Characteristics of an Entrepreneur (Unit 1.1)
• An entrepreneur is someone who makes a business idea happen either by their own effort or by organizing other people to do the work.
• Successful entrepreneurs need: ⇒ Understanding of the market
ú Knowing what customers want and how well current businesses are meeting them.
⇒ Initiative
ú Seizing opportunities, this requires confidence and the ability to be a risk taker.
⇒ Creativity
ú The ability to come up with new and unique ideas. ⇒ Determination
ú Keep on going when the going gets tough. ⇒ Passion
ú The drive and enthusiasm to achieve something. ⇒ Persuasive abilities
⇒ Risk Taking
• Enterprise: is the set of skills and attitudes that help an individual turn an idea into reality.
• People start a business for financial or non-financial reasons. ⇒ Financial: ú Make profit ú Financial security ú Wealth ⇒ Non-financial: ú Personal Satisfaction ú Challenge
ú Working for yourself
• Leadership Styles:
⇒ MANAGERS: the five functions of managers are:
ú PLAN: Select organizational goals and set targets to achieve them. ú COORDINATE: Coordinate resources and staff across departments,
especially when they must be shared.
ú DIRECT: Keep everyone connected to objectives and on track. Communicate goals and instructions.
ú CONTROL: Compare the actual results to targets set. Reward good work and investigate failure to meet targets. Plan for problems and introduce improvements.
⇒ Leadership Vs. Management:
ú Management involves getting things done through other people, leadership means inspiring staff to achieve goals.
⇒ Leadership Styles: four main types: ú Democratic:
§ Encourages participation in decision making § Strong coaching, listening and motivating skills § Teamwork and communication is important
§ Prepared to make final decision when agreement can't be reached
⇒ Autocratic:
ú Full control of decision making ú Employees have little or no input ú Good in crisis situations
ú Motivation through rewards
⇒ Laissez-Faire:
ú Gives employees as much freedom as possible
ú Managers communicate goals to employees but allow them to choose how to complete objectives, make decisions and resolve problems on their own.
⇒ Bureaucratic:
ú Everything is done 'By the book' or by the policy ú They enforce the rules
ú If it isn't covered by the book, the manager refers to the next level above
⇒ Paternalistic:
ú A paternalist manager acts like a 'father' ú They try to do what is best for their staff
ú There will be consultation to find out the views of the employees, but decisions are made by the manager
ú Paternalistic managers are interested in the security and social needs of their staff but it is still an autocratic approach.
• Factors Effecting leadership Style: ⇒ Nature of the task
⇒ Personality ⇒ Time constraints
⇒ Skills of manager and workforce ⇒ Rate of change
⇒ Level of risk
• Douglas McGregor:
⇒ An American psychologist ⇒ Worked in the 1950s
⇒ Developed a theory about human behavior at work called “theory X and theory Y”
⇒ Considerations:
ú Theory X and theory Y are extremes, it is likely that most managers would fall somewhere in between.
ú A theory Y manager would create a more pleasant workplace/environment.
ú A theory X manager may be better when dealing with casual workers or at times of crisis.
Identifying a business opportunity 1.2
• What is a market?
“A place where buyers and sellers meet, in order to exchange goods and services for money”
• Creating a Market:
⇒ A market can be held anywhere
o It doesn’t have to be a supermarket. o It doesn’t even need a building.
⇒ Indeed one of the biggest markets in the world the meeting between buyers and sellers is virtual.
• Supply:
“The amount of a product that suppliers (sellers) offer for sale at a given price”
• Why supply increases if prices increase: ⇒ Most firms want to make profit.
⇒ If the price of a product increases then:
o More profit will be made on each item sold § Assuming costs don’t change.
o Other firms may be encouraged to start making and selling the product. § As they see the opportunity to make a profit.
⇒ This direct relationship between the quantity supplied and price can be shown on a supply curve.
• The supply Curve:
⇒ The supply curve shows how the quantity supplied changes as the price of the good changes.
⇒ A fall in price (P1èP2) causes a fall in the quantity supplied (Q1èQ2). ⇒ A rise in price (P1èP3) causes an increase in the quantity supplied (Q1èQ3)
• Factors of Supply:
⇒ So any change in price results in a shift along the supply curve. ⇒ Other factors of supply:
o Costs of production
o Legislation a government policy o Changes in production technology o Weather
⇒ If any of these factors change the supply curve itself will shift.
