CHAPTER 1: BUSINESS’S

OBJECTIVES AND FUNCTIONS

1. Introduction to business
2. Managing a business
 Chapter 1 – Introduction to business
Content

• What is an organisation?

• What is business?

• Stakeholders in the business

• What are the business’s objectives?

• Mission, goals, plans and standards

 Chapter 1 – Introduction to business
What is an organisation?
• An ‘organisation’ is a group of individuals working
together to achieve one or more objectives.
• A social arrangement for the controlled performance of
collective goals, which has a boundary separating it
from its environment.
 Chapter 1 – Introduction to business
Why do organisations exist?

Overcome people’s Let people specialize

individual limitations in what they do best

Accumulate and
Save time
share knowledge

Pool expertise Enable synergy

 Chapter 1 – Introduction to business
How do organisations differ?

Ownership Control

Profit of non-
Activity
profit orientation

Sources of
Size
finance

Technology Legal status

 Chapter 1 – Introduction to business
What is a business?
 Chapter 1 – Introduction to business
What is a business?
Profit-oriented organisation Not for profit organisation
Refers to as “ business” Structure and run likes
business
Companies are owned by Not owned by shareholders or
shareholders partners.
Sole trader is owed by one Aim not maximise profit or the
individual wealth of owners.
Partnerships are owned by Focused on providing goods
collectives partners and services at minimised costs
Aim maximise profit or the
wealth of owners.
 Chapter 1 – Introduction to business
What is a business?

Business: An organisation (however small) that

is oriented towards making a profit for its owners
so as to maximise their wealth and that can be
regarded as an entity separate from its owners.
 Chapter 1 – Introduction to business
Stakeholders in the business

• A person or group of persons who has a stake in the

organization.
• They have an interest to protect in respect of what the
organization does and how it performs.
 Chapter 1 – Introduction to business
Stakeholders in the business
Shareholders (or Money A return on their investment so that their
Primary

partners or invested wealth increases:

proprietor) • Steady, growing profits paid out by the
business
• Growth in the capital value of their
share of the business
Directors/manager Livelihoods, • Fair and growing
s careers and • Career progression remuneration
Employees and reputations • Safe working environment
trade unions • Training
Secondary

• Pension
Customers Their custom • Products/services that are of good
quality and value
• Fair terms of trade
• Continuity of supply
Suppliers The items • Fair terms of trade
they supply • Prompt payment
• Continuity of custom
 Chapter 1 – Introduction to business
Stakeholders in the business
Lenders Money lent A return on their investment:
• Interest
• Repayment of capital
Government National infrastructure Reasonable employment and other
Secondary

and its used by business business practices

agencies The welfare of employees Compliance with regulations
Tax revenue Steady or rising stream of tax revenue
The local National infrastructure Reasonable employment and other
community used by business business practices
and the public The welfare of employees
at large
The natural The environment shared Reasonable environmental and other
environment by all business practices
 Chapter 1 – Introduction to business
Natural capital, Sustainability and Corporate responsibility
• The world's stocks of natural assets which include geology, soil,
Natural capital air, water and all living things. It is from this natural capital that
humans derive a wide range of services, often called ecosystem
services, which make human life possible

• the ability to “meet the needs of the present without

Sustainability compromising the ability of future generations to meet their own
needs”.

Business • How far a business can operate in sustainable way, and how it
sustainability should interact with individuals and governments in doing so.

Corporate • The actions, activities and obligations of business in achieving

responsibility sustainability.
 Chapter 1 – Introduction to business
Sustainability

Tangible
resources Intangible
resources
 Chapter 1 – Introduction to business
What are the business’s objectives?

➢ Primary objective: making as

much profit as possible so as to
increase shareholder wealth.
➢ Secondary objective: support
the primary objective: market
position, product development,
technology, employees and
management.
 Chapter 1 – Introduction to business

Is wealth maximisation always the primary objectives?

Profit satisficing
Decisions might be taken by managers with their own
managerial objectives in mind rather than the aim of
wealth maximisation.
 Chapter 1 – Introduction to business
Is wealth maximisation always the primary objectives?
Revenue maximisation:
A business may act to maximise revenue in order to
maintain or increase its markets share, ensure survival
and discourage competition.
 Chapter 1 – Introduction to business

Multiple objectives:
• Market standing
• Innovation
• Productivity
• Physical and financial
resources
• Profitability
• Manager performance and
development
• Worker performance and
attitude
• Social responsibility
 Chapter 1 – Introduction to business
Is wealth maximisation always the primary objectives?

Constrain theory:
• The theory is a methodology for identifying the most
important limiting factor that stands in the way of
achieving a goal.

• Sometime maximize profit is not the most important.

 Chapter 1 – Introduction to business
System of planning and control:
Chapter 1 – Introduction to business

• “The business’s function in

society” expressed in terms of
how it satisfies its various
stakeholders.
 Chapter 1 – Introduction to business
Element of mission:
Purpose
Why the business
exist

Strategy & Scope Values

What business and What management
how believes in

Standards &
behaviours
The rules that guide
how the business
…..
 Chapter 1 – Introduction to business

❖ A vision statement answers the

question: “What will success look
like?”
❖ The pursuit of this image of success is
what motivates people to work
together.

❖ https://www.youtube.com/watch?v=wHXkpNtjNgk
❖ https://www.youtube.com/watch?v=aPQ5vZTY1Xg
❖ https://www.youtube.com/watch?v=-QgzmxNtEvw
 Chapter 1 – Introduction to business

Goal
Goal: A desired end results
2 types of goals:

❖ Non-operational aims (qualitative goals) and

❖ Operational objectives (quantitative goals).

 Chapter 1 – Introduction to business

Characteristics of objectives
 Chapter 1 – Introduction to business
Purpose of objectives
‘Objectives are needed in every area where performance
and results directly and vitally affect the survival and
prosperity of the business’ (Peter Drucker). Objectives in
these key areas should enable

• Implement
• Publicise
• Appraise
• Assess and control actual performance
 Chapter 1 – Introduction to business

Plans

• Plan: State what should be

done to achieve the
operational objectives.
Chapter 1 – Introduction to business

• Standards and targets

specify a desired level of
performance

• Physical standards
• Cost standards
• Quality standards
Practice question
 Practice question
1.Anders Aid is a charity providing youth services in large
cities. The chief executive is involved in preparing a
document outlining the services provided by the charity.
She wants to stress that it always seeks to operate at
maximum efficiency. In stressing this aspect of the charity's
operations, the chief executive is highlighting the charity’s:

A. vision
B. mission
C. primary objective
D. secondary objective
 Practice question
2.Which two of the following characteristics do all
organisations have in common?

A. Pursuing controlled performance

B. Pursuing individual goals

C. Pursuing profit

D. Pursuing a social arrangement

E. Pursuing complete integration with the environment

 Practice question
3.The directors of Dexion plc have made strategic decisions
in the past to enhance their own prestige rather than the
wealth of the company's shareholders. However, at the
recent AGM the shareholders expressed satisfaction at the
company's recent profit record. It would appear, therefore,
that the directors are involved in:

A. constraining the business

B. revenue maximisation
C. satisficing
D. profit maximisation
 Practice question
4.Borneo plc has increased sales revenue by 8% in each of
the last few years. A stated objective of Borneo plc is now to
increase sales volume by 10%. Which key characteristic of
quantitative operational goals does Borneo's objective lack?

A. Being specific
B. Being measurable
C. Being achievable
D. Being time-bound
 Practice question

5.Bedard plc states in its annual report that it sees itself

as becoming the European market leader for synthetic
tents by 20X1. This statement is the company’s:

A. plan

B. vision

C. mission

D. objective
 Chapter 1 – Managing a business
Content
▪ What is management?
▪ Power, authority, responsibility, accountability and delegation
▪ Types of manager
▪ The management hierarchy
▪ The management process
▪ Managerial roles
▪ Culture
▪ Management models
▪ Business functions
▪ Marketing management
▪ Operations management
▪ Procurement
▪ Human resource management
▪ Information technology
 Chapter 1 – Managing a business
What is management?

Management: Getting things done through other people.

• Setting objectives
• Monitor progress and results to ensure an organisation
met objectives.
• Communicate and sustain corporate value, ethics and
operating principles.
• Look after the interest of organisation’ owner and
stakeholders.
 Chapter 1 – Managing a business
What is management?
Management
purpose and process

AUTHORITY RESPONSIBILITY
Right to do st Obligation to do st

POWER ACCOUNTABILITY
Ability to get Obligation to report to sb
thing done (superior) how (delegated)
authority is exercise
 Chapter 1 – Managing a business

Power is ability to get things done

• Coercive power
• Reward (or resource) power
• Legitimate (or position) power
• Expert power
• Referent (or personal) power
• Negative power (Handy)
 Chapter 1 – Managing a business

Nisar lqbal is a manager in the IT department of his firm. He has a

degree in computer science and 14 staff reporting to him. What
types of power can Nisar exert as a manager in order to make
sure a project is completed on time?
See Answer at the end of this chapter.
 Chapter 1 – Managing a business

• The right to do something, or to ask someone

else to do it and expect it to be done.

• Authority is thus another word for position or

legitimate power
Chapter 1 – Managing a business

Managerial authority is excercised in

such areas:

- Making decisions within the scope of

authority given to the position.

- Assigning tasks to subordinates and

expecting satisfactory performance of
these tasks
 Chapter 1 – Managing a business
Responsibility and accountability

• The obligation a person has to

Responsibility fulfil a task which s/he has
been given.

