Chapter (6) Accounting and Finance

Financial accounting
Accountant record financial transactions
Professionally responsible keeping accurate accounts
Qualified people for prepared Financial Statement

1)Income statement 2) Statement of Financial Position 3) Cash Flow Statement 4) Ratio

(Trading, Profit and (Balance Sheet)
Loss account)

Show Show Show

Profit/ loss Asset/ liabilities/ Equity Actual cash rec &paid
(Own and Owe )
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1)Income statement (Trading Profit and Loss Account ---- show Profit / Loss)
Def
a document that records the income of a business and all cost incurred (expenditure) to earn
that income over a period of time (eg 1year = 12 months)
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Income statement
Sales Revenue --- (Price X Quantity ) Income received from sales of g&s
Less, Cost of sales --- (Op inv + Pur - Cl inv) --- Cost of producing or buying of g&s

Gross profit --- sales revenue > cost of sales

Add, Other income --- eg rent received, interest received, commission received
Less, Other expenses (Overhead) --- eg rental charges, wages & salaries, electricity
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Operating profit --- TR less all cost or subtracting OH cost from GP
Less, Interest (finance charges) --- Cost of borrowed money
Less, Taxation (Corporation tax)
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Net profit after tax (PAT)(Profit after tax )
Less, dividend --- a payment, out of profits, to shareholders as reward for their investment
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Retained profit/earning ---profit kept in the firm after owners have taken their share of profit
(paying out dividend)

Advantages of using Income statement (Show) (Usefulness)

1) show how much profit is being made (show the profitability of the business) ----owner – see
--- return on their investment / possibility of RE for investment / measure the success of the
business – if the profit high --- symptom of success of the business
2)show how much revenue is being made --- if sales low --- can consider ways to increase sales
3 show how much expenses is being incurred (show whether expenses are being kept under
control) --- if cost (expenditure) too high --- can reduce unnecessary expenses.
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Profit is used to (Advantages of profit) (Importance of Profit) (benefits of RP)

1)For expansion of the business---- get profit --- can reinvestment for expansion --- finance
purchase of NCA (no need to pay interest) ----- Can expend --- become larger --- gain EOS ---
average cost decline ---- P or P
2)Reinvest in Research and Development (R &D )--- innovation --- customer satisfaction ---
loyalty ---- word of mouth advertising ----- improve image and reputation
3)can Attract the investors---- if high profit --- willing to invest --- can get additional funds ---
more investment --- become larger.
Can Pay more dividend --- happy shareholder --- want to invest --- so can attract the investors4
4) can measure the success of the business --- if get high profit --- success

Ways to improve Profit / Profitability (Sales - Cost = Profit )

1)encourage sales ---- reduce the price --- willingness to buy and ability to pay increased ---
Sales and profit will be increased
2)Reduce the cost ---reduce purchase cost --- care purchasing --- cost will decline --- can get
more profit
OR
OH expenditure --- reduce unnecessary expenditure ---- cost will decline --- can get more profit
3)Invest in new technology (machine ) --- increase in Output and productivity --- gain EOS ---
Average cost decline --- can get more profit
OR
improve quality--- customer satisfaction ---- word of mouth advertising ---- more reliable for
potential customers ---- customer loyalty --- sales and profit will be increased
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High revenue lead to
(+) Have more customer --- TR increased --- increased in Profit
(-)If credit sales --- possibility of BD (Bad Debts) increased --- loss --- increased in cost --- less
profit
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Possible causes (Reasons) for fall in Profit ( Sales - Cost = Profit )
1)decline in Sales --- may be country face with recession
2)increased in Cost --- may be due to increase in Purchase cost
3)increased in Cost --- may be due to increase in overhead expenditure
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Ways to reduce cost of sales.

For factory For Trading business

1)reduce material cost --- cheap RM 1) reduce purchase cost of FG
2)reduce labour cost --- low skilled labour or improve efficiency

2)Balance sheets (Statement of financial position)

A document which show the value of a business’s Assets (Own) and Liabilities and Owner’s
Equity (Owe to) at a particular time. (date)

Balance sheet (Format)

(I)Assets 1) Non-current asset
2)Current asset

(II)Liabilities 1) Non-current liabilities

2)Current liabilities

(III)Owner’s equity (Capital)

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Asset
Own by the business.

