Economic Sciences Basics (ECSB) WS 24/25 - Introduction to Business and Economy - PDF

Economic Sciences Basics (ECSB) WS 24/25  COURSE UNIT 1: INTRODUCTION TO BUSINESS AND ECONOMY PT: 1 Learning Objectives I. Comprehend the concept of BUSINESS. II. Understand the classification of products and markets III. Explore the chara...

Economic Sciences Basics (ECSB) WS 24/25  COURSE UNIT 1: INTRODUCTION TO BUSINESS AND ECONOMY PT: 1 Learning Objectives I. Comprehend the concept of BUSINESS. II. Understand the classification of products and markets III. Explore the characteristics and various forms of businesses. IV. Acquire a fundamental understanding of basic economic principles. Mariola Muci / ECSB WS24 Definition of Business Cambridge Dictionary Mariola Muci| ECSB SS24 Definition of Business “A business is any activity that seeks to provide goods and services to others while operating at a profit and sometimes for purposes other than profits”. Delivering goods and services (fill the needs and wants) Medium to earn money Done for a basic purpose: For profit Not-for-profit/ to serve public Mariola Muci| ECSB SS24  Good’s Tangible items or products that are manufactured, produced, or acquired for the purpose of meeting the needs and wants of consumers. Examples? Mariola Muci| ECSB SS24 Services Intangible activities or tasks that individuals or businesses provide to others in exchange for compensation. Mariola Muci| ECSB SS24 Types of Businesses Businesses can be classified by three main criteria's: SIZE FUNCTION Legal Form Mariola Muci| ECSB SS24  According to SIZE SMALL AND MEDIUM-SIZED E N T E R P R I S ES ( S M ES ) L A RG E E N T E R P R I S ES Mariola Muci| ECSB SS24 SMALL AND MEDIUM SIZED BUSINESS (SME’S) A large percentage of businesses are of small size (19 out of 20 businesses in the USA) Small and Firms that are; - independently owned and operated Medium-sized - are not dominant on their field Businesses - meet certain size of sales or number of employees. Mariola Muci| ECSB SS24 SMALL AND MEDIUM SIZED BUSINESS (SME’S) https://single-market-economy.ec.europa.eu/smes/sme-definition_en SMALL AND MEDIUM SIZED BUSINESS (SME’S) Mariola Muci| ECSB SS24  SMALL AND MEDIUM SIZED BUSINESS (SME’S) AD VA N TA G E S D I S AD VA N TA G E S Easy to form Weaknesses in competing with large Facing low costs companies Effective in owner-worker relations Limited Growth “Inadequate” Management Mariola Muci| ECSB SS24  LARGE ENTERPRISES Scale: Operate on a massive scale, serving numerous customers, have a wide geographic reach. Diversity: Offer a broad range of products or services to cater to various market segments. Complexity: Have complex organizational structures with multiple departments and specialized teams. Global Presence: Possess presence in international markets Resources: Possess significant financial, human, and technological resources, enabling them to invest in innovation, research, and expansion. Mariola Muci| ECSB SS24  LARGE ENTERPRISES AD VA N TA G E S D I S AD VA N TA G E S Professional management High levels of bureaucracy Financial strength Higher operational costs Diversification of products , services Complex decision making Mariola Muci| ECSB SS24 According To FUNCTION M A N U FA C T U R I N G C O M PA N I E S S E R V I C E C O M PA N I E S M A R K E T I N G A N D R E TA I L ( M E R C H A N D I S I N G ) C O M PA N I E S H Y B R I D C O M PA N I E S Mariola Muci| ECSB SS24  M A N U FA C T U R I N G C O M PA N I E S : Concentrate on producing goods, transforming raw materials into finished products. Mariola Muci| ECSB SS24  S E R V I C E C O M PA N I E S : Provide intangible products. They offer services rather than physical goods. Mariola Muci| ECSB SS24 R E TA I L ( M E R C H A N D I S I N G ) C O M PA N I E S Act as intermediaries between manufacturers and the end customers, purchasing products in bulk and offering them in smaller quantities H Y B R I D C O M PA N I E S “companies that may be classified in more than one type of business”. This type of business blurs the lines between product-based and service-based business models. Mariola Muci| ECSB SS24 According to the Legal Form SOLE PROPRIETORSHIP PA R T N E R S H I P S C O R P O R AT I O N S  According to the Legal Form SOLE PA R T N E R S H I P S C O R P O R AT I O N S P R O P R I E TO R S H I P (One-man owned firm) Form of business ownership in which the company is owned by a single person.  SOLE PROPRIETORSHIP AD VA N TA G E S D I S AD VA N TA G E S Simplicity in procedures & Minimal Unlimited Liability administrative complexity Limited Resources Profit Retention Limited Expertise Tax Benefits Leaving Legacy  LIABILITY CONCEPT Legal responsibility a person or entity has for their actions or inactions. Two types of liabilities: Unlimited vs Limited Unlimited Liability: Owners are personally responsible for all the debts and obligations of the business. If the business cannot pay its debts, creditors can go after the owner’s personal assets, such as homes, vehicles, and savings, to settle the debts. Limited Liability: Individual’s financial responsibility for business debts is limited to the amount of their investment in the company. Personal assets (homes, cars, and savings) are protected and cannot be used to settle business debts. LIABILITY CONCEPT  According to the OWNERSHIP SOLE PA R T N E R S H I P S C O R P O R AT I O N S P R O P R I E TO R S H I P (One-man owned firm) The company is operated by two or more people who are Form of business co-owners by voluntary legal ownership in which the agreement. company is owned and operated by a single person. General Partnership Limited Partnership Types of Partnerships General Partnership Limited Partnership An ordinary partnership which is Composed of one or more general owned and operated by two or partners and one or more limited more people. partners. The general partners manage the Both co-owners are fully business and are fully responsible responsible for business debts in its profits and losses. with all their personal assets. Limited partners share the profits of It is easy to form and dissolve. the business, but are liable for Unlimited Liability. losses limited to the extent of their investment. Mariola Muci| ECSB SS24 Questions to ask when choosing a business partner… Mariola Muci| ECSB SS24  According to the OWNERSHIP SOLE PA R T N E R S H I P S C O R P O R AT I O N S P R O P R I E TO R S H I P (One-man owned firm) Partnership is a form of A Corporation is a legal entity ownership in which the which assets and liabilities It is defined as the form company is operated by two are separated from those of of business ownership in or more people who are co- its owners. which the company is owners by voluntary legal owned and operated by a agreement. Enables investors to share in the single person. ownership (and profits) of the business without working there or General Partnership having other commitments to it Limited Partnership  Corporations Corporations are legal entities separate from their owners, with limited liability and the ability to raise capital through the sale of stocks or shares. ❖ Separate Legal Entity: Corporations are distinct legal entities from their owners. ❖ Perpetual Existence: They can continue to exist even if shareholders change. ❖ Ownership through Stock: Ownership is represented by shares of stock. ❖ Complex Structure: Corporations have formal governance structures with boards of directors and officers. ❖ Shareholders are only liable for the corporation’s debts and obligations up to the amount they have invested in the company. OWNERS ARE SH ARE S OWNERS OF SH ARE S ARE SH AR EHOLE RS Management of Corporations MANAGEMENT Shareholders elect the Board of Directors (BOD) among themselves to represent their interests. BOD selects the top management of the company. BOD and Top managers manage the company together. BOD recruits the CEO and monitors Top management activities. BOD always acts as body.  