Understanding the Nature and Purpose of Business PDF - AQA

# Understanding the Nature and Purpose of Business ## Build your own business studies dictionary - As you progress through this book, it may be useful to build up your own glossary/dictionary of terms. - This should ease your revision and help to ensure that you can define terms clearly. - Know...

# Understanding the Nature and Purpose of Business ## Build your own business studies dictionary - As you progress through this book, it may be useful to build up your own glossary/dictionary of terms. - This should ease your revision and help to ensure that you can define terms clearly. - Knowing the exact meaning of terms will also allow you to write relevantly on the other, non-definition questions. ## Read each chapter thoroughly - On completion of each topic, aim to have read each page of the relevant section or chapter and use the questions at the end of each section or chapter to test yourself. - If you adopt this approach for every topic in the book, your revision should be just that: revising what you have already learned rather than learning material for the first time. ## Complete the practice exercises and case studies - Try to tackle the practice exercises and case studies in each chapter, even if not asked to do so by your teacher. - Completion of these exercises and case studies will help you to check that you have understood the basic ideas in the chapters. It will also help you to develop the best approach to answering business questions. ## Develop your communication and data-handling skills - There is no need to have studied GCSE Business before starting the AS or A-level courses; the AQA A-level specification, which includes the AS specification, assumes that you have no prior understanding of the subject. - However, the course does expect you to have already developed certain skills during your previous education programme. These skills are communication and the ability to use, prepare and interpret business data. You should be able to understand and apply averages (the mean, median and mode); prepare and interpret tables, graphs, histograms, bar charts and pie charts; and use index numbers. ## Focus on the higher-level skills - It is tempting to focus chiefly on the facts when you are revising. - Remember that analysis and evaluation are also important. Try to think of ways to apply your learning. For example, as people become richer they buy more products, but some firms (those making luxuries) will probably benefit more than those providing necessities. ## Read the Chief Examiner's Report - This report will alert you to the strengths and weaknesses shown by previous students and will help you to refine your approach. - Along with previous examination papers and mark schemes, these reports are available in PDF format from the AQA website (www.aqa.org.uk). ## Acknowledgements - The authors would like to express their thanks to numerous individuals who have contributed to the completion of this book. - John dedicates this book to his grandchildren - Saskia, Rupert, Gabriel and Zephyr: a new generation of book lovers. - Gwen is grateful to John, who is always calm, relaxed and supportive, allowing her the time and space to complete this work. # Understanding the Nature and Purpose of Business This chapter provides an understanding of the nature and purpose of business. It is split into two parts. The first part examines why businesses exist by focusing on business objectives. - It explains the terms 'business mission' and 'business objectives' and considers the relationship between a business's mission and its objectives. - It discusses why businesses formally identify their mission and why they set objectives. - It concludes by identifying and discussing the most common business objectives, including profit, growth, survival, cash-flow and social and ethical objectives. - The second part examines the measurement and importance of profit. - In examining the measurement of profit, it includes explanations of revenue (also known as turnover and sales), fixed costs, variable costs and total costs. # Why Businesses Exist Businesses exist essentially to provide goods and services for their customers. - Customers could be in the UK or abroad, they might be individuals, other businesses or government departments. - If a business can meet the needs of its customers in terms of the cost and quality of the goods or services it provides, it is likely to be successful and to survive in the longer term. Most businesses begin in a small way, often being set up by a single individual or a small group of individuals. Individuals who have a business idea that they develop by setting up a new business and encouraging it to grow are known as entrepreneurs. - They take the risk and reap the subsequent profits that come with success or bear the losses that come with failure. - The initial motivation for setting up a business varies. - Some individuals decide to set up in business because they have a talent or skill they wish to use to provide goods and services that they believe will sell. - Others may have spotted a gap in the market that they feel they can fill. # Relationship between Mission and Objectives - The mission of a business is its essential purpose or intentions. - It is sometimes stated in terms of the main aim or aims of a business. - The mission of a business is usually stated in qualitative rather than numerical terms. - A mission statement is the means of communicating to key stakeholders (i.e. individuals or groups with an interest in the business such as shareholders, employees, suppliers and customers) what the organisation is doing and what it ought to be doing. Business objectives are designed to enable a business to achieve its aims or mission. - They can be set at corporate (or company-wide) level and at functional (or departmental or divisional) level. - Corporate objectives govern the objectives set by each department or division of a business. - (Unless otherwise stated, business objectives in this chapter will focus on corporate objectives. Functional objectives in relation to marketing, operations, finance and human resources will be discussed in detail in Chapters 7, 11, 16 and 20 respectively.) Before an organisation can set its business objectives, it must have a clear understanding of its overall purpose, i.e. its mission. - This is because the mission or corporate aims of a business will determine the way in which it is intended the business will develop, which in turn will provide a clear focus from which the business objectives can be set. - The fact file on Disney and the case study on Whitbread later in this chapter illustrate the relationship between mission and objectives. # Common Business Objectives Business objectives vary depending on the size of the business and its legal structure. - For example, the main objective of a corner shop may simply be to survive, whereas a multinational business may be more concerned with promoting its corporate image and growing larger. - Some common business objectives are described below. ## Profit - Profit maximisation is often cited as the most important business objective, but in practice firms are more likely to aim for a level of profit that satisfies the owners of the business. - In order to achieve this overall objective, appropriate functional objectives will be needed, for example: effective marketing in order to increase sales; minimising costs in order to improve profit margins (the difference between revenue and costs for each item sold); effective utilisation of capacity; and improving staff productivity by reducing staff turnover and staff absenteeism. ## Growth - Growth may relate to increasing market share, sales turnover (the value or volume of sales), number of outlets or number of business areas. - Growth may be linked to another objective to become the market leader in terms of sales value, sales volume or profits. - Business growth can be achieved by increasing the size of the existing business or by takeovers of, and mergers with, other businesses. - In order to achieve the overall objective of growth, appropriate functional objectives might include increasing market share, retaining profit in the business in order to finance growth, increasing capacity by expanding the number of sites, recruiting more staff and improving training provision. - Growth is less likely to be an important objective for small businesses that value their independence. - External factors, such as the size of the market, the level of competition and the state of the economy, as well as the financial health of a business are likely to influence the attainment of business objectives related to growth. ## Survival - Although most businesses wish to do more than simply survive, survival is a key objective for many small or new businesses, especially if they are operating in highly competitive markets. - Survival is even more significant during periods of uncertainty and difficult economic conditions. - When incomes are falling and demand is weak, many businesses will aim to survive until trading conditions improve and they can focus more positively on objectives related to profit and growth. - Functional objectives that will assist a business's survival might include: - achieving minimum levels of sales revenue to ensure costs are met and market share is retained - maintaining appropriate levels of stock in order to meet demand but not to tie money up in goods and materials whose value may be declining - maintaining the required number of well-trained staff to meet production needs and to be prepared for when the market picks up. ## Cash Flow - A business must ensure that it has sufficient cash flowing into the business in order to cover the amount it must pay out in any period. - Maintaining a healthy cash flow is therefore vital for all businesses. - Even profitable firms can be vulnerable if they fail to manage their cash flow properly. - For example, a car repair business may give its customers three months to pay their bills but is only given two months before it must pay its tyre suppliers. - If there is insufficient cash to pay its tyre suppliers on time, suppliers may refuse to provide tyres, which will mean the car repairer is unable to carry on its business. - This might happen even though the business has plenty of customers and the potential to be profitable. ## Social and Ethical Objectives - Social and ethical objectives are clearly evident in non-profit organisations such as charities, which are set up with the sole purpose of achieving particular social or ethical objectives. - For example, Shelter's key objective is to give people the help they need and campaign relentlessly in order to achieve their vision of a 'safe, secure and affordable home' for everyone. - Commercial or for-profit organisations are also likely to have social and ethical objectives. # Measurement and Importance of Profit ## Revenue and Price - Setting a price is a difficult task. - Typically, a business must set a price that is high enough to cover the costs of making goods or providing a service and leave a surplus that is profit. - However, a high price will mean a smaller number of customers are likely to buy the product. - The business must find the ideal selling price - the one that helps it to make the most profit. ## Total Revenue - Total revenue may also be described by the following terms: - income - revenue or sales revenue - turnover or sales turnover. ## Effect of Changes in Sales Volume on Total Revenue - When asked to look at the effect of a change in sales volume on total revenue, you should assume that the selling price remains unchanged, regardless of sales volume. - Therefore, if sales volume doubles, total revenue will double; if sales volume falls by 10 per cent, total revenue will fall by 10 per cent. - In both cases, the selling price will stay the same. - This is an oversimplification of what actually happens in real life, but it is helpful to firms because it allows them to make fairly accurate predictions about how total revenue will change as sales volume changes. In turn, this will assist them in making logical business decisions. - In Chapter 8, the section on price elasticity of demand will provide an insight on how total revenue might change in a different way as sales volume rises. ## Costs - A business can increase profits by reducing costs. - More efficient methods, such as cutting down on staff or reducing the amount of wastage on the production line, can increase profit. - However, the business must be careful that these cost savings do not reduce quality. - If quality is reduced, total revenue may be affected as customers will be less likely to buy the products. ## Classifying Costs - Costs are classified as fixed, variable and total. - There are two principal reasons for classifying costs: - To assess the impact of changes in output on the costs of production: a firm can compare additional revenue from an increase in sales volume to see if it exceeds the extra costs incurred. A firm aiming to make a profit should increase sales volume if the extra revenue exceeds the additional costs of increasing output. - To calculate the costs of making a particular product in a multi-product company: it can be difficult to work out whether it is worthwhile making a product. It is easy to calculate the sales income of a product, but many costs (e.g. office rent, canteen facilities) are not specific to any single product made by a firm. ## Costs and Output - A company can use the link between costs and output to calculate the financial implications of changing its level of output. - In reality, it is impossible to predict the exact change in each and every cost, so general classifications of costs are used to estimate the likely effect of output changes on individual costs. - To simplify the calculations, costs are classified as fixed, variable and total costs. - If there is an x% rise in output, it is assumed that: - fixed costs do not change - variable costs change by the same percentage as the change in output (a rise of x% in this case). - This is an oversimplification of real life, but it