Non-current asset (NCA) (Fixed assets)

Own by the business.
Held more than one year (> 1 yr) and for use
Eg land and buildings. Fixture and fitting (furniture) , Plant and machinery, Computer.

Current asset
Own by the business.
Held less than one year.
Include - Inventory. Trade receivable (Debtor). Bank. Cash

Inventory
Good for resales. may be Raw material, Work in Progress, Finished goods

Trade receivable (Credit customer = Debtor = TR)

Value of payments to be received from the customers who have bought goods on credit.
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Liabilities
Owe to others

Non-current liabilities
Owe to others. Repayable more than 1 year.
eg Bank Loan, Mortgage, Debenture (Plc)

Current –liabilities
Owe to others. Repayable within one year.
Include Trade payable (Creditors) , Bank overdraft, Accrued expense

Trade payable (Credit supplier = Creditors = TP)

Value of debts for goods bought on credit payable to supplier.
Owner’s equity (Capital)
Owe to Owner (company --- Shareholder)
for company include -- Share capital, Retained earning
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Share capital
Total value of capital raised from shareholder by issue of shares.

Retained earning
profit kept in the firm after owners have taken their share of profit

Usefulness (advantages of Balance sheet)

1)Indicate what the business is worth --- seeing NCA --- known worth of the Firm
2)What the business is owed and owed ---- seeing CA and CL – short term owns and owe to
3)How the business finance its activities ----- own capital (Equity )or loan capital (NCL )

Working capital
Current asset -- Current liabilities = Net current assets (Working Capital)
The capital available to a business in the short term (to pay for day to day expenses)
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Working capital cycle
the movement of “cash and other liquid resources “into and out of the business
Include
Inventories purchased on credit, Production of g&s, goods sold to customer on credit. Cash
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Working capital management
Days eg now
1)Stock holding days xx 7days 5 days
2)(+) TR collection days xx 10 days 7 days
3)(+) Processing days xx 6 days 5 days
4)(–) TP payment days (xx) (8 days) (10 days)
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Working Capital (days) xx 15 days 7 days
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*** Working capital day high (days – longer) , the business may be in trouble.
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Way to improve WC (Ways to reduce WC days)
1)Reducing the inventory levels ---- use JIT
2)Reducing the amount of time taken from customer --- provide cash discount (settlement
discount )
3)Reduce processing day --- use new technology – quicker
4)Negotiating longer credit terms with its suppliers. ---- will extend the credit period

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Usefulness (advantages) (reasons why WC is importance)
1)Inventory should not over and under --- If over ---- later may be damage / out of date or
If under---- stock out cost --- dissatisfaction
2)Can pay Current Liabilities on time --- if not enough money ---- business can raise the finance
in advance --- can reduce the financial difficulty
3)Can take advantages of special offers from supplier --- this can reduce of material --- P or P
4)Cover unexpected cost.

Ratios (Formula) measure the financial performance of the business

(i)Profitability ratios
1)Gross profit margin (GPM) = ( Gross profit ÷ Sales Revenue )x100 = %

2)Net profit margin (NPM) = (Net profit ÷ Sales Revenue )x100 = %

3)Return on Capital employed = (Net profit ÷ Capital Employed) x100 =%

Comment
Increased --- show better performance
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(ii)Short-term solvency (liquidity) ratio
1)Current ratio = (Current assets ÷ Current Liabilities) = xx : 1

2)Quick ratio = (Current assets - Inventory) ÷ Current Liabilities = xx : 1

(Acid test ratio)

Comment
If Ans > 1 --- Business can pay its current debts on time. No financial difficulties
If Ans < 1 --- Business cannot pay its current debts on time.
Therefore, damage image and reputation.
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(iii) Long term solvency ratio
Gearing ratio = (Long term Debts ÷ Equity) x 100 = %

Comment
If Ans > 50% --- high geared. Difficult to obtain further loan.
need to pay more Interest which is expenses for the business
there may be financial difficulties.
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Recommendation
In conclusion, to gain more accurate decision more information will be needed.