Management of Corporations D E L E G AT I O N ( R E P R E S E N TAT I O N ) R E L AT I O N S H I P S Owners of the business Shareholders Board of Representative Body elected by the Directors owners Top Managers assigned by BOD Top Managers Middle Managers assigned by Top Middle Managers Managers First-line Managers assigned by Middle First-line Managers Managers  COURSE UNIT 1: INTRODUCTION TO BUSINESS AND ECONOMY PT: 2 Types of Businesses Businesses can be classified by three main criteria's: SI ZE FU N C T I O N L e ga l Fo r m Mariola Muci| ECSB SS24  LIABILITY CONCEPT Legal responsibility a person or entity has for their actions or inactions. Two types of liabilities: Unlimited vs Limited Unlimited Liability: Owners are personally responsible for all the debts and obligations of the business. If the business cannot pay its debts, creditors can go after the owner’s personal assets, such as homes, vehicles, and savings, to settle the debts. Limited Liability: Individual’s financial responsibility for business debts is limited to the amount of their investment in the company. Personal assets (homes, cars, and savings) are protected and cannot be used to settle business debts. LIABILITY CONCEPT  According to the OWNERSHIP SO L E PA RT N E RS H I P S CO R P O R AT I O N S P RO P R I E TO RSH I P (One-man owned firm) The company is operated by two or more people who are Form of business co-owners by voluntary legal ownership in which the agreement. company is owned and operated by a single person. General Partnership Limited Partnership Types of Partnerships General Partnership Limited Partnership (Partner 1: General Partner (Partner 1: General Partner Partner 2: General Partner) Partner 2: Limited Partner) An ordinary partnership which is Composed of one or more general owned and operated by two or more partners and one or more limited people both considered as general partners. partners. The general partners manage the General partners are fully business and are fully responsible in its responsible for business debts with profits and losses. all their personal assets. Limited partners share the profits of the It is easy to form and dissolve. business, but are liable for losses limited Unlimited Liability. to the extent of their investment. Mariola Muci| ECSB SS24 Questions to ask when choosing a business partner… Mariola Muci| ECSB SS24  According to the OWNERSHIP SO L E PA RT N E RS H I P S CO R P O R AT I O N S P RO P R I E TO RSH I P Partnership is a form of A Corporation is a legal entity (One-man owned firm) ownership in which the which assets and liabilities It is defined as the form company is operated by two are separated from those of of business ownership in or more people who are co- its owners. which the company is owners by voluntary legal owned and operated by a agreement. Enables investors to share in the single person. ownership (and profits) of the business without working there or General Partnership having other commitments to it Limited Partnership  Corporations Corporations are legal entities separate from their owners, with limited liability and the ability to raise capital through the sale of stocks or shares. ❖ Separate Legal Entity: Corporations are distinct legal entities from their owners. ❖ Perpetual Existence: They can continue to exist even if shareholders change. ❖ Ownership through Stock: Ownership is represented by shares of stock. ❖ Complex Structure: Corporations have formal governance structures with boards of directors and officers. ❖ Shareholders are only liable for the corporation’s debts and obligations up to the amount they have invested in the company. (limited liability) O W N E R S AR E R E P R E S E N T E S B Y S H AR E S O W N E R S O F S H AR E S AR E S H AR E H O L E R S Management of Corporations MANAGEMENT Shareholders elect the Board of Directors (BOD) among themselves to represent their interests. BOD selects the top management of the company. BOD and Top managers manage the company together. BOD recruits the CEO and monitors Top management activities. BOD always acts as body.  Management of Corporations D E L E G AT I O N ( R E P R E S E N TAT I O N ) R E L AT I O N S H I P S Owners of the business Shareholders Board of Representative Body elected by the Directors owners Top Managers assigned by BOD Top Managers Middle Managers assigned by Top Middle Managers Managers First-line Managers assigned by Middle First-line Managers Managers Types of Corporations Business Alliances Why companies form alliances? Access to New Mark ets Increase the Mark et Power Inno vat io n and R& D Knowledge Sharing T YPES O F ST R AT EG IC A L L IA N C ES Companies usually use different strategic moves/ alliances to expand their operations: ❖ Joint Ventures ❖ Franchises ❖ Mergers ❖ Acquisitions T YPES O F ST R AT EG IC A L L IA N C ES JOINT VENTURES Two or more companies create partnership for a specific purpose (project). Usually, equal shares and mutual control. Partnering companies do not lose their identity. A B It usually has a defined duration in time. C JOINT VENT URES In 2012, Toyota and Subaru announced a joint venture to collaborate on the development of a new sports car platform. Toyota 86 (known as the Toyota GT86 in some regions), Subaru BRZ, and Scion FR-S (sold by Toyota in the United States). https://www.subaru.co.jp/en/alliance/  F R A N C H ISES Arrangement where the business owner (called a franchisor) sells and allows another (the franchisee) to use its trademark, trade name, or copyright, under specified conditions. New terms: franchisor A company that develops a product concept and sells others the rights to make and sell the products. franchise The right to use a specific business’s name and sell its products or services in a given territory.  F R A N C H ISES Arrangement where the business owner (called a franchisor) allows another (the franchisee) to use its trademark, trade name, or copyright, under specified conditions. Popular businesses for franchising might be: Restaurants Gas stations Financial Services, Hotels Top franchises in the world (2023 ranking): https://www.entrepreneur.com/franchise500  F R A N C H ISES Advantages Disadvantages Management and marketing Large start-up costs assistance. Personal ownership Shared profit (you are still your own boss) (franchisor often demands a percentage commission based on sales (royalty fee)) Financial advice and assistance. Coattail effects (the actions of other franchises have an impact on your future growth) Lower failure rate. Restrictions on selling  MER G ER S Business alliance in which two or more companies combine to form a single entity. The new venture is established, companies lose their old identity. Generally friendly agreement. A B C  MERGERS Advantages Disadvantages Increased Market Share Cultural Clashes Companies expand their market Merging companies often have presence, different corporate cultures, management styles Diversification Integration Challenges Allows companies to diversify their The process of merging operations, products, services systems, and processes can be complex and costly Cost reductions Shared resources, elimination of duplicate functions etc  MER G ER S In 2020, the Raytheon Corp. and United Technologies formed a new company, Raytheon Technologies Corp. Raytheon Corp. - manufacturing concentrations in weapons and military products. United Technologies Corp. - manufacture products in numerous areas, including aircraft engines, aerospace systems.  T YPES O F MER G ER S VERTICAL Joins two firms operating in different stages of related businesses. Ex: Flour mill company that specializes in processing wheat and producing flour decides to vertically integrate by acquiring a bakery chain that uses flour as a primary ingredient in its products. One of the companies gains more control over the supply or distribution of its products.  T YPES O F MER G ER S HORIZONTAL Joins two firms in the same industry/stage and allows them to diversify or expand their products. One of the primary objectives is to increase market share by eliminating a competitor. Coca-Cola and Pepsi (hypothetical): Both companies operate in the same industry, producing and selling similar products.  T YPES O F MER G ER S CONGLOMERATE Joints firms in completely unrelated industries in order to diversify business operations and investments. Ex: Samsung Group has subsidiaries and affiliates in various industries, including electronics (Samsung Electronics), shipbuilding (Samsung Heavy Industries), construction (Samsung C&T).  A c q u is i t io n s One company buys all or controls the shares of another company (It is more like buying a house than entering a marriage). Acquiring company (B) is called parent company, acquired B A company (A) is called subsidiary. Companies do not lose their old identity Generally unfriendly takeover  A c q u is i t io n s Google acquired Android in 2005 for an estimated $50 million. The acquisition gave Google the tools it needed to compete in a market dominated by Microsoft and Apple. 47% of U.S. smartphone owners use a Google Android device as of May 2020. Mariola Muci| ECSB SS24  Acquisitions Advantages Disadvantages Rapid Growth High Acquisition Costs Acquisitions allow a company to quickly (particularly when purchasing large or enter new markets or expand successful companies) Access to New Technologies and Integration Difficulties Resources Similar to mergers, acquisitions can Acquiring a company can provide face challenges in integrating the access to proprietary technologies, operations, systems, patents Reduced Competition The acquiring company can eliminate or significantly reduce competition THE BEST GLOBAL BRAND FOR 2023? Mariola Muci| ECSB SS24 28 Case Study Answer the three questions. 29  Assignment Case Study: Domino’s Pizza Answer the following questions and share your opinion in class. Questions: 1. Why do franchises like Domino’s have a lower business failure rate than businesses started from scratch? 