• Shifting the supply curve could be caused by: ⇒ Changes in production costs
⇒ Changes in production taxes and/or subsidies ⇒ Changes in technology
⇒ The weather/climate (primary commodities) ⇒ The number of producers in the market
⇒ There is no change in price
⇒ However, firms are now willing to supply more ⇒ The quantity supplied therefore increases (Q1èQ2)
• Demand:
“The quantity of a good service that buyers (consumers) wish to purchase at a given price.”
⇒ Most people want to buy for the lowest price ⇒ This is exactly how most consumers behave:
o When prices are high, demand will be low. o When prices are low, demand will be high. • Why demand decreases if prices increases:
⇒ Most consumers are looking to buy as cheaply as possible: o Everyone likes a bargain
o Nobody likes to be “ripped off” ⇒ If the price of a product increases then:
o People won’t be able to afford to buy as many • Assuming their income stays the same o Instead people may look for cheaper alternatives
• E.g. buying margarine instead of butter.
⇒ This indirect (or inverse) relationship between the quantity demand and price can be shown on a Demand curve.
• The demand Curve:
⇒ The demand curve shows how the quantity demanded changes the price of the good changes.
⇒ A fall in price (p1èP2) causes an increase in the quantity demanded (Q1èQ2).
⇒ A rise in price (P1èP3) causes a decrease in the quantity demand (Q1èQ3).
• The factors of demand:
⇒ Factors affecting demand: o Income
o The price of other goods (competitor products/substitute products) o Tastes and Customs
o Changes in populations o Advertising
o The law
o Government policies o Attitudes and information
⇒ If these factors change, the demand curve will shift.
• Shifting the demand curve:
⇒ Shifting in the demand curve can be caused by: o Increases in consumer population
o Increases income
o Consumer tastes shift toward the good in question. o The price of substitutes rises.
o The price of a complementary good fails. o The bank of England cuts interest rates. ⇒ There is no change in price.
⇒ However, consumer are now willing to buy more. ⇒ The quantity demanded therefore increases (Q1èQ2)
• Market equilibrium – Determining price
⇒ By combining supply and demand we can show how a market works. ⇒ The two curves should cross at one point
⇒ This point is called equilibrium.
• Product orientation and market orientation: ⇒ Product Orientation:
o When a business bases its marketing mix on what the business sees as its internal strengths, the business’s marketing is said t be “product orientated”.
o A product-orientated firm has its primary focus on its products and on the skills, knowledge and systems that support the product.
⇒ Market orientation:
o A market orientated business is one that organizes its activities, products and services around the wants and needs of its customers. o The business bases its marketing mix on its perception of what the
market wants.
⇒ Advantages of product orientated Organizations: o Firms can focus on internal quality:
§ Technological investments can be applied to a wide range of products
§ Economies of scale can more easily occur § Allows outsourcing of production
§ The organization is essentially a design house ⇒ Disadvantages of product orientated organizations:
o changes in market structure will not be responded to o fashion and taste are not accounted for in the public mix o technology applied can be left behind
⇒ Advantages of Market orientation:
o The business should be flexible to changes in demand patterns o The business, through market research, will have a strong
understanding of the needs of the customer
o New products should have a greater chance of success ⇒ Disadvantages of Market Orientation:
o High cost of market research
⇒ Market orientation gets the right product. Product orientation gets the product right.
⇒ Tools of market orientation: o Market research o Market testing o Customer focus ⇒ Tools of product Orientation:
o Product research o Product testing o Product focus
Evaluating a Business Opportunity 1.3
• In order to find out what customers want, firms will carry out MARKET RESEARCH • Market research can be defined as:
“The systematic gathering, recording and analysis of data in order to better
understand the behavior of consumers.”
• The information collected can be used to:
⇒ Identify new business opportunities or ideas
⇒ Identify patterns in consumer behavior and forecast likely demand. ⇒ Identify the main competitors.
• Researching The Market:
Market research can be carried out in two main ways. ⇒ Primary Research:
o Sometimes called field research.
o This is new information that has been collected first hand. o It could be:
§ Collected by the firm.
§ Collected by specialist research companies.
⇒ Secondary Research:
o Sometimes called desk research.
o This is information that’s already been collected. o It could be information:
§ From within the firm. § Or outside the firm.
• Carrying out primary research:
⇒ Primary research will be carried out by asking a sample of people o It would be impossible to ask every prospective customer. ⇒ Sampling involves selecting few people to interview
o So its important that they are representative of the whole market. ⇒ Sampling methods include:
o Probability Sampling. o Non-Probability Sampling. • Probability Samples:
o Here, every single member of the population has an equal chance of being chosen.
⇒ Systematic random sampling:
o With this method, every n th member of the population is surveyed, for
example every 5th.