Benefits of ratio analysis (reason to measure the performance of the business)

1)Can compare the result ---- similar business or previous year and this year --- help to provide
financial decision.
2)Can make investment decision -- Can easily identify important information, profitability and
liquidity
3)Measure the performance of the business

Limitation
1)ratios are past data --- difficult to estimate the future which is more important than past
2)Do not include all (non-financial) the strength and weakness of the business--- eg quality
and skills of employee
3)Not include the external factors ---eg legislation, exchange rate (PEST)

Income statement Statement of Financial Position

Sales/ Revenue Non-current Assets
Less, Cost of sales
Gross profit
Add, Income
Less, Operating Expenses
Operating profit
Less, finance charges Current assets
Less, Taxation Inventory
Net profit for the year TR
Less, Dividend Cash & Bank
Retained earning
Opening Retained profit Financed by
Closing Retained Profit Share Capital
Retained earning

Non-current Liabilities
Loan/ Debenture

Current Liabilities
TP
Bank Overdraft
Accrued expenses

Working capital = Net current Asset = Current Asset - Current liabilities

Stakeholder
A person or group of people who interested in the activities of the business
User of the Income statements (the usefulness of profit data to stakeholders.)

1)Owners /Shareholders
Profit after tax belongs to the owner/ shareholders. They can see how much they have earned for
their investment in the business.
Shareholders (Investors)
Want to know how big a profit or loss the firm makes. Know success of the business
Wants to know if the business is worth more at the end of the year than it was at the beginning.
Usually the higher the profit the higher the dividend payments which is return on their
investment.
Future growth of the business --- worth increased.
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2)Employees
High profit increases job security
Employees might expect to receive a good pay (wages and salaries) rise if a business making
good levels of profit.
Some business has profit-sharing schemes, so high profits means high share of profit for
employees.
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3)Lenders (Bank)
They want to be sure that profit is enough to pay interest on loans (afford to pay them back)
Is the business earring enough profit to be able to repay loan when due?
To sees whether business has enough security
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4)Government
The higher the profit the more tax the government will receive. --- Gov can spend more on I/H/E
--- improve country’s status .
The job opportunities for workers. (likely to expand and create more jobs)
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5)Supplier
A firm that is profitable will continue to purchase raw material and other suppliers. This helps
suppliers to earn profits.
To see if the business is secure and liquid enough to pay off its debts
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Manager
They can compare profit from one year to the next, or with competitor’s profits,
to measure the performance of the business.
Use for taking decision and controlling the operation of a business.
To find out how the average wage in the business compares with the salaries of directors.
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Competitors
Considering a bid to take over the firm
To compare the performance of their business.
Local community
To see if the business is profitable and likely to expand, which could be good for the local
economy.
To determine whether the business is making losses and whether this could lead to closure.
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Customers
To assess whether the business is secure
To determine whether they will be assured of future supplies of the goods they are purchasing
To establish whether there will be security of spare parts and service facilities.
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User of Balance sheet
1)Shareholder / Owner
Seeing NCA (Land and building) ---- worth of the business

2)Manager
Seeing CA and CL and NCL --- to control the business (loan)

3)Bank (Lender)
Seeing NCA --- enough security

Cash flow
Cash flow
The flow of money into and out of a business
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Financial budget
A plan showing future financial target.
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Cash flow forecast (Cash budget)
the Prediction of all expected receipts and Payment for expenses of a business over a future
time period which shows the expected cash balance at the end of each month.
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Cash budget (format) P1 P2 P3 P4

Cash inflow (total)
(-) Cash out flow (total)
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Net cash in/(out)flow
(+) Opening bank balance
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Closing bank balance

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New cash flow
Cash inflow - Cash outflow = Net cash flow
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Identify two stages in the cash flow cycle
- Cash need to pay for material and labour
- Goods purchase / goods sold / cash payment received for goods sold
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Cash flow forecast (Advantages) (usefulness)
1)can identify cash shortage --- help to identify in advance when a business might need to
borrow cash.
2)Monitoring the cash flow ---- can find out where problem have occurred. eg cash required to
purchase good or to purchase NCA (Plant and machinery) --- can find how to solve that problem.
3)Supporting application for funding --- potential lenders (eg Bank) may demand the CFF and
help when planning the business
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Reason why CFF might not be accurate (limitation)

1)depend on the qualification and experience (ability) of budget holder ---- if no/little ability ---
not useful ---- waste of time to preparation of CFF
2)It is estimation only --- there may be unexpected cash in and out flow.

