Icaew BTF WB 2023

The Institute of Chartered Accountants in England and Wales
Business, Technology
and Finance
Workbook
For exams in 2023
icaew.com
Business, Technology and Finance
The Institute of Chartered Accountants in England and Wales
ISBN: 978-1-0355-0152-6
Previous ISBN: 978-1-5097-4202-8
e-ISBN: 978-1-0355-0211-0
First edition 2007
Fifteenth edition 2022
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examinations, and should not be used as professional advice.
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© ICAEW 2022
Contents
Welcome to ICAEW iv
Business, Technology and Finance v
Key resources vi
Professional skills required by the ACA qualification vii
1 Introduction to business 1
2 Managing a business 27
3 Organisational and business structures 67
4 Introduction to business strategy 103
5 Introduction to risk management 151
6 The finance function and financial information 199
7 Business finance 243
8 The accountancy profession 281
9 Governance and ethics 305
10 Corporate governance 337
11 The economic environment of business and finance 361
12 External regulation of business 405
13 Data analysis 427
14 Developments in technology 465
Glossary of terms 495

Index 513
Questions within the Workbook should be treated as preparation questions, providing you with a
firm foundation before you attempt the exam-standard questions. The exam-standard questions are
found in the Question Bank.
ICAEW 2023 Contents iii

Welcome to ICAEW
I’d like to personally welcome you to ICAEW.
As we continue the global recovery from COVID-19, the role of the accountancy profession has never
been more important.
As an ICAEW Chartered Accountant, you will make decisions that will define the future of global
business in a fast-changing and volatile world.
Whether studying for our internationally recognised Certificate in Finance, Accounting and Business
(ICAEW CFAB) or our world-leading chartered accountancy qualification, the ACA, you will acquire
exceptional knowledge and skills – with technology, sustainability and ethics at the heart of your
learning. A focus on capabilities such as judgement and scepticism will enable you to make the right
decisions in diverse and often complex environments.
You will be equipped to flourish and to lead in areas that are transforming the business landscape.
This includes embracing technological change and harnessing digital disruption, to help our
profession deliver greater value. It also includes putting climate change and sustainability at the heart
of business strategy. We will equip you to be adaptable and agile in your work and all within a set of
values fundamental to trust and transparency, which will set you apart from others.
Joining over 195,000 ICAEW Chartered Accountants and students worldwide, you are now part of a
global community. This unique network of talented and diverse professionals work in the public
interest to build economies that are sustainable, accountable and fair.
You are also joining a community of 1.8m chartered accountants and students as part of Chartered
Accountants Worldwide – a family of leading institutes, of which we are a founder member.
We will support you through your studies and throughout your career: this is the start of a lifetime
relationship, and we will be with you every step of the way to ensure you are ready to face the
challenges of the global economy. Visit the Key resources section to review the resources available as
you study.
With our training, guidance and support, you will join our members in realising your career
ambitions, developing world-leading insights and maintaining a competitive edge.
We will enable a world of sustainable economies, together.
I wish you the best of luck with your studies.
Michael Izza
Chief Executive
ICAEW
iv Business, Technology and Finance ICAEW 2023

Business, Technology and Finance
You can access this guide and more exam resources on our website. If you are studying this exam as
part of the ACA qualification go to icaew.com/examresources or if you are studying the ICAEW CFAB
qualification go to icaew.com/cfabstudents.
Module aim
To provide you with an understanding of how businesses operate and how finance functions help
businesses to achieve their objectives.
On completion of this module, you will be able to:
• identify the general objectives of businesses and the functions and tasks that businesses perform
in order to meet their objectives;
• specify the nature, characteristics, advantages and disadvantages of different forms of business
and organisational structure;
• identify the purpose of financial information produced by finance functions, specify how finance
functions support business operations, including the measurement of risk, and identify sources
and methods of financing for businesses;
• specify the importance and attributes of the accountancy profession and the role that governance
plays in the management of a business, including how a business can promote corporate
governance, sustainability, corporate responsibility and an ethical culture;
• specify the impact on a business of the external environment in which it operates; and
• specify key issues in relation to data and its collection, visualisation and analysis, and identify key
features, benefits and risks of different technologies.
Method of assessment
The Business, Technology and Finance exam is 1.5 hours long. The exam consists of 50 questions
worth two marks each, covering the areas of the syllabus in accordance with the weightings set out in
the specification grid. The questions are presented in the form of multiple choice, or multiple
response.
Ethics and professional scepticism

Ethical thinking will be required across all areas of the syllabus. A specific weighting is given in the
syllabus area ‘Key issues for the accountancy profession and business’ which includes ethics and
business ethics, in the table below. The policies and procedures necessary to promote an ethical
culture will be emphasised. Students will be expected to apply professional scepticism. Additionally,
under the syllabus area ‘The external environment of business’, students must demonstrate an
awareness of the needs of different stakeholders, and in the ‘Technology and data analysis’ area they
must be able to identify types of data bias, their causes and effects.
Specification grid
This grid shows the relative weightings of subjects within this module and should guide the relative
study time spent on each. Over time the marks available in the assessment will equate to the
weightings below, while slight variations may occur in individual assessments to enable suitably
rigorous questions to be set.
Weighting (%)
1 Business objectives and functions 10
2 Business and organisational structures 10
3 The role of finance and the finance function 25
4 Key issues for the accountancy profession and business 20
5 The external environment of business 15
6 Technology and data analysis 20
ICAEW 2023 Introduction v

Key resources
Whether you’re studying the ICAEW CFAB or ACA qualification with an employer, at university,
independently, or as part of an apprenticeship, we provide a wide range of resources and services to
help you in your studies.
ACA students, you can access dedicated exam resources, guidance and information for the ACA
qualification via your dashboard at icaew.com/dashboard.
ICAEW CFAB students, you can also access dedicated exam resources, guidance and information at
icaew.com/cfabstudents.
Syllabus and technical knowledge grids

The syllabus presents the learning outcomes for each exam and should be read in conjunction with
the relevant technical knowledge grids.
Exam support
A variety of exam resources and support have been developed to help you through your studies and
each exam. This includes expert guides, sample exams, hints and tips, webinars from our tutors, and
more.
Tuition
The ICAEW Partner in Learning scheme recognises tuition providers who comply with our core
principles of quality course delivery. If you are not receiving structured tuition and are interested in
doing so, take a look at ICAEW recognised Partner in Learning tuition providers in your area at
icaew.com/tuitionproviders
Errata sheets
These documents will correct any omissions within the learning materials once they have been
published. You should refer to them when studying.
Student support team

Our student support team is here to help and advise you, so do not hesitate to get in touch. Email
studentsupport@icaew.com or call +44 (0)1908 248 250. If you are browsing our website, look out
for the live help boxes. You will be able to speak directly to an adviser. Mia, our ChatBot, is also on
hand to answer your queries.
Student Insights
Access our practical and topical student content on our dedicated online student hub, Student
Insights at icaew.com/studentinsights. You’ll find interviews, guides and features giving you fresh
insights, innovative ideas and an inside look at the lives and careers of our ICAEW students and
members. No matter what stage you’re at in your journey with us, you’ll find content to suit you.
ICAEW Business and Finance Professional (BFP)

ICAEW Business and Finance Professional (BFP) is an internationally recognised designation and
professional status. It demonstrates your business knowledge, your commitment to professionalism
and that you meet the standards of a membership organisation. Once you have completed the
ICAEW CFAB qualification or the ACA Certificate Level, you are eligible to apply towards gaining BFP
status. Start your application at icaew.com/becomeabfp.
vi Business, Technology and Finance ICAEW 2023

Professional skills required by the ACA qualification
The following professional skills areas are present throughout the ACA qualification.
Skill area Overall objective
Assimilating and using Understand a business or accounting situation, prioritise by

information determining key drivers, issues and requirements and identify any
relevant information.
Structuring problems and Structure information from various sources into suitable formats for
solutions analysis and provide creative and pragmatic solutions in a business
environment.
Applying judgement Apply professional scepticism and critical thinking to identify faults,
gaps, inconsistencies and interactions from a range of relevant
information sources and relate issues to a business environment.
Concluding, Apply technical knowledge, skills and experience to support

recommending and reasoning and conclusion and formulate opinions, advice, plans,
communicating solutions, options and reservations based on valid evidence and
communicate clearly in a manner suitable for the recipient.
The level of skill required to pass each exam increases as ACA trainees progress upwards through
each Level of the ACA qualification. The skills progression embedded throughout the ACA
qualification ensures ACA trainees develop the knowledge and professional skills necessary to
successfully operate in the modern workplace and which are expected by today’s forward-thinking
employers.
At Certificate Level, the ACA Professional Skills which you are expected to demonstrate in the exam
are summarised as follows:
Assimilating and using information
• Understanding the situation and the requirements
• Identifying and using relevant information
• Identifying and prioritising key issues
Structuring problems and solutions
• Structuring data
• Developing solutions
Applying judgement
• Applying professional scepticism and critical thinking
• Relating issues to the broader business environment, including ethical issues
Concluding, recommending and communicating
• Concluding and recommending
• Communicating
To help you develop your ability to demonstrate competency in each professional skills area, each
chapter of this Workbook includes up to four Professional Skills Guidance points.
Each Professional Skills Guidance point focuses on one of the four ACA Professional Skills areas and
explains how to demonstrate a particular aspect of that professional skill relevant to the topic being
studied. It is advised you refer back to the Professional Skills Guidance points while revisiting specific
topics and during question practice.
ICAEW 2023 Introduction vii

viii Business, Technology and Finance ICAEW 2023
Chapter 1
Introduction to business
Introduction
Learning outcomes
Syllabus links
Assessment context
Chapter study guidance
Learning topics
1 What is an organisation?
2 What is a business?
3 Stakeholders in the business
4 What are the business’s objectives?
5 Mission, goals, plans and standards
6 Sustainability and climate change
Summary
Further question practice
Technical references
Self-test questions
Answers to Interactive questions
Answers to Self-test questions
Introduction
Learning outcomes
• State the general objectives of businesses
• State the general objectives of strategic management and specify the strategic management
process and interrelationship between a business’s vision, mission and strategic objectives
The specific syllabus references for this chapter are: 1a, 1b
1
Syllabus links
Objectives of businesses will be developed further in this assessment, and then in the Business
Strategy and Technology assessment at the Professional level. Sustainability and corporate
responsibility are studied further in Business Strategy and Technology at the Professional level.
1
Assessment context
While the material in this chapter is essentially introductory, questions on business objectives will be
directly assessed.
Questions are likely to be set in multiple choice format, either as a straight test of knowledge or in a
scenario.
1

Use this schedule and your study timetable to plan the dates on which you will complete your study
of this chapter.
Topic Practical significance Study approach Exam approach Interactive

Questions
1 What is an Approach While the material in

organisation? Read through the this chapter is
You will come across section fairly essentially
many different types quickly. Learn the introductory,
of organisation, both definition of an questions on
in your career and in organisation. business objectives
your exams. This will be directly
Stop and think examined.
section introduces the
concept of an Think about an Questions are likely
organisation and organisation that to be set either as a
discusses the ways in you are familiar straight test of
which organisations with, perhaps your knowledge or in a
differ. employer. Think scenario.
about how the
factors in 1.4 apply
to that
organisation.
2 What is a business? Approach Questions will focus

An important Read through this on the meaning of
distinction is between short section business and the
businesses and not- focussing on the terms primary and
for-profit differences secondary objectives.
organisations. between not-for-
profit and
profit-oriented.
2 Business, Technology and Finance ICAEW 2023

Questions
Stop and think

Think of an
example of a not-
for-profit
organisation. What
is its primary
objective?
3 Stakeholders in the Approach Questions could IQ1: Corporate

business Learn what require you to identify responsibility
Organisations need to stakeholders are the stakeholders of a This is a good
know who their and the distinction particular example about
significant between primary organisation. how a group of
stakeholders are so and secondary stakeholders’
they can try to meet stakeholders. expectations
their objectives. Stop and think might influence
the objectives of
Does a business an organisation.
need to only
consider the needs
of its shareholders
and can it ignore
other
stakeholders?
4 What are the Approach Questions will focus

business’s objectives? Read through this on why businesses
Identifying the section and be may follow objectives
objectives of a aware of different other than
business is important objectives that maximising profit or
so that management organisations may wealth, so remember
know what they have have. Note the why this might occur.
to focus on. word ‘satisficing’
and ensure you
know what this
means.
Stop and think
Do you think that
the secondary
objectives of a
business may
conflict with the
primary objective?
5 Mission, goals, plans Approach Exam questions in IQ2: Goals

and standards Note the meaning this area will usually Tests your
Organisations need to of mission, vision, test your knowledge understanding of
know what their and goals. Be of the differences the importance
objectives are so that aware of their role between the different of non-
they can ensure that in planning and types of objectives. operational
plans and work controlling an They also focus on goals.
performed meet these organisation. the meaning of
objectives. Without SMART.
Stop and think
knowing the
objectives there is a Think of an
risk that organisations organisation you
ICAEW 2023 1: Introduction to business 3

Questions
may become know well. Do you

directionless. know what its
mission and vision
is? What goals
might it have?
6 Sustainability and Approach IQ3: Great

Climate Change Make sure you Questions are likely Sportswear
Businesses cannot know the meaning to test your Limited
ignore the wider of sustainability understanding of why Helps to test your
impact that they have and the three businesses cannot understanding of
on society and on the different types of ignore sustainability the importance
planet. This section sustainability. and climate change. of businesses
looks at why these are Ensure you know They may also test behaving in a
relevant to a business. the meaning of your understanding socially
People, Profits and of the role of the acceptable way
Planet. Make sure accountant in dealing even if that
you understand the with these issues. appears to
importance of conflict with
climate change and maximising
the impact is has profits in the
on business as well short run.
as the impact that
businesses can
have on climate
change.
Stop and think
What actions does
your employer or
educational
institution take in
respect of climate
change? Do they
have a published
policy about their
approach? Find out
and read it.
Once you have worked through this guidance you are ready to attempt the further question practice
included at the end of this chapter.

Section overview
• There are many different types of organisation in both the not-for-profit and business sectors.
• Organisations exist because the collective efforts of people are more productive as a result of
them.
• All organisations share the feature that they are designed to get things done.
• Organisations differ in terms of ownership, control, activity, profit orientation, size, legal status and
technology.
1.1 Introduction to organisations

Here are some examples of organisations, categorised as to whether they are profit-oriented (private
sector)1 or not-for-profit (charity/public sector)2.
• A multinational car manufacturer (eg, Ford)1
• An accountancy firm (eg, KPMG)1
• A charity (eg, UNICEF)2
• A trade union2
• A local authority2
• An army2
• A club2
1.2 Why do organisations exist?

Organisations exist because they:
• overcome people’s individual limitations, whether physical or intellectual;
• let people specialise in what they do best;
• save time, because people can work together or do two aspects of a different task at the same
time;
• accumulate and share knowledge (eg, about how best to build cars);
• let people pool their expertise; and
• enable synergy: the combined output of two or more individuals working together exceeds their
individual output (‘None of us is as smart as all of us’)
In brief, organisations enable people to be more productive.
1.3 What do organisations have in common?

The definition below states broadly what all organisations have in common.
Definition
Organisation: A social arrangement for the controlled performance of collective goals, which has a
boundary separating it from its environment.
The following table shows how this definition applies to two examples of organisations: a car
manufacturer and an army.

Characteristic Car manufacturer Army
(eg, Ford)
Social arrangement: People work in different Soldiers are in different

individuals gathered together divisions, making different cars regiments, and there is a chain
for a purpose of command from the top to
the bottom
Controlled performance: Costs and quality are reviewed Strict disciplinary procedures,
performance is monitored and controlled. Standards are training
against the goals and adjusted constantly improved
if necessary to ensure the
goals are accomplished
Collective goals: the Sell cars, make money Defend the country, defeat the
organisation has goals over enemy, international peace
and above the goals of the keeping
people within it
Boundary: the organisation is Physical: factory gates Physical: barracks

distinct from its environment Social: employment status Social: different rules than for
civilians
1.4 How do organisations differ?

Organisations also differ in many ways. Here are some possible differences:
Factor Example
Ownership (public vs private) Private sector: owned by private investors/shareholders

Public sector: owned by the nation and managed by the
government
Control By the owners themselves, by people working on their behalf, or

indirectly by government-sponsored regulators
Activity (ie, what they do) Manufacturing, healthcare, services (and so on)
Profit or non-profit orientation Business exists to make a profit. An army or a charity, on the
other hand, are not profit-oriented
Size Small local business to multinational corporation
Legal status Company, or an unincorporated body such as a club,

association, partnership or sole trader
Sources of finance Borrowing, government funding, share issues
Technology High use of technology (eg, banks) vs low use (eg, corner shop)
1.4.1 Differences in what organisations do

Organisations have many different types of activity, depending on the industry they are engaged in.
Industry Activity
Agriculture Producing and processing food
Manufacturing Acquiring raw materials and, by the application of labour and

technology, turning them into a product (eg, a car)
Extractive/raw materials Extracting and refining raw materials (eg, mining)
Energy Converting one resource (eg, coal) into another (eg, electricity)

Industry Activity
Retailing/distribution Delivering goods to the end consumer
Intellectual production Producing intellectual property (eg, software, publishing, films,

music)
Technology Digitalising products (eg, e-books) and processes (eg, selling

insurance online)
Service industries Providing intangible services such as banking, accountancy and

advertising, including public services such as education and
healthcare
Section overview
• Organisations have secondary objectives that support their primary objectives.

• For a profit-making organisation, the primary objective is to maximise the wealth of its owners; for
a non-profit organisation it is to provide goods and services for its beneficiaries.
• A business is an organisation which aims to maximise its owners’ wealth but which can be
regarded as an entity separate from its owners.
2.1 Profit vs non-profit orientation

Businesses aim to make profits (they have a profit orientation) while for non-businesses there is a
different primary focus or objective. The basic difference in orientation between the two different
types of organisation is expressed in the figure below. Note the distinction between primary and
secondary objectives. A primary objective is the most important: the other objectives support it. We
shall come back to this.

Profit-oriented Not-for-profit
organisation organisation
Owners Public beneficiaries
Primary Maximise profit/ Provision of

objective dividend/wealth goods/services
Profit Output (goods/services)
Secondary Output of Revenue from Minimise cost of

objective goods/services goods/services primary goal
Inputs (materials, Inputs (materials,

Costs
labour, finance) labour, finance)
Revenue (taxation)
Figure 1.1: Profit and not-for-profit organisations
Profit-oriented organisations are generally referred to as ‘businesses’, though this is in fact a rather
loose term.
• Businesses are profit-oriented but they encompass a variety of legal structures (as we shall see in
the chapter Organisational and business structures).
– Companies are owned by shareholders.
– A sole tradership is owned by one individual (usually called the proprietor).
– Partnerships are owned collectively by the partners.
• Not-for-profit organisations are frequently structured and run like a business, so that they benefit
from the economy, efficiency and effectiveness in using resources that profit orientation brings,
but they are not generally owned by shareholders, proprietors or partners. They do not primarily
aim to maximise profit or the wealth of their owners, but instead are focused on providing goods
and services to their beneficiaries at minimised cost.
• The type of work engaged in by the organisation does not of itself determine whether it is a
profit-orientated or not-for-profit organisation; a business can be involved in providing medical or
education services just as much as can a charitable or government organisation.
Examples of not-for-profit organisations:
• charities
• clubs and associations
• trade unions
• professional bodies and institutes such as ICAEW
• government
• governmental agencies
• local authorities
• hospitals
• schools, colleges and universities

2.2 Definition of a business
It is the primary objective of the organisation that determines whether or not it is a business.
Although as we have seen ‘business’ is a loose term which has no legal definition as such, it is useful
to have a working definition at this point.
Definition
Business: An organisation (however small) that is oriented towards making a profit for its owners so
as to maximise their wealth and that can be regarded as an entity separate from its owners.
3 Stakeholders in the business

Section overview
• A stakeholder is a person who has an interest of some kind in the business.

• A company’s primary stakeholders are its shareholders. The primary stakeholders in a sole
tradership or partnership also comprise the business’s owners. Secondary stakeholders in a
business are directors/managers, employees, customers, suppliers, lenders, government and its
agencies, the local community, the public at large and the natural environment.
You can see from the figure ‘profit and not-for-profit organisations’ that a profit-oriented business
exists primarily to maximise the wealth of its owners, while a not-for-profit organisation (such as a
charity or a government department) exists primarily to provide services (and/or goods) for its
beneficiaries.
In both cases the organisations have stakeholders who are interested in what the organisation does.
Definition
Stakeholder: Literally a person or group of persons who has a stake in the organisation. This means
that they have an interest to protect in respect of what the organisation does and how it performs.
Professional skills focus: Assimilating and using information
The examiner may test your ability to identify and use relevant information in the scenario to
determine what are the primary and secondary objectives of an organisation.
A company’s primary stakeholders are its shareholders. It is their money, invested in the business,
which is literally ‘at stake’ because it can be lost if the business performs badly, though it can earn a
decent return if the business does well. The company owes it to the shareholders to look after their
interests, but it also has secondary stakeholders to whom it has responsibilities, and who may put it
under pressure.
Stakeholders in a What is at stake? What do they typically

business expect of the
business?
PRIMARY Shareholders (or Money invested A return on their

partners or proprietor) investment so that
their wealth increases:
• Steady, growing
profits paid out by
the business

business?
• Growth in the
capital value of
their share of the
business
SECONDARY Directors/managers Livelihoods, careers Fair and growing

Employees and trade and reputations remuneration
unions Career progression
Safe working
environment
Training
Pension
Customers Their custom Products/services that

are of good quality
and value
Fair terms of trade
Continuity of supply
Suppliers The items they supply Fair terms of trade

Prompt payment
Continuity of custom
Lenders Money lent A return on their

investment:
• Interest
• Repayment of
capital
Government and its National infrastructure Reasonable

agencies used by business employment and
The welfare of other business
employees practices
Tax revenue Compliance with

regulations
Steady or rising
stream of tax revenue
Analysts/ Time spent Accurate and honest

advisers/experts Their reputation information from the
business
Continuity of custom
Prompt payment
The local community National infrastructure Reasonable

and the public at large used by business employment and
The welfare of other business
employees practices
The natural The environment Reasonable

environment shared by all environmental and
other business

business?
practices
Interactive question 1: Corporate responsibility

What expectations would the local community have of a company operating a gas-fired power
station within two miles of a medium-sized town?
See Answer at the end of this chapter.
4 What are the business’s objectives?

Section overview
• Every business has a hierarchy of objectives, with a primary objective supported by secondary
objectives. Together these form multiple objectives.
• Profit and wealth maximisation is usually the primary objective, though sometimes managers
pursue a policy of profit satisficing only.
4.1 The hierarchy of objectives

The fact that a business is oriented towards making a profit means that the simple answer to the
question ‘what are the business’s objectives?’ is: making as much profit as possible so as to increase
shareholder wealth.
In fact there is a hierarchy of objectives, with one primary objective and a series of secondary
(subordinate) objectives, which should combine to ensure the achievement of the primary objective.
4.1.1 Primary objective

For a business the primary objective is financial: making as much profit as possible (profit
maximisation) so as to increase shareholder wealth.
• Profit is revenue less costs. It measures how the business creates value by making sure the cost of
inputs (labour, materials and finance) is less than the output (revenue generated).
• Shareholder wealth can only be maximised if profit is earned at an acceptable level of risk:
focusing solely on maximising profit and ignoring risk can lead to decreased shareholder wealth
(and financial collapse). Avoiding unnecessary risk should go hand-in-hand with making profits so
as to maximise shareholder wealth.
• Profit cannot be pursued at any cost. Any business is subject to the laws and regulations of the
country in which it operates, and it also has social responsibilities, as we saw briefly above.
4.1.2 Secondary objectives

Secondary objectives support the primary objective. Here are some examples:
• Market position
Achieve a particular market share of each market that the business operates in; grow sales,
customers or potential customers; avoid reliance on a single customer for too big a proportion of
total sales; enter or leave markets when the time is right
• Product development
Bring in new products; develop a product range; invest in research and development; provide
products of a certain quality at a certain price level
• Technology

Improve how much is produced from the resources available; reduce the cost per unit of output;
develop or exploit appropriate technology
• Employees and management
Train employees in necessary skills; reduce the number of employees leaving and having to be
replaced (labour turnover); create an innovative, flexible culture; employ high quality leaders
Professional skills focus: Concluding, recommending and communicating
Recommendations for one business may not be appropriate for another if the two businesses have
different primary or secondary objectives.
4.2 Is wealth maximisation always the primary objective?

Where the person who has put their money at stake (often called the ‘entrepreneur’) is in full
managerial control of the business, as in the case of a small owner-managed company or
partnership, assuming wealth maximisation as the primary would seem to be very reasonable. Even
in companies owned by shareholders, but run by non-shareholding managers, we might expect the
wealth maximisation assumption to be valid.
However, managers do not necessarily make decisions that will maximise shareholder wealth.
• They may have no personal interest in the creation of wealth, except insofar as they are
accountable to owners.
• The market may lack competitive pressure to be efficient by minimising costs and maximising
revenue, for example where there are few businesses in the market.
4.2.1 Profit satisficing

Decisions might be taken by managers with their own managerial objectives in mind rather than the
aim of wealth maximisation. A company’s managers may choose to achieve simply a satisfactory
profit, by operating at profit and risk levels which are acceptable to shareholders, and which provide
enough profits for future investment in growth, but which are not designed actively to maximise
profit and shareholder wealth. This is called ‘satisficing‘ and is linked to a view of the strategy process
called ‘bounded rationality‘ put forward by the economist Herbert Simon – an issue we shall return to
in the chapter Introduction to business strategy.
4.2.2 Revenue maximisation

A business may act to maximise revenue (not necessarily profit or wealth) in order to maintain or
increase its market share, ensure survival, and discourage competition. This is a view put forward by
the economist William Baumol. Managers benefit personally from following this objective because
of the prestige of running a large company, and also because salaries and other benefits may be
higher in bigger companies than in smaller ones.
4.2.3 Multiple objectives

Management writer Peter Drucker (1954) points out that:
‘To manage a business is to balance a variety of needs and goals… The very nature of business
enterprise requires multiple objectives’. He suggests that objectives are needed in eight key areas.
• Market standing: this includes market share, customer satisfaction, size of product range and
distribution resources
• Innovation: in all major aspects of the business especially in relation to technology eg,
automation, cognitive technology and ‘the internet of things’ which we shall study in the chapter
Developments in Technology
• Productivity: meeting targets for the number of outputs (items produced or tasks completed)
within set timescales
• Physical and financial resources: efficient use (minimising waste) of limited resources (including
people, space, materials, plant and equipment, finance and so on)
• Profitability: as discussed earlier

• Manager performance and development: managerial effectiveness in meeting objectives and
creating a positive environment in the business; grooming of managers for continuity (managerial
succession)
• Worker performance and attitude: labour productivity, stability (controlled labour turnover),
motivation and morale, development of skills and so on
• Corporate responsibility: in areas such as community and environmental impacts, labour
standards and employment protection
4.2.4 Constraints theory

Herbert Simon (1947) has also pointed out that decisions for some business areas are taken without
reference to the wealth objective at all. This is not because managers are ignoring profit, but because
profit is not the most important constraint in their business. This situation is seen most clearly in
constraints such as the need for good staff relations, or in regard to compliance with regulations
(such as environmental protection laws). It is also seen in the need to satisfy customers with quality
products and service, which may lower profitability.
4.3 Environmental, social and governance (ESG)

While wealth maximisation may be the primary objective for many businesses, there is increasing
recognition that objectives other than financial performance should be considered. Even where
shareholders only wish to consider their wealth, the value of a business is not only affected by
financial performance, but also by other factors that affect the risk and return of investments. These
other factors are referred to as environmental, social and governance issues.
• Environmental: An organisation’s activities may have an impact on the natural environment. Poor
environmental behaviour can lead to fines, loss of reputation and legal claims by those affected
by the poor environmental behaviour.
• Social: Social refers to the relationship the organisation has with stakeholders and society as a
whole. Issues such as labour relations and modern slavery can impact on the reputation of
businesses or lead to a breakdown in relations with key stakeholder groups.
• Governance: Governance refers to the way an organisation is managed and led – for example, the
structure of the board of directors and how the activities of the directors are monitored by other
stakeholders, such as shareholders. Poor governance can lead to significant problems, such as
poor decision making, taking on too much risk or even fraud.
• Ethical behaviour: While not specifically included in the ESG acronym, ethical behaviour underlies
all three of the factors. Ethics is about doing the right thing, from a moral perspective.
Organisations may pursue objectives relating to ESG even if they reduce financial wealth because
they believe that it is ethically correct to pursue those objectives.
Investors are increasingly expecting the companies they invest in to adopt objectives relating to ESG,
in addition to financial objectives. Environmental and social issues are discussed in more detail in the
section Sustainability and climate change, later in this chapter. Governance and ethics are discussed
in Chapter 9.
5 Mission, goals, plans and standards

Section overview
• A business’s planning and control cycle ensures that its objectives, mission and goals are met by
setting plans, measuring actual performance against plans, and taking control action.
• The direction of the business is expressed in its mission, which sets out its basic function in society
in terms of how it satisfies its stakeholders.
• The mission encompasses the business’s purpose, strategy, policies, standards of behaviour and
values.
• The business’s goals can be classified as its aims (which are non-operational and qualitative) and
its operational, quantitative objectives.
• Operational objectives should be SMART: specific, measurable, achievable, relevant and time-
bound.

• Plans and standards set out what should be done to achieve the operational objectives.
• The organisation’s plans are a result of its strategic planning process.
5.1 Planning and control system

Businesses need to direct their activities by:
• deciding what they want to do to achieve their primary objective – these become detailed
objectives that the business sets out to achieve, such as ‘grow revenue by 20%’ or ‘reduce costs by
10%’;
• deciding how and when to do it and who is to do it (setting plans and standards);
• checking that they achieve what they want, by measuring and monitoring what has been done
and comparing it with the plan; and
• taking control action to correct any deviation
The overall framework for this is the system of planning and control in Figure 1.2.
Comparison On target.
Plans and Actual
Objectives of performance No corrective
standards performance
with plans/standards action required
Control action? Control action?

Deviations
identified
Figure 1.2: Planning and control system
Where there is a deviation from plan, a decision has to be made as to whether to adjust the plan
(because it was unachievable) or adjust how the plan is performed (because performance was sub-
standard).
Professional skills focus: Structuring problems and solutions
Plans and standards should always be set in relation to the objectives of the organisation. Actual
performance must relate to how well the organisation is performing against these objectives.
5.2 Mission
The overall direction of a business is set by its mission.
Definition
Mission: ‘The business’s basic function in society’ expressed in terms of how it satisfies its various
stakeholders.
Elements of mission Comments
Purpose Why does the organisation exist and for whose benefit (eg,
shareholders)?
Strategy What is the operational logic of the organisation:

• What do we do?
• How do we do it?

Elements of mission Comments
Policies and standards of What do our people actually do and how do they behave? The
behaviour mission of a hospital is to save lives, and this affects how doctors
and nurses interact with patients.
Values What does the organisation believe to be important – what are its
core principles?
Even though the mission may be very general, you can see it should have real implications for the
policies and activities of the organisation, and how individuals go about what they do.
5.2.1 Vision
Some businesses also have a vision of the future state of the industry or business which determines
what its mission should be. For instance, ‘being the leading provider of X by 2020’ is a vision of a
business’s future, which ties it in to a mission of ‘providing high-quality environmentally-friendly X to
all our customers’.
5.3 Goals: aims and objectives
Definition
Goal: ‘A desired end result’ (Shorter Oxford English Dictionary, 2007)
Identifying goals give flesh to a business’s mission. There are two types of goal:
• Non-operational aims, or qualitative goals: for example, a university’s aim may be ‘to seek truth’.
(You would not see: ‘increase truth by 5%’.)
• Operational objectives, or quantitative goals: for example, ‘to increase sales volume by 10%’.
Characteristics of operational objectives Example
Objectives should be SMART: • Operational aim: cut costs

• Specific • Operational objective: reduce budgeted
• Measurable expenditure on office stationery by 5% by 31
December 20X9
• Achievable
• Relevant
• Time-bound
Interactive question 2: Goals

Most organisations establish quantifiable operational goals (objectives). Give reasons why non-
operational goals (aims) might still be important.
5.3.1 The purpose of setting operational objectives in a business

• Implement the mission, by setting out what needs to be achieved
• Publicise the direction of the organisation to managers and staff, so that they know where their
efforts should be directed
• Appraise whether decisions are valid, by assessing whether these are sufficient to achieve the
stated objectives
• Assess and control actual performance, by using objectives as targets for achievement

5.4 Plans and standards
Definition
Plans: State what should be done to achieve the operational objectives. Standards and targets
specify a desired level of performance.
The desired level of performance for what is done can be expressed as a standard to be met, in
terms of:
• Physical standards eg, units of raw material per unit produced
• Cost standards. These convert physical standards into money measurement by the application of
standard prices. For example, the standard labour cost of making product X might be 4 hours at
£12 per hour = £48
• Quality standards. These can take a variety of forms, such as percentage of phone calls answered
within three rings (customer service quality standard)
5.5 How are plans set?

The strategic planning process, which we shall see in detail in the chapter Introduction to business
strategy, sets the overall mission, goals, plans and standards that the business will try to achieve.
6 Sustainability and climate change

Section overview
• Sustainability means meeting the needs of the present without compromising the ability of future
generations to meet their own needs. There is increasing pressure on organisations to act in a
sustainable manner.
• Sustainability can be considered under three headings — social, environmental and economic
(SEE) or under the headings people, planet and profit.
• Climate change refers to the long-term shifts in temperature as a result of increased greenhouse
gas emissions. Climate change is considered to be the defining issue of our time by the United
Nations.
• The UN has adopted an agenda for sustainable development that includes 17 sustainable
development goals.
• Business activity contributes to climate change, for example by exacerbating the emissions of
greenhouse gasses. Organisations also suffer from the consequences of climate change.
• The role of accountants in respect of climate change and sustainability is not to be campaigners
or to analyse the causes and consequences of climate change, but to help companies in selecting
and implementing solutions.
6.1 Sustainability
Definitions
Sustainability: The ability to meet the needs of the present without compromising the ability of
future generations to meet their own needs. Brundtland Report 1987
Sustainable development: Aims to ensure that economic activity can continue without causing
permanent harm to society and the planet. It describes a world of thriving economies and just
societies based on what nature can afford.
Organisations are increasingly being held to account for the wider impact their activities are having
on society. While economic activity makes positive contributions to society, such as providing
employment and producing vital goods and services, it can also have adverse effects. Exacerbation

of climate change, destruction of ecological systems and failure to look after the welfare of
employees are some of the ways in which economic activities by organisations have the potential to
cause harm.
Sustainability can be considered under three categories: social, environmental, economic (often
referred to using the SEE acronym).
6.1.1 Social sustainability

Social sustainability involves meeting the needs of a wider group of stakeholders and society as a
whole. The organisation’s activities should not exploit or harm any groups or individual. Examples of
socially sustainable behaviour include fair treatment of employees, avoiding unethical activities and
relationships such as bribery and corruption, and contributing to the societies in which the
organisations operate.
6.1.2 Environmental sustainability

Environmental sustainability means that an organisation’s activities do not harm nature or the
biodiversity of the planet. Climate change is a major environmental concern. Climate change is
discussed in more detail later in this section.
6.1.3 Economic (financial) sustainability

Economic activity and growth are sustainable if they can occur without harming social and
environmental sustainability. An organisation’s activities are economically sustainable if the
organisation can provide a return to its stakeholders over the long term while meeting its
obligations to society. Some businesses and entrepreneurs take a very short-term view, but one of
the objectives of most businesses is to thrive in the long term.
6.1.4 A balanced approach

In reality, organisations need to achieve a balance between the three. It may not be possible for an
organisation to make a return to shareholders without harming nature (eg, an airline cannot operate
without causing carbon emissions). However, organisations can reduce the harm they cause, and
take actions to remedy this (eg, many airlines encourage passengers to contribute to the cost of
planting trees, as these remove carbon dioxide from the atmosphere). Further discussion of the steps
businesses can take to become more sustainable is discussed later in this chapter.
6.2 Triple bottom line

‘The bottom line’ is a term that is commonly used to refer to the bottom line of the statement of
profit or loss (the profit after tax). Historically the bottom line was seen as the most important
indicator of an organisation’s performance in the eyes of its shareholders.
In the 1990s John Elkington suggested that a broader view of an organisation’s performance
required a ‘triple bottom line’. The first bottom line is the ‘people account’, which indicates how
socially responsible an organisation is. The second is the ‘planet account’, showing the ecological
impact that an organisation has. The third is the ‘profit account’ – the traditional profit after tax.
Elkington’s triple bottom line model was one of the first attempts to define a corporate reporting
system that would measure more than just the profits of a business. The idea is that if organisations
have to report on their people and planet behaviour, then they would have an incentive to improve
it. In practice it can be difficult to quantify social and environmental bottom lines, but organisations
are encouraged to disclose more information about their activities in this area.
Thanks to the introduction of the triple bottom line, many large multi-national companies began to
pay more attention to the ethical standards of their suppliers, particularly where many activities had
been outsourced to suppliers in countries with low labour costs and lax regulations relating to the
rights of workers.
Profit, people and planet is essentially the same as the social, environmental and economic aspects
of sustainability described above.

6.3 Climate change and the environment
Definition
Climate change: Long-term shifts in temperatures and weather patterns. Some of these shifts occur
due to natural causes, such as variations in the solar cycle. Since the 1800s, human activities have
been the main driver of climate change.
According to the United Nations, ‘Climate change is the defining issue of our time, and we are at a
defining moment’.
Human activities contribute to climate change through the creation of greenhouse gases, principally
carbon dioxide, methane, nitrous oxide and ozone. These are produced by activities such as the
burning of fossil fuels (eg, oil and coal), deforestation and the use of landfill sites for waste disposal.
Greenhouse gasses accumulate in the earth’s atmosphere and trap the heat from the sun. Climate
change has many adverse effects, including severe weather conditions (eg, droughts and floods) and
melting polar ice caps leading to rising sea levels.
The Paris Agreement of 2015 is a legally binding treaty in which 193 parties (192 countries plus the
EU) have committed to reduce their carbon emissions. The aim of the agreement is to limit increases
in global temperatures by the end of this century to 2.0 degrees Celsius above pre-industrial levels.
Scientists believe that this can be achieved but will require a huge reduction in carbon emissions and
the use of technology to remove carbon from the atmosphere.
In the UK, the government has committed to a legally binding target of net zero emissions by 2050.
Definition
Net Zero: The amount of greenhouse gases emitted into the atmosphere would be balanced by
schemes to remove them, for example by planting trees or using technology to remove carbon from
the atmosphere. If there are net zero emissions of carbon dioxide, global warming could halt.
6.4 UN Sustainable Development Goals

In September 2015, the UN adopted the 2030 Agenda for sustainable development. This built on
earlier developments and agreements to build a global partnership for sustainable development to
improve human lives and protect the environment. At the centre of the agenda are the 17
sustainable development goals (SDGs). The 17 goals are listed in the chapter Governance and
ethics.
6.5 Sustainability and business

6.5.1 Impact of business activity on the environment
Business activity can harm the environment in many ways. Below are some common examples:
• Emission of greenhouse gases during the production process. This can be reduced by more
efficient technology and the use of filters.
• Manufacturing products or using packaging that is made from non-sustainable materials (eg,
single-use plastic which cannot be reused or recycled). The effect of this can be reduced by
switching to the use of reusable materials.
• Use of fossil fuels for heating. The effect of this can be reduced by effective insulation, but using
renewable sources of energy such as solar and wind power are a more effective means of
reducing environmental damage.
• Transporting goods in petrol- and diesel-powered trucks; this can be reduced by using electric
vehicles.
• Sending waste to landfill sites increases carbon emissions because methane is produced as the
waste degrades.
6.5.2 Impact of climate change on organisations

Climate change impacts on organisations in a number of ways, including the following:

• Extreme weather such as floods and storms can lead to disruption of an organisation’s operations
and damage to assets, or in extreme cases it can threaten the safety of employees.
• The changing regulatory environment brings additional costs to organisations in terms of
compliance with stricter regulations, reporting and fines for failure to comply.
• Reputational damage for organisations that are not striving to act in a sustainable manner. This
can lead to loss of sales or even disruption of operations by activist groups.
6.5.3 Actions to support sustainability

There are many actions that businesses can take to reduce their impact on the environment and to
increase their sustainability. The 4Rs of recycling, ‘reduce, reuse, recycle, replace’ is a useful
framework for supporting sustainability:
• Reduce – reduce the amount of waste that is produced. Waste is generally disposed of in landfill
sites, which utilises land that could be used for other purposes and creates methane gasses, or
burned in incinerators, which causes greenhouse gasses.
• Reuse – make products or sell products in packaging that can be reused or recycled rather than
single use packaging (such as single use plastics) which cannot be recycled. Plant and machinery
could be upgraded or repaired rather than being thrown away.
• Recycle – avoid sending waste to landfill sites if it can be recycled. Recycling reduces the use of
new products (eg, the cost of recycling aluminium drinks cans is approximately 10% of the cost of
producing new aluminium from aluminium ore). It also reduces the use of landfill sites, which use
another finite resource, land.
• Replace refers to replacing resources that have been used. For example, planting new forests to
replace forests that have been cut down for their timber.
All the actions above are interlinked – reduce leads to less need to recycle, for example. It also shows
that sustainability and climate change are interlinked.
6.6 Role of accountants in sustainability and climate change

Accountants have a key role to play in helping organisations to manage their sustainability activities
and their response to climate change. The role of the accountant is discussed in more detail in the
chapter The accountancy profession.
Interactive question 3: Great Sportswear Limited

Great Sportswear Limited (GSL) is a UK-based company which sells branded sportswear (clothes and
footwear) throughout the world. Many of its brands are promoted by well-known sports stars, who
appear in GSL’s advertisements and wear its products when competing in events.
GSL designs its products in-house but outsources their manufacture to partners outside the UK
where labour costs per unit are much lower. Recently, it has come to the attention of GSL’s board of
directors that one of the company’s partners employs children at its factories. These children are paid
very low wages and work long hours, so they are unable to attend school.
Requirement
Discuss the factors the board of GSL should consider when deciding whether to continue to work
with this partner

Summary
Ownership BUSINESS
Control
Activity
Profit or non profit Social arrangement
Size
Organisation and collective goals
Legal status
Finance
Technology
Stakeholders Sustainability and
Climate Change
Objectives
Missions
Goals
Plans
Standards

1 Knowledge diagnostic
Before you move on to question practice, confirm you are able to answer the following questions
having studied this chapter. It not, you are advised to revisit the relevant learning from the topic
indicated.
Confirm your learning
1 Can you explain the differences between businesses and not-for-profit organisations?
(Topic 2)
2 Can you identify the primary and secondary stakeholders of a business? (Topic 3)
3 Can you discuss why managers of a business many not always make decisions that
maximise the wealth of its owners? (Topic 4)
4 Can you give examples of objectives at each level of a hierarchy of objectives for a
business? (Topic 5)
5 Can you explain the meaning of sustainability? And can you explain the three types of
sustainability? (Topic 6)
6 Do you understand the effect of organisations on climate change and the implications of
climate change for organisations? (Topic 6)
7 Can you explain the ‘Triple bottom line’ approach to corporate reporting? (Topic 6)
2 Chapter Self-test question practice

Aim to complete all self-test questions at the end of this chapter. Once completed, attempt all
questions in the Introduction to business chapter of the Business, Technology and Finance Question
Bank. Refer back to the learning in this chapter for any questions which you did not answer correctly
or where the suggested solution has not provided sufficient explanation to answer all your queries.
Once you have attempted these questions, you can move on to the next chapter, Managing a
business.

• Drucker, P.F. (1954) The practice of management. New York, Harper & Row.
• Simon, H.A. (1947) Administrative Behaviour: A Study of Decision Making Processes in
Administrative Organization. New York, Macmillan Inc.
• United Nations Department of Economic and Social Affairs: The 17 Goals [online] Available from:
https://sdgs.un.org/goals [Accessed 7 April 2022]
• World Commission on Environment and Development (1987) Our Common Future (Brundtland
Report) United Nations. Available from
https://sustainabledevelopment.un.org/content/documents/5987our-common-future.pdf
[Accessed 7 April 2022]

Self-test questions
Answer the following questions.

2 List four ways in which organisations may differ from each other.
3 A government funded agency exists to provide services to a group of beneficiaries. What would its
secondary objective be?
5 What three things are normally expected of a business by its suppliers as stakeholders?
6 State two possible primary business objectives other than profit/wealth maximisation.
7 Define what is meant by a business’s mission.
8 Which of the following actions taken by a road haulage company would contribute to its social
sustainability?
A Switching away from diesel-powered trucks to electrically propelled vehicles
B Taking the procurement director of a new customer out for lunch
C Sponsoring a local football team
D Entering into a long-term contract with a fuel provider to guarantee fuel supplies
9 Accountants provide advice to the organisations they work for or the clients that they advise.
Requirement
Which of the following statements is true in relation to the role of the accountant in respect of climate
change?
A Accountants must ensure that organisations maximise profits regardless of their contribution to
climate change
B Accountants should campaign to ensure that organisations take appropriate action to limit the
volume of carbon emissions
C Accountants have a role to play in managing risks, including the risks related to climate change
D Accountants have no role in relation to climate change – that is the responsibility of scientific
advisers
10 Inch plc’s operational objective for its Yem manufacturing division is ‘increasing manufacturing
activities within a year’. On which of the SMART criteria for objectives does this objective fail?
A Specific
B Measurable
C Relevant
D Time-bounded
Now go back to the Introduction and ensure that you have achieved the Learning outcomes listed for
this chapter.

Answer to Interactive question 1

The local community would expect jobs and therefore prosperity to flow from the company, as well
of course as electricity. It would also expect safe operating practices and a long-term view taken of
how the gas would be transported to the station, and any waste would be transported from the site. It
would be concerned about direct pollution from gases etc, and would expect the company to
minimise these. It would be concerned about the possibility of gas explosions, and would require
reassurance about security procedures to deal with this risk. People would also be concerned about
the overall effect on the world’s environment, and would expect the company to make efforts to
minimise its carbon footprint.

Aims can be just as helpful as quantifiable objectives. Customer satisfaction, for example, is not
something which is achieved just once. Some goals are hard to measure and quantify, for example ‘to
retain technological leadership’. Quantified objectives are hard to change when circumstances
change, as changing them looks like an admission of defeat: qualitative aims may support greater
flexibility.

• The lower cost of child labour may reduce the cost of the goods produced for GSL, increasing
GSL’s profit margins.
However:
• It is morally wrong and a breach of human rights to benefit from the exploitation of child labour,
so for this reason alone GSL should not consider continuing the relationship.
• If GSL did continue the relationship, it is likely that customers would become aware of GSL’s
knowing use of child labour, for example if a journalist discovered the matter. This would do huge
damage to GSL’s reputation, leading to people boycotting the company’s products. It is likely that
the sports stars who promote the brands would no longer wish to be associated with the
company, which would destroy the value of its brands. Therefore, from a business point of view it
would also not be advisable to continue with the partner; GSL would be seriously damaging its
economic sustainability by doing so.

1 An organisation is a social arrangement for the controlled performance of collective goals, which has
a boundary separating it from its environment.
2 They may differ in terms of who owns them (public or private), who controls their operations (owners
or managers), what they do, whether they are oriented towards making a profit, how big they are,
their legal form (club, association, sole tradership, partnership, or company), where they get their
money from and what technology they use.
3 To minimise the costs of providing the services
4 A business is an organisation that is oriented towards making a profit for its owners, but that can be
regarded as an entity separate from its owners.
5 Fair terms of trade; prompt payment; continuity of custom
6 Two of: profit satisficing; revenue maximisation; multiple objectives
7 A business’s mission is its basic function in society expressed in terms of how it satisfies its
stakeholders.
8 Correct answer(s):
C Sponsoring a local football team
C Accountants have a role to play in managing risks, including the risks related to climate change
B Measurable
The objective is time-bound and specific, as it is clear in which direction it wants activities to go.
Being related to manufacturing it can be said to be relevant. However, it gives no indication of how
the ‘increase’ is to be measured.

Chapter 2
Managing a business
Introduction
Learning outcomes
Syllabus links
Assessment context
Learning topics
1 What is management?
2 Power, authority, responsibility, accountability and delegation
3 Types of manager
4 The management process
5 Managerial roles
6 Culture
7 Management models
8 Business functions
9 Marketing
10 Operations and production
11 Procurement
12 Human resource management (HRM)
13 Information technology
14 Introduction to organisational behaviour
Summary
Self-test questions
Introduction
Learning outcomes
• Identify the functional areas within businesses (marketing, operations/production, procurement,
HR, IT and finance) and show how the functions assist the achievement of business objectives
• Identify the nature and functions of management, and show how this is influenced by human
behaviour
Specific syllabus references for this chapter are: 1c, 1d.
2
Syllabus links
The material in this chapter will be developed further in this assessment, and then in the Business
Strategy and Technology assessment at the Professional level.
2
Assessment context
Questions on the nature of management, business functions and organisational behaviour will be set
in the assessment in either MCQ or multiple response format. They will be either straight tests of
knowledge or applications of knowledge to a scenario.
2

Use this schedule and your study timetable to plan dates on which you will complete your study of
this chapter.
Topic Practical significance Study Approach Exam approach Interactive

questions
1–4 Nature of Approach Questions on the IQ1:

management Read sections 1 to nature of management Management
Management is about 4 quickly to get an could easily appear in power
getting the people idea of the the exam. This question
who work for the principles at issue Questions are likely to helps to
business to work when managing a be based on short understand the
effectively and do the business, then scenarios, and test different power
right things to help study each section your ability to apply classifications.
the business succeed. again more slowly, the knowledge to
Sections 1–4 making sure you these.
introduce the learn the Essential points are:
important definitions and can
terminology of distinguish • Distinction between
management which is between the power, authority,
then built on later in concepts of power, responsibility,
the chapter. authority, accountability and
responsibility, delegation
accountability and • Handy’s power
delegation. Learn bases
the different types
of power classified
according to
Charles Handy.
You should learn
too the distinctions
between the
different types of
manager, and the

questions
four parts of the

management
process.
Stop and think
You may already
have experience of
being managed, or
even of managing
other people.
What do you think
makes a good
manager, and what
exactly do
managers get up
to?
5 Managerial roles Approach Questions on this area

In your career you This is a short are highly examinable.
may be given the section. Learn the Questions are based
opportunity to fulfil a three management on scenarios or
managerial role. This roles as described knowledge based.
section describes by Mintzberg.
what managers do. Stop and think
Think of activities
that you have seen
a manager at work
perform. Which of
the roles does
each activity
represent?
6 Culture Approach This is another highly

The culture of an Try to understand examinable area.
organisation will have the meaning of Typically a question
implications for many culture from the will describe a
aspects of definitions given. particular culture and
management, such as Learn Quinn’s ask you to identify
how staff will accept cultural types. which of Quinn’s
or reject new ideas, cultural types is being
Stop and think exemplified.
or how customers will
be treated. Think of an
organisation that
you have been a
part of, such as
your current
employer, or an
educational
institution that you
attended. How
would you
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culture of that
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Quinn’s cultural
types?
ICAEW 2023 2: Managing a business 29

questions
7 Management models Approach This is an important

The two management Read this section exam area. Exam
models presented in carefully, making questions in this area
this topic provide sure you tend to be more
alternative understand the knowledge based,
approaches. You may meaning of the testing that you can
be in a situation of two models of identify the
having to determine management - characteristics of
which approach best rational goal different models.
fits an organisation in model and internal
your role as a process model
manager or Stop and think
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What type of
management
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in a high-class
restaurant?
8–13 Non finance Approach Questions will test your IQ2: Product
functions Read quickly knowledge of the marketing
These areas are through sections 8 purposes of the This question
important throughout to 13 before functions and some of helps you to
your qualification and studying each the theories included understand the
come into many of section, and their within them such as the marketing mix by
the later papers. definitions, more 7Ps of marketing, so applying it to a
slowly. make sure you learn real-life situation.
these.
Stop and think
Can you think of
ways that
accountants can
support the non-
finance functions
described in these
sections?
14 Introduction to Approach Questions on this area IQ3: Human

organisational Read this section could be tests of behaviour
behaviour carefully. Try to knowledge, or they This question
Managers want learn each theory, could be tests of tests your depth
employees to be perhaps by application with a of understanding
motivated so they making brief notes scenario. It is important of scientific
contribute to summarising each to know the theories management.
achieving the one. well.
objectives of the Stop and think
organisation. This
section looks at a Think about a
number of factors group that you
and theories relating have been a
to the behaviour of member of. It
groups and what could be a
influences them. department at
work or a sports
team for example.
How did your team

questions
behave?

1 What is management?
Section overview
• Management means getting things done through other people.

• Managers act on behalf of owners in the organisation.
Definition
Management: ‘Getting things done through other people’ (Metcalf and Harper, 1942).
We defined an organisation in the chapter Introduction to business as ‘a social arrangement for the
controlled performance of collective goals’. This definition itself suggests the need for management.
• Objectives have to be set for the organisation.
• Somebody has to monitor progress and results to ensure that objectives are met.
• Somebody has to communicate and sustain corporate values, ethics and operating principles.
• Somebody has to look after the interests of the organisation’s owners and other stakeholders.
In a business managers act, ultimately, on behalf of owners (shareholders). In practical terms,
shareholders rarely interfere, as long as the business delivers profits year on year.
In a public sector organisation, management acts on behalf of the government. Politicians in a
democracy are in turn accountable to the electorate. More of the objectives of a public sector
organisation might be set by the ‘owners’ – ie, the government – rather than by managers. The
government might also tell senior managers to carry out certain policies or plans, thereby restricting
their discretion.
2 Power, authority, responsibility, accountability and

delegation
Section overview
• A number of significant forces are at work in an organisation and need to be managed. They
include power, authority, responsibility, accountability and delegation.
• Power is the ability to get things done.
• Authority is the right to do something or to require someone else to do it.
• Responsibility is the obligation that someone has to do the thing that the person in authority over
them has required.
• Accountability is the responsible person’s liability to answer for what has happened to those with
a legitimate interest in the matter.
• Delegation means giving someone else the responsibility and authority to do something, while
remaining responsible and accountable for that thing being done properly.
2.1 What is needed for effective management?

Businesses have a large number of different activities to be co-ordinated, and large numbers of
people whose co-operation and support is necessary for a manager to get anything done. As you
have probably noticed if you have worked for any length of time, organisations rarely run like
clockwork, and all depend on the directed energy of those within them. They need managers.
To understand how managers can do their jobs effectively, we need to understand the differences
between power, authority, responsibility, accountability and delegation.

2.2 Power
Definition
Power: The ability to get things done.
Power is not something a manager ‘has’ in isolation: it is exercised over other individuals or groups,
and – to an extent – depends on those other people recognising the manager’s power over them.
Social psychologists John French and Bertram Raven (followed by the management writer Charles
Handy) classified power as coming from various bases or sources.
Base of power Description
Coercive power The power of physical force or punishment. Physical power is rare in
businesses, but intimidation may feature, eg, in workplace bullying.
Reward (or Based on control over valued resources. For example, managers have access
resource) power to information, contacts and financial rewards for team members. The
amount of resource power a manager has depends on the scarcity of the
resource, how much the resource is valued by others, and how far the
resource is under the manager’s control.
Legitimate (or Associated with a particular position in the organisation. For example, a
position) power manager has the power to authorise certain expenses, or issue instructions,
because the authority to do so has been formally delegated to her.
Expert power Based on experience, qualifications or expertise. For example, accountants

have expert power because of their knowledge of the tax system. Expert
power depends on others recognising the expertise in an area which they
need or value.
Referent (or Based on force of personality, or ‘charisma’, which can attract, influence or
personal) power inspire other people.
Negative power The power to disrupt operations: for example, by industrial action, refusal to
(Handy) communicate information, or sabotage.
Questions in this area often provide a short scenario containing information about a manager or
supervisor and ask you what type of power that person has, testing your ability to apply technical
knowledge to support reasoning. Start by eliminating those types of power which are obviously not
displayed, then try to decide which of the remaining types of power most closely match the situation
in the scenario.
Interactive question 1: Management power

Nisar Iqbal is a manager in the IT department of his firm. He has a degree in computer science and
14 staff reporting to him.
Requirement
What types of power can Nisar exert as a manager in order to make sure a project is completed on
time?

2.3 Authority
Definition
Authority: The right to do something, or to ask someone else to do it and expect it to be done.
Authority is thus another word for position or legitimate power.
Managerial authority is exercised in such areas as:

• Making decisions within the scope of authority given to the position. For example, a supervisor’s
authority is limited to their team and has certain limits. For items of expenditure more than a
certain amount, the supervisor has to go to the manager.
• Assigning tasks to subordinates, and expecting satisfactory performance of these tasks.
2.4 Responsibility and accountability
Definitions
Responsibility: The obligation a person has to fulfil a task which they have been given.
Accountability: A person’s liability to be called to account for the fulfilment of tasks they have been
given by persons with a legitimate interest in the matter.
The terms reflect two sides of the same coin.

• A person is responsible for a piece of work when they are required to ensure that the work is
done.
• The same person is accountable to a superior when they are given work by that superior.
One is thus accountable to a superior (or other persons with legitimate interest) for a piece of work
for which one is responsible.
2.5 Delegation
The principle of delegation is that a manager may make subordinates responsible for work, but they
remain accountable to their own manager for ensuring that the work is done and they retain overall
responsibility. Appropriate decision-making authority must be delegated alongside responsibility.
We will come back to delegation at the end of this chapter.
3 Types of manager
Section overview
• Different types of manager have different types of authority.

• A manager may have line, staff, functional or project authority.
Types of manager in a business can be classified according to the types of authority they hold.
• A line manager has authority over a subordinate.
• A staff manager has authority in giving specialist advice to another manager or department, over
which they have no line authority. Staff authority does not entail the right to make or influence
decisions in the advisee department. An example might be a human resources manager advising
a finance line manager on selection interviewing methods.
• A functional manager has functional authority, a hybrid of line and staff authority, whereby the
manager has the authority, in certain circumstances, to direct, design or control activities or
procedures in another department. An example is where a finance manager has authority to
require timely reports from managers in other departments.

• A project manager has authority over project team members in respect of the project in progress;
this authority is likely to be temporary (for the duration of the project) and the project team are
likely still to have line managers who also have authority over them.
There are inevitable tensions involved in staff managers asserting staff authority in giving specialist
advice to other managers.
Problem Possible solution
The staff manager can undermine the line Clear demarcations for line, staff and functional
manager’s authority. managers should be created.
Lack of seniority: line managers may be more Use functional authority (via policies and
senior than staff managers. procedures). Experts should be seen as a
resource, not a threat.
Expert staff managers may lack realism, going They should be fully aware of operational issues
for technically perfect but commercially and communicate regularly with the line
impractical solutions. managers.
Staff managers lack responsibility for the They should be involved in implementing their
success of their ideas. suggestions and share accountability for
outcomes.
4 The management process

Section overview
• The process of management comprises planning, organising, controlling and leading.

• Planning involves setting detailed objectives and targets in the light of the overall objective,
forecasts and resources.
• Plans should be constantly reviewed and updated in the light of actual performance.
• Organising involves identifying the processes, technology and people that are required and then
allocating and co-ordinating the work.
• Controlling follows on from reviewing plans in the light of experience; control actions will often
have to be taken to ensure that the overall objective can still be met.
• Leading means generating effort and commitment in a team.
4.1 The management process

The efforts of people in the business (in particular the activities of direct operational staff) need
organising, and as we have seen it is the primary role of managers to ‘get things done through other
people’ (according to Mary Parker Follett). This ‘organising’ role is actually part of a management
process which comprises four main tasks: planning, organising, controlling and leading.
4.2 Planning
Following on from the business’s overall objective, mission and goals, managers need to set the
direction of the work to be done. This includes:
• pinpointing specific aims
• forecasting what is needed
• looking at actual and potential resources
• developing objectives, plans and targets
• using feedback from the control part of the process to make necessary amendments to the plan
(as we saw in the chapter Introduction to business when we looked at Figure 1.2: Planning and
control systems)

4.3 Organising
Managers allocate time and effort in such a way that the objectives, plans and targets are likely to be
met. This includes:
• defining what processes, technology and people are required
• allocating and co-ordinating work
4.4 Controlling
Managers monitor events so they can be compared with the plan and remedial action can be taken if
required.
4.5 Leading
Managers generate effort and commitment towards meeting objectives, including motivation of staff.
We shall see more about this later in this chapter.
5 Managerial roles
Section overview
• Managers actually do a great many things in the course of the management process, namely
handling data and information, dealing with people, and making decisions.
• Decisions have to be made regarding resource allocation, handling disturbances, negotiating,
problem-solving and acting in an entrepreneurial way.
The management process sets out what managers have to achieve and how, but it does not as such
describe what managers actually do. Henry Mintzberg, the management writer, defines what
managers do in terms of three key roles:
• The informational role (checking data received and passing it on to relevant people, as well as
acting as the ‘spokesperson’ for their team in relation to other teams or his or her own manager).
• The interpersonal role (acting as leader for their own team and linking with the managers of other
teams).
• The decisional role. It is in this role that managers actually ‘do’ what we perceive as managing. In
this role they:
– allocate resources to operations – for instance, deciding that three people are needed on an
audit assignment;
– handle disturbances – such as dealing with an awkward client, or sorting out a crisis in staffing
caused by illness;
– negotiate for what they need – this may be with more senior managers or with client staff;
– solve problems that arise; and
– act as entrepreneur – spotting gaps in the market, or unmet needs in clients.
6 Culture
Section overview
• The organisation’s culture has a very profound effect on how managers perform their roles.
• Culture incorporates the common assumptions, values and beliefs that people in an organisation
share.
• Organisational culture varies depending on whether the business is inward or outward looking,
and on whether there is a greater comparative need for flexibility or control.
• Internal process cultures look inwards and seek control over their environment.

• At the other extreme, open systems cultures look outwards and are very flexible about the effects
of the environment.
• A human relations culture is inward-looking but is flexible as it focuses on the needs of people.
• A rational goal culture is very aware of the external environment but seeks to control it and its own
processes.
Managers have to operate within what is often referred to as the ‘culture’ of their particular business.
Definition
Culture: The common assumptions, values and beliefs that people share; ‘the way we do things
round here’.
The management writer Robert E Quinn emphasises two distinct tensions that affect the type of
culture a particular business manifests:
• the tension between having flexibility and having control
• the tension between whether the business is inward- or outward-looking
The figure below identifies four different cultural types, which may characterise entire businesses or
just parts of businesses.
Flexibility
Human relations Open systems

culture culture
Inward-looking Outward-looking
Internal process Rational goal
culture culture
Control
Figure 2.1: Types of business culture
Each cultural type can be briefly characterised as follows:

• Internal process culture: The business looks inwards, aiming to make its internal environment
stable and controlled. Goals are known and unchanging, and there are defined methods, rules
and procedures. Security, stability and order motivate staff. Example: public sector organisations.
• Rational goal culture: Effectiveness is defined as achieving goals that satisfy external
requirements. The business is structured and controlled so as to deal effectively with the outside
world. Competition and the achievement of goals motivate staff. Example: large established
businesses.
• Open systems culture: The external environment is a source of energy and opportunity, but it is
ever-changing and unpredictable. The business must be highly flexible and open to new ideas, so
it is very adaptable in structure. Staff are motivated by growth, creativity and variety. Example: a
new business unit working with fast-changing technology.
• Human relations culture: The business looks inwards, aiming to maintain its existence and the
well-being of staff. Staff are motivated by a sense of belonging. Example: support service units.
7 Management models
Section overview
• Complex realities such as are found in any business of any size can be ‘modelled’ or described
fully, so that their workings can be understood and the effects of future policies and decisions can
be predicted.

7.1 What is a model?
Models are used in management theory to represent a complex reality, such as a client’s business,
which is then analysed and broken down into its constituent parts.
Some management models are based on the fact that the culture of the business pervades
everything it does. Of particular importance are the two control-oriented cultures that we saw above:
rational goal and internal process.
Models can be used to help structure problems and solutions. It is important to understand the
objective of the models in the syllabus so you know when to apply them.
7.2 The rational goal model of management

A business with a rational goal culture uses the reason why the business does something to make
sure it is done as well as possible.
Some rational goal ideas commonly seen in organisations today are:
• Systematic work methods
• Detailed division of labour
• Centralised planning and control
• ‘Low involvement’ employment relations, such as contract workers
7.3 The internal process model of management

The internal process model looks at how the organisation is doing things, not at why. In businesses
with an internal process model of management we tend to find:
• Rationality – use of the most efficient means to meet the business’s objectives
• Hierarchical lines of authority – managers have closely defined areas of authority, and have none
outside those areas
• Detailed rules and procedures – businesses which are subject to tight regulation and public
scrutiny, such as those in the financial services sector, tend to have more rules and procedures
• Division of labour – tight limits are set on the areas of responsibility of staff
• Impersonality – appraisals of staff performance are based on objective criteria, not personal
preference
• Centralisation (we shall come back to this in the chapter Organisational and business structures)
Businesses today operate in an environment which requires a high degree of control (because of
regulations), but in which there is a high degree of competition and a need for flexibility and
innovation because of the pace of change in technology. Therefore, management will apply the
principles of both the rational goal and the internal process models.
8 Business functions
Section overview
• The key functions in any business are marketing, operations/production, procurement, human
resources, finance and information technology.
The functions that need to be performed in a business depend on many variables, such as what
industry it is in, how geographically spread it is, and what its plans are for the future. Historically these
functions have been identified generically as the following:
• Marketing, including sales and customer service
• Operations or production, usually including research and development (R&D) and procurement

• Procurement
• Human resources
• Finance
• Information technology
The finance function is a major focus of the Business, Technology and Finance syllabus and will be
covered in the chapter The business’s finance function and throughout this Workbook. Here we shall
introduce a few of the principles that underlie the other functions.
9 Marketing
Section overview
• Marketing is the management process which identifies, anticipates and supplies customer
requirements efficiently and profitably. It forms one of the key functions in any business.
• A customer may buy goods and services but the person who uses them is called the consumer.
• Businesses may work in consumer or industrial markets.
• The elements of product marketing comprise the marketing mix, which entails price, product,
place (distribution) and promotion. For services it also includes people, processes and physical
evidence.
• Most markets require segmentation so that homogenous groups can be targeted.
• Important issues related to product marketing include quality, reliability, packaging, branding,
aesthetics, mix and servicing.
• The right price can make or break a product. Setting the price in the light of costs, competition,
customers (demand) and corporate objectives is a key aspect of marketing management and one
in which accountants very often play a supporting role.
• Making sure products are in the right place at the right time so that customers can buy them is
vital.
• The key ‘place’ or distribution decision is whether to sell direct (higher margin, lower volume due
to inaccessibility) or whether to go via intermediaries (lower margins, but higher volumes).
• Promotion incorporates advertising, sales promotions, public relations and personal selling via a
sales team.
• Push techniques of promotion ensure that the product is there for the customer to buy; pull
techniques persuade them to do so.
9.1 What is marketing?
Definition
Marketing: The set of human activities directed at facilitating and consummating exchanges. It
therefore covers the whole range of a business’s activities.
OR
The management process which identifies, anticipates and supplies customer requirements
efficiently and profitably.
A distinction can be made between:

• a customer, who purchases and pays for a good or service; and
• a consumer, who is the ultimate user of the good or service.
Thus, if a business is a manufacturer of corn flakes, its customers are wholesalers as well as
supermarkets and small shops, but it is the consumer who eats the corn flakes.

9.2 Consumer and industrial markets
Markets can be analysed in terms of the product (goods or services) or the end-user, or both. The
most common distinction is between consumer and industrial markets.
Consumer markets are the markets for goods and services bought by individuals for their own or
family use. Products bought by consumers in these markets can be categorised in several ways:
• Fast-moving consumer goods (FMCGs). These are high volume, low unit value, fast repurchase,
such as bread, baked beans
• Consumer durables. These have low volume but high unit value. They may be further divided into:
– white goods, eg, fridges, freezers
– brown goods, eg, mobile phones, cars
– soft goods: these may be thought of as synonymous with consumer durables, eg, clothes, bed
linen
• Services. These involve delivering intangible goods or services rather than goods to the
consumer. Examples include:
– Insurance
– Broadband
– Utilities (such as gas, electricity and water)
– Holidays
A business which operates in the consumer market, selling to consumers, is often described as being
in the ‘business to consumers’, or B2C, market. The main goods and services covered by industrial
markets are shown below.
Raw materials Processed materials Capital goods Supplies Services

and components
Iron ore Steel Tablet PCs Stationery Accountancy
Timber Textiles Servers Carbide tips Legal
Coal Packing materials Buildings Lubricants Distribution
Crude oil Microchips Vehicles Printer toners Web design
Businesses operating in industrial markets are often described as ‘business to business’ or B2B.
9.3 The marketing mix and segmentation
Definition
Marketing mix: The set of controllable marketing variables that a firm blends to produce the
response it wants in the target market (Kotler, 1997).
The most common way of presenting the marketing mix for tangible products is the four Ps.
• Product: quality of the product as perceived by the potential customer. This involves an
assessment of the product’s suitability for its stated purpose (ie, its features and benefits), its
aesthetic factors, its durability, brand factors, packaging, associated services, etc.
• Price: prices to the customer, discount structures for the trade, promotion pricing, methods of
purchase, alternatives to outright purchase.
• Promotion: advertisement of a product, its sales promotion, the company’s public relations effort,
salesmanship, use of social media.
• Place: distribution channel decisions, website selling (e-tailing), location of outlets, position of
warehouses, inventory levels, delivery frequency, geographic market definition, sales territory
organisation.
Where the business provides services, a further three Ps are involved, making ‘the seven Ps of
services marketing’:

• People: The people employed by the service deliverer are uniquely important given they are
likely to have regular interactions with customers. Service businesses therefore need to have
excellent recruitment and selection policies, good training programmes (both in procedures and
the service ethos), standard consistent operational procedures (eg, airlines), the flexibility to
enable staff to give good service, and effective motivational programmes.
• Processes: These often determine the structure of the ‘service encounter’. There are some
important ‘moments of truth’ that determine how effective a service is, such as enquiries and
reservations before the service is granted, registration procedures, timing of when the service is
consumed (the internet allows the purchase of many services to be done 24/7, for instance), and
what happens after the service has been consumed.
• Physical evidence: This refers to items that give physical substance such as logos, staff uniforms
and store layout/design – it gives the customer who buys a service ‘something to show for it’.
How the elements are mixed varies enormously from product to product, and from business to
business as can be seen below.
Company products/ Online clothes Major national drinks Mainframe computer

Marketing mix retailer manufacturer manufacturer
variable
Product Similar to those of Similar to those of Very advanced, subject

several other several other to continual
retailers, both online manufacturers amendment, with a
and ‘bricks and distinct place in the
mortar’ market
Price A vital factor. Similar level and Different from that of its
Probably lower than structure to that of broad competitors.
similar physically several other Customer looks for
retailed goods manufacturers service and ‘value for
money’ rather than
initial cost
Promotion Website is the sole A high percentage of A low percentage of

source of orders and product cost. Use of TV product cost. Use of
the major marketing and various press and trade press and up-
expense social media. Sales market magazines and
promotions important newspapers
Sales. No sales A large team of selling- A large team of sales

people as such oriented, well-trained people trained to
sales people combine selling skills
with good knowledge
of the product and its
use
Place (distribution) No intermediaries. Extensive use of No intermediaries.

Distribution wholesalers, retailers and Small vehicle fleet.
determined by licensees of premises. Relatively infrequent
postal and courier Frequent deliveries, deliveries. Little storage
systems regional warehouses, of finished items
company owns its
transport fleet
A business operating in one market may vary the marketing mix for various segments of that market.
Definition
Market segmentation: The division of the market into homogeneous groups of potential customers
who may be treated similarly for marketing purposes.

This segmentation allows the organisation to vary its marketing mix to each of the segments it caters
for. For instance, Ford operates in the new car market but does not sell one car in one way to the
whole market. It segments the market (separating it into various sub-markets which have shared
characteristics) and then targets the consumers within the segment using varying marketing mixes. It
places different emphasis on the mix variables depending on the segment targeted.
Segment of market Target segment by placing most emphasis on
High income groups Promotion – to create the image of quality, status
Families with children Product – size, safety
Low-income groups Price – low: Product – reliability, economy
Questions may test your ability to understand the situation and identify the needs of specific
customers or clients. Knowing the needs of the different segments above may help in such
questions.
Interactive question 2: Product marketing

Pick a product that you see in the supermarket and try to identify how the various elements of the
marketing mix have been used in marketing it to you.
9.4 Product
Definition
Product: Anything that can be offered to a market for attention, acquisition, use or consumption that
might satisfy a want or need. It includes physical objects, services, persons, places, organisations and
ideas. Marketers tend to consider products not as ‘things’ with ‘features’ but packages of ‘benefits’
that satisfy a variety of consumer needs.
There are three main elements of a product:

• Basic (or core) product – a car. This looks at the perceived or real benefits to be gained from the
product, eg, Volvo cars satisfy safety/security needs, BMWs satisfy ego or status needs
• Actual product – a Ford Focus
• Augmented product – Ford Focus with 0% finance or extended warranty. Essentially an
augmented product can be thought of as having more features per £
General factors to be considered when taking a product from basic to actual and augmented include
the following:
• Quality and reliability – often linked to the pricing decision, these are used for positioning the
product. Level and consistency should be considered
• Packaging – is it functional (eg, round a fridge) or part of the overall appeal (eg, perfume)?
• Branding – this is often very important in highly competitive markets
• Aesthetics – smell, taste, appearance, etc
• Product mix – range of products, eg, different Ford Focus models
• Servicing/associated services – are these required?
• Technology – the degree of technology involved and how up-to-date the technology is

9.5 Price
At what level the product should be priced is highly relevant in any marketing mix. Price is
particularly important as it is the only P producing revenue (the other three incur costs).
9.5.1 The four Cs of pricing

• Costs: In order to make profits a business should ensure that its products are priced above their
total cost, including their share of overheads. In the short term it may be acceptable to go below
this if the price is still above the variable cost of producing one unit, thus ensuring a positive
contribution towards the cost of overheads.
• Competitors: Only a monopoly can set any price it wants, and even this is often subject to
government price controls and/or regulatory monitoring and approval. In very competitive
markets the individual business has no choice, with the price being dictated by the market. The
reality is usually somewhere between these two extremes. Relative pricing is extremely important
in many markets, that is the price must be comparable to those of competitors.
• Customers: As with all other marketing decisions, a consideration of customer expectations is
essential in setting prices. If possible, a business should try to determine exactly how customer
demand is affected by changes in price (price elasticity), and therefore how many sales will result
at a given price.
• Corporate objectives. Possible pricing objectives are:
– To maximise profits.
– To achieve a target return on investment. This results in an approach based on adding
something to the quantified cost to the business of providing the product.
– To achieve a target revenue figure.
– To achieve a target market share.
– To match the competition, rather than leading the market, where the market is very price-
sensitive.
– To drive competitors out of the market through predatory pricing with a view to raising prices
subsequently.
We shall see more about market price and factors affecting demand in the chapter The economic
environment of business and finance.
9.6 Place (distribution)

Providing customers with satisfying products at a price they like, while important, is not sufficient to
ensure success. Such products must also be made available in adequate quantities, in the locations
where customers expect to find them and at the times when customers want to buy them.
The basic decision to be made when considering distribution is whether to sell direct, often via the
internet:
Producer Consume
Figure 2.2: Selling direct
Or whether to use intermediaries to give a longer distribution chain:
Producer Wholesalers Retailers Consume
Intermediaries
Figure 2.3: Selling through intermediaries
Advantages of selling direct Advantages of using intermediaries
• No need to share profit margins • More efficient logistically

Advantages of selling direct Advantages of using intermediaries
• Control over ultimate sale • Costs usually lower

• Speed of delivery to ultimate consumer • Consumers expect choice at point of sale
likely to be quicker • Producers may not have sufficient resources
to sell direct
9.7 Promotion
Promotion is all about communication, thus informing customers about the product and persuading
them to buy it. There are five main types of promotion (the communication mix):
• Advertising
• Sales promotion (such as ‘buy one, get one free’ offers)
• Public relations
• Digital marketing (such as social media and display advertising on websites)
• Direct marketing (such as mailshots)
• Personal selling
We may distinguish two techniques for promotion in Figure 2.4.
Promotion techniques
Push Pull
Ensuring products/ services are Persuading the ultimate

available to consumers by consumers to buy
encouraging intermediaries, eg,
Sainsburys, to stock items
Figure 2.4: Push and pull promotion techniques
When determining its promotion package, the business should consider the customer and the
ultimate consumer (in a B2C market). In a B2B market, the business needs to consider buyer,
customer and user: these may be one and the same, but if not, all three have to be satisfied:
• The business = the customer
• Its purchasing manager = the buyer
• A direct operational worker = the user
10 Operations and production

Section overview
• Operations and production involve creating the goods or services that the business supplies to
customers by transforming inputs into outputs.
• The key dimensions are the Four Vs: volume, variety, variation in demand and visibility.
• The key variables that must be balanced in order to deliver effective operations are the overall
level of demand for the goods and services, resources, capacity, inventory levels and
performance levels of the processes required.
• Research and development (R&D) involves pure and/or applied research, and/or development.
Applied research and development may be into products or processes.
• Procurement involves acquiring goods and services in the right procurement mix, as to quantity,
quality, price and lead time.

10.1 Operations and production
Definition
Operations (or production) management: Creating as required the goods or services that the
business is engaged in supplying to customers by being concerned with the design, implementation
and control of the business’s processes so that inputs (materials, labour, other resources, information)
are transformed into output products and services.
All operations involve a transformation process, but they can differ in four different ways or
dimensions, referred to as the ‘four Vs’ of operations: volume, variety, variation in demand and
visibility. Each of these affects the way in which an operation will be organised and managed.
Volume: Operations differ in the volume of inputs they handle and the volume of output
they produce.
• High volume might lend itself to a capital-intensive operation, with
specialisation of work and well-established systems for getting the work done.
Unit costs should be low.
• Low volume means that each member of staff will have to perform more than
one task, so that specialisation is not achievable. Unit costs of output will be
higher than with a high-volume operation.
Variety: This refers to the range of products or services an operation provides, or the
range of inputs handled. For example, an operation might produce goods to
customer specification, or it might produce a small range of standard items.
• High variety: the operation needs to be flexible and capable of adapting to
individual customer needs. The work may therefore be complex, and unit costs
will be high
• Low variety: the operation should be well-defined, with standardisation,
regular operational routines and low unit costs
Variation in Demand might vary with the time of the year (eg, in the tourist industry) or even
demand: the time of day (eg, telecoms traffic, commuter travel services). Variations in
demand might be predictable, or unexpected, and in degree it may be highly
variable or not so variable at all.
• High variation (fluctuating demand): the operation has a problem with capacity
utilisation so it will try to anticipate variations in demand and alter its capacity
accordingly (eg, the tourist industry takes on part-time staff during peak
demand periods). Unit costs are likely to be high because facilities and staff are
under-used in off-peak periods
• Low variation (stable demand): the operation should achieve a high level of
capacity utilisation, and unit costs will accordingly be lower
Visibility: This is the extent to which an operation is exposed to its customers and can be
seen by them. Some operations are partly visible to the customer and partly
invisible: this distinction is often made in terms of ‘front office’ and ‘back office’
operations.
• High visibility calls for staff with good communication and inter-personal skills.
More staff are needed and so the operation is more expensive to run.
Customer satisfaction with the operation will be heavily influenced by
perception (eg, customers will be dissatisfied if they have to wait), and staff
need high customer contact skills. Unit costs of a visible operation are likely to
be high.
• Low visibility means that there is a time lag between production and
consumption, allowing the operation to use its capacity more efficiently.
Customer contact skills are not important, and unit costs should be low.

Operations management is concerned therefore with balancing key variables:
• External and internal demand for goods and services
• Resources
• Capacity of the long-term assets of the business such as machinery, buildings and computer
systems, and of the other assets of the business such as people (staff)
• Inventory levels
• Performance of the process which creates the goods or services
10.2 Research and development (R&D)

The research and development (R&D) function may involve pure research and/or applied research
and/or development.
Definitions
Pure research: Original research to obtain new scientific or technical knowledge or understanding.
There is no obvious commercial or practical end in view.
Applied research: Research which has an obvious commercial or practical end in view.
Development: The use of existing scientific and technical knowledge to produce new (or
substantially improved) technology, products or systems, before starting commercial production
operations.
Applied research and also development may be intended to improve products or processes.
• Product research: finding new and improved products for the market. The new product
development (NPD) process must be carefully controlled; although new products are a major
source of competitive advantage, they can cost a great deal of money to bring to market.
• Process research: developing new and better ways of producing the goods/services. Digital
technology is behind many of the improvements made in both products and processes in
business.
The R&D function is sometimes seen as part of the operations function (say if its focus is on process
research), sometimes as part of the marketing function (especially if its focus is NPD), and sometimes
as a separate function entirely.
Technology development is a constant feature of many businesses, as they cannot afford to stand still
and technology in both products and processes moves very fast. For example, many car insurance
companies use ‘black boxes’ to monitor a driver’s driving style and tailor insurance premiums
accordingly. This is an example of the internet of things – devices, which are not just computers or
mobile phones, that connect over the internet to perform a range of tasks.
11 Procurement
Section overview
• An organisation’s procurement team manages the links between the organisation and its
suppliers and customers as part of a supply chain. It can be a source of competitive advantage.
Definition
Procurement: The acquisition of goods and/or services at the best possible total cost of ownership,
in the right quantity and quality, at the right time, in the right place and from the right source for the
direct benefit or use of the business.
Internal to an organisation, procurement is about making sure suitable resources are available to the
various operational areas when they are required. It can therefore be part of the operations function

or it may be a function on its own. Its object should be to obtain the best procurement mix,
comprising four elements.
• Quantity: The size and timing of orders from suppliers will be dictated by the balance between:
– time: delays in production caused by insufficient inventories or staff
– cost of holding inventories: tied up capital, storage space, deterioration, insurance, risk of
pilferage
• Quality: The quality of input resources affects the quality of outputs and the efficiency of the
operations/production function. For instance, the production department will need to be
consulted about the quality of goods required for a manufacturing process, and the marketing
department about the level of service acceptable to customers of a restaurant.
• Price: Favourable short-term trends in prices may influence the procurement decision, but it
should really have an eye to the best value over a period of time – considering quality, delivery,
urgency of order, inventory-holding requirements and so on.
• Lead time: This is the time between placing and delivery of an order, and it can be crucial to
efficient inventory control and production planning. The reliability of suppliers’ delivery
arrangements must therefore be assessed.
11.1 The five rights of procurement

An organisation’s procurement team can help the organisation secure competitive advantage if it
manages the links between the organisation and its suppliers and customers effectively as part of a
supply chain (see below).
To be effective, supply chains must be responsive and reliable. The relationships between
organisations within a supply chain must demonstrate a high degree of mutual understanding. Such
relationships are often based on the following five rights of procurement. These rights effectively
add ‘place’ to the procurement mix. The aim is to ensure that the organisation has materials and staff
of:
• The right quality, in
• The right quantity, at the
• The right price, in
• The right place, at
• The right time.
The supplier delivery aspect of procurement is also known as inbound logistics, which together with
outbound logistics and distribution (getting the completed products out to customers or retailers)
forms part of an organisation’s value chain. We shall look at the value chain later in our studies.
11.2 The supply chain
Definition
Supply chain: The network of organisations, their systems, resources and activities that are required
to turn raw resources into a product or service provided to a consumer.
External to an organisation, procurement is about getting raw materials into the business and
finished products and services out to the consumer via a supply chain.
Integration between the organisation and other supply chain members, both upstream and
downstream, can be facilitated by integrated information systems.
Definitions
Upstream supply chain members: The elements of the supply chain which provide the materials and
production of the goods and services (ie, suppliers and the production function).
Downstream supply chain members: The elements of the supply chain that are involved after the
product has been manufactured or service provided (ie, the marketing function and customers).

The supply chain has a tiered nature. An organisation’s procurement team deals mainly with Tier 1
suppliers (suppliers who supply directly to the organisation), however, it should also have concern
with Tier 2 suppliers (who are suppliers to the Tier 1 suppliers). This is because their output becomes
the input of the Tier 1 suppliers, which in turn the organisation uses in its own products and services.
This tiered nature of the supply chain is of high importance to organisations in terms of sustainability
and ethics. It is important that the organisation promotes sustainability by requiring sustainable and
ethical behaviour from all participants in its supply chain.
Whilst companies do not control their suppliers, they can choose who they transact with. Whilst it is
easier to ignore unethical or unsustainable business practices evident within the supply chain,
companies increasingly understand they have a responsibility not to engage with suppliers who
routinely demonstrate unethical or unsustainable business practices, as this is increasingly expected
by stakeholders and is important to long-term sustainable profitability.
Examples of unethical transactions in the supply chain
• Mineral and mining companies which exploit workers and cause damage to the environment.
• Supply chain results in excessive CO2 emission, deforestation, pollution of air, earth and water
supplies.
• Hazardous health and safety practices and use of child workers.
• Making payments into the supply chain which are used to fund terrorism and money laundering.
• Bribery payments in order to gain access or favourable terms within the international supply
chain.
• Transactions with international companies who are subject to sanctions and other legally-binding
trade restrictions.
The resilience of supply chains was severely tested during the emergence from the Covid pandemic
in 2021. A shortage of computer chips had an impact on many industries, including car
manufacturers, smart phone manufacturers and personal computer manufacturers. Many
supermarkets were unable to obtain sufficient supplies of many staple products, often because of a
shortage of HGV drivers.
Climate change can have significant impact on supply chains. It can lead to reductions in the yield of
agricultural produce and natural materials such as wood (eg, droughts in Brazil in 2021 led to a huge
disruption to the global supply of coffee). Heavy rainfall and floods can restrict transport routes
leading to delays. Hurricanes and storms can lead to damage to property or disruptions to
operations. This means that supply chains need to incorporate flexibility to absorb the impact of
these disruptions.
Context example: Apple and Foxconn

The multinational business, Apple, designs all of its smartphones and computers in the USA, but the
manufacturing of these devices takes place in China. Apple’s main manufacturer is Foxconn, a
business that employs hundreds of thousands of staff just to produce Apple’s products. Foxconn has
come under fire for working practices which have been reported to have caused a number staff to
attempt suicide and unfortunately a number of these attempts resulted in the deaths of the
employees concerned.
Due to its close relationship with Foxconn, Apple’s reputation has been tarnished and it has had to
work with Foxconn to ensure working conditions are improved.
We shall look at supply chain management and procurement and logistics further in the chapter
Introduction to business strategy.
12 Human resource management (HRM)

Section overview
• Managing human resources means creating, developing and maintaining an effective workforce
which matches the business’s requirements and which responds effectively to the environment.

• Hard approaches to HRM focus on workers as resources; soft approaches emphasise that they are
human, with short- and long-term needs and goals.
• Harvard’s four Cs model of HRM suggests that it should achieve: commitment, competence,
congruence and cost-effectiveness in the workforce.
12.1 What is human resource management (HRM)?
Definition
Human resource management: “The creation, development and maintenance of an effective
workforce, matching the requirements of the business and responding to the environment” (Naylor,
2003).
Hard and soft approaches to HRM have been identified, representing opposite ends of the
spectrum.
• The hard approach emphasises the resources element of HRM. Human resources are planned
and developed to meet the wider objectives of the business, as with any other resource such as
materials or money. It involves managing the functions of HRM (set out below) to maximise
employee effectiveness and control staff costs.
• The soft approach emphasises the human element of HRM. It is concerned with employee
relations, the development of individual skills and the welfare of staff. It is exemplified in
developing:
– short-term commitment, competence, congruence and cost-effectiveness (the four Cs model,
see below); and
– long-term individual well-being, organisational effectiveness and societal well-being.
HR management is also concerned with ensuring compliance with laws relating to employment (eg,
Equality Act 2010).
12.2 The Harvard four Cs model of HRM

The four Cs model was developed at Harvard as a means of investigating HRM issues in a wider
environmental context rather than merely as a set of functions as listed above. It argues that HRM
policies need to be derived from a critical analysis of:
• stakeholder demands, including employees as one legitimate stakeholder group; and
• situational factors (eg, labour market conditions, management style, technology, ownership,
competitive conditions).
The model suggests that the effectiveness of HRM should be evaluated under four headings:
• Commitment. Assesses employees’ motivation, loyalty and job satisfaction. These factors are likely
to measure an employee’s commitment to a business. Measures can include labour turnover (how
many people leave in a period compared with how many on average are employed),
absenteeism, exit interviews, and satisfaction surveys.
• Competence. Relates to employees’ skills, abilities and potential. These may be measured by a
skills inventory and appraisal system. The objective of HRM policies in this area should be to
attract, retain, motivate, train and promote the right people.
• Congruence. This is a measure of the extent to which management and employees share a
common vision for the business and act consistently to attain that vision. Evidence of congruence
can include absence of grievances, conflicts and strikes, and the state of industrial relations.
• Cost-effectiveness. Concerns operational efficiency and productivity. Outputs are aimed to be
achieved at the lowest input cost. Labour cost and effectiveness by comparison to competitors
may be a measure of HRM achievement in this area.

13 Information technology
Section overview
• There are a number of considerations that should be made when managing the IT function.
The ICAEW’s Information Technology Faculty has prepared a guide entitled ‘Managing IT in the SME:
A guide for Finance Directors’. The guide states that ‘The mission for the IT function is to add
persistent value, through the effective application of appropriate technology.’
The following table summarises some of the advice that the guide provides in regard to managing
an IT function:
Management action Advice
Monitoring IT developments are often rapid. Companies whose finance directors

are unaware of them could be missing out on opportunities to develop
the business and its systems for the better. Therefore it is vital to
maintain an awareness of potentially useful developments and any
compliance obligations. Examples of such developments include cloud
computing, automation and Cognitive Technologies which we shall look
at in the chapter Developments in technology.
Planning IT functions and the effective management of change require careful

planning and preparation to ensure everything runs smoothly and
without disruption.
Structure IT management tasks should be prioritised and documented. There

should be a rolling programme of ‘business as usual’ and ‘forward
change’ activities.
Staffing and skills IT teams require the right people to be recruited and retained.
The guide also provides detailed advice in the following areas:
13.1 IT delivery and IT support

IT delivery and IT support may be performed by different teams.
IT delivery activities include:
• IT service operations eg, data extraction, report production, report distribution
• capacity monitoring and management
• customer billing and budgeting
• business operations availability and performance to agreed service levels
• service continuity/contingency management
IT support activities include:
• maintaining the appropriate configuration of IT service components/infrastructure ie, hardware,
software and networks;
• physical and logical integrity of the infrastructure eg, routine administration, preventative
maintenance performance;
• security and access control; and
• prevention, investigation and resolution of operational events, incidents and problems.
13.2 External support

There are a number of external support resources available to a business. These include user groups
and peer support (networking) communities. Despite the fact that organisations are unique, they very
often use the same hardware, software and services as others.

13.3 Outsourcing
Outsourcing is an arrangement where an organisation contracts out a specific business function. The
benefits of outsourcing an IT function include allowing the business to focus on its core activities
and obtaining better IT functions and service than what is achievable using in-house staff.
Outsourcing brings a number of new challenges, such as increased formality in the provision of the
IT function and having to allow the provider to manage the service at arm’s length. There are also
contractual issues that need to be considered such as service level agreements.
13.4 Innovation
Due to the pace of change and developments of IT possibilities, a business must support innovation
and invest in new IT to avoid being left behind by competitors who may use IT for competitive
advantage. For example, distributed ledger technology provides opportunities to improve the
accuracy of asset recording. Another example is the development digital assets, such as sound and
vision media, that provide businesses with the opportunity to distribute their products to a wider
audience. We shall consider these innovations further in the chapter Introduction to financial
information.
14 Introduction to organisational behaviour

Section overview
• Organisational behaviour describes individual and group behaviour in organisations.

• Organisational behaviour is affected by many variables, only some of which have obvious
manifestations (they appear above the waterline in the organisational iceberg). These overt
variables include customers, organisational goals, technology, physical facilities, organisational
design, financial resources, overt competence and skills, and rules and regulations.
• There are also some very important variables which are not usually physically manifested but
which are capable of undermining an organisation. These covert variables include attitudes,
patterns of communication, informal team processes, personalities, conflict, political behaviour
and underlying competencies and skills.
• Important models of human behaviour in organisations include Taylor’s scientific management
theory. Taylor emphasises the importance of remuneration as a key need and therefore motivator
of people.
• Maslow’s more complex content theory of the hierarchy of people’s needs specifies that people’s
behaviour stems from their desire to fulfil their needs, but that once certain needs (eg, for a good
level of pay) are fulfilled they no longer motivate.
• Teams or groups of people in organisations who communicate with each other and who have a
leader, a common sense of identity, a common aim, group norms of behaviour are often very
effective.
• Groups go through a number of stages as they develop: forming, storming, norming and
performing (Tuckman).
• In an active work group there are a number of key roles, including those of the leader, shaper,
‘plant’, evaluator, resource-investigator, company worker, team worker and finisher (Belbin).
• The effectiveness of a manager is determined by the degree of autonomy and authority they
have, and what sort of leadership style they manifest.
• Leadership style varies from being exploitative and authoritative to being participative.
• Delegation is a very important means by which managers get things done but it has drawbacks as
well as advantages.

14.1 What is organisational behaviour?
Definition
Organisational behaviour: The study and understanding of individual and group behaviour in an
organisational setting in order to help improve organisational performance and effectiveness (
Mullins, 2016).
Organisational behaviour is not about human behaviour alone, but about how people’s behaviour
interlinks with the business’s formal structure, the tasks to be undertaken, the technology and
processes used, the management process and the external environment.
14.2 The organisational iceberg

A useful image for how human behaviour is affected by many variables and is manifested in
organisational behaviour is put forward by Hellriegel, Slocum and Woodman (1998) as the
‘organisational iceberg’ (see the figure below).
‘One way to recognise why people behave as they do at work is to view an organisation as an
iceberg. What sinks ships isn’t always what sailors can see, but what they can’t see.’
In other words, as well as the formal aspects of a business which one can see ‘above the waterline’
(they are ‘overt’), there are many behavioural aspects which one cannot see as such (they are ‘covert’,
or under the water). It is these covert aspects which tend to cause the most problems!
Customers
Formal
Iceberg visible
aspects
above waterline
(overt)
Formal Physical Organisation
Technology
goals facilities design
Financial Surface competencies Rules and

resources and skills regulations
Attitudes
Communication patterns
Informal team processes
Personality Submerged
Behavioural
Conflict iceberg
aspects
Political behaviour beneath
(covert)
waterline
Underlying competencies
and skills
Figure 2.5: The organisational iceberg

14.3 Motivation
Definition
Motivation: The degree to which a person wants certain behaviours and chooses to engage in them.
In order to understand ‘what’ motivates people we shall look first at a content theory of motivation,
then focus on creating conditions that meet individuals’ needs.
Motivated workers are characterised by:
• higher productivity
• better quality work with less waste
• a greater sense of urgency
• more feedback and suggestions made for improvement
• more feedback demanded from superiors
Clearly these are desirable features to have. Research has shown that motivated employees will work
at 80%–95% of their ability whereas employees lacking motivation will typically work at 30% of their
ability. Demotivated workers are likely to become alienated.
14.3.1 Maslow’s content theory: the hierarchy of needs

One way of understanding individual behaviour is in terms of the individual’s needs, which may be
conscious or subconscious. The basic model is in Figure 2.6.
People have needs
They formulate goals and strategies to satisfy those needs
Behaviour
Figure 2.6: Basic model of need-driven behaviour
The psychologist Abraham Maslow (1954) suggested a hierarchy of such needs to explain an
individual’s motivation.
Self-
actualisation
need
Status/ego needs
Social needs
Safety/security needs
Basic/physiological needs
Figure 2.7: Maslow’s hierarchy of needs
• A person will start at the bottom of the hierarchy or pyramid and will initially seek to satisfy basic
physiological needs – food, shelter, clothing etc.

• Once these needs are satisfied they no longer motivate and the individual concerned moves up
to the next level; safety/security needs.
• Safety needs could encompass physical safety (eg, wearing a hard hat on a building site) and/or
protection against unemployment and the consequences of sickness, as well as being
safeguarded against unfair treatment.
• Again, once these needs are satisfied (eg, by company rules re dismissal, health and safety,
pension policies) they no longer motivate and the person moves up to the next level in the
hierarchy.
• Social needs recognise that people want to belong to a group. Being a member of an effective
team, or enjoying good social interaction with colleagues, satisfies these needs so they no longer
motivate, and the individual moves up to the next level in the hierarchy.
• Status/ego needs involve the desire to have the respect and esteem of others. This could be
satisfied, for example, by gaining a promotion.
• Self-actualisation needs are concerned with what people think about themselves, whether they
feel that their lives are worthwhile and that they have meaning. For many this can only be satisfied
by ongoing success and new challenges.
Needs may be met in or out of the workplace. For example, a person who is captain of a local sports
team may not feel the need to engage so much in social activities at work.
Maslow’s hierarchy does not mention money in its list of specific factors (social needs etc). One of the
important emphases of the theory was on the significance of non-financial motivators. However,
Maslow did see money as a contributory factor – ie, money itself is not important except where it
helps one satisfy the basic and safety needs.
While money is likely to be very important in satisfying basic physiological needs it is only important
regarding status needs if status symbols such as BMWs, Rolex watches, etc, are valued by others.
Professional skills focus: Applying judgement
When considering the most appropriate methods of motivation of staff (eg, designing reward
systems for employees) it is important to consider what methods will best motivate them. Their
position in Maslow’s matrix would certainly be something to consider.
14.4 Group behaviour
Definition
Group: A collection of people with the following characteristics
14.4.1 The usefulness of groups

For businesses, groups are used to:
• bring together several skills
• plan and organise
• solve problems/take decisions
• distribute information
• arbitrate or make awards
• coordinate between departments
For individuals in businesses, groups are useful to:
• satisfy social and status needs (Maslow)
• give support
• provide social contact and personal relationships
14.4.2 Stages of group development

The educational psychologist Bruce Tuckman formulated four stages through which groups proceed.

• Forming. At this initial stage, the group is no more than a collection of individuals who are seeking
to define the purpose of the group and how it will operate.
• Storming. Most groups go through this conflict stage. Here, preconceptions are challenged, and
norms of attitude, behaviour etc, are challenged and rejected. Members compete for chosen
roles within the group (eg, leader, comedian). If successful, this stage will have forged a stronger
team with greater knowledge of each other and their objectives.
• Norming. This stage establishes the norms under which the group will operate. Members
experiment and test group reaction as the norms become established. Typically, the norming
stage will establish how the group will take decisions, behaviour patterns, level of trust and
openness, individuals’ roles, and so on.
• Performing. Once this final stage has been reached the group is capable of operating to full
potential, since the difficulties of adjustment, leadership contests etc, should have been resolved.
Tuckman suggested that groups are inefficient at the forming and storming stages, become more
efficient at the norming stage but really need to reach the performing stage for maximum efficiency.
14.4.3 Team roles

The management writer Meredith Belbin observed that people adopt one or more of the following
eight roles when placed within a particular type of group context, this is a team.
• The leader – co-ordinating (not imposing) and operating through others
• The shaper – committed to the task; may be aggressive and challenging; will also always promote
activity
• The plant – thoughtful and thought-provoking
• The evaluator – analytically criticises others’ ideas; brings team down to earth
• The resource-investigator – not a new ideas person but tends to pick up others’ ideas and adds to
them; is usually a social type of person who often acts as a bridge to the outside world
• The company worker – turns general ideas into specifics; is practical and efficient; tends to be an
administrator handling the scheduling aspects
• The team worker – concerned with the relationships within the team; is supportive and defuses
potential conflict situations
• The finisher – unpopular, but a necessary individual: the progress chaser ensuring that timetables
are met
Belbin suggested that an effective team will have each personality type represented, subject to the
following:
• Only one leader and/or shaper is required
• Equal numbers of plants and evaluators
• Equal numbers of company workers and team workers
• Not too many finishers (probably one is enough)
Belbin later suggested an additional role: the specialist, brought in from outside the team.
14.5 Leadership style

The effectiveness of any given manager will be influenced by their:
• authority: having sufficient rights to control and judge the actions of subordinates
• autonomy: giving subordinates necessary and reasonable freedom of action to carry out their
roles
• leadership: exercising the power conferred by right in such a way as to win a willing and positive
response from subordinates
There has been extensive research into ‘managerial effectiveness’ and numerous attempts to
describe/identify the ‘best’ leadership ‘style’ to adopt.
14.5.1 Likert’s authoritative-participative continuum

The organisational psychologist Rensis Likert identified four basic leadership styles, in the figure
‘Likert’s four leadership styles’.

Exploitative – Benevolent –
Consultative Participative
authoritative authoritative
Decisions Complete trust

Increasing trust in subordinates’ ability
imposed + discussion
Motivated Motivated by rewards

More participative motivation style
by threats – goals agreed
Centralised
High degree
decision- Increasing delegation
of delegation
making
Little superior/
Frequent
subordinate Increasing communication
communication
communication
Superior +
Superior +
subordinates
Increasing teamwork subordinates
act as individuals
act as a team
– no teamwork
Figure 2.8: Likert’s four leadership styles
• Exploitative-authoritative
– Decisions are imposed by managers on subordinates.
– Subordinates are motivated by threats.
– Authority is centralised with minimal delegation.
– There is little communication between superior and subordinate.
– There is no teamwork (ie, managers and subordinates do not act as a team).
• Benevolent-authoritative
– Leadership is by a condescending form of the master–servant relationship.
– Subordinates are motivated by rewards.
– There is some degree of delegation of responsibility.
– There is little communication between superior and subordinate.
– There is relatively little teamwork.
• Consultative
– Superiors have substantial but not complete trust in their subordinates.
– Motivation is by rewards and some involvement in objective-setting.
– There is an increasing degree of delegation.
– There is some communication between superior and subordinate.
– There is a moderate amount of teamwork.
• Participative
– Superiors have complete confidence in subordinates.
– Motivation is by rewards and participation in objective-setting.
– There is a high degree of delegation.
– There is much communication between superior and subordinate.
– There is a substantial amount of teamwork.

Interactive question 3: Management effectiveness
Consider a manager for whom you have worked in the past, or perhaps the manager of the audit on
which you are currently engaged. Consider objectively how effective that manager was, and try to
identify what in particular the manager was/is good/bad at.
14.6 Delegation
Definition
Delegation: Delegation involves giving a subordinate responsibility and authority to carry out a given
task, while the manager retains overall responsibility.
Advantages of delegation:
• The manager can be relieved of less important activities.
• It enables decisions to be taken nearer to the point of impact and without the delays caused by
reference upwards.
• It gives businesses a chance to meet changing conditions more flexibly.
• It makes the subordinate’s job more interesting.
• It allows for career development and succession planning.
• It brings together skills and ideas.
• Team aspect is motivational.
• It allows performance appraisal.
Problems caused by poor delegation:
• Too much supervision can waste time and be demotivating for the subordinate.
• Too little supervision can lead to subordinates feeling abandoned and may result in an inferior
outcome if they are not completely happy with what they are doing.
• Manager tries to delegate full responsibility, that is s/he uses delegation to ‘pass the buck’.
• Manager only delegates boring work.
• Manager tries to delegate impossible tasks because s/he cannot do it themselves.
• Managers may not delegate enough because they fear their status is being undermined, and they
want to stay in control.
• Subordinates may lack the skills and training required.

Summary
Price
Costs Competition
Procurement
• The right quality, in Customers
• The right quantity, sourced for R&D Corporate Objectives
• The right price, which are delivered to Pure
• The right place, at Applied
• The right time. Marketing mix
Development
Product Price Place
Evaluation of 4Cs Segmentation
Promotion People Processes
Hard • Commitment
Physical evidence
Balance variables: (resources) • Competence
• Demand approach • Confidence
• Resources Soft (human • Cost-effectiveness
• Capacity resources) Markets
• Inventory approach • Industrial B2B
• Processes • Consumer B2C
HRM Marketing
Volume Finance
Operations/production Business functions
Variety (Chapter 6)
Variation in
demand IT
Visibility Behaviour in
organisation (2/2) A business cannot run itself
It needs to be managed
Effective management = Culture

harnessing forces of Types of manager
Internal process
Line Staff
Rational goal
Functional Project
Open systems
Power Human relations
Authority
May be delegated
Responsibility
Management process
Accountability
Management roles
Planning Organisation Control Leading
Management (Chapter 2)
hierarchy
(Chapter 3) Informational Interpersonal
Decisional

Overt Covert
variables variables
Organisational
iceberg
Delegation
How organisations behave Features

Authority
How managers behave Behaviour in How groups behave Roles

in organisations organisations within organisations (Belbin)
Leadership style Development

Motivation (Tuckman)
• Form
• Storm
Maslow's • Norm
hierarchy • Perform

indicated.
1 Do you know the meaning of the terms ‘power’, ‘authority’, ‘responsibility’, ‘accountability’
and ‘delegation’? (Topic 1)
2 Do you know what the four activities are that the process of management includes?
(Topic 4)
3 Can you describe the four types of culture identified by Robert E. Quinn? (Topic 6)
4 Can you name the six key functions in any business? (Topic 8)
5 Do you know what each of the ‘seven Ps’ of marketing involve? (Topic 9)
6 Can you explain the difference between ‘push’ and ‘pull’ promotion techniques? (Topic
9)
7 Do you understand the four dimensions (‘four Vs’) of operations? (Topic 10)
8 Can you list the ‘five rights’ of procurement? (Topic 11)
9 Do you understand what the supply chain is? (Topic 11)
10 Do you know the meaning of ‘hard’ and ‘soft’ approaches to human resource
management? (Topic 12)
11 Can you explain Maslow’s hierarchy of needs? (Topic 14)
12 Do you know the four steps in Tuckman’s group development model? (Topic 14)
13 Do you know the eight different team roles described by Belbin? (Topic 14)

questions in the Managing a business chapter of the Business, Technology and Finance Question
Once you have attempted these questions, you can move on to the next chapter, Organisational and
business structures.

• Belbin, M. (1993) Team Roles at Work. Oxford, Butterworth-Heinemann.

• Kotler, P. (1997) Marketing Management: Analysis, Planning, Implementation and Control. London,
Prentice Hall.
• Likert, K. (1946) New Patterns of Management. New York, McGraw Hill.
• Maslow, A. (1954) Motivation and Personality. New York, Harper and Row.
• Metcalf, H.C. and Harper, L.U. (1942) The collected papers of Mary Parker Follett. New York and
London, Human Organization.
• Mullins, L.J. (2016) Management and Organisational Behaviour. London, Pearson.
• Naylor, J. (2003) Management. Harlow, Pearson.
• Tuckman, B. (2001) Learning and Motivation Strategies. Harlow, Prentice Hall.

Self-test questions

1 When a manager delegates a task to a subordinate, which of the following must also be delegated?
A Power
B Authority
C Responsibility
D Accountability
2 Cedric is the manager of his company’s digital marketing strategy. If Kara, a human resources
manager, attempted to alter the strategy, Cedric could prevent her from doing so by exercising:
A line authority
B staff authority
C functional authority
D project authority
3 Ethel has been given responsibility for identifying the processes, technology and up to five people
required to complete a particular project, and then to allocate the work and co-ordinate it. In terms of
the management process, Ethel is:
A planning
B controlling
C organising
D leading
4 Which two of the following qualities are typical of a rational goal culture?
A Inward looking
B The need to be flexible
C The need to control the environment
D Outward looking
5 Which two of the following elements of the marketing mix are peculiar to services marketing?
A Price
B Place
C People
D Promotion
E Processes
F Product
6 Strand plc operates in the fast-moving consumer goods market, where it is a medium-sized player.
When determining how much to charge its customers for one of its established products, the main
influence on Strand plc will be its:
A customers
B costs
C corporate objectives
D competitors
7 Randalf, a manager with Trent plc, is faced with a decision about a service that is being marketed to
consumers. The service requires four people for delivery and costs £1,000 when these people are
directly employed. A sub-contractor has told Randalf that he would charge Trent plc £1,000 to deliver
the service to customers. This decision is about:

A marketing management (place)
B operations management (procurement)
C finance (relative costs)
D human resources management
8 In terms of the organisational iceberg, which of the following is a covert variable affecting
organisational behaviour?
A Political behaviour
B Organisational design
C Organisational goals
D Regulations
9 Sitin’s team leader has told him that as a member of the team he is very committed to the team’s task
and always promotes activity, but that sometimes he can be too aggressive and challenging. In terms
of Belbin’s roles, Sitin is the team’s:
A plant
B evaluator
C shaper
D finisher
this chapter.


Nisar has resource power by virtue of the fact he manages 14 IT staff, and he has position power as
their manager. He has expert power by virtue of his qualification. There is no information on which to
base an assessment of his coercive, personal or negative power.

