Resources.
Marketing.
Finance.
Production.
Federal decentralisation: Authority is divided between different product lines. E.g.
separate truck/car/bus divisions.
Regional decentralisation: In multinationals, each base in each country has authority to
make its own decisions.
Decentralisation by project means: For a certain project, decision-making authority is
given to a team chosen from all functional departments.
Is complete decentralisation a good idea?

It is dangerous to let the lower-level management make all the decisions. Therefore, it is wise for
the central management to decide on major issues, long-term decisions, and growth and business
objectives. If these issues are not centralised then there would be a lack of purpose or direction in
the business.

Chapter 11: Managing a business
What do managers do?


All organizations have managers. They can come by the name of director, headmaster, etc... But they all
perform similar tasks. These tasks are:

Planning:

Planning for the future involves setting goals for a business. These goals give the business a sense of
direction and purpose. Now the whole business will have something to work towards. Managers also need
to plan for resources which will be needed. These are only two strategies managers use to keep the
business running.



Organising:

A manager cannot do everything by himself. Therefore, jobs must be delegated to employees. Employees
need sufficient resources to complete their job, so managers need to organise people and resources
effectively.


Co-ordinating:


Managers need to bring people together in a business for it to succeed. This is called co-ordination. If
different functional departments do not co-ordinate, they could be doing completely different things
which does not follow any common plan. Managers could co-ordinate the departments by holding regular
meetings or setting up a project team with different members from different departments.


Commanding:


Commanding refers to guiding, leading and guiding subordinates which is very important in any
organisation. Managers need to make sure that all subordinates are following targets and deadlines. It is
the responsibility of the manager to ensure that all tasks are completed and therefore instruction and
guidance must be provided to employees so that they can do so.


Controlling:


Controlling means evaluating the performance of subordinates, so that corrective action can be carried out
if the subordinates are not sticking to goals.

To sum up, this is what management gives to any organisation:

A sense of control and direction.
Co-ordination between departments, preventing wastage of efforts.
Control of employees.
Making the most out of resources (organisation)
What makes a good manager?

There are different views of why some managers are better than others. Some say that managers are born
that way, while others say good managers are trained. However, good managers do have these distinct
characteristics:
Intelligence: to understand difficult ideas and deal with different issues.
Initiative: to be able to think of solutions and take control of situations.
Self-confidence: to be willing to lead others and be a model image.
Assertiveness and determination: to be able to take command of others and take ideas and solutions to the
end.
Communication skills: to be able to inform subordinates in a clear way so that they will respond
positively.
Energy and enthusiasm: to work with high effort and involvement so that others will follow.
Styles of leadership:

Different managers use different styles of leadership, and each one makes subordinates react in a certain
way. It is important for the managers to choose the appropriate leadership style for the right situation.
These styles will be discussed in Chapter 13: Motivation at work.

Management involves taking risks:

All managers need to make decisions in what they do, whether it is planning, organising, co-ordinating,
act. All as you know, all decisions involve some sort of risk.

Are all decisions as important as each other?

There are three types of decisions which has their type of importance and the length of time that is is
going to affect the business. They are:
Strategic: These are very important decisions that will affect the overall success of an organisation. They
are long-term decisions such as company goals or growth. They are usually taken by the top management.
Tactical: These are decisions that are less important decisions that are taken more frequently. They can
include: new ways to train staff, new transportation routes used, advertising methods, etc... They are
usually taken by the middle management.
Operational: They are day-to-day decisions taken by the lower management. They tend to be repetitive
and previous experience could be used to help making these decisions. They can be: inventory/stock
levels, ordering goods, dealing with customers.
All of these decisions involve risk. Since they all cost time, money and opportunity cost one should think
well before making a decision.

In business, decisions need to be made and the risks need to be accepted. People like sole traders who
have unlimited liability risk losing all that they own by setting up a business are called entrepreneurs. As
we already know they are the managers and risk-takers of a company. Managers in a limited company are
not "real" entrepreneurs, because they are not risking their assets but the capital of the shareholders.

How can managers reduce risks when taking decisions?