2. How is a franchise different from a partnership? 3. What important questions should you ask before becoming a franchisee in a company like Domino’s Mariola Muci| ECSB SS24 30 Economic Sciences Basics (ECSB) WS 24/25  COURSE UNIT 2: Introduction to Economy Part: I Learning Objectives Comprehend Fundamental Economic Concepts. Analyze and assess diverse global economic systems. Analyze the trend toward mixed economies. 5 WEALTH Definition Cambridge Dictionary Wealth, in economic terms, refers to the total value of assets owned by an individual or entity, minus any liabilities. It includes financial holdings, property, and investments, serving as a measure of economic well-being. https://dictionary.cambridge.org/dictionary/english/wealth 4 Some countries are wealthier than others. Why? The Concept of WEALTH Key reasons why some countries are wealthier than others: o Geography (Geographical position, natural resources) o Political Stability and Governance (Stable governments and strong institutions foster economic growth) o Access to Global Markets (Countries integrated into the global economy, with open trade policies) o Historical Context (Conflicts, economic conditions in the past) o Human Capital (Education and skill levels of the workforce) To understand wealth, you must also understand basic Economics. Annual Real GDP growth (Global level) https://www.imf.org/external/datamapper/NGDP_RPCH@WEO/OEMDC/ADVEC/WEOWORLD 7 Wealth Creation according to Adam Smith Scottish economist, Adam Smith believed freedom was vital to the survival of any economy, especially the freedom to own land or property and to keep the profits that result from working the land or running a business. He believed people will work long and hard if they have incentives for doing so—that is, if they know they’ll be rewarded. Adam Smith (1723-1790) 8 How Businesses Benefit the Community Adam Smith wrote the book “The Wealth of Nations” in 1776. Adam Smith is considered the "father of economics" because of his theories on capitalism, free markets, and supply and demand. “Freedom is vital to the economy survival. Results from freedom of land, property and profit keeping will prosper the economies of the countries”. (Smith, 1776) How Businesses Benefit the Community In Adam Smith’s view, businesspeople work primarily for their prosperity and growth. Yet as people try to improve their situation in life, their efforts serve as an “invisible hand” that helps the economy grow and prosper through the production of needed goods, services, and ideas. The Invisible Hand Theory: Society benefits when people act in self-interest. Adam Smith: The Wealth of Nations, 1776. Economy vs Economics Economy refers to the production, consumption, and distribution of goods and services in a specific region. Business Administration Economics is the study of how individuals and societies allocate resources to satisfy their wants and needs. 6 What is ECONOMICS? ECONOMICS - The study of how society chooses to employ resources to produce goods and services. The science of scarcity while individuals wants, and desires are unlimited. Scarcity = Limited Resources 14 The two branches of Economics MACROECONOMICS MICROECONOMICS Studies the economy as a whole. Analyzes the behavior and decision- making processes of individual consumers and firms 15 The two branches of Economics 1. Macroeconomics- the branch of economics that studies the overall behavior and performance of an entire economy. It focuses on indicators such as: – gross domestic product (GDP), – inflation, – unemployment, – government policies, to understand how they impact economic growth, stability, and the well-being of a nation's population. 16 The two branches of Economics 2. Microeconomics- the branch of economics that examines the behavior of individual agents, such as: – consumers, – firms, – markets, to understand how they make decisions and allocate resources in a specific economic context. 17  TYPES OF ECONOMIES Free-market economies - economic system where most goods and services are produced, distributed, and priced by private individuals and businesses based on supply and demand, with minimal government intervention or regulation. Command economies - economic system in which the government or a central authority exercises significant control over the production, distribution, and pricing of goods and services, typically through central planning and ownership of key industries. Free Market Economies 1. Free-Market Capitalism All or most of the factors of production and distribution— such as land, factories, railroads, and stores—are owned by individuals. The economic system that has led to wealth creation in much of the world by supporting the Private Ownership. 19 Free Market Economies 1.Free-Market Capitalism Capitalism is the foundation of economic system such as: ❖ U.S, ❖ UK, ❖ Europe, ❖ Canada. Businesspeople, not government officials, decide what to produce and how much, what to charge, and how much to pay workers. Economic Sciences Basics (ECSB) WS 24/25  COURSE UNIT 2: Introduction to Economy Part: II How Businesses Benefit the Community In Adam Smith’s view, businesspeople work primarily for their prosperity and growth. Yet as people try to improve their situation in life, their efforts serve as an “invisible hand” that helps the economy grow and prosper through the production of needed goods, services, and ideas. Economy vs Economics Economy refers to the production, consumption, and distribution of goods and services in a specific region. Business Administration Economics is the study of how individuals and societies allocate resources to satisfy their wants and needs. 6 The two branches of Economics MACROECONOMICS MICROECONOMICS Studies the economy as a whole. Analyzes the behavior and decision- making processes of individual consumers and firms 5  TYPES OF ECONOMIES Free-market economies - economic system where most goods and services are produced, distributed, and priced by private individuals and businesses based on supply and demand, with minimal government intervention or regulation. Command economies - economic system in which the government or a central authority exercises significant control over the production, distribution, and pricing of goods and services, typically through central planning and ownership of key industries. Free Market Economies 1. Free-Market Capitalism All or most of the factors of production and distribution— such as land, factories, railroads, and stores—are owned by individuals. The economic system that has led to wealth creation in much of the world by supporting the Private Ownership. 7  RIGHTS IN THE FREE MARKET CAPITALISM PRIVATE PROFITS COMPETITION CHOICE PROPERTY Individuals can buy, Profits belong to Individuals/busine Individuals can sell, and use land, the owner and act sses are free to choose where buildings, machinery; and they can pass as incentives for compete and to they want to work land to their children. business owners promote goods and what they and services want to purchase Pricing in Free- Market Capitalism In a free market, prices are not entirely determined by sellers. They are determined by buyers and sellers negotiating in the marketplace. How is a price determined that is acceptable to both buyers and sellers? The answer is found in the microeconomic concept of: Supply and Demand The Economic Concept of Supply Quantity of products owners are willing to sell at different prices at a specific time. The higher the price the higher the quantity supplied. P Qs Increased Profit Incentive Covering Production Costs Expanding Production Capacity The various points on the curve indicate how many T-shirts sellers would provide at different prices. The Economic Concept of Supply Determinants of Supply: Cost of production, Technology, Input prices (such as labor and raw materials), Government policies, Competitors. Changes in these determinants can shift the entire supply curve to the left (indicating a decrease in supply) or to the right (indicating an increase in supply). The Economic Concept of Supply Ex: Supply Curve "Imagine you are running a lemonade stand, and you want to sell lemonade at a local fair. You've calculated how many cups of lemonade you're willing to supply at different prices.“ Draw the Supply graph. Price Y-axis Quantity Supplied X-axis Coordinates: (1:10) (2:20) (3:30) etc… The Economic Concept of Demand Quantity of products that people are willing to buy at different prices at a specific time. The higher the price the lower the demand. P D The various points on the graph indicate the quantity demanded at various prices. The Economic Concept of Demand Determinants of Demand: Price of the Good/Service Income Consumer Preferences and Tastes Consumer Expectations Seasonal Factors The Economic Concept of Demand Ex: Demand Curve "Imagine you are selling ice cream at a local park. You've calculated how many ice cream cones people are willing to buy at different prices.