In FMCG, such as you see in a supermarket, the supplier will have made tremendous efforts to use all
aspects of the marketing mix to persuade you to buy and use the product. In terms of product, it will
have been designed to satisfy a range of your needs, including how you may feel about packaging
and the look of it. Its price will have been designed to be affordable to its target market while
securing both a profit and an edge over competitors for both the manufacturer and the supermarket.
The product has been placed in the supermarket via a network of intermediaries, although large
chains like Tesco frequently deal directly with producers and handle the distribution (inbound
logistics) themselves too. It will be placed in a position in the supermarket such that you are
encouraged to see it and want it; products vie for shelf space at eye level in the supermarket, and
where ranges are situated is a key element of supermarket marketing. Fresh produce is often placed
at the entrance to be appealing to the eye and draw you in; the fragrance of fresh bread is often
piped over from the bakery to appeal to your sense of smell at the entrance too. Promotion extends
beyond placement on the shelves to include offers such as buy one get one free (BOGOF),
advertising and direct marketing via various media.

The manager’s style – the degree to which they are authoritative or participative – should be
evaluated by considering how they made decisions, delegated, communicated, motivated and
operated the team. If you found the manager was good it was probably because they focused on
employees, set high standards for output but were flexible about methods, trusted you and
delegated happily, and encouraged you to join in with decisions and generally feel involved.

B Authority
To ensure the task is completed, the subordinate must be given authority to make decisions relating
to it. The manager remains accountable and responsible to their superiors for the task. A manager
cannot delegate their power.
C functional authority
Cedric has line authority only over his immediate subordinates. He has general staff authority by
which he can advise other line managers on the strategy, but in an issue such as this where he is
responsible for the strategy, he can exercise functional authority to prevent Kara from changing it.
C organising
C The need to control the environment
D Outward looking
C People
E Processes
D competitors
FMCG are highly competitive markets so the prices charged by competitors will in the end be the
greatest influence.
B operations management (procurement)
A Political behaviour
C shaper

Chapter 3
Organisational and business

structures
Introduction
Learning outcomes
Syllabus links
Assessment context
Learning topics
1 The management hierarchy
2 Introduction to organisational structure
3 Types of organisational structure
4 Centralisation and decentralisation
5 Span of control: tall and flat businesses
6 Mechanistic and organic organisations
7 Introduction to business structure
8 Sole tradership
9 Partnerships
10 Companies
11 Which business structure should a business take?
12 Alliances
Summary
Self-test questions
Introduction
Learning outcomes
• Identify the differences between businesses carried out by sole traders, partnerships, limited
liability partnerships, companies, alliances and groups, and show the advantages and
disadvantages of each of these business structures
• Identify different organisational structures and specify their advantages and disadvantages
Specific syllabus references are: 2a, 2b.
3
Syllabus links
Legal aspects of partnerships and companies are developed further in Law at Certificate level.
Accounting for sole traders, partnerships and companies is covered in Accounting at Certificate
level. Groups are covered in Financial Accounting and Reporting at Professional level. Choosing the
right organisational and business structures from a strategic perspective is developed in Business
Strategy and Technology at Professional level. Optimising the financial aspects of organisational and
business structures are covered in Financial Management at Professional level.
3
Assessment context
Questions on organisational and business structures will be set in the assessment in either MCQ or
multiple response format. They will be either straight tests of knowledge or applications of
knowledge to a scenario.
3

of this chapter.

questions
1–4 Organisational Approach Questions will either be IQ 1: Building

structure Spend time set as a straight test of blocks: helps
An organisation’s learning knowledge or in a you understand
structure will have Mintzberg’s scenario. the building
many implications – building blocks Essential points are: blocks in
for example how and organisation Mintzberg by
• Management relating them to
much degree of types. In section 2, hierarchy
control managers make sure you can your firm, so is
exert over staff, and understand the • Mintzberg’s building highly
the way in which advantages and blocks recommended.
people work together disadvantages. • Mintzberg’s types of
in the organisation. Appreciate the business structure
more flexible and their features
modern • Functional/divisional/
approaches.
matrix structures
Stop and think
Think of the
organisation you
work for: Its
structure is
determined by a
variety of factors
such as regulation,

questions
tax efficiency and

history. It must
consider the
optimum balance
of local autonomy
and centralised
direction.
4–6 Centralisation and Approach Questions in this area IQ 2: Work

decentralisation, Read through will test your knowledge loads relates
span of control and these sections and of the different the concept of
mechanistic and be aware of the structures, and the span of control
organic advantages of advantages and to your own
organisations. centralisation. disadvantages of each workplace or
Companies Understand the one. that of a client.
sometimes change span of control Essential points are:
their structure in and the benefits of • Centralisation and
order to achieve their flat and tall decentralisation
objectives more structures.
effectively. Recently • Business shapes (tall
Understand the or flat), the
the trend is towards a meaning of the
flatter, decentralised management
terms mechanistic hierarchy, span of
structure which is and organic and
more lean and can control and scalar
be aware of the chains.
better meet the features of both.
needs of customers.
Stop and think
How is the
organisation that
you work for
structured? What is
good and what is
bad about it?
7–11 Business structures Approach Questions will test your IQ3:

One area that new These sections knowledge of the Incorporation
businesses need to discuss different different features of encourages you
consider is what legal legal structures each type of legal to think about
structure to use. The that businesses structure. business
choice for small can choose. Essential areas are: structures in a
businesses is often Ensure you practical way.
• Definitions and
between sole trader understand the features of sole
or limited company. features of each of traders, partnerships
Knowing the these structures and companies
advantages and and in particular
disadvantages of the concept of • Advantages and
these different limited or disadvantages of
structures is unlimited liability. each business
fundamental structure
Stop and think
knowledge to the • Deciding whether to
accountant. What are the legal incorporate
formats of
businesses that
you are familiar
with? If you work in
practice, your firm
is probably a
ICAEW 2023 3: Organisational and business structures 69

questions
partnership or a
limited liability
partnership. Your
clients may be
limited liability
companies. Some
of the small shops
you visit may be
sole traders.
12 Alliances Businesses often Typically questions may

Alliances are collaborate with describe a particular
common in many each other, as this type of arrangement
industries – for allows them to and ask you to identify
example, in the oil share expertise what type of alliance is
industry large and resources. This being used.
companies share section describes
resources such as different forms of
pipelines. It’s alliance. Make sure
important to be you understand
aware of these. the features of
each type of
alliance.

1 The management hierarchy
Section overview
• The relationships of power, authority, responsibility, accountability and delegation together form a
management hierarchy in most organisations, with a few managers holding the most power and
authority towards the apex, with many managers holding less power and authority beneath them.
• It is the manager at the very apex – the Chief Executive – who has ultimate authority and bears
responsibility to the shareholders.
Businesses of any size develop a management hierarchy, with some management positions holding
more power and authority than others; the less powerful managers being accountable to the more
powerful ones, and the latter being responsible for the performance of the managers lower down
the hierarchy. As in the figure below, the hierarchy is usually represented as a pyramid, as top
managers are far less numerous than direct operational staff.
Authority/
Characteristics Power responsibility Accountability
Top Few in number, responsible

managers: for overall direction and
managing performance of the business
the business
Many, responsible for ensuring

Middle managers:
performance targets are met by
managing managers
first-line managers
Numerous, responsible for

First-line managers: managing
ensuring direct operational staff
staff on direct operations
do what is required
Very numerous, accountable

Direct operational staff: doing the work to first-line managers for
getting the job done
Figure 3.1: The management hierarchy
2 Introduction to organisational structure

Section overview
• Organisational structure sets out how the various functions in the organisation are arranged.
• Organisational structure comprises six building blocks (Mintzberg): the operating core over which
the middle line has authority; together these are facilitated by the technostructure and support
staff. The strategic apex controls the entire organisation, and in turn it is guided by the
organisation’s overarching ideology.
• Classical principles of organisational structure emphasised: division of work, the scalar chain, the
identity of authority and responsibility, centralisation, unity of command and direction, initiative,
subordination of individual interests, discipline and order, stability, equity, fair remuneration and
esprit de corps.
• While some classical principles still apply, in practice the values of multi-skilling and flexibility are
very important.
• The organisation’s structure is conveyed via an organisation chart or manual, and/or in job
descriptions.

2.1 What is organisational structure?
Definition
Organisational structure: Formed by the grouping of people into departments or sections and the
allocation of responsibility and authority, organisational structure sets out how the various functions
(operations, marketing, human resources, finance, etc,) are formally arranged.
Organisational structure is a framework intended to:

• link individuals in an established network of relationships so that authority, responsibility and
communications can be controlled;
• allocate the tasks to be done to suitable individuals or groups;
• give each individual or group the authority required to perform the allocated tasks, while
controlling their behaviour and use of resources in the interests of the business as a whole;
• co-ordinate the objectives and activities of separate groups, so that overall aims are achieved
without gaps or overlaps in the flow of work; and
• facilitate the flow of work, information and other resources through the business.
2.2 The building blocks and co-ordinating mechanisms of organisational structure

Henry Mintzberg (1979) suggests that all businesses can be analysed into six building blocks, as
shown in Figure 3.2: the operating core, middle line and strategic apex (the management hierarchy
that we saw in the chapter Managing a business) plus support staff and the technostructure, all taking
place within an overall ideology.
IDEOLOGY
Strategic
Apex
e
tur
Su
ruc
pp
ort
ost
hn
Sta
Middle
Tec
ff
Line
Operating Core
Figure 3.2: Mintzberg’s building blocks
Building block Function
Operating core People directly involved in the process of obtaining inputs, and converting
them into outputs, ie, direct operational staff
Middle line Conveys the goals set by the strategic apex and controls the work of the
operating core in pursuit of those goals, ie, middle and first-line managers
Strategic apex Ensures the organisation follows its mission. Manages the organisation’s
relationship with the environment, ie, top managers

Building block Function
Support staff Ancillary services such as PR, legal counsel, the cafeteria and security staff.
Support staff do not plan or standardise operations. They function
independently of the operating core
Technostructure Analysts determine and standardise work processes and techniques

Planners determine and standardise outputs (eg, goods must achieve a
specified level of quality)
Personnel analysts standardise skills (eg, through training programmes)
Ideology Values, beliefs and traditions, ie, (the business culture)
Interactive question 1: Building blocks

Where do you fit into the organisational structure of your firm? Try to identify the point at which the
firm narrows to form the ‘middle line’ and also those departments which are part of the
technostructure and support. What do you think the overarching ideology of the firm is?
Coordinating mechanisms integrate these building blocks into a cohesive unit, as follows:
• Direct supervision: giving of orders by a superior to a subordinate
• Standardisation of work: laying down standard operating procedures
• Standardisation of skills: requiring workers to have particular skills or qualifications
• Standardisation of outputs: specification of results such as the setting of targets
• Mutual adjustment: informal communication and self-government
2.3 Basic principles of organisational structure

Basic theories state that organisations are based on the management hierarchy which we saw above
in section 1. There is a line of decision-making power from the top of the organisation to the bottom.
Hierarchies are based on a number of principles.
Principle Comment
Division of work Work should be divided and allocated rationally, based on specialisation.
Scalar chain Authority should flow vertically down a clear chain of command from
highest to lowest rank. This principle is linked to the concept of span of
control, which is the number of individuals under the direct supervision of
any one person. (This is discussed further below.)
Correspondence of The holder of an office should have enough authority to carry out all the
authority and responsibilities assigned to them.
responsibility
Appropriate Decisions should be taken at the top of the organisation where

centralisation appropriate.
Unity of command For any action, a subordinate should receive orders from one boss only.
(for people) Fayol saw dual command as a disease, whether it is caused by imperfect
demarcation between departments, or by a superior giving orders directly
to an employee without going via the intermediate superior.
Unity of direction There should be one head and one plan for each activity.

Principle Comment
(for the organisation)
Equity Organisational policies should be just.
2.4 Other approaches to organisational structure

Modern management theorists emphasise values such as:
• Multi-skilling. Contrary to the idea of specialisation, multi-skilled teams (where individuals are
trained to perform a variety of team tasks, as required) enable tasks to be performed more
flexibly, using labour more efficiently.
• Flexibility. This is perhaps the major value in modern management theory. It arises from the
competitive need to respond swiftly (and without organisational trauma) to rapidly changing
customer demands and technological changes, particularly resulting from the overwhelming
scale and availability of digital data, as we shall see in the chapter Introduction to financial
information. You will also look at workforce flexibility when studying for your Business Strategy
and Technology assessment. Organisations and processes are being re-engineered to flexible
structures such as the following:
– Smaller, multi-skilled, temporary structures, such as project or task-force teams
– Multi-functional units, facilitating communication and co-ordination across departmental
boundaries. This is called matrix organisation (which we shall see more about later), and it blurs
the principle of ‘unity of command’, since an employee may report both to their departmental
superior and to a project or product manager whose job is to manage all areas of activity
related to the product or project.
– Flexible deployment of the labour resource; for example, through part-time, temporary and
agency working, contracting out tasks, flexitime, annual (rather than daily) hours contracts, zero
hours contracts and so on.
– Virtual organisations where staff and resources are geographically dispersed, linked by the
internet and associated technology. The organisation itself has little if any physical presence
such as a building, etc.
Exam questions may provide you with information about an organisation and ask you to select the
most appropriate structure. It is important that you are aware of the features of the different
organisation structures and the advantages and disadvantages of each so that you are able to select
the most appropriate structure.
2.5 Communicating the organisational structure

There are three main methods of communicating the structure of the business: an organisation chart,
and organisation manual and a series of job descriptions. These are outlined in the figure
Communicating organisational structure.

Organisation of the business
Organisation chart Job description
Pictorial representation
of the structure
Advantages Disadvantages • A result of 'job analysis'

• Need to analyse • Frequent updating as • Includes responsibilities,
organisation detail people leave authority and work involved
• Provides at-a-glance • Informal relationships • Typical descriptions
information not shown – Job title
• Highlights formal • May imply managers – Department
relationships at the same level – Grade/level
are equally important – Duties and responsibilities
• May encourage
– Limits of authority
bureaucracy
– Superiors and subordinates
Figure 3.3: Communicating organisational structure
3 Types of organisational structure

Section overview
• Mintzberg’s six building blocks can be combined to form five different organisational structures: a
simple structure, a machine bureaucracy, a professional bureaucracy, a divisionalised structure
(geographic or product/brand) or an adhocracy.
• These organisational structures are typified in part by whether the external environment is either
simple or complex, and either static or dynamic.
Mintzberg’s building blocks and coordinating mechanisms in Figure 3.2 are generally combined in
one of five different types of organisational structure. Each is characterised by different types of
external environmental and internal factors.
Types of External Internal Key Key Typical

organisationa environment factors building coordinating structure
l structure block mechanism
Simple Simple Small Strategic Direct Entrepreneurial

Dynamic Young apex supervision
Simple tasks
Machine Simple Large Techno- Standardisation Functional

bureaucracy Static Old structure of work
Regulated
Professional Complex Professional Operating Standardisation –

bureaucracy Static Simple core of skills
systems
Divisionalised Simple Very large Middle line Standardisation Divisional

Static Old of outputs

Types of External Internal Key Key Typical
organisationa environment factors building coordinating structure
l structure block mechanism
Diverse Divisible
tasks
Adhocracy/ Complex Young Operating Mutual Matrix

Innovative Dynamic Complex core adjustment
tasks
We shall look at what simple, complex, static and dynamic mean in the context of external
environment in the chapter Introduction to business strategy.
The suitability of each structure will be dependent on the size of the business; generally speaking, as
a business grows it will progress from entrepreneurial to functional to divisional structure. A matrix
structure may occur independently or within a functional or divisional structure.
3.1 Entrepreneurial structure

Features
• Similar to Mintzberg’s simple structure
• Entrepreneur has specialist knowledge of product/service
• Entrepreneur has total control over running of the business
Entrepreneur
Employees
Figure 3.4: Entrepreneurial structure
The entrepreneurial structure is most suitable where there is one product or a group of similar
products.
Advantages
• Quick decisions can be made with skill and flair
• Goal congruence – the entrepreneur’s objectives are pursued exclusively
• Flexible/adaptable to change
Disadvantages
• Cannot expand beyond a certain size (too many decisions need to be made and too many people
need to be managed)
• Cannot easily cope with diversification into new products/services about which the entrepreneur
does not have specialist skills/knowledge
• Lack of career structure for lower-level employees
• May be too centralised, ie, too much decision-making power retained by entrepreneur
3.2 Functional structure

Features
• Similar to Mintzberg’s machine bureaucracy
• Jobs grouped by common feature, eg, production, and ranked in hierarchy, eg, managers,
supervisors, employees
• Clear lines of reporting and authority exist
• Formal procedures and paperwork characterise this type of structure

• The vertical flow of authority (scalar chain) can go up and down through the structure from top to
bottom
Board of Directors
Managing Director (MD)
Production Marketing IT Finance HR
Manager Manager
Product A Product B
Manager Manager Manager

Process 1 Process 2 Process 3
Figure 3.5: Functional structure (bureaucratic)
The functional bureaucratic structure is most suitable where there is:

• single product/closely related product forms
• relatively stable environment, ie, one not subject to rapid change
• a smaller enterprise
Advantages
• Good career opportunities, employees can progress ‘up through the ranks’
• Can be efficient as functional tasks are well-known and understood by individuals
• Exploits specialist functional skills
Disadvantages
• Structure is very rigid and unsuitable for:
– growth
– diversification
• Tendency towards authoritative non-participative management style as clear levels of authority
are enforced
• Poor decisions/slow decisions which have to pass along a line of authority
• Functional heads may build empires and interfunctional disputes may result
3.3 Divisional structure
Definition
Divisionalisation: The division of a business into autonomous regions (geographic divisionalisation)
or product businesses (product/brand divisionalisation), each with its own revenues, expenditures
and capital asset purchase programmes, and therefore each with its own profit responsibility.
Features
• Similar to Mintzberg’s divisionalised structure
• Business is split into divisions – division is usually by product/brand or by geography/location
• Divisions are typically given responsibility for their profits and assessed in terms of profit (profit
centre)

• The typical approach is to use a holding or parent company and subsidiaries (a group structure –
we shall come back to this later in this chapter)
Group Board of
Directors
Group services,
eg, finance, IT
Division 1 Division 2 Division 3

Board Board Board
Division manager
Production HR Marketing
Figure 3.6: Divisional structure
Each division of the organisation might be:

• a subsidiary company under the holding company (we shall come back to this)
• a profit centre within a single business
Successful divisionalisation requires certain key conditions.
• Each division must have properly delegated authority, and must be held properly accountable to
the group board (eg, for profits earned).
• Each division must be large enough to support the quantity and quality of management it needs.
• The division must not rely on head office for excessive management support.
• Each division must have a potential for growth in its own area of operations.
• There should be scope and challenge in the job for the management of each division.
• If divisions deal with each other, it should be as ‘arm’s length’ transactions. There should be no
insistence on preferential treatment to be given to a ‘fellow division’ by another division of the
overall organisation.
The divisional structure is most suitable when:
• there are larger, more diversified businesses
• there is diversity by product and/or location
Advantages
• Flexible in adapting to growth and diversification – extra divisions can simply be added into the
structure
• Good for developing managers as they are given responsibility for divisional profit
• Reduces the number of levels of management
• Encourages a greater attention to efficiency, lower costs and higher profits
• Better decisions on performance made by managers ‘in the know’
• Releases top management to concentrate on strategic issues
• Reduces the likelihood of unprofitable products and activities being continued
Disadvantages
• Squabbles over allocation of central costs can occur
• Interdivisional trading problems, ie, at what transfer price should the trades take place?

• It may be impossible to identify completely independent products or markets for which separate
divisions can be set up
3.4 Matrix structure

Features
• Similar to Mintzberg’s adhocracy
• Formalises vertical and lateral lines of communication
• Managers appointed for projects or customers – project or customer managers liaise with
managers from each function (functional managers)
• May be temporary, ie, for one-off contract
Board of Directors
Managing Director
Production Marketing HR Finance IT

manager manager manager manager manager
Manager Project A 0 0 0 0 0
Manager Project B 0 X 0 0 0
Manager Project C 0 0 0 0 0
0 = Individual in structure
X = Reports both to Marketing Manager and Manager Project B
Figure 3.7: Matrix structure showing project managers
The matrix structure is most suitable to:

• complex/hi-tech industries;
• educational establishments where there may be lecturers reporting to both subject and course
heads; and
• research and development (R&D) departments.
Advantages
• Reflects importance of project or customer, so may improve relationships and sales
• Business co-ordinated with regard to technology, information, etc
Disadvantages
• Conflicting demands on staff time (staff have to serve two bosses)
• Conflicting demands over allocation of other resources
• Dilution of authority of functional heads
You may be required to demonstrate your ability to understand the key information in the scenario
provided in the exam question. Ensure you are aware of what types of business structure are
appropriate for each context and identify what context is given in the scenario.

4 Centralisation and decentralisation
Section overview
• An organisational structure is centralised when decision-making authority is concentrated in its

strategic apex.
• Centralisation offers greater control and coordination.
• Decentralisation offers greater flexibility.
4.1 What is centralisation?

We can look at centralisation in two ways.
• Geography. Some functions may be centralised rather than ‘scattered’ in different offices,
departments or locations.
So, for example, secretarial support, IT support and information storage may be centralised in
specialist departments (whose services are shared by other functions) rather than carried out by
staff/equipment duplicated in each division.
• Authority. Centralisation also refers to the extent to which people have to refer decisions upwards
to their superiors. Decentralisation therefore implies increased delegation, and autonomy at lower
levels of the business.
We shall use the terms centralisation/decentralisation to refer to how much authority/decision-
making ability is diffused throughout the organisational structure.
• Centralised structures: upper levels retain authority to make decisions
• Decentralised structures: authority to make decisions (ie, commit people, money and resources)
is passed down to lower levels of the hierarchy
Definition
Centralised organisation: One in which decision-making authority is concentrated in one place, that
is the strategic apex.
4.2 Factors affecting the amount of decentralisation in a business

• Leadership style: if it is authoritative, the business will be more centralised
• Size of organisation: as size increases, decentralisation tends to increase
• Extent of activity diversification: the more diversified, the more decentralised
• Effectiveness of communication: decentralisation will not work if information is not
communicated downwards
• Ability of management: the more able, the more decentralisation
• Speed of technological advancement: lower managers are likely to be more familiar with
changing technology, therefore decentralise
• Geography of locations: if spread, decentralise
• Extent of local knowledge needed: if required, decentralise
4.2.1 Which is better – centralisation or decentralisation?

Generally, centralisation offers greater control and coordination, while decentralisation offers greater
flexibility as authority is delegated.
Pro centralisation Pro decentralisation (delegation of authority)

Pro centralisation Pro decentralisation (delegation of authority)
Decisions are made at one point and so are Avoids overburdening top managers, in terms
easier to co-ordinate. of workload and stress.
Senior managers can take a wider view of Improves motivation of more junior managers
problems and consequences. who are given responsibility and authority.
Senior management can balance the interests Greater awareness of local problems by
of different functions, eg, by deciding on the decision makers. (Geographically dispersed
resources to allocate to each. organisations are often decentralised on a
regional/area basis for this reason.)
Senior managers keep control. Greater speed of decision-making, and

response to changing events, since no need to
refer decisions upwards. This is particularly
important in rapidly changing markets.
Quality of decisions is (theoretically) better due Helps develop the skills of junior managers:
to senior managers’ skills and experience. supports managerial succession.
More likely to produce congruent decisions as Separate spheres of responsibility can be

decision-makers are more likely to pursue same identified: controls, performance measurement
objectives. and accountability are better.
Possibly cheaper, by reducing number of Communication technology allows decisions to

managers needed and so reduced costs of be made locally, with information and input
overheads – simpler structure. from head office if required.
Crisis decisions are taken more quickly at the

centre, without need to refer back.
Policies, procedures and documentation can be

standardised business wide.
Transfer pricing is less of a problem.
5 Span of control: tall and flat businesses

Section overview
• A manager’s span of control quantifies how many people are reporting directly to them.
• The scalar chain describes the series of links between the most senior managers and the direct
operational staff in an organisation.
• Wide spans of control/short scalar chains create flat management hierarchies.
• Narrow spans of control/long scalar chains create tall management hierarchies.
5.1 Span of control
Definition
Span of control: The number of people (subordinates) reporting to one person.
The classical management theorist Lyndall Urwick took some of Henri Fayol’s principles and
theorised that:
• There needs to be tight managerial control from the top of a business downwards.

• The span of control should therefore be restricted, to allow maximum control consistent with the
manager’s capabilities: usually between three and six subordinates.
• If the span of control is too wide (there are too many subordinates), too much of the manager’s
time will be taken up with routine problems and supervision, leaving less time for planning. Even
so, subordinates may not get the supervision, control and communication that they require.
• If the span of control is too narrow (there are too few subordinates), the manager may fail to
delegate, keeping too much routine work to himself and depriving subordinates of decision-
making authority and responsibility. There may be a tendency to interfere in or over-supervise the
work that is delegated to subordinates – and the relative costs of supervision will thus be
unnecessarily high. Subordinates tend to be dissatisfied in such situations, having too little
challenge and responsibility and perhaps feeling that the superior does not trust them.
Influences on the span of control:
• A manager’s capabilities limit the span of control: there are physical and mental limitations to any
single manager’s ability to control people and activities.
• The nature of the manager’s workload: the more nonsupervisory work in a manager’s workload,
the narrower the span of control and the greater the delegation of authority to subordinates
should be.
Manager's work
Solitary work Entrepreneurial Interaction Supervision

(some planning activities with superiors
and scheduling) ('external' dealings) and colleagues
Non-supervisory work
Figure 3.8: The manager’s workload
• The geographical dispersion of subordinates: dispersed teams take more effort to supervise.
• Subordinates’ work: if all subordinates do similar tasks, a wider span is possible. If close group
cohesion is desirable, a narrower span of control might be needed.
• The nature of problems that a manager might have to help subordinates with. Time consuming
problems suggest a narrower span of control.
• The degree of interaction between subordinates. If subordinates can help each other, a wider
span is possible.
• The amount of support that supervisors receive from other parts of the organisation or from
technology (eg, computerised work monitoring, data analytics, cloud technology, or ‘virtual
meetings’ with dispersed team members).
Interactive question 2: Work loads

For your own firm, or perhaps for one of your audit clients, select a manager who you believe may be
overworked. Think about what amount of time that manager seems to spend ‘doing’ their own work,
and how much time they spend supervising staff. How far do you think the manager’s problems are
caused by having too wide a span of control, and what effect does this have?
5.2 Tall and flat businesses

The management hierarchy determines the ‘shape’ of the organisation; longer scalar chains create
taller businesses.

Definitions
Scalar chain: The chain of command from the most senior to the most junior.
Tall business: One which, in relation to its size, has a large number of levels in its management
hierarchy, normally because there are narrow spans of control.
Flat business: One which, in relation to its size, has a small number of hierarchical levels, normally
because there are wide spans of control.
Tall business vs Flat business
Figure 3.9: Tall and flat organisational structures
• In the tall business (seven layers), each manager has only three subordinates.
• In the flat business (three layers) each manager has seven subordinates.
The span of control concept, therefore, has implications for the length of the scalar chain (Figure
3.10).
MD
Divisional
directors Top
Department management
managers
Section managers MD
Middle
management
Assistant managers Top managers
Supervisors Middle managers

Front line
management
Team leaders Front line managers
Direct operational staff Direct operational staff
Tall business Flat business
Figure 3.10: Scalar chain in tall and flat business
5.2.1 Are tall or flat businesses better?
Tall business
For Against
Narrow control spans Inhibits delegation

For Against
Small groups enable team members to Rigid supervision can be imposed, blocking
participate in decisions initiative
A large number of steps on the promotional The same work passes through too many hands
ladder – helps management training and career
planning
Increases administration and overhead costs
Slow decision-making and responses, as the

strategic apex is further away
Flat business
For Against
More opportunity for delegation Requires that jobs can be delegated. If

managers are overworked they are more likely
to be involved in crisis management
Managers may only get a superficial idea of

what goes on
Relatively cheap Sacrifices control
In theory, speeds up communication between Middle managers are often necessary to

strategic apex and operating core convert the grand vision of the strategic apex
into operational terms
6 Mechanistic and organic organisations

Section overview
• Mechanistic organisations (bureaucracies) suit relatively static, slow-changing operating

environments.
• Organic organisations are suited to relatively dynamic operating environments.
6.1 What are mechanistic and organic organisations?

The terms ‘mechanistic’ and ‘organic’ were coined by sociologists Tom Burns and G M Stalker to
describe organisations which are:
• stable, efficient and suitable for slow-changing operating environments (mechanistic
organisations, or ‘bureaucracies‘)
• flexible, adaptive and suitable for fast-changing or dynamic operating environments (organic
organisations)
Mechanistic and organic organisations can be distinguished from each other on a number of factors.
Factor Mechanistic organisation Organic organisation
The task Tasks are specialised and broken Specialist knowledge and expertise
down into sub-tasks. contribute to the common task of the
organisation.
How the task fits People are concerned with Each task is seen and understood to be
in completing the task efficiently, set by the total situation of the
rather than how the task can business: focus is on the task’s

Factor Mechanistic organisation Organic organisation
improve organisational contribution to organisational

effectiveness. effectiveness.
Coordination Managers are responsible for co- People adjust and redefine their tasks
ordinating tasks. through interaction and mutual
adjustment with others.
Job description There are precise job descriptions Job descriptions are less precise:
and delineations of responsibility. people do what is necessary to
complete the task.
Legal contract v Hierarchical structure of control. An Network structure of control. An

common interest individual’s performance and individual’s performance and conduct
conduct derive from a contractual derive from a supposed community of
relationship with an impersonal interest between the individual and the
business. business, and the individual’s
colleagues.
Decisions Decisions are taken by senior Relevant technical and commercial

managers who are assumed to knowledge and decision-making
know everything. authority can be located anywhere.
Mission Insistence on loyalty to the concern Commitment to the business’s mission

and obedience to superiors. is more highly valued than loyalty as
such.
6.2 Mechanistic organisations: bureaucracy
Definitions
Bureaucracy: ‘A continuous organisation of official functions bound by rules’ (Weber, 2015).
Continuous organisation: The business does not disappear if people leave: new people will fill their
shoes.
Official functions: The business is divided into areas (eg, operations, marketing) with specified
duties. Authority to carry them out is given to the managers in charge.
Rules: A rule defines and specifies a course of action that must be taken under given circumstances.
6.2.1 Characteristics of bureaucracy
Characteristic Description
Hierarchy of roles Each lower office is under the control and supervision of a higher
one.
Specialisation and training There is a high degree of specialisation of labour.
Professional nature of Managers are employees; promotion is according to seniority and

employment achievement; pay scales are prescribed according to the position or
office held in the organisation structure.
Impersonal nature Employees work within impersonal rules and regulations and act
according to formal, impersonal procedures.
Rationality The hierarchy of authority and office structure is clearly defined.

Duties are established and measures of performance set.

Characteristic Description
Uniformity in the Procedures ensure that, regardless of who carries out tasks, they
performance of tasks should be executed in the same way.
Technical competence All managers are technically competent. Their competence within
the area of their expertise is rarely questioned.
Stability The business rarely changes in response to environmental pressures.
6.2.2 Advantages of bureaucracies

• Ideal for standardised, routine tasks. For example, processing driving licence applications is fairly
routine, requiring systematic work.
• They can be very efficient in stable environments.
• Rigid adherence to procedures may be necessary for fairness, adherence to the law, safety and
security (eg, procedures for data protection).
• Some people are suited to the structured, predictable environment. Bureaucracies tend to be
long-lived because they select and retain bureaucratically-minded people.
6.2.3 Disadvantages of bureaucracies

• Slow decision-making, because of the rigidity and length of authority networks
• Uniformity creates conformity, inhibiting the personal development of staff
• They suppress innovation: they can inhibit creativity, initiative and openness to new ideas and
ways of doing things.
• They find it hard to learn from their mistakes, because of the lack of feedback (especially upwards)
• Slow to change: environmental change therefore causes severe trauma
• Poor uptake or use of technology: technology policies are restrictive and slow to change
• Communication is restricted to established channels, ignoring opportunities for networking,
upward feedback and suggestions that may contribute to customer service and innovation
6.3 Organic organisations

Organic structures have their own control mechanisms.
Control mechanism Description
Status Although organic businesses are not hierarchical in the way that
bureaucracies are, there are differences of status, determined by
people’s greater expertise, experience and so forth.
Commitment The degree of commitment employees have to the goals of the

business and the team is more extensive in organic than in
mechanistic systems.
Shared values and culture Hierarchical control is replaced by the development of shared
beliefs and values. In other words, corporate culture becomes a
powerful guide to behaviour.

7 Introduction to business structure
Section overview
• A business may take the business structure of a sole tradership (one owner), a partnership (more
than one owner) or a limited company (usually many more than one owner).
• All businesses have unlimited liability for their own debts.
So far we have considered various factors affecting organisational structure. A key influence in
practice is the business structure it takes. In fact, this means what legal form the business takes.
Businesses may take one of three basic legal forms:
• sole tradership
• partnership
• companies
In addition, any business may form an alliance with other businesses, or it may form a group
structure. We shall look at each of these points in turn.
8 Sole tradership
Section overview
• In a sole tradership there is unlimited liability of the owner for the business’s debts.
• There is no legal distinction between the owner and the business, but separate ledger accounts
and financial statements should be maintained for tax purposes.
• Sole traders may borrow money and employ people, but they have unlimited risk.
• A sole tradership ceases to exist on the death of the owner, though assets (including goodwill)
and liabilities can be sold by their estate.
Definition
Sole tradership: A single proprietor owns the business, taking all the risks and enjoying all the
rewards of the business.
8.1 Features of a sole tradership

• There is no legal distinction between the proprietor and the business.
• The proprietor is wholly liable for the debts of the business, borrowing money in his/her own
name.
• The business is usually financed by a mixture of owner’s capital (including retained earnings),
loans and short-term credit.
• While a sole trader can offer a lender a fixed charge over assets such as buildings and machinery
as security, they cannot use floating charges over all the business assets as a company can.
• Sole traders take drawings from the business.
• Many sole traders employ people to do some or all of the actual work in the business, but it is
usual for the proprietor to take a very active role, doing many different tasks and managing the
business in a very ‘hands-on’ way.
• A sole tradership business can be sold as a going concern by its owner.

• If a sole trader dies, the business’s assets and liabilities form part of their estate but the sole
tradership as such ceases to exist – there is no perpetual succession.
8.2 Advantages and disadvantages of sole tradership

A sole trader has the flexibility of ‘being their own boss’, taking all the decisions and getting things
done in their own preferred way. There is no publicity requirement of sole traders beyond the
requirement to prepare financial statements for taxation purposes, and this offers both privacy and
cost savings.
However, the fact that they have sole charge can be a disadvantage as there are limits to the skills
and the time of one individual. While no-one shares the profits there is also no-one to share the load.
Frequently sole traders overwork and find it difficult to take a holiday. It is also hard to expand unless
there are new ideas and new capital.
Sole traders who have employees have the same responsibilities in respect of them as any other
business, and of course the sole trader also has the significant responsibility of unlimited liability for
the business’s debts.
9 Partnerships
Section overview
• In a general partnership there is unlimited liability of the partners for the business’s debts.
• The partnership does not have a separate legal existence.
• General partnerships may borrow money and employ people, but they have unlimited risk and
cease to exist on the death of one partner.
• All partners in a limited liability partnership may have limited liability.
Definition
Partnership: The relation which subsists between persons carrying on a business in common with a
view of profit.
Two or more people who own a business, agreeing to take all the risks and enjoy all the rewards of
the business, are called a partnership. They agree between themselves how the risks, rewards and
property are shared. They may agree to contribute different amounts of capital, to take different
shares of profits and losses, to own partnership property in different shares, or to guarantee salaries
to certain partners. It is up to them.
Partnership is a common form of business structure. It is flexible, because it can either be a formal or
informal arrangement, so it can be used for large organisations or for a small husband and wife
operation.
Partnership is normal practice in the professions as historically professions prohibited their members
from carrying on practice through limited companies. In some professions this has been relaxed, and
other professions permit their members to trade as limited liability partnerships (LLPs) which have
many of the characteristics of companies. Non-professional businesses have never been restricted in
this way and generally prefer to trade through a limited company for the advantages this can bring.
9.1 Features of a partnership

In many ways trading as a partnership is not so different from trading as a sole trader.
• How far the business is legally distinct from its owners depends on the form of partnership used,
but frequently the partners are jointly and severally liable for the debts of the partnership.
• The financing issues that face sole traders also face many partnerships.
• Partners take drawings from the business.

• While all the partners may be as actively involved in the business as the typical sole trader, there is
more scope for partners to specialise, and/or to ‘take a back seat’ in the business.
• A share in a partnership is not a form of property as such and selling it can be difficult.
• If a partner dies, the partnership may automatically be dissolved – there is no ‘perpetual
succession’.
There are three forms of partnership: general, limited (not covered further here) and limited liability
partnerships.
9.2 General partnerships

In a general partnership regulated by the Partnership Act 1890, the partnership has no separate legal
identity. All partners are jointly and severally liable for the partnership’s debts. If one partner
becomes personally insolvent, for instance, the others must take on his or her own ‘share’ of the
partnership’s debts themselves. Usually the partners have a partnership agreement in place, which
sets out the terms on which they agree to operate together in business. If there is no partnership
agreement, the Partnership Act 1890 sets out how the partnership is run.
9.3 Advantages and disadvantages of general partnerships

Partners have the flexibility of ‘being their own boss’, taking all the decisions and getting things done
in their own preferred way, but without the loneliness and pressure of the sole trader. There is no
publicity requirement of general partnerships beyond the requirement to prepare financial
statements for taxation purposes.
Multiple partners will have different skills and more time to devote to management and expansion
than one individual. There is someone to share the load and less chance of overwork. New ideas and
new capital are more readily available.
Partners with employees have the same responsibilities in respect of them as any other business. In a
general partnership they each have unlimited liability for the business’s debts, but they have to share
profits.
The relationship between the partners is of crucial importance to whether the partnership realises its
potential. It is based on trust; if the relationship fails and partners fall out, the agreement is at an end
and the partnership essentially ceases to exist. Moreover, partners can be left with liability for debts
run up by another partner, sometimes without their knowledge.
9.4 Limited liability partnerships (LLPs)

Professionals are frequently bound by professional rules to operate as partnerships, of a limited size
in some cases. This historically meant that the partners had to trade with unlimited liability for
partnership debts, which represented a significant restriction on the amount of risk that the partners
were willing to take on. It is possible to form limited liability partnerships (LLPs) under the Limited
Liability Partnership Act 2000; these are little different from limited companies, which we shall see
next. In particular, LLPs have a legal identity separate from their owners. Because of this, some of the
funding restrictions suffered by general and limited partnerships are relaxed, though there are
similar publicity requirements for LLPs as for limited companies.
10 Companies
Section overview
• In a limited company, the owners (shareholders) have limited liability for the unpaid debts of the
company.
• The company is legally distinct from its owners.
• The death of a shareholder has no effect on the company; their shares are personal property
which can be transferred to another person.
• Private companies, unlike public companies, may not offer their securities for sale to the public.
They are generally smaller as well.

Definition
Company: A legal entity registered as such under statute (the Companies Act 2006).
A business which trades as a company may be no different from a partnership or sole trader in any
other way than in one important fact: while sole traders and partners as owners take all the risks in
the business, having (generally) unlimited liability for the debts of the business, the owners of a
limited company (its shareholders) have limited liability for its debts beyond any amount they may
still owe for the shares they hold. The company has unlimited liability for its own debts.
10.1 Features of a limited company

• The company is legally distinct from its owners.
• As well as a fixed charge, the company can offer a floating charge over its changing assets as
security for lending.
• Shareholders take dividends, not drawings, from the business.
• Directors run the company; shareholders do not take part in the management of the business
unless they are also directors and/or employees, but they have no automatic right to be directors.
• Shares are a form of property that can easily be sold by their owners, especially if the company
has a public listing of shares on a public stock exchange; transferring ownership of shares to
another person has no direct effect on the company.
• If a shareholder dies, their shares are transferred to another person without any effect on the
company at all – there is what is known as ‘perpetual succession’.
As the company’s shareholders enjoy the benefit of limited liability for the company’s debts, there
are stringent rules in place which protect the capital contributed by shareholders as a ‘buffer’ for
creditors. If the company becomes insolvent, shareholders cannot receive any of their capital back
until creditors are paid in full.
A company’s constitution is open to public scrutiny. The constitution sets out the company’s relations
with the external world and also how shareholders relate to the company, its directors and each
other.
10.2 Types of company
Definitions
Public company: A company whose constitution states that it is public and that it has complied with
the registration procedures for such a company. It may offer its shares and other securities for sale to
the public at large.
Private company: A company which has not been registered as a public company under statute. It
may not offer its securities to the public at large.
In the UK a public company is a company registered as such under statute (the Companies Act 2006)
with the Registrar of Companies. Any company not registered as public is a private company.
Public companies (plcs) do not necessarily have their shares listed on a public stock exchange.
A company must have at least one shareholder. Unless there are clauses in the constitution to the
contrary, there are no limits to the number of shares or shareholders a company can have. Public
companies must have at least two directors and must have at least £50,000 share capital issued, with
at least 25% of this (£12,500) paid up at registration.
10.3 Advantages of companies

• The separate legal personality of the company
• The limited liability of its members (shareholders)
• Perpetual succession. A change in the ownership of a company does not affect its continued
existence

• Transferability of interests. Shareholders in a company can sell their shares either to other
shareholders or to outsiders. It is not possible for partners to assign or transfer their interest in a
partnership unless the other partners consent. They would have to retire from the partnership,
hence causing its dissolution (unless other provision is made in the partnership agreement)
• Security for loans includes floating as well as fixed charges
10.4 Disadvantages of companies

• Separation of ownership and control. A sole trader and the partners in a firm can all participate in
the day-to-day management of the entity: it is effectively ‘their’ business. The shareholders of a
company, however, do not have such a right, and their input is limited to what can be achieved by
the passing of resolutions.
• Ownership of assets. Due to the concept of separate legal personality, a company owns its own
assets and a shareholder does not have any right to just take a share in them. A sole trader owns
their own business’s assets, and the partners in a firm own the assets jointly, so that when a
partner leaves, they are entitled to the value of their share of the assets.
• Accounting records and returns. Sole traders and general partnerships do not have to keep their
accounting records in any format prescribed by the Companies Act 2006, and they do not have to
undergo an audit. Companies, both private and public, are subject to stringent legal rules. This
degree of bureaucracy can deter businesses from incorporation.
• Publicity. Due to the need to file financial statements, discussed above, it is possible for third
parties, such as competitors and creditors, to obtain information about the company’s financial
position and such sensitive issues as the remuneration of directors. Partnerships and sole traders
do not need to make any of this information publicly available.
• Regulations and expense. The law – primarily the Companies Act 2006 – sets out very stringent
rules that all companies must follow on areas as diverse as the maintenance of capital, the
contents of the constitution and the amount that can be lent to directors. This adds to the
bureaucracy encountered by companies, and can be expensive.
You may be asked to recommend the appropriate business structure for a particular organisation.
You should have the relevant technical knowledge of the different business types, how they operate,
and the advantages and disadvantages of them.
Interactive question 3: Incorporation

In what circumstances can you see that the disadvantages of incorporation may outweigh the
advantages?
11 Which business structure should a business take?

Section overview
• Many operational, business, legal, practical and financial factors must be considered when
deciding which business structure should be adopted for a particular business.
The following factors should be considered when deciding whether a general (non-LLP) partnership
should become a company:

Factor Company Partnership (non-LLP)
Entity Is a legal entity separate to its Has no existence outside of its

members members
Liability Members’ liability can be limited Partners’ liability is unlimited
Succession Perpetual succession – change in Traditional partnerships are dissolved

ownership does not affect when any of the partners leaves
existence
Owners’ interests Members own transferable shares Partners cannot transfer their interests
in a partnership
Assets Company owns the assets Partners own assets jointly
Management Company must have at least one All partners can participate in
or two director(s) management
Constitution Formal: Company must have a Informal: A partnership may have a

written constitution written partnership agreement, but the
agreement may just be verbal
Financial A company must file financial Partners do not have to make financial
statements statements so that the public has statements public
access to them
Security A company may offer a floating A partnership may not give a floating
charge over its assets charge on assets
Withdrawal of Strict rules concerning repayment More straightforward for a partner to

capital of subscribed capital withdraw capital
12 Alliances
Section overview
• A business of whatever form may enter into various types of alliance with other businesses,
creating business structures in the form of joint ventures, licences, strategic alliances, agency or a
group structure.
12.1 Joint venture

A separate business – usually but not always a limited company – can be formed in which the
businesses take a financial stake (usually, but not always, as shareholders) and management is
provided as agreed.
Benefits
• Less capital is required than if the businesses were on their own, so there is less risk
• Reduces competition
• Enables firms to gain access to restricted markets
• Access to the skills of each party
Disadvantages
• Disputes over how the business should be run, costs incurred, management charges, etc
• If the joint venture breaks down, the special skills of a business may be used against it by its
former joint venture partner

• Possible lack of financial support
12.2 Licences
A licensing agreement is a permission to another company to manufacture or sell a product, or to
use a brand name.
Most licences are restricted geographically so in the case of a sales licence, the licensor (who grants
the licence) can retain control over where the product is sold and can prevent competition with his
own products or those of other licensees. The most common form of licensing agreement is the
franchise, which usually involves an annual fee plus a minimum order for goods, usually at a discount.
12.3 Strategic alliances

A strategic alliance is an informal or weak contractual agreement between parties or a minority cross-
shareholding arrangement (a cross-shareholding is where each party takes a small number of shares
in the other parties). Normally no separate company is formed. National airlines have created such
alliances to cross-book passengers. Similarly, some European telecom companies have created
alliances to aid international expansion.
The benefits and disadvantages are similar to those of joint ventures.
In addition:
• The looser arrangement is easier to break
• They may contravene competition laws, eg, be viewed as an illegal cartel (we shall see more
about cartels in the chapter External regulation of business)
• There may be less commitment than to a joint venture, so the benefits are not as great
12.4 Agents
Agents can be used as the distribution channel where local knowledge and contacts are important,
eg, exporting. The agreements may be restricted to marketing and product support.
Other situations where agents are used include:
• sale of residential property
• holidays
• financial services, eg, insurance brokers
The main problem for a business that uses agents is that it is cut off from direct contact with the
customer.
12.5 Groups
As companies are entitled to own shares, groups of companies may form. In its simplest form, a
group of companies might look like Figure 3.11.
Parent company
owns all the shares of
Subsidiary company
Figure 3.11: Simple group structure
In practice, groups are usually much larger and much more complex. There is no necessity for all the
subsidiary company’s shares to be held by the parent company and in many groups, there are
significant minority shareholders of subsidiary company shares.
Advantages
• Funds can be moved around a group of companies as required as can people and tax losses.

• Having distinct parts (in separate companies) or one whole (the group) allows different structures
and cultures to be developed as appropriate to each business in the group.
• Risk of failure is spread; provided the parent company has paid fully for the shares it holds in the
subsidiary, the insolvency of the subsidiary will not necessarily involve any liability for the parent
company.
• Minority shareholdings can be retained in subsidiaries by the entrepreneurs who set up each
business. This can help to keep the entrepreneur in the business.
• Skills, expertise, equipment and administration matters can be shared and/or centralised.
Disadvantages
• Financial reporting for groups can become extremely complex.
• Groups of companies require a great deal of administration in terms confirming the public
information held about them etc.
• While legally the risk is spread, the failure of a group company can have very detrimental effects
on all the other companies in the group.
Exam questions may test your ability to relate issues to the environment by asking what type of
alliance might be most appropriate in a particular scenario. Understand the business reasons for
collaboration to help decide which of the different forms might be most appropriate.

Summary
Organisational structure
Business • Span of Mintzberg's Management Organisational Basic

functions control blocks hierarchy charts etc principles
• Size of
business
Degree of
centralisation
Other
Scalar approaches
chain Authority
Geography
Tall Flat Centralised: Decentralised:
structure structure Types Upper levels Authority is
retain authority delegated
Professional Simple/ Machine

Innovative bureaucracy/ Divisionalised
bureaucracy Entrepreneurial
functional
Organic Mechanistic Matrix
Nature of
environment
Simple Complex
Static Dynamic

Business structure
Owners' liability
for debts
Unlimited Limited
Sole General Limited

Companies
trader partnerships liability
partnerships
Alliances Public Private

• Shares • May not
may be offer shares
offered to to public
the public

indicated.
1 Can you describe each of the six building blocks suggested by Mintzberg? (Topic 2)
2 Do you know the different types of organisational structure that Mintzberg described?
(Topic 3)
3 Can you explain the advantages and disadvantages of entrepreneurial structure,

functional structure, divisional structure, and matrix structure? (Topic 3)
4 Do you know the advantages of centralised and decentralised structures? (Topic 4)
5 Do you know the meaning of span of control, scalar chain, tall business and flat
business? (Topic 5)
6 Can you describe the different legal structures that businesses can take, and can you
explain the main features of each one? (Topics 7–11)
7 Can you describe joint ventures, licences, strategic alliances, agents and groups?
(Topic 12)

questions in the Organisational and business structures chapter of the Business, Technology and
Finance Question Bank. Refer back to the learning in this chapter for any questions which you did not
answer correctly or where the suggested solution has not provided sufficient explanation to answer
all your queries. Once you have attempted these questions, you can move on to the next chapter,
Introduction to business strategy.

• Weber, M. (2015) Bureaucracy from Rationalism and Modern Society. New York, Palgrave.

Self-test questions

1 According to Henry Mintzberg, five building blocks of an organisation exist within an overarching
sixth element. He called this sixth element:
A the environment
B the technostructure
C the ideology
D the strategic apex
2 Which three of the following are basic principles of organisational structure?
A The scalar chain
B The matrix structure
C Flexibility of personnel
D Unity of direction
E Division of work
3 Tranche Ltd is a company that was set up by Rosa Tranche, a 25-year-old entrepreneur, in 2015. It
operates in a sector in which innovation is key and which changes very quickly. There are a great
many factors that drive both supply and demand. Tranche Ltd’s three staff are together engaged in
varying and complex tasks which require a high degree of intelligence, flexibility and self-direction.
Tranche Ltd would be expected to have:
A an adhocracy structure
B a divisionalised structure
C a machine bureaucracy structure
D a simple structure
4 The board of Cranford plc has decided that its existing organisational structure is unsuited to the
demands of its current environment and strategy and wish to change to one that is more
decentralised. Which of the following aspects of Cranford plc and its management would hamper
decentralisation?
A It has many employees working in various locations.
B It operates in several different sectors.
C It has senior and junior managers who are technically able.
D It has senior managers who have an authoritative leadership style.
5 Which of the following factors directly limits how many subordinates should report to a single
manager?
A The size of the business
B Where the manager is situated in the management hierarchy
C How far the manager is engaged in dealings with customers and suppliers
D The length of the scalar chain
6 A bureaucracy is suited to a situation where the business’s environment is:
A dynamic and complex
B static and complex
C static and simple
D dynamic and simple
7 Which of the following statements about sole tradership is correct?

A The business has perpetual succession
B The owner has limited liability for unpaid business debts
C The owner must do all the work
D The business may borrow money against a fixed charge on the sole trader’s assets
8 Pedro, Lynn and Shilpa wish to go into business together. None of them wishes to publicise whether
or not they make a financial success of the business. Which business structure should it take?
A A general partnership
B A sole tradership
C A limited liability partnership
D A limited company
9 Which, if any, of the following businesses has limited liability for its debts?
B A limited liability partnership
C A limited company
D None of the above
10 A franchise is a form of:
A joint venture
B licensing agreement
C strategic alliance
D agency
this chapter.


You are likely to be part of the operating core of your firm, along with other unqualified and part-
qualified accountants. The organisational structure probably narrows at the level of senior managers,
who report upwards to a small number of partners. At the strategic apex will be not only key fee-
earning partners but also other senior partners who are responsible for strategic aspects of the firm.
The technostructure will comprise the systems and processes that allow the business to function,
such as the financial system and IT. Support staff will include administrative staff plus finance and HR
staff, plus the training department. The overarching ideology is perhaps one of professionalism,
expertise, ethical values and commercial awareness.

Often managers are expected to supervise a large number of staff, say 10 or 15, while still doing a
great deal of their ‘own’ work, such as planning and scheduling, dealing with clients and suppliers,
performing technical work and having meetings with colleagues and senior managers. At some point
some aspect of their work will suffer, and very often it is all aspects. Staff suffer from too wide a span
of control by having too little of the right kind of supervision, and too much of the wrong kind, by
feeling neglected, and by having to deal with a stressed manager.

Where a sole trader or some partners have historically been used to taking all the risks and having all
the rewards of a business, having to share control with other shareholders in a formal way can be
problematic. Often, they don’t like the publicity and the administration that incorporation involves,
and in particular don’t like the fact that customers, competitors and suppliers have access to financial
information on the business. The expense and disruption of an audit is often felt to be
disproportionate to the benefit gained by the business itself.

C the ideology
A The scalar chain
D Unity of direction
E Division of work
Flexibility is a more modern approach, while the matrix structure cuts across the classical principle of
unity of command.
A an adhocracy structure
Both the divisionalised and the bureaucratic organisational structure would be unsuitable as the
business is so small and young. The simple structure is unsuitable as the tasks involved are complex
D It has senior managers who have an authoritative leadership style.
C How far the manager is engaged in dealings with customers and suppliers
C static and simple
D The business may borrow money against a fixed charge on the sole trader’s assets
Their desire to avoid publicity prevents them from operating as either a company or a limited liability
partnership as both forms must file details with the Registrar. Only an individual can operate as a sole
trader.
D None of the above
B licensing agreement

Chapter 4
Introduction to business
strategy
Introduction
Learning outcomes
Syllabus links
Assessment context
Learning topics
1 What is strategy?
2 Introduction to strategic management
3 The strategic planning process
4 Analysing the environment
5 Analysing the business
6 Corporate appraisal
7 Setting strategic objectives
8 Choosing a corporate strategy
9 Implementing the strategy
Summary
Self-test questions
Introduction
Learning outcomes
• State the general objectives of strategic management and specify the strategic management
process and interrelationship between a business’s vision, mission and strategic objectives
• Identify the relationship between a business’s overall strategy and its functional strategies and the
nature and purpose of strategic plans, business plans and operational plans including how a
strategic plan is converted into fully-integrated business and operational plans
Specific syllabus references are: 1b, 1e
4
Syllabus links
The topics covered in this introduction to strategic management are developed further in Business
Strategy and Technology at the Professional level, and in the Advanced level.
4
Assessment context
Questions on the strategic management process and on the differences between strategies and
plans at different levels in the business will be set in the assessment in either MCQ or multiple
response format. They will be either straight tests of knowledge or applications of knowledge to a
scenario.
4

of this chapter.

questions
1–3 Introduction to Approach Questions on the

strategy and strategic The first three strategic management
management and sections process and on the
planning introduce differences between
Every well-managed strategy so read strategies and plans at
business should have through them different levels in the
an overall direction or fairly quickly, but business could easily
strategy, around note the levels of appear in the exam.
which all the more strategy in Questions are likely to
detailed plans of the section 1, and be be set in a scenario
business are aware of the context. Knowledge-
constructed. While nature of type questions are also
the strategic strategic likely, based on
management process decisions. The particular principles,
is not something that strategic theories or models.
you are likely to planning model Essential points are:
encounter in practice in 3.1 provides a
early in your training, useful map of the • Different levels of
it is something of rest of the strategy within a
which you should be chapter. business
aware as it underlies Stop and think • The meaning of a
the activities of formal strategic
organisations that are Why is it planning
your clients. important to
perform strategic
planning? Are

questions
there any
disadvantages of
having a formal
approach to
strategic
planning?
4 Analysing the Approach Questions will test your IQ1: Business

environment Learn what understanding of the environment
Before making PESTEL stands models - for example It is important to
decisions about what for and ensure identifying which part work through this
strategies to adopt, it you understand of the PESTEL or question to
is useful to analyse how each factor Porter’s five forces a practice applying
the external can affect a particular factor relates the PESTEL factors.
environment to business. Learn to.
IQ2: Product
ensure that the the five forces Essential points are rivalry This will
strategies are from Porter’s • PESTEL analysis help you see the
appropriate. model and rivalry in a real-
ensure you • Porter’s five forces
world
understand • Competitor analysis environment.
them.
Stop and think
Analyse the food
retailing industry.
5 Analysing the Approach As with the previous IQ3: Creating

business This section section, exam value provides a
Companies need to contains some questions could test great opportunity
have the right very important your understanding of to test your
resources and models, so the models covered in understanding of
competences to spend time this section, for the value chain.
make a success of learning these example by giving
their strategies, so it is and understand information about a
useful to analyse the how they will product and asking
internal environment help to analyse a you to identify which
before making business’s matrix in the Boston
strategic decisions. internal Consulting Group
resources and matrix it belongs to:
competences. Essential points are:
The value chain • Porter’s value chain
is not just a list of
activities – it is a • BCG matrix
map that helps • Product lifecycle
businesses to
identify which
are the
processes that
are essential to
add value.
Stop and think
Think about a
business you are
familiar with,
such as a
supermarket that
ICAEW 2023 4: Introduction to business strategy 105

questions
you visit
regularly. What
activities does
this business
perform that add
value - in other
words why do
you pay the
business instead
of trying to
provide the
product or
services for
yourself?
6 Corporate appraisal Approach Questions on this area IG4: Opportunities

This summarises the Read through may focus on and threats
results of the external this section fairly categorising particular Do a SWOT
and internal analysis. quickly. Learn the factors within the four analysis of
SWOT analysis is a format of a quadrants of the SWOT something you are
useful tool to use in SWOT chart and matrix or identifying an expert on – your
practice to appreciate read the ideas which particular career!
the strengths and provided in the strategies might be
weaknesses of a section to help most appropriate given
client. you understand a SWOT analysis.
the model, but
you don’t need
to learn the
ideas.
Stop and think
If a business has
identified that it
has a weakness
in an area, eg
provision of IT
services, what
could the
business do to
overcome that
weakness?
7 Setting strategic Approach Questions in this area

objectives Read through the typically provide
Strategies must chapter section. information about a
achieve the Learn particular stakeholder
objectives of the Mendelow’s and require you to
stakeholders so some matrix and choose from a list of
analysis must be understand the appropriate options in
performed to identify links between terms of dealing with
the objectives of the strategy and that stakeholder.
organisation. These objectives. Questions on the
will be the result of hierarchy might test
Stop and think where a particular
what the powerful
stakeholders want. Who are the objective fits in within
stakeholders in a the hierarchy.
state funded Essential points are:

questions
school? What do • Mendelow’s matrix

each of the • Hierarchy of
stakeholders objectives
want from the
school? Which
stakeholders
have the power
to make
decisions, and
how do the other
stakeholders
influence those
decisions?
8 Choosing a corporate Approach This section is a

strategy Focus on popular area for exam
After all the analysis understanding questions and you may
performed in the Porter’s generic well see questions in
previous sections, strategies and your exam from this
businesses can now Ansoff’s matrix. section. Questions on
select appropriate Make sure you Porter or Ansoff may
strategies. This understand the provide you with a
involves generating terms ‘suitability’, particular strategic
strategic choices, and ‘feasibility’ and option and ask you
then evaluating them ‘acceptability’ which of Porter’s
to decide which to which can be generic strategies, or
implement. used to evaluate which quadrant on
a strategy. Ansoff’s matrix that
strategy fits into.
Stop and think
Essential points are:
Think of a large
well -known • Porter’s generic
company such as competitive
Apple. Which of strategies
Porter’s generic • Ansoff’s matrix
strategies is • SFA analysis
closest to Apple’s
strategy?
9 Implementing the Approach Know the difference

Strategy This final section between business and
High level strategies is short. Ensure functional strategy. You
must be turned into you know the should also know
operational plans so different levels of about strategic/
at each level of the plan that are business/ operational
business the required to plans
managers and staff convert a
know what they are strategy into
trying to achieve. action.
Stop and think
An SBU is
following a price
leadership
strategy. What
functional
strategies for the

questions
production
function would
support this?

1 What is strategy?
Section overview
• A business’s strategy is concerned with its long-term direction and objectives, its environment, the
resources it has and the return it makes for its owners. It can be seen as a plan, a ploy, a pattern, a
position and a perspective.
• Strategies exist at corporate, business and functional/operational levels in the business.
• Corporate strategy covers the business as a whole.
• Business strategies exist for each strategic business unit (SBU), including their competitive
strategies.
• Functional strategies exist for production/operations, marketing, finance and HR within each SBU.
1.1 What is meant by ‘strategy’?

There are probably as many different definitions of ‘strategy‘ (or ‘corporate strategy’) as there are
textbooks on the subject. Two possible definitions are as follows:
Definition
Strategy: ‘Strategy is the direction and scope of an organisation over the long term, which achieves
advantage for the organisation through its configuration of resources within a changing environment,
to meet the needs of markets and to fulfil stakeholder expectations.’ (Johnson, Scholes and
Whittington, 2007).
’Strategy is concerned with an organisation’s basic direction for the future, its purpose, its ambitions,
its resources and how it interacts with the world in which it operates.’ (Lynch, 2000).
From these definitions we can say that strategy is concerned with:

• the long-term direction (objectives) of the business
• the environment in which it operates
• the resources at its disposal
• the return it makes to stakeholders
1.2 Levels of strategy

Strategy can exist at several levels in a business as shown in Figure 4.1.
Corporate
Business
Functional (operational)
Figure 4.1: Levels of strategy
1.3 Corporate strategy

Corporate strategy is generally determined at main board level for the business as a whole. The
types of matter dealt with include:
• determining the overall corporate mission and objectives

• overall product/market decisions, for example to expand, close down, enter a new market,
develop a new product etc, via methods such as organic growth, merger and acquisition or joint
venture etc
• other major investment decisions besides those for products/markets, such as information
systems, IT development
• overall financing decisions – obtaining sufficient funds at lowest cost to meet the needs of the
business
• relations with external stakeholders, such as shareholders, lenders, government, etc
• the organisation’s policies relating to ESG, sustainability and climate change
1.4 Business strategies

These normally form in strategic business units (SBUs), and relate to how a particular market is
approached, or a particular SBU acts.
Definition
Strategic business unit (SBU): A section, within a larger business, which is responsible for planning,
developing, producing and marketing its own products or services.
Competitive strategy is normally determined at this level covering such matters as:
• how advantage over competitors can be achieved; and
• marketing issues, such as the marketing mix.
1.5 Functional strategies

These refer to the main functions such as production/operations, procurement, finance, IT, human
resources and marketing, and how they deliver effectively the strategies determined at the corporate
and business levels.
2 Introduction to strategic management

Section overview
• Strategic management involves making decisions on the business’s scope and long-term
direction, and resource allocation.
• Strategic planning involves a planning and control process at the strategic level.
• A formal approach to strategic planning involves strategic analysis, strategic choice,
implementation of the strategy chosen, and review and control.
2.1 What is strategic management?

The formal approach to strategic management, on which we shall be concentrating in this chapter,
states that all organisations need to plan if they are not to drift.
Strategic management involves:
• taking decisions about the scope of a business’s activities;
• the long-term direction of the business; and
• the allocation of resources.
It involves an entire cycle of planning and control at a strategic level, that is strategic planning.
2.1.1 Formal strategic planning

A formal or rational approach to strategic planning involves four key stages:
• Strategic analysis
• Strategic choice

• Implementation of chosen strategies
• Review and control
We shall look at each stage in detail later.
Definitions
Planning: The establishment of objectives and the formulation, evaluation and selection of the
policies, strategies, tactics and action required to achieve them. Planning comprises long-
term/strategic planning, and short-term/operational planning.
Strategic plan: A statement of long-term goals along with a definition of the strategies and policies
which will ensure achievement of these goals.
2.2 Making strategic decisions

If we assume that strategic management follows the formal model with a logical sequence which
involves analysing the current situation, generating choices relating to competitors, products and
markets (strategic choice) and implementing the chosen strategies (strategy implementation), then to
develop a strategy a business has to answer the following questions.
• What is it good at?
• How might the market change?
• How can customer satisfaction be delivered?
• What might prevent the plan from coming into being?
• What should be done to minimise risk?
• What actions should be followed?
3 The strategic planning process

Section overview
• Strategic planning incorporates internal and external analysis then corporate appraisal, which
together inform the business’s choice of mission, goals and strategic objectives. Any resulting gap
between where the business is currently headed and where the strategy process has indicated it
should be headed is addressed by making appropriate strategic choices, which are then
implemented, reviewed and controlled.
• Strategic choice involves generating strategic options and evaluating these, then selecting the
most appropriate.
• The business needs to choose competitive, product/market and institutional strategies.
• Implementing strategies involves setting more detailed objectives and plans, then seeing them
through.
3.1 The stages of strategic planning

We can divide strategic planning into a number of different stages: strategic analysis, strategic
choice, strategic implementation and ongoing review and control (see Figure 4.2).

External Internal
analysis analysis
Corporate
appraisal
Strategic
analysis
Mission, goals
and objectives
Review and
control
Strategic Strategic
choice choice
Strategy Strategy
implementation implementation
Figure 4.2: Strategic planning process
3.2 Strategic analysis
Stage Comment Key tools, models, techniques
Step 1 External Identify opportunities and threats • PESTEL analysis

analysis in the business’s external • Porter’s five forces analysis
(analysing the environment
environment) • Competitor analysis
Step 2 Internal Identify strengths and weaknesses. • Resource audit

analysis Analyse the business’s current • Distinctive competencies
(analysing the resources, products, customers,
business) systems, structure, results, • Value chain
efficiency, effectiveness • Supply chain
• Product life cycle
• BCG matrix
Step 3 Corporate Combines Steps 1 and 2 • SWOT analysis

appraisal
Step 4 Mission, goals Mission denotes values, the • Stakeholder analysis

and objectives business’s rationale for existing; • Mission statement
goals interpret the mission for
different stakeholders; objectives
are quantified embodiments of the
mission

3.3 Strategic choice
Stage Comment Key tools, models, techniques
Strategic options Coming up with new ideas: • Porter’s generic strategies

generation • How to compete (secure • Ansoff’s product/market
competitive advantage) in the strategies
market
• Where to compete
• Method of growth
Strategic options Evaluating each strategic option • Stakeholder analysis

evaluation carefully and objectively • Risk analysis (see the chapter
Introduction to risk
management)
• SFA analysis
Strategy selection Choosing between the alternative

strategies
At the end of the process, the business should have three types of strategy:
• Competitive strategies: the generic strategies for competitive advantage a business will pursue.
They determine how it competes
• Product/market strategies determine where it competes and the direction of growth (which
markets a business should enter or leave)
• Institutional strategies determine the method of growth (ie, relationships with other businesses)
3.4 Strategy implementation

Strategy implementation is the conversion of the strategies chosen into detailed objectives for
operating units, and plans to achieve them.
4 Analysing the environment

Section overview
• The business’s external environment incorporates the physical, the general and the task
environments.
• The task environment may be simple or complex.
• Each environment may be static or dynamic.
• PESTEL analysis is used to analyse the general environment, namely its political, economic,
social/demographic, technological, ecological and legal factors.
• Political factors: capacity expansion, demand, divestment/rationalisation, emerging industries,
entry barriers and competition.
• Economic factors: wealth (changes in GDP), inflation, interest rates, tax, government spending, the
business cycle and productivity.
• Social factors (demography): growth, age and geography of population, household and social
structure, employment and wealth.
• Technological factors: the nature and pace of change in technology in the industry and its
cost/opportunity cost.
• Environmental/ecological factors: regulation of waste and pollution, business’s susceptibility to
natural disasters such as flooding or earthquakes as well as the general climate (temperature,
sunlight levels and humidity).
• Legal factors: changes in civil and criminal laws, employment and health/safety regulations, data
protection, consumer protection, environmental regulation.

• Porter’s five forces analysis of the business’s competitive environment: potential entrants,
customers, suppliers, substitute goods/services, and competitors. The relative bargaining power
of customers and suppliers together with the degree of threat from the others determines how
much rivalry there is between businesses and therefore how profitable the industry is likely to be.
• Competitor analysis involves looking at the business’s different types of competitor: brand,
industry, generic and form. For each type, their strategy, assumptions about the industry, situation
and capability should be analysed to determine how they will respond to the business’s
competitive strategy (their reaction profile): laid back, tiger, selective or stochastic.
4.1 What is in the business’s external environment?

Businesses exist within an environment which strongly influences what they do and whether they
survive and develop. Strategic planners must take account of potential environmental impacts in
order to produce plans that are realistic and achievable.
Definition
Environment of a business: Everything outside its boundaries. It may be segmented according to
Figure 4.3 into the physical, the general and the task environment.
Economy Ecolog
gy y
nolo So
ch cie
Te ty
w (a
La
anisations Stak
nd
org
Cu
eh
cs
ing ol
ltu
et
liti
d
re)
Po
er
m
s
Co
Goods to
Suppliers customers
Business
Materials Pollution
Labour Wage to labour
Capital Profit to
investors
Ge ne t
ral environmen
Physical environment
Figure 4.3: The business’s external environment
Definitions
General environment: Covers all the political, legal, economic, social/demographic, ecological and
technological (PESTEL) influences in the countries a business operates in.
Task environment: Relates to factors of particular relevance to the business, such as its competitors,
customers and suppliers of resources.

The task environment may be simple, for instance where there are few competitors and predictable
outcomes and suppliers, or highly complex.
With regard to environmental issues there is a further variable to be dealt with: the time horizon of
changes in the external environment. Some have long-term impact, which can be dealt with by
careful planning, but some have short-term or immediate impact, which require crisis management.
4.2 Environmental uncertainty

No business can predict the future with absolute certainty. Strategic planning has to take place in the
context of an uncertain future environment – competitors may enter or leave markets, new
technologies may be discovered, governments may change, etc.
A business needs to think about how static or dynamic its future environment is likely to be. We have
already seen the chapter Organisational and business structures that these qualities can affect the
business’s structure.
4.2.1 Static environments

Some businesses exist in relatively static environments. For example, raw material producers such as
farmers often experience only slow environmental change. Other businesses are insulated from
change by institutional factors. Solicitors, for example, traditionally felt themselves to be protected
from competition by regulation.
The ‘Four Ss’ can be used to describe a static environment:
• Static – environmental change is slow
• Single – product/market
• Simple – technology
• Safe
In static situations there is often great value in studying the business’s historic and current
environment. As change is only slow the past can be a useful predictor of the future.
4.2.2 Dynamic environments

Most businesses face environments characterised by rapid change and complexity.
The ‘four Ds’ can be used to describe a dynamic environment:
• Dynamic – the speed of environmental change appears to increase through time
• Diverse – many businesses are now multiproduct and operate in many markets; business is also
increasingly international
• Difficult – because of the above factors analysis of the environment is not easy
• Dangerous – because of the above factors ignoring the environment can have serious
consequences for the business
In dynamic environments the past is often a poor guide to the future.
4.3 Analysing the general environment: PESTEL analysis

Using PESTEL analysis we can consider the environmental factors affecting a business’ industry under
six general headings as seen in Figure 4.4:
• Political factors
• Economic factors
• Social/demographic factors
• Technological factors
• Environmental/ecological factors
• Legal factors

Economic factors
• Globalisation Technological factors
• Business cycles • Government investment and R&D
• Interest rates policy
• Inflation • New discoveries: products and
• Unemployment methods of production
• Exchange rates • Speed of technology transfer
• Levels of R&D spending by
competitors
Ecological factors • Developments in other industries
• Sustainability issues, eg, energy, that could transfer across
natural resources • New developments: big data, data
• Pollution analytics and cyber security
• Green issues • Opportunity cost of failing to keep up
Pestel analysis
Social/demographic factors Political factors

• Income distribution • Social welfare policy
• Social mobility • Taxation policy
• Levels of education/health • Regulations
• Size of population • Government stability
• Location
• Age distribution Legal factors
• Lifestyle changes
• Competition legislation
• Consumerism
• Environmental protection laws
• Attitudes to work and leisure
• Employment law
• Green consumers
• Consumer protection
• Health and safety regulations
Figure 4.4: Possible items in a PESTEL analysis
The aim is to identify the factors which are currently affecting the industry and those which are likely
to become significant in the future. To avoid this becoming merely a listing exercise, the business
must identify the few key influences from all those identified by the analysis, that is, the key
opportunities available to it in the external environment, and the key threats which it faces.
Interactive question 1: Business environment

You have developed an idea to set up a business publishing brief study notes for student
accountants when you qualify. Have a try at analysing the external environment in which such a
business would exist.
4.3.1 Political influences

Political influences on businesses are dominated by the influence of government, which can and very
often does have a profound effect on the structure of entire industries.
Capacity Government policy can encourage businesses to increase or cut their

expansion capacity.

• Direct taxes can reduce demand and hence supply
• The tax system offers capital allowances to encourage investment in
equipment
• A variety of incentives exist for locating capacity in a particular area
• Incentives are used to encourage investment by foreign businesses
Demand • The government is a major customer

• Government can also influence demand by legislation, taxes or subsidies
Divestment and Government may take decisions regarding the selling off or closure of
rationalisation businesses, especially in sensitive areas such as defence.
Emerging These can be promoted by the government or damaged by it.

industries
Entry barriers Government policy can discourage firms from entering an industry, by
restricting investment or competition or by making it harder, by use of quotas
and tariffs, for overseas firms to compete in the domestic market.
Competition • The government’s purchasing decisions will have a strong influence on

the strength of one business relative to another in the market (eg,
armaments)
• Regulations and controls in an industry will affect the growth and profits
of the industry, eg, minimum product quality standards
• As a supplier of infrastructure (eg, roads), the government is also in a
position to influence competition in an industry.
• Governments and supra-national institutions such as the World Trade
Organization (WTO) might impose policies which keep an industry
fragmented, and prevent the concentration of too much market share in
the hands of one or two producers.
We shall see more about the effect of regulation and other government interventions on businesses
in the chapters The economic environment of business and finance, and External regulation of
business.
4.3.2 Economic factors

The economic environment is an important influence at local and national level. Here are some
factors to which businesses must attend.
Factor Impact
Local economic trends: Type of industry in the area. Office/factory rents. Labour rates. House
prices.
National economic trends:
Overall growth or fall in Increased/decreased demand for goods (eg, dishwashers) and
wealth (Gross Domestic services (eg, holidays).
Product or GDP)
Inflation Low in most countries; distorts business decisions; wage inflation

compensates for price inflation.
Interest rates How much it costs to borrow money (the interest rate) affects cash
flow. Some businesses carry a high level of debt. How much
customers can afford to spend is also affected as rises in interest
rates affect people’s mortgage and other debt payments.
Tax levels Corporation tax affects how much businesses can invest or return to
shareholders. Income tax and VAT affect how much consumers have

Factor Impact
to spend, hence their demand.
Government spending Suppliers to the government (eg, construction firms) are affected by
government spending.
The business cycle Economic activity is always punctuated by periods of growth

followed by decline, simply because of the nature of trade. The UK
economy has been characterised by periods of ‘boom’ and ‘bust’.
Government policy can cause, exacerbate or mitigate such trends,
but cannot abolish the business cycle. Industries which prosper
when others are declining are called counter-cyclical industries.
Productivity An economy cannot grow faster than underlying growth in

productivity without risking inflation.
We shall look at the economic environment in more detail in the chapter The economic environment
of business and finance.
4.3.3 Social/demographic factors

How a country’s population is made up – its demography – gives rise to factors that are important in
strategic planning.
Factor Comment
Growth The rate of growth or decline in a national population and in regional

populations.
Age Changes in the age distribution of the population.
Geography The concentration of population into certain geographical areas.
Household and A household is the basic social unit and its size might be determined by the
family structure number of children, whether elderly parents live at home etc. In the UK, there
has been an increase in single-person households and lone parent families.
Social structure The population of a society can be broken down into a number of
subgroups, with different attitudes and access to economic resources.
Employment In part, this is related to changes in the workplace and in legislation. There is
a move to a flexible workforce; factories have a group of core employees,
supplemented by a group of peripheral employees, on part-time, temporary
or zero-hours contracts, working as and when required.
Wealth Rising standards of living lead to increased demand for certain types of
consumer goods.
Social factors are also important in the context of society’s changing attitudes to certain issues such
as marriage, crime, sustainability etc. Very often these attitudes are voiced by the established media
(newspapers, TV, radio) and by social media (Twitter etc).
4.3.4 Technological factors

Technological change is rapid, and businesses must adapt themselves to it. It affects activities as
follows.
• The type of products or services that are made and sold
• The way in which products are made: equipment, new raw materials, automation (see the chapter
Introduction to financial information).
• The way in which services are provided, for example the internet.
• The way in which markets are identified (for instance, cognitive technologies, see the chapter
Developments in technology).
• The way in which businesses are managed.

• The means and extent of communications with external clients.
• The way in which businesses manage and analyse data (data science, big data and data analytics).
• The methods by which information is stored and communicated (cloud computing and
accounting, digitalisation of tax, distributed ledger technology, digital assets and the internet of
things).
• The risk of losing data or it being damaged through cyber-attack (cyber risk and security).
• The importance of developing and retaining knowledge and skills in technology (data science,
cognitive technologies, digital marketing).
4.3.5 Ecological factors
Factor Example
Resource inputs Managing physical resources sustainably (eg, replanting forests)
Waste output Managing more efficiently so as not to attract fines
Legislation The effect of transport on the natural environment, ‘food miles’
Government Pollution and recycling regulations
Disasters Increasing levels of natural disasters eg, mudslides, drought due to

global warming
Demand Consumers demanding environmentally friendly products and

disapproving of excessive waste packaging etc
Pressure groups Green activities have huge influence
Natural capital Being aware of the world’s stock of air, water, and land, and the
balance between renewable and non-renewable stocks of these
We shall discuss the impact of technology in more detail in the chapter Developments in technology.
4.3.6 Legal factors
Factor Example
General legal framework: Basic ways of doing business, negligence proceedings

contract, tort, agency
Criminal law Theft of industrial secrets, insider dealing, bribery, fraud, fraudulent
trading, market abuse, money laundering
Company law Directors and their duties, reporting requirements, takeover

proceedings, shareholders’ rights, insolvency, corporate
governance
Employment law Trade union recognition, minimum and living wage, unfair
dismissal, redundancy, maternity, equality, gender pay gap,
diversity, who qualifies as a ‘worker’
Health and safety law Fire precautions, safety procedures
Data protection Use of information about employees and customers
Consumer protection Laws to protect consumers (eg, refunds and replacement, ‘cooling
off’ period after credit agreements), what is or is not allowed in
advertising
Environment Pollution control, waste disposal
Tax law Corporation tax payment, digitalisation of tax, collection of income

tax (PAYE) and National Insurance contributions, VAT

4.4 Analysing the competitive (task) environment: Porter’s five forces analysis of an
industry
When looking at the competitive aspect of the task environment of the business, a very useful model
is the five forces analysis put forward by the strategist Michael Porter. To understand this model we
need to distinguish between a market and an industry.
Definitions
Market: Comprises the customers or potential customers who have needs which are satisfied by a
product or service.
Industry: Comprises those businesses which use a particular competence, technology, product or
service to satisfy customer needs, and which therefore compete with each other.
Porter states that there are five competitive forces which influence the state of competition in an
industry as a whole, illustrated in Figure 4.5:
• New entrants
• Customers
• Substitutes
• Suppliers
• Competitors in the industry
Collectively these determine the profit potential of the industry as a whole, because of the threats
they represent (new entrants and substitutes), the bargaining power they hold (customers and
suppliers), and the degree of rivalry that exists among current competitors in the industry.
Potential entrants
Threat of
new entrants
Bargaining
power of
suppliers Industry competitors
Suppliers Rivalry among Customers
existing firms Bargaining
power of
customers
Threat of substitute
products or services
Substitutes
Source: Adapted from Porter's Competitive Strategy
Figure 4.5: Porter’s five forces
4.4.1 The threat of new entrants (and barriers to entry to keep them out)
A new entrant into an industry will bring extra capacity and more competition. The strength of this
threat is likely to vary from industry to industry, depending on:
• the strength of the barriers to entry which discourage new entrants
• the likely response of existing competitors to the new entrant
Barriers to entry Comment
Scale economies

Barriers to entry Comment
As scale of operations increases, the cost per unit of the product or service
falls. This means that new entrants must start their operations on a large
scale or suffer a vast disadvantage. A high level of fixed costs also requires
entry on a large scale.
Static market If the market as a whole is not growing, the new entrant has to capture a
large slice of the market from existing competitors.
Product Existing firms in an industry may have built up a good brand image and
differentiation strong customer loyalty over a long period of time; they may promote a
large number of brands to crowd out the competition.
Investment When investment requirements are high, the barrier against new entrants
requirements will be strong, particularly when the investment would possibly be high-risk.
Switching costs Switching costs refer to the costs (time, money, convenience) that a
customer would have to incur by switching from one supplier’s products to
another’s. Although it might cost a consumer nothing to switch from one
brand of frozen peas to another, the potential costs for the retailer or
distributor might be high.
Access to Distribution channels carry products to the end-buyer. New distribution

distribution channels are difficult to establish, and existing distribution channels are
channels hard to gain access to.
Cost advantages of Include:

existing producers, • Patent rights
independent of
scale economies • Experience and know-how (the learning curve)
• Government subsidies and regulations
• Favoured access to raw materials
We shall look at economies of scale in more detail in the chapters The economic environment of
business and finance and External regulation of business.
Entry barriers might be lowered by:
• changes in the environment
• technological changes
• novel distribution channels for products or services
4.4.2 The threat from substitute products

A substitute product is a good/service produced by another industry which satisfies the same
customer needs.
Context example: The Channel Tunnel

Passengers have several ways of getting from London to Paris, and the pricing policies of the various
industries transporting them there reflect this.
(a) Le Shuttle carries cars in the Channel Tunnel. Its main competitors are the ferry companies,
offering a substitute service. Therefore, Le Shuttle sets its prices with reference to ferry company
prices, and vice versa.
(b) Eurostar is the passenger rail service from London to Paris/Brussels. Its main competitors are not
the ferry companies but the airlines. Initially, prices on the London-Paris air routes fell with the
commencement of Eurostar services, and some airlines cut the number of flights they offered.
Low-cost airlines changed this equation by offering a cheaper alternative.

4.4.3 The bargaining power of customers
Customers include both the ultimate consumer and the buyers forming the distribution channel.
Customers want better quality products and services at a lower price. Satisfying this might force
down the profitability of suppliers in the industry. Just how strong the bargaining of customers is
depends on several factors.
• How much the customer buys
• How critical the product is to the customer’s own business
• Switching costs (the cost to the customer of switching supplier)
• Whether the products are standard items (hence easily copied) or specialised
• The customer’s own profitability
• Customer’s ability to bypass the supplier or to take over the supplier
• The skills of the customer’s purchasing staff, or the price-awareness of consumers
• The importance of product quality to the customer
4.4.4 The bargaining power of suppliers

Suppliers can exert pressure for higher prices in the industry but their bargaining power is
dependent on several factors:
• Whether there are just one or two dominant suppliers to the industry, able to charge monopoly
or oligopoly prices (we shall see more about this in the chapter The economic environment of
business and finance)
• The threat of new entrants or substitute products to the supplier’s industry
• Whether the suppliers have other customers outside the industry, and so do not rely on the
industry for the majority of their sales
• The importance of the supplier’s product to the customer’s business
• Whether the supplier has a specialised product which buyers need to obtain
• Whether switching costs for their customers would be high
4.4.5 The rivalry amongst current competitors in the industry

The intensity of competitive rivalry within an industry will affect the profitability of the industry as a
whole. Competitive actions might take the form of price competition, advertising battles, sales
promotion campaigns, introducing new products for the market, improving after sales service or
providing guarantees or warranties.
The intensity of competition will depend on the following factors.
Factor Comment
Market growth Rivalry is intensified when firms are competing for a greater market share in a
total market where growth is slow or stagnant.
Cost structure High fixed costs are a temptation to compete on price, as in the short run any
sales are better than none at all.
Switching Suppliers will compete more fiercely if buyers switch easily (eg, Coke v Pepsi).
Capacity A supplier might need to achieve a substantial increase in output capacity, in

order to obtain reductions in costs per unit.
Uncertainty When one firm is not sure what another is up to, there is a tendency to respond
to the uncertainty by formulating a more competitive strategy.
Strategic If success is a prime strategic objective, firms will be likely to act very
importance competitively to meet their targets.
Exit barriers Make it difficult for an existing supplier to leave the industry.
• Long-term assets with a low break-up value (eg, there may be no other use
for them, or they may be old)

Factor Comment
• The cost of redundancy payments to employees

• If the business is a division or subsidiary of a larger enterprise, the effect of
withdrawal on the other operations within the group
Interactive question 2: Product rivalry

Select an industry with which you are very familiar, such as fashionable clothing. Try to identify
whether or not there is rivalry among the competing businesses in the industry.
4.5 Analysing the competitive (task) environment: competitor analysis

To analyse the situation and potential activities of competitors within the industry (the fifth force in
Porter’s model) we can use competitor analysis. The objective of this is to draw out those areas
where the business competes well and has a competitive advantage, and those where this is held by
the business’s rivals.
A business must define who its current competitors actually are. This group may be larger than is
immediately apparent. Coca-Cola, for example, competes against the following.
• Pepsi in the cola market, and retailers’ own brands
• All other soft drinks
• Tea and coffee
• Coca-Cola’s chief executive declared that “the main competitor is tap water: any other definition is
too narrow
4.5.1 Types of competitor

The marketing writer Philip Kotler lists four types of competitor depending on the relative level at
which the competitor operates.
• Brand competitors are similar firms offering similar products: for example, McDonald’s and
Burger King
• Industry competitors have similar products but are different in other ways, such as geographical
market, range of products or distribution methods: for example, online retailing (eg, Amazon) and
traditional retailing
• Generic competitors compete for the same disposable income with different products: for
example, iTunes (music) and Netflix (movies)
• Form competitors offer distinctly different products that satisfy the same needs: for example,
manufacturers of matches and those of cigarette lighters
For each competitor, the following factors can be analysed.
Factor to be analysed Comment
Competitor’s strategy • What are the business’s stated financial goals? What trade-offs are
(for the business as a made between long-term and short-term objectives?
whole and the relevant • Do managerial beliefs (eg, that the firm should be a market leader)
business unit) affect its goals?
• Organisation structure: what is the relative status of functional areas?
• What are the managers like? Do they favour one particular type of
strategy?
• To what extent does the business cross-subsidise others in the group
if the business is part of a group? What is the purpose of the
business: to raise money for the group?

Factor to be analysed Comment
The competitor’s • What does a competitor believe to be its relative position in the
assumptions about the industry (in terms of cost, product quality)?
industry • Are there any cultural or regional differences that indicate the way
the competitors’ managers are likely to respond?
• What does the competitor believe about the future for the industry?
• Does the competitor accept the industry’s ‘conventional wisdom’?
The competitor’s • distribution • organisation

current and potential • operations • research and engineering
situation with regard
to: • overall costs • managerial ability
• marketing and selling • products
• financial strengths
Competitor’s capability • What does the competitor do distinctively well – what are its core
competences?
• Does the competitor have the ability to expand in a particular
market?
• What competitive advantages and disadvantages does the
competitor possess?
All these are combined in a competitor reaction profile. This indicates the competitor’s vulnerability
and the right ‘battleground’ on which to fight.
Kotler lists four reaction profiles.
• The laid-back competitor does not respond to moves by its competitors.
• The tiger competitor responds aggressively to all opposing moves.
• The selective competitor reacts to some threats in some markets but not to all.
• The stochastic competitor is unpredictable.
Exam questions may test your ability to identify and use information to define business issues. When
analysing the external environment, it is important to remember that PESTEL is used for analysing the
macro environment, while Porters five forces and Competitor analysis are used to analyse the specific
industry that the business operates in.
5 Analysing the business

Section overview
• Internal analysis encompasses the business’s resources and competencies, value chain, supply
chain and products/markets.
• A resource audit looks at the business’s machinery, culture, structure and intangible assets,
management and the information they use, markets, materials, people, processes and finance.
• Activities in the value chain are designed to create value: the extra amount or margin that the
customer is prepared to pay for a product/service over and above its input costs.
• Primary value-adding activities: inbound and outbound logistics, operations, marketing and
service. Secondary activities support the value-adding ones: infrastructure, HRM, technology and
procurement.

• The business’s supply chain describes all the suppliers and partners who together support the
mutual effort to produce goods and services for customers. This integrated supply chain needs to
be managed effectively.
• The product life cycle describes how a product shows different levels of profitability and
investment over the different phases during which it is on the market: introduction, growth,
maturity and decline.
• The Boston Consulting Group (BCG) matrix analyses product and SBUs in terms of their relative
market share and potential for market growth, and identified appropriate strategies for each one.
5.1 What aspects of the business should be analysed?

Having completed its analysis of the external general and task environment, the business should next
analyse itself (its internal environment). This primarily involves analysis of:
• its resources and competencies, using a position and resource audit;
• its ‘value chain’;
• its supply chain; and
• its products and markets, using the product life cycle and the BCG matrix
5.2 Analysing resources and competencies (the position audit)

To develop a strategic plan, an organisation’s management must be aware of its current position.
Definition
Position audit: Part of the planning process which examines the current state of the entity in respect
of:
• resources of tangible and intangible assets and finance
• its competencies, that is what it has the ability to do well via its combination of resources, skills etc
• products, brands and markets
• operating systems such as production and distribution
• internal organisation
• current results
• returns to shareholders
• sustainability of business (eg, carbon emissions)
The 9 Ms model categorises the factors to be reviewed in a resource audit as follows.
Resource Example
Machinery Age. Condition. Utilisation rate. Value. Replacement. Technologically up-to-date?

Cost.
Make-up Culture and structure. Patents. Goodwill. Brands.
Management Size. Skills. Loyalty. Career progression. Structure.
Management Ability to generate and disseminate ideas. Innovation. Information systems.

information
Markets Products and customers.
Materials Source. Suppliers and partnering. Waste. New materials. Cost. Availability. Future
provision.
Men and Number. Skills. Wage costs. Proportion of total costs. Efficiency. Labour turnover.
women Industrial relations. Succession plans.
Methods How are activities carried out?

Resource Example
Money Credit and turnover periods. Cash surpluses/deficits. Short-term and long-term
finance. Gearing levels.
A resource audit should go on to consider how well or how badly resources have been used, and
whether the business’s systems are effective and efficient.
Every business operates under resource constraints, that is, limited resources.
Definition
Limiting factor or key factor: Anything which limits the activity of an entity. An entity seeks to
optimise the benefit it obtains from the limiting factor. Examples are a shortage of supply of a
resource or a restriction on sales demand at a particular price.
Once the limiting factor has been identified, the planners should:
• in the short term, make best use of the resources available; and
• try to reduce the limitation in the long term.
5.3 Analysing Porter’s value chain

The value chain model of corporate activities, developed by Michael Porter once again, offers a
bird’s eye view of the business and what it does. Competitive advantage, says Porter, arises out of the
way in which businesses organise and perform activities in taking inputs from the environment,
processing them, and selling them on at a selling price that is greater than the costs incurred.
Activities may be value drivers or cost drivers.
Definitions
Activities: The means by which a business creates value in its products. (They are sometimes referred
to as value activities.)
Value drivers: Elements of a product or service and activities that increase the amount of value
consumers place on it. They are a means of differentiating the product or service from the
competition and may include product features or intangibles such as branding.
Cost drivers: Any activity that affects the cost of a product or service.
Context example: Value chain in a restaurant

A restaurant’s activities can be divided into buying food, cooking it, and serving it (to customers).
There is no reason, in theory, why the customers should not do all these things themselves, at home.
The customer, however, is not only prepared to pay for someone else to do all this but is also
prepared to pay more than the cost of the individual resources (food, wages etc). The ultimate value
a business creates is measured as the amount customers are willing to pay for its products or services
above the cost of carrying out value activities. A business is profitable if the realised value to
customers exceeds the collective cost of performing the activities.
• Customers purchase value, which they measure by comparing a business’s products and services
with similar offerings by competitors
• The business creates value by carrying out its activities either more efficiently than other
businesses, or by combining them in such a way as to provide a unique product or service
Activities incur costs, and, in combination with other activities, provide a product or service which
earns revenue.
Interactive question 3: Creating value

Outline different ways in which the restaurant can ‘create’ value.

5.3.1 Activities in the value chain

Porter (2004) grouped the various activities of an organisation into a value chain (Figure 4.6).
Firm infrastructure
Support Human resource management
M
ar
activities
gi
Technology development
n
Procurement
Inbound Outbound Marketing
M
Operations Service
ar
logistics logistics & sales
gi
n
Primary activities
Figure 4.6: Value chain
The margin is the excess the customer is prepared to pay over the cost to the business of obtaining
resource inputs and providing value activities.
Definition
Value chain: The sequence of business activities by which, in the perspective of the end-user, value is
added to the products or services produced by an entity.
Primary activities are directly related to production, operations, sales, marketing, delivery and
service.
Primary activity Comment
Inbound logistics Receiving, handling and storing inputs to the production system (ie,
warehousing, transport, inventory control)
Operations Convert resource inputs into a final product. Resource inputs are not only
materials. ‘People’ are a ‘resource’, especially in service industries
Outbound logistics Storing the product and its distribution to customers: packaging,
warehousing, testing etc
Marketing and sales Informing customers about the product, persuading them to buy it, and
enabling them to do so: advertising, promotion etc
Service Installing products, repairing them, upgrading them, providing spare parts
and so forth
Support activities provide purchased inputs, human resources, technology and infrastructural
functions to support the primary activities.
Support activity Comment
Procurement Acquire the resource inputs to the primary activities (eg, purchase of
materials, subcomponents, equipment). See the section on analysing the
supply chain below
Human resource Recruiting, training, developing and rewarding people

management

Support activity Comment
Technology Product design, improving processes and/or resource utilisation

development
Firm infrastructure Planning, finance, quality control: Porter believes these are crucially
important to an organisation’s strategic capability in all primary activities
Linkages connect the activities of the value chain.

• Activities in the value chain affect one another. For example, more costly product design or
better quality production might reduce the need for after-sales service.
• Linkages require coordination. For example, reducing the level of inventory held requires smooth
functioning of operations, outbound logistics and service activities such as installation.
5.3.2 Using the value chain

A business can secure competitive advantage by:
• inventing new or better ways to do activities;
• combining activities in new or better ways;
• managing the linkages in its own value chain to increase efficiency and reduce costs; and
• managing the linkages in the value system
5.4 Analysing the supply chain

A simple view of the support activity of procurement would be to state that it is just about getting the
best price from suppliers for the best quality goods and services, based on an arm’s length
relationship with the supplier. Increasingly, however, a business looks beyond their immediate
suppliers (Tier 1 suppliers) to the whole supply chain supporting the business (Tier 1, Tier 2 suppliers,
as discussed in the chapter Managing a business) in a mutual effort to produce goods and services.
The business therefore needs to analyse its supply chain and see whether the principles of supply
chain management can be applied to improve efficiency.
Exam questions may test your ability to understand the specific issues that may arise in the context of
the situation described. You may be required to identify which activities are the most important for
the organisation. You will need to think about the particular business area and which activities
customers of that business value.
Definition
Supply chain management (SCM): Optimising the activities of businesses working together to
produce goods and services.
SCM is a means by which the business aims to manage the chain from input resources to the
consumer. It can involve the following aspects.
• Reduction in the number of suppliers and much closer partnership relationships with those that
remain
• Reduction in customers served for the sake of focus, and concentration of the company’s
resources on customers of high potential value
• Price and inventory co-ordination. Businesses co-ordinate their price and inventory policies to
avoid problems and bottlenecks caused by short-term surges in demand, such as promotions
• Linked computer systems – electronic data interchange (EDI) creates links between systems of
customers and suppliers that enable documents to be generated, transmitted and processed
electronically
• Early supplier involvement in product development and component design

• Carefully designed distribution system
• Joint problem-solving among supply chain partners
• Supplier representative on site
• Ensuring that all parties in the supply chain adhere to acceptable social and ethical practices (eg,
avoiding the exploitation of labourers in countries where labour laws are lax).
The aim is to co-ordinate the whole chain, from raw material suppliers to end customers. The chain
should be considered as a network rather than a pipeline – a network of vendors supports a network
of customers, with third parties such as transport firms helping to link the businesses.
5.5 Analysing products and markets: the product life cycle
Definition
Product life cycle: How a product demonstrates different characteristics of profit and investment over
time. Analysing it enables a business to examine its portfolio of goods and services as a whole.
The profitability and sales of a product can be expected to change over time. The product life cycle
is an attempt to recognise distinct stages in a product’s history. Marketing managers distinguish
between different aspects of the product.
• Product class: this is a broad category of product, such as cars, washing machines, newspapers
(also referred to as the generic product)
• Product form: within a product class there are different forms that the product can take, for
example five-door hatchback cars or two-seater sports cars; twin tub or front loading automatic
washing machines; national daily newspapers or weekly local papers, and so on
• Brand: the particular type of the product form (eg, Ford Focus)
The product life cycle applies in differing degrees to each of the three aspects. A product class (eg,
cars) may have a long maturity stage, and a particular brand might have an erratic life cycle (eg, Rolls
Royce) or not. Product forms however tend to conform to the classic life cycle pattern in Figure 4.7.
£
Sales
– Time
Profit/loss
Introduction Growth Maturity Decline
Figure 4.7: Product life cycle
Stage in life cycle Comments
Introduction A new product takes time to find acceptance by would-be purchasers and
there is a slow growth in sales. Unit costs are high because of low output and
expensive sales promotion. There may be early teething troubles with
production technology. The product for the time being is a loss-maker.

Stage in life cycle Comments
Growth If the new product gains market acceptance, sales will eventually rise more
sharply and the product will start to make profits. Competitors are attracted
and as sales and production rise, unit costs fall.
Maturity The rate of sales growth slows down and the product reaches a period of
maturity which is probably the longest period of a successful product’s life.
Most products on the market will be at the mature stage of their life. Profits
are good.
Decline Eventually, sales will begin to decline so that there is over-capacity of

production in the industry. Severe competition occurs, profits fall and some
producers leave the market. The remaining producers seek means of
prolonging the product life by modifying it and searching for new market
segments. Many producers are reluctant to leave the market, although some
inevitably do because of falling profits. Some producers may continue even
where there are losses, perhaps to support complementary products.
In the strategic analysis process, planners should assess:

• the stage of its life cycle that any product has reached
• each product’s remaining life, ie, how much longer the product will contribute to profits
• how urgent is the need to innovate, to develop new and improved products?
5.6 Planning products and markets: the BCG matrix

Another useful way to look at the products/services the business is engaged in and the markets it
services is to analyse them using the Boston Consulting Group (BCG) matrix.
BCG developed a matrix (Figure 4.8) based on research that assesses a business’s products in terms
of potential cash generation and cash expenditure requirements. Products, or SBUs, are categorised
in terms of market growth rate and relative market share.
Definition
Market share: One entity’s sale of a product or service in a specified market expressed as a
percentage of total sales by all entities offering that product or service.
• Assessing rate of market growth as high or low depends on the conditions in the market.
• Relative market share is assessed as a ratio: it is market share compared with the market share of
the largest competitor. Thus, a relative market share greater than 1 indicates that the product or
SBU is the market leader.
BCG Matrix
Relative market share
High Low
High Stars Build Question marks Build OR Harvest

Market growth
Low Cash cows Hold OR Harvest Dogs Hold OR Divest
• Stars. In the short term, these require capital expenditure (investment) in excess of the cash they
generate, in order to maintain their market position, but they promise high returns in the future.
Strategy: build (forgo short-term earnings and profits to build market share)
• In due course, stars will become cash cows. These need very little capital expenditure and
generate high levels of cash income. However, it is important to remember that apparently mature
products can be invigorated, possibly by competitors, who could thus come to dominate the
market. Cash cows can be used to finance the stars. Strategy: hold (maintain the market position)
or harvest (take maximum earnings in the short term at the expense of long-term development) if
weak

• Question marks. Do the products justify considerable capital expenditure in the hope of
increasing their market share, or should they be allowed to die quietly as they are squeezed out of
the expanding market by rival products? Strategy: build or harvest
• Dogs. These may be ex-cash cows that have now fallen on hard times. Although they will show
only a modest net cash outflow, or even a modest net cash inflow, they are cash traps which tie up
funds and provide a poor return on investment. However, they may have a useful role, either to
complete a product range or to keep competitors out. Strategy: divest (release resources for use
elsewhere) or hold
A business’s portfolio of products should be balanced, with cash cows providing finance for stars and
question marks, and a minimum of dogs.
6 Corporate appraisal
Section overview
• Corporate appraisal brings together the results of the external and internal analyses so that the
business can assess its strengths, weaknesses, opportunities and threats (SWOT analysis).
• Key areas for SWOT analysis are marketing, products/brands, distribution/logistics, research and
development of new products, finance, production capacity, inventory, management, staff,
technology and organisational structure.
Corporate appraisal brings together the analyses to date.
Internal appraisal
From the
of the business's
internal
STRENGTHS
analysis
WEAKNESSES
External appraisal
From the of the
external OPPORTUNITIES
analysis THREATS
facing the business
The business’s unique strengths, weaknesses, opportunities and threats are analysed using SWOT
analysis.
6.1 SWOT analysis
Definition
Corporate appraisal: A ‘critical assessment of the strengths and weaknesses, opportunities and
threats (SWOT analysis) in relation to the internal and environmental factors affecting an entity in
order to establish its condition before the preparation of the long-term plan’ (CIMA, 2005).
It is important to remember the phrase ‘critical assessment’ used in the definition above. A simple
listing of four types of factors is not likely to produce a robust and workable strategy. The managers
involved must have a detailed and intimate understanding of the nature and implications of the
factors. In particular, it is important to be realistic, erring neither towards optimism nor towards
pessimism.
6.1.1 Strengths and weaknesses

The internal appraisal seeks to identify:
• shortcomings in the business’s present skills and resources
• strengths in its skills and resources which it should seek to exploit

The precise content of the SWOT analysis will depend on the business. Here are some ideas.
Area Issues
Marketing Fate of new product launches

Use of advertising and social media
Market shares and market sizes
Growth markets
Success rate of the sales team
Level of customer/client service
Digital marketing
Products and brands Analysis of sales

Margin, and contribution to fixed costs
Product quality
Reputation of brands
Age and future life of products
Price elasticity of demand (see the chapter The economic
environment of business and finance)
Pricing policies (see the chapter Managing a business)
Distribution/logistics Service standards

Delivery fleet facilities
Geographical availability
GPS monitoring of delivery vehicles
Research and development Relevance

Costs
Benefits
Workload
Computer modelling systems
Finance Availability of funds

Contribution
Returns on investment
Accounting ratios
Cloud accounting
Plant and equipment/ Production capacity

production Value of assets
Land and buildings
Economies of scale (see the chapter The economic environment
of business and finance)
Use of robots
Raw material and finished Sources of supply

inventory Turnover periods
Storage capacity
Obsolescence and deterioration
Management and staff Age

Skills

Area Issues
Industrial relations
Training
Recruitment
Communications
Electronic communication
Technology How advanced?

Kept up-to-date?
Bespoke or off-the-shelf
How secure?
Fit with business strategy
Automation and cognitive technologies
Business management and Organisation structure

organisation Leadership style
Communication links
Information systems
Impact on the environment (eg, carbon emissions)
Social impact
6.1.2 Opportunities and threats

The external appraisal should identify:
• profit-making opportunities which can be exploited by the business’s strengths; and
• environmental threats (a declining economy, competitors’ actions, government legislation,
industrial unrest, climate change, etc) against which the business must protect itself
For opportunities, it is necessary to answer the following questions:
• What opportunities exist in the business environment?
• What is the capability profile of competitors? Are they better placed to exploit these
opportunities?
• What is the company’s comparative performance potential in this field of opportunity?
For threats, it is necessary to answer the following questions:
• What threats might arise, to the business or its environment?
• How will competitors be affected?
Opportunities and threats might relate to any or all of the items covered in the PESTEL analysis plus
those in the five forces analysis (customers, suppliers, new entrants, substitutes, and of course
competitors).
Interactive question 4: Opportunities and threats

Consider your chosen career. How well-placed are you to make a success of it?
6.2 Combining the elements of the SWOT analysis

SWOT analysis indicates the types of strategy that appear to be available, to exploit strengths and
opportunities and to deal with weaknesses and defend against threats.
• Major strengths and profitable opportunities can be exploited, especially if strengths and
opportunities are matched with each other

• Major weaknesses and threats should be countered, or a contingency strategy or corrective
strategy developed
The SWOT analysis is summarised on a cruciform chart. In the example below, the development of
potential strategies from the analysis is illustrated.
Strengths Weaknesses
£10 million of capital available. Heavy reliance on a small number of customers.

Production expertise and appropriate Limited product range, with no new products
marketing skills. and expected market decline.
Small marketing organisation.
Opportunities Threats
Government tax incentives for new investment. Major competitor has already entered the new
Growing demand in a new market, although market.
customers so far relatively small in number.
The business seems to be in imminent danger of losing its existing markets. A new market
opportunity exists to be exploited and since the number of customers is currently few, the relatively
small size of the existing marketing force would not be an immediate hindrance.
In practice, a combination of financial, competition and institutional strategies will be required, as
we shall see.
7 Setting strategic objectives

Section overview
• Analysis of the business’s mission and objectives allows it to determine exactly what it is trying to
achieve.
• Stakeholder analysis – ie, what the business’s stakeholders are trying to achieve – informs this
analysis.
• Stakeholders have internal and external sources of power, and have varying levels of interest in
the business. Relative power and interest are assessed via stakeholder mapping, which
determines how far the business should reflect what the stakeholders want. This should be
incorporated in its mission statement.
• The business’s mission feeds down to its corporate strategy (strategic objectives), then its
competitive, investment and financial strategies/goals/targets, its business strategies and its
functional/operational strategies, plans and standards.
7.1 What are we trying to achieve?

It is at this point that we look at the business mission and objectives. What is the business about, who
is it for, and what is it aiming to achieve? To answer these questions, we need to conduct a detailed
stakeholder analysis, before formulating the business’s mission and objectives.
7.2 Stakeholder analysis

In the chapter Introduction to business, we outlined what a stakeholder is. We now need to look at
how stakeholders’ goals and objectives for the business are balanced in order to determine what the
business’s goals and objectives should be, in the light of corporate appraisal.
Because of the different interests at stake, the needs and objectives of each set of stakeholders are
bound not to correspond; indeed, they often conflict.

Stakeholders Conflict
Shareholders vs managers/directors Profit vs growth
Shareholders vs managers/directors Growth via merger vs independence
Shareholders vs employees Cost efficiency vs jobs
Customers vs shareholders and Service levels vs profits and costs

managers/directors
Shareholders vs bankers Return vs risk
Ultimately the business’s objectives tend to follow the wishes of the most dominant stakeholders, its
directors/managers, but they are constrained by those of other stakeholders, notably shareholders.
The business needs to pay attention to all stakeholders, whether their needs determine or indeed
have any effect on the business’s objectives depends on the relative power of the stakeholder
groups.
7.2.1 Stakeholder mapping: power and interest

The economist Aubrey L Mendelow maps stakeholders on a matrix (Figure 4.8) whose axes are
power held and the level of interest in the business’s activities. These factors help define the type of
relationship the business should seek with its stakeholders.
Level of interest
Low High
A B
Low
Power
Minimal Effort Keep Informed
C D
High
Keep Satisfied Key Players
Figure 4.8: Mendelow’s power/interest matrix
Power is the means by which stakeholders can influence a business’s objectives. Sources of power
may be internal or external.
Internal sources of power Comment

(for directors/managers
and employees)
Hierarchy Formal power over others in the business shown by span of control
Influence/reputation Informal power from either charismatic leadership or group

consensus on a particular issue
Relative pay Better paid employees such as directors and managers have more
position power as a result
Control of strategic For example, trade unions when demand for output is high and
resources labour is scarce, or size of budget allocation
Knowledge skills Individuals deriving power from their specialist knowledge or skills
Environmental control Finance and marketing staff may have a more detailed knowledge of
the external environment than other functional staff, such as
production

Internal sources of power Comment
(for directors/managers
and employees)
Strategic implementation Many people are involved in implementing strategy, and the use of
involvement personal discretion in decision-making can give some element of
power
External sources of power Comment
Control over strategic Major suppliers, banks (finance) and shareholders (finance) can exert
resources this form of power
Involvement in Distribution outlets have greater knowledge of customer

implementation requirements than manufacturers and can therefore dictate to
manufacturers, rather than vice versa
Knowledge and skills Subcontractors have power if they perform vital activities for a
business
External links Public services often consult a wide variety of external stakeholders
in decision-making and therefore these stakeholders have an
informal influence over the organisation
Legal rights Eg, government, planning authorities
The interests of stakeholders involve consideration of two factors.