• A person's liability to be
called to account for the
fulfilment of tasks s/he has
Accountability been given by persons with
a legitimate interest in the
matter.
Chapter 1 – Managing a business

Delegation is a process of
transferring authority to a
subordinate.
 Chapter 1 – Managing a business
Types of manager

A line manager A staff manager

A functional manager A project manager

 Chapter 1 – Managing a business
Types of manager
Problem Possible solution
The staff manager can undermine the Clear demarcations for line, staff and
line manager's authority functional managers should be created.
Lack of seniority: line managers may Use functional authority (via policies
be more than staff managers and procedures), senior
Experts should be seen as a resource,
not a threat.
Expert staff managers may lack They should be fully aware of
realism, going technically perfect but operational issues and for
commercially impractical solutions. communicate regularly with the line
managers,
Staff managers lack responsibility for They should be involved in
the success of their ideas. implementing their suggestions and
share accountability for outcomes.
 Chapter 1 – Managing a business
Management hierarchy
Characteristics

Few in number, responsible for overall

Top
managers
direction and performance of the
: business
managing
the
business
Many, responsible for ensuring
Middle managers: performance targets are met by first-line
managing managers
managers

Numerous, responsible for ensuring

First-line managers: managing
staff on direct operations
direct operational staff do what is
required

Direct operational staff: doing the work Very numerous, accountable to first-line
managers for getting the job done
 Chapter 1 – Managing a business
Management process

Planning

Leading Organizing

Controlling
Chapter 1 – Managing a business
Chapter 1 – Managing a business

The common assumptions,

values and belief that people
share.
 Chapter 1 – Managing a business
Culture
Robert E Quinn

Flexibility
Inward-looking Human relations Open systems Outward-looking
culture culture
Internal process Rational goal
culture culture
Control
 Chapter 1 – Managing a business
Open
Rational
systems

External
goal
model
model
Means: plans, structure Means: adaptability
Goals: efficiency and Goals: responsiveness to
productivity environ, growth

FOCUS
Control Flexibility

Means: cohesion, morale

Means: authority, rules Goals: human resource
Goals: stability, output development
Internal

Internal Human
process relations
model model
 Chapter 1 – Managing a business
The rational goal model of management
Five principles:

Determine the one best way of doing a particular task

Select the best person to do this task on the basis of their

mental and physical capabilities

Train the worker to follow the set procedure very precisely

Give financial incentives to ensure the work is done in the

prescribed way

Give all responsibility to plan and organise work to the manager, not
to the worker
 Chapter 1 – Managing a business
The rational goal model of management

Elements of model

Systematic work methods

Detailed division of labour

Centralised planning and control

'Low involvement' employment relations, such

as contract workers
 Chapter 1 – Managing a business
Internal process model of management

Focus at how the organisation is doing things not why.

• Rationality
• Hierarchical lines of authority
• Detailed rules and procedures
• Division of labour
• Impersonality
• Centralisation
 Chapter 1 – Managing a business
Business functions

Marketing Operation
includes or Procurement
sales Production

Human Information
Finance
resources technology
 Chapter 1 – Managing a business
Marketing management
• Marketing: The set of human activities directed at
facilitating and consummating exchanges.

OR
• Marketing: The management process which identifies,
anticipates and supplies customer requirements efficiently
and profitably.

• Key emphasis on customer needs

• Marketing research, product development, distribution and
promotion all important
 Chapter 1 – Managing a business
Marketing management
Customer vs. Consumer

Customer
purchases the
product Consumer uses the
product
 Chapter 1 – Managing a business
Marketing management

Consumer and industrial markets

• FMCGs

• Consumer durables

• Services

• B2C
 Chapter 1 – Managing a business
Marketing mix
Price

Physical
environment Product

Marketing
Process mix Promotion

People Place
 Chapter 1 – Managing a business
Marketing mix

Product • This includes product features, durability, design,

brand name, packaging, warranties and guarantees

Place • Choice of distribution channels, transportation, outlet

management, stocks and warehouses

Promotion • Advertising, personal selling, publicity, sales and

promotion techniques

Price • Price levels, discounts, allowances, payment terms

and credit policy
 Chapter 1 – Managing a business
Marketing mix
People Process Physical evidence
• Individual on • Customer focus • Sales/staff contact
marketing experience of
activities brand

• Individual on • Business-led • Product packaging

customer contact
• Recruitment • IT-supported • Online experience
• Culture/image • Design features
• Training and skills • Research and
development
• Remuneration
 Chapter 1 – Managing a business
Market segmentation
The division of the market into homogeneous groups of
potential customers who may be treated similarly for
marketing purposes
 Chapter 1 – Managing a business

• is one which accepts the needs of

A marketing- potential customers as the basis
oriented business for its operations.
 Chapter 1 – Managing a business
Marketing orientation

Sales orientation

Product orientation

Production orientation
 Chapter 1 – Managing a business
Product
• Anything that can be offered to a market for attention,
acquisition, use or consumption that might satisfy a want
or need.
• It includes physical objects, services, persons, places,
organisations and ideas.
• Marketers tend to consider products not as 'things' with
'features' but packages of 'benefits' that satisfy a variety of
consumer needs.
 Chapter 1 – Managing a business

Actual product

Basic (or core) Augmented

product product

Elements
of a
product
 Chapter 1 – Managing a business
General factor of Product

Quality and
Packaging Branding
reliability

Servicing/
Aesthetics Product mix associated
services
 Chapter 1 – Managing a business
Price
At what level the product should be priced is highly relevant
in any marketing mix.

Influences on price policy

• Costs
• Competitors
• Customers
• Corporate objectives
 Chapter 1 – Managing a business
Place
Producer Consumer

Or to use intermediaries to give a longer distribution chain

Producer Wholesalers Retailers Consumers

INTERMEDIARIES
 Chapter 1 – Managing a business
Place
Advantages of using use
Advantage of selling direct
intermediaries
• No need to share profit • More efficient logistically
margins Costs usually lower
• Control over ultimate sale • Consumers expect choice at
point of sale
• Speed of delivery to • Producers may not have
ultimate consumer likely to sufficient resources to sell
be quicker direct
 Chapter 1 – Managing a business
Promotion

Sales promotion
(such as 'buy one,
Advertising Public relations
get one free'
offers)

Direct marketing
(such as
Personal selling
mailshots, popups
on websites etc
 Chapter 1 – Managing a business
Promotion
PROMOTION TECHNIQUES

PUSH PULL

Ensuring Persuading the ultimate

products/services are consumers to buy
available to consumers
by encouraging
intermediaries.
 Chapter 1 – Managing a business
Operation or production management
Creating as required the goods or services that the business
is engaged in supplying to customers by being concerned
with the design, implementation and control of the business's
processes so that inputs (materials, labour, other resources,
information) are transformed into output products and
services.
 Chapter 1 – Managing a business
Process design – the Four Vs
Low repetition High repetition
Multi-skilling Specialisation
Less systemization
Low Volume High
Capital intensive
High unit cost Low unit cost

Flexible Well defined

Complex Routine
Customised
High Variety Low
Standardised
High unit cost regular
Low unit cost
Changing capacity
Flexibility Stable
Anticipation Variation Routine
In touch with High Low Predictable
demand in demand High utilization
High unit cost Low unit cost

Short waiting Delay between

tolerance production and
Importance of High Visibility Low consumption
perception Low contact
Co-production High staff utilization
High unit cost Low unit cost
 Chapter 1 – Managing a business
Operation or production management

Operations management is concerned balancing key

variables:

• External and internal demand for goods and services

• Resources
• Capacity of the long-term assets of the business such as
machinery, buildings and computer systems, and of the
other assets of the business such as people (staff)
• Inventory levels
• Performance of the process which creates the goods or
services
 Chapter 1 – Managing a business
Research and development
• original research to obtain new scientific or technical knowledge
Pure research or understanding. There is no obvious commercial or practical
end in view.

Applied research • research which has an obvious commercial or practical end in

view.

• the use of existing scientific and technical knowledge to

Development produce new products or systems, prior to starting commercial
production operations.

Product research • finding new and improved products for the market.

Process research • developing new and better ways of producing the

goods/services
 Chapter 1 – Managing a business
Operation or production management

Procurement: the acquisition of

goods and/or services at the best
possible total cost of ownership,
in the right quantity and quality, at
the right time, in the right place
and from the right source for the
direct benefit or use of the
business

Technology can be used to control and monitor for production

and delivery of goods and services
 Chapter 1 – Managing a business
Operation or production management
Procurement mix

Lead-
Price time

Quality

Quantity
Chapter 1 – Managing a business

'The creation,
development and
maintenance of an
effective workforce,
matching the
requirements of the
business and responding
to the environment'
(John Naylor).
 Chapter 1 – Managing a business
Human resources
Responsibility:
• Personnel planning and control
• Production of job descriptions and person specifications
in terms of what is needed regarding experience, skills
and education
• Development of policies for compliance with legal and
other employment standards
• Development of training courses
• Designing remuneration packages and drawing up
employment contracts
 Chapter 1 – Managing a business
Approaches to HRM

Hard HRM Soft HRM

• Employees as a resource • Employees as a cost
• “People” issues • “Market” issues
• Commitment • Compliance
• Integration/co-operation • Control
• Qualitative/negotiation • Quantitative/rational
 Chapter 1 – Managing a business
The Harvard four Cs model of HRM

Commitment • Assesses employees' motivation, loyalty and job satisfaction.

• Relates to employees' skills, abilities and potential. The objective

Competence of HRM policies in this area should be to attract, retain, motivate,
train and promote the right people.

• This is a measure of the extent to which management and

Congruence employees share a common vision for the business and act
consistently to attain that vision.

• Concerns operational efficiency and productivity. Outputs are

Cost- aimed to be achieved at the lowest input cost. Labour cost and
effectiveness effectiveness by comparison to competitors may be a measure
of HRM achievement in this area
 Chapter 1 – Managing a business
The organizational behavior - Iceberg
 Chapter 1 – Managing a business
Models of human behaviour
Taylor's model: scientific management
• People are rational economic animals concerned with
maximising their economic gain
• People respond as individuals, not groups
• People can be treated in a standardised fashion, like
machines Taylor's conclusions were as follows:
• Main motivator: high wages
• Manager's job: tell workers what to do
• Workers' jobs: do what they are told and get paid
 Chapter 1 – Managing a business
McGregor's model: Theory X and Theory Ya
Theory X
• Individuals dislike work and avoid it where possible
• Individuals lack ambition, dislike responsibility and prefer to be led
• A system of coercion, control and punishment is needed to achieve
business objectives
• Above all, the individual desires security
Theory Y
• Physical and mental effort in work is as natural as rest or play
• Commitment to objectives is driven by rewards - self-actualisation is the
most important reward (see Maslow's hierarchy below)
• External control and threats are not the only way to achieve objectives -
self-control and direction are very important
• People learn to like responsibility
• The intellectual potential of the average human is only partially utilised - it
needs to develop further
 Chapter 1 – Managing a business

Motivation
The degree to which a person
wants certain behaviours and
chooses to engage in them.

