Unit 4

Production is the effective management of resources in producing goods and services.

The operations department in a firm overlooks the production process. They must:
●​ Use the resources in a cost-effective and efficient manner
●​ Manage inventory effectively
●​ Produce the required output to meet customer demands
●​ Meet the quality standards expected by customers

Productivity

Productivity is a measure of the efficiency of inputs used in the production process over a
period of time. It is the output measured against the inputs used to produce it. The
formula is:

Businesses often measure the labour productivity to see how efficient their employees are in
producing output. The formula for it is:

Businesses look to increase productivity, as the output will increase per employee and so
the average costs of production will fall. This way, they will be able to sell more while also
being able to lower prices.

Ways to increase productivity:

●​ improving labour skills by training them so they work more productively and waste
lesser resources
●​ introducing automation (using machinery and IT equipment to control production) so
that production is faster and error-free
●​ improve employee motivation so that they will be willing to produce more and
efficiently.
●​ improved quality control and assurance systems to ensure that there are no wastage
of resources

Inventory Management
●​ Types of Inventory:
○​ Raw materials
○​ Work-in-progress (unfinished goods)
○​ Finished goods (unsold)
●​ Purpose: To meet unexpected demand.
●​ Reorder Process:
○​ Reorder when inventory reaches the reorder level to restore maximum stock.
○​ Lead time: Time taken for reordered supplies to arrive.
●​ Risks: Holding too much inventory increases maintenance costs.
 ●​ Buffer Inventory Level:
○​ Minimum stock needed to meet customer demand during lead time.
○​ Inventory reaches buffer level during lead time and rises to maximum once
reordered stock arrives.

Lean Production

Lean production refers to the various techniques a firm can adopt to reduce wastage and
increase efficiency/productivity.

The seven types of wastage that can occur in a firm:

●​ Overproduction– producing goods before they have been ordered by customers. This
results in too much output and so high inventory costs
●​ Waiting– when goods are not being moved or processed in any way, then waste is
occurring
●​ Transportation-moving goods around unnecessarily is simply wasting time. They also
risk damage during movement
●​ Unnecessary inventory-too much inventory takes up valuable space and incurs cost
●​ Motion-unnecessary moving of employees and operation of machinery is a waste of
time and cost respectively.
●​ Over-processing-using complex machinery and equipment to perform simple tasks
may be unnecessary and is a waste of time, effort and money
●​ Defects– any fault in equipment can halt production and waste valuable time. Goods
can also turn out to be faulty and need to be fixed- taking up more money and time

By avoiding such wastage, a firm can benefit in many ways

●​ less storage of raw materials, components and finished goods- less money and time
tied up in inventory
●​ quicker production of goods and services
●​ no need to repair faulty goods- leads to good customer satisfaction
●​ ultimately, costs will lower, which helps reduce prices, making the business more
competitive and earn higher profits as well

Now, how to implement lean production? The different methods are:

Kaizen (Continuous Improvement):
●​ Involves small groups of workers discussing problems and suggesting solutions.
●​ Aims to increase efficiency and reduce waste.
●​ Workers, being directly involved in production, can best identify issues.
●​ Example: Rearranging the factory floor by repositioning machinery and equipment..

Benefits:
●​ increased productivity
●​ reduced amount of space needed for production
●​ improved factory layout may allow some jobs to be combined, so freeing up
employees to do other jobs in the factory

Lean Production Methods:

●​ Just-in-Time (JIT) Inventory Control:
○​ Supplies arrive precisely when needed, eliminating inventory storage.
○​ Parts are produced just in time for the next stage, and finished goods are ready
for immediate delivery.
○​ Requires reliable suppliers and an efficient reordering system.
 ○​ Benefits:
■​ Reduces inventory holding costs.
■​ Frees up warehouse space.
■​ Immediate sale of finished goods improves cash flow.
●​ Cell Production:
○​ Divides production into self-contained units, each handling a specific part.
○​ Improves worker morale by fostering teamwork and task focus.

Methods of Production:
●​ Job Production:
○​ Products are made to order and customized (e.g., wedding cakes, tailored suits,
films).
○​ Advantages:
■​ Ideal for one-off products and personal services.
■​ Meets the exact customer requirements.
■​ Varied tasks improve worker morale.
■​ Highly flexible production method.
○​ Disadvantages:
■​ Requires skilled (and expensive) labor.
■​ Higher costs due to being labor-intensive.
■​ Production time is often long.
■​ Mistakes can be costly to fix.
■​ Specially purchased materials can increase costs.