• Where their interest rests, eg, shareholders want dividends and capital growth, employees want
higher pay and good conditions, customers want low prices, reliable supplies, and so on
• How interested they are, for instance they will be interested if there are alternatives (job, supplier,
customer etc), if they are the industry regulator, or if there is a significant capital investment
When considering a potential strategy, the stakeholder should be placed in the appropriate
quadrant depending on the nature and level of their power and level of interest. The quadrant where
they are placed – A, B, C or D – determines how they should be approached.
• Key players are found in segment D: strategy must be acceptable to them at least and ideally they
should participate in it. An example would be a major customer.
• Stakeholders in segment C must be treated with care. While often passive, they are capable of
moving to segment D. The business should intervene with these stakeholders and keep them
satisfied. Large institutional shareholders might fall into segment C.
• Stakeholders in segment B do not have great ability to influence strategy, but their views can be
important in influencing more powerful stakeholders, perhaps by lobbying. They should therefore
be kept informed by education and communication. Community representatives and charities
might fall into segment B.
• Minimal effort is expended on segment A – they can simply be directed.
A single stakeholder map is unlikely to be appropriate for all circumstances. In particular,
stakeholders may move from quadrant to quadrant when different potential future strategies are
considered.
Exam questions may test your ability to evaluate the impact of a business proposal on an entity.
When considering whether strategies are appropriate, it is necessary to consider how key
stakeholders would react to them, particularly stakeholders in segment D and C of Mendelow’s
matrix.

7.3 Determining the mission and strategic objectives
As we saw in the chapter Introduction to business, the business’s mission describes its basic function
in society. The mission can be set at the beginning of the strategic planning process, or it can derive
from it after the corporate appraisal. It can include the business’s vision of its future state, or the
future state of the industry.
The mission feeds down into a set of strategic objectives, which are statements of intent to particular
stakeholders such as shareholders or employees, building on stakeholder analysis. These are broken
down further into goals, expressed as targets for the business as a whole and for SBUs in it. In this
way, the targets for SBUs are designed with the business’s strategic objectives and mission in mind,
so there is goal congruence. This ‘top down’ approach to formulating the final strategic plan can be
expressed as a hierarchy (Figure 4.9).
Mission statement Mission
Strategic
Corporate strategy
objectives
Competitive
Investment strategies Goals = targets
Financial
Business strategies Strategies
Functional strategies Plans and standards
Figure 4.9: Hierarchy of objectives and strategies (top down approach)
For each SBU in the business, business and functional (or operational) strategies need to be
determined which will ensure that targets are met. These are then broken down into detailed plans
to be implemented according to specified standards.
7.3.1 Mission statement
Definition
Mission statement: A formal document that states the business’s basic function in society expressed
There is no standard format for a mission statement, but a good basis is to include the four elements
we saw in the chapter Introduction to business: purpose of the business, strategy (what it does and
how), values and policies and standards of behaviour.
7.3.2 Strategic objectives
Definition
Strategic objectives: The primary strategic objective – in the case of a business, to make a profit for
shareholders – plus other major objectives addressed to the stakeholders.
An example of a statement of strategic objectives is as follows:

‘Our primary aims are to provide a sound investment for our shareholders by increasing shareholder
value and also worthwhile job prospects for our employees. Our objectives are increasing levels of

customer satisfaction, real growth in earnings per share and a competitive return on capital
employed.’
In the chapter Introduction to risk management we shall see how the business’s attitude to and
appetite for risk feeds into the strategic planning process at this point.
7.3.3 Goals and targets

For the business as a whole and for SBUs in it, the strategic objectives should be translated into
quantified and specific goals. In relation to the statement of strategic objectives above, for the
business concerned these could be as follows.
Area Goals Target
Revenue Growth £3 million from £2.5 million this year
Gross margin Increase Cost of sales represents 65% of revenue,

down from 70%
Expenses Reduce Overheads cut to £300,000 from £450,000
Earnings per share Growth From £300,000/1.2m = 25p

To £660,000/1.2m = 55p
Return on capital More competitive From £300,000/6m = 5%

employed To £660,000/6.6m = 10%
Shareholder value Increase Move from share price of £2 per share to

£2.20
Employee job Worthwhile Ensure fewer employees leave the business

prospects and more enter training to ensure career
progression
Customer loyalty Ensure customers are Raise customer service levels. We shall see
increasingly satisfied more about targets in the chapter The
business’s finance function.
7.3.4 Strategies, plans and standards

The strategies that are chosen by the business need to be ones which can achieve the targets set out,
for instance to increase sales, reduce costs and raise capital. As we saw in section 2 of this chapter,
these are initially specific business strategies that tie in with the overall corporate strategy of the
business, comprising:
• the competitive strategy – which products and markets do we operate in?
• the investment strategy – what systems, structure and assets do we need to invest in?
• the financial strategy – how are we going to raise the necessary funds?
A functional strategy for each area – operations, marketing, HR, procurement, IT and finance – plus
detailed plans and standards are then developed that will ensure the targets are met.
8 Choosing a corporate strategy

Section overview
• The business needs a competitive strategy, an investment strategy and a financial strategy.
• Generic competitive strategies are cost leadership (being the producer at the lowest cost, not
necessarily the producer who charges the lowest prices to consumers), differentiation (being the
producer of unique and desirable products) and focus (being a niche producer for part only of a
market, concentrating either on cost or on differentiation in that niche).

• Product/market strategies comprise market penetration (sell more of the current product in the
current market), product development (sell new product in the current market), market
development (sell the current product in a new market) and diversification (sell new product in a
new market).
• Corporate strategies can be evaluated using SFA analysis in terms of Suitability, Feasibility and
Acceptability to stakeholders.
8.1 Do we have to choose a new corporate strategy?

The business can simply choose to continue with its current corporate strategy. Assuming there is a
gap between what the business is already achieving and what it wants to achieve, however, there will
be a need to select competitive, financial and investment strategies that will ensure that strategic
objectives are met.
Porter’s generic competitive strategies and Ansoff’s matrix provide suggested competitive strategies
from which the business selects on the basis of how effectively they meet its objectives.
8.2 Porter’s generic competitive strategies
Definition
Competitive strategy: ‘Taking offensive or defensive actions to create a defendable position in an
industry; to cope successfully with…competitive forces and thereby give a superior return on
investment for the business.’ (Porter, 1980).
Michael Porter holds there are three generic competitive strategies: cost leadership, differentiation
and focus (niche).
Definitions
Cost leadership: Producing at the lowest cost in the industry as a whole (not necessarily being the
producer offering the lowest prices to the consumer, though the cost leader can compete freely on
price in the marketing mix).
Differentiation: The provision of a product or service which the industry as a whole believes to be
unique.
Focus (or niche) : Involves a restriction of activities to only part of the market (a segment) through:
• providing goods and/or services at lower cost in that segment (cost-focus); and
• providing a differentiated product or service to that segment (differentiation-focus)
Cost leadership and differentiation are industry-wide strategies. Focus involves segmenting the
market but involves pursuing, within one or just a few segments only, a strategy of cost leadership or
differentiation.
8.2.1 Cost leadership

By producing at the lowest cost, the cost leader can compete on price with every other producer in
the industry, and earn higher unit profits, if it so chooses.
How to be the cost leader
• Set up production facilities to obtain economies of scale
• Use the latest technology
• Concentrate on improving productivity
• Minimise overhead costs
• Get favourable access to sources of supply
• Relocate operations to cheaper countries

8.2.2 Differentiation
The business competes on the basis of particular characteristics of its products. Products may be
categorised as follows.
• Breakthrough products offer a radical performance advantage over competition, perhaps at a
drastically lower price.
• Improved products offer better performance at a competitive price.
• Competitive products offer a particular combination of price and performance.
How to differentiate
• Build up a brand image
• Give the product special features to make it stand out
• Exploit other activities of the value chain such as marketing and sales or service
• Use IT to create new services or product feature
• Offer products that do not have a harmful impact on the environment
8.2.3 Focus (or niche) strategy

The business concentrates its attention on one or more particular segments or niches of the market,
and does not try to serve the entire market with a single product.
• A cost-focus strategy: aim to be a cost leader in a particular niche
• A differentiation-focus strategy: pursue differentiation for a chosen niche
8.3 Ansoff’s matrix: product/market strategies

The mathematician Igor Ansoff drew up a matrix (Figure 4.10) describing how a combination of a
business’s activities in current and new markets, with existing and new products, can lead to four
different competitive strategies for growth.
Product
Existing New
Current
Market Product
Market
penetration development
Market
New
Diversification
development
Figure 4.10: Ansoff’s product/market matrix
8.3.1 Existing products in current markets: pursue market penetration

• Maintain or increase share of current markets with existing products, eg, through competitive
pricing, advertising, sales promotion
• Secure dominance of growth markets
• Restructure a mature market by driving out competitors
• Increase usage by existing customers (eg, airmiles, loyalty points, differential pricing)
8.3.2 Existing products in new markets: pursue market development

• New geographical areas and export markets
• Different package sizes for products eg, food and other domestic items
• New distribution channels to attract new customers
• Differential pricing policies to attract different types of customers and create new market
segments

8.3.3 New products in current markets: pursue product development
• Introduce new products to existing and new customers in current markets
• Product development forces competitors to innovate
• Newcomers to the market might be discouraged
8.3.4 New products in new markets: pursue diversification

The business should have a clear idea about what it expects to gain from diversifying to new
products and new markets at the same time.
• Growth. New products and new markets should be selected offering prospects for growth which
the existing product-market mix does not
• Surplus funds not required for other expansion needs can be invested in diversification, or they
could be returned to shareholders
8.4 SFA analysis

If a business has developed alternative corporate strategies it needs to:
• evaluate each strategy; then
• choose the best one.
Gerry Johnson and Kevan Scholes set three criteria for evaluating and choosing strategies, to be
applied in a process known as SFA analysis: Suitability, Feasibility and Acceptability.
8.4.1 Suitability of the strategy

Does the strategy fit the business’s operational circumstances? Does it:
• exploitstrengths?
• rectify weaknesses?
• neutralise or deflect environmental threats?
• help the business to seize opportunities?
• satisfy the business’s objectives?
• generate/maintain competitive advantage?
• involve an acceptable level of risk?
• meet the technological challenges facing the industry and business?
• enable the business to meet its sustainability objectives?
8.4.2 Feasibility of the strategy

Can the strategy in fact be implemented?
• Is there enough money?
• Is there the ability to deliver the goods/services specified in the strategy?
• Can we deal with the likely responses that competitors will make?
• Do we have access to technology, materials and resources?
• Do we have enough time to implement the strategy?
Strategies which do not make use of existing competences, and which therefore call for new
competences to be acquired, might not be as feasible as alternative strategies because:
• gaining competences via organic growth takes time; and
• acquiring new competences can be costly
8.4.3 Acceptability of the strategy to stakeholders

The acceptability of a strategy relates to people’s expectations of it. It is here that stakeholder
analysis can be brought in, which we saw earlier in this chapter.
• Financial considerations. How far do alternative strategies contribute to meeting the dominant
objective of increasing shareholder wealth?
• Customers may object to a strategy if it means reducing service, but on the other hand they may
have no choice.

• Government. A strategy involving a takeover may be prohibited under competition law (see the
chapter External regulation of business). Similarly, the environmental impact may cause key
stakeholders to withhold consent.
• The public. Is the strategy socially and environmentally sustainable, and does it avoid
unacceptable increases in greenhouse gases?
• Risk. Different shareholders have different attitudes to risk. A strategy which changed the
risk/return profile, for whatever reason, may not be acceptable. We shall look at risk in more detail
in the chapter Introduction to risk management.
This skill includes the ability to present recommendations in accordance with defined criteria. The
SFA model assists you in recommending strategies based on these criteria. You must be clear about
the meaning of these criteria.
9 Implementing the strategy

Section overview
• To implement the chosen corporate strategy, the competitive, investment and financial strategies
need to be broken down so there are business strategies and plans for each SBU, and within
these there are functional strategies and operational plans. These are then expressed in budgets.
9.1 Breaking the strategy down

The selected corporate strategy comprises competitive, investment and financial strategies (see
Figure 4.9). There are then further broken down as we have seen into business and functional
strategies.
• Business strategies determine how competitive advantage is gained by a particular SBU, and in
particular how the marketing mix must be adjusted to achieve this.
• Functional strategies develop the business strategy for an SBU as it affects the:
– marketing function;
– production/operations function
– human resources function;
– finance function; and
– IT function
9.2 Levels of plan

To implement the strategies, plans need to be produced.
• The strategic plan, as we have seen, embodies the corporate strategy and strategic objectives. It
sets out the general direction that will be taken to achieve the corporate objectives but it is not
itself very detailed.
• The business plan for the business as a whole or for an SBU sets out the market(s) to be served,
how the business/SBU will serve the market(s), and what finance is required (based on the
business strategy).
• The operational plan specifies what is expected of each function in the business as a whole or an
SBU, based on the relevant functional strategy, and how specific actions will be taken in order to
meet that expectation.
Finally, budgets are prepared that set out the business’s plan for a defined period, expressed in
money terms. Usually a business has a variety of budgets at different levels of detail. The board of
directors has a summarised or master budget for the whole entity that expresses the entire strategic

plan, while separate functions in an SBU of that entity have detailed budgets for what each particular
function needs to do to ensure that the master budget is achieved.

Summary
Strategic management
• Scope of activities • Long-term direction • Allocation of resources
Strategic planning Benefits/drawbacks
Strategic analysis Strategic choice Strategic plans

• Internal analysis • Generic competitive • Corporate plan (corporate
(resource audit, strategies (Porter) mission/objective
position audit, value • Product/market Product/market
chain, supply chain, strategies (Ansoff) Investment decisions
product life cycle, • Strategic evaluation Financial)
BCG matrix) (stakeholder analysis, • Business plan
• External analysis risk analysis, (compeition strategy)
(PESTEL, five forces, suitability, feasibility, • Operational plans
competitor analysis) acceptability) (Business and functional
• Corporate appraisal • Strategy selection strategies)
(SWOT) • Budgets
• Establish mission,
goals objectives
(stakeholder
analysis, mission
statement, strategic
objective, goals and
targets, strategies,
plans and standards)

indicated.
1 Can you distinguish between corporate, business and functional strategies? (Topic 1)
2 Do you know what PESTEL stands for, and do you know how each of these may impact
on a business’s strategy? (Topic 4)
3 Do you understand each of the five forces within Porter’s model and are you aware of
how each will impact on the competitive nature of an industry? (Topic 4)
4 Can you name the activities in Porter’s value chain and can you distinguish between
primary activities and support activities? (Topic 5)
5 Can you describe the four stages of the product lifecycle? (Topic 5)
6 Can you name the four quadrants of the Boston Consulting Group matrix? (Topic 5)
7 Can you draw a SWOT chart? (Topic 6)
8 Can you draw a Mendelow’s matrix? (Topic 7)
9 Can you name and explain Porter’s three generic strategies? (Topic 8)
10 What are the four strategies for growth in Ansoff’s product/market matrix? (Topic 8)
11 What are the three levels of plan that are produced from the strategy? (Topic 9)

questions in the Introduction to business strategy of the Business, Technology and Finance Question
Once you have attempted these questions, you can move on to the next chapter, Introduction to risk
management.

• CIMA (2005). CIMA Official Terminology. Oxford, CIMA.

• Crask, J. (2014) Building a resilient organisation. London, ICSA Information and Training.
• Johnson, G., Scholes, K. and Whittington, R. (2007) Exploring Corporate Strategy. 8th edition.
Harlow, Pearson Education Limited.
• Porter, M. (1980) Competitive Strategy. New York, Free Press.

Self-test questions

1 Competitors exist in the business’s:
A physical environment
B general environment
C task environment
D internal environment
2 Linker plc has just been informed of a significant new regulation with which it needs to comply
immediately. In relation to this, which of the following statements is true?
A There has been a change in Linker plc’s task environment which it can cope with using planning.
B There has been a change in Linker plc’s general environment which it can cope with using crisis
management.
C There has been a change in Linker plc’s task environment which it can cope with using crisis
management.
D There has been a change in Linker plc’s general environment which it can cope with using
planning.
3 Minion plc has conducted a five forces analysis of its industry. This states that competition in the
industry will become less intense in the medium term. Which of the following factors alone would
explain this?
A The government has set a minimum capital requirement for anyone entering the industry.
B A product which claims to eliminate the need for Minion plc’s product has been launched.
C The income levels of Minion plc’s target market are being eroded by inflation.
D A key raw material is now in short supply.
4 Xenon plc runs restaurants while Zenos plc operates a chain of cinemas. The two companies are:
A industry competitors
B generic competitors
C form competitors
D brand competitors
5 A competitor with a stochastic reaction profile:
A reacts aggressively to all opposing moves by competitors
B does not react to any moves by competitors
C reacts to some moves by competitors, but not all
D reacts unpredictably to competitor moves
6 Which of the following is a primary activity in Porter’s value chain?
A HRM
B Procurement
C Outbound logistics
D Technology development

7 Penpen plc’s ‘freb’ product has high market share in a market that is fully saturated. In terms of the
BCG matrix, for Penpen plc the ‘freb’ is:
A a star
B a cash cow
C a question mark
D a dog
this chapter.


You may have thought of some of these factors, or maybe some others. You should have structured
your analysis using the PESTEL framework.
• Political factors: status/value of professional exams in education and employment system,
potential regulation of tuition and study methods, effect of laws on the future of the accountancy
profession as a whole, possible political instability.
• Economic factors: effect of business cycle on recruitment of student accountants, effect of interest
and exchange rates on business, potential for global market.
• Social factors: acceptability of accountancy as a profession, levels of education of entry level
accountants, size of population and therefore number of student accountants.
• Technological factors: in what format will study notes be published, and how accessible is the
technology to the target market? Can technology help to prevent copyright infringements? How
are technological developments, including use of big data, distributed ledger technology,
automation and cognitive technologies, changing the accountancy profession and the areas in
which students need to be trained?
• Ecological factors: how to produce and market study notes in a ‘green’ way.
• Legal factors: employment and health and safety issues; how can the study notes keep up with
changes to the law that need to be included in them?

You should have attempted an analysis of the industry from the perspective of the five forces that
together determine the degree of competition in it: buyers’ and suppliers’ bargaining power, the
threat of substitutes and new entrants, and the number and power of industry competitors. If you
selected one business in an industry such as fashion clothing then you will quickly have realised that
it is highly competitive. There are relatively low barriers to entry and a very high level of substitutes
available, so competition is intense. Customers are notoriously fickle and have strong bargaining
power, though suppliers have less power so the industry is able to push costs lower all the time.

Each of these options is a way of organising the activities of buying, cooking and serving food in a
way that customers will value.
• It can become more efficient, by automating the production of food, as in a fast food chain.
• The chef can develop commercial relationships with growers, so he or she can obtain the best
quality fresh produce at a good price.
• The chef can specialise in a particular type of cuisine (eg, Nepalese, Korean).
• The restaurant can be sumptuously decorated for those customers who value ‘atmosphere’ and a
sense of occasion in addition to a restaurant’s purely gastronomic pleasures.
• The restaurant can serve a particular type of customer (eg, celebrities).

You should have answered this question by using SWOT analysis in terms of your strengths and
weaknesses, and the opportunities and threats that face you. It should naturally have led you onto
considering how you can overcome your weaknesses and build on your strengths. It should have
made you think about whether you know enough about where the opportunities for doing what you
want with your career really lie, and about what potential threats to these may lie ahead.

C task environment
B There has been a change in Linker plc’s general environment which it can cope with using crisis
management.
A regulation is a political/legal factor in the general environment; a regulation taking effect in a short
timescale requires crisis management, while one taking place in the long term requires planning.
A The government has set a minimum capital requirement for anyone entering the industry.
A minimum capital requirement is a barrier to entry, so new entrants will be deterred and
competition will decrease. Each of the other factors should lead to increased competition: B is a new
substitute, C increases the bargaining power of customers, and D increases the bargaining power of
suppliers.
B generic competitors
Restaurants and cinemas compete for the part of consumers’ income that is allocated to
leisure/entertainment
D reacts unpredictably to competitor moves
A, B and C describe tiger, laid back and selective reactions respectively.
C Outbound logistics
All the others are secondary, support activities.
B a cash cow

Chapter 5
Introduction to risk
management
Introduction
Learning outcomes
Syllabus link
Assessment context
Learning topics
1 Introduction to risk
2 Risks for businesses and their investors
3 Types of risk
4 Risk concepts and measurement
5 The objectives of risk management
6 The risk management process
7 Crisis management
8 Business resilience
9 Disaster recovery and business continuity planning
Summary
Self-test questions
Introduction
Learning outcomes
• Identify the main components of the risk management process and show how they operate
• Identify the key issues in relation to crisis management, business resilience, business continuity
planning and disaster recovery
• Specify types of risk and techniques for measuring risk, including: measures of central tendency
(mean, mode, median); measures of spread (range, standard deviation, variance, co-efficient of
variation); the normal distribution; skewness
Specific syllabus references are: 1f, 1g; 3f
5
Syllabus link
The topics covered in this introduction to risk management are also developed in assurance at
Certificate level, in Audit and Assurance, Business Strategy and Technology, and Financial
Management at Professional level, and in the Advanced level assessments.
5
Assessment context
Questions on risk management will be set in the assessment in either MCQ or multiple response
format. They will be either straight tests of knowledge or applications of knowledge to a scenario.
5

of this chapter.
Topic Practical Study approach Exam approach Interactive

significance questions
1–2 Introduction to risk/ Approach Questions on risk IQ1: Business

Risks for businesses The first two management could risk gets you to
and their investors sections of the easily appear in the think about risks
The effective chapter introduce exam. that businesses
management of risk the concept of risk Questions are likely to you know may
is a key task in any and the risks faced be set in a scenario face
business and by businesses. context. Knowledge-type
accountants can get Note the definition questions are also likely,
heavily involved in of risk and the set on particular
the process of difference principles or definitions.
identifying, between risk and Essential points are:
measuring and uncertainty.
monitoring risk. • Risk, uncertainty and
Stop and think their effects on
Whether a business
thrives or fades is What does the businesses
determined at least term ‘risk’ mean to themselves and their
in part by how it you? Have you investors
manages the risks considered how
that things may go you manage the
wrong, and how far risks that worry
it exploits its you most in your
opportunities, life? Do you just
where things go accept that we all
well. Risk have to live with
management is, risk or do you try
to find ways to

therefore, not minimise how

merely a defensive much you would
attempt to avoid suffer if a
losses; it is integral perceived risk
to seeking and actually
exploiting happened? These
competitive are the issues that
advantage. In face businesses as
addition, effective well.
risk evaluation and
management is
increasingly
becoming a
regulatory
requirement.
3 Types of risk Approach Questions on types of

It is important to be Read through the risk are likely to come up
able to identify the topic to be aware in your exam. They will
risks that an of the different test that you know the
organisation faces. types of risk. Learn meaning of the different
While different the difference types of risk.
companies face between business Essential points are:
different types of risk, financial risk • Difference between
risk, many of the and operational business risk, financial
risks included here risk. risks and operational
are common to a Stop and think risks.
majority of
businesses. What types of
industry
experience low
business risk and
what types of
industry
experience higher
business risk?
4 Risk concepts and Approach There may be questions ICQ 2: Mean,

measurement Work carefully requiring you to median and
Having a systematic through this interpret the meaning of mode
approach to important section. particular measures. ICQ 3: Measures
managing and Ensure you There may also be of dispersion
measuring risk understand the questions involving
should lead to more various concepts. basic calculations of the
effective decision For the measures of central
making regarding quantitative tendency and
the risks that are measures, ensure dispersion. There will be
being taken on by you understand questions about the
organisations the meaning of advantages and
these and their disadvantages of the
importance to methods discussed.
decision makers.
5–6 Objectives and Approach Questions on this area IQ4: Indemnity

process of risk Know the meaning could easily come up in insurance: This
management of risk the exam, particularly question looks at
management from from topic 6 dealing with risks specific to
ICAEW 2023 5: Introduction to risk management 153

There may be topic 5. The risk management. accountants in

regulatory or legal process of risk Questions are likely to practice
requirements for management is include practical
some companies to covered in detail scenarios to see if you
have a formal risk in topic 6. Learn can apply your
management the steps in the knowledge (eg, by
process in place. risk management recommending a risk
These sections process in Figure response to a particular
explain what risk 5.6, and learn the situation).
management four possible Essential points are:
involves. responses to risk.
• Risk concepts:
Stop and think exposure, volatility,
Assess the risk of impact and
your home being probability
destroyed by fire, • Definition of risk
in terms of management
probability and
the impact this • Risk management
would have on process
your life. How have • The risk assessment
you managed this map
risk? Does this
match the risk
responses given in
Figure 5.6?
7–9 Crisis management, Approach Questions in this area IQ5:

business resilience Read through are likely to present you Contingency
and disaster topics 7, 8 and 9 at with practical scenarios planning helps
recovery and least twice: and ask you what steps you to think
business continuity remember crisis might be appropriate about how you
planning management, (eg, in a disaster might plan for
The impact of some business resilience recovery plan). the occurrence of
risks can be so large and business Essential points are: a specific crisis.
that they threaten continuity plans • Crisis management
the very existence of are extreme forms
the organisation. of risk • Business resilience
These three sections management. • Business continuity
look at how Stop and think plans
management can
plan for such risks. What types of plan
could your
employer put in
place so that the
business could
recover from a
major crisis such
as the destruction
of head office by
fire?

1 Introduction to risk
Section overview
• Risk means that something can turn out differently to what you expected, or wanted.
• Risk exists in any situation, while uncertainty arises only because there is inadequate information.
• Pure risk is the possibility that something will go wrong, and speculative risk is the possibility that
it will go well.
• Downside or pure risk represents a threat: things may turn out worse than expected.
• Upside or speculative risk represents an opportunity: things may turn out better than expected.
1.1 What is risk?

You know what risk is in everyday terms. You know it is risky to climb a tall ladder, no matter what you
may think there is at the top. You know it is risky to bet your life savings on a horse race, no matter
how much you think you might win.
These things are risky because at the point when you decide to do them you cannot be sure how
bad the outcome will be. You may fall off the ladder and injure yourself when you are half-way up.
The horse you back may be beaten at the winning post.
On the other hand, you cannot be sure how good the outcome may be, either: you cannot be sure
that the opportunities won’t ever amount to anything. If you don’t risk climbing the ladder you will
never be the owner of whatever it is at the top. Most people would think it is too risky to throw away
their life savings on a race, but there is always the chance that your horse will win. If you don’t place
the bet you will miss the opportunity.
Risks and opportunities exist because nobody knows what will happen in the future, and nobody can
control it. Of course you can control whether or not you climb the ladder, but you cannot stop others
from doing so, and you cannot stop entirely unexpected things from happening.
These issues can be summarised in the following definition of risk.
Definition
Risk: The possible variation in an outcome from what is expected to happen.
We can break this definition down to highlight the following issues to do with risk:
• Variability: events in the future cannot be predicted with certainty
• Expectation: we expect something to happen, or perhaps hope that it will not happen
• Outcomes: this is what actually happens compared with what is intended or expected to happen
1.2 What is uncertainty?

Risk and uncertainty are not the same things:
• Risk (the possibility of variation) exists in any situation
• Uncertainty arises only because we are ignorant of all the facts: we lack information
Definition
Uncertainty: The inability to predict the outcome from an activity due to a lack of information.
You can never avoid this uncertainty, in anything you do: it is something that you have to make
decisions about, or something you need to manage. If you decide to take a risk, or follow up an
opportunity, the outcome may be hugely beneficial – or it may ruin you.

1.3 What are upside and downside risks?
Because events could turn out either better or worse than expected, sometimes we refer to two-way
risk or symmetrical risk.
The risk that something will go wrong is called ‘downside risk’, if it is likely that things will go right the
term ‘upside risk‘ is used.
1.4 How far does risk affect a business achieving its objectives?
When considering whether a business will be successful and achieve its objectives, the term ‘pure
risk‘ describes the possibility that something will go wrong, speculative risk is the possibility that
something could go better than expected (though it could go worse). If we all focused on pure risk
then there would be little point in taking a risk; the fact that something could go well is the basis on
which business flourishes. It is helpful for businesses to think about risk in the context of managing
events with an eye on achieving objectives.
Definitions
Downside risk: The possibility that an event will occur and adversely affect the achievement of
objectives.
Upside risk (opportunity): The possibility that an event will occur and positively affect the
achievement of objectives.
In this chapter we shall be concentrating on risk.
2 Risks for businesses and their investors

Section overview
• Risks for a business include poor market conditions, poor control and poor outcomes of
investments. Often businesses look particularly at the risks that they will fail to achieve their critical
success factors (CSFs). How far the business is prepared to take on these risks is a measure of its
risk appetite.
• The risk to those who finance the business (owners and lenders) is that they will suffer poor rather
than high returns on their investment.
• Both businesses and financiers have particular attitudes to the level of risk they are prepared to
endure: risk averse, risk neutral and risk seeking.
2.1 Risks for the business

If the objective of a business is to maximise shareholder value then risks for the business are risks of
losses, resulting (directly or indirectly) in negative cash flows. When losses become severe, there
might be a risk of insolvency, leading to the liquidation of the business.
The activities of certain businesses are inherently risky because they are potentially dangerous to
public well-being: transport and pharmaceutical businesses are obvious examples.
The risks faced by businesses in general are as follows.
• There are risks that trade conditions might be poor, and sales might fall or costs might rise. A
new product launch might be unsuccessful, or an expensive research and development project
might fail to produce a new commercial product.
• There is a risk that inadequate controls (quality controls, administrative controls, controls over
people etc) within the business may result in losses through inefficiency, damage to business
reputation, or deliberate fraud.
• A business might face risks of a financial nature, and losses might occur because of the way it has
financed an operation.

• Environmental, Social and Governance (ESG) risks are becoming increasingly significant (eg, the
risks of businesses’ reputations being harmed as a result of failing to address their contribution to
climate change).
• The larger the business, the more varied are the risks.
Interactive question 1: Business risk

Try to identify a small business with which you have some familiarity, such as an audit client or one
you have worked for in a vacation. What risks does the business, as opposed to its owner(s), face?
2.2 Risks for investors

Lenders have to bear the risk that the business will default on its debt obligations, and fail to make an
interest payment or even become insolvent and be unable to repay the loan principal. A lender will
expect a higher return than that offered on, say, government securities or gilts (commonly taken to
be a risk-free investment), to compensate for the added risk.
Shareholders are the ultimate bearers of risk. If a company becomes insolvent, they will lose all their
investment. More important, if company profits fall, dividends and the share price are also likely to
fall. Lenders are entitled to interest before any profits can be paid as dividend, so that the risk to
income is much less for lenders than for equity shareholders.
Risk for shareholders is two-way: there is the possibility of poor returns (no dividends or low
dividends, and a fall in the share price), or profits and dividends might be higher than expected, and
the share price might rise by more than anticipated. Risk is greater for shareholders when there is a
greater possibility of wide variations in profits, dividends and share prices from year to year. The
range of potential variation in returns is known as the volatility of returns.
2.3 Risk and strategic planning

In the strategic planning analysis process, it is important to focus on risks that are specific to the
business, or the industry sector in which it operates, rather than general ones. They should be
mapped to the relevant threats and opportunities that they represent to the business. A plan for
managing each specific risk can then be formulated.
It is often useful to relate risks to the business’s critical success factors (CSFs), as a significant risk is
one that would create an obstacle to any of the CSFs.
Definition
Critical success factor (CSF): ‘Those product features that are particularly valued by a group of
customers and, therefore, where the organisation must excel to outperform the competition.’
(Johnson & Scholes, 2002)
2.3.1 Risk appetite

Not all risk is bad, and returns are generally higher for higher-risk projects. As part of the planning
process, the business needs to decide what its ‘appetite’ for risk is and apply this in choosing
appropriate strategies.
Definition
Risk appetite: The extent to which a business is prepared to take on risks in order to achieve its
objectives.
The approach should be as follows.

(a) Decide what the business wants to achieve (the strategic objective).
(b) Decide what the business’s ‘risk appetite’ is, in other words the extent to which it is prepared to
take on risks in order to achieve its objective.

(c) Find strategies to achieve the objectives that do not involve more risk than the business is willing
to accept.
(d) If there are no methods of reducing the risk to an acceptable level, the objective needs to be
amended.
2.3.2 Attitudes to risk

• A risk averse attitude is that an investment would be chosen if it has a more certain but possibly
lower return than an alternative less certain, potentially higher return investment.
• A risk neutral attitude is that an investment would be chosen according to its expected return,
irrespective of the risk.
• A risk seeking attitude is that an investment would be chosen on the basis of it offering higher
levels of risk, even if its expected return is lower than an alternative no-risk investment with a
higher expected return.
The concept of expected values is discussed in more detail in section 4 below.
3 Types of risk
Section overview
• Business risk arises from the business’s nature, industry and environment.
• Financial risks can be controllable or uncontrollable.
• Operational risks arise from things just going wrong.
3.1 Business risk

Business risk arises from the nature of the entity’s business, its industry and the conditions it operates
in. Business risk is willingly taken by the business as part of its objective of making a return.
Business risk includes:
• Strategy risk: The risk that the business’s objectives will not be achieved because it chooses the
wrong corporate, business or functional strategy. A key strategy risk in the current era of rapid
technological change is to fail to keep up with technological developments.
• Enterprise risk: The chance that a strategy will succeed or fail, and therefore whether the business
should have undertaken it in the first place.
• Product risk: The chance that customers will not buy the company’s products or services in the
expected quantities.
• Financial risk arises in part from how the business is financed and in part from changes in the
financial markets such as to interest rates and exchange rates (see section 3.2).
• Sustainability and climate relatedrisk: In 2018, four of the top five risks identified in the World
Economic Forum’s Global Risk Report survey were environmental or societal (see section 3.3).
• Operational risk is the risk that something will just go wrong. It is not a risk that a business
willingly accepts and indeed a large part of both management and risk management is
attempting to make sure that potential operational risks do not occur (see sections 3.4 and 3.5).
3.2 Financial risk

Financial risk is a key concern to businesses and to professional accountants. There are two types:
• Controllable financial risk is financial risk arising from factors that are within the business’s direct
control. They arise in particular from:
– How far the business chooses to finance itself by debt rather than shares (gearing risk). High
borrowing, in relation to the amount of shareholders’ capital in the business, increases the risk
of volatility in earnings, and insolvency.
– How far the business deals with customers who end up not paying (credit risk).

– How far the business’s costs are incurred in such a way that there is increased likelihood of it
running short of cash (liquidity risk). A business is exposed to greater liquidity risk if, for
instance, it has a high proportion of fixed costs which must be paid whatever its level of
revenue.
• Uncontrollable financial risk is financial risk arising from factors that operate independently of the
business. The key factor here is market risk, that is the risk of losses resulting from changes in
market prices or rates that the entity itself cannot control but can deal with or manage. These
include share prices, commodity prices, interest rates and foreign exchange rates. Management
of these financial risks is a key role for accountants using hedging and other techniques.
Financial risk is assessed in greater detail in Financial Management at the Professional Level.
3.3 Sustainability and climate related risks

Sustainability and climate related risks is a broad term that covers many potential risks. Some
important examples are:
• Risks caused by climate change, such as increased instances of flooding or drought or other
extreme weather that leads to disruption of operations and damage to assets.
• Reputationalrisks – poor environmental or social behaviour can harm the reputation of an
organisation leading to a fall in sales and providers of finance, such as investors and banks,
refusing to provide additional finance. This can have a significant impact on the value of a
business.
• Governance risks – poor corporate governance structures can lead to poor strategic decision
making and, in extreme cases, fraud.
• Regulatory risks – risks of failing to adhere to regulations relating to environmental and social
issues, such as laws on carbon emissions or anti bribery laws. This can lead to fines or other
sanctions.
3.4 Operational risk

Unlike business risk, operational risk is not willingly incurred by the business in order to make a
return. Operational risk relates to things that just go wrong. A useful way of describing it is in terms of
what causes it.
Definition
Operational risk: The risk that actual losses, incurred because of inadequate or failed internal
processes, people and systems, or because of external events, differ from expected losses.
• Process risk is the risk that a business’s processes may be ineffective (fail to achieve their
objectives) or inefficient (achieve their objectives but at excessive cost).
• People risk is the risk arising from staff constraints (for example insufficient staff, or inability to pay
good enough wages to attract the right quality of staff), incompetence, dishonesty, or a corporate
culture that does not cultivate risk awareness, or encourages profits without regard to the
methods used to make them.
• Systems risk is the risk arising from information and communication systems such as systems
capacity, security and availability, data integrity, and unauthorised access and use. A key aspect of
systems risk arises from the interconnectedness of computer systems via the internet, known as
cyber risk (see below).
• Event risk is the operational risk of loss due to single events that are unlikely but may have serious
consequences. These include:
– disaster risk: a catastrophe occurs, such as fire, flood, ill health or death of key people, terrorism
and so on;
– regulatory risk: new laws or regulations are introduced, affecting the business’s operations and
profitability;
– reputation risk: the business’s activities damage its reputation in the eyes of stakeholders; and
– systemic risk: failure by a participant in the business’s supply chain or system to meet its
contractual obligations, so the system itself is at risk

Another way of classifying event risks is according to their sources in the environment.
– Physical risks: such as climate and geology
– Social risks: changes in tastes, attitudes and demography
– Political risks: changes determined by government, or by a change of government
– Legal risks: the consequences of being unable to enforce contracts, of breaking the law or
otherwise of failing to meet legal duties or obligations. Legal risk can also arise from changes in
legislation and regulations
– Economic risks: changing economic conditions such as a recession
– Technology risks: changes in production or delivery technology and from the threat of cyber
attack
– Cyber risk: the risk of financial loss, disruption or damage to the reputation of an organisation
from failure of its information technology systems due to accidents, breach of security, cyber-
attacks or poor systems integrity. Cyber risk and controls for dealing with it are covered in more
detail in the chapter Developments in technology.
– Climate risk: the risk of disruption related to climate change – such as damage caused by
floods or droughts.
Exam questions may test your ability to recognise specific issues that may arise in the context. This
could include providing details about a specific risk and asking what type of risk it is.
4 Risk concepts and measurement

Section overview
• The risk a business is facing is measured in terms of exposure, volatility, impact and probability.
• Statistical techniques have wide application. In the context of this chapter, they can be used to
analyse risk.
• Measures of central tendency include the mean, median, mode and expected values. These can
use used to indicate the average or central value than can be expected by a particular event or set
of data.
• Measures of dispersion measure the variability of data or events. As such they are good measures
of risk, as the higher the variability is, the higher the level of risk. Dispersion can be measured
using the range, the variance, standard deviation and co-efficient of variation.
• Frequency distributions show the number of times a particular value occurs in a set of data. These
can be shown graphically.
• The normal distribution is a particular frequency distribution that often occurs with very large sets
of data, where the data is distributed symmetrically around the mean. A normal distribution is
defined by its mean and standard deviation.
• Some distributions are not symmetric, and are referred to as skewed.
4.1 Key risk concepts

The scale of any risk for a business depends upon four key risk concepts.
• Exposure is the measure of the way in which a business is faced by risks. Some businesses will by
their very nature be less exposed than others. A transport company such as an airline or a railway
operator is considerably more exposed to the risk that its customers will be injured while using its
services than is a bank or a firm of accountants. A business that has minimal debt finance and no
overseas customers or suppliers has little or no exposure to the risks of either interest rate
movements or exchange rate movements.

• Volatility is how the factor, to which a business is exposed, is likely to alter. A coffee producer is
dependent on good weather; businesses like fashion and music are subject to changes in public
taste. Some businesses operate in regions that are politically unstable.
• Impact (or consequence) refers to measures of the amount of the loss if the undesired outcome
occurs. Impact might be measured purely in financial terms, or in terms of delay, injuries/loss of
life or other ways depending on the risk being faced.
• Probability (or likelihood) means how likely it is that a particular outcome will occur. In some
cases, it is possible to estimate probability on the basis of past experience (historical records)
combined with information about all the factors involved and how they interact. In others it is
much harder to estimate probability because no historical data exists. The development of an
entirely new product is an example.
The greatest risks for a particular business will arise when:
• exposure is high;
• the underlying factor is volatile;
• the impact is severe; and
• the probability of occurrence is high.
Different combinations of these four risk concepts result in different levels of response from the
business.
4.2 Statistics
Analysis of risk may involve the use of statistics.
Definitions
Statistics: A branch of mathematics that involves the collection, description, analysis, and inference of
conclusions from quantitative data (Investopedia).
Data set: A collection of data about a population, or a sample of a population (eg, the values of a
variable such as age of all ICAEW students would be a data set).
Population and sample: A population is the entire set of data (eg, all sales invoices issued during a
particular month). A sample can be taken from the population (eg, a sample of 40 invoices is taken
from all the invoices issued during a particular month). The sample may be analysed to find out more
about the population from which it is taken.
Descriptive statistics: Describe the properties of sample and population data, such as the average
value and the degree of variability.
Inferential statistics: The analysis of samples to draw conclusions about the population.
This chapter covers descriptive statistics, which are relevant to analysis of risk. We look at measures
of central tendency, which aim to describe a typical or average element in a population. We then
examine measures of dispersion (spread) which describe how spread out the values are in a set of
data.
Inferential statistics is discussed in the chapter Data analysis.
4.3 Measures of central tendency (average)

Measures of central tendency attempt to measure the ‘average’ or typical value of a given set of data.
This is the value that represents the central value of all the possible values. In relation to risk, the
average is what the typical or expected value would be: it gives an impression of the size of all the
values in the data set.
Measures of central tendency commonly used are:
• Median
• Mode
• Mean
• Expected value

Definitions
Median: The middle value in a data set when the values are placed in order, from smallest to largest.
If there is an even number of values, then the median is the value halfway between the two middle
values. For large data sets if the number of values is n, the median is the (n + 1)/2-th value.
Mode: The value which occurs most often in a data set.
Mean: What most people think of as the ‘average’. It is the arithmetic mean, denoted as
X
and is calculated by taking the sum (Σ) of all the values (x) and dividing by the number of values (n) in
the data set:
X
X=∑
n
Context example: Measures of central tendency

The monthly profits of a garden centre last year were:
Profits
Month £000
January 50
February 52
March 74
April 105
May 120
June 125
July 120
August 85
September 65
October 58
November 52
December 54
Total 960
Median
In order to calculate the median of the data, the monthly profits need to be ranked in order of value,
and the median is the middle value:
Profits Order
Month £000
January 50 1
February 52 2
November 52 3
December 54 4
October 58 5
September 65 6
March 74 7

Profits Order
Month £000
August 85 8
April 105 9
May 120 10
July 120 11
June 125 12
Since there is an even number of months, there is no exact middle value, as the median is the 6.5th
value (calculated as (12 + 1)/2). This will be taken as the value exactly half-way between the sixth
value (65) and the seventh value (74):
65 + 74
= = 69.5
2
Mode
The mode is the value that appears most often in a set of data. In the example above there are two
modes – 52 and 120 as these values both occur twice. All the other values occur once only.
Where there are two modes, the data is said to be bi-modal. In this case, the mode does not really
provide any useful information as neither of these values represent a ‘typical’ month.
Mean
The mean is calculated by dividing the sum of all values by the number of values (n). In this case the
sum of all the values is the total revenue for the year (£960,000) and n is 12. The mean is therefore:
Mean = Σ(x)/n =
960,000
= £80,000
12
Interactive question 2: Mean, median and mode

Mrs Baker owns a giftshop in Bigtown. Her daily sales for the last week were as follows:
Day Sales (£)

Monday 2,000
Tuesday 2,500
Wednesday 6,400
Thursday 6,400
Friday 12,000
Saturday 14,000
Sunday 12,700
Requirement
Calculate the mean, median and mode of the daily sales for the week.

4.3.1 Evaluation of measures of central tendency
Mean Median Mode
Advantages • It is easy to • It is easy to • It is easy to find and

calculate and is understand. understand.
widely understood. • It is not distorted • It is the value of at
• It is representative by very large or least one actual
of all the values in very small, value in the data
the data set as they exceptional values set.
are included in the (known as outliers). • If the data is
calculation (eg, qualitative not
sales from all 12 quantitative (eg,
months were used the data comprises
in calculating the individuals’ choice
average monthly of favourite flavour
revenue). of a food product),
• It is suited to the mode is the
further statistical only measure of
analysis. central tendency
that can be used.
• It is not influenced
by extreme
outliers.
Disadvantage • It may not return a • It may not return a • It does not take all
value that is the value that is the the values in the
same as an actual same as an actual data set into
value in the data value in the data account, so it is less
set (eg, the average set. representative.
household has 1.4 • It does not take all • There can be more
cars but one the values in the than one mode in
cannot own 0.4 of a data set into which case it may
car). account, so it is less not be a good
• It may return the representative. reflection of the
same result for two • It is difficult to central tendency.
very different sets identify in large • It is not suited to
of data, so may not data sets as the further statistical
be comparable values have to be analysis.
between different ordered.
data sets.
• It is not suited to
• May be distorted further statistical
by outliers, which analysis.
are values that are
significantly
different from most
of the other data
values, and that
may arise due to
errors in
measurement or
very unusual
circumstances.
Context example: Outliers

A runner has kept a log of how many kilometres she runs each week during training:

Week number Kilometres run
Week 1 3
Week 2 49
Week 3 49
Week 4 50
Week 5 50
Week 6 50
Week 7 50
Week 8 51
It can be seen that week 1 is significantly lower than the other weeks, and is therefore an outlier.
There might be a reason why the runner only ran 3 km that week – perhaps she was injured.
The mean distance covered each week is 44 km. This is below the actual distance run every week
except for week 1, and is therefore not really a representative measure of the runner’s weekly
distance. The mean has been distorted by the outlier.
Some statisticians ignore outliers. If week 1 is ignored, the mean weekly distance run is 49.85
kilometres, which is a much more representative indicator of the runner’s weekly distance.
Context example: Same mean for very different data sets

An employer has recorded how many people were absent from work during the last 10 days at two
of its sites:
Site 1 Site 2
Monday 7 1
Tuesday 2 2
Wednesday 3 3
Thursday 4 3
Friday 5 3
Monday 6 3
Tuesday 4 10
Wednesday 8 10
Thursday 9 10
Friday 7 10
Total 55 55
Mean 5.5 5.5
The mean number of absentees was 5.5 per day in both sites which might suggest that both sites
have the same level of absenteeism. When the data is examined in more detail, however, it can be
seen that there is a big difference in the profile of absenteeism. In particular, site 2 has very high
absenteeism rate in the second week and a very low level in the first, while the level of absentees in
site 1 is closer to the mean on most days. These different profiles are not visible from the mean.
4.3.2 Expected values

An expected value is a weighted average value that you might expect to get if you take some action
where the possible outcomes are variable, but you can estimate the probability of each outcome
occurring. Imagine if you are planning to sell an item on eBay. You are told that there is a 20% chance

that you will not sell the item, a 30% chance that you will achieve a price of £30 and a 50% chance
that you will sell the item for £50. Your expected selling price is £34, being (20% × 0) + (30% × 30) +
(50% × 50).
Context example: Expected values

Jack plc has the opportunity to invest £100,000 in a project. The project manager has identified three
scenarios: best case, worst case, and most likely – for the project’s annual return, with related
probabilities and returns.
Annual return
Probability under the
of scenario scenario
occurring £
Worst case scenario 0.3 2,000
Most likely scenario 0.6 5,000
Best case scenario 0.1 10,000
The expected return for the investment can be calculated using a weighted average:
Annual return Expected return

under the scenario (probability x return)
Probability £ £
Worst case scenario 0.3 2,000 600
Most likely scenario 0.6 5,000 3,000
Best case scenario 0.1 10,000 1,000
Expected return 4,600
The expected return of £4,600 is not actually predicted as a return for any of the three scenarios; it is
the average of the annual returns that would be expected over a number of years. It is a measure of
the investment’s return for decision-making and risk evaluation purposes.
An expected value is a type of mean. If an action is repeated many times, the expected value
represents the expected mean of the outcomes achieved over time.
4.4 Measures of dispersion

Measures of dispersion (spread) indicate how widely dispersed the values in a data set are. Using the
example of the daily sales of a gift shop, if sales were the same every day, then there would be no
dispersion. If the values change significantly from day to day, then the values are more widely
dispersed. Greater dispersion means greater risk.
Imagine putting savings into a bank account that pays interest of 5% per annum. There will be no
dispersion in your returns, and therefore no risk (other than a negligible risk that the bank goes bust
and you lose your savings).
Alternatively, if you invested your savings in shares of companies listed on the stock exchange, your
returns would be variable. Some years, the market will rise, making your shares more valuable, other
years the market may fall, and your savings will lose some of their value, so there may be capital
gains and losses. Some years dividends may be paid, other years they may not, so the income from
the investment may be variable. The returns on shares are more dispersed, and therefore there is
more risk associated with them.
The measures of spread that you need to know are:
• range;
• standard deviation;
• variance; and
• co-efficient of variation

Definitions
Range: The difference between the highest and lowest value in a set of data.
Deviation: For each value in a data set, deviation refers to how far from the mean that value is.
Mathematically this is written as:
(X−X)
Variance: The average of the squared deviations of the values in a data set from the mean of that
data:
(X−X)2
Variance = ∑ where n is the number of items in the data set
n
Standard deviation: Standard deviation =
Variance
Coefficient of variation: Co-efficient of variation =
Standard deviation
mean
4.4.1 Range
The range is simply the difference between the highest and lowest value in a set of data. The larger
the range is, the more dispersed the data is. This is a fairly simplistic measure, and suffers from the
following disadvantages:
• It only considers the lowest and highest value in the set of data so does not take into account the
dispersion of the other values.
• The range may be distorted by outliers.
4.4.2 Deviation, variance and standard deviation

For each value in a set of data, its deviation shows how far above or below the mean that value is. If
the deviation is positive, this shows that the value is above the mean, while a negative deviation
implies that the value is below the mean.
In order to show how dispersed that data is, we can calculate the average deviation from the mean.
However, if we simply calculated the average deviation, by adding together the values of all
deviations from the mean, the sum of the positive deviations would offset the negative variations
leading to a mean deviation of zero. This would not be useful. The solution therefore is to square the
deviations before adding them together, because the square of a negative number is a positive
number.
The variance is the average of the square of each deviation from the mean.
The formula for the variance is:
∑(X−X)2
where X represents each value and X represent the mean of the distribution.
n
The standard deviation is the square root of the variance. The standard deviation shows the average
deviation from the mean, ignoring whether the deviation is positive or negative. A larger standard
deviation signifies greater variability/ spread in the values in a data set and therefore greater risk. The
size of the standard deviation is also affected by the size of the data in the data set, as data sets that
contain higher absolute values will tend to have higher standard deviations, given the same level of
dispersion. This problem with the standard deviation is solved by using the co-efficient of variation
(see below).
Context example: Calculation of variance and standard deviation

The monthly profits of a garden centre last year were:

Month Profits £000
January 50
February 52
March 74
April 105
May 120
June 125
July 120
August 85
September 65
October 58
November 52
December 54
Total 960
The mean monthly profits were £80,000. The calculation of the standard deviation and variance are
as follows:
Month Deviation Deviation squared
X (X−X) (X−X)2
£000 £000 £000
January 50 -30 900
February 52 -28 784
March 74 -6 36
April 105 25 625
May 120 40 1,600
June 125 45 2,025
July 120 40 1,600
August 85 5 25
September 65 -15 225
October 58 -22 484
November 52 -28 784
December 54 -26 676
Total 960 9,764
Explanation: The second column, X shows the profits of the month, in thousands, eg, in January it was
50. The third column,
(X−X)
shows the difference between the profits of the month and
X
the mean monthly profits of 80. In January, monthly profits are 50,

so (X−X) is –30. The fourth column is simply the third column squared, eg, in January it is –30× –30
= 900.
∑(X−X)2 9,764
The variance is = = 813.67 ie, £813,670
n 12
The standard deviation is 813.67 = 28.5249 ie, £28,525

Note: The examiner would not expect you to calculate a variance or standard deviation in the exam.
However, you may be required to show that you understand the meaning of the standard deviation
and are aware of its advantages and disadvantages.
4.5 Coefficient of variation

As an absolute number, the standard deviation can be lack meaning. Standard deviations may be
large simply because the values in a set of data are high.
The co-efficient of variation relates the standard deviation of a data set to the size of the data set
using the mean (expected) value of the data.
Context example: Calculation of coefficient of variation

In the previous example, the mean monthly profits of the garden centre were given as £80,000 and
the standard deviation was £28,525.
28,525
The coefficient of variation was therefore = 0.36 (or 36%)
80,000
This shows that the standard (average) monthly deviation from the mean was 36% of the mean.
The coefficient of variation is a useful way to compare the risk of different potential projects:
Context example: Comparing risk using coefficient of variation

A business is reviewing monthly profit from two products. It has produced the following table
showing the monthly profit levels for the last five months for two products:
Product 1 –
profit/(loss) Product 2 – profit/(loss)
£ £
Month 1 (1,000) 16,000
Month 2 1,000 18,000
Month 3 5,000 22,000
Month 4 12,000 29,000
Month 5 15,000 32,000
Average contribution 6,400 23,400
Standard deviation 6,184 6,184
Both products have the same standard deviation, which may suggest that they bear the same level of
risk. However, the differences in profits for product 1 are relatively much larger.
The co-efficient of variation for the two products is as follows:
Product 1 Product 2
Standard deviation £ 6,184 6,184

Product 1 Product 2
Average profits £ 6,400 23,400
Coefficient of variation 96.6% 26.4%
As the coefficient of variation of product 1 is higher than for product 2, we can conclude that it is
riskier than product 2.
Interactive question 3: Measures of dispersion

Mrs Baker owns a giftshop in Bigtown. Her daily sales for the last week were as follows:
Day Sales
Monday 2,000
Tuesday 2,500
Wednesday 6,400
Thursday 6,400
Friday 12,000
Saturday 14,000
Sunday 12,700
The mean daily sales were £8,000 per day. The standard deviation was £4,559.
Requirement
Calculate the range and the coefficient of variation. Explain the meaning of the standard deviation
and coefficient of variation in relation to the gift shop.
4.6 Uses in risk management

The bigger the standard deviation is, the more widely dispersed the possible outcomes of an event
are, so a bigger standard deviation means a higher risk.
If decision makers have information about the expected values and standard deviations of the
projects they are considering, they can make more informed decisions, balancing the risks and
rewards. In general:
if risks are higher (indicated by higher standard deviations), decision makers require higher expected
values to compensate them for this.
If two projects have the same expected return, decision makers would choose the project with the
lower standard deviation (assuming the two projects are mutually exclusive, so they cannot both be
chosen). However, a higher standard deviation may also result from having larger numbers in the
data set, so the co-efficient of variation is a better measure of the relative risk and should be used
when evaluating the relative risk of two or more mutually exclusive projects that have different
means.
Standard deviations may be used as a screening device, to reject decisions where the risk is
considered to be too high, given the risk appetite of the decision makers.
Often, accurate information about potential values and their associated probabilities is not available.
Sometimes historic values can be used as an approximation. In the financial markets, for example,
historic values about the standard deviation of prices are used when assessing the risks of particular
securities.

4.7 Frequency distributions
The way that the data in a data set is distributed can also vary. A frequency distribution shows how
often values within particular ranges occur in a data set. The monthly profits from the garden centre
can be summarised in the following frequency diagram, showing how many months the profits fall
within certain ranges:
Frequency Monthly profits
6
0
50-59 60-69 70-79 80-89 90-99 100-109 110-119 120-129 Profits
Figure 5.1: Frequency diagram of profits from the garden centre
There is no particular pattern to the data above. In five of the 12 months, profits were in the lowest
range (£50,000 - £59,000). In three of the months, they were in the highest range (£120,000 -
£129,000). In the other months, they were spread among the other ranges.
As data sets become larger, however, the higher frequencies tend to be centred around the centre of
the frequency diagram. A frequency diagram for a large data set (in this case, the heights of adults in
a country) would look like this:
Height
1200
1000
800
600
400
200
0
110-119 120-129 130-139 140-149 150-159 160-169 170-179 180-189 190-199 Height
in cms
Figure 5.2: Frequency diagram for a larger data set
If a curve was drawn that linked the centre points of each bar, we would have a ‘bell-shaped curve’ as
follows:
Height of adults
Frequency
1200
1000
800
600
400
200
0
110-119 120-129 130-139 140-149 150-159 160-169 170-179 180-189 190-199 Height
in cms

Figure 5.3: Frequency diagram for a distribution using a line chart
This curve is known as a frequency distribution as it shows the relative frequency of the data taking
different values.
4.8 The normal distribution

Many large data sets in the real world approximate the normal distribution:
34.1% 34.1%
13.6% 13.6%
0.1% 2.1% 2.1% 0.1%
–3σ –2σ –1σ μ 1σ 2σ 3σ
68.2%
95.4%
99.7%
Figure 5.4: Normal distribution
Ц is the mean of the distribution (and the median and the mode)
Ϭ represents a standard deviation
The area under the curve shows the probabilities of being within certain ranges of the mean, where
distance from the mean is measured in standard deviations.
The normal distribution has the following consistent properties:
• The mean of the distribution = the median = the mode
• The distribution is symmetrical – the probability of identifying a value as equal to or below the
mean is 50% and the probability of it being equal to or above the mean is also 50%.
• The probability of being within particular ranges of the mean depends on the standard deviation:
– 34.1% lie between the mean and one standard deviation below the mean, and 34.1% lie
between the mean and one standard deviation above the mean.
– 68.2% of values lie between one standard deviation below and one standard deviation above
the mean.
– 95.4 % of values lie between two standard deviations below and two standard deviations above
the mean.
– 99.7% of values lie within three standard deviations below and three standard deviations above
the mean.
Some useful values are:
• 95% of values lie with 1.96 standard deviations above and 1.96 standard deviations below the
mean.
• 99% of values lie within 2.58 standard deviations above and 2.58 standard deviations below the
mean.
Context example: Normal distribution

The mean number of units produced by a machine is 1,000 per day, with a standard deviation of 25
units. The Production Manager wishes to know what is the probability of producing between 950 and
1,000 units per day. Assume that daily output is normally distributed.

950 units is two standard deviations below the mean of 1,000 units. We are therefore looking at the
probability of being in the range between the mean and two standard deviations below the mean.
Using the normal distribution (refer to Figure 5.4 above), we can see that there is a 47.7% probability
of being between the mean and two standard deviations below it (34.1% + 13.6%).
There is therefore a 47.7% chance that the machine will produce between 950 and 1,000 units per
day.
Context example: Normal distribution 2

The number of units produced by a machine is 1,000 per day, with a standard deviation of 25 units.
The Production Manager wishes to know what is the probability of producing between 975 and 1025
units per day. Assume that daily output is normally distributed.
In this case, we are looking for the probability of being between one standard deviation below the
mean and one standard deviation above the mean. Referring to Figure 5.4 above we can see that the
probability of being in the range from one standard deviation below to one standard deviation
above the mean is 68.2%.
Note: This has a much higher probability than being between the mean and two standard deviations
from the mean.
There is therefore a 68.2% chance that production will be between 975 and 1025 units per day.
4.9 Skewness
The normal distribution is symmetrical, with half the values lying above the mean, and half lying
below. It is often useful to assume, when evaluating data, that it has a normal distribution, but in fact
most distributions are not symmetrical, and are therefore said to be skewed or asymmetric to some
degree.
• A left-skewed (negatively skewed) distribution has the majority of values concentrated on the
right-hand side of the distribution. There are fewer values on the left-hand side of the distribution
but these are more spread out, so the curve has a long left-hand tail but appears to lean slightly to
the right. The mode typically occurs at the highest point in the distribution, and typically the
median is to the left of the mode (so it has a lower value than the mode) and the mean is to the
left of the median (so it has a lower value than both the mode and the median)’.
• ‘A right-skewed (positively skewed) distribution has the majority of values concentrated on the
left-hand side of the distribution. There are fewer values on the right-hand side of the distribution
but these are more spread out, so the curve has a long right-hand tail but appears to lean slightly
to the left. Again, the mode typically occurs at the highest point in the distribution, and typically
the median is to the right of the mode (so it has a higher value than the mode) and the mean is to
the right of the median (so it has a higher value than both the mode and the median).
• The normal distribution is not skewed, and the mean = the median = the mode at the highest
point of the distribution.
Skewness can be illustrated by the following diagrams:
Mode
Median
Mean
Left skewed
Figure 5.5: Left skewed distribution

Mode
Median
Mean
Right skewed
Figure 5.6: Right skewed distribution
In a very skewed set of data, with extreme values at one end of the distribution, the mean of the data
is not representative of the data as a whole. This means the data is more difficult to analyse using
statistics. Skewness if often indicative of bias in the data. See the chapter Data analysis for more
discussion of data bias.
5 The objectives of risk management

Section overview
• Risk management involves identifying, analysing and controlling those risks that threaten the
assets or earning capacity of the business so as to reduce the business’s exposure by either
reducing the probability or limiting the impact, or both.
5.1 What is risk management?
Definition
Risk management: The identification, analysis and economic control of risks which threaten the
assets or earning capacity of a business.
Risk management is actively used by many businesses, some of which employ risk managers. Smaller
businesses and individuals may not recognise a specific task of risk management but will
nevertheless have developed their own methods of analysing and managing risk.
The purpose of risk management is to understand and then to minimise cost-effectively the
business’s exposure to risk and the adverse effect of risks, by:
• reducing the probability of risks occurring in the first place; and then if they do occur
• limiting the impact they will have on the business
5.2 When is risk management necessary?

• There may be legal requirements to manage risk; you are required by law to insure your car, for
instance.
• Risk management (in the form of insurance) may be required by licensing authorities and
regulatory bodies. For example, a football stadium would not be allowed to operate if it did not
have public liability insurance: ICAEW members in public practice must have professional
indemnity insurance (PII).
• Financial organisations may require risk management; if you have a mortgage your lender no
doubt requires you to have buildings insurance to protect its security.

Interactive question 4: Indemnity insurance
Find out, if you can, the basis of the requirement that chartered accountants should have to have
professional indemnity insurance (PII), and what it is designed to achieve.
Large, listed companies in the UK are required to determine the nature and extent of their significant
risks and to maintain sound risk management systems.
A risk-based management approach is a requirement for all UK companies with a premium listing
under the UK Corporate Governance Code. We shall see more about this in the chapter Corporate
governance.
6 The risk management process

Section overview
• Risk management involves identifying risk, assessing and measuring it in terms of exposure,
volatility, impact and probability, controlling it by means of avoidance, transfer and reduction,
accepting what remains and then monitoring and reporting on events.
• Risks can be identified by considering what losses would ensue: property, liability, personnel,
pecuniary and interruption loss.
• Once identified, the gross risk is measured by multiplying its probability (a value between 0 and
1) by the impact (the value of the loss that would arise). The aim of risk management is to
minimise gross risk.
• Some risk can be avoided by not doing the risky activity, and some can be reduced by taking
precautionary measures. Some of what remains of the gross risk can be transferred to someone
else, especially by insurance. The remaining gross risk must be accepted or retained.
• All the elements of the risk management process must be monitored and reported on to an
appropriate person.
6.1 What is involved in the risk management process?
Awareness and
identification
Analysis: assessment
and measurement
Avoidance Response and control Sharing
Acceptance Reduction
Monitoring and reporting
Figure 5.7: Risk management process

• Risk awareness and identification, using techniques such as brainstorming and analysis of past
experience to identify the business’s exposure to risks.
• Risk analysis (assessment and measurement): this considers the volatility of particular factors, the
probability of an event occurring and the severity of the impact if it does. Measurement may be
qualitative or quantitative.
• Risk response and control: in essence a risk can be avoided (do not do the risky activity), reduced
(eg, by strictly controlling processes), shared (eg, with an insurer) or simply accepted.
• Risk monitoring and reporting is a continuous process.
We shall look at each element of the risk management process in turn.
6.2 Risk awareness and identification

Risk awareness is partly a state of mind, but it is also dependent on how well the matter under
consideration is understood.
Suppose a UK business was considering launching a new product in China but knew absolutely
nothing about doing business in China. It is highly likely that it will not be aware of the many risks to
which the business could be exposed because of factors such as different regulations, different ways
of approaching customers, differences in disposable income and so on. The risks remain to be
identified.
Definition
Risk identification: Identifying the whole range of possible risks and the likelihood of losses
occurring as a result of these risks.
Risk identification must be a continuous process, based on awareness and knowledge that:
• potential new risks may arise; and
• existing risks may change
Exposure to both new and altered risks must be identified quickly and managed appropriately.
There are two approaches to identifying risks, which operate most effectively when combined.
• A top-down approach is led by the senior management/board of the business, spending time on
attempting to identify key risks. Often, this is linked to the business’s CSFs: what might happen to
prevent us from achieving each CSF?
• A bottom-up approach involves a group of employees, with an expert in risk management,
working together to identify risks at the operational level upwards.
Categories of loss:
• Property loss – possible loss, theft or damage of any static or moveable assets
• Liability loss – loss occurring from legal liability to third parties, personal injury or damage to
property
• Personnel loss – due to injury, sickness or death of employees
• Pecuniary loss – as a result of defaulting receivables
• Interruption loss – a business being unable to operate due to one of the other types of loss
occurring
Identifying too many risks can make the risk management process overly complex. The business
should focus its efforts on significant risks: those that are potentially damaging to the business’s
value.
6.3 Risk analysis: assessment and measurement

After risks have been identified, there should be a process of judging whether each risk is serious,
and which risks are more serious than others.

Definitions
Risk assessment: For each risk its nature is considered, and the implications it might have for the
business achieving its objectives; an initial judgement is then made about the seriousness of the risk.
Risk measurement: Identifying the probability (likelihood) of the risk occurring, quantifying the
resultant impact (consequence) and calculating the amount of the potential loss using expected
values for gross risk.
Gross risk: The potential loss associated with the risk, calculated by combining the impact and the
probability of the risk, before taking any control measures into account.
An aim of risk assessment should be to identify those risks that have the greatest significance, and so
should receive the closest management attention.
Significance can be measured in terms of the potential loss arising as a result of the risk, that is its
gross risk. This depends on:
• the potential impact, quantified as an expected value (usually using weighted averages as we saw
earlier in the section on risk concepts and measurement).
• the probability of occurrence, measured mathematically, as a decimal between 0 and 1
Gross risk = Probability × Impact
A method that is frequently used to assess risks is to plot each one on a risk map, showing impact on
a scale of 1 to 10 (or just low to high) on one axis, and probability on a similar scale on the other axis.
High
High significance
Impact
Low
Low significance
Low High
Probability
Figure 5.8: Risk assessment map
With regard to controlling risk the greatest attention may then be paid to risks that fall in the high
significance (high impact/high probability quadrant), bearing in mind that the quantum of each in
terms of gross risk should also be considered: a ‘high significance’ gross risk of only £10,000 will
probably draw less attention than a medium significance risk of £1 million, for example.
An alternative way to measure risk is by using measures of dispersion, such as the standard deviation
or co-efficient of variation, as described above in the section of risk concepts and measurement.
In the chapter Corporate governance, we shall look at corporate governance and risk assessment
relevant to large, listed companies in the UK (the UK Corporate Governance Code and the FRC’s
guidance on risk management, internal control and related financial and business reporting).
You may need to identify which quadrant a particular risk should be included in. You will need to
think about the impact (big or small) and the probability of the risk occurring.

6.4 Risk response and control
Measurement (qualitative or quantitative) and assessment establish priorities that determine the
amount of management time that should be spent developing and implementing a response to
control any particular risk: obviously, large gross risks in the high significance quadrant should be
considered first.
The possible responses to a risk, so as to control it, are as follows.
• Avoidance: not doing the risky activity. This may not be an option, but the first question should
always be ‘Do we need to do this risky activity at all?’
• Reduction: doing the activity, but using whatever means are available to ensure that the
probability of the event occurring and the impact if it does are as small as possible.
• Sharing: for example, taking out insurance against the risk, but only after every effort has been
made to reduce it, so that insurance premiums are kept as low as possible. Another sharing
strategy might be to enter an agreement with one or more other companies (joint ventures,
outsourcing arrangements and partnerships with suppliers are all examples). Hedging is a means
of sharing market risk. Risk sharing is sometimes called risk transfer, but it is rare to be able to
transfer all the risk.
• Acceptance (sometimes called retention): this should only be considered if the other options are
not viable, for example if the costs of extra control activities and the costs of insuring against the
risk are greater than the cost of the losses that will occur if the event happens. The concept of
materiality should apply: immaterial risks can be accepted. Nevertheless, risks that have been
accepted should still be kept under review: new developments may mean that a different
response becomes more appropriate.
• The risk map can be expanded to include risk responses depending on the assessment and
measurement of the risk.
High impact, low probability

High impact, high probability
These risks might be shared using
High
These risks must be controlled,

insurance, and at the same time
using avoidance, reduction
the impact might be reduced so
and/or sharing
that insurance premiums are lower
Impact
Low impact, low probability

Low impact, high probability
Often these risks are just
Low
accepted, as the cost of Reduction is the key

avoiding, reducing or sharing response here
them exceeds the benefits
Low High
Probability
Figure 5.9: Risk responses
The controls that are put in place in response to risks can take a variety of forms:
• Physical controls such as locks, speed limits and clothing protect people, assets and money
• Financial controls such as credit checks, credit limits and customer deposits protect money and
other financial assets
• System controls include procedural controls, so that processes are carried out in the right way,
software controls in computer systems, and organisation controls on people so that, for instance,
they do not exceed their authority. Together system controls protect the business’s ability to
perform its work.
• Management controls include all aspects of management that ensure the business is properly
planned, controlled and led, such as the organisation’s structure, and the annual budget.
We shall see more about controls later in this Workbook.

Questions may test your ability to demonstrate understanding of the business and this includes risk.
A risk matrix is a useful way of summarising the different risks a business faces, and emphasizing
which of these require more attention or controlling.
6.4.1 ALARP
An alternative approach to risk management is ALARP, which stands for ‘as low as reasonably
practicable’. ALARP is the basis of many regulations relating to health and safety at work in the UK,
where employers are expected to take actions to reduce risk faced by employees to a level that is
‘reasonably practicable’, but have no duty to go beyond this.
Definition
Reasonably practicable: Reasonably practicable means that the risk (the probability of an event
occurring and the impact that the event would have), has been reduced to a level that is
proportionate, given the cost that would be involved in reducing it any further. Reducing the risk
below this point would require an excessive amount of expenditure or effort to achieve very small
additional reductions in the risk. Reasonably practicable implies a higher level of risk than ‘as low as
possible’.
Applying the ALARP principle to health and safety at work means that employers are expected to
take action to reduce risks where the cost of those actions is not disproportionate in relation to the
risk. Requiring staff to wear protective clothing may reduce the risk of serious harm without causing
significant cost to an employer, so it would be expected that such a measure should be taken.
Spending millions to reduce the chance of two employees receiving minor injuries might be
considered disproportionate, so the employer would not be expected to do that. Clearly, some
judgement may be required in determining whether additional efforts to reduce the risks further
would be disproportionate.
6.5 Monitoring and reporting risk

Monitoring risk should be a continuous, ongoing process, such that if a risky event does occur then
the action taken should include an immediate review of the management of that risk, followed by
changes as necessary. In this sense ‘monitoring’ is a form of control.
• Has corrective action now been taken? Has it been effective?
• Was the risk identified in the first place, and if not, why not?
• If the risk was identified and planned for but the event still occurred, is it because early warning
indicators were not monitored?
• If the response and/or controls were ineffective what changes or new procedures are necessary?
All identified risk management problems that could affect the organisation’s ability to achieve its
objectives should be reported to those in a position to take necessary action.
• The chief executive regarding serious problems
• Senior managers regarding risk management problems that affect their units
• Managers in increasing levels of detail as the process moves down the organisational structure
The board of directors or audit committee should also be informed. The board or committee may ask
to be made aware only of problems that meet a specified threshold of seriousness or importance.
Premium listed companies (see the chapter Business finance, section 6) are required to follow the
main principles of the UK Corporate Governance Code so the board must:
• carry out robust assessments of the company’s emerging and principal risks;
• monitor the company’s risk management and internal control systems at least annually;
• state whether it is appropriate to adopt the going concern basis of accounting in annual and half-
yearly statements; and
• explain how the board assessed the prospects of the company in its annual report

We shall see more about this in the chapter Corporate governance.
7 Crisis management
Section overview
• Crisis management involves identifying a crisis and planning a response to it.

• Three main types of crisis are financial, public relations and strategic.
• Businesses need contingency plans to deal with a crisis should it occur.
7.1 What is a crisis?
Definition
Crisis: An unexpected event that threatens the wellbeing of a business, or a significant disruption to
the business and its normal operations which impacts on its customers, employees, investors and
other stakeholders.
Crises can be fairly predictable and quantifiable, or totally unexpected.
7.2 What is crisis management?
Definition
Crisis management: Identifying a crisis, planning a response to the crisis and confronting and
resolving the crisis.
Crisis management is much more commonly used in businesses now.

• Crises such as natural disasters and terrorism have been seen to have an even more extreme
effect in the context of global trade, so businesses are more motivated to manage crises better.
• Society is more litigious than it used to be, and businesses are expected to be able to deal better
with crises now than in the past.
• Better IT and other technology systems allow businesses to be able to do more to avert and/or
manage a crisis.
• Social media means that publicity surrounding any sort of crisis is widespread and can feed on
itself, raising the potential for very severe reputational consequences if damage limitation does
not swing into action quickly.
7.3 Types of crisis

There are three main types of crisis in terms of their effects on the business:
• Financial crisis – short-term liquidity or cash flow problems, and long-term solvency problems
• Public relations crisis – negative publicity that could adversely affect the success of the business
• Strategic crisis – changes in the business environment that call the viability of the business into
question, such as new technology making old products or processes obsolete
There are many types of crisis in terms of their cause.
• Natural event – physical, especially environmental, destruction due to natural causes such as
earthquake
• Industrial accident – buildings collapse, fire, release of toxic fumes, sinking or leaking of a ship
• Product or service failure – product recall of faulty or dangerous goods; communications, systems
or machine failure causing massive reduction in capacity; health scare related to the product or
industry

• Public relations disaster – pressure group or unwelcome media attention; adverse publicity in the
media; removal/loss/prosecution of chief executive officer or other key management
• Business crisis – sudden strike by workforce; sudden collapse of key supplier; withdrawal of
support by major customer; competitor launches new product; sudden shortfall in demand
• Management crisis – hostile takeover bid; death of key management; managers poached by main
competitor; boardroom battles
• Legal/regulatory crisis – product liability; new regulations increase costs or remove competitive
edge; employee or other fraud
7.4 Managing a crisis

A crisis happens when a risk becomes a reality. The business should seek to prevent crises, and to
have contingency plans should a crisis occur. It should also act to resolve an actual crisis in the most
effective way.
7.4.1 Crisis prevention

The business should always seek to prevent a crisis by planning ahead and projecting likely
outcomes; it should avoid decisions that have the potential to turn into a crisis.
7.4.2 Contingency planning

The business should make a contingency plan for the worst and/or most likely crises to occur. This
must be kept up to date, and staff should be trained in how it should be implemented in the event of
a crisis.
7.4.3 Effective action in the event of a crisis

• Assess objectively the cause(s) of the crisis
• Determine whether the cause(s) will have a long-term or short-term effect
• Project the most likely course of events
• Focus resources on activities that mitigate or eliminate the crisis
• Look for opportunities
In the event of a public relations crisis:
• act immediately to prevent or counter the spread of negative information; this may require
intense media activities; and
• use media to provide a counter-argument or question the credibility of the original negative
publicity
Interactive question 5: Contingency planning

Consider what you would do if, at a time when your business has a small overdraft and very little
money expected in shortly, it is faced with a large demand from a government body which requires
settlement in one month.
8 Business resilience
Section overview
• Business resilience can be assessed using two factors: the processes and functions that protect
the organisation; and cross-cutting characteristics of the organisation that drive resilience.
• There are a number of features that resilient organisations share as well as a number of challenges
to building resilience.
• Organisations should measure their current levels of resilience in order to identify areas that can
be improved.

8.1 What is business resilience?
Definition
Business resilience: A business’s ability to manage and survive against planned or unplanned shocks
and disruptions to its operations.
Organisations exist within the business environment. This environment is highly dynamic with
changes happening much of the time. Usually, these changes are small and unlikely to significantly
adversely affect most businesses (such as minor changes to legislation or tax rates). However, from
time-to-time, larger events can occur which shock organisations and can have significant detrimental
effects on them (for example, strict new laws being enforced; economic recessions and major
uncertainties in the political or social contexts; new technologies and/or new competitors disrupting
an industry, as e-commerce has done to ‘traditional’ retailing).
Other changes might be planned by the organisation itself. It may, for example, choose to make a
major investment overseas, close down a significant operation, or stretch itself financially by taking
on high levels of debt.
Business resilience is the ability of an organisation to manage all of these changes and survive,
regardless of how disruptive these changes are.
According to the ICSA Solutions report ‘Building a resilient organisation’ (Crack, 2014), an
organisation’s resilience can be described on two axis.
Axis 1: Processes and functions that protect the organisation
• Risk management
• Business continuity planning
• Security
• IT disaster recovery
• Health and safety
• Crisis management
• Internal audit
• Governance
Axis 2: More general (‘cross-cutting’) characteristics of the organisation that drive resilience
• The level of trust employees have in the organisation and its management
• The level of trust of customers in the organisation
• The ability of the organisation to innovate
• The extent that organisational values are understood
• The extent that organisational values drive employee behaviour
• The ability of the organisation to operate risk management
• Employee morale
• Leadership and senior management involvement
Interactive question 6: Failing organisations

For an organisation that you are familiar with, or have read about in the press or online, that has
failed, consider the following:
• Why did it fail?
• What are the key factors (internal/external) which led to its failure?
• What do successful organisations in the same industry do differently, which has led to them being
successful?

8.2 Resilient organisations
The ICSA report identifies the following features of resilient organisations:
• Have diversified resources and assets to facilitate alternative approaches and adaption to change
• Build strong relationships and networks (both internal and external)
• Have the ability to respond rapidly and decisively to an emerging crisis
• Have the ability to review and adapt based on experience and changing circumstances
The report also identifies the following challenges to building a resilient organisation:
Challenge Explanation
Lack of expertise As organisations become more complex, a

greater degree of expertise is required to
ensure that approaches and activities used are
robust and result in an appropriate level of
resilience.
Lack of input from senior management Directors delegate delivery of resilience

policies and procedures to operational
managers who may not fully understand what is
required, or the urgency of the task in hand.
Siloes for delivery Implementation of resilience programmes may

lack cross-organisational collaboration, with
each business function only being concerned
with their specific area. Therefore synergy that
would be created if all business areas worked
together is lost.
Limited sharing of risk information Siloes also limit information sharing. Rather than
sharing the outputs of their work on resilience,
functions tend to keep the information to
themselves. Therefore the opportunity to
improve resilience by cross-referencing and
sharing results of investigations is lost.
8.3 Measuring resilience

Because an organisation’s environment is constantly changing, the level of its resilience will also
change. For example, it might have procedures in place to ensure that if interest rates rise, to say 5%,
that it can cope financially, but what happens if interest rates rise to 10%?
Therefore it is important that organisations have a means of measuring their resilience, so that it can
adapt if necessary.
The ICSA report identifies the following four metrics that can be used to measure resilience:
• Compliance – how well the organisation complies with its standards and policies
• Completeness – the scope of resilience (ie, how wide a range of issues is the organisation
prepared for)
• Value – qualitative and quantitative measures of how well the organisation can meet specific
outcomes
• Capability – evidence, collected through exercises and reviews, of the extent to which the
organisation has put resilience processes and procedures in place
8.4 Supply chain resilience

Supply chain disruption is a particular issue for companies that adopt a just-in-time approach to
inventory management. Such organisations receive deliveries almost at the point when the materials
are needed in the production process and very little if any, spare inventory is held. Therefore any

disruption to the supply chain (such as late deliveries or the failure of a supplier) will have a major
impact on production.
Additionally, the more that companies outsource or work with partners (such as virtual organisations)
the more they depend on, and therefore must be able to rely on, their supply chain. In a similar way
to just-in-time organisations, virtual organisations will feel a great impact from any disruption to their
supply chain. Disruption in this case may relate to the failure of IT systems to transfer data or
information, as well as the failure of suppliers to meet deadlines or if they cease operations.
In response to this potential supply chain disruption, the FM Global Resilience Index is a data-driven
tool and repository that ranks business resilience in 130 countries. The purpose of the index is to
help executives evaluate and manage supply chain risk.
Note: Cyber resilience is discussed in the chapter Developments in technology.
9 Disaster recovery and business continuity planning

Section overview
• A disaster is a major crisis or event which causes a breakdown in the business’s operations and
resultant losses.
• A business needs to recover from a disaster as quickly as possible. This is helped if the business
has a business continuity plan in place.
9.1 Disasters
Definition
Disaster: The business’s operations, or a significant part of them, break down for some reason,
leading to potential losses of equipment, data or funds.
We have seen that event risk is the operational risk of loss due to single events that are unlikely but
that may have serious consequences. Political risk is one example and is often associated especially
with less developed countries where events such as wars or military coups may result in an industry
or a business being taken over by the government and having its assets seized.
Here are some examples, along with some responses and controls, based on reduction and sharing
of the risk of the disaster where it cannot be avoided.
• A fire safety plan is an essential feature of security procedures, in order to prevent fire, detect fire
and put out the fire. Fire safety includes:
– site preparation (for example, appropriate building materials, fire doors);
– detection (for example, smoke detectors);
– extinguishing (for example, sprinklers); and
– training for staff in observing fire safety procedures
• Flooding and water damage can be countered by the use of waterproof ceilings and floors
together with the provision of adequate drainage.
• Keeping up maintenance programmes can counter the leaking roofs or dripping pipes that result
from adverse weather conditions. The problems caused by power surges resulting from lightning
can be countered by the use of uninterruptible (protected) power supplies. This will protect
equipment from fluctuations in the supply. Power failure can be protected against by the use of a
separate generator.
• Threats from terrorism can be countered by physical access controls and consultation with police
and fire authorities.
• Accidental damage can be avoided by sensible attitudes to behaviour while at work and good
layout of workspaces.

Any system which has suffered a disaster must recover as soon as possible so that further losses are
not incurred, and current losses can be rectified.
What is considered a disaster is relative to the size of the business and the significance of the item
that breaks down. The failure of a hard drive in a single PC could be extremely serious for a small
business which depended on that one computer, but in a large business it might cause minimal
inconvenience, so long as backup copies of data files are maintained.
Minor breakdowns occur regularly and require short-term recovery plans such as agreements with a
maintenance company for same or next-day on-site repairs. Disasters which result in the destruction
of a major facility or installation require a long-term plan.
9.2 Business continuity plans

A business continuity plan will typically provide for:
• Standby procedures so that some operations can be performed while normal services are
disrupted
• Recovery procedures once the cause of the breakdown has been discovered or corrected
• Personnel management policies to ensure that the above are implemented properly
The plan must cover all activities from the initial response to the disaster (crisis management),
through to damage limitation and full recovery. Responsibilities must be clearly spelt out for all
tasks.
The contents of business continuity plans often include the following.
Section Comment
Definition of responsibilities It is important that somebody (a manager or co-ordinator) is

designated to take control in a crisis. This individual can then
delegate specific tasks or responsibilities to other designated
people.
Priorities Limited resources may be available for processing. Some tasks are
more important than others. These must be established in
advance. Similarly, the recovery plan may indicate that certain
areas must be tackled first.
Backup and standby These may be with other installations, or with a business that
arrangements provides such services (eg, maybe the hardware vendor).
Alternatively, other processes may be possible, for instance taking
cash when credit/debit card processing is interrupted.
Communication with staff The problems of a disaster can be compounded by poor

communication between members of staff.
Public relations If the disaster has a public impact, the recovery team may come
under pressure from the public or from the media.
Risk assessment Some way must be found of assessing the particular requirements
of the problem.
Context example: ICAEW’s business continuity plan

The ICAEW has its own business continuity plan, details of which can be found on its website
www.icaew.com/about-icaew/regulation-and-the-public-interest/business-continuity-plan
The plan covers its operational sites in Milton Keynes and London and accepts that the ICAEW may
need to materially reduce its immediate operations if the disruptive event is major.
Initially, the focus will be on recovering key business-critical activities. These have already been
identified and will be guided by business impact analysis (BIA).
In the case of a major event occurring, the priority will be to:
• protect and preserve the safety and well-being of employees, visitors and contractors;
• recover mission critical systems and resume critical ICAEW business operational activities;

• communicate appropriately with employees, media, principal contractors and stakeholders; and
• continuously manage the recovery process to ensure timely and efficient resumption of normal
business.

Summary
The future is uncertain
EITHER OR
Positive event may occur Adverse event may occur Classifying risk
= OPPORTUNITY = RISK
Measuring risk
Faced by Faced by Risk concept • Mean
business investor Risk management • Volatility • Median
Aim to: minimise • Exposure • Mode
limit • Impact • Range
reduce • Probability • Standard deviation
Critical success factors • Coefficient of variation
Risk management Business resilience

Risk Strategic planning process
appetite Chapter 4 • see Fig 5.2 Effects
Crisis
Causes
Attitude to risk Crisis

• Risk-averse management
• Risk-neutral • Contingency
• Risk-seeking planning
• Prevention
• Action Occurs
Business continuity plan Disaster recovery plan

1 Knowledge diagnostics
indicated.
1 Can you distinguish between ‘risk’ and ‘uncertainty’? (Topic 1)
2 Do you know what risk appetite means and are you aware of the three different
attitudes to risk and what they are? (Topic 2)
3 Do you know the meaning of business risk, financial risk and operational risk? Can you
give examples of each? (Topic 3)
4 Do you know the meaning of ‘exposure’, ‘volatility’, ‘impact’ and ‘probability’ in the
context of risk? (Topic 4)
5 Do you understand the meaning of the mean, median and mode, can you calculate
them, and can you describe the advantages and disadvantages of these as measures
of central tendency (Topic 4)
6 Can you interpret the range, standard deviation and co-efficient of variation of a set of
data and do you understand what, for example, a high standard deviation and a high
co-efficient of variation mean in relation to risk? (Topic 4)
7 Do you understand the concept of the normal distribution, and how it can be used to
determine the probability of a value or range of values occurring in a set of data?
(Topic 4)
8 Do you know the meaning and implications of skewness in a distribution, and can you
remember the order of the mean, median and mode in left tailed and right tailed
distributions?
9 Can you define risk management? (Topic 6)
10 What is involved in the risk management process? (Topic 7)
11 What are the four potential responses to a risk? (Topic 7)
12 Do you know what the types of crisis are in terms of their effects and their cause? (Topic
8)
13 Do you know what actions business could take in the event of a crisis? (Topic 8)
14 Do you know the meaning of business resilience? (Topic 9)
15 Can you remember the four metrics that can be used to measure business resilience?
(Topic 9)
16 Can you state what areas are included in a business continuity plan? (Topic 10)

questions in the Introduction to risk management chapter of the Business, Technology and Finance
Question Bank. Refer back to the learning in this chapter for any questions which you did not answer
correctly or where the suggested solution has not provided sufficient explanation to answer all your

queries. Once you have attempted these questions, you can move onto the next chapter,
Introduction to financial information.

• ICAEW (2018) Audit Insights: Cyber security. London, ICAEW.

• ICAEW (2013) Audit Insights: Cyber security. London, ICAEW.
• ICSA Solutions (2014) Building a resilient organisation. London, ICSA Publishing.

Self-test questions

1 Which of the following is a definition of risk?
A That events in the future cannot be predicted with certainty
B The element of a decision which is unknown
C The inability to predict the outcome of an activity due to a lack of information
D The possibility that an event will occur and adversely affect the achievement of objectives
2 Which of the following is a downside risk for a business?
A That costs might rise
B That revenue might rise
C That controls may succeed
D That quality might improve
3 Benbuck plc has had a wide range of returns to shareholders in recent years. This means that as an
investment, Benbuck plc shares are:
A volatile and low risk
B non-volatile and low risk
C volatile and high risk
D non-volatile and high risk
4 Strang plc is considering an investment in new production machinery. It has identified that the
machinery may soon become obsolete on the grounds of low productivity. This business risk could
be identified as:
A a product risk
B a strategy risk
C an enterprise risk
D an event risk
5 Mimso Bank plc’s staff appear to be unaware of the importance of risk. For Mimso Bank plc this is:
A a business risk
B an enterprise risk
C a financial risk
D an operational risk
6 The size of the gross risk facing a business is measured as:
A volatility (exposure)
B impact (exposure)
C impact (probability)
D volatility (probability)
7 Which two of the following statements relating to the mean are correct?
A It reflects all values in a data set
B It is not distorted by outliers
C It will always return a value that is the same as an actual value in the data set
D It is widely understood
8 Which statement about the standard deviation is correct?
A the value of the standard deviation is not affected by the size of the values in the data set

B the standard deviation does not reflect all the values of a set of data
C the standard deviation can take positive or negative values
D the lower it is, the more concentrated the data is around the mean
9 Which two of the following statements about the normal distribution are correct?
A the distribution is skewed to the right
B the mean and mode do not necessarily take the same value
C the probability of any value in the data set being equal to or less than the mean is 50%
D more than half of the values in a data set lie within one standard deviation of the mean
10 If a distribution is positively (right) skewed, what is the typical order (from lower to higher) of the
values of the mean, median and mode?
A mode, median, mean
B median, mean, mode
C mode, mean, median
D median, mode, mean
11 In terms of risk management, choosing to transfer some risk is part of:
A risk awareness
B response awareness
C assessment awareness
D monitoring awareness
12 Brando plc has 40 employees engaged in an activity that has been identified as having a high
element of risk to the company’s reputation. The company decides that the activity is necessary but
that only 10 staff should be engaged in it in future, and these staff should receive extra training. The
risk responses that Brando plc has applied are:
A avoidance and reduction
B transfer and acceptance
C reduction and acceptance
D avoidance and transfer
13 Heller & Co is a firm of solicitors which has long been aware that the departure of one partner, Mike
Heller, would constitute a crisis for the firm. It has therefore ensured that he is highly paid and that
Sue Jones, another partner, shadows his work and knows his clients. On 15 June Mike walks out of
the firm and provokes a serious crisis, which the firm’s very expensive PR consultants handle. The area
of crisis management which Heller & Co has neglected to address in their management of the crisis
is:
A crisis prevention
B contingency planning
C analysis of the causes of Mike’s actions on 15 June
D Taking action to mitigate the crisis
14 Klib plc operates in a politically unstable country. It has arranged that a consultancy firm with access
to similar facilities as Klib plc has a complete set of backup files for Klib plc. This strategy is part of
Klib plc’s:
A risk management
B crisis management
C disaster recovery planning
D operational planning
15 Which of the following statements best describes a cyber-attack?
A Accidental damage to a computer system caused by an inexperienced user

B Data corruption caused by poor systems integrity
C Deliberate action through the internet causing loss or damage to an organisation
D Data loss caused by physical damage such as vandalism to a computer system
16 What is the meaning of business resilience?
A The ability of a business to continue its planned strategic direction and not become distracted
by external changes.
B A business’s ability to maintain its market share in a competitive environment.
C A business’s ability to manage and survive against planned or unplanned shocks and disruption
to its operations.
D A business’s ability to continue to deliver stable growth in profits over the longer term.
17 One of the threats that Blogs Co has identified to its cyber resilience is that broadband and Wi-Fi
networks may become unavailable, so people working from home would be unable to access Blog
Co’s systems.
Requirement
In terms of the ICAEW report ‘Developing a cyber-resilience strategy’, what type of threat has Blog
Co identified?
A Mobile threat
B Networking and cloud considerations
C Access controls in the mobile world
D Denial of service
18 A firm of chartered accountants, XYZ LLP is updating the priority of the tasks in its business continuity
plan and wishes to be consistent with the priorities used in the ICAEW’s own business continuity
plan.
Requirement
Which of the following tasks is likely to have the highest level of priority?
A Ensuring all systems recover from the disaster
B Communicating with staff and other key stakeholders
C Recovering mission critical systems so business activities can be resumed
D Protecting the safety and wellbeing of employees, visitors and contractors
this chapter.


For many small businesses the most evident risk is that customers do not buy what they supply,
whether because of competition, fashion or an economic downturn. This is also the risk that is most
difficult to deal with, though being well-informed and innovative help to ensure that the business can
react adequately. There is a real risk too that the costs of providing the goods or service will rise,
which again is hard to contend with as the business may have little or no bargaining power. The risks
from inadequate controls are less likely though more catastrophic; most small business owners are
very closely involved in the running of it and keep close control of quality, administration and staff,
but there are plenty of businesses which have gone under due to one fraud, or one lapse of quality.
Finance is also a serious risk; bank overdrafts can be called in on demand, and cash flow has often
caused very severe problems, even winding up, in otherwise successful businesses.

Mean = £8,000. Median = £6,400. Mode = £6,400.
The mean = the sum of all the values ÷ number of values
Total sales for the week were £(2,000 + 2,500 + 6,400 + 6,400 + 12,000 + 14,000 + 12,700) =
£56,000
Number of days = 7
Therefore mean = Σ(x)/n = £8,000
To calculate the median, daily sales must be ranked in order (2,000, 2,500, 6,400, 6,400, 12,000,
12,700, 14,000). Since we have 7 values, the median is the 4th value being £6,400.
The mode is the most frequently occurring value. The only value that occurs more than once is
£6,400 which occurs twice. The mode is therefore £6,400.

The range is the difference between the highest and lowest values, being £10,700 (12,700 - 2,000).
£10,700.
Standard deviation 4,559

The coefficient of variation is = = 57%
mean 8,000
The meaning of the standard deviation is that on average, the difference between daily sales and the
mean is £4,559. The coefficient of variation is 57%, meaning that on average, sales deviate from the
mean by 57% each day. Sales are therefore very volatile.

PII is a requirement not of the law but of ICAEW itself, which acts as regulator of its members both in
and out of public practice. PII is intended to provide funds to persons who have suffered financial
loss as a result of the negligence of a chartered accountant; this is paid to the injured party, not to
the chartered accountant, but it is an example of how a person (the chartered accountant) may
transfer some of the risks they face to another entity, in this case the insurance company.

You should not wait for further evidence before acting. Immediately take action to maintain or
increase cash flow:
• Accelerate receipts from customers even if this requires the granting of discounts
• Decelerate payments to suppliers even if this means losing discounts
• Increase short-term sales but maintain or increase margins on sales if possible

• Reduce expenses:
– Eliminate non-essential expenses
– Sell surplus long-term assets
– Reduce payroll if possible
– Renegotiate the overdraft and other debts

There is no ‘answer’ to this question as such, because responses will depend on the organisation that
you chose. However, this is a useful exercise to get you thinking about business resilience issues from
a ‘real-world’ point of view.

D The possibility that an event will occur and adversely affect the achievement of objectives
Option A describes variability, option B is not a definition of risk and option C defines uncertainty.
A That costs might rise
All of the other options are upside risks.
C volatile and high risk
Volatility measures the variation of returns in terms of profits, dividends and share prices – the more
volatile the return, the higher the risk.
B a strategy risk
D an operational risk
This is a people risk, which is a kind of operational risk.
C impact (probability)
A It reflects all values in a data set
D It is widely understood
The mean could be distorted by outliers, so statement B is not correct.
The mean may return a value that is not the same as an actual value in the data set, so C is not
correct.
D the lower it is, the more concentrated the data is around the mean
If the size of the values in the data is higher, the standard deviation is likely to be larger too, which is
why the coefficient of variation is used. A is therefore wrong.
The standard deviation does use all the data in a data set (via the variance).
The standard deviation can either be positive or (in rare cases) zero. It cannot be negative.
C the probability of any value in the data set being equal to or less than the mean is 50%
D more than half of the values in a data set lie within one standard deviation of the mean
The normal distribution is symmetrical – it is not skewed. Therefore A is incorrect.
The mean, median and mode all have the same value in the normal distribution. So B is incorrect.
Since the distribution is symmetrical, 50% of the values do lie at or below the mean.
The probability of any value being in the range from one standard deviation below the mean to one
standard deviation above the mean is 68.2% (you would not be expected to memorise this value, but

it is important to understand that the majority of the data in the normal distribution is located within
one standard deviation of the mean). D is therefore correct.
A mode, median, mean
The mode is typically at the top of the hump in a distribution. In a skewed distribution the median is
next to the mode and the mean is next to the median. In a positive skewed (right hand) distribution,
the sequence is mode, median, mean as both the median and the mean are a higher value than the
mode, sliding down the long right-hand tail of the distribution which is humped to the left.
B response awareness
A avoidance and reduction
Reducing the number of staff is a form of avoidance; training the remaining ones is a form of risk
reduction.
C analysis of the causes of Mike’s actions on 15 June
C disaster recovery planning
C Deliberate action through the internet causing loss or damage to an organisation
Cyber-attacks are deliberate and take place through the internet.
C A business’s ability to manage and survive against planned or unplanned shocks and disruption
to its operations.
B Networking and cloud considerations
Mobile threat refers to the risk of mobile devices containing confidential information or access the
business’s networks being lost or stolen. Access controls in the mobile world relates to the threat of
poor access controls on the company’s main systems relating to providing access to mobile devices.
A denial of service attack is not mentioned as a category of cyber resilience threats in the ICAEW
report, but is a type of cyber-attack where the perpetrators try to crash a target system.
D Protecting the safety and wellbeing of employees, visitors and contractors
This is the first priority in the ICAEW’s business continuity plan. It recognises that when a disaster
occurs (eg, an earthquake or terrorist attack) the safety of humans is paramount.

Chapter 6
The finance function and

financial information
Introduction
Learning outcomes
Syllabus links
Assessment context
Learning topics
1 What does the finance function do?
2 The structure of the finance function
3 Managing the finance function
4 Uses and types of financial information
5 Users of financial information and their information needs
6 Limitations of financial information in meeting users’ need
7 Information processing and management
8 Information security
9 Measuring performance
10 Measuring climate change, sustainability management and
natural capital
11 Establishing financial control processes and internal controls
Summary
Further Question Practice
Self-test questions
Introduction
Learning outcomes
• Specify the role of financial information prepared by finance functions in:
– supporting businesses in pursuit of their objectives, including business partnering;
– providing for accountability of management to shareholders and other stakeholders;
– reflecting business position and performance; and
– supporting users in making decisions
• Identify the main considerations in establishing and maintaining accounting and financial
reporting functions and financial control processes.
• Identify, in the context of accounting and other systems, key aspects of:
– information processing;
– information security; and
– information management
• Specify why the management of a business require performance measurements including in
relation to sustainability, natural capital and climate change.
• Identify the accountant’s role in preparing and presenting information for the management of a
business.
Specific syllabus references are: 3a, 3b, 3c, 3d, 3e
6
Syllabus links
The topic of what the finance function does and how and why it does it are also discussed in
Accounting, Assurance and Management Information at Certificate level, in Financial Accounting and
Reporting and Financial Management at Professional level, and at the Advanced level.
6
Assessment context
Questions on the finance function will be set in the assessment in either MCQ or multiple response
6

of this chapter.

1–3 Role, structure and Approach Questions on the

management of the Note the four finance function could
finance function specific tasks of the easily appear in the
The role and finance function and exam.
management of the be aware of what is Questions are likely to
finance function is involved. Read the be set in a scenario
of key importance sections on business context. Knowledge-
to any business and partnering and be type questions are also
to any accountant aware of how likely, set on particular
involved with that finance can support principles or definitions.
business. other functions. Be Essential points are:
aware of the factors
that influence the • Tasks of the finance
structure of the function

finance function. • Meaning of Business

Stop and think partnering
What actually • Structure of the

happens in the finance function
finance function of a
business, as
opposed to its
marketing,
production/operatio
ns and human
resources functions?
How does the
finance function fit
in, and how does it
support the other
functions and
thereby help the
business to achieve
its strategic
objectives?
4–5 Users of financial Go through these This is an important area

information and sections carefully as that may well be tested
their information they contain a lot of in your exams. Exam
needs material that could questions will tend to
The information in feature in exams. Be focus on the qualities of
this section helps aware of the users information in financial
you to understand of financial statements.
the fundamentals of information and Essential points are:
what financial what they want.
Learn the qualitative • Meaning of planning,
information aims to controlling, recording
achieve. It forms the characteristics of
financial statements. transactions,
foundations of the performance
financial reporting Stop and think measurement and
exams later on. Why do you think decision making.
the term ‘accurate’ is • Users of financial
not one of the information
fundamental
characteristics, and • Information to
what is the support decisions
difference between • Qualitative
faithful characteristics of
representation and financial statements
accuracy?
6 Limitations of Approach Knowing the limits of

financial Read through the financial information is
information section to make important and there
yourself aware of could be a question in
the limitations of your exam on this area.
financial Questions are likely to
information. test your knowledge of
the weaknesses of
Stop and think financial statements as a
As an employee, source of information.
what information
ICAEW 2023 6: The finance function and financial information 201

would you like to

know about the
organisation you
work for? How much
of this is financial?
What non-financial
information would
be interesting to
you?
7 Information Approach Questions could be

processing and Start by learning the knowledge based or be
management meaning of data scenario based,
Data processing processing and the requiring you to apply
involves taking CATIVA principles. knowledge of the
unprocessed data Then read the rest of terminology, particularly
and converting it the section noting the different types of
into useful the different types of system.
management system. Essential points are:
information. Stop and think • Information
Accountants have a processing: CATIVA
key role in helping Think of examples of
businesses develop data. What • Cloud accounting,
systems that will processes are TPS and MIS
provide them with required to convert • Information
the information they this data into useful management
need. information? systems
• Distributed ledger
technology and
digital assets
8 Information security Approach Information security is a

Information security Read through the crucial aspect of risk
covers threats to section ensuring you management for most
information from all are aware of the businesses. There could
sources, not just different threats to well be questions on this
cyber threats (which security of area in your exam. You
are covered in the information. Learn need to be aware of the
chapter the qualities of risks to information and
Developments in secure information the different types of
technology) using the ACIANA controls that are used to
acronym. Ensure mitigate these risks.
you are familiar with Essential points are
the different types of • Information security:
controls over ACIANA
information.
• Different types of
Stop and think control
What controls exist
over the data that
you input into the
systems you use at
your workplace to

ensure the data you

enter is accurate?
9 Measuring Approach Questions in this area IQ1: Economy,

performance This is an important tend to focus on the efficiency and
Measuring section, so spend meaning of the effectiveness
performance is one time working terminology of helps to
of the key roles of though this, performance understand the
the accountant. It is understanding the measurement. difference
also one of the most different areas that Essential points are between these
challenging, as performance three terms.
• Meaning of “three
identifying measurement Es” (economy
appropriate metrics focuses on. efficiency and
is not always Stop and think effectiveness)
straightforward.
Think of a business • Nature of key
that you are familiar performance
with. What are its indicators
critical success • Purpose of the
factors? What KPIs balanced scorecard
would you use to and the four
measure its perspectives.
performance?
10 Measuring climate Approach Green issues are a hot

change, Read through the topic in finance so we
sustainability section and can expect questions on
management and understand why this area in the exam.
natural capital climate change and Essential points are:
There is more and sustainability are • Impact of climate
more recognition of relevant to change on
the fact that businesses. Be businesses.
businesses have a aware of the
responsibility to frameworks and • Four areas of
stop damaging the know at a higher disclosure in the
environment and to level what they TCFD.
start operating in a include, but don’t try • Be aware of the GRI
sustainable manner. to memorise all the disclosures and the
Accountants have a detailed fact that GRI covers
role in helping requirements. economic, social and
provide information Stop and think environmental
about this. reporting.
From the
perspective of a • The Climate
shareholder, are Disclosure Standard
there any benefits to Board’s framework
taking actions to • The new International
reduce carbon Sustainability
emissions? Standards Board
• The value framework
11 Establishing Approach Essential points are:

financial control Read through the • Purpose of internal
processes and section. Be aware of controls
internal controls what internal • Control activities
controls are. Learn

Many financial and the control activities

management roles listed. Be aware of
involve being able the responsibility of
to assess or give senior management
advice on internal for ensuring that an
controls. effective internal
control and risk
management
process is in place.

1 What does the finance function do?
Section overview
• The finance function looks after the business’s money. Its tasks are: recording transactions,
management accounting, financial reporting and treasury management.
• The finance function supports the business’s pursuit of its strategic objectives by providing
information to measure performance and support decision-making, and by ensuring the business
has sufficient funds for its activities.
In the chapter Managing a business, we saw that the main functions of a business are marketing,
operations/production, procurement, human resources, IT and finance. This reflects the model of the
business as taking three basic types of resource – materials, labour and money – to produce goods
and services which generate profit. It is a major part of the finance function’s role to look after the
business’s money.
In this chapter we provide an overview of the work of the finance function and how it supports
achievement of the business’s objectives.
1.1 The tasks of the finance function

The finance function is involved in four specific, but often interrelated, tasks.
Definitions
Recording financial transactions: Ensuring that the business has an accurate record of its revenue,
expenses, assets, liabilities and capital.
Management accounting: Providing information to help managers and other internal users in their
decision-making, performance measurement, planning and control activities.
Financial reporting: Providing information about a business to external users that is useful to them in
making decisions and for assessing the stewardship of the business’s management.
Treasury management: Managing the funds of a business, namely cash and other working capital
items, plus long-term investments, short-term and long-term debt, and equity finance.
The separate parts of the finance function carry out the following tasks in fully computerised
accounting systems:
• Recording financial transactions:
– Recording financial transactions (payroll, credit sales, credit purchases, and cash receipts and
payments) in the accounting records
– Entering summaries of transactions in the permanent records (nominal, receivables and
payables ledgers) from the accounting records
– Ensuring that resources are properly controlled (stewardship)
– Cloud accounting, machine learning, automation and distributed ledger technology will
increasingly affect how financial transactions are recorded, who they are recorded by, and who
can access and rely on them (see the chapter Introduction to financial information)
• Management accounting:
– Preparing financial information for internal users (internal reporting for planning and control to
those charged with management and with governance)
– Identifying or determining the unit cost of the goods and/or services produced by the
business, including classification into fixed and variable costs, or direct and indirect costs (cost
accounting)
– Planning ahead by preparing forecasts and budgets
– Helping management decision-making (cost-volume-profit (CVP) analysis, including breakeven
and limiting factor analysis)

– Preparing performance measures and identifying reasons for good and bad performance,
including variance analysis
– Analysing capital investment decisions
– Determining sales and transfer prices
• Financial reporting:
– Preparing financial information including financial statements for external users (external
reporting) to enhance good corporate governance (see the chapters Governance and ethics
and Corporate governance)
– Tax reporting (eg, to HM Revenue and Customs (HMRC) in the UK)
– Regulatory reporting
• Treasury management:
– Preparing and monitoring cash budgets
– Managing surpluses and deficits in cash balances
– Managing working capital from day to day so as to optimise cash flow, including inventory,
receivables and payables management
– Analysing short-term and long-term financing decisions
– Managing investments
– Managing foreign exchange
– Managing financial risk
– Raising long-term finance (debt and equity) (see the chapter Business finance)
1.2 Business partnering – supporting the pursuit of business objectives
Definition
Business partnering: Involves the finance function working alongside other business functions rather
than being a separate function on their own. Instead of only reporting on organisational
performance, the role of the finance function becomes one of providing advice and support to the
other areas of the business, to help them maximise their performance.
ICAEW’s guide Finance business partnering: a guide (2018) provides an explanation of business
partnering. In business partnering, finance functions are embedded into the various organisational
functions. This often means that they work alongside members of, for example, the marketing,
operations, procurement and human resources functions. However, this is not always the case and
business partnering may be achieved remotely, or by the finance function forming close
relationships with the other business functions. Whatever practical form business partnering takes,
finance functions are often used as sources of financial expertise that provide insights into the
performance of the business functions that they support. However, this role can expand to other
aspects such as:
• involvement in strategy formulation, implementation and communication;
• involvement in commercial decision making and negotiations;
• leading on business analysis; and
• being a sounding board, trusted adviser, critical friend and facilitator of productive business
discussions
Such roles mean that members of the finance team are in a position to add as much value to the
organisation as they can. Other examples of support and insight that the finance function provides to
specific business areas include:
• marketing – insights into the drivers of revenue, analysis of sales volumes, and advice on pricing
(such as price elasticity of demand)
• operations/production – variance analysis to identify reasons behind increases or decreases in
cost per unit, decision support for new products or closing down operations
• IT – monitoring of KPIs for IT performance such as system downtime and age of IT equipment to
identify need for investment in new equipment

• HR – analysis of payroll costs and productivity of employees
• procurement – monitoring of supplier performance against service level agreements (such as
whether delivery schedules were met and in regards to quality of materials delivered)
• research and development – project appraisal to recommend new areas to research and develop
new products in, monitoring and controlling costs against budget
As well as the advice and support provided through business partnering, the finance function
supports the business in achieving its objectives in other ways, for example by:
• undertaking transaction processing and ensuring there are sufficient financial control processes
in the system;
• providing information to support decisions and measure performance (financial reporting and
management accounting); and
• ensuring there is finance and cash available for the business’s activities (treasury management)
1.3 Factors relating to effective business partnering

1.3.1 Dilemmas
There is a risk that a finance business partner may get too close to the business function managers.
This may lead to a compromise of objectivity and independence. This could potentially lead to:
• subverting governance processes through misreporting; and
• sidestepping controls with wide-reaching consequences
A second dilemma is that insufficient time is allocated to business partnering because:
• people who lack the necessary knowledge, skills and attitudes to perform business partnering
may divert their attention to tasks they feel more comfortable with, instead of prioritising business
partnering work; and
• resistance by operational managers can make business partnering roles stressful making it
preferable to spend time elsewhere
2 The structure of the finance function

Section overview
• Many businesses centralise some if not all of the finance function’s tasks.
• All aspects of the finance function’s tasks depend on the efficient and effective initial recording of
financial transactions.
How the finance function is organised depends on the size of the business and its overall
organisational structure. In many businesses, even very large ones, some if not all of the finance
function’s tasks are centralised. This is particularly helpful with respect to overall management of cash
and to external reporting, but it is not so helpful with respect to making sure that local operational
managers get all the information and support they need (internal reporting). Total centralisation is
even more problematic when the business operates in global markets, where exchange rates and
time differences make the structure unwieldy.
A typical finance function which performs all the tasks set out above would be structured as in Figure
6.1. Note that the data and information provided by those responsible for recording financial
transactions feed into each of the other three sections.
Against some items we have noted where you will encounter detailed coverage elsewhere in the
ICAEW syllabus. We refer to:
• ACC Accounting; Financial Accounting and Reporting
• MI Management Information
• FM Financial Management
• TAX Principles of Taxation; Tax Compliance

Finance function
Recording financial transactions (ACC):

• Computerised accounts
• Ledgers
Management accounting Treasury management Financial reporting:

(MI): (FM/MI): • Financial statements (ACC);
• Cost accounting • Cash budgets see also Chapter 6
• Budgeting • Long-term finance • Tax (TAX)
• Management decisions • Provision of information to
decision-making • Managing financial risk external regulators (ACC);
• Performance • Raising investment see also Chapter 6
measurement finance
• Capital budgeting and • Management of cash,
decision making including foreign
• Pricing exchange
• Management of working
capital
Internal reporting External reporting
Figure 6.1: The finance function
3 Managing the finance function

Section overview
• As with any other of the business’s functions, the finance function needs to be effectively
organised and led, with its performance properly planned and controlled.
The optimum structure for any particular business’s finance function will be affected by all the factors
considered in the chapter Organisational and business structures, in particular:
• its business structure (sole trader, partnership, company)
• its organisational structure, size and geographical dispersion, including the degree of
centralisation required
• its markets
• its technology (such as the use of cloud accounting and cognitive technologies)
• its history and ownership
• its culture (human relations, open systems, internal process or rational goal)
Within the finance function its managers are responsible for ensuring that the function is properly
managed and achieves its objectives. The way in which they do this is to perform the tasks of
management that we saw in the chapter Managing a business.
3.1 Planning and control

The overall direction of the finance function’s work needs to be planned and controlled, including:

• forecasting what is needed (the processing that needs to be done, and the reports and finance
that need to be available)
• evaluating available resources, such as qualified staff and robust information systems
• developing objectives, plans and targets
• implementing the plan and measuring performance
• using feedback from measuring performance to make necessary amendments to the plan
3.2 Organising and leading

Time and effort in the finance function need to be organised so that its objectives and targets are
met, including:
• defining what processes, technology and people are required
• allocating and co-ordinating work
• generating effort and commitment in finance staff
Questions may ask you what is an appropriate structure for a finance function. You may be required
to demonstrate understanding of the business, its strategy, industry and wider context.
4 Uses and types of financial information

Section overview
• Financial information comprises information about a business’s activities expressed in monetary

terms.
• Information on a business’s finances is used for planning, controlling, recording transactions,
measuring performance and making decisions.
• Planning, operational, tactical and strategic information are all required.
Definition
Financial information: A broad definition is that financial information is information about an entity’s
activities expressed in monetary terms. A narrower definition, contained in the IFRS® Conceptual
Framework, is that financial information is information contained in an entity’s financial report. This
includes information on the entity’s income, expenses, assets, liabilities and equity.
4.1 Why do businesses and managers need financial information?

