The purpose and nature of businesses
By the end of this chapter, you should know the following information:
- The purpose of businesses
- The reasons for starting a business
- The basic functions and types of businesses that exist
- Business enterprise and entrepreneurship
- The dynamic nature of business
The purpose of businesses
The purpose of a business is to produce goods and/or supply services that are in demand to customers in a voluntary transaction.
A good is a physical product, for example a motorbike, while a service is an intangible item that you cannot physically touch such as legal advice.
A business will have people that work for it and this can range from one person to potentially thousands of employees all working to keep the business continuing.
It is important to distinguish between a customer and a consumer.
If you buy a mobile phone for example and then use it yourself too, you are the customer (the person who bought it) and also the consumer (the person who uses it). If however, you buy the phone but then give it to your sister, you are the customer but your sister will be the consumer.
A business is successful if it can meet the needs and wants of its customers effectively. The difference between a need and want in business is a need is a basic human requirement, such as food and drink while a want is a desire for a particular product.
- A good is a physical product, such as a motorbike.
- A service is an intangible product that you cannot touch such as legal advice or a ride on a bus.
- A customer is someone who buys the product from the business.
- A consumer is someone who uses the goods and services that are produced by the business
Reasons for starting a business
Individuals who embark on their own business ventures are termed entrepreneurs. These entrepreneurs are prepared to undertake risks to establish enterprises of their own. They possess the determination, drive, and focus necessary to start their own businesses instead of working for others. The aptitude to embrace risks in order to develop a business concept is commonly known as entrepreneurship.
What are the objectives of entrepreneaurs?
There are numerous reasons why individuals might choose to become entrepreneurs:
- They desire to be their own boss and make their own decisions, rather than working for someone else.
- They wish to retain the full profits of a business for themselves, unlike when they work for others.
- They are driven by the ambition of establishing their own enterprise based on their own ideas and the potential of earning significant money.
- They aim to validate their abilities to themselves and potentially benefit others, achieving a sense of accomplishment.
- They are dissatisfied with their current job and seek more flexible working conditions that suit their preferences.
- They have identified a business opportunity which they believe can be profitable.
- They intend to provide a service for others. For example, some businesses are founded to assist the local community or particular groups, and these are often referred to as social enterprises, which do not always focus on profit-making.
Setting up a business presents numerous exciting opportunities – individuals can make their own choices and create something new. If the enterprise is successful, it can lead to a profound sense of personal achievement. Establishing a business offers a chance to demonstrate their abilities and possibly earn more than they could by working for someone else.
- A entrepreneur is someone that is willing to take on the risk of starting a new business
- Entrepreneurship refers to the ability to be an entrepreneur and to take risks in the development of a business idea
- A social enterprise is a business that has been set up to help improve society in some way rather than just simply make a profit.
Factors of production: land, labour, capital and enterprise
Factors of production are the resources or materials that businesses use to produce their goods or services. These are:
- Land – the physical land and the site on which the business is located, and other natural resources a business might use.
- Labour – the skills and numbers of employees employed by a business
- Capital – the equipment used to provide the goods or services, such as machinery and equipment
- Enterprise – the skills of the people involved in the business to identify business opportunities and bring together resources to meet these opportunities.
What a business is able to produce will depend on the quality and quantity of its resources and the way in which these resources are effectively combined and managed.
What is opportunity cost?
The opportunity cost is the sacrifice we make whenever we decide to do anything. If we decide to go out drinking tonight, we sacrifice the work we could have done had we stayed at home. If we stay at home, we sacrifice the enjoyment of going out. There is always a trade-off when we do anything. Whenever you make a decision, it is important to consider the opportunity cost and what are you giving up.
For example, if you decide to set up your own business, you may be giving up a more secure income in your existing job. If you decide to invest your savings in a business, then you are not using these savings to earn money through the interest that could have accrued from holding it in the bank.
What are the characteristics of entrepreneurs?
In any given nation, there are likely thousands or even millions of entrepreneurs, and while their traits can vary significantly, some characteristics are commonly observed among them:
- Innovative: Entrepreneurs are adept at recognizing opportunities. They are capable of identifying issues with current methods and envisioning more effective approaches. They possess a clear vision of what could be improved.
- Risk-takers: Entrepreneurs are willing to take the gamble that their concept will work, despite knowing that many new ideas do not succeed. Establishing a business demands both time and emotional commitment. A wrong decision can lead to the loss of savings and a sense of failure, so resilience is key.
- Hardworking and resolute: Starting a business is often challenging. For fledgling businesses, there may be tough negotiations and a lack of public awareness. Entrepreneurs must put in considerable effort to gain traction and deal with suppliers, often shouldering the burden alone at the outset, which can be demanding.