“ Y-axis Price Draw the Demand graph. X-axis Quantity Demanded Coordinates: (1:20) (2:15) (3:10) etc…  The Equilibrium Point Point at which the supply of a product or service perfectly matches its demand in a market. The quantity that consumers are willing to buy equals the quantity that producers are willing to sell, and the market price stabilizes. Other scenarios… Shortage- If the price is below the equilibrium level, then the quantity demanded will exceed the quantity supplied. Surplus- If the price is above the equilibrium level, then the quantity supplied will exceed the quantity demanded Market price for T-shirts: $15  Competition within Free Markets Perfect Monopolistic Competition Competition Oligopoly Monopoly Perfect Competition Market structure characterized by a large number of small, homogeneous firms and a multitude of buyers, where no single firm has the power to influence market 1. Perfect Competition prices. Key Characteristics: a. Many Buyers and Sellers: Numerous small firms and buyers participate in the market. b. Homogeneous Products: Products are identical in quality and features. c. Ease of Entry and Exit: Firms can easily enter or exit the market. d. Price Taker: Individual firms have no control over the market price, they are passive in terms of pricing Perfect Competition Possible Challenges: Limited Profits: Firms may struggle to make substantial profits due to competitive pricing. Lack of Incentive for Quality: Homogeneous products may lead to a lack of incentive for product quality improvement. Example: Agricultural Products 19 Monopolistic Competition Market structure characterized by many firms selling similar, but not identical, products. Each firm has some degree of market power and can differentiate its products to some extent. Key Characteristics: a. Many Sellers: Numerous firms compete within the same industry. b. Product Differentiation: Firms produce similar but not identical products, allowing for branding and differentiation. c. Easy Entry and Exit: New firms can enter the market, and existing ones can exit relatively easily. d. Non-Price Competition: Firms compete not only on price but also through advertising, branding, and product quality. Monopolistic Competition Possible Challenges: Intense Competition: Fierce competition can limit pricing power and erode profit margins. Costs of Product Differentiation: Investing in branding and product diversity can be expensive. Example: Fast food, clothing etc. Oligopoly Market structure characterized by a small number of large firms dominating an industry. These firms have significant market power and can influence prices. Key Characteristics: a. Few Dominant Firms: A small number of major firms control the majority of the market share. b. High Market Concentration: These firms often dominate the industry, leading to limited competition. c. Interdependence: Actions of one firm significantly affect the others, leading to strategic decision-making. d. Barriers to Entry: High startup costs and other barriers limit new firms from entering the market. Oligopoly Possible Challenges: Collusion Risks: Firms may collude to fix prices or reduce competition, leading to antitrust concerns. (Collusion: secret or illegal agreement between competing firms in an industry to work together to manipulate market conditions to their advantage.) Limited Choices: Few firms can lead to limited product variety and consumer choices. Examples: telecom, automotive, and airline industries Monopoly Market structure where a single firm or entity dominates the entire industry, 4. Monopoly with no close substitutes and significant market power. Key Characteristics: 1. Single Seller: A sole company controls the production and sale of a particular product or service. 2. Unique Product: The product offered by the monopoly has no close substitutes, creating a lack of alternatives for consumers. 3. Significant Market Power: The monopolist has the power to set prices and determine output levels. 4. High Barriers to Entry: Barriers such as patents or government regulation prevent new competitors from entering the market. Monopoly Possible Challenges: 4. Monopoly Consumer Welfare: Monopolies can lead to higher prices and reduced consumer choice. Lack of Competition: The absence of competition can stifle innovation and efficiency. Profit/Price controlling: Profits and are usually controlled by public service commissions to protect the interest of buyers. Examples: Public utilities: water and electricity, and certain tech companies that dominate their respective markets. To bring it all together… 26 Command Economies Economic system in which the government or a central authority exercises significant control over the production, distribution, and pricing of goods and services, typically through central planning and ownership of key industries. SOCIALISM COMMUNISM 27 SOCIALISM Socialists acknowledge the major benefit of capitalism—wealth creation—but believe that wealth should be more evenly distributed than occurs in free-market capitalism. Collective needs and reducing inequalities are more important than maximizing profit. Reduce income and wealth inequalities through mechanisms like progressive taxation, social welfare programs, and public ownership of resources. Ex: Angola, Ethiopia, Laos. ADVANTAGES DISADVANTAGES Social equality “Brain Drain” / Few inventions Free education through college, Takes away of free health care, and free child businesspeople’s incentives. care 28 SOCIALISM In class experiment: Imagine that after the first ECSB exam, students with grades of 90 and above have to give some of their points to those who make 70 and below so that everyone ends up with grades in the 80s. Would those who got 90s study as hard for the second exam? What about those who got 70s? Can you see why workers may not work as hard or as well if they all get the same benefits regardless of how hard they work? ☺ 29 COMMUNISM Economic and political system in which the government makes all economic decisions and owns almost all the major factors of production. Usually citizens are not allowed to practice certain religions, change jobs, or move to the town of their choice. Lack of supply and demand: The government doesn't know what and how to produce. (Shortages of many items, including food and clothing). Lack of freedom and motivation: Citizens usually do not wok work hard because the incentives are missing. Ex: Cuba, North Corea 30 MIXED ECONOMIES Combines aspects of both capitalism and socialism. Coexistence of private and public ownership, where businesses and individuals can own and operate private enterprises, but the government also plays a role in regulating the economy and providing certain goods and services. Government Regulation: The government regulates markets to correct market failures, protect consumers, and ensure fair practices. Ex: Most European countries 31 Bring it all together… Refer to the book 32  Key Economic Indicators Two of the major indicators of economic conditions are: Gross Domestic Unemployment Product Rate ( GDP) 1. Gross Domestic Product ( GDP) Gross domestic product (GDP), the monetary value of all finished goods and services made within a country during a specific period of time. GDP is often used as an indicator of the general health of the economy. 1. Gross Domestic Product ( GDP) Review the following information about our hypothetical country for a specific year: Consumption (C): $5,000 Investment (I): $2,000 Government Spending (G): $1,500 Exports (X): $1,200 Imports (M): $900 2. Calculate the Gross Domestic Product (GDP) for this country using the expenditure approach. 3. How do each of the components (consumption, investment, government spending, and net exports) contribute to the GDP? 4. What do you think this GDP figure tells us about the economic health and performance of the country? 35 1. Gross Domestic Product ( GDP) GDP formula: GDP = C + I + G + (X - M) GDP = $5,000 (Consumption) + $2,000 (Investment) + $1,500 (Government Spending) + ($1,200 (Exports) - $900 (Imports)) GDP = $5,000 + $2,000 + $1,500 + ($1,200 - $900) GDP = $5,000 + $2,000 + $1,500 + $300 GDP = $8,800 2. Consumption (C) represents the total spending by households in the country. Investment (I) includes spending on capital goods, such as machinery and factories. Government Spending (G) represents the expenditures made by the government. Net exports, calculated as (X - M), account for the difference between exports and imports. 3. The GDP figure of $8,800 indicates the total value of all goods and services produced within the country’s borders during the specified time period. It reflects the economic health and performance of the country. 