●​ Batch Production:
○​ Produces similar products in batches (e.g., cookies, houses with the same
design).
○​ Advantages:
■​ Flexible production that can switch between products.
■​ Offers variety to both workers and consumers.
■​ Machinery breakdown in one batch does not halt other productions.
○​ Disadvantages:
■​ Moving finished and semi-finished goods can be costly.
■​ Resetting machines between batches delays production.
■​ Requires large amounts of raw materials, increasing costs.

●​ Flow Production:
○​ Produces large quantities continuously on a production line (e.g., soft drinks
factory).
○​ Advantages:
■​ High output of standardized products.
■​ Low long-term costs, enabling low prices.
■​ Benefits from economies of scale in purchasing.
■​ Automated lines can run 24/7.
■​ Fast and cheap production.
■​ Capital-intensive, reducing labor costs and boosting efficiency.
○​ Disadvantages:
■​ Repetitive work can lower worker motivation.
■​ Large inventories of raw materials and finished goods are costly.
■​ High capital costs to set up production lines.
■​ Machinery breakdown halts entire production.
Factors Affecting Production Method Choice:
●​ Nature of the Product:
○​ Customized/personal products → Job production.
○​ Standardized products → Flow production.
●​ Size of the Market:
○​ Large market → Flow production.
○​ Small or niche markets → Batch or job production.
○​ High demand but low quantity → Batch production.
●​ Nature of Demand:
○​ Steady demand → Flow production.
○​ Irregular or low demand → Batch or job production.

●​ Size of the Business:

○​ Small firms with limited capital → Batch or job production.
○​ Large firms with more resources → Flow production.

Technology and Production:

●​ Automation: Computer-controlled equipment performs mechanical tasks (e.g., spray
painting cars).
●​ Mechanization: Machines operate with human control.
●​ CAD (Computer-Aided Design): Software for quickly designing and viewing products
in 3D.
●​ CAM (Computer-Aided Manufacturing): Computers control production machines
and robots.
●​ CIM (Computer Integrated Manufacturing): Combines CAD and CAM to design and
produce products directly.
●​ EPOS (Electronic Point-of-Sale): Scans items at checkout, shows prices, prints
receipts, and updates/reorders stock automatically.
●​ EFTPOS (Electronic Funds Transfer at Point-of-Sale): Connects tills to banks for debit
card payments via PIN entry.

Advantages of Technology in Production:

●​ Increases productivity.
●​ Improves job satisfaction by reducing boring tasks.
●​ Produces better quality products.
●​ Enables quicker communication and less paperwork.
●​ Allows more accurate demand forecasting via inventory monitoring.
●​ Supports introduction of new products with advanced methods.

Disadvantages of Technology in Production:

●​ Increases unemployment as machines replace labor.
●​ High setup costs.
●​ Technology becomes outdated quickly, requiring costly updates.
●​ Employees may resist or struggle to adapt to new systems.

Costs
●​ Fixed Costs:
○​ Do not change with output in the short run.
○​ Incurred even if output is zero.
○​ Also called overhead costs.
○​ Example: Rent.
 ●​ Variable Costs:
○​ Change directly with output produced or sold.
○​ Examples: Material costs, wages paid per output.
○​
●​ Formulas:
○​ Total Cost = Total Fixed Costs + Total Variable Costs
○​ Total Cost = Average Cost × Output
○​ Average Cost (Unit Cost) = Total Cost ÷ Total Output

●​ Uses of Cost Data:

○​ Setting prices (e.g., price set above average cost to make profit).
○​ Deciding whether to continue or stop production (if costs exceed revenue, may
stop).
○​ Choosing the best location (preferring cheaper cost areas).

Scale of Production:
●​ As output increases, average cost per unit decreases.

Economies of Scale (reduce average costs as firm grows):

1.​ Purchasing Economies: Bulk buying discounts on large orders.
2.​ Marketing Economies: Larger firms can afford their own distribution and advertising,
reducing costs per unit.
3.​ Financial Economies: Bigger firms get lower interest rates due to better loan
repayment chances.
4.​ Managerial Economies: Can hire specialist managers to improve efficiency and
reduce costs.
5.​ Technical Economies: Can invest in large machinery and automated production lines
to lower costs.

Diseconomies of Scale (increase average costs when firm grows too large):
●​ Poor communication slows information flow and reduces efficiency.
●​ Low worker morale from feeling undervalued lowers productivity.
●​ Slow decision-making due to longer management chains delays actions.
Solution: Firms break into smaller, self-managed units to improve communication and
control, avoiding diseconomies.