CFF show
1)cash position
2)ability to cover expenses for expansion
3)Liquidity position
5)ability to pay interest and repayment of loan.
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Difference between profit and cash

Some of these differences between cash and profit include:
- Money invested in a business, or borrowed by a business, increases cash but does not
increase profit
- Capital expenditure, such as buying a new machine, decreases cash but does not decrease
profit
- Sales of goods on credit are recorded in the income statement as soon as the goods have
been sold. This increases profit but cash does not increase until the buyer pays for the
goods.
Profit Cash
Sold goods on credit incre -
Purchase of goods on credit decre: -
Purchase of fixed assets on cash - decre:
Put cash into the business - incre:

Cash importance for Short term survival

Profit importance --- reinvest for expansion --- Long term expansion
Both

Financing

Why business need money (importance of cash) Causes (Reasons) of CF problem

1)Fall in sales --- slowing paying customers/ new competitors --- cash receive delay --- occur
CF problem
2)Sudden increase in order--- increase in expenditure on RM and Lab --- high capital
investment --- occur CF Problem
3)Increase in interest rate on loan --- need to pay interest more (interest – cost for firms) ---
face with financial difficulties
4)To start the business ----- need to purchase NCA (eg P&M, MV etc) and required for
Working Capital
5)Face with financial difficulties – eg compensation to customer / employee
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Solutions of CF problems
1)owner put additional capital or issue of share
2)make loan or OD
3)encourage sales --- reduce the price ---- willingness to buy and ability to pay increased
4)reduce unnecessary expenditure --- by using lean production --- JIT --- can reduce holding
cost
5)Trade credit
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Types of Expenditure

1)Capital expenditure 2) Revenue expenditure

Money spend on purchase of NCA Money spend on day to day running of the business
One off expenditure eg to pay W&S, electricity
Show at BS show at IS under Expenses
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Source of finance
1)Internal ---- RE, sales of NCA, running down stock, Owner saving
2)External --- Short term --- Trade credit, OD, Operating lease
Long term --- Loan, issue of share, Finance lease, Hire purchase
For SME --- Microfinance
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(I)Internal source of finance
Money received from inside the organization.
Include
a) Owner saving or RE
b) sales of NCA
c)running down stock (inventory)
(+) no need to pay interest --- no cost of borrowed money --- P or P
( +) no repayment --- no maturity date --- cannot face with financial difficulties
TYPES of Internal source of finance

a) Owner saving
Put more of the saving into the unincorporated business (sole trader / partnership)
(+) No interest is paid --- less cost of borrowed money --- P or P
(+) Available quickly --- less time ---- can gain competitive advantages

(-) Saving may be too low --- not enough for requirement --- delay expansion
(-) Increase the risk by owner ---- unlimited liability
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a) Retained earnings / profit

Profit kept in the business (Company) after owners (Shareholders) have taken their share
of profit.
(+) no need to pay interest
(+) no need to repayment back --- reduce the risk of financial difficulty at maturity date

(- ) for new business ---- not enough profit to retain --- delay expansion
(- ) for SME --- profit too low for expansion needed
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b) Sales of existing assets

Sold of the assets which are no longer required by the business

(+) No interest paid and do not have to borrow any money
(+) Better use of capital tied up --- idle assets --- sold--- get money --- can use at other purpose
--- so efficient use of money.

( -) Time taken to sell---- so, it is not suitable for immediate cash requirement.
( -) no spare Assets ---- May not have any spare asset to sell and bad for new business
(-) May not raise enough money --- if AS value --- too low
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c)Running down stocks(Inventory) to raise cash

Keep lessen the stock

(+) Reduce opportunity cost ---- Firm less investment in stock --- so, extra money --- can spend
for other purpose
(+) Reduce storage cost --- P or P

(-) Not enough goods are kept in stock --- customer dissatisfaction --- damage image &
reputation

(II)External source of finance

Money received from outside the organization.
There are two types ---- Short term ---- Trade credit. OD . OL
Long term
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TYPES of Short term source of finance
a) Trade credit

Purchase goods (Inventory) from suppliers on credit.

