unit 3 revision business studies

8/11/2019 Unit 3 Revision Business Studies

http://slidepdf.com/reader/full/unit-3-revision-business-studies 1/19

by Sophia Abramchuk

Making Business Decisions

Unit 4a Business Studies

4.3.1 What is a Mission Statement The mission statement of a business sets out what the mainpurpose of a business is e.g. why it existsThe mission is likely to be determined by the values oforganisation (i.e. its culture)

The aims of the business expressed in ‘qualitative terms’such as the desire to ‘be the best in the industry’ They highlight the culture, values and beliefs of the businessShould be short, specic and convey to everyone the value ofthe brand and why it exists It will include information for all stockholders A more inspirational and motivating version of a corporate aim

Corporate aims are broad long term ideas on how thebusiness should develop. Can be very vague e.g. to beprotable/successful in the future

An effective Mission StatementIdenties the reason why the business existsA good mission statement will help to develop SMARTcorporate objectives, and be supported and adhered to in alllevels of the business Ensures that everyone is focused and working towardsachieving goals Many believe that a Mission Statement should have a grand

scale, be socially meaningful and be measurable

A pyramid of terms Corporate objectivesDerived from mission statement/corporate aims General objectives that refer to the business as a wholeNeed to be practical and effective, e.g. relating to survival,prot, market standing, social responsibility “They are specic, measurable,r elastic and measurable(SMART) goals which an organisation plans to achieve withina given time period. These goals will inuence its internaldecisions”

Strategy A plan of actions that has been designed to full an objectives.A strategy cannot be formed until an objective has beendened

Are Mission Statements useful

Stakeholders and objectives

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by Sophia Abramchuk

Supermarket wants to open a new superstore on agreeneld site - Local community can have the conict withshareholders of the business. This is due to the interest ofshareholders to maximise sales and do whatever they need toattract as many customers, without ethical considerations.The local community will be interested in preserving thegreenland and environment, because building of asupermarket implies a lot of pollution, distraction of naturalhabitat and the rural area around it. It might be possible thatlocal community will benet from cheap food supply from thesupermarket as well as this will create jobs and improveemployment in the area, but on the other hand it can beargued that there is urban space in the city that can be usedand which will not have the same environmental impact withthe same benets. And shareholders will want to minimise thecosts of wages and production, so it is possible that the localworkers will be paid less as well as more pollution and wastewill be implemented.A meat processing business wants to open a new abattoir

close to a residential area- restaurants and residents of thearea. For restaurants the suppliers will be closer, the transportcosts and fresh produce, but the local residents will feeluncomfortable with the meat production.

Summary Despite the apparent number of conicts most stakeholderswill have some common ground, e.g. long term protabilityBUT There are some irreconcilable differences e.g. local residentswill never be keen on a new runway/airport near their home.

Conicts between ethical objectives and prot-

based objectivesArgument- being ethical/socially responsible increases costsBUTSome ethical companies- highly protableCan avoid need for outsider regulation (which can be costly) Can improve motivation/leadership

Corporate Social Responsibility Social Responsibility and business ethics are notthe same things Social-responsibility - broad concept that concerns theimpact that the business has on society as a wholeEthics relates to the way a individual or group behaves andthe way society judges this as right or wrong

Means taking decisions that take account of allstakeholder interests.Because #Desire to behave responsibly Positive public image #Smokescreen to hind behind Spin-offs:Good public relations exercise #Can increase sales #Reduces potential stakeholder conict

Ethical Decisions making conictFollowing codes of practice that embody moral values:What to manufacture eg arms & cigarettes make prot butboth are destructive #Where to manufacture eg movement of production overseasto reduce costs causing unemploymentCapital and labour –ie machinery or more jobs #Pay & working conditions eg trade off between beVerstandards and lower costs #The environment trade of between controlling pollution andlower costs # Ethical Behaviour and Protability #Trade off between ethical behaviour and protability? #

However companies with ethical behaviour still make prot egKraft foods, PepsiCo, Dell, IBM

Drawback to behaving ethically Labour costs increase #Supplies and materials higher costs #Controlling environmental damage increase costs #Change in organisation culture expensive #If Competitors less ethical so lower costs/prices #Advantages to behaving ethically :Favourable media attention #Improved public image can lead to increased sales and brand

loyalty#

Ethically produced products can carry a premium price withoutdamaging sales #More motivated workforce and possible increases inproductivity #Improved relationships with suppliers leading to beVer qualityservice #Can actually be protable

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Corporate culture Organisational culture The way we do things around here- a result of tradition,history and structure The values, attitudes and believes of the people working in an

organisation that control the way they interact with each otherand with external stakeholder groups

Google organisational culture It comes fromPeople and talent and skills, collection of special peopleCorporate aimsAtmosphere and environmentNo bureaucracyFreedom to workDifferent backgroundMulticultural food, sports, care for workersWorking habitsNo dress code, casual and open plan ofceMultinational culture

Sources of organisational structure

Weak and Strong CultureWeakEmployees don’t support the corporate culture Productivity and motivation likely to be lowDanger of ‘us’ and ‘them’ mentallyCapable staff may move on, leaving disaffected discontentstaff behindStaff need to be forced to comply with company rules End results to be poor performanceStrongEmployees believe the corporate culture and strongly supportitStaff tend to be more loyal Staff turnover is reducedMutual respect between management and employees grow Motivation tends to be high Productivity tends to be higher Good communication existsA strong culture may encourage superior performance

Success depends uponPeople in the organisation; their skills and their ability to workindependently or as part of a teamSituation facing the business- do cultures need to change indifcult times e.g. recessionProducts/services being sold

Problems of changing organisational cultureDemotivation of employees that need to adopt to a new wayof “doing things around here” Takes time and effort, reduces productivity and motivation ifnew culture is more strict and allows less freedomNeed to invest in trainingCultural clashes between different groups inside the business(Mergers and takeovers)International businesses, diversity, scale, size, geographicalspread of the organisationCurrent management/leadership stylesCurrent organisational structureLack of experience in managing cultural changeNegative outcomes of change