36  2. Unemployment Rate The unemployment rate refers to the percentage of civilians at least 16 or 18 years old who are unemployed. The moment people are not working means they at the same time are not creating businesses and are not producing. Germany Unemployment Rate 2023  "How does the Unemployment Rate impact the economy?" Economic Growth High unemployment reduces consumer spending, leading to lower demand for goods and services and slower economic growth. Government Finances High unemployment strains government budgets, increasing spending on unemployment benefits and social safety nets, potentially causing deficits. Consumer Confidence: High negatively affects businesses. unemployment erodes consumer confidence, leading to reduced spending, which 38 2. Unemployment Rate Link; https://worldpopulationreview.com/country-rankings/unemployment-by-country 39 TYPES OF UNEMPLOYMENT Management according to the Economic Principle In companies, input is transformed into output in the transformation processes: Scarce Economic Infinite ressources principle needs Cf. Vahs/Schäfer-Kunz (2015), p. 8f. following Wöhe (2002), p. 1f. 17 Management according to the Economic Principle In companies, input is transformed into output in transformation processes: This is why it is necessary to manage: Management means using scarce resources in a way that satisfies needs in the most advantageous way possible. Cf. Vahs/Schäfer-Kunz (2015), p. 8f. following Wöhe (2002), p. 1f. 18 Economic Key Figures output quantity monetized output Productivity = Efficiency = input quantity monetized input 1.Productivity: Shows how much 1.Efficiency: This is the measure of how output (often in terms of quantity) is well resources (inputs) are being utilized generated for a given input. to produce a specific output. 2.Output Quantity: The total 2.Monetized Output: Value of the output amount of products, services, or of a process or system when expressed goods produced by the process or in monetary terms. It's the total financial system value of the products or services produced. 3.Input Quantity: The resources, materials, labor, or other factors that 3.Monetized Input: Value of the go into the process to produce the resources or inputs that went into the output. It includes everything that's process or system when expressed in required to make the output. monetary terms 20 Assignment In groups of 2-3 people from the same home country, research and present key information about your country. (PPT/ CANVA/ OTHER) Include the following information: Economic System Political System GDP Unemployment Rate Presentation Date In-class: 05-11-2024 More information on e-learning. 44 Economic Sciences Basics (ECSB) WS 24 Course Unit 3: BUSINESS LEGAL ENVIRONMENT Learning Objective Understanding and analyzing the content of legal form decisions. Legal Forms Legal forms represent formal structures applicable to certain types of enterprises that regulate the legal relations of the enterprise both internally and externally. Overview of legal forms according to legal basis and degree of autonomy LEGAL FORMS of public law of private law Public enterprises such as: Institutions Sole Partnerships Corporations Foundations proprietorship Public corporations Civil law Private limited partnerships (GbR) companies (GmbH) Public limited General companies (AG), partnerships (OHG) Societas Europaea SE) Limited commercial partnerships (KG) The most common legal forms in Germany Sole Proprietorship: 67.8 % of companies 9.74 % of sales revenues. Private limited liability companies (GmbH): 15.9 % of the companies, 38.4 % of sales revenues Public limited liability companies (AG): 0.2 % of the companies, 14.3 % of sales revenues See Vahs/Schäfer-Kunz (2015), p. 134. Content of legal form decisions 1. Subject: commercial enterprise or not 2. Legal capacity: no legal capacity,partial legal capacity, full legal capacity 3. Capital endow ment: required or not 4. Stakeholder / Partner /Ow ner: minimum number and type allowed 5. Changeability of equity structure: entry, withdrawal, change, exclusion 6. Organisation: joint vs. individual power of representation; management is shareholder or not 7. Liability: unlimited / limited liability 8. Profit / loss distribution: interest payment, by capital contribution, 9. Co-determination: necessary or not 10. Publicity: what, to whom, how detailed 11. Legal form dependent expenses: one-off/ current 12. Taxation of profits: type and amount of taxes (income tax, corporation tax) See Vahs/Schäfer-Kunz (2015), p. 135 (1) Subject of the company 1. Commercialbusiness: A merchant is someone who operates a commercial business. 1. Primary Goal: Profit maximization. These businesses exist to make money for their owners or shareholders. 2. Revenue Generation: Generate income by selling products or services to customers in exchange for payment. 3. Examples: Retail stores, restaurants, technology companies, manufacturing firms, and service providers etc. 2. Non-Commercial Business: 1. Primary Goal: Driven by a mission or purpose other than profit, such as serving a social, charitable, or public interest goal. 2. Revenue Generation: Generate income through grants, donations, government funding, or other non-profit sources. 3. Examples: Non-profit organizations, government agencies, educational institutions, and charitable foundations. Content of legal form decisions 1. Subject: commercial enterprise or not 2. Legal capacity: no legal capacity,partial legal capacity, full legal capacity 3. Capital endow ment: required or not 4. Stakeholder / Partner /Ow ner: minimum number and type allowed 5. Changeability of equity structure: entry, withdrawal, change, exclusion 6. Organisation: joint vs. individual power of representation; management is shareholder or not 7. Liability: unlimited / limited liability 8. Profit / loss distribution: interest payment, by capital contribution, 9. Co-determination: necessary or not 10. Publicity: what, to whom, how detailed 11. Legal form dependent expenses: one-off/ current 12. Taxation of profits: type and amount of taxes (income tax, corporation tax) See Vahs/Schäfer-Kunz (2015), p. 135 (2) Legal capacity Legal capacity of companies = refers to an individual or entity's ability to enter into binding legal agreements, make decisions, and be held accountable under the law. – No legal capacity – Partial legal capacity – Full legal capacity Companies that are legal entities have full legal capacity Legal persons/legal entities shall be organisations which, through their organs (CEO, other representatives), may participate in legal transactions as holders of rights and obligations in the same way as natural persons. For example legal persons can …. – own business assets – enter into contracts and liabilities – acquire property, rights, real estate – commit crimes – sue and be sued in court (2) Legal capacity NO LEGAL CAPACITY FULL LEGAL CAPACITY PARTIAL LEGAL CAPACITY SOLE PROPRIETORSHIP CORPORATION PARTNERSHIP Owner is the holder of Company itself holds the Company and the rights and obligations rights and obligations owners hold rights and obligations Natural Person Legal Person (acts through its organs: CEO, Managers etc) Content of legal form decisions 1. Subject: commercial enterprise or not 2. Legal capacity: no legal capacity,partial legal capacity, full legal capacity 3. Capital endowment (initial investment): required or not 4. Stakeholder / Partner /Ow ner: minimum number and type allowed 5. Changeability of equity structure: entry, withdrawal, change, exclusion 6. Organisation: joint vs. individual power of representation; management is shareholder or not 7. Liability: unlimited / limited liability 8. Profit / loss distribution: interest payment, by capital contribution, 9. Co-determination: necessary or not 10. Publicity: what, to whom, how detailed 11. Legal form dependent expenses: one-off/ current 12. Taxation of profits: type and amount of taxes (income tax, corporation tax) See Vahs/Schäfer-Kunz (2015), p. 135 Content of legal form decisions 1. Subject: commercial enterprise or not 2. Legal capacity: no legal capacity,partial legal capacity, full legal capacity 3. Capital endowment (initial investment): required or not 4. Stakeholder / Partner /Ow ner: minimum number of persons needed to found a company 5. Changeability of equity structure: entry, withdrawal, change, exclusion 6. Organisation: joint vs. individual power of representation; management is shareholder or not 7. Liability: unlimited / limited liability 8. Profit / loss distribution: interest payment, by capital contribution, 9. Co-determination: necessary or not 10. Publicity: what, to whom, how detailed 11. Legal form dependent expenses: one-off/ current 12. Taxation of profits: type and amount of taxes (income tax, corporation tax) See Vahs/Schäfer-Kunz (2015), p. 135 Content of legal form decisions 1. Subject: commercial enterprise or not 2. Legal capacity: no legal capacity,partial legal capacity, full legal