Risks are the results of failure. Risks cannot be eliminated, but they can be reduced by the process of
making decisions. Here are the steps:
Set goals: It is impossible to make decisions if the aims are not clear.
Identify and analyse the problem: Managers all make decisions to solve a problem. This problem might
be how to use your salary in the most efficient way possible, how to spend the rest of your life, etc... It is
imperative that you must understand the problem before finding a solution for it. Otherwise, you might
make the wrong decision.
Collect data on all possible alternative solutions: It is always important to analyse all possible solutions to
find which one is the best. The data collected should also contain constraints and limitations on the
possible decisions (e.g. the law).
Make the final decisions and put it into effect: This is called implementing the decision. This means that
the manager must see to it that the decision is carried out and is working to plan.
Review and evaluation of decision: This is looking back at the decision to identify pros and cons of a
decision so that the experience can be used in the future. This is often hard to do especially when the
wrong decision is made. It is nevertheless necessary.
Here is a decision-making flow chart from the book that will help you visualise the process:




Management responsibilities in departments:

Human resources department:
Forecasting staffing needs.
Recruiting staff.
Preparing the job descriptions and job specifications.
Planning and implementing staff training programmes.
Interviewing and selecting staff.
Negotiating with worker representatives, such as union leaders, on wages and working conditions.
Keeping staff records.
Disciplining staff
The role of this department is becoming more and more important as the cost of hiring staff rises, so that
it is crucial for the HR department to manage people firmly and fairly. An unsuccessful HR department
results in a high staff turnover (people leaving the business early). The department must also make sure
that the business and staff comply with all employment laws.

Marketing department:
Market research for:
New products.
New markets.
New opportunities.
Planning the release of new products, often working with the Production and R&D departments.
Decide on the best marketing mix (discussed later) for a product and implementing it.
Keeping track of products so extension strategies can be used or to take the product off the market.
The marketing department is crucial for the business to keep in touch with its customers. No business can
survive without this kind of function.

Accounting and finance department:

Recording all financial transactions.
Collecting all the data and presenting it as the regular accounts.
Preparing all budgets.
Analysing the profitability of new projects.
Deciding on which source of finance to use.
Keeping control over business cash flow.
Production department/Operations management:
Ordering stock/inventory of materials and resources used for producing goods.
Developing and designing new products.
Locating in the most cost-effective place possible.
Deciding on the methods of production and machinery. Purchase of new machinery will involve the
Finance department.
Controlling production to maintain high levels of efficiency.
Maintaining the efficiency of machines.
Keeping the quality high to meet the standards of the consumers. All staff will need to co-operate because
poor quality is normally blamed on bad staff.
Administration department:

The responsibilities of the Administration department varies with the business it is in. For example, in
smaller businesses, the administration department would be the same as the Accounts and Finance
department. A larger business will have more specialized administrative department. These are what the
the department does:
Clerical and office support services: Ensure the smooth running of all other departments.
Sorting of incoming mail and sorting and franking of outgoing mail.
Reception will greet visitors, answer calls, and schedule rooms for meetings.
Office tasks will include filing all records. E.g. visitors and calls.
Information and data processing.
Responsibility for the IT system:
The IT department is part of the Administration department.
Allows information to be delivered between departments accurately.
Provides managers with data to help in decision making.
Cleaning, maintenance and security:
Vital for safe and healthy working conditions.
Failure to maintain equipment and the building (e.g. air conditioner) will result in reduced efficiency.
The widespread use of computers means that many workers in all departments can do some of these tasks
by themselves (clerical and support services), reducing the function of the Administration department and
make them less common in businesses.

Chapter 12: Communication in business
What is effective communication and why is it necessary?

Communication is when a message transferred from one person to another and is understood by the latter.
We communicate everyday (by talking, by chatting, by texting, etc.) but we need to learn how to
communicate effectively. Effective communication means that:
"The information or message being sent is received, understood and acted upon in the way intended."
In business, ineffective communication or communication failure could result in serious problems.



Why do people within business need to communicate with each other?


In business, if we do not communicate, we would be working as individuals with no co-ordination with
anybody else in the business. The management, whose tasks are guiding, instructing and commanding
subordinates could not be done because they cannot communicate with them. Here are some common
messages found in the workplace:
No Smoking (sign)
You are fired because you are always late (letter)
Do not touch (sign)
There will be a fire drill 11:00 today (noticeboard)
There are many more things that are communicated. Consequences would be severe if these matters are
not communicated effectively.