Types of Culture Power This type of culture has few rules- so decisions can be madequicklyCentralised and concentrated between few people culture

control bus Role Traditional business structure- often reected in anorganisational chartA hierarchy will exist with delegated authority- it comes from aperson’s position in the structureTaskInvolves forming teams to address specic task- reected by a“Matrix organisational structure”Person Where individual employees focus on themselves that thebusiness- which can create problemsThis type of culture is more common where employees havesimilar qualications- e.g. accountants

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Corporate StrategyOnce the corporate objectives have been decided, a busiesmust begin to plan how they will be achieved

What is Corporate Strategy? Long term plan to achieve corporate objectives Can be implemented in a number of ways e.g. Entering/leaving certain markets Acquiring new companies Introducing/phasing out products and services etc. No one way to do this but different approaches which can beused which are looked at in this presentation

Developing Corporate Strategy – Portfolio Analysis

The Boston Matrix #An attempt by the Boston Consulting Group to analyse the

product portfolio of a rm

Market share – does the product being sold have a low orhigh market share? Market growth – are the numbers of potential customers in themarket growing or not

The Boston Matrix AnalysisStars are high growth products competing in markets wherethey are strong compared with the competition.Often Stars need heavy investment to sustain growth.Eventually growth will slow and, assuming they keep theirmarket share, Stars will become Cash CowsQuestion marks are products with low market shareoperating in high growth markets.This suggests that they have potential, but may needsubstantial investment to grow market share at the expense oflarger competitors. Management have to think hard about“Question Marks” - which ones should they invest in? Whichones should they allow to fail or shrink?Cash cows are low-growth products with a high marketshare. These are mature, successful products with relativelylittle need for investment.They need to be managed for continued prot - so that theycontinue to generate the strong cash ows that the companyneeds for its StarsUnsurprisingly, the term “dogs” refers to products that havea low market share in unattractive, low-growth markets. Dogs

may generate enough cash to break-even, but they are rarely,if ever, worth investing in. $ Dogs are usually sold or closed.

How Useful is the Boston Matrix? Balanced portfolio needed Stars and problem children – potentialCash cows will eventually fade away so stars/problemchildren need nurturing. Helps to think about balance in product range BUT Only a snapshot of current position No real predictive value High market growth doesn’t mean the market is attractive High market share does not mean the product is able togenerate cash

Focus on market share and market growth ignores otherissues such as developing a sustainable competitiveadvantage Useful when comparing with the product life cycle

Achieving Competitive Advantage through DistinctiveCapabilities Competitive Advantage Any feature of a business that enables it to completeeffectively. May be based on price, quality, service, reputationor innovation. Distinctive Capabilities The ideas, resources and capabilities that a businesspossesses that are better than those of its competitors. Goal of business strategy is to achieve competitive advantagethat is sustainable for as long as possible. The moredistinctive capabilities a business has, the more likely it is tocreate a competitive advantage and to make it last

Impact of Strategic and Tactical Decisions

Strategic Decisions

Made in order to meet the objectives of the business. Theyare usually long term in nature. For example, should we entera new market? Tactical Decisions Shorter term steps taken to achieve the strategy. Forexample, what price should we charge? Both types of decisions will impact upon human resources,physical resources and nancial resources.

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Porter’s 5 Forces Analysis

(Michael Porter, a key business management author) A way to look at the competitive environment 5 forces (factors) which determine the protability of anindustry Ultimate aim of competitive strategy is to cope with and ideallychange those rules in favour of the business When the collective strength of those 5 forces is favourable, abusiness will be able to earn above average rates of return on

capital When they are unfavourable, a business will be locked intolow returns or widely uctuating returns

The Bargaining Power of Suppliers Suppliers want to maximise prot The more power a supplier has over competitors the higherthe prices they can charge Limiting the power of the supplier will improve the competitiveposition of a business To do this it can:Grow vertically Seek out new suppliers Minimise the information provided to suppliers in order toprevent the supplier realising its power over the consumer

The Bargaining Power of Consumers The less customers there are, the more power they haveBuyers want to obtain supplies for the lowest price If buyers or customers have enough market power they areable to beat down prices offered by suppliers One way a business can improve its competitive positionagainst buyers is to extend into the buyers’ market throughforward vertical integration It could encourage other businesses to set up in itscustomer’s market to reduce the power of existing customers It could try to make it expensive for customers to switch to

another supplier e.g. games console manufacturers keep upthe price of computer games for their machines by makingthem technically incompatible with other machines

Threat of New Entrants If businesses can easily come into an industry and leave itagain if prots are low, it becomes difcult for existingbusinesses in the industry to charge high prices and makehigh prots Existing businesses are constantly under threat that is theirprots rise too much, this will attract new suppliers into themarket who will undercut their prices. Businesses can counteract this by creating barriers to entrye.g. patents/copyright or creating strong brands which willattract customer loyalty and make customers less pricesensitive Large amounts of advertising can be a deterrent because itrepresents a large cost to a new entrant which might have tomatch the spending to grow some market share.Large sunk costs (costs which have to be paid at the start butare difcult to recoup if the business leaves the industry, candeter new entrants

Substitutes The more substitutes there are for a particular product theercer the competitive pressure on a business making theproduct A business making a product with few or no substitutes islikely to be able to charge high prices and make high prots A business can reduce the number of potential substitutesthrough research and development and then patenting thesubstitutes itself Sometimes a business will buy the patent for a new inventionfrom a third party and do nothing with it simply to prevent theproduct coming to market Businesses can also use marketing tactics to stop the spreadof substitute products e.g. a local newspaper might usepredatory pricing if a new competitor come into its market todrive it out again

Rivalry Amongst Existing Firms The degree of rivalry among existing rms in an industry willalso determine prices and prots for any single rm If rivalry is erce, businesses can reduce the rivalry by formingcartels or engaging in anti-competitive practices (in UK/EUlaw this is illegal but not uncommon) Businesses can reduce competition by buying up their rivals(horizontal integration) In industries where there are relatively few businesses, oftenbusinesses don’t compete on price

This allows them to maintain high protability Instead they tend to compete by bringing out new productsand through advertising, thus creating strong brands As a result their costs are higher than they might otherwisebe, but they can also charge higher prices than in a morecompetitive market creating high prots

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by Sophia Abramchuk

Porter’s Generic Strategies 3 generic strategies that businesses could follow in order togain a competitive advantage.