Break-even:
●​ The break-even output is the quantity where total revenue equals total costs—no
profit or loss is made.
●​ Break-even chart:
○​ Shows costs and revenues at different output levels.
○​ Fixed costs stay constant regardless of output.
○​ Variable costs rise with output (e.g., $3 per unit).
○​ Total costs = Fixed costs + Variable costs.
○​ Total revenue = Price per unit × Output.
○​ Break-even point is where the total revenue line crosses the total cost line (e.g.,
output 1000 units).
●​ Advantages:
○​ Helps managers see profit/loss at each output level.
○​ Allows simulation of changes in costs or prices to assess impact.
○​ Shows margin of safety (how much sales can drop before loss occurs).
■​ Margin of Safety = Actual Sales – Break-even Sales
 ●​ Limitations:
○​ Assumes all produced units are sold (not always true).
○​ Fixed costs may change if production scale changes.
○​ Costs are assumed linear but may vary (e.g., overtime pay increases variable
costs).

●​ Formula for Break-even​

Break-even output = Total fixed costs ÷ Contribution per unit
●​ Where:​
Contribution per unit = Selling price – Variable cost per unit

Quality means producing goods or services that meet customer expectations and are free
from faults or defects.

Importance of Quality:
●​ Builds brand image
●​ Creates brand loyalty
●​ Maintains a good reputation
●​ Increases sales
●​ Attracts new customers

Consequences of Poor Quality:

●​ Loss of customers to competitors
●​ Increased costs due to replacements and repeated service
●​ Damaged reputation leading to lower sales and profits

Methods to Achieve Quality:

1.​ Quality Control
2.​ Quality Assurance
3.​ Total Quality Management (TQM)

Quality Control
●​ Checks quality at the end of production (goods or services)

Advantages:
●​ Removes faults before reaching customers, improving satisfaction
●​ Requires less training for inspectors

Disadvantages:
●​ Hiring quality checkers can be costly
●​ Identifies defects but not their causes, making problem-solving hard
●​ Reworking or replacing faulty products is expensive

Quality Assurance
●​ Checks quality throughout the entire production process
Advantages:
●​ Faults caught early, improving customer satisfaction
●​ Easier to identify and fix problems at each stage
●​ Less waste and rework compared to quality control
Disadvantages:
●​ More expensive due to continuous checks and required technology
●​ Requires strict employee adherence to quality standards
Total Quality Management (TQM)
●​ Continuous improvement with quality focus at every stage
●​ Emphasizes involvement of all workers and customer satisfaction
●​ Uses quality circles (worker teams) to discuss and solve issues
Advantages:
●​ Quality embedded in every part of production
●​ Eliminates faults before product reaches customers
●​ No customer complaints, stronger brand image
●​ Reduces waste and costs, improves efficiency
Disadvantages:
●​ High cost of employee training
●​ Depends heavily on employee motivation and commitment

How Customers Can Assure Product or Service Quality:

●​ Look for quality marks such as ISO (International Organization for Standardization)
on products, indicating the business follows recognized quality standards.
●​ For services, rely on a good reputation and positive customer reviews as indicators
of quality.

Factors Affecting Location Decisions for Manufacturing Firms:

●​ Production Method:
○​ Job production: small scale, less need to be near raw materials.
○​ Flow production: large scale, needs to be close to components to reduce
transport costs.
●​ Market:
○​ For perishable consumer goods, factories must be close to the market for quick
sales.
●​ Raw Materials/Components:
○​ Location near raw materials is important, especially if freshness matters (e.g.,
fruit for juice).

●​ External Economies:
○​ Nearness to supporting firms providing services like equipment maintenance.
●​ Availability of Labour:
○​ Close to areas with the right skills or high unemployment for unskilled workers.
○​ Wage rates also influence location choice.
●​ Government Influence:
○​ Incentives/grants for setting up in rural or high-unemployment areas.
○​ Regulations or restrictions in certain zones.
●​ Transport & Communication Infrastructure:
○​ Proximity to good roads, railways, ports, and airports is vital, especially for
exports.
●​ Power and Water Supply:
○​ Reliable access to utilities is necessary for factory operations.
●​ Climate:
○​ Can affect certain industries (e.g., dry climate benefits silicon chip
manufacturing).
●​ Owner’s Personal Preferences
Factors Affecting Location Decisions of a Service-Sector Firm
●​ Customers:​
Need to be in convenient, accessible places (e.g., restaurants, hairdressers, post
offices).
●​ Technology:​
With online services, proximity to customers matters less; firms may locate where rent
and wages are low (e.g., banks).
●​ Availability of Labour:​
Need to be near residential areas if many workers are required; skilled workers
influence location choice. Work-from-home lessens this factor nowadays.
●​ Climate:​
Important for tourism-related services.
●​ Nearness to Other Businesses:​
Service firms close to large companies they serve; may locate near competitors to
attract customers.
●​ Rent and Taxes
●​ Owner’s Personal Preferences