Businesses and managers require financial information for:
• planning;
• controlling;
• recording transactions; and
• performance measurement
4.1.1 Planning
Once a decision has been made, say on what competitive strategy to follow, it is necessary to plan
how to implement the steps necessary to make it effective. Planning requires a knowledge of, among
other things, available resources, possible timescales for implementation and the likely outcome
under alternative scenarios.

4.1.2 Controlling
Once a plan is implemented, its actual performance must be controlled. Information is required to
assess whether implementation is proceeding as planned or whether there is some unexpected
deviation from plan. It may consequently be necessary to take some form of corrective action.
4.1.3 Recording transactions

Information about each transaction or event is required for a number of reasons.
• Documentation of transactions can be used as evidence in a case of dispute
• There may be a legal requirement to record transactions, for example for accounting and audit
purposes
• Detailed information on production costs can be built up, allowing a better assessment of
profitability
4.1.4 Performance measurement

Just as individual operations need to be controlled, so overall performance must be measured in
order to enable comparisons of the actual outcome with the plan. This may involve collecting
information on, for example, costs, revenues, volumes, timescale, profitability and long-term
sustainability.
4.1.5 Decision making

Information is required as a basis on which to make informed decisions. This completes the full circle
of the business management process.
4.2 Type of information

Information can be classified according to the use to which it is put. The same type of information
will not be provided to a front-line manager of a team of machine operatives as to the board of
directors. This is because the front-line manager needs to know how many operatives can be
employed on one shift, for instance, while the board of directors want to know whether enough
skilled operatives can be available in the medium-term to resource increased production of a
successful new product.
Information can thus be classified as follows.
• Planning information helps people involved in the planning process
• Operational information helps people carry out their day-to-day activities, eg, how many
operatives are needed on one shift
• Tactical information helps people deal with short-term issues and opportunities, eg, monthly
variance reports for the factory
• Strategic information supports major long-term decision making, eg, can resources be made
available to expand production?
5 Users of financial information and their information

needs
Section overview
• Different stakeholders use financial information for different purposes, and require different
amounts and types of information for these purposes.
• Financial information is useful when it supports decision-making by users, and allows them to
hold managers to account.
• Financial information should have the fundamental qualitative characteristics of relevance and
faithful representation and the enhancing qualitative characteristics of comparability, verifiability,
timeliness and understandability.

5.1 What is financial information used for?
The Conceptual Framework for Financial Reporting (also known as the IFRS Framework), issued by
the International Accounting Standards Board (the Board) sets out the objectives of financial
information. It is focused on published financial statements in particular, rather than financial
information in general, but it usefully points out that nearly all users use financial information to make
decisions, such as those to:
• decide when to buy, hold or sell an equity investment or a debt instrument;
• decide whether to provide or settle loans or other forms of credit; and
• decide how to vote or otherwise influence management decisions
5.2 Who uses financial information?

The following are the primary users of financial information and their specific information needs.
Primary users Need financial information to:
Present and potential investors ( • (Make decisions about buying, selling or holding equity,
shareholders) therefore need information on:
– risk and return of investment; and
– ability of company to pay dividends
• Perform financial due diligence prior to the acquisition of
a business or when making a significant investment. Due
diligence is an investigation into the organisation’s assets,
liabilities, income, expenses and capital via the financial
statements and other information to help make a decision
about its commercial value.
Lenders and other payables • Make decisions about buying, selling or holding debt
instruments and providing or settling loans or other forms
of credit
• Assess whether loans will be repaid, and related interest
will be paid, when due
Other users and their financial information needs are as follows:
Other users Need financial information to:
Employees • assess their employer’s stability and profitability

• assess their employer’s ability to provide remuneration,
employment opportunities and retirement and other benefits
Customers • assess whether business will continue in existence – important

where customers have a long-term involvement with, or are
dependent on, the business, eg, where they are supply chain
partners
Suppliers and other • assess the likelihood of being paid when due
business partners
Governments and its • assess allocation of resources and, therefore, activities of

agencies, including businesses
prudential and market • help in regulating activities
regulators
• assess taxation income
• provide a basis for national statistics
• help direct policy on, for instance, health and safety and equal
opportunities issues

Other users Need financial information to:
The public and community • assess trends and recent developments in the business’s
representatives prosperity and its activities – important where the business
makes a substantial contribution to a local economy, eg, by
providing employment and using local suppliers
5.3 When is financial information useful?

Financial information is useful to users when it:
• helps them to make decisions; and
• shows the results of management’s stewardship of the resources entrusted to them
For financial information to meet these two objectives it must be prepared on the basis of two
underlying assumptions:
• The accrual basis of accounting: the effects of transactions and other events are recognised
when they occur (not as they are realised in cash), and they are recorded and reported in the
financial statements of the periods to which they relate
• The business is a going concern and will continue in operation for the foreseeable future
5.4 Information for making decisions and making managers accountable

When users make decisions, they need financial information to evaluate:
• The ability of a business to generate cash so as to:
– pay employees and suppliers;
– meet interest payments;
– repay loans; and
– pay dividends
• The timing and certainty of cash flows
Primary users therefore need information about the entity’s ‘economic phenomena’:
• the economic resources of the entity
• claims against the entity
• the effects of transactions and other events and conditions that change those resources and
claims
Information on these phenomena also helps the user to evaluate how efficiently and effectively the
entity’s management and governing board have discharged their stewardship responsibilities to use
the entity’s resources.
In order to evaluate whether the business can generate sufficient cash on time the user needs
information on the business’s:
• financial position (its statement of financial position);
• financial performance (its statement of profit or loss); and
• changes in financial position (its statement of cash flows)
These are contained in the business’s financial statements
5.4.1 Information on financial position
Factors affecting the Information on this factor is useful for predicting

business’s financial position
The economic resources it The business’s ability to generate cash in the future
controls
Its liabilities What the organisation owes to third parties, for example debts
and other claims against the entity
Its financial structure • future financing needs

Factors affecting the Information on this factor is useful for predicting
business’s financial position
• how future profits and cash flows will be distributed among

stakeholders
• the business’s likely success in raising new equity and
borrowing
Its liquidity Whether cash will be available in the near future after taking
account of current financial commitments
Its solvency The availability of cash in the longer term to meet financial
commitments as they fall due
Its adaptability Its capacity to adapt to changes in the environment in which it

operates
5.4.2 Information on financial performance

Information on the business’s profitability, especially variability in profits over time, helps the user to
predict or assess:
• potential changes in the economic resources the business is likely to control in the future;
• the business’s capacity to generate cash flows from its existing resource base; and
• how effectively the business might employ additional resources
5.4.3 Information on changes in financial position

Information on the business’s past cash flows helps the user to predict or assess its investing,
financing and operating activities during the reporting period. This helps the user to assess:
• how able the business is at generating cash; and
• how well the business uses cash that it has generated
5.5 Qualitative characteristics of financial statements

The IFRS Framework states that if financial information is to be useful, it must be relevant and
faithfully represent what it purports to represent. The Framework also states that the usefulness of
financial information is enhanced if it is comparable, verifiable, timely and understandable.
Definitions
Fundamental qualitative characteristics: The attributes that are fundamental in making information
provided in financial statements useful to users (IFRS Framework):
• Relevance
• Faithful representation
Enhancing qualitative characteristics: The attributes that enhance the fundamental usefulness of
information provided in financial statements to users (IFRS Framework):
• Understandability
• Comparability
• Verifiability
• Timeliness
5.5.1 Fundamental qualitative characteristic: relevance

The IFRS Framework states that financial information is relevant if it is capable of making a difference
in the decisions made by users, by means of its predictive value, confirmatory value or both.
• It has predictive value if it can be used as an input to processes employed by users to predict
future outcomes. Financial information need not be a prediction or forecast to have predictive
value, as it can be in some other form and be employed by users in making their own predictions.

• It has confirmatory value if it provides feedback about (confirms or changes) previous evaluations.
In other words, information is relevant to users when it influences their decisions because they can
thereby:
• evaluate past, present or future events; and
• correct or confirm past evaluations
Relevance is affected by:
• the nature of certain items: Some pieces of information are highly relevant whatever their
monetary value, such as the acquisition of a new business with significantly increased risks.
• the materiality of certain items: Materiality is an entity-specific aspect of relevance based on the
nature or magnitude, or both, of the items to which the information relates in the context of an
individual entity’s financial report. In other words, a piece of information is material if omitting it or
misstating it could influence decisions that users make on the basis of financial information about
a specific reporting entity.
• the IFRS Framework confirms that measurement uncertainty does not prevent information from
being useful. However, if measurement uncertainty is very high, then it may be more useful to use
slightly less relevant information that has a lower level of measurement uncertainty.
5.5.2 Fundamental qualitative characteristic: faithful representation

To be useful, financial information must faithfully represent the entity’s economic phenomena (as
defined in the IFRS Framework) in words and numbers. To be a faithful representation it must
therefore be:
• complete, including all necessary descriptions and explanations;
• neutral (ie, without bias in the selection or presentation of information); or
• free from error (with no errors or omissions in the description of the phenomena, and with no
errors in the process used to produce the reported information)
In regard to neutrality, the Framework states that neutrality is supported by the exercise of prudence.
This is the exercise of caution when making judgements under conditions of uncertainty. Prudence
does not allow the overstatement or understatement of assets, liabilities, income or expenses.
5.5.3 Enhancing qualitative characteristic: understandability

Information should be clear and concise if it is to be readily understandable. Users are assumed to
have a reasonable knowledge of economic and business affairs and to be willing to be reasonably
diligent in the way they study financial information. Relevant information should not be excluded
from financial statements merely because it is hard to understand.
5.5.4 Enhancing qualitative characteristic: comparability

Measurement and display of the financial effect of like transactions and other events must be carried
out in a consistent way:
• throughout the business
• over time
• across different businesses
5.5.5 Enhancing qualitative characteristic: verifiability

The IFRS Framework states that verifiability means different knowledgeable and independent
observers could reach consensus, although not necessarily complete agreement, that a particular
depiction is a faithful representation using either direct or indirect methods. Information about the
future cannot be verified as such, but a statement of underlying assumptions about any such
information will help verifiability.
5.5.6 Enhancing qualitative characteristic: timeliness

The IFRS Framework states that timeliness means having information available to decision-makers in
time to be capable of influencing their decisions. Generally, the older the information is the less
useful it is. However, some information may continue to be timely long after the end of a reporting
period because, for example, some users may need to identify and assess trends.

5.6 The cost constraint on useful financial reporting
The IFRS Framework acknowledges that there is a cost constraint on the financial information that can
be provided. The benefits derived from information for all users should justify the cost of providing it.
6 Limitations of financial information in meeting users’

need
Section overview
Financial information may be of limited usefulness because its presentation is standardised and
aggregated, it is backward looking and it omits non-financial information.
As far as they go, general purpose financial statements are of most use to investors, lenders and
other payables. Their use for other interested parties, especially regulators, may be more limited. In
fact, the usefulness of financial information is limited in general by a number of factors.
6.1 Standardised and aggregated representation

Financial information, particularly financial statements, is usually highly standardised in terms of
their overall format and presentation although businesses are very diverse in their nature. This may
limit the usefulness of the information.
Financial statements are highly aggregated in that information on a great many transactions and
balances is combined into a few figures in the financial statements, which can often make it difficult
for the reader to evaluate the components of the business.
6.2 Backward-looking
Financial statements cover a period that has already ended; they are inherently historical and
backward-looking, whereas most users of financial information base their decisions on expectations
about the future. Financial statements contribute towards this by helping to identify trends and by
confirming the accuracy of previous expectations, but they cannot realistically provide the complete
information set required for all decisions by all users.
6.3 Omission of non-financial information

By their nature, financial statements contain information that is financial, not non-financial such as:
• narrative description of major operations
• discussion of business risks and opportunities
• narrative analysis of the business’s performance and prospects
• management policies and how the business is governed and controlled
Instead, these are normally covered in the strategic report and the Directors’ Report, published
alongside the financial statements.
6.4 Other sources of information

There are other sources of information available to at least some users of the basic financial
statements.
• Information on the internet and social media, Press reports and other media coverage are
available to all.
• In owner-managed businesses, the owners have access to internal management information
because they are the management. This information is, potentially, available on a continuous real-
time basis and will include:
– future plans for the business;
– budgets or forecasts; and
– management accounts, including, for example, divisional analysis

• Banks will often gain additional access to business information under the terms of loan
agreements.
• Potential investors, if they are planning to take a major stake or even a controlling interest, will
negotiate additional access to information.
• Suppliers may be able to obtain reports on the business’s credit standing via credit reference
agencies such as Experian. These are also used by lenders.
• Some information, such as brochures and publicity material (eg, press releases), is available to all.
• Brokers’ reports on major companies are available fairly widely.
7 Information processing and management

Section overview
• In the information processing system data is input, processed and then output as information.
• Information processing needs to be complete, accurate, timely, inalterable, verifiable and
assessable (CATIVA).
• The transaction processing system (TPS) performs, records and processes routine information for
marketing, production/operations, finance and HR functions.
• The management information system (MIS) processes data into information that supports and
facilitates decision-making by managers.
Definition
Information processing: Data, once collected, is converted into information for communicating
more widely within the business.
7.1 CATIVA criteria

To be effective, information processing should meet the following CATIVA criteria:
Completeness Everything that needs to be processed should be processed.
Accuracy Processing should be done so that the data remains true to its sources, and the
information produced contains no errors.
Timeliness Processing should occur in line with data availability and information needs,
which means real time (instantaneously) in many cases.
Inalterability The process should be open to neither unauthorised intervention while in

action nor alteration once completed (this aids accuracy and security).
Verifiability The sources of the data and the trail from data through processing to
information should be capable of being followed through.
Assessability The effectiveness of the processing should be open to scrutiny so that its
quality can be judged.
7.1.1 Information systems

Just as materials and labour are processed into outputs by the business’s production or operations
system, so are data processed into information by the business’s information systems.
Definitions
System: A set of interacting components that operate together to accomplish a purpose.
Business system: A collection of people, machines and methods organised to accomplish a set of
specific functions.

Information systems (IS): All systems and procedures involved in the collection, storage, production
and distribution of information.
Information technology (IT): The equipment used to capture, store, transmit or present information.
IT provides a large part of the information systems infrastructure.
Information management: The approach that a business takes towards the management of its
information including planning IS/IT developments, the organisational environment of IS, control and
technology.
A system has three component parts: inputs, processes and outputs. Other key characteristics of a
system are the environment and the system boundary – as shown below:
System boundary
Environment Environment
Input (data) Output (information)

Processing
• The data input may be output from other systems; for example, the output from a transactions
processing system forms the input for a management information system (as we shall see).
• Processing transforms input data into output information. There is not necessarily a clear
relationship between the number of inputs to a process and the number of outputs.
• Output information is the result of the processing.
• A system boundary separates the information system from its environment. For example, the
marketing information system and the accounting information system are generally separate, but
there may be an interface between the two systems to allow the exchange of resources. There
may also be interfaces between internal and external information systems, for instance between a
processing system and the sales system of its major suppliers.
• Anything which is outside the system boundary belongs to the system’s environment and not to
the system itself. A system accepts inputs from the environment and provides outputs into the
environment. The parts of the environment from which the system receives inputs may not be the
same as those to which it delivers outputs. The environment exerts a considerable influence on
the behaviour of a system; but the system can do little to control the behaviour of the
environment.
In relation to financial information, the two information processing systems in which we are most
interested are:
• the transaction processing system; and
• the management information system
7.2 The transaction processing systems
Definition
Transaction processing systems (TPS): A system which performs, records and processes routine
transactions.
A TPS is used for routine tasks in which data items or transactions must be processed so that
operations can continue. A TPS supports most business functions in most types of business.

Transaction processing systems
Sales/marketing Manufacturing/ Finance/ Human resources

system production system accounting system system
Major • Sales • Scheduling • Budgeting • Personnel

functions management • Purchasing • Nominal ledger records
of system • Marketing • Benefits
• Shipping/ • Invoicing
research receiving • Salaries
• Management
• Promotion • Engineering accounting • Labour relations
pricing
• Operations • Training
• New products
Major • Sales order • Materials resource • Nominal ledger • Payroll

parts of system planning • Accounts • Employee
systems • Marketing • Purchase order receivable records
research control /payable • Employee
system • Engineering • Budgeting benefits
• Pricing • Quality control • Treasury • Career path
system management systems
7.3 The management information system (MIS)
Definition
Management information system: Converts data from mainly internal sources into information (eg,
summary reports, exception reports). This information enables managers to make timely and
effective decisions for planning, directing and controlling the activities for which they are
responsible.
An MIS provides regular reports and (usually) on-line access to the business’s current and historical
performance. The MIS transforms data from underlying TPS into summarised files that are used as the
basis for management reports. It:
• supports structured decisions at operational and management control levels
• is designed to report on existing operations
• has little analytical capability
• is relatively inflexible
• has an internal focus
8 Information security
Section overview
• Information is a valuable commodity and therefore needs to be kept secure.

• Risks to data include human error, technical error, natural disasters, deliberate damage and
industrial action.
• Information security involves prevention, detection and deterrence of risks to data, plus recovery
and correction procedures and threat avoidance.
• A secure information system is only available when needed and maintains confidentiality. The
information is authentic and has integrity. Changes must be authorised. It is designed so that
users will not have to reject the information on the basis that it is faulty in any way (ACIANA – see
later).
• Information security is ensured by means of physical access, security and integrity controls.

8.1 Why is information security important?
If you own something that you value – you look after it. Information is valuable and it deserves
similar care.
Definition
Security (in information management): The protection of data from accidental or deliberate threats
which might cause unauthorised modification, disclosure or destruction of data, and the protection
of the information system from the degradation or non-availability of services.
The risks to data are as follows:

• human error
• entering incorrect transactions
• failing to correct errors
• processing the wrong files
• technical error such as malfunctioning hardware or software
• natural disasters such as fire, flooding, explosion, impact, lightning
• deliberate actions such as fraud
• commercial espionage
• malicious damage
• industrial action
• cyber risks, such as data corruption, hacking or being held to ransom
Many of these are the physical and cyber risks that we saw in the chapter Introduction to risk
management; risk management and controls are key issues in ensuring the security of information
systems.
8.2 Ensuring the security of information

Aspects of security include the following:
• Prevention. It is in practice impossible to prevent all threats cost-effectively, but prevention is
better than cure.
• Detection. Detection techniques are often combined with prevention techniques: a log can be
maintained of unauthorised attempts to gain access to a computer system.
• Deterrence. As an example, computer misuse by personnel can be made grounds for disciplinary
action.
• Recovery procedures. If the threat occurs, its consequences can be contained (for example,
checkpoint programs).
• Correction procedures. These ensure the vulnerability is dealt with (for example, by instituting
stricter controls).
• Threat avoidance
8.3 Qualities of a secure information system: ACIANA
Availability Information can always be accessed by authorised people.
Confidentiality Information cannot be accessed by anyone who does not have the right
to see it.
Integrity Data is the same as in its sources and has not been accidentally or
deliberately reduced, altered, destroyed or disclosed.
Authenticity Data and information are taken from bona fide sources.

Non-repudiation Information is not open to being rejected by its intended users on the
grounds of faults in the system.
Authorisation Changes in the system can only be made by persons who are
accountable for them.
8.3.1 Physical access controls

• Personnel, including receptionists and, outside working hours, security guards can help control
human access
• Door locks can be used where frequency of use is low. (This is not practicable if the door is in
frequent use.)
• Locks can be combined with:
– a keypad system, requiring a code to be entered; and
– a card entry system, requiring a card to be ‘swiped’
• Intruder alarms
• Laptops, tablets, smartphones and other devices with access to the system should be kept secure
• Staff should be allocated an individual personal identification number, or PIN, which identifies
him or her to the building
8.3.2 Security controls in the system

These help to prevent:
• human error:
– entering incorrect transactions
– failing to correct errors
– processing the wrong files
• technical error such as malfunctioning hardware or software
• deliberate actions such as fraud
• commercial espionage
• malicious damage
8.3.3 Integrity controls in the system

Data will maintain its integrity if it is complete and not corrupted.
• The original input of the data must be controlled in such a way as to ensure that the results are
complete and correct. Input controls should ensure the accuracy, completeness and validity of
input.
– data verification involves ensuring data entered matches source documents
– Data validation involves ensuring that data entered is not incomplete or unreasonable. Various
checks include:
◦ check digits. A digit calculated by the program and added to the code being checked to
validate it
◦ control totals. For example, a batch total totalling the entries in the batch
◦ hash totals. A system generated total used to check processing has been performed as
intended
◦ range checks. Used to check the value entered against a sensible range, eg, ledger account
number must be between 5,000 and 9,999
◦ limit checks. Similar to a range check, but usually based on an upper limit, eg, must be less
than 999,999.99
• Any processing and storage of data must maintain the completeness and correctness of the data
captured. Processing controls should ensure the accuracy and completeness of processing.
Programs should be subject to development controls and to rigorous testing. Periodic running of
test data is also recommended.

• Reports or other output should be set up so that they, too, are complete and correct. Output
controls could include:
– investigation and follow-up of error reports and exception reports produced by the system
– batch controls to ensure all items are processed and returned
– controls over distribution/copying of output
– labelling of storage media
The system should have a back-up and archive strategy, including:
• regular back-up of data (at least daily);
• archive plans; and
• a disaster recovery plan including off-site storage
Users of the system should be given a password. While unauthorised persons may circumvent
physical access controls, a logical access system can use passwords to prevent access to data and
program files, by measures such as:
• identification of the user;
• authentication of user identity; and
• checks on user authority
Personnel selection is important. Key people with access to the system should be carefully recruited.
There should also be:
• job rotation and enforced vacations;
• systems logs; and
• review and supervision
For other staff, segregation of duties is a core security requirement. This involves division of
responsibilities into separate roles:
• data capture and data entry
• computer operations
• systems analysis and programming
You may be required to identify a control to reduce a particular risk. Ensure you understand which
risks each control above is designed to reduce.
9 Measuring performance
Section overview
• Performance measures may be qualitative, or they may be financial or non-financial quantitative

measures.
• They are calculated to assess the business’s profitability, activity and productivity, in particular:
– resource use: effectiveness, economy and efficiency;
– critical success factors (CSFs) using key performance indicators (KPIs); and
– sustainability: social, environmental and economic issues
• Performance measures should be focused on the user and what they need them for.
• Comparability (with budgets, trends, other parts of the business and other businesses), often
using benchmarking, is a key issue for performance measurement.
• Problems with performance measures are due to information and comparison problems.
• The balanced scorecard combines measures relating to: financial performance, customers,
innovation and learning, and business processes.

• Organisations are working on how best to measure the natural capital they use so that the use of
natural capital is at the core of all business decisions.
The planning and control system model (Figure 1.2 in the chapter Introduction to business) showed
us that actual performance follows on from setting operational objectives and developing plans and
standards; what is achieved is then compared with the plan so that control action may be taken to
deal with any deviations. Provided this planning and control model is followed effectively the
organisation’s objective should be achieved.
It is on measuring performance and making the comparison that a great deal of the work of the
accountant is focused. Each business will have different ways of measuring its performance and will
place greater emphasis on certain factors over others.
9.1 Types of performance measure

• Qualitative measures are subjective and judgemental, and are not expressed in numerical terms
(we do not consider these further here).
• Quantitative measures are objective and based on data which must be reliable; they are
expressed in numerical terms and can be separated into:
– financial measures (based on data as to sales, profit etc); and
– non-financial measures (based on data as to number of items produced or phone calls
answered etc)
Both types of measure can be incorporated into a business-wide set or balanced scorecard of
measures for use by senior managers and directors, as we shall see later in this chapter.
In general, there are three points of reference for measurement in a business.
• Profitability
Profit has two components: cost and revenue. All parts of a business and all activities within it
incur costs, and so their success needs to be judged in relation to cost (these will be called cost
centres). Only some parts of a business receive revenue, and their success should be judged in
terms of both cost and revenue (as profit centres).
• Activity
All parts of a business are also engaged in activities (activities cause costs). Activity measures
could include the following.
• number of orders received from customers, a measure of the effectiveness of marketing
• number of machine breakdowns attended to by the repairs and maintenance function
Each of these items could be measured in terms of physical numbers, monetary value, or time spent.
• Productivity
This is the quantity of the service or product produced in relation to the resources put in, for
example so many items processed per hour or per employee. It defines how efficiently resources
are being used.
The dividing line between productivity and activity is thin, because every activity could be said to
have some ‘product’ (if not it can be measured in terms of lost units of product or service).
9.2 Measuring profitability

Profit consists of revenue less the business’s costs. It is measured initially in £s in absolute terms, for
instance ‘net profit of £18,000’. More meaningfully it is then measured in relative terms, usually
relative to revenue (‘net margin of 18% on revenue of £100,000’) and capital (‘return is 1.8% on
capital of £1 million’).
If the desired level of profit is not achieved, the owner will close the business and try something else.
Exactly the same idea applies to large companies financed by shares: if shareholders do not receive
what they perceive to be an adequate return on their investment they will take their money
elsewhere.
This concept of profit is important to the business’s managers. If profit is to be a business’s primary
objective, it must be specified in quantified terms, that is a specific target rate of profit must be set.
Effectively, this rate can only be determined by examining the opportunity cost of investing in the

business: this is given by the rate of profit available on alternative investments with similar
characteristics, particularly risk. This is then the minimum rate of return acceptable to the
shareholders.
9.3 Measuring resource use: effectiveness, economy and efficiency

A business uses a great many different types of resource in going about its operations so as to
achieve its objectives. As well as materials, labour and finance (as we saw in Figure 1.1 in the chapter
Introduction to business), there are also:
• physical assets (buildings, machinery etc)
• competences (what the business is good at doing)
• intangible assets (eg, licenses and development costs, that would be recognised in financial
statements; customer goodwill, corporate image, brands, digital assets, that would not be
recognised in financial statements)
• the way in which the business is structured
• the knowledge that is available to the business
Efficient use of resources is concerned with the economy with which resources are used, and the
effectiveness of their use in achieving the objectives of the business.
• Economy the is reduction or containment of cost; this can be measured against targets.
• Effectiveness is the measure of achievement and is assessed by reference to objectives, such as
whether planning and control mechanisms work, and whether the target profit has been attained.
• Efficiency means being effective at minimum cost or controlling costs without losing operational
effectiveness. Efficiency is therefore a combination of effectiveness and economy.
The accountant needs to supply managers with measurements of the business’s performance so that
an assessment can be made as to whether objectives of strategic business units (SBUs), or indeed the
whole business are being met, and if so how:
• productively: what is output relative to what is input?
• effectively: how far are targets and objectives achieved?
• efficiently: what is the gain that the business has achieved?
Many businesses emphasise the importance of developing resources, capabilities and competencies
that will improve efficiency in the future, and so develop and measure critical success factors and key
performance indicators to show whether performance has been good in key areas.
Interactive question 1: Economy, efficiency and effectiveness

An electronics company makes one product. The production process is labour intensive. The market
for this product is highly competitive so quality is extremely important.
Requirement
Suggest one measure each for economy, efficiency and effectiveness for the company.
9.4 Measuring critical success factors (CSFs)

CSFs (which we saw in the chapter Introduction to risk management) differ from one business to
another; in some areas of business keeping the right price level for the consumer may be key,
whereas in others it may be quality, or delivery, and so on. CSFs concern not only the resources of the
business but also the competitive environment in which it operates.
9.5 Identifying key performance indicators (KPIs)

Once a business has identified its CSFs and the things it must be good at to succeed (its core
competences) it must identify key performance indicators (KPIs) in relation to them. Achievement of
these KPIs at a certain level or target mean the business should be able to outperform its rivals.

Definition
Key performance indicator (KPI): A measure of the level of performance in an area where a target
level must be achieved in order for the business to outperform rivals and achieve competitive
advantage.
Context example: CSFs, core competences, KPIs and targets

CSFs, core competences, KPIs and targets
An internet retailer identifies that its CSF is delivering goods to mainland UK consumers within 24
hours of an order being placed over the internet. One of the core competences associated with that
CSF is having sufficient capacity and reliability in its IT systems. A KPI to be measured for this is the
level of downtime in its IT systems per month. If the business can achieve its target downtime of only,
say, 2% per month then it may be satisfied that it is on the way to achieving its CSF.
One way of deciding on which KPIs to measure and what targets to set for them is to use
benchmarking, defined as follows.
Definition
Benchmarking: The establishment, through data gathering, of targets and comparators, through
whose use relative levels of performance (and particularly areas of underperformance) can be
identified. By the adoption of identified best practices it is hoped that performance will improve.
(CIMA Official Terminology)
9.6 Limitations of financial measures

Using financial measures is not fool proof. There are many problems in trying to identify trends and
make comparisons. Below are just a few.
• Information problems
– The base information may be out of date, so timeliness of information leads to problems of
interpretation
– Historical cost information may not be the most appropriate information for the decision for
which it is being used
– For external users, information often comes from published financial statements which
generally comprise summarised information; more detailed information may be needed
– Analysis of financial measures only identifies symptoms, not causes, and thus is of limited use
on its own
• Comparison problems: trends
– Effects of price changes make comparisons difficult unless adjustments are made
– Impacts of changes in technology affect the value of assets, the likely return and future markets
– A changing environment affects the results reflected in the accounting information
– Changes in accounting policies can affect the reported results
– There can be problems in establishing a normal base year to compare other years with
• Comparison problems: different businesses. Analysing measures for different businesses and
comparing them can be difficult because of:
– selection of industry norms and the usefulness of norms based on average
– different firms having different financial and business risk profiles, and the impact of this on
analysis
– different firms using different accounting policies
– impacts of the size of the business and its comparators on risk, structure and returns
– impacts of different environments on results, eg, different countries or home-based versus
multinational firms

9.7 The balanced scorecard
A business of any size whose strategic objective is the maximisation of profit to build shareholder
wealth will soon lose profits and therefore capital value if it fails to manage its key resources of
capacity, labour, materials and cash productively, effectively and efficiently. On the other hand, its
strategic objective would probably not be undermined if it used 5% more paper clips than it had
budgeted for.
The balanced scorecard combines traditional financial performance measures with measures of
other key areas: operational and staff performance, and customer satisfaction. The scorecard was
developed by Robert Kaplan and David Norton, and it produces a set of measures that allows top
managers to focus on factors that are significant in achieving long-term control and direction of the
business, and hence profitability in the long term.
Definition
Balanced scorecard: An integrated set of performance measures linked to the achievement of
strategic objectives.
The balanced scorecard looks at the business from four important perspectives and answers four
basic questions when establishing the business’s vision of itself and its future strategy.
Perspective Question
Customer How do customers see us? VISION AND

Examples of measures: satisfaction ratings, STRATEGY
retention rates, returns rates
Internal business processes (ways of doing What must we excel at?

something)
Examples of measures: product quality, failure
rates
Innovation and learning How can we continue to

Examples of measures: employee retention improve and create value?
rates, time to market for new products
Financial How do we look to our

Examples of measures: gross margin, net shareholders?
margin, return on capital employed, gearing,
interest cover
You could be required to determine appropriate metrics for measuring the performance of a
business, possibly using the balanced scorecard. It is crucial that you think about the objectives of
the organisation as performance must be related to the extent to which a business has achieved its
objectives.

10 Measuring climate change, sustainability management
and natural capital
Section overview
• Accountants are required to provide information on a range of areas relating to the environment
and sustainability and a number of frameworks have evolved recently to assist in provision of
useful information.
• The triple bottom line aims to give a more complete measure of a business’s performance by
measuring three areas: social, environmental and economic.
• The Financial Reporting Council (FRC) has stated that the board of directors of companies should
consider the impact that their business has on the environment.
• The Task Force on Climate-related Financial Disclosures (TFCFD) identifies several classes of risk
and opportunities relating to climate change, that should be considered in measuring the values
of a business’s assets and liabilities.
• The Global Reporting Initiative (GRI) has issued a set of standards that can be applied by
businesses in their sustainability reporting.
• The Natural Capital Protocol provides a framework that can be used in assessing a business’s use
of natural capital
• The International Sustainability Standards Board (ISSB) was founded in November 2021 to
provide a comprehensive set of global sustainability-related disclosure standards. The ISSB will
coordinate its agenda with that of the Global Reporting Initiative.
Accountants are increasingly involved in providing information on a range of matters outside the
traditional area of profitability/return.
10.1 Triple bottom line

In the chapter Introduction to business, we looked at the important issue of sustainability and how a
wider view of an organisation’s performance can be given by the triple bottom line (also known by
the SEE acronym: social, environmental, economic).
As well as traditional financial performance reporting frameworks, accountants can measure social
and environmental performance as follows:
Issues Examples of areas to be measured
Social Health and safety, workers’ rights (in the business itself and its supply chain),
pay and benefits, diversity and equality, impacts of product use, responsible
marketing, data protection and privacy, community investment, and
eradication of bribery, fraud and money laundering
Environmental Climate change, pollution, emissions levels, waste, use of natural resources,
impacts of product use, compliance with environmental legislation, air quality
Economic Economic stability and growth, job provision, local economic development,
healthy competition, compliance with governance structures, transparency,
long-term viability of businesses, investment in innovation/NPD
10.2 Climate change

The Financial Reporting Council (FRC) in its response to the UK Government’s Green Finance
Strategy stated that ‘the boards of UK companies have a responsibility to consider their impact on
the environment and the likely consequences of any business decisions in the long term’.
The UK Government’s Green Finance Strategy, and the response of the FRC also have implications
for sources of finance (see the chapter Business Finance) and governance (see the chapter
Governance and ethics).

10.2.1 Task Force on Climate-related Financial Disclosures (TCFD)
The Task Force on Climate-related Financial Disclosures (TCFD) was set up by the Financial Stability
board, (an international organisation of central banks and other regulatory bodies). There was
concern that asset valuations in the financial markets do not correctly reflect climate related risks,
due to insufficient information. The task force was set up to develop recommendations for more
effective climate-related disclosures.
Disclosures are the information that a company must provide in its financial statements and other
public information about its strategy, operations and financial position and performance, so that
users of these reports can make informed decisions in relation to the company. While much work has
been performed by accounting bodies such as the Board to ensure that users are given high quality
relevant and reliable financial information, better information is needed about the impact
companies have on climate change, the effect of climate change on the company and the company’s
response to these.
TCFD identifies several classes of risks and opportunities relating to climate change:
Risks Opportunities
Acute: extreme weather events

Chronic: changing weather patterns and rising
mean temperature and sea levels
Policy and legal: these relate to changes in Resource efficiency: cost savings due to more
regulations and exposure to litigation efficient use of resources, and recycling
Technology: relates to risk of existing products Energy sources: use of new sources of energy
and services being replaced with lower and use of government incentives
emissions options, and unsuccessful investment
in new technologies
Market: changing costs of raw materials and Products and services: development of new,
changing customer behaviour low emission goods and services
Reputation: risk of loss of reputation among Markets: access to new markets

customers and other stakeholders (eg,
investors)
Its recommendations, which were published in 2017, recommend four core areas of disclosure:
• Governance: disclosures relating to the organisation’s governance around climate related risks
and opportunities
• Strategy: the impact of climate-related risks and opportunities on the organisation’s business
strategy and financial planning
• Risk management: how the organisation identifies, assesses and manages climate related risks
• Metrics and targets: to assess and manage relevant climate-related risks and opportunities (eg,
greenhouse gasses)
Since the recommendations were published in 2017, they have gained global support from around
the world. In the UK for example, all companies with a listing on the London Stock Exchange are
required to adopt TCFD disclosures on an apply or explain basis for accounting periods beginning
on or after 21 January 2022 (1 January 2021 for issuers with a premium listing).
10.3 Sustainability management

IFAC (the International Federation of Accountants) states that the accountant’s involvement in
sustainability management is about improving business decision making in:
• responding to uncertainty and risk
• developing existing and new markets
• innovating processes, products and services that can provide benefits to society
• improving operational efficiency and lowering costs by way of sustainable operations
• engaging employees, customers and suppliers in the drive towards sustainability

An important area for accountants is performance measurement of the business’s sustainability
management.
10.4 GRI Sustainability Reporting Standards (GRI Standards)

The Sustainability Reporting Standards issued by the Global Reporting Initiative (GRI) are the best-
known example of a global, voluntary code for corporate responsibility and sustainability reporting.
A GRI-based report typically includes economic, social and environmental performance information,
and sets out the organisation’s direct and indirect impacts. An updated version of the standards was
issued during the year 2021 and applies to reports published on or after 1 January 2023.
There are three ‘universal’ standards (GRI 1, GRI 2 and GRI 3) that apply to all organisations that
choose to apply GRI standards. These are supported by various sector standards that help
organisations to identify which topics are likely to be material to organisations operating in those
industries (eg, GRI 11 relates to the oil and gas sector). Topic standards provide guidance on what
disclosures should be made for topics that are material to the organisation (eg, GRI 304 deals with
disclosures relating to the organisation’s impact on biodiversity, see below).
GRI 1 Foundation 2021 sets out the overall structure of GRI guidance and provides key concepts for
sustainability reporting, such as the concept of a stakeholder.
GRI 2: General disclosures requires disclosure about the organisation, including information on the
following topics:
• The organisation’s legal name and form. Information should also be provided about all entities
that are included in the sustainability report (eg, subsidiaries)
• The organisation’s activities, value chain and other business relationships
• Information about the organisation’s employees, giving details such as analysis by gender, the
proportion of employees who are not given guaranteed hours of work, and the proportion of
permanent and temporary employees
• Information about the governance arrangements of the organisation, such as structure of the
board of directors, details of board committees, the role of the board with respect to sustainability
and details of any conflicts of interest. It includes guidance about board remuneration
• Strategies of the organisation, including sustainable development strategies and processes to
remediate the negative impacts that the organisation has
GRI 3: Material Topics 2021 provides guidance to organisations on identifying material topics that
should be included in their sustainability report. A topic is material if the organisation’s activities have
a severe impact on it. Examples of topics include occupational health and safety or water and
effluents. If a topic is material to an organisation, then it should apply the topic standard for that
topic.
GRI 3 also provides its own disclosure requirements relating to material topics:
• The process used in determining its material topics
• A list of its material topics
• For each material topic:
– the actual and potential negative impacts on the economy, environment and people (and
whether the impact is through its own activities or as a result of business relationships)
– its policies regarding the material topic
– the actions taken to manage the topic (eg, actions to mitigate the potential impact and actions
to manage positive impacts)
– how the effectiveness of the actions is tracked and measured
– how engagement with stakeholders has informed the actions taken
The following brief outlines give a flavour of two of the topic standards:
• GRI 302: Energy requires disclosure of the organisation’s energy management (as per GRI 3). In
addition, the organisation is required to disclose total fuel consumption from non-renewable and
renewable sources, analysed by type of energy; energy consumption outside of the organisation,
by upstream and downstream organisations, related to the main activity of the organisation (eg,
energy consumption by businesses transporting the organisation’s goods); and any reduction in
energy consumption over time as a result of efficiency or conservation.

• GRI 304 Biodiversity requires organisations to provide information about how the organisation
manages its biodiversity-related impacts. This includes details of sites located next to protected
areas,significant impacts that the organisations activities, products or services on the biodiversity.
Organisations are also required to disclose any activities taken to protect or restore habitats. It
should also disclose the impact that the organisation has on protected species.
10.5 Natural capital

A related area is that of assessing natural capital so that businesses can take account of how far they
depend on it and how much they impact on it (dependencies and impacts) so they can include
natural capital in their decision making. The Natural Capital Protocol was developed by the Natural
Capital Coalition to provide a standardised framework for businesses to use when assessing natural
capital. The protocol consists of nine steps split over four stages (Frame, Scope, Measure and Value,
Apply). This protocol will also help businesses to meet the UN Global Goals for Sustainable
Development (see the chapter Governance and ethics).
(Natural Capital Coalition, 2016)
10.6 Climate Disclosure Standards Board

The Climate Disclosure Standards Board (CDSB) publishes the CDSB Framework for Reporting
Environmental and Climate Change Information. Its aim is to ensure that information about natural
capital is given the same prominence as financial capital in a company’s mainstream reports. This
enables users of the reports to appreciate not only financial considerations but also the impact the
business has on climate change and natural capital. It also highlights the environmental
opportunities and risks faced by the business. The framework was updated in December 2019.
In drawing up its framework, the see the CDSB aims to use principles and characteristics used in
traditional financial reporting (eg the CDSB framework has adapted the IFRS framework’s
qualitative characteristics of useful financial information). The framework also draws upon many
other voluntary frameworks such as the GRI standards discussed above.
The Framework consists of:
• guiding principles to ensure that the information provided is useful to investors in decision
making, is complete and correct; and
• reporting requirements, which set out the type of environmental information that should be
included in mainstream reports. That requirements are organised as follows:
– the organisation’s environmental policies and strategy, risks and opportunities, and
governance
– the organisations environmental results, performance and impact
– management’s future outlook regarding environmental results, performance and impact.
The CDSB is now part of the new International Sustainability Standards Board (ISSB) that was formed
in November 2021. See below.
10.7 International Sustainability Standards Board

The International Sustainability Standards Board (ISSB) was set up in November 2021 by the IFRS
foundation. Its objective is ‘to deliver a comprehensive global baseline of sustainability-related
disclosure standards that provide investors and other capital market participants with information
about companies’ sustainability-related risks and opportunities to help them make informed
decisions’. (IFRS org)
It took over the work of two other bodies, Climate Disclosure Standards Board (CDSB) and the Value
Reporting Foundation thereby taking over responsibility for the Integrated Reporting Framework. It
has also signed a joint cooperation agreement with GRI in which the ISSB and GRI will seek to
coordinate their work programmes and standard-setting objectives.
The Integrated Reporting Framework is a framework that gives guidance on producing a concise
report that aims to show how an organisation has created value for a range of stakeholders. Value
refers to the creation or erosion of six capitals by an organisation:
• Financial capital, which is the traditional view of capital. Value is created if a company increases its
equity.

• Manufactured capital is the physical resources such as buildings, machinery and equipment that
are available to the organisation. Organisations increase their natural capital by purchasing or
manufacturing new physical resources.
• Intellectual capital refers to intellectual property and organisational knowledge developed by the
organisation. Intellectual capital may be created by investing in research and development to
increase the knowledge of the organisation.
• Human capital means the skills, competences and motivation of the workforce that are developed
by the organisation. Human capital can be increased by providing career development
opportunities and training to staff.
• Social and relationship capital refers to the relationships that the organisation has developed with
a wider group of stakeholders, such as local communities and other organisations. Examples of
contributing to social and relationship capital might include supporting local charities or funding
scholarships.
• Natural capital means the environmental resources, such as the biodiversity, clean air, water and
natural resources. Economic activity can deplete natural capital, but many organisations are taking
steps to help rebuild natural resources that have been destroyed, such as by financing wildlife
sanctuaries or reforestation projects.
Natural capital is discussed further in the chapter Governance and ethics.
Exam questions may test your ability to recognise specific ‘green’ issues. Ensure you understand the
aims of the reporting frameworks above and are aware of the types of disclosure that businesses are
required to make.
11 Establishing financial control processes and internal

controls
Section overview
• In the finance function there need to be effective financial controls. These depend on an effective
control environment, risk assessment, control activities, effective information and communication,
and good monitoring.
• Internal control is a process designed to ensure reasonable assurance about whether the
company has achieved its objectives, via effective and efficient operations, reliable financial
reporting and compliance with applicable laws and regulations.
• COSO states that internal controls consist of five integrated components: the control
environment; risk assessment; control activities; information and communication; monitoring
activities.
• The FRC’s guidance on risk management and internal control emphasises that an internal control
system should: facilitate effective and efficient operations; reduce risks; ensure the quality of
reporting; ensure compliance with applicable laws and regulations.
11.1 Why are financial control processes needed?

The central importance of the finance function and the risks it faces mean that specific financial
control processes need to be implemented by its managers, in order to address risks faced by the
business’s money and other financial assets. Financial control is a form of internal control.

11.2 What is internal control?
Definition
Internal control: A process, effected by an entity’s board of directors, management and other
personnel, designed to provide reasonable assurance regarding the achievement of objectives
relating to operations, reporting and compliance (COSO Internal Control – Integrated Framework,
2013).
From this definition we can see that internal control:

• is geared to the achievement of objectives in one or more categories (operations, reporting and
compliance);
• is a process consisting of tasks and activities: it is a means to an end, not an end in itself;
• is effected by people, not merely by policy manuals, systems and forms;
• can be expected to provide only reasonable assurance, not absolute assurance, to an entity’s
management and board that operations are effective and efficient, financial reporting is reliable
and laws and regulations are being complied with; and
• is adaptable to structure, applying to the entire entity or to a particular subsidiary, division,
operating units or business process
Internal controls are covered fully in the Assurance syllabus.
11.3 Effective internal control (COSO)

According to COSO, internal control consists of five integrated components which together provide
an effective framework for describing and analysing the internal control system implemented in a
business:
• Control environment
• Risk assessment
• Control activities
• Information and communication
• Monitoring activities
11.3.1 Control environment

The control environment sets the tone of a business and the control consciousness of its people. It
provides discipline and structure. The control environment comprises:
• the integrity and ethical values of the business
• the ability of the board of directors to carry out its governance oversight responsibilities
• the organisational structure and assignment of authority and responsibility
• the process for attracting, developing and retaining competent individuals
• the rigour of the business’s performance measures, incentives and rewards to drive
accountability for performance
11.3.2 Risk assessment

We saw in the chapter Introduction to risk management that every business faces a variety of risks.
There must be adequate risk management via assessment, measurement and control activities to
address any risks that threaten achievement of the business’s objectives.
11.3.3 Control activities
Definition
Control activities: The actions established through policies and procedures that help ensure
management’s directives to mitigate risks to the achievement of objectives are carried out.

Control activities occur at all levels of the business, at various stages within business processes, and
over the technology environment. They do not just take place in the finance function. They include
manual and automated activities such as:
• approval
• authorisation
• verification
• reconciliation
• business performance reviews
• segregation of duties
Segregation (or separation) of duties is important where power could be abused if only one person
was responsible for a transaction or asset from beginning to end. An example would be the purchase
of a non-current asset such as a car. If only one person had the power to:
• authorise its purchase;
• record the amount payable and/or pay the bill; and
• have custody of the car
then there is nothing stopping that person from buying the most expensive car possible then
absconding with it.
11.3.4 Information and communication

Information systems produce reports, including operational, financial and compliance-related
information, that make it possible to run and control the business. In a broader sense, effective
communication must ensure information flows down, across and up the business. Effective
communication with external parties, such as customers, suppliers, regulators and shareholders, is
also important for control.
11.3.5 Monitoring activities

The components of internal control need to be monitored to assess the quality of the internal control
system’s effectiveness over time. This is accomplished through ongoing evaluations or separate
evaluations, or some combination of the two. Deficiencies in internal control that are detected
through these monitoring activities should be reported to more senior managers. Corrective action
should be taken to ensure continuous improvement of the system.
11.4 Risk management and internal control (FRC)

The Financial Reporting Council (FRC) publishes a document on this area entitled Guidance on risk
management, internal control and related financial and business reporting. Following this guidance is
a matter of most concern for listed companies when meeting their corporate governance obligations
(see the chapters Governance and ethics and Corporate governance). It is, however, useful for all
businesses to be aware of the points made by the FRC.
Definition
Risk management and internal control system: A system encompassing the policies, culture,
organisation, behaviours, processes, systems and other aspects of a company that, taken together:
• Facilitate its effective and efficient operation by enabling it to assess current and emerging risks;
respond appropriately to risks and significant control failures; safeguard its assets
• Help to reduce the likelihood and impact of poor judgement in decision-making; risk-taking that
exceeds the levels agreed by the board; human error; or control processes being deliberately
circumvented
• Help ensure the quality of internal and external reporting
• Help ensure compliance with applicable laws and regulations, and also with internal policies with
respect to the conduct of business
(FRC Guidance on risk management, internal control and related financial and business reporting)

11.4.1 Who is responsible for internal control?
The board of directors as a whole has responsibility for:
• policy making on an effective system of internal control in the company, covering financial,
operational and compliance controls
• reviewing how effectively the internal control system addresses the risks that face the company
• reporting on the internal control system to shareholders each year
Managers are responsible for implementing internal control, and for day-to-day monitoring of the
system.
11.4.2 What constitutes a sound system of internal control?

A sound internal control system aims to prevent the risks that face the business from actually
occurring and causing the business harm. Managers and the board should therefore take a risk-
based approach to determining whether the internal control system is sound, including:
• the nature and extent of the risks facing the company
• The likelihood of the risks concerned materialising
• the company’s ability to reduce the likelihood of the risks arising, and of the impact on the
business of risks that do materialise
• the exposure to risks before and after risks are managed or mitigated, as appropriate
• the operation of the relevant controls and control processes
• the effectiveness and relative costs and benefits of particular controls
• the impact of the values and culture of the company, and the way that teams and individuals are
incentivised, on the effectiveness of the systems
The system of internal control should:
• be embedded in the operations of the company and form part of its culture;
• be capable of responding quickly to evolving risks to the business arising from factors within the
company and to changes in the business environment; and
• include procedures for reporting any significant control failings or weaknesses immediately to
appropriate levels of management, together with details of corrective action being taken
You could be required to identify suitable controls for a business. To do this you need to think about
what particular risks that business faces, and which controls would reduce the risk most effectively.

Summary
Qualitative characteristics
Limitations
• Relevance
• (Lack of) timeliness
Yes No • Cost/benefit
• Comparability Is it useful?
• Conventionalised
• Backward-looking
• Verifiability
• Financial only
• Timeliness Financial statements with
information on
• Financial position
• Financial performance Effects of poor financial
• Changes in financial position information
• Undermine integrity of
What is financial markets
needed? • Fail to serve the public
Needs of users interest
• To make decisions
• To hold management to
account
• To predict cash flows
Value:
Underlying assumptions Qualities of good
Source
• Accrual basis For external use information: Assimiliation
• Going concern ACCURATE Accessibility
Relevance
Financial information
Information processing Risks For internal use

and management
Sources of data
Information Uses Types
• Internal
security • Recording transactions • Planning
• External
• Prevention • Planning/controlling • Operational
• Big data
• Detection • Measuring performance • Tactical
• Internet of things
• Deterrence • Making decisions • Strategic
• Recovery
Information processing • Correction
• InputoProcessingoOutput • Avoid threats
• Qualities: CATIVA
• TPS
• Cloud accounting
• Distributed ledger technology Types of control
Qualities of • Physical access
• Digital assets
secure systems:
• Security
ACIANA
• Integrity
Information management
• Cybersecurity
• MIS
• ESS/EIS
• DSS
• Expert systems
• KWS
• OAS
• Internet
• Data science
• Data analytics
• Intelligent systems
• Automation
• Machine learning
• Artificial intelligence

• Recording financial
transactions
• Management
accounting
• Financial reporting Managing the finance function
• Treausry • Planning and control
management • Organising and leading
Finance function
Business Partnering Structure
Uses Characteristics
• Planning • Relevance Fundamental
• Controlling • Faithful representation Characteristics
• Recording transactions • Understandability
Enhancing
• Performance • Comparability
qualitative
measurement • Verifiability
characteristics
• Decision making • Timeliness
Financial
information
Information processing • Financial position
• Completeness • Financial performance
• Accuracy • Changes in financial position
Users
• Timeliness
• Investors
• Inalterability
• Lenders Measuring Climate Change,
• Verifiability performance Sustainability,
• Employees
• Assessability Natural capital
• Customers • Resource use
• Suppliers • Critical success • Triple bottom line
Systems • The government factors • TFCFD
• The public • Sustainability • Global Reporting
Initiative
Systems • Natural Capital
security Limitations Balanced Protocol
Therefore
• Standardised scorecard • Climate
• Backward Disclosure
looking Standards Board
Objectives
• Omission of
non financial
Internal controls
• Effective internal
control
• Risk management

indicated.
1 Do you know what are the four specific tasks of the finance function? (Topic 1)
2 Do you know the meaning of ‘business partnering’ and are you aware of how the finance
function may support the other functions within the business as a partner? (Topic 1)
3 Do you know the factors that affect the structure of a finance function? (Topic 2)
4 Can you state what financial information is used for? (Topic 4)
5 Do you understand who the users of financial information are, and what makes useful
financial information? (Topic 5)
6 Do you know what the two fundamental qualitative characteristics and the four
enhancing qualitative characteristics of financial statements are, in the IFRS Framework?
(Topic 5)
7 What does CATIVA stand for in terms of effective data processing? (Topic 7)
8 Are you aware of the threats to the security of data, and the controls to ensure that data
is secure? (Topic 8)
9 Do you know the meaning of ‘benchmarking’? (Topic 9)
10 Do you know the four perspectives of the Balanced Scorecard? (Topic 9)
11 What are the risks and opportunities presented by climate change? (Topic 10)
12 Are you aware of the four areas of disclosure recommended by the Task Force on
Climate Related Financial Disclosures (TCFD)? (Topic 10)
13 Do you know the structure of the Green Reporting Initiative (GRI) standards and are you
aware of the types of information that might be included in a report that aims to follow
GRI standards? (Topic 10)
14 Do you know in outline the contents of the Climate Disclosure Standards Board (CDSN)
framework? (Topic 10)
15 What is the purpose of an internal control system? (Topic 11)
16 What are the five components that form an effective internal control framework
according to COSO? (Topic 11)

questions in The finance function and financial information chapter of the Business, Technology and
Finance Question Bank. Refer back to the learning in this chapter for any questions which you did not
answer correctly or where the suggested solution has not provided sufficient explanation to answer
all your queries. Once you have attempted these questions, you can move on to the next chapter,
Business finance.

• CIMA (2005) CIMA Official Terminology. Oxford, CIMA.

• COSO Internal Control – Integrated Framework, 2013
• Global Reporting Initiative (2021) GRI 1: Foundation 2021; GRI 2 General Disclosures 2021; GRI 3:
Material Topics 2021. GRI.
• Guidance on risk management, internal control and related financial and business reporting –
2014 (FRC)
• ICAEW (2018) Finance business partnering: a guide. London, ICAEW.
• International Accounting Standards Board (2018) Conceptual Framework for Financial Reporting.
[Online]. Available from: http://eifrs.ifrs.org [Accessed 12 May 2021].
• Natural Capital Coalition (2016) Natural Capital Protocol. [Online]. Available from:
https://capitalscoalition.org [Accessed 13 June 2022].
• Task Force on Climate-related Financial Disclosures (May 2022). Task Force on Climate-related
Financial Disclosures Overview. [Online]. Available from:
https://assets.bbhub.io/company/sites/60/2022/05/TCFD_Overview_Booklet_Digital.pdf
[Accessed 13 June 2022].
• United Nations (n.d.) The Sustainable Development Agenda [Online]. Available from:
https://www.un.org/en/our-work/support-sustainable-development-and-climate-action [Accessed
13 June 2022].

Self-test questions

1 Linus is an accountant for Magna plc, which is considering a substantial new project. Linus has been
asked to help in determining whether it should be financed by retained earnings, equity, loans or a
mix of all sources. It would appear that Linus is employed by Magna plc’s finance function’s:
A transaction recording section
B treasury management section
C financial reporting section
D management accounting section
2 Womble plc’s managers are quick to address immediate problems as they arise in operations on the
basis of financial information they receive. The company’s trial balance always agrees. Monthly
variance reports, however, consistently show that the operation is failing to meet its targets. It would
appear that Womble plc’s financial information fails to provide managers information for:
A Decision making
B Recording transactions
C Planning and control
D Measuring performance
3 Which of the following groups is not a primary user of a company’s financial statements?
A the government
B shareholders
C potential investors
D lenders
4 Which of the following is the CATIVA definition of verifiability of information processing?
A the data remains true to its sources and contains no errors
B the process is not open to unauthorised intervention or amendment
C the effectiveness of processing is open to scrutiny so that its quality can be judged
D the trail from data through processing to output information can be followed through
5 Moody plc is reviewing its internal control system. Its control activities should be directed at
controlling:
A threats to its operations
B its operations
C threats to achievement of its objectives
D achievement of its objectives
6 In the balanced scorecard, measures of how quickly and fully employee suggestions are
implemented would be included in:
A financial perspective measures
B customer perspective measures
C internal business process perspective measures
D innovation and learning perspective measures
7 Anja works in the finance function of Mark Ltd. Her duties involve maintaining the sales ledger, and
providing information to the credit control department. It is clear that Anja is employed by Mark Ltd
in its finance function’s:
A financial reporting section

C management accounting section
D financial transaction recording section
8 Sven, a management accountant, is currently helping to prepare a performance report which uses
the balanced scorecard technique. Sven is calculating measures of product quality and product
failure rates. The measures calculated by Sven will be included in the final balanced scorecard’s:
A financial perspective
B internal business process perspective
C innovation and learning perspective
D customer perspective
9 Someday plc is introducing a set of performance measures in its finance function. A key measure for
the sales ledger part of the system is the number of invoices recorded per hour of employee time.
The point of reference for this performance measure is:
A productivity
B activity
C profitability
D economy
10 Which body was set up due to concerns that asset valuations in the financial markets do not correctly
reflect climate related risks due to insufficient information?
A Global Reporting Initiative (GRI)
B Natural Capital Protocol
C Task Force on Climate-related Financial Disclosures (TCFD)
D Climate Disclosure Standards Board (CDSB)
11 Which of the following disclosures would appear under social performance information in a GRI
based report?
A Average hours of training that the organisation’s employees have undertaken during the
operating period
B Percentage of the procurement budget that is spent with local suppliers
C Significant fines for non-compliance with environmental laws and regulations
D Total volume of water withdrawn from local wells
12 Raj plc operates supermarkets. The company has identified that it will outperform its rivals if it always
has inventory of its 100 top-selling products in its shops. Availability of these items is Raj plc’s:
A key performance indicator
B core competence
C target
D critical success factor
this chapter.


Economy might be labour cost per hour, which could be compared to a budgeted cost. Efficiency
might look at how many units were prepared per labour hour. Effectiveness relates to the
requirement for quality, so the percentage of products returned might be a measure of effectiveness.

C Planning and control
The trial balance balancing suggests that the TPS is effective, and managers can make well-informed
decisions when they have to. The company knows it is missing targets so it is measuring
performance, so its failures must be due to lack of information to plan and then control operations.
A the government
The International Accounting Standards Board identifies shareholders, potential investors and
lenders as being the primary users of a company’s financial statements.
D the trail from data through processing to output information can be followed through
A describes accuracy; B describes inalterability; C describes assessability
C threats to achievement of its objectives
This is the objective of control activities as described in the COSO framework.
D innovation and learning perspective measures
D financial transaction recording section
The maintenance of the sales ledger involves entering transactions into the accounting system which
is the role of the financial transaction recording section. Financial reporting section involves using the
output from the accounting systems to prepare reports to external users, but are not involved in
maintaining the transactions. The treasury function is involved in managing the business’s finance
liquidity. The management accounting section provides information to management.
B internal business process perspective
Measure of product quality and product failure relate to the internal processes of the business. They
will have an impact on the other perspectives, particularly the customer and financial perspectives,
but relate primarily to internal business processes.
A productivity
C Task Force on Climate-related Financial Disclosures (TCFD)

A Average hours of training that the organisation’s employees have undertaken during the
operating period
D critical success factor

Chapter 7
Business finance
Introduction
Learning outcomes
Syllabus links
Assessment context
Learning topics
1 Why is business finance important?
2 The banking system
3 The money markets
4 The capital market for business finance
5 Sources of equity finance
6 Sources of debt finance
7 Financing a growing business
8 Financing exports
9 Green finance
Summary
Self-test questions
Introduction
Learning outcomes
• Specify the relationship between a business and its bankers and other providers of financial
products and services
• Identify the characteristics, terms and conditions and role of alternative short, medium and long-
term sources of finance available to different businesses
• Identify the processes by which businesses raise equity, capital and other long-term finance
including green finance
• Identify appropriate methods of financing exports, including:
– bills of exchange
– letters of credit
– export credit insurance
Specific syllabus references are: 3g, 3h, 3i, 3j
7
Syllabus links
The implications of a financing decision will be seen in Financial Management, Financial Accounting
and Reporting, Business Planning: Taxation, and Audit and Assurance at Professional level. It will be
explored further at Advanced level.
7
Assessment context
Questions on sources of finance will be set in the assessment in either MCQ or multiple response
7

of this chapter.

questions
1 Why is business Approach Questions on

finance important? Make sure that you balancing short- and
The financial health of study section 1 very long-term finance
a business will be carefully, on the could appear.
directly impacted by nature of finance, Questions are likely to
how it funds itself – in concepts of risk and be set in a scenario
particular the amount return and the context. They could
of debt used ie, the financing decision require you to look at
capital structure and read through numerical information
decision. Business the context example (eg, identifying
finance is therefore to ensure you whether a company is
something that will understand why adopting an aggressive
enter the working using short term or defensive approach
context of most liabilities to finance to financing its current
accountants. current assets can assets).
be risky. Essential points are:
Stop and think • Risk v return
Company finance is • Balancing short-
similar to personal term and long-term

questions
finance. Think about finance

how you finance
your own assets –
such as your home,
car, smart phone
and other assets.
Are you using short-
term or long-term
finance for these,
and why?
2 The banking system Approach There could be

Businesses have an Read through questions testing your
ongoing capital section 2 on the knowledge of the
requirement if they banking system terminology in this
are to continue to quickly, then go section including the
meet the back and make sure roles of the different
shareholders’ you are clear about constituents and
objective of the roles of financial regulators of the
maximising wealth. intermediation in banking system.
The implicit growth general and the Essential points are:
agenda that this different types of • Types of bank
creates means bank in particular.
companies need The four contractual • The
access to sources of relationships banker/customer
finance. between banks and relationships
their customers are • Duties and rights of
also important, as banks and
are the bank’s and customers
the customer’s • Role of regulators of
duties.
banks
Stop and think
Which of the
financial institutions
mentioned do you
personally use?
3–4 The money and Approach Exam question is this

capital markets Read quickly area are likely to focus
When businesses through sections 3 on your understanding
have surplus cash, and 4 on money of what the instruments
they will want to markets and the are (for example the
invest it, possibly in capital market for difference between
short term assets. The business finance. gilts and treasury bills).
money markets Ensure you are Essential points are:
provide a range of familiar with the • Money market
instruments. If different types of instruments
companies wish to instruments.
raise finance to make • Constituents of the
Stop and think capital market
new investments, the
capital markets will The UK has a very
offer a range of sophisticated
different options. As financial system.
advisors, accountants What advantages
are required to have a does this have to UK
high-level knowledge businesses?
ICAEW 2023 7: Business finance 245

questions
of these markets,
although specialist
advice will need to be
sought (eg, from an
investment bank)
when companies
decide to participate
in the markets.
5 Sources of equity Approach This is an area that is a

finance This is an important rich source of exam
Understanding the section. Make sure questions. Questions
different sources of you understand the will test your
finance to a business terminology knowledge of the
and being able to introduced (eg, different ways of
give advice on these Offer for Sale, Offer issuing equity (eg, the
at a higher level is for subscription). difference between an
something that is offer for sale and a
Stop and think placing).
expected of
accountants. Why might Essential points are:
company go to the
expense of getting a • Retained earnings
stock market listing? • Rights issues
• Different ways of
issuing new shares
• Preference shares
6 Sources of debt Approach As with the section

finance Another important above on equity
Equity finance is section. Ensure you finance, this section is
largely a long-term know all the also a rich source of
source of finance, different types of exam questions
while debt provides a debt finance, and Essential points are:
range of options with how they work. Also • The maturity profile
different maturities. the terminology of each source of
As such they provide relating to loan debt
a flexible source of stock (bonds) is
finance. important. • Conditions
attaching to each
Stop and think source (eg, security)
If the coupon on a
bond is 5%, how
could the return on
the bond be higher
than this?
7 Financing a growing Approach Questions in this area IQ1: Problems

business Make sure you know tend to focus on your of small
Smaller businesses the meaning of understanding of how businesses
have a more limited business angels and the various sources of helps you think
range of options than venture capital. finance work (eg, the about the
larger well- Read and difference between important issue
established appreciate the venture capital and of why smaller
companies. If you advantages and business angels. businesses may
have clients that are disadvantages of Essential points are: have difficulties
small and medium these, as well as the raising finance.
• Crowd funding
sized, they may want advantages of a

questions
to know what sources listing on AIM. • Business angels IQ2: Financing

of finance are Stop and think • Venture capital a business
available to them. through its
Why are the finance • Alternative growth phase is
options for small investment market a great
companies limited? (AIM) question
testing your
knowledge of
the different
sources of
finance and
when they are
appropriate.
8 Financing exports Approach Exam questions tend to

Trading abroad Understand the risks test your knowledge of
brings additional of international what the various
risks. This section trade and learn how instruments (eg, bills of
shows how business the instruments exchange) are.
can mitigate them. discussed here help
to mitigate them.
Stop and think
Why would the
collection of
outstanding trade
receivables in
foreign countries be
more challenging?
9 Green finance Approach Exam questions in this

Environmental issues Understand the area are likely to focus
and technology are meaning of Green on the meaning of
two areas that are finance, using green ‘green finance’ and the
changing the work of bonds as an conditions that finance
the accountant. example. Be aware must satisfy to be
of the UK Green considered ‘green’ (eg,
Finance Institute. green bond principles)
Stop and think

Why is it necessary
to have principles
such as the green
bond principles for
green financial
instruments?

1 Why is business finance important?
Section overview
• Businesses need money to pay expenses and acquire assets to support the business. How they
raise this money (the financing strategy) is a central part of the corporate strategy, alongside
competitive.
• The sources of finance can be categorised as equity, provided by owners, and debt, provided by
lenders in exchange for interest.
• Every business has immediate, short-term, medium-term and long-term needs for finance, and
each one faces risk in the way it finances itself.
• Businesses may be aggressive, average or defensive in their financing policies.
• Risk and return go hand in hand, and businesses need to bear in mind the risk-return trade-off of
investors.
• A business is financed by a mix of equity (higher risk/higher return) and debt (lower risk/lower
return).
1.1 How is business financed

Without money a business could not exist: it could not pay its expenses, it could not acquire
inventory, and it could not employ labour. It would not want to exist: businesses exist to make money,
that is, a profit. All businesses require a level of finance to get started, and then a balance of money
coming in and going out in order to stay in existence.
• Most of a business’s stakeholders have finance at stake in the business; shareholders and lenders
obviously invest directly in the business, but in addition managers’ and other employees’ personal
finances depend on it, suppliers need to be paid by it, customers depend on it for goods and
services that will in turn support their finances, and the government wants tax revenue from it (see
the chapter Introduction to business).
• The primary objective of a business is a financial one: to increase shareholders’ wealth by creating
shareholder value (see the chapter Introduction to business).
• How much finance the business needs and how this can be raised often determine the business
structure/legal form it takes (see the chapter Organisational and business structures).
• Together with its competitive strategy and its investment strategy, the business’s financial strategy
is central to its overall corporate strategy (see the chapter Introduction to business strategy).
• Businesses are exposed to financial risks of various kinds and must find ways of managing these
risks (see the chapter Introduction to risk management).
A business is financed:
• by equity (from its owners in return for drawings or dividends);
• by debt (from lenders in return for interest); or
• by a combination of equity and debt.
There are many forms of these two types of capital, but what distinguishes them is their different
levels of risk.
• Debt holders face lower risk but lower returns:
– they receive interest before equity holders receive any dividends
– debt is often secured by fixed or floating charges
– in the event of company failure, debt holders rank higher than equity holders to receive their
capital back
– the ‘price’ they pay is a lower rate of return on their capital
• Equity holders face higher risk but can enjoy higher returns: they suffer the downside of any loss
but any profits after interest and tax go to the equity holders, not the debt holders.
Risk and return go hand in hand. Therefore, in structuring its finances, a business must have regard to
the risk-return trade-off desired by potential investors.

1.2 Balancing short-term and long-term finance
A key decision for any business is how it is going to finance both its operations now and its plans for
the future. Its need for finance ranges from the very immediate short term to the very long term:
• immediate needs: to pay wages and day-to-day expenses
• short-term needs: to pay for goods/services bought on credit (payables)
• medium-term needs: to pay for an increase in inventory and receivables as the business grows,
and to pay tax on profits earned
• long-term needs: to pay for non-current assets required in the long term such as machinery,
vehicles and buildings. (However, the financing is only part of the overall decision as to whether
or not to acquire the new asset.)
Wages, payables, receivables and inventory all form part of the business’s working capital, which is
made up of current assets less current liabilities. While the management of working capital is
covered in your Management Information syllabus at Certificate level, the fact that it produces the
need for finance over different terms means we need to consider it briefly here.
1.3 Financing current assets

Levels of inventory plus receivables less payables fluctuate but for most businesses a proportion of
current assets will effectively be permanent. The methods of financing this level are best seen
diagrammatically in Figure 7.1.
Assets Assets
£ £ Short-
Short- term
term finance
Fluctuating Fluctuating
current assets finance current assets
Long-
Permanent Permanent
Long- term
current assets current assets
term finance
finance
Non-current assets Non-current assets
Time Time
Some permanent current All permanent and some fluctuating

assets are financed by current assets are financed out of
short-term credit longterm sources
More profitable but riskier Less profitable but less risky
Figure 7.1: Financing working capital investment
The options set out in Figure 7.1 are only two of many possible approaches. For example, the use of
short-term credit could be extended to finance a proportion of the non-current assets or,
alternatively, all of the business’s finance requirements could be provided by long-term finance.
The choice is a matter for managerial judgement of the trade-off between the relative cheapness of
short-term finance versus its risks.
Context example: Financing current assets

The statements of financial position for two companies are shown below:
Company A Company B
£’000 £’000
Non-current assets
Property plant and equipment 500,000 500,000
Intangible assets 100,000 100,000
Total non-current assets 600,000 600,000

Company A Company B
£’000 £’000
Current assets
Inventory 41,200 41,200
Trade receivables 44,550 44,550
Cash and cash equivalents 10,250 0
Total current assets 96,000 85,750
Total assets 696,000 685,750
Equity and liabilities

Share capital 100,000 100,000
Retained earnings 350,000 350,000
Total equity 450,000 450,000
Long-term liabilities
Bonds 200,000 100,000
Current liabilities
Trade payables 30,000 60,000
Bank overdraft 0 59,750
Tax payable 16,000 16,000
Total current liabilities 46,000 135,750
Total equity and liabilities 696,000 685,750
Company A is using a defensive approach to financing. Current liabilities equal 48% of current
assets, so 52% of current assets are financed using long term finance, the equity plus the bonds.
There is little risk that Company A would not be able to pay off its current liabilities as they become
due. However, Company A requires significant long-term finance – in this case the company has
£100,000 more bonds than Company B, and therefore has a higher interest charge to pay.
Company B is using a much more aggressive approach. Current liabilities are equal to 158% of
current assets. This means that all of Company B’s current assets, and some of its non-current assets
are being financed by current liabilities. This is risky, because if Company B’s payables required
payment, or if the bank asked for immediate repayment of the overdraft, it might be difficult for
Company B to find the cash to pay them with. The company would need to try to arrange other
sources of finance, such as new bonds, or try to sell some assets to raise cash. When companies need
cash in a hurry, they often suffer losses – for example, selling assets at below their value, or borrowing
at high rates of interest in order to get finance quickly.
1.4 The cost of short-term finance

Short-term finance is usually cheaper than long-term finance due to the risks taken by lenders. For
example, if a bank were considering two loan applications, one for one year and the other for 20
years, all other things being equal it would demand a higher interest rate on the 20-year loan. This is
because it feels more exposed to risk on long-term loans, as more could possibly go wrong over a
period of 20 years than over a period of one year. Long-term finance includes equity finance which is
particularly expensive: because of the risk they suffer shareholders expect high returns, and
dividends are not tax deductible.

Occasionally this situation can be reversed. Sometimes short-term interest rates will be higher than
long-term rates, as when the market expects interest rates to fall in the long run. But if finance has
been borrowed long-term, early repayment may not be possible or, if allowed, early repayment
penalties may be experienced. The flexibility of short-term finance may, therefore, reduce its overall
cost.
Finally, short-term finance also includes items such as the credit period offered by suppliers (trade
payables); it can therefore have a low average cost since interest is charged by banks on overdrafts
but not by ordinary suppliers unless an agreed credit period has been exceeded.
1.5 The risks to borrowers of short-term finance

The price paid for the reduced cost of short-term finance, such as trade credit and bank overdraft
facilities, is an increase in risk suffered by borrowers.
• Renewal risk
Being short-term the finance has to be continually renegotiated as relationships with suppliers
change or the various overdraft facilities expire. Either because of economic conditions (eg, a
credit squeeze) or because of the financial situation of the business, such renewal may be difficult
to obtain.
• Interest rate risk
If the business is constantly having to renew its funding arrangements, it will be at the mercy of
fluctuations in short-term interest rates.
1.6 Making the decision between short-term and long-term finance

No single ideal financing package can be recommended as it all depends upon the risk appetite and
the perceived risk/return trade-off of each individual business.
Businesses may be categorised as having aggressive, average or defensive positions in this area:
• an aggressive business has more short-term finance than equity; it may return a higher profit but
at the cost of greater risk.
• an average business matches its maturities so it has less risk than in the aggressive business but
less return as well:
– permanent current assets are financed by long-term debt
– fluctuating current assets are financed by short-term trade credit and overdrafts
• A defensive business sacrifices profitability for liquidity by having little short-term finance, which
finances only some of the fluctuating current assets. This is a low-risk, low return business.
The financing choice must be made by the treasury managers of the individual business, bearing in
mind the willingness of suppliers of finance to lend or extend credit and the risk of its industrial
sector.
You may need to demonstrate an ability to draw realistic conclusions about whether a business’s
approach to financing is less defensive or aggressive than another company. Calculate what
percentage of current assets are financed by current liabilities and if information is available.
1.7 Investing surplus cash in the short term

If a business identifies a short-term surplus of cash, it should aim to invest it to earn a return. If the
surplus is of a longer-term nature, it should be invested in longer-term projects to increase
shareholder wealth or returned to shareholders as dividends.
Surplus finance can be invested in various financial products in the money markets, which we shall
come back to shortly. Most businesses will be looking for a variety of investments in order to spread
the risks involved, and to ensure flexibility.

2 The banking system
Section overview
• Financial intermediation means that banks ‘stand in the middle’ and match up people with excess
cash and those who have a deficit of cash.
• The banking system comprises retail, commercial and investment banks. Banks are heavily
regulated.
• Retail banks operate systems for ensuring that money paid in at one bank can be drawn out at
another.
• The bank/customer relationship is legally quite complex, involving four contractual relationships
(receivable/payable, bailor/bailee, principal/agent and mortgagor/mortgagee) and a fiduciary
relationship.
If a business is to raise additional short or long-term finance or to invest surplus cash, then this will be
done either through a bank or within the money or capital markets.
2.1 Financial intermediation

Banks take deposits from customers and then use that money to lend money to other customers. This
process is known as financial intermediation. The banks act effectively as middlemen providing
finance for those that want loans from the deposits made by savers.
Benefits of financial intermediation:
• Small amounts deposited by savers can be combined to provide larger loan packages to
businesses.
• Short-term savings can be transferred into long-term loans.
• Search costs are reduced as companies seeking loan finance can approach a bank directly rather
than finding individuals to lend to them.
• Risk is reduced as an individual’s savings are not tied up with one individual borrower directly.
2.2 Banks
• Retail banks (clearing banks) take deposits from households and make loans to households and
short term loans to businesses. They also operate the payments services that enable individuals
and businesses to make payments to each other using various technologies including Faster
Payments, Bacs and Chaps, as well as cheques.
• Commercial and investment banks provide a range of services to businesses and governments.
Activities include arranging and underwriting the issue of new securities (eg, shares and bonds)
on behalf of their customers, providing advice on strategic issues such as mergers and
acquisitions, providing instruments for hedging and risk management, such as forward exchange
contracts, and operating and dealing in the capital markets.
• While a distinction has been made between retail banks and commercial and investment banks,
the UK banking market is dominated by a small number of large banking groups that provide all
of these services.
Banks as a key part of the financial system are heavily regulated in the UK. They are affected by the
activities of the Bank of England, which has two main roles in the UK: carrying out monetary policy
and ensuring financial stability.
2.2.1 Monetary policy

The Bank of England is banker to the banks, lending money to the banking sector through its
financial market operations at the base rate set by its Monetary Policy Committee (MPC). The MPC
decides on the base rate in order to meet a target for overall inflation in the economy set each year
by the Chancellor of the Exchequer. The aim of this is monetary stability, which we shall see more
about in the chapter The economic environment of business and finance.
The base rate is not necessarily the interest rate at which banks lend and borrow money among
themselves (the most well-known of these rates is the London Inter Bank Offered Rate, or LIBOR), nor

is it the rate at which customers receive interest on their deposits or pay interest on their advances.
There are a great many other factors affecting these rates, but the base rate is nevertheless important
as it is the rate which is often used as a comparator for the performance of organisations and their
projects.
2.2.2 Financial stability

As well as monetary stability, the Bank of England also seeks to ensure the financial stability and
resilience of the UK’s financial system as a whole. A key way in which it does this is via its Financial
Policy Committee (FPC), which takes action to remove or reduce systemic risks in the UK financial
system as a whole. An example of a systemic risk of this nature is reliance of banks and building
societies on wholesale money markets, the stalling of which was a key factor in the financial crisis that
hit the system from 2007. The FPC has a secondary objective to support the economic policy of the
Government.
Following the financial crisis, the Financial Services Act 2012 broke up the previous regulator of
operators in the financial industry, the Financial Services Authority (FSA), and created instead a twin
peaks regulatory regime, half of which is operated by the Bank of England. The twin peaks regime
operates via two separate bodies as follows.
• The Prudential Regulation Authority (PRA) is part of the Bank of England and is responsible for
the prudential regulation and supervision of banks, building societies, credit unions, insurers and
major investment firms. It is forward-looking, seeking to spot problems in individual firms before
they can create instability for the system as a whole. The PRA has two statutory objectives:
– to promote the safety and soundness of firms, by focusing primarily on the harm that firms can
cause to the stability of the UK financial system; and
– to secure, in relation to insurers, an appropriate degree of protection for policyholders
• The Financial Conduct Authority (FCA) is an independent body responsible for:
– promoting effective competition;
– ensuring that relevant markets function well; and
– regulating the conduct of all financial services firms, which includes acting to prevent market
abuse and ensuring that consumers get a fair deal from financial firms
The FCA also operates the prudential regulation and supervision of financial services firms which are
not supervised by the PRA, such as asset managers and independent financial advisers.
2.2.3 Forms of money transmission

Several forms of money transmission are offered by banks to their customers:
• Faster Payments Scheme – a same-day clearing system for amounts from £1 up to £250,000 using
either the phone or the internet to make the instruction.
• Electronic Funds Transfer (EFT) – this refers to any computer-based system used to perform
financial transactions electronically. Although the term is used for a number of different concepts
it is most commonly associated with cardholder-initiated transactions in shops, where a
cardholder makes use of a debit card or credit card in an electronic funds transfer at point of sale
(EFTPOS).
• Banks Automated Clearing System (BACS) – this is an EFT system that deals with salaries and
direct debits. The account of the payer is debited on the same day as the account of the recipient
is credited.
• Clearing House Automated Payment System (CHAPS) – an electronic bank-to-bank same-day
value payment system made within the UK in sterling.
• Society for Worldwide Interbank Financial Telecommunication (SWIFT) – this is the worldwide
financial messaging network which exchanges messages between banks and other financial
institutions so that a similar service to CHAPS is possible for international transfers of money.
• Payment gateways – when goods are purchased on e-commerce web sites using a credit card,
the operator of the website (the merchant) sends a payment authorisation request to the card
issuer via a payment gateway. An authorisation message is sent back to the operator of the web
site (via the payment gateway). The authorisation is “cleared” when the merchant has sent the
goods to the customer, and the issuing bank then pays the merchant. The authorisation process
takes 2–3 seconds.

• Digital commerce platforms such as PayPal are transforming the way that individuals can make
payments to each other using just an e-mail address. Many platforms enable international
payments to be made at a fraction of the cost that banks charge.
• General clearing (mainly of cheques) – a small number of people still use cheques to make
payments. A clearing house exists where banks settle up cheques drawn on their customers’
accounts in favour of customers of the other banks. This covers items of any size but there is a
short delay before amounts are cleared and can be drawn.
2.3 The bank/customer contractual relationships

When money is paid into a bank by an individual or business and an account is opened then that
individual or business becomes a customer of the bank.
The legal relationship between the bank and its customer is actually quite complex. There are
potentially four main contractual relationships between the bank and the customer.
2.3.1 Receivable/payable (debtor/creditor) relationship

When the customer deposits money the bank owes money (it is the customer’s receivable/debtor)
and the customer is a payable/creditor of the bank. If the customer’s account is overdrawn however
the bank is owed money (it is a payable/creditor of the customer) and the customer is the bank’s
receivable/debtor.
This relationship is essentially a contract between the bank and the customer.
• The bank borrows the customer’s deposits and undertakes to repay them.
• The bank agrees to execute payments authorised by the customer, subject to the bank’s
authorisation procedures, and provided that the customer has sufficient funds in their account.
• The bank will refund the customer for any unauthorised payments taken from the account unless
the customer is negligent (eg, did not keep passwords secure).
• The bank accounts for and provides access to funds paid into the customer’s bank account.
• The bank will only cease to do business with the customer with reasonable notice.
• The bank is not liable to pay the customer until the latter demands payment.
Note: The term debtor is synonymous with receivable, and the term creditor is synonymous with
payable.
2.3.2 Bailor/bailee relationship

This element of the relationship concerns the bank accepting the customer’s property for storage in
its safe deposit. The bank as bailee undertakes to take reasonable care to safeguard the property
against loss or damage and also to re-deliver it only to the customer (the bailor) or someone
authorised by the customer.
2.3.3 Principal/agent relationship

An agent is someone who acts on behalf of another party, the principal. Within banking the
principal/agent relationship exists where, for example, a bank executes a payment on the instructions
of the customer. The receiving bank acts as an agent of the customer, as principal, when it accepts
payments on behalf of the customer from another individual’s bank, and then pays the proceeds into
the customer’s account.
2.3.4 Mortgagor/mortgagee relationship

If the bank asks the customer to secure a loan with a charge over its assets, then the relationship
between the two is that of mortgagor (the customer) and mortgagee (the bank). If the customer does
not repay the loan, then the bank has the right to sell the assets and use the proceeds to pay off the
loan.
2.4 The bank/customer fiduciary relationship

The bank and the customer also have a fiduciary relationship which means that the bank as the party
with more relative power is expected to act with good faith in its relationship with the customer. This
is a legal requirement, which goes beyond any specific terms in the customer’s agreement with the
bank.

2.4.1 The bank’s duties to the customer
• It must honour a customer’s payment orders (such as written cheques and automated payment
transfers) provided they are correctly made out, there is no legal reason for not honouring them
and the customer has enough money or sufficient overdraft limit to cover the amount of the
cheque.
• The bank must credit cash/payment orders that are paid into the customer’s account.
• If the customer makes a written request for withdrawal of money in its account, the bank must
repay the amount on demand.
• The bank must comply with the customer’s instructions given by direct debit mandate or
standing order.
• The bank must provide a statement showing the transactions on the account within a reasonable
period and provide details of the balance on the customer’s account. This requirement is often
satisfied by providing online statements.
• The bank must respect the confidentiality of the customer’s affairs (especially in regards to data
protection legislation) unless the bank is required by law, public duty or its own interest to
disclose details or where the customer gives his consent for such disclosure.
• The bank should use care and skill in its actions.
• The bank must provide reasonable notice if it is to close a customer’s account.
• Increasingly, banks are viewed as having a responsibility for money lost when fraud occurs in a
customer’s account through unauthorised/illegal use of ATM or digital channels (eg, internet
banking).
Many banks and electronic payments institutions have signed up to the voluntary Contingent
Reimbursement Model (CRM) Code, which offers greater protection for customers from authorised
push payment (APP) scams, where customers are tricked into authorising a payment to a scammer.
Under the code, the banks agree to:
• adopt more procedures to detect, prevent and respond to APP scams; and
• take greater care to prevent accounts being used to launder the proceeds of APP scans
2.4.2 The customer’s duties to the bank

• keep safe all the ways of accessing money in the account (eg, cards, e-wallets)
• to tell the bank of any unauthorised payments from their bank account
• not to disclose information such as passwords or personal identification (PIN) numbers that would
enable unauthorised access to their bank accounts
Note that there is no specific legal duty on a customer to check their bank statements.
2.4.3 The rights of the bank

• to charge reasonable bank charges and commissions over and above interest
• to use the customer’s money in any way provided that it is legal and morally acceptable
• to be repaid overdrawn balances on demand (although banks rarely enforce this)
• to be indemnified against possible losses when acting on the customer’s behalf
2.5 Fintech
Like many industries the banking industry is experiencing challenges from new businesses using
technology to compete with the banks’ traditional business model. Fintech is discussed in more
detail in the chapter Developments in technology.

3 The money markets
Section overview
• The money markets offer opportunities for investing surplus finance using Treasury bills, deposits,
certificates of deposit, Gilts, bonds and commercial paper.
Definitions
Money Markets: The money markets is a term that covers a vast array of markets buying and selling
different forms of money or marketable securities. The money markets are a wholesale market that
provides financial institutions with a means of borrowing and investing to deal with short-term
fluctuations in their own assets and liabilities.
Marketable securities: Short-term highly liquid investments that are readily convertible into cash.
Companies might use them to invest short-term surplus finance (see above).
The main traders in the money markets are banks, the government (through the Bank of England)
and local authorities, plus brokers and other intermediaries.
3.1 Money market financial instruments

There are a variety of different financial instruments that are traded in the money markets. The main
types are:
• Treasury bills issued by the Debt Management Office of HM Treasury, which have a minimum
investment for members of the public of £500,000+, run for one to six months and are highly
secure and liquid, but offer low returns. They can be converted into cash by selling them in the
discount market
• Deposits – money in the bank accounts of banks and other financial intermediaries, which offer
investment periods ranging from overnight to five years. They are available from banks, local
authorities and building societies with yields exceeding that of Treasury bills
• Certificates of deposit (CDs) – issued mainly by commercial banks, a certificate of deposit
endures for a fixed term of between one month and five years at a fixed rate of interest, and can
be sold earlier than maturity in the CD market
• Gilts issued by the Debt Management Office, which are longer-term government debt that offer a
large range of maturities (five to 50 years) and rates based on money market rates
• Bonds, which are debentures and loans of companies quoted on the Stock Exchange; rates
fluctuate with general interest rates and there is good liquidity
• Commercial paper – IOUs issued by large companies which can be either held to maturity or sold
to third parties before maturity
The inter-bank market is a market for very short-term borrowing, often overnight, between banks. It
is used to smooth fluctuations in the banks’ receipts and payments. The main interest rate charged in
this market is the London Inter-Bank Offered Rate (LIBOR). The individual banks then use this rate in
order to determine the interest rate that they will offer to their customers.
4 The capital market for business finance

Section overview
• The capital market for businesses comprises: national stock markets, the retail and wholesale
banks, bond markets, leasing, debt factoring and international markets.
• A company can raise capital in the capital markets by issuing marketable securities:
– equity, or ordinary share capital

– preference shares
– loan stocks or debentures
Capital markets provide a source of funds for businesses (mostly companies) and an exit route for
investors.
Definition
Capital market: The national and international markets in which a business may obtain the finance it
needs for its short-term and long-term plans.
There is no single capital market: there are many ways in which businesses can access finance. The
level of global connectedness brought about by the internet means that increasingly we see
borderless businesses. These cut across national boundaries and national capital markets.
National stock For companies in the UK this includes the Main Market and the AIM (
markets Alternative Investment Market) of the London Stock Exchange. They act as:
• Primary markets ie, a source of new finance via new share issues, and as
• Secondary markets for securities such as shares that are already in issue
The London Stock Exchange’s Professional Securities Market (PSM) allows
businesses to raise capital from professional investors using specialist
securities.
The banking system This can be split between the retail market (for individuals/small
businesses) and the wholesale market (for large companies).
Bond markets Generally these are for very large organisations to raise typically very large
amounts of money.
Leasing This is a very important source of business finance for a whole variety of
entities.
Debt factoring This is normally used by smaller businesses to help finance their working
capital requirements.
International Typically available to larger companies, these allow finance to be raised in

markets different currencies, typically in very large amounts.
Raising new long-term business finance invariably involves issuing securities in the form of shares
(equity) or bonds (debt).
Definitions
Equity: represents the ordinary shares in the business. Equity shareholders are the owners of the
business and through their voting rights exercise ultimate control.
Preference shares: form part of the risk-bearing ownership of the business but, since they are entitled
to their dividends before ordinary shareholders, they carry less risk. As their return is usually a fixed
maximum dividend, they are similar in many ways to debt.
Loan stocks and debentures: are typically fixed interest rate borrowings with a set repayment date.
Most are secured on specific assets or assets in general such that lenders are protected (in
repayment terms) above unsecured payables in a liquidation.

5 Sources of equity finance
Section overview
• Retained earnings (profits earned over time but not immediately paid out to owners) are the main
source of long-term finance for most businesses.
• Rights issues of shares: the law protects shareholders by requiring that any new issues are first
offered to the existing shareholders.
• New issues of marketable securities may be done via:
– placings: the most common form of issue for companies first coming to market
– offer for sale: used by large companies raising large amounts in a high profile (but expensive)
manner
– direct offer (offer for subscription): rarely used – involves a company issuing shares directly to
investors)
• Pricing of new issues is difficult but getting the issue underwritten, or using an offer for sale by
tender, can help.
• Going public by obtaining a full listing has advantages and disadvantages.
There are broadly three methods of raising equity:
Method Real world use
Retaining earnings (profits), rather than paying By far and away the most important source of
them out as dividends equity
Rights issues of new shares to existing The next most important source
shareholders
New issues of shares to the public: an issue of The least important source of new equity in
new shares to new shareholders practice
5.1 Retained earnings

The profits earned by a business can either be paid out to owners in the form of dividends or
reinvested in the business. Shareholders will still expect a return on the funds re-invested in the
business, ie, they will expect the funds to be invested in projects which increase their wealth.
Retained earnings represent a very easy and important source of finance, particularly for young
growing businesses where there may be a continual need for finance but where it is impractical to
keep raising it using rights/new issues and debt.
5.2 Rights issues of shares
Definition
Rights issue: A rights issue is an issue of new shares for cash to existing shareholders in proportion to
their existing holdings.
Legally a rights issue must be made before a new issue to the public. Existing shareholders have
rights of first refusal (pre-emption rights) on the new shares and can, by taking them up, maintain
their existing percentage holding in the company. However, shareholders can, and often do, waive
these rights by selling them to others.
5.2.1 Factors to be considered when making rights issues

• Issue costs – these have been estimated at around 4% on £2m raised but, as many of the costs are
fixed, the percentage falls as the sum raised increases

• Shareholder reactions – shareholders may react badly to companies continually making rights
issues as they are forced either to take up their rights or sell them. They may therefore sell their
shares, driving down the market price
• Control – unless large numbers of existing shareholders sell their rights to new shareholders there
should be little impact in terms of control of the business by existing shareholders
• Unlisted companies – often find rights issues difficult to use, as shareholders who do not have
sufficient funds to take up their rights may not be able to sell them if the shares are not listed. This
could mean that the company is forced either to use retained earnings or to raise loans
5.3 New issues of shares

These may take the form of placings, offers for sale or direct offers (offers for subscription).
5.3.1 Placings
Placings are the most common method of issuing shares when a company first comes onto the
market. They work as follows:
The investor base in a placing is made up of institutional investors, contacted by the issuing house.
The general public does not tend to have access to the shares when first offered, although they can
be involved in any subsequent trading in the shares.
• Benefit: lower transaction costs (eg, advertising, administration) than public offers
• Drawback: by only offering to a narrow pool of institutional investors, the spread of shareholders
is more limited, which reduces the efficiency of the market in the shares (we shall come back to
the efficient markets hypothesis later in this chapter)
5.3.2 Public offers

There are two methods of making a public offer:
• offer for sale/Initial Public Offering (IPO); and
• direct offer (offer for subscription).
An IPO is similar to an offer for sale, but is the initial sale of shares to the public by the company.
Further sales of shares are by offer for sale. In practice IPOs/offers for sale are the most common; in
either method the issue is likely to be underwritten (see below). There is no restriction on the amount
of capital raised by public offer. They are best illustrated diagrammatically:
Direct offer or
Offer for sale Offer for
or IPO subscription
X plc X plc
Shares sold to an
issuing house
(investment bank)
Shares direct
Issuing house
to general public
Issuing house offers

shares for sale to
general public
Investing public Investing public
Figure 7.2: Types of Public Offer
Both methods use very similar procedures. These include advertising, eg, in newspapers, following
the legal requirements, and Stock Exchange regulations in terms of the large volumes of information
which must be provided (listing particulars, prospectus etc). Great expense is incurred in providing
this information, as it requires the involvement of lawyers, accountants and other advisors.

5.3.3 Pricing of new issues
A company does not want to set the issue price too high, causing the issue to fail, or too low, as this
will result in more new shares being issued than is necessary, which detracts from the wealth of
existing shareholders. There are two ways in which the pricing problem can be addressed by:
• underwriting the issue; and
• using an offer for sale by tender
Definitions
Underwriting: is the process whereby, in exchange for a fixed fee (usually 1–2% of the total finance to
be raised), an institution or group of institutions will undertake to purchase any securities not
subscribed for by the public. The main disadvantage of underwriting is its cost, which depends on
the characteristics of the company issuing the security and the state of the market. The cost is
payable even if the underwriter is not called upon to take up any securities. Effectively, underwriting
is an insurance policy that guarantees that the required capital will be raised.
Offer for sale by tender: the investing public is invited to tender (offer) for shares at the price it is
willing to pay. A minimum price, however, is set by the issuing company and tenders must be at or
above the minimum.
The procedure for an offer for sale by tender is as follows:

(a) Receive all tenders.
(b) Set the actual issue price (a single price), either at:
– the highest price at which the entire issue is sold, all tenders at or above this price being
allotted in full; or
– a lower price, with tenders at or above this lower price receiving only a proportion of the shares
tendered for. This prevents the concentration of shares in the hands of one party.
As the shares are issued at only one price and not at several, investors who made tenders at high
prices will usually pay less than the amount tendered.
5.4 Preference shares

Preference shares usually carry no voting rights and have no right to share in excess profits.
• Benefits: They can be attractive if a company is looking to raise new capital but wants to avoid
additional debt and does not want to dilute the ordinary shareholders’ influence.
• Drawbacks: While the dividend on ordinary equity shares will vary from one period to the next,
preference shares offer a fixed rate of dividend each year. This is not guaranteed and if the
company has insufficient profits the dividend may not be paid. However, most preference shares
are ‘cumulative’ so that all arrears in preference dividends have to be paid before equity
dividends can be paid. They are expensive to issue and to finance.
5.5 Going public

At some stage a successful large company may decide to obtain a full listing (‘go public’ or ‘float’) on
the Main Market of the London Stock Exchange. This may be a premium listing, a standard listing or
an admission via the high growth segment of the Main Market.
With a premium listing the company is expected to meet the UK’s highest standards of regulation
and corporate governance, and as a consequence may enjoy a lower cost of capital through greater
transparency and through building investor confidence.
Companies with a standard listing have a slightly lower requirement as to regulation and
governance, and may include overseas companies with a UK listing.
It is also possible to have an admission via the high growth segment, which has EU regulated market
status but sits outside the UK’s listing regime.
Smaller companies may use lower-level markets such as AIM.
Advantages of going public
• gives access to a large source of finance

• improves the marketability of shares, which should increase the value of the company
• improves the standing of the company, as it will be under more scrutiny once listed, so raising
more finance may then be easier
Disadvantages/problems of going public
• cost: costs run into hundreds of thousands of pounds even for modest issues
• dilution of control (at least 25% of the company has to be in public hands)
• need to have traded for three years
• having to answer to other investors – often professional institutional investors
• greater scrutiny of the affairs of the company and the actions of the directors
• listing might not be successful unless the business is worth at least £50m (often referred to as
market sentiment)
• possibility of being taken over
• extra costs of control and reporting systems to meet the increased demands on the company. A
listing agreement commits directors to certain levels of compliance, of reporting to shareholders
and of corporate governance (we shall see more about this in the chapter Corporate governance)
The process for obtaining a full listing on the Stock Exchange involves a number of specialist
advisors.
Company sells shares Sponsor: usually an Investing public

to raise capital investment bank, can also be
stockbroker, accountant etc
• Assesses whether flotation
Corporate broker is appropriate Solicitors
(Can be same organisation • Helps draft prospectus • Deal with
as sponsor, in which case • Co-ordinates all advisors legal aspects
roles are combined) • Prices and underwrites
• Advises on market the issue
conditions and likely
demand
• Generates interest with
Accountant
investors Registrars
• Helps with issue method • Involved in long-form
• Record ownership
and pricing report (financial controls,
of shares
• May organise track record, financing
sub-underwriting and forecasting)
Figure 7.3: Going public
6 Sources of debt finance

Section overview
• Overdraft – short-term finance from a bank.

• Debt factoring – use of debt factors helps manage the risks of offering credit.
• Term loans – traditional finance from the banking sector.
• Loan stock – financial instruments detailing interest, repayment, redemption date and ownership.
• Leasing – a major source of funding for capital expenditure.
• Other forms of debt – relevant to a variety of organisations depending on the context.

6.1 Overdraft
Definition
Overdraft: A short-term loan of variable amount, up to a limit from a bank, typically repayable on
demand. Interest is charged on a day-to-day basis at a variable rate.
Overdrafts are used by businesses to meet their short-term cash deficits. They are inappropriate as
part of a company’s long-term capital base because they are normally repayable on demand. This
means that the bank offering the overdraft is not committed to making that money available on an
ongoing basis, as would be the case with say a term loan (see section below).
In spite of this, many companies take the risky step of having a permanent overdraft ie, they use it as
a long-term source of finance.
6.1.1 Advantages of an overdraft

• flexibility: An overdraft can be used and repaid as desired, giving the borrower flexibility
• cost: Overall interest cost can be lower than a term loan, as interest is only paid when overdrawn
6.1.2 Disadvantages of an overdraft

• risk: As it is repayable on demand it is not suitable as a long-term source of capital, since banks
can – and do – demand immediate repayment
• cost: If the account is permanently in overdraft, the overall interest cost is higher than with a term
loan as the interest rate is generally higher
• control: The bank may require security on assets of the business
6.2 Debt factoring
Definition
Debt factoring: The business receives loan finance and insurance – known as non-recourse factoring
– so that in the event that a customer does not pay, the business does not have to repay the loan.
The services typically offered by a debt factor include:
Finance against sales Offering credit to customers creates cash flow problems, which can be
particularly acute for small businesses. Debt factors help by giving the
client a loan of, say, 80% of the amount due from customers. When
customers pay at the end of their credit period, the debt factor uses
this to settle the loan, and returns the balance, less charges, to the
client.
Insuring receivables Offering credit to customers invariably carries a cost in the form of
irrecoverable debts. Debt factors can assess the risk of whether
customers will pay and offer insurance, in return for a premium.
Managing the running of The debt factor can carry out all aspects of running a receivables
the receivables ledger ledger eg, invoicing, credit control and accounting and collection etc.
For small businesses keen to keep their overheads down it can make
sense to outsource this function to a specialist, efficient agency.
Factoring may be ‘with recourse’ or ‘non- recourse’. As described above, the factoring company
makes a loan to the client based on the value of the amounts due from customers. As customers pay
their debts, this is used to repay the loan to the factor. If ‘with recourse’ factoring is used, the factor
will have the right to demand payment from the client in respect of any bad debts. If the agreement
is non-recourse, the factor bears the cost.

6.2.1 Disadvantages of using debt factors
The use of debt factors may harm the reputation of a business for two reasons:
(a) The use of factors may be interpreted as an indicator that the company is in financial difficulty. As
factoring becomes more widely used however, this is becoming less likely.
(b) The use of a factor means that there is less contact with customers. Calls to the customer relating
to the collection of debts will be made by the factor rather than by the business. Some
customers may resent having to deal with a third party, particularly if the factor is too aggressive
in their methods of collection.
6.3 Term loans
Definition
Term loan: A term loan is a loan – typically but not always from a bank – where the repayment date
(its termination) is set at the time of borrowing and, unlike overdrafts, they are not repayable on
demand, unless the borrower defaults on repayment.
• Interest rates on term loans can be fixed or variable. The variable (or ‘floating’) rate is usually set at
a certain % above base rate or LIBOR. Variable rates avoid the problem of the business being
locked into a high fixed rate loan but they make cash flow planning difficult. A fixed rate loan
could, of course, lock the business into a low interest rate but these are not always available.
• Arrangement fees are usually payable on term loans, but these are small compared with issue
costs for loan stocks on the London Stock Exchange.
• Security: Term loans are usually secured against assets or, in smaller companies, by directors’
personal guarantees.
• Flexibility: Repayment schedules are flexible and interest ‘holidays’ of typically up to two years
can be negotiated to allow new ventures to become established before cash has to be used to
repay a loan.
6.4 Loan stock
Definition
Loan stock: Debt capital in the form of securities issued by companies, the government and local
authorities. These are also referred to as bonds or debentures.
The holder of loan stock has much more assurance about what cash they will receive and when,
which is attractive compared to the uncertainty faced by a shareholder.
Loan stock is both an investment for the lender and borrowing for the company, so its terms are
drafted according to what the parties want.
Coupon (interest) • The annual interest is the coupon rate x the nominal value of the stock,
rate eg, on £100,000 nominal of 10% loan stock the annual coupon is
£10,000.
• Can be fixed rate (usually referred to as bonds), or variable rate (usually
referred to as floating rate notes).
• The coupon can sometimes be set at zero, in which circumstance the
yield to investors is generated by the difference between what they
buy the bond for and the redemption value. This generates a capital
gain rather than income.
Redemption value • A £100,000 loan can be repaid at par (with £100,000) or at a premium
(say, £105,000) or discount (say £95,000) to the par value.

• In receiving £105,000 investors will find the stock more attractive and
so be happier to accept a lower- or zero-coupon rate, which eases the
company’s cash flow.
Redemption date • Loan stocks are normally medium- to long-term. Some bonds are
undated (perpetual or irredeemable).
• If the holder needs the capital back on undated bonds, they must sell
the loan stock.
Recipient • With UK domestic bonds issued on the London Stock Exchange, the
bond holder’s name is recorded on a register, as with shares.
• Some bonds, eg, some eurobonds, are ‘bearer’ bonds. The holder of
the bond – whoever that is – will receive the payments due.
6.5 Leasing
Definition
Lease: A lease is a financing arrangement whereby the owner of an asset (such as a finance company
or bank) known as the lessor, transfers the risks and rewards of ownership, or the right to use the
asset, to the purchaser (known as the lessee) for a particular period of time.
Leasing is an important source of finance and is a common means of financing for vehicles, office
and production equipment, etc. Under a lease arrangement, the purchaser pays the owner of an
asset a regular payment (usually monthly) for the right to use the asset for a particular period of time.
At the end of the lease period, the asset may be transferred back to the owner, or may be purchased
by the purchaser depending on the type of arrangement entered into.
The table below distinguishes buying and leasing an asset.
Buying asset outright Leasing the asset
This simply involves purchasing an asset when it This is essentially the rental of an asset.
is required.
Finance is usually paid in full when the purchase The lease period may be for less than, equal to,
is made, although it may be paid in stages (eg, or more than the asset’s useful life.
a deposit paid on purchase with the balance
paid on delivery).
Financing decisions must consider whether the Financing decisions must take account of
organisation has sufficient cash available or can interest payments on the lease. This can make
access capital in other ways (such as through the overall cost of a lease more expensive than
loans or rights issues) to buy the asset upfront. buying up-front.
The purchaser owns the asset from the moment Ownership of the asset remains with the lessor
of purchase. but may transfer to the lessee at the end of the
lease period.
The purchaser takes on the risks or rewards of The lessor may be responsible for repairs and
ownership from the moment of purchase (so maintenance depending on the type of lease
responsible for repair and maintenance costs entered into.
and risk of loss or damage to the asset).
The sale cannot usually be cancelled once The leases are usually not able to be cancelled,
agreed unless there is a fault with the asset. although this is sometimes possible for the
payment of an early cancellation charge.

Selecting the rights source of finance requires you to consider the context. Factors to consider
include the amount of debt the business already has, whether it has assets that can be used as
security for further borrowing, the length of time the finance is required for and the amount of
finance required.
7 Financing a growing business

Section overview
• Problems – growing businesses have particular characteristics that manifest themselves as

problems in raising finance.
• Solutions – there are a diversity of sources of finance that have arisen to meet the particular issues
facing growing businesses, including business angels, crowdfunding, venture capital (VC), and
AIM (Alternative Investment Market).
Interactive question 1: Problems of small businesses

What are the likely characteristics of small but growing businesses that create financing problems?
Small businesses are unlisted so it is more difficult for equity investors to buy and sell shares. Small
businesses therefore usually rely on retained earnings, rights issues, term loans from banks and
leasing. If a business wishes to grow these sources of finance might prove insufficient, but the
business may not be ready for a listing on the London Stock Exchange. There may be a funding gap,
which may be met in various ways.
Understanding the wider context of the business is part of structuring problems. Ensure you know
what problems small and growing businesses have raising finance.
7.1 Business angels and crowdfunding

Business angels are experienced individuals who invest in start-up, early stage or expanding
businesses. They tend to invest collectively and at an earlier stage than most formal venture
capitalists (see below). In other respects, they are similar in terms of investment, returns required and
so on.
Crowdfunding is a means of financing a new business or a new project for an existing business by
raising a specific sum of money from individuals, usually via the internet. The business, as project
initiator, does not have to engage directly with the individuals but can publicise the project on a
platform such as KickStarter or Funding Circle. The individuals contribute money as loans, equity or
simply donations, or by pre-buying a product or service that has not yet been launched.
There are many different models of crowdfunding:
• Loan-based or investment-based crowdfunding (debenture-based lending and equity-based
investment) are the largest sectors of crowdfunding and are regulated by the FCA.
• Other forms of crowdfunding, such as donation and rewards-based crowdfunding, are still
unregulated by the FCA.

7.2 Venture capital (VC)
Definition
Venture capital : is the provision of risk-bearing capital, usually in the form of a participation in equity,
to companies with high growth potential.
A company which has potential, but with little assurance that the potential can be fulfilled, is high risk
so providers of venture capital will expect high returns (eg, 25%–40% per annum). In addition, the VC
will often (though not always) request a presence on the board of the company. Venture capital can
be distinguished from other forms of equity finance because:
• it is more participatory (they usually expect 20% to 49.9% of the shares of a company, large
enough to allow the venture capitalists to exert some control over the running of the business, but
not so large that they become majority shareholders)
• it is provided with regard more for the long term than the short term, although the actual
involvement by the VC is unlikely to extend beyond the medium term
• the investor provides advice and is able to influence management, but does not take on the
running of the business themselves
• much of the return from providing the capital is in the form of capital gains after three to five
years rather than steadily from the beginning, since by their nature companies needing venture
capital will not be able to pay cash dividends in the early years
• A key issue is the VC’s exit route, ie, how the VC can liquidate the investment. This can be by:
– a trade sale – the VC’s shares, or indeed the whole company, is sold to another company;
– flotation; or
– buy-back of shares on re-financing
7.3 AIM (Alternative Investment Market)

AIM has less stringent regulations than the Main Market of the London Stock Exchange and is
designed to provide an alternative source of capital for companies that are unwilling to join the Main
Market but that have a substantial value (most have a value of at least £1m, though there is no
minimum market capitalisation requirement for joining AIM). Entry documentation is made as simple
as possible so there are lower entry costs but the annual cost of listing on the AIM is still quite high.
Interactive question 2: Financing a business through its growth phase

Ian’s Sandwich Empire
Ian starts up on his own selling sandwiches from home, and the business develops into a national
one over time. Given the characteristics at each stage, suggest possible sources of finance.
Stage Characteristics Possible sources of finance
Start-up Very small scale.

Make at home.
Deliver by car to local customers (offices,
trading estates etc).
Growth to £100,000 Need small premises and a van.

revenue pa
(Organic) growth to Need new larger premises with

£500,000 revenue pa refrigeration and refrigerated vans.
Growth to £2 million Established a brand/name/reputation and

revenue pa by wants to expand regionally.
acquisition

Stage Characteristics Possible sources of finance
Growth to £5 million Want to use brand/name/reputation more

revenue pa widely – sell ready-made sandwiches to
local independent retail outlets and local
branches of national retail chains (using
their brand) on credit.
Growth to £50 million Expand to national scale, by combination

revenue pa of organic growth and acquisition.
8 Financing exports
Section overview
• Overseas trade raises additional trading risks, which include physical, credit, trade and liquidity
risks.
• Credit (irrecoverable debt) risks can be reduced in a variety of ways, including the use of bills of
exchange, letters of credit and export credit guarantees.
8.1 Trading risks

Both importers and exporters will face risks which are greater than those faced by domestic traders
as a consequence of political risk and cultural risk as well as the increased distances and times
involved.
Types of trading risk include:
• physical risk – the risk of goods being lost or stolen in transit, or the documents accompanying
the goods going astray
• credit risk – the possibility of payment default by the customer. This is discussed further below
• trade risk – the risk of the customer refusing to accept the goods on delivery (due to substandard/
inappropriate goods), or the cancellation of the order in transit
• liquidity risk – the inability to finance the credit given to customers
Such risks may be reduced with the help of banks, insurance companies, credit reference agencies
and the government’s export credit agency, UK Export Finance.
Other ways to reduce these risks include risk transfer. For example, a business shipping parcels
overseas may agree a contract obliging the courier to pay for losses in excess of its statutory liability.
8.2 Reducing credit risk

Methods of minimising credit or irrecoverable debt risks are broadly similar to those for domestic
trade: the company should vet the creditworthiness of each customer, and grant credit terms
accordingly. There are further methods however in particular relation to foreign trade.
8.2.1 Bills of exchange

A bill of exchange is a document that is drawn up by the exporter (seller) and sent to the overseas
buyer’s bank, which accepts the obligation to pay the bill by signing it. Payment is therefore
guaranteed by the buyer’s bank, which means that the seller can then sell or ‘discount’ the bill to a
third party in return for cash now. Thus the procedure both mitigates the risk of irrecoverable debts
and can also provide liquidity.

8.2.2 Letters of credit
Letters of credit provide a method of payment in international trade which gives the exporter a risk-
free method of obtaining payment. The arrangement must be made between the exporter, the buyer
and participating banks before the export sale takes place.
• The exporter receives immediate payment of the amount due to him, less the discount, instead of
having to wait for payment until the end of the credit period allowed to the buyer.
• The buyer is able to get a period of credit before having to pay for the imports.
Letters of credit are slow to arrange, and administratively cumbersome; however, they are usually
essential where the risk of non-payment is high, or when dealing for the first time with an unknown
buyer.
The procedures are as follows where there is a UK exporter and a foreign buyer, say in Brazil
(obviously it could work equally well for a Brazilian seller and a UK importer).
• The parties first of all agree a contract for the sale of the goods, which provides for payment
through a letter of credit.
• The buyer then requests a bank in Brazil to issue a letter of credit in favour of the exporter. This
bank is known as the issuing bank.
• The issuing bank, by issuing its letter of credit, guarantees payment to the exporter. Banks are
involved in the credits, not in the underlying contracts.
• The issuing bank asks a bank in the UK to advise the credit to the exporter.
• The advising bank in the UK agrees to handle the credit on terms arranged with the issuing bank
in Brazil.
8.2.3 Export credit insurance
Definition
Export credit insurance: is insurance against the risk of non-payment by foreign customers for export
debts.
Some private companies provide credit insurance for short-term export credit business, and UK
Export Finance provides long-term guarantees to banks on behalf of exporters.
Export credit insurance is not essential if exporters are reasonably confident that all their customers
are trustworthy, but it helps cover some of the special risks involved in exporting.
• Time: If an export customer defaults on payment, the task of pursuing the case through the courts
will be lengthy, and it might be a long time before payment is eventually obtained.
• Variety: export credit insurance covers non-payment for a variety of risks (described below), not
just the buyer’s failure to pay on time.
The guarantee contained in short-term export credit protects against non-payment by an overseas
customer as a consequence of: the creditworthiness of the foreign buyer (buyer risks) and also the
economic and political risks in the overseas country (country risks). Particular aspects of these two
risk types are as follows:
Buyer risks Country risks
Insolvency of the buyer A general moratorium on debts to overseas

suppliers which might be decreed by the
government of the buyer’s country
The buyer’s failure to pay within six months of Political events, economic difficulties,
the due date, in cases where the buyer has legislative measures or administrative measures
accepted the goods sent to him by the exporter arising outside the UK which prevent or delay
payments under the contract
The buyer’s failure to accept the goods sent to A ‘shortfall’ in revenue to the exporter caused
him (provided non-acceptance of the goods by foreign exchange losses when the exporter
has not been caused or excused by the has to accept payment in a local currency for a

Buyer risks Country risks
exporter’s own actions, and the insurer decides debt which should be paid in sterling
it would serve no useful purpose for the
exporter to take up or pursue legal proceedings
against the buyer)
9 Green finance
As noted in the chapter Introduction to business, sustainability and climate change are becoming
more important to businesses. Not only are businesses required to provide more information about
their environmental behaviour, but new sources of finance are being developed, to finance projects
or companies that aim to improve the environment, since many investors have preferences for
investing in such activities.
Green finance is any source of finance that is used specifically to finance projects or activities that
lead to environmental benefits. This includes green bonds, green loans, grants and venture capital
funds that specialise in investing in green projects.
Using green finance would help a company meet its sustainability and corporate responsibility goals.
9.1 Green bonds
Definition
Green bonds: Green bonds are any type of bond instrument where the proceeds will be exclusively
applied to finance or re-finance, in part or in full, new and/or existing eligible green projects and
which are aligned with the four core components of the Green Bond Principles (ICMA, 2018).
9.1.1 Green Bond Principles

The Green Bond Principles were issued by the International Capital Market Association (ICMA) in
2015 and were most recently updated in 2021. They are voluntary guidelines for issuers of green
bonds. The four components of the GBP are:
(a) Use of Proceeds: it should be stated in the legal documentation for bonds that the proceeds will
be used for projects that should provide clear environmental benefits
(b) Process for Project Evaluation and Selection: there should be defined processes in place to
determine which projects are eligible
(c) Management of proceeds: the proceeds of the issue of the bonds should be kept in a separate
account or tracked by the issuer
(d) Reporting: issuer should make and keep readily available information on the use of the
proceeds
Environmental objectives that the GBP recognises as being eligible are climate change mitigation,
climate change adaptation, natural resource conservation, biodiversity conservation, and pollution
prevention and control.
The ICMA is also responsible for the Social Bond Principles, Sustainability Bond Guidelines and
Sustainability-Linked Bond Principles.
9.1.2 Market for Green Bonds

The market for Green Bonds is growing exponentially according to research from Climate Bonds
Market Intelligence. This organisation estimates that during the year 2021 more than $517 billion of
green bonds were issued globally. This is up from around $4.2 billion in the year 2012.
In September 2021, the UK government issued its first Green Gilt raising £10 billion to finance green
government projects, such as zero emission buses, offshore wind farms and schemes to decarbonise
homes and buildings. The Gilts are issued in accordance with the UK government’s Green Bond
Framework, which is aligned with the four core components of the ICMA Green Bond Principles.

9.2 Green Finance Institute
The Green Finance Institute (GFI) was established in 2019 by the UK Government (HM Treasury and
Department for Business, Energy and Industrial Strategy) and the City of London Corporation.
It is a commercial organisation that aims to remove barriers to investment towards ‘impactful, real-
economy outcomes, to benefit our environment, society and business’. The aim is to ensure that
finance is available for both public and private sector organisations to help achieve a net-zero carbon
economy. This is achieved by providing guidance to banks and financial institutions on technical
matters relating to environmental investment.
Recent initiatives of the GFI include the launch of GFI Hive, an online resource that provides
knowledge on best practice investing in nature, and a Green Mortgage Hub that provides
information to mortgage lenders to help them launch green mortgage products. These can be used
by homeowners to finance a reduction in energy use and investment in cleaner forms of energy.
When deciding if green finance is the right option for a business, it is necessary to consider the
preferences of the major stakeholders. Will the finance be more expensive than traditional methods
of financing?

Summary
Money
Relationship Bank of England
transmission
Retail Commercial and investment
Banks Money markets
Financial Banking system Capital

intermediation markets
Business finance Exports
Trade credit Equity

Short Long
Overdraft term term Loans
finance finance
Cost v Risk Cost v Risk
Green Finance

indicated.
1 Can you explain the main differences between equity and debt? (Topic 1)
2 Do you know the roles of the banks and the Bank of England? (Topic 2)
3 Do you know the meaning of ‘money markets’ and are you aware of the instruments
that are traded on the money markets? (Topic 3)
4 Do you know what are the different exchanges and markets that make up the capital
markets? (Topic 4)
5 Do you know the three broad methods of raising equity finance and can you discuss
the advantages and disadvantage of each? (Topic 5)
6 Do you know the two methods of making a public offer of shares? (Topic 5)
7 Do you know the advantages and disadvantage of a stock market listing? (Topic 5)
8 Can you identify five types of debt finance? (Topic 6)
9 Can you explain why small growing businesses have difficulties raising finance? (Topic
7)
10 Can you explain how business angels, venture capital and the AIM market work? (Topic
7)
11 Do you know what additional risks businesses have when trading internationally?
(Topic 8)
12 Do you know the instruments that are available to businesses that trade internationally
to reduce the risks? (Topic 8)
13 Can you explain the meaning of the term ‘green finance’? (Topic 9)

questions in the Business finance chapter of the Business, Technology and Finance Question Bank.
Refer back to the learning in this chapter for any questions which you did not answer correctly or
where the suggested solution has not provided sufficient explanation to answer all your queries.
Once you have attempted these questions, you can move on to the next chapter, The professional
accountant.

• ICMA (June 2018) Green Bond Principles. [Online]. Available from: www.icmagroup.org/green-
social-and-sustainability-bonds/green-bond-principles-gbp/ [Accessed on 5 May 2020].

Self-test questions

1 Capital markets in the UK are split into:
A the London Stock Exchange and the Bank of England
B stock markets and bond markets
C primary and secondary markets
D securities markets and banks
2 Which of the following organisations underwrites the issue of securities?
A Retail banks
B Insurance companies
C Investment Banks
D The Bank of England
3 A bank undertakes to store and take reasonable care of a customer’s property and to re-deliver it to
the customer when required.
Requirement
In regards to the bank and customer relationship, in which capacity is the bank acting?
A Mortgagor
B Bailee
C Mortgagee
D Bailer
4 Which of the following statements concerning the fiduciary relationship between a bank and its
customers is not correct?
A The bank agrees to honour a customer’s payment orders.
B The bank agrees to receive payments into the customer’s account.
C The customer has a duty to tell the bank of any unauthorised payments on their account.
D The customer agrees to carefully check their bank statements.
5 Which of the following statements concerning preference shares is correct?
A Preference shares carry the same voting rights as ordinary shares.
B Preference shares carry the right to a fixed rate of dividend each year.
C The payment of a preference share dividend is guaranteed each year.
D Preference shares are always a type of debt capital.
6 Which of the following statements correctly describes the coupon rate of a debt instrument?
A It is the interest charge payable on the debt instrument.
B It is the amount repayable at the end of the term of the debt instrument.
C It is the credit risk of the debt instrument.
D It is the amount payable on the debt instrument in excess of the Bank of England’s base rate.
7 Which of the following sources of finance to companies is the most widely used in practice?
A Bank borrowings
B Rights issues
C New share issues
D Retained earnings

8 Which of the following financial instruments are available from commercial banks?
A Gilts
B Commercial paper
C Certificates of deposit
D Treasury bills
9 The customer of Finkle Ltd has refused to take delivery of goods because it says they do not meet its
quality requirements. Which type of risk is this an example of?
A Physical
B Credit
C Trade
D Liquidity
this chapter.

Financing problems of small businesses
Management A lack of knowledge about the possible sources of finance available,

and a potential lack of financial acumen, may compound the inherent
problems facing a small business.
History Businesses in their early stages of development are small. Such

businesses lack any convincing trading history upon which potential
investors can rely, making them unattractive investments.
Size A small business will lack assets to offer as security. It will also have less
diversity of products and markets to spread risk, and the small scale of
business will not generate reliable cash flows, all of which preclude
investment finance.
Stage Characteristics Possible sources of funds
Start-up Very small scale. Savings or second mortgage on home. Borrow from
Make at home. family and friends (no security or past record, so bank
reluctant to lend).
Deliver by car to local
customers (offices,
trading estates etc).
Growth to Need small premises Borrowing from bank to purchase premises (secured
£100,000 and a van. by premises and personal guarantees) or lease
revenue pa premises. Possibly grant, but unlikely as not
innovating, employing people in an area of high
unemployment (eg, former coalfield) or
manufacturing.
(Organic) Need new larger Borrowings from bank secured by premises or lease.
growth to premises with Become a limited company (Ltd) and bring in new
£500,000 refrigeration and shareholders/money.
revenue pa refrigerated vans.
Possibly grant, as it may be possible to site the new
premises in an area offering grants to create
employment.
Growth to £2 Established a (Secured) bank borrowings remain. Acquisition is

million brand/name/reputation higher risk. Main possibilities:
revenue pa and wants to expand (issue more shares)
by acquisition regionally.
(venture capital or business angels (although they
tend to prefer bigger deals than this)
(loans (at higher interest than bank, acknowledging
the higher risk and lack of security)
Growth to £5 Want to use Main sources likely to be:

million brand/name/reputation (continuing bank borrowings (secured)
revenue pa more widely – sell ready-
made sandwiches to (venture capital or business angels)

Stage Characteristics Possible sources of funds
local independent retail (now at a viable size for this)

outlets and local (loans/debentures)
branches of national
retail chains (using their (invoice discounting (now they have receivables and
brand) on credit. they are reputable)
Growth to Expand to national scale, Convert to plc and float on Stock Exchange (AIM or
£50 million by combination of Main Market).
revenue pa organic growth and
acquisition.

C primary and secondary markets
Securities markets comprise stock markets and bond markets; together with banks they operate in
the primary capital market (ie, as a source of funds for business), but they also act as the secondary
market which ensures that holders of securities can sell and buy securities so as to manage their
wealth.
C Investment Banks
Investment banks underwrite the issue of securities.
B Bailee
In this example, the bank is the bailee.
D The customer agrees to carefully check their bank statements.
The customer is not obliged to carefully check their banks statements. The other statements are true.
B Preference shares carry the right to a fixed rate of dividend each year.
Preference shares are a form of share capital which pay a fixed rate of dividend each year. However,
payment is not guaranteed if the company has insufficient profits to pay the dividend. They do not
carry voting rights like ordinary shares do.
A It is the interest charge payable on the debt instrument.
The coupon rate is the interest rate payable on the debt instrument. It is the redemption value which
is the amount repayable at the end of the term of the debt instrument.
D Retained earnings
Retained earnings is the most widely used source of finance.
C Certificates of deposit
Certificates of deposit (CDs) are issued mainly by commercial banks. They endure for a fixed term of
between one month and five years at a fixed rate of interest and can be sold earlier than maturity in
the CD market.
Treasury bills are issued by the Debt Management Office of HM Treasury, which have a minimum
investment for members of the public of £500,000. Gilts are also issued by the Debt Management
Office. They are longer-term government debt that offer a large range of maturities (five to 50 years)
and rates based on money market rates.
Commercial paper are IOUs issued by large companies which can be either held to maturity or sold
to third parties before maturity.

C Trade
Trade risk is the risk of the customer refusing to accept the goods on delivery (due to substandard/
inappropriate goods), or the cancellation of the order in transit. Physical risk is the risk of goods
being lost or stolen in transit, or the documents accompanying the goods going astray. Credit risk is
the possibility of payment default by the customer. Liquidity risk is the inability to finance the credit
given to customers.

Chapter 8
The accountancy profession
Introduction
Learning outcomes
Syllabus links
Assessment context
Learning topics
1 Introduction to the accountancy profession
2 The importance of the accountancy profession
3 The structure of the accountancy profession
4 Regulation of professions
5 The Financial Reporting Council (FRC)
6 Regulation of the accountancy profession in the UK
7 Professional responsibility
8 Technical competence
Summary
Self-test questions
Introduction
Learning outcomes
• Identify the importance of the accountancy profession to the public interest and to the
effectiveness of capital markets, and the links between the public interest, technical competence
and professional responsibility, including the attributes of professional scepticism, professional
judgement and the public trust
• Specify the key features of the regulatory framework within which professional accountants work,
including the basics of how anti-money laundering requirements affect them
Specific syllabus references are: 4a, 4b
8
Syllabus links
The topic of professionalism in accounting underlies many areas of the Certificate, Professional and
Advanced syllabuses.
8
Assessment context
Questions on the professional accountant and the accountancy profession will be set in the
assessment in either MCQ or multiple response format. They will be either straight tests of
knowledge or applications of knowledge to a scenario.
8

of this chapter.

questions
1–2 The accountancy Approach Questions on the IQ1:

profession Read through professional Accountancy
As a professional sections 1 and 2 to accountant will almost profession
working in the grasp the main certainly appear in your requires you to
accountancy focus of this exam. think about
profession, it is chapter: the Questions are likely to what a career in
important to necessity for an be set in a scenario accountancy
understand the individual context, though means and
meaning of being a professional knowledge-type what the term
professional and be accountant to show questions are also profession
guided by this in all integrity likely, on particular means.
your work. (professional principles or
responsibility) and definitions.
expertise (technical Essential points are:
competence). Note
also the role of the • attributes of
account in relation professions
to sustainability and • meaning of financial
climate change. reporting and
Stop and think assurance
In what way do • meaning of public
accountants support interest and how the
the public interest accounting
as well as their own? profession works in
What would happen the public interest

questions
if there was no
public trust in
professional
accountants?
3–6 The accounting Approach Questions on the IQ2: Regulation

profession and Read sections 3 to 6 structure and You must
regulation quickly then again regulation of the complete
Professional training, much more profession will almost interactive
professional carefully, making certainly appear in your question 2 and
principles and sure you exam. learn the
accounting principles understand the Questions are likely to answer, which
together should principles behind be set in a scenario sets out the
ensure that how and why the context, though aims of
professional accountancy knowledge-type regulation of
accountants carry out profession is questions are also the
their roles and tasks regulated; these likely on particular accountancy
to a high standard. topics are highly principles or profession.
examinable. definitions.
Stop and think Essential points are:
You are probably • FRC
well aware that both • Accountancy and
the profession and audit regulation
business in general
are increasingly
subject to
regulation,
‘oversight’ and,
some would say,
interference. Why is
this so, and how has
it affected the
profession and the
people in it?
7–8 Professional Approach This is an important

responsibility Read through area, so may well
As a trainee chartered sections 7 and 8 feature in your exam.
accountant you are noting how the Essential points are:
obliged to comply ICAEW as regulator • the role of ICAEW in
with the ICAEW code aims to maintain regulation of the
of ethics. Although public trust in the profession
not covered in detail profession.
in this exam, you • how the ICAEW
Stop and think ensures the
need to understand
the importance of Can you think of any technical
integrity and stories you may competence of its
competence. have read in the members
financial press • the reserved areas
recently where the (activities) that must
work of accountants be carried out by
did not display the member of
competence recognised
expected? What professional
impact does this regulators
have on the
ICAEW 2023 8: The accountancy profession 283

questions
profession?

1 Introduction to the accountancy profession
Section overview
• A professional has skill, technical competence and professional values.

• The accountancy profession is concerned with assurance and financial reporting so that people
may make resource allocation decisions.
A profession can be considered as an occupational area or vocation that involves prolonged training
leading to a formal qualification. It can be defined by a group of attributes which distinguish it from
other, non-professional groups.
Some common attributes of professions include:
Attribute Explanation
Formal regulatory process Professions are permitted to set their own licensing rules and
regulations which form a barrier to new entrants into the
profession and its market, and they protect the profession
from competition.
Professions are also able to restrict entry to membership,
through the qualification process, to ensure the skill and
technical competence of members and that the supply of
professional experts remains limited in relation for demand for
their services.
Professions typically have a supporting body of theory and
knowledge (such as Accounting standards in the Accountancy
profession).
Professions may gain monopoly control over specialist areas of
work, which may be protected by the law, so that non-
members are not permitted to do this work.
Great degree of autonomy Public trust in professions allow them a high degree of
autonomy in how they organise and regulate themselves as
well as how they operate.
Professional values Professions set core values that they expect members to meet.
These values are often set out in codes of ethics and conduct.
A common professional value is to work in the public interest.
Self-regulation Professionals judge each other, and hold each other to

account, for not meeting professional values, such as bringing
the profession into disrepute.
Co-regulation Loss of public trust in professions can lead to a move from

purely self-regulation by the profession towards co-regulation.
This consists of regulations from external sources in addition
to regulation by the profession.
1.1 The accountancy profession

The Institute of Chartered Accountants in England and Wales was formed in 1880 by Royal Charter;
the earliest accountancy societies can be traced back to Scotland in 1853.
For the purpose of this chapter, the term professional accountant means a member of ICAEW.

Definitions
Professional: A person who: accepts a responsibility to operate in the public interest; ‘professes’ to
have skill resulting from a coherent course of study and training based on professional values; and
continues to develop and enhance those skills by experience and continuing professional education.
Accountancy: The profession of accounting which comprises measurement, preparation, validation,
disclosure, auditing of and provision of assurance and advisory services on financial information.
Accountancy profession: The profession concerned with the measurement, disclosure or provision of
assurance about financial information that helps managers, investors, tax authorities and other
decision makers make resource allocation decisions.
At the heart of the accounting profession are:

• financial reporting; and
• assurance (the main example of which is audit).
Definitions
Financial reporting: The provision of financial information about an entity to external users that is
useful to them in making decisions and for assessing the stewardship of the entity’s management.
Assurance: The expression of an opinion or conclusion by a professional accountant in public
practice which is designed to enhance the confidence of intended users.
Interactive question 1: Accountancy profession

Consider the idea of following a career as a professional chartered accountant. What would be your
motives? What would be the reactions of your friends and family? Would these be different if you
were considering a career in general management under a large company’s Management Trainee
Scheme? If so, where do the differences lie? What does the term ‘profession’ mean to you?
Note: You will learn more about accounting in the Accounting module and more about the work of
the auditor in the Assurance module.
2 The importance of the accountancy profession

Section overview
• The accountancy profession is concerned with supporting the effective working of capital markets
and the public interest.
• Because accountancy is technically complex, the public interest is best served by having access to
professionals on whom they can rely.
• Public confidence in accountants is driven by their integrity (professional responsibility) and
expertise (technical competence).
The work of the accountancy profession supports:

• the effective working of capital markets; and
• the public interest.

2.1 The effective working of capital markets
The accountancy profession is actively involved in ensuring that organisations (both private and
public sector) have access to sufficient finance. We have covered sources of finance in the chapter
Business Finance.
The capital markets can only operate effectively where there is accurate and open information which
can be used by investors and other providers of finance to make decisions, as we saw in the chapter
Introduction to financial information. If there is inadequate information, or if information is available
to some people and not others (asymmetric information), then some or all investors are at a
disadvantage. They will not make optimum decisions and will not make the returns that they seek.
Ultimately confidence in the capital markets will erode, and the source of new capital for business
would dry up.
If financial statements demonstrate the qualitative characteristics that we saw in the chapter
Introduction to financial information, they are more likely to be relied upon by investors. It is by
making sure there is high quality, accurate financial reporting and assurance that the professional
accountant supports the effective working of capital markets for the benefit of businesses.
We shall be seeing in the chapter The economic environment of business and finance more about
how (capital) market failures can undermine certain aspects of business.
2.2 The public interest

ICAEW Code of Ethics (January 2020) makes the following statement regarding public interest:
A distinguishing mark of the accountancy profession is its acceptance of the responsibility to act
in the public interest. A professional accountant’s responsibility is not exclusively to satisfy the
needs of an individual client or employing organisation.
Accountants have to be aware that people other than their clients or employers may rely on their
work. Investors, creditors, governments, other business organisations and the general public may
also rely on accounts prepared by accountants. These bodies may have no contractual relationship
with the accountant, but public interest means that accountants have to recognise their responsibility
eg, by ensuring that the financial statements they prepare are free from material error or
misstatement.
Working in the public interest means that professional accountants must keep up to date with the
expectations of society so they can fulfil their role and build confidence in the profession.
Confidence in the profession’s expertise and integrity, as demonstrated in high quality financial
reporting and assurance, links:
• professional accountants in business – the accountants who, as members of boards of directors or
in exercise of the authority devolved by boards of directors, are responsible for preparing a
company’s financial statements – with
• professional accountants in public practice who, as auditors or as professionals on other
assurance engagements, are responsible for reporting on these statements
A key consequence of working in the public interest is that ICAEW members must report acts of
misconduct which, if they were to go unreported, could adversely affect the good name of the
profession. To assist members, the ICAEW issues guidance on their responsibilities relating to
defaults and unlawful acts encountered in the course of professional work and to their position
where disclosure is made.
Accountants should apply the following attributes to their work:
• professional scepticism
• critical thinking
• professional judgement
Definitions
Professional scepticism: Assessing information, estimates and explanations critically, with a
questioning mind, and being alert to possible misstatements due to error or fraud.
Critical thinking: The ability to analyse and evaluate issues objectively and rationally, keeping a clear
head when forming judgements about matters being considered.

Professional judgement: The application of relevant training, professional knowledge, skill and
experience commensurate with the facts and circumstances, including the nature and scope of the
particular professional activities, and the interests and relationships involved.
Acting in the public interest also implies that the accountant acts in an ethical manner. The ICAEW
Code of Ethics is described in detail in the Ethics Learning Programme and discussed in more detail
in section 7 below.
The skill structuring problems and solutions includes the ability to demonstrate understanding of the
wider context. The public interest is the wider context of the work of the accountant.
2.3 Role of accountants in relation to sustainability and climate change

Accountants have an important role to play in supporting organisations in meeting their
requirements and expectations regarding sustainability and climate change, or more widely, in their
ESG management. Accountants have a mindset that enables them to bring clarity to complex issues,
including sustainability and climate change.
Sustainability solutions can be broadly divided into solutions based on regulation and intervention,
and solutions based on market forces.
2.3.1 Regulation and intervention

Solutions based on regulation and intervention include:
• mandatory reporting requirements – (eg, in the UK from April 2022, climate-related disclosures
are mandated for listed companies). Accountants will have a role in collecting and reporting this
information
• regulations – accountants have a role in ensuring compliance with regulations relating to
sustainability
• taxes and tariffs – there may be taxes levied on certain activities eg, pollution taxes.
• grants may be available to help organisations improve their environmental behaviour (eg, grants
to invest in more efficient machinery)
• compliance audits or audits of sustainability reports may be required
The role of accountants in supporting solutions based on regulation and intervention are covered in
more detail in other modules.
2.3.2 Market forces

Market forces also encourage organisations to take on the challenges of sustainability and climate
change.
Risk management: Climate change brings significant additional risks for organisations. Accountants
have a role to play in helping organisations to manage their risks. Climate risk and risk management
have already been discussed in the chapter Introduction to risk management.
Strategy: Accountants have a significant role to play in analysing the external environment and how
it will impact the organisation and its strategies. However, organisations also need to be aware of the
impact that their own activities have on the environment and on social and community issues,
including being aware of the activities of suppliers and customers. Strategy was discussed in the
chapter Introduction to business strategy.
Finance: Providers of finance are increasingly preferring to finance organisations whose activities are
environmentally and socially sustainable, and who can demonstrate that they are economically
sustainable into the long term. In the UK for example, the government’s Green Finance strategy
recognises the importance of the financial sector in helping to achieve its target of net zero by 2050.
Organisational finance, including green finance, was covered in the chapter Business finance.
Governance: Stakeholders are increasingly requiring environmental and social data in addition to
the financial data that has been the traditional remit of the accountant. Much of this data will be

provided by non accountants, although accountants may be expected to review and check it before
reporting it. Governance is discussed in the chapter Governance and ethics.
Metrics and targets: Accountants are involved in measuring the performance of organisations in
both financial and non-financial terms. This involves setting of targets and comparing actual
performance against those targets, and interpreting the results. Performance measurement is
discussed in the chapter The finance function and financial information.
Supply chain management: A supply chain includes all activities relating to the flow and
transformation of goods from the initial raw material stage until they reach the final user. The supply
chain usually involves many different organisations. Supply chain management involves the
organisation managing these activities to achieve competitive advantage. This extends to managing
the environmental and social impact of the supply chain (eg, ensuring that all suppliers are adhering
to acceptable employment practices, wherever they are located). Supply chain management was
discussed in the chapter Introduction to business strategy.
2.3.3 Limitations to the role of the accountant in relation to sustainability and climate change
From the discussion above, it should be clear that accountants are supporting organisations in both
meeting their objectives and fulfilling their obligations regarding sustainability and climate change.
Their role is not to be:
• campaigners responsible, for example, for persuading the directors of a company to improve
their behaviour; or
• scientists responsible for analysing the causes and implications of climate change
3 The structure of the accountancy profession

Section overview
• The international global organisation for accountants is IFAC.

• Anyone can call themselves an accountant in the UK.
3.1 International Federation of Accountants (IFAC)

IFAC is the global organisation for the accountancy profession. It has over 175 member organisations
and associates, including ICAEW. IFAC members represent almost three million accountants
worldwide, employed in public practice, industry and commerce, government and education in over
130 countries and jurisdictions.
The aim of IFAC is to protect the public interest by encouraging high quality practices by the world’s
accountants. This includes best practice guidance for professional accountants employed in
business, plus a membership compliance programme.
Through its framework-based Code of Ethics, on which ICAEW’s own Code of Ethics is largely based,
IFAC encourages accountants worldwide to adhere to consistent professional ethics.
3.2 Who can call themselves an accountant in the UK?

There is no legal requirement in the UK for an accountant to be a paid-up member of any
professional body at all, let alone one of the CCAB or IFAC bodies. The term ‘accountant’ enjoys no
special position in English law. Anyone is free to advertise as an ‘accountant’ and offer the full range
of accountancy services, except in the reserved areas (statutory audit, investment business,
insolvency and probate) where statute demands specific levels of competence. Institute members
are therefore open to competition from anyone, whether professionally qualified or not, who
chooses to enter the market.
Anyone who offers accounting services in the UK must be supervised for money laundering
purposes by one of a wide range of supervisory bodies, including ICAEW and the other CCAB
bodies, AAT and other bodies authorised as supervisors. The ICAEW’s role in anti-money laundering
supervision is discussed in section 4 below.

Structuring problems requires an appreciation of the wider context in an industry. This section helps
you to appreciate the wider industry in which accountants work.
4 Regulation of professions
Section overview
• Professions are regulated so that the various aspects of the public interest are kept in balance.
• Regulation of professions can take the form of government or government agency regulation,
self-regulation by the profession itself, or a combination.
• An oversight mechanism can be used to ensure that self-regulation works, and this is the
approach taken to regulation of the UK accountancy profession.
4.1 Why regulation of professions is necessary

Regulation of professions (either self-regulation or external regulation, or a combination) is needed
to provide the public interest with protection and assurance in situations where the issues are too
technically complex for the public to be reasonably expected to look after their own interests. The
activities of many professions typically fall into such a category.
Interactive question 2: Regulation

What do you think should be the aims of regulation of the accountancy profession?
Many of the aims of regulation result in different priorities for different aspects of the ‘public
interest’. Subjective judgements are needed to balance interests.
Regulation should not:
• protect vested interests from competition;
• be for personal gain or to satisfy prurient interest;
• be disproportionate to the benefit gained, such as imposing huge and costly quantities of
detailed restrictions in a heavy-handed and over-rigid manner; or
• distort competition by imposing extra burdens on some, but not others
You may be required to recognise specific issues relating to the regulation of accountants. Make sure
you are aware of the importance of regulation and how it helps support the public interest.
4.2 Methods of regulation

Regulation can be:
• by government directly via legislation;
• by separate agencies established by government (delegated legislation);
• by the profession/industry itself (self-regulation – as follows); or
• by a combination of methods

4.3 Self-regulation
Self-regulation in theory provides a common sense, flexible approach because there is detailed
knowledge within the profession of the issues facing it. It should result in a more efficient and
effective outcome.
Self-regulation only works if:
• the regime does not seem to act against the public interest;
• regulatory guidance and its importance are both understood and enforced;
• members of the profession ‘buy in’ to the process; and
• there is no unjustifiable self-protecting regulation
In fact, self-regulation works best when there is an oversight mechanism to ensure that the entire
process is working.
4.3.1 The oversight mechanism

Society requires proof of good intent and actions. It is more ready to lay blame and to seek legal
remedies (‘litigiousness’). Any form of regulation therefore requires an oversight mechanism to
ensure that it is achieving what it set out to achieve. In the case of self-regulation, it is particularly
important that the oversight mechanism be independent, to counter accusations of self-interest.
The key participants in an effective oversight mechanism are therefore likely to be:
• the government – the ultimate guardian of the public interest in a democracy
• regulators operating in relevant sectors
• members of the profession, to provide an informed insight based on professional experience and
in-depth technical knowledge
• members of the public, independent of the profession, with the character and intellectual ability
to make sound judgements on complex issues
5 The Financial Reporting Council (FRC)

Section overview
• The FRC’s goal is to support investment by ensuring high quality corporate reporting, auditing
and corporate governance by setting standards, reviewing quality, regulating, overseeing self-
regulation, and taking disciplinary action.
• The FRC has two main committees: the Conduct Committee is responsible for professional
oversight, professional discipline, corporate reporting review and audit quality review, and the
Codes and Standards Committee is responsible for codes and standards in relation to actuarial
policy, accounting and reporting policy, audit and assurance, and corporate governance.
5.1 What does the FRC do?

The FRC acts as the UK’s independent regulator for corporate reporting and governance. Its goal is
to foster a climate in which investment can flourish.
The FRC is engaged in:
• setting standards for corporate governance (see the chapter Corporate governance), financial
(corporate) reporting and audit and assurance
• monitoring and reviewing the quality of audit and financial reporting in large entities
• regulating the audit profession
• overseeing self-regulation in the accountancy, audit and actuarial professions (see above)
• acting as the ultimate disciplinary body for the accountancy and actuarial professions
Despite the FRC’s efforts, the ability of the audit and accountancy profession to counter fraud,
accounting errors and other irregularities in clients to the satisfaction of government and the public
is sometimes called into question. For example, in January 2018, Carillion, the UK’s second largest

construction company and listed on the London Stock Exchange, went into compulsory liquidation.
The directors were accused of misrepresenting the financial realities of the business which meant
that the auditors failed to spot that the business was failing. A report into the collapse pointed
towards the possible break-up of the top four accounting firms as a response, with suggestions that
the relationships these firms develop with certain clients impair their ability to properly scrutinise the
business and the information provided by management.
This skill includes applying technical knowledge to support reasoning and conclusions. It is
important that you know about the roles of the FRC as they have a significant role in monitoring the
accounting profession in the UK.
5.2 Conduct Committee: professional oversight

The FRC has a non-statutory role overseeing how the professional accountancy bodies regulate their
members beyond those who are statutory auditors. The FRC’s Professional Oversight team oversees
the regulation of the accountancy profession in relation to financial reporting (as we shall see later in
this chapter).
5.3 Conduct Committee: professional discipline

FRC’s Conduct Committee operates independent investigative and disciplinary schemes for
accountants and actuaries in the UK. Its Professional Discipline team is responsible for operating and
administering the Accountancy Scheme, covering members of the UK accounting bodies.
The Accountancy Scheme aims to protect the public, maintain public confidence in the accountancy
profession and uphold proper standards of conduct. It deals with cases which raise important issues
affecting the public interest in the UK and which need to be investigated to determine whether or
not there has been any misconduct by an accountant or accountancy firm.
5.4 Codes and Standards Committee: corporate governance

The FRC maintains and updates two codes in relation to corporate governance: the UK Corporate
Governance Code and the Stewardship Code. We shall be looking at these in detail in the chapter
Corporate governance of this Workbook.
6 Regulation of the accountancy profession in the UK

Section overview
• The UK government is responsible for the statutory elements of the regulatory framework of the
accountancy profession.
• ICAEW is the primary regulator of its members, which is the form of self-regulation adopted in the
UK. In respect of reserved areas, it has additional regulatory duties.
• The FRC oversees self-regulation by the accountancy profession and makes sure that it is effective.
It has statutory powers for regulating auditing.
Following lengthy debate, the regulatory regime for the accountancy profession involves:
• the government
• self-regulation by the accountancy profession
• an oversight mechanism by the FRC
6.1 The role of the government

The government is responsible for the legislative elements of the regulatory framework, though the
FRC acts as adviser to the government on necessary legislative changes. The government delegates

certain statutory powers to the FRC, but the government remains responsible via these powers and
so has a continuing responsibility for the system’s effectiveness.
6.2 Self-regulation by the accountancy profession

The professional accountancy bodies, including ICAEW, have primary responsibility for regulation of
their members acting in their professional capacity so as to maintain standards and the professional
standing of accountancy.
In relation to audit, investment business, insolvency and probate (reserved areas) certain
professional bodies, including ICAEW, act as recognised professional regulators. They must have the
necessary arrangements in place to ensure that members and firms comply with the statutory
requirements.
6.2.1 The role of ICAEW

In relation to its membership ICAEW has direct responsibility for:
• entry and education requirements (see the section Technical competence, below)
• eligibility to engage in public practice
• eligibility for the performance of reserved activities under statutory powers delegated by the
government
• professional conduct requirements
• dealing with professional misconduct by its members
• supervising members in relation to anti-money laundering regulations
The role of the ICAEW in respect of its members is discussed in more detail in the section
Professional responsibility, below.
6.2.2 Public practice and business membership

ICAEW members may work in public practice, or they may work in business. Public practice refers to
firms that provide accountancy, assurance or related services. Accountants working in business may
be involved in many different roles such as acting as a manager or director, acting as an accountant
or financial controller, or even moving into other areas.
All members of the ICAEW are required to comply with the professional conduct requirements.
Members working in public practice are subject to more detailed regulatory requirements, such as
the requirement for owners of partners of the practice to hold a practising certificate, and the anti-
money laundering supervision discussed in the next section. Members working in practice are
therefore more highly regulated by the ICAEW than those working in business.
6.2.3 Anti-money laundering supervision

Money laundering is defined in UK law as using or possessing criminal property or facilitating the use
or possession of criminal property. Essentially this involves using the proceeds of criminal activities or
trying to disguise the source of those proceeds. In the UK, many businesses operating within certain
industries, including the accountancy profession, legal profession and financial services businesses,
are required to register with an anti-money laundering (AML) supervisory body. The ICAEW is one of
the AML supervisory bodies in the UK and as such, monitors the compliance of its members
including member firms, with money laundering regulations. The ICAEW reports to the Office of
Professional Body AML Supervision (OPBAS).
The regulations for accountants relating to money laundering include vetting procedures for new
clients, and a requirement to report suspicious activities. These requirements are covered in more
detail in other modules.
The ICAEW’s activities with respect to anti money laundering activities include educating members
on the laws, ensuring members have procedures in place to comply with the laws, and conducting
monitoring visits to members to check if there is any involvement in money laundering.
6.3 The FRC’s oversight mechanism

The FRC Professional Oversight team has three main roles regarding the oversight of audit and
accountancy:
• Non-statutory oversight of the professional accountancy bodies in the way they exercise their
regulatory responsibilities to their members beyond those who are statutory auditors

• Statutory oversight of the regulation of statutory auditors by the recognised supervisory and
qualifying bodies, including ICAEW. This means the FRC is responsible for the recognition,
supervision and de-recognition of those accountancy bodies responsible for supervising the work
of statutory auditors or offering an audit qualification. As recognised supervisory bodies, they
must have in place amongst other things effective arrangements for registration, monitoring and
disciplining of auditors
• Independent monitoring of the quality of the auditing function by the Audit Quality Review
Committee in relation to major public interest entities (listed companies plus some other entities
that affect the public interest)
On audit, the FRC has statutory powers in relation to recognised supervisory bodies (RSBs) and
recognised qualification bodies (RQBs):
• It can recognise and de-recognise them.
• It can require information from them.
• It can serve an enforcement order on them that they are failing to meet their statutory
responsibilities.
• It can fine them for failing to meet their statutory responsibilities.
On accountancy the FRC does not have statutory powers but can investigate and make
recommendations on:
• education;
• training;
• continuing professional education and development;
• standards;
• ethical matters;
• professional conduct;
• professional discipline;
• registration; and
• monitoring
In relation to the FRC’s recommendations ICAEW is committed to:
• considering them carefully; and either
• implementing them within a reasonable period; or
• giving reasons in writing for not doing so
7 Professional responsibility
Section overview
• Ethics tell us how to behave.

• Professional ethics tell professional accountants how to behave both well and in line with the
standards required by and expected of the profession.
• Members of ICAEW must ensure that they warrant the public trust.
• To maintain public confidence in its members’ technical competence ICAEW has a regulatory role
that ensures: rigorous entry and education requirements; additional requirements for accountants
in public and some other types of practice; a requirement for PII for accountants in public
practice.
• To ensure public confidence further, the Financial Reporting Council (FRC) operates an oversight
mechanism over how ICAEW self-regulates.

7.1 What are ethics and ethical behaviour?
Definitions
Ethics: A system of behaviour which is deemed acceptable in the society or context under
consideration. Ethics tell us ‘how to behave’.
Ethical behaviour: Acting in a manner which is perceived to be acceptable in the circumstances – or
‘behaving well’.
7.2 Public trust and professional ethics

Many of the areas in which professional accountants operate are technically complex. Advice is
provided on which others, such as shareholders in audited companies, may rely. It is therefore
important that the public should have confidence in the integrity of professional accountants. Public
trust requires professional accountants to behave ethically.
For a professional accountant, ethical behaviour extends beyond just ‘behaving well’. Being a
member of a skilled profession entails behaving in line with the particular standards that are
expected of, and required by, the whole profession. This ensures that public trust in both the
profession and individual accountants is earned and maintained.
Definition
Professional ethics: Identifying ethical dilemmas, understanding the implications and behaving
appropriately in line with a code of behaviour that is accepted among fellow professionals as being
correct.
Upholding professional ethics is a key part of being a professional accountant.

• An accountant’s ethical behaviour serves to protect the public interest, as we have seen.
• Ethical issues may be a matter of law and regulation and accountants are expected to apply them.
• By upholding professional standards, the profession’s reputation and standing are protected, and
public trust in the profession is retained.
• Consequences of unethical behaviour by an individual accountant include disciplinary action
against the accountant by their employer, ICAEW or the FRC and adverse effects on jobs, financial
viability and business efficacy in their organisation.
• Accountants employed in the public sector have a duty to protect taxpayers’ money.
7.3 Professional regulation by the ICAEW

As well as requiring professional accountants in public practice to comply with professional ethics,
the accountancy profession has other methods by which public confidence is maintained in the
professional responsibility of accountants. Professional regulation by ICAEW itself entails:
Rigorous entry and education requirements
Specific additional requirements for

professional accountants engaged in the
Together, these help to ensure technical
reserved areas of audit, investment business
competence
and insolvency work
Professional accountants in public practice to

hold professional indemnity insurance (PII)
Oversight regulation of ICAEW’s professional The Professional Conduct department of the

regulation of its members by the Financial ICAEW implements ICAEW’s disciplinary
Reporting Council (FRC) procedures, including handling of complaints
Rigorous disciplinary involving ICAEW and, against its members and member firms. A
ultimately, the FRC complaint in relation to a very serious matter
which may affect the reputation of the

accountancy profession may be referred
straight to the FRC’s Accountancy scheme for
investigation.
8 Technical competence
Section overview
• ICAEW’s entry and education requirements aim to ensure that accountants have the knowledge,
understanding, skills, abilities, personal commitment and professional abilities required.
• There are further requirements regarding continuing membership, and regarding accountants in
reserved areas of practice.
8.1 ICAEW’s entry and education requirements

The success of the accountancy profession in the UK has always been closely identified with its
commitment to training and education.
By undertaking prescribed training and education the student accountant is:
• acquiring the knowledge and understanding that underlie what accountants do
• developing the skills and abilities necessary to perform the tasks and roles undertaken by the
professional accountant
• building personal commitment and professional ethics
Accounting training covers both fundamental values and competencies and increasing quantities of
technical knowledge and skills in tax, financial reporting, governance and related assurance
requirements. A balance is needed between knowing the underlying principles and rules that apply
to all or most transactions and knowing detailed requirements related to specialised transactions.
There is an increasingly strong argument that the ability to read, understand and apply principles and
rules is more important in students and newly-qualified accountants than knowledge of detailed
technical rules.
Students should develop the ability to:
• apply basic accounting skills;
• understand the accounting principles underlying financial reporting and assurance;
• understand what the numbers that come out of the reporting process are telling them;
• apply professional scepticism appropriately in their work; and
• apply critical thinking and professional judgement in their work
8.2 Continuing membership of ICAEW

To continue in membership all professional accountants must:
• obey the Institute’s rules and regulations;
• pay the subscription fee annually; and
• undertake continuing professional development (CPD): this involves certain levels of relevant
reading and/or course attendance. The purpose of the CPD requirements is to maintain expertise
in a professional environment and individual career, especially regarding levels of technical and
ethical competence
Members engaged in public practice must in addition:
• hold a Practising Certificate: this is obtained by showing that the member has maintained
appropriate levels of education and work experience;
• implement the ICAEW Code of Ethics;
• be covered by professional indemnity insurance (PII); and
• comply with the ICAEW anti-money regulations

8.3 Reserved areas of practice
Most activities carried out by accountants are open to all. However, there are four activities, known as
reserved areas, which legislation requires to be carried out by members of certain bodies which are
‘recognised professional regulators’:
• statutory audit
• investment business
• insolvency
• probate
The purpose of the legislation is to ensure, in the public interest, that those practising in the reserved
areas have the required level of technical competence and are subject to an appropriate disciplinary
regime.
The Institute is a recognised professional regulator for each of the four reserved areas. Its Audit
Regulations, DPB (investment business) Handbook, Insolvency Licensing Regulations and Probate
Regulations are drawn up to meet the requirements of the legislation. They apply only to members or
firms registered, authorised or licensed to carry out these activities.

Summary
Financial reporting The accounting

Structure
Assurance profession
Importance Regulation
• Effective working
of capital markets
• Public interest Methods of regulation
Role of government
Financial Reporting Council Self regulation Professional responsibility
FRC's oversight mechanism
What does FRC do? Ethics and ethical

Conduct committee - behaviour?
professional oversight Public trust and
Conduct committee - professional ethics
professional discipline Professional regulation
Codes and standards by the ICAEW
committee
Professional competence

indicated.
1 Are you aware of the meaning of profession and do you know what the accountancy
profession involves? (Topic 1)
2 Do you know how the work of the accountant benefits society as a whole? (Topic 2)
3 Do you know the role played by IFAC in the global accountancy profession? (Topic 3)
4 Do you know who can call themselves an accountant in the UK? (Topic 3)
5 Do you understand how the accountancy profession is regulated in the UK (Topic 5)
6 Do you know what the Financial Reporting Council (FRC) does? (Topic 6)
7 Do you know the different areas over which the ICAEW regulates its members? (Topic 7)
8 Can you distinguish between which areas FRC has statutory and non-statutory regulatory
roles? (Topic 7)
9 Do you know what are the four reserved areas which ICAEW has regulatory authority over?
(Topic 8)
9 Do you know what professional competence involves? (Topic 8)

questions in The professional accountant chapter of the Business, Technology and Finance Question
Once you have attempted these questions, you can move onto the next chapter, Structure and
regulation of the accountancy profession.

• ICAEW Code of Ethics

Self-test questions

1 In relation to self-regulation of the accountancy profession, the most important aspect of the
oversight mechanism is that it should be seen to be:
A fair
B authoritative
C objective
D independent
2 The FRC has statutory responsibility for monitoring the quality of the:
A audit profession
B accountancy profession
C investment business profession
D insolvency profession
3 The body which runs an independent disciplinary process for the accountancy profession is the:
A FRC
B FCA
C FPA
D FRRP
4 Statutory monitoring of the quality of audit is carried out by:
A the FCA
B the FPA
C the FRC
D ICAEW
5 The public must have confidence in the integrity of professional accountants because:
A the reputation of the profession depends on it
B they provide advice on technically complex areas on which others rely
C this will encourage more people to enter the profession
D this will encourage more people to seek the services of a professional accountant
6 ‘The application of relevant training, professional knowledge, skill and experience commensurate
with the facts and circumstances, including the nature and scope of the professional activities, and
the interests involved and relationships.’
Requirement
What does the definition above relate to?
A Professional scepticism
B Professional judgement
C Critical thinking
D Professional scepticism
7 Which of the following is an aim of regulation of the accountancy profession?
A to protect the profession from competition
B to protect ICAEW members from unqualified accountants
C to protect the public from being misled
D to protect small accountancy firms from big ones

this chapter.


Many people want to be chartered accountants because it is a ‘good career’ rather than because
they are intrinsically interested in assurance and financial reporting; these are interests that come
later. But it is worth thinking through why you think it is a good career’. Certainly the rewards are
worth it, but what about the hard work in qualifying, and the expectation that you will behave
professionally at all times? The requirement for objective assessment in technical competence
(assessments etc,) distinguishes the accountancy profession from most Management Trainee
Schemes, plus the need to pay annual subscriptions and to keep up your technical expertise. Are
professionals ‘set apart’ as a result of all this?

Regulation should:
• protect the public from being misled, or from suffering from abuse of power through knowledge
or monopoly;
• in a market economy, facilitate competition and reduce barriers to trade;
• in the case of professions, ensure that technical, educational and ethical standards are
maintained at a level the public has a right to expect;
• be flexible enough to ensure the right result in each of the infinite variety of circumstances that
occur in practice, as we have seen in the principles-based framework approach to accounting;
• take account of reasonable and informed opinion to ensure that justice is reasonably seen to be
done;
• enforce the standards required firmly but fairly to ensure that the general support of those subject
to the regulation is retained, but that transgressors are effectively dealt with; and
• be transparent in its setting and enforcement to maintain confidence that the public interest is
being safeguarded

D independent
All these qualities are important, but independence is of the greatest importance if the mechanism is
not to be seen as pursuing the self-interest of the profession.
A audit profession
The FRC has a statutory responsibility for monitoring the audit profession, but only a non statutory
responsibility for the other activities of the accountancy profession (see Topic 7). Investment business
is overseen by the FCA. The insolvency profession is monitored by recognised professional bodies
(including the ICAEW).
A FRC
The FRC is the Financial Reporting Council. One of its roles is to oversee the regulation of the
professions, and it operates in independent disciplinary process. The FCA is the financial conduct
authority which regulates the financial services industry. The FRRP is the Financial Reporting Review
Panel, which monitors the financial reports of UK companies but does not run a disciplinary process.
C the FRC
The FRC has a statutory authority to monitor the audit profession and monitors the audits of all public
interest entities. The ICAEW as a recognised supervisory body is responsible for monitoring all other
audit work performed by its member firms.
B they provide advice on technically complex areas on which others rely
As stated in the ICAEW code of ethics (refer back to Topic 2).
B Professional judgement
This is the definition of professional judgement (refer back to Topic 2)
C to protect the public from being misled
Regulation aims to ensure that the public can rely on the work of accountants, rather than to protect
the interests of the accountants themselves.

Chapter 9
Governance and ethics
Introduction
Learning outcomes
Syllabus links
Assessment context
Learning topics
1 What is governance?
2 Perspectives on corporate governance
3 Stakeholders’ governance needs
4 Symptoms of poor corporate governance
5 What is meant by ‘good practice’ in corporate governance?
6 The effect of types of financial system on governance
7 Governance structures
8 Ethics, business ethics and an ethical culture
Summary
Self-test questions
Introduction
Learning outcomes
• State the reasons why governance is needed and identify the role that governance plays in the
management of a business
• Identify the key stakeholders and their governance needs for a particular business
• Specify how differences in legal systems and in national and business cultures affect corporate
governance
• Specify the nature of ethics, business ethics, sustainability and corporate responsibility
• Specify the policies and procedures a business should implement in order to promote an ethical
culture
Specific syllabus references are: 4c, 4d, 4f, 4h, 4i
9
Syllabus links
Governance is developed further as a topic in Audit and Assurance and Financial Accounting and
Reporting at the Professional level, and at the Advanced level. Ethics are a continuing theme in all
assessments.
9
Assessment context
Questions on governance and ethics will be set in the assessment in either MCQ or multiple
scenario.
9

of this chapter.

questions
1–4 Governance, Approach Questions on IQ1: Corporate

stakeholders’ needs Read through governance and ethics governance is a
and poor sections 1 to 4 quickly are almost certain to useful question
governance and then again more appear in your exam. to test your
Governance and slowly, making sure Questions are likely to understanding
ethics have become you understand the be set in a scenario of the meaning
major issues in idea that there is a context, though of corporate
recent years and fundamental tension knowledge-type governance.
ones which have a between questions are also
direct impact on shareholders and likely on particular
many areas in which directors that needs definitions and
professional to be addressed via principles.
accountants operate, corporate Essential points are:
especially audit and governance.
financial reporting. • agency theory:
Stop and think information and
What does the word accountability
‘governance’ mean to • perspectives on
you? How is it corporate
different to governance
‘management’? Who
governs a business – •

questions
shareholders or • symptoms of poor

directors/managers? corporate
And who is it governance
governed for?
5 What is meant by Approach This section is likely to

‘good practice’ in Study section 5 very be examined using
corporate closely, learning the application type
governance? key elements of good questions relating to
Accountants are governance. Learn good governance or
required to advise the definitions knowledge-based
companies on many relating to natural question about the
areas, including capital, and definitions.
governance. You sustainability and Essential points are:
must understand the learn the UN • areas that good
importance of good sustainable practice is
governance before development goals concerned with
going on to discuss (SDGs).
the Wates Principles • key elements of
Stop and think good corporate
later in this chapter,
and the UK Are you aware of any governance
Corporate recent high profile • a business’s
Governance code in corporate failures? responsibilities in
the chapter Was the failure due to relation to natural
Corporate poor practice in capital,
governance. corporate sustainability and
governance? corporate social
responsibility.
6 The effect of types Approach Questions on this area IQ2: Risk Tests
of financial system Next, read section 6 tend to focus on: your
on governance on financial systems, • the characteristics understanding
You may come national culture and of market-based of the risk
across different legal systems, making and bank-based attitudes of a
approaches to sure you can see why financial systems. market based
corporate the importance of financial
• Hofstede’s Cultural system.
governance if you institutional dimensions and
have clients with shareholders derives their impact on
businesses outside from the nature of the governance
the UK. It is UK financial system, systems
important to and why in some
appreciate the other countries banks
reasons for the dominate
different Stop and think
approaches.
Try to analyse the UK
culture using the
table and consider if
the UK approach to
governance is what
you would expect.
7 Governance Approach This is a popular area

structures Learn the OECD for questions, which
This section deals Principles, the will tend to test your
with some aspects of distinction between knowledge of
codes other than the unitary and dual particular codes:
ICAEW 2023 9: Governance and ethics 307

questions
UK code (which is board structures, and

dealt with in the the outline of the Essential points are:
chapter Corporate overall UK
governance). governance structure, • OECD Principles –
including the Wates what are the six
principles. principles?
Stop and think • unitary v dual
boards – what do
What impact would these terms mean?
each of the Wates
Principles have on the • UK legal
success of an requirements
organisation? relating to
corporate
governance
• Wates Principles
8 Ethics, business Approach There may well be IQ3: Ethical

ethics and an ethical Read very carefully questions dealing with pressures
culture section 8 on business the relevance of ethics encourages you
ICAEW members values and ethics, and in business. to think about
and students are the ways in which an Essential points are: why it may be
required to comply ethics-based culture difficult in
• ethical principles – practice for
with the ICAEW’s can be promoted. such as the Nolan
code of ethics. This businesses to
Stop and think Principles – what do always behave
code does not apply they mean?
to businesses other Could a company that ethically
than member firms adopts poor ethical • meaning of
of the ICAEW. behaviour, such as business ethics and
However, employing workers examples of what
accountants working on very low wages, are the minimum
in business have a prosper in the long acceptable
role to play in term? business ethics
ensuring that the • the meaning of
businesses they corporate
work for operate in responsibility
an ethical manger. • what is included in
a corporate code of
ethics?

1 What is governance?
Section overview
• Governance is the system by which an organisation is directed and controlled so that its
objectives are achieved in an acceptable and sustainable manner.
• Agency theory states that managers and directors act as shareholders’ agents when managing the
company.
• Managers and directors should reflect the interests of shareholders, not their own interests.
Historically, they were able to pursue their own interests because they had better information than
shareholders and were not held accountable to them.
Management is essentially a very practical matter: ‘getting things done’. It should not be confused
with a term that is frequently used interchangeably with management, which is governance.
Governance incorporates concepts of ethics, risk management and stakeholder protection,
extending way beyond management alone. Governance is not the same thing as managing a
business and running business operations. It is concerned with exercising overall control, to ensure
that the objectives of the company are achieved in an acceptable and sustainable manner. If a
business is properly led, directed and controlled then it should be able to get things done properly
and should be sustainable in the long term.
Interactive question 1: Corporate governance

You have probably heard a great deal about ‘good corporate governance’ in the press and maybe in
the office too. What do you think it means? Why is it an important issue?
1.1 Why is governance an important issue?

In getting things done, a business’s managers can lose sight of:
• whom they are seeking to benefit; and
• the fact they should not harm others.
This is often referred to as the agency problem.
1.2 Agency problem: shareholders and management

Managers of a company are there to ensure that the interests of the shareholders, who in large
companies are not usually also the managers, are looked after. Managers therefore effectively act as
the ‘agents‘ of the shareholders when managing the company, though not in the full legal sense. This
means that:
• ownership and control are separated; and
• conflicts arise between the interests of those in control of the company and those who own it
These issues are known together as agency theory or stewardship theory.
Historically, when managers ran a company in a way that suited their own interests, without due
regard to the interests of the shareholders, they often got away with it because:
• they had better information than the shareholders about what was going on; and
• they were not sufficiently accountable for their stewardship, decisions and actions
1.2.1 The importance of information

Shareholders make decisions to invest in the company’s shares, and/or to hold onto the shares,
largely on the basis of information supplied by managers in the company’s name. The value of a
shareholder’s investment can therefore be at risk from receiving inadequate information to judge
what is happening.

1.2.2 The need for accountability
Shareholders also rely on managers to account to them for their stewardship of the company’s
resources. Through a combination of withholding information, failing to report to shareholders as
required (basically, hiding information) and making decisions that are in their own rather than the
company’s interests, managers and company directors have historically been able to avoid true
accountability to shareholders.
You could potentially be asked what would be the best governance structure for a particular
organisation. All corporate governance structures try to solve the agency problem but recognise that
there may be different principals (the different stakeholders) who have different levels of influence
and power.
2 Perspectives on corporate governance

Section overview
• Corporate governance is the set of relationships between a company’s management, board,

shareholders and other stakeholders that provides the structure through which the company’s
objectives are set, attained and monitored. It specifies the distribution of rights and
responsibilities between stakeholders, and establishes rules and procedures for making decisions
about the company’s affairs.
• Three governance all emphasise shareholders but the public policy and stakeholder perspectives
place more emphasis on non-shareholders, and on the need to balance the interests of all
stakeholders.
Definitions
Corporate governance: ‘A set of relationships between a company’s management, its board, its
shareholders and other stakeholders…that provides the structure through which the objectives of
the company are set…attained…and monitored’ (OECD, 2015).
Corporate governance: ‘The system by which companies are directed and controlled’ (Cadbury
Committee, 1992).
2.1 What is corporate governance?

There are four broad perspectives on what the objectives of corporate governance should be.
2.1.1 The public policy perspective on corporate governance

Some would argue that the aim of corporate governance is to ensure that the company meets:
• the objectives of its shareholders;
• the interests of other individuals and groups with a direct ‘stake‘ in the company; and
• the interests of the public at large
South Africa’s King Report on corporate governance is South Africa’s equivalent of the UK Corporate
Governance Code. It was first published in 1994 and is now in its fourth incarnation.
King IV sets out voluntary corporate governance principles which are to be achieved, by careful
application of recommended practices.
Core aspects of the King Report are leadership, sustainability and good corporate citizenship. The
report considers all three aspects to reflect the interests of the public at large. For example,
companies with good leaders are more likely to be successful and therefore employ more people
and offer better job security. Sustainability benefits the public through reduced environmental

impact of business operations (such as cleaner air). Good corporate citizenship offers potentially a
multitude of benefits depending on what the business decides to do. For example, it may offer
support to local families in need, provide sponsorship to local amenities or allow staff time off to
work on charitable projects. Therefore, the report is an example of the public policy perspective on
corporate governance.
This perspective acknowledges that companies don’t act in isolation but are an integral part of
society and should therefore be accountable to current and future stakeholders.
2.1.2 The stakeholder perspective on corporate governance

Taking a narrower ‘stakeholder view’, corporate governance means a balance between economic
and social goals and between individual and communal goals. The framework of corporate
governance should therefore:
• encourage the efficient use of resources through efficient investment;
• require accountability from the company’s senior management (its board of directors) to
shareholders for the way it has managed and taken care of those resources; and
• aim to align the interests of shareholders and companies with those of other stakeholders
2.1.3 The corporate perspective on corporate governance

We normally think of the aim of a company as being to maximise the wealth of the shareholders,
provided it conforms to the rules of society (its laws and customs). This means that a company’s
senior management should balance the interests of shareholders with those of other stakeholders in
order to achieve long-term sustained value for shareholders.
2.1.4 The stewardship perspective on corporate governance

Probably the narrowest view of corporate governance is to take the approach that the law requires
directors to act in the best interests of the company when acting as ‘stewards’ of the company’s
resources. This is called the stewardship approach or perspective, and it is related most directly to
solving the agency problem outlined above.
2.2 Definitions of corporate governance

Whether a corporate, public policy or stakeholder perspective is taken, rather than the OECD’s
definition set out above, we could use the following:
Definition
Corporate governance: A structured system for the direction and control of a company that:
• specifies the distribution of rights and responsibilities between stakeholders, such as the
shareholders, the board of directors and management; and
• has established rules and procedures for making decisions about the company’s affairs
3 Stakeholders’ governance needs

Section overview
• Governance extends beyond management to take explicit account of stakeholders.

• Stakeholders’ interests can often be in conflict, and it is not enough simply to let the most
powerful (the shareholders) ‘win’.
• Stakeholders need the company’s corporate governance to ensure that: their interests and
expectations will be reflected in the company’s objectives; the scope for conflict of interests is
reduced; the company follows good practice in corporate governance and business ethics.

3.1 Conflicts between stakeholders’ interests
No company can exactly meet all the expectations of all its stakeholders all of the time. There is often
a conflict of interests between different stakeholder groups, with each group wanting different
things, in order to achieve incompatible objectives. In most cases the company will set itself a
strategy that at least attempts to balance these conflicting interests while acknowledging that the
interests of shareholders are dominant.
Occasionally however there will be a serious conflict of interests.
3.1.1 What are the symptoms of a serious conflict of interests?

There is no standard way in which a serious conflict of interest becomes apparent. It may become
evident by:
• financial collapse without warning, as in the case of US energy corporation Enron in 2002
• directors trying to disguise the true financial performance of the company from shareholders by
‘dressing up’ the published financial statements so shareholders cannot judge properly the
condition of their investment
• disputes over directors’ remuneration such as huge salaries, bonuses, pension schemes, share
options, golden hellos and golden goodbyes and other benefits and, in general, directors’
rewards that do not vary according to the company’s performance and the benefits obtained for
the shareholders
• decisions taken by a board of directors to satisfy their own wish for power and rewards rather than
to boost the interests of shareholders, such as recommendations on shareholders accepting
certain takeover bids and offers
3.2 Stakeholders’ governance needs

• For their interests and expectations to be reflected in the company’s objectives
• For the scope for conflicts to be reduced
• For the company to adhere to good practice in corporate governance
• For the company to adhere to good business ethics
4 Symptoms of poor corporate governance

Section overview
• There is a range of symptoms that, alone or together, may indicate poor corporate governance in
an organisation.
The following symptoms can indicate that there is poor corporate governance:
• domination of the board by a single individual or group, with other board members merely
acting as a rubber stamp
• no involvement by the board, for example meeting irregularly, failing to consider systematically
the organisation’s activities and risks, or basing decisions on inadequate information
• inadequate control function, for instance no internal audit, or a lack of adequate technical
knowledge in key roles, or a rapid turnover of staff involved in accounting or control
• lack of supervision of employees
• lack of independent scrutiny by external or internal auditors
• lack of contact with shareholders
• emphasis on short-term profitability, leading to concealment of problems or errors, or
manipulation of financial statements to achieve desired results
• misleading financial statements and information

Worked example: Poor corporate governance
TechPoint plc is a medium sized public company that produces a range of components used in the
manufacture of computers. The board of directors consists of Chair Max Mallory, Chief Executive
Richard Mallory, and Finance Director Linda Mallory, all of whom are siblings. There are five other
unrelated executive directors. All directors receive bonuses based on sales. The company’s sales are
made by individual salesmen and women each of whom has the authority to enter on the company’s
behalf into contracts unlimited in value without the need to refer to a superior or consult with other
departments. It is this flexibility that has enabled the company to be very profitable in past years.
However, a number of bad contracts in the current year have meant that the Finance Director has re-
classed them as ‘costs’ to maintain healthy sales and to protect the directors’ bonuses.
Requirement
What are the corporate governance issues at TechPoint plc?
Solution
The main corporate governance issues are:
• domination by a small group: all the key directors are related which gives them power over the
other executives.
• short-term view: directors’ bonuses are based on short-term sales and caused the manipulation
of accounts to achieve them.
• lack of supervision: the sales force can tie the company into large loss-making contracts without
any checks. There is no authorisation or communication with other departments which means the
company may take on contracts that it cannot fulfil. The company has been hit hard with bad
contracts in the current year.
5 What is meant by ‘good practice’ in corporate

governance?
Section overview
• Good practice in corporate governance is concerned with: risk management; ethical and
sustainable behaviour; transparency; integrity; accountability; reducing the potential for conflict;
reconciling the interests of shareholders and directors.
• Key elements in corporate governance: the board (executive and non-executive directors, and
committees); senior management; shareholders; external auditors; internal auditors.
Good practice in corporate governance is concerned with:

• risk management and reduction, and good internal controls
• ethical and sustainable pursuit of the business’s strategy in a way which safeguards against
misuse of resources, physical or intellectual and which aims at ensuring success over the long
term
• openness and transparency: disclosure of information
• integrity and probity: applying the spirit of the law as well as its letter, and being honest in all
dealings
• accountability: monitoring and judging directors’ performance based on the returns that the
company has achieved under their stewardship
• reducing the potential for conflict
• reconciling the interests of shareholders and directors as far as possible
Key elements of good corporate governance are as follows:
• the board of directors

– executive directors of a very high standard in terms of their decision-making and of the culture
that they create in the company
– non-executive directors (NED) who are independent of the executives yet who accept that they
have collective responsibility with the rest of the board for corporate governance
– committees of the board of directors as a whole that are properly constituted and have the
power and resources to make the decisions delegated to them by the main board.
• Senior management of high quality and able to:
– put into effect the decisions of the board; and
– ‘whistleblow‘ on the activities of the company should the need arise
• shareholders who are proactive at meetings and generally ensure that the board is acting in their
best interests and within the spirit of good corporate governance
• external auditors working on behalf of the shareholders totally independently of the directors
when reaching a conclusion as to whether the company’s financial statements show a true and fair
view
• internal auditors who are independent of the directors as far as possible, reporting to the Audit
Committee of the board or to some other committee dominated by non-executives
• corporate values and culture which are very important due to their effect on how individuals
behave (ie, do the values and standards of behaviour expected in an organisation encourage
people to behave ethically?)
• the workforce, which makes up the majority of the organisation in terms of individuals, is highly
important in terms of fulfilling the objectives of the organisation’s corporate governance policies.
It is important that the policies and practices towards its workforce support its long-term success,
and part of this means organisations need to engage with their employees. However, it is equally
important that employees are able to raise concerns they have (not least because this could help
to alert management to potential ethical problems within an organisation.)
5.1 Natural capital, sustainability and corporate responsibility

Throughout this workbook, the importance of sustainability and working to eliminate climate change
has been discussed. Good corporate governance also implies taking account of wider areas of
corporate responsibility, such as its impact and dependency on the natural environment, how far its
strategy is sustainable in terms of the world’s resources in the long term, its management of its
human resources, how well it manages risk, the extent of its charitable support, and how far it goes
beyond complying with just the minimum standards required by laws and regulations.
The use by organisations of natural capital (for example fossil fuels, air, water, plants, trees and
animals) is increasingly under public scrutiny as more and more people become concerned about
the impact of humans on the planet.
Definitions
Natural capital: The stock of renewable and non-renewable natural resources that combine to yield a
flow of benefits or ‘services’ to people (eg, biodiversity as plants and animals, air, water, soils,
minerals).
The flows can be ecosystem services or abiotic services; which provide value to business and to
society.
Natural capital is one of the capitals included in the integrated reporting framework that was
Ecosystem services: The benefits to people from ecosystems, such as timber, fibre, pollination, water
regulation, climate regulation, recreation, mental health, and others.
Abiotic service: Benefits to people that do not depend on ecological processes but arise from
fundamental geological processes and include the supply of minerals, metal, and oil and gas, as well
as geothermal heat, wind, tides and the annual seasons.
Biodiversity: Biodiversity is critical to the health and stability of natural capital as it provides resilience
to shocks like floods and droughts, and it supports fundamental processes such as the carbon and
water cycles as well as soil formation. Therefore, biodiversity is both a part of natural capital and also
underpins ecosystem services. (Natural capital coalition (2016))

The idea of natural capital is closely associated with sustainability and corporate responsibility.
From the introduction to sustainability in the chapter Introduction to business, we can see that
sustainability concerns the use of both of the following:
• tangible resources such as natural capital (such as raw materials) and energy; and
• intangible resources such as human/intellectual capital, and relationships with stakeholders
Definition
Corporate responsibility: Corporate responsibility is about the impact an organisation makes on
society the environment and the economy. (CIPD)
Corporate responsibility concerns the organisation’s ideas and values on how to use resources, such
as natural capital, promoting the positive impacts of their use and reducing the impact of any
negative impacts.
Corporate governance, in its widest sense, is therefore about far more than the agency problem of
motivating managers to act in the best interests of the shareholders. It is about the problem of
ensuring that in pursuing their objectives, organisations act responsibly, both in terms of their social
impact and their environmental impact. Investors and customers in particular are increasingly
expecting organisations to take these issues seriously, and organisations that fail to do this will lose
customers and find it difficult to raise finance, so will fail to achieve their financial objectives.
5.2 UN Sustainable Development Goals

The UN established 17 Sustainable Development Goals (SDGs) that aim to improve the world for
everyone. In 2015, world leaders signed up to them.
The purpose of the Goals is to focus and help governments, businesses organisations, society and all
individuals to come together and build a better future for everyone.
The overall aims of the Goals are to end poverty, fight inequality and stop climate change. The UN
Global Compact is an organisation that supports the SDGs by obtaining commitments from
businesses to meet the principles and support the Goals.
This is a list of the 17 UN SDGs:
Goal Meaning
1. No poverty End poverty in all its forms, everywhere
2. Zero hunger End hunger, achieve food security and improved nutrition,
and promote sustainable agriculture
3. Good health and wellbeing Ensure healthy lives and promote wellbeing for all at all ages
4. Quality education Ensure inclusive and equitable quality education and

promote lifelong learning opportunities for all
5. Gender equality Achieve gender equality and empower all women and girls
6. Clean water and sanitation Ensure availability and sustainable management of water
and sanitation for all
7. Affordable and clean energy Ensure access to affordable, reliable, sustainable and
modern energy for all
8. Decent work and economic Promote sustained, inclusive and sustainable economic
growth growth, full and productive employment and decent work
for all
9. Industry, innovation and Build resilient infrastructure, promote inclusive and

infrastructure sustainable industrialisation, and foster innovation
10. Reduced inequality Reduce inequality within and among countries

Goal Meaning
11. Sustainable cities and Make cities and human settlements inclusive, safe, resilient
communities and sustainable
12. Responsible consumption and Ensure sustainable consumption and production patterns
production
13. Climate action Take urgent action to combat climate change and its impacts
14. Life below water Conserve and sustainably use the oceans, seas and marine
resources for sustainable development
15. Life on land Protect, restore and promote sustainable use of terrestrial
ecosystems, sustainably manage forests, combat
desertification, halt and reverse land degradation and halt
biodiversity loss
16. Peace, justice and strong Promote peaceful and inclusive societies for sustainable
institutions development, provide access to justice for all and build
effective, accountable and inclusive institutions at all levels
17. Partnerships for the goals Strengthen the means of implementation and revitalise the
global partnership for sustainable development
6 The effect of types of financial system on governance

Section overview
• The type of financial system in an economy affects the type of corporate governance that prevails.
• There are two broad types of financial system: bank-based and market-based. Which one
operates in a particular economy depends on: household preference re saving; degree of
financial intermediation; balance of debt and equity in business finance.
• Which system is in place depends on: whether there is instability associated with financial
markets; how far government intervenes in and regulates the system; how effective markets as
opposed to intermediaries are at allocating resources; how far markets are limited by market
imperfections, such as transaction costs, insider dealing and asymmetric information.
• In bank-based financial systems, bank lending is the most important source of business finance,
after retained earnings, and banks and businesses are highly integrated.
• In market-based financial systems, markets are more important than banks for long-term finance.
This means that the dominant force in external finance for businesses is represented by
institutional shareholders.
• The increasing influence of institutional shareholders means that there is increasing pressure on
companies: to conduct themselves well; to respond to the requirements of active or ‘engaged’
institutional shareholders; to provide good information via financial reporting.
In the chapter Business finance, we looked at the UK financial system and its role in business finance.
We now need to determine why the type of financial system overall influences so profoundly the
approach taken to corporate governance.
6.1 Types of financial system

There are two broad types of financial system:
• bank-based systems
• market-based systems
Whether a system favours banks or the markets is determined by how the factors we saw in the
chapter Business finance are balanced, namely:

• how households prefer to hold their assets
• the degree of dominance of the system by financial intermediaries and therefore by indirect
investment as opposed to direct investment
• how businesses are financed, that is the balance of retained earnings, debt and equity
In turn, many of these preferences in a system are determined by its attitude to some of the
problems inherent in any system that is designed to ensure the flow of funds from savers to
borrowers:
• instability associated with financial markets
• the degree of government intervention in and regulation of the system (government activity has
become increasingly discredited)
• how effective markets as opposed to intermediaries are at allocating resources (in economic
terms, markets are perceived as being better at this)
• how far markets are limited by market imperfections, such as:
– transaction costs;
– insider trading; and
– asymmetric information.
Market imperfections are covered in the chapters The economic environment of business and
finance and External regulation of business of this Workbook.
6.2 Bank-based financial systems

We can characterise a bank-based financial system as follows:
• households prefer to bear little risk and so allocate more of their financial assets to cash and cash
equivalents ie, deposits with banks
• households have less access to investments in physical assets such as housing ie, less choice
• where households do invest in securities, this is primarily done via intermediaries such as pension
and mutual funds, so institutional shareholders are influential
• there is comparatively more government regulation, often as a result of historic financial
catastrophes
• banks are highly concentrated and integrated in terms of providing both banking (deposit-
taking) and non-banking (insurance, etc) services
• bank lending is the most important source of business finance, after retained earnings
• banks and businesses are highly integrated: banks have a long-term relationship with the
businesses they lend to, usually cemented by the bank:
– holding equity in the business as well as debt
– having equity held by the business (a ‘cross-holding‘)
– having access to detailed management information so there is less risk that their lending will be
jeopardised by undesirable activities
– being involved in the business’s strategic decisions, often by having seats on the board
– becoming actively involved if there are financial problems
• Markets are volatile and speculative because companies are dependent on bank finance and
thus have high gearing
Together these factors mean that the dominant force in external finance for businesses is
represented by banks. However, most bank-based systems are becoming increasingly market
oriented, with less regulation and a higher profile for financial markets.
Interactive question 2: Risk

In the UK households hold proportionately more of their assets in the form of equity than in many
other countries. What does this say about UK households’ attitude to risk?

6.3 Market-based financial systems
We can characterise a market-based financial system as follows:
• households bear more risk and so hold proportionately more equity and proportionately fewer
deposits with banks
• households have greater access to investments in physical assets such as housing ie, more choice
• high levels of indirect investment via intermediaries such as pension and mutual funds mean that
institutional shareholders have a great deal of influence
• markets are more important than banks for long-term finance, though retained earnings remain
the most important source of funds
• they are comparatively unregulated
• banks are more fragmented with less integration of banking and non-banking services (though
this has changed to a large degree)
• banks have less close relationships with the businesses they lend to, not holding equity and not
being involved in decision making
Together these factors mean that the dominant force in external finance for businesses is
represented by institutional shareholders.
6.4 Financial intermediation and the importance of information

In both types of system financial intermediation is of increasing importance, because intermediation
is seen as the way to overcome market imperfections, especially that of asymmetric information.
While lending banks in bank-based systems have access to information about companies that is not
shared with investors in the financial markets, so too have institutional shareholders in market-based
systems historically been kept better-informed than the general public about the affairs of the
business in which the intermediary holds debt and equity.
The increasing influence of institutional shareholders means that there is increasing pressure on
companies:
• to conduct themselves well (good corporate governance);
• to respond to the requirements of institutional shareholders; and
• to provide good financial information via financial reporting
6.5 National culture and legal systems

Every nation has a different culture and therefore a different set of values and even ethics. This leads
to a difference in corporate governance approaches around the world, because of different opinions
on the meaning of ‘good governance’. The UK Corporate Governance Code is only one example of
an approach.
Research has shown that different types of culture (as categorised by Hofstede’s Cultural
Dimensions) have influenced certain aspects of corporate governance codes.
The table below summarises Hofstede’s Cultural Dimensions and how they might affect corporate
governance.
Masculinity v A masculine culture means a fact-based, aggressive or ‘hard’ decision-

Femininity making style. For corporate governance:
• the focus is on money and achievement
• diversity is less likely to be advocated (eg, may be expected that CEO
will be male)
• gender roles are more clearly defined
A feminine culture is an intuitive, consultative style. In terms of corporate
governance:
• ‘feminine’ cultures tend to favour policies on quality of life
• more balance and gender diversity in boards
Individualism v

Collectivism Some cultures place a high value on the performance of individuals,
others place more value on team performance. In corporate governance:
• cultures that value individualismencourage debate and expression of
ideas and therefore support a diverse mix of directors
• collectivism tries to maintain harmony and therefore is less likely to
support strong, diverse opinions
Power distance (PD) The PD dimension reflects the degree to which a person’s position and
status is valued. Cultures with a high PD score encourage bureaucracy
and respect for authority and a person’s rank in an organisation.
• They believe that power should be concentrated in a small group.
• There will be less emphasis on separating out the roles of the CEO
and chair and less need for independent non-executive directors
(NEDs).
Cultures with a low PD score encourage flatter organisational structures
and more value is placed on personal responsibility and autonomy.
• There will be more emphasis on separating the role of CEO and chair
and on the need for independent NEDs.
Long-term This relates to how different cultures view time horizons in terms of
orientation appraising business success, for example in regards to business planning
and measuring performance.
Cultures that take a short-term view will seek to reward directors for
short-term performance (such as bonuses based on annual performance)
Cultures that take long-term view will encourage rewards based on long-
term performance, such as share options that can only be exercised after
a specific period of time.
Uncertainty This dimension reflects the different attitudes to risk-taking. Cultures with
avoidance low levels of uncertainty avoidance will tolerate more risk and are not
afraid to take chances and make changes. Cultures with higher levels of
uncertainty avoidance prefer lower levels of risk and seek the protection
of rules, analysis of data and the establishment of roles and
responsibilities.
In terms of corporate governance, cultures with low uncertainty
avoidance will not seek to restrict or control risk-taking to the same
degree as cultures with high uncertainty avoidance.
Cultures with higher levels of uncertainty avoidance promote internal
controls, risk management and other rules and procedures to mitigate
business risk to an acceptable level, and to make life as predictable and
controllable as possible.
Indulgence v Highly indulgent cultures seek personal gratification of basic and natural
Restraint human drives related to enjoying life and having fun. Cultures that desire
the opposite – restraint – suppress personal gratification and place more
emphasis on regulation of people’s conduct and behaviour and
establishing social norms.
In terms of corporate governance, indulgent cultures are unlikely to
restrict personal gratification or anything that promotes it (such as
frivolous spending on corporate hospitality). Cultures that are more
restrained are more likely to control such spending.
For example, cultures categorised as being highly masculine, rather than feminine oriented are
unlikely to promote gender diversity amongst board members. However, the reverse is true in
cultures that are highly oriented towards individualism, because boards are seen to have more
legitimacy if they reflect a broader range of people. Similarly, in countries which have high ‘power
distance’ scores – with a recognition that power is concentrated in the hands of a small minority – the
rationale for separating the role of chief executive officer (CEO) and chair, and the need for

independent non-executive directors (NEDs) on a board, might be less apparent than in countries
with lower ‘power distance’ scores.
Legal systems also have an impact on corporate governance codes. For example, countries such as
the UK with common-law legal systems that evolve over time as legal cases are heard, often have a
different approach to corporate governance to countries with civil-law legal systems in-which the
laws are codified.
You may be required to demonstrate understanding of the wider context in considering whether
proposed solutions (eg, proposed governance structures) are appropriate. Culture should always be
taken into account.
7 Governance structures
Section overview
• A governance structure is the set of legal or regulatory methods that has been put in place to
ensure good corporate governance. It may comprise both direct regulation and non-statutory
codes of practice.
• The OECD’s principles on corporate governance are: promotion of transparent and fair markets;
protection of shareholders’ rights; equitable treatment of shareholders; recognition of the rights
of shareholders; timely and accurate disclosure of information; an effective board.
• A board of directors may be unitary or have a dual (management and supervisory) structure.
• The UK’s governance structure emphasises shareholders, especially institutional shareholders:
insurance companies, pension funds, investment trusts and their investment managers.
• The UK’s governance structure incorporates: statute (the Companies Act 2006); a code of practice
(the FRC’s UK Corporate Governance Code); the FCA rules (for listed companies); and the Wates
principles.
7.1 What is a governance structure?
Definition
Governance structure: The set of legal or regulatory methods put in place in order to ensure
effective corporate governance.
There are two basic governance structures:

• statutes
• codes of practice
Different countries use different combinations of statutes and codes of practice, depending in part
on whether they have principles-based or a shareholder-led approach to governance structures.
7.2 Principles-based approach to governance structures

In most countries the approach to governance structure is determined initially by the desire to
adhere to certain principles of good corporate governance, as set out in the OECD‘s Principles of
Corporate Governance (revised in 2015).
The OECD Principles cover:
(a) Ensuring the basis for an effective corporate governance framework. This framework should
promote transparent and fair markets, and the efficient allocation of resources. It should be
consistent with the rule of law and support effective supervision and enforcement.

(b) The rights and equitable treatment of shareholders and key ownership functions.
(c) The company’s relationships with Institutional investors, stock markets and other intermediaries.
(d) The rights of stakeholders in corporate governance, including the importance of creating
sustainable and financially sound companies that in turn create wealth and jobs.
(e) Accurate and timely disclosure and transparency regarding financial performance and position,
ownership and governance.
(f) The responsibilities of the board to guide the company, to monitor its management and to be
accountable to shareholders.
Principle V enshrines in particular:
• The need for and status of the external audit
• The need for an effective approach to the provision of analysis or advice by analysts, brokers,
rating agencies and others, that is:
– relevant to decisions by investors; and
– free from material conflicts of interest that might compromise the integrity of their analysis or
advice
7.3 Shareholder-led approach to governance structures

In the UK in particular, greater emphasis has been placed on the role of shareholders in governance
structures. This is because they are market-based financial systems where institutional shareholders
have very high levels of investment in the shares of leading companies.
Institutional shareholders is a broad term for organisations which invest money on behalf of other
people (their beneficiaries). In the UK they comprise:
• insurance companies
• pension funds
• investment trusts
• investment managers who act as agents of the above bodies, eg, unit trusts
Good corporate governance is greatly helped when institutional shareholders have an agenda for
dialogue with boards of directors and follow that up so they can secure their own interests and those
of their beneficiaries. Where this is the case, as in the UK, determining the appropriate governance
structure is said to be a shareholder-led process rather than a principles-based one.
7.4 Possible structures for the board of directors

There are two types of structure for the board of directors as a whole:
• a unitary board is responsible for both management of the business and reporting to the
shareholders, via the financial statements and shareholder meetings. This is the basic system
under UK statute.
• a dual or supervisory board structure, as is seen in Germany for instance, with roles split between:
– the management board, with responsibility to manage the company using similar powers to
the unitary board; and
– the supervisory board: an independent separate board elected by the shareholders and the
employees, often comprising a series of committees with delegated powers. In Germany the
supervisory board has powers to:
◦ appoint and remove members of the management board;
◦ request information from members of the management board;
◦ receive formal reports on policy, financial performance, the state of the company’s affairs and
exceptional occurrences;
◦ approve or not approve the statement of profit or loss and other comprehensive income, the
statement of financial position and dividends declared;
◦ inspect books and records;
◦ perform independent reviews; and
◦ convene shareholder meetings

7.4.1 Workers and the board
Under the UK Governance Code, boards are required to consider the interests of stakeholders,
particularly workers, when making decisions.
Effective engagement procedures are required to achieve this, and the UK Corporate Code provides
that, in order to ensure engagement with the workforce, companies should do one or more of the
following:
• appoint a director from the workforce
• establish a formal workforce advisory panel
• have a non-executive director designated to specialise in workforce issues
7.5 The governance structure of the UK

In the UK company law sets out a great many of the rules on corporate governance, especially with
regard to:
• the board of directors (a unitary board is required)
• directors’ powers and duties
• the relationship of the company with directors, such as loans to directors and the interests of
directors in company contracts
• accountability for stewardship and financial reporting via the financial statements
• rules on meetings and resolutions
Statutory provisions on corporate governance are outside the scope of the Business, Technology and
Finance syllabus.
In addition to these statutory rules, large companies (both UK and overseas companies) that have a
premium listing in the Main Market of the London Stock Exchange are regulated by the FCA’s listing
rules. They must:
• comply with the main principles of the FRC’s UK Corporate Governance Code contained in the
FCA’s Listing Rules (see the chapter Corporate governance); and
• comply with the supporting provisions of the Code; or
• explain why they have not so complied
As mentioned in the chapter The business’s finance function, the FRC has stated that boards of UK
companies have a responsibility to consider their impact on the environment, and the likely
consequences of any business decision.
Finally, the board is subject to the shareholders in general meeting as well as to laws and
regulations.
Context example: Gender pay gap

Under the Equality Act 2010 (Gender Pay Gap Information) Regulations 2017, all businesses with
over 250 employees must publish and report on the difference between the average earnings of
their male and female employees. These regulations help to demonstrate the UK’s system of
corporate governance which consists of a combination of legal and non-legal rules, regulations and
codes.
The main two sources are the non-legal Corporate Governance Code and the legal Companies Act
2006. However, the system extends beyond these two sources and includes other sources such as
the gender pay gap regulations.
One of the cornerstones of UK corporate governance is transparency. This means that business
organisations should not use rules and regulations to hide or give a misleading picture of a particular
situation. The gender pay gap regulations support transparency by forcing large organisations to
publicly share information on the average salaries of their male and female employees separately,
whereas before, publicly available salary information was a combination of the two.
We saw above that companies should display integrity and probity, and also that one of the key
governance needs of stakeholders is for the company to adhere to good business ethics. We shall
look at these points, and the related idea of an ethics-based culture in a company now, and then
return to the UK Corporate Governance Code in the chapter Corporate governance.

7.5.1 Companies (Miscellaneous Reporting) Regulations
In 2018, the UK government introduced The Companies (Miscellaneous Reporting) Regulations.
These are aimed at larger private companies, which are not required to comply with the UK
Corporate Governance Code (because they are private). The requirements were issued in
recognition of the fact that large companies have a significant impact on the interests of many
stakeholder groups, even if they are private.
The regulations require companies to include a statement in their annual reports that discloses their
corporate governance arrangements. The regulations apply to companies that meet one or more of
the following limits:
• more than 2,000 employees globally; or
• a turnover of over £200 million globally; or
• a balance sheet total (total assets) of over £2 billion
7.5.2 Wates Principles

The Wates Principles are a voluntary code that aim to help large private companies meet the
Companies (Miscellaneous Reporting) Regulations. The code is followed using an ‘apply and
explain’ approach, whereby companies have to follow the six principles and explain how they have
done so. They were developed by a coalition of interested groups set up by the FRC including the
Institute of Directors and the Trades Union Congress and several private companies (the Coalition
group). The code consists of six principles:
Number Principle
1 Purpose and leadership An effective board develops the purpose of a company, and
ensures that its values, strategy and culture align with that
purpose.
2 Board composition A board should include an effective chair, and a balance of

skills, backgrounds, experience and knowledge, with individual
directors having sufficient capacity to make a valuable
contribution.
3 Directors’ The board and individual directors should have clear

responsibilities understanding of their accountability and responsibilities. The
board’s policies and procedures should support effective
decision-making and independent challenge.
This principle also includes the requirement to establish formal
and robust internal control systems.
4 Opportunity and risk A board should promote the long-term sustainable success of
the company by identifying opportunities to create and
preserve value, and establishing oversight for the identification
and mitigation of risks.
5 Remuneration A board should promote executive remuneration structures

aligned to the long-term sustainable success of a company,
taking into account pay and conditions elsewhere in the
company.
6 Stakeholder Directors should foster effective stakeholder relationships

relationships and aligned to the company’s purpose. The board is responsible for
engagement overseeing meaningful engagement with stakeholders,
including the workforce, and having regard to their views when
taking decisions.
The Wates Principles ‒ is a voluntary code. If companies follow the principles, it will satisfy their
requirements under the Companies (Miscellaneous Reporting) Regulations to disclose their
corporate governance requirements. A company that chooses to follow the Wates Principles should
apply the six principles, paying attention to the guidance that accompanies them. Unlike the UK
Corporate Governance code (see the chapter Corporate governance) there are no additional
provisions within the principles. The guidance is therefore less detailed than the full UK code.

Companies that choose not to follow the Wates Principles have no requirement to disclose non-
compliance with the code or its principles. They may still have an obligation to disclose their
corporate governance arrangements under the Companies (Miscellaneous Reporting) Regulations,
but do not need to mention if they have applied the Wates Principles or not.
Questions may test your ability to apply technical knowledge to support your conclusions. It is
important to know who is required to follow the codes mentioned above, and be aware of the
comply or explain principle.
8 Ethics, business ethics and an ethical culture

Section overview
• Acceptable business values may include: integrity, objectivity, accountability, openness, honesty,
truth, transparency, fairness, responsibility and trust.
• Business ethics are the ethical standards that society expects of businesses.
• An ethical culture can be promoted by: ethical leadership from the board; corporate codes of
ethics; supporting policies and procedures.
• An ethical profile produced by means of an ethical audit measures the consistency of a company’s
values base.
8.1 What is an ethical culture?
Definition
Ethical culture: A business culture where the basic values and beliefs in a company encourage
people within the company to behave ethically.
Every organisation has a different set of beliefs and values, which together make up its culture, as we
saw in the chapter Managing a business. The importance of ethical values in a company’s culture is
that they underpin both policy and behaviour throughout the company, from top to bottom.
8.1.1 The ethical organisation

Organisations do not become ethical by chance; it is a conscious decision made by the owners or
directors of the business to develop an ethical culture.
Many companies are founded for ethical reasons by an entrepreneur who has specific ethical beliefs.
For example, the Body Shop was founded by an individual who was passionately against the use of
animals in testing beauty products. Such organisations often attract like-minded employees and
therefore an ethical culture develops naturally.
However, other organisations may wish to develop an ethical culture for other reasons. For example,
there may be pressure from shareholders or other stakeholders to become more ethical.
Alternatively, other organisations within an industry may be moving towards a more ethical stance
and therefore there is a competitive reason to change; or organisations may see an opportunity to
differentiate themselves from their competitors on the basis of their ethical organisation credentials
and wish to take advantage of that.
These organisations may not naturally have an ethical culture and therefore one must be developed,
promoted and communicated through the organisation.
Regardless of the reasons why the organisation wishes to have or maintain an ethical culture,
employees are expected to adhere to certain expectations. (We shall consider corporate ethical
codes later in this chapter). The starting point for the ethical culture must, however, come from
corporate values and the directors.

Ethical values are promoted in the company by the board of directors which should be committed
to:
• openness and transparency in decisions and use of resources;
• promoting good relationships wherever possible; and
• high standards in their own personal behaviour, especially preparing adequately for and
attending meetings, and being involved in decision making
Stakeholders, including customers, employees, investors, government and regulators, increasingly
exert pressure on companies about their values and their business ethics.
8.1.2 Ethical principles and values

Some of the Nolan Principles established by the Committee for Standards in Public Life are a useful
starting point for ethical values in a company as a whole:
• Integrity
• Objectivity
• Accountability
• Openness
• Honesty
The Institute of Business Ethics lists further ethical values:
• Respect
• Transparency
• Fairness
• Responsibility
• Trust
Along with the ethical values listed above are statutory requirements of all companies:
• Equality for all
• No discrimination on any grounds
• Freedom of information
8.2 What are business ethics?
Definition
Business ethics: The application of ethical values to business behaviour and functions. Ethics goes
beyond the legal requirements for a business and is, therefore, about discretionary decisions and
behaviour guided by values. (Institute of Business Ethics, n.d.)
Acceptable business ethics may comprise as a minimum:

• paying staff decent wages and pensions
• providing good working conditions for staff
• paying suppliers in line with agreed terms
• sourcing supplies carefully
• using sustainable or renewable resources
• being open and honest with customers
The important point to note, however, is that society’s expectations, which can and do change,
mould business ethics. Expectations have an effect at three levels:
• at the overall level of ‘what is the role of business in society?’
• at the level of a specific company, and what it can do to manifest business ethics
• at the level of individuals within the company
Corporate responsibility is a related concept, which extends the importance of business ethics to the
business making a commitment to all its stakeholders.

Definition
Corporate responsibility: The commitment the business makes to its stakeholders to increase its
positive impacts and decrease its negative ones (Institute of Business Ethics, n.d.)
Corporate responsibility is a measure of how far a company exceeds the minimum obligations it
owes to stakeholders and society by virtue of regulations and corporate governance. In particular, it
is concerned with the company’s obligations to those stakeholders which are unprotected by
contractual or business relationships with the company, namely local communities, consumers in
general and pressure groups.
Interactive question 3: Ethical pressures

In what areas of a business would you say there were the greatest pressures not to behave ethically,
and from what source does this pressure come?
8.3 How can an ethical culture be promoted?

An ethical culture can be promoted by a combination of:
• ethical leadership from the board of directors;
• codes of ethics or business conduct; and
• policies and procedures to support ethical behaviour
8.3.1 Ethical leadership from the board of directors

Most of the scandals which created so much interest in corporate governance and business ethics
since the first years of this century centred on the fact that the company involved was being led by
unethical directors: it had an unethical ‘tone at the top‘. The degree of their unethical behaviour may
range from criminal dishonesty to a simple failure to accept responsibility. Such behaviour
undermines trust.
The board should provide ethical leadership to the company: it should lead by example and set an
ethical tone at the top. Boards should also set the foundations for an open culture in their
organisation. They should foster a support and reporting network so that staff feel that they are able
to raise issues, that their concerns will be heard without fear of retribution and that their contributions
are valued.
The Institute of Business Ethics identifies the following attributes and behaviours of ethical leaders:
Attributes Behaviours
Openness Be open minded and willing to learn, and encourage others to learn
Courage Be determined and direct; actively stamp out poor behaviour
Ability to listen Be aware of what is going on and know that doing the right thing is the right
thing to do
Honesty Be considerate and cautious in managing expectations
Fair mindedness Be independent and willing to challenge the status quo
In its 2016 report ‘Corporate culture and the role of boards’, the FRC made the following
observations on ethical corporate culture:
Observation Comment
Demonstrate leadership Leaders, in particular the chief executive, must embody the
desired culture, embedding this at all levels and in every aspect
of the business. Boards have a responsibility to act where
leaders do not deliver.

Observation Comment
Recognise the value of culture A healthy corporate culture is a valuable asset, a source of
competitive advantage and vital to the creation and protection
of long-term value. It is the board’s role to determine the
purpose of the company and ensure that the company’s values,
strategy and business model are aligned to it. Directors should
not wait for a crisis before they focus on company culture.
Be open and accountable Openness and accountability matter at every level. Good
governance means a focus on how this takes place throughout
the company and those who act on its behalf. It should be
demonstrated in the way the company conducts business and
engages with and reports to stakeholders. This involves
respecting a wide range of stakeholder interests.
Embed and integrate The values of the company need to inform the behaviours
which are expected of all employees and suppliers. Human
resources, internal audit, ethics, compliance, and risk functions
should be empowered and resourced to embed values and
assess culture effectively. Their voice in the boardroom should
be strengthened.
Assess, measure and engage Indicators and measures used should be aligned to desired
outcomes and be material to the business. The board has a
responsibility to understand behaviour throughout the
company and to challenge where they find misalignment with
values, or need better information. Boards should devote
sufficient resource to evaluating culture and consider how they
report on it.
Align values and incentives The performance management and reward system should
support and encourage behaviours consistent with the
company’s purpose, values, strategy and business model. The
board is responsible for explaining this alignment clearly to
shareholders, employees and other stakeholders.
Exercise stewardship Effective stewardship should include engagement about

culture and encourage better reporting. Investors should
challenge themselves about the behaviours they are
encouraging in companies and reflect on their own culture.
8.3.2 Corporate codes of ethics

There is no general ethical code, such as the UK Corporate Governance Code, which companies can
use as their own corporate code of ethics. Instead, each company should draw up their own code of
ethics which is suited to their own unique situation, values and culture.
Definition
Corporate code of ethics: A formalisation of principles, values, responsibilities and obligations.
Organisations have several reasons for introducing corporate codes of ethics.

• Communication: codes of ethics communicate the standard of behaviour expected of employees.
• Consistency of conduct: with the message effectively communicated, the behaviour of employees
can be standardised or made consistent across all its operations and locations. Customers,
suppliers and other stakeholders will receive similar treatment wherever they are.
• Risk reduction: standardised behaviour reduces the risk of unethical actions as employees who
are unethical will ‘stand out’ and can be dealt with. This reduces the risk of a few employees
irrevocably damaging the reputation of the organisation and the trust people have in it.
The functions of a corporate code of ethics are:

• to tell the world at large what the company is striving to achieve in terms of ethical conduct
• to communicate a guide for the company as a whole to follow in its dealings with third parties
• to provide guidance for individuals within the company as to how to act
• to describe what the company aims to do in the event that an employee highlights unethical
behaviour and abuse within the company
A company should have three objectives for a corporate code of ethics in mind:
• To improve behaviour
• To build the company’s reputation and the trust of stakeholders in the company
• To improve performance and build value
8.3.3 Whistleblowing and complaints systems

A key way for organisations to support ethical behaviour is by introducing (and making employees
aware of) a whistleblowing or complaints system to help identify and deter unethical behaviour. The
purpose of such systems is to enable employees to draw the organisation’s attention to
unprofessional or unethical behaviour that has occurred, or is currently occurring in the workplace.
Reporting can be facilitated in a number of ways, but a common approach is to set up an employee
helpline for employees to call if they have any concerns. Such helplines are especially useful because
they allow employees who have concerns regarding their line manager (or other senior managers
above them) to report their unethical behaviour to someone outside of their immediate managerial
hierarchy.
8.4 ICAEW members and business ethics

There is no requirement on ICAEW’s members in business to implement ICAEW’s Code of Ethics for
the business itself, nor to implement policies and procedures such as a unique code of ethics for the
business, or an ethical audit. However, members in business are encouraged by ICAEW to promote
an ethics-based culture as far as possible, and of course must apply the Code in relation to their own
conduct.
The Code recognises that the extent to which members in business will be able to encourage and
promote an ethics-based culture depends on their seniority withing the organisation. As examples,
the Code suggests members could introduce, implement and oversee:
• ethics education and training programs
• ethics and whistleblowing policies
• policies and procedures designed to prevent non-compliance with laws and regulations
8.4.1 Ethics in business functions

One of the key sources of ethical issues facing accountants is the prospect of business strategies
being proposed which conflict with ethical principles.
The table below briefly summarises some of the ways in which ethics affects different business
functions (and therefore where there is potential for conflict between ethics and business strategies).
Business function Impact of ethics
Marketing Targeting of marketing efforts

Is it ethical to target children or vulnerable people?
Operations Production processes

Should the organisation use the cheapest method of production, rather
than more expensive, but more environmentally friendly alternatives?
Procurement Sourcing of materials

Is it ethical to source meat and animal products from cheap suppliers with
low standards of animal welfare?
Should the organisation use overseas suppliers that exploit workers with
poor pay and conditions, or which pollute their local environments?

Business function Impact of ethics
HR Terms of employee contracts

Are zero hours contracts and low pay rates ethical?
IT Privacy and security of data

As well as a legal obligation, organisations have an ethical obligation to
collect, store and manage data in a way that is in the best interests of those
that the data concerns.
Finance Paying suppliers

Should large organisations take advantage of small suppliers by forcing
down prices, or by demanding long credit periods, as a way of improving
their cash operating cycle?
Tax strategy
Should multinational companies structure their business so that profits are
taxed in countries with low tax rates? Minimising tax costs will help to
maximise the value a company can deliver to its shareholders, but is it ‘fair’
to deprive governments of tax revenue which could help fund public
services such as healthcare and education?
This skill includes recognising key ethical issues for accountants undertaking work in accounting and
reporting, so the information above about accountants working in business is relevant to this skill.

Summary
Governance:
Direction and control of company
Agency problem:
Managers have better ...shareholders,

information than and who own the
are not accountable to... company
Conflicts of Corporate governance Perspectives

interest • Distribution of rights/responsibilities • Corporate
between shareholders and managers • Public policy
Stakeholders’ governance • Sets rules for procedures for making • Stakeholder
needs: decisions for the company
• Stewardship
• Interest and expectations
reflected in objectives
• Scope for conflict of
interest to be reduced
• Good practice in • Natural capital
Good practice in corporate governance
corporate governance • Sustainability
• Openness/transparency
• Good business ethics (2/2) • Corporate
• Integrity/accountability
responsibility
• Reducing potential for conflict
• Reconciling shareholders'/directors' interest
Key elements:
Unitary • Board of directors
(exec and non-exec, Which type of governance?
Dual committees) Affected by:
• Senior management
• Shareholders
• External auditors
Type of governance Type of financial National culture and
• Internal auditors structure system legal systems
• Corporate values and culture
• The workforce
OECD Shareholder- Market- Bank-

Principles led based based
Code of
Statutory
practice
UK governance structure
• Company law
• UK Corporate Governance Code
• Wates Principles

'How we should behave'
Business values
• Integrity • Respect
Promoted by board • Objectivity • Transparency
of directors
'ethical leadership' • Accountability • Fairness
• Openness • Responsibility
• Honesty • Trust
Business ethics
'How the company should behave'
Ethical
culture • Transparent • Trustworthy
• Open • Accepting of responsibility
Business conduct
Whistleblowing
and complaints
systems

indicated.
1 Do you know the meaning of ‘governance’ and ‘agency theory’? (Topic 1)
2 Do you know the four broad perspectives on what the objectives of corporate
governance should be? (Topic 2)
3 Can you list at least five possible symptoms of poor corporate governance? (Topic 4)
4 What are the key elements of good corporate governance and what is their role in it?
(Topic 5)
5 Can you understand the meaning of natural capital, sustainability and corporate
responsibility and do you know their relevance for corporate governance? (Topic 5)
6 Do you know how the differences between bank based and market-based financial
systems? (Topic 6)
7 Do you know Hofstede’s Cultural Dimensions and can you discuss the impact of each
dimension on the approach to corporate governance? (Topic 6)
8 Do you know what is meant by a principles-based approach to corporate governance?

(Topic 7)
9 Do you know the governance structure in the UK? (Topic 7)
10 Can you list the six principles of the Wates code? (Topic 7)
11 How many of the 13 ethical principles and values listed in Topic 8 can you remember?
(Topic 8)
12 Do you know what is meant by business ethics and corporate responsibility? (Topic 8)
13 Can you list the functions of a corporate code of ethics? (Topic 8)

questions in the Governance and ethics chapter of the Business, Technology and Finance Question
Once you have attempted these questions, you can move on to the next chapter, Corporate
governance.

• Cadbury Committee (1992) Report of the committee on the financial aspects of corporate
governance. London, Gee.
• FRC (2018) The Wates Corporate Governance Principles for Large Private Companies. London,
FRC.
• ICAEW (2020) ICAEW Code of Ethics. London, ICAEW.
• Institute of Business Ethics (n.d.) What is business ethics. [Online]. Available from:
www.ibe.org.uk/knowledge-hub/what-is-business-ethics.html [Accessed 20 April 2021].
• OECD (2015) G20/OECD Principles of Corporate Governance. Paris, OECD Publishing.
• World Forum on Natural Capital (2018) What is natural capital? [Online]. Available from:
https://naturalcapitalforum.com/about/ [Accessed 20 April 2021].
• Report of the World Commission on Environment and Development: Our Common Future
Available from https://sustainabledevelopment.un.org/content/documents/5987our-common-
future.pdf [Accessed 20 April 2021].
• CIPD Corporate responsibility: an introduction [Online]. Available from:
https://www.cipd.co.uk/knowledge/strategy/corporate-responsibility/factsheet#gref [Accessed
20 April 2021].
• Natural Capital Coalition (2016) Natural Capital Protocol [Online]. Available from:
https://capitalscoalition.org/capitals-approach/natural-capital
protocol/?fwp_filter_tabs=training_material [Accessed 20 April 2021].
• Un.org Sustainable development goals [Online]. Available from:
https://www.un.org/sustainabledevelopment/ [Accessed 14 June 2022]

Self-test questions

1 The agency problem concerns the misalignment in interests and conflicts of interest between:
A banks and financial markets
B regulators and professional bodies
C government and industry
D directors and shareholders
2 In a company with weak corporate governance managers may be able primarily to pursue their own
rather than the company’s interests because, in relation to shareholders:
A they have more information and high levels of accountability
B they have less information and high levels of accountability
C they have more information and low levels of accountability
D they have less information and low levels of accountability
3 In comparison with the corporate and the public policy perspectives on corporate governance, the
stakeholder perspective places least emphasis on:
A accountability
B alignment of interests of shareholders and other stakeholders
C good information
D efficient use of resources
4 Good practice in corporate governance requires that openness and transparency should be
supported by:
A reducing the potential for conflicts of interest
B disclosure of information
C reconciling the interests of shareholders and directors
D judging performance of directors on the basis of return on investment
5 In countries with a dual board structure, the supervisory board is elected by:
A shareholders only
B employees only
C shareholders and employees only
D shareholders, employees and members of the management board
6 Business ethics are primarily moulded by the expectations of:
A directors
B customers
C government
D society
this chapter.