Cost Leadership – Tesco, RyanairCompetitive Advantage comes from: Providing a Basic Good at Minimum Cost (i.e. to become thelowest cost producer) Must have the lowest costs in the industry to succeed at thisstrategy. Can be achieved by a range of methods e.g. economies ofscale, best technology, increased productivity, more skilledworkers etc. This gives pricing exibility: Could have very low prices andincrease market share OR could keep prices at industryaverage and have large prots. Must keep their source of low cost savings secret from rivalsto maintain an edge!

Differentiation - apple Competitive Advantage comes from: Creating products which are unique Could be in terms of functions, design, features, after-salessupport or durability. Requires an effective R&D dept. and a highly skilledworkforce to make top quality products Enables the business to charge higher prices and achievehigher prot margins

FocusCompetitive Advantage comes from: Offering a specialised product in a niche market Business targets a particular segment or segments within themarket and focuses on satisfying their needs. Cost focus –focus on cost and price. Differentiation focus - concentrate ondistinctive nature of the product. Businesses using focus strategies aim their products at nichemarkets, e.g./ SAGA = over 50’s. They can tailor theirproducts to meet their customers’ exact needs.

The Key to Success with Porter Firms must choose one of these 4 strategies, they will notsucceed if they try to follow some “middle course”.

Competition vs co-operation Competition Traditional way – compete and maintain a competitiveadvantage Globalisation/trade liberalisation – more competition Internet – increases competitive pressure Corporate strategy more difcult as level of competition andspeed of change increase Strategic decisions need to be exible in order to cope withcompetitive threatsCo-operation Factors which may persuade a business to co-operate: Avoid the pressures of competition (e.g. Ba and Iberia runsome routes jointly) Resources can be shared for mutual benet Managerial time and effort can be put towards pushing the co-operative venture rather than ghting off the opposition Co-operation may be a legal requirement (e.g. in India andChina a joint venture might be required by law before MNCs

can enter a domestic marketplace)

Political, Legal and Other Inuences on Strategy Political E.g. economic policy MNCs operating under different Governments may facedifferent regulations Legal Changes in law may mean businesses have to change theway they operate e.g. working time directive/minimum wage Other E.g. social/technological can alter strategy as some objectivebecome easier or obsolete

Economic policy – to achieve economic growthFiscal policy – taxes + expenditure of the governmentMonetary policy – control of money supply and interest ratesSupply side policy – managing supply through education/trainingInation – costs rise or demand increase

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by Sophia Abramchuk

4.3.2 Making strategic decisionsAnsoff’s Matrix Ansoff’s Matrix is a ways of classifying marketing strategies interms of existing and new products in existing and newmarketsThe degree of risk involved in each strategy is an importantelement of the analysis Strategies Market penetration This is about increasing market share by concentrating onexisting products in existing markets. This strategy arises by:Finding new customers Taking customers from competitorsPersuading existing customers to increase usage e.g. cerealsto be eaten as a snack during the day and just for breakfast New product developmentThis is about launching new products into your editing market.Strategies may include:

Changing an existing productDeveloping new productsMarket developmentThis is about nding new markets for existing products. Thiscan be carried out in the following ways:Repositioning the product to target a different market segmente.g. Land Rover’s traditional market was farming and militaryuse; it has now repositioned the product to appeal to towndwellers Moving into new markets e.g. opening branches abroad

DiversicationDeveloping a new product in a new market. This is the mostrisky strategy but can also lead to the most extraordinarysuccess.

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Investment AppraisalThe importance of investmentInvestment in capital (e.g. medium to long term assets)features; Substantial nancial resources required

Opportunity and nancial costs: therefore riskShould aim to achieve nancial as well as corporateobjectives

Investment appraisalThe process of analysing the nancial merits of a possiblefuture investmentInvestment appraisal is a decision making tool whichexamines whether capital investment is worthwhile, or whichfrom a range of options is the best to undertake

Payback periodThis method calculates how long it takes a project to pay backthe initial investment involvedIt concentrates on cash-ow, highlighting projects that quicklyrecover their initial investmentRegard payback as one of the rst methods you use toassess competing projects- an initial screening tool, butinappropriate as a basis for sophisticated investmentdecisions This formula is used to nd the month when payback occurs:Remaining cash needed to payback/net inow expected inthat year x 12 monthsAdvantages Helps to see how long the capital will take to paybackVery simplistic and easy to useQuick

DisadvantagesDoesn't look at protability of the capital in long termOnly a forecast, other tools should be used to complement tomake the decision

Steps to calculate Payback Create a table of cash inows and outows over the life of theinvestment Identify in which year investment cost is recouped Narrow down the month using the formula:

Remaining cash needed to payback x 1 2months

Net inow expected in that year Express result as ‘Payback of x achieved in x years and xmonths’

88,000/125,000 x 12= 8.448, 2 years and 9 months

Average Rate of Return This method calculates the expected annual return from theinvestment, expressed as a percentage of the capital investedin the project. Quantitatively – the higher the rate of return, the “better” theinvestment is! ARR – Pros and Cons Simply and relatively easy to understand Expressed in percentage terms which may make it easier formanagers to use Focus on prot / return ARR doesn't take account of the project duration or the timingof cash ows over the course of the project A subjective tool – there is no denitive signal given by theARR to help managers decide whether or not to invest

Steps to calculate ARR… Create a table of cash inows and outows over the life of theinvestment

Calculate the total ‘prot’ from the investment Divide the prot over the life of the investment to give anannual prot rate Calculate the average rate of return using the followingformula:

Average annual prot x100% Initial investment

Express result as % return

Net Present Value (NPV) This method calculates the present value of all future cashows from each investment project. To do this, rstly the future cash ows are set down in a table,year by year Future cash ows are “discounted” to arrive at a presentvalue, using a discount factor (given in the exam) that relatesto the cost of capital or borrowing for the company NPV Pros and ConsMakes an allowance for the opportunity cost of investing Takes into account cash inows and outows for the durationof the investment Choosing the discount rate is difcult – especially for long-term projects A complex method to calculate and easily misunderstood Choosing the discount rate is difcult – especially forlong-term projects

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Steps to calculate NPV

Create a table of cash inows and outows over the life of theinvestment Multiply the inows by the given discount factor (e.g. 5%,

10%) Calculate the total ‘value’ of the investment (discountedinows – discounted outows) Express the result as a monetary value in today's terms Investment Appraisal – The Reality The main idea with investment appraisal is to evaluate thelikely success and value of capital investments to help thecompany succeed in the long term. In reality, nancial considerations are only part of the storywhen it comes to making investment decisions.

Bear in mind these facts when answering questions Politics Permeate Decisions are ultimately made andinuenced by humans, who think well beyond the gures(unless they are boring accountants). They will consider theirown objectives (especially if there is a divorce betweenownership and control) and will favour projects giving them,for example, more power and reward. Corporate Objectives: Companies may undertakeinvestments for reasons other than prot maximisation. Forexample, they may be trying to protect their long term security,or deny competitors an opportunity Mistakes and Errors: It’s actually really difcult to accuratelyestimate future cash-ows for most projects, and indeed theactual cost / time required to complete an investment. Thisundermines the accuracy of all quantitative methods.

Decision Tree The ‘tree’ is a diagram that compares all possible outcomes ofmulti-stage decisions In order to make a decision it is necessary to calculatethe expected value (EV) of every decision- this considers

the estimated value and probability of each eventTo calculate the expected value using a diagram- workbackwards from right to left; subtract the original cost of eachoptionThe option with the highest expected value would normally bechosenAdvantages The diagram may highlight possibilities that had not previouslybeen considered It requires numerical values to be placed upon decisions- thistends to require research, and thus improves resultsIt takes into account the risks involved in decisions, andmakes the decision-maker aware of them DisadvantagesTime-lags may mean data used is out of data as process istime-consumingIt does not consider non-numerical factors, e.g. laws The probabilities used are often estimatedThe diagram can quickly become complex and unmanageable

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by Sophia Abramchuk

Critical Path AnalysisCPA is a planning tool- not a decision making tool“ A method of organising the activities in a project to nd themost efcient method of completing the project without

wasting resources (time, money, materials.)”

Aims of CPATo plan complex operationsTo identify when a project must commenceTo illustrate the order of activitiesTo identify critical activities – which are those activities whichmust be completed rstTo identify the times when resources can be reallocated

The oatWith the network complete you can now identify any idle time.This spare time is known as the oat.Resources can be allocated to other duties during the oattime.To make an AnalysisA list of activities – assign each a letter and lengthInformation on the order of tasks to be completedThe time it takes to complete each taskAny constraints on completing

Assessing the value of CPAEfciency: shows those tasks, which can be carried out at thesame time. Shows critical tasks and ones that can be delayed.Decision making: estimating the length a project will take-analysis of the tasks involved should lead to deadlines beingmet more effectively as the implications of delays can be

assessed, identied and prevented.Time based management: ensure project is done as quick aspossible

Working capital control: identifying when resources will berequired can help a business to manage its working capitalcycle. Especially important if a business operated in a just intime system of stock control.

Advantages: Maximises efciency in the use of timeImprove efciency and generate costs saving in the use ofrecourseBenecial to monitoring cash owIdentify potential problems in implementing operationIdenties where and when recourses (including human ones)are neededDisadvantages:Usefulness may be limited in complex and large scaleoperationNecessity of having clear and reliable informationSkilled management and team philosophy is essential

Although critical path analysis is clearly of value a businessmust not assume that simply because it produces a networkits project will be completed without delay Information used to estimate times in networks may beincorrect Changes sometimes take place when new projects are carriedout; unforeseen events such as weather

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Special order/ unexpectedcontribution Total contribution- the difference between a product’s salesrevenue and its variable costs

Non-nancial factors to consider before accepting theorder Capacity- a business must ensure that it has enoughrecourses to complete the order e.g. are workers prepared to

work extra hours? Is there enough space in the factory, etc.Customer response- if existing customers nd out thatproducts have been sold to other at a lower price this maycause resentmentFuture orders- sometimes up-protable orders are acceptedin anticipation of future, more protable orders from the newcustomers Current utilisation- an unprotable order might be acceptedto keep employees occupiedRetaining customer loyalty- A business might accept anunprotable order from a regular customer as a favour inorder to retain them loyal.

Question : Single product manufacturer has this cost structure:Materials £25 per unitDirect labour £28 per unit Variable overheads £12 per unit Fixed overheads total £420 000 Product price £120Annual output 80% of the total capacity is 20 000DIY store wants to buy extra 4000 units per annum, to sellas ‘own label’Price £85£10 000 of set up costsFor the business:Prot- Rev - TC

Rev= £120 x 20 000= £2 400 000TC= FC + VC= 420,000 + (£65 x 20 000)=£1 300 000 BE= 420 000/ 55 (present contribution= 120- (25+28+12)) =7,636Margin of safety is 20 000-7 636= £12 364Forecast prot is £680 000 (12 364x £55) and revenue £916000 (£120 x 7 636) For DIY store order:Contribution= £340 000 (sales revenue)- 22x4000 = 80 000 -10 000 (set up production costs)= 70 000 BE= £420 000/ 20= 21,000 units of the DIY order will have tobe sold without other orders to break evenCapacity of 80% out of 20 000= spare

Contingency planningContingency planning - preparing for unwanted and non-routine possibilities such as: A severe recession