Factors Affecting Location Decisions of a Retailing Firm

●​ Shoppers:​
Must be located where customers frequently visit (e.g., malls).
●​ Nearby Shops:​
Proximity to other shops and competitors can attract more customers and help
monitor competition.
●​ Customer Parking Availability:​
Convenient parking increases shopper visits.
●​ Availability of Suitable Premises:​
Vacant spaces needed for setup and future expansion.
●​ Rent and Taxes:​
Must be affordable.
●​ Access to Delivery Vehicles:​
Important if offering home deliveries.
●​ Security:​
Areas with lower crime and security guards preferred.

Why Businesses Locate in Different Countries

●​ Access to new overseas markets.
●​ Availability of cheaper or unique raw materials.
●​ Access to cheaper and/or skilled labor.
●​ Lower rent and taxes.
●​ Government grants and incentives.
●​ Avoid trade barriers and tariffs by producing within the country.

The Role of Legal Controls on Location Decisions

●​ Governments encourage businesses to locate in high-unemployment or
under-developed areas through grants and subsidies.
●​ Governments discourage locating in overcrowded or environmentally sensitive areas
through planning restrictions.
Unit 5
Finance in Business

Finance is the money required by a business to set up, expand, and run day-to-day
operations.

Types of Capital
●​ Start-up Capital: Initial money to buy fixed and current assets before trading begins.
●​ Working Capital: Money needed for day-to-day running expenses.
●​ Capital Expenditure: Money spent on fixed assets (lasting more than a year), e.g.,
machinery, buildings.
●​ Revenue Expenditure: Money spent on day-to-day expenses (short-term), e.g., wages,
rent.

Sources of Finance
Internal Finance (from within the business)
●​ Retained Profit: Profit kept in the business after owner’s share.
○​ Advantages: No repayment or interest.
○​ Disadvantages: Not available to new businesses; may be insufficient; reduces
owner’s profit share.
●​ Sale of Existing Assets: Selling unused assets.
○​ Advantages: Frees up capital; no debt created.
○​ Disadvantages: Not available for new businesses; sale may take time and fetch
less value.
●​ Sale of Inventories: Selling finished goods or unwanted stock.
○​ Advantage: Reduces holding costs.
○​ Disadvantage: May lead to stock shortages.
●​ Owner’s Savings: Money invested by the owner(s).
○​ Advantages: Quickly available; no interest.
○​ Disadvantages: Increases owner’s personal financial risk.

External Finance (from outside the business)

●​ Issue of Shares: Only for limited companies.
○​ Advantages: Permanent capital; no repayment or interest.
○​ Disadvantages: Dividends must be paid; ownership dilution.

●​ Bank Loans:
○​ Advantages: Quick; flexible terms; low rates for large companies.
○​ Disadvantages: Interest payments; repayment required; collateral often
needed.
●​ Debentures: Long-term loan certificates.
○​ Advantages: Long-term finance (e.g., 25 years).
○​ Disadvantages: Interest payments; repayment required.
●​ Debt Factoring: Selling debtor invoices to a specialist.
○​ Advantages: Immediate cash; no debt collection by business.
○​ Disadvantage: Factor charges a percentage, reducing cash received.
●​ Grants and Subsidies: Financial aid from government or agencies.
○​ Advantages: Free money (no repayment).
○​ Disadvantages: Usually conditional (e.g., location requirements).
●​ Micro-finance: Small loans for small businesses in poor regions.
 ●​ Crowdfunding: Raising small amounts from many people online; no repayment or
dividends required.

Short-Term Finance
●​ Overdrafts: Allow spending beyond bank balance, interest charged only on amount
overdrawn.
○​ Advantages: Flexible; cheaper than loans long-term.
○​ Disadvantages: Variable interest; can be recalled by bank suddenly.
●​ Trade Credit: Delay in paying suppliers.
○​ Advantages: No interest or repayments.
○​ Disadvantages: Risk losing discounts or suppliers refusing future credit.

Long-Term Finance
●​ Loans: Bank or private loans.
●​ Debentures
●​ Issue of Shares
●​ Hire Purchase: Buy assets paying in installments with interest.
○​ Advantages: No large upfront cash needed.
○​ Disadvantages: Initial deposit required; high interest.
●​ Leasing: Use an asset by paying rent, with an option to buy.
○​ Advantages: No large upfront cost; maintenance by lessor.
○​ Disadvantages: Total cost may exceed buying outright.
○​ Sale and Leaseback: Selling owned assets and leasing them back.