Maslow’ content theory

 Chapter 1 – Managing a business
Motivation
Herzberg's content theory

Hygiene factors Motivating factors

(1) (2)

Workers no Positive
Dissatisfaction longer satisfaction and
and demotivation dissatisfied but motivation
not yet motivated
 Chapter 1 – Managing a business
Motivation
Herzberg's content theory: hygiene and motivating factors
Hygiene factors Motivator factors
• Salaries, wages and other benefits • Sense of personal achievement
• Company policy and administration • Status
• Good inter-personal relationships • Recognition
• Quality of supervision • Challenging/simulating work
• Job security • Responsibility
• Working conditions • Opportunity for advancement
• Work/life balance • Promotion
• Growth
When in place, these factors result in…. When in place, these factors result in…
• General satisfaction • High motivation
• Prevention of dissatisfaction • High satisfaction
• Strong commitment
Content theories of motivation
 Chapter 1 – Managing a business
Group behaviour
Group: A collection of people with the following
characteristics:

• Common sense of identity

• Common aim or purpose
• Existence of group norms
• Communication within the group
• The presence of a leader
 Chapter 1 – Managing a business
Stages of group development

Stage 5
Adjourning
Stage 4
(Group may
Performing discard
Stage 3
(Group either their
Norming members
Stage 2 goals or
(Members work toward members
Storming work
Stage 1 getting their leave)
(Members together, jobs done)
Forming come to developing
(Members resist control close
get to know by group relationship
each other leaders and and feeling
and seek to show of
establish hospitality) camaraderie
ground rules)
 Chapter 1 – Managing a business
Team roles
Team role Contribution
Plant thoughtful and thought-provoking

Resource not a new ideas person but tends to pick up others' ideas and adds to
investigator them; is usually a social type of person who often acts as a bridge to
the outside world
Company turns general ideas into specifics; is practical and efficient; tends to be
worker an administrator handling the scheduling aspects
Shaper committed to the task; may be aggressive and challenging; will also
always promote activity
Monitor analytically criticises others' ideas; brings team down to earth
Evaluator
Team worker concerned with the relationships within the team; is supportive and
defuses potential conflict situations
Completer unpopular, but a necessary individual: the progress chaser ensuring
Finisher that timetables are met
Leader co-ordinating (not imposing) and operating through others
 Chapter 1 – Managing a business
Leadership style

Authority

Autonomy

Leadership
 Chapter 1 – Managing a business
Likert's authoritative – participative continuum
 Chapter 1 – Managing a business
Likert’s leadership style

Four characteristics of effective managers

• Employee-centred rather than work-oriented

• Set high standards but are flexible in terms of methods to
use to achieve those standards

• Natural delegators with high levels of trust

• Encourage participative management
 Chapter 1 – Managing a business
Mc Gregor’s theory

Attitude

We dislike work, find it boring, and will avoid it if we can We need to work and want to take an interest in it.
Under the right conditions, we can enjoy it.
Direction
We must be forced or coerced to make the right effort we will direct ourselves towards a target that we accept.
Responsibility

We would rather be directed than accept responsibility, We will seek and accept responsibility, under the right
which we avoid conditions.
Motivation

We are motivated mainly by money and fears about Under the right conditions, we are motivated by the
their job security desire to realize our own potential
Creativity

Most of us have little creativity – except when it comes We are highly creative creatures – but are rarely
to getting around rules recognized as such or given the opportunity to be.
Chapter 1 – Managing a business

Delegation involves giving a

subordinate responsibility and
authority to carry out a given task,
while the manager retains overall
responsibility
 Chapter 1 – Managing a business
Delegation
Advantages of delegation:
• Manager can be relieved of less important activities
• It enables decisions to be taken nearer to the point of
impact and without the delays caused by reference
upwards
• It gives businesses a chance to meet changing conditions
more flexibly
• It makes the subordinate's job more interesting
• It allows for career development and succession planning
• It brings together skills and ideas
• Team aspect is motivational
• It allows performance appraisal
 Chapter 1 – Managing a business
Delegation
Problems caused by poor delegation;
• Too much supervision can waste time and be demotivating for the
subordinate
• Too little supervision can lead to subordinates feeling abandoned
and may result in an inferior outcome if they are not completely
happy with what they are doing
• Manager tries to delegate full responsibility, that is s/he uses
delegation to 'pass the buck'
• Manager only delegates boring work
• Manager tries to delegate impossible tasks because s/he cannot do
it themselves
• Managers may not delegate enough because they fear their status
is being undermined, and they want to stay in control
• Subordinates may lack the skills and training required
 Chapter 1 – Managing a business
Information Technology
Management Advice
action
Monitoring IT developments are often rapid and difficult to keep up-to-date with.
Companies whose finance directors are unaware of them could be
missing out on opportunities to develop the business and its
systems for the better. Therefore it is vital to maintain an awareness
of potentially useful developments and any compliance obligations,
by building up a list of contacts and information sources which can
be turned to from time-to-time.
Planning IT functions and the effective management of change require careful
planning and preparation to ensure everything runs smoothly and
without disruption.
Structure IT management tasks should be prioritised and documented. There
should be a rolling programme of 'business as usual' and 'forward
change' activities.
Staffing and skills IT teams require the right people to be recruited and retained. This
means employing staff with suitable skills and experience in data
science (see Chapter 6) and to matching them to the most
appropriate roles.
 Chapter 1 – Managing a business
Information Technology

IT delivery and IT support

• IT delivery and IT support may be performed by different teams.

External support
• include user groups and peer support (networking) communities.
Businesses very often use the same hardware, software and services as
others.
Outsourcing
• allowing the business to focus on its core activities and obtaining better IT
functions and service than what is achievable using in-house staff.
Innovation
• support innovation and invest in new IT to avoid being left behind by
competitors who may use IT for competitive advantage
Practice questions
 Practice question
1.Peter is an HR specialist within Yelland plc. He is
responsible for a new payroll database to be used by all
functions in the company. If Karen, a production manager,
attempted to alter the database parameters, Peter could
prevent her from doing so by exercising:

A. project authority
B. functional authority
C. staff authority
D. line authority
 Practice question
2. Rianna is a senior manager with Vivra plc. She works in
the finance function of the company, but has no formal
qualifications in finance. She is highly influential within the
finance function with both subordinates and also with
managers who are more senior to herself. This is because
of her ability to motivate and persuade those around her
with her personality and intellectual abilities. Rianna
exhibits which type of power within Vivra plc?
A. Referent power
B. Expert power
C. Legitimate power
D. Coercive power
 Practice question
3.Which two of the following models of human behaviour
emphasise the importance of remuneration as a key need
and, therefore, motivator of people?
A. Theory X
B. Scientific management
C. The hygiene factor
D. Theory Y
E. The hierarchy of needs
 Practice question
4.A new project team has been established by Crockett plc.
At today's weekly progress meeting there was a long
discussion about how the project's performance will be
measured. Some speakers felt the primary objective was
profit, so financial measures should take priority. Others
argued that minimising adverse environmental impacts was
the primary objective, so environmental measures would be
more appropriate. From these discussions, it is evident that
the project team is at which stage of group development?
A. Forming
B. Storming
C. Norming
D. Performing
 Practice question
5. Gregorian plc is engaged by the government as the sole
operator of a licensing system in the UK. The company has set
procedures for applications from businesses seeking licences,
for inspections of the operations of applicants and existing
licensees and for dealing with breaches of the rules. All staff
within Gregorian plc are fully trained in these procedures. They
are judged primarily by their ability to put the procedures into
practice on every assignment. It is clear that Gregorian plc has:
A. an internal process culture
B. a rational goal culture
C. an open systems culture
D. a human relations culture
 Practice question
6.Which two of the following factors form part of the
Harvard model for investigating human resource
management issues in organisations?

A. Consistency
B. Clarity
C. Competence
D. Congruence
E. Competitiveness
 Practice question
7.Which three of the following are classified as hygiene
factors by Frederick Herzberg?

A. A sense of challenge in a job

B. Working conditions of a job
C. Relationships with other staff
D. Recognition
E. Quality of supervision received
 Practice question

8.Wastby plc has noticed a recent downturn in productivity in

one of its key production departments. It has established that a
group of production workers are currently demotivated because
of the actions of a previous manager who has now been
replaced. Stephen, the replacement manager, must find ways to
improve the motivation of the group. In terms of the management
process, Stephen needs to:

A. plan
B. organise
C. Control
D. lead
 Practice question
9.Peterburn plc organises a production department using the
principles of F W Taylor's 'scientific management' model.
Which two of the following are likely to characterise the
operations of this production department?
A. Job rotation
B. Identification of the single best way of performing a task
C. Effective training in the performance of tasks
D. Management delegation of responsibility to frontline workers
E. Identification of a range of suitable ways of performing a task
 Practice question
10.In terms of the organisational iceberg, which two of the
following are overt variables affecting organisational behaviour?

A. Formal goals
B. Attitudes
C. Underlying competencies and skills
D. Organisation design
E. Communication patterns
CHAPTER 2: ORGANISATIONAL
STRUCTURES AND BUSINESS
STRATEGY
1. Organisational structures
2. Business strategy
 Chapter 2.1 – Organisational and
business structures
Content
• Introduction to organisational structure
• Types of organisational structure
• Centralisation and decentralisation
• Span of control: tall and flat businesses
• Mechanistic and organic organisations
• Introduction to business structure
• Sole tradership
• Partnerships
• Companies
• Which business structure should a business take?
• Alliances
 Chapter 2.1 – Organisational and
business structures
Organisational structure
Formed by the grouping of people into departments or
sections and the allocation of responsibility and authority,
organisational structure sets out how the various functions
are formally arranged
 Chapter 2.1 – Organisational and
business structures
Organisational structure
• Link individuals

• Allocate the tasks

• Give each individual or group the authority required to
perform the allocated tasks.

• Co-ordinate the objectives and activities of separate

groups.

• Facilitate the flow of work, Information

• Resources through the business.

 Chapter 2.1 – Organisational and
business structures

The building blocks and co-ordinating mechanisms of

organisational structure – Mintzberg
 Chapter 2.1 – Organisational and
business structures
The building blocks and co-ordinating mechanisms of organisational structure
Building block Function
People directly involved In the process of obtaining inputs, and converting
Operating core
them into outputs, ie direct operational staff.

Conveys the goals set by the strategic apex and controls the work of the
Middle line
operating core in pursuit of those goals, ie, middle and first-line managers.