The process of effective communication:

Effective communication involves four features:
The transmitter/sender who sends the message. He has to choose the next two features carefully for
effective communication.
The medium of communication. It is the method of communication, e.g. noticeboard, letter, etc...
The receiver who receives the message.
Feedback means that the receiver has received the message and responds to it. This confirms that the
message has been understood and acted upon if necessary.
One-way and two-way communication

There are two types of communication. One-way communication is when there is no feedback required
for the message, or the receiver is not allowed to reply. This might be the sign that says "No smoking", or
your boss saying: "give me a biscuit". The other is two-way communication, when feedback is required.
Therefore, both people are now involved in the communication process. This could lead to better and
clearer information.

Pros of two-way communication:
The sender can now know whether the receiver has understood and acted upon the message or not. If they
have not, the message might have to be sent again or made clearer. Effective communication takes place
only if the message is understood by the receiver.
Both people are involved in the communication process. This makes the receiver feel more important
which might motivate them to make better contributions to the topic discussed.
Internal and external communication

Internal communication is messages sent between people inside a business. For example:
The boss talking to his subordinates.
A report sent to the CEO.
External communication refers to messages sent to people or organisations outside the business. For
example:
Orders for goods from suppliers.
Talking to customers.
Advertising to the public.
Both types of communication is almost the same, the only difference is who is being communicated with.

Why external communication has to work well

External communication can greatly affect the efficiency and image of a business. Imagine if the wrong
information is sent to a supplier and a customer. The supplier would send wrong materials while the
customer might buy products from another company. Here are some cases which ineffective external
communication might turn out to be very dangerous:
The Finance Manager writes to the tax office inquiring about the amount of tax that must be paid this
year.
The Sales Manager receives an order of 330 goods to be delivered on Wednesday.
The business must contact thousands of customers because a product turned out to be dangerous. An add
must be put into the newspaper so that customers can return the product for a refund.
Different ways of communicating: the communication media

Information can be transmitted in several ways:
Verbal: Involves the sender speaking to the receiver.
Written: The message is written to the receiver.
Visual: Using charts, videos, images or diagrams to communicate a message.
There is no best method of communication, so the appropriate medium of communication must be
selected depending on the situation. First the sender also has to analyse the advantages and disadvantages
of each type of communication.

Verbal communication

Verbal/Oral communication might be:
One-to-one talks.
Telephone conversations.
Video conferencing.
Meetings.
Pros:
Information is transferred quickly. This is an efficient way to communicate in meeting to lots of people.
There is opportunity for immediate feedback which results in two-way communication.
The message might be enforced by seeing the speaker. Here the body language and facial expression
could make the message easily understood.
Cons:
In big meetings, we do not know if everybody is listening or has understood the message.
It can take longer for verbal feedback to occur than written feedback.
Verbal communication is inappropriate for storing accurate and permanent information if a message. (E.g.
warning to a worker)
Written communication including electronic communication

Here are some written forms of communication:
Letters: Used for both external and internal communication. Follows a set structure.
Memos: Used only for internal communication.
Reports: Detailed documents about any problem. They are done by specialists who send them to
managers to analyse before meetings. These reports are often so detailed that they cannot be understood
by all employees.
Notices: Pinned to noticeboards that offer information to everyone. However, there is no certainty on
whether they are read or not.
Faxes: Written messages sent to other offices via telephone lines.
E-mails: Messages sent between people with the same computing facilities. The message is printed if a
hard copy is needed.
Intranet: A network inside a business which lets all employees with a computer message each other.
Internet: The global network for messaging anyone. (E.g. customers, suppliers)
Pros:
There is hard evidence of the message which can be referred to and help solve disputes in the future over
the content of the message.
It is needed when detailed information is transferred: it could be easily misunderstood. Some countries the
law states that businesses need to put safety notices up because people could forget them.
The written message can be copied and sent to many people.
Electronic communication is a quick and cheap way to get to many people.
Cons:
Direct feedback is not always possible, unless electronic communication is used. However, this could
result in too many emails sent (information overload). Direct feedback via other means of written
communication is hard.
It is not as easy to check whether the message has been understood or acted upon.
The language used might be difficult to understand. The message might be too long and disinterest the
reader.
There is no opportunity for body language to be used to enforce the message.
Visual communication

Here are some forms of visual communication:
Films, videos, and PowerPoint displays: often to help train new staff or inform sales people about new
products.
Posters: can be used to explain a simple but important message. (E.g. propaganda poster)
Charts and diagrams: Can be used in letters or reports to simplify and classify complicated data.
Computer technology could help in the design of these charts or diagrams. A printed copy might be
needed for hard data to add to reports and documents.
Pros:
Present information in an appealing and attractive way that encourages people to look at it.
They can be used to make a written message clearer by adding a picture or a chart to illustrate the point
being made.
Cons:
No feedback is possible. People need to check via verbal or written communication to check that they
have understood the message.
Charts and graphs might be difficult for some people to understand. The message might be misunderstood
if the receiver does not know how to interpret a technical diagram.
Formal and informal communication

Formal communication is the channel of communication that is recognised by the business, such as
notices on boards, emails and memos. Formal means of communication is important. It shows that the
information given is true.