- Organised: Operating a business requires a broad array of skills and the capacity to make numerous decisions. Entrepreneurs often need to juggle various tasks and are typically required to coordinate materials, workforce, production, orders, deliveries, and finances, necessitating strong organisational skills.
Types of businesses
Businesses can be classified based on where they sit within the production process:
- The primary sector is made of of businesses that are in the first stage of production and use raw materials. Examples of such include farms, oil companies and fishing fleets.
- The secondary sector is made up of businesses that are in the second stage of the production process. They will use primary resources and convert these into products. Examples of secondary sector businesses include manufacturers.
- The tertiary sector is the final stage and comprises of businesses that provide services. Examples include fast food stores, estate agents and even delivery companies.
The functions of a business
A business must engage in several core activities to operate effectively and meet its objectives. These can be broken down into four main functions:
- Operations: This area is concerned with the actual production of the goods or services. It involves managing the day-to-day processes that contribute to the creation of the product, such as conducting quality checks, maintenance, and the logistics of getting the product out to the market.
- Human Resources: This function focuses on the people who work within the business. It encompasses various aspects of managing personnel, from hiring and recruitment to training and development. In large organisations, this might involve overseeing thousands of employees.
- Marketing: This function is critical for the promotion and sale of the product or service. It involves understanding customer needs and desires, and then creating a strategy to communicate the benefits of the product in such a way that customers are persuaded to purchase.
- Finance: The financial function is integral to the business's sustainability, dealing with the management of funds. It includes tasks such as budgeting, financial reporting, and investment planning to ensure that the business has the resources it needs to continue operations and grow.
The business environment
A business will be influenced by changes in the 'business environment.' This term encompasses all the external factors that can impact a business.
Changes in the business environment can be categorised under several headings:
- Technological Change: The pace of technological advancement is swift, creating new markets and products. For instance, Snapchat is a relatively recent phenomenon. Technology also transforms our shopping habits and the products we purchase. Consider the alternative accommodations provided by platforms like Airbnb, which now enable individuals to stay in another person's home instead of a traditional hotel.
- Economic Change: This includes various economic elements external to a business, such as the cost of borrowing money, known as the interest rate, the rate at which prices rise, referred to as inflation, and the overall income within the economy, known as the Gross Domestic Product or GDP. The term 'economic environment' often refers to these factors.
- Legal Change: Changes in laws and regulations can influence business costs, such as the requirement for businesses to pay a statutory minimum wage to their employees, or demand for products, such as restrictions on tobacco company advertising.
- Environmental Expectations: The public and consumers are increasingly interested in how a business impacts the environment. Questions such as what resources a business uses, how products are manufactured, and the logistics of product distribution are now significant considerations. The business's environmental impact can affect consumer choice, regardless of demand shifts. People are concerned about environmental issues not only for the present but also for the impact on future generations.
The business environment is always in flux, which highlights its dynamic nature. Regularly reviewing relevant news websites and the market landscape will reveal the extent of some of these changes. In response, a business must keep adapting and remain agile to how factors such as income, culture, new competitors and even changes in consumer attitudes shift.
A good example is smoking which has seen a constant decrease in the UK due to changes in legislation (laws prohibiting how they are sold), social attitudes (prohibitions on how they are marketed and promoted) and economic factors (they have become really expensive).
There are different ways in which businesses can be set up in the UK and we will examine what these are and the advantages and disadvantages of each. By the end of this topic, you will know about each of the following types of ownership:
- What a sole trader is
- What a partnership is
- A private limited company (ltd)
- What a public limited public company is
- What a not-for-profit organisation is
- The advantages and disadvantage of each of these types of ownership
When a business is formed as a sole trader, it is owned and managed by one person although can employ other staff. Setting up as a sole trader is simple, you can start trading straight away and you are not required to register with the government or fill out lots of forms to begin trading. This makes operating as a sole trader popular and is why this business setup is often the first experienced by successful entrepreneurs.
What are the advantages of being a sole trader?
The main advantages of being a sole trader are as follows:
- Becoming a sole trader is quick and easy to set up when compared to other types of businesses which require registering with the government.
- All decisions are made by yourself (the owner) and there is complete autonomy without the need to consult with other people. This results in fast decision making and the work and business operating in the way you want them to.
- All profits are kept by yourself, the sole trader and this means the businesses success results in you benefiting completely. There is no need to share the rewards with others unlike other business set ups.
What are the Disadvantages of being a sole trader?
The main disadvantages of being a sole trader are as follows:
- It can be highly stressful to make every decision by yourself, and some individuals may find it overwhelming to manage all aspects of the business.