Factors Affecting Choice of Finance Source

●​ Purpose: Long-term asset purchase vs. day-to-day expenses.
●​ Time Period: Short-term needs favor overdrafts; long-term needs favor loans/shares.
●​ Amount Needed: Large sums suit loans or shares; small sums suit overdrafts or asset
sales.
●​ Legal Form: Only limited companies can issue shares/debentures.
●​ Control: Issuing shares can dilute ownership.
●​ Risk (Gearing): More borrowing increases business risk and interest burden.

Finance from Banks and Shareholders

Banks more likely to lend if:
●​ Cash flow forecasts and detailed financial plans provided.
●​ Past and forecast income statements show profits.
●​ Details of existing finance and collateral/security available.
●​ Business plan clearly explaining purpose and goals.
Shareholders more likely to invest if:
●​ Share prices rising.
●​ High profits and dividends.
●​ Strong company reputation and growth plans.

Importance of Cash
●​ Cash is crucial for a business to pay workers, suppliers, landlords, and the government.
●​ Without enough cash, a business risks liquidation—selling all assets to pay debts.
●​ Adequate cash ensures the business can meet all short-term payments promptly.

Cash Flow
●​ Cash flow = cash inflows minus cash outflows over a period.
Cash Inflows Examples:
●​ Sales revenue from products.
●​ Payments from debtors (customers who owe money).
●​ Loans and external borrowing.
●​ Sale of business assets.
●​ Investment from owners/shareholders.

Cash Outflows Examples:

●​ Buying goods/materials.
●​ Paying wages, salaries, rent, and other expenses.
●​ Purchasing fixed assets.
●​ Repaying loans.
●​ Paying creditors (suppliers owed money).

Cash Flow vs Profit:

●​ Cash flow only accounts for actual cash transactions.
●​ Profit includes income and expenses whether paid or not.

Cash Flow Cycle

●​ Cash flows into the business → used to pay expenses and buy assets → more cash
generated from sales → cycle repeats.

Cash Flow Forecasts

●​ An estimate of future cash inflows and outflows (usually monthly).
●​ Helps managers:
○​ Know how much cash is available to pay bills or repay loans.
○​ Identify when to borrow money to avoid running out of cash (insolvency).
○​ Spot if excess cash can be invested for profit.

Example Calculation:
●​ Net Cash Flow = Total Cash Inflows – Total Cash Outflows
●​ Closing Cash Balance = Opening Cash Balance + Net Cash Flow
●​ Closing balance for one month is the opening balance for the next.

Uses of Cash Flow Forecasts

●​ Planning the required cash to start a business.
●​ Banks require forecasts when lending loans.
●​ Managing business finances to avoid cash shortages or surpluses.

Overcoming Cash Flow Problems

When cash shortages occur, businesses can:
●​ Increase bank loans: inject cash but add interest and repayment obligations.
●​ Delay payments to suppliers: reduces outflows temporarily but risks losing supplier
trust.
●​ Speed up debtor payments: increases cash inflows but may cause customers to
switch competitors.
●​ Delay or cancel capital purchases: reduces cash outflows but may reduce efficiency
long-term.
Long-term solutions include attracting investors, cutting costs, and boosting sales.
Working Capital
●​ Capital needed for day-to-day expenses.
●​ Includes liquid assets that can quickly be converted to cash, such as:
○​ Cash for expenses.
○​ Money owed by debtors.
○​ Inventory (finished goods ready to sell).
Note: Too much inventory increases costs; too little may halt production.

Accounts and Final Accounts

●​ Accounts are financial records of all business transactions.
●​ Final Accounts are prepared at the end of the financial year.
●​ They show:
○​ Profit or loss made during the year.
○​ The worth (financial position) of the business.

Profit
●​ Profit = Sales Revenue – Total Costs
●​ If total costs exceed sales revenue, the business makes a loss.

How to Increase Profit:

●​ Increase sales revenue.
●​ Cut costs.

Why Profit is Important:

●​ Reward for enterprise: Entrepreneurs start businesses to earn profit.
●​ Reward for risk-taking: Profit compensates for risks taken by investors.
●​ Source of finance: Profits (retained earnings) can be reinvested in the business.
●​ Indicator of success: High profits attract investors and signal business health.
●​ For social enterprises, profit is secondary; main focus is social welfare, but profit helps
growth.

Profit vs Cash Flow:

●​ Profit includes all earned income and expenses, whether paid or unpaid.
●​ Cash flow only counts actual cash received and paid during the period.