capacity 3. Capital endowment (initial investment): required or not 4. Stakeholder / Partner /Ow ner: minimum number of persons needed to found a company 5. Changeability of equity structure: entry, withdrawal, change, exclusion 6. Organisation: joint vs. individual power of representation; management is shareholder or not 7. Liability: unlimited / limited liability 8. Profit / loss distribution: interest payment, by capital contribution, 9. Co-determination: necessary or not 10. Publicity: what, to whom, how detailed 11. Legal form dependent expenses: one-off/ current 12. Taxation of profits: type and amount of taxes (income tax, corporation tax) See Vahs/Schäfer-Kunz (2015), p. 135 Content of legal form decisions 1. Subject: commercial enterprise or not 2. Legal capacity: no legal capacity,partial legal capacity, full legal capacity 3. Capital endowment (initial investment): required or not 4. Stakeholder / Partner /Ow ner: minimum number of persons needed to found a company 5. Changeability of equity structure: entry, withdrawal, change, exclusion 6. Organisation: joint vs. individual power of representation 7. Liability: unlimited / limited liability 8. Profit / loss distribution: interest payment, by capital contribution, 9. Co-determination: necessary or not 10. Publicity: what, to whom, how detailed 11. Legal form dependent expenses: one-off/ current 12. Taxation of profits: type and amount of taxes (income tax, corporation tax) See Vahs/Schäfer-Kunz (2015), p. 135 (6) Organization The legal form determines how the three areas of ownership, management and supervision are organizationally embedded. Representation and management: – Individual power of representation and management: Each managing director may decide independently of the approval of the other directors. – Collective power of representation and management: Each transaction requires the consent of all other managing directors 117 Management vs. Representation Management ≠ Representation = = the shaping and directing of all the execution of all transactions ordinary business internally in a on behalf of the company in company. relation to third parties In most cases, managing directors also represent the company in relation to third parties. 118 Content of legal form decisions 1. Subject: commercial enterprise or not 2. Legal capacity: no legal capacity,partial legal capacity, full legal capacity 3. Capital endowment (initial investment): required or not 4. Stakeholder / Partner /Ow ner: minimum number of persons needed to found a company 5. Changeability of equity structure: entry, withdrawal, change, exclusion 6. Organisation: joint vs. individual power of representation; management is shareholder or not 7. Liability: unlimited / limited liability 8. Profit / loss distribution: interest payment, by capital contribution, 9. Co-determination: necessary or not 10. Publicity: what, to whom, how detailed 11. Legal form dependent expenses: one-off/ current 12. Taxation of profits: type and amount of taxes (income tax, corporation tax) See Vahs/Schäfer-Kunz (2015), p. 135 (7) Liability UNLIMITED LIABILITY LIMITED LIABILITY Shareholders/partners have The liability of the unlimited and personal liability shareholders/partners is both with the assets of the limited and indirect: company and with their entire to the assets of the private assets. company to a predetermined liability amount, which may differ from the capital contribution to the company. Content of legal form decisions 1. Subject: commercial enterprise or not 2. Legal capacity: no legal capacity,partial legal capacity, full legal capacity 3. Capital endowment (initial investment): required or not 4. Stakeholder / Partner /Ow ner: minimum number of persons needed to found a company 5. Changeability of equity structure: entry, withdrawal, change, exclusion 6. Organisation: joint vs. individual power of representation; management is shareholder or not 7. Liability: unlimited / limited liability 8. Profit / loss distribution: interest payment or by capital contribution 9. Co-determination: necessary or not 10. Publicity: what, to whom, how detailed 11. Legal form dependent expenses: one-off/ current 12. Taxation of profits: type and amount of taxes (income tax, corporation tax) See Vahs/Schäfer-Kunz (2015), p. 135 (8) Profit and loss distribution Fixed interest rate on capital contributions Profit privileges (e.g. preference shares) Disqualification ShareholderA Shareholder B Shareholder C Capital contribution of of of Distribution of 400 € profit 280 €to interest the capital contribution at 4%. =1000 € * 4% =2000 € * 4% =4000 € * 4% 120 € residual profit per capita Total → Specification in the shareholders/partnership agreement possible! Content of legal form decisions 1. Subject: commercial enterprise or not 2. Legal capacity: no legal capacity,partial legal capacity, full legal capacity 3. Capital endowment (initial investment): required or not 4. Stakeholder / Partner /Ow ner: minimum number of persons needed to found a company 5. Changeability of equity structure: entry, withdrawal, change, exclusion 6. Organisation: joint vs. individual power of representation; management is shareholder or not 7. Liability: unlimited / limited liability 8. Profit / loss distribution: interest payment, by capital contribution 9. Co-determination: allow employees to participate in the decision making process 10. Publicity: what, to whom, how detailed 11. Legal form dependent expenses: one-off/ current 12. Taxation of profits: type and amount of taxes (income tax, corporation tax) See Vahs/Schäfer-Kunz (2015), p. 135 (9) Co-determination Entrepreneurial co-determination: Involvement of employees in supervisory boards or even management bodies of companies. Content of legal form decisions 1. Subject: commercial enterprise or not 2. Legal capacity: no legal capacity,partial legal capacity, full legal capacity 3. Capital endowment (initial investment): required or not 4. Stakeholder / Partner /Ow ner: minimum number of persons needed to found a company 5. Changeability of equity structure: entry, withdrawal, change, exclusion 6. Organisation: joint vs. individual power of representation; management is shareholder or not 7. Liability: unlimited / limited liability 8. Profit / loss distribution: interest payment, by capital contribution 9. Co-determination: necessary or not 10. Publicity: what, to whom, how detailed 11. Legal form dependent expenses: one-off/ current 12. Taxation of profits: type and amount of taxes (income tax, corporation tax) See Vahs/Schäfer-Kunz (2015), p. 135 (10) Publicity In the context of legal systems, publicity refers to the principle that certain legal actions, decisions, or statuses must be made publicly accessible or known to ensure transparency, accountability, and fairness. Transparency in Legal Proceedings Publication of Laws and Regulations Land and Property Registration Financial Transactions Content of legal form decisions 1. Subject: commercial enterprise or not 2. Legal capacity: no legal capacity,partial legal capacity, full legal capacity 3. Capital endowment (initial investment): required or not 4. Stakeholder / Partner /Ow ner: minimum number of persons needed to found a company 5. Changeability of equity structure: entry, withdrawal, change, exclusion 6. Organisation: joint vs. individual power of representation; management is shareholder or not 7. Liability: unlimited / limited liability 8. Profit / loss distribution: interest payment, by capital contribution 9. Co-determination: necessary or not 10. Publicity: what, to whom, how detailed 11. Dependent expenses: one-off/ current 12. Taxation of profits: type and amount of taxes (income tax, corporation tax) See Vahs/Schäfer-Kunz (2015), p. 135 (11) Legal form dependent expenses: Expenses that vary from the legal structure of a business. It costs money to run a business (ongoing expenses): Expenses and payments regarding: -Certificates, -Entrance in the commercial register, -Contract building expenses, -Financial bookkeeping. Content of legal form decisions 1. Subject: commercial enterprise or not 2. Legal capacity: no legal capacity,partial legal capacity, full legal capacity 3. Capital endowment (initial investment): required or not 4. Stakeholder / Partner /Ow ner: minimum number of persons needed to found a company 5. Changeability of equity structure: entry, withdrawal, change, exclusion 6. Organisation: joint vs. individual power of representation; management is shareholder or not 7. Liability: unlimited / limited liability 8. Profit / loss distribution: interest payment, by capital contribution 9. Co-determination: necessary or not 10. Publicity: what, to whom, how detailed 11. Legal form dependent expenses: one-off/ current 12. Taxation of profits: type and amount of taxes See Vahs/Schäfer-Kunz (2015), p. 135 (12) Taxation of profits: Income tax Corporation tax A corporate tax is a tax on the profits