⇒ Stratified random sampling:
o This involves dividing the sample into market segments, based on existing knowledge.
⇒ Cluster Sampling:
o This method splits the whole market into small areas, and sampling is carried out in those areas believed to be typical.
• Non-Probability Samples: ⇒ Quota Sampling:
o A certain number of people with given characteristics will be interviewed.
⇒ Convenience Sampling:
o Interviews everyone available. ⇒ Judgment Sampling:
o This allows the interviewer to select people who they judge to be representative of the market.
• Secondary Data:
⇒ It can be obtained from two sources: o Inside the business:
§ Existing research data § Past promotional data § Sales records
§ Stock records § Financial records § Customer database
o Outside the business:
§ Government statistics
§ Commercial firms. (E.g. Mintel)
§ International publications. (E.g. World Bank) § Competitors annual reports
§ The media
• Investigating the market:
⇒ In order to asses the demand for a product a business must consider: o The size of the market
o Market niches (Gap in market) o Existing market segments o Potential Market growth ⇒ The size of the market:
o Firms will need to think about the size of the market: § A large market means lots of potential customers
§ A small market means potential profits would be limited.
⇒ In order to asses whether there is a market for the idea, it is important to consider:
o The number of competitors. o The potential market growth. ⇒ It is crucial to Consider:
o Market share o Market growth. • Calculating market share:
Market Share (%)= Value of Product Sales/Value of market sales x 100
• Calculating Market Growth:
⇒ Ideally a firm will want to enter a market that is growing o This means more products are being sold
⇒ Market growth refers to an increase in the size of the market for a particular product.
o If the market is shrinking then market growth will be negative.\ • Market share Vs. Market Growth:
⇒ Ideally a firm will want a big market share of a growing market ⇒ However, this is not always possible
⇒ Most businesses will break a market into smaller manageable chucks, called segments.
⇒ This means consumers with similar characteristics together.
• Segmenting the market:
⇒ Geographic Segmentation:
o Based on Geographic Patterns ⇒ Demographic Segmentation:
o Age, Gender, income, etc. ⇒ Psychographic Segmentation:
o Social Class
⇒ Behaviorist Segmentation: o Behavior Patterns ⇒ Geographic Segmentation:
o His is a simple form of segmentation based on geographic Patterns. o This could compare:
§ Spending levels § Income levels § Employment levels § Buying Habits
⇒ Demographic Segmentation:
o This refers to ways of separating people according to their characteristics.
o There are three main ways: § Age:
ú People of different ages buy different products. § Gender:
ú Men and women behave differently, and buy different things.
§ Income:
ú People with different disposable income levels will purchase different products, even with the same brand.
o This separates households according to their social class, life-style and/or personality.
⇒ Behavioristic Segmentation:
o This considers consumer behavior patterns including: § What people buy
§ How often people buy
§ How loyal customers are to certain brands
o The introduction and use of loyalty cards has made this much easier for firms to do.
• Problems with Mass marketing:
⇒ It can carry high levels of fixed costs in the form of capital e.g. buildings, land and machinery.
⇒ Vulnerability to changes in tastes and fashions, meaning chances of spare capacity and therefore capacity under utilization.
⇒ Very difficult to appeal directly and satisfy needs of individual customers. ⇒ Regular market research however, can help to reduce the risks of mass
market failure.
• Product differentiation:
⇒ The extent to which the consumer views your product or service as being different from those of your competitors.
⇒ By generating a clear difference in the eyes of the consumer, you can benefit from:
o Increased sales volume
o Greater scope for charging higher prices.
⇒ Mass market firms use product proliferation (Changing something slightly) to serve a variety of different consumer needs. However, the need for mass production limits the number of different products that can be offered.
• Niche Marketing
⇒ This is when a business targets a product or service at a small segment of a larger market. E.g. Cars, specialist clubs.
• Small firms and niche markets
⇒ Few large firms directly compete in niche markets.
⇒ This allows firms to charge higher (premium) prices. ⇒ Little opportunity for economies of scale.
⇒ Lack of scope for large scale manufacturing.
⇒ Greater opportunity for understanding the specific needs of their customer and changing accordingly.
⇒ More effective targeting of their customers base via promotions. Effective use of their limited resources.
• Problems with niche marketing:
⇒ The small scale limits opportunities for large profits.
⇒ Unit costs tend to be higher due to purchasing items in small quantities. ⇒ Specialist firms are vulnerable to changes in tastes and fashions.
⇒ Larger firms might be attracted to a rapidly expanding niche market.