Bankruptcy of a major customerA sudden change in demand

A contingency plan ensures that a business is proactiverather than activeManagers are forced to look for potential; changes in theenvironment rather than merely dealing with changeswhen they occur

Contingency plans could include:Ensuring that new products are in development if there is asudden fall in demand for existing productsTraining employees to be ‘multi-skilled’ so that they canperform many jobs to cover absence or meet changes indemandUsing more than one supplier to ensure that a problem withone supplier will not jeopardise production

Contingency planning uses variable resources such astime and money, presenting an opportunity cost

To decide on which events to plan for a rm mayconsider:Likelihood- how likely is a particular event is to happen?Impact- what is potential damage if it does occur? The greater the likelihood and potential damage of an eventthe more likely a rm is to prepare a contingency plan for it

When good times go bad, the impacts of a crisis:When an unexpected event does happen a contingency planshould allow effective crisis management. Decisions will nothave need rushed, and there is a clear process to deal withthe crisis.

When managing a crisis it is important to:Identify the key factors as quickly as possible- what is thescale of the crisis, people involved etc Have a suitable and effective communication system in place(the school’s emergency closure line for example)Ensure all communication with third parties outside of theorganisation is clearly co-ordinated to ensure the businesscreates an impression that they are in control of situationHave authority and recourses available to make decisionsquickly

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Liquidity, protability ratios,balance sheets Concept/Stages of Ratio Analysis Ratio Analysis : a method of assessing a rm's nancial

situation by comparing two sets of linked data.

Stages in using ratio Analysis Identifying the reason for the investigation, is the info neededto decide wether to become an investor,customer or supplieror is it being used by the organisation to improve efciency. Decide on relevant ratio to achieve purpose of the user. Gather info required and then calculate the ratio. Interpret the ratio. what is the meaning of the results? Make appropriate comparisons in order to understand signicance of ratio. Take appropriate actions then reevaluate with same processafter implementation.

Ratio Comparisons Ratios alone are meaningless therefore we compare themwith other results. Inter-rm Comparisons - Between 2 companies, a companyshould compare to rival competitors, in order to assess itsrelative performance. these should be selected as the oneswith the most in common in order to take into external factorswhich should effect the both. Intra-rm Comparisons - Within a company. the efciency ofdifferent divisions or areas of a company can be compared.Should also be between similar areas. Comparisons to a Standard - Certain levels are seen asefcient, a company can compare to these standards toassess objectively

Comparisons Over Time - Whatever basis is used, acompany ratio should be compared over time to see trends inefciency and to allow for exceptional events.

Users of ratios Managers - Identify efciency of the rm and its differentareas, to plan ahead and see effectiveness of policies Employees - Whether the rm can afford wage rise and tosee if prots are being fairly distributed Government - To review success of its economic policies andnd ways to improve efciency overall. Competitors - To compare their performance against rivalrms and discover their relative strengths and weaknesses. Suppliers - To know the sort of payment terms that are beingoffered to other suppliers, and can they afford to pay. Customers - Know the future and make sure guaranties andafter sale services are secure Shareholders - Compare nancial benets with otherinvestments.

Types of Ratio Protability Ratio - These compare prots with the size ofthe rm, as prot is often primary aim of a company (ROCE) Liquidity Ratios - These show whether a rm is likely to beable to meet its short-term liabilities. although prot showslong-term success its vital to hold sufcient liquidity to avoiddifculties in paying debts. (Current Ratio & Acid Test Ratio)

Gearing - Focuses on long-term liquidity and shows whethera rm's capital structure is likely to be able to continue to meet

interest payments on, to repay long term debts. (GearingRatio) Financial Efciency Ratio - Focuses on management ofworking capital, used to asses the efciency of rm inmanaging assets and short- term liabilities. (Asset turnover,Inventory turnover, Payables days & Receivables days) Shareholders Ratios - Focus on drawing conclusions aboutnancial shareholder benets from their company shares.(Divided per Share & Divided Yield)

Measuring protabilityGross Prot MarginThe amount of prot a business makes on its cost of sales.The mark up prot on each item sold.The higher the margin the better A high gross prot may suggest a USP adding value to theitems sold, low material costs or a high selling price.This can be improved by reducing raw material costs orincreasing the selling price.

Net Prot MarginThe amount of prot a business/product generates afterpaying expenses, as a percentage of turnoverThe higher the prot margin the better A failing net prot margin may suggest that the business iswasting money through unnecessary expenditure

Protability Ratio Return On Capital Employed The capital employed is a measure of the value of theresources used by a business and is an excellent guide to itssize. Prot targets are often expressed as a ROCE whichuses the formula below: ROCE = Operating Prot /Capital Employed x 100 Measures the efciency with which the rm generates protfrom the funds invested in the business.Compares net prot to the amount of money in the businessA higher percentage gure is betterCan be compared with: previous gures; alternativeinvestments, e.g. bank rates.

Liquidity Ratios Liquidity: the ability a business has to repay its debtsCurrent assets: what you own - stock cash debtorsCurrent liabilities: what you owe – short term loans Two liquidity ratios - Current ratio & Acid test ratio used inorder to assess the ability of an organisation to meet its short-

term Liabilities.

Current Ratio: In order to meet liabilities a rm can draw onits current assets,bank balance,debtors and stock that is sold.Generally, higher numbers are better, implying that the rmhas a higher amount of current assets when compared tocurrent liabilities and should easily be able to pay off its short-term debt. Current ratio = Current assets/current liabilities Company should aim to be between 1.5:1 and 2:1 as an idealratio

Acid Test Ratio : Firms cannot be sure that their inventorieswill sell quickly so acid test is used as an alternative. Acid testignores inventories in its calculation considering only cash,bank balances and receivables.