Ensures the organisation follows its mission. Manages the organisation's

Strategic apex
relationship with the environment. Top managers.
Ancillary services such as PR, legal counsel, the cafeteria and security
staff.
Support staff
Support staff do not plan or standardise operations. They function
independently of the operating core.
Analysts determine and standardise work processes and techniques.
Planners determine and standardise outputs (eg goods must achieve a
Technostructure
specified level of quality).
Personnel analysts standardise skills (eg through training programmes).
Ideology Values, beliefs and traditions, ie the business culture.
 Chapter 2.1 – Organisational and
business structures
The building blocks and co-ordinating mechanisms of organisational structure

Interactive question 1: Building blocks

Where do you fit into the organizational structure of your
firm? Try to identify the point at which the firm narrows to
form the ‘middle line’ and also those departments which are
part of the technostructure and support. What do you think
the overarching ideology of the firm is?
See Answer at the end of this chapter.
 Chapter 2.1 – Organisational and
business structures
Co-ordinating mechanisms

Standardisation of
Direct supervision
work

Standardisation of Standardisation of
skills outputs

Mutual adjustment
 Chapter 2.1 – Organisational and
business structures
Classical principles of organisational structure - Henri Fayol
14 principles

Specialisation of Authority Discipline

labor

Unity of command Unity of direction Subordination of

individual interests

Remuneration Centralisation Scalar chain (Line

of authority)

Order Equity Personnel tenure

Initiative Esprit de Corps

 Chapter 2.1 – Organisational and
business structures
Modern management emphasise to value

• Muiti skill
• Flexibility
 Chapter 2.1 – Organisational and
business structures
Communicating the organisational structure
Organisation
of he
business

Organisation Organisation Job

chart manual description

Pictorial representation of the structure Includes • A result of ‘job analysis’

• Includes responsibilities, authority
Advantages Disadvantages
• Details about all and work involved
• Need to • Frequent updating
positions in the • Typical descriptions
analyse as people leave
organisation ➢ Job title
organisation • Informal
• Standard ➢ Department
detail relationship not
principles anda ➢ Grade/level
• Provides at- show
working ➢ Duties and responsibilities
a-giance • May imply
practices ➢ Limits of authority
information managers at the
➢ Superiors and subordinates
same level are
equally important
• May encourage
bureaucracy
 Chapter 2.1 – Organisational and
business structures
Types of organisational structure
Types of Key co- Typical
External Key building ordinating
organizational Internal factors
enviroment block structure
structure mechanism
Small
Simple Direct Entrepreneuria
Simple Young Strategic apex
Dynamic supervision 1
Simple tasks
Large
Machine Simple Standardisation
Old Technostructure Functional
bureaucracy Static of work
Regulated
Professional Complex Professional Standardisation
Operating core -
bureaucracy Static Simple systems of skills
Simple Very large
Static Standardisation
Divisionalised Old Middle line Divisional
of outputs
Diverse Divisible tasks
Adhocracy/ Complex Young Mutual
Operating core Matrix
Innovative Dynamic Complex tasks adjustment
 Chapter 2.1 – Organisational and
business structures
Entrepreneurial structure
▪ Has specialist knowledge of product/service
▪ Has total control over running of the business
Advantages
o Quick decisions can be made with skill and flair
o Goal congruence - the entrepreneur's objectives
are pursued exclusively
o Flexible/adaptable to change
Disadvantages
o Cannot expand beyond a certain size
o Cannot easily cope with diversification
o Lack of career structure for lower level employees
o May be too centralisedur
 Chapter 2.1 – Organisational and
business structure
Functional structure
• Similar to Mintzberg's machine bureaucracy

• Jobs grouped by common feature

• Clear lines of reporting and authority exist

• Formal procedures and paperwork

• The vertical flow of authority (scalar chain)

 Chapter 2.1 – Organisational and
business structures
Functional structure
 Chapter 2.1 – Organisational and
business structures
Functional structure
Most suitable:
• Single product/closely-related product forms
• Relatively stable environment
• Smaller enterprise
Advantages
• Good career opportunities, employees can progress 'up through theranks’
• Can be efficient as functional tasks are well-known and understood by individuals
• Exploits specialist functional skills
Disadvantages
• Structure is very rigid and unsuitable for
- Growth
- Diversification
• Tendency towards authoritative non-participative management style as clear levels of authority
are enforced
• Poor decisions/slow decisions which have to pass along a line of authority
• Functional heads may build empires and inter-functional disputes may result
 Chapter 2.1 – Organisational and
business structures
Divisional structure
 Chapter 2.1 – Organisational and
business structures
Divisional structure
Suitable:
• There are larger, more diversified businesses
• There is diversity by product and/or location
Advantages
• Flexible in adapting to growth and diversification - extra divisions can simply be added into the structure
• Good for developing managers as they are given responsibility for divisional profit
• Reduces the number of levels of management
• Encourages a greater attention to efficiency, lower costs and higherprofits
• Better decisions on performance made by managers 'in the know'
• Releases top management to concentrate on strategic issues
• Reduces the likelihood of unprofitable products and activities beingcontinued
Disadvantages
• Squabbles over allocation of central costs can occur
• Interdivisional trading problems, ie at what transfer price should the trades takeplace?
• It may be impossible to identify completely independent products or markets for which separatedivisions
can be set up
 Chapter 2.1 – Organisational and
business structures
Matrix structure
 Chapter 2.1 – Organisational and
business structures
Matrix structure
Suitable
• Complex
• hi-tech industries
• Educational establishments
• R&D departments

Advantages Disadvantages
Reflects importance of project or Conflicting demands on staff time
customer, so may improve (staff have to serve two bosses)
relationships and sales
Business co-ordinated with regard to Conflicting demands over allocation of
technology, information… other resources
Dilution of authority of functional
heads
 Chapter 2.1 – Organisational and
business structures

Centralised organization: One in which decision-making

authority is concentrated in one place, that is the strategic
apex.
 Chapter 2.1 – Organisational and
business structures
Centralisation and Decentralisation
Centralised structures

upper levels authority to make

decisions

Decentralised structures
retain authority (ie
to make commit people,
decisions money and
resources) is
passed down to
lower levels of the
hierarchy
 Chapter 2.1 – Organisational and
business structures
Factors affecting the amount of decentralisation in a business

• Leadership style

• Size of organisation

• Extent of activity diversification

• Effectiveness of communication

• Ability of management

• Speed of technological advancement

• Geography of locations

• Extent of local knowledge needed

 Chapter 2.1 – Organisational and
business structures
Which is better?
Pro centralisation Pro decentralization (delegation of authority)
Decisions are made at one point and so are easier to co- Avoids overburdening top managers, in terms of workload and
ordinate. stress.
Senior managers can take a wider view of problems and Improves motivation of more junior managers who are given
consequences. responsibility and authority.

Greater awareness of local problems by decision makers.

Senior management can balance the interests of different
(Geographically dispersed organisations are often decentralised o n
functions, eg by deciding on the resources to allocate to each.
a regional/area basis for this reason.)

Greater speed of decision making, and response to changing

Senior managers keep control. events, since no need to refer decisions upwards. This is
particularly important in rapidly changing markets.

Quality of decisions is (theoretically) better due to senior Helps develop the skills of junior managers: supports managerial
managers' skills and experience. succession.

More likely to produce congruent decisions as decision-makers Separate spheres of responsibility can be identified: controls,
are more likely to pursue same objectives. performance measurement and accountability are better.

Possibly cheaper, by reducing number of managers needed and Communication technology allows decisions to be made locally,
so reduced costs of overheads - simpler structure. with information and input from head office if required.

Crisis decisions are taken more quickly at the centre, without need to refer back.

Policies, procedures and documentation can be standardised business-wide.

Transfer pricing is less of a problem.
 Chapter 2.1 – Organisational and
business structures
Span of control
The number of people (subordinates) reporting to one person
 Chapter 2.1 – Organisational and
business structures
Influences on the span of control:

• A manager's capabilities

• The nature of the manager's workload

• The geographical dispersion of subordinates

• Subordinates' work

• The nature of problems

• The degree of interaction between subordinates

• The amount of support that supervisors receive from other parts of
the organisation or from technology
 Chapter 2.1 – Organisational and
business structures
Tall and flat businesses
• Scalar chain: The chain of command from the most
senior to the most junior.

• Tall business: One which, in relation to its size, has a

large number of levels in its management hierarchy,
normally because there are narrow spans of control.

• Flat business: One which, in relation to its size, has a

small number of hierarchical levels, normally because
there are wide spans of control.
Chapter 2.1 – Organisational and
business structures
 Chapter 2.1 – Organisational and
business structures
Tall business
For Against
Narrow control spans Inhibits delegation
Small groups enable team members to Rigid supervision can be imposed,
participate in decisions blocking initiative

A large number of steps on the

promotional ladder - assists The same work passes through too many
management training and career hands
planning
Increases administration and overhead
costs
Slow decision making and responses, as
the strategic apex is further away
 Chapter 2.1 – Organisational and
business structures
Flat business
For Against
Requires that jobs can be delegated. If
More opportunity for delegation managers are overworked they are more
likely to be involved in crisis management
Managers may only get a superficial idea
of what goes on
Relatively cheap Sacrifices control

In theory, speeds up communication Middle managers are often necessary to

between strategic apex and operating convert the grand vision of the strategic
core apex into operational terms
 Chapter 2.1 – Organisational and business
structures
Mechanistic and organic organisations
Factor Mechanistic organisation Organic organisation

Tasks are specialised and broken down into Specialist knowledge and expertise contribute to the
The task
sub-tasks. common task of the organisation.

People are concerned with completing the task Each task is seen and understood to be set by the
How the task fits
efficiently, rather than how the task can improve total situation of the business: focus is on the task's
in
organisational effectiveness. contribution to organisational effectiveness.

Managers are responsible for coordinating People adjust and redefine their tasks through
Co-ordination
tasks. interaction and mutual adjustment with others.

There are precise job descriptions and Job descriptions are less precise: people do what is
Job description
delineations of responsibility. necessary to complete the task.

Hierarchical structure of control. An individual's Network structure of control. An individual's

Legal contract/ performance and conduct derive from a performance and conduct derive from a supposed
common interest contractual relationship with an impersonal community of interest between the individual and the
business. business, and the individual's colleagues.

Decisions are taken by senior managers who Relevant technical and commercial knowledge and
Decisions
are assumed to know everything. decision-making authority can be located anywhere.