• Mass Marketing Outline:
⇒ Mass marketing involves targeting everyone within the market.
⇒ It tends to make use of mass media methods such as television, radio, cinema and national newspaper.
⇒ It requires a large amount of money to operate effectively. ⇒ It is usually dominated by a few firms.
⇒ The mass market is also highly competitive.
• Benefits of Mass Markets:
⇒ Large scale production is possible.
⇒ Clear advantages from economies of scale. ⇒ Lower costs per unit via bulk purchasing etc.
⇒ Mass media marketing is used to reach as large a potential target market as possible.
⇒ Can be dominated by the larger firms creating significant barriers to entry for competitors.
⇒ Mass marketing helps increase brand awareness and to encourage consumers to try other products.
• Trade Offs & Opportunity cost: ⇒ Scarcity:
o The main resources that we have a limited amount of are money and time.
o At times, choices will have to be made as we don’t have enough money/time to be able to do everything we want to do.
o Money and time can only be spent once. ⇒ Opportunity Cost:
“The opportunity Cost is the cost of missing out on the next best alternative.”
⇒ Opportunity Costs for a small business:
o Choosing to start up in business rather than earning a steady salary. o Picking one business idea over another.
o Choosing to spend money on fixtures and fittings rather than staff training.
o Spending too much Money on stock. ⇒ Deciding Between Business Investments:
o Estimations of potential returns
o Considering the cash outlay required for each idea (Bigger outlay or expenditure = Bigger Risk)
o Is the timing right?
o Do you have the skills to make the business work? • Trade-offs:
⇒ Trade-offs are what you have to give up in order to get what the most. ⇒ These things are not always quantifiable.
• Product trials:
⇒ What are product trials?:
o Products trails are when a product is tested in the market before a launch to asses likely demand levels.
⇒ Why is Test marketing carried out?:
o Launching a new product is very risky. o 5/6 new products fail.
o It is also hugely expensive
o Test marketing can prevent unviable products being rolled out to the whole market at huge expense.
⇒ Types of product trials: o Sales research:
§ Customers are given the chance to try the product. o Controlled test marketing:
§ The product is only available in a few stores. o Test marketing:
§ The product is launched in a limited area.
⇒ Benefits of Product trials:
o It can save millions and can save damage to a companies reputation if trial uncovers a problem.
o It is a good way to get customers to try a product.
o It provides customers feedback which can be used to make improvements.
o Can provide information for firms to help them produce more accurate sales-forecasts.
⇒ The reasons product trials are declining:
o Firms are scared that competitors will find out about their new products and produce a “copycat” product.
o Major supermarkets now use centralized distribution channels which makes it difficult to get a product into a few shops.
o Better marketing research techniques now mean that product trials are no longer necessary.
o Globalization now means that companies are using whole companies as test markets.
⇒ Product trials are useful for new businesses who:
o Don’t have access to sophisticated market research information. o Cant afford a national product launch.
o Want to avoid expensive mistakes.
o Can use the results as a bargaining tool to get supermarket shelf space:
o HOWEVER:
Product trials slow down the time taken to get a product to marketing and things could be crucial.
⇒ If test marketing is used then the area chosen needs to be given careful considerations.
⇒ The size of the market-economy V. accuracy.
⇒ Is it representative of the whole market? (distribution, income, population.)
• Product positioning:
⇒ Firms need to identify the segments that would be most suitable for their product
⇒ Ideally a firm will want to enter a growing market, since this means more is being sold to consumers.
⇒ A firm will also have to consider the competition: o What are their strengths?
o What are their weaknesses? o How are they different.
⇒ Identifying the competition: To analyze the competition they must first be identified.
⇒ Identifying strengths and weaknesses:
o Once the competition has been identified, their strengths and weaknesses can be considered.
o This can be used to identify ways of making your product different. ⇒ Market Mapping:
o Once a firm has knowledge of their competitors they can identify gaps in the market.
o This is often done using “Market Mapping”
o This allows similar products in a market to be mapped using two variables quality and price.
⇒ Gaining a competitive advantage:
o Methods of obtaining a competitive advantage: § Value for Money
§ Facilities § Brand Name § Taste
§ Customer Service: Delivery, After Sales service. § Images
§ Location
⇒ What is Value Added? o It can be defined as:
“The increase in the benefits of a good or service which are created at each stage of production”
o This means that value can be added simply by making a product more appealing to customers
o Methods of adding value include: o Changing raw materials
o Packaging o Branding
⇒ Calculating Value Added:
Value added can be calculated using the formula: Value added = Value of Output – Value of input
⇒ Added Value and Survival:
o It is by adding value that a business is able to make a profit. o As such the method of adding Value used a less important than the
fact that value is added.
o A business that does not add value will not survive in the long-term
• Market Mapping:
• What is a market map:
• A market map is a tool used by business when they are considering entering a new market or launching a new product.