Good corporate governance is more than good management and effective leadership: it is about
directing and controlling a company so that it meets the objectives that have been agreed with
stakeholders, particularly shareholders, and so that it meets the needs of users and the markets for
information, accountability and good behaviour. This should ensure that the company has a
sustainable future in the long term.

Equity is a riskier form of investment than cash and cash equivalents so it would appear that UK
households are less risk averse than households in other countries.

The pressure not to behave ethically in business mainly derives from the need to gain commercial
advantage in a fiercely competitive world. Areas where unethical behaviour often occurs are:
• procurement – bribe taking, exploitation of suppliers
• excessive client and supplier entertainment
• inflated directors’ expenses
• engaging in conflicts of interests
• disclosing or using confidential information

D directors and shareholders
C they have more information and low levels of accountability
C good information
B disclosure of information
C shareholders and employees only
D society

Chapter 10
Corporate governance
Introduction
Learning outcomes
Syllabus links
Assessment context
Learning topics
1 The role of the UK Corporate Governance Code
2 Content of the UK Corporate Governance Code
3 The role of external audit
4 The role of internal audit
Summary
Self-test questions
Introduction
10
Learning outcomes
• Identify and show the distinction between the roles and responsibilities of those charged with
corporate governance and those charged with management, including the basics of the UK’s
corporate governance code
• Identify the roles and responsibilities within a business of the executive board, any supervisory
board, the audit committee and others charged with corporate governance, the internal audit
function and those responsible for the external audit relationship
Specific syllabus references are: 4e, 4g
10
Syllabus links
Corporate governance is developed further in Audit and Assurance at the Professional level, and in
Corporate Reporting at the Advanced level.
10
Assessment context
Questions on corporate governance will be set in the assessment in either MCQ or multiple
scenario.
10

of this chapter.

questions
1 Role of the UK Approach Questions on this

Corporate Read through topic could come up
Governance Code section 1 carefully, in exams. Questions
The London Stock noting that only are likely to test your
Exchange listing companies with a knowledge of which
rules require premium listing are companies are
companies with a required to apply it. required to apply the
premium listing to Ensure you know Code, and the
apply the Code. exactly what meaning of comply
comply or explain or explain.
means: apply the
principles, and
either comply with
the provisions or
explain any non-
compliance.
Stop and think
Do you think that
‘comply or explain’
might lead to
companies trying
to avoid applying
provisions? What
would happen if
they did this?

questions
2 Content of the UK Learn the five There are likely to be IQ1: Board
Corporate sections of the exam question on effectiveness
Governance Code Code. Move onto this area. Exams Helps you to
Many roles in your the detail of each could be based on remember the main
professional career section. Try to scenarios, or straight theme of the first
will involve advising memorise these in knowledge. section of the Code.
on corporate as much detail as Essential points are:
you can. Read IQ2: Chair’s
governance or • Roles of chair and responsibilities tests
evaluation the through the
provisions as these chief executive your understanding
existing corporate of the role of the
governance will provide • Roles of executive
additional help in and non- chair.
arrangements of
companies. Even if understanding the executive IQ3: Remuneration
companies are not purpose behind directors helps you to think
premium listed and the principles. about factors that
• Meaning of
required to apply the Learn the should be
independence for
Code, it is provisions relating considered in
non-executive
considered to be to the number of determining
directors
best practice. non-executive executive directors’
directors and the • Number of non- remuneration.
remuneration executive
committee. directors required
on the main
Stop and think
board and on the
You are probably various
aware of some committees
high-profile • Role and
corporate failures
objectives of
from the news.
nominations
What do you know
committee
about the system of
governance in • Role and
those businesses? objectives of
Did their audit committee
governance • Role and
structures objectives of
contribute to the remuneration
failure? committee
3–4 The role of external Approach External audit is one

and internal audit Next read through of the three
You need to sections 3 and 4 on fundamental
understand the role the roles of activities of
of the auditor in external and accountants, so
providing assurance internal audit in questions on
that the financial corporate auditing may well
statements show a governance. come up in the
true and fair view. exam.
Stop and think
Internal auditors play Questions are likely
more of a consulting Why do the internal to be set in a
role, helping audit function scenario context,
businesses to report to the audit though knowledge-
improve their committee and not type questions are
internal controls. the finance also likely.
director?
Essential points are:
•
ICAEW 2023 10: Corporate governance 339

questions
• Which directors
are responsible
for dealing with
internal and
external auditors
• Purpose of the
external audit
• Roles of internal
auditors
• Importance of
independence for
internal auditors

1 The role of the UK Corporate Governance Code
Section overview
• The FRC promotes good corporate governance via the UK Corporate Governance Code and
related guidance, and by encouraging stakeholder engagement.
• Irrespective of the UK Corporate Governance Code, all companies must treat shareholders
equally.
• The Code contains principles for companies to apply.
• The disclosure statement for the Code requires a premium listed company to state that it applies
the principles, and then either to state that it complies with the provisions of the Code, or to
explain why it does not so comply with them.
The Corporate Governance Committee of the FRC is responsible in the UK for promoting high
standards of corporate governance. It aims to do so by:
• maintaining an effective UK Corporate Governance Code and promoting its widespread
application;
• ensuring that related guidance, such as that on internal control, is current and relevant; and
• encouraging stakeholder engagement.
1.1 What is the UK Corporate Governance Code?

The UK Corporate Governance Code is a code of practice that follows a corporate perspective on
corporate governance (see Section 2 in the chapter Governance and ethics). It includes
requirements of shareholders as well as of companies themselves. The most recent version is the UK
Corporate Governance Code 2018.
Compliance with the Code is not a legal requirement. However, the London Stock Exchange Listing
Rules require all premium listed companies:
• to apply the Code’s Principles; and
• to include in their annual reports:
– a statement of how they have applied the Principles;
– a statement of compliance with the provisions of the Code; or
– an explanation of non-compliance with any of the provisions
This is known as the ‘comply or explain’ regime.
Smaller and unlisted companies are encouraged to follow the Code as an example of ‘best practice’.
Companies may experience pressure from their stakeholders if they do not adopt it. Alternatively,
larger private companies may choose to adopt the Wates Code, covered in the chapter Governance
and ethics.
The principles of the Code are designed to help boards discharge their duties in the best interests
of their companies by:
• encouraging all involved in a company to accept their legal obligations. This includes the board
of directors (including non-executive directors), auditors and shareholders
• encouraging the scrutiny of corporate stewardship (with investors being encouraged to discuss
with companies any departures from recommended practice)
• imposing certain checks and controls on executive directors but without restricting the
commercial enterprise aspect of business
1.2 Compliance with the UK Corporate Governance Code

Nothing in the Code overrides the general statutory requirement of companies to treat shareholders
equally with respect to access to information.
While companies with a premium listing on the London Stock Exchange must apply the Code’s
principles, departure from compliance with certain provisions may be justified in particular

circumstances. However, shareholders are encouraged not to consider departures as necessarily
being breaches of the Code.
According to the Code, the effective application of the principles should be supported by high-
quality reporting on the provisions. As described above, this is on a ‘comply or explain’ basis and
organisations should avoid a ‘tick-box approach’.
Non-compliance on a particular provision may be justified depending on the circumstances.
Justification is based on a range of factors, including the size, complexity, history and ownership
structure of a company.
When explaining non-compliance, the explanation should set out the background, provide a clear
rationale for the action the company is taking, and explain the impact that the action has had. Where
a departure from a provision is intended to be limited in time, the explanation should indicate when
the company expects to conform to the provision.
The Code makes it clear that explanations are a positive opportunity to communicate, rather than an
onerous obligation.
1.2.1 Disclosure statement: comply or explain

Under the Listing Rules, premium listed companies must make a disclosure statement about the
Code:
• reporting on how the company applies the principles in the Code; then either
• confirming that it complies with the Code’s provisions; or where it does not
• explaining why it does not comply
2 Content of the UK Corporate Governance Code

Section overview
• The corporate governance principles and provisions in the UK Corporate Governance Code come
under the main areas of: (i) board leadership and company purpose; (ii) division of
responsibilities; (iii) composition, succession and evaluation; (iv) audit, risk and internal control;
and (v) remuneration.
The Code contains five sections, each of which is set out as a series of principles that are
supplemented by detailed provisions. The five main sections are:
• board leadership and company purpose
• division of responsibilities
• composition, succession and evaluation
• audit, risk and internal control
• remuneration
The principles and provisions presented in the Code are very detailed. Summarise the key points of
the Code, thinking about the purpose of each principle and noting down those you consider to be
most important.
2.1 Board leadership and company purpose

Board leadership and company purpose focuses on the overall role of the board, and in particular
the importance of it setting the overall purpose, values and strategy of the business.
As we have seen previously, a strategy is important to an organisation because it forms a roadmap,
taking the business from where it is now to where it wants to be in the future. Having a clear purpose
and values are important because they form the foundations of the company’s culture.

The principles and provisions related to board leadership and company purpose are shown below.
However, please note that all directors – both executives and non-executives – must act in what they
consider to be the best interests of the company, consistent with their statutory duties. (These are set
out in ss.170–177 Companies Act 2006, and are not examinable in Business, Technology and
Finance).
It is increasingly important that companies consider sustainability and the environment. The code
calls for companies to focus on long-term sustainability by forging strong relationships with key
stakeholders, to align their culture and strategy with its objectives, and value diversity.
Premium listed companies must comply with these Principles:
Principles
A A successful company is led by an effective and entrepreneurial board, whose role is to

promote the long-term sustainable success of the company, generating value for
shareholders and contributing to wider society.
B The board should establish the company’s purpose, values and strategy, and satisfy itself that
these and its culture are aligned. All directors must act with integrity, lead by example and
promote the desired culture.
C The board should ensure that the necessary resources are in place for the company to meet
its objectives and measure performance against them. The board should also establish a
framework of prudent and effective controls, which enable risk to be assessed and managed.
D In order for the company to meet its responsibilities to shareholders and stakeholders, the
board should ensure effective engagement with, and encourage participation from, these
parties.
E The board should ensure that workforce policies and practices are consistent with the
company’s values and support its long-term sustainable success. The workforce should be
able to raise any matters of concern.
2.1.1 Provisions
The Provisions in the Code provide more detail about the actions a company needs to take in order
to comply with the overall Principles.
Premium listed companies must either comply with the following provisions or explain why they have
not done so.
• The board should assess the basis on which the company generates and preserves value over the
long term. It should describe in the annual report how opportunities and risks to the future
success of the business have been considered and addressed, the sustainability of the company’s
business model and how its governance contributes to the delivery of its strategy.
• The board should assess and monitor culture. Where it is not satisfied that policy, practices or
behaviour throughout the business are aligned with the company’s purpose, values and strategy,
it should seek assurance that management has taken corrective action. The annual report should
explain the board’s activities and any action taken. In addition, it should include an explanation of
the company’s approach to investing in and rewarding its workforce.
• In addition to formal general meetings, the Chair should seek regular engagement with major
shareholders in order to understand their views on governance and performance against the
strategy.
Committee chairs should seek engagement with shareholders on significant matters related to their
areas of responsibility. The Chair should ensure that the board as a whole has a clear understanding
of the views of shareholders.

• When 20% or more of votes have been cast against the board recommendation for a resolution,
the company should explain, when announcing voting results, what actions it intends to take to
consult shareholders in order to understand the reasons behind the result. An update on the
views received from shareholders and actions taken should be published no later than six months
after the shareholder meeting. The board should then provide a final summary in the annual
report and, if applicable, in the explanatory notes to resolutions at the next shareholder meeting,
on what impact the feedback has had on the decisions the board has taken and any actions or
resolutions now proposed.
• The board should understand the views of the company’s other key stakeholders and describe in
the annual report how their interests and the matters set out in section 172 of the Companies Act
2006 have been considered in board discussions and decision making.
The board should keep engagement mechanisms under review so that they remain effective.
For engagement with the workforce, one or a combination of the following methods should be
used:
• A director appointed from the workforce
• A formal workforce advisory panel
• A designated NED
• If the board has not chosen one or more of these methods, it should explain what alternative
arrangements are in place and why it considers that they are effective.
• There should be a means for the workforce to raise concerns in confidence and – if they wish –
anonymously. The board should routinely review this and the reports arising from its operation. It
should ensure that arrangements are in place for the proportionate and independent
investigation of such matters and for follow-up action.
• The board should take action to identify and manage conflicts of interest, including those
resulting from significant shareholdings, and ensure that the influence of third parties does not
compromise or override independent judgement.
• Where directors have concerns about the operation of the board or the management of the
company that cannot be resolved, their concerns should be recorded in the board minutes. On
resignation, a NED should provide a written statement to the Chair, for circulation to the board, if
they have any such concerns.
Interactive question 1: Board effectiveness

According to the UK Corporate Governance Code, what are the main things a board should do in
order to provide effective and entrepreneurial leadership for its company?
2.2 Division of responsibilities

Division of responsibilities focuses on how the board should be organised and the roles of the Chair
and the executive and non-executive directors. It also explains how the board should be supported
by the company secretary.
For a board to be effective, it is important that all of its members know what is expected of their role.
Independence of NEDs is also important for their objectivity and ability to hold the executive
directors to account of necessary.
Principles
F The Chair leads the board and is responsible for its overall effectiveness in directing the
company. They should demonstrate objective judgement throughout their tenure and
promote a culture of openness and debate. In addition, the Chair facilitates constructive
board relations and the effective contribution of all NEDs, and ensures that directors receive
accurate, timely and clear information.

Principles
The board should include an appropriate combination of executive and non-executive (and,
in particular, independent non-executive) directors, such that no one individual or small group
of individuals dominates the board’s decision making. There should be a clear division of
responsibilities between the leadership of the board and the executive leadership of the
company’s business.
H NEDs should have sufficient time to meet their board responsibilities. They should provide
constructive challenge, strategic guidance, offer specialist advice and hold management to
account.
I The board, supported by the company secretary, should ensure that it has the policies,
processes, information, time and resources it needs in order to function effectively and
efficiently.
2.2.1 Provisions
not done so.
The chair should be independent on appointment when assessed against the circumstances set out
in Provision 10. The roles of Chair and chief executive should not be exercised by the same
individual.
A chief executive should not become Chair of the same company.
If, exceptionally, this is proposed by the board, major shareholders should be consulted ahead of
appointment. The board should set out its reasons to all shareholders at the time of the appointment
and also publish these on the company website.
• The board should identify in the annual report each NED it considers to be independent.
Circumstances which are likely to impair, or could appear to impair, a NEDs independence
include, but are not limited to, whether a director:
– is or has been an employee of the company or group within the last five years;
– has, or has had within the last three years, a material business relationship with the company,
either directly or as a partner, shareholder, director or senior employee of a body that has such
a relationship with the company;
– has received or receives additional remuneration from the company apart from a director’s fee,
participates in the company’s share option or a performance-related pay scheme, or is a
member of the company’s pension scheme;
– has close family ties with any of the company’s advisers, directors or senior employees;
– holds cross-directorships or has significant links with other directors through involvement in
other companies or bodies;
– represents a significant shareholder; or
– has served on the board for more than nine years from the date of their first appointment
Where any of these or other relevant circumstances apply, and the board nonetheless considers that
the NED is independent, a clear explanation should be provided.
• At least half the board, excluding the Chair, should be NEDs whom the board considers to be
independent.
• The board should appoint one of the independent NEDs to be the senior independent director
(SID) to provide a sounding board for the Chair and serve as an intermediary for the other
directors and shareholders. Led by the SID, the NEDs should meet without the Chair present at
least annually to appraise the Chair’s performance, and on other occasions as necessary.
• NEDs have a prime role in appointing and removing executive directors. NEDs should scrutinise
and hold to account the performance of management and individual executive directors against
agreed performance objectives. The Chair should hold meetings with the NEDs without the
executive directors present.

• The responsibilities of the Chair, chief executive, SID, board and committees should be clear, set
out in writing, agreed by the board and made publicly available. The annual report should set out
the number of meetings of the board and its committees, and the individual attendance by
directors.
• When making new appointments, the board should take into account other demands on
directors’ time. Prior to appointment, significant commitments should be disclosed with an
indication of the time involved. Additional external appointments should not be undertaken
without prior approval of the board, with the reasons for permitting significant appointments
explained in the annual report. Full-time executive directors should not take on more than one
non-executive directorship in an FTSE 100 company or other significant appointment.
• All directors should have access to the advice of the company secretary, who is responsible for
advising the board on all governance matters. Both the appointment and removal of the company
secretary should be a matter for the whole board.
Companies may not comply with all the provisions in the Code – for example, the chair and chief
executive may be the same person. You might have to evaluate if the explanations for non-
compliance are reasonable. Try to understand the reason for the provision that was not complied
with and think about whether in the specific circumstances that reason is significant or not.
Interactive question 2: Chair’s responsibilities

What are the Chair’s responsibilities in relation to the running of the board?
2.3 Composition, succession and evaluation

Composition, succession and evaluation focuses on the work of the nomination committee to
appoint new directors. It also explains that all directors are subject to annual re-election and that
they, the board, and its committees are subject to annual performance review.
This area of the Code has great importance because it helps to ensure that high quality directors are
appointed and that the composition of the board is balanced in terms of experience and other
factors such as diversity. The annual performance reviews and re-election of directors helps to ensure
that under-performing directors are identified and provided with additional support, or removed.
Principles
J Appointments to the board should be subject to a formal, rigorous and transparent

procedure, and an effective succession plan should be maintained for board and senior
management. Both appointments and succession plans should be based on merit and
objective criteria and, within this context, should promote diversity of gender, social and
ethnic backgrounds, cognitive and personal strengths.
K The board and its committees should have a combination of skills, experience and
knowledge. Consideration should be given to the length of service of the board as a whole
and membership regularly refreshed.
L Annual evaluation of the board should consider its composition, diversity and how effectively
members work together to achieve objectives. Individual evaluation should demonstrate
whether each director continues to contribute effectively.
2.3.1 Provisions
not done so.

• The board should establish a nomination committee to lead the process for appointments,
ensure plans are in place for orderly succession to both the board and senior management
positions, and oversee the development of a diverse pipeline for succession.
A majority of members of the committee should be independent NEDs. The Chair of the board
should not Chair the committee when it is dealing with the appointment of their successor.
• All directors should be subject to annual re-election. The board should set out in the papers
accompanying the resolutions to elect each director the specific reasons why their contribution is,
and continues to be, important to the company’s long-term sustainable success.
• The Chair should not remain in post beyond nine years from the date of their first appointment
to the board. To facilitate effective succession planning and the development of a diverse board,
this period can be extended for a limited time, particularly in those cases where the Chair was an
existing NED on appointment. A clear explanation should be provided.
• Open advertising and/or an external search consultancy should generally be used for the
appointment of the Chair and NEDs. If an external search consultancy is engaged, it should be
identified in the annual report alongside a statement about any other connection it has with the
company or individual directors.
• There should be a formal and rigorous annual evaluation of the performance of the board, its
committees, the Chair and individual directors. The Chair should consider having a regular
externally facilitated board evaluation. The external evaluator should be identified in the annual
report and a statement made about any other connection it has with the company or individual
directors.
• The Chair should act on the results of the evaluation by recognising the strengths and addressing
any weaknesses of the board. Each director should engage with the process and take appropriate
action when development needs have been identified.
2.4 Audit, risk and internal control

The focus of audit, risk and internal control is to support the integrity of financial statements by
ensuring that organisations have formal and transparent policies and procedures in place to allow
independent and effective internal and external audit functions and that internal controls are in place
to manage risk.
Financial statements are used by a range of stakeholders, not just existing shareholders, but also by
those looking to invest in an organisation or to extend credit or other forms of financing to it.
Therefore, it is vital for the financial statements to be robust and accurate representations of the
organisation’s financial position so that all stakeholders can rely on them when making decisions.
Principles
M The board should establish formal and transparent policies and procedures to ensure the
independence and effectiveness of internal and external audit functions and satisfy itself on
the integrity of financial and narrative statements.
N The board should present a fair, balanced and understandable assessment of the company’s
position and prospects.
O The board should establish procedures to manage risk, oversee the internal control
framework, and determine the nature and extent of the principal risks the company is willing
to take in order to achieve its long-term strategic objectives.
2.4.1 Provisions
not done so.
• The board should establish an audit committee of independent NEDs, with a minimum
membership of three, or in the case of smaller companies, two. The Chair of the board should
not be a member. The board should satisfy itself that at least one member has recent and
relevant financial experience. The committee as a whole shall have competence relevant to the
sector in which the company operates.

• The main roles and responsibilities of the audit committee should include:
– monitoring the integrity of the financial statements of the company and any formal
announcements relating to the company’s financial performance, and reviewing significant
financial reporting judgements contained in them;
– providing advice (where requested by the board) on whether the annual report and accounts,
taken as a whole, is fair, balanced and understandable, and provides the information necessary
for shareholders to assess the company’s position and performance, business model and
strategy;
– reviewing the company’s internal financial controls and internal control and risk management
systems, unless expressly addressed by a separate board risk committee composed of
independent NEDs, or by the board itself;
– monitoring and reviewing the effectiveness of the company’s internal audit function or, where
there is not one, considering annually whether there is a need for one and making a
recommendation to the board;
– conducting the tender process and making recommendations to the board, about the
appointment, reappointment and removal of the external auditor, and approving the
remuneration and terms of engagement of the external auditor;
– reviewing and monitoring the external auditor’s independence and objectivity;
– reviewing the effectiveness of the external audit process, taking into consideration relevant UK
professional and regulatory requirements;
– developing and implementing policy on the engagement of the external auditor to supply non-
audit services, ensuring there is prior approval of non-audit services, considering the impact
this may have on independence, taking into account the relevant regulations and ethical
guidance in this regard, and reporting to the board on any improvement or action required;
and
– reporting to the board on how it has discharged its responsibilities
• The directors should explain in the annual report their responsibility for preparing the annual
report and accounts, and state that they consider the annual report and accounts, taken as a
whole, is fair, balanced and understandable, and provides the information necessary for
shareholders to assess the company’s position, performance, business model and strategy.
• The board should carry out a robust assessment of the company’s emerging and principal risks.
The board should confirm in the annual report that it has completed this assessment, including a
description of its principal risks, what procedures are in place to identify emerging risks, and an
explanation of how these are being managed or mitigated.
• The board should monitor the company’s risk management and internal control systems and, at
least annually, carry out a review of their effectiveness and report on that review in the annual
report. The monitoring and review should cover all material controls, including financial,
operational and compliance controls.
• In annual and half-yearly financial statements, the board should state whether it considers it
appropriate to adopt the going concern basis of accounting in preparing them, and identify any
material uncertainties to the company’s ability to continue to do so over a period of at least 12
months from the date of approval of the financial statements.
• Taking account of the company’s current position and principal risks, the board should explain in
the annual report how it has assessed the prospects of the company, over what period it has
done so and why it considers that period to be appropriate. The board should state whether it has
a reasonable expectation that the company will be able to continue in operation and meet its
liabilities as they fall due over the period of their assessment, drawing attention to any
qualifications or assumptions as necessary.
2.5 Remuneration
Remuneration focuses on the work of the remuneration committee to develop policy on the
remuneration of executive directors and how remuneration should be set.
Directors’ remuneration is important, because if it is set correctly, it will be aligned with company
strategy and therefore support the long-term success of the business. It is important for directors not
to be rewarded for poor performance or to excess because of the negative publicity this might

create as well as being potentially inconsistent with the interests of stakeholders. In this regard, it is
important for directors not to be involved in the setting of their own remuneration.
Principles
P Remuneration policies and practices should be designed to support strategy and promote
long-term sustainable success. Executive remuneration should be aligned to company
purpose and values, and be clearly linked to the successful delivery of the company’s
long-term strategy.
Q A formal and transparent procedure for developing policy on executive remuneration and
determining director and senior management remuneration should be established. No
director should be involved in deciding their own remuneration outcome.
R Directors should exercise independent judgement and discretion when authorising

remuneration outcomes, taking account of company and individual performance, and wider
circumstances.
2.5.1 Provisions
not done so.
• The board should establish a remuneration committee of independent NEDs, with a minimum
membership of three, or in the case of smaller companies, two. In addition, the Chair of the board
can only be a member if they were independent on appointment and cannot Chair the
committee. Before appointment as Chair of the remuneration committee, the appointee should
have served on a remuneration committee for at least 12 months.
• The remuneration committee should have delegated responsibility for determining the policy for
executive director remuneration and setting remuneration for the Chair, executive directors and
senior management. It should review workforce remuneration and related policies and the
alignment of incentives and rewards with culture, taking these into account when setting the
policy for executive director remuneration.
• The remuneration of NEDs should be determined in accordance with the Articles of Association
or, alternatively, by the board. Levels of remuneration for the Chair and all NEDs should reflect the
time commitment and responsibilities of the role. Remuneration for all NEDs should not include
share options or other performance-related elements.
• Where a remuneration consultant is appointed, this should be the responsibility of the
remuneration committee. The consultant should be identified in the annual report alongside a
statement about any other connection it has with the company or individual directors.
Independent judgement should be exercised when evaluating the advice of external third parties
and when receiving views from executive directors and senior management.
• Remuneration schemes should promote long-term shareholdings by executive directors that
support alignment with long-term shareholder interests. Share awards granted for this purpose
should be released for sale on a phased basis and be subject to a total vesting and holding
period of five years or more. The remuneration committee should develop a formal policy for
post-employment shareholding requirements encompassing both unvested and vested shares.
• Remuneration schemes and policies should enable the use of discretion to override formulaic
outcomes. They should also include provisions that would enable the company to recover and/or
withhold sums or share awards and specify the circumstances in which it would be appropriate to
do so.
• Only basic salary should be pensionable. The pension contribution rates for executive directors,
or payments in lieu, should be aligned with those available to the workforce. The pension
consequences and associated costs of basic salary increases and any other changes in
pensionable remuneration, or contribution rates, particularly for directors close to retirement,
should be carefully considered when compared with workforce arrangements.

• Notice or contract periods should be one year or less. If it is necessary to offer longer periods to
new directors recruited from outside the company, such periods should reduce to one year or
less after the initial period. The remuneration committee should ensure compensation
commitments in directors’ terms of appointment do not reward poor performance. They should
be robust in reducing compensation to reflect departing directors’ obligations to mitigate loss.
• When determining executive director remuneration policy and practices, the remuneration
committee should address the following:
– clarity – remuneration arrangements should be transparent and promote effective engagement
with shareholders and the workforce;
– simplicity – remuneration structures should avoid complexity and their rationale and operation
should be easy to understand;
– risk – remuneration arrangements should ensure reputational and other risks from excessive
rewards, and behavioural risks that can arise from target-based incentive plans, are identified
and mitigated;
– predictability – the range of possible values of rewards to individual directors and any other
limits or discretions should be identified and explained at the time of approving the policy;
– proportionality – the link between individual awards, the delivery of strategy and the long-term
performance of the company should be clear. Outcomes should not reward poor performance;
and
– alignment to culture – incentive schemes should drive behaviours consistent with company
purpose, values and strategy
Executive remuneration has been one of the most controversial issues in corporate governance. If
you are asked to provide advice on the appropriateness of a particular remuneration scheme, try to
evaluate it by reference to the provisions in the Corporate Governance Code relating to
remuneration.
Interactive question 3: Remuneration

Which factors should the remuneration committee address when determining executive directors’
remuneration?
3 The role of external audit

Section overview
• The external (statutory) audit reports on whether the financial statements present a true and fair
view of the company’s financial performance and position.
• For listed companies, it also reports on the remuneration report and the company’s compliance
with the UK Corporate Governance Code.
3.1 What is an external audit?

The financial statements of larger companies are subject to external audit (‘statutory audit’ in the
Companies Act 2006) each year by an auditor carrying out an independent and objective
investigation, unless they are exempted.
The purpose of the external audit is to issue an opinion in an audit report whether the financial
statements produced by the directors give a ‘true and fair view’ of the financial performance of the
company during the reporting period and of its financial position as at the end of the period.

Auditors of listed companies also have to report on:
• the directors’ remuneration report; and
• the company’s compliance with the UK Corporate Governance Code
External auditors are appointed by the directors. Typically, (as identified in the principles of the UK
Corporate Governance Code), the external auditors are recommended by the audit committee, but
the appointment decision is then taken by the board as a whole. This is endorsed by a shareholder
vote.
Organisations may also ask their external auditors to provide assurance about any information they
provide about their sustainability or environmental impact. Several reporting frameworks for
sustainability reporting were discussed in the chapter The finance function and financial information.
Assurance reports are not currently mandatory for sustainability and environmental reports, but they
give them credibility.
3.2 What is the external audit’s role in corporate governance?

The role of the external audit is a key issue in corporate governance, but in relation to corporate
governance as a system the external auditor simply reports an independent and expert opinion on
how the company is complying with the UK Corporate Governance Code. The responsibility to do
something about it remains with the directors and shareholders.
4 The role of internal audit

Section overview
• Internal audit reports on the company’s internal controls and risk management system.
• The audit committee monitors the role and performance of internal audit, including appointing its
head and ensuring it has sufficient resources.
Definition
Internal audit: An independent part of the company which monitors the effective operation of its
internal control and risk management systems. Internal audit is itself a key element of the company’s
system of internal control.
The independence of Internal auditors should be preserved so they can carry out the following tasks
based on detailed reviews of areas of the company:
• assessing how risks are identified, analysed and managed
• advising management on embedding risk management processes into business activities
• advising management on improving internal controls
• ensuring that assets are being safeguarded
• ensuring that operations are conducted effectively, efficiently and economically in accordance
with the company’s policies
• ensuring that laws and regulations are complied with
• ensuring that records and reports are reliable and accurate
• helping management to detect or deter fraud
• helping management to identify savings and opportunities
We saw above that internal audit plays a role in ensuring good corporate governance, along with the
board, management, shareholders and external audit. Its remit extends beyond that of external audit
however, as it covers operational controls and non-financial compliance issues.
The UK Corporate Governance Code recommends that the board’s audit committee should monitor
and review the effectiveness of the internal audit function. This includes:
• appointing the head of internal audit

• ensuring the function has sufficient resources eg, staff, access to management, and a framework
of professional standards
Ideally internal auditors should be able to confer privately with the audit committee, without the
presence of management, and should have direct access to any member of the board.
You may have to provide reasoned advice about the role that an internal audit department should
perform in a particular company. Think about the size of the company and the nature of the risks.

Summary
External Corporate governance Internal

audit for listed companies audit
Statutory requirement to Requirement to

treat shareholders equally 'comply or explain'
re information re UK Corporate
Governance Code
Board leadership Composition, Audit, risk

Division of succession
and company and Remuneration
responsibilities and evaluation
purpose internal control
Effective and Role of Appointment Internal/external Remuneration

entrepreneurial the Chair procedure audit policies committee
board and procedures
Appropriate Skills, knowledge Fair, balanced Formal and

Company
combination of and experience and transparent
purpose, values
executives/ of the board understandable procedure
and strategy
non-executives and committees assessment of
the company
Resources to Time available Annual evaluation Internal control Independent

meet objectives for of directors and and risk judgement
and measure non-executives the board management and discretion
performance procedures
Responsibilities Company
to shareholders secretary
and stakeholders support
Workforce
policies and
practices

indicated.
1 Can you list the five sections of the UK Corporate Code? (Topic 2)
2 Do you know the main activities of an effective board of directors, as discussed in the
first section of the Code? (Topic 2)
3 Do you understand the roles of the Chair and non-executive directors in a board? (Topic
2)
4 Do you know what should be considered in making an annual evaluation of the board?
(Topic 2)
5 Do you know what the policies and procedures of the board should try to achieve in
respect of internal and external audit functions? (Topic 2)
6 Do you know the board’s role regarding risk management? (Topic 2)
7 Who has delegated responsibility for determining the policy for executive director
remuneration? (Topic 2)
8 What is the main purpose of the external auditors? (Topic 3)
9 What is the role of internal audit? (Topic 4)

questions in the Corporate governance chapter of the Business, Technology and Finance Question
Once you have attempted these questions, you can move on to the next chapter, The economic
environment of business and finance.

UK Corporate Governance Code – 2018 (FRC)

Self-test questions

1 Non-executive directors have a prime role in:
A setting the company’s strategic aims
B providing entrepreneurial leadership
C constructively challenging proposals on strategy
D determining remuneration levels for non-executive directors
2 Trent plc’s Chief Executive Terence Darby has been appointed by the Board as its next Chair. The
company has consulted major shareholders about this. It should set out its reasons for the
appointment to all shareholders:
A at the time of appointment and in the next annual report
B at the time of appointment and also publish them on the company’s website
C in the next annual report only
D at the time of appointment and in the next three annual reports
3 Which of the following statements concerning remuneration committees and director remuneration
is correct?
A The remuneration committee must review workforce remuneration and related policies when
setting executive director remuneration.
B Non-executive remuneration may include share options but no other types of performance
related pay.
C Non-executive remuneration must either reflect the time commitment involved or the
responsibilities of the role, but not both.
D The remuneration committee sets the remuneration of executive directors but not the
remuneration of the chair or non-executive directors.
4 Biz plc currently has a premium listing of the London Stock Exchange. It has 12 board members,
including the chair. How many independent non-executive directors should Biz plc have in order to
comply with the Provisions of the UK Corporate Governance Code?
A 3
B 4
C 6
D 8
5 The board’s Chair may chair the nomination committee when it is dealing with the appointment of a
non-executive director. True or false?
6 Which of the following circumstances would indicate that a non-executive director cannot be
considered independent?
A They were an employee of the company 10 years ago.
B They had a material business relationship with the company five years ago.
C They are a member of the company’s pension scheme.
D They have served on the board for six years since their appointment.
7 The requirement for an annual re-election of directors applies to:
A all directors
B all executive directors only
C all executive directors and non-executives who have served nine years
D all non-executives who have served nine years

8 The audit committee should comprise:
A only independent non-executive directors, at least one of whom should have recent and relevant
financial experience
B both independent and non-independent non-executive directors
C a balance of non-executive and executive directors
D both non-executive and executive directors, at least one of whom should have recent and
relevant financial experience
9 Implementing policy for an effective system of internal control is the responsibility of:
A managers
B the Chair
C the audit committee via the internal audit function
D the board of directors as a whole
this chapter.


The board should set the company’s purpose, values and strategy, ensure that it has the right
resources to meet its objectives, ensure effective engagement with stakeholders and shareholders,
and ensure that workforce policies are consistent with company’s values and will support its long-
term success.

The Chair is responsible for the overall effectiveness of the board in directing the company. They
must promote a culture of openness and debate, facilitate constructive board relations, and ensure
that directors receive accurate, timely and clear information.

Executive remuneration needs to be linked to the successful delivery of a company’s long-term
strategy.
However, when determining executive directors’ pay, the remuneration committee should address
the following factors: clarity, simplicity, risk, predictability, proportionality and alignment to company
purpose and values.

C constructively challenging proposals on strategy
Principle H of the Corporate Governance Code
B at the time of appointment and also publish them on the company’s website
Provision 9 of the Corporate Governance Code
A The remuneration committee must review workforce remuneration and related policies when
setting executive director remuneration.
Provisions 33 and 34 of the Corporate Governance Code
C 6
Provision 11 of the Corporate Governance Code. Excluding the Chair, Biz plc has 11 directors. A
majority must be independent non-executives, which means there must currently be 6/11.
5 True. Provision 17 of the Corporate Governance Code. The Chair is only prevented from chairing the
nomination committee when it is dealing with the appointment of their successor.
C They are a member of the company’s pension scheme.
A all directors
A only independent non-executive directors, at least one of whom should have recent and relevant
financial experience
A managers
The board sets the policy, the management implements it.

Chapter 11
The economic environment

of business and finance
Introduction
Learning outcomes
Syllabus links
Assessment context
Learning topics
1 Introduction to the economic environment
2 The macroeconomic environment
3 The market mechanism
4 Demand
5 Supply
6 The equilibrium price
7 Elasticity
8 Types of market structure
9 The failure of perfect competition
Summary
Self-test questions
Introduction
11
Learning outcomes
• Specify the signalling, rewarding and allocating effects of the price mechanism on business
(including the concept of price elasticity)
• Specify the potential types of failure of the market mechanism and their effects on business
• Identify the key macro-economic factors that affect businesses
Specific syllabus references are: 5a, 5b, 5c
11
Syllabus links
The economic environment is relevant in Business Strategy and Technology, and Financial
Management at Professional level, and at the Advanced level.
11
Assessment context
Questions on the economic environment will be set in the assessment in either MCQ or multiple
scenario.
11

of this chapter.

questions
1–2 Macro-economic Approach Questions on the

environment This chapter covers economic
Every business the economic environment will
needs to be aware of environment in certainly come up in
the factors in the which businesses your exam.
wider operate. Read Questions will be set
macroeconomic through section 1 in either a scenario
environment that will quickly, then focus context or as a test of
affect its operations. on section 2 on knowledge of key
As your exposure to macroeconomics. principles.
different businesses There is a lot to take Essential points are:
increases you will in here and it is a
good idea to spend • Macroeconomics
appreciate how
significant the effect as long as you can • The role of
of the economic on this section. government,
environment is on all Stop and think consumers, savers
areas of enterprise. and businesses in
What effect do the national
interest rates, economy
exchange rates,
inflation and the • The business cycle
business cycle have • Inflation
on businesses? What • Government policy
determines how
on aggregate
much we earn and
demand (monetary
what we pay for
and fiscal policy)
goods and services?
What would be the • Quantitative easing

questions
effect of a key • Government

competitor going supply-side
out of business? How policies
can we decide what
to do when we have
limited resources?
3–6 Market mechanism, Approach Questions in this area IQ1: Substitute

demand, supply and Now read section 3 may well come up and or
market prices to gain an test your knowledge complementary
While much of the understanding of the of the impact of the goods?
information about market mechanism various factors on the Gives you
supply and demand (demand and supply) market price of a practice in
curves, and the as it applies in the product. thinking about
establishment of a microeconomic Essential points are: the relationships
market price are environment, then • The market in economics.
somewhat study section 4 on mechanism IQ2: Income
theoretical, the demand very distribution
principles (eg, that as carefully. Make sure • Factors that
influence demand helps you
the price goes up, you understand the understand how
demand generally differences in • Impact of income
falls) are useful changes in demand substitutes, distribution can
guides for business. that involve moving complements and impact on
along the demand income levels on demand for
curve (price) and the demand products.
changes that shift the • Giffen goods and IQ3: Market
whole demand curve
inferior goods prices in
(all other factors).
Know which factors • Factors that financial
are within the control influence supply markets looks at
of the business. changes in
• Establishment of an
Follow through the supply and
equilibrium price
worked example and demand in the
• Effects of price financial
make a good
regulation markets.
attempt at the
interactive questions. IQ4: Price
Next pay the same determinants
degree of attention helps to think
to section 5 on about the
supply and its influences on
determinants. Again, prices in two
make sure you know different
the difference markets.
between the factors
that involve a move
along the supply
curve (price) and
those that involve a
shift in the curve (all
other factors). Only
once you are happy
with these topics,
should you study
section 6 on the
equilibrium price
and the various
factors that impact
ICAEW 2023 11: The economic environment of business and finance 363
questions
on it.
7 Elasticity Approach There may be IQ5: Price

Elasticity is a useful How far is demand questions in your elasticity of
tool for measuring affected by the exam on elasticity. Not demand is an
how a change in the various factors only could you be important
price will impact considered? The required to calculate question to
demand and answer to this is in elasticity, you may ensure you can
revenue for a section 7 on need to show you calculate this.
product or service. It elasticity: price and understand the IQ6: Effect of
is also useful to see income elasticity of meaning of elasticity. PED on revenue
that the demand for demand, cross Essential points are: enables you to
one good may be elasticity of demand, • Elasticity concepts test your
affected by the price and price elasticity of and calculations knowledge of
of another. supply are all the meaning of
important concepts • Meaning of perfect PED.
which you must elasticity, perfect
inelasticity, unitary IQ7: Demand
understand and be for a good looks
able to calculate, so elasticity.
at a practical
study this section • Cross elasticity of policy issue
very closely. demand relating to the
• Positive elasticity of price elasticity of
demand demand.
• Income elasticity of
demand
• Factors influencing
price elasticity of
demand
8–9 Types of market Approach Questions on this area

structure Read through may come up in the
In some section 8 on types of exam. They tend to be
uncompetitive market structure very mainly knowledge
markets, suppliers carefully, learning the type questions, testing
may have too much characteristics of your knowledge of the
power, which may each type. Then different types of
not be in the public study section 9 on market, but there
interest. This section free markets, making could be short
looks at different sure you are clear scenario questions
types of market that about the arguments too, where you are
vary in terms of the for and against asked to identify what
amount of completely type of market you are
competition. unregulated markets, dealing with.
and the reasons why Essential points are:
markets fail. These • Market structures
are highly
examinable topics. • Free markets
Stop and think • The four types of
market failure
Why are water and
electricity industries
regulated?

1 Introduction to the economic environment
Section overview
• A business’s economic environment comprises the macroeconomic environment (national and

global influences) and its own microeconomic environment, especially how market forces affect it.
We saw in the chapter Introduction to business strategy how PESTEL analysis can help a business
identify important factors in the environment in which it functions. In this chapter we shall focus on
the economic environment of business and finance.
There are two economic environments that affect businesses:
• The macroeconomic environment in which all businesses have to operate, which incorporates:
– national influences: the business cycle, government policies (eg, fiscal and monetary policy),
interest rates, exchange rates, inflation; and
– global influences: internationalisation of trade, influence of regional economic groups such as
the EU, globalisation of markets
• The microeconomic environment of the particular business, which basically involves looking at
how the market (or price) mechanism works.
2 The macroeconomic environment

Section overview
• The macroeconomic environment comprises firstly the national economy (GDP, factors of
production, growth) and also the global economy.
• The government acts as producer, purchaser, investor and transferor in the national economy.
• The consumer’s role is to consume, the level of consumption being affected by: changes in the
marginal propensity to consume and disposable income; changes in wealth distribution;
government policy; new technology; interest rates; price expectations. Savers are affected in an
equal but opposite way.
• Investment by businesses is key to the health of the national economy. This is affected by: interest
rates; expectations and business confidence; consumer demand; opportunity cost; new
technology.
• The main stages of the business/trade cycle are: boom, recession, depression and recovery.
• Most governments aim for stable prices, so inflation must be kept under control.
• Types of inflation: demand-pull and cost-push (fiscal and credit).
• Policies to influence aggregate demand: monetary (interest rates) and fiscal (taxation, borrowing
and spending) policy.
• Policies to influence aggregate supply: spending levels; privatisation; tax reductions; workforce
amendments; deregulation/relaxing competition laws; free movement of capital.
Businesses operate in the economy as a whole and changes in the macroeconomic environment can
have major implications for them.
2.1 The national economy

The amount of national output by firms or government agencies which produce goods and services
in the national economy is measured as its gross domestic product or GDP. To create GDP four
factors of production are employed, each of which enjoys a return:
Factor of production Return
Land Rent
Labour Wages
Capital Interest
Entrepreneurship Profit
GDP equals the amount of expenditure incurred by those who purchase the output:
• Consumers (or households)
• The government
• Foreign buyers (the overseas sector)
The level of national output is important because it is a measure of the economic activity in a
country:
• It is an aggregate of personal incomes – the bigger this is, the more income individual inhabitants
will be earning on average (assuming a stable population).
• More income means more spending by consumers (households) on the output of firms, and more
spending (ignoring the effects of price rises) means that a higher output of goods and services is
required to be produced.
• Growth in GDP per head of population is an economic policy objective of most, if not all,
governments. The growth potential of an economy will depend on the amount of factors of
production available, and their productivity.
2.1.1 The role of the government in the national economy

The government has several functions within the national economy.
• It acts as the producer of certain goods and services instead of privately owned firms, and the
production of public administration services, education and health services, the police force,
armed forces, fire services and public transport are all aspects of output. The government in this
respect acts, like firms, as a producer and must also pay wages to its employees.
• It acts as the purchaser of final goods and services and adds to total consumption expenditure.
National and local government obtain funds from the firms or households of the economy in the
form of taxation and then use these funds to buy goods and services from other firms.
• It invests by purchasing capital goods, for example building roads, schools and hospitals.
• It makes transfer payments from one section of economy to another, for example by taxing
working households and paying pensions, and by paying unemployment benefits and social
security benefits.
2.1.2 The role of the consumer in the national economy
Definition
Disposable income: Income available to individuals after payment of personal taxes. It may be
consumed or saved.
Total spending or consumption by households is affected by six influences.

• Changes in disposable income, and the marginal propensity to consume. Changes in disposable
income are affected by matters such as pay rises and changes in tax rates. An increase in
disposable income from a pay rise, or because of a reduction in tax rates, may simply increase
consumption and have no effect on savings. If a household believes that saving is a good thing;
however, it will save as much as possible of the increase, and spend as little of it as possible. How
far an increase in disposable income is allocated to consumption rather than saving is known as
the marginal propensity to consume (MPC).
• In the economy as a whole, a general belief in the value of saving may mean that the MPC is low.
The prestige attached to the possession of consumer goods may, however, overcome the
admiration for saving, making the MPC high.

• Changes in the distribution of wealth. Some sections of the population will have a higher MPC
than others so a redistribution of wealth might affect consumption. (A redistribution of wealth
might be accomplished by taxing the rich and giving to the poor in the form of more government
allowances.)
• Government policy. Government can influence consumption levels through taxation and/or
public spending. For example, an increase in direct taxation will reduce disposable income and
therefore will also reduce consumption.
• The development of major new products. When such developments happen, they can create a
significant increase in spending by consumers who want to buy the goods or services.
• Interest rates. Changes in interest rates will influence the amount of income that households
decide to save, and also the amount that they might elect to borrow for spending. High interest
rates will make saving more attractive while low interest rates will reduce the cost of credit and will
therefore increase borrowing and levels of consumption.
• Price expectations. Expectations of price increases may increase current consumption while
expectations of price reductions may have the opposite effect.
2.1.3 The role of the saver in the national economy

Saving is the amount of income which is not consumed. Therefore, not surprisingly, the influences
which affect savings are very similar to those that affect consumption – but in mirror image.
• Income. The level of income will be a key determinant in the level of savings. It is difficult to save
when your income is very low!
• Interest rates and the cost of credit. If interest rates rise, saving becomes more attractive relative
to consumption. Similarly, as the cost of credit rises, borrowing becomes less attractive so as a
result people will save more.
• Long-term savings. A large amount of household savings goes into long-term, contractual savings
such as pension schemes. These savings may be less likely to vary with income than with
demographics – for example, savings into pension schemes have risen alongside increases in life
expectancy in developed countries.
2.1.4 The role of investment by businesses in the national economy

An investment involves the acquisition of more fixed capital (buildings, machinery, plant and
equipment) or inventories of goods and so on. The total volume of investment in the economy, from
the private sector or the public sector or both, depends on:
• the interest rate on capital (the price of money)
• expectations about the future and business confidence, including expectations about future cash
flows and profit flows arising from the investment
• the strength of consumer demand for goods
• the opportunity cost of investment
• the level of new technology to be invested in
If interest rates are high, the effects are as follows (low interest rates have a mirror image effect):
• firms will demand a higher return when appraising investments and so some investments may not
occur, thereby restricting economic growth (firms will be less willing to invest, but remember they
cannot always cut their investment plans quickly and at short notice)
• individuals will be tempted to consume less of their income and save more, so that they will
invest more of their savings – that is, to hold less cash and more interest-bearing investments
New technology will be a boost to investment:
• If it reduces the unit costs of production via new methods of production (such as robotics) then
new technology will increase profitability. Firms will invest in order to achieve lower costs and
remain competitive.
• If it leads to new types of good, then new technology will stimulate demand. Firms will invest to
make the product and meet the consumer demand.
Private sector investment will come from retained earnings, new issues of shares, or borrowing (as
we saw in the chapter Business finance). However, in an economic recession (see below) profits
might be low, and investors might lack confidence in a recovery, so that new share issues are
impossible on a large scale.
Public sector investment might be financed by higher taxation, or by an increased deficit between
government income and expenditure, that is, a higher Public Sector Net Cash Requirement (PSNCR).
This might force up interest rates in the capital markets and crowd out private sector investment.
2.2 The business/trade cycle
Definition
Business cycles/trade cycles: The continual sequence of rapid growth in GDP, followed by a
slowdown in growth and then a fall. Growth then comes again, and when this has reached a peak, the
cycle turns once more.
Four main phases of the business cycle can be distinguished.

• Recession (A)
• Depression (B)
• Recovery (C)
• Boom (D)
Recession tends to occur quickly, while recovery is typically a slower process. The figure below can
be used to help explain how this is so.
Actual
Output output
D
Trend in
A output
Time
Figure 11.1: The business/trade cycle
2.2.1 Recession
At point A in the figure above, the economy is entering a recession.
• Consumer demand falls
• Investment projects already undertaken begin to look unprofitable
• Orders are cut
• Inventory levels are reduced
• Business failures occur as firms find themselves unable to sell their goods
• Production and employment fall
• General price levels begin to fall
• Business and consumer confidence diminish
• Investment remains low
• The economic outlook appears to be poor
Recession can begin relatively quickly because of the speed with which the effects of declining
demand will be felt by businesses suffering a loss in sales revenue. The knock-on effects – of reducing
inventory and cutting back on investment – exacerbate the situation and add momentum to the
recession.

2.2.2 Depression
Eventually, in the absence of any stimulus to demand, a period of full depression may set in and the
economy will reach point B.
2.2.3 Recovery
At point C the economy has reached the recovery phase of the cycle. This can be slow to begin
because of the effect of recession/depression on levels of confidence. Governments will try to limit
the decline by boosting demand in the economy as a whole (we shall come back to this). Once
begun, recovery is likely to quicken as confidence returns.
• Output, employment and income will all begin to rise
• Business expectations will be more optimistic so new investment will be more readily undertaken
• The rising level of demand can be met through increased production by bringing existing
capacity into use and by hiring unemployed labour
• The average price level will remain constant or begin to rise slowly
Decisions to purchase new materials and machinery may lead to benefits in efficiency from new
technology. This can enhance the relative rate of economic growth in the recovery phase once it is
under way.
2.2.4 Boom
As recovery proceeds, the output level climbs above its trend path, reaching point D, in the boom
phase of the cycle. During the boom:
• capacity and labour will become fully used, causing bottlenecks in some industries which are
unable to meet increases in demand (no spare capacity, shortage of skilled labour or key material
inputs);
• further rises in demand will therefore be met by price rather than production increases;
• business will be profitable, with few firms facing losses; and
• expectations of the future may be very optimistic and the level of investment expenditure high
2.2.5 Avoiding the ‘boom and bust’ cycle

Governments generally seek to stabilise the economic system, trying to avoid the distortions of a
widely fluctuating cycle.
• In a recession they will try to boost overall demand
• In a boom they will try to keep dampen overall demand through raising taxation or interest rates,
and by reducing public expenditure
• We will come back to these points when we look at fiscal and monetary policy.
2.3 Inflation
Definitions
Inflation: An increase in price levels generally, and a decline in the purchasing power of money.
Deflation: Falling prices generally, which is normally associated with low rates of growth and
recession.
2.3.1 Why is inflation a problem?

Most governments aim for stable prices. A high rate of price inflation is harmful and undesirable for
the following reasons.
• Redistribution of income and wealth
Inflation leads to a redistribution of income and wealth from suppliers to customers because
outstanding amounts lose ‘real’ value with inflation. In addition, those with fixed incomes, such as
pensioners and the low-paid, fare worse than those with significant earning power, as the nominal
amount of a fixed income stays the same but its purchasing power falls.
• Balance of payments effects
If a country has a higher rate of inflation than its major trading partners, its exports will become
relatively expensive and imports relatively cheap, although its exchange rate will usually alter to
take account of this.
• Price signalling and ‘noise’
Prices act as signals to both consumers and producers, affecting both demand and supply
respectively. Inflation, particularly at high rates, can undermine the ability of the price mechanism
to influence the allocation of resources in an economy. Business confidence is undermined
because planning and forecasting are less accurate. Inflation is often referred to as ‘noise’ in an
economy for this reason.
• Wage bargaining
Wage demands increase in times of high inflation. A wage/price spiral may take hold, which will
reinforce the problem and valuable time is wasted negotiating new wage rates rather than
producing new goods.
• Consumer behaviour
People may stockpile goods fearing price increases later, which could create shortages for other
people. Consumers will be more anxious to consume now rather than waiting until costs rise; this
will raise consumption levels and possibly push prices up even further – a spiral that can
contribute to hyper-inflation (extremely high rates of inflation).
2.3.2 Types of inflation
Definitions
Demand pull inflation: Price rises resulting from a persistent excess of demand over supply in the
economy as a whole. Supply cannot grow any further once ‘full employment’ of factors of production
is reached.
Cost push inflation: Price rises resulting from an increase in the costs of production of goods and
services, eg, of imported raw materials or from wage increases.
There are two main causes of demand-pull inflation.

• Fiscal. An increase in government spending or a reduction in taxes will raise demand in the
economy.
• Credit. If levels of credit extended to customers increase, perhaps because of a decrease in
interest rates, expenditure is likely to rise. In this case, inflation is likely to be accompanied by
customers increasing their debt burdens.
Once the rate of inflation has begun to increase, expectational inflation can occur. Regardless of
whether the factors that have caused inflation are persistent or not, there will be a generally held
view of what inflation is likely to be. To protect future income, wages and prices will therefore be
raised in anticipation of the expected amount of future inflation. This can lead to the vicious circle of
a wage price spiral, in which inflation becomes a relatively permanent feature because of people’s
expectations that it will occur.
Context example: Real life example

In February 2022, inflation in the UK, measured by the consumer price index, rose at an annual rate of
6.2%. This was the highest annual rate of inflation in the UK since 1992. The increase was caused by
rising prices for energy and food in particular, leading to increases in the cost of transport and
household goods. This led to food inflation of 5.1 per cent. In the light of this cost push inflation,
Andrew Bailey, the governor of the Bank of England, called for restraint in pay bargaining to stop
inflation getting out of control.
2.4 Government objectives and policies

To achieve economic growth and control inflation the macroeconomic policies used by the
government are:
• influencing overall demand in the economy (aggregate demand) via:

– monetary policy: government policies on the money supply, the monetary system, interest
rates, exchange rates and the availability of credit
– fiscal policy: government policies on taxation, public borrowing and public spending; and
• influencing overall supply in the economy (aggregate supply) via supply-side policies
2.4.1 Monetary policy and aggregate demand

Interest rates – the price of money – are a target of monetary policy if it is considered that there is a
direct relationship between interest rates and the level of expenditure in the economy, or between
interest rates and the rate of inflation. In the UK, the objective of monetary policy has been principally
to reduce the rate of inflation to a sustainable low level, though since 2008 interest rates have also
been used to support consumer spending in order first to avoid and then to shorten the recession
which followed the banking crisis.
Effects of a rise in interest rates
• The price of borrowing in the economy will rise
– If companies see the rise as relatively permanent, rates of return on investments will become
less attractive and investment plans may be curtailed. Spending will fall. Corporate profits will
fall as a result of higher interest payments. Companies will reduce inventory levels as the cost of
having money tied up rises.
– Households will reduce or postpone consumption in order to reduce borrowings, and should
become less willing to borrow for house purchase. Spending will fall.
(Although it is generally accepted that there is likely to be a connection between interest rates and
investment (by companies) and consumer expenditure, the connection is not a stable and
predictable one, and interest rate changes are only likely to affect the level of expenditure after a
considerable time lag.)
• The exchange rate for sterling will be higher than it would otherwise be. This will keep the cost of
exports higher and the cost of imports will be cheaper.
• There will be capital inflows as foreign investors will be attracted to sterling investments.
• The reductions in spending and investment will reduce aggregate demand in the economy.
2.4.2 Quantitative easing

Quantitative easing is a tool that has been used by many advanced economies, including the UK, in
recent years, to alleviate the threat of recessions.
Definition
Quantitative easing: is a form of expansionary monetary policy which involves the central bank
(Bank of England in the UK) buying existing government bonds (gilts) and corporate bonds as a way
of adding liquidity to the financial system.
Interest rates have historically been the preferred tool of central banks for monetary policy, as
described in the section above. When interest rates are already very low however, cutting interest
rates further may not be feasible, particularly if rates are already close to zero.
In the UK, quantitative easing was first used in the wake of the banking crisis of 2008. Many banks
were very close to going bankrupt as a result of the crisis, so banks stopped lending to each other.
This led to a liquidity crisis, where banks did not have sufficient funds to lend to businesses.
Quantitative easing was used as a means of alleviating this liquidity crisis.
Quantitative easing works as follows:
1. The Bank of England creates electronic cash and uses this to buy government and corporate
bonds from banks, thus injecting cash into the accounts of the banks.
2. The price of bonds rises, leading to a fall in the yield of the bonds. The banks therefore buy other
higher yielding assets such as shares. This provides liquidity to the sellers of the shares.
3.The low yields on bonds also reduce interest rates, which reduce the cost of borrowing by
businesses. Businesses therefore borrow and this stimulates spending on investments, which leads
to more demand in the real economy.
2.4.3 Fiscal policy and aggregate demand
Definition
Fiscal policy: The government’s policy on government spending, taxation and borrowing.
• Spending. The government spends money at national and local levels to provide goods and
services, such as a health service, public education, a police force, roads, public buildings and so
on, and to pay its administrative work force. It may also, perhaps, provide finance to encourage
investment by private industry, for example by means of grants. Increased government spending
increases the size of the economy, so expenditure and therefore GDP will rise.
• Taxation. Expenditure must be financed, and the government must have income. Most
government income comes from taxation, but some income is obtained from direct charges to
users of government services such as National Health Service charges. Increased taxation without
increased government spending reduces the size of the economy. A government might
deliberately raise taxation to reduce inflationary pressures.
• Borrowing. The government must borrow the amount by which its expenditure exceeds its
income. In the UK government this is known as the Public Sector Net Cash Requirement (PSNCR).
Where the government borrows from has an impact on the effectiveness of fiscal policy.
The government’s ‘fiscal stance’ may be neutral, expansionary or contractionary, according to its
effect on national income.
• Increased borrowing and spending (expansionary fiscal stance)
• Increased taxation but no increase in spending (or decreased borrowing and decreased
spending) (contractionary fiscal stance)
• Increased taxation and spending (broadly neutral fiscal stance (income diverted from one part of
the economy to another)
2.4.4 Supply-side macroeconomic policies

Macroeconomic demand-side intervention by government using monetary and fiscal policy may be
harmful:
• Demand management interventions are inflationary in the long run.
• High taxes act as a disincentive to economic activity.
• The possibility of politically motivated policy changes creates damaging uncertainty in the
economy, discouraging long-term investment.
The main supply side macroeconomic policies are:
• more involvement of the private sector in the provision of services
• reduction in taxes in order to increase incentives to supply
• increasing flexibility in the labour market by curbing the power of trade unions
• improving education and training so the quality of labour and hence the economy’s productive
capacity are enhanced
• increasing competition through deregulation and privatisation of utilities
• abolition of exchange controls and allowing the free movement of capital
We shall now look at the business’s microeconomic environment.
You may be required to demonstrate that you can understand the impact of the economic
environment on a business and its plans.
2.4.5 Recent UK government policy

The main aim of fiscal policy from 2010 until 2019 was to control government spending in order to
repay the government debts that were built up in the wake of the financial crisis of 2008.

Government policy was to not borrow for current day to day spending. This period of ‘austerity’ was
associated with freezes on public sector wages.
Since the end of 2019, the government has signalled a move away from this austerity towards a new
period of increased public spending, aimed at increasing economic growth.
The government has also signalled a more interventionist supply side approach, with programmes
such as its levelling up agenda – which aims to create jobs in former industrial areas that are
associated with higher rates of unemployment and low wages.
Monetary policy has been aimed at keeping inflation below 2%. Demand in the economy has been
weak since the economic crisis of 2008, and interest rates have been kept at historically low levels of
around 0.5% per annum since that date. Should inflation return, the Bank of England would consider
increasing interest rates to counter that threat.
In November 2020, the Bank of England introduced a further quantitative easing programme,
moving to a total of £895 billion to build confidence and liquidity in the economy. The last part of this
programme was completed in December 2021.
As the economy has emerged from the Covid-19 pandemic, economies around the world have
experienced a resurgence in inflation due to a slow-down in output during the pandemic, and a
sudden surge in demand as economies emerged from pandemic restrictions. The price of fuel has
also risen substantially as a result in a fall in supply from Russia. In response to the new threat of
inflation, the Bank of England increased interest rates to 0.75% and has suggested that further rises
in interest rates may be necessary, but forecasts that inflation will fall to around 2% again in two to
three years’ time.
3 The market mechanism

Section overview
• In a market buyers and sellers exchange ‘goods’ via the market mechanism, which determines
price according to the interaction of supply and demand.
Definition
Market mechanism: The interaction of demand and supply for a particular item.
3.1 What is a market?

The concept of a market in microeconomics goes beyond the idea of a single geographical place
where people meet to buy and sell goods. It refers to the buyers and sellers of goods or services
who influence its price. Markets can be worldwide, as in the case of oil, wheat, cotton and copper for
example. Others are more localised, such as the housing market or the market for second-hand cars.
Definition
Market: A situation in which potential buyers and potential sellers (or ‘suppliers’) of an item (or
‘good’) come together for the purpose of exchange.
Markets for different goods are often inter-related. All goods compete for customers so that if more
is spent in one market, there will be less to spend in other markets.
3.2 How is the market price of goods determined?

Price theory (or demand theory as it is sometimes referred to) is concerned with how market prices
for goods are arrived at, through the interaction of demand and supply.
4 Demand
Section overview
• Demand quantifies how much of a good buyers would buy at a certain price level.
• The demand curve is usually downward sloping from left to right when price is measured on the y
(vertical) axis and quantity is measured on the x (horizontal) axis. This means that a rise in price
causes a fall in the quantity demanded.
• Within one demand curve only price determines the level of demand.
• Other determinants of demand will shift the demand curve left or right. These include: substitutes
and complements; income levels (normal and inferior goods); fashion and expectations;
advertising; income distribution.
• The level of demand can change quite rapidly in response to a change in a determinant.
4.1 What is meant by ‘demand’?
Definition
Demand: The quantity of a good that potential purchasers would buy, or attempt to buy, if the price
of the good were at a certain level.
If demand is satisfied, actual quantities bought equals demand. If some demand is unsatisfied, more
would-be purchasers are trying to buy a good that is in insufficient supply.
4.2 The demand schedule and the demand curve

The relationship between demand for a good and the price of the good can be shown graphically as
a demand curve. The demand curve is derived by estimating in a demand schedule how much of a
good would be demanded at various hypothetical market prices.
Context example: Demand schedule and demand curve

Suppose that the following demand schedule shows demand for biscuits by one household over a
period of one month.
Price per Kg Quantity demanded at this price

£ Kg
1 9.67
2 8.00
3 6.25
4 4.50
5 2.67
6 1.00
We can show this schedule graphically on a demand curve (Figure 11.2), with:
• Price on the y axis
• quantity demanded on the x axis

Price
(£)
D B
A6
4 Demand curve
E
G2
1
D
0
0 1 2 3 4 5 6 7 8 9 10 Quantity (kg)
Figure 11.2: Demand for biscuits
Changes in demand caused by changes in price only are represented by movements along the
demand curve, from one point on the curve to another. The price has changed, so the quantity
demanded changes, but the demand curve itself stays in the same place.
A demand curve generally slopes down from left to right for the following reasons.
• For the individual consumer, a fall in the price of the good makes it relatively cheaper compared
to other goods so expenditure will be shifted to the good whose price has fallen. It is the relative
price of the good that is important. A fall in the relative price of a good increases demand for it.
• A fall in the good’s price means that people with lower incomes will also be able to afford it or
more of it. The overall size of the market for the good increases. The converse argument applies
to an increase in prices; as a price goes up, consumers with lower incomes will no longer be able
to afford the good or will buy something else whose price is relatively cheaper, and the size of the
market will shrink.
You may be required to analyse market conditions. The demand curve and the price elasticity of
demand (see section 7 below) can be useful tools for this.
4.3 What factors determine demand?

Several factors influence the total market demand for a good. One of these factors is obviously its
price, but there are other factors too since people buy not just one good with their money but a
whole range of goods and services.
Within the control of the business (see the Seven Ps

chapter Managing a business):
Price
Marketing research Product
Product research and development Price

Promotion
Within the control of the business (see the Seven Ps
chapter Managing a business):
Advertising Place
Sales promotion People
Training and organisation of sales force Processes

Physical evidence
Effectiveness of distribution
After sales service
Granting of credit to customers
Outside the control of the business

• Price of substitute goods (items to which the consumer will switch if the price changes)
• Price of complementary goods (items which the consumer buys as a result of buying the goods,
such as blades for razors)
• Consumers’ income
• Fashion and expectations
4.3.1 Price
In the case of most goods (with some exceptions, such as Giffen goods, which we will look at later),
the higher the price, the lower will be the quantity demanded. It is common sense that at a higher
price, a good does not give the same value for money as it would at a lower price, so people will not
want to buy as much. This dependence of demand on price applies to all goods and services, from
bread and salt to houses and satellites.
A demand curve shows how the quantity demanded will change in response to a change in price
provided that all other factors affecting demand are unchanged – that is, provided that there is no
change in the prices of other goods, tastes, expectations or the distribution of household income.
4.3.2 Other factors affecting demand

A different demand curve needs to be produced if there is a change in the other factors affecting
demand. We call this a shift of the demand curve. If the change means that demand rises, then the
downward-sloping demand curve moves to the right; if demand falls then it moves to the left.
4.3.3 Inter-related goods: substitutes and complements

A change in the price of one good will not necessarily change demand for another good. For
example, we would not expect an increase in the price of cocoa to affect the demand for cars.
However, there are goods for which the market demand is interrelated, referred to as either
substitutes or complements.
• Substitute goods are goods that are alternatives to each other, so that an increase in the demand
for one is likely to cause a decrease in the demand for another. Switching demand from one good
to another ‘rival’ good is substitution. Examples of substitute goods and services are:
– Rival brands of the same commodity, like CocaCola and Pepsi
– Tea and coffee
– Bus rides and car rides
– Some different forms of entertainment
Substitution takes place when the price of one good rises or falls relative to the substitute good.
• Complements are goods that tend to be bought and used together, so that an increase in the
demand for one is likely to cause an increase in the demand for the other. Examples of
complements are:
– cups and saucers;
– holidays and travel insurance; and
– cars and the components and raw materials that go into their manufacture

Interactive question 1: Substitute or complementary goods?
What might be the effect of an increase in the ownership of domestic freezers on the demand for
perishable food products?
4.3.4 Income levels: normal and inferior goods

More income gives people more to spend, so they will want to buy more goods at existing prices.
However, a rise in income will not increase market demand for all goods and services. The effect of a
rise in income on demand for an individual good will depend on the nature of the good.
• A rise in income may increase demand for a particular good. This is what we might normally
expect to happen, so they are called normal goods.
• Demand for another good may rise with income up to a certain point but then fall as income rises
beyond that point. Goods whose demand eventually falls as income rises are called inferior
goods: examples might include cheap brands of sausages or wine. The reason for falling demand
is that as incomes rise, demand switches to superior products, for example gourmet sausages and
champagne.
4.3.5 Income distribution

Market demand for a good is influenced by the way in which the national income is shared among
people. In a country with many rich and many poor households and few middle income ones, we
might expect a relatively large demand for luxury cars and yachts and also for bread and potatoes. In
a country with many middle-income households, we might expect high demand for medium-sized
cars and foreign holidays, and other ‘middle income’ goods.
Interactive question 2: Income distribution

What do you think might be the demand for swimming pools amongst a population of five
households enjoying total annual income of £1 million, if the distribution of income is either as under
assumption 1 or as under assumption 2?
Annual income
Assumption 1 Assumption 2
£ £
Household 1 950,000 200,000
Household 2 12,000 200,000
Household 3 13,000 200,000
Household 4 13,000 200,000
Household 5 12,000 200,000
1,000,000 1,000,000
4.3.6 Fashion and expectations

A change in fashion will alter the demand for a product. For example, when it became fashionable to
drink wine with meals, expenditure on wine increased. In addition, there may be passing ‘crazes’,
such as football strips during the World Cup.
If consumers expect that prices will rise, or that shortages will occur, they may attempt to stock up on
the product, thereby creating excess demand in the short term which will increase prices. This can
then lead to panic buying. Examples include fear of war or the effect of strikes. Similarly, if prices are
expected to fall, purchasing might be postponed – a potential effect of deflation in the economy.
4.4 Shifts of the demand curve
When there is a change in one of these demand determinants other than price, the relationship
between demand quantity and price will also change, and there will be a different price/quantity
demand schedule and so a different demand curve. We refer to such a change as a shift of the
demand curve.
Figure 13.3 depicts a demand curve shifting to the right, from D0 to D1. For example, at a single
price, price P1, demand for the good would rise from Q0 to Q1. This shift could be caused by any of
the following:
• a rise in household income
• a rise in the price of substitutes
• a fall in the price of complements
• a positive change in tastes towards this good
• an expected rise in the price of the good
A fall in demand at each price level would be represented by a shift of the demand curve in the
opposite direction: to the left. Such a shift may be caused by the opposite of the changes above.
Price of
the goods
(£)
P1
D1
D0
0
0 Q0 Q1 Quantity demanded
Figure 11.3: Outward shift of the demand curve
Remember that:
• movements along a demand curve are caused by changes in the good’s price; and
• shifts of the demand curve are caused by changes in any of the other factors which affect
demand for a good, other than its price

5 Supply
Section overview
• Supply quantifies how much of a good sellers will supply at a certain price level.
• The supply curve is usually upward sloping from left to right when price is measured on the y axis.
This means that a rise in price causes a rise in the quantity supplied.
• Within one supply curve only price determines the level of supply.
• Other determinants of supply will shift the supply curve. These include: prices of other goods;
prices of related goods; costs; changes in technology; other seasonal and random factors.
• For most goods and services, the level of supply changes less rapidly than demand in response to
a change in a determinant.
5.1 What is meant by ‘supply’?
Definition
Supply: The quantity of a good that existing suppliers or would be suppliers would want to produce
for the market at a given price.
The quantity of a good that can be supplied to a market varies up or down, as a result of either:
• existing suppliers increasing or reducing their output quantities; or
• suppliers stopping production altogether and leaving the market, or new suppliers entering the
market and starting to produce the good
If the quantity that suppliers want to produce at a given price exceeds the quantity that purchasers
demand, there will be an excess of supply, with suppliers competing to win what demand there is.
Oversupply and competition result in price-competitiveness and ultimately a fall in price.
5.2 The supply schedule and the supply curve

A supply schedule and supply curve are constructed in a similar manner to a demand curve (from a
schedule of supply quantities at different prices) but show the quantity suppliers are willing to
produce at different price levels. It is an upward sloping curve from left to right, because greater
quantities will be supplied at higher prices.
Context example: Supply schedule and supply curve

The supply schedule for product Y is as follows.
Price per unit Quantity that suppliers would supply at this price
£ Units
100 10,000
150 20,000
300 30,000
500 40,000
The relationship between supply quantity and price is shown as a supply curve in Figure 11.4.
Price
(£)
600
500
400
300
200
100
0
0 10,000 20,000 30,000 40,000 Quantity supplied (units)
Figure 11.4: Supply curve
5.3 What factors influence supply?

• The price obtainable for the good.
• The prices of other goods. An increase in the price of other goods would make the supply of a
good whose price does not rise less attractive to suppliers, or they may want to switch to
supplying something else.
• The price of related goods in ‘joint supply‘. For instance, leather and beef are related goods which
are produced jointly when cattle are slaughtered. If the price of beef rises, more will be supplied
and there will be an accompanying increase in the supply of leather.
• The costs of making the good, including raw materials costs, wages, etc. A rise in the price of one
raw material will cause producers to shift away from supplying goods whose costs and profits are
closely related to the price of that raw material, towards the supply of goods where the cost of
that raw material is less significant.
• Changes in technology. Technological developments which reduce costs of production (and
increase productivity) will raise the quantity of supply of a good at a given price.
• Other factors, such as changes in the weather in the case of agricultural goods, natural disasters
or industrial disruption.
The supply curve itself shows how the quantity supplied will change in response to a change in price,
provided that all other conditions affecting supply remain unchanged. If supply conditions (the price
of other goods, or costs of making the goods, or changes in technology) alter, a different supply
curve must be drawn. In other words, a change in price will cause a shift in supply along the supply
curve. A change in other supply conditions will cause a shift of the supply curve itself.
A shift of the supply curve as the result of a fall in costs, either in absolute terms or relative to the
costs of other goods, is shown in Figure 11.5. If the market price of the good is P1, suppliers will be
willing to increase supply from Q0 to Q1 under the new supply conditions.

Price
(£)
S0 S1
P1
0
0 Q0 Q1 Quantity supplied (units)
Figure 11.5: Outward shift of the supply curve
5.4 The effect of time on supply and demand

We need to distinguish between short-run and long-run responses of both supply and demand to
changes in determinants. In the short run both supply and demand are relatively unresponsive to
changes in price, as compared to the long run.
• In the case of supply, changes in the quantity of a good supplied often require the laying off or
hiring of new workers, or the installation of new machinery. These changes, brought about by
management decisions, take some time to implement.
• In the case of demand, it takes time for consumers to adjust their buying patterns, although
demand often responds more rapidly than supply to changes in price or other demand
conditions.
Response times vary between markets. In stock markets, for example, supply and demand for
company shares respond very rapidly to price changes, whereas in markets for fuel oils or
agrichemicals response times are much longer.
Interactive question 3: Market prices in financial markets

In a stock market the ‘products’ bought and sold include shares in companies. What can you say
about the supply of and demand for these ‘products’, and how quickly does their price change in
response to changes in supply and demand factors?
6 The equilibrium price

Section overview
An efficient market brings supply and demand into equilibrium at the market price, which is where
the supply and demand curves intersect.
6.1 Price signals and incentives
People who want goods only have a limited disposable income and they must decide what to buy
with the money they have. The prices of the goods they want will affect their buying decisions
(ignoring other factors).
Businesses’ supply decisions will be influenced by both demand and supply considerations.
• Market demand conditions influence the price that a supplier will get for its output. Prices act as
signals to suppliers, and changes in prices should stimulate a response from a supplier to change
its production quantities.
• Supply is also influenced by production costs and profits. The objective of maximising profits
provides the incentive for suppliers to respond to changes in price or cost by changing their
production quantities.
Decisions by businesses about what industry to operate in and what markets to produce goods for
will be influenced by the prices obtainable and the costs incurred. Although some businesses have
been established in one industry for many years, others are continually opening up, closing down or
switching to new industries and new markets. Over time, businesses in an industry might also
increase or reduce the volume of goods they sell.
6.2 What is the equilibrium price?

The market mechanism brings demand and supply into equilibrium.
Definition
Equilibrium price: The price of a good at which the volume demanded by consumers and the
volume businesses are willing to supply are the same.
This can be illustrated by drawing the market demand curve and the market supply curve on the
same graph (Figure 11.6).
Price
(£)
Supply
A B
P1
P0
C D
Demand
0 Q Quantity supplied (units)
Figure 11.6: Market equilibrium or the equilibrium price
At price P1 in Figure 11.6, suppliers want to produce more than is demanded at that price the
amount of the over-supply being equal to the distance AB. The reaction of suppliers as unsold
inventories accumulate would be:
• to cut down the current level of production (reduce supply) in order to clear unwanted
inventories; and/or
• to reduce prices in order to encourage sales.

The opposite will happen at price P0, where there is an excess of demand over supply, equal to the
distance CD. Output would increase and/or the price would rise.
At price P the amount that suppliers are willing to supply is equal to the amount that customers are
willing to buy. There will be no unusual variation in inventory and, as long as nothing else changes,
there will be no change in price. Consumers will be willing to spend a total of (P × Q) on buying Q
units of the product, and suppliers will be willing to supply Q units to earn revenue of (P × Q). P is the
equilibrium price.
The forces of supply and demand push a market to its equilibrium price and quantity.
• If there is no change in the determinant of supply or demand, the equilibrium price will rule the
market and will remain stable.
• If the equilibrium price does not rule, the market is in disequilibrium, but supply and demand will
push prices towards the equilibrium price.
• Shifts in the supply curve or demand curve because of determinants other than price will change
the equilibrium price and quantity.
6.3 Adjustments to equilibrium

Equilibrium price, supply and demand must adjust following a shift of the demand or supply curve.
There are four possibilities, therefore, which are illustrated by Figure 11.7 and Figure 11.8.
(1) Increase in consumer incomes (2) Product becomes unfashionable
Price Price
£ £
D1 D2 S D2 D1 S
= expansion = contraction
P2 in supply P1 in supply
P1 P2
0 Q1 Q2 Quantity 0 Q2 Q1 Quantity
Figure 11.7: Adjustments in equilibrium
Increase in consumer incomes Product becomes unfashionable
Prediction Prediction
• Rise in market price • Fall in market price

• Rise in quantity supplied • Fall in quantity supplied
(3) Improvement in production technology (4) Rise in factor costs
Price Price
D S1 S2 D S2 S1
£ £
= expansion = contraction
P1 P2
in demand in demand
P2 P1
0 Q1 Q2 Quantity 0 Q2 Q1 Quantity
Figure 11.8: Adjustments in equilibrium
Improvement in production technology Rise in factor costs
Prediction Prediction
• Fall in market price • Rise in market price

• Rise in quantity supplied • Fall in quantity supplied
Interactive question 4: Price determinants

Explain, in detail, what conditions will determine price in:
(a) a retail fruit and vegetable market; and
(b) an auction of antiques and paintings
6.4 Price regulation

The regulation of prices by government provides an illustration of how demand and supply analysis
can be applied. Government might introduce regulations either:
• to set a maximum price for a good, perhaps as part of an anti-inflationary economic policy (such
as a prices and incomes policy) so that suppliers cannot charge a higher price even if they wanted
to; or
• to set a minimum price for a good below which a supplier is not allowed to fall. For example,
OPEC (the Organisation of Petroleum Exporting Countries) in the past attempted to impose
minimum prices for oil on the world markets
• If this price is higher than the equilibrium price, its existence will have no effect at all on the
operation of market forces.
• But if the maximum price is lower than what the equilibrium price would be, there will be an
excess of demand over supply. The low price attracts customers but deters suppliers so supply
will fall unless there is scope for the market to exist outside government-sanctioned channels – a
so-called ‘black market‘.

7 Elasticity
Section overview
• Price elasticity of demand (PED) measures how far demand for a good will change in response to
a change in its price.
• The PED of a good is affected by: the availability of substitutes; time; pricing by competitors;
whether it is a necessity or a luxury; what percentage of income is spent on it; whether it is habit-
forming.
• Income elasticity of demand measures how far demand for a good will change in response to a
change in income levels.
• Some goods are cross-elastic, so there is a relationship between a change in price for one good
and a change in demand for the other.
• Price elasticity of supply measures how far supply of a good will change in response to a change
in its price.
Definition
Elasticity: The extent of a change in demand and/or supply given a change in price.
7.1 Price elasticity of demand

If prices went up by 10% would the quantity demanded fall by 5%, 20%, 50% or what? Price elasticity
of demand (PED) is a measure of the extent of change in demand for a good in response to a
change in its price. It is measured as:
Change in quantity demanded, as a percentage of original demand

PED =
Change in price, as a percentage of original price
Since demand usually increases when the price falls, and decreases when the price rises, elasticity
usually has a negative value. It is usual to ignore the minus sign, therefore, but note that there are
types of goods where elasticity is actually positive (we shall come back to this).
Proportional change in quantity

PED =
Proportional change in price
Q2−Q1 P2−P1
=
[ Q1
÷
] [P1 ]
(Where P1, Q1 are the initial price and quantity; P2, Q2 are the subsequent price and quantity.)
PED less than 1 = inelastic demand
PED more than 1 = elastic demand
PED = 1 = unit elasticity
Worked example: Price elasticity of demand

The price of a good is £1.20 per unit and annual demand is 800,000 units. Market research indicates
that an increase in price of 10 pence per unit will result in a fall in annual demand of 70,000 units.
Requirement
Calculate the elasticity of demand when the price is £1.20.
Solution
At a price of £1.20, annual demand is 800,000 units. For a price rise:
70,000
% change in quantity × 100% = 8.75% (fall)
800,000
10p
% change in price × 100% = 8.33% (rise)
120p
−8.75
Price elasticity of demand at price £1.20 = = −1.05
8.33
Ignoring the minus sign, the price elasticity at this point is 1.05. Demand is elastic at this point,
because the elasticity is greater than one.
Interactive question 5: Price elasticity of demand

Using the same details and assuming that the demand curve is a straight line, calculate the elasticity
of demand when the price is £1.30.
7.2 Elastic and inelastic demand

The value of price elasticity of demand may be anything from zero to infinity. Demand is referred to
as:
• inelastic if the absolute value is less than 1; and
• elastic if the absolute value is greater than 1
Think about what this means.
• Where demand is inelastic, the quantity demanded changes by a smaller percentage than the
percentage change in price.
• Where demand is elastic, demand changes by a larger percentage than the percentage change
in price.
7.2.1 Special values of price elasticity of demand

There are three special values of price elasticity of demand: 0, 1 and infinity.
• Demand is perfectly inelastic: PED = 0. There is no change in quantity demanded, regardless of
the change in price. This is the case where the demand curve is a vertical straight line.
• Demand is perfectly elastic: PED = (infinitely elastic). Consumers will want to buy an infinite
amount, but only up to a particular price level. Any price increase above this level will reduce
demand to zero. This is the case where the demand curve is a horizontal straight line.
• Unit elasticity of demand: PED = 1. The percentage change in quantity demanded is equal to the
percentage change in price. Demand changes proportionately to a price change.
7.3 What is the significance of price elasticity of demand?

The price elasticity of demand is relevant to total spending on a good or service, which in turn is a
matter of interest to suppliers, to whom sales revenue accrues, and government, which may receive a
proportion of total expenditure in the form of taxation.
• When demand is elastic, an increase in price will result in a fall in the quantity demanded such
that total expenditure will fall.
• Demand inelasticity above zero means an increase in price will still result in a fall in quantity
demanded, but total expenditure will rise.
• With unit elasticity, expenditure will stay constant given a change in price.
Information on price elasticity of demand therefore indicates how consumers can be expected to
respond to different prices, so the effect of different prices on total revenue and profits can be
predicted.

If you are asked about any increase in price, consider the elasticity of demand. If elasticity of demand
is less than 1, any increase in the price will lead to higher revenue.
Interactive question 6: Effect of PED on revenue

Product A currently sells for £5, and demand at this price is 1,700 units. If the price fell to £4.60,
demand would increase to 2,000 units.
Product B currently sells for £8 and demand at this price is 9,500 units. If the price fell to £7.50,
demand would increase to 10,000 units.
Requirements
In each of these cases, calculate:
(a) the price elasticity of demand (PED) for the price changes given; and
(b) the effect on total revenue, if demand is met in full at both the old and the new prices, of the
change in price
7.3.1 Positive price elasticities of demand: Giffen goods and Veblen goods
When the price of a good rises, there may be a substitution effect: consumers will buy other goods
instead because they are now relatively cheaper. But there will also be an income effect in that the
rise in price will reduce consumers’ real incomes and will therefore affect their ability to buy goods
and services. The 19th century economist Sir Robert Giffen observed that this income effect could be
so great for certain basic goods (called Giffen goods) that the demand curve may be upward
sloping. The price elasticity of demand in such a case would be positive.
Giffen observed that among the labouring classes of his day, consumption of bread rose when its
price rose. This happened because the increase in price of this commodity, which made up a high
proportion of individuals’ consumption, had a significant effect on real incomes: people had to
increase their consumption of bread because they could not afford other foods to supplement their
diets.
The demand curve for a good might also slope upwards if it is bought for purposes of ostentation,
so that having a higher price tag makes the good more desirable to consumers and thus increases
demand. Such goods are sometimes called Veblen goods.
7.4 Factors influencing price elasticity of demand for a good

Factors that determine price elasticity of demand are similar to the factors – other than price – that
affect the volume of demand. The PED is really a measure of the strength of these other
determinants of demand.
7.4.1 Availability of substitutes

The more substitutes there are for a good, especially close substitutes, the more elastic will be the
price elasticity of demand for the good. For example, in a supermarket, a rise in the price of one
vegetable such as carrots is likely to result in a switch of customer demand to other vegetables, many
vegetables being fairly close substitutes for each other. This factor is probably the most important
influence on price elasticity of demand.
7.4.2 The time horizon

Over time, consumers’ demand patterns are likely to change, and so if the price of a good is
increased, the initial response might be very little change in demand (inelastic demand) but then as
consumers adjust their buying habits in response to the price increase, demand might fall
substantially. The time horizon influences elasticity largely because the longer the period of time
which we consider, the greater the knowledge of substitution possibilities by consumers and the
greater provision of substitutes by suppliers.
7.4.3 Competitors’ pricing
If the response of competitors to a price increase by one business is to keep their prices unchanged,
the supplier raising its prices is likely to face elastic demand for its goods at higher prices. If the
response of competitors to a reduction in price by one supplier is to match the price reduction
themselves, the supplier is likely to face inelastic demand at lower prices. This is a situation which
probably faces many large suppliers with one or two major competitors.
7.4.4 Luxuries and necessities

Necessities tend to have a more inelastic demand curve, whereas luxury goods and services tend to
be more elastic.
7.4.5 Percentage of income spent on a good

The smaller the percentage of an individual’s income spent on purchasing the good, the more
inelastic demand will be.
7.4.6 Habit-forming goods

Goods such as cigarettes and alcohol tend to be inelastic in demand. Preferences are such that
habitual consumers of certain products become desensitised to price changes.
Interactive question 7: Demand for a good

Under a health strategy, the UK government wishes to increase the purchase of organic food by
consumers by 3% in volume terms. UK government economists have analysed data which reveal that
the price elasticity of demand for organic food is –1.6.
Requirement
By how much should the government encourage suppliers to change the price of organic food,
assuming all other determinants of demand remain the same?
7.5 Income elasticity of demand
Definition
Income elasticity of demand: An indication of the responsiveness of demand to changes in
household incomes.
% change in quantity demanded

Income elasticity of demand =
% change in household incomes
• Demand for a good is income elastic if income elasticity is greater than 1, so that quantity
demanded rises by a larger percentage than the rise in income. For example, if the demand for
downloads will rise by 10% if household incomes rise by 7%, we would say that the demand for
downloads is income elastic. These are luxury goods.
• Demand for a good is income inelastic if income elasticity is between 0 and 1 and the quantity
demanded rises less than the proportionate increase in income. For example, if the demand for
baked beans will rise by 6% if household incomes rise by 10%, we would say that the demand for
baked beans is income inelastic. These are normal goods or necessities.
• Demand for a good is negatively income elastic where, in response to an increase in income,
demand actually falls. These are inferior goods. An example could be coach travel, where
passengers might switch to faster, but more expensive, trains as their income rises.

7.6 Cross elasticity of demand
Definition
Cross elasticity of demand: A measure of the responsiveness of demand for one good to changes in
the price of another good.
% change in quantity of good A demanded *

Cross elasticity of demand =
% change in the price of good B
*(given no change in the price of A)
Cross elasticity depends upon the degree to which goods are substitutes or complements.
• If the two goods are substitutes, such as tea and coffee, cross elasticity will be positive, so a rise in
the price of one will increase the amount demanded of the other.
• If the goods are complements, such as real coffee and cafetieres, cross elasticity will be negative,
so a rise in the price of one will decrease demand for the other.
• For unrelated goods, such as tea and oil, cross elasticity will be 0.
7.7 Price elasticity of supply
Definition
Price elasticity of supply: A measure of the responsiveness of supply to a change in price.
% change in quantity supplied

Price elasticity of supply (PES) =
% change in price
• Where the supply of goods is fixed whatever price is offered, for example in the case of antiques,
vintage wines and land, supply is perfectly inelastic and the elasticity of supply is zero. The supply
curve is a vertical straight line.
• Where the supply of goods varies proportionately with the price, there is unit elasticity of supply
and the supply curve is an upward slope passing through the origin.
• Where the producers will supply any amount at a given price but none at all at a slightly lower
price, elasticity of supply is infinite, or perfectly elastic. The supply curve is a horizontal straight
line.
7.7.1 Elasticity of supply and time

As with elasticity of demand, the elasticity of supply for a product varies according to the time period
over which it is measured. Three lengths of time period may be considered.
• The market period is so short that supplies of the product in question are limited to existing
inventory. In effect, supply is fixed.
• The short run is a period long enough for supplies of the product to be altered by increases or
decreases in current output, but not long enough for the long-term plant and machinery used in
production to be altered. This means that suppliers can produce larger quantities only if they are
not already operating at full capacity; they can reduce output fairly quickly by means of layoffs
and redundancies.
• The long run is a period sufficiently long to allow suppliers’ long-term equipment to be altered.
There is time to build new factories and machines, and time for old ones to be closed down. New
suppliers can enter the industry in the long run.
8 Types of market structure
Section overview
• The market for a good may be structured on the following lines: perfect competition; monopoly;
monopolistic competition; oligopoly (including duopoly).
Definition
Market structure: A description of the number of buyers and sellers in a market for a particular good,
and their relative bargaining power.
8.1 Perfect competition

Perfect competition is characterised by:
• many small (in value) buyers and sellers which, individually, cannot influence the market price;
• no barriers to entry or exit, so businesses are free to enter or leave the market as they wish;
• perfect information such that production methods and cost structures are identical;
• homogeneous (identical) products; and
• no collusion between buyers or sellers
The consequences of perfect competition include:
• suppliers are ‘price takers‘ not ‘price makers’, that is they can sell as much as they want but only at
the market-determined price;
• all suppliers only earn ‘normal’ profits; and/or
• there is a single selling price (see Figure 11.9)
Price
(£)
Market price
Quantity
Figure 11.9: Perfect competition – demand curve
Perfect competition is often seen as an ideal state (for consumers) but very rarely if ever occurs in
practice, mainly due to the fact that:
• there are often barriers to entry;
• there is asymmetric information (see the chapter Governance and ethics for an example of this in
the financial markets);
• goods are differentiated; and
• there may be collusion
We shall see more about these issues a little later.

8.2 Monopoly
Monopoly is characterised by:
• One supplier (or one dominant supplier)
• Many buyers
• Barriers to entering the industry, for instance the capital cost of setting up a national grid of
electricity would be prohibitive for most businesses. Other barriers include:
– patent protection;
– access to unique resources;
– unique talent;
– public sector monopoly; and
– size domination of market
The consequences of monopoly include:
• The fact that businesses can EITHER set the selling price OR determine the quantity supplied, but
the market will determine the other factors
• Monopolists can earn greater than normal profits (‘supernormal profits‘)
Monopolies can be further classified as follows:
• A pure monopoly is a monopoly by virtue of there being only one supplier in the market.
• An actual monopoly is a monopoly by virtue of there being one supplier with a dominant market
share.
• A government franchise monopoly is a pure monopoly that has arisen specifically by virtue of a
government deciding to operate in that way.
• A natural monopoly is a monopoly that arises by virtue of the market displaying such high levels
of fixed costs and low marginal costs (eg, public utilities) that economies of scale are such that
there is no fear of entry into the market from others.
Monopolies are usually (but not always) seen as operating against the interests of consumers, so
there is extensive regulation to control them (see the chapter External regulation of business).
8.3 Monopolistic competition

Monopolistic competition is characterised by:
• many buyers and sellers (as in perfect competition);
• some differentiation between products (not homogeneous as in perfect competition);
• branding of products to achieve this differentiation;
• some (but not total) customer loyalty;
• few barriers to entry; and
• significant advertising in many cases
Examples include:
• Pubs
• Hairdressers
• In both cases, customers display a loyalty or preference to one supplier so that they will not switch
purely on price, as they would do in perfect competition.
Consequences include:
• increases in prices cause loss of some customers; and
• only normal profit earned in the long run (as in perfect competition)
8.4 Oligopoly
Oligopoly is characterised by:
• a few large sellers but many (often small) buyers;
• product differentiation; and
• a high degree of mutual interdependency
Examples include:
• The oil industry (Shell, Esso, BP)
• Banking (Lloyds, HSBC, Barclays)
• Washing powder (P&G, Unilever)
Consequences include:
• businesses compete through non-price competition, particularly advertising and branding;
• price cuts are generally copied by competitors; and
• price increases are not always copied
8.4.1 Duopoly
Duopoly is characterised by:
• two dominant suppliers who between them control prices; and
• a temptation for the two suppliers to act in collusion (which is an illegal breach of competition
laws in most countries)
Consequences include higher prices as competition is very limited.
9 The failure of perfect competition

Section overview
• Free markets are often seen as efficient in resource allocation.

• This efficiency may be allocative or productive.
• However, markets can and do fail because of: market imperfections (monopoly, monopsony,
asymmetric information, and slowness of response); externalities; public goods; economies of
scale (internal and external).
• Internal economies of scale arise from: specialisation of labour; division of labour; larger and
more specialised machinery; dimensions; buying economies; indivisibility of operations; holding
inventory.
9.1 Is perfect competition (a free market) the best structure?

The following arguments are put forward by advocates of the free market.
• Free markets are efficient. Suppliers and buyers react fairly quickly to changes in market
conditions in making their output and purchasing decisions; resource allocation within the
economy is quick to adapt to the new conditions.
• Free markets are impersonal. Prices and levels of output are arrived at as a result of numerous
decisions by consumers and suppliers, and not as the result of regulation or central planning.
• The market forces of supply and demand result in an efficient allocation of economic resources.
– Buyers will want lower prices and suppliers will want higher prices, and a balance of supply and
demand is struck in the market through the price mechanism.
– Suppliers will decide what goods to supply, and in what quantities, by relating their prices to
the costs of production (and the costs of the scarce resources needed to produce them).
– If the price of a product is too high, buyers will want to buy less of it. If the price is too low,
producers will make less of it and switch their production resources into making something
different.
In this context, there are two types of potential efficiency:
• Allocative efficiency is achieved when goods and services that are wanted by buyers are
produced in optimum quantities. Allocative efficiency occurs when resources are allocated in such
a way that it is impossible to re-allocate factors of production to increase overall benefit.

• Productive efficiency is achieved when the economy produces its goods and services at the
lowest factor cost. It occurs when factors of production are organised in such a way that the
average cost of production is at its lowest point.
However, the arguments in favour of a free market are based on the assumption that there is ‘perfect
competition’, including:
• a large number of competing suppliers, each producing a homogeneous product and each
having only a small share of the market
• buyers and suppliers having perfect information about markets and prices
• there is perfect mobility of factors of production, which can be switched easily from making one
type of good into making another
• there is free entry and exit of suppliers into and out of the market
In reality, these assumptions are often not valid. Instead, the free market often fails to allocate
resources efficiently.
9.2 Market failure
Definition
Market failure: A situation in which a free-market mechanism fails to produce the most efficient (the
‘optimum’) allocation of resources.
Market failure is caused by a number of factors:

• Market imperfection with one, or a few, suppliers exerting market power
• Externalities
• The existence of public goods and benefits that are gained by third parties
• Economies of scale. Large-scale production leads to reductions in costs per unit, which are not
matched by price reductions. This leads to above-normal profits and enables large companies to
dominate smaller companies.
9.3 Market imperfection

Market imperfection describes any situation where actual behaviour in the market differs from what it
would be if there were ‘perfect’ competition in the market. The following are examples of market
imperfection.
• If a monopoly supplier controls a market, it might prevent other suppliers from entering the
market (for example, by claiming patent rights, or launching a strong marketing campaign with
the intention of keeping customers away from the new suppliers). By restricting supply in this way,
the monopolist may keep prices higher than they would be in a competitive market, and/or may
cause customers to have to put up with poorer goods than might be available in a competitive
market.
• Just as monopolies are suppliers which dominate supply to a market, monopsony buyers are
large individual buyers who dominate demand in a market. Monopsonists may exert control over
the market, extracting low prices or other favourable conditions from suppliers. An example
sometimes quoted is the immense buying power built up by large supermarkets.
• Consumers may make bad purchasing decisions because they have incomplete and inaccurate,
or asymmetric, information about all goods and services that are available.
• It takes time for the price mechanism to work. Firms cannot suddenly enter a new market or shut
down operations. The slow response of the price mechanism to changes in demand creates
some short-run inefficiency in resource allocation.
9.4 Externalities
In a free market, suppliers and buyers make their output and buying decisions for their own private
benefit, and these decisions determine how the national economy’s scarce resources will be
allocated to production and consumption. Private costs and private benefits, as opposed to social
costs and benefits, therefore determine what goods are made and bought in a free market.
• Private cost measures the cost to the supplier of the resources it uses to produce a good.
• Private benefit measures the benefit obtained directly by a supplier or by a buyer.
• Social cost measures the cost to society as a whole of the resources that a supplier uses.
• Social benefit measures the total benefit obtained, both directly by a supplier or a buyer, and
indirectly (at no extra cost), by other suppliers or buyers.
It can be argued that a free-market system would result in a satisfactory allocation of resources,
provided that private costs are the same as social costs and private benefits are the same as social
benefits. In this situation, suppliers will maximise profits by supplying goods and services that benefit
customers and that customers want to buy. By producing their goods and services, suppliers are
giving benefit to both themselves and the community.
However, there are instances when either:
• suppliers or buyers do things which give benefit to others, but no reward to themselves; or
• suppliers or buyers do things which are harmful to others, but at no cost to themselves
When private cost is not the same as social cost, or when private benefit is not the same as social
benefit, an allocation of resources which reflects private costs and benefits only may not be socially
acceptable. Here are some examples of situations where private cost and social cost differ.
• A supplier produces a good and, during the production process, pollution is discharged into the
air. The private cost to the supplier is the cost of the resources needed to make the good. The
social cost consists of the private cost plus the additional ‘costs’ incurred by other members of
society, who suffer from the pollution.
• The private cost of transporting goods by road is the cost to the haulage company of the
resources used to provide the transport. The social cost would consist of the private cost plus the
social cost of environmental damage, including the extra cost of repairs and maintenance of the
road system, which sustains serious damage from heavy goods vehicles.
Here are some examples of situations where private benefit and social benefit differ.
• Customers at a café in a piazza benefit from the entertainment provided by professional
musicians, who are hired by the café. The customers of the café are paying for the service in the
prices they pay, and they obtain a private benefit from it. At the same time, other people in the
piazza, who are not customers of the café, might stop and listen to the music. They will obtain a
benefit, but at no cost to themselves. They are free riders, taking advantage of the service without
contributing to its cost. The social benefit from the musicians’ service is greater than the private
benefit to the café’s customers.
• A large firm pays for the training of employees as accountants, expecting a certain proportion of
these employees to leave the firm in search of a better job once they have qualified. The private
benefits to the firm are the benefits of the training of those employees who continue to work for
it. The total social benefit includes the enhanced economic output resulting from the training of
those employees who go to work for other firms.
9.4.1 What is an externality?
Definition
Externality: The difference between the private and the social costs, or benefits, arising from an
activity. Less formally, an ‘externality’ is a cost or benefit which the market mechanism fails to take into
account because the market responds to purely private signals. One activity might produce both
harmful and beneficial externalities.
Interactive question 8: Externality

Much Wapping is a small town where a municipal swimming pool and sports centre have just been
built by a private company.
Requirement
Which of the following is an external benefit of the project?
A the increased trade for local shops
B the increased traffic in the neighbourhood

C the increased profits for the private company
D the increased building on previously open land in an inner-city area
9.5 Public goods

Some goods, by their very nature, involve so much ‘spill over’ of externalities that they are difficult to
provide except as public goods whose production is organised by the government.
In the case of public goods, the consumption or use of the good by one individual or group does not
significantly reduce the amount available for others. Furthermore, it is often difficult or impossible to
exclude anyone from its benefits, once the good has been provided. As a result, in a free market,
individuals benefiting from the good would have no economic incentive to pay for it, since they
might as well be ‘free riders’ if they can, enjoying the good while others pay for it.
National defence is perhaps the most obvious example of public good. It is obviously not practicable
for individuals to buy their own defence systems. Policing is another example, although the growth of
private security firms illustrates how some areas of policing are becoming ‘privatised’.
9.6 Economies of scale

When large companies are able to produce goods at a low unit cost because of economies of scale,
but either do not pass these savings onto buyers, or use the advantage to dominate smaller
companies, there is a market failure to allocate resources efficiently.
9.6.1 Reasons for economies of scale

The economies of scale attainable from large scale production may be categorised as:
• internal economies: economies arising within the business from the organisation of production;
or
• external economies: economies attainable by the business because of the growth of the industry
as a whole.
Internal economies of scale arise from the more effective use of available resources, and from
increased specialisation, when production capacity is enlarged.
• Specialisation of labour. In a large undertaking, a highly skilled worker can be employed in a job
which makes full use of their skills. In a smaller undertaking, individuals must do a variety of tasks,
none of which they may do very well (‘Jack-of-all-trades – master of none’).
• Division of labour. Because there is specialisation of labour there is also division of labour, ie,
work is divided between several specialists, each of whom contributes their share to the final
product. A building will be constructed, for example, by labourers, bricklayers, plumbers,
electricians, plasterers and so on. Switching between tasks wastes time, and division of labour
avoids this waste.
• Large undertakings can make use of larger and more specialised machinery. If smaller
undertakings tried to use similar machinery, the costs would be excessive because the machines
would become obsolete before their physical life ends (ie, their economic life would be shorter
than their physical life). Obsolescence is caused by falling demand for the product made on the
machine, or by the development of newer and better machines.
• Dimensional economies of scale refer to the relationship between the volume of output and the
size of equipment (eg, storage tanks) needed to hold or process the output. The cost of a
container for 10,000 gallons of product will be much less than 10 times the cost of a container for
just 1,000 gallons.
• Buying economies may be available, reducing the cost of material purchases through bulk
purchase discounts.
• Indivisibility of operations. There are operations which:
– must be carried out at the same cost, regardless of whether the business is small or large;
average fixed costs always decline as production increases;
– vary a little, but not proportionately, with size (ie, ‘semi-fixed’ costs); and
– are not worth considering below a certain level of output (eg, advertising campaigns)
• Holding inventory becomes more efficient. The most economic quantities of inventory to hold
increase with the scale of operations, but at a lower proportionate rate of increase.
External economies of scale occur as an industry grows in size. For example:
• a large skilled labour force is created, and educational services can be geared towards training
new entrants
• specialised ancillary industries develop to provide components, transport finished goods, trade
in by-products, provide special services and so on – for instance, law firms may be set up to
specialise in the affairs of the industry
The extent to which both internal and external economies of scale can be achieved will vary from
industry to industry, depending on the conditions in that industry. In other words, large sized firms
are better suited to some industries than others.
• Internal economies of scale are potentially more significant than external economies to a supplier
of a product or service for which there is a large consumer market. It may be necessary for a
supplier in such an industry to grow to a certain size in order to benefit fully from potential
economies of scale, and thereby be cost competitive and capable of making profits and surviving.
• External economies of scale are potentially significant to smaller businesses which specialise in
ancillary services to a larger industry. For example, the development of a large worldwide
industry in drilling for oil and natural gas offshore led to the creation of many specialist suppliers,
making drilling rigs and various types of equipment. Thus, a specialist business may benefit more
from the market demand created by a large customer industry than from its own internal
economies of scale.
Where market failure is likely, governments may regulate industries. You need to be aware of
regulatory issues that could impact a business.
9.6.2 Sustainability and climate change

Climate change is an example of an externality, where the costs of economic activity have been
largely borne by society as a whole rather than by the businesses that caused them. Working towards
net zero and a more sustainable economy requires controls to incentivise businesses to reduce their
carbon emissions and operate in a sustainable fashion.
As discussed in the chapter Introduction to business, solutions to climate change can be broadly
divided into regulation and intervention, or market forces. The market forces solutions are
governance, risk management and strategy.

Summary
Aggregate Aggregate
supply demand
Government
Economic environment
Consumers
Macroeconomic Microeconomic
environment of the business environment of the business
Businesses
Market structure The market mechanism
Perfect Monopolistic
Monopoly Oligopoly
competition competition
Efficiency in Market failure Supply Effect of time Demand

allocating resources
Market
imperfections
Determinants
Determinants Movement
Externalities • Price
• Price along curve
• Substitutes
• Price of other
Public goods • Complements
goods
• Income levels
• Prices of goods Shift
Economies • Fashion/
in 'joint supply' of curve
of scale expectations
• Costs
• Income
• Technology
distribution
Supply curve Equilibrium (market) price (P) Demand curve
Elasticity
Price elasticity Income elasticity Price elasticity

Influences Cross elasticity
of supply of demand of demand
Elastic Unit Inelastic
Giffen Veblen
indicated.
1 Can you define the term gross domestic product (GDP)? (Topic 2)
2 Do you know the four main phases of the business cycle? (Topic 2)
3 Do you know what monetary and fiscal policy involve? (Topic 2)
4 Do you know what a shift in the demand curve means and can you name some factors
that might lead to shifts? (Topic 4)
5 Do you know what factors influence the supply of goods? (Topic 5)
6 Can you explain the meaning of equilibrium price (market equilibrium)? (Topic 6)
7 Can you understand how a shift in the demand curve to the left or to the right will affect
the equilibrium price of a product? (Topic 6)
8 Do you know how to calculate the price elasticity of demand, and can you interpret its
meaning? (Topic 7)
9 Can you state the characteristics of perfect competition? (Topic 8)
10 Do you know the meaning of monopoly, monopolistic competition, oligopoly, and

duopoly? (Topic 8)
11 Can you explain allocative efficiency and productive efficiency? (Topic 8)
12 Can you state four factors that might contribute to market failure? (Topic 9)

questions in The economic environment of business and finance chapter of the Business, Technology
and Finance Question Bank. Refer back to the learning in this chapter for any questions which you
did not answer correctly or where the suggested solution has not provided sufficient explanation to
answer all your queries. Once you have attempted these questions, you can move on to the next
chapter, External regulation of business.

Self-test questions

1 In terms of the economic environment, the business cycle is part of:
A national influences in the macroeconomic environment
B global influences in the macroeconomic environment
C the microeconomic environment of the firm
D the price mechanism in the microeconomic environment of the firm
2 Which three of the following are determinants of demand?
A price
B cost of production
C income levels
D changes in production technology
E fashion
3 Grets and Pands are substitutes. Which of the following statements will be true?
A A rise in the price of Grets will lead to a rise in demand for Pands.
B A rise in the price of Pands will lead to a rise in demand for Pands.
C A fall in the price of Grets will lead to a rise in demand for Pands.
D A fall in the price of Pands will lead to a fall in demand for Pands.
4 When demand for a good rises as incomes rise but then falls back as incomes pass a certain point,
the good is termed:
A giffen
B normal
C inferior
D veblen
5 A shift of the demand curve to the right could be caused by which of the following conditions?
A a rise in household income
B a negative change in tastes for the goods
C a fall in the price of a substitute
D a rise in the price of a complement
6 When there is a fall in factor costs the effect will be:
A to shift the supply curve to the right so the market price falls and demand rises
B to shift the demand curve to the right so supply and the market price rise
C to shift the demand curve to the left so supply and the market price fall
D to shift the supply curve to the left so the market price rises and demand falls
7 When the government imposes a maximum price on a market, when will supply be reduced?
A always
B if the maximum price is set above equilibrium
C if the maximum price is set below equilibrium
D never
8 The price of a good is £1.50 and annual demand is 50,000 units. Research has shown that dropping
the price to £1.40 will increase demand by 5,000 units. What is the PED of the good at £1.50?
A 0.10
B 0.67
C 1.50
D 0.10
9 The price of Seagrims has fallen by 5% in the last month, and in the same period demand for Halcets,
where there has been no price change, has risen by 8%. What is the cross-price elasticity of demand
between Seagrims and Halcets?
A –1.600
B –0.625
C 1.600
D 0.025
10 The oil industry is an example of which kind of market structure?
A perfect competition
B monopoly
C duopoly
D oligopoly
this chapter.

• Domestic freezers and perishable products are complements because people buy freezers to
store perishable products.
• Perishable products are supplied either as fresh produce (for example, fresh meat and fresh
vegetables) or as frozen produce, which can be kept for a short time in a refrigerator but for
longer in a freezer. The demand for frozen produce will rise (the demand curve will move to the
right), while the demand for fresh produce will fall (the demand curve will move to the left).
• Wider ownership of freezers is likely to increase bulk buying of perishable products. Suppliers can
save some packaging costs and can therefore offer lower prices for bulk purchases.

Under assumption 1, the demand for swimming pools will be confined to household 1. Even if this
household owns three or four properties, the demand for swimming pools is likely to be less than
under assumption 2, where potentially all five households might want one.

The supply of shares in a particular company is relatively static, although new shares will be issued
from time to time. Demand for a company’s shares will depend largely on how well the company is
performing, although broader economic considerations are also influential. The price mechanism
responds very rapidly – a share price may fluctuate up and down at very short intervals, often
undergoing several changes in the course of a single day. With computers processing programmed
transactions on behalf of traders all the time, in reality share prices are continuously changing even if
just fractionally.

(a) A retail fruit and vegetable market
The market will probably consist of many small traders, each with their own stall and competing
with each other.
The supply conditions affecting prices are:
(1) Costs: the main cost to traders will be the cost of their own wholesale supplies, although
there will also be costs of renting a stall and costs of wages/labour. Even so, costs will be
lower in a market of this kind than in a shopping centre.
(2) The availability of stalls: the prices that traders can charge will depend to some extent on
the number of stalls that there are and the ease with which new traders can acquire a stall
and enter the market.
The demand conditions affecting price are:
(1) The price of similar goods in shops
(2) Shopping habits – for example whether householders are accustomed to buying their food
from markets
(3) The quality of the goods on the market and how they compare with similar goods in shops
(4) How much money shoppers have to spend
(b) An auction of antiques and paintings
The items up for auction will probably have a reserve price. Once the price bid during the
auction rises above the reserve price, the seller cannot supply more of the items. They can only
sell the item at whatever the maximum bid price happens to be.
The supply of items for auction is unlikely to be influenced by cost of the items. The factors which
are relevant to the supply decision are:
(1) The reserve price – the minimum price the supplier will accept
(2) The expected price – the supplier might put an item up for auction in the expectation of
receiving a certain price
(3) Other circumstances (such as personal factors) influencing the supplier’s decision to sell at
all
The price obtained at an auction is mainly determined by demand. Factors influencing
demand are:
(1) The number of potential customers at the auction and the amount of money they have to
spend
(2) The investment value of the items
(3) The tastes of customers and the artistic value they perceive in the items up for sale
(4) The price of similar items at recent auctions elsewhere

We can use the same price/quantity change data, assuming that the demand curve is a straight line,
although we are now looking at a different point on the curve.
At a price of £1.30, annual demand is 730,000 units.
For a price fall from £1.30 of 10 pence:
70,000
% change in demand × 100% = 9.59% (rise)
730,000
10p
% change in price × 100% = 7.69% (fall)
130p
9.59
Price elasticity of demand = = −1.25,
−7.69
or 1.25 ignoring the minus sign.
Demand is even more elastic at this point than it was at £1.20.

(a) Product A
At price £5:
300
Change in quantity = 17.6%
1,700
−40
Change in price = −8%
£5
17.6%
PED = = −2.2
−8%
Demand is elastic and a fall in price should result in such a large increase in quantity demanded
that total revenue will rise.
£
Revenue at old price of £5 ( 1,700 (8,500)
Revenue at new price of £4.60 ( 2,000 9,200

£
Increase in total revenue 700
(b) Product B:
At price £8
500
Change in quantity = 5.3%
9,500
−50p
Change in price = −6.25%
£8
Demand is inelastic and a fall in price should result in only a relatively small increase in quantity
demanded. Total revenue falls.
£
Revenue at old price of £8 (× 9,500) (76,000)
Revenue at new price of £7.50 (× 10,000) 75,000
Fall in total revenue (1,000)

As demand for organic food is elastic, the government can expect a strong response to a reduction
in price, that is an expansion of demand down the demand curve as the price drops. This can be
calculated as follows:
Target increase in demand: 0.03
PED: –1.6
Percentage change in price needed to achieve target increase: 0.03/1.6 × 100% = 1.875%

The correct answer is:
A the increased trade for local shops
Item (b) is an external cost of the project, since increased volumes of traffic are harmful to the
environment. Item (c) is a private benefit for the private company which built the complex. Item
(d) would only be an external benefit if a building is better for the people in the inner-city area
than the use of open land, which is unlikely. Item (a) is correct because the benefits to local
shops are additional to the private benefits of the sports firm and as such are external benefits.
A national influences in the macroeconomic environment
A price
C income levels
E fashion
A A rise in the price of Grets will lead to a rise in demand for Pands.
C inferior
A a rise in household income
A to shift the supply curve to the right so the market price falls and demand rises
C if the maximum price is set below equilibrium
C 1.50
(5,000/50,000)/(£0.10/£1.50)
A –1.600
+0.08/–0.05
D oligopoly

Chapter 12
External regulation of
business
Introduction
Learning outcomes
Syllabus links
Assessment context
Learning topics
1 Why is regulation of businesses necessary?
2 What form does the regulation of businesses take?
3 Direct regulation of competition in a market
4 Direct regulation of externalities
5 Direct regulation of people in business
6 The effect of international legislation
7 International trade
Summary
Self-test questions
Introduction
12
Learning outcomes
• Specify the principal effects of national and international regulation upon businesses
• Show how the needs of different stakeholders in a business (eg, shareholders, the local
community, employees, suppliers, customers) impact upon it
Specific syllabus references are: 5d, 5e
12
Syllabus links
Regulation is developed further in Business Strategy and Technology at Professional level and at the
Advanced level.
12
Assessment context
Questions on business regulation will be set in the assessment in either MCQ or multiple response
12

of this chapter

1–2 Why is regulation Approach You will almost IQ1: Irreversibility

necessary/what In this chapter, we certainly encounter a Helps you think
form does the return to the principles question on business about the
regulation of of regulation, this time regulation in your meaning of the
business take? in the context of exam. principle of
For many people businesses rather than Questions are likely to irreversibility.
working in the accountancy be set in a scenario
business, the profession. Read context, although
practical reality is through section 1 very knowledge-type
that there is a carefully. It draws questions on key
great deal of together quite a few points and principles
regulation of their ideas that we have are also possible.
activities, which already seen, such as Essential points are:
imposes a burden market failure,
from which they protection of the • Why business is
feel little benefit. public interest and the regulated
nature of regulation. • Intended outcomes
Then study section 2 of regulation
equally carefully, • Responses to
completing the
regulation
interactive questions
and making sure you
understand the
intended and actual
effects of regulation
on business.
Stop and think
Why are businesses
regulated so much

and what is regulation

intended to achieve?
What does it actually
achieve?
3–5 Direct regulation Approach This is an area where

of competition, Sections 3–5 deal with questions could come
externalities, and some specific up in the exam. They
people in examples of tend to focus on
business government situations where
There are many regulation of business: regulation is
potential criminal competition (section necessary.
activities that 3) externalities Essential points are:
companies or (section 4). Study each • Different forms of
individuals could of these sections very regulation of
be involved in. carefully before competition
The government, paying equally close
through its attention to section 5, • Role of the
agencies, aims to on direct regulation of Competition and
discourage these people engaged in Markets Authority
crimes and punish business activities. • Different penalties
companies or Stop and think that could be
individuals who levied for anti-
commit them. Most of these competitive
regulations are there behaviour
to ensure that
companies or • Meaning of Insider
individuals do not take trading, market
unfair advantage of abuse, market
their situations to the manipulation,
detriment of other fraudulent and
individuals or wrongful trading,
companies. directors’
disqualification,
money laundering
6 The effect of Approach Exam questions in this

international Skim through section area could test your
legislation 6, just to make you knowledge of
The UK has aware of how international
signed up to a international organisations such as
number of regulation may also be the WTO.
international relevant.
organisations that
have some
regulatory
authority. These
regulations may
have relevance to
UK businesses.
7 International Approach Questions on this area IQ2: Developing

trade Read this section in generally focus on the technologies and
Many businesses detail, noting the different types of tariff international
operate at an advantages and barriers and their regulation gets
international level. disadvantages of impact on companies’ you to think about
In recent years international trade, sales. how technological
developments
ICAEW 2023 12: External regulation of business 407

there has been an and impediments to may lead to the

increase in international trade. emergence of
protectionism. Stop and think international
The UK’s regulations.
departure from Are governments in
the EU will also the major industrial
have some nations currently
implications for helping to increase
importers and international trade or
exporters in terms are they increasing
of possible barriers? What impact
additional tariff does this have on
barriers. businesses?

1 Why is regulation of businesses necessary?
Section overview
• Regulation of businesses addresses market failure and protects the public interest.
• Governments intervene in markets to address market failure caused by market imperfection,
externalities, asymmetric information and lack of equity.
• Regulation also aims to protect the public interest of employees, suppliers, customers, the local
community and the public at large from the self-interest of shareholders, directors and managers.
• Effect of regulation: facilitation of competition; protection of public from abuse of power;
flexibility; fair enforcement; transparency.
• Forms of regulation: legislation/delegated legislation; self-regulation plus oversight; a
combination.
Regulation of business is needed:

• to address market failure and externalities; and
• to protect the public interest
Definition
Regulation: Any form of state interference with the operation of the free market. This could involve
regulating demand, supply, price, profit, quantity, quality, entry, exit, information, technology, or any
other aspect of production and consumption in the market.
1.1 Addressing market failure

As we saw in the chapter The economic environment of business and finance market failure occurs
when the market mechanism fails to result in economic efficiency, so the outcome is sub-optimal in
terms of allocation of resources.
Government often seeks to intervene in the case of market failure, and has several alternative ways of
doing so:
• Providing public goods such as street lighting
• Providing merit goods such as education which are in the long-term interests of society
• Controlling the means of production through state ownership of industries
• Re-distributing wealth through the system for direct taxation of income
• Creating demand for output that creates jobs, such as defence contracts, or major public works
such as road building
• Influencing supply and demand through:
– price regulation (minimum or maximum prices)
– indirect taxation on expenditure on some goods and services, so that supply is restricted as the
price to consumers includes the tax but suppliers only receive the net-of-tax price (the supply
curve shifts to the left)
– subsidies paid by the government to suppliers (shifting the supply curve to the right), in order:
◦ to encourage more production
◦ to keep prices lower for socially desirable goods whose production the government wishes
to encourage
◦ to protect a vital industry such as agriculture
• Influencing markets through persuasion
• Regulating markets through legislation and other means
In this chapter we shall be concentrating on legislation and regulation of markets.

Of the various forms of market failure, the following are the cases where regulation of markets can
often be the most appropriate policy response.
• Market imperfection – where monopoly power is leading to inefficiency, government will
intervene through controls on, say, prices or profits in order to try to reduce the effects of the
monopoly.
• Externalities – a possible means of dealing with the problem of external costs and benefits is via
some form of regulation. Regulations might include, for example, controls on emissions of
pollutants, restrictions on car use in urban areas, the banning of smoking, compulsory car
insurance and compulsory education.
• Asymmetric information – regulation is often the best form of government action whenever
informational inadequacies are undermining the efficient operation of markets. This is particularly
so when consumer choice is being distorted. Examples here would include: regulation of financial
reporting and financial services; legally enforced product quality/safety standards; consumer
protection legislation; the provision of job centres and other means of improving information
flows in the labour market.
• Equity – the government may resort to regulation to improve social justice. For example,
legislation to prevent discrimination in the labour market; regulation to ensure equal access to
goods such as health care, education and housing; minimum wage regulations and equal pay
legislation.
We shall come back to regulations with respect to market imperfection and externalities shortly.
1.2 Protecting the public interest

Just as regulation of the accountancy profession is needed to provide the public interest with
protection and assurance, so too with businesses, which are the source of most wealth creation and
economic power, but which are focused as we have seen on meeting the interests of:
• Shareholders; and
• directors and managers
External regulations on businesses of many different forms are designed to ensure that the needs of
the other stakeholders can be met.
1.3 Functions of the regulation of business

People find it difficult to trust business entities that exist to make profits for the benefit of one very
select group of people, the shareholders. Experience has taught society that this objective has
historically been pursued at the expense of the public interest, so society has increasingly demanded
that business activities should be externally regulated, to restore the balance of power.
2 What form does the regulation of businesses take?

Section overview
• Business is subject to a great deal of formal legislation/regulation.

• Regulation is efficient where the total benefits to some people outweigh the total costs to others.
• Outcomes of regulation: market failures are addressed; social standing of some groups is
enhanced; the collective desires of society are enacted; particular preferences in society are
developed; irreversibility is dealt with.
• Business responses to regulation: non-response; mere compliance; full compliance; innovation
(the Porter hypothesis).
2.1 What is regulation?

In a legal sense, a regulation is a rule created by the government, an administrative agency or
another body which interprets a statute, or the circumstances of applying the statute. It is a form of
secondary or delegated legislation which is used:

• to implement a primary piece of legislation appropriately; and
• to take account of particular circumstances or factors emerging during the gradual
implementation of, or during the period of, a primary piece of legislation
2.2 Outcomes of regulation

Regulation has costs for some and benefits for others. Efficient regulation exists where the total
benefits to some people exceed the total costs to others.
Regulation is justified using various reasons and therefore can be classified in several broad
categories according to its intended outcome. Regulations may be put in place to:
• address market failures (see above)
• increase or reduce the social standing of various social groups
• see through the collective desires of a significant section of society
• enhance opportunities for the formation of diverse preferences and beliefs in society
• affect the development of particular preferences across society as a whole
• deal with the problem of irreversibility (current activities will result in outcomes from which future
generations may not recover at all)
One aspect of applying judgement is appraising public interest and regulatory issues in a business’s
environment. It is therefore important to be aware of the different types of regulations that affect
businesses.
Interactive question 1: Irreversibility

Try to think of at least two ways in which regulations of which you are aware from your general
business knowledge seek to deal with the problem of irreversibility.
2.3 Regulation in respect of sustainability

In the chapter Introduction to business, the issues of sustainability and climate change were
discussed. Solutions to climate change include both market forces and regulation and intervention
by governments. The types of regulation relating to sustainability and climate change include the
following:
• Reporting – governments can introduce legislation on what disclosures should be provided in the
annual reports of companies relating to greenhouse gas emissions and sustainability reports.
Mandatory climate related financial disclosure requirements are being introduced in the UK for
listed companies and large private companies.
• Laws and regulations – for example, the UK Climate Change Act which aims to limit carbon
emissions.
• Taxes and tariffs – for example, in the UK there are taxes on petrol and diesel, which encourage
consumers and businesses to switch to electric vehicles.
• Grants – could be provided to encourage businesses and households to invest in systems that
would reduce their carbon emissions, such as grants to install solar panels.
• Compliance audits – governments may require audits to confirm compliance with environmental
laws.
2.4 Business responses to regulation

Businesses can respond in a variety of ways to regulation:
• Entrenchment of a particular practice (nil or non-response)

• Mere compliance, so that the desired regulatory outcome is met simply by passing on the cost of
compliance to clients and consumers
• Full compliance, so that behaviour is changed and products and processes are adjusted to
comply with regulations
• Innovation: the Porter hypothesis (see below)
We shall deal with compliance in the next section of this chapter.
2.4.1 The Porter hypothesis

The economist Michael Porter formulated the hypothesis that strict environmental regulations trigger
the discovery and introduction of cleaner technologies and environmental improvements, the
innovation effect. This makes production processes and products more efficient, and the cost savings
achieved are sufficient to compensate for both the compliance costs directly attributed to new
regulations and the innovation costs. Overall, therefore commercial competitiveness is improved.
Concluding, recommending and communicating may be tested by identifying risks about particular
advice. Regulatory risk is the risk that there are changes in regulations that may harm a business.
2.5 Regulatory compliance
Definition
Regulatory compliance: Systems or departments in businesses which ensure that people are aware
of and take steps to comply with relevant laws and regulations.
2.6 The role of regulatory bodies

There is a considerable level of business regulation in the UK, and there are a great many bodies
which oversee and enforce these regulations. Examples include the FRC, the PRA and the FCA, which
we saw in the chapter Structure and regulation of the accountancy profession, plus the Competition
and Markets Authority (CMA).
We shall look at the work of this last regulator now.
3 Direct regulation of competition in a market

Section overview
• The level of competition in a market is regulated because the closer a market gets to perfect
competition, the more efficient the allocation of resources in that market.
• Anti-competitive agreements and the abuse of a dominant position are prohibited in the UK.
• Anti-competitive agreements result from collusion between ‘competitors’ in the same market, and
result in price fixing, production limitation, sharing markets, and different trading conditions and
supplementary obligations for consumers.
• A dominant position arises where one business is able to behave independently of competitive
pressures. As a result it may: impose unfair prices; limit developments; apply different trading
conditions and supplementary obligations on consumers. A business will not be considered
dominant unless it controls 40% of the market.
• A cartel of businesses is involved in collusion on prices, discounts, production etc.
• A business that is party to an anti-competitive agreement or a cartel or that abuses a dominant
position may be fined up to 10% of its worldwide annual revenue. Cartels may lead to criminal
sanctions.
• Regulation of competition is effected by the Competition and Markets Authority (CMA).

3.1 Why is the regulation of competition important?
In a market economy the allocation of resources is generally determined by the price mechanism. In
the chapter The economic environment of business and finance we saw that the uninhibited and
rather idealised operation of the price mechanism is called perfect competition, but we also saw that
there are plenty of circumstances where competition is far from perfect, and conditions exist for
monopolies to take over.
Generally, monopolies are not in the public interest as they do not allocate resources efficiently. The
government seeks to diminish them by fragmenting an industry via legislation, so that market share is
not concentrated in the hands of one or two producers. The same effect is also achieved indirectly
sometimes, for instance in the case of new pharmaceutical products, where stringent testing and
government approval are required before they can be marketed.
3.2 How is competition regulated in the UK?

The Competition Act 1998 prohibits agreements, business practices and conduct that damage
competition, namely:
• anti-competitive agreements (Chapter I of the Act)
• abuse of a dominant position (Chapter II)
In addition, the Enterprise Act 2002 makes cartel activity a criminal offence.
The laws apply to all businesses, of whatever size, although there are provisions for immunity,
exception and exemption.
3.3 Prohibiting anti-competitive agreements

Both informal and formal agreements, whether or not they are in writing, are prohibited if they are
agreements resulting from collusion between businesses that have as their object or effect the
prevention, restriction or distortion of competition. Many different types of agreement may fall within
the prohibitions; Chapter I provides an identical illustrative list of examples of agreements to which
the prohibition applies:
• Fixing purchase or selling prices or other trading conditions
• Agreeing to limit or control production, markets, technical development or investment
• Sharing markets or supply sources
• Applying different trading conditions to equivalent transactions, thereby placing some parties at
a competitive disadvantage
• Making conclusion of contracts subject to acceptance of supplementary obligations
Market conditions that lead to increased collusive behaviour are covered under the section on cartels
below.
Agreements will only fall within the Chapter I prohibition if they have an ‘appreciable effect on
competition’; whether this is so in a particular case depends on a number of factors, such as the
market share of the businesses involved in the agreement.
Note though that agreements:
• to fix prices;
• to impose minimum resale prices; or
• to share markets
will generally be seen as capable of having an appreciable effect regardless of how small the
businesses involved are.
A business that is found to be party to an anti-competitive agreement can be fined up to 10% of its
annual worldwide revenue.
3.4 Prohibiting the abuse of a dominant position

Chapter II prohibits the abuse by one or more businesses of a dominant position in a market.

Definition
Dominant position: One where the business is able to behave independently of competitive
pressures, such as other competitors, in that market.
Chapter II gives examples of specific types of conduct that are particularly likely to be considered as
an abuse where the business is in a dominant position. These include:
• imposing unfair purchase or selling prices;
• limiting production, markets or technical development to the prejudice of consumers;
• applying different trading conditions to equivalent transactions, thereby placing certain parties at
a competitive disadvantage; and
• attaching unrelated supplementary conditions to contracts
Factors that help to determine whether there is dominance by a business include:
• its market share – generally, a business is unlikely to be considered dominant if it has less than
40% of the market;
• the number and size of competitors; and
• the potential for new competitors to enter the market
A business that is found to be abusing a dominant position can be fined up to 10% of its annual
worldwide revenue.
3.5 Prohibiting cartels
Definition
Cartel: An agreement between businesses not to compete with each other. The agreement is usually
verbal and often informal.
Cartel members typically agree or collude on:

• prices
• output levels
• discounts
• credit terms
• technology
• which customers they will supply
• which areas they will supply
• who should win a contract (bid rigging)
Cartels can occur in almost any industry and can involve goods or services at the manufacturing,
distribution or retail level. Some sectors are more susceptible to cartels than others because of their
structure or operations. Cartels or collusive behaviour in general are more likely to occur in industries
or sectors where:
• there are few competitors;
• the products have similar characteristics, leaving little scope for competition on quality, service, or
cost;
• communication channels between competitors are already established;
• the industry is suffering from excess capacity; and
• there is general economic recession
A business that is found to be a member of a cartel can be fined up to 10% of its annual worldwide
revenue, whether there was dishonesty involved or not. In addition, participation in agreements
between undertakings at the same level in the supply chain (horizontal agreements) may expose
individuals responsible for those agreements to criminal sanctions under the Enterprise Act 2002.
Businesses and individuals in a cartel who end their involvement and confess may be granted
immunity or a significant reduction of any fine.

3.6 The Competition and Markets Authority (CMA)
The CMA is the government body responsible for promoting effective competition in markets across
the UK economy, with a complementary consumer protection role.
CMA is responsible for:
• investigating mergers which could restrict competition
• conducting market studies and investigations in markets where there may be competition and
consumer problems
• investigating where there may be breaches of prohibitions against anti-competitive agreements
and abuses of dominant positions
• bringing criminal proceedings against individuals who commit the cartel offence
• enforcing consumer protection legislation to tackle practices and market conditions that make it
difficult for consumers to exercise choice
• cooperating with sector regulators and encouraging them to use their competition powers
• considering regulatory references and appeals
In most merger, takeover and market cases the CMA is responsible for making decisions specifically
on competition issues and for making and implementing decisions on appropriate remedies. It does
not have to determine whether matters are against the public interest. The public interest test is
replaced by tests focused specifically on competition issues.
Key implications for businesses are that:
• CMA officials can enter premises and demand relevant documents to establish whether any of
the prohibitions has been infringed
• the CMA can impose a fine for failure to comply with an interim measure in respect of a merger of
up to 5% of annual revenue
• there will be adverse publicity
• competition Disqualification Orders may be made against the directors
4 Direct regulation of externalities

Section overview
• Externalities (external costs and benefits) are regulated by a variety of methods designed
ultimately to affect the level of supply: price regulation; direct taxation or tariffs; subsidies to
suppliers; quotas, standards and fines.
To intervene in the level of supply in a market where there are problems of external costs and
benefits, such as pollution and other environmental damage, the government can use:
• price regulations (setting maximum or minimum selling prices, as we saw in the chapter The
economic environment of business and finance)
• direct or indirect taxation or tariffs
• subsidies to suppliers, for instance to encourage exports
• regulation, by means of:
– quotas, that is physical limits on output so that output is set at the social optimum;
– standards that must be complied with; and/or
– fines for those businesses that do not meet the necessary standards
Context example: Regulation of pollution by emissions trading

As part of government environmental and sustainability policies many businesses are set standards
for pollution control and quotas for emissions (which may be bought and sold as tradable permits
on the emissions trading market), plus they may be fined if they create unacceptable levels of
pollution. It is hard however to pre-set pollution fines and output quotas without having accurate and

reliable estimates for private benefits, private costs and external environmental damage arising from
pollution. In addition, compliance with environmental regulations is costly to enforce, and it may be
impossible to monitor all businesses accurately because of imperfect information. Finally, setting the
levels of the fines can be difficult: some businesses may not cut their emissions of pollutants if the
fine they receive is less than the private benefit they derive from polluting. Fines must have some
impact, which is perhaps best determined by setting them as a percentage of revenue or gross
profit.
There will be ethical and public interest implications of businesses adopting anti-competitive
practices.
5 Direct regulation of people in business

Section overview
Directors and other people engaged directly in managing companies are subject to direct
regulation:
• to prevent insider dealing, market manipulation and market abuse, if the company’s shares are
listed
• to prevent wrongful trading if the company is insolvent, and fraudulent trading whether or not the
company is insolvent
• to control the activities of directors who have been involved with insolvent companies, or who
have committed some other forms of misdemeanour
• to prevent money laundering
It is not only businesses as entities that are subject to regulation. Individuals too are regulated in the
way they manage and deal with listed and insolvent businesses, in order to protect the public interest
and the interests of company creditors.
5.1 Insider dealing and market manipulation

People ‘in the know’ commit a crime under the Criminal Justice Act 1993 if they use knowledge they
have as business ‘insiders’ to make a profit or avoid a loss when buying or selling shares on the back
of that knowledge and at the expense of open dealings in the market. The crime of insider dealing
extends to getting someone else to deal, and to disclosing the relevant information at all.
Significant inside knowledge – of a takeover, an oil strike or a massive fall in profits – will affect the
share price when it becomes known, so insiders who benefit from dealing in advance of the
knowledge becoming generally known are guilty of market manipulation under the Financial
Services Act 2012.
5.2 Market abuse

People engaged in the stock market are expected to observe the Code of Market Conduct issued by
the FCA, which embodies the standard of behaviour that is reasonably expected of such a person. If
they fail to do so they may have committed a civil offence under the Market Abuse Regulation (MAR).
The Code of Market Conduct describes ‘market abuse’ as behaviour which occurs in relation to
qualifying investments trading on a prescribed market, that is securities listed on the London Stock
Exchange.
The Code of Market Conduct provides the following examples of market abuse:
• Insider dealing, including:

– improper disclosure creating an unfair market place; and
– misuse of information as an insider
• Manipulating transactions and thus creating a false or misleading impression about supply,
demand, prices and values in the market
• Manipulating devices – trading and then employing fictitious devices or any other form of
deception or contrivance, such as spreading misleading information, to distort the price
• Dissemination – giving out information that conveys a false or misleading impression where the
person who disseminates the information knows it to be false or misleading
• Distortion and misleading behaviour to induce another person to act in a particular way in the
market
The Market Abuse Regulation strengthens existing UK market abuse regulation in a number of areas:
• Extending insider dealing to spot contracts and clarifying that the rules also apply to amending or
cancelling existing market orders after being party to inside information. The rules also apply to
recommending or inducing another to transact on the basis of inside information.
• Creating a ‘market soundings’ framework to allow legitimate disclosures of inside information in
certain circumstances.
• Extending market manipulation rules to apply to attempted market manipulation and spot
contracts.
• Making certain transactions exempt from the rules (such as buy-back and stabilisation schemes
and instances of ‘Accepted Market Practice’ (AMP)).
• Placing obligations on organisations, such as in regard to disclosure of insider lists, suspicious
transactions and managers’ transactions. There are also obligations in regard to investment
recommendations and whistleblowing.
5.3 Fraudulent trading

Directors of companies must be very careful of the danger of continuing to trade when the company
is insolvent – that is, when the company cannot pay its debts as they fall due. If a company that is
being liquidated as insolvent is found to have been carried on with the intent to defraud creditors, or
indeed for any fraudulent purpose, directors and managers who were knowingly party to this are
said to have engaged in fraudulent trading and can be personally liable for the company’s debts
under the Insolvency Act 1986.
Directors of any company that engages in fraudulent trading may also face criminal sanctions,
whether or not insolvency is involved, under the Companies Act 2006.
A business may be carried on fraudulently just by making one transaction or by paying off debts
rather than making trading contracts.
5.4 Wrongful trading of an insolvent company

Even if there is no fraud involved, a director engaged in wrongful trading may still be required by a
liquidator to make a contribution to an insolvent company’s assets under the Insolvency Act 1986.
This may arise where the director knew, or should have known, that there was no reasonable
prospect of the company avoiding insolvent liquidation, or where the director took insufficient steps
to minimise the potential loss to creditors. Professional accountants are more at risk of falling foul of
these rules than anyone else, as their skills, knowledge and experience mean they are judged by
higher standards than those applied to non-professionals. This is true even if they are accountants
employed as sales or marketing directors, for instance, rather than as finance directors.
5.5 Disqualification of directors

To protect the public in general and creditors in particular, a person may be disqualified from acting
as director or manager of companies for a wide range of reasons under the Company Directors
Disqualification Act 1986. These include:
• insider dealing
• fraudulent or wrongful trading
• violating competition laws (see above)

• being convicted of an offence in connection with the promotion, formation, management or
liquidation of a company or with the receivership or management of a company’s property
• being the director of an insolvent company
• being unfit to act as director or manager, such as failing to read the company’s accounts
• being consistently in default regarding company law requirements, such as failing to keep proper
accounting records
• being a threat to the public interest
• making loans from company funds that were unlikely to be repaid
5.6 Money laundering

There are very extensive regulations on money laundering that were made following the Proceeds of
Crime Act 2002, particularly the Money Laundering Regulations 2017. The CCAB issued the Anti-
Money Laundering Guidance for the Accountancy Sector in March 2018, and this is approved by the
Treasury as ‘relevant guidance’ within the meaning of the Money Laundering Regulations 2017.
Courts must consider relevant guidance when determining whether an accountant’s conduct gives
rise to certain offences under either the Act or the Regulations.
It is this guidance which practitioners must implement and comply with if they are not to breach the
anti-money laundering requirements. As noted in the chapter Structure and regulation of the
accountancy profession, the ICAEW is an AML supervisor and ensures its members comply with anti-
money laundering laws and regulations.
6 The effect of international legislation

Section overview
• International legislation regulates some markets more than others; the effect is generally not
global.
• International legislation for the regulation of business is driven to a great extent by: international
bodies (WTO, IMF, ICC); governments (especially the US and regional trade groups such as the
EU); businesses (especially US corporations).
The emergence of global regulation does not necessarily happen at the same time as the
globalisation of either markets or business organisations. Gambling, for example, via the internet, is a
global market, but it is regulated in different ways by different states. By contrast, regulations relating
to prescription drugs are now largely global in effect, but national markets are kept isolated from one
another by differences in government policy on medicine as a welfare benefit.
The processes that result in developments in global regulation are complex and vary from industry to
industry. But some common features emerge.
• The US has huge influence over the globalisation of regulation; the EU has similar influence in
continental Europe.
• International organisations such as the World Trade Organisation (WTO), International Monetary
Fund (IMF) and International Chamber of Commerce (ICC) also have extensive power to influence
the development of regulations.
• US corporations are very effective at enrolling the power of their own government and
international bodies to promote their interests.
Regulation has great potential both to further and to frustrate business plans. The adoption of one
company’s patented technology as a global standard confers huge benefit; conversely, regulations
relating to pollution or working conditions have great potential to drive up costs. It is therefore in the
interests of businesses to remain alert to the general thrust of regulation as it affects their industries,
and to participate in the processes of lobbying and representation that underpin it.

7 International trade
Section overview
• The benefits of industrialisation have been sought by most economies via either import
substitution or exports.
• International free trade supports the efficient allocation of resources in the world by encouraging:
specialisation; evening out of surpluses and deficits of resources; competition; economies of
scale; closer political links.
• Barriers to free international trade (protectionism) are formed by: tariffs; customs duties; quotas
on imports; embargoes; hidden subsidies; import restrictions; exchange rate manipulation.
7.1 What are the economic advantages of international free trade?

The doctrine of comparative advantage states that countries should stick to what they are best at,
which may suggest preserving the status quo. Nevertheless, the benefits of industrialisation have
been sought by many nations via two main routes.
• Import substitution: a country aims to produce manufactured goods which it previously imported.
It does this by protecting local producers.
• Export-led growth: relying on cheap labour, businesses ensure economic growth by exporting.
The success of this particular strategy depends on the existence of open markets elsewhere.
Although export-led growth has meant that global trade has opened up, the existence of global free
trade and markets should not be taken for granted in terms of all products and services, or indeed in
all territories. Services in particular are still subject to managed trade (for example, some countries
prohibit foreign firms from selling insurance) and there are some services which by their very nature
can never be exported (eg, hairdressing).
Encouraging international free trade has the following advantages.
• Countries specialise in items they produce comparatively most efficiently so resources are
allocated efficiently.
• Some countries have a surplus of raw materials to their needs, and others have a deficit. A country
with a surplus (eg, of oil) can take advantage of its resources to export them. A country with a
deficit of a raw material must either import it, or accept restrictions on its economic prosperity and
standard of living.
• Competition is increased among suppliers in the world’s markets. Greater competition reduces
the likelihood of a market for a good in a country being dominated by a monopolist, and will
force businesses to be competitive and efficient, producing goods of a high quality.
• Larger markets are created for a business’s output, and so some businesses can benefit from
economies of scale by engaging in export activities. Economies of scale improve the efficiency of
the use of resources, reduce output costs and also increase the likelihood of output being sold to
the consumer at lower prices than if international trade did not exist.
• The development of trading links provides a foundation for closer political links.
Note, however, that high transport costs can negate the advantages of specialisation and
international trade.
7.2 Barriers to free international trade

Many legislative and other barriers to free trade exist because governments try to protect home
industries against foreign competition. This is known as protectionism and it has become
increasingly common in recent years. For example in 2019, the USA and China became involved in a
trade war with both sides imposing tariffs (see below) on imports from the other country.
Protectionism can be practised by a government in several ways:
• tariffs or customs duties
• import quotas
• embargoes (bans on certain imports or exports)

• hidden subsidies for exporters and domestic producers
• import restrictions
• government action to devalue the nation’s currency (reduce its foreign exchange value)
7.2.1 Tariffs or customs duties

Tariffs or customs duties are taxes on imported goods. The effect of a tariff or duty is to raise the
price paid for the imported goods by domestic consumers, while leaving the price paid to foreign
producers the same, or even lower. The difference is transferred to the government sector.
An ad valorem tariff is one which is applied as a percentage of the value of goods imported. A
specific tariff is a fixed tax per unit of goods.
7.2.2 Import quotas and embargoes

Import quotas are restrictions on the quantity of a product that is allowed to be imported into the
country. The quota has a similar effect on consumer welfare to that of import tariffs, but the overall
effects are more complicated.
• Both domestic and foreign suppliers enjoy a higher price, while consumers buy lower quantities
at the higher price
• Domestic producers supply more
• There are fewer imports (in volume)
• The government collects no revenue
An embargo on imports from one particular country is a total ban, ie, effectively a zero quota.
7.2.3 Hidden subsidies and import restrictions

An enormous range of government subsidies and assistance for exports, and deterrents against
imports, have been practised.
• For exports – export credit guarantees (insurance against irrecoverable debts for overseas sales),
financial help (such as government grants to the aircraft or shipbuilding industry) and
administrative assistance
• For imports – complex import regulations and documentation, or special safety standards
demanded on imported goods and so on
When a government gives grants to its domestic producers, for example regional development
grants for new investments in certain areas of the country or grants to investments in new industries,
the effect of these grants is to make unit production costs lower. These give the domestic producer a
cost advantage over foreign producers in export markets as well as domestic markets.
Understanding the business context is one of the skills included within assimilation and using
information. One factor in the business context is likely to be the extent of international trade in the
industry and the extent of barriers to trade.
Interactive question 2: Developing technologies and international regulation

Think about the increasing use of technologies such as the increasing use of smart phones and the
growth of large multinational technology companies. How do you think their emergence will affect
international regulation?

Summary
Free trade
agreements Barriers to
free trade
International
organisations
Trade Economic
advantages
Effect of
international legislation
Regulation of
people
Regulation of
Nature Purpose • Insider trading
business • Market abuse
• Fraudulent
• Legislation Outcomes Responses • Address market trading
• Delegated failure • Wrongful
legislation • Address trading
Role of regulatory
• Self- externalities • Disqualification
bodies
regulation • Protect public of directors
interest • Money
Direct regulation laundering
of externalities
Regulation of
• Price regulation (Ch 13) competition
• Taxation
• Tariffs • Anti-competitive agreements
• Subsidies • Abuse of dominant position
• Cartel activity
CMA

indicated.
1 Do you know the meaning of ‘market imperfection’, ‘externalities’, ‘asymmetric

information’ and ‘equity’? (Topic 1)
2 Can you list the four responses that businesses may take to regulation? (Topic 2)
3 Can you remember examples of anti-competitive agreements that are prohibited under
the Competition Act 1998? (Topic 3)
4 Do you know what are the different ways that governments might intervene in markets
where there are problems of external costs and benefits? (Topic 4)
5 Do you know who the ‘Code of Market Conduct’ applies to and what it deals with? (Topic
5)
6 Do you know what influences international regulations? (Topic 6)
7 Do you know what the barriers to international trade are? (Topic 7)

questions in the External regulation of business chapter of the Business, Technology and Finance
queries. Once you have attempted these questions, you can move on to the next chapter Data
Analysis.

Self-test questions

1 The provision of public goods by government is an example of intervention to address market failure
caused by:
A market imperfection
B externalities
C asymmetric information
D lack of equity
2 By the direct taxation of income government is seeking to:
A provide public goods
B provide merit goods
C redistribute wealth
D create demand
3 Regulation of financial reporting is an example of intervention in order to alleviate market failure
caused by:
A market imperfection
B externalities
D lack of equity
4 Grando plc operates in a market where compliance with regulations has added £1.50 to the cost of
each unit produced. As a result, Grando plc has raised its price from £12.60 per unit to £14.10. It has
not made any other changes. Grando plc’s response is an example of:
A mere compliance
B full compliance
C non-response
D innovation
5 Of a market worth £12.5m, Topping plc has a £2m share and Bartholomew plc has a £3.5 million
share. They require customers to sign an agreement that they will pay a £10,000 penalty if the
customer terminates the contract within two years. This is an example of:
A an abuse of dominant position by both companies
B an anti-competitive agreement between the two companies
C a cartel of the two companies
D all of the above
6 In-depth inquiries into the regulation of major industries are conducted by:
A the Financial Conduct Authority (FCA)
B the Competition and Markets Authority (CMA)
C the Financial Reporting Council (FRC)
D the London Stock Exchange (LSE)
7 A UK industry has been lobbying Parliament to require goods bought from three Asian countries for
sale in the UK to be subject to additional safety checks. From the perspective of supporting free
trade the UK Government may be reluctant to agree as this would be an example of:
A a tariff
B a quota

C dumping
D an import restriction
this chapter.


There are many possible examples. One of the most obvious is government regulations on emissions
and climate change, which seek to prevent the destruction of the natural environment – a pretty
important irreversible effect of current activities on future generations! Another important example is
the regulation of pensions, which should seek to prevent erosion of the funds available for future
pensioners.

There are many possible answers to this question. International regulations (for example in regard to
data protection) must adapt to take into account the speed of data and information as well as the
many forms it has and the uses it can be put to. Taxation of large technology companies has also
been an area that international governments are trying to agree on to ensure that revenues are taxed
in the countries that they are earned in.

B externalities
C redistribute wealth
A mere compliance
B an anti-competitive agreement between the two companies
As neither company has 40% of the market, neither is in a dominant position.
B the Competition and Markets Authority (CMA)
D an import restriction

Chapter 13
Data analysis
Introduction
Learning outcomes
Syllabus links
Assessment context
Learning topics
1 Use of data in business
2 Sources of data and information
3 Qualities of good information
4 Data analysis
5 Spreadsheets
6 Potential problems with data
7 Presentation of information
8 Big data
9 Data science
Summary
Self-test questions
Introduction
13
Learning outcomes
• Specify the purpose of data, the different types and sources of data, the importance of data
comparability and the role of professional scepticism in relation to data collection, analysis and
visualisation
• Specify principles in relation to the collection and analysis of data, including populations, surveys,
presentation of simple frequency distributions, basic sampling and data ethics
• Identify types of error in data and types of data bias, including their causes and effects
• Identify issues in relation to the use of spreadsheets and the visualisation and interpretation of
data in graphs, charts etc
• Identify the characteristics of big data
• Specify uses of data science and data analytics by organisations
Specific syllabus references are 6a, 6b, 6c, 6d, 6e, 6f
13
Syllabus links
Knowledge of data analysis is developed throughout the ACA scheme. At the certificate level the
Management Information module also requires an understanding of issues around data bias. At the
professional level, the Business Strategy and Technology module requires the ability to use data to
evaluate strategic decisions and risks. At the advanced level the Audit and Assurance and Corporate
Reporting modules require students to analyse datasets that include thousands of transactions.
13
Assessment context
Questions on data analysis will focus on why data is used and potential problems with data analysis.
Questions will be set in multiple choice format, either as a straight test of knowledge or in a
scenario.
13

of this chapter.

Questions
1 Use of data in business Approach Questions are

We live in the This section is likely to focus on
information age, where introductory in the meaning of
many of the largest nature. Read planning, control
companies owe their through it and be and decision
success to their ability to aware of the making, and
make the best use of difference identifying which
information and data. between data of these activities
and information, a particular piece
and the main of data is most
activities that useful for.
data is used for.
Stop and think
Think about the
planning,
controlling and

Questions
decision-making
activities that you
perform in your
personal life.
What information
do you use when
you perform
these?
2 Sources of data and Approach Questions on

information Read fairly sources of data
As an accountant quickly through are likely to focus
working in a business, internal and on which
you may be asked to external data particular source
help identify sources of sources as you would be best for
data. As this section may be aware of a particular type
shows there are many many of these. of data.
new sources, particularly Make sure you
thanks to the ‘internet of understand the
things’. concept of the
internet of things.
3 Qualities of good Approach Exam questions IQ 1: Good

information Make sure you are likely to focus information
Providing information is understand and on which
the core task of the appreciate the particular facets
accountant. Knowing components of of good
what makes good the ACCURATE information are
quality information is mnemonic and present in, or
something that you will learn this. missing from, a
find useful throughout particular piece
Stop and think of information.
your career.
Think about a
piece of
information you
used recently –
for example
instructions on
how to find
something.
Analyse it using
the ACCURATE
acronym.
4 Data analysis Approach Exam questions

As an accountant, you The examiner will focus on your
would need to expects you to ability to interpret
understand the results of understand the analysis. Ensure
data analysis and the purpose of the you know what
potential pitfalls, without statistical the various
necessarily having techniques used. analyses mean,
detailed statistical You would not be particularly the
knowledge. This section expected to mean, standard
introduces the basic perform deviation, and
statistical methods. calculations for regression. Can
most of these you interpret the
items. Take this different values
ICAEW 2023 13: Data analysis 429

Questions
section slowly, of the correlation

ensuring you coefficient? Do
understand the you know what
concepts type I and type II
covered. errors are?
Stop and think
Do any of your
outside interests
include reading
analysis of any
data? Perhaps
you analyse the
performance of
your favourite
sports team?
How did you
learn to
understand the
analysis given?
5 Spreadsheets Approach Exam questions

Read through the would not
first section which require you to
introduces the use
concept of a spreadsheets.
spreadsheet. If They are likely to
you have used a test your
spreadsheet understanding of
application, you their use and the
will know the potential
information in problems and
this section. solutions.
Spend more time
on sub sections 2
and 3 which deal
with the use of
spreadsheets in
finance and
potential
problems with
their use.
Understand the
principles in the
ICAEW list of
principles.
6 Potential problems with Approach Exam questions

data Ensure you know will test whether
An important quality of a the meaning of you know the
professional accountant comparability meaning of the
is professional and the different terms. They are
scepticism. When types of data likely to be
looking at data analysis bias. Learn the scenario based
an accountant needs to meaning of the (eg, proving you
know what questions to two types of error with an example
ask to ensure that the (type 1 and type of some data that
is compromised,

Questions
data is reliable. This 2) from and asking you to

section looks at ways in hypothesis identify what type
which the reliability of testing. of bias or error
data may be exists).
compromised.
7 Presentation of Approach Exam questions

information Review the will focus on your
Being able to present different types of ability to interpret
information well is a skill chart shown and charts, or on your
that all professional staff ensure that you ability to choose
will find useful. understand them. which type of
You would not diagram would
need to produce be most
such diagrams in appropriate for a
the BTF exam. Be particular
aware too of the situation.
principles of
good
presentation.
8-9 Big data and data Approach Exam questions

science Learn the could test
Big data is an area that meaning of big definitions of the
has been growing in data and the 4Vs. concepts
importance over the last Ensure that you covered in these
10 years. Initially it was understand the two sections.
only large companies factors that have
that had the resources to led to the growth
analyse big data but of big data. Make
developments in sure you know
technology have meant the meaning of
that sophisticated data data science and
analysis is open to most data analytics.
business organisations. Appreciate how
big data and data
analytics can
create value for
companies.
Ensure you know
the different
types of big data
(structured/
unstructured) and
source
(processed data,
open data and so
on).

1 Use of data in business
Section overview
• Data refers to unprocessed facts, information is data that has been processed and is therefore
useful.
• Information can help organisations to plan, control and make decisions more effectively.
1.1 What is data and information?

These two terms are often used interchangeably, and it is useful at this point to make sure you are
clear about the distinction between them.
Definitions
Data: Distinct pieces of information, which can exist in a variety of forms – as numbers or text on
pieces of paper, as bits or bytes stored in electronic memory, or as facts stored in a person’s mind.
Information: The output of whatever system is used to process data or to organise it in a useful way.
This may be a computer system, turning single pieces of data into a report, for instance.
1.2 Types of data

Quantitative data is data that concerns quantitative variables such a measurements or counts. It is
expressed as numeric values (eg, the number of units sold per day, or the height of individuals).
Quantitative data lends itself to statistical and other analysis.
Qualitative data is data about variables that are derived from qualitative attributes (eg, gender, or
nationality), which cannot be expressed in numerical terms. As discussed in the chapter Introduction
to risk management it is more difficult to analyse such data using statistical analysis. It would not be
possible for example to talk about the mean favourite colour of a group of individuals. The mode can
be used as a measure of central tendency (eg, the most popular colour is blue). If the colours were
ordered according to the rainbow and each one was ascribed a number, we could identify the
median as well as the mode and that would be meaningful.
Discrete data can only take exact values (usually a whole numbers), and usually refers to items that
can be counted (eg, the number of people in a group).
Continuous variables can take any value within a range (for example the height of individuals). If we
were collecting data about the height of individuals, and only specified whole numbers (170 cm, 171
cm etc) we would exclude the heights of people who fall between these values (eg, 170.4 cm). It
would not be practical to precisely list all possible heights, as infinitesimally small differences in
height between individuals would need to be specified. With continuous variables, we therefore
specify ranges, and analyse the values based on which range they fall in (eg 170–171 cm, 171–172
cm etc).
1.3 Uses of data

The amount of data that is created by society is increasing at an exponential rate. According to
Bernard Marr, every two days we create as much data as we did from the beginning of time until
2003. Some of the most successful companies in the world owe their success to their ability to use
data to give themselves a competitive advantage. Data can be analysed and used to inform the
management of businesses. Essentially, data can be used for the following activities:
• planning
• decision making
• control
1.3.1 Planning
Businesses need to plan their activities to ensure that they have sufficient resources (labour,
materials and production capacity) to meet their anticipated demand. Analysis of data can help

managers make more accurate forecasts of what will happen and therefore better plans (eg,
supermarkets need to plan which products to stock, and in what quantities, based on anticipated
customer demand).
1.3.2 Decision making

Organisational managers constantly make decisions, from short-term operational decisions to
longer-term strategic decisions. At the strategic level, businesses need to plan new products or
services, and therefore need information about what customers want (or what they will want) in the
future. Often decisions may be mutually exclusive, meaning that managers have to choose between
two or more potential actions. If such decisions are supported by good data, then better decisions
will be made leading to organisations achieving their objectives (eg, profits) more effectively.
When making decisions about risk, having more accurate information about the expected returns
and standard deviations of different projects would enable managers to better manage risk (eg,
selecting the project with the lower standard deviation where two projects have the same return
(assuming the two projects are mutually exclusive, so they cannot both be chosen). Refer back to the
chapter Introduction to risk management for detail about the use of information to support decision
making relating to risk.
1.3.3 Control
Control involves ensuring that an organisation is achieving its objectives and taking action to
remedy situations where the organisation is deviating from its plans. Traditionally, financial
information was widely used for this purpose, such as comparing actual profits against budgets.
Thanks to technology, much more quantitative, non-financial data is now available that enables
organisations to monitor their operations in greater detail, in real time (eg, the use of sensors in
machines that can alert the users if the machine is starting to malfunction).
Note: Refer back to the chapter The finance function and financial information for more detail about
the uses of financial information. See section 8 below for the uses of big data.
2 Sources of data and information

Section overview
• Useful data/information comes from both inside and outside the organisation, from a variety of
sources.
• The internet of things is an important source of data. Smart devices, software, sensors and
security devices are all part of the internet of things.
2.1 Internal data sources

Knowledge Content
Capturing data/information from inside the organisation involves the following:
• a system for collecting or measuring transactions data – for example: sales, purchases, inventory
etc, – which sets out procedures for what data is collected, how frequently, by whom, and by what
methods, and how it is processed, filed or communicated
• informal communication of information between managers and staff (for example, by word-of-
mouth or at meetings)
• communication between managers
Inside the business, data/information come from the following internal sources:
• The accounting records: Computerised accounting systems hold information that may be of great
value outside the finance function, for example, sales information for the marketing function. To
maintain the integrity of its accounting records, a business operates controls over transactions.
These also give rise to valuable information. An inventory control system, for example, will include
details of purchase orders, goods received notes, goods returned notes and so on, which can be
analysed to provide management information about speed of delivery, say, or the quality of
supplies.

• Human resources and payroll records, holding information on people, their skills and aspirations,
and so on.
• Machine logs and computer systems in production/operations containing information about
machine capacity, fuel consumption, movement of people, materials used, and work in progress,
set up times, maintenance requirements and so on.
• Procurement data systems (for example, Electronic Data Interchange (EDI) systems which share
data between organisations in the supply chain) hold information on the organisation’s purchases
of raw materials and other goods and services that they buy in.
• Timesheets in service businesses, notably accountants and solicitors, containing data on the time
spent on various activities, both to justify fees to clients and to assess the efficiency and
profitability of operations.
• Staff: Information may be obtained either informally in the course of day-to-day business or
through meetings, interviews or questionnaires.
2.2 External data sources

Capturing data information from outside the business may be formal or informal.
Formal collection of data from outside sources includes the following:
• a business’s tax specialists will gather information about changes in tax law and how this will
affect the business
• obtaining information about any new legislation on health and safety at work, or employment
regulations, must be the responsibility of a particular person who must then pass on the
information to managers affected by it
• research and development (R&D) work often relies on information about other R&D work being
done by another business or by government institutions
• marketing managers need to know about the opinions and buying attitudes of potential
customers. To obtain this information, they carry out marketing research exercises
Informal gathering of information from the environment goes on all the time, consciously or
unconsciously, because the employees of an organisation learn what is going on in the world
around them – from the internet, social media, newspapers, television reports, meetings with
business associates or the trade press.
A business’s files (paper and computerised) include information from external sources such as
invoices, letters, emails, advertisements and so on received from customers and suppliers.
Sometimes additional external information is required, requiring an active search outside the
business. The following sources may be identified, accessed usually via the internet:
• the government
• advice or information bureaux, such as Reuters or Bloomberg
• data sharing portals (web-based access to shared data)
• consultancies of all sorts
• newspaper and magazine publishers
• specific reference works which are used in a particular line of work
• libraries and information services
• the systems of other businesses
2.3 The internet of things

The internet of things is increasingly becoming an important source of data, with smart technology at
the forefront. Examples of technology that form the internet of things include the following:
• smart devices (gas and electricity meters, smartphones, radio-frequency identification (RFID) tags
and fitness trackers)
• software (such as applications to control the smart devices)
• sensors (such as motorway traffic sensors and ‘black boxes’ used in cars for insurance purposes)
• security devices (such as CCTV and number plate recognition technology) that can be tracked via
the internet

Smart phones, which can provide data about the location of the owners and their movements.
3 Qualities of good information

Section overview
• Information should be ACCURATE and complete. It should have a benefit that is in proportion to
its cost, and it should be targeted at its user. It should be relevant and from an authoritative
source. It should be provided at the time when it is needed, and it should be easy to use.
• What makes information valuable is its source, its ease of assimilation, its accessibility and its
relevance.
• The cost of obtaining information should be less than the benefits it brings.
Information of whatever type is of good quality if it has eight key characteristics, which are easiest to
remember if you use the mnemonic ACCURATE.
Note that the second A here stands for ‘Authoritative’, an increasingly important concern given the
huge proliferation of information sources available online today.
Quality Example
Accurate Figures should add up, the degree of rounding should be appropriate, there
should be no typographical errors, items should be allocated to the correct
category, and assumptions should be stated for uncertain information (no
spurious accuracy).
Complete Information should include everything that it needs to include, for example
external data if relevant, or comparative information.
Cost- It should not cost more to obtain the information than the benefit derived from
beneficial having it. Providers of information should be given efficient means of collecting
and analysing it. Presentation should be such that users do not waste time
working out what it means.
User-targeted The needs of the user should be borne in mind, for instance senior managers
may require summaries, whereas junior ones may require detail.
Relevant Information that is not needed for a decision should be omitted, no matter how
‘interesting’ it may be.
Authoritative The source of the information should be a reliable one (not, for instance, ‘Joe
Bloggs’ Predictions Page’ on the internet, unless Joe Bloggs is known to be a
reliable source for that type of information).
Timely The information should be available when it is needed.
Easy to use Information should be clearly presented, not excessively long, and sent using
the right medium and communication channel (email, phone, hard-copy report
etc).

Exam questions may describe some information and ask you to identify which of the qualities of
good information is missing. It is therefore important to know the meaning of these terms.
Interactive question 1: Good information

Managers often complain that they are weighed down by information which they struggle to make
sense of and to use. Which of the ACCURATE qualities of good information are most often ignored in
information given to managers?
4 Data analysis
Section overview
This section provides an overview of data analysis, explaining the stages of data analysis, before
describing some data analysis techniques:
• Descriptive statistics which was covered in the chapter on risk management
• Inferential statistics, which aims to make inferences about a population of data by taking a sample
from it. Inferential statistics can be either:
– exploratory data analysis, which aims to identify relationships between different variables in a
set of data; or
– confirmatory data analysis using a sample of data to infer information about a population from
which the sample was drawn.
4.1 What is data analysis?

Data analysis involves obtaining useful information from data to give insights for management. A
well-planned data analysis programme involves the following stages:
(a) Identifying the information needs of the business. This will depend on the business’s objectives
and strategies (eg, an online retailer might want to know what products its target market wants).
(b) Collecting the data. This involves identifying the sources of the data. Data may already be
available withing the business’s systems, or it may be necessary to invest in new sources. (See
section 2 above for sources of data.)
(c) Analysing the data – using statistical techniques to convert the data into the information
required.
(d) Presenting the information. Decisions need to be made about how best to communicate the
information to the managers of the business. Managers may not be statisticians, so it is important
that the information is presented in such a way as to be easily understood. Information could be
presented using graphics or visualisations for example, or using tables. (Presentation of
information is discussed in section 6 below.)
(e) Using the information to make better decisions, improve the performance of the business or
make better plans. (The purpose of data and information was discussed in section 1 above.)
The process above is likely to be an iterative one - which means that rather than the stages occurring
in sequential order, earlier stages may be repeated based on feedback obtained at later stages (eg,
during the data analysis stage, insights obtained may lead analysts to modify the second phase,
identifying additional sources of data).
Data analysis may be based on the whole population or on a sample.

Definition
Population: Population – the entire set of data from which a sample is selected for analysis (eg, sales
to all customers in the last year.)
4.2 Analysing the data

A number of types of analysis can be used. The broad categories of statistical analysis commonly
used are as follows:
Definitions
Descriptive statistics: The use of statistics that summarise the data in a data set. Examples of
descriptive statistics are the measures of central tendency (mean, median and mode) and measures
of dispersion (range, variance and standard deviation) discussed in the chapter Introduction to Risk
Management.
Inferential statistics: Statistical methods that deduce the characteristics of a bigger population from
a small but representative sample.
Exploratory data analysis: Identifying relationships in a set of data – for example, patterns that the
business was not aware of that could be useful (eg, finding out that customers with particular
characteristics are more likely to churn. Churn is a term used to refer to customers who switch to
other providers of a service.) Exploratory data analysis may use regression and correlation, which are
covered in the Management Information module.
Confirmatory data analysis: Using statistical methods to confirm a pre-determined hypothesis (eg, a
factory believes that on average, 5% of its output is faulty, and wants to investigate to see if this is
correct). Confirmatory data analysis is discussed in more detail in the section on sampling below.
4.3 Sampling
Definition
Sampling: Analysing a sample of data from a population, and based on this, making inferences
about the population.
Sometimes, the whole population may be used in data analysis (eg, audit software tools enable all
sales invoices in a particular year to be analysed). Developments in information technology and the
growth of big data over the past 20 years has made it more feasible to analyse whole populations of
data.
More often, information about the whole population is not available. It is often unfeasible or even
impossible to find out information about every item in a population. In order to perform statistical
analysis therefore, samples are taken, and inferences are made about the population based on
analysis of the sample (eg, in order to find out the mean salary of ICAEW members, a sample of
ICAEW members could be taken. The mean salary of the members of the sample would be used as
an estimate for the mean salary of all ICAEW members).
4.3.1 Representative samples

When making inferences, it is probable that the statistics obtained from the sample will not be
exactly the same as the population, so it has to be recognised that they are an estimate. In order to
make estimates more reliable, statisticians try to ensure that as far as possible, their samples are
representative of the population from which they are taken.
Definition
Representative sample: A sample that reflects the characteristics of the population from which it is
drawn. If a sample is representative of the population, sample results can be analysed and valid
inferences can be made about the population as a whole.

If a sample does not reflect the characteristics of the population as a whole, then incorrect inferences
could be made. For example, if we are trying to determine the average income of families in a
particular region, we might take a sample of families from that region and calculate their average
income. We would use this as our estimate of the average income of all families in the region. If our
sample was not representative however, our estimate would be incorrect. If our sample of families all
lived in a particularly affluent area, for example, then it is likely that the average income of the sample
would be higher than the average income of families of the region. Our inference about the
population based on this sample would be incorrect.
In order to make it more likely that a sample is representative, the following factors need to be
considered:
Method of sample selection: Our method of selecting items from a population to form a sample
should be such that all members of the population have an equal chance of being selected. In
practice it may often be difficult to achieve this as there may be no listing that contains all items from
a particular population. Statisticians refer to a sampling frame, which is the list of items that the
sample will be drawn from. Ideally, the sampling frame should include all items in the population.
Sample size: The general principle is that the larger the sample size is, the more likely it is to be
representative. A rule of thumb is that a sample size should contain at least 30 items. As samples
become larger, they tend to reflect more accurately the characteristics of the population. Using larger
samples also allows for filtering of results – for example, analysing the sample into male and female
participants, and making inferences about these.
4.3.2 Sampling methods

Sampling methods that aim to give every item in a population the chance of being selected include:
Simple random sampling: A sample should be drawn from the whole population. Every item in the
population is assigned a number. Random number generators are then used to select a sample of
numbers, and the items with the corresponding number are selected for the sample. The
disadvantage of random sampling is that in spite of the sample being selected randomly, it may not
be representative of the population.
Systematic sampling: All items in the population are assigned a number. A random number
generator is then used to select the first item to be chosen. After this, every nth item is chosen (eg,
every 10th item). Systematic sampling could provide a sample that is more representative than a
simple random. For example, if the population is numbered 1 to 100, it is possible that a random
sample of 10 items might be heavily biased – eg, too many numbers below 50. In systematic
sampling, this bias will not be present.
Stratified sampling: The population is divided into sub populations (strata) based on a particular
characteristic. The number of items in the sample from each strata is determined based on the
relative size of each strata. The sample is then taken by randomly selecting the appropriate number
of items from each strata. The advantage of stratified sampling is that it ensures that all strata are
represented in the sample.
For example, a population of trade receivables contains 200 customer balances. In the population of
200 customers, 40 customers (20%) have a balance greater than £1,000, 140 customers (70%) have a
balance between £0 and £1,000, and 20 customers (10%) have a credit balance. The auditors wish to
select a stratified sample of 30 items in total for testing. They will randomly select 6 (20% × 30)
customer balances from the strata with balances greater than £1,000, 21 (70% × 30) customer
balances between £0 and £1,000, and 3 (10%× 30) credit balances.
4.3.3 Practical considerations in sample selection

While statisticians would clearly like to use sampling methods that provide the most representative
samples, practical considerations also need to be taken into account when determining sampling
methods. In particular, the costs of a particular sampling method need to be compared with the
benefits. The costs of using a sampling method that may give a less representative sample may be
considerably less that using a sampling method where all items in the population could be chosen.
For example, conducting a customer survey on a social network platform would involve only
including members of that social network in the sample and would ignore the opinions of customers
that do not use the platform, but the costs could be considerably lower than contacting customers by
traditional methods such as post.

4.3.4 Professional scepticism
You may recall from the chapter The accountancy profession that accountants should apply
professional scepticism to their work. This involves assessing information, estimates and
explanations critically, with a questioning mind, and being alert to possible misstatements due to
error and fraud.
When dealing with the results of statistical analysis, professional scepticism would imply knowing the
right questions to ask to assess the reliability of the analysis. If inferences have been drawn from
samples, it would be pertinent to ask about the size of the sample used, the sampling method used,
the age of the data (older data could be out of date and therefore not useful) and the questions that
were asked.
4.4 Surveys
Surveys are widely used by organisations to obtain useful information for decision making (eg,
market research surveys can help businesses to decide what products to develop). This section deals
with good practice in designing surveys.
4.4.1 Writing good survey questions

(a) Use simple, short, clear questions to ensure that the reader understands the question. There
should be no ambiguity or scope for misinterpretation of the question. Long, waffly questions
can be off putting to respondents.
(b) Ask questions thatrequire specific answers rather than judgement (eg, rather than asking ‘do
you eat in restaurants often?’ ask ‘how many times per month do you eat in restaurants?’). This is
because different respondents will have different opinions on what often means.
(c) Avoid broader questions such as, ‘do you like our product?’ Try to identify the facets that make
the product likeable and ask more detailed questions. For example, ‘do you like the design of
the product?’, ‘do you find the product easy to use?’, ‘does the product meet your needs?’
(d) Using scales can provide more information than requiring yes/no answers. Respondents could
be asked to place a tick in one column – for example where the columns are ‘strongly agree,
agree, neither agree nor disagree, disagree, strongly disagree’ or they could be asked to
evaluate something on a scale of 1 to 5. Avoid using very large scales (such as on a scale of 1 to
20) as most participants will choose either the two extremes, or the centre, so the remaining
values will be redundant.
(e) Avoid leading questions. A leading question is one where the phrasing of the question might
bias the answer. For example, ‘do you avoid buying products that come in single use plastic?’
would bias the reader as the question clearly suggests that they should avoid buying such
products. Instead, the question could be rephrased as, ‘how often do you buy products that
come in single use plastic?’
(f) Avoid ‘double-barrelled’ questions – a double-barrelled question is a question that is actually
two questions in one. For example, ‘do you enjoy maintaining your home and garden?’ would
be difficult to answer for a person who enjoys maintaining their garden but not their home.
(g) If trying to get opinions on new products, qualitative data can be as important as quantitative.
Rather than just knowing that 45% of people surveyed like the new product, it would be as
important to know what those 45% liked about the product (and what the other 55% did not
like). The use of focus groups can be more useful than surveys in obtaining such information. A
focus group is an informal meeting where a small group of potential customers are shown a
proposed new product or service and asked to discuss it.
4.4.2 Survey length

If surveys are too long, the respondents will suffer ‘survey fatigue’ at which point they will either stop
the survey or provide random answers to the remaining questions. It is important therefore to try to
keep the surveys short. Prioritise the questions and ask only the important ones.
4.4.3 Selecting respondents for surveys

It is important to define what is the target population, whose opinion the survey is trying to ascertain.
If we are conducting a survey to discover what teenagers in the UK think of a new product, our target
population is all of the teenagers in the UK.

The survey respondents are a sample of that population. The respondents of a survey should be
representative of the population as a whole. Discussion of what makes a sample representative is
discussed in more detail earlier in this chapter. The following factors need to be considered when
identifying people who will be invited to participate in the sample:
1. The number of respondents should be large enough to form a representative sample. Generally, it
is better to have more respondents than less.
2. The respondents should belong to the target population. If the survey is trying to identify the
opinions of teenagers in the UK, there is no point in asking adults to complete the survey, for
example.
4.4.4 Problems of low response rate

When invitations are sent to people to participate in surveys, the response rates are generally low. A
response rate of 50% is considered to be excellent. A low survey rate gives rise to a risk of ‘self-
selection bias’, which means that those who respond to the survey are not a representative sample of
the population that the survey is aiming to find out about. It may be, for example, that people with
busy jobs and high workloads would not respond to the survey, while people with more spare time
would. This would mean that the opinions of people with busy jobs would be ignored from the
results of the survey, leading to incorrect conclusions.
Types of bias, such as self-selection bias, are discussed in more detail in the section Potential
problems with data, later in this chapter.
5 Spreadsheets
Section overview
Spreadsheet applications, such as Microsoft Excel, Google Sheets and Apple numbers, enable the
storage and analysis of data.
A spreadsheet application provides the user with an array made up of cells. Numerical values, text or
formulae can be entered into the cells.
Within finance, spreadsheets are used for many purposes, including budgeting and forecasting and
‘what-if’ and scenario analysis. Smaller businesses may maintain their accounting records in
spreadsheets.
The use of spreadsheets is not without risks. Risks include the risk of errors in the spreadsheet, lack
of consistency about the way spreadsheets are designed and the styles used, poor design, lack of
documentation of the spreadsheet design, and loss of data.
The ICAEW has published a list of 20 principles of good spreadsheet practice, which aim to mitigate
some of these risks.
5.1 Introduction to spreadsheets
5.1.1 Exam context

You will not be required to use a spreadsheet in the BTF exam, but you may be required to show an
understanding of the principles of spreadsheets and what they can be used for. Later exams, such as
Business Strategy and Technology, will require you to use spreadsheets in the exam.
5.1.2 What is a spreadsheet?

A spreadsheet is an application that enables the user to store and analyse data. Well known
spreadsheet applications include Microsoft Excel, Google Sheets and Apple Numbers.
A spreadsheet consists of an interface made up of an array of cells into which data can be entered.
Each cell has a unique reference number, based on which column and row it is in. For example, in the
spreadsheet in Figure 13.1 below, the word ‘Sunday’ is in cell A4, while sales for Tuesday are shown
in cell B6.

Figure 13.1: Basic spreadsheet
A B C D E F G H I
1
2 Day Sales
3
4 Sunday 0
5 Monday 2,000
6 Tuesday 3,000
7 Wednesday 2,500
8 Thursday 3,100
9 Friday 3,400
10 Saturday 4,200
11
12 Total 18,200
13
5.1.3 Types of data

Any cell in a spreadsheet can store one of the following:
• Text. A text cell usually contains words, but may contain numbers that do not represent numeric
values for calculation purposes (eg, a Part Number)
• Values. A value is a number that can be used in a calculation. Many of the cells in column B above
contain sales values.
• Formulae. A formula is an expression that calculates the value in a cell, usually referring to other
cells. For example, the formula = B4+B5 would add the values of cells B4 and B5.
• Functions are predefined formulae. In Figure 13.1, the cell B12 contains a function = sum(B4:B10)
which adds up the values in all the cells from B4 to B10, giving the total sales for the week. (You
cannot see the function above, only the output of the function is shown.) Modern spreadsheet
applications have the ability to use dozens of formulae and functions including arithmetical,
financial and statistical functions.
5.1.4 Worksheets and workbooks

Multiple spreadsheets (worksheets) may be contained within a workbook (eg, a workbook
containing sales data might have a different worksheet for each branch). It is possible for formulae in
one worksheet to refer to data in another one.
5.1.5 Presentation of data in a spreadsheet

Spreadsheets are very flexible, enabling the overall structure of a spreadsheet to be designed in the
way the creator considers most appropriate. All spreadsheets need to be planned and then
constructed carefully.
The data within cells can be formatted in various different ways. The spreadsheet in Figure 13.2
includes several formatting features:
Figure 13.2: Presentation of data

A B C D E
1
2 2023 2024 2025 2026
3 S$000 S$000 S$000 S$000
4 Revenue 47,000 54,050 62,158 71,482
5 Commission on freelance del 17,000 19,550 22,482 25,854
6 Total revenue 64,000 73,600 84,640 97,336
7 Direct costs
8 Drivers salaries (24,000) (26,400) (29,040) (31,944)
9 Operational workers (19,000) (20,900) (22,990) (25,289)
10 Fuel costs (3,000) (3,300) (3,795) (3,382)
11 Depreciation trucks (10,500) (11,550) (12,705) (13,976)
12 Total direct costs (56,500) (62,150) (68,530) (75,041)
13
14 7,500 11,450 16,110 22,295
15 11.72% 15.56% 19.03% 22.91%
• The overall layout of the spreadsheet in Figure 13.2 table is laid out logically. Each column shows
the data for a particular year, and each row shows the values for a particular type of cost or
revenue. There is also a calculation of gross profit and gross profit margin in rows 14 and 15.
• The text in row 2, and in cell A4 and A7 has been shown in bold. This adds emphasis.
• The currency heading in row 3 are italicised - this helps to distinguish the headings from the
values below.
• The cells in row 5 make use of a bottom border – this is often used to show that the cells below (ie,
row 6) contain a sub total. The cells in row 12 contain a single line border at the top and a double
line border at the bottom. This highlights that this is an important total, and it is the last total in this
data.
• The number format chosen for most of the values is a standard number, with a comma to
distinguish the 1,000s and no decimal places. Brackets are used to show a negative number
(although other conventions could also be used, such as a minus sign before the number or a
negative number could appear in red). In row 15, a percentage number format has been shown,
in this case with two decimal places.
• Several formulae and functionshave been used in the spreadsheet above. Formulae and
functions all begin with an equals sign (=). B12 is the sum of the values in cells B8 to B11. The
function = SUM(B8:B11) has been used. B14, gross profit, is the difference between total revenue
(in cell B6) and total direct costs (in cell B12) and has been calculated using the formula =B6-B12.
The gross profit margin in cell B15 uses the formula = B14/B6. Similar formulae have also been
used in the corresponding cells in columns C, D and E. The formulae themselves cannot be seen
in the spreadsheet above, only the results of the calculations made by the formula, although there
is a setting in most spreadsheet packages whereby the formulae can be displayed. You will not be
tested on knowledge of formulae or functions in the exam but may be required to identifywhich
particular cells in a spreadsheet contain them.
5.1.6 Visualisations
A number of charts or diagrams can be created from the numbers in a spreadsheet, including pie
charts, bar charts and line charts. If the underlying data in a spreadsheet is changed, the
visualisations based on this data will be automatically updated. Visualisations are described further
in Section 7, but it should be noted here that a wide range of the visualisations described in section 7
can be produced within a spreadsheet.
5.2 Use of spreadsheets in finance

Since spreadsheets have the ability to contain large amounts of data and give the user the flexibility
to determine how that data is presented, spreadsheets can be applied to a wide number of tasks.
Within the finance function, some common uses of spreadsheets include the following:
• accounting records for small businesses
• budgets and forecasts
• what-if analysis/scenario analysis

5.2.1 Accounting records for small businesses
Small businesses or other small organisations with a limited number of transactions often keep their
accounting records in spreadsheets. Typically, these include worksheets showing bank transactions,
sales invoices and supplier listings. The transactions are recorded and can be analysed appropriately.
The following is an example of the use of a spreadsheet to record and analyse the bank payment
transactions of a sports club:
Figure 13.3: Analysis of bank transactions
A B C D E F G H
1 Bank account payments
Football
2 Tennis Courts Pitch Grass Water & Waste
Date Voucher Amount Maintenance Electricity Disposal
3 10/02/20X1 Veolia 27.90 27.90
4 17/01/20X1 Michael Cook 57.00 57.00
5 17/01/20X1 Gareth Davies 30.00 30.00
6 18/01/20x1 DD EDF Energy 59.00 59.00
7
8 Totals for month 173.90 57.00 30.00 59.00 27.90
9
In the UK, if businesses are registered for VAT, they must maintain certain records in a digital format
which are used to complete and file the business’s VAT returns. Many small businesses, which do not
use accounting software packages, keep their VAT records in spreadsheets in order to meet this
requirement.
5.2.2 Budgets and forecasts

A budget is a financial plan for a period – typically one year. In many organisations, departments have
to prepare their own budgets, which are then sent back to the finance function that consolidates
these to produce a budget for the company overall. Spreadsheets can assist the budgeting process
in the following ways:
• Budget templates – standardised budget templates can be sent to each department to ensure
that all departmental budgets follow the same format. This helps departmental managers know
what information they need to provide in their budget and ensures that consistent information is
provided.
• Formulae perform arithmetic calculations – such as summing costs and calculating profit totals. If
any of the budget inputs is changed, the totals are automatically recalculated saving time
performing manual arithmetic. If the underlying cost or revenue data is changed, the spreadsheet
will automatically recalculate the revised budgeted profits
• Consolidations – departmental budgets can be saved as worksheets within a workbook, and
these can be automatically added up to calculate a budget for the whole organisation. If the
budget from one department is then amended, the consolidated budget will also be updated
automatically.
Spreadsheets can also be used for financial forecasts. As with budgets, once a forecast has been set
up in a spreadsheet, the user can change the assumptions used and the spreadsheet will
automatically recalculate the forecast based on the new assumption.
5.2.3 What-if analysis and scenario analysis

What-if analysis is used in financial modelling. A financial model can be set up in a spreadsheet, such
as a cash flow forecast for the next 10 years. The various assumptions used in the model can then be
changed in the spreadsheet to see what happens – eg, what if sales revenue growth is zero, what if
sales revenue growth is 10% etc. The spreadsheet will recalculate the cash flows based on the
different assumptions.
5.3 Risks from spreadsheet use

Where businesses rely on spreadsheets (for example in financial models) there are potential risks:

Errors in spreadsheets: There could be errors in the formulae, errors in entering data, or errors in the
logic of the spreadsheet, leading to the final outputs (the values that the spreadsheet is designed to
calculate) being incorrect.
Context example: Public Health England

During the coronavirus pandemic, Public Health England used a spreadsheet to calculate the daily
number of new infections. The data originated from test results, sent by private testing companies in
a template. These templates were automatically uploaded onto a central spreadsheet maintained by
Public Health England, which calculated the number of positive test results.
Between 25 September 2021 and 2 October 2021, the number of cases reported by Public Health
England was 50,786, but it was later discovered that the true number of cases for this period was
higher by 15,841.
The error was caused by the use of an older version of Microsoft Excel, which could only handle
65,000 lines of data, and since the details of each test created several rows of data, the spreadsheet
could only manage 1,400 cases. When the number of cased exceeded 1,400, further cases were
ignored and missed from the total.
Lack of consistency in style and design of spreadsheets. Where different people within an
organisation are producing spreadsheets, if there are no standards in place for the use of
spreadsheets, it can lead to inconsistent presentation. This can make it hard for users to understand
them.
Poor design. Many spreadsheets evolve over time, so little consideration is given to the overall
structure. This can lead to poor structure, for example overly complex methods or poor presentation.
Lack of documentation of inherited or reused spreadsheets. Where responsibility for updating or
maintaining a spreadsheet designed by one person is passed onto a second person, problems may
occur if the design of the spreadsheet has not been documented. The new user may not be fully
aware of the implications of changing a formula, for example.
Loss of data. If important data is kept in spreadsheets, then there is a risk that data will be lost if the
spreadsheet file is corrupted or deleted (accidentally or intentionally). Procedures should be in
place to ensure that all important spreadsheets are backed up regularly.
5.4 Principles of good spreadsheet practice

The ICAEW has published a set of principles of good spreadsheet practice. The aim of the principles
is to help reduce the amount of time wasted by poor spreadsheet design and reduce the number of
errors caused. The principles do not provide detailed guidance about good spreadsheet design.
Instead, they provide a framework for good spreadsheet development and use within organisations.
The principles are presented below with brief explanations in brackets. The principles are available
on the ICAEW website with more detailed explanations.
The spreadsheet’s business environment:
1. Determine what role spreadsheets play in your business and plan your spreadsheet standards
accordingly
2. Adopt a standard for your organisation and stick to it (eg, standards over cell formats)
3. Ensure that everyone involved in the creation or use of spreadsheets has an appropriate level of
knowledge and competence
4. Work collaboratively, share ownership, peer review
Designing and building your spreadsheet:
5. Before starting, satisfy yourself that a spreadsheet is the appropriate tool for the job
6. Identify your audience. If a spreadsheet is intended to be understood and used by others, the
design should facilitate this
7. Include an ‘About’ or ‘Welcome’ sheet to document the spreadsheet
8. Design for longevity (eg, it should be possible in future to adapt the spreadsheet for changes in
tax rates or quantities)

9. Focus on the required outputs; start spreadsheet design by identifying the required outputs and
work backwards to determine what inputs and logic are required
10. Separate and clearly identify inputs, workings and outputs (a well-structured spreadsheet is
easier to understand and maintain)
11. Be consistent in structure (eg, use columns for different years and use a specific column for year
one, with subsequent years being presented to the right of this)
12. Be consistent in the use of formulae (eg, groups of cells using the different formulae should be
separated from each other)
13. Keep formulae as short and simple as practicable
14. Never embed numbers in a formula if they might change (eg, in a formula calculating sales value
from sales volume and sales prices, ensure that the sales volume and sales prices are entered into
separate cells and not within the formula cell)
15. Perform any calculation once and then refer back to that calculation (don’t have a calculation for
the same value in many different cells)
16. Avoid using advanced features when simpler features could achieve the same result
Spreadsheet risks and controls:
17. Have a system of backup and version control, which should be applied consistently within an
organisation (eg, controls to identify which is the latest version of a spreadsheet)
18. Rigorously test the workbook (to help identify any mistakes in a spreadsheet, it is recommended
that it should be tested by a peer)
19. Build in checks, controls and alerts from the outset and during the course of spreadsheet design
(eg, a formula to check that the balance sheet balances)
20. Protect parts of the worksheet that are not supposed to be changed by user (eg, cells containing
formulae can be locked so that users do not accidentally change them)
6 Potential problems with data

Section overview
As users of information, accountants need to exercise professional scepticism in relation to the

reliability of data, accountants need to question its comparability and whether it might contain bias
Hypothesis testing involves making a hypothesis about a population statistic (eg, the mean) and
then testing a sample of data to see if this hypothesis is correct. The nature of hypothesis testing is
such that there is always the possibility that the wrong conclusions are drawn from the sample – the
two types of error are called type I and type II errors.
6.1 Professional scepticism

In the context of data analysis, areas that accountants may question include comparability of data
from different sources, and data bias which means its data is not representative of the population
from which it is drawn.
6.2 Comparability of data

One potential issue with data or statistics from different sources is that of comparability.
Definition
Comparability: The extent to which differences between statistics from different geographical areas,
non-geographic domains, or over time, can be attributed to differences between the true values of
the statistics (OECD).

The definition above makes the point that data is only comparable if it is free from differences due to
factors other than the underlying statistics themselves. If data is impacted by these, then incorrect
conclusions could be drawn.
Comparability may be distorted by two main sources:
• use of different definitions; or
• Use of different measuring tools, compilation and presentation practices.
Context example: Differences in definitions

An important statistic used in economics is the rate of unemployment. Different methods are used to
measure unemployment in different countries. In some countries, households are surveyed, while in
others businesses are surveyed. In some countries, people are not classed as unemployed until they
have been out of work for three months, in other countries the period is different. This can lead to
differences in statistics simply because of the different methods used rather than to the underlying
unemployment.
6.3 Data bias and representative samples

If sample data is used to make inferences about the population, then it is important that the sample
is representative of the population and free from bias. If not, wrong conclusions may be reached.
One important factor is the size of the sample. The larger the sample is, the more likely it is to be
representative of the population. However, increasing sample sizes can increase the costs of
collecting data significantly, so a balance needs to be struck between the size of the sample and the
costs. Users of data should question the size of the samples used.
Another issue relating to samples is bias.
Definition
Data bias: Where the data in the sample is not representative of the population for reasons other
than the size of the sample.
Context example: Unrepresentative samples

During elections, pollsters call samples of voters and ask them how they intend to vote in the
forthcoming election. They use this as a basis for predicting what the results of the election will be.
One reason that polls are often wrong is because people are not always honest when talking about
their voting intentions, perhaps feeling embarrassed about admitting which party they truly intend to
vote for.
There are several different types of data bias.
Type of bias in data Meaning
Selection bias This occurs when the data is not selected

randomly and leads to a sample that is not
representative of the population. In order to be
representative, all items in the population
should have an equal chance of being selected
for the sample.
Self-selection bias This is a type of selection bias. It occurs when

individuals select themselves to be part of a
sample.
Example – online questionnaire
People are often provided with the opportunity
to be entered into a prize draw if they complete

an online questionnaire. Only people who are

interested in being entered into the draw are
likely to participate in the questionnaire. The
questionnaire will not therefore reflect the
opinions of those who are not.
Observer bias This occurs when observing and recording

results and relates to interpretation. The
researcher allows their assumptions (which may
be unconscious) to influence their observations.
Omitted variable bias Exploratory data analysis aims to identify

relationships between data – for example,
finding out what characteristics people who are
potential customers display.
Omitted variable bias is where key variables are
not included within the data to be analysed. For
example, the researcher may omit to record the
ages of people even though this might be a
factor that determines whether a person is a
potential customer.
Cognitive bias This relates to human perception and includes

bias depending on how data is presented (eg,
infographics or the order of presentation), the
context in which it is presented, and ‘anchoring’,
where the perception of whether something is
good or not is influenced by being shown a
previous or expected value for that variable.
Example – recognising the context of
performance
A company’s profits for the year show a 20%
increase compared to the previous year. This
information is likely to sound impressive to
shareholders. If, however, shareholders are first
told that the market growth was 30% over the
last year, shareholders will recognise the
company’s 20% growth as less impressive.
Confirmation bias This occurs when people see data that confirms
their beliefs and they ignore (consciously or
sub-consciously) data that disagrees with their
beliefs.
Example – new product/market research
Managers who have already made a decision
(eg, to invest in a new product) may ignore
marketing research that suggests that the
product will not be successful, while fully paying
attention to research that confirms their
decision.
Survivorship bias This is where the sample contains only items

that survived some previous event.
Example – exam results
An accountancy firm only lets students sit the
BTF exam if they achieve at least 45% in the
mock exam. The firm boasted that 95% of their

students passed BTF in the last sitting. This 95%

did not include the students who had not been
allowed to sit the exam because they had
achieved less than 45% in their mock exams.
6.4 Type I and type II errors

Hypothesis testing involves using data to confirm whether a predetermined idea or ‘null hypothesis’
is true, or whether an alternative hypothesis is true. A sample is taken to see if it confirms the null
hypothesis or contradicts it, in which case the alternative hypothesis is true. The null hypothesis is
rejected if the sample shows a result that is statistically significantly different from the result expected
by the hypothesis.
Definition
Statistical significance: the results generated by testing or experimentation are unlikely to occur by
chance or randomly, but occur due to a specific cause.
Note: Determining statistical significance is beyond the scope of the BTF syllabus.
In hypothesis testing there is a risk that wrong conclusions are reached as follows:
• A type I (‘false positive’) error occurs where the null hypothesis is true, but because the sample
result is significantly different, the null hypothesis is rejected.
• A type II (‘false negative’) error occurs when the null hypothesis is false, but it is accepted
because the sample result is not statistically significantly different to the null hypothesis.
Context example: Type I error

A sports retail company believes (correctly) that the average age of its customers is 28.0 years. It has
decided to test this hypothesis.
A sample of 100 customers was taken. The sample had a mean age that was significantly different
from 28 years. The hypothesis was rejected, and the marketing company concluded wrongly that the
average age of its customers was not 28.0 years. This is a type I error.
Context example: Type II error

A sports retail company believes (incorrectly) that the average age of its customers is 28.0 years. It
has decided to test this hypothesis.
A sample of 100 customers was taken. The sample had a mean that was not significantly different to
28.0. The hypothesis was therefore accepted, and the marketing company concluded that the
average age of its customers was 28.0 years. In actual fact, the average age of its customers was not
28 years. The company has made a type II error, in accepting an incorrect null hypothesis.
7 Presentation of information
Section overview
Thought should be given to what is the best, most effective way to present the results of data
analysis. Data can be presented using tables, charts, or a combination of the two. The objectives of
good presentation are:
• Easy for the users to understand. This will be the case if the data is presented using an
appropriate format.

• The presentation should accurately reflect the underlying data. An appropriate scale should be
used.
• The information may need to be accompanied by some commentary to help users interpret the
message.
7.1 Using data visualisation
Definition
Data visualisation: Data visualisation is the use of charts and diagrams to present information.
The advantage of visualisation is that high level information can often be more quickly understood if
presented in the form of charts and diagrams compared to tables of numerical data.
Many software applications are available that can produce professional looking charts and diagrams
from data. In spreadsheet software, for example, many different charts are available that use data
within the spreadsheet, and automatically refresh themselves when the spreadsheets are amended.
While software applications are a useful tool, care needs to be taken in how they are used.
The sections below examine some more common types of chart, and discuss when they are most
useful.
7.2 Bar charts

Bar charts (column charts) present information using bars, where the length of the bars represents
the value of the data. Bar charts are useful for presenting discrete data where comparisons are made
between different data sets – for example, sales in different periods, or sales by region. Clustered bar
charts show the components that make up the total as well as the total itself. Figure 13.1 shows a
clustered bar chart, where the total sales are represented by one bar for each period, and this is then
broken down by region, with a different coloured bar representing each different region. The bars
are repeated for several time periods. They are useful provided that there are not too many sub-
components. If there are too many, the charts begin to become too cluttered and may confuse users:
Sales
900,000
800,000
700,000
600,000
500,000
400,000
400,000
200,000
100,000
20X8 20X9 20Y0 20Y1
Total North South East West
Figure 13.4: Bar Charts
An alternative presentation of the clustered bar chart is a component bar chart (stacked column)
which shows one column representing the total, broken into the components that make up that total.

Sales
900,000
800,000
700,000
600,000
500,000
400,000
400,000
200,000
100,000
20X8 20X9 20Y0 20Y1
North South East West
Figure 13.5: Component Bar Charts
7.3 Pie charts

Pie charts are a useful way of showing the components that make up a total. The larger the angle of
a particular component is, the higher is its proportion of the total. Unlike clustered and component
bar charts, they only show information for one period of time. The advantage is that seeing the size of
the components visually gives the user immediate perspective on the relative size of the different
components.
The limitation of pie charts is that they can only analyse one variable at a time – for example, it would
not be possible to see an analysis of sales and profits on the same pie chart.
Sales
Household products
Drinks
Books and
magazines
Food products
Figure 13.6: Pie Charts
7.4 Line charts

Line charts are useful for showing trends in a data series (eg, sales over time). The advantage of line
charts is that it is easier to see trends in the data. A further advantage is that several data series could
be presented within the same chart – for example, sales and profits could be plotted as two separate
lines.

Quarterly Sales and Profits
450,000
400,000
350,000
300,000
250,000
200,000
150,000
100,000
50,000
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
20X8 20X9 20Y0 20Y1
Sales Profits
Figure 13.7: Line Charts
7.5 Principles of effective visualisations

In order to be clear and informative for users, the following principles should be adopted when using
visualisations. While these may sound like common sense, it can be easy to forget them when
dealing with complex data:
(a) The appropriate type of chart should be used for the data presented. An inappropriate method –
such as a pie chart for multiple variables – may confuse rather than enlighten the user.
(b) An appropriate scale should be chosen. If the scale is too small, it may be that different values
will not look very different.
(c) Charts should have a clear title as to data and time period, and clear labelling, with legends
provided if appropriate.
(d) The use of colours or shading helps to distinguish between the different components in a chart
and make them clear.
Essentially, the qualities of good information discussed above also apply to charts.
8 Big data
Section overview
The developments in technology over the past decades have enabled organisations to collect and
process much larger volumes of data. The ability to store much higher volumes of data, and new
methods of collecting data, such as the internet of things has led to an explosion in the data that is
collected by organisations. The increased use of social media containing commercially useful
information means more types of information are available. More sophisticated analysis techniques
that enable analysis of text and photographs in addition to numerical data allow greater insights to
be achieved. These developments are often referred to as ‘big data’.
Definition
Big data: those datasets whose size is beyond the ability of typical… software to capture, store,
manage and analyse (Manyika et al)
8.1 Characteristics of big data

There are four key characteristics of big data (the four Vs):
• Volume: The amount of big data accessible to a business is vast. It is available relatively easily and
in ever-increasing volumes.

• Velocity: Big data can be streamed into the business at great speed, so data about sales, for
instance, or inventory is available effectively in real time. Previously a business would have waited
for periodic, summarised reports.
• Variety: Big data is available about a huge variety of issues, for instance about customers,
competitors, transactions or social media activity. Because it comes from a variety of sources big
data is unstructured, which means that it needs to be analysed before it can be useful.
• Veracity: This is to do with the trustworthiness or accuracy of big data. All data sets contain
inaccuracies, bias, anomalies and irrelevancies (‘random noise’), and it is important that as much
as possible is done to clean up this ‘dirty data’ so that it can be relied upon when analysed.
While big data is positive because it connects the business with its customers and the competitive
environment, the sheer size can be overwhelming.
8.2 Types of big data

Nemschoff points out that big data is typically either structured or unstructured. He classifies big data
as follows:
• Structured data is data, which is obtained with a particular purpose in mind, so has an inherent
structure derived from the way in which it is collected, typically from website clicks or other
particular actions:
– created data – data which has been created on purpose by an organisation, usually for product
or market research (for example data created when customers login to their online account
with a retailer, or when RFID tags on inventory are logged via the internet as the inventory is
moved around)
– provoked data – data obtained from people who have been given the opportunity to express
their views (for example ratings and reviews left on a clothing retailer’s website by customers)
– transacted data – data collected about actual transactions such as sales, including all the steps
or website traffic that led up to each transaction
– compiled data – data collected by a third party such as a market research, credit rating or
polling organisation and accessed by a business
• Unstructured data is obtained without a particular objective so has no inherent structure within
itself:
– captured data – data which is created passively from unrelated activity and captured without a
specific purpose, for example from a smartphone which allows data to be captured about a
person’s location, or from a search engine which captures which websites have been accessed
by which computers
– user-generated data – data which internet users create and voluntarily place online, such as
tweets, photos, etc
8.3 Sources of big data

Another way of classifying types of big data is to analyse its sources:
• processed data from information systems held by traditional business and other organisations
• open data, which refers to the release of large amounts of primarily public sector data, such as
geo-spatial data, transport data, government financial data and public service data
• human-sourced data from social networks, blogs, emails, text messages and internet searches
• machine-generated data from the internet of things: from fixed and mobile sensors, and from
computer and website logs
8.4 Importance of big data

ICAEW sets out the driving forces behind the increasing importance of big data:
• new sources of data, for instance the huge increase in unstructured human-sourced and machine-
generated data (open data, social media and the internet of things)
• exponential growth in computing power and storage, which means that entire data sets can be
captured and processed, regardless of their size and complexity
• new infrastructure for knowledge creation, such as crowdsourcing and open-source software

9 Data science
Section overview
Data science covers the whole life cycle of data, from acquisition and exploration to analysis and
communication of the results. It is not only concerned with the tools and methods to obtain, manage
and analyse data: it is also about extracting value from data and translating it from asset to product.
The importance of big data and its uses to businesses means that employees require skills in data
science.
Definition
Data science: Deals with collecting, preparing, managing, analysing, interpreting and visualising
large and complex datasets (Imperial College London, 2018).
9.1 Data analytics

Value is extracted from big data by data scientists through the process of data analytics. This means
that data is assembled using fields within the source data itself, rather than using predetermined
formats which can be very restrictive. The data assembled can then be filtered, sorted, highlighted
and presented visually using, typically, bar charts and pie charts. Both the extraction of data and
subsequent presentation of information are richer and more varied than was possible previously, and
allow far wider and deeper analysis.
Definition
Data analytics: The process of using fields within the source data itself, rather than predetermined
formats, to collect, organise and analyse large sets of data to discover patterns and other useful
information which an organisation can use for its future business decisions.
9.2 Benefits of big data, data science and data analytics

As we have seen, big data, data science and data analytics are all closely related. Big data is the raw
data available to organisations in vast amounts. Data science is the collection and management of
that data, and data analytics is the processing of the data (often by data scientists) to create insights
which are useful to the organisation.
There are a number of benefits that all three can bring to an organisation. ICAEW points out that big
data and data analytics are being used to:
• gain insights;
• predict the future; and
• automate non-routine decision making.
A report by the management consultants McKinsey highlights the following ways in which big data
and data analytics can be used by a business to create value:
• Enhancing transparency: Data analytics of big data create insights into issues affecting the
business that may not have previously been fully understood, such as customer buying patterns or
market price fluctuations.
• Performance improvement: Real-time, analysed information allows managers to make better
decisions which result in better profitability.
• Market segmentation and customisation: Insights into customer needs from analysed big data
allow the business to tailor product designs and prices to particular customers or groups of
customers.
• Decision making: Real-time information allows managers to make better day-to-day decisions, for
instance about pricing or stocking of goods.

• Innovation: Analysed big data can reveal completely new ideas which result in new products and
services. Big data also underlie the growth of virtual – or ‘borderless‘ – organisations which we saw
in the chapter Organisational and business structures.
• Risk management: Data analytics can use big data to assist with the identification, quantification
and management of risk.
9.3 Risks of big data, data science and data analytics

Knowledge Content
Despite the benefits, there are a number of risks that big data, data science and data analytics
create:
• Storage: The sheer volume of big data means that organisations must monitor and flex storage
levels to avoid running out of space.
• Workforce skills: Increasing amounts of data and the need for its analysis and interpretation
means that organisations need to ensure that they have sufficient data scientists and analysts with
an appropriate mix of knowledge and experience to get the most out of the data that they have.
• Data dependency: Organisations can become dependent on data to make business decisions,
which puts them at risk of making poor decisions if there are errors in the data or if it is
misinterpreted by data scientists. This links back to big data’s characteristic of veracity (or
trustworthiness of data).
• Information overload: Data analytics of big data can create huge numbers of insights into the
business and its environment. There is a risk that too much information becomes available which
may actually hamper the speed that business decisions can be made.
• Data privacy: Collecting, storing and analysing data puts the organisation at risk of breaching
data privacy legislation, such as the Data Protection Act 2018 in the UK. Organisations need to be
aware of the legislation and take all necessary steps to comply with it.
• Data security: Big data and its analysis can be a source of competitive advantage for
organisations. The data and its analysis needs to be protected from cyber security risks to prevent
this highly valuable information from falling into the wrong hands.
Exam questions could test your ability to demonstrate understanding of the business’s strategy in
relation to the use of big data by producing a list of potential risks, and ask which is a risk of big data.
Be aware of the risks of big data, particularly in relation to security and privacy.
9.4 Data ethics

The increasing collection and analysis of data, particularly personal data held about individuals,
raises complex ethical issues. The overarching principles of data ethics, as set out by the UK
government guidance for use in the public sector are: transparency, accountability and fairness. The
first two of these principles are equally applicable to the private sector.
9.4.1 Transparency
Are businesses transparent about how they use data, particularly if using techniques such as AI (see
the chapter Developments in technology) in aggregated data. Information about data held and data
processes should be published.
9.4.2 Fairness
The processes for collecting, storing and analysing data should aim to avoid unintended
discriminatory effects on individuals and social groups. This is most obviously done by mitigating
bias in data which may influence an outcome to ensure that outcomes arising from data respect the
dignity of individuals and are non-discriminatory.

9.4.3 Privacy
Individuals have a right to privacy. If organisations are routinely collecting and processing
information about individuals, this can threaten that privacy. Information should therefore only be
collected with the consent of the individual and within relevant regulations on privacy.
9.4.4 Ownership of data

Businesses can increase their revenues by selling the data they collect to other organisations. Not
only is this a further threat to privacy, but there is also a question of who owns the data. Does it
belong to the data subject, or does it belong to the business simply because they collected it?
9.4.5 Consent
Do users genuinely consent to the collection of data and its use? Most web sites use cookies, which
are small applications that sit on the user’s devices and collect data about the individuals. Web sites
do warn you that they use cookies and ask for consent before you can visit the site, but most people
just ‘agree’ without spending the time to really understand what you are consenting to. You may be
consenting to your data not only being collected, but also used to generate revenue.
9.4.6 Open data

There is a question of whether data collected should be available for all to use. Open data is data
that anybody can access or share (Open Data Institute). Currently there is a movement that all data
should be open, as it benefits society as a whole.

Summary
Use of Data in business

Data vs information
• Planning
• Decision making
• Controlling
Sources of data
and information
• Internal Presentation of data
• External Data analysis • Data visualisation
Qualities of • Internet of things • Identify • Principles of
good information needs effective
information • Collect the data visualisations
'Accurate' • Analyse the data
mnemonic • Present the
Descriptive statistics Data bias
information
Exploratory data Type I errors
analysis Type II errors
Regression Sampling
Confirmatiory data
Correlation Hypothesis testing
analysis
Big Data Data ethics Spreadsheets

• 4 Vs • Transparency • Introduction to
• Fairness spreadsheets
• Privacy • Use of spreadsheets
Data Science • Ownership in finance
• Data analytics of data • Risks from
• Benefits and risks spreadsheet use
• Principles of good
spreadsheet practice

indicated.
1 Can you identify the three management activities that are supported by data and
information? (Topic 1)
2 Can you give three examples of internal data sources and three examples of external
data sources? (Topic 2)
3 Can you state what each of the letters in the ACCURATE acronym stand for, in relation to
qualities of good information. (Topic 3)
4 Can you list the stages in a well-planned data analysis programme? (Topic 4)
5 Can you distinguish between the different types of data bias? (Topic 5)
6 Can you identify the meaning of type I and type II errors? (Topic 5)
7 Can you identify when bar charts, pie charts and line charts are most appropriate? (Topic
6)
8 Can you list what the four Vs stand for in the context of big data? (Topic 7)
9 Can you define data science? (Topic 8)
10 Can you list some of the ethical problems associated with data analysis? (Topic 9)

questions in the Data analysis chapter of the Business, Technology and Finance Question Bank. Refer
back to the learning in this chapter for any questions which you did not answer correctly or where the
suggested solution has not provided sufficient explanation to answer all your queries. Once you have
attempted these questions, you can move on to the next chapter, Developments in Technology.

Marr, B (2017) Data Strategy: How to Profit from a World of Big Data, Analytics and the Internet of
Things, Kogan Page Limited.
Manyika, J., Chui, M., Brown, B., Bughin, J., Dobbs, R., Roxburgh, C., and Byers, A.H. (2011) Big Data:
The next frontier for innovation, competition, and productivity. [Online]. Available from:
www.mckinsey.com/business-functions/mckinsey-digital/our-insights/big-data-the-next-frontier-for-
innovation [Accessed 5 April 2021].
Nemschoff (2014) 7 Important Types of Big Data. [Online]. Available from
https://www.smartdatacollective.com/7-important-types-big-data/ [Accessed 5 April 2021].
ICAEW (2019) Big Data and Analytics: The Impact on the Accountancy Profession [Online] Available
from: https://www.icaew.com/-/media/corporate/files/technical/technology/thought-leadership/big-
data-and-analytics.ashx [Accessed 5 April 2021].

Self-test questions

1 Ian has to make a decision about whether to allow overtime tonight to Gonzalez, a customer service
adviser, but he is unsure whether this extra time is needed between 7pm and 9pm on a Wednesday.
The type of information he needs to answer this query is:
A planning
B operational
C tactical
D strategic
2 Rachel has presented some information on how to measure performance to a panel of managers at
Jab plc. She found this information on the internet the previous evening as a PowerPoint file and has
presented it to the panel unedited. Within five minutes they found it to be highly informative and
targeted at the issues they are concerned with.
Requirement
Which ACCURATE criteria for good information does Rachel’s information fail to meet?
A being cost beneficial
B being relevant
C being easy to use
D being authoritative
3 Pap plc makes a single product with five operatives working five machines in a 35-hour week, for
which they are paid £10.60 per hour. National insurance etc, adds another £173 to the weekly labour
bill. Last week the gross cost of labour was £2,200.
Requirement
In which internal source should the managers of Pap plc refer to identify why the bill was this size?
A the payroll
B the computerised accounting system
C the machine logs
D the workers
4 An analyst has produced some information about a company’s online customers for the company’s
marketing department. The information includes mean age and mean spending by age.
Requirement
What type of analysis has the analyst produced?
A Descriptive statistics
B Exploratory data analysis
C Confirmatory data analysis
D Sampling
5 A large supermarket group wishes to carry out a survey to ascertain customers’ opinions about some
new products that it is considering launching. It has decided to do a survey on one of the large social
networking sites.
Requirement
Which of the following statements about the survey is correct?
A the survey will provide opinions that are representative of all customers
B the survey will suffer from selection bias

C the survey will suffer from survivorship bias
D the survey will take into account the opinion of the whole population
6 In the context of hypothesis testing, what does a type I error mean?
A the sample mean was calculated incorrectly
B the null hypothesis is rejected when it is actually correct
C the null hypothesis is accepted when it is actually incorrect
D the selection of the sample was biased
7 A finance director is preparing a presentation of the company’s results and wishes to produce a slide
showing sales for the current and previous periods, analysed by product group. There are four main
product groups.
Requirement
What type of chart would be most appropriate for this?
A a pie chart
B a component bar chart
C a line chart
D a table
8 Which of the characteristics of big data refers to the fact that the data may include text, photographs
and sound files?
A Volume
B Velocity
C Variety
D Veracity
9 What is the process where value is extracted from big data known as?
A Data science
B Data extraction
C Data analytics
D Data creation
this chapter.


The most frequent problem encountered by managers is that the information is not targeted at the
user, that is the information system has not been designed with users and their needs in mind.
Information that is not actually relevant to the decisions they make is often included. Management
information is frequently not easy to use, and it is late ie, not timely.

B operational
By its short-term nature the information could not be planning or strategic; the fact that this is a day-
to-day issue means it is not tactical.
D being authoritative
Clearly the users have found the information easy to use and relevant, and the fact that Rachel spent
very little time in generating it makes it cost-beneficial.
A the payroll
The first place to look is the payroll, which will show whether the variance comes from the pay rate,
the number of workers paid, or the national insurance etc. The other sources will provide further
information to back up the evidence in the payroll.
A Descriptive statistics
Descriptive statistics describes the properties of sample and population data which is the case here,
as the analyst has provided information about the properties (mean age and spending) for the
population of customers. Exploratory analysis aims to find relationships between the data, such as
how spending might be related to age. No such analysis has been produced in this case.
Confirmatory data analysis aims to find out if an existing hypothesis is correct or not, but again no
such actions have been taken here. Sampling involves taking a sample of data and making inferences
about the population. Here, it appears that the analyst has used the whole population of customers.
B the survey will suffer from selection bias
The survey will not be representative of all customers as it does not represent the views of any
customers who do not use the large social networking site.
The survey suffers from selection bias – not all members of the population (of customers) have a
chance of being selected for the survey.
Survivorship bias relates to a situation where people who have not survived a particular event would
not be chosen in the sample. This is not the case here.
B the null hypothesis is rejected when it is actually correct
A type I error means that a hypothesis is rejected when it is actually correct, because data from a
sample is significantly different from the hypothesised value, so B is correct. C describes a type II
error. A type I error does not mean that the sample mean was calculated incorrectly, so A is wrong.
Nor does a type I error mean that the selection of the sample was biased.
B a component bar chart
A pie chart would be appropriate if the finance director wanted to show sales by product group for
only one year. However, since they wish to show the previous period too, two pie charts would be

required, and the comparison between the two periods would not be so clear as they are shown in
different charts.
A component bar chart would be appropriate. The length of each bar would represent total sales for
the two years, and the analysis of the sales would be shown within each bar by using different
colours for the portion of the bar representing revenue from each of the product groups.
It would not be very easy to distinguish between the different product groups if a line chart were
used. Line charts are more appropriate for looking at one or two variables over several time periods
to show trends.
Presenting the data in a table would not provide the same impact as showing the data in a chart.
C Variety
One of the issues of big data is variety – which refers to the fact that data comes in many forms, such
as text and photographs, which require special systems to analyse them, so C is the correct answer.
Volume refers to the amount of data, not the form. Velocity refers to the fact that big data is
continuously being updates, so analysis had to occur quickly. Veracity means that the information can
be trusted, as it is from a reliable source.
C Data analytics
Value is extracted from big data through the process of data analytics by data scientists

Chapter 14
Developments in
technology
Introduction
Learning outcomes
Syllabus links
Assessment context
Learning topics
1 Developments in technology
2 Technology developments and the accountancy profession
3 Use of technology to support other business functions
4 Information systems
5 Risks and ethical issues
6 Cyber risk
Summary
References
Self-test questions
Introduction
14
Learning outcomes
• Specify different types of cyber risk and attack and the steps organisations can take to improve
cyber security
• Specify the features and uses of cloud accounting, the internet of things, digital assets,
blockchain, distributed ledger technology and fintech
• Identify the effect of technology developments, including those relating to artificial intelligence,
machine learning and robotic process automation, on the accountancy profession
Specific syllabus references are 6g, 6h, 6i,
14
Syllabus links
Knowledge of technology is developed further in Business Strategy and Technology at the
Professional Level.
14
Assessment context
Questions on technology will focus on understanding the different types of technology, what they
do, and their respective advantages and disadvantages.
Questions will be set in multiple choice format, either as a straight test of knowledge or in a scenario.
14

of this chapter.

Questions
1 Developments in Approach Technology is an

technology Ensure that you important part of
understand all of this exam, as its
the types of name suggests. It
technology is very likely that
(cloud, the you will have
internet of things questions from
etc,) and are this area in your
aware of their exam. Questions
applications in typically test your
business and understanding of
their advantages. the meaning of
the
Stop and think developments, as
What recent well as their
developments in advantages.
technology have
impacted on your
own life – either
at work or in your
personal life.
2 Technology Approach Questions on this

developments and the Read this section area are likely to
accounting profession and ensure you focus on
particular

Questions
appreciate which developments

aspects of the and whether or
accountant’s job not they are
are now relevant to the
automated and job of the
which still require accountant.
human input.
Stop and think
How do you think
the job of an
accountant will
change over the
course of your
career?
3 Use of technology to Approach Exam questions

support other business As with section 1, are likely to focus
functions this section on the meaning
requires you to of the technical
learn some definitions, as
technical terms well as how
and to appreciate technology can
how technology help in particular
has impacted on business
specific business functions.
functions.
4 Information systems Approach Exam questions IQ 1: Expert

Read through the in this area tend systems tests
section and note to focus on your
the different definitions. understanding of
types of why expert
information systems might be
systems. used.
5 Risks and ethical issues Approach Exam questions

Read through this in this area are
section and think likely to provide
about the risks situations and ask
and ethical issues you to identify
raised. what risks are
associated with
Stop and think that situation.
What concerns
do you have
about big
companies
keeping personal
information
about you?
6 Cyber risk Approach Cyber-crime is a

Cyber risk is a new type of Read through the significant source
risk that has become chapter, ensuring of risk so
widespread over the last you know the questions on this
twenty years, with some major types of area could well
come up in the
ICAEW 2023 14: Developments in technology 467

Questions
very high-profile cyber- threat, and what exam.

attacks. Cyber-attacks can controls and Essential points
cause a great deal of security are:
damage, including loss of businesses
sales, operations being should put in • Types of risk
stopped, and loss of place to reduce • Controls/
reputation. Businesses the threat of technical
need to take action to cyber-attacks. controls to
reduce the risk of cyber- Stop and think reduce risk
attacks.
What controls
exist to stop
authorised
access to your
account on your
bank’s internet
banking site or
app?
7 Cyber resilience Approach Questions in this

Cyber resilience is an Be aware as you area are likely to
important component in read this section present you with
business resilience that cyber practical
discussed in the chapter resilience is scenarios and ask
Risk management. about more than you what steps
just security might be
against cyber appropriate.
threats – it Essential points
identifies are:
procedures to • Meaning of
ensure that the cyber
organisation’s resilience
systems can
survive if the • Threats
cyber security • Information
controls fail or if security plans
other event • Issues
occur.
Stop and think
Are you aware of
how the
organisation you
work for, or study
at, deals with the
issues mentioned
in this chapter?

1 Developments in technology
Section overview
This section looks at the following technologies:

• cloud computing
• internet of things
• digital assets
• distributed ledgers
• blockchain
• fintech
• crypto currencies
• cognitive technologies: machine learning, artificial intelligence and robotic process automation
1.1 Cloud computing
Definition
Cloud computing: The provision of computer system services by a third party, which are accessed by
the user through the internet. Typical services include data storage, software as a service, and
infrastructure as a service.
Cloud computing is a service that provides a business with computing. Resources such as software
and information are provided to computers via the internet, in a similar way to electricity being
supplied over the electricity network.
Instead of running software on their computer, the user logs in to an account remotely. The software
and storage for the account exists on the service’s computer cloud – not on the user’s computer.
Processing is also performed in the cloud.
Many accounting packages are provided via cloud computing, and we shall consider these below.
Cloud Service Provider
Server
Cloud User
Router
Host
Network
Cloud
Router Cloud Vendor’s Infrastructure
Figure 14.1: Cloud computing
A cloud can be private or public. A public cloud sells services to anyone on the internet. A private
cloud is a proprietary network or a data centre that supplies hosted services to a limited number of
people. Private or public, the goal of cloud computing is to provide easy, scalable access to
computing resources and IT services.
A cloud service has three distinct characteristics:

• It is sold on demand, typically by the minute or the hour. The user pays for the service as it is
consumed, either for the short term (for example, for processing time) or for a longer duration (for
example, for cloud-based storage or vault services).
• It is elastic – users can use as much or as little of the service as they want.
• The service is fully managed by the provider (the user just needs a computer and internet access).
1.1.1 Cloud accounting

Cloud accounting is one application of cloud computing. Accountancy software is provided in the
cloud by a service provider. The user accesses this software to process their accounting transactions
and run reports, just as they would if the software was installed on their own computer.
Xero.com (a provider of cloud accounting software) identifies a number of risks and problems with
traditional accounting software which are solved by running cloud accounting software:
• The data in the system is not up-to-date, and neither is the software.
• It only works on one computer and data bounces from place to place (for example, on a USB
drive). This is not secure or reliable.
• Only one person has user access. Key people cannot access financial and customer details.
• It is costly and complicated to keep backups (if this is done at all).
• It is expensive, difficult and time-consuming to upgrade the software.
• Customer support can be expensive and slow.
(xero.com)
Whilst it addresses these issues, cloud accounting increases cyber risks from hacking and loss of or
damage to data. The user does not retain back-up copies of their data on their local computer, and
therefore is reliant on security and back-ups being provided by the service provider.
Questions may test your knowledge of the advantages and disadvantages of cloud computing.
1.2 The internet of things

The internet of things was described in the chapter Data analysis. The term refers to the increasing
number of devices that send data over the internet to a data processor, where the information is
processed.
Examples include:
• Sensors on machines that send information on the performance of the machine to a monitor.
• Radio Frequency Identification Tags – small tags containing chips that are attached to products.
The chips contain information about the product, including a unique identification number, and
other relevant information. These enable the location of the product to be monitored.
• Smart meters and other smart devices that can be accessed remotely via the internet.
1.3 Digital assets

Some investments in data and information by a business become a source of revenue for the
business. Data and information created and stored digitally can form a digital asset. Examples
include software, photos, film and videos, drawings, original music, digital documents, technical data,
websites, graphics and presentations in advanced digital form.
Definition
Digital asset: Any text or media file that is formatted into a binary source and that includes the right
to use it; digital files that do not carry this right are not considered digital assets.
Digital assets continue to exist as technology progresses regardless of the device where the digital
asset is stored or created.

There are two types of digital asset:
• media assets (images and multimedia)
• textual content (documents)
Unless digital assets are to be made freely available, the business must ensure their security is
maintained via encoding, encryption or watermarks. Care must be taken to ensure licences for use
are carefully worded and the ownership of the copyright or other form of intellectual property is clear
to users.
1.4 Distributed ledger technology
Definition
Distributed ledger technology: Technology that allows people who do not know each other to trust
a shared record of events.
Distributed ledger technology is a technology that changes the need for an organisation to store
and manage data and information centrally. It allows multiple organisations to access an accurate,
immutable shared record, that provides clarity about ownership of assets and existence of
obligations and facilitates the transfer of ownership of assets.
Conceptually, a distributed ledger is similar to a spreadsheet that is shared by a group of people.
Each time a transaction is made, this is recorded in the spreadsheet. Any member of the group can
propose updates to the spreadsheet, but there must be procedures in place to agree the validity of
these before they are accepted by the group. One method that is commonly used to achieve this
validation in distributed ledgers is blockchain (described below).
Distributed ledger technology is transforming the notions of centralisation and decentralisation in
many business areas. Replicated and synchronised digital data is shared across the organisation’s
network, however geographically spread, so there is no concept of centralised data storage, and no
question of certain parts of the organisation having less or more information than others. Distributed
ledger technology can also be used by multiple organisations which have a shared interest in
ensuring that the record of data that they are relying on is accurate.
Context example: Everledger system

One example of the use of distributed ledger technology is the Everledger system used in the
diamond industry. Everledger creates an identity for each diamond by recording its unique
specification across data points. The ledger indelibly records each time the diamond is changed (eg,
cut) or traded so that its ownership and transactions can be traced. This helps to prevent fraud and
enables diamond traders to ensure that they only buy diamonds that have been mined in an ethical
manner (such as by ensuring compliance with the Responsible Minerals Initiative).
1.5 Blockchain
Blockchain is a process that is used in many distributed ledger systems, to ensure that only valid
transactions are recorded. The highest profile use of blockchain is in the recording of transactions in
Bitcoin and other crypto currencies.
The concept of blockchain is that transactions are entered onto the ledger in blocks. When a
member of the community records a new block, it must be validated by an agreed number of other
members of the community.
The validation process involves checking a mathematical code that is attached to the block, referred
to as a hash. The hash is a cryptographic code, which is based on the data in the transaction. The
other members of the community check that the hash is correct, given the data in the block. Once
the hash has been checked, and the block validated by a sufficient number of members of the
community, the block is accepted as a valid entry.
Each subsequent block will contain an opening hash, being the closing hash from the previous block.
This makes is very difficult for changes to be made to a block once it has been recorded, because
any changes to a block would change the closing hash which would mean that it would no longer
equal the opening hash of the subsequent blocks.

While many distributed ledgers use blockchain, it should be noted that blockchain and distributed
ledgers are not the same thing. It would be possible to operate a distributed ledger without using
blockchain, provided some alternative procedure could be used to verify transactions.
1.6 Fintech
Like many industries the banking industry is experiencing challenges from new businesses using
technology to compete with the banks’ traditional business model.
Definition
Fintech: Software and other modern technologies used by businesses that provide automated and
improved financial services (Fintech weekly).
The growth of fintech has been driven not only by technology, but also by the poor reputation of the
traditional retail banks, which are seen by many as providing poor service to customers. Traditional
banks are experiencing competition from ‘challenger banks‘ and standalone ‘banking apps‘ offering
limited services eg, just payment services.
Challenger banks are small, often newly formed banks that aim to compete with the established
banks. They use technology to operate a lower cost base (eg, some are online banks only with no
branches). Like the traditional banks, they are fully licenced banks which enjoy some degree of
independent protection for depositors.
Other Fintech providers provide limited services (eg, payment apps) but are not fully licensed banks.
They may still require licences to operate (eg, payment apps require electronic money licences).
Examples of fintech include:
• crowd funding
• peer to peer lending, where borrowers are matched directly with savers
• online currency conversion
• digital wallets such as Apple pay. Users can make payments in stores or online using an app on
their mobile devices, and the payment is charged to the credit card without the user having to
have the card on their person, or disclosing the details of their credit cards to the agents.
1.7 Crypto currencies

Crypto currencies are digital tokens that allow users to trade with each other online. They are an
alternative to traditional currencies. One of the major differences between traditional and crypto
currencies is that making payments using crypto currencies does not involve a third party (a bank or
a digital payment service such as PayPal). It is similar in this respect to paying with cash. This can save
transaction costs and provide greater privacy to the traders.
Many crypto currencies use distributed ledgers and blockchains to record transfers of ownership
from one individual to another. Holders of the currency keep their currency in a digital wallet, which
can be maintained online or offline.
While digital currencies are beginning to be accepted by established financial institutions and
companies, there are risks:
(a) Volatility – the price of currencies is subject to large swings.
(b) Online digital wallets where the currencies are stored can be hacked.
(c) It is difficult to ascertain what the intrinsic value of a crypto currency is. The value comes from
the market.
(d) The privacy associated with using crypto currencies for payments could provide opportunities
for criminals to avoid money laundering regulations.
1.8 Artificial intelligence, machine learning and automation

Artificial Intelligence (AI), machine learning and automation are a step further on from data science,
big data and data analytics. They take these developments to the next level because they form
intelligent systems. Computers are now using data to learn and make their own decisions. They then
carry out actions based on those decisions, without any human intervention. In the broadest sense,
we refer to these developments as cognitive technologies. We then look at more specific types of

cognitive technologies, namely artificial intelligence, machine learning and robotic process
automation.
Definitions
Cognitive technologies: Technologies involving machines that can analyse data to extract patterns
and meaning, derive new information, and identify strategies and behaviours to act on the results of
their analysis.
Artificial intelligence (AI): The use of computers to do tasks which are thought to require human
intelligence. It typically refers to tasks such as learning, knowing, sensing, reasoning, creating things,
problem-solving, and generating and understanding language.
Machine learning: A form of AI which uses computer algorithms that improve automatically through
experience using very large data sets. The algorithms build a mathematical model based on sample
data to make predictions or decisions without being explicitly programmed to do so and with
minimal human intervention. They adaptively improve their performance as the number of samples
available for learning increases.
Automation: The creation of technology and its application in order to control and monitor the
production and delivery of goods and services, performing repetitive tasks that were previously
decided on and performed by humans.
Robotic Process Automation (RPA): A combination of process automation and machine learning so
that the robots can learn how to do manual tasks by observing humans at work.
1.8.1 Cognitive technologies

Cognitive technologies and automation are used in manufacturing of goods, transport, utilities,
defence, facilities, operations, IT (as we saw in the chapter Managing a business), and are
increasingly used in services, including professional services. In recent times, artificial intelligence has
become of great significance in all aspects of how organisations operate and will continue to do so
into the future. Examples include ‘chat’ functions on websites, route optimisation for logistics firms,
and banks using AI to help detect fraudulent transactions in customer accounts.
Cognitive technologies come in many forms and have many applications, from processing huge
data sets to controlling robots and drones. The ideas and concepts are drawn from the areas of
artificial intelligence, machine learning, and a range of fields such as psychology, linguistics and
brain sciences, forming many interdisciplinary relationships.
These systems, and in particular artificial intelligence, are key to how expert systems (which we shall
consider later in this chapter) work.
1.8.2 Artificial intelligence

The concept of artificial intelligence is that machines can be programmed to think like humans. When
human make decisions, we use two types of intelligence:
• Intuition – making decisions very quickly based on experience of what has happened before.
• Reasoning – using logic and reasoning to make a decision. This is slower than intuitive thinking.
Historically, artificial intelligence was based around programming machines to follow a set of pre-
determined rules. Applications included expert systems, which helped to make decisions that had
previously been made by experts. An example of how artificial intelligence can be used by
businesses is to provide customer service online or via apps. Many websites now use live chat
functions to handle customer queries. Expert systems can be used to help filter out customers with
basic questions by asking what the query is and offering potential answers to the query when the
customer first logs into the chat box.
1.8.3 Analytical type of AI

Analytical AI has cognitive intelligence (it uses cognition to create a representation of the world)
based on past experience that it uses to inform future decisions.

1.8.4 Human-inspired type of AI
This type of AI has a degree of emotional intelligence (an understanding of human emotions), as well
as cognitive elements, that is drawn on in decision making.
Computers are already being trained to recognise human emotions – such as changes in
expressions and voice inflections, that indicate emotions such as anger, joy and happiness. The
difficulty in developing this type of AI is that computers have to learn by effectively memorising
thousands of different emotions and being told what they mean. Computers lack intuition.
1.8.5 Humanised type of AI

This type of AI has several types of human intelligence characteristics (such as cognition, emotional
and social intelligence). This is the highest form of AI and allows the system to be self-conscious and
self-aware when interacting with humans.
Rich Cook states that ‘self-awareness means that we know we exist and are aware of what is
happening around us’. According to Rich Cook, it may be possible to programme computers to
appear to be self-aware, but they cannot truly have self-awareness. Essentially computers are very
complex calculating machines, but they lack common sense and judgement.
1.8.6 Machine learning

In recent years, machine learning has greatly increased the ability of machines to analyse data. By
analysing patterns in the data, machines are able to develop their own rules rather than following
pre-defined programmed rules. The machines are initially given training data to analyse, so that they
can learn the basic purpose of the analysis and an initial set of rules. As the machine works on more
and more data, it modifies and updates the rules based on new patterns that it identifies in the
underlying data.
Machine-learning decisions are based on two important aspects of analytics:
• prediction (‘predictive analytics’): anticipating what will happen, based on patterns in the data
• prescription (‘prescriptive analytics’): providing recommendations for what to do in order to
achieve objectives or goals (eg, maximise sales)
Context example: Use of machine learning to calculate credit scores

Bernard Marr (2018) provides several interesting examples of the use of AI and machine learning.
One of these is credit agency Experian, which provides credit scores on individuals for use by
providers of consumer credit. Experian uses a huge amount of data about individuals from around
the world, which is used in providing those scores. The company uses machine learning to improve
the way the scores are calculated, by identifying what information about the individuals is relevant
and what is not relevant in deciding if consumers are credit worthy.
Bernard Marr also describes how Volvo cars are fitted with sensors that monitor the performance of
the cars in different driving conditions. The company uses machine learning to improve its
knowledge of when parts need replacing or when cars need servicing. This information can be used
for many purposes, including improving parts or validating warranty claims. It uses this information to
provide better service to its customers and to continue its excellent safety record.
Automation is used in processing bank transactions. Many bank payments and receipts are now
processed entirely without human involvement.
Context example: Real life example

Several online retailers use machine learning to identify patterns in historic purchases, to help
customers find products that may be of interest to them. The Polaris search engine, used on
Walmart’s online sales platform was able to learn what customers wanted when they entered
particular phrases – for example, when customers entered ‘House’, Polaris was able to learn that they
wanted products related to the TV series ‘House’, they did not want to buy a house or goods related
to their house.

1.8.7 Robotic process automation
Traditionally, robotics involved robots performing fairly basic, repetitive tasks. The robot had to be
programmed to perform these tasks. The scope of tasks that can be automated has been greatly
expanded by the emergence of robotic process automation, which combines robotics with machine
learning.
Robotic process automation enables machines to learn for themselves how to do particular
processes, by watching humans and learning from them. Essentially, the processes have to be
routine, with little creativity or judgement required.
Context example: Use of robotic process automation in recruitment

Many tasks associated with recruitment can automated – such as sending standard emails to
applications asking them to complete standard forms. A bot could be put on the workstation of the
relevant employees and it would gradually learn from them and be able to take over routine tasks
(eg, opening the email, replying with a standard response etc). This would leave the employee to
deal with more complex tasks.
2 Technology developments and the accountancy

profession
Section overview
The pace of technological development in the areas of accountancy and audit is very fast and has far
reaching impacts on the work of the accountancy and audit professional.
Developments in information technology affect and disrupt all areas of business. This disruption is a
consequence of the developments being both rapid in pace and wide and deep in their scope. As
part of the accountancy profession, accountants help to run businesses (by performing business
functions) and also help to serve them (if they are clients). This means that developments in
information technology affect the profession directly due to the impacts on the work that is done
and how it is performed. This is especially true in relation to transactions processing, assurance and
auditing. For example, one impact of technology is that accountants are freed up to do more value-
adding work (such as providing advice) because technology performs a greater share of the more
basic functions that accountants used to do.
The following two tables show how technology has impacted both accountants and auditors:
Technology development Impact on accounting
Automation, machine learning The automation of transaction-level accounting means that

and artificial intelligence (AI) maintaining ledgers and preparing reconciliations, for
instance, is no longer performed by humans.
More powerful cognitive Computers become faster at processing and sharing data, and
technologies because they learn from the data, they can make decisions. For
example, they can learn where the debit side of bank
payments should be recorded. This frees up the accountant to
perform value-adding roles.
System innovations and Accountants are required to provide more advice on the
applications adoption of innovations and how to use and account for them.
For example, accountants could provide advice on whether
an entity should use a distributed ledger or on how it can
comply with HMRC’s Making Tax Digital scheme.
Digital contracts and transactions

Technology development Impact on accounting
Accountants are involved in new ways of recording

transactions. For example:
Self-verifying smart contracts. These invoke automatic
execution of defined rules to securely hold and transfer legal
title to an asset, including how to account for it so the same
cost and revenue are recognised by the two parties to a
transaction.
Distributed ledger technology and triple entry bookkeeping.
These mean that every accounting transaction recorded by an
entity is also posted to a public ledger.
New types of data, information The digital revolution has increased the need for accountants
and risks to exercise professional scepticism and critical thinking to
make sound professional judgements. For example:
• When deciding which information to enter into technology-
enabled tools.
• When interpreting and communicating system outputs.
• When mitigating risks, such as cyber risks, to the
usefulness of information produced by a system to end
users.
New types of goods and Accountants need to advise clients and employers on how to
services account for items arising from new technology such as digital
assets.
Transparency in recording and Distributed ledgers, for instance, mean there is more clarity
sharing data about resources due to the improved recording of
transactions. This also means there are more accounting
resources available for planning and valuation and more
certainty about measuring value.
Technology development Impact on auditing
Audit analytics, machine learning These systems allow complete checks on data and allow
and artificial intelligence 100% of transactions to be audited automatically on a
continuous basis.
Audit technologies may be embedded within an entity’s
accounting system which may lead to the businesses placing
an even greater emphasis on internal audit.
Smart contracts The audit of smart contracts can take place as the smart
contract is being created, before transactions under it occur.
Data analytics Predictive analytics helps to target risk and improves the
relevance of audits.
Software controls and data sets The work of auditors will focus on validating controls within
the accounting software and on interpreting complex data
sets.
Distributed ledger technology Properly functioning distributed ledgers and software reduce
and advanced accounting the need for auditors to audit transactions and verify the
systems ownership of assets.
Regulation Innovations, including all those in these two tables, are so

different to what has gone before that the regulation of
auditing will need to adapt.

Technology affects the work of individual accountants in a very wide variety of ways. Accountants in
general need IT literacy and adaptability so they can advise effectively, and increasingly will require
wider skills, for example, in data science and coding.
Exam questions may require you to demonstrate your knowledge of the different technologies, and
how they can be appropriate in different situations.
3 Use of technology to support other business functions

Section overview
This section looks at the application of technology in the operations, procurement and marketing
areas of the business.
3.1 Procurement and operations

Technology has enabled the procurement process to become more effective. Electronic data
interchange (EDI) has been used for many years and involves the replacement of paper documents
with electronic messages. Documents such as purchase orders can be sent to suppliers using EDI,
often without human involvement, for example sending a new purchase order automatically when
inventory levels are low. More recently, the use of cloud-based technology has improved the ease
with which companies can connect their systems with their suppliers.
E-procurement involves the use of internet-based technologies to identify and select suppliers,
leading to a wider group of potential suppliers to choose from. This includes suppliers publishing
electronic catalogues, and potential buyers sending requests for information (RFI) electronically.
The internet of things is relevant to e-procurement because devices such as radio frequency
identification tags (RFIDs) can be attached to products that send information about the products via
the internet. One application of this is to track the location of products. In the pharmaceutical
industry, it is important that information such as the expiry date of drugs, and the temperature at
which they have been stored is maintained to ensure that only drugs that are in usable condition are
sold.
The latest trend is the use of artificial intelligence and big data to automatically monitor and analyse
the performance of the procurement processes in order to identify inefficiencies or other areas
where improvements to the procurement process can be made.
3.2 Marketing function

All aspects of marketing products are increasingly affected by advances in technology, especially by
cognitive systems. For example, when marketing flights the price aspect of the marketing mix can be
adjusted by a cognitive system which takes account of timing when the consumer is using the online
booking system. Prices are set based on anticipated demand and can be programmed to increase
the price as more seats are booked or as the time to the flight gets nearer. Therefore, the price
customers pay increases the closer to the time of the flight they book.
4 Information systems
The following types of information systems have been used by businesses for the last two or three
decades so are not as recent as the developments discussed in section 1 above. They still have
relevance as they are used in practice.

Definitions
Executive support system (ESS) or Executive information system (EIS): Software that pools data from
internal and external sources and makes information available to senior managers in an easy-to-use
form. ESS help senior managers make strategic, unstructured decisions.
Decision support system (DSS): Combines data and analytical models or data analysis tools to
support both semi-structured and unstructured decision making.
Expert system: Captures human expertise in a limited domain of knowledge to allow users to benefit
from expert knowledge and information. The computer system holds specialised data and rules
about what to do in, or how to interpret, a given set of circumstances. In particular they can be used
to support strategic decisions, for example, to help determine the amount of resources needed to
expand production.
Knowledge work system (KWS): Facilitates the creation and integration of new knowledge into an
organisation.
Office automation system (OAS): A system that increases the productivity of data and information
workers.
Context example: Information management systems for the medical profession
Executive support The general managers of hospitals will have information on bed usage,
systems (ESS) costs of procedures, the demographics of the hospital catchment area,
the priorities of government, the care provided nearby and the
potential for epidemics or other issues. They will use this to set
priorities and decide the levels of provision for the coming years.
Management Managers exist at many levels such as practices, wards, clinics,

information systems procurement divisions etc. They will use information on demand and
(MIS) resource availability, costs and revenues etc, to ensure care is given
within budget.
Decision support Clinical staff may use systems such as scans, blood test data,
systems (DSS) information on the patient’s history and information on drug doses and
effects to decide how to treat the patient.
Expert systems Some telephone ‘triage’ services (eg, the NHS 111 service in the UK)
gather information from the caller about the symptoms using a
structured set of questions. The system will infer potential causes and
will generate further questions leading to a preliminary diagnosis and
decision on a course of action, such as calling paramedics,
recommending pain killers, etc.
Knowledge work Clinical staff will complete records and reports on office automated
systems (KWS) systems. They may keep up to date with their areas with on-line
journals. Some specialists use teleconferencing and image sharing
workflow systems to discuss cases or to provide expert diagnoses to
remote hospitals.
Office automation The patient appointment system will be automated and all
systems (OAS) correspondence typed. The hospital menus will be prepared in a
graphics package as will occasional signage.
Transaction processing The pharmacy will order and dispense inventory through its TPS.
systems (TPS)
4.1 Expert systems

Expert systems assist humans in making a decision. The expert system provides the knowledge and
rules concerning the process, allowing decisions to be made by humans who are not necessarily

experts in that particular field. Expert systems are an example of an early application of artificial
intelligence.
Context example: Expert system for loan applications

Financial institutions use expert systems to process straightforward loan applications. The user enters
certain key facts into the system such as the loan applicant’s name and most recent addresses, their
income and monthly outgoings, and details of other loans. The system will then:
• check the facts given against its database to see whether the applicant has a good credit
record;
• perform calculations to see whether the applicant can afford to repay the loan; and
• match up other criteria, such as whether the security offered for the loan or the purpose for
which the loan is wanted is acceptable, and to what extent the loan applicant fits the lender’s profile
of a good risk (based on the lender’s previous experience)
A decision is then suggested, based on the results of this processing. This is why it is often possible
to get a loan or arrange insurance over the phone or internet, whereas in the past it would have been
necessary to go and speak to a bank manager or send details to an actuary and then wait for him or
her to come to a decision.
4.1.1 Business applications of expert systems

• Legal or tax advice, for example to enable an employee of a legal firm, who is not legally trained,
to determine whether a potential client might have a case to claim damages. If the expert system
determines from the answers to set questions that a case might be brought, then it can be passed
to legally trained employees who can deal with it.
• Forecasting of economic or financial developments, or of market and customer behaviour. Expert
systems can process economic or other data in order to make predictions of what might happen
in the future (for example to analyse economic growth and interest rates to predict inflation rates).
• Surveillance, for example of the number of customers entering a supermarket, to decide what
shelves need restocking and when more checkouts need to be opened, or of machines in a
factory, to determine when they need maintenance. Expert systems can also be used to predict
demand for particular products, for example, based on customer trends and weather forecasts,
the demand for ‘seasonal’ products (such as ice cream in hot weather) can be predicted to ensure
that shops have enough stock to meet demand.
• Diagnostic systems, to identify causes of problems, for example in production control in a factory,
or in healthcare. Expert systems can be used as a first port of call if an information system or piece
of technology fails in a production line. Such systems can ask questions to help identify what the
fault might be and recommend potential solutions to avoid having to wait for IT staff to
investigate.
• Project management. Expert systems can help with the scheduling and rescheduling of projects
based on predicted timescales and current progress towards the project’s completion. They
might also help to predict and deal with bottlenecks in the implementation phase of the project.
• Education and training, expert systems can analyse student answers to online questions and
diagnose weaknesses in their knowledge. Once weak areas are identified, steps to address them
can be recommended, such as suggesting extra reading or question practice as appropriate.
Interactive question 1: Expert systems

Explain why businesses use expert systems for decision-making tasks when humans may be
considered to be naturally better able to perform them than computers.

5 Risks and ethical issues
Section overview
The changes brought about by the increased use of technologies presents additional risks and
ethical dilemmas which are outlined in this section.
• Obsolescence risk – the risk that investments in technology quickly become obsolescent
• Inexplicability risks – the risks that humans do not understand the algorithms developed by the
machine in machine learning
• Data protection and data bias issues
• Ethical risks – particularly with regard to confidentiality and the ethics of decisions made by
machines
5.1 Obsolescence risk

A risk of the technology developments is obsolescence risk. This is the risk that businesses invest in
expensive new technologies, which almost instantly become obsolete, so their investment is
wasted.
Obsolescence risk presents businesses with a dilemma. If they do not invest in the technology, they
will not remain competitive. If they do, then there is a risk that the investment will not generate the
returns that would justify making the investment.
The following steps could be taken to mitigate the effects of obsolescence risk:
(a) Outsourcing activities rather than investing in machinery and technology to perform activities in
house. This transfers the risk of obsolescence to the partner. It is important that agreements with
such partners allow the agreements to be terminated early.
(b) Trying to invest in technology that it might be possible to update as new developments occur.
(c) Aiming to invest in technology that has a shorter payback period. The payback period is the
period it takes until the company makes sufficient cash profits from the investment to cover the
cost of the investment.
5.2 Inexplicability risk

One of the risks associated with artificial intelligence is the risk that the algorithms developed by the
machines become too complex for humans to understand. This can make it difficult for businesses to
explain what processing has been performed on data. It can also make it difficult to check the output
of processing. This problem becomes explicit when the machines make decisions or classifications
that are clearly wrong. This is because machine learning is limited to the previous data that has been
analysed, so new external factors that the machine is unaware of may not be taken into account.
Inexplicability can also be a problem when businesses are asked to justify a decision – for example,
if a bank turns down a loan application, and the loan applicant asks for the reason, the bank may be
unable to explain it. This is also in contravention to the Data Protection Act 2018 which requires
companies to be able to explain how automated decisions about data subjects are made. (Note,
many countries have similar laws to the UK Data Protection Act).
5.3 Data protection

Privacy issues relating to the collection and analysis of data were discussed in the chapter Data
analysis. The GDPR specifies that companies should only hold personal data for specified purposes,
and the data should not be held for longer than required. The use of AI means that companies could
be tempted to breach these regulations, by hanging onto data for longer than necessary, or
collecting more data than is necessary.
5.4 Automation risks

Automation risks relate to whether or not businesses have the right staff with the skills to work in a
more automated environment. Automation might also threaten controls such as segregation of
duties.

5.5 Ethical risks
The ethical risks relating to the analysis of data were outlined in the chapter Data analysis. Artificial
Intelligence potentially leads to further ethical issues:
• Confidentiality is a fundamental principle for ICAEW members and students. AI often involves the
sharing of information, and this can lead to potential for increasing the number of breaches.
• If a machine makes a mistake, who is responsible? The developers or the person operating the
machine?
• How can machines be trained to make ethical decisions? Machines learn from historic data, so it
may be possible that there will be an element of ethical considerations in past data. However,
machines would not be able to cope with new ethical dilemmas that have not occurred in the test
data
Context example: Use of AI

One development in AI is driverless cars. If a driverless car causes an accident, who is to blame? Is it
the driver for not overriding the auto pilot controls? Is it the company that developed that car, or the
technology in the car?
6 Cyber risk
Section overview
• Cyber risk is a type of operational risk that has become increasingly relevant to businesses over
the last few years. It is important to understand cyber risks and how they can be mitigated.
• Cyber risk is the risk of financial loss, disruption or damage to the reputation of an organisation
from failure of its information technology systems due to accidents, breach of security, cyber-
attacks or poor systems integrity.
• Cyber-attacks are deliberate actions against an organisation. They include some low-level cyber
threats (eg, phishing) as well as more serious attacks (hacking and DDoS).
• Organisations can implement Cyber Essentials to improve their cyber security.
Definition
Cyber risk: The risk of financial loss, disruption or damage to the reputation of an organisation from
failure of its information technology systems due to accidents, breach of security, cyber-attacks or
poor systems integrity.
Such a risk could materialise in the following ways:

• deliberate and unauthorised breaches of security to gain access to information systems for the
purposes of espionage, extortion or embarrassment (cyber-attacks)
• unintentional or accidental breaches of security, which nevertheless may still constitute an
exposure that needs to be addressed
• poor systems integrity resulting in incomplete or corrupted data or processing
6.1 Cyber-attack and threats to computer systems
Definition
Cyber-attack: A deliberate action through the Internet against an organisation with the intention of
causing loss, damage or disruption to activities.

The National Crime Agency (NCA) website identifies the following as the most common cyber-
attacks and threats to computer systems:
• hacking: using specialist software and tools to gain unauthorised access to systems (especially
social media and email accounts) – see below
• phishing: bogus emails that ask the user for security information and personal details
• malicious software (such as file hijacker/ransomware): where criminals hijack a user’s files and
hold them to ransom
• distributed denial of service (DDoS) attacks: overwhelming websites and other online services
with vast amounts of internet traffic which is designed to crash, or stop the system from working –
see below
Other types of cyber-attack, which are less common include:
• webcam manager: where the user’s webcam is taken over
• keylogging: where criminals record what the user types onto their keyboard
• screenshot manager: where screenshots are taken of the user’s computer screen
• ad clicker: where a user’s computer is directed to click a specific link
6.2 Hacking
Hacking is one of the main methods that attackers use to gain access to computer networks. This is
achieved by the use of specialist software and other tools. The intruders are able to gain
unauthorised access to the network and take administrative control. This means they are able to
amend, copy and delete records, or even stop the network from operating.
The main risk of hacking is that data stored on the network could be compromised. Personal data
(such as HR or customer records) as well as strategic and other sensitive data can be used by the
attackers to make money, usually through its sale to third parties, or to achieve some other purpose
such as furthering a political agenda.
Another risk is that damage to computer networks could put the business’s physical infrastructure in
danger, compromising its ability to operate. For example, if a travel company’s computer network
goes down there is a risk that day-to-day business activities, such as booking new holidays and
managing existing ones, will cease with major implications for both the business and its suppliers
and customers.
6.3 Distributed denial of service (DDoS) attacks

DDoS attacks are designed to disrupt an organisation’s online presence by preventing legitimate
users from accessing the organisation’s online services. This is achieved by overwhelming the
organisation’s website and communications links with a wave of internet traffic that the system is
unable to handle.
Criminals are able to organise DDoS attacks through the use of botnets. These are large groups of
individual computers that the criminals have previously compromised. On a signal sent by the
organiser of the attack, the affected machines are instructed to send messages simultaneously to the
target.
6.4 Preventing and tackling cyber-attacks

The National Crime Agency (NCA) suggests that the following steps should be taken to prevent
cyber-attacks:
• Choose strong passwords and do not reuse them for multiple log ins. Using passwords that are
easy to guess or using the same password for many different systems or websites makes it much
easier for hackers to guess the passwords and gain unauthorised access. Password management
apps can be used to suggest passwords and remember them. Many web browsers such as
Google Chrome include built in password management software.
• Install security software such as anti-virus and two factor authentication. Two factor authentication
helps to verify the identity of the user at log in by sending a one-time use code to a second
device, such as a smart phone. Access to the system requires the code to be entered.
• Keep all security software and operating systems updated. Updates fix security weaknesses
identified in software and apps that could be used by hackers to gain access.

There are a number of basic actions that businesses can take to counter the threat of cyber-attacks
with better cyber security.
Basic action Explanation
Report cyber- If cyber-attacks and other cyber incidents are reported, it allows law
attacks/incidents enforcement agencies to investigate. This improves their
understanding of the scale of cyber-attacks and helps shape future
responses to them, as well as making sure that their resourcing and
funding as appropriate.
Cyber risk mitigation The more devices that an organisation connects to the internet, the
more exposed it is to potential attack. Cyber security is the main
method of mitigating cyber risk and is vital to protect the business’
operating capability, finances and reputation. Even basic cyber
security methods can reduce the risk of most attacks.
Manage cyber security To be most effective, cyber security should be integrated with risk
management. The aim of cyber security is to increase the difficulty
that a cyber attacker faces in order to make a successful attack.
The appropriate level of cyber security depends on the size of the
organisation and the cyber risk that it faces. Small organisations or
those with relatively low cyber risk should focus on the
fundamentals. Larger organisations or those with high cyber risk
should aim for greater depth of security.
Promote awareness Organisations should promote best practice to its stakeholders,

such as employees, in regard to cyber security. This could include
setting a strong password policy and encryption methods, and
making sure that users apply them.
Share knowledge and Organisations should share knowledge and expertise with other
expertise businesses and stakeholders. All parties are likely to gain
something by sharing what they know.
Develop cyber skills and Organisations should consider cyber security training programs for
awareness new staff or employ staff with good cyber security skills to help
improve the depth of knowledge within the business.
Exam questions may test your ability to identify relevant controls to counter particular risks. Ensure
you understand how the steps above can help to reduce cyber risks.
6.5 Importance of cyber security
Definitions
Cyber security: The protection of systems, networks and data in cyberspace; the procedures used by
a business to protect its information system (hardware, software and information) from damage,
disruption, theft or other loss.
Critical information assets: Asset which are fundamental to an organisation’s core activities and their
performance, as well as its overall capability and viability.
The security of computer systems is of vital importance to businesses.

• It is a legal obligation under data protection law and other regulations to protect certain types of
data in a computerised system.

• Information accessed, stored, processed and made available online is of vital strategic and
commercial importance.
• The connectedness of computer systems makes the threat of external attack ever more likely.
ICAEW’s Audit Insights, cyber security report (ICAEW, 2018) explains that many organisations have
legacy IT systems. These are often fragmented, non-standard systems that are often supported just
by spreadsheets. In the long-term, organisations with such systems will need to invest in technology
in order to reduce complexity and to have resilience, recovery and responses to cyber breaches in
place.
In the first of the Audit Insights, cyber security reports (ICAEW, 2013), the following key challenges
and priorities for boards in managing cyber risks were identified.
• Businesses should consider cyber risk in all their activities: the challenge here is to move cyber
risk from being pigeon-holed as ‘IT’ to be seen as an integral part of all business risks.
• Businesses need to accept their security will be compromised: this emphasised a different
mindset, recognising some level of compromise as inevitable and broadening cyber security
activities beyond prevention to include intelligence, detection and response.
• Businesses should focus on their critical information assets: given the inevitability of breaches,
businesses need to prioritise their security activities around their most valuable pieces of data,
although identifying these was often a major challenge.
• Most businesses don’t get the basics right: the real challenge for businesses of all sizes is
achieving basic cyber hygiene.
The content of these reports is important when we consider business resilience which was covered
in the chapter Risk Management.
6.6 Technical controls for cyber security

The ‘Cyber Essentials‘ scheme was developed by the UK Government and industry bodies to show
organisations how to protect themselves against low-level cyber risks. It lists five controls, in simple
terms, that an organisation should have in place. Each of these controls are supported by technical
protections:
Controls Technical protections
Use a firewall to secure its internet connection Boundary firewalls and internet gateways –
software that intercepts network traffic in and
out of a system
Choose the most secure settings for its devices Secure configuration – ensuring the system is
and software set up with cyber security as a priority
Control who has access to data and services Access control – physical and network
procedures to restrict access to a system
Protect itself from viruses and other malware Malware protection – software that prevents and
removes unwanted programs from a system
such as anti-virus software
Keep devices and software up to date (also Patch management – ensuring the latest
known as ‘patching’) updates to software are installed
These minimum cyber security controls should be applied to all areas of the business, such as cloud
services, business and personal devices or specific technologies used in the organisation. We shall
look at information security in more detail in the chapter Introduction to financial information.
6.7 Cyber resilience
Definition
Cyber-resilience: The ability of an organisation to ensure that its data and information are reliable,
available, has integrity and is adequately protected from unauthorised access.

Cyber security is an important part of an organisation’s resilience. It is a function that helps protect
organisations against the risk of cyber-attack and therefore provides resilience against this type of
threat. Security measures are, however, no guarantee of total protection and therefore it is vital for
organisations to have alternative, back-up plans to deal with cyber-attacks that do get through the
defences.
As well as cyber security, organisations should also have appropriate IT disaster recovery procedures
set up. Such systems provide back-ups of the data and information held by the organisation that can
be used to replace data and information lost in a cyber-attack.
According to the ICAEW report, Developing a cyber-resilience strategy (2014), the following are
threats to an organisation’s cyber-resilience:
• Mobile threats – this is the risk that mobile devices containing information, data and connections
to an organisation’s system are lost or stolen.
• Networking and cloud considerations – this is the risk that broadband, wi-fi and other network
connections become unavailable and therefore users working remotely or via the cloud cannot
access the organisation’s systems or data.
• Access controls in the mobile world – this is the threat that access controls to the organisation’s
main system are compromised due to inferior controls being in place on mobile devices. In some
instances, the organisation does not have control over access if this is provided by third parties.
• Other threats – the report identifies a number of other threats, such as attacks on company
websites, social media and email. There are also threats such as fire, hardware failure and burglary
that will also prevent access to company systems.
To counter cyber-resilience threats, organisations should develop an information security plan.
Whilst the contents and details of a company’s plan will depend on its business and systems, it
should cover the following areas:
• securing system and device configurations
• network security
• user privileges
• home and mobile working
• removable media controls
• user education and awareness
• web services
• legal requirements
• compliance
• incident management
• monitoring
The report covers some specific cyber-resilience issues that organisations need to consider.
• Understand where all the information is – key information that is vital to the business should be
identified and located.
• Separate systems with different levels of trust – once the key information is identified and
located, trust levels can be set for networks so that there is adequate protection in place (such as
firewalls between networks).
• User access rights and obligations – principles should be established to determine the rights that
people, organisations and systems have in regards to data and information. For example, only a
few individuals should be granted full administrator rights that enable them to amend and delete
data. There should be rules in place that set how and where data may be accessed (such as
restrictions on accessing the system in a public place).
• Address specific weaknesses – policies and procedures should be established to minimise the
risk to systems (such as rules governing how data may be transmitted to and from mobile
devices).
• Cover all key legal issues – the organisation must ensure full compliance with the Data Protection
Act.

• Address third party relationships – where systems are provided by third parties the relationship
should be managed. In some instances (such as where a bespoke system is provided) this can be
set out in a contract and a degree of control achieved. However, for some systems (such as email
services) this is not always possible and the organisation should set out policies and procedures
to control how such services are selected.
• Conformance assessment and penetration testing – the organisation should set out policies to
control the extent to which systems conform to certain security profiles. These assessments should
be regular in order to determine whether systems are meeting security criteria.
• In-house versus external managed security services – organisations may establish in-house data
security teams, and this allows maximum control over data security. However, smaller
organisations may need to outsource security due to the costs of resourcing it. If this is the case,
then it is important for the organisation to retain as much control over it as possible.
• Define specific responsibilities – policies should establish where responsibility for the various
aspects of cyber-resilience lie. Users should be aware of what should happen if threats to cyber-
resilience occur.
• Monitoring and review – policies and procedures in relation to cyber-resilience should be
regularly monitored and reviewed. They should be revised in order for the business to maintain
an acceptable risk profile.
Cyber risk and resilience have prompted a number of cyber security standards. ICAEW’s report Audit
Insights: cyber security (2018) explains the following examples.
Standard Description
ISO 27001 This is the best-established information security standard. It is a

management system that provides a long list of potential controls that
organisations can choose to adopt, based on their risk assessment. It is
supplemented by a variety of more specific security standards in the
27000 series, such as business continuity.
Cyber essentials This was created in 2014 by the UK Government, after it concluded
that none of the existing standards met their specific needs. This aims
to provide a baseline of cyber hygiene for all organisations and is
being pushed down supply chains for government contracts.
NIST (National Institute This is a US framework that incorporates risk-based cyber security
of Standards and standards based on different industry sectors. They are also often
Technology) pushed down supply chains, such as defence, and are fairly
prescriptive in nature.
PCI-DSS (Payment Card This is a standard that is specific to payment cards – anyone
Industry Data Security processing payment card transactions has to pass the assessment and
Standard) show compliance. This is a highly prescriptive standard, identifying the
controls to be adopted with regard to payment card data.
SOC for Cybersecurity This was published by the AICPA (American Institute of CPAs). It is for
the reporting of cyber risk management, and for providing assurance
opinions on the cyber risk management programme and associated
controls. While it is US-centric, it shows the potential demand for
better reporting and assurance around cyber risks.

Summary
The accountancy Developments in technology Information systems to

profession • Cloud computing support the business
• Automation of • Internet of things • Executive support
transaction-level • Digital assets systems
accounting • Distributed ledgers • Decision support
• Free to perform value • Blockchain systems
adding roles • Fintech • Expert system
• Advice on innovations • Crypto currencies • Knowledge work
• Digital contracts • Cognitive technologies, systems
• Automatic audit machine learning, AI • Office automation
technologies • Robotic process automation systems
Other business functions Risks and

ethical issues
Cyber risk
Cyber resilience

having studied this chapter. If you do not, you are advised to revisit the relevant learning from the
topic indicated.
1 Do you know the meaning of the following terms: Cloud accounting, internet of things,
digital assets, distributed ledgers, blockchain, fintech, crypto currency and cognitive
technologies? (Topic 1)
2 Can you distinguish between artificial intelligence, machine learning and robotic process
automation? (Topic 1)
3 Can you identify ways in which technology has impacted on the work of both accountants
and auditors? (Topic 2)
4 Can you list ways in which technology has been used in procurement, operations and
marketing? (Topic 3)
5 Do you know the meaning of the terms: Executive support system, Decision support
system, Expert system, Knowledge work system, Office automation system? (Topic 4)
6 Do you understand the following risks associated with technology? Obsolescence risk,
inexplicability risk and automation risks? (Topic 5)
7 Do you know what the most common types of cyber-attack are? (Topic 6)
8 Do you know the technical controls over cyber security? (Topic 7)
9 Do you know the meaning of cyber resilience? (Topic 7)

questions in the Developments in technology chapter of the Business, Technology and Finance
queries. Once you have attempted these questions, you can move on to revision for the exam.

References
• Computer Security Resource Center (2016) Cloud Computing. [Online]. Available from:
https://csrc.nist.gov/Projects/Cloud-Computing [Accessed 22 June 2021].
• Cook, R. (n.d.) Will computers become self-aware, The Keyboard org [Online]. Available from:
www.thekeyboard.org.uk/computers%20become%20self%20aware.htm [Accessed 22 June
2021].
• Imperial College London (2018) Data Science Institute Brochure. London, Imperial College
London.
• Marr, B. (2018) 27 Incredible Examples of AI And Machine Learning In Practice, Forbes [Online].
Available from: https://www.forbes.com/sites/bernardmarr/2018/04/30/27-incredible-examples-
of-ai-and-machine-learning-in-practice/#224973b37502 [Accessed 22 June 2021].

Self-test questions

1 Which of the following is/are a type of digital asset?
(1) image files copied from a website without the owner’s knowledge
(2) videos downloaded from YouTube
(3) music downloaded from an artist’s website
(4) electronic versions of accounting standards downloaded from the IASB®
A (1) and (2) only
B (2) and (4) only
C (2), (3) and (4) only
D (3) only
2 Which of the following best describes distributed ledger technology?
A a system for authorising new transactions on a shared record, using a cryptographic code
B an accounting system that is held on a remote server, and accessed by users over the internet
C technology that allows people to trust a shared record of events
D an online cash book, where the debit side and the credit side are maintained by separate
individuals
3 Which of the following statements about Crypto Currencies is correct?
A Crypto currency transactions require the use of a third-party payment agent such as PayPal.
B Crypto currencies are regulated by central banks.
C Crypto currencies use distributed ledgers to record changes of ownership.
D Crypto currencies are a risk-free method of holding wealth.
4 A news website requires users to log in. The website then monitors which particular topics the user
appears to be most interested in. This information is used to customise the order in which articles are
presented to the user on future visits, with articles on topics that are of highest interest presented
most prominently.
Requirement
What is this process an example of?
A robotic process automation
B machine learning
C an expert system
D blockchain
5 Which of the following tasks, performed by an accountants and auditors, is least likely to be
automated?
A entering transactions into ledger accounts
B auditing bank transactions
C interpreting the financial performance of a business
D filing tax returns
6 Cranfield, a highway engineer, inputs some data about the stage of completeness of the road-
building project he is working on into his laptop each night, and by the morning the system has
produced a report telling him which tasks will need completing that day and how many labourers will
be required.

Requirement
What is Cranfield’s system an example of?
A an expert system
B a management information system
C a transaction processing system
D a human resources system
7 Which of the following statements best describes a cyber-attack?
A accidental damage to a computer system caused by an inexperienced user
B data corruption caused by poor systems integrity
C deliberate action through the internet causing loss or damage to an organisation
D data loss caused by physical damage such as vandalism to a computer system
8 One of the threats that Blogs Co has identified to its cyber resilience is that broadband and Wi-Fi
networks may become unavailable, so people working from home would be unable to access Blog
Co’s systems.
Requirement
In terms of the ICAEW report ‘Developing a cyber-resilience strategy’, what type of threat has Blog
Co identified?
A mobile threat
B networking and cloud considerations
C access controls in the mobile world
D denial of service
this chapter.


The primary reason has to do with the relative costs. A ‘human’ expert is likely to be more expensive
either to employ or to use on a consultancy basis.
Secondly, enshrining an expert’s accumulated wisdom in a computer system means that this wisdom
can be accessed by more people. The delivery of complicated services to customers, and decisions
whether or not to extend credit and so forth, can be made by less experienced members of staff. If a
manufacturing company has a complicated mixture of plant and machinery, then the repair engineer
may accumulate a lot of knowledge over a period of time about the way it behaves: if a problem
occurs the engineer will be able to make a reasoned guess as to where the likely cause is to be
found. If this accumulated expert information is made available to less experienced staff, it means
that some of the learning curve is avoided.
An expert system is advantageous because it saves time, like all computer systems (in theory at least)
but it is particularly useful as it possesses both knowledge and limited reasoning ability.

C (2), (3) and (4) only
A digital asset is any text or media file that is formatted into a binary source and that includes the
right to use it; digital files that do not carry this right are not considered digital assets.
C technology that allows people to trust a shared record of events
A describes blockchain, which is often use in distributed ledger systems, but is not in itself a
distributed ledger. B describes a cloud-based accounting system. D could be true of many
accounting systems, including manual ones.
C Crypto currencies use distributed ledgers to record changes of ownership.
The correct answer is C. Crypto currencies are like online cash, so do not require the use of a third-
party payment agent. They are not regulated by central banks (although the central banks of some
countries have banned the trading of crypto currencies). Crypto currencies are not risk free – the
value of the currencies tends to be very volatile, and some owners have had their digital wallets
hacked, and their crypto currency stolen, so they are not a risk-free method of holding wealth.
B machine learning
The correct answer is machine learning, as the website is ‘learning’ what the preferences of the user
are by monitoring the data.
C interpreting the financial performance of a business
The correct answer is C, Interpreting the financial performance of a business. While data analytics can
provide detailed analysis, interpretation of the analysis is likely to require some human input.
It is possible to automate the other items. Entering routine transactions into ledger accounts can be
performed by robotic process automation. Auditing analytics systems enable auditors to audit
routine transactions automatically. Filing tax returns is also a task that many accounting software
packages can do, as part of HMRC’s making tax digital programme.
A an expert system
The system is analysing the data in order to determine the optimal work plan. As such it is replacing a
task that the project manager would previously have to perform manually. This is therefore an
example of an expert system.
C deliberate action through the internet causing loss or damage to an organisation
Cyber-attacks are deliberate and take place through the internet.
B networking and cloud considerations
Mobile threats refer to the risk of mobile devices containing confidential information or access the
business’s networks being lost or stolen. Access controls in the mobile world relates to the threat of
poor access controls on the company’s main systems relating to providing access to mobile devices.

A denial of service attack is not mentioned as a category of cyber resilience threats in the ICAEW
report, but is a type of cyber-attack where the perpetrators try to crash a target system.

Glossary of terms
Abiotic service:
Benefits to people that do not depend on ecological processes but arise from fundamental
geological processes and include the supply of minerals, metal, and oil and gas, as well as
geothermal heat, wind, tides and the annual seasons.
Accountability: A person’s liability to be called to account for the fulfilment of tasks they have been
given by persons with a legitimate interest in the matter.
Accountancy: The profession of accounting which comprises measurement, preparation, validation,

disclosure, auditing of and provision of assurance and advisory services on financial information.
Accountancy profession: The profession concerned with the measurement, disclosure or provision of
assurance about financial information that helps managers, investors, tax authorities and other
decision makers make resource allocation decisions.
Activities: The means by which a business creates value in its products. (They are sometimes referred
to as value activities.)
Applied research: Research which has an obvious commercial or practical end in view.
Artificial intelligence (AI): The use of computers to do tasks which are thought to require human
intelligence. It typically refers to tasks such as learning, knowing, sensing, reasoning, creating things,
problem-solving, and generating and understanding language.
Assurance: The expression of an opinion or conclusion by a professional accountant in public

practice which is designed to enhance the confidence of intended users.
Authority: The right to do something, or to ask someone else to do it and expect it to be done.
Authority is thus another word for position or legitimate power.
Automation: The creation of technology and its application in order to control and monitor the
production and delivery of goods and services, performing repetitive tasks that were previously
decided on and performed by humans.
Balanced scorecard: An integrated set of performance measures linked to the achievement of

strategic objectives.
Benchmarking: The establishment, through data gathering, of targets and comparators, through
whose use relative levels of performance (and particularly areas of underperformance) can be
identified. By the adoption of identified best practices it is hoped that performance will improve.
(CIMA Official Terminology)
Big data: those datasets whose size is beyond the ability of typical… software to capture, store,
manage and analyse (Manyika et al)
Biodiversity: Biodiversity is critical to the health and stability of natural capital as it provides resilience
to shocks like floods and droughts, and it supports fundamental processes such as the carbon and
water cycles as well as soil formation. Therefore, biodiversity is both a part of natural capital and also
underpins ecosystem services. (Natural capital coalition (2016))
Bureaucracy: ‘A continuous organisation of official functions bound by rules’ (Weber, 2015).
Business: An organisation (however small) that is oriented towards making a profit for its owners so
as to maximise their wealth and that can be regarded as an entity separate from its owners.
ICAEW 2023 Glossary of terms 497

Business cycles/trade cycles: The continual sequence of rapid growth in GDP, followed by a
slowdown in growth and then a fall. Growth then comes again, and when this has reached a peak, the
cycle turns once more.
Business ethics: The application of ethical values to business behaviour and functions. Ethics goes
beyond the legal requirements for a business and is, therefore, about discretionary decisions and
behaviour guided by values. (Institute of Business Ethics, n.d.)
Business partnering: Involves the finance function working alongside other business functions rather
than being a separate function on their own. Instead of only reporting on organisational
performance, the role of the finance function becomes one of providing advice and support to the
other areas of the business, to help them maximise their performance.
Business resilience: A business’s ability to manage and survive against planned or unplanned shocks
and disruptions to its operations.
Business system: A collection of people, machines and methods organised to accomplish a set of
specific functions.
Capital market: The national and international markets in which a business may obtain the finance it
needs for its short-term and long-term plans.
Cartel: An agreement between businesses not to compete with each other. The agreement is usually
verbal and often informal.
Centralised organisation: One in which decision-making authority is concentrated in one place, that
is the strategic apex.
Climate change: Long-term shifts in temperatures and weather patterns. Some of these shifts occur
due to natural causes, such as variations in the solar cycle. Since the 1800s, human activities have
been the main driver of climate change.
Cloud computing: The provision of computer system services by a third party, which are accessed by
the user through the internet. Typical services include data storage, software as a service, and
infrastructure as a service.
Coefficient of variation: Co-efficient of variation =
Standard deviation
mean
Cognitive technologies: Technologies involving machines that can analyse data to extract patterns
and meaning, derive new information, and identify strategies and behaviours to act on the results of
their analysis.
Company: A legal entity registered as such under statute (the Companies Act 2006).
Comparability: The extent to which differences between statistics from different geographical areas,
non-geographic domains, or over time, can be attributed to differences between the true values of
the statistics (OECD).
Competitive strategy: ‘Taking offensive or defensive actions to create a defendable position in an

industry; to cope successfully with…competitive forces and thereby give a superior return on
investment for the business.’ (Porter, 1980).

Confirmatory data analysis: Using statistical methods to confirm a pre-determined hypothesis (eg, a
factory believes that on average, 5% of its output is faulty, and wants to investigate to see if this is
correct). Confirmatory data analysis is discussed in more detail in the section on sampling below.
Continuous organisation: The business does not disappear if people leave: new people will fill their
shoes.
Control activities: The actions established through policies and procedures that help ensure
management’s directives to mitigate risks to the achievement of objectives are carried out.
Corporate appraisal: A ‘critical assessment of the strengths and weaknesses, opportunities and
threats (SWOT analysis) in relation to the internal and environmental factors affecting an entity in
order to establish its condition before the preparation of the long-term plan’ (CIMA, 2005).
Corporate code of ethics: A formalisation of principles, values, responsibilities and obligations.
Corporate governance: ‘A set of relationships between a company’s management, its board, its
shareholders and other stakeholders…that provides the structure through which the objectives of
the company are set…attained…and monitored’ (OECD, 2015).
Corporate governance: ‘The system by which companies are directed and controlled’ (Cadbury
Committee, 1992).
Corporate governance: A structured system for the direction and control of a company that:
• specifies the distribution of rights and responsibilities between stakeholders, such as the
shareholders, the board of directors and management; and
• has established rules and procedures for making decisions about the company’s affairs
Corporate responsibility: Corporate responsibility is about the impact an organisation makes on

society the environment and the economy. (CIPD)
Corporate responsibility: The commitment the business makes to its stakeholders to increase its
positive impacts and decrease its negative ones (Institute of Business Ethics, n.d.)
Cost drivers: Any activity that affects the cost of a product or service.
Cost leadership: Producing at the lowest cost in the industry as a whole (not necessarily being the
producer offering the lowest prices to the consumer, though the cost leader can compete freely on
price in the marketing mix).
Cost push inflation: Price rises resulting from an increase in the costs of production of goods and
services, eg, of imported raw materials or from wage increases.
Crisis: An unexpected event that threatens the wellbeing of a business, or a significant disruption to
the business and its normal operations which impacts on its customers, employees, investors and
other stakeholders.
Crisis management: Identifying a crisis, planning a response to the crisis and confronting and
resolving the crisis.
Critical information assets: Asset which are fundamental to an organisation’s core activities and their
performance, as well as its overall capability and viability.
Critical success factor (CSF): ‘Those product features that are particularly valued by a group of
customers and, therefore, where the organisation must excel to outperform the competition.’

(Johnson & Scholes, 2002)
Critical thinking: The ability to analyse and evaluate issues objectively and rationally, keeping a clear
head when forming judgements about matters being considered.
Cross elasticity of demand: A measure of the responsiveness of demand for one good to changes in
the price of another good.
Culture: The common assumptions, values and beliefs that people share; ‘the way we do things
round here’.
Cyber risk: The risk of financial loss, disruption or damage to the reputation of an organisation from
failure of its information technology systems due to accidents, breach of security, cyber-attacks or
poor systems integrity.
Cyber security: The protection of systems, networks and data in cyberspace; the procedures used by
a business to protect its information system (hardware, software and information) from damage,
disruption, theft or other loss.
Cyber-attack: A deliberate action through the Internet against an organisation with the intention of
causing loss, damage or disruption to activities.
Cyber-resilience: The ability of an organisation to ensure that its data and information are reliable,
available, has integrity and is adequately protected from unauthorised access.
Data: Distinct pieces of information, which can exist in a variety of forms – as numbers or text on
pieces of paper, as bits or bytes stored in electronic memory, or as facts stored in a person’s mind.
Data analytics: The process of using fields within the source data itself, rather than predetermined
formats, to collect, organise and analyse large sets of data to discover patterns and other useful
information which an organisation can use for its future business decisions.
Data bias: Where the data in the sample is not representative of the population for reasons other
than the size of the sample.
Data science: Deals with collecting, preparing, managing, analysing, interpreting and visualising
large and complex datasets (Imperial College London, 2018).
Data set: A collection of data about a population, or a sample of a population (eg, the values of a
variable such as age of all ICAEW students would be a data set).
Data visualisation: Data visualisation is the use of charts and diagrams to present information.
Debt factoring: The business receives loan finance and insurance – known as non-recourse factoring
– so that in the event that a customer does not pay, the business does not have to repay the loan.
Decision support system (DSS): Combines data and analytical models or data analysis tools to
support both semi-structured and unstructured decision making.
Deflation: Falling prices generally, which is normally associated with low rates of growth and
recession.
Delegation: Delegation involves giving a subordinate responsibility and authority to carry out a given
task, while the manager retains overall responsibility.

Demand: The quantity of a good that potential purchasers would buy, or attempt to buy, if the price
of the good were at a certain level.
Demand pull inflation: Price rises resulting from a persistent excess of demand over supply in the
economy as a whole. Supply cannot grow any further once ‘full employment’ of factors of production
is reached.
Descriptive statistics: Describe the properties of sample and population data, such as the average
value and the degree of variability.
Descriptive statistics: The use of statistics that summarise the data in a data set. Examples of
descriptive statistics are the measures of central tendency (mean, median and mode) and measures
of dispersion (range, variance and standard deviation) discussed in the chapter Introduction to Risk
Management.
Development: The use of existing scientific and technical knowledge to produce new (or
substantially improved) technology, products or systems, before starting commercial production
operations.
Deviation: For each value in a data set, deviation refers to how far from the mean that value is.
Mathematically this is written as:
(X−X)
Differentiation: The provision of a product or service which the industry as a whole believes to be
unique.
Digital asset: Any text or media file that is formatted into a binary source and that includes the right
to use it; digital files that do not carry this right are not considered digital assets.
Disaster: The business’s operations, or a significant part of them, break down for some reason,
leading to potential losses of equipment, data or funds.
Disposable income: Income available to individuals after payment of personal taxes. It may be
consumed or saved.
Distributed ledger technology: Technology that allows people who do not know each other to trust
a shared record of events.
Divisionalisation: The division of a business into autonomous regions (geographic divisionalisation)

or product businesses (product/brand divisionalisation), each with its own revenues, expenditures
and capital asset purchase programmes, and therefore each with its own profit responsibility.
Dominant position: One where the business is able to behave independently of competitive
pressures, such as other competitors, in that market.
Downside risk: The possibility that an event will occur and adversely affect the achievement of
objectives.
Downstream supply chain members: The elements of the supply chain that are involved after the
product has been manufactured or service provided (ie, the marketing function and customers).
Ecosystem services: The benefits to people from ecosystems, such as timber, fibre, pollination, water
regulation, climate regulation, recreation, mental health, and others.
Elasticity: The extent of a change in demand and/or supply given a change in price.

Enhancing qualitative characteristics: The attributes that enhance the fundamental usefulness of
information provided in financial statements to users (IFRS Framework):
• Comparability
• Verifiability
• Timeliness
Environment of a business: Everything outside its boundaries. It may be segmented according to

Figure 4.3 into the physical, the general and the task environment.
Equilibrium price: The price of a good at which the volume demanded by consumers and the
volume businesses are willing to supply are the same.
Equity: represents the ordinary shares in the business. Equity shareholders are the owners of the
business and through their voting rights exercise ultimate control.
Ethical behaviour: Acting in a manner which is perceived to be acceptable in the circumstances – or

‘behaving well’.
Ethical culture: A business culture where the basic values and beliefs in a company encourage
people within the company to behave ethically.
Ethics: A system of behaviour which is deemed acceptable in the society or context under
consideration. Ethics tell us ‘how to behave’.
Executive support system (ESS) or Executive information system (EIS): Software that pools data from
internal and external sources and makes information available to senior managers in an easy-to-use
form. ESS help senior managers make strategic, unstructured decisions.
Expert system: Captures human expertise in a limited domain of knowledge to allow users to benefit
from expert knowledge and information. The computer system holds specialised data and rules
about what to do in, or how to interpret, a given set of circumstances. In particular they can be used
to support strategic decisions, for example, to help determine the amount of resources needed to
expand production.
Exploratory data analysis: Identifying relationships in a set of data – for example, patterns that the
business was not aware of that could be useful (eg, finding out that customers with particular
characteristics are more likely to churn. Churn is a term used to refer to customers who switch to
other providers of a service.) Exploratory data analysis may use regression and correlation, which are
covered in the Management Information module.
Export credit insurance: is insurance against the risk of non-payment by foreign customers for export
debts.
Externality: The difference between the private and the social costs, or benefits, arising from an
activity. Less formally, an ‘externality’ is a cost or benefit which the market mechanism fails to take into
account because the market responds to purely private signals. One activity might produce both
harmful and beneficial externalities.
Financial information: A broad definition is that financial information is information about an entity’s
activities expressed in monetary terms. A narrower definition, contained in the IFRS® Conceptual
Framework, is that financial information is information contained in an entity’s financial report. This
includes information on the entity’s income, expenses, assets, liabilities and equity.

Financial reporting: Providing information about a business to external users that is useful to them in
making decisions and for assessing the stewardship of the business’s management.
Financial reporting: The provision of financial information about an entity to external users that is
useful to them in making decisions and for assessing the stewardship of the entity’s management.
Fintech: Software and other modern technologies used by businesses that provide automated and
improved financial services (Fintech weekly).
Fiscal policy: The government’s policy on government spending, taxation and borrowing.
Flat business: One which, in relation to its size, has a small number of hierarchical levels, normally
because there are wide spans of control.
Focus (or niche) : Involves a restriction of activities to only part of the market (a segment) through:
• providing goods and/or services at lower cost in that segment (cost-focus); and
• providing a differentiated product or service to that segment (differentiation-focus)
Fundamental qualitative characteristics: The attributes that are fundamental in making information
provided in financial statements useful to users (IFRS Framework):
• Relevance
General environment: Covers all the political, legal, economic, social/demographic, ecological and
technological (PESTEL) influences in the countries a business operates in.
Goal: ‘A desired end result’ (Shorter Oxford English Dictionary, 2007)
Governance structure: The set of legal or regulatory methods put in place in order to ensure
effective corporate governance.
Green bonds: Green bonds are any type of bond instrument where the proceeds will be exclusively
applied to finance or re-finance, in part or in full, new and/or existing eligible green projects and
which are aligned with the four core components of the Green Bond Principles (ICMA, 2018).
Gross risk: The potential loss associated with the risk, calculated by combining the impact and the
probability of the risk, before taking any control measures into account.
Group: A collection of people with the following characteristics
Human resource management: ”The creation, development and maintenance of an effective

workforce, matching the requirements of the business and responding to the environment” (Naylor,
2003).
Income elasticity of demand: An indication of the responsiveness of demand to changes in

household incomes.
Industry: Comprises those businesses which use a particular competence, technology, product or
service to satisfy customer needs, and which therefore compete with each other.
Inferential statistics: The analysis of samples to draw conclusions about the population.
Inferential statistics: Statistical methods that deduce the characteristics of a bigger population from
a small but representative sample.

Inflation: An increase in price levels generally, and a decline in the purchasing power of money.
Information: The output of whatever system is used to process data or to organise it in a useful way.
This may be a computer system, turning single pieces of data into a report, for instance.
Information management: The approach that a business takes towards the management of its
information including planning IS/IT developments, the organisational environment of IS, control and
technology.
Information processing: Data, once collected, is converted into information for communicating
more widely within the business.
Information systems (IS): All systems and procedures involved in the collection, storage, production
and distribution of information.
Information technology (IT): The equipment used to capture, store, transmit or present information.
IT provides a large part of the information systems infrastructure.
Internal audit: An independent part of the company which monitors the effective operation of its
internal control and risk management systems. Internal audit is itself a key element of the company’s
system of internal control.
Internal control: A process, effected by an entity’s board of directors, management and other
personnel, designed to provide reasonable assurance regarding the achievement of objectives
relating to operations, reporting and compliance (COSO Internal Control – Integrated Framework,
2013).
Key performance indicator (KPI): A measure of the level of performance in an area where a target
level must be achieved in order for the business to outperform rivals and achieve competitive
advantage.
Knowledge work system (KWS): Facilitates the creation and integration of new knowledge into an
organisation.
Lease: A lease is a financing arrangement whereby the owner of an asset (such as a finance company
or bank) known as the lessor, transfers the risks and rewards of ownership, or the right to use the
asset, to the purchaser (known as the lessee) for a particular period of time.
Limiting factor or key factor: Anything which limits the activity of an entity. An entity seeks to
optimise the benefit it obtains from the limiting factor. Examples are a shortage of supply of a
resource or a restriction on sales demand at a particular price.
Loan stock: Debt capital in the form of securities issued by companies, the government and local
authorities. These are also referred to as bonds or debentures.
Loan stocks and debentures: are typically fixed interest rate borrowings with a set repayment date.
Most are secured on specific assets or assets in general such that lenders are protected (in
repayment terms) above unsecured payables in a liquidation.
Machine learning: A form of AI which uses computer algorithms that improve automatically through
experience using very large data sets. The algorithms build a mathematical model based on sample
data to make predictions or decisions without being explicitly programmed to do so and with
minimal human intervention. They adaptively improve their performance as the number of samples
available for learning increases.
Management: ‘Getting things done through other people’ (Metcalf and Harper, 1942).

Management accounting: Providing information to help managers and other internal users in their
decision-making, performance measurement, planning and control activities.
Management information system: Converts data from mainly internal sources into information (eg,
summary reports, exception reports). This information enables managers to make timely and
effective decisions for planning, directing and controlling the activities for which they are
responsible.
Market: Comprises the customers or potential customers who have needs which are satisfied by a
product or service.
Market: A situation in which potential buyers and potential sellers (or ‘suppliers’) of an item (or
‘good’) come together for the purpose of exchange.
Market failure: A situation in which a free-market mechanism fails to produce the most efficient (the
‘optimum’) allocation of resources.
Market mechanism: The interaction of demand and supply for a particular item.
Market segmentation: The division of the market into homogeneous groups of potential customers
who may be treated similarly for marketing purposes.
Market share: One entity’s sale of a product or service in a specified market expressed as a
percentage of total sales by all entities offering that product or service.
Market structure: A description of the number of buyers and sellers in a market for a particular good,
and their relative bargaining power.
Marketable securities: Short-term highly liquid investments that are readily convertible into cash.
Companies might use them to invest short-term surplus finance (see above).
Marketing: The set of human activities directed at facilitating and consummating exchanges. It
therefore covers the whole range of a business’s activities.
OR
The management process which identifies, anticipates and supplies customer requirements
efficiently and profitably.
Marketing mix: The set of controllable marketing variables that a firm blends to produce the
response it wants in the target market (Kotler, 1997).
Mean: What most people think of as the ‘average’. It is the arithmetic mean, denoted as
X
and is calculated by taking the sum (Σ) of all the values (x) and dividing by the number of values (n) in
the data set:
X
X=∑
n
Median: The middle value in a data set when the values are placed in order, from smallest to largest.
If there is an even number of values, then the median is the value halfway between the two middle
values. For large data sets if the number of values is n, the median is the (n + 1)/2-th value.
Mission: ‘The business’s basic function in society’ expressed in terms of how it satisfies its various
stakeholders.

Mission statement: A formal document that states the business’s basic function in society expressed
Mode: The value which occurs most often in a data set.
Money Markets: The money markets is a term that covers a vast array of markets buying and selling
different forms of money or marketable securities. The money markets are a wholesale market that
provides financial institutions with a means of borrowing and investing to deal with short-term
fluctuations in their own assets and liabilities.
Motivation: The degree to which a person wants certain behaviours and chooses to engage in them.
Natural capital: The stock of renewable and non-renewable natural resources that combine to yield a
flow of benefits or ‘services’ to people (eg, biodiversity as plants and animals, air, water, soils,
minerals).
The flows can be ecosystem services or abiotic services; which provide value to business and to
society.
Natural capital is one of the capitals included in the integrated reporting framework that was
Net Zero: The amount of greenhouse gases emitted into the atmosphere would be balanced by
schemes to remove them, for example by planting trees or using technology to remove carbon from
the atmosphere. If there are net zero emissions of carbon dioxide, global warming could halt.
Offer for sale by tender: the investing public is invited to tender (offer) for shares at the price it is
willing to pay. A minimum price, however, is set by the issuing company and tenders must be at or
above the minimum.
Office automation system (OAS): A system that increases the productivity of data and information
workers.
Official functions: The business is divided into areas (eg, operations, marketing) with specified
duties. Authority to carry them out is given to the managers in charge.
Operational risk: The risk that actual losses, incurred because of inadequate or failed internal
processes, people and systems, or because of external events, differ from expected losses.
Operations (or production) management: Creating as required the goods or services that the
business is engaged in supplying to customers by being concerned with the design, implementation
and control of the business’s processes so that inputs (materials, labour, other resources, information)
are transformed into output products and services.
Organisation: A social arrangement for the controlled performance of collective goals, which has a
boundary separating it from its environment.
Organisational behaviour: The study and understanding of individual and group behaviour in an
organisational setting in order to help improve organisational performance and effectiveness (
Mullins, 2016).
Organisational structure: Formed by the grouping of people into departments or sections and the
allocation of responsibility and authority, organisational structure sets out how the various functions
(operations, marketing, human resources, finance, etc,) are formally arranged.
Overdraft: A short-term loan of variable amount, up to a limit from a bank, typically repayable on
demand. Interest is charged on a day-to-day basis at a variable rate.

Partnership: The relation which subsists between persons carrying on a business in common with a
view of profit.
Planning: The establishment of objectives and the formulation, evaluation and selection of the
policies, strategies, tactics and action required to achieve them. Planning comprises long-
term/strategic planning, and short-term/operational planning.
Plans: State what should be done to achieve the operational objectives. Standards and targets
specify a desired level of performance.
Population: Population – the entire set of data from which a sample is selected for analysis (eg, sales
to all customers in the last year.)
Population and sample: A population is the entire set of data (eg, all sales invoices issued during a
particular month). A sample can be taken from the population (eg, a sample of 40 invoices is taken
from all the invoices issued during a particular month). The sample may be analysed to find out more
about the population from which it is taken.
Position audit: Part of the planning process which examines the current state of the entity in respect
of:
• resources of tangible and intangible assets and finance
• its competencies, that is what it has the ability to do well via its combination of resources, skills etc
• products, brands and markets
• operating systems such as production and distribution
• internal organisation
• current results
• returns to shareholders
• sustainability of business (eg, carbon emissions)
Power: The ability to get things done.
Preference shares: form part of the risk-bearing ownership of the business but, since they are entitled
to their dividends before ordinary shareholders, they carry less risk. As their return is usually a fixed
maximum dividend, they are similar in many ways to debt.
Price elasticity of supply: A measure of the responsiveness of supply to a change in price.
Private company: A company which has not been registered as a public company under statute. It
may not offer its securities to the public at large.
Procurement: The acquisition of goods and/or services at the best possible total cost of ownership,
in the right quantity and quality, at the right time, in the right place and from the right source for the
direct benefit or use of the business.
Product: Anything that can be offered to a market for attention, acquisition, use or consumption that
might satisfy a want or need. It includes physical objects, services, persons, places, organisations and
ideas. Marketers tend to consider products not as ‘things’ with ‘features’ but packages of ‘benefits’
that satisfy a variety of consumer needs.
Product life cycle: How a product demonstrates different characteristics of profit and investment over
time. Analysing it enables a business to examine its portfolio of goods and services as a whole.

Professional: A person who: accepts a responsibility to operate in the public interest; ‘professes’ to
have skill resulting from a coherent course of study and training based on professional values; and
continues to develop and enhance those skills by experience and continuing professional education.
Professional ethics: Identifying ethical dilemmas, understanding the implications and behaving
appropriately in line with a code of behaviour that is accepted among fellow professionals as being
correct.
Professional judgement: The application of relevant training, professional knowledge, skill and
experience commensurate with the facts and circumstances, including the nature and scope of the
particular professional activities, and the interests and relationships involved.
Professional scepticism: Assessing information, estimates and explanations critically, with a

questioning mind, and being alert to possible misstatements due to error or fraud.
Public company: A company whose constitution states that it is public and that it has complied with
the registration procedures for such a company. It may offer its shares and other securities for sale to
the public at large.
Pure research: Original research to obtain new scientific or technical knowledge or understanding.
There is no obvious commercial or practical end in view.
Quantitative easing: is a form of expansionary monetary policy which involves the central bank
(Bank of England in the UK) buying existing government bonds (gilts) and corporate bonds as a way
of adding liquidity to the financial system.
Range: The difference between the highest and lowest value in a set of data.
Reasonably practicable: Reasonably practicable means that the risk (the probability of an event
occurring and the impact that the event would have), has been reduced to a level that is
proportionate, given the cost that would be involved in reducing it any further. Reducing the risk
below this point would require an excessive amount of expenditure or effort to achieve very small
additional reductions in the risk. Reasonably practicable implies a higher level of risk than ‘as low as
possible’.
Recording financial transactions: Ensuring that the business has an accurate record of its revenue,
expenses, assets, liabilities and capital.
Regulation: Any form of state interference with the operation of the free market. This could involve
regulating demand, supply, price, profit, quantity, quality, entry, exit, information, technology, or any
other aspect of production and consumption in the market.
Regulatory compliance: Systems or departments in businesses which ensure that people are aware
of and take steps to comply with relevant laws and regulations.
Representative sample: A sample that reflects the characteristics of the population from which it is
drawn. If a sample is representative of the population, sample results can be analysed and valid
inferences can be made about the population as a whole.
Responsibility: The obligation a person has to fulfil a task which they have been given.
Rights issue: A rights issue is an issue of new shares for cash to existing shareholders in proportion to
their existing holdings.
Risk: The possible variation in an outcome from what is expected to happen.

Risk appetite: The extent to which a business is prepared to take on risks in order to achieve its
objectives.
Risk assessment: For each risk its nature is considered, and the implications it might have for the
business achieving its objectives; an initial judgement is then made about the seriousness of the risk.
Risk identification: Identifying the whole range of possible risks and the likelihood of losses
occurring as a result of these risks.
Risk management: The identification, analysis and economic control of risks which threaten the
assets or earning capacity of a business.
Risk management and internal control system: A system encompassing the policies, culture,
organisation, behaviours, processes, systems and other aspects of a company that, taken together:
• Facilitate its effective and efficient operation by enabling it to assess current and emerging risks;
respond appropriately to risks and significant control failures; safeguard its assets
• Help to reduce the likelihood and impact of poor judgement in decision-making; risk-taking that
exceeds the levels agreed by the board; human error; or control processes being deliberately
circumvented
• Help ensure the quality of internal and external reporting
• Help ensure compliance with applicable laws and regulations, and also with internal policies with
respect to the conduct of business
(FRC Guidance on risk management, internal control and related financial and business reporting)
Risk measurement: Identifying the probability (likelihood) of the risk occurring, quantifying the
resultant impact (consequence) and calculating the amount of the potential loss using expected
values for gross risk.
Robotic Process Automation (RPA): A combination of process automation and machine learning so
that the robots can learn how to do manual tasks by observing humans at work.
Rules: A rule defines and specifies a course of action that must be taken under given circumstances.
Sampling: Analysing a sample of data from a population, and based on this, making inferences
about the population.
Scalar chain: The chain of command from the most senior to the most junior.
Security (in information management): The protection of data from accidental or deliberate threats
which might cause unauthorised modification, disclosure or destruction of data, and the protection
of the information system from the degradation or non-availability of services.
Sole tradership: A single proprietor owns the business, taking all the risks and enjoying all the
rewards of the business.
Span of control: The number of people (subordinates) reporting to one person.
Stakeholder: Literally a person or group of persons who has a stake in the organisation. This means
that they have an interest to protect in respect of what the organisation does and how it performs.
Standard deviation: Standard deviation =
Variance

Statistical significance: the results generated by testing or experimentation are unlikely to occur by
chance or randomly, but occur due to a specific cause.
Note. Determining statistical significance is beyond the scope of the BTF syllabus.
Statistics: A branch of mathematics that involves the collection, description, analysis, and inference of
conclusions from quantitative data (Investopedia).
Strategic business unit (SBU): A section, within a larger business, which is responsible for planning,
developing, producing and marketing its own products or services.
Strategic objectives: The primary strategic objective – in the case of a business, to make a profit for
shareholders – plus other major objectives addressed to the stakeholders.
Strategic plan: A statement of long-term goals along with a definition of the strategies and policies
which will ensure achievement of these goals.
Strategy: ‘Strategy is the direction and scope of an organisation over the long term, which achieves
advantage for the organisation through its configuration of resources within a changing environment,
to meet the needs of markets and to fulfil stakeholder expectations.’ (Johnson, Scholes and
Whittington, 2007).
’Strategy is concerned with an organisation’s basic direction for the future, its purpose, its ambitions,
its resources and how it interacts with the world in which it operates.’ (Lynch, 2000).
Supply: The quantity of a good that existing suppliers or would be suppliers would want to produce
for the market at a given price.
Supply chain: The network of organisations, their systems, resources and activities that are required
to turn raw resources into a product or service provided to a consumer.
Supply chain management (SCM): Optimising the activities of businesses working together to
produce goods and services.
Sustainability: The ability to meet the needs of the present without compromising the ability of
future generations to meet their own needs. Brundtland Report 1987
Sustainable development: Aims to ensure that economic activity can continue without causing
permanent harm to society and the planet. It describes a world of thriving economies and just
societies based on what nature can afford.
System: A set of interacting components that operate together to accomplish a purpose.
Tall business: One which, in relation to its size, has a large number of levels in its management
hierarchy, normally because there are narrow spans of control.
Task environment: Relates to factors of particular relevance to the business, such as its competitors,
customers and suppliers of resources.
Term loan: A term loan is a loan – typically but not always from a bank – where the repayment date
(its termination) is set at the time of borrowing and, unlike overdrafts, they are not repayable on
demand, unless the borrower defaults on repayment.
Transaction processing systems (TPS): A system which performs, records and processes routine
transactions.

Treasury management: Managing the funds of a business, namely cash and other working capital
items, plus long-term investments, short-term and long-term debt, and equity finance.
Uncertainty: The inability to predict the outcome from an activity due to a lack of information.
Underwriting: is the process whereby, in exchange for a fixed fee (usually 1–2% of the total finance to
be raised), an institution or group of institutions will undertake to purchase any securities not
subscribed for by the public. The main disadvantage of underwriting is its cost, which depends on
the characteristics of the company issuing the security and the state of the market. The cost is
payable even if the underwriter is not called upon to take up any securities. Effectively, underwriting
is an insurance policy that guarantees that the required capital will be raised.
Upside risk (opportunity): The possibility that an event will occur and positively affect the
achievement of objectives.
Upstream supply chain members: The elements of the supply chain which provide the materials and
production of the goods and services (ie, suppliers and the production function).
Value chain: The sequence of business activities by which, in the perspective of the end-user, value is
added to the products or services produced by an entity.
Value drivers: Elements of a product or service and activities that increase the amount of value
consumers place on it. They are a means of differentiating the product or service from the
competition and may include product features or intangibles such as branding.
Variance: The average of the squared deviations of the values in a data set from the mean of that
data:
(X−X)2
Variance = ∑ where n is the number of items in the data set
n
Venture capital : is the provision of risk-bearing capital, usually in the form of a participation in equity,
to companies with high growth potential.

Index
A Authenticity, 219
Abiotic service, 314 Authorisation, 220
Acceptability of the strategy to stakeholders, 141 Authoritative, 435
Acceptance, 178 Authoritative-participative continuum, 55
Accountability, 34, 313, 325 Authority, 34, 73, 80
Accountancy, 286 Automation, 473
Accountancy profession, 286 Autonomy, 55
Accounting records, 433 Availability, 219
Accounting records and returns, 91 Availability of substitutes, 387
Accuracy, 216 Avoidance, 178
Accurate, 435
B
ACIANA, 219
B2B, 40, 44
Activities, 126
B2C, 40, 44
Activities in the value chain, 127
Backup and standby arrangements, 185
Actual monopoly, 391
Backward-looking, 215
Actual product, 42
Bailor/bailee relationship, 254
Adaptability, 213
Balance of payments, 369
Adhocracy, 76
Balanced scorecard, 222, 225
Advertising, 44
Bank’s duties, 255
Agency problem, 309
Bank-based financial systems, 317
Agents, 93
Bank/customer contractual relationships, 254
Aggregated, 215
Banking system, 252, 257
AIM (Alternative Investment Market), 266
Bar charts, 449
ALARP, 179
Bargaining power, 120
Alliances, 92
Bargaining power of customers, 122
Allocating resources, 317
Bargaining power of suppliers, 122
Allocation of economic resources, 392
Barriers to entry, 120, 120
Allocative efficiency, 392
Base of power, 33
Alternative Investment Market, 257
Basic (or core) product, 42
Analysing products and markets, 129
BCG matrix, 130
Analysing resources and competencies (the
position audit), 125 Belbin, 55
Ansoff’s matrix, 140 Beliefs and values, 86
Anti-money laundering supervision, 293 Benchmarking, 224
Applied research, 46 Biodiversity, 314
Archive strategy, 221 Black market, 384
Artificial intelligence (AI), 473 Board of directors, 322, 325, 326
Aspects of security, 219 Bond markets, 257
Assessability, 216 Borderless, 454
Assurance, 286 Botnets, 482
Asymmetric information, 317, 318 Bottom-up approach, 176
Attitudes to risk, 158 Bounded rationality, 12
Audit analytics, 476 Brand, 129
Audit, investment business, insolvency, 293 Brand competitors, 123
Augmented product, 42 Branding, 42
ICAEW 2023 Index 515

Budgets, 142 Commitment, 49
Build, 130 Committee for Standards in Public Life, 325
Building blocks, 72 Committees of the board of directors, 314
Bureaucracies, 84 Communicating the organisational structure, 74
Bureaucracy, 85 Communication, 232
Burns, 84 Communication mix, 44
Business, 7, 9, 265 Community representatives, 212
Business angels, 265 Company, 90
Business continuity plan, 185 Company worker, 55
Business continuity planning, 184 Comparability, 214
Business cycle, 118, 368 Comparison problems, 224
Business ethics, 325 Competence, 49
Business functions, 38 Competition, 117
Business partnering, 206 Competition laws, 93
Business plan, 142 Competitive (task) environment, 120
Business resilience, 181, 182 Competitive advantage, 141
Business strategies, 110, 138, 142 Competitive rivalry, 122
Business structure, 87 Competitive strategies, 113
Business system, 216 Competitive strategies for growth, 140
Competitive strategy, 138, 139
C
Competitor analysis, 123
Capacity, 46
Competitor reaction profile, 124
Capital market, 257
Competitors, 43
Cartel, 93, 414
Competitors in the industry, 120
Cash cows, 130
Competitors’ pricing, 388
Cash flows, 212
Complements, 376, 389
CATIVA, 216
Complete, 214, 435
Centralisation, 38, 73, 80, 207
Completeness, 216
Centralised organisation, 80
Complex, 75
Centralised planning and control, 38
Comply, 322
Centralised structures, 80
Component bar chart, 449
Certificates of deposit, 256
Conceptual Framework for Financial Reporting,
Changes in financial position, 212 211
Changes in technology, 380 Confidentiality, 219
Climate change, 18, 226 Conflicts between stakeholders’ interests, 312
Climate Disclosure Standards Board, 229 Congruence, 49
Cloud accounting, 470 Constraints theory, 13
Cloud computing, 469 Consumer, 39
Clustered bar chart, 449 Consumer durables, 40
Codes of ethics, 326, 327 Consumer markets, 40
Coefficient of variation, 167 Contingency planning, 181
Coercive power, 33 Continuing professional development (CPD),
Cognitive technologies, 473 296
Column charts, 449 Continuous organisation, 85
Commercial paper, 256 Continuous variables, 432
Contract workers , 38

Control, 208 Cyber risk, 160, 481
Control activities, 231, 231 Cyber security, 483
Control environment, 231 Cyber-resilience, 484
Controlling, 36, 210
D
Coordinating mechanisms, 73
Data analytics, 476
Coordination, 80, 85, 128
Data protection law, 483
Core competences, 124
Data set, 161
Corporate appraisal, 112, 131
Data validation, 220
Corporate code of ethics, 327
Data verification, 220
Corporate governance, 177, 309, 310, 310, 311
DDoS attacks, 482
Corporate objectives, 43
Debentures, 257
Corporate perspective on corporate
governance, 311 Debt factoring, 257, 262, 262
Corporate responsibility, 13, 315, 325 Debt holders, 248
Corporate strategy, 109, 138, 139, 248 Decentralised structures, 80
Correction procedures, 219 Decision making, 210
Cost, 222 Decision support system (DSS), 478
Cost centres, 222 Decisional role, 36
Cost drivers, 126 Decline, 130
Cost leadership, 139, 139 Deflation, 369
Cost push inflation, 370 Degree of rivalry, 120
Cost standards, 16 Delegated authority, 78
Cost-beneficial, 435 Delegated legislation, 290
Cost-effectiveness, 49 Delegation, 34, 57
Cost-focus, 139 Demand, 117, 374
Cost-focus strategy, 140 Demand and supply, 373
Costs, 43 Demand curve, 375
Costs of making the good, 380 Demand pull inflation, 370
Coupon (interest) rate, 263 Demand theory, 373
Crisis, 180 Demography, 118
Crisis management, 115, 180 Descriptive statistics, 161
Crisis prevention, 181 Detection, 219
Critical information assets, 483 Determinants of demand, 387
Critical success factor, 157 Deterrence, 219
Critical success factors, 223 Development, 46
Cross elasticity of demand, 389 Deviation, 167
Cross-holding, 317 Differentiation, 139
Crowdfunding, 265 Differentiation-focus, 139, 140
Crypto currencies, 472 Digital asset, 470
CSF, 176 Digital contracts and transactions, 475
Cultural types, 37 Direct marketing, 44
Culture, 37, 86 Direct supervision, 73
Customer, 39 Director, 10
Customer’s duties, 255 Disaster, 184
Customers, 10, 122, 211 Disaster risk, 159

Disciplinary regime, 297 Elasticity of supply and time, 389
Discrete data, 432 Electronic data interchange, 477
Disequilibrium, 383 Employees, 10, 211
Disposable income, 366 Enterprise risk, 158
Distributed ledger technology, 471, 476 Entrepreneurial structure, 76
Distribution, 41 Entry and education requirements, 295
Distribution channels, 121 Entry barriers, 117
Diversification, 80, 141 Environment, 217
Divest, 131 Environment of a business, 114
Dividends, 90 Environmental uncertainty, 115
Division of labour, 38, 38, 395 Environmental, social and governance, 13
Division of work, 73 Equilibrium price, 381, 382
Divisional structure, 77 Equity, 257
Divisionalisation, 77 ESG, 13
Divisionalised, 75 Ethical behaviour, 295
Dogs, 131 Ethical values, 325
Dominant position, 414 Ethics, 295, 309
Downside risk, 156 Eurostar, 121
Downstream supply chain members, 47 Evaluator, 55
Drawings, 90 Event risk, 159, 184
Drucker, 12 Excess of supply, 379
Dual or supervisory board, 321 Executive directors, 314
Duopoly, 392 Executive support system (ESS), 478
Dynamic, 75 Exit barriers, 122
Dynamic environments, 115 Expectation, 155
Expectational inflation, 370
E
Expert power, 33
E-procurement, 477
Explain, 322
Easy to use, 435
Export credit insurance, 268
Ecological factors, 119
Exposure to risk, 174
Economic environments, 365
External analysis, 112
Economic factors, 117
External appraisal, 133
Economic resources, 212
External auditors, 314
Economic risks, 160
External economies, 395
Economies of scale, 121, 393, 395
External economies of scale, 396
Economy, 223
External environment, 114
Ecosystem services, 314
Externalities, 393
Effect of time on supply and demand, 381
Effective action in the event of a crisis, 181 F
Effective internal control, 231 Failure of perfect competition, 392
Effective management, 32 Faithful representation, 214
Effective working of capital markets, 287 Fashion and expectations, 377
Effectiveness, 223 Fast-moving consumer goods, 40
Efficiency, 223 Feasibility, 141
Elasticity, 385 Ffer for sale, 258

Fiduciary relationship, 254 Generic competitors, 123
Finance, 223 Generic product, 129
Finance function, 39 Giffen goods, 376, 387
Financial Conduct Authority (FCA), 253 Goal, 15, 138
Financial crisis, 180 Goal congruence, 137
Financial information, 209, 318 Going concern, 212
Financial intermediation, 252, 318 Going public, 260
Financial measures, 222 Good business ethics, 312
Financial performance, 212 Good practice in corporate governance, 313
Financial Policy Committee (FPC), 253 Governance structure, 320
Financial position, 212 Governance structure of the UK, 322
Financial reporting, 205, 286 Government and its agencies, 10
Financial Reporting Council (FRC), 295 Government franchise monopoly, 391
Financial risk, 158, 248 Government intervention, 317
Financial Services Act 2012, 253 Government spending, 118
Financial strategy, 138, 248 Governments and its agencies, 211
Financial structure, 212 Green Bond Principles, 269
Financing current assets, 249 Green bonds, 269
Finisher, 55 Green finance, 269
Fintech, 255 Green Finance Institute, 270
Firm infrastructure, 128 GRI Standards, 228
Fiscal policy, 371, 372 Gross risk, 177
Five forces analysis, 120 Group, 54, 93
Fixed charge, 90 Group behaviour, 54
Flat business, 83 Growth, 130
Flexibility, 74, 80
H
Floating charge, 90
Habit-forming goods, 388
FMCGs, 40
Harvest, 130
Focus, 139
Hellriegel, 52
Form competitors, 123
Herbert Simon, 12
Formal strategic planning, 110
Hierarchy, 73, 135
Forming, 55
Hierarchy of needs, 53
Four Cs model of HRM, 49
Hierarchy of objectives, 11
Four Ps, 40
Holding inventory, 396
FRC’s guidance on risk management, 177
Honesty, 325, 326
Free market, 392
Human resource management, 49, 127
Free riders, 394
Hypothesis testing, 448
French, 33
Frequency distributions, 171 I
Functional manager, 34 ICAEW, 285
Functional strategies, 110, 142 ICAEW Code of Ethics, 296
Functional structure, 76 ICMA), 269
Identifying key performance indicators, 223
G
Ideology, 73
General environment, 114
IFRS® Conceptual Framework, 209

Impact, 161, 174 International Federation of Accountants (IFAC),
Implementing the strategy, 142 289
Importance of information, 309, 318 International Sustainability Standards Board, 229,

229
Importance of the accountancy profession, 286
Internet of things, 477
Inalterability, 216
Interpersonal role, 36
Inbound logistics, 127
Interruption loss, 176
Incentives, 382
Introduction, 129
Income distribution, 377
Inventory levels, 46
Income elasticity of demand, 388
Investing surplus cash, 251
Income levels, 377
Investment banks, 252
Industrial markets, 40
Investment strategy, 138
Industry, 120
Investors, 211
Industry competitors, 123
Issue costs, 258
Inelastic demand, 386
Inferior goods, 377 J
Inflation, 369 Job descriptions, 74
Information on changes in financial position, 213 John Elkington, 17
Information on financial performance, 213 Johnson, Scholes and Whittington, 109
Information security, 219 Joint supply, 380
Information systems, 216 Joint venture, 92
Information technology, 50
Informational, 36 K
Innovation and learning, 225 Kaplan, 225
Input controls, 220 Key factor, 126
Insider trading, 317 Key performance indicator (KPI), 224
Instability, 317 Key players, 136
Institutional shareholders, 318, 318, 321 King Report, 310
Institutional strategies, 113 Knowledge work system (KWS), 478
Integrity, 219, 325 Kotler, 123
Integrity controls, 220 L

Intellectual property, 7 Labour, 223
Inter-related goods, 376 Laid-back competitor, 124
Interaction of demand and supply, 373 Le Shuttle, 121
Interest rates, 117 Lead time, 47
Intermediaries, 43 Leadership, 55, 326
Internal analysis, 112 Leadership style, 55, 80
Internal appraisal, 131 Leading, 36, 209
Internal auditors, 314 Lease, 264
Internal business processes, 225 Leasing, 257, 264
Internal control, 231, 232 Legal factors, 119
Internal economies, 395 Legal form, 248
Internal economies of scale, 396 Legal requirements, 174
Internal process model, 38 Legal risks, 160
International Accounting Standards Board (the Legislation, 290
Board), 211
Legitimate (or position) power, 33

Lenders, 10, 157, 211 Market position, 11
Levels of plan, 142 Market segmentation, 41
Levels of strategy, 109 Market share, 130
Liability loss, 176 Market structure, 390
Licences, 93 Market-based financial systems, 318
Limitations of financial measures, 224 Marketable securities, 256
Limited liability, 90 Marketing, 39, 39
Limited liability partnerships, 89 Marketing and sales, 127
Limited resources, 126 Marketing managers, 434
Limiting factor, 126 Marketing mix, 40
Line manager, 34 Mary Parker Follett, 35
Lines of authority, 38 Maslow’s content theory, 53
Linkages in the value system, 128 Master budget, 142
Liquidity, 213 Materiality, 178, 214
LLPs, 89 Materials, 223
Loan stock, 257, 263 Matrix organisation, 74
Local community, 10 Matrix structure, 79
London Inter-Bank Offered Rate (LIBOR), 256 Maturity, 130
Long run, 389 Maximum price, 384
Luxuries, 388 Measuring critical success factors, 223
Lynch, 109 Measuring profitability, 222
Measuring resource use, 223
M
Mechanistic organisations, 84
Machine bureaucracy, 75
Median, 162
Machine learning, 473, 476
Membership of ICAEW, 296
Macroeconomic environment, 365
Mendelow, 135
Main Market, 257
Microeconomic environment, 365
Management, 32
Middle line, 72
Management accounting, 205
Minimum price, 384
Management board, 321
Mintzberg, 36, 72
Management hierarchy, 71, 72
Mission, 14, 85, 109
Management information, 215
Mission statement, 137
Management models, 37
Mission, goals and objectives, 112
Management process, 35
Mode, 162
Manager’s workload, 82
Monetary policy, 252, 371
Managerial objectives, 12
Money laundering, 293
Managerial roles, 36
Money market financial instruments, 256
Managing the finance function, 208
Money markets, 256
Market, 120, 373
Monitoring, 232
Market development, 140
Monitoring risk, 179
Market failure, 287, 393
Monopolistic competition, 391
Market growth, 130, 130
Monopoly, 391
Market imperfection, 317, 393
Monopsony, 393
Market mechanism, 373
Mortgagor/mortgagee relationship, 254
Market penetration, 140
Motivation, 53

Ms model, 125 Organic structures, 86
Mullins, 52 Organisation, 5
Multi-skilling, 74 Organisation chart, 74
Multiple objectives, 12 Organisation manual, 74
Organisational behaviour, 52
N
Organisational iceberg, 52
Natural capital, 229, 314
Organisational structure, 72
Natural environment, 10, 314
Organising, 36, 209
Natural monopoly, 391
Outbound logistics, 127
Necessities, 388
Outcomes, 155
Need for accountability, 310
Output controls, 221
Negative power, 33
Outsourcing, 51
Net Zero, 18
Overdraft, 262
Neutral, 214
Oversight mechanism, 291
New entrants, 120, 122
Ownership and control, 309
Niche, 139
Nolan Principles, 325 P
Non-executive directors, 314 Packaging, 42
Non-financial information, 215 Participative, 56
Non-financial measures, 222 Partnership, 88
Non-profit orientation, 7 Partnership relationships, 128
Non-repudiation, 220 Password management apps, 482
Normal goods, 377 Passwords, 482
Norming, 55 Pecuniary loss, 176
Norton, 225 People, 159
Perfect competition, 390
O
Performance measurement, 210
Objectives, 109
Performing, 55
Objectivity, 325
Perpetual succession, 90
OECD, 320
Personnel loss, 176
Of financial system on governance, 316
PESTEL analysis, 115, 365
Offer for sale by tender, 260
Physical, 219
Offer for subscription, 258
Physical access controls, 220
Office automation system (OAS), 478
Physical risks, 160
Official functions, 85
Physical standards, 16
Oligopoly, 391
Pie charts, 450
Openness, 313, 325, 326
Place, 40, 43
Operating core, 72, 72
Placing, 258
Operational information, 210
Planning, 35, 111, 208
Operational plan, 142
Planning and control, 110
Operational risk, 159, 159
Planning and control system, 14
Operations, 45, 127
Planning information, 210
Operations and production, 45
Planning products and markets, 130
Opportunities, 116, 133
Plans, 16
Ordinary shares, 257
Plant, 55
Organic organisations, 84

Policies and standards of behaviour, 15 Product risk, 158
Political influences, 116 Product/market strategies, 113, 140
Political risks, 160 Productive efficiency, 393
Population and sample, 161 Productivity, 12, 118
Porter, 139 Profession, 286
Porter’s generic competitive strategies, 139 Professional, 286
Porter’s value chain, 126 Professional bureaucracy, 75
Position audit, 125 Professional discipline, 292
Possible structures for the board of directors, 321 Professional ethics, 295
Power, 33 Professional indemnity insurance (PII), 174, 295,
Power/interest matrix, 135 296
Practising Certificate, 296 Professional oversight, 292
Preference shares, 257, 260 Professional responsibility, 294
Prevention, 219 Professional scepticism, 287, 296
Price, 40, 43, 376 Profit, 11
Price determinants, 384 Profit centres, 222
Price elasticity of demand, 385 Profit satisficing, 12
Price elasticity of supply, 389 Profitability, 222
Price regulation, 384 Project manager, 35
Price signals, 382 Promotion, 40, 44
Price takers, 390 Property loss, 176
Price theory, 373 Prudential Regulation Authority (PRA), 253
Pricing of new issues, 260 Public, 212
Primary, 7 Public company, 90
Primary activities, 127 Public goods, 393, 395
Primary objective, 11, 248 Public liability insurance, 174
Principal/agent relationship, 254 Public offers, 259
Principles of Corporate Governance, 320 Public policy perspective on corporate

governance, 310
Principles of good spreadsheet practice, 444
Public practice, 287, 296
Principles-based, 320
Public relations, 185
Principles-based approach to governance
structures, 320 Public relations crisis, 180
Private benefit, 394 Public relations crisis:, 181
Private company, 90 Public sector, 6
Private cost, 393 Public Sector Net Cash Requirement, 372
Private sector, 6 Public trust, 295
Probability, 161 Publicity, 91
Probate, 297 Pure monopoly, 391
Process, 159 Pure research, 46
Processing controls, 220 Pure risk, 156
Procurement, 46, 127 Purpose, 14
Product, 40, 42
Q
Product development, 11, 141
Qualitative characteristics, 287
Product differentiation, 121
Qualitative characteristics of financial statements,
Product life cycle, 129 213

Qualitative data, 432 Responsibility, 34, 73
Qualitative measures, 222 Retail banks, 252
Qualities of good information, 435 Retained earnings, 258
Quality, 42 Retention, 178
Quality standards, 16 Revenue, 222
Quantitative data, 432, 432 Revenue maximisation, 12
Quantitative easing, 371 Reward (or resource) power, 33
Quantitative measures, 222 RFID, 434
Question marks, 131 RFID tags, 452
Quinn, 37 Rights issue, 258, 258
Rights of the bank, 255
R
Risk, 142, 155, 155
Range, 167
Risk analysis, 176
Rational goal, 38
Risk and strategic planning, 157
Rational goal model, 38
Risk appetite, 157
Raven, 33
Risk assessment, 177, 185, 231
Receivable/payable (debtor/creditor)
Risk averse attitude, 158
relationship, 254
Risk awareness, 176
Recipient, 264
Risk concepts and measurement, 160
Recognised professional regulator, 297
Risk identification, 176
Recording financial transactions, 205
Risk management, 174, 219, 309
Recording transactions, 210
Risk management process, 175
Recovery procedures, 219
Risk measurement, 177
Redemption date, 264
Risk monitoring and reporting, 176
Redemption value, 263
Risk neutral attitude, 158
Reduction, 178
Risk response, 178
Referent (or personal) power, 33
Risk response and control, 176
Regulation, 38, 91, 117, 391, 409
Risk seeking attitude, 158
Regulation by the ICAEW, 295
Risk transfer, 178
Regulation of professions, 290
Risk-based management approach, 175
Regulation of the accountancy profession, 292
Risks for investors, 157
Regulatory bodies, 174
Risks for the business, 156
Regulatory compliance, 412
Risks of big data, 454
Regulatory risk, 159
Rivalry amongst current competitors in the
Relevance, 213
industry, 122
Relevant, 435
Robotic Process Automation (RPA), 473
Reporting risk, 179
Role of ICAEW, 293
Representation, 215
Role of the government, 292
Reputation risk, 159
Rules, 85
Research and development, 46, 434
Rules and procedures, 38
Reserved areas, 293
Reserved areas of practice, 297 S
Resource allocation, 392 Sales promotion, 44
Resource audit, 125 Scalar chain, 73, 83
Resource-investigator, 55 Scale economies, 120
Resources, 46 Scenario analysis, 443

Secondary objectives, 7, 11 Spreadsheets, 440
Security, 218, 219 Staff manager, 34
Security controls, 220 Stages of group development, 54
SEE, 17 Stakeholder analysis, 134
Segment of market, 42 Stakeholder mapping, 135
Segregation of duties, 221, 232 Stakeholder perspective on corporate
Selective competitor, 124 governance, 311
Self-regulation, 291 Stakeholder protection, 309
Self-regulation by the accountancy profession, Stakeholders, 9, 325

293 Stakeholders’ governance needs, 311
Sell direct, 43 Stalker, 84
Senior management, 314 Standard deviation, 167
Separate legal personality, 90 Standardisation of work, 73
Separation of ownership and control, 91 Standardised, 215
Service, 127 Standards, 16
Services, 40 Stars, 130
Setting strategic objectives, 134 Static, 75
Seven Ps, 40 Statistics, 161
Shaper, 55 Statutory requirements, 325
Shareholder-led approach to governance Stewardship, 310
structures, 321 Stewardship approach, 311
Shareholders, 9, 157, 211, 314 Stochastic competitor, 124
Shares, 90 Storming, 55
Shift of the demand curve, 378 Strategic alliances, 93
Shift of the supply curve, 380 Strategic apex, 72
Short run, 389 Strategic business unit (SBU), 110
Short-term finance, 250, 251 Strategic choice, 113
Significant risks, 176 Strategic crisis, 180
Simon, 13 Strategic decisions, 111
Simple, 75 Strategic information, 210
SMART, 15 Strategic management, 110
Smart contracts, 476 Strategic objectives, 137, 137
Smart devices, 434 Strategic plan, 111, 142
Social, 118 Strategic planning process, 16, 111
Social benefit, 394 Strategies, plans and standards, 138
Social cost, 394 Strategy, 14, 109, 109
Social risks, 160 Strategy implementation, 113
Social, environmental, economic, 17 Strategy risk, 158
Sole tradership, 87 Strengths, 131, 141
Solvency, 213 Structure of the accountancy profession, 289
Sources of big data, 452 Structure of the finance function, 207
Sources of information, 215 Subscription fee, 296
Span of control, 81 Substitute products, 121
Specialisation, 85 Substitutes, 120, 376, 389
Specialisation of labour, 395 Suitability, 141
Speculative risk, 156

Supernormal profits, 391 The time horizon, 387
Supervisory board, 321 Threat avoidance, 219
Suppliers, 10, 211 Threat of new entrants, 120
Supply, 379 Threats, 116, 120, 133
Supply chain, 47 Tiger competitor, 124
Supply chain management, 128, 128 Timeliness, 214, 214, 216
Supply curve, 379 Timely, 435
Supply-side macroeconomic, 372 Tone at the top, 326
Support activities, 127 Top-down approach, 176
Support staff, 73 Trade cycle, 368
Surveys, 439 Trade unions, 10
Sustainability, 16 Transaction costs, 317
Sustainability management, 227 Transaction processing systems (TPS), 217
Sustainable Development Goals, 18 Transfer payments, 366
Switching costs, 121, 122 Transparency, 313
SWOT analysis, 131 Treasury management, 205
Symmetrical risk, 156 Triple bottom line, 17, 226, 226
System, 216 Twin peaks regulatory regime, 253
System boundary, 217 Two factor authentication, 482
Systematic work methods, 38 Type of culture, 37
Systemic risk, 159 Type of information, 210
Systems risk, 159 Types of company, 90
Types of competitor, 123
T
Types of crisis, 180
Tactical information, 210
Types of financial system, 316
Tall business, 83
Types of manager, 34
Targets, 16, 137, 138
Types of market structure, 390
Task environment, 114
Types of organisational structure, 75
Task Force on Climate-related Financial
Types of performance measure, 222
Disclosures, 227
Types of risk, 158
Task-force teams, 74
Tasks of the finance function, 205 U
Tax levels, 117 UK Corporate Governance Code, 175, 179
Team roles, 55 UN Sustainable Development Goals , 315
Team worker, 55 Uncertainty, 155
Technical competence, 296, 297 Underlying assumptions, 212
Technological factors, 118 Understandability, 214
Technology development, 128 Underwriting, 260
Technology risks, 160 Unit elasticity of demand, 386
Technostructure, 72, 73 Unitary board, 321
Term loan, 263 Unity of command, 73
The accountancy profession, 285 Unity of direction, 73
The board of directors, 313 Unlimited liability, 90
The Financial Reporting Council (FRC) , 291 Upside risk, 156
The four Cs of pricing, 43 Upside risk (opportunity), 156
The internet of things, 434

Upstream supply chain members, 47
Urwick, 81
Usefulness of groups, 54
User-targeted, 435
V
Value, 11, 15, 86
Value chain, 127
Value drivers, 126
Variability, 155
Variance, 167
Variety, 452
Veblen goods, 387
Velocity, 452
Venture capital (VC), 266
Veracity, 452
Verifiability, 214, 216
Virtual, 454
Virtual organisations, 74
Vision, 15
Volatility, 176
Volatility of returns, 157
Volume, 451
W
Wage price spiral, 370
Wates Principles, 323
Weaknesses, 131, 141
Wealth, 11
Weber, 85
What-if analysis, 443
Whistleblow, 314
Whistleblowing and complaints systems, 328
Workbooks, 441
Worksheets, 441


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The Institute of Chartered Accountants in England and Wales

Glossary of terms 495

ICAEW 2023 Contents iii

iv Business, Technology and Finance ICAEW 2023

Ethics and professional scepticism

1 Business objectives and functions 10

2 Business and organisational structures 10

3 The role of ﬁnance and the ﬁnance function 25

4 Key issues for the accountancy profession and business 20

5 The external environment of business 15

6 Technology and data analysis 20

ICAEW 2023 Introduction v

Syllabus and technical knowledge grids

Student support team

ICAEW Business and Finance Professional (BFP)

vi Business, Technology and Finance ICAEW 2023

Skill area Overall objective

Assimilating and using Understand a business or accounting situation, prioritise by

Concluding, Apply technical knowledge, skills and experience to support

ICAEW 2023 Introduction vii

Chapter study guidance

Topic Practical signiﬁcance Study approach Exam approach Interactive

1 What is an Approach While the material in

2 What is a business? Approach Questions will focus

2 Business, Technology and Finance ICAEW 2023

Stop and think

3 Stakeholders in the Approach Questions could IQ1: Corporate

4 What are the Approach Questions will focus

5 Mission, goals, plans Approach Exam questions in IQ2: Goals

ICAEW 2023 1: Introduction to business 3

may become know well. Do you

6 Sustainability and Approach IQ3: Great

4 Business, Technology and Finance ICAEW 2023

1.1 Introduction to organisations

1.2 Why do organisations exist?

1.3 What do organisations have in common?

ICAEW 2023 1: Introduction to business 5

Social arrangement: People work in different Soldiers are in different

Boundary: the organisation is Physical: factory gates Physical: barracks

1.4 How do organisations differ?

Ownership (public vs private) Private sector: owned by private investors/shareholders

Control By the owners themselves, by people working on their behalf, or

Size Small local business to multinational corporation

Legal status Company, or an unincorporated body such as a club,

Sources of ﬁnance Borrowing, government funding, share issues

1.4.1 Differences in what organisations do

Agriculture Producing and processing food

Manufacturing Acquiring raw materials and, by the application of labour and

Extractive/raw materials Extracting and reﬁning raw materials (eg, mining)

6 Business, Technology and Finance ICAEW 2023

Retailing/distribution Delivering goods to the end consumer

Intellectual production Producing intellectual property (eg, software, publishing, ﬁlms,

Technology Digitalising products (eg, e-books) and processes (eg, selling

Service industries Providing intangible services such as banking, accountancy and

• Organisations have secondary objectives that support their primary objectives.

2.1 Proﬁt vs non-proﬁt orientation

ICAEW 2023 1: Introduction to business 7

Owners Public beneﬁciaries

Primary Maximise proﬁt/ Provision of