Insistence on loyalty to the concern and Commitment to the business's mission is more highly
Mission
obedience to superiors. valued than loyalty as such.
 Chapter 2.1 – Organisational and
business structures
Mechanistic: bureaucracy
• Continuous organisation: The business does not
disappear if people leave: new people will fill their shoes
• Official functions: The business is divided into areas with
specified duties, Authority to carry them out is given to the
managers in charge

• Rules: A rule defines and specifies a course of action that

must be taken under given circumstances
 Chapter 2.1 – Organisational and
business structures
Characteristics of bureaucracy
Hierarchy of
roles

Stability Specialisation
and training

Professional
Technical
nature of
competence
employment

Uniformity in
the Impersonal
performance nature
of tasks
Rationality
 Chapter 2.1 – Organisational and
business structures
Mechanistic: bureaucracy
Advantages Disadvantages
• Ideal for standardised, routine • Slow decision-making
tasks.
• Efficient in stable environments • Creates conformity

• Rigid adherence to procedures • Suppress innovation

may be necessary for fairness
• Bureaucracies tend to be long- • It hard to learn from their mistakes
lived because they select and
retain bureaucratically-minded
people
• Slow to change, poor uptake or use
technology
• Communication is restricted to
established channels
 Chapter 2.1 – Organisational and
business structures
Organic organisations
Control
Description
mechanism
Status Although organic businesses are not hierarchical in the
way that bureaucracies are, there are differences of
status, determined by people's greater expertise,
experience and so forth.
Commitment The degree of commitment employees have to the goals
of the business and the team is more extensive in organic
than in mechanistic systems
Shared Hierarchical control is replaced by the development of
values and shared beliefs and values. In other words, corporate
culture culture becomes a powerful guide to behaviour.
 Chapter 2.1 – Organisational and
business structures
Business structure
 Chapter 2.1 – Organisational and
business structures
Sole tradership
A single proprietor owns the business, taking all the risks and enjoying all the
rewards of the business.
Features
• No legal distinction
• The proprietor is wholly liable for the debts of the business, borrowing money
• Financed by a mixture of owner's capital
• Sole traders take drawings from the business
• Proprietor to take a very active role: doing many different thing
• Managing the business
• A sole tradership business can be sold as a going concern by its owner
• If a sole trader dies, the business's assets and liabilities form part of their
estate but the sole tradership as such ceases to exist
• No perpetual succession
 Chapter 2.1 – Organisational and
business structures
Sole trader
Advantages Disadvantage
• The flexibility • Limits to the skills and the time of
one individual
• 'being their own boss' • Sole traders overwork
• No publicity requirement of sole • Find it difficult to take a holiday
traders
• Offers both privacy and cost • Hard to expand
savings
• Sole trader
• Unlimited liability for the business's
debts.
 Chapter 2.1 – Organisational and
business structures
Partnership
• It can either be a formal or informal arrangement.
➢ The financing issues that face sole traders also face many general
and limited partnerships
• Partners take drawings from the business
• All the partners may be as actively involved in the business as
the typical sole trader.
• A share in a partnership is not a form of property as such and
selling it can be difficult
• If a partner dies, a general or limited partnership is dissolved -
there is no 'perpetual succession‘
➢ There are three forms of partnership: general, limited and limited
liability partnerships
 Chapter 2.1 – Organisational and
business structures
General partnerships
• All partners are jointly and severally liable for the
partnership's debt.
• Have a partnership agreement in place, which sets out the
terms on which they agree to operate
together in business.
 Chapter 2.1 – Organisational and
business structures
Partnership
Advantages and disadvantages of general and limited partnerships
• Partners are flexibility of 'being their own boss’ but without the
loneliness and pressure of the sole trader
• No publicity requirement of general limited partnerships to prepare
financial statements for taxation purposes.
• Multiple partners will have different skills
• More time to devote to management and expansion
• Each have unlimited liability for the business's debts, but they have
to share profits.
• It is based on trust
• if the relationship fails and partners fall out, the agreement is at an
end and the partnership ceases.
 Chapter 2.1 – Organisational and
business structures
Partnership

Limited liability partnerships

• These are little different from limited companies

• A legal identity separate from their owners

• There are similar publicity requirements for LLPs as for limited

companies.
 Chapter 2.1 – Organisational and
business structures
Company
A legal entity registered as such under statute (the
Companies Act 2006).

The company has unlimited liability for its own debts

 Chapter 2.1 – Organisational and
business structures
Company
Features
• Legally distinct from its owners
• The company can offer a floating charge over its changing
assets as security for lending
• Shareholders take dividends, not drawings, from the business
• Directors run the company
• Shares are a form of property that can easily be sold by their
owners
• If a shareholder dies transferred to another person without any
effect on the company at all - there is what is known as
'perpetual succession'
 Chapter 2.1 – Organisational and
business structures
Company
• Public company: A company whose constitution states
that it is public and that it has complied with the
registration procedures for such a company. It may offer
its shares and other securities for sale to the public at
large.
• Private company: A company which has not been
registered as a public company under statute. It may not
offer its securities to the public at large.
• Any company not registered as public is a private
company
 Chapter 2.1 – Organisational and
business structures
Company
Advantages of companies Disadvantages of companies
• Separate legal personality • Separation of ownership and
control
• Limited liability of its • Ownership of assets
members
• Perpetual succession • Accounting records and
returns
• Transferability of interests • Publicity
• Security for loans includes • Regulations and expense
floating as well as fixed
charges
 Chapter 2.1 – Organisational and
business structures
Which business structure should a business take?
Factor Company Partnership (non-LLP)
Is a legal entity separate to Has no existence outside of its
Entity
its members members
Members' liability can be Partners' liability is usually
Liability
limited unlimited
Perpetual succession - Traditional partnerships are
Succession change in ownership does dissolved when any of the
not affect existence partners leaves
Owners' Members own transferable Partners cannot transfer their
interests shares interests in a partnership
Assets Com pany owns the assets Partners own assets jointly
 Chapter 2.1 – Organisational and
business structures
Which business structure should a business take?
Factor Company Partnership (non LLP)
Management Company must have at least All partners can participate in
one or two director(s) management
Constitution Company must have a A partnership may have a written
written constitution partnership agreement, or the
agreement may just be verbal
Financial A company must deliver Partners do not have to send their
financial statements to the financial statements to the
Registrar Registrar
Security A company may offer a A partnership may not give a
floating charge over its floating charge on assets
assets
Withdrawal of Strict rules concerning More straightforward for a partner
capital repayment of subscribed to withdraw capital
capital
 Chapter 2.1 – Organisational and
business structures
Alliances
Joint venture
A separate business can be formed in which the businesses take a
financial stake and management is provided as agreed.
Benefits
• Less capital is required than if the businesses were on their own, so
there is less risk
• Reduces competition
• Enables firms to gain access to restricted markets
• Access to the skills of each party
Disadvantages
• Disputes over how the business should be run, costs incurred,
management charges, etc
• If the joint venture breaks down, the special skills of a business may
be used against it by its former joint venture partner
• Possible lack of financial support
 Chapter 2.1 – Organisational and
business structures
Alliances
Licences: A licensing agreement is a permission to
another company to manufacture or sell a product, or to
use a brand name.
• restricted geographically
• the licensor can retain control over where the product
is sold and can prevent competition with his own
products or those of other licensees
• The most common form of licensing agreement is the
franchise, which usually involves an annual fee plus a
minimum order for goods, usually at a discount
 Chapter 2.1 – Organisational and
business structures

• A strategic alliance is an informal or weak contractual

agreement between parties or a minority cross
shareholding arrangement

• Benefits and disadvantages are similar to those of joint

ventures
 Chapter 2.1 – Organisational and
business structures
Alliances

Agents
• Agents can be used as the distribution channel where
local knowledge and contacts are important, eg
exporting. The agreements may be restricted to
marketing and product support.

• The main problem for a business that uses agents is that

it is cut off from direct contact with the customer
 Chapter 2.1 – Organisational and
business structures
Alliances
Groups
As companies are entitled to own shares, groups of
companies may form. In its simplest form
Parent company

owns all the shares of

Subsidiary company
 Chapter 2.1 – Organisational and
business structures
Group
Advantages Disadvantages
• Funds can be moved around a group • Financial reporting for groups can
of companies become extremely complex
• Having distinct parts or one whole (the • Groups of companies require a
group) great deal of administration
• Risk of failure is spread • The failure of a group company can
have very detrimental effects on all
the other companies in the group
• Minority shareholdings can be retained
in subsidiaries by the entrepreneurs
who set up each- business.
• Skills, expertise, equipment and
administration matters can be shared
and/or centralised
 Chapter 2.1 – Organisational and
business structures
Practice question

1.Michael is a manager at a large car manufacturing factory. He is

responsible for a team of car production workers who fit seats into
the new vehicles. He sets the team clear targets for seat
installations each day, based on the goals handed down to him by
the directors. He monitors performance closely to ensure targets
are met. It is clear that, in terms of Henry Mintzberg's building
blocks, Michael is part of the organisation's:
A. operating core
B. middle line
C. strategic apex
D. technostructure
 Chapter 2.1 – Organisational and
business structures
Practice question

2.Which three of the following are included in the 14 classical

principles of organisational structure according to Henri Fayol?

A. Decentralisation

B. Initiative

C. Order

D. Fair remuneration

E. Ideology
 Chapter 2.1 – Organisational and
business structures
Practice question

3.Marchant Ltd is a relatively new company operating in a complex

and ever-changing environment. It offers high technology project
management expertise to the construction industry. The company
has five senior managers who are functional specialists. Project
managers are each responsible at any one time for a specific
contract. In terms of organisational structure, Marchant Ltd would
be classified as:

A. a machine bureaucracy
B. a professional bureaucracy
C. divisionalised
D. an adhocracy
 Chapter 2.1 – Organisational and
business structures
Practice question

4.Spitzbergen plc wants to decentralise as many aspects of its

activities as it can. However, it is facing difficulties in achieving the
required level of decentralisation of the company's finance function.
Which three of the following characteristics of the company and its
finance function are likely to have created difficulties in achieving
decentralisation?

A. Homogeneous financial requirements across the company

B. The company's large size
C.The high level of financial expertise available throughout the
company
D. The authoritarian leadership style of the finance director
E. Poor downward communication
 Chapter 2.1 – Organisational and
business structures
Practice question

5.In terms of its organisational structure, Daventry plc is a

flat business. This characteristic gives which advantage to
the managers of the company?

A. Participative decision making

B. Facilitation of management training
C. Greater opportunity to delegate
D. Narrow spans of control
 Chapter 2.1 – Organisational and
business structures
Practice question

6. Debesh and Mayghar are two sole traders who want to

amalgamate their businesses. Both wantto retain day-to-day
control of their respective operations, but they do not want to be
individually responsible for the full extent of the merged business's
borrowings. They want to keep their affairs as private as possible.
They should be advised to establish the merged business as:

A. a general partnership
B. a public limited company
C. a limited liability partnership
D. a private limited company
 Chapter 2.1 – Organisational and
business structures
Practice question

7. Greatbatch plc must have a minimum of:

A. one shareholder and two directors

B. two shareholders and one director
C. three shareholders and two directors
D. two shareholders and two directors
 Chapter 2.1 – Organisational and
business structures
Practice question

8.Marchmount plc is a diversified manufacturing company

divided into several divisions. Each division contains an
autonomous product business, with its own profit and capital
investment responsibilities, delegated by the holding
company's board of directors. Marchmount plc's key
organisational building block will therefore be the:
A. strategic apex
B. technostructure
C. middle line
D. operating core
Chapter 2.2: Introduction to
business strategy
 Introduction to business strategy
Content
• What is strategy?
• Introduction to strategic management
• The strategic planning process
• Analysing the environment
• Analysing the business
• Corporate appraisal
• Setting strategic objectives
• Choosing a corporate strategy
• Implementing the strategy
 Introduction to business strategy

What is meant by 'strategy'?