of a corporation. The taxes are paid on a company's taxable income, which includes revenue minus cost of goods sold (COGS), general and administrative (G&A) expenses, selling and marketing, research and development, depreciation, and other operating costs. Corporate tax Germany: 15% ECSB Course Evaluation Please scan the QR code and evaluate Economic Sciences Basics (ECSB) WS24 Course Unit 3: BUSINESS LEGAL ENVIRONMENT Legal forms and legal form decisions Legal forms represent formal structures applicable to certain types of enterprises that regulate the legal relations of the enterprise both internally and externally. Overview of legal forms according to legal basis and degree of autonomy LEGAL FORMS of public law of private law Public enterprises such as: Institutions Sole Partnerships Corporations Foundations proprietorship Public corporations Civil law Private limited partnerships (GbR) companies (GmbH) Public limited General companies (AG), partnerships (OHG) Societas Europaea SE) Limited commercial partnerships (KG) Content of legal form decisions 1. Subject: commercial enterprise or not 2. Legal capacity: no legal capacity, partial legal capacity, full legal capacity 3. Capital endowment: required or not 4. Stakeholder / Partner /Owner: minimum number and type allowed 5. Changeability of equity structure: entry, withdrawal, change, exclusion 6. Organisation: joint vs. individual power of representation 7. Liability: unlimited / limited liability 8. Profit / loss distribution: interest payment, by capital contribution, 9. Co-determination: allow employees to participate in the decision-makingprocess 10. Publicity: what, to whom, how detailed 11. Legal form dependent expenses: one-off/ current 12. Taxation of profits: type and amount of taxes (income tax, corporation tax) See Vahs/Schäfer-Kunz (2015), p. 135 6 The Content of Sole Proprietorships Criteria Sole Proprietorship Subject Liability Stakeholder/ Owner Capital Endowment Profit / Loss Distribution Legal Capacity Organization Taxation 7 The Content of Sole Proprietorships Criteria Sole Proprietorship Subject Commercial Business Liability Unlimited Stakeholder/ Owner 1 Natural Person Capital Endowment No minimum amount Profit / Loss Distribution 100% to the owner Legal Capacity NO Legal Capacity Organization Individual power of representation Taxation Income Tax 8 The Content of General Partnership Business structure in which two or more individuals or entities jointly own and operate a business. Criteria General Partnership OHG Subject Commercial Business Liability Unlimited Stakeholder/ Owner +2, General Partners Capital Endowment No minimum amount Profit / Loss Distribution Per head Legal Capacity Partial Legal Capacity Organization Individual Power of Representation Taxation Income Tax Legal capacity of partnerships to engage in legal transactions, independent of their owners (partners), varies depending on the type of partnership and the jurisdiction. 9 The Content of Limited Commercial Partnership Business structure in which at least one partner is a general partner with unlimited liability for the partnership's debts and one or more partners are limited partners with liability limited to their investment. Criteria Limited Commercial Partnership KG Subject Commercial Business Liability Limited Stakeholder/ Owner +2, General + Limited Partners Capital Endowment No minimum amount Profit / Loss Distribution Per head Legal Capacity Partial Legal Capacity Organization Individual Power of Representation Taxation Income Tax 10 The Content of Private Limited Corporation Business entity whose ownership is restricted to a small group, such as founders, family, or private investors. Shares are usually held privately and they are not publicly traded on stock exchanges. Criteria Private Limited Corporation GmbH Subject Commercial Business. Legal Entity Liability Limited to Capital Investment Stakeholder/ Owner At least 2 natural, legal persons Capital Endowment (DE) 25.000 € Profit / Loss Distribution Depends of initial capital investment Legal Capacity Full Legal Capacity Publicity No publicity needed Taxation Corporate Tax 11 The Content of Public Limited Corporation Business structure that offers shares to the public and is listed on stock exchanges, making it possible for investors to buy and trade its shares. Criteria Public Limited Corporation AG Subject Commercial Business. Legal Entity Liability Limited to Capital Investment Stakeholder/ Owner At least 2 natural, legal persons Capital Endowment 50.000 € Profit / Loss Distribution Depends of initial capital investment Legal Capacity Full Legal Capacity Publicity Disseminate information contained within financial documents Taxation Corporate Tax 12  ASSIGNMENT  Title: Legal Form Analysis Presentation Objective: Analyze the legal form decisions of a chosen national or international company and present your findings in an in-class presentation. Instructions: 1. Company Selection: Choose a company for analysis. 2. Legal Form Analysis: Research the company's legal structure and decisions. 3. Presentation: Create a maximum 5-6 slide PowerPoint presentation. 4. Team: Work in pairs of two or three. 5. Submission: Submit on e-learning until Dec 9-th. 6. Presentation Date: Present in class on 10/12/2024. 7. Late submissions won’t be accepted and you won’t have the opportunity to present in class. Please scan the QR code and evaluate the ECSB Course. Economic Sciences Basics (ECSB) WS 24/25 Course Unit 4: INTRODUCTION TO FINANCIAL ACCOUNTING 164 Learning Objectives o Demonstrate the role that accounting and financial information play for a business and its stakeholders. o Understand the fundamentals of financial accounting. o Understand the three main financial statements and how they are interlinked. 165 ACCOUNTING “Accounting represents the systematic and comprehensive recording, summarizing, analyzing, and reporting of financial transactions of a business“. 4 The Importance of ACCOUNTING Small and large enterprises often survive or fail according to how well they handle their financial procedures. Financial management is the heartbeat of competitive businesses. Accounting information helps keep the heartbeat stable. 5 The Importance of learning ACCOUNTING 6 The Importance of ACCOUNTING in Business 1. Financial Performance Evaluation: Financial accounting provides a clear and structured way to assess a company's financial performance. 2. Decision-Making: Financial accounting data informs decision- making at various levels of a business. It helps management make choices about investments, pricing, and cost control. 3. Budgeting and Planning: Companies use financial accounting to create budgets and financial forecasts, which are essential for setting goals and tracking progress. 4. Resource Allocation: It helps in determining where to allocate resources efficiently. Understanding which departments or projects are profitable and which are not is key to optimizing resource allocation. 7 ACCOUNTING Accounting represents the systematic and comprehensive recording, summarizing, analyzing, and reporting of financial transactions of a business. Financial transactions include: buying and selling goods and services, acquiring insurance, paying employees, using supplies. The method we use to record and summarize accounting data into reports is through the accounting system. 8 The Accounting System 1. The inputs to an accounting system include sales documents and other documents. 2. The data are recorded, classified, and summarized. 3. They’re then placed into summary financial statements such as the income statement and balance sheet and statement of cash flows 9 Types of Accounting: Financial and Managerial Accounting The systematic and comprehensive recording, summarizing, Accounting analyzing, and reporting of financial transactions of a business. Focuses on the recording and reporting of an organization's Financial financial information to external stakeholders, such as Accounting investors, potential investors, creditors or tax authorities. Legal requirements or standards apply. Provides information and analysis to managers inside the Managerial organization to assist them in decision making. Accounting Concerned with measuring and reporting costs of production and other functions; preparing budgets (planning); checking whether or not units are staying within their budgets (controlling); and designing strategies to minimize taxes. Michel/Shaked (1996); Narayanan (2017); Ross et al. (2005) Financial Accounting Principles Guidelines that accountants and managers must follow when preparing an auditing information for external reporting purposes: – US GAAP (Generally Accepted Accounting Principles) – IFRS (International Financial Reporting Standards) Michel/Shaked (1996); Narayanan (2017); Ross et al. (2005) Financial Accounting Principles Guidelines that accountants and managers must follow when preparing