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ATR= Current assets - Inventories/current liabilitiesThe ideal Acid Test Ratio is between 0.75:1 and 1:1

Gearing Gearing examines the capital structure of a rm and its likelyimpact on the rm's ability to stay solvent. Gearing (%) = Non-current Liabilities/ (Total equity + Non- current liabilities) X 100 Non-current liabilities normally take the form of loans, such asdebentures or long-term loans from the bank High Gearing is greater than 50%. High gearing ratio showsthat a business has borrowed a lot of money in relation to itstotal capital. Low Gearing is below 25%. Low gearing ratio indicates that arm has raised most of its capital from shareholder, in theform of share capital and retained prot. Gearing Benets Benets of High Gearing There are relatively few shareholders, so it is easier for

existing shareholders to keep control of the company. The company can benet from a very cheap source of nancewhen interested. In times of high prot, interest payments are lower thanshareholders' dividend requirements, allowing greater retainedprot. Benets of Low Gearing Is permanent share capital avoids creditors pushing them intoliquidation. A low gearing company avoids the problem of having to payhigh levels of interest on borrowed capital when interest ratesare high. The company avoids the pressure facing highly gearedcompanies that must repay their borrowing at some stage.

Financial Efciency Ratios Asset Turnover: This ratio measures how well a companyuses its assets in order to achieve sales revenue. Asset Turnover = Revenue / Net Assets High AT shows the business is using assets efciently toachieve sales. Low AT shows the business is not using assets efciently toachieve sales. Capital intensive rms will have lower asset turnover thanlabour intensive rms, because capital owned is included innet assets where labour is not.

Stock Turnover This ratio measures the number of times a year a businesssells and replaces stock.Stock turnover= Cost of Goods Sold/Avg Stock Held the stock turnover gure represents the number of times in ayear that a rm sells the value of its stock. 3 time a year =once every 4 months The stock turnover can be improved by:Reducing the average level of stocks held, without losingsalesIncreasing the rate of sales without raising the level of stocksIn different industries the rate of stock turnover will bedifferent, e.g. greengrocer would have a ration of 250 to 300days of turnover due to the need of his stock to be fresh,whereas a business operating in service would have a zeroturnover as no stock is held.

Factors inuencing the rate of Stock Turnover The Nature of the Product - Perishable products or productsthat become dated, e.g. (newspapers) have high stockturnover. The Importance of Holding Stock - Clothes retailers need tohold high levels of stock to encourage shoppers The Length of the Product Life Cycle - Fashionableproducts are expected to sell quickly and products with shortlife cycles must also have a rapid turnover. Stock Management System - Just-In-Time stock control =low levels of stock so stock turnover is faster. Quality of Management - Poor market research may lead toinappropriate stock levels = low stock turnover. The Variety of Products - Company with 20 products willhold greater levels of stock than a company with 1.

Limitations of Ratio Analysis Accounting information is historic in natureNot easy to make accurate projections of future performance

from the data Only focused on monetary items- what about changes in staff/ strength of product portfolio/future new product pipeline/age ofkey assets etc.Does not take into account the nature of the business: thequalitative factors: size; market penetration/business activity/ objectivesTake a look too at the chairman’s director’s for furtherguidance

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Human RecoursesCompetitiveness

Efciency can be measured by calculating the productivity of a

rmProductivity - the amount that can be produced with theresources that are available

Factors that affect efciency Labour intensive- relatively few machines are needed-common where specialist skills are required; in the servicesector Capital intensive- relies more upon machinery- e.g. whereidentical products are produced

Capital or labour intensive The size of the business Capital equipment can be expensive Small rms may be unable to afford to buy machinery Even if they can afford it, they will have to calculate whetherthe cost can be justiedThe relative costs of inputs New technology is expensiveIt may be cheaper not to automateEven if a job can be automated it may not be cost-effectiveThis depends on the wage demands of staff

The product of service Products which can be mass produced will be capitalintensive- e.g. cars Whilst custom-made product, and many services will belabour intensive- e.g. hairdressing

Labour Turnover

This is the measure of how quickly the staff in the workplacechangeIdeal rate It depends upon The level of unemployment in the regionWhether staff are full or part-timeThe level of skills required by staff E.g. Private sector- 16.8% Public sector- 12.6% Voluntary sector- 16.4%

Why is Labour turnover important Positive New workers may be more enthusiasticA rm can employ staff who have the specic skills requiredfor different jobs

New staff may bring new ideas and new ways of workingNegative Recruiting new workers is expensive New staff will need training and induction, which is costly andtime consuming It can have a negative impact on staff morale, if lots of staffare leaving

Voluntary Labour Turnover- sometimes workers will leave a job voluntarily, due to retirement; nding another job andvolunteering for redundancyThis can be helpful to a business that is looking to decreasetheir labour costs- since they may not have to replay the staffthat leave

Internal and external inuences on workforceplanning The process of anticipating in advance the human resourcerequirements of the organisation, both in terms of the number

of individuals required and the appropriate skill mix.Recruitment and training policies are devices with a long-termfocus, in order to ensure the business is able to operatewithout being limited by a shortage of appropriate labour

Internal inuences The are of rise in workforce productivity- automation canimprove productivity, as well as motivating employees through

job enrichment, agreeing nancial objectives and otherappraisal systems; there is a lot evidence that this isexpensive, but little that it is effective The business strategy itself-expansion strategies- ifproven to be success, a business can double pressure toemploy and train new stuff The attitude of the leadership towards the structure ofhierarchy- if a new leader decides to delayer theorganisation, the job losses and the retaining needs will causework (and stress) for the HR department; this will need to bebuilt into the workforce plan The attitude of the leadership towards a diverseworkforce- there is a tendency to hiring white males,educated in the private sector; diversity strategy is thepreferable, as this practice could benet from greaterunderstanding among the staff of the lives of people fromother cultures.