The long-term direction (objectives) of

the business

The environment in which it operates.

The resources at its disposal.

The return it makes to stakeholders.

 Introduction to business strategy
Levels of strategy
 Introduction to business strategy
Corporate strategy

Determining the overall corporate mission and objectives

Overall product/market decision

Major investment decisions

Overall financing decisions

Relations with external stakeholders

 Introduction to business strategy
Strategic business unit (SBU):
SBU: A section, within a larger business, which is
responsible for planning, developing, producing and
marketing its own products or services.
• Competitive strategy is normally determined at this level
covering such matters as:
• How advantage over competitors can be achieved
• Marketing issues, such as the marketing mix
Functional (operational) strategies
These refer to the main functions within each SBU, such
as: production/operations, finance, human resources and
marketing..
Introduction to business strategy
 Introduction to business strategy

• Taking decisions about the scope of a business's

activities.

• The long-term direction of the business.

• The allocation of resources.
 Introduction to business strategy

Formal strategic planning

Strategic analysis

Strategic choice

Implementation of chosen strategies

Review and control

 Introduction to business strategy
Formal strategic planning
• Planning: The establishment of objectives and the
formulation, evaluation and selection of the policies,
strategies, tactics and action required to achieve them.
 Introduction to business strategy
Strategic positioning

Positioning-based strategic planning process

 Introduction to business strategy
Strategic analysis
Stage Comment Key tools, models,
techniques
Step 1 External Identify opportunities and • PESTEL analysis
analysis threats • Industry life cycle
• Porter's five forces
analysis
• Competitor analysis
Step 2 Internal Identify strengths and • Resource audit
(analysis the weaknesses • Distinctive competences
business) Analyse the business's • Value chain
current resources, products, • Supply chain
customers, • Product life cycle
systems, structure, results, • BCG matrix
efficiency, effectiveness
Step 3 Corporate Combines Steps 1 and 2 • SWOT analysis
 Introduction to business strategy
Strategic analysis
Stage Comment Key tools, models,
techniques
Step 4 Mission, Mission denotes values, the • Stakeholder analysis
goals and business's rationale for • Mission statement
objectives existing; goals interpret the
mission for different
stakeholders; objectives are
quantified embodiments of
the mission
Step 5 Gap analysis Compares outcomes of Step • Gap analysis
3 with Step 4
 Introduction to business strategy
Strategic choice

Stage Comment Key tools, models, techniques

Strategic Come up with new ideas: • Resource-based strategies
options • How to compete in the market • Positioning-based strategies
generation • Where to compete • Porter's generic strategies
• Method of growth • Ansoff's product/market
strategies
Strategic Normally, each strategy has to be • Stakeholder analysis
options evaluated on the basis of 'SFA': • Risk analysis
evaluation • Acceptability to stakeholders • SFA analysis
• Suitability to the business
operational circumstances
• Feasibility in terms of available
finance, resources, time and
competences
Strategy Choosing between the alternative
selection strategies
 Introduction to business strategy

Strategy implementation is the conversion of the strategies

chosen into detailed plans or objectives for operating units.
 Introduction to business strategy
Analysing the environment
 Introduction to business strategy
Environmental uncertainty

Single Simple
product/market technology

Static
environmental Safe
change is slow
Static
environments
- Four Ss
 Introduction to business strategy
Dynamic environments
• Dynamic — the speed of environmental change appears to increase
through time

• Diverse — many businesses are now multiproduct and operate in

many markets; business is also increasingly international

• Difficult — because of the above factors analysis of the environment

is not easy

• Dangerous — because of the above factors ignoring the environment

can have serious consequences for the business
 Introduction to business strategy

Analysing the environment

• General environment: Covers all the political, legal,
economic, social/cultural, ecological and technological
(PESTEL) influences in the countries a business
operates in.
 Introduction to business strategy
PESTEL
 Introduction to business strategy
Analysis Porter's five forces analysis
competitive/task
environment
 Introduction to business strategy
Competitor analysis – Types of competitor

Brand Industry Generic Form

competitors competitors competitors competitors
 Introduction to business strategy

Competitor analysis - Kotler lists four reaction profiles

• The laid back competitor does not respond to moves by

its competitors
• The tiger competitor responds aggressively to all
opposing moves
• The selective competitor reacts to some threats in some
markets but not to all
• The stochastic competitor is unpredictable
 Introduction to business strategy
Analysing the business

Its resources and

competencies,
using a position and Its 'value chain'
resource audit

Its products and

markets, using the
Its supply chain product life cycle
and the BCG matrix
 Introduction to business strategy

Analysing resources and competencies (the position audit)

Position audit: Part of the planning process which examines the
current state of the entity in respect of;
• Resources of tangible and intangible assets and finance
• Its competencies, that is what it has the ability to do well via its
combination of resources, skills….
• Products, brands and markets
• Operating systems such as production and distribution
• Internal organisation
• Current results
• Returns to shareholders
 Introduction to business strategy
Resource audit – 9 Ms model

Machinery

Make-up

Management

Management Information

Markets

Materials

Men and women

 Introduction to business strategy
Analysis value chain Porter's value chain

PRIMARY ACTIVITIES
 Chapter 2.2: Introduction to business
strategy
Analysing the supply chain
• Reduction in the number of suppliers and much closer 'partnership'
relationships with those that remain
• Reduction in customers served for the sake of focus, and concentration
of the company's resources on customers of high potential value
• Price and inventory co-ordination. Businesses co-ordinate their price
and inventory policies to avoid problems and bottlenecks caused by
short-term surges in demand, such as promotions
• Linked computer systems — electronic data interchange saves on
paperwork and warehousing "expense
• Early supplier involvement in product development and component
design
• Carefully designed distribution system
• Joint problem - solving among supply chain partners
• Supplier representative on site
 Chapter 2.2: Introduction to business
strategy
Analysis products and markets The product life cycle

Product class: this is

a broad category of
product, such as cars, Brand: the particular
washing machines, type of the product
newspapers form

Product form: within

a product class there
are different forms
that the product can
take
 Chapter 2.2: Introduction to business
strategy
The product life cycle
 Chapter 2.2: Introduction to business
strategy
Planning products and market: the BCG matrix
 Chapter 2.2: Introduction to business
strategy
Corporate appraisal
SWOT analysis
 Chapter 2.2: Introduction to business
strategy
SWOT analysis

The external appraisal should identify:

Strengths and weaknesses

- Shortcomings in the - Profit-making

business's present opportunities which
skills and resources. can be exploited by

Opportunities and threats:

- Strengths in its skills the business's
and resources which strengths
it should seek to - Environmental threats
exploit (a declining economy,
competitors' actions,
government
legislation, industrial
unrest etc) against
which the business
must protect itself
 Chapter 2.2: Introduction to business
strategy
SWOT analysis
Combining the elements of the SWOT analysis

Major strengths and profitable

opportunities can be exploited,
especially if strengths and
opportunities are matched with each
other

Major weaknesses and threats

should be countered, or a
contingency strategy or corrective
Strategy developed
 Chapter 2.2: Introduction to business
strategy
Setting strategic objectives
Stakeholder analysis
 Chapter 2.2: Introduction to business
strategy
Stakeholder analysis

• strategy must be acceptable to them, at least

Key players in D and ideally they should participate in it.

• must be treated with care. While often

Stakeholders in C passive, they are capable of moving to
segment D.

• do not have great ability to influence strategy,

but their views can be important in influencing
Stakeholders in B more powerful stakeholders, perhaps by
lobbying.

Minimal effort is
expended on • they can simply be directed
segment A
 Chapter 2.2: Introduction to business
strategy
Determining the mission and strategic objectives

A formal document that states the business's basic

function in society expressed terms of how it satisfies its
stakeholders.
 Chapter 2.2: Introduction to business
strategy
Determining the mission and strategic objectives

Strategic objectives Goals and targets

The primary strategic

objective in the case The strategic
of a business, to objectives should be
make a profit for translated into
shareholders — plus quantified and
other major specific goals.
objectives addressed
to the stakeholders.
 Chapter 2.2: Introduction to business
strategy
Choosing a Porter’s generic competitive strategies
corporate strategy
 Chapter 2.2: Introduction to business
strategy
Choosing a corporate strategy
Porter’s generic competitive strategies
Cost leadership: Producing at the lowest cost in the industry as, a
whale.
Differentiation: The provision of a product or service which the industry
as a whole believes to be unique.
Focus (or niche): involves a restriction of activities to only part of the
market (a segment) through:
• Providing goods and/or services at lower cost in that segment (cost-
focus)
• Providing a differentiated product or service to that segment
(differentiation-focus)
 Chapter 2.2: Introduction to business
strategy
Choosing a corporate strategy
Ansoff's matrix: product/market strategies
 Chapter 2.2: Introduction to business
strategy
Choosing a corporate strategy
Strategic choice – SAF + S framework

• The chosen strategy should enable the company in

Suitability addressing its strategic position and achieve its strategic
objectives in the long run

• This need to answer the question of whether it is practically

possible for the company to undertake the chosen strategy
Feasibility considering the problem of constraints (resources and
competencies)

• The suggested/chosen strategy should help the stakeholders

Acceptability in achieving the short term and long term of the company

• If the chosen strategy meets all of the above criteria’s it is

Sustainability essential that the strategy also passes through the final test
of sustainability
 Chapter 2.2: Introduction to business
strategy
Implementing the strategy
Breaking the strategy down
• Business strategies determine how competitive advantage
is gained by a particular SBU, and in particular how the
marketing mix must be adjusted to achieve this.
• Functional strategies develop the business strategy for an
SBU as it affects the:
• Marketing function
• Production/operations function
• Human resources function
• Finance function
 Chapter 2.2: Introduction to business
strategy
Implementing the strategy
Levels of plan

• Strategic plan

• Business plan

• Operational plan
 Chapter 2.2: Introduction to business
strategy
Practice question
1.Manuel is performing a detailed strategic analysis for
Smertin plc. He is working on the internal analysis. Which
three of the following strategic management techniques
will Manuel most likely use in undertaking his analysis?

A. The BCG matrix

B. The value chain
C. PESTEL analysis
D. Five forces analysis
E. The product life cycle
 Chapter 2.2: Introduction to business
strategy
Practice question
2.The chief executive of Darley plc is considering several
strategic options for the company. The Johnson and
Scholes criteria against which these can be judged are:

A. economy, effectiveness and efficiency

B. economy, expectation and efficiency
C. acceptability, congruence and feasibility
D. acceptability, suitability and feasibility
 Chapter 2.2: Introduction to business
strategy
Practice question
3.A cigarette manufacturing company is conducting a PESTEL
analysis. Which three of the following factors might be expected
to appear within its analysis?

A. New sources of supply for tobacco

B.Government pressure to reduce levels of smoking among the
population
C. A merger of two close competitor companies
D. A ban on smoking in public places
E. Increases in the tax applied to cigarettes
 Chapter 2.2: Introduction to business
strategy
Practice question
4.Barriers to entry to the market for Product A in Country X are
high. Which three of the following factors are most likely to
contribute towards this situation?

A. An abundance of available raw materials

B. High fixed costs in the market
C.Existing distribution channels making extensive use of
intermediaries
D. Differentiated products in the market
E. Stable levels of demand for Product A in CountryX
 Chapter 2.2: Introduction to business
strategy
Practice question
5.Archway Ltd sells windows in the north-west of England. It
has many competitors, from large national firms through to
small local businesses across the region. Competitors in the
market regularly use price cuts and other sales promotions to
win business. In the past Archway Ltd has sometimes matched
the price moves of its competitors and at other times it appears
to have ignored them. Furthermore, there is no clear pattern to
Archway Ltd's response to price cuts. It appears that, in terms of
Philip Kotler's competitor reaction profiles, Archway Ltd is a:
A. laid-back competitor
B. tiger competitor
C. selective competitor
D. stochastic competitor
 Chapter 2.2: Introduction to business
strategy
Practice question

6.Portway Ltd manufactures and sells fabric roller blinds

for use in domestic houses. Parsimus Ltd manufactures
curtains for use in domestic houses. Portway Ltd and
Parsimus Ltd are:

A. brand competitors
B. industry competitors
C. generic competitors
D. form competitors
 Chapter 2.2: Introduction to business
strategy
Practice question
7.Tashkent Taste Ltd operates a national chain of restaurants.
Saul, a management consultant, is reviewing the company's
activities in providing its services to customers. In particular,
in terms of Porter's Value Chain, Saul is focusing on the
support activities of the company. Saul will, therefore, be
analysing which three of the following?
A. Technology development
B. Procurement
C. Firm infrastructure
D. Marketing and sales
E. Service
 Chapter 2.2: Introduction to business
strategy
Practice question

8.In the car market, sports utility vehicles (SUVs) are an

example of a:

A. product form
B. brand
C. product class
D. generic product
Chapter 3: THE ROLE OF FINANCE
1. Financial information
2. The business’s finance function
3. Sources of finance
 Introduction to financial information
Content
1 Why is business finance important?
2 Uses and types of financial information
3 Qualities of good information
4 Sources of data and information
5 Development in information technology
6 Information processing and management
7 Information security
8 Users of financial information and their information needs
9 Limitations of financial information in meeting users' needs
10 The effects of poor financial information
 Introduction to financial information
Uses and types of financial information
Businesses and managers require financial information for:

Recording Decision
Planning transactions making

Controlling Performance
measurement
 Introduction to financial information
Uses and types of financial information

Planning

• Planning requires a knowledge of available resources, possible

time-scales for implementation and the likely outcome under
alternative scenarios.

Controlling
• Once a plan is implemented, its actual performance must be
controlled.
 Introduction to financial information
Uses and types of financial information
Recording transactions

Documentation of transactions can be used as evidence

in a case of dispute.

Legal requirement to record transactions, for example

for accounting and audit purposes.

Detailed information on production costs can be built

up, allowing a better assessment of profitability

The efficiency of labour utilised in providing a particular

service can be measured.
 Introduction to financial information
Uses and types of financial information

Performance measurement
• Comparisons of the actual outcome with the plan.
• Collecting information of costs, revenues, volumes, time-
scale, profitability and long-term sustainability.

Decision making
• Information is required to make informed decisions.
 Introduction to financial information
Type of information

Strategic
information

Tactical information

Operational information
 Introduction to financial information
Qualities of good information

ACCURATE
Accurate
Complete
Cost-beneficial
User-targeted
Relevant
Authoritative
Timely
Easy to use
 Introduction to financial information
What makes information valuable

• Its source
• Ease of assimilation
• Accessibility
• Relevance

The cost and value of information

• The extra benefits expected from getting it, and

• The extra costs of obtaining it
 Introduction to financial information
Data and information

Data Information Database

Distinct pieces of
information, which
can exist in a
variety of forms - A structured
The output of
as numbers or text collection of
whatever system
on pieces of records or data
is used to process
paper, as bits or that is stored in a
data.
bytes stored in computer system
electronic memory,
or as facts stored
in a person's mind.
 Introduction to financial information
Internal data sources
• A system for collecting or measuring transactions data.
• Informal communication of information between managers and
staff.

• Communication between managers.

- The accounting records

- Human resources

- Machine logs and computer system

- Timesheets in service businesses

- Staff
 Introduction to financial information
External data sources
Formal Informal
• Business tax specialists • The internet in general
• New legislation • The government
• Research and • Advice or information bureaux, such as
development Reuters or Bloomberg
• Marketing manager • Consultancies of all sorts
• Newspaper and magazine publishers
• Specific reference works which are
used in a particular line of work
• Libraries and information services
• The systems of other businesses via
electronic data interchange (EDI)
 Introduction to financial information
Development in information technology

Big data
Introduction to financial information
Structured
Any data that can be stored, accessed and processed in the
form of fixed format is termed as a 'structured' data.
Unstructured
Any data with unknown form or the structure is classified as
unstructured data.
Introduction to financial information
Sources of big data

• Business resilience
• Open data
• Human-sourced data
• Machine-generated data
 Introduction to financial information
Importance of big data

• New sources of data, for instance the huge increase in

unstructured human-sourced and machine-generated data
(open data, social media and the internet of things)
• Exponential growth in computing power and storage, which
means that entire data sets can be captured and processed,
regardless of their size and complexity
• New infrastructure for knowledge creation, such as
crowdsourcing and open source software
 Introduction to financial information
Uses of Big data
Enhancing transparency

Performance improvement

Market segmentation and customization

Decision making

Innovation

Risk management
 Introduction to financial information
Information processing
and management Completeness

Information
processing Assessability Accuracy

Data once
collected is
converted into
CATIVA
information for criteria
communicating
more widely within
the business Verifiability Timeliness

Inalterability
 Introduction to financial information
Information systems
Definition

• A collection of people, machines and methods

A business system organised to accomplish a set of specific functions

Information • All systems and procedures involved in the collection,

systems (IS) storage, production and distribution of information

Information • The equipment used to capture, store, transmit or

technology (IT) present information

• The approach that a business takes towards the

Information management of its information including planning
management IS/IT developments, the organisational environment of
IS, control and technology.
 Introduction to financial information

System boundary
 Introduction to financial information
Transaction processing system (TPS): A system which performs, records
and processes routine transactions.
Transaction processing systems
Manufacturing/ Finance/ Human
Sales/marketing
production accounting resources
system
system system system
Major • Sales • Scheduling • Budgeting • Personal
functions of management • Purchasing • Nominal records
system • Marketing • Shipping/ ledger • Benefits
research receiving • Invoicing • Salaries
• Promotion • Engineering • Management • Labour
pricing • Operations accounting relations
• New products • Training
Major parts • Sales order • Materials • Nominal • Payroll
of systems system resource ledger • Employee
• Marketing planning • Accounts records
research • Purchase receivable/ • Employee
system order control payable benefits
• Pricing system • Engineering • Budgeting • Career path
• Quality control • Treasury systems
management
www.vietsourc ng.com ietsourcing.edu.vn
 Introduction to financial information
Cloud computing
Cloud computing: A model for enabling ubiquitous, convenient, on-demand
network access to a shared pool of configurable computing resources (eg,
network, servers, storage, applications, and services) that can be rapidly
provisioned and released with minimal management effort or service provider
interaction.
 Introduction to financial information
Cloud computing
 Introduction to financial information
The management information system (MIS)

Management
• Converts data from mainly
information internal sources into information.
system (MIS)

Executive support • A sophisticated database that

system (ESS) or pools data from internal and
external sources and makes
Executive information available to senior
information managers in an easy-to-use
system (EIS) form.
 Introduction to financial information
The management information system (MIS)

Decision support system • Combines data and analytical models or data

analysis tools to support both semi-structured
(DSS) and unstructured decision making.

• Captures human expertise in a limited domain

Expert system of knowledge to allow users to benefit from
expert knowledge and information.

Knowledge work system • Facilitates the creation and integration of new

(KWS) knowledge into an organisation.

Office automation system • A system that increase the productivity of data

(OAS) and information workers.
 Introduction to financial information
The management information system (MIS)
Worked example: Expert system for loan applications
Financial institutions use expert systems to process straightforward loan
applications. The user enters certain key facts into the system such as the loan
applicant's name and most recent addresses, their income and monthly outgoings,
and details of other loans. The system will then:
• Check the facts given against its database to see whether the applicant has a
good credit record
• Perform calculations to see whether the applicant can afford to repay the loan
• Match up other criteria, such as whether the security offered for the loan or the
purpose for which the loan is wanted is acceptable, and to what extent the loan
applicant fits the lender's profile of a good risk (based on the lender's previous
experience)
A decision is then suggested, based on the results of this processing. This is why it
is often possible to get a loan or arrange insurance over the phone or internet,
whereas in the past it would have been necessary to go and speak to a bank
manager or send details to an actuary and then wait for him or her to come to a
decision
 Introduction to financial information
Business applications of expert systems

Legal Forecasting Surveillance

Diagnostic Project Education and

systems management training
 Introduction to financial information
Distributed ledger technology
Distributed ledger technology (DLT) is a digital system for
recording the transaction of assets in which the transactions
and their details are recorded in multiple places at the same
time. Unlike traditional databases, distributed ledgers have
no central data store or administration functionality.
In a distributed ledger, each node processes and verifies
every item, thereby generating a record of each item and
creating a consensus on each item's veracity. A distributed
ledger can be used to record static data, such as a registry,
and dynamic data, i.e., transactions.
 Introduction to financial information
Distributed ledger technology
Work example: Everledger
One example of the use of distributed ledger technology is in fraud prevention in the
diamond industry. Everledger is a system that creates an identity for each diamond by
recording its unique specification across date points. The ledger indelibly records each
time the diamond is traded so that its ownership and transactions can be traced.
Everledger works across the diamond industry but distributed ledger technology can also
be used within an organisation, or by an organisation with its trading partners.
Work example: Bitcoin
Another example of distributed ledger technology is Bitcoin. Bitcoin is cryptocurrency, a
type of currency that does not have a physical form – it is entirely virtual, purely existing
online.
Bitcoins are simple computer files which are kept in their owner’s digital wallet, on their
smartphone or computer. Owners can transfer ownership of their Bitcoins to others
electronically by transferring them from digital wallet to digital wallet. Therefore it is a
means of paying people for goods and services.
Bitcoins are created by mining (processing date to solve complex problems). Once mined,
the Bitcoin is available to be used. Every time a Bitcoin is transferred, the transaction is
recorded on the blockchain. This allows the transaction history of all Bitcoins to be
recorded, making it possible to ensure owners can only spend or transfer Bitcoins that they
actually own. It also prevents Bitcoins being copied or being illegally generated.
 Introduction to financial information
Information security
Security: the protection of data from accidental or deliberate
threats which might cause unauthorised modification,
disclosure or destruction of data, and the protection of the
information system from the degradation or non-availability
of services
 Introduction to financial information
Information The risks to data:
security • Human error
• Entering incorrect transactions
• Failing to correct errors
• Processing the wrong files
• Technical error such as malfunctioning hardware
or software
• Natural disasters such as fire, flooding, explosion,
impact, lightning
• Deliberate actions such as fraud
• Commercial espionage
• Malicious damage
• Industrial action
 Introduction to financial information
Ensuring the security of information

Prevention Detection Deterrence

Recovery procedures Correction procedures Threat avoidance

 Introduction to financial information
Qualities of a secure information system: ACIANA
Availability Information can always be accessed.

Information cannot be accessed by anyone who does not

Confidentiality
have the right to see it.

Data is the same as in its sources and has not been

Integrity accidentally or deliberately reduced, altered, destroyed or
disclosed.

Authenticity Data and information are taken from bona fide sources.

Information is not open to being rejected by its intended

Non repudiation
users on the grounds of faults in the system.

Changes in the system can only be made by persons who

Authorisation
are accountable for them.
 Introduction to financial information
Physical access controls
➢ Personnel
➢ Door locks
➢ Locks
• keypad system
• card entry system
➢ Alarms
➢ Laptops, tablets, smartphones and other devices
➢ Personal identification number, or PIN
 Introduction to financial information
Integrity controls in the system
Data will maintain its integrity if it is complete and not
corrupted.
• Data verification involves ensuring data entered matches
source documents
• Data validation involves ensuring that data entered is not
incomplete or unreasonable.
Various checks include:
• Check digits
• Control totals
• Hash totals
• Range checks.
• Limit checks
 Introduction to financial information
Integrity controls in the system
• Any processing and storage of data must maintain the completeness
and correctness of the data captured.
• Processing controls should ensure the accuracy and completeness of
processing.
• Programs should be subject to development controls and to rigorous
testing.
• Periodic running of test data is also recommended
• Reports or other output should be set up so that they, too, are complete
and correct.
• The system should have a back-up and archive strategy, including:
• Regular back-up of data (at least daily)
• Archive plans
• A disaster recovery plan including off-site storage
 Introduction to financial information
Integrity controls in the system
Users of the system should be given a password.
• Identification of the user
• Authentication of user identity
•Checks on user authority
Personnel selection is important
• Job rotation and enforced vacations
• Systems logs
• Review and supervision
Segregation of duties is a core security requirement
• Data capture and data entry
• Computer operations
• Systems analysis and programming
 Introduction to financial information
Who uses financial information?
Primary users Need financial information to:
Present and Make decisions about buying, selling or holding equity,
potential investors therefore need information on:
(shareholders) • Risk and return of investment
• Ability of company to pay dividends
Lenders and other • Make decisions about buying, selling or holding
payables debt instruments and providing or settling loans or
other forms of credit
• Assess whether loans will be repaid, and related
interest will be paid, when due
Other users and their financial information needs are as follows:
Employees • Assess their employer's stability and profitability
• Assess their employer's ability to provide
remuneration, employment opportunities and
retirement and other benefits
 Introduction to financial information
Who uses financial information?
Primary users Need financial information to:
Customers Assess whether business will continue in existence - important
where customers have a long-term involvement with, or are
dependent on, the business, eg where they are supply chain
partners
Suppliers and other Assess the likelihood of being paid when due
business partners
Governments and its • Assess allocation of resources and, therefore, activities of
agencies, including businesses
regulators • Assist in regulating activities
• Assess taxation income
• Provide a basis for national statistics
• Help direct policy on, for instance, health and safety and equal
opportunities issues
The public and Assess trends and recent developments in the business's
community prosperity and its activities - important where the business makes a
representatives substantial contribution to a local economy, by providing
employment and using local suppliers
 Introduction to financial information

Financial information is useful to users when it:

Helps them to make decisions, and

Shows the results of management's

stewardship of the resources entrusted to
them
 Introduction to financial information

Information for making decisions and making managers

accountable
• The ability of a business to generate cash
•The timing and certainty of cash flows
User needs information on the business's:
• Financial position (its statement of financial position)
• Financial performance (its statement of profit or loss and
other comprehensive income) and
• Changes in financial position (its statement of cash flows)
 Introduction to financial information
Information on Financial position
Factors affecting the
business’s financial Information on this factor is useful for predicting
positions
The economic The business's ability to generate cash in the future
resources it controls
Its financial • Future borrowing needs
structure • How future profits and cash flows will be distributed
among stakeholders
• The business's likely success in raising new equity
Its liquidity Whether cash will be available in the near future after taking
account of current financial commitments
Its solvency The availability of cash in the longer term to meet financial
commitments as they fall due
Its adaptability Its capacity to adapt to changes in the environment in which it
operates
Introduction to financial information
 Introduction to financial information
Limitations of financial information
• Conventionalised representation

• Backward-looking

• Omission of non-financial information

• Narrative description of major operations

• Discussion of business risks and opportunities

• Narrative analysis of the business's performance and
prospects

• Management policies and how the business is governed

and controlled
 Introduction to financial information
Other sources of information
• Banks

• Potential investors

• Suppliers

• Brochures and publicity material

• Brokers' reports on major companies are available fairly widely

• Press reports and other media coverage

 Introduction to financial information
Practice question

1.Gamma Bank produces daily reports for each of its 250

branches. These enable staff to monitor and manage customer
accounts where an unauthorised overdraft has either arisen or
increased during the last business day. In terms of financial
information, these reports can be classified as:

A. planning information
B. operational information
C. tactical information
D. strategic information
 Introduction to financial information
Practice question

2.The market research department of Tetro plc increasingly

makes use of information from the internet to analyse its
competitive environment and the market responses to new
product offerings. Use of information from this source raises
concerns regarding which characteristic of useful information?
A. Completeness
B. Authority
C. Cost-effectiveness
D. Relevance
 Introduction to financial information
Practice question

3.Identify which of the following statements about an

information processing system is correct.

A. Rules and information are processed to suggest decisions

B. Information is input and processed to produce data
C. Data are input and processed to produce information
D. Rules and information are used to produce data
 Introduction to financial information
Practice question

4.The finance director of Amalgam plc wants to tell her fellow

directors about what undermines the usefulness of published
financial statements. Which three of the following issues should
she highlight in this regard?
A.Accounting standards mean financial statements are comparable
across periods
B. Financial statements are aggregated
C. Financial statements contain expectations about the future
D. Financial statements reflect the past
E.Narrative, non-financial information is absent from the financial
statements
 Introduction to financial information
Practice question

5.Megasave Supermarkets operates a chain of discount food

stores. The company's point-of-sale terminals produce
information that is used by the logistics division to determine
delivery requirements for each store. To be effective, the logistics
division's information processing must meet the criteria of
completeness, timeliness and verifiability. Which three of the
following criteria must also be met?
A. Accountability
B. Inalterability
C. Accuracy
D. Assessability
E. Inclusiveness
 Introduction to financial information
Practice question

6.The finance function of Almerica plc uses check digits and

control totals in its financial reporting system to maintain its
integrity. These two input controls are a form of:

A. data verification
B. data validation
C. range check
D. mlimit check
 Introduction to financial information
Practice question

7.Financial statements must be prepared in a way that

considers materiality. This is an aspect of which of the
following characteristics of financial information?

A. Understandability
B. Relevance
C. Faithful representation
D. Comparability
Chapter 3.2: The business's finance
function
 Chapter 3.2: The business financial function
Content

✓ What does the finance function do?

✓ The structure of the finance function

✓ Managing te finance function

✓ Measuring performance
✓ Establishing financial control processes and internal
controls
 Chapter 3.2: The business financial function
The tasks of the finance function

Recording financial
transactions

Management accounting
The tasks of the finance function
Financial reporting

Treasury management
 Chapter 3.2: The business financial function
The finance business partner
• Finance business partners are accountants who work closely with a
particular business unit creating a real and active partnership with
both operations and management.
• Their role is to provide 'real time' support and analysis, to be a
trusted adviser and to add value that will assist in decision making.
• Critical to their success is an ability to communicate their message,
to understand their audience and deliver the information in a clear
and user friendly manner.
• It is this mix of analytical, commercial and communication skills
which are at the heart of successful finance business partnering.
 Chapter 3.2: The business financial
function
The structure of the finance function
 Chapter 3.2: The business financial
function

Measure performance

Qualitative
measures
Measure
Financial measures
performance
Quantitative
measures
Non-financial
measures
 Chapter 3.2: The business financial
function

Measuring performance

Profitability

Measuring performance Activity

Productivit
 Chapter 3.2: The business financial
function
Measuring resource use: effectiveness, economy & efficiency

• the is reduction or containment of cost; this

Economy can be measured against targets.

• is the measure of achievement and is

assessed by reference to objectives, such as
Effectiveness whether planning and control mechanisms
work, and whether the target profit has been
attained.

• means being effective at minimum cost or

controlling costs without losing operational
Efficiency effectiveness. Efficiency is therefore a
combination of effectiveness and economy.
 Chapter 3.2: The business financial
function
Measuring resource use: effectiveness, economy and efficiency.

Productively
• what is output relative to
what is input?

Effectively
• how far are targets and
objectives achