Understanding business activity

Nature of Business Activity

• Needs: goods or services that we need in order to live

• Wants: goods or services which people would like to have. But are not essential

for living.

• People’s wants are unlimited (you will always want something) but the resources

available to produce them are limited which leads to scarcity (the basic economic

problem)

• Scarcity: there are not enough products to fulfil the wants of the population

• Resources (also known as factors of production) include: Land, Labour, Capital &

Enterprise

o Land – any natural resource used in production

o Labour – mental and physical efforts of a human

o Capital – man-made goods used in production

o Enterprise – the risk-taking ability of an entrepreneur

• As there are limited resources, people are always forced to make a choice. This

means that we will be giving something up, this is known as opportunity cost

• Opportunity cost: it is the next best alternative that is given up by choosing

another item.

Specialisation
• Specialisation: when people and businesses focus on what they are best at.

• Division of labour is when production is split in different tasks and each worker

performs one of these tasks

 Advantages Disadvantages

Workers specialized in certain task, Workers become bored of doing the

increases efficiency same job. Efficiency might fall

Less time is wasted from one If a worker is absent, no other worker

workbench to another, more efficiency can do the job. Efficiency might fall

As the business is more efficient, Employees have to rely on each other to

output increase which may lead to produce products, leading to a fall in
economies of scale productivity

Workers become more skilled and

experienced, reducing the mistakes
made

Purpose of Business Activity:

• Businesses combine scarce factors of production to produce goods or services to

satisfy people’s wants

• A business also employs people as worker and pays them wages to allow them

to consume products as well

Added Value
• Added value is the difference between the selling price and the cost of bought-in

raw materials and components.

Added Value = selling price – total cost

• It is NOT the profit because added value does not include the price to pay for

labour, transport etc.

• To increase added value, a business can either:

o Increase the selling price of product, while keeping the total cost of

material the same

o Create a brand image

 o Improve packaging

o Make products more appealing by adding features

o Provide higher quality goods and services

• Decrease the total cost of materials, while keeping the selling price of the

product the same.

Classification of Businesses
• Businesses can be put into three sectors:

o Primary sector – extraction of natural resources. Ex. farming, fishing

o Secondary sector – manufacturing and production of goods. Ex. car

manufacturer

o Tertiary sector – provides services. Ex. hairdressing, banking

• The relative importance of these sectors in an economy depends on:

o Number of workers employed

o Value of output produced

• Deindustrialisation occurs when there is a decline in the importance of the

secondary sector.

• This can happen due to:

o Depletion of primary resources in home country

o Cheaper goods by developing countries

o Ability to spend more income on services

Mixed Economy
• Has both a private sector and a public sector.

o Private Sector: Businesses NOT owned by government, will make own

decisions on what and how to produce. The main aim is to make profits.
 o Public Sector: Owned by the government. Government will make

decisions on what and how to produce (i.e. healthcare, education,

defence, public transport). The main aim is to provide a service to

customers.

• Privatization refers to the selling of a public sector business to the private sector.

• Privatisation may occur as private sector is more efficient, competitive and will

be able to make good quality goods leading to higher profits.

• But private sector does not have social objectives, making their products

unaffordable.

Enterprise, Business Growth & Size

• An entrepreneur is a person who organises, operates and takes risk to make

the business better

• Characteristics of entrepreneurs:

o Hard working

o Risk Takers

o Creative

o Effective Communicators

o Optimistic

o Self-confident

o Innovative

o Independent.

• Advantages and disadvantages of being an entrepreneur:

 Advantages Disadvantages

Independent, able to choose entrepreneurs will have to put their own money
how to use time and money into the business.

Able to put own ideas into

many entrepreneur’s businesses fail (risky)
practice

May become successful and

Lack of knowledge and experience in starting and
very profitable if business
operating a business
grows

Able to make use of personal Lost income from not being employee for
interests and skills another business (Opportunity cost)

Will have to invest their own savings as well as

Profits to themselves, no need
find other sources of finance , which is time
to share them with anyone
taking and expensive

Who needs to know the size of a business?

• Investors

• Government

• Competitors

• Workers

• Bank

Business Plans
• A business plan contains business objectives, important details about the

operations, finance, and the owners

• Business plans assist entrepreneurs because:

o It helps gain finance. banks will ask for a business plan before

agreeing to a loan or overdraft for the business

 o It forces the entrepreneur to plan ahead carefully, which reduces

risk of the business failing.