does enable firms to make reasonably accurate predictions about how costs will change as output changes, enabling them to make logical business decisions. ## Relationship between Costs and Price - In many industries, increases in costs, such as raw materials and labour, are 'passed on' to the consumer in the form of higher prices. - Although business theory suggests that higher prices will lead to a fall in the quantity demanded (and possibly in sales revenue), demand is less likely to fall if every business is increasing its prices. - This is likely to happen when costs are increasing, because all firms will be affected in a similar way and they will all be trying to maintain a profit margin (the difference between the selling price of an item and the cost of making or buying that item). ## Profit - Profit is a prime objective of most firms. - Profit = total revenue - total costs. - There are two ways of improving profit: - increase sales revenue - decrease costs. - A combination of both is the ideal way of achieving additional profit. ## Measuring Profit - A business will want to choose the most profitable level of output and/or want to assess how changes in output and sales might affect profit. ## Importance of Profit - Profit is a reward. - Business owners take a risk when using their money to purchase shares or take ownership of a business. - To compensate for the risk that they have taken, business owners are entitled to the profits made by the business. - Every six months, public limited companies usually pay a dividend to their shareholders. - This dividend payment represents the share of the profits allocated to shareholders. - Some shareholders depend on the dividend payment as a source of income, particularly retired people who rely on their shares to provide a steady flow of money. - These shareholders may have a greater interest in making sure that a high dividend is paid. - Without this opportunity to earn a reward it is unlikely that people would invest in businesses. - In practice, profits are not always given to owners as dividends. - Many businesses retain some of their profits so that they can buy more resources in order to make more profit in future years. - In this way, owners are still being rewarded, but are waiting to receive some of those rewards. - Profit is a motivator. - For owners of businesses, profit is a motivator. - Sole traders are entitled to all of the profits from their businesses, while many private limited companies will be owned by the people running the business. - In many companies there are profit-sharing schemes, in which staff are given incentives to work effectively by receiving a share of the profit made. - The John Lewis Partnership uses this type of incentive to reward its employees. - Profit is a measure of success. - It is possible to assess the performance of a business by comparing its profits to those of other companies, particularly its competitors. - However, before using profit to measure success it is important to examine the business's objectives, as some businesses give profit a lower priority than others. - Profit is a guide for future investment. - The efficiency of different sectors of the economy can be analysed by observing where profits are high and where they are low. - Prospective investors can use changes in profit levels as a guide to those markets where it is becoming easier to make profit and those where losses are more likely. - In this way scarce resources are constantly moved away from unprofitable activities towards profitable activities. - Profit is a source of finance. - In order to fund expansion plans and capital investment, the company directors will wish to keep some of the profits in the business. - This avoids the need to pay interest on borrowed money or to sell more shares in order to finance expansion. - Retained (or 'ploughed-back') profits increase the assets of a business and should therefore increase the value of the company. - Furthermore, retained profits should help the business to increase its future profits (and thus increase future dividends). - In the UK, this is the main source of capital for established businesses, because it is very cost-effective and convenient. - It does not have to be repaid and does not require payment of interest. - In practice, most firms will strike a balance between paying dividends and retaining profits. - Profit is attractive to stakeholders. - For example, workers will be eager to apply for a job in a profitable company; customers will be more likely to want to purchase products from a successful company; and suppliers will be keen to obtain contracts with a business that is making a profit, as they will be a reliable customer in the future. # Understanding Different Business Forms This chapter focuses on different business forms. It begins with an explanation of the difference between private and public sector organisations. Private sector organisations are then considered in detail. The important concepts of unincorporated and incorporated businesses and of unlimited and limited liability are introduced first. Then private sector for-profit organisations are considered, including sole traders, partnerships, private limited companies and public limited companies. In relation to limited companies, consideration is given to ordinary share capital, market capitalisation and dividends. The role of shareholders and why they invest is considered, and the influences on share price and significance of share price changes are discussed. A summary of the range of non-profit organisations in the private sector, such as charities and mutual societies, is included. The chapter concludes with a discussion of the effects of ownership on an organisation's mission, objectives, decisions and performance. # Different forms of business Forms of business range from very small one-man operations to multinational corporations. Some business forms are set up in order to make profits for their owners and others are established to pursue community or charitable aims. Some business forms operate in the public or governmental sector and others in the private sector. Different business forms are supported by different legal structures that influence how they operate, how they can be financed, what their responsibilities are and what their objectives are. - Private sector organisations are owned, financed and run by private individuals. They range from the smallest sole trader business to huge multinational businesses. Although most private sector organisations aim to make a profit, a large number of organisations in the private sector are non-profit organisations, including charities and mutual societies. - Public sector organisations (also known as state-owned or government organisations) are owned and operated by the government, whether at national, regional or local level. These organisations mainly provide essential services, including education, health care, police services, refuse collection and social work. They are usually funded by taxation and tend to be less profit-oriented than private sector organisations.