an auditing information for external reporting purposes: – US GAAP (Generally Accepted Accounting Principles) US GAAP refers to the standardized framework of accounting rules, standards, and procedures used in the United States for financial reporting. Financial Accounting Standards Board (FASB) develops this principles Securities and Exchange Commission (SEC) enforce the principles for publicly traded companies. US GAAP is considered rule-based, meaning it provides detailed, specific guidelines for accounting practices. Michel/Shaked (1996); Narayanan (2017); Ross et al. (2005) Financial Accounting Principles Guidelines that accountants and managers must follow when preparing an auditing information for external reporting purposes: – IFRS (International Financial Reporting Standards) IFRS is a globally accepted framework for preparing financial statements. It is used in over 140 countries, including the European Union, Canada, and parts of Asia and Africa. It is principles-based and provides broad guidelines rather than strict, detailed rules (unlike US GAAP, which is rule-based). Allows companies more flexibility in how they apply accounting standards but requires professional judgment in interpreting and implementing them. Michel/Shaked (1996); Narayanan (2017); Ross et al. (2005) The Basic Financial Accounting Concepts Accounting Standards provide guidance on accounting policy decisions so that businesses will record transactions and events similarly: – The entity concept: accounts kept for an entity are distinct from the people who own, run or do business with the entity, ensuring that personal transactions do not mix with business transactions. – The money measurement concept: financial accounting deals only with transactions that can be represented in monetary terms (ex: customer satisfaction can‘t be included). – The consistency concept: an entity should use the same accounting methods and procedures from period to period unless there is a sound reason to change. Narayanan (2017) The Basic Financial Accounting Concepts – The materiality concept: only important and relevant information that could impact financial decisions should be included in financial statements. (ex: A company with total annual revenues of $10 million accidentally omits a transaction worth $500. This small error is considered immaterial because it does not significantly impact the overall financial results). – The matching concept: expenses should be recognized and matched with the revenues they help generate in the same accounting period. (ex: A company pays its employees a monthly salary of $50,000 on the 5th of each month for work performed in the previous month. For example, salaries for January are paid on February 5th. Even though the salaries are paid in February, they relate to work done in January). – The reliability of evidence concept: rely as much as possible on objective, verifiable documentary evidence instead of subjective judgements of a person. The three main Financial Statements Balance Income Cash Flow Sheet Statement Statement (Statement of (Profit and Loss Financial Statement) Position) The three main Financial Statements Balance sheet “snapshot” of what the firm owns and how it is financed how a company generates and uses cash over a particular period Cash Flow Statement Income Statement performance over a period of time: income and expenses Corporatefinancinstitute.com 172 Financial Accounting: Cash Accounting vs. Accrual Accounting Cash Accounting Accrual Accounting Records sales when the Recognizes revenues cash is received and and expenses as they expenses when they are are earned or incurred, paid. even though they may not have been received or paid in cash. Michel/Shaked (1996); Narayanan (2017); Ross et al. (2005)  Financial Accounting: Cash Accounting vs. Accrual Accounting Cash Accounting Accrual Accounting Ex: On January 5th, ABC Consulting provides Ex: On January 5th, ABC Consulting marketing advice to a client. The agreed-upon provides marketing advice to a client. The fee is $1,000. agreed-upon fee is $1,000. Accrual Accounting: ABC Consulting Cash Accounting: No entry is made on January recognizes the revenue when the service is 5th because the service was provided, but no provided, regardless of when the cash is cash has been received yet. received. 1. Debit: Service Revenue $1,000 Payment Received: 2. Credit: Accounts Receivable $1,000 1. On January 15th, the client pays ABC Payment Received: Consulting $1,000 for the marketing 1. On January 15th, the client pays ABC advice. Consulting the $1,000 for the marketing 2. Cash Accounting: ABC Consulting advice. records the transaction on January 2. Accrual Accounting: ABC Consulting 15th when the cash is received. records the receipt of cash against the 1. Debit: Cash $1,000 accounts receivable. 1. Debit: Cash $1,000 2. Credit: Service Revenue $1,000 2. Credit: Accounts Receivable $1,000 ACCOUNTING “Accounting represents the systematic and comprehensive recording, summarizing, analyzing, and reporting of financial transactions of a business“. 1 The Accounting System 1. The inputs to an accounting system include sales documents and other documents. 2. The data are recorded, classified, and summarized. 3. They’re then placed into summary financial statements such as the income statement and balance sheet and statement of cash flows 2 The three main Financial Statements Balance Income Cash Flow Sheet Statement Statement (Statement of (Profit and Loss Financial Statement) Position) The three main Financial Statements Balance sheet “snapshot” of what the firm owns and how it is financed how a company generates and uses cash over a particular period Cash Flow Statement Income Statement performance over a period of time: income and expenses Corporatefinancinstitute.com 172 Business Activity and the Balance Sheet Business activities- Events that affect assets, liabilities and owner’s equity of the business and its balance sheet. Accounting Transactions Types of accounting Transactions: Financing- Related to creditors, debitors and owners such as borrowing or paying loans, payment of stockholders etc. Investing- Acquisition and disposal of assets for use in the business. Operating- Related to cusomers such as sales, payment of employees or other suppliers. I. The Balance Sheet Reports an entity‘s financial situation at a particular point in time, States what the firm owns and how it is financed, Two sides: On the left are the Assets, on the right are the Liabilities and Shareholders/Owners equity. Michel/Shaked (1996); Narayanan (2017); Ross et al. (2005) I. The Balance Sheet Example I. The Balance Sheet Has three main sections: – Assets („ressources controlled by the entity“) – Liabilities (financial obligations and debts that an organization owes to external parties) – Owner‘s equity (ownership interest in the assets of the business) MUST always balance. Fundamental Accounting Equation: Assets = Liabilities + Owner‘s Equity Assets - Liabilities = Owner‘s Equity Assets - Owner‘s Equity = Liabilities Assets in the Balance Sheet Assets are economic resources (things of value) owned by a firm. Assets include productive, tangible items such as equipment, buildings, land, furniture, and motor vehicles that help generate income, as well as intangible items with value like patents, trademarks, copyrights. Accountants list assets on the firm’s balance sheet in order of their liquidity, or the ease with which they can convert them to cash. Assets in the Balance Sheet Assets are thus divided into three categories, according to how quickly they can be turned into cash: 1. CURRENT ASSETS are items that can or will be converted into cash within one year. They include cash, accounts receivable, and inventory. 2. FIXED ASSETS are long-term assets that are relatively permanent such as land, buildings, and equipment. (On the balance sheet we can also refer to these as property, plant, and equipment.) 3. INTANGIBLE ASSETS are long-term assets that have no physical form but do have value: Patents, trademarks, copyrights. Assets in the Balance Sheet ① Current assets: Items that can be converted to cash within one year. ② Fixed assets: Items such as land, buildings, and equipment that are relatively permanent. ③ Intangible assets: Items of value such as patents and copyrights that don’t have a physical form. Liabilities in the Balance Sheet Liabilities are what the business owes to others—its debts. Current liabilities are debts due in one year or less. Long-term liabilities are debts not due for one year or more. The following are common liability accounts recorded on a balance sheet: 1. Accounts payable are current liabilities or bills the company owes others for merchandise or services it purchased on credit but has not yet paid for. 2. Notes payable can be short-term or long-term liabilities (like loans from banks) that a business promises to repay by a certain dat