- A sole proprietor must oversee all facets of the enterprise: the fiscal matters, marketing, and the operational side of the business. Not everyone excels in these areas.
- If the business encounters difficulties, you bear unlimited liability, which implies that you could forfeit everything you possess.
- The workload for a sole trader can be considerable. As you strive to grow the business, it may become challenging to find time for a break, risking the business's momentum.
- Should the sole proprietor pass away, the business typically ceases to operate, regardless of its history.
- As a sole trader, amassing significant capital can be challenging. It often relies on personal funds or loans from acquaintances to start the business. Banks may be hesitant to lend due to the high failure rate of new enterprises and often impose steep interest rates on loans.
- A business run by a sole proprietor is often smaller in scale and may not possess the buying leverage of larger companies, potentially resulting in higher costs and reduced profit margins.
In accordance with the 1890 Partnership Act, a partnership is formed when two or more individuals collaborate to pursue a shared goal. For instance, a group of medical professionals might join together to establish a practice, or a team of designers could unite to start a studio. Partnerships are typically composed of a minimum of two individuals but can include up to twenty, encompassing professions like lawyers, accountants, auctioneers, and real estate agents.
Deed of Partnership
When establishing a partnership, those involved are advised to formalise a Deed of Partnership. This legal document delineates several aspects of the partnership, such as:
- The division of profits and how much work each partner does.
- The amount of money each partner contributes initially.
- The rights related to decision-making and leaving the business.
- The process of valuing the business if new members are considered or if a partner exits.
- The method of resolving disputes within the partnership.
The purpose of the Deed is to ensure clarity on how decisions are made and how profits are distributed. Without such a Deed, profits are divided equally, regardless of the individual input.
Advantages of Partnerships
The advantages of a business set up as a partnership are as follows:
- Partnerships enable multiple individuals to contribute financially, reducing the reliance on personal funds.
- More people are involved in a partnership compared to a sole trader, which can lead to more comprehensive strategizing and problem-solving, with partners benefiting from each other’s expertise.
- Partners can specialize in different areas of the business, offering a wider range of services than a sole trader might be capable of.
- Partners can support one another during absences, making it less burdensome than running a business alone.
Disdvantages of Partnerships
The disadvantages of a business set up as a partnership are as follows:
- The different partners may all have differing ideas on how they want to run the business which can lead to dispute. Having multiple partners invites the potential for disagreements on key decisions making it difficult to run the business effectively or responsively to the business environment.
- Decisions made in a partnership set up can take longer to make as all equal partners will need to agree to such. This hinders efficiency compared to a sole trader for example, who can make the decision themselves quickly without the need to discuss this at any length.
- The rewards of the business have to be divided amongst the partners rather than kept by one person, as would be the case as a sole trader.
- A partnership often means the partners all have unlimited liability and if a mistake is made by one partner, they are all responsible for it. This can create problems as the poor or bad behaviour of one partner can seriously damage another partners life in different ways.
A company is financed by its investors, known as shareholders. While various types of shares exist, the most commonly issued are 'ordinary shares.' Holders of these shares are typically entitled to one vote per share during company decisions. For instance, owning 51% of the shares equates to 51% of the voting power.
Legally, a company is recognized as its own entity, separate from its owners, capable of owning assets such as property and equipment. This separation also implies that when members of the public buy shares, they're investing in the company itself, not the individuals behind it. This structure affords shareholders limited liability, a crucial factor that encourages investment by reducing the risk of losing personal assets if the company encounters difficulties.
The governance of a company is in the hands of its shareholders. Daily operational decisions, however, are made by managers. In private limited companies, shareholders may also act as managers, but in public limited companies, there is typically a distinction between shareholders and management, leading to potential disparities in objectives. For instance, managers might prioritize long-term growth, while shareholders could be more interested in immediate financial returns, creating possible conflicts.
In the UK, under the 1980 Companies Act, there are two types of companies which are:
- Private limited company (ltd)
- Public limited company (plc)
Both types are owned by shareholders with limited liability however there are key differences which we will explore below.
- A company is a business with its own legal entity. It can own assets (items), owe money to people and also sue or be sued by other people or companies.
- A shareholder is a person or organisation that owns a part of the company through the purchase of shares.
Private limited company (ltd)
A private limited company will put 'ltd' after their names (e.g. Acme ltd) and will not publicly advertise its shares for sale. Private limited companies are usually owned by family members and there can be restrictions on whom the shares could be sold to (through it's Articles of Association) which allows the business to be kept within a family or certain group of owners.
Advantages of a private limited company
- The liability of shareholders is restricted, safeguarding personal assets and making it more appealing for investors to contribute capital without the fear of unlimited liability. Should things not go as planned, their financial risk is confined.
- Customers often perceive a company as more prestigious than a sole proprietorship, potentially giving the company an edge in the market.
- The company's existence is not tied to its founders. If the original owners pass away, the company continues, with the ownership of shares transferring within the business structure.
- Professional managers can be appointed to oversee daily operations, allowing owners to focus on strategic aspects while profits are shared among the shareholders.
Disadvantages of a private limited company
- Establishing a private limited company involves several legal formalities, including registration, which requires both time and financial resources.
- Companies are obligated to produce and disclose their financial statements to the public, which can lead to a loss of confidentiality and could potentially benefit competitors.
- The accounts of the company need to be regularly checked by an independent accountant (known as an auditor) which results in additional costs.
- The company will need to pay corporation tax and this can under some circumstances be higher than income tax if there business was set up as a sole trader.
- Every investor in the company become a shareholder and they subsequently have a vote on on the direction of the business. The values of such investors may not necessarily be the same as the original owners and this can lead to clashes on the direction of the company or how it is run.
Public limited company (plc)
A public limited company will put 'plc' after their names (e.g. Acme plc) and can advertise their shares for sale or be listed on the Stock Exchange if it has a share capital of over £50,000. With public limited companies (plc) it is not possible to restrict who the shares can be sold to and means shareholders can subsequently sell them on to whoever they wish via the Stock Exchange.
The share price and increase or decrease dependent on demand which in itself has benefits and drawbacks.
Advantages of public limited companies
- Plcs can promote their shares to the general populace, leading to increased capital potential due to wider market access. This could facilitate significant fundraising for business expansion.
- Such companies often receive more media attention, which can translate to heightened public interest and serve as an economical form of advertising.
- Public limited companies generally carry more prestige compared to private companies, potentially boosting customer confidence.
- Investors in plcs have the flexibility to sell their shares with relative ease given the active trading on stock exchanges, providing liquidity to their investment.
Disadvantages of public limited companies
- While increased media exposure can be beneficial, it also means that any negative events are more likely to be highlighted, possibly damaging the company's reputation.
- A plc has less control over its shareholder base, risking the possibility of a takeover if a competitor acquires enough shares.
- Plcs face stricter regulations than private limited companies, necessitating the provision of detailed annual financial reports to shareholders and the public, which can be costly and reveal sensitive information.
- Transitioning from a private to a public limited company can introduce new stakeholders with different perspectives, potentially leading to conflicts in the company’s strategic direction.
When a private limited company decides to become a public limited company, this is called a floatation. To do this, the shares must be sold to the general public and the firm needs to meet the Stock Exchanges rules.
Shares in public limited companies are usually owned by financial institutions such as banks or insurance companies and such financial institutions often pressure the companies to pay out profits in the form of dividends. While this may make shares in such companies lucrative to own, it means that the plcs then have less funds to invest in the business itself and it's growth.
In the UK, only approximately 14% of plc shares are actually owned by individuals.
Not-for-profit organisations, such as charities are set up to achieve specific aims and objectives rather than turn over a profit for the benefit of shareholders. For example, you have many charities that are set up to help causes such as homelessness or disaster relief in countries that may be struck by natural events such as earthquakes or tsunami's. You may even have someone set up a not-for-profit for young people in the form of a youth club to help educate or offer diversionary activity that tackles crime.
Similar to profit based companies, not-for-profit organisations will have to raise money to operate and invest but the key difference is it's purpose is not to make a profit but usually to serve a social good or cause, known as social objectives. It will be set up to help society in some form and any profits that are made will be invested back into the business to help its societal objectives further.
How to choose the right business structure?
Choosing the correct structure for a business is contingent on various factors. Initially, many entrepreneurs opt for sole trader due to its straightforward setup and commencement process, without the need for registration or complex legalities. In the early phases, the entrepreneur's focus is less on the potential risks and more on the growth of the business, making the protection of personal assets through limited liability less urgent.
However, as the business expands, the need to shield personal wealth might grow, prompting the entrepreneur to consider attracting external investors and restructuring the business to facilitate further growth and limit personal liability.
For those driven by societal benefits rather than profit, establishing a not-for-profit organization is a viable option. Such entities reinvest all earnings back into their social missions rather than distributing profits to shareholders.
Setting business aims and objectives
This next section looks at how businesses set their aims and objectives. The AQA GCSE Business specification states you need to know the following:
- What are business aims and objectives
- Purpose of setting objectives
- Role of objectives in running a business
- Changing objectives
- Use of objectives in judging success