to

1

• Introduction
• to
• Business

2
Topics covered

• Organization of a Business
• The Business Environment
• Management
• Managing Employees
• Marketing
• Financial Management
• Special Topics

3
I. Organization of Business

• Planning a Business
• Stakeholders
• Creating a Business Idea
• Key Functions of a Business
• Developing the Business Plan

4
Origins of the stakeholder concept

• What is a stake?
• A share in an undertaking that can be categorized
  as one or more of the following
• an interest
• a right (either legal or moral)
• ownership

5
Attempting to define stakeholders

• Stakeholders Individuals groups with a
  multitude of interests, expectations, demands
  as to what business should provide to society
• If the corporation is the institutional
  centerpiece of a complex society
• who do companies belong to in whose interests
  should they be run?

Interdependencies exist whereby some stakeholders
may be unknowing and/or unwilling participants
(more on this later).
6
Creating a business idea

• Identify a Competitive Advantage
• Recognize experience and skills

• Differentiate the Product
• Distinguish product or service from others

• Determine Necessary Resources
• Employees, workspace, materials, etc.

• Assess the Feasibility
• Will profits be sufficient?

7
Functions of a business

• Management
• Means by which resources are used
• Marketing
• Means by which products or services are
  developed, priced, distributed, promoted
• Finance
• Means by which firms obtain and use funds
• Accounting
• Summary analysis of financial condition
• Information Systems
• Technology people that bring information to
  people for decision-making

8
Developing the business plan
A business plan is a detailed description of the
proposed business, including the product or
service, resources needed for production,
marketing to sell the product, and financing
requirements. It typically contains the
following sections

• Description and proposed ownership structure
• Assessment of the Business Environment
• Economic, the specific industry, the global
  environment
• Management Plan
• Organizational structure, production, human
  resources
• Marketing Plan
• The target market, product characteristics,
  pricing, promotion, distribution
• Financial Plan
• Financing overall financial feasibility

9
I. Organization of Business

• Selecting a Form of Ownership
• Sole Proprietorship
• Partnership
• Corporation

10
Selecting a form of business ownership
Sole proprietorship owned by a single owner

• All earnings go to sole owner
• Easy to establish
• Complete control

• All losses go to sole owner
• Unlimited liability
• Limited funds and skills

pros
cons
Partnership owned by two or more people or
entities

• Access to additional funds
• Losses are shared
• More specialization

• Control is shared
• Unlimited liability
• Profits are shared

pros
cons
Corporation tax-paying, state-chartered entity
that is legally distinct from owners

• Limited liability
• Access to funds
• Transfer of ownership

• Expensive to establish
• Financial disclosure
• Agency problems taxes

pros
cons
11
I. Organization of Business

• Business Ethics Social Responsibility
• Ethical Decision Making
• Stakeholder Perspectives

12
Key questions in stakeholder management

• What economic, legal, ethical, philanthropic
  responsibilities does our firm have to its
  stakeholders?

Philanthropic ResponsibilitiesBe a good
corporate citizen. Ethical ResponsibilitiesBe
ethical. Legal ResponsibilitiesObey the
law. Economic ResponsibilitiesBe profitable.
Must it be hierarchical?
13

Business is the collection of private,
profit-oriented organizations ranging in size
from sole proprietorships to corporate giants.
Should our expectations
differ based on size? Society is a broad group
of people other organizations, interest groups,
a community, a nation. Business society
interrelate in a macroenvironment as
stakeholders.
Competitors
The Earth
Trade Partners
Suppliers
Creditors
14
Who are businesses really responsible to?

• Fundamentally, businesses are responsible to
  their resource base. Without a healthy
  environment there are no shareholders, no
  employees, no customers, no business.
• Do your business like you plan to be here for the
  next 100 years.
• Patagonia, Inc., 2003 www.patagonia.com

15
Strategic benefits of moving toward a sustainable
business model

• Reduced costs
• New revenue sources
• Competitive advantage
• Access to capital
• Mitigation of risk
• Better relationships with stakeholders
• Improved organizational effectiveness
• Strengthened governance

16
II. Business Environment

• Economic Conditions
• Macroeconomic Factors
• Market Price Determination
• Government Influence

17
Assessing economic conditions
Macroeconomic factors growth, inflation,
interest rates

• Indicators of growth gross domestic product
  (GDP), unemployment, industrial production index,
  new housing starts, personal income level
• Inflation the increase in the general level of
  prices of products/services over a specified
  period of time
• Interest rate the cost of borrowing money

18
Assessing economic conditions
How market prices are determined

• Supply demand conditions
• Equilibrium the price at which the quantity
  supplied equals the quantity demanded
• Factors that influence market prices
• Consumer income and preferences
• Production expenses