• The main parts of a business plan include: name, type of organization,

business aim and forecast profit

Government Support for Start-Ups

• Governments encourage entrepreneurs to set up a business because start-ups:

o Reduce unemployment, new businesses create jobs

o Increase competition, gives consumers more choice

o Increase output, economy benefits from increased output of goods and

services

o Can grow further and become large and important businesses which pay

government more taxes

• Governments may give support to entrepreneurs by:

o Business ideas & help, they set up support sessions held by experienced

business people

o Finance, they may lend loans at low interest rates or grants

o Governments provide grants for training employees to make them more

efficient and productive

o Governments allow entrepreneurs to use research facilities in

universities

Business Size
• There are several different measurements of business size and they all have

limitations:
 Measurements Limitations

The number of people employed in the Some businesses employ few people
business but produce high output values

high level of output does not mean

The value of output of the business
business is big

different businesses sell different

The value of sales
products (expensive and cheap)

The total value of capital (money) some companies may use cheap labor
invested into the business (capital giving high output with low-cost
employed) equipment

• No way of measuring the size is considered correct as each method gives

different answers. Businesses choose the method they think is the best.

Therefore, businesses may use more than one method.

Reasons for business Growth

• Some businesses want to grow because:

o Higher profits

o More status for owners and managers

o can benefit from Economies of Scale (lower costs)

o Larger share of its market, ‘big names'

Ways of business growth

• Businesses can either grow by:

o Internal Growth

o External Growth

• Internal Growth is when the business expands its existing operations

 • External Growth is when the business takes over or merges with another

business.

• There are three types of External Growth:

o Horizontal Integration – firm taking over/merging with another firm in the

same industry

▪ Ex. a paper company taking over another paper company

▪ Benefits include economies of scale and higher market share

▪ Problems include diseconomies of scale and difficult to control and

manage the business

o Vertical Integration – firm taking over/merging with another firm in same

industry but different stage of production (there is forwards and

backwards)

▪ Ex. paper manufacturing company taking over paper selling

company

▪ Benefits include profits by supplier/retailer are absorbed and

personal attention is given

o Conglomerate Merger - firm merging/taking over another firm in a

different industry. (also known as ‘diversification’)

▪ Ex. paper company taking over a food company

▪ Benefits include spread of risks and transfer of ideas.

Why small businesses are at greater risk

• Established by youngsters who lack managed experience
 • Borrow money to begin so will have to repay whether or not business is

successful

• Start-ups have lesser experience and information about the market in order to

make informed decisions

• New entrepreneurs may not have a realistic picture of the market

Why Businesses Fail

• Poor management – from lack of experience, poor choice of managers (family

business), bad decisions

• Failure to plan for change – businesses need to adapt everchanging business

environment. Must take risks.

• Poor money management – lack of money to pay workers, suppliers, landlords,

etc.

• Over-expansion – (diseconomies of scale), management problems and finance

• Competition with other businesses – new businesses are at more risk of failing

than existing businesses.

• This is because start-ups have lack of money, resources, poor planning & don’t

have much research

Sole Trader
• A business owned by just one person. It’s the smallest type of business. Can

employ other people however.

o Useful for people who are setting up new business

o Do not need much capital to get business running

o Will be dealing mainly with the public

 Advantages Disadvantages

Easy to set up, do not require a lot of Capital is usually provided by owner, hard
money to set up to get capital to expand firm

They are their own boss, has the

They have unlimited liability (responsible
freedom to choose their own
for any debts of the business, bank can
holidays, work hours, prices, who to
take away possessions to pay back)
employ

Close relationship with customers Business is likely to remain small

Does not have to share profits No one to discuss business matters with

They are unincorporated (business has

Does not have to give information
same identity as the owner). So, business
about the business
ends when owner dies

Lesser legal restrictions

Partnerships
• A business in which 2 to 20 people agree to own it. Usually small

businesses but bigger than sole traders.

o Useful for people who want to form a business but don’t want the

legal complications

o Industries such as medicine or law where you are not allowed to

form a company

o Partners that know each other very well

• Requires a Partnership Agreement

 Advantages Disadvantages

Easy to set up, do not require a lot

Capital is usually provided by partners
of money

More capital invested (more

Partners have unlimited liability
expansion)

Partners can disagree on decisions. If one of

Partners are motivated because any
the partners is inefficient, they all lose
losses are shared by the partners
money

Responsibilities are shared (focused They are unincorporated. If one of the

on different parts of business) partner dies, the partnership ends

• Contents of Partnership Agreement:

o Amount of capital invested by all partners

o Tasks to be done by each partner

o The way profits are shared out

o How long partnership will last

o Arrangements for absence, retirement and how partners could be

let known

Private Limited Company (LTD)

• An LTD is different from the other because it can sell shares and it is

an incorporated business.

• Company must be owned by at least 2 shareholders

o A shareholder buys shares of an LTD company which represent

part ownership of the company

 o Dividend is the amount of profit each shareholder gets

• Shares are sold privately to friends and family

• Has separate identity from owners, incorporated, so company accounts

are separate from the owners’

• Must have: Articles of Association and Memorandum of Association

• Article of Association – must contain the RULES in which the company

will be managed. Contains:

o Rules for shareholder meetings

o List of directors and their jobs

o Voting rights of shareholders

o Details of how accounts are recorded

• Memorandum of Association – must contain important information

about the company:

o Company name, address

o What the business does

o Number of shares to be sold

Advantages Disadvantages

Shares can be sold to lots of people.