Income Statement (Profit & Loss Account)

●​ Records all income and costs over the financial year.
●​ Shows the profit or loss made.

Key Elements:
Term Explanation

Sales Revenue Total sales made

Cost of Sales Variable costs + (Opening inventory – Closing inventory)

Gross Profit Sales Revenue – Cost of Sales

Expenses Overheads and fixed costs

Net Profit Gross Profit – Expenses

 Profit after Tax Net Profit – Tax

Dividends Profit shared with shareholders

Retained Profit Profit after tax and dividends, kept in the business for
growth

Uses of Income Statement

●​ Helps managers know if the business made a profit or loss.
●​ Allows comparison with past years or competitors.
●​ Identifies profitable and loss-making products.
●​ Assists in deciding which products to launch using forecasted income statements.

Balance Sheet (Statement of Financial Position)

●​ Prepared at the end of the financial year alongside the income statement.
●​ Shows the value of a business’s assets and liabilities at a specific point in time.
●​ Helps assess the financial health and stability of the business.

Key Components

Assets
Items of value owned by the business.
●​ Fixed / Non-current Assets:
○​ Used for more than a year (e.g., buildings, vehicles, equipment).
○​ Value decreases yearly due to depreciation.
●​ Current / Short-term Assets:
○​ Held for a short period (e.g., inventory, trade receivables (money owed by
customers), cash).
●​ Intangible Assets:
○​ Non-physical assets like copyrights, patents that add value.

Liabilities
Debts owed by the business.
●​ Non-current / Long-term Liabilities:
○​ Debts repayable over a period longer than one year (e.g., loans, debentures).
●​ Current / Short-term Liabilities:
○​ Debts repayable within one year (e.g., trade payables to suppliers, overdraft).

Key Financial Relationships

●​ Working Capital = Current Assets – Current Liabilities​
(Shows the liquid cash available for day-to-day operations.)

●​ Shareholders’ Equity = Total Assets – Total Liabilities​

(Represents the net worth or residual interest of the shareholders.)

●​ Total Assets = Total Liabilities + Shareholders’ Equity​

(The fundamental accounting equation.)

●​ Capital Employed = Shareholders’ Equity + Non-current Liabilities​

(Shows total permanent capital invested in the business.)
Uses of the Balance Sheet
●​ Assess Liquidity:​
Compare current assets to current liabilities to see if the firm can meet short-term
debts.
●​ Evaluate Financial Structure:​
Compare total debt to equity to calculate the debt-equity ratio — important for
lenders to assess risk.
●​ Dividend Assessment:​
Investors look at cash reserves to determine if dividends can be paid.
●​ Asset Management:​
Managers use it to identify assets that could be sold to raise finance without harming
operations, such as excess inventory.

Ratio Analysis
Ratio analysis uses financial statement data to assess a business’s performance and financial
strength.

1.​ Profitability Ratios

Return on Capital Employed (ROCE):​
ROCE = (Net Profit ÷ Capital Employed) × 100%​
Where:
●​ Net Profit = Profit after tax
●​ Capital Employed = Shareholders' Equity + Non-Current Liabilities

Gross Profit Margin (GPM):​

Gross Profit Margin = (Gross Profit ÷ Sales Revenue) × 100%​
Where:
●​ Gross Profit = Sales Revenue – Cost of Sales
Net Profit Margin (NPM):​
Net Profit Margin = (Net Profit ÷ Sales Revenue) × 100%​
Where:
●​ Net Profit = Gross Profit – Expenses

2.​ Liquidity Ratios

Current Ratio:​
Current Ratio = Current Assets ÷ Current Liabilities
Liquid Ratio (Acid Test Ratio):​
Liquid Ratio = (Current Assets – Inventory) ÷ Current Liabilities

2. Liquidity Ratios
These ratios assess the company’s ability to pay its short-term debts.
●​ Current Ratio:​
Shows the ratio of current assets to current liabilities.​
Current Ratio=Current Assets ÷ Current Liabilities​
A ratio above 1 is generally favourable.