• A market map allows the business to examine the existing competitors/products in a market.
• They can see which areas of the market are overcrowded or spot potential gaps.
• In order to construct a market map the company decided on 2 key factors of the market.
• Choosing the right factors:
⇒ Each market will have different key features o Examples would be:
o High price/low price o For the young/old o Modern/traditional o For men/women o Trendy/classic o Fashion/Functional o Luxury/Everyday o Light/Filling ⇒ Adding Value:
“Adding value means creating something that has a higher value to customers than the bought value”
⇒ Ways to add value:
o The amount of value added is the difference between the materials and the selling price.
o Value added can be increased either by reducing costs or by increasing the price.
o To add more value firms usually add a feature to the product that makes it more valuable to the customer which allows them to charge a higher price.
⇒ Different ways to add value:
o Convenience And speed: In Britain most people will pay extra to save their own time.
o God design: A beautifully designed dress might sell for $400, while one using exactly the same quantity of material might sell for just $40. o High quality manufacture or service: A Lexus sells at $100,000
because it is regarded as one of the best-made cars in the world; it never breaks down and is like sitting in a huge leather armchair. o Brand Name: A Nike swoosh add tens of pounds to the value of a
pair of trainers.
o USP: A features which is different from other similar products ⇒ The importance of value added:
o People starting businesses often forget about everyday costs. There are obvious ones such as gas and electricity and phones, but others
such as the cost of wastage (theft, damaged goods), of the cost of recruiting and training staff.
o All these costs have to be paid for out of the value added. So there needs to be a big enough difference between price and bought in costs to allow internal costs to be paid for.
Economic Considerations (1.4)
• Government and the economy:⇒ There are 3 types of economy: o Free market economy:
the government is not involved in business activity. o Mixed economy:
A mixture of government control and private business organizations o Central planned or command economy:
All decisions made by the government
⇒ Government Control Of Economy
o The sole function of the government is to enable citizens to become wealthier and have better standard of living.
⇒ Government Objectives: o Full employment o Economic growth o Low inflation
o A positive balance of payment o A stable economy
⇒ Full employment
o People at work produce valuable goods and services
o Work provides people with incomes and they can support themselves o When people spend they help keep other people employed
o Unemployed people have to be provided for by the state and taxes need to be increased to pay for this
⇒ Economic Growth:
o Satisfies peoples needs and wants o Raises standard of living
o More products to sell abroad and can earn money to buy imports o More jobs are created and raises incomes and profits
⇒ Low inflation:
o Inflation is the rate at which the price of goods and services increases. o High inflation will reduce exports and encourage cheaper imports.
Harmful to UK firms.
o High inflation causes cash flow problems for firms.
o Encourages employees to ask for higher wages which in turn causes inflation.
⇒ Positive balance of payment: o Makes UK richer
o Helps to keep the value of the pound high which makes the price of imports cheaper and this helps to keep inflation low.
o If the value of the pound is strong interest rates do not need to be high to protect it.
⇒ A stable economy:
o Easier for businesses to plan for the future
o People will not be suddenly threatened with unemployment, higher prices etc.
o People and businesses who borrow money will know exactly how much this will cost.
o Foreign investors will be willing to invest in the UK. ⇒ Two prominent Economic policies used by governments are:
o FISCAL POLICY: adjusting the level of demand in the economy by altering spending and taxation; lower taxes more money to spend; greater expenditure in public sector create demand reduce unemployment.
o MONETARY POLICY: Control the economy through interest rates and the money supply. Target rate for inflation set by the government and Monetary Policy Committee sets the level of interest rate and supply of money to meet this target.
• Interest Rates:
⇒ the cost of borrowing money and the return for lending money (or reward for saving).
⇒ Also represents an opportunity cost.
• How businesses are affected by interest rates:
⇒ Investment decisions and spending on capital goods ⇒ Debt burden on loans
⇒ Opportunity Cost of saving
⇒ Changes in the level of consumer spending ⇒ Business confidence
• Consumer demand:
⇒ Changes in the cost of borrowing for goods purchased on credit (usually larger items)
⇒ Changes in mortgage repayments (implications on disposable income). ⇒ Consumer confidence.