Difficult to set up (legal formalities).
More capital to expand
 Advantages Disadvantages

Owners are able to keep control of

Shares are difficult transfer. Requires
company as long as they don’t sell too
other shareholders to agree
many shares

All shareholders have limited liability

Accounts are less secret than other
(bank can only take amount of money
forms of business
invested)

Company continues after a shareholder Company cannot offer it shares to the

dies public

• Private Limited Companies are useful for family businesses or

businesses/partnerships where owners want to expand more (as you can sell

shares)

Public Limited Company (PLC)

• A PLC is similar to LTD only the shares can be sold to the public. It is the

biggest type of business.

• Shareholders of PLCs may attend an Annual General Meeting where

they may vote for the board directors

Advantages (in addition to those

Disadvantages
in LTDs)

Opportunity to raise high capital Difficult to set up (legal formalities) &

sums accounts are even more public

No restriction of buying, selling or Danger of business being taken over due to

transferring shares public shares

Selling shares to public is expensive

• DON’T GET CONFUSED, Public Limited Companies are NOT in

the PUBLIC sector, they are in PRIVATE sector

Joint Venture
• A joint venture is when two or more businesses start a project together sharing

capital risks, and profits

Advantages Disadvantages

Costs are shared, good for expensive Profits have to be shared if project is
projects successful

Might have disagreements over important

Shared knowledge of two businesses
decisions

Risks are shared Different methods of running business

Franchise
• A franchise is an agreement of a business based upon an existing

brand/business

• The franchisor is the main business/brand

• The franchisee is the individual to start up franchise

• In a franchise, the franchisor allows the franchisee to trade under its name and

(sell) its products for a fee

• The franchisee pays an original fee to franchisor and a percentage of its profit for

the privilege

• Franchisor provides support, such as:

o Advertising

o Legal advice

o Employee training

o Financial advice
 • Franchise agreements last 5 – 20 years, if franchisee cancels the agreement early

there may be large fines

Risk, Ownership & Limited Liability

• Risk - the uncertainty of profits or danger of loss, events that could cause

business to fail

• Ownership – who owns the business (partnership = partners, LTDs and

PLCs = the shareholders)

• The people with risk are usually the owners

• Liability – how much the shareholders of a company are liable for the

debts in the business

o Limited Liability – liability of shareholders is limited to the amount

of money they invested (PLC & LTD)

o Unlimited liability – owners of business are held responsible for

all the debts of the business (not just their investment) (Sole trader

& partnerships)

Public Sector
• The public sector includes every business owned by the government.

• Businesses in the public sector are public services, i.e. education, transport,

hospitals, and police

• Usually these businesses have been nationalized (used to be private sector but

government bought it)

• Capital comes from taxes, by tax payer

 Advantages Disadvantages

Reduces wastage of resources (if a

Low efficiency due to lack of competition
monopoly)

Easily manipulated by the government to

Allows access of essentials to everyone
exploit citizens

Continued even if in losses Not flexible as profit is not a main aim

Keeps in mind social costs of decisions Will have to be subsidized if in losses,

(non-profitable) opportunity cost

Business Objectives
• Business objectives are aims or targets a business works towards

• Benefits of having business objectives:

o Employees have a clear target to work towards

o Decisions made keeping in mind objectives

o Clear & measurable objectives will make sure the entire organisation

works towards the same goal

o Managers will be able to compare performance

o A business objective maybe changed if economic conditions change or

one objective has already been achieved

• Private sector business objectives:

o Business Survival - Adjust to business environment, change price of

products if necessary

o Generating profit – pay a return to owners or provide finance to invest

further in business
 o Returns to shareholders - discourage shareholders from selling their

shares. Can be increased by increasing profit or increasing the share price

o Growth of business – increase salaries, economies of scale. only

achieved if customers are satisfied with the product

o Market Share – the proportion of the total market sales by one business,

gives good publicity, more influence over suppliers and customers

o Service to community – provide jobs, support disadvantaged groups in

society, protect environment

Stakeholder objectives
• A stakeholder is any person with a direct interest in the performance of a

business

• There are two types of stakeholder groups:

o Internal Stakeholders work/own the company (owners, managers,

workers)

o External Stakeholders are outside of the business (consumers,

government, banks)

• Each stakeholder group has different objectives for the performance of

the business

• Internal Stakeholder’s objectives are payments or profits, they want

business growth, so value of investment increases or they get higher

status/power
• Customers objectives are reliable products, value for money, good

quality, good design and good service

• Government objectives include: money from taxes, will employ more

people, increase country’s output

• Banks objectives are to make profit out of loans

• Since different stakeholders have different objectives, it may cause

conflict, to try to please all the stakeholders

• For example: customers want cheap products but workers want higher

salaries.

• Therefore, managers have to compromise to decide which objectives are

best for the company