●​ Liquid Ratio / Acid Test Ratio:​

Like current ratio but excludes inventory (less liquid).​
Liquid Ratio=Current Assets−Inventory ÷ Current Liabilities​
Shows ability to meet short-term debts without relying on selling inventory.
Uses of Financial Accounts and Ratios
User Group Uses of Accounts & Ratios

Managers - Control performance of products/divisions

- Identify profitable and unprofitable products
- Plan expense reduction- Improve liquidity by managing
liabilities

Shareholders - Evaluate profitability (especially ROCE)

- Decide on buying/selling shares
- Assess risk via liquidity ratios
- Compare performance over years and against competitors

Creditors - Assess cash position and risk before extending credit/supplies

Banks - Evaluate risk before lending loans

Government - Use profits for tax assessments- Assess business viability for
job protection

Workers/Trade Unions - Monitor company’s stability and future job security

Other Businesses - Compare performance or evaluate takeover opportunities

Limitations of Using Accounts & Ratio Analysis

●​ Ratios are based on past data and may not predict future performance.
●​ External users only get limited published accounts; may lack full insight.
●​ Inflation can distort year-to-year comparisons.
●​ Different companies may use different accounting methods, causing unreliable
comparison
Unit 6
The Business/Trade Cycle
An economy doesn’t grow constantly; it goes through a cycle of phases:
1.​ Growth
○​ GDP rises
○​ Unemployment falls
○​ Living standards improve
○​ Businesses expand and profits increase
2.​ Boom
○​ GDP reaches its peak
○​ Excess spending causes rapid inflation
○​ Business costs rise, profits become uncertain
3.​ Recession
○​ GDP starts to fall due to reduced demand
○​ Businesses cut back production
○​ Unemployment rises
4.​ Slump
○​ GDP is very low, prices fall (deflation)
○​ Unemployment is very high
○​ Many businesses close down
○​ Recovery begins when government boosts demand

Economic Objectives of the Government

1. Maintain Economic Growth

●​ Increase in GDP means more goods and services, higher incomes, and better living
standards.
●​ If GDP falls (recession): unemployment rises, living standards fall.

2. Achieve Price Stability

●​ Inflation is the rise in average prices over time (deflation if prices fall).
●​ High inflation effects:
○​ Real incomes fall (purchasing power decreases)
○​ Domestic goods less competitive internationally
○​ Demand and profits fall, reducing expansion chances
○​ Living standards decline

3. Reduce Unemployment
●​ Low unemployment means higher output, incomes, and living standards.
●​ High unemployment effects:
○​ Output and GDP fall
○​ Income inequality rises
○​ Government spending on benefits rises
○​ Demand for goods falls

4. Maintain Balance of Payments Stability

●​ Balanced exports and imports.
●​ If imports > exports: currency depreciation (exchange rate falls).
 ●​ If exports > imports: country consumes less than it produces.

5. Reduce Income Inequality

●​ Narrow the gap between rich and poor.
●​ Inequality leads to poor living standards and unequal consumption.

Government Economic Policies

Fiscal Policy
●​ Government adjusts spending and taxation to influence the economy.
●​ Increase spending & reduce taxes: boost production, employment, GDP growth.
●​ Reduce spending & increase taxes: reduce production, employment, GDP.
Monetary Policy
●​ Central bank adjusts interest and exchange rates to influence money supply.
●​ Increase interest rates: reduce borrowing and spending, lower GDP and
employment.
●​ Reduce interest rates: increase borrowing, spending, GDP, and employment.

Supply-Side Policies
●​ Aim to improve productivity and efficiency:
○​ Privatisation: sell government firms to private owners for better efficiency
○​ Improve education/training: better skills increase productivity
○​ Increase competition: reduce monopolies and deregulated markets for more
competition

How Businesses React to Policy Changes

●​ Impact varies by industry and scale of the policy change.
●​ Businesses may adjust investment, production, hiring, and pricing strategies based on
these policies.

Business’ Impact on the Environment

Social Responsibility
●​ When business decisions benefit stakeholders beyond shareholders (workers,
community, suppliers, banks, etc.).
●​ Especially important regarding environmental issues like air pollution, water
contamination, and landscape damage.

Why Businesses Want to be Environment-Friendly | Why Businesses Don’t Want to be

Environment-Friendly
​
Sense of social responsibility to reduce pollution and global warming | Reducing/recycling
waste is expensive due to costly machinery and skilled labor, reducing profits​
Avoid depleting scarce non-renewable resources, preserving future resource availability |
Environment-friendly methods increase production costs, leading to higher product prices​
Consumer demand favors eco-friendly products | Higher prices reduce competitiveness and
sales​
Avoid legal action or backlash from governments, communities, and environmental groups |
Some businesses argue pollution cleanup is a government responsibility
Externalities

Definition: Effects of business activities on others (stakeholders) outside the business.