(+) cheapest source for finance ---- good taken by firm but no immediate cash payment.
These money can spend for other purpose

(-) Lead to bad relationship ---- if late payment --- bad relationship with supplier ---- damage
image and reputation.
(-) Will demand payment on delivery ---- in serious case supplier will demand payment on
delivery.
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b) Overdraft
An agreement with the bank which allows a business to spend more money than they have in
its account up to an agreed limit.

(+)Not require security --- if business has not enough security --- suitable
(+) Interest have to pay on overdraft ---- amount of interest may be lower ---- cost of borrowed
money – lower ---- P or P

( -) Repayable on demand ---- if business cannot pay on time --- damage image and reputation.
(-) interest rate may be varying day to day---- difficult to plan(budget) for.
(- )High rate of interest

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c)Operating Lease (short term lease)

Obtaining the use of asset (equipment) by paying a fixed amount per time for a fixed
period of time.
(+) Only monthly payment --- (rental charges) --- amount required for rent may be lower --- can
reduce financial difficulties.
(+) Do not have to find all the money --- only have to pay rental charges which is low ---
affordable for firm.

(-) Never ownership ----the asset is not owned by the business and at the end of the lease term it
can give the equipment back to the leasing firm.
(-) More expensive than buying right.
TYPES of Long -term source of finance

a) Finance Lease (long term lease)

Obtaining the use of asset (equipment) by paying a fixed amount per time for a fixed
period of time.
(+) Only monthly payment --- (rental charges) --- amount required may be lower --- can reduce
financial difficulties.
(+) Repairs made for them. -- In finance lease --- lessor will incurred the repair and
maintenance expenditure ---- cost may be lower ---- P or P
(+) effective use of Cash --- if the equipment --- easy to become out of date --- lease the asset is
better option.

(-) Never ownership ----the asset is not owned by the business and at the end of the lease term it
can give the equipment back to the leasing firm.
(-) More expensive than buying right.
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b) Issue of shares
Sold (issue) share to friends and relatives (for Ltd)
Sold (issue) share to general public (for plc)

(+) Raise additional capital (more capital) --- can get large amount of money --- more
investment ---- can expand --- become larger
(+) No need to pay interest --- only have to pay dividend when the business get profit ---- less
risk (burden)
(+) Additional expertise in business and less risk
(+) No need to repayment and security

(- ) Have to pay out dividend --- each individual can get low amount of return.
(-) Dilution of control ---- number of owners (shareholder) high --- loss of control for existing
owner.

Factor to be consider before issue of shares

1)Dilution of control --- number of owners (shareholder) high --- loss of control for existing
owner.
2)Share issue (sell) cost --- if share issue high ---- less profit.
3) Have to pay out dividend --- each individual (shareholder ) can get low amount of return.

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Right issue
Existing shareholders are given the right to buy additional shares at a discounted price.
(sold shares to existing shareholders at below market price.)
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c)Loan
Provision of finance by a bank which the business will repay with interest over an agreed
period of time.

Debenture (Plc)
Issue by Public limited company (Plc ) to public.
(+) Paid back in fixed installments --- Payment for each installment lower ---- business
affordable
(+) Fixed rate of interest --- by comparing with OD , pay fixed interest rate so, can budget for it

(-) High rate of interest paid --- it is expense for business --- lower profit
(-) Loan repayment at maturity date --- financial difficulties may occur and damage image and
reputation.
(-) for SME, difficult to obtain bank loans --- may not have enough security
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d)Hire purchase (HP)
The purchase of an assets by paying a fixed repayment amount per time period over an
agreed period of time.

(+) become ownership ---- the asset is owned by the purchasing firm on completion of the final
repayment.
(-) expensive ------ because interest charges may be high --- cost high ---- can get lower profit

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Bank loan Overdraft

1)Fixed maturity date Repayable on demand
2)Require security no need --- security
3)Amount high Amount low
4)Fixed interest rate Vary day to day.

Source of finance for SME (small and medium enterprise) (eg street vendor)

1)Microfinance {Micro credit}

(Professor Muhammad Yunus, founder and Managing Director of Grameen Bank)
Def: Providing financial services - including small loan - to poor people not served by
traditional banks. (Use in low income countries)

Features
Small amounts of capital loaned to entrepreneurs who are come from poor background
so, do not have any savings or loan received from family or friends.
These loans are usually repaid after a relatively short period of time. (Within 6 months to a
year)
Once the loan has been repaid it then becomes available to other borrowers.
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2)Crowd funding
Asking a large number of people each for a small amount of money to raise finance for a
project.
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Choice of the method of finance is depend on
1)purpose and time period
2)amount needed --- money required for capital expenditure (to purchase Plant and machinery)
--- Amount require high --- should use internal or external (long term) source of finance.
3)Status and size of the business --- if SME --- limited source of finance will be available.
4)financial situation (risk) of the business --- if high geared ---- more collateral will be required.

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Factors to be consider before invest or make loan

1)Bank will demand Forecasted IS --- def
Forecasted BS (statement of financial position) --- def
CF forecast --- def
Business Plan ---- def
Reason for required loan
Gearing ratio

2)Shareholder Forecasted IS
 Forecasted BS (statement of financial position)

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Business plan
A detailed document giving evidence about a new or existing business, and aims to convince
external lenders and investors to extend finance to the business.

Adv
1)can compare --- Plan // Actual result --- deviation --- can correct immediately --- risk may be
lower

Disadv
1)Forecasting only --- there may be unexpected events.
2) depend on ability of the planner

Business costs and revenue (use for Manufacturing Business)

1) Total Revenue - Total Cost = Profit

2) Selling Price X Quantity = Total Revenue

3) a) Total Cost per unit X Quantity = Total Cost

b) Direct cost + Indirect = Total Cost
c)Variable costs + Fixed costs = Total Cost
4) Average cost = Total cost
(TC per unit) Quantity

Direct cost (Prime costs)

Cost that can be directly related to a particular product
Direct material + Direct labour = Direct costs (Prime costs)
(Major RM) (Hand on labour)

Indirect cost (Overhead)

Cost which cannot be directly related to a particular product.
Indirect material + Indirect labour + Indirect expenses = Indirect costs (Overhead)
(minor RM) (Hand off labour )

Variable costs (Variable behavior cost)

Cost which vary with the number of items sold or produced
All direct cost is variable cost.
Eg DM. DL

Fixed costs (Fixed behavior cost)

Cost which do not vary with the number of items sold or produced
All fixed cost is overhead.
Eg supervisor salary. Rent

Marginal cost
Extra direct cost of making an additional unit

Cost effective
Return on money spend is high enough to justify the spending.

An efficient business
To achieve objective in a cost-effective manner.

Ways to reduce Average cost

1)use cheap RM --- cost of production / but low quality
2)use division of labour and specialization

Reasons for important to know the cost of the business

1)To calculate selling price and profit
2)To compare with other product cost

5)Profit =?
TR - Variable cost = Contribution - Fixed cost = Profit
(P xQty) (VC per unit x Qty) (Q)

6)Break-even level of production = Total Fixed cost (Q)

Contribution per unit

Contribution per unit = Selling price – VC per unit

(DM + DL )

Break - even point of production (BE level of output)

The level of output at which Total costs equal Total revenue
Business has neither a profit nor a loss is made.

7)Marginal of safety = Current level of output (Q) - Bread-even level of output.

The amount by which the sales level exceeds the break-even level of output.

Break-even chart at ZERO unit at Que given unit

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1)Sales (s.p x Qty)
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2)Variable cost (V.C per unit X Qty)
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3)Fixed cost
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4)Total cost (VC + FC)
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Three examples of uses of the break-even chart

1)A marketing decision
2)An operations- management decision
3)Choosing between two locations for a new factory.

Advantages of Break- Even chart

1)Shows the level of output needed to break-even i.e minimum amount of product sold to just
cover cost.
2)Shows the margin of safety --- target amount to ensure a loss is not made.
3)easy to construct and interpret ---- allows comparisons to be made between different price and
cost levels.
4)use to assess the effect of decisions, eg selecting most profitable location.
5)Can monitor the business and can show if it need to do something to stimulate sale.

Limitation of Break – even chart

1)Assumes no stock held ---- in practice, production unit is not equal to sales uints
2)Lines used are assumed to be straight – bulk --- discount and long run --- labour may be
increase in motivation or decrease in efficiency
3)Costs are not necessarily constant, eg if the firm expands the scale of operation

Economies and diseconomies of scale

Economies of scale
Situation at which Falling average costs due to expansion.