• Effect on exchange rate:
⇒ You should understand the:
o Importance of HOT MONEY FLOWS.
o FLOATING EXCHANGE RATE – based on demand and supply of sterling.
• Imports and Exports:
⇒ If interest rates fall this will lead to a fall in the value of the pound è Fall in export prices and rise in import prices.
⇒ Price Elastic = Price Effects Demand (if price is high, demand is low).
• Inflation:
⇒ What is inflation?:
o Most people know that inflation is about rising prices.
o But it is not simply about increases in the prices of individual goods or services, as these rise and fall all the time in a market economy. o Inflation is a more general phenomenon – it is a widespread rise in the
level of prices across the economy.
⇒ Measuring inflation - RPI: o The retail price index:
§ This was the favored measure of inflation by the UK government until 2003.
§ It measures changes in the value of the average basket of goods.
§ Each good is given a weighted value to reflect its importance and to show the proportion of income spent upon them by the
average family.
⇒ Problems with RPI:
o The major problem with the RPI was that it was felt to only reflect the average person.
o This meant that pensioners and other low income groups often suffered lower than inflation rises in their pensions and benefits, making them worse off.
o Higher fuel prices especially effected these groups badly. ⇒ Consumer price index:
o The CPI measures changes through time in the price level of consumer goods and services purchased by households.
o From 2003 the UK now use the CPI t measure inflation.
o This tends to provide a lower measure in percentage terms of inflation and hence the target has been readjusted to 2%.
o The CPI provides a more accurate indication of inflation with the economy but fails to measure housing costs.
• Inflation(continue):
⇒ Causes of inflation:
o Cost Push inflation:
§ This occurs when there is an increase in the cost of production (e.g. higher wages, raw materials, fuel, tax etc.)
§ This forces firms to raise their prices to protect their profit margins.
o Demand Pull:
§ This occurs when prices rise due to excess demand within the economy.
§ If consumers’ incomes rise but there is no rise in the supply will become limited and high levels of demand will force prices to rise to act as a rationing mechanism.
⇒ Inflation and Expectations:
o Consumer and business expectations about what they think will happen with inflation are very important.
o If these groups believe that inflation will rise then they are likely to demand higher wage rises and increase prices respectively.
o This will create additional inflationary pressures and generate an inflationary spiral.
⇒ Hampers Longer-term Planning:
o With high inflation and the association economic instability, firms find it more difficult to plan ahead.
o And longer-term developments often have to give way to short-term expenditure.
o Firms are discouraged from making longer-term investments and tend to restrict capital spending to high-return projects or those allowing a relatively quick payback, and to assets that of insulation from inflation.
⇒ Increases risks and borrowing costs:
o When inflation is high and unpredictable it adds substantially to financial risks, so savers and lenders require some insurance against the uncertainty of the future value of their money – i.e. a risk premium in the form of a higher interest rate.
⇒ That means higher borrowing costs, which discourages investment.
⇒ Exchange rates:
o Exchange rates: are the price of one currency in terms of another. o Bi-lateral exchange rates: compare one currency against another. o Exchange rates are determined much like any other price in a free
market, via demand and supply.
⇒ Factors that influence the pound:
o Inflation: if inflation in the UK is lower than elsewhere, then UK exports will become more competitive and there will be an increase in demand for pounds. Also foreign goods will be less competitive and so UK citizens will supply less pounds to buy foreign goods. Therefore the rate of the pound will tend to increase.
o Interest Rates: If UK interest rates rise relative to elsewhere, it will become more attractive to deposit money in the UK, therefore demand for sterling will rise. This is known as “hot money flows” and is an important short run determinant of the value of a currency.
o Speculation: If speculators believe the sterling will rise in the future, they will demand more now to be able to make profit. This increase in demand will cause the value to rise.
Therefore, movements in the exchange rate do not always reflect economic fundamentals, but are often driven by the sentiments of the financial markets. For examples, if markets see news which makes an interest rate increase more likely, the value of the pound will probably rise in anticipation.
o Change in Competitiveness: if British goods become more attractive and competitive this will also cause the value of the exchange rate to rise. This is important for determining the long run value of the pound. o Relative strength of other currencies: Between 1999 and 2001 the
pound appreciated because the euro was seen as weak currency. o Balance of payments: If there are more imports than exports, the
value of the pound falls due to less goods being manufactured in the home country. This leads to fewer exported goods, therefore having a knock on effect on the value of the currency due to less demand.
⇒ The Demand Curve for Sterling:
o The demand for the pound comes from demand for our exports from abroad. We want to be paid in pounds, no matter where our customers come from, and so people abroad have to purchase pounds on the foreign exchange market.
o If demand for exports increases, then demand for the pound on
the foreign exchange market increases.
o Demand for the pound also comes from the demand for saving in UK bank accounts – if the UK interest rate goes up compared to interest rates abroad, then people abroad will want to save their money in UK bank accounts. Because you can save only pounds (rather than dollars or euros) in UK banks.
o Demand for the pound on the foreign exchange market will rise if the interest rate rises. The stocks of funds that move around the world in search of the best return I called hot money.
o Long term capital movements are also important. So, inwards investment into the UK increases demand for the pound.
o Supply of the pound onto the foreign exchange market comes from our demand for imports. People abroad want to be paid in their own
currency, so we take our pounds along to the foreign exchange market, releasing them on to the market in return for other currencies.
o SO, supply of the pound on the foreign exchange market increases if demand for imports increases.
o If the interest rates abroad increases relative to the interest rate in the UK, then funds will move from the UK to overseas bank accounts, increasing the supply of the pound on foreign exchange markets. o If there is net outwards investment from the UK economy, then the
supply of pound will increase.
⇒ Depreciation:
o Depreciation means that the value of the pound, in terms of other currencies goes down.
⇒ Appreciation:
o Appreciation means that the value of the pound, in terms of other currencies goes up.
⇒ Advantages of a strong pound:
o It keeps inflation under control:
§ A high pound leads to lower import prices – this boosts the real living standards of consumers at least in the short run.
§ When the sterling is strong, it is cheaper to import raw materials, components and capital inputs – good news for growing businesses that rely on imported components or who are wishing to increase their investment of new technology from counties overseas.
§ A strong exchange rate helps to control inflation – domestic producers face stiff international competition from cheaper imports and will look to cut their costs accordingly.
§ Cheaper prices of imported foodstuff etc. will also have a negative effect on the rate of consumer price inflation.
⇒ Disadvantages of a strong pound: o The balance of trade and goods:
§ Cheaper imports lead to rising imports penetration and larger trade deficit. (Basically more imports than exports).
Sources of finance (1.5)
• Definition:
⇒ Finance: this is money.
⇒ Sources of finance: This I where you get finance from.
• Why do businesses need finance?: ⇒ Starting up:
o Buildings, machinery, raw materials and office equipment. ⇒ Everyday bill payments (working capital):
o Short-term finance required for the day-to-day running of a business. ⇒ Take over bid.
⇒ Replace machinery/equipment. ⇒ Internal growth.
⇒ Expansion.
• The purpose of finance:
⇒ “Different sources of finance have different implications for a business, so it is important that the most appropriate method of finance is chosen for the purpose that the business has in mind.”
• Sources of finance: ⇒ Internal:
o “Finance which is raised internally, does not increase the debts of the business”
e.g. Retained profit, personal savings, sale of unwanted assets, sale and lease back.
⇒ External:
o “Finance provided by people or institutions outside the business, creates a debt that will require payment”
e.g. Loans, overdraft, shares, Debentures.
(A debenture is a document that acknowledges the debt, the company is liable to pay a specified amount with interest.
⇒ Time periods for finance:
o Generally considered to be:
§ Short-term è Up to 3 years. § Medium-term è 3 – 10 years.
§ Long-term è Over 10 years.
⇒ Short term finance:
o It is needed for the day-to-day running of a business and is usually for a period of up to 3 years.
o In order to understand short-term finance it is necessary to understand the concept of cash flow.
⇒ Cash flow:
o A business needs sufficient inflows of cash finance, its day-to-day outgoings.
⇒ Sources of short-term finance:
o All commercial banks offer various methods of short-term finance for businesses:
§ Overdraft
§ Short-term loans
§ Hire purchase (external) § Trade credit (internal)
⇒ External short-term finance:
o Overdraft: the bank allows the business to draw more money from their bank account than they actually have in it.
o Advantages:
§ Very quick to arrange
§ Only pay interest on amount overdrawn
§ A good short-term solution to a cash flow problem. o Disadvantages:
§ Only suitable for smaller amounts
§ Has to be repaid within a short amount of time § Interest or charges are paid.
o Short-term loan: an amount of money is borrowed from the bank, then repaid (with interest) over a set period of time (0 – 3 years).
⇒ Factors which influence a bank’s decision to lend: o Past trading record.
o Purpose of the finance. o Business proposal.
o Current financial position. o Financial projections.
o Nature of the market/sales forecast. ⇒ Banks use this information to:
o Determine who qualifies for a loan.
o Determine what interest rate they will lend at.
o Interest rates - Cost of borrowing money (reward for savings) o What credit limit to set.
o Banks also use this information to determine which customers are likely to bring in the most revenue.
⇒ Security:
o Something that acts as assurance to a lender that will get its money back if a business is unable to pay back money it has “borrowed” . o If the business fails to repay the loan, the bank – as holder of the
deeds – is legally entitled to sell the factory and office in order to recover any amount outstanding on the loan.
⇒ Internal short-term finance:
o Trade credit: items are bought from suppliers on a “buy now pay later” basis.
o Advantages:
§ Gives businesses more cash to use in immediate future. § Does not incur interest charges.
o Disadvantages:
§ Can only be used to buy certain goods.
§ Bills usually have to be settled within 30, 60 or 90 days.
⇒ Sources of medium-term finance:
o Various different forms of medium-term finance are available to a business:
§ Medium-term loan § Hire purchase
§ Leasing
⇒ External medium-term finance:
o The rate of interest payable on a medium-term loan depends on: § How much is borrowed
§ How long the money is needed for § The security that is provided.
o Businesses have the option to chose either a variable rate or a fixed rate loan.
o VARIABLE: interest varies with whatever decision the bank of England make with regard to interest rates.
o FIXED RATE: interest is fixed for the duration of the loan. o Hire purchase: can also be medium-term.
o Leasing: Pay installments over a set period of time to rent an item – businesses never actually own the item.
⇒ Long-term finance:
o Usually thought of as being for periods in excess of 10 years. o This finance is for securing the resourcing for long-term growth. ⇒ Sources of long-term finance:
o For the long-term, a business essentially has the choice of raising finance by borrowing or through the issue of shares.
§ Long term loans (external) § Issue of shares (external)
§ Sale and leaseback (internal) § Retained profit (internal)
⇒ External long-term finance:
o Long-term loan: an amount of money is borrowed from the bank, then repaid (with interest) over a set period of time (10+ years).
o Loans for buildings – mortgages o Variable rate or Fixed rate
o Fixed rate – not fixed for whole length of the loan.
o Issues of shares – A share in the business is sold to an individual or another business – also known as equity finance. This money is then used to purchase new assets.
è Shareholders are entitled to a dividend (share of company profits).
o Rights issue - when a company issues more shares. ⇒ Internal long-term finance:
o Sale and leaseback – asset is sold but then leaseback – usually for a long period of time.
o Advantages:
§ Large sum of money is created.
§ Business can operate as normal after the sale.
§ Leasing company is responsible for maintenance of the item. o Disadvantages:
§ High interest is often charged
§ Item does not belong to the business anymore § No guarantee that lease will be renewed
o Retained profit – profit retained for purpose of using in the future. ⇒ Other sources of finance:
o Government assistance o Venture capital
o Business angles
⇒ A business’s choice of finance: o Depends on many factors:
§ The type of business – sole traders and partnerships cannot issue trades.
§ The amount of control desired – becoming a partnership or company can weaken control.
§ Security – a lack of security may mean that banks are unwilling to grant a loan.
§ Existing levels of debt – if high banks, they will think twice about lending.
• Break-even Revenue:
⇒ Break-Even Analysis:
o Once a firm knows the total costs and revenue it can calculate the break even point.
o This is defined as:
“Break even occurs when Total Costs are equal to Total Revenue. In effect the business is Neither making Profit or Loss.”
Which means = Total Revenue – Total Costs = 0
⇒ Is the Break-Even point achievable? -Yes?
+Then there are no worries and carry on… -No?:
o Then a number of actions must be taken: § Cut costs:
ú Can cheaper raw materials be used? ú Can cheaper premises be found?
ú Do we need all the stuff we have budgeted for? § Raise prices:
ú Is this practical.
ú Are the customers willing to pay higher prices? ú What are your competitors charging?
§ Broaden the product range:
ú Can complementary products be sold to boost sales?
⇒ Margin of safety”
o The margin of safety can be used t asses how close to its break-even point a firm is.
o Defined:
“The amount by which demand can fall before a firm incurs losses i.e. how close the firm is to break-even level of output.”
o And is calculated using this formula:
Margin of safety = Total output – Break-Even output.
⇒ Why bother?
o It is useful when deciding whether a new product is going to be viable. o Can the required quantity be realistically produced and sold?
o It can be used to see how changes to any one of the variables will effect the break-even point:
§ Price – if price is increased will profits increase? § Costs - if costs increase how is profit effected?
§ Output – How does this effect both selling price and costs? o It can allow a business to calculate the level of output needed to
achieve a given level of profit.