19
Assessing economic conditions
Governmental influences

• Monetary policy decisions on the money supply
• Government purchase of Treasury securities
  reduces interest rates through increasing supply
  of available funds (assuming demand is stable)
• Government raises interest rates by reducing
  money supply by taking its funds out of banks
• Fiscal policy decisions on how government sets
  tax rates spends money

20
II. Business Environment

• Industry Conditions
• Demand
• Competition
• Labor Issues
• Regulatory Concerns

21
Industry traits that influence business
performance

• Industry demand
• The total demand for the products in an industry
• Industry competition
• Firms competing for market share
• Labor environment
• Some industries have highly specialized labor
  requirements
• Regulatory environment
• Government-imposed rules regulating practices

22
Exposure to industry conditions

• Market share
• Firms with larger market share benefit more from
  increase in demand and suffer more when demand
  declines than small firms
• When focus is narrow
• Diversification reduces exposure

Competing within an industry

• Assessing competitors
• Segments (subsets) narrowly defines industry
• Develop a competitive advantage
• Low-cost production
• Better quality
• Product differentiation

23
Porters Five Force Competitive Model
Threat of Mobility (Potential Entrants)
Industry Competitors (Segment Rivalry)
Supplier Power
Buyer Power
Threat of Substitutes
24
Porters Five Force Competitive Model continued

• Each force represents a threat in a particular
  business aspect
• Threat of intense segment rivalry
• Threat of new entrants
• Threat of substitute products
• Threat of buyers growing bargaining power
• Threat of suppliers growing bargaining power
• Together the five forces determine the intrinsic
  long-run profit attractiveness of the market
  segment

25
Competitive Situation Analysis

• Identification of competitors
• Consider strategic tactical differences and
  similarities
• Gain insight into potential defensive or
  offensive strategies to curtail or exploit
  competitors strengths and weaknesses
• Review terms of sales, target market,
  positioning, marketing strategies, pricing,
  promotions
• Use primary secondary research methods

26
Competitive Situation Analysis, continued

• WORKSHEET
• Business Element Your Co. Firm A Firm B
  Firm C Firm D
• Market Share/Sales
• Target Market
• Mktg Objectives
• Positioning
• Product/Brand/Pkg
• Distribution
• Promotional Mix
• Research Devlpmt
• Summary of Strengths
• Weaknesses

27
II. Business Environment

• Global Considerations
• External Internal Factors
• Systematic Assessment
• Four Key Environments
• Foreign Entry Modes
• Exchange Rate Considerations

28
The Complexity of Foreign Market Entry external
internal considerations
EXTERNAL Target Country Factors
Market
Home Country
Production
Environment
Foreign Market Entry Mode Decision
Product
Resources Commitment
INTERNAL Company Factors
29
Assessing best prospects a systematic approach
Step 1 Sequentially screen each environmental f
actor
Step 2 Select and rank countries for
further investigation
30
Assessing best prospects a sequential process of
screening four key environments

• Demographic/Physical
• Population
• Distribution
• Climate
• Distance
• Demographics
• Communication
• Natural resources

• Political
• System of government
• Political stability
• Ideology
• Govt. involvement
• Attitudes
• Economic develop-
• ment priorities

31
Assessing best prospects a sequential process of
screening four key environments, continued

• Economic
• Level of development
• Growth (GNP)
• Role of foreign trade
• Currency stability
• Per capita income
• Income distribution
• Disposable income

• Socio-Cultural
• Literacy rate
• Educational level
• Presence of middle class
• Similarities differences
• to home market
• Language
• Culture

32
Choosing a Foreign Entry Mode considering the
attributes

• Using Agents
• Goods are consigned
• Greater risk of loss
• Exclusive marketing
• territories
• Non-transferable
• Termination may be
• difficult

• Using Distributors
• Distributor buys goods
• Less risk of loss
• Antitrust laws may limit
• control of distribution
• Transferable
• May be easier to
• terminate

33
Choosing a Foreign Entry Mode considering the
attributes, continued

• Joint Ventures
• Access to financing, raw
• materials talent
• Fewer barriers to entry
• Broadened distribution
• Shared risk
• R D cost is shared
• Investment support

• Strategic Alliances
• Complementary strengths
• Strategic advantages
• Franchise agreements
• Performance-based
• contracts
• Clear roles goals
• Progress monitored

34
Exchange Rate Considerations

• Exchange rates move in ways that affect firms
• Importers benefit from strong local currency
• Exporters benefit from weak local currency
• Example

WON
RUBLE

• Korean stores must pay more won for Russian
  goods
• As cost of imported goods increases, demand for
  Russian goods decreases
• Demand for Korean goods increases

35
Hedging against foreign exchange rate movements

• Forward contracts
• Provides for an exchange of currencies at a
  specified rate at a future point in time
• Does not guarantee rate will be more favorable
• Overall, foreign exchange rate movement
  represents a form of risk that always exists in
  global business operations

36
III. Management

• Managing Effectively
• Levels Functions of Managers
• Managerial Skills
• Time Management

37
Functions of managers

• Top Management
• Sets plan to expand or revise products, borrow
  funds, change pricings and advertising strategies
• Communicates plans to all managers
• Middle Management
• Decides how to increase sales, resolves
  complaints, adds personnel, changes production
  procedures
• Supervisory Managers
• Provides job assignments training, resolves
  conflict, improves quality

38
Planning, organizing, leading, controlling

• Planning for the future
• Setting objectives
• Organizing employees resources to
• meet goals
• Occurs continuously throughout the life of the
  firm
• Leading
• Providing instructions on how the task should be
  completed
• Controlling
• Monitoring and evaluating employee tasks

39
Important managerial skills

• Conceptual
• To understand relationships between tasks
• Interpersonal
• To communicate with employees other
  stakeholders
• Technical
• To perform specific day-to-day tasks
• Decision-making
• To assess alternative choices on resource
  allocation

40
Guidelines for effective time management

• Set priorities
• Focus on whats important
• Schedule appropriate time intervals
• Allow sufficient time to focus on large tasks
• Minimize interruptions
• To allow for completion of assignments
• Set short-term goals on long-term projects
• To successfully move toward completion
• Delegate tasks
• Allow employees to assist enhance their skills

41
III. Management

• Organizational Structure
• Achieving the Strategic Plan
• Assessing Decentralization
• How Structure Affects the Control of Foreign
  Operations
• Methods of Structuring

42
A traditional organizational structure
Board of Directors
President
VP Mfg
VP Finance
VP Marketing
VP Human Resources
Info Systems
In todays information-based environment,
business is moving away from a hierarchy toward
flatter structure
43
Chain of command some definitions

• Span of control
• The number of employees each manager manages
• Centralized
• Most authority is held by high-level managers
• Decentralized
• Authority spread among several divisions or
  managers
• Whether to decentralize authority depends on
  managers skills and level or responsibility
  (time)
• Autonomy
• Divisions make their own decisions act
  independently

44
Forms of structure

• Line and staff
• Includes positions for make decision-making
  (line) those designed to support the efforts of
  line positions (staff)
• Two alternatives for greater employee input
• Matrix
• Enables various parts of the firm to interact and
  focus on specific projects
• Intrapreneurship
• Employees generate ideas as if they were running
  their own firms

45
Four main methods of departmentalizing are by

• Function
• Tasks are separated by employee functions
• Product
• Tasks are separated by product
• Location
• Tasks are concentrated in a division to serve a
  specific geographical location
• Customer
• Tasks are separated by customer type

46
III. Management

• Improving Productivity Quality
• Production Process Resources
• Site Selection
• Design Layout
• Production Control
• The Role of Technology

47
Production process resources

• Resources
• Key resources used for production are human
  resources, materials, equipment, buildings (the
  plant)
• Production (or conversion) process
• Where resources (both human otherwise) are used
  to produce products/services
• Production (or operations) management
• Management of the process of resource conversion

48
Plant site selection many factors influence
decisions

• Cost of workspace
• Cost supply of labor
• Tax incentives
• Source of demand for the product/service
• Access to transportation
• A site evaluation matrix can be used to rate key
  factors

Sites Land Cost Labor Supply
Transportation Site 1
_________________________________________ Site 2
Rating percent of total weight filled in
for each Site 3 ___________________________
______________
49
Plant design layout considerations

• Site characteristics
• Cost of land, slope, etc. guide design
  considerations
• Production process
• Assembly-line, fixed position, flexible
  manufacturing all point to distinct layout plans
• Product line
• Narrow versus broad has implications on layout
• Desired production capacity
• Planning for growth and off-site work options

50
Production control considerations

• Purchasing materials
• Selecting supplier negotiating discounts
  production components with supplier (outsourcing)
  
• Inventory control
• Managing to minimize cost maximize efficiency
• Routing
• Identifying sequence of tasks to complete
  production
• Scheduling
• Setting time periods for tasks based on critical
  path
• Quality control (by technology, employees,
  customers)
• Identifying improvements in the production process

51
Key methods to improve production efficiency

• Benchmarking
• Evaluating through comparison to a specified
  level
• Technology
• Automating tasks to increase speed of the
  production process eliminate the use of
  employees
• Economies of scale
• To reduce the average cost per unit through
  volume
• Restructuring
• Revising the production process to reduce
  expenses
• Downsizing (reducing the number of employees)
• Integration of the production tasks
• Managing the entire supply chain (start to finish)

52
IV. Managing Employees

• Motivating the Workforce
• Theories on Motivation
• Compensation Programs
• Enhancing Job Satisfaction
• Motivating Across Countries

53
Main theories on motivation

• Maslows Hierarchy of Needs
• People rank their needs by category
• As they progress up a hierarchy they are
  motivated to reach the next category

Self-Actualization
Esteem
Social
Safety
Physiological
54
Main theories on motivation, continued

• Hawthorne Studies
• Employees are motivated by attention

• Herzbergs Job Satisfaction Study
• Factors that prevent job dissatisfaction are not
  the same as those that enhance job satisfaction

• Expectancy Theory
• Employees motivated if compensation is aligned
  with goals, are achievable, offer some reward

55
Main theories on motivation, continued

• McGregors Theories X Y
• X When supervisors believe employees dislike
  work they give them less responsibility
  employees are not motivated
• Y When supervisors believe employees prefer
  responsibility they delegate more, which
  motivates employees

• Theory Z
• Employees are more satisfied when involved in
  decision-making, therefore more motivated

56
Main theories on motivation, continued

• Equity Theory
• Employees more motivated if compensation is
  aligned with relative contribution to firms
  output

• Reinforcement Theory
• Employees are more motivated if rewarded for high
  performance (positive reinforcement) penalized
  for poor performance (negative reinforcement)

57
Ways firms can motivate employees by providing

• Adequate compensation that is aligned with
  performance
• Reasonable measure of job security
• Flexible work schedules
• Employee involvement programs

58
IV. Managing Employees

• Hiring, Training, Evaluating
• Human Resource Planning
• Equal Opportunity
• Employee Benefits
• Training Development
• Evaluating Performance

59
Human resource planning

• Forecasting HR needs
• Influenced by retirements, downsizing, expansion

• Job analysis
• Determines tasks necessary credentials
• Used to develop job description

• Recruiting
• Internal (from within through promotions or
  lateral assignments) external (outside sources)
• Involves multiple screening steps for applicants

60
Equal opportunity

• Discrimination hurts a firm in 3 ways
• Deprives the firm of creativity through diversity
• Deprives potential employee(s) of meaningful work
• Such discrimination is illegal, if not locally,
  quite likely in countries with which many firms
  do business now or in the future

61
Compensation packages

• Salary
• Pay for a job over a specific period
• Stock options
• Allows employees to purchase shares of firms
  stock at a specific price
• May create conflict of interest (temptation to
  inflate earnings)
• Commissions
• Based on meeting sales goals
• Bonuses
• One-time payment based on performance

62
Compensation packages, continued

• Profit sharing
• Sharing a portion of firms earnings with
  employees
• Employee benefits
• Additional privileges beyond payments, such as
  paid vacations, medical life insurance,
  pensions
• Perquisites (Perks)
• Other non-monetary privileges
• Free parking
• Company car
• Club memberships
• Expense account

63
Employee development

1. Technical
2. Decision-making
3. Customer Service
4. Safety
5. Human Relations

The firm benefits through providing ongoing
training development in 5 key skill sets
64
Employee performance evaluation

• Five key steps
• Segmenting into clear criteria
• Assigning rating to each criteria
• Weighing each criteria
• Determining overall performance rating using the
  weighted average of all criteria
• Discussing evaluation with employees to identify
  strengths developing a plan to address
  weaknesses

65
V. Marketing

• Creating Pricing Products
• Product Line Mix
• Identifying a Target Market
• Pricing Strategies
• The Marketing Plan

66
Marketing the perspective

• The Four Ps become the Four Cs

Four Ps Four Cs
Customer solution
Product
Customer cost
Price
Convenience
Place
Communication
Promotion
From Kotler, 2000
67
Product Line Mix

• Product analysis questions to ask
• What products are sold, industry-wide?
• What products does your firm sell?
• How are they made?
• What do they look like?
• Advantages strengths?
• Disadvantages weaknesses?

68
Why form product lines?

1. Advertising economies as several products are
   advertised under the umbrella of the product
   line
2. Package uniformity through common look yet
   individual product identities
3. Standardized components reduce manufacturing and
   inventory costs
4. Efficient sales distribution as retailers take
   full product line
5. Equivalent quality perception through brand
   recognition

69
Product Width, Depth, and Consistency

• Product mix width refers to the number of
  products offered
• Product line depth is the number of products in a
  particular product line
• Product mix consistency refers to the extent
  product lines are similar in terms of
• End use
• Distribution outlets
• Target markets
• Price range

70
Consumer Behavior Trends
demographics

• Analyze demographic trends related to age, work
  status, educational level, income trends and
  averages, family composition, ethnic background
  look at total product usage by segment note
  shifts and how they will affect the business
• Monitor demographic aspects of geographic trends
• Psychographic analysis, the study of consumer
  lifestyles and attitudes, provides insight into
  disposable income availability, health and
  environmental concerns, clothing preferences, etc.

psychographics

• geographics

71
Consumer Behavior Trends Lifestyle dimensions

72
Market Segmentation, Targeting, Positioning

• Identify basis
• for segmentation
• 2. Develop profiles

• Develop measures
• of target
• effectiveness
• 4. Select segments

Segmentation

• 5. Develop positioning
• for each segment
• Develop marketing
• mix for each segment

Targeting
Positioning
73
Requirements for effective segmentation

• Existence of customers with similar wants
• Segment members are identifiable
• Segment members are accessible
• Segment responds to marketing efforts
  differently
• than market as a whole
• Specialized communication media are available
• Seller has competitive advantage in target
  segment
• Segment is large enough to produce substantial
  profit

74
Requirements for effective positioning

• Assessing current competitor positions
• Determining dimensions underlying these positions
• Selecting a position where marketing efforts have
  greatest impact

Positioning may be base on one or more aspects

• Attribute
• Price Quality
• Use or Application

• Product/Service User
• Product Class
• Competitor

75
Steps necessary to create a new product

• Develop a product idea which may be in response
  to changes in consumer needs or preferences
• Assess feasibility through comparison of expected
  benefits with the proposed cost do market
  research
• Design test the product with some consumers in
  the target market
• Distribute promote for access awareness
• Post-audit the product to determine whether
  revisions are needed

76
Factors affecting pricing decisions

• External factors
• Nature of market
• demand
• Competition
• Economy
• Government
• Resellers

• Internal factors
• Marketing objectives
• Marketing mix strategy
• Costs

Pricing Decisions
77
Factors affecting pricing decisions, continued

• Price considerations
• What is the pricing structure in the product or
  service category? Is there a range?
• Your pricing structure relative to the
  competition
• Are discounts, promotional allowances, return
  policies, etc. important selling tools in the
  product category?

78
9 marketing mix price point strategies on
price/quality
Price
Price
79
Factors affecting pricing decisions, continued

• Price Elasticity Diagrams

Inelastic demand
Elastic demand
P 2 P 1
P 2 P 1
Q 2 Q 1
Q 2 Q 1
80
Factors affecting pricing decisions, continued

• Price elasticity considerations
• When you raise or lower prices, how does it
  effect demand?
• Are consumers price sensitive in this product or
  service category?
• Where is your product or service priced in
  relation to competitors?

81
Factors affecting pricing decisions, continued

• Cost structure considerations
• Fixed variable costs associated with sales
• Costs of goods/services sold
• Margin profit expectations/requirements
• Gross price or sales figures

82
Marketing plan

• The marketing plan ties it all together
• Target market the customer profile (age, income
  level, etc.)
• Product characteristics features benefits
• Pricing the price relative to competitors
• Distribution how customers will access the
  product
• Promotion how customers will know of the product

83
V. Marketing

• Distributing Products
• Channels
• Market Coverage
• Transportation Choices
• Accelerating the Distribution

84
Distribution Pushing or pulling through the
channel system

• Pushing a product through the channel means using
  normal promotion efforts
• Personal selling
• Advertising
• Pulling means getting consumers to ask
  intermediaries for the product
• Aggressive promotion to final consumers through
  use of coupons or samples

85
Distribution channel considerations by business
category

• Retail operations
• Where do consumers shop?
• What importance do various types of outlets have
  related to the product?
• What new channels are emerging?
• What channels does the competition use?
• Do you have adequate penetration of outlets to
  maximize sales in any given market?
• Does expansion into new territories make sense?
• Is the product best suited for mass, selective,
  exclusive, or a combination of distribution
  methods?

86
Distribution channel considerations by business
category

• Service firms
• Where do the consumers of your service shop?
• What are current emerging methods of delivery?
• How does the competition deliver services? Why?
• Does expansion make sense?
• Does the product best lend itself to mass,
  selective, exclusive, or a combination of
  distribution methods?
• Do company-owned office, franchises, or
  dealerships provide the best service delivery
  method?

87
Market coverage exclusive, selective, or
intensive
88
Transportation considerations

• Truck
• Usually quick and can make several stops but cost
  can fluctuate with fuel prices has environmental
  issues
• Rail
• Useful for heavy products when sender receiver
  are located close to stations
• Air
• May be relatively inexpensive for light weight
  itemsstill involves truck for door to door
  service
• Water
• Often used for bulk still involves trucks

89
Accelerate the distribution process

• Streamline the channels
• Bypass regional warehouse and ship direct to
  customers
• Integrate production and distribution
• Provides for quick response to market changes
  through closed interaction between production and
  distribution
• Vertical channel integration
• 2 or more levels of distribution are managed by a
  single firm such as when a manufacturer also does
  retailing (or a retailer begins manufacturing)
• Cost/benefit analysis should guide decisions

90
V. Marketing

• Promoting Products
• Promotion Mix
• Advertising
• Personal Selling
• Sales Promotion
• Public Relations
• Evaluation Promotional Efforts

91
Promotional Strategy Elements of the promotional
mix

• Impersonal, 1-way
• Multi-media options
• Builds awareness
• Locates customers

• Free samples
• Contests
• Trade shows
• Coupons, bonuses
• Short-term tool

Complementary
Advertising
Sales Promotion
Appro aches

• Face-to-face
• Provides feedback
• Employs telephone sales
• (telemarketing)
• For industrial goods

• Builds image
• Evaluates attitudes
• Identifies public interest
• Executes program to
• generate publicity/news

Public Relations
Personal Selling
92
Subsets of advertising

• Pioneering
• Intended to create demand
• Heavy during introductory stage of product life
  cycle
• Offers in-depth information on benefits
• Competitive
• Intended to influence demand for brand
• Used as product enters growth phase
• Less informative, more emotional appeal
• Price may be key promotional weapon
• Comparative
• Compares attributes of two or more specific
  brands
• Makes claims of superiority over competing brand

93
International Product/Promotion Strategy
Considerations

• International communication adaptation involves
• adapting to local markets on four levels
• One message used everywhere with minor variation
  in language, name, and colors
• One theme used everywhere with copy adapted to
  local market
• A global pool of ads is developed for use as
  appropriate
• Media sales promotions techniques are fully
  adapted to different markets

94
Evaluating the effects of promotion

• Compare sales to pre-established goal
• Track sales activity by promotional method
• Provide a way for customers to let you know how
  they learned about your product or service
• Use coupons coded by promotional activity
• Include questionnaires with product offer
  complementary service or discount for completion
• Provide incentive for referrals
• Change methods as appropriate

95
VI. Financial Management

• Accounting Financial Analysis
• How Firms Use Accounting
• Interpreting Financial Statements
• Responsible Reporting
• Ratio Analysis

96
Overview The financial structure of an
organization

Board of Directors
President
VP Sales
VP Mfg
VP Finance
Treasurer
Controller
Tax Dept
Cost Acctg
Inventory Mgr
Credit Mgr
Financial Acctg
Dir Capital Budgeting
97
How firms use accounting

• Reporting to shareholders
• Reporting to creditors
• Certifying accuracy
• Decision support
• Control through auditing

• Accounting
• Summary analysis of a firms financial
  condition
• Bookkeeping
• Recording of a firms financial transactions
• Financial accounting
• Accounting performed for reporting purposes

98
Interpreting financial statements

• Income statement
• Reports costs, revenue, earnings over a
  specified period
• Balance sheet
• Reports book value of assets, liabilities,
  owners equity at a given point in time
• Ratios help evaluate 4 aspects of financial
  status
• Liquidity ability to meet short-term
  obligations
• Efficiency how a firm utilizes its assets
• Financial leverage firms relative use of debt
• Profitability net income relative to various
  size levels

99
Ratio analysis

• Definition
• An evaluation of relationships between financial
  statement variables
• Comparison with industry averages
• Can be difficult as firms operate in more than
  one industry distortion can occur
• Accounting practices vary among firms
• Firms with seasonal swings show deviations (less
  if annual figures are used)
• Sources for industry data
• Robert Morris Associates Annual Statement
  Studies
• Dun Bradstreet

100
Ratio analysis, continued
Liquidity Current Ratio Current Assets Current
Liabilities
Liquidity Quick Ratio CashMktbl SecAccts
Recv Current Liabilities
Efficiency Inventory Turnover Cost of Goods
Sold Inventory
Efficiency Assets Turnover Cost of Goods Sold
Assets
Leverage Debt-to-Equity Long-Term Debt Owners
Equity
Leverage Times Interest Earned Earnings before
Intr Taxes Annual Interest Expense
101
VI. Financial Management

• Financing
• Methods of Debt Financing
• Methods of Equity Financing
• Issuing Securities
• Other Funding Methods
• Deciding the Capital Structure

102
Overview The financial decision-making process

103
Sources of money Debt

• Commercial loan from a bank
• Loan from friends and family
• Issuance and sale of bond
• Advantages
• Provides opportunity to develop credit history
• Ownership is not diluted
• Disadvantages
• Collateral and/or co-signers may be required
• Cost of capital may be high
• Restrictions may apply

104
Sources of money Equity

• Personal funds and sweat equity in the form of
  time and labor
• Utilization of owner equipment and other
  resources
• Non-loan infusions from friends and relatives
• Employee investors
• Customer membership fees and prepayments
• Venture capitalists and other impersonal
  investors
• Joint venture partnerships

105
Sources of money Equity

• Advantages
• Equity is risk capital that carries no
  guarantee or protection regarding the original
  investment
• Usually has no requirement regarding payback or
  interest payments
• Disadvantages
• Represents dilution of ownership that affects
  entrepreneurs claim to profits and control

106
Sources of money Trade Credit

• Advantages of using suppliers as a credit source
• Often easily obtained
• Amount of credit usually expands and contracts
  with the needs of the firm
• Often take the form of credit terms and cash
  discounts
• Typically does not involve a formal agreement or
  contract
• Fosters supplier commitment in the success of the
  business

107
Sources of money Barter Arrangements

• Definition and considerations
• Trade of goods and/or services
• Often linked by exchange or service organizations
  that may charge a fee plus take a percentage of
  the cash value
• Transactions are often taxable at cash value

108
VI. Financial Management

• Expanding the Business
• Investment Decisions
• Capital Budgeting Tasks
• Mergers Buyouts
• Global Investing

109
Basics of capital budgeting sales and cost
forecasting

• Construction of pro forma statements
• Latest financial statements
• Sales forecast
• Cost accounting forecast
• Financial market data
• Preliminary projections
• Modifications revisions
• Evaluation are more revisions needed?
• Capital rationing identification of projects to
  finance

110
Time Value of Money Money has different value
today than in the future

• Reasons
• Inflation/deflation
• Opportunity costs the foregone investment
  options
• Risk factors
• Less flexibility re time preference for
  consumption
• Financial management remedy
• Cash flow is discounted to reflect the
  reduction of value

111
Investment appraisal using discounted cash flows

• Firms rarely have the resources to accept all
  good capital projects investment opportunities
• Rationing capital for investment in a project or
  business requires careful analysis
• Two of the most common methods for ranking
  investments in projects are 1) net present value
  2) internal rate of return calculations
• Both methods take into consideration the time
  value of money

112
Investment appraisal using discounted cash flows,
continued

• Net present value
• Weighs the investment in absolute dollars against
  its return in discounted cash
• Formula is discounted incoming cash flows minus
  outgoing initial cash flows
• DISCOUNTED RETURN minus INVESTMENT
• Requires assumption about the prevailing cost of
  money, also called a hurdle rate
• Discount rate varies for each period
• Typically uses calculator function or table
• Investment or project with highest NPV is deemed
  most desirable

113
Investment appraisal using discounted cash flows,
continued

• Internal rate of return
• Weighs the investment relative to the cost of
  money (interest rate)
• Solves an equation
• INVESTMENT FUTURE PAYMENT / (1rate)
• Determines rate of interest that would cause the
  discounted (incoming) cash flows to be equal to
  the investment (i.e., zero difference)
• Typically uses calculator function or table
• The investment option or project with the highest
  IRR is deemed most desirable

114
Investment appraisal using discounted cash flows,
continued

• Internal rate of return calculation drawbacks
• Assumes cash flows can be reinvested at an IRR
  which may not be a reasonable assumption
• There may be multiple IRRs, requiring additional
  calculation using NPV before decision can be made
  
• Can lead to mistaken accept/reject decisions when
  evaluating mutually exclusive projects when there
  are differences in scale, size, or differences in
  the time patterns of cash flow

115
Investment appraisal using discounted cash flows
summary

• The main difference between NPV and IRR
  calculations is the interest rate used and the
  form of the answer (dollars versus rate)
• Whichever method is used, the goal should be to
  maximize NPV for the overall budget that is
  accepted
• Firms using IRR therefore frequently also
  calculate NPV

116
Lease/buy/rent decision criteria

• Cash flow to lease or rent requires smaller
  payments over time versus immediate cash outlay
  for purchase
• Commitment becoming locked in through
  purchases
• Cost overall cost for each method, including
  interest, down payments, transfer costs, etc.
• Tax consequences purchases and leases are
  eligible for depreciation offsets to income cash
  outlays for rentals are usually deductible
  expenses
• Obsolescence risk related to commitment leases
  and rental agreements usually allow for upgrade

117
Lease/buy/rent decision criteria, continued

• While some decisions may be based on NPV
  comparisons between the cost of debt to purchase
  and the cost of leasing, a decision matrix
  ensures consideration of all relevant variables
• Matrix scores are dependent on specific tax
  consequences and other situational conditions
• Important functional area perspectives include
  accounting and marketing

118
A hypothetical lease/buy/rent decision matrix
showing positive and negative aspects, depending
on the specifics of the item
119
Expanding a business through mergers
acquisitions

• Reasons to merge
• To achieve immediate growth
• To create economies through volume
• To combine resources and expertise
• To reduce taxable income through loss

120
Short-term investment decisions

• Liquidity management
• Management of short-term assets and liabilities
  to assure adequate liquidity
• Accounts receivable management
• Sets the limit on credit available to customers
  length of period for repayment
• Inventory management
• Determines amount of inventory held
• Cash short-term securities
• Typically generate lower returns

121
Financing small firms and startups

• Business start-ups fail largely due to inadequate
  funding
• Owner usually is required to commit savings,
  mortgage assets, and borrow from friends and
  family
• Government agencies often have targeted loan
  programs that provide funds and technical support

122
VII. Special Topics

• Using Information Technology
• Computers Managing Information Technology
• The Internet
• Emerging Technologies and Implications

123
Managing information technology

• Most common uses of computers
• Computational models
• Data processing systems
• Interorganizational systems
• Interorganizational systems (IOS)
• Using computers technology to move information
  across the firm
• Enterprise resource planning systems (ERP)
• Software programs that automate all procedures
  support flow of information

124
Managing information technology, continued

• Some key information systems challenges
• Managing the architecture
• Acquiring software
• Managing development
• Managing implementation
• Managing the security
• Two key developments
• Evolution of the worldwide network
• Emergence of truly intelligent systems

125
VII. Special Topics

• Managing Risk
• Identifying Exposure
• Hedging Economic Risk
• Firm-Specific Risk
• Losses, Liabilities Lawsuits
• Remedies for Business Failures

126
Managing risk
Business risk the possibility a firms
performance will be lower than expected due to
exposure to specific conditions

• Types of economic exposure
• Industry conditions
• Economic growth interest rates
• Demand for firms product
• Expenses incurred through production
• Global economic growth exchange rates
• Hedging economic risk
• Derivative instruments whose values are derived
  from values of other securities, indices, or
  interest rates
• Interest rate swap from fixed rate to adjustable
  payments

127
Managing risk, continued

• Firm-specific characteristics
• Limited funding
• Reliance on one product or service
• Reliance on one customer or supplier
• Reliance on a key employee
• Ways to reduce exposure
• Diversification of products, suppliers,
  customers, funders
• Provide safe products working conditions

128
Managing risk, continued

• Losses, liabilities, lawsuits
• Property losses related to damage
• Liability losses related to damage caused by the
  firms actions to others or their property
• Lawsuits related to product defects employee
  treatment
• Ways to protect against risk
• Eliminate the business operations causing the
  risk
• Shift the risk through purchase of insurance
• Assume the risk by creating self-insurance (a
  fund)

129
Managing risk, continued

• Remedies for business failures
• Extension, providing additional time to generate
  the necessary cash to cover payments
• Composition, specifying a firm will provide
  creditors with a portion of what they are owed
• Private liquidation, whereby assets are
  liquidated funds distributed to creditors
• Reorganization liquidation under bankruptcy,
  whereby the court system directs sale and payment

but, of course, you will never experience this!
130
VII. Special Topics

• Synthesis of Business Functions
• Valuation of a Business
• How Decisions Affect Value
• Relationships Among Strategies

131
Valuation

• A firms value is equal to the present value of
  its expected future cash flows
• Cash flows in any period are the difference
  between inflows (revenue) outflow (expenses)
• Decisions affecting value
• Management, marketing, financial decisions that
  increase cash flows enhance value
• Management decisions related to resource
  consumption affect cash outflows (expenses)
• Marketing decisions focus on increasing revenue
• Finance decisions affect interest expenses

132
Relationship among strategies

• Management, marketing, finance decisions lead
  to strategies
• Decisions in one area are made only after
  considering information from one or more of the
  others

Management decisions
Marketing decisions
Finance decisions
133
Some parting words
Now that you have had your Introduction to
Business it is on to the development of your
most excellent business plan. Good luck!
134
Introduction to Business Reference Sources

• Introduction to Business, Jeff Madura, Mason, OH
  South-Western/Thompson Learning, 2004
• Marketing Management The millennium edition,
  Philip Kotler, Upper Saddle River, NJ Prentice
  Hall, 2000
• R. Scott Marshall, professor of business,
  Portland State University, Portland, Oregon, 2002
• Michael Sisavic, professor of business, Portland
  State University, Portland, Oregon, 2002

135
Introduction to Business Reference Sources

• Financial, Budgeting Cost Control (1996). Les
  Anderson, PhD., Portland, OR Portland State
  University
• Financial Management Theory and Practice (1999).
  Eugene F. Brigham, Louis C. Gapenski and Michael
  C. Ehrhardt, Stamford, CT The Dryden Press
• Lecture notes from BA 561 Financial Management
  (2001). Janet Hamilton, PhD., Portland, OR PSU
• The Essentials of Financial Management (1998).
  Omer L. Carey, PhD and Musa M.H. Essayyad, PhD.,
  Piscataway, NJ Research and Education Association