External inuences

External opportunities -such as the period when adeveloping country moves from commodity based purchasing(rice, chicken, oranges) towards modern products, servicesand brands Legislation- now the legistalition towards the requirements toget hired and discrimination became more laissez-fair; nowbusinesses can decide on what sex, different race or age ofworkers to hire; this is reversed by more restrictions onmigration policies, some rms making use of the inow ofskilled workers and some putting extra training and time intoBritish workers to get the required skills that can be in shortsupply

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4.3.4. Company growth Business size can be measured in many ways- e.g.assets, sales revenue, operating prot, market share,value added, number of employees Growth implies increase in one or more of the above metrics

Large companies enjoy Great volume of sales Higher sales revenue Larger prots Higher market share Greater inuence over market prices Economies of scale Greater stability- they are more robust and better able to copewith economic problems

Aims of business growth To increase prot To achieve market leadership/dominanceTo enjoy economies of scale and therefore lower unit costs To control outlets and/or suppliers To spread risks by diversifyingTo reduce the range of takeover To increase security To remain competitiveTo ride uctuations in the economyFor survival As a defensive strategyTo increase status To obtain the benets of synergyReasons of personal ambition

Economies of scale- an advantage of producing on a largescale; unit costs fall as the scale of production rises

Financing growth by borrowing (this has consequences forgearing and interest cover); share issue (consequences forcontrol); and internal nance (reinvestment of past prots butat the expense of dividends)

Prots are essential for growth The ploughing back of past prots is a major source of fundsfor growth Only protable rms generate the funds for reinvestmentDebt nance for expansion is usually dependent upon a trackrecord of successful and protable operations The success of a share issue is also dependent on past andcurrent performance

Obstacles to growth Financial constraints- lack of vince for investmentMarket size limitations- the market is too small for the rm togrow Lack of personal ambition in the ownerInternal resistance to change- e.g. from middlemanagement and workforce Organisational inexibility- inability to cope with a new,larger organisationCompetitor activity- aggressive competition prevents

acquisition of a large market share Resource constraints- capacity constraints or lack osphysical assets

Problems of growth Cash ow problems Danger of overtrading - expanding with insufcient workingcapital Diseconomies of scale- paper work and problemsassociated with large scale Personnel problems- employee motivation and employeeproblems Risk of loss of direction and control

Organic growth This is expansion from within Organic/internal growth arises from within the business eitherby selling more of existing products or by launching new ones Growth by- reinvesting prots back into the business toincrease capacity; using the existing, internal resources of thebusiness

The mechanism for organic growth

Prots are re-investedThis increases capacity As a result output and sales rise Increased product leads to a rise in the capital (balance sheet)value of the business

Favourable conditions for organic growthWhen the market is growing fastWhen one rm’s performing better than others and thereforegains market share When new rms enter the market

Reasons for pursuing organic growth Absence of suitable acquisition targets might make this theonly route for expansionInvolves less risk and disruption that external growthCan be planned more carefully than external growth Can b nanced from own resources without need to raiseexternal nanceSame style of management and organisational culture can bemaintainedEconomies of scale available from more efcient use ofcentral head ofce functions

AdvantagesMakes best use of existing resourcesConsistent with existing culture

Leads to economies of scale Easier to control Can be planned carefullyCan be nanced from retained protsInvolves less riskLong term, working relationships maintainedCapitalises on existing expertiseDisadvantages Takes place slowly as the rm builds capacity and growsmarkets Firms have to acquire resources Organic growth is limited by growth in the market It can result in an over-cautious approach Handicapped by limitations of existing skills and expertise May be too slow for the dynamics of the market

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External growth Growth by acquisition/take-over or merger Instead of build up resources internally the rm seeks toacquire additional resources from other businessesResources acquired include capacity, a workforce, tangibleassets, technology, and a consumer baseIt is a much used strategic option A voluntary joining together of companies is known as amerger, a forced acquisition of one company by anotherknown as a take over (or acquisition)

When is external growth is a preferred strategyExisting products are in the later stages of its life cycle Business lacks knowledge or resources to develop internally Speed of growth is a high priority Costs are more favourable than those of organic growth

Advantages Quick access to resources the business needs

Overcome barriers to entry Helps spread risks Wider range of products and greater geographical spread Provides cost saving opportunities Reduces competitionEconomies of scale Provides benets of synergy (the interaction of elements thatwhen combined produce a total effect that is greater than thesum of the individual elements, contributions) DisadvantagesHigh cost involved Problems of valuation Clash of cultures Upset customers; customers might not remain loyal Involves high riskProblems of integration Problems of implementing the changesResistance from employees Problems in achieving the benetsIncompatibility of management styles, structure and cultures Negative synergy (2+2=3!) Often driven more by personal ambitionForms rarely take non-nancial factors in to account High failure rate Diseconomies of scale

Mergers

Dened as a voluntary and permanent combination ofbusinesses whereby one go more rms integrate theiroperations and identities with those of another Or a combining and pooling of business organisations to forma new business Shareholders come together to share the resources of theenlarged or merged organisationIt usually involves the two existing businesses surrenderingindependence, shareholders exchanging their existing sharesfor shares in the merged company and the new businesstaking on a new identity

Acquisition One rm (the acquirer) purchasing and absorbing theoperations of another (the acquired) The purchase of a controlling interest in another rm

The acquired business becomes either a subsidiary of or fullyabsorbed by the other The word takeover means the same as acquisition althoughthe rem is often used in the case of a hostile takeover A hostile takeover is made agains the advice andrecommendations of the directors of the company being takenover

Reasons for making an acquisitionTo gain economies of larger scaleTo acquire intangible assets (patents, trade marks, brands)To acquire assets that can be protably sold off (a practiceknown as asset stripping)To secure access to suppliers of distribution channels To spread risks by diversifyingTo increase market shareTo reduce competition in the market To overcome barriers to entry to new marketsTo defend itself agains a takeover threat

To buy-in a new product rangeTo eliminate competitionTo acquire skills, knowledge, competency

SynergySynergy occurs when the combined results produce a betterrate of return than would be achieved by using the sameresources independentlyThe benets of combining exceed the aggregate i.e. 2+2=5Synergy is an example of the whole is greater than the sum ofits parts Synergy is any unrealised potential open to a group frommixing and matching resources betterThe resulting rm is more efcient and effective than theaggregate of the previous rms

Acquisitions usually fall The results of external growth are often disappointing- in factexternal growth is notoriously difcult to achieve successfully At least 50% of all mergers and acquisitions fail to add valueto the existing rms The benets of synergy are often elusive. Rather thanperforming better than the previously independent enterprisesit is quite common for the enlarged company to perform lesswell than prior to acquisition or mergerPorter found that in a study he undertook 53% of relatedacquisitions were soon followed by divestment (selling off).