Minimum efficient scale (MES)

The plant size which minimizes a firm’s average costs.

Diseconomies of scale
Situation at which Rising average costs when a firm become too big.
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Internal economies of scale (MRT PMF)
The cost benefits that an individual firm can enjoy when it expands.

Reasons
1)Purchasing economies ***
become larger ---- Bulk purchasing ---- can get cheap price --- reduce the Average cost decline.
2)Marketing economies
Become larger --- own fleet of delivery vehicles --- so cost effective
3)Technology economies ***
Become larger --- can buy Larger plant ---- increased in Output/ productivity --- more efficient
than smaller one
4)Financial economies
Large businesses have larger variety of source of finance --- cost of capital lower
5)Managerial economies ***
Large business Afford to appoint specialist manager --- increased in efficiency and
effectiveness / lower loss or wastage
6)Risk-bearing economies
Large business have wider range of product and wider variety of market --- lower risk of failure
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External economies of scale
The cost benefits that all firms in the industry can enjoy when the industry expends. (growths).

Reasons
1)Skilled labour --- pool of skilled unemployed --- reduce training cost & wages
2)Infrastructure --- Gov provide infrastructure (Road / Bridge) --- no need to incurred
3)Ancillary and commercial services eg Bank , Insurance
4)Co-operation
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Advantages of economies of scale (gain EOS --- Consequences)

1)increased in Profit ---- Average cost may be decline ----- profit increased --- reinvest in R&D
--- innovation increase ---- more customer choice – improve image
2)more competitive ---- Average cost may be decline – can reduce the price --- can charge
competitive price --- can get more customers / sales
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Diseconomies of scale (disadvantages of EOS)

Reason
1)bureaucracy ----- bounded by rules and regulation --- strict --- inflexible ---time taken
to fill the forms and write the reports --- cost will be increased
2)labour relation ---- bounded by rules and regulation ---- lack of empathy ---- conflict between
employees ---- demotivation--- increased Labour turnover and absenteeism
3)control and co-ordination
number of employees ---
billions of $ high ---so, difficult to control--- wastage --- loss/ cost increased
dozens of plants

Growth of firms (Expansion of the business)

Method of growth (Ways)

(1) Internal growth (Organic growth)
Growth achieved through the expansion of current business activities
Eg
Increasing the output
selling more in its existing markets or new markets

(2) External growth

Growth achieved by mean of Takeover or Merger

a) Takeover or acquisition
The purchase of one business by another
b) Merger or integration
The joining together of two or more business, usually to make one new one.
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Method of integration (Takeover)
(a)Horizontal integration
The merging of two firms which are in exactly the same line of business.
(i.e same industry and at the same stage of production)

(b)Vertical integration
Merging with a firm that operate in a different stage of production

There are two types

(i)Backward vertical integration
Merging with a firm that operates in the previous stage of production
Eg petroleum company joining forces with an oil exploration company

(ii)Forward vertical integration

merging with a firm that operates in the next stage of production.
Eg Petroleum company joining forces with a chain of petrol retailers.

(c) Conglomerate or diversifying merger

The merging of two firms which are in different industry and different stage of production.
(i.e different industry and at the different stage of production)
Eg
mining and hospital

Motives for growth (advantages of growth)

1)To increase market share ---- become larger --- sales increased --- Increase profit
2)To attain Economies of scales --- become larger --- output increased --- average cost decline –
can get more Profit or can reduce the Price --- more competitive
3)Reduce risks of failure --- sell at many market / produce wide range of produce --- risk
diversification.
4)Survival
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Limiting to growth (Reason for not growing )
1)Limited market (niche market) ---- limited by size of market --- number of customer is low
2)Aim of the entrepreneur --- some owner is not motivated by growth – wants completely
control over the business
3)Low Barriers to entry --- Some market, the set-up costs are relatively low. So, little to
discourage new entrants joining the market. So, high level of competition
4)face with Diseconomies of scale
5) Lack of finance

Internal growth (expand --- Current operating activity)

Advantages
1)Set up business to own preferences --- choose the employee/ choose the location/ opening
hour
2)Can keep all the profit --- amount of profit high --- reinvest --- wealth creation.
3)More control over the operation --- get more satisfaction for owner

Disadvantages
1)Capital required ---- face financial difficulties
2)Time and advertising costs ----- need to build up customer bored.