Informal communication might be communication between friends and co-workers. There is no set
structure and the information transferred is not recognised by the business. This channel of
communication could be used by the manager to try out new ideas, before publicly announcing it to the
rest of a company. However, informal communication can result in gossip can rumour, and managers
have no way to remove these informal links from people.

Communication nets

There are many groups of people in any organisation, and each of them communicate in different ways.
People have connections with each other, and these links form communication nets. There are three
standard types of communication nets:

Chain network:


+ Can be used to transfer important messages from higher management levels to lower levels.
- This often leads to one way communication.
- The message could become altered as it passes through different management levels.

Wheel network:


+ The central management can pass messages to all departments quickly.
- The departments cannot communicate directly between themselves.

Connected network:


+ This is used to create or discuss new ideas.
+ It specialises in two-way communication.
- Can be time-consuming.
- There is no clear leader or sender of messages.

Which network works best?

There is again, no best network. A company is likely to use different network at different times or for
different groups.
The chain network is for communicating important business policies.
The wheel network is used for sending different messages to different departments.
The connected network is used to generate new ideas or solutions to problems where group discussion is
the most effective.
The direction of communications


Here is an organisation chart from the book explaining the direction of communications within the
business. The arrows are labelled A, B and C which shows the direction of communication:
Arrow A (downwards communication):
Used by managers to send important messages to subordinates.
Does not allow feedback.
The message might be altered after passing different levels.
Arrow B (upwards communication):
Used by subordinate send feedback to managers.
Feedback from subordinates ensures that there is effective communication.
Feedback results in higher morale and new ideas contributed to the business.
Arrow C (horizontal/lateral communication):
People at the same level of management communicate with each other.
Information and ideas can be exchanged both formally and informally.
Can cause conflict between departments. (E.g. Production department asks the Finance department for a
budget to hire new staff but is rejected)
Barriers to effective communication

As we already know, the four parts of effective communication includes the sender, medium, receiver and
feedback. However, communication may fail if there are problems with one of these four features. If one
part fails, it becomes a barrier to effective communication which might cause a breakdown in
communication resulting in serious consequences to the business. Here are some common barriers to
effective communication and how to overcome them.

Problems with sender:
Problem: Language is too difficult to understand. Technical jargon may not be understood.
Solution: The sender should ensure that the receiver can understand the message.
Problem: There are problems with verbal means of communication. (E.g. speaking too quickly)
Solution: The sender should make the message as clear as possible and ask for feedback.
Problem: The sender sends the wrong message to the wrong receiver.
Solution: The sender must ensure that the right person is receiving the right message.
Problem: The message is too long with too much detail which prevents the main points from being
understood.
Solution: The message should be brief so that the main points are understood.

Problems with the medium:
Problem: The message may be lost.
Solution: Check for feedback. Send the message again!
Problem: The wrong channel has been used.
Solution: Ensure the appropriate channel is selected.
Problem: Message could be distorted after moving down a long chain of command.
Solution: The shortest channel should be used to avoid this problem.
Problem: No feedback is received.
Solution: Ask for it! Use different methods of communication (e.g. meeting)
Problem: Breakdown of the medium.
Solution: Use other forms of communication.

Problems with the receiver:
Problem: They might not be listening or paying attention.
Solution: The importance of the message should be emphasised. Request feedback.
Problem: The receiver might not like or trust the sender, and may be unwilling to act upon the message.
Solution: Trust is needed for effective communication. Use another sender to communicate the message.

Problems with the feedback:
Problem: There is no feedback.
Solution: Ask for feedback. Use a different method of communication which allows feedback.
Problem: The feedback is received too slowly and may be distorted.
Solution: Direct lines of communication should be available between the subordinate and the manager.
Note: The forms of communication are: verbal, written and visual.
The methods of communication can be: telephone, e-mail, meeting, etc...