The gure rose to 74% in the case of unrelated acquisitions Reasons for failure of acquisitionsCultural incompatibilityLack of communicationLoss of key personnelPrice paid for acquisition was too high Lack of research prior to acquisitionPersonnel ambition over-ruled businessIncreased bureaucracyThe creation of a lumbering giant that is soon outpaced bysmaller rivals Many “mergers fail because the new company’s managementunderestimated, ignoring or mishandled the integration tasks”

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Impact of competition legislation in the UK Monopolies are considered to be against the interests ofconsumers Competition legislation seeks to ensure that rms with a largemarkets share do not abuse their positionA dominant rm is one with a 25% (or greater) market share The commission can rule agains a merger or, alternatively,impose conditions

Ansoff’s Growth Matrix Ansoff identied four growth strategies which are in order ofincreasing risk: Market penetration- selling more of the same product to thesame type of customerMarket development- selling the existing product to a newtype of customerProduct development- selling new products to existingcustomersDiversication- selling new products to new customers

Directions of growth Related growth The joining of rms in the same industryVertical integration: different stage in production chainHorizontal integration: same stage in the production chainDiversicationJoining together of two forms in different industries Centric diversication- linked by some feature in commonsuch as transferable skills Conglomerate diversication: where there is no obvious risk

Alternatives to organic and external growthConsortia- formal agreement between companies tocollaborateJoint venture with another rmLicensing- allowing other rms to produce goods Franchising- allows the franchisee to undertake part of thebusinessSub-contracting/outsourcing non-core activities

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Greggs and Growth Suitability of the growth options

The options can be assessed against three key criteria: Suitability: - does the chosen strategy:

– Build on strengths and/or solve weaknesses? # – Exploit opportunities and/or respond to potential threats? –Satisfy the goals and objectives of the business? #

– Fit the culture of the business? Acceptability:

– Depends on the views of the key stakeholders # – What level of risk does the business want to take? Feasibility:

– What resources are available to support the strategy? (e.g.nance, experience; management resources)

Strategic Option: Organic Growth Suitability Fits well with existing strategy and objective of store roll outs "Greggs has considerable experience of this approach #

Good t with the corporate growth objectives Acceptability Enables Greggs to protect and develop its USP #Low risk because this is core business – more of the same "Could be considered as an essential strategy Feasibility A favourable option, but the market remains competitive Probably possible to nance this option using internal nance(as they have done up to now)

Strategic Option: Growth by Acquisition Suitability Limited previous experience of growth by acquisition butLogical to expand through horizontal integration in this market Acceptability Shareholders might be supportive if the right opportunityarises #Medium to high risk because acquisitions and the anticipatedsynergies are hard to deliver in practice Feasibility Would require an integration strategy #Would require signicant capital to purchase the competitor,but Greggs does have a strong balance sheet and low gearing Could work if they bought a regional bakery to plug some ofthe current gaps in UK coverage

Strategic Option: Product development of a Coffee Chain Suitability Supports the corporate growth objective #Builds upon Greggs’ current strengths at extending theirproduct lines with low prices Would need to be certain that competitors did not havesomething better, but it may well become essential in thismarket in the future to adopt this strategy in order to ourish Acceptability Low/Medium risk this is new ground for Greggs, but manycompetitors already have coffee shop formats Feasibility Greggs can move into this product space quite quickly

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Some more work may be required to set up the distributionand delivery networks and to integrate it within their corebusiness

Strategic Option: Market Development at Transport Hubs Suitability There probably are gaps in the market in new territories,especially for “food on the go” The strategy is a good t with their growth objective and it hassynergies with the local bakery proposition Acceptability Greggs is very experienced at developing new markets #Low/Medium risk with the prospect of good returns for earlysuccess Feasibility Financial investment is probably available for a phasedexpansion into new territories from internal nance becausethe Balance Sheet is strong Requires signicant up front work building joint ventures and

local partnerships /franchises with companies such as Moto

Strategic Option: Diversication into Wholesale FrozenFood at home and abroad Suitability Greggs has some experience of the frozen food sectorthrough its arrangements with Iceland Plays to Greggs’ strengths as a food manufacturerGreggs does not have an international business model at themoment

Acceptability Acceptable in the medium term, so long as it does not meantaking their eye off the ball in the core retail bakery market Medium risk, returns may be tight in a wholesale environment" International option is high risk and may be a 10-20 yearplay Feasibility Sensible level of nancial investment required

-Organic growth, continue with their expansion plan onreaching new places in the UK as its a more secure as theyalready know the UK market due to their experience and theirbrand is already known, therefore no massive advertisement . -Also another option thats appropriate for Greggs is themovement into transport hubs and business parks because itsstill UK and they would need to operate in the same way,more applicable to their “food on the go” business model-Continue with their diversication plans in Iceland andfranchise with Motto

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Rivalry of Industry Competitors (High)• Fragmented market with many large

and small players• Intense competition between brands

• Short product life cycles• Reasonably easy to launch new

product lines

Threats of Substitution (Low/Medium)• Bread is the UK staple diet, but• Potatoes, rice and cereals could become more

popular if wheat prices keep rising• Growth of ‘bake at home’ market to save money

Threat of New Entrants (Medium/High)• Entry costs are quite low• It is expensive to build a brand, but brands

are not essential in baking, nor areeconomies of scale

• Companies who can compete on very

healthy eating or niche dieting positionscould do well

• Customer Power (High)• Very easy to switch brands• Market is price sensitive• Customers can determine

market trends

Supplier Power (Low)• Numerous, diluted suppliers• Suppliers sell commodities

(wheat, dough)• Relatively easy for Retailers

to switch suppliers if theywant to

unit 3 revision business studies

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