Type Description Examples

Private Costs Costs paid by the business Building factory, hiring workers,
machinery

Private Gains to the business Profits from sales

Benefits

External Costs borne by society due to Noise, air pollution, loss of farmland
Costs business actions

External Gains to society from business New jobs, tax revenue, improved
Benefits activity infrastructure

●​ Social Costs = Private Costs + External Costs

●​ Social Benefits = Private Benefits + External Benefits

Cost-Benefit Analysis (CBA):

●​ Governments/businesses weigh social costs against social benefits to decide if a
project should proceed.
●​ Only proceed if social benefits > social costs.

Sustainable Development
●​ Development that does not harm future generations’ living standards.
●​ Achieve economic growth while conserving resources for the future.
●​ Examples:
○​ Using renewable energy
○​ Recycling waste
○​ Using fewer resources
○​ Developing eco-friendly products and processes

Environmental Pressures
●​ Pressure Groups: Organizations that influence business/government decisions (e.g.,
Greenpeace).
●​ Tactics include consumer boycotts and media campaigns.
●​ Pressure groups can damage business reputations and force changes.
●​ Government Regulations:
○​ Laws limiting factory locations (e.g., natural beauty areas)
○​ Penalties and taxes on pollution
○​ Pollution permits (licenses to pollute within limits)
○​ Permits can be traded among firms to encourage lower pollution

Ethical Decisions
●​ Based on moral principles: “doing the right thing.”
●​ Examples: child labor, bribery, association with unethical partners.
●​ Ethical choices can improve brand image, government relations, and avoid pressure
group conflicts.
●​ But ethical actions may increase costs by avoiding cheaper unethical options.
Globalization

Definition
Globalization refers to the increasing integration of worldwide trade, capital, and labor
movement across countries. Goods, services, workers, and money now flow more freely
between nations.

Causes of Globalization
●​ Increasing number of free trade agreements (no tariffs or quotas)
●​ Improved, cheaper transportation (air, sea, land) and communication (internet)
●​ Rapid industrialization of emerging economies (e.g., China, India) boosting exports
and trade

Advantages of Globalization
●​ Businesses can sell in new foreign markets → increased sales & profits
●​ Ability to set up production in countries with cheaper labor/materials
●​ Import foreign products for domestic sales profitably
●​ Import cheaper materials and components for production

Disadvantages of Globalization
●​ Increased foreign competition can threaten domestic firms, causing closures
●​ Multinational investment increases competition in local markets
●​ Domestic employees may leave for better-paying multinational jobs, raising labor
costs
●​ Consumers gain more choice and lower prices, but job losses may occur if local firms
close

Protectionism

Definition
Government policies to protect domestic industries from foreign competition by imposing
trade barriers.

Types of Trade Barriers

●​ Import quotas: Limits on quantity of imports
●​ Tariffs: Taxes on imported goods

Effects
●​ Reduces foreign goods available and makes them more expensive
●​ Helps domestic firms compete better
●​ Limits free trade and globalization

Debate
●​ Free trade advocates argue specialization based on comparative advantage raises
global living standards.

Multinational Companies (MNCs)

Definition
Firms operating in multiple countries (e.g., Shell, McDonald’s, Nissan).
Reasons for Becoming Multinational
●​ Lower production costs (cheaper labor, materials)
●​ Access raw materials in other countries
●​ Produce closer to markets to reduce transport costs
●​ Avoid trade barriers (tariffs, quotas)
●​ Expand markets and spread risk
●​ Stay competitive with rivals expanding abroad

Advantages for Host Country

●​ Job creation
●​ Increased GDP
●​ Technology transfer and new ideas
●​ Reduced imports, increased exports
●​ Government tax revenue increase
●​ More product choices for consumers

Disadvantages for Host Country

●​ Jobs often low-skilled; skilled jobs may go to foreign workers
●​ Possible exploitation with low wages and poor conditions
●​ Local firms may be outcompeted and forced out
●​ Use of scarce non-renewable resources
●​ Profit repatriation back to home country reduces local tax revenue
●​ Potential political/economic influence over government by MNCs

Exchange Rates

Definition
The price of one currency in terms of another (e.g., €1 = $1.2).

How Exchange Rates Change

●​ Determined by supply and demand of currencies
●​ Currency appreciates when its value rises
●​ Currency depreciates when its value falls

Effects of Appreciation
●​ Exporters: Disadvantaged (exports more expensive)
●​ Importers: Advantageous (imports cheaper)

Effects of Depreciation
●​ Exporters: Advantageous (exports cheaper)
●​ Importers: Disadvantageous (imports more expensive)

Summary
Situation Exporters Importers

Currency Lose Benefit from cheaper

appreciates competitiveness imports

Currency Gain Face higher import costs

depreciates competitiveness
(Assuming goods are price elastic — consumers respond to price changes.)