External growth
Advantages
1)Save time and less expenditure on advertising
2)Already established business --- more customer and goodwill
3)More ideas --- innovation / creativity increased --- satisfaction

Disadvantages
1)Expensive --- for takeover
2)Inconsistency and possible redundancies for duplicated works
3)Poor reputation --- own business image – damage
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Takeover (acquisition)
(1) For firm
Advantages
1)Gain EOS --- become larger --- output increased --- average cost decline ---- P or P
2)more ideas --- innovation / creativity increased ---- can provide more service --- satisfaction ---
improve image and reputation
3)More Market share --- sales increased ----can get more profit --- reinvest for expansion /
R& D
4)Gain brand name of rival --- less competitive ---- become monopoly

Disadvantages
1)Management issued (inconsistency) --- conflict --- lead to failure / more risk
2)Dis EOS
3)poor reputation of business being take over.
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(2) for employees
(+) job prospects may be increase ---- chance of promotion increased (for skilled labour)
(-) unemployment increased --- short run --- job security may be decrease (possible of
redundancies)
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(3) For management
(+) position and status may be increase
(+) prestige may be increase
(-) complexity in work --- more stress
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(4) For government
(+) increase tax --- can spend more on I/ H/E --- country status improved
(+) Job creation --- people income increased --- D for g&s increased --- need to produce more
--- GDP increased --- can gain economic growth / Poverty reduce / unemployment decline
(-) less competition ---- monopoly --- DIS ADV
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5)For consumer
Effect on price and choice

Advantages and disadvantages of large and small firm

The size of a firm can be measured by

1)Output (manufacturing) and turnover (sales) (Retail) --- if output high --- seen as large firm
2)Number of employees --- mostly use in labour intensive business --- if number of employee
high --- seen as large business
3)The amount of capital employed (used) --- if small amount of investment --- seen as small
business
4)Quantity of customer

Small firms
Advantages
1)Flexibility --- easy to change --- better understanding of customers’ needs and wants ---
customer satisfaction --- image and reputation improved.
2)can provide Personal service --- eg credit / free delivery ---- customer satisfaction
3)Better communication --- better customer relationship --- complaint --- immediate response
Disadvantages
1)Lack of finance ---- limited source of finance --- delay expansion
2)Give up managerial EOS ---- Difficult attracting right staff
3)Vulnerability ---- more difficult to survive than large firms

Large firms
Advantages
1)Economies of scale
Purchasing EOS – need to buy in bulk --- get discount ---- cost decline --- P or P
Technical EOS --- can buy large machine --- increased efficiency and effectiveness
2)Market domination --- market leader ---- increased in sales / profit --- reinvest for expansion /
R&D

Disadvantages
1)Diseconomies of scale
Bureaucracy ---- need to set R and R --- not flexible --- high paper work --- time and cost high
Difficult to control --- too many Plant, labour , money --- difficult to control ---- wastage
increased ---- cost will be increased

Reason why firms differ in size

1)different in capital investment
2)depend on market --- niche / mass
3)need for personal services

Judging success

Measures of success of the business

1)Profit --- if get high profit --- success
2)Size --- larger than
3)Product quality and innovation organization strive for high quality and technical excellence
4)Social responsibility organization wants to become good corporate citizens.
Carry out a social audit to judge the social impact and
ethical behavior of the business.
5)Customer satisfaction setting the target is important when judging the success of
the business. (number of complaints / Return of good)
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Social audit
The collection of information and reporting on the impact that a business has on
society and environment.
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Why might a business collapse? (shut down)
(1) People --- not have the necessary skill (Lack of skill)
Eg skill --- people management, financial management, purchasing management

(2) run out of cash (Lack of finance)

Cash shortage caused by inadequate start-up capital, taking too much business too quickly
(overtrading), poor cash flow management, non-payment by customers, unexpected expenditure

(3)A sharp fall in business

Caused by new competition, sudden changes in consumer’s tastes
a recession, poor product quality or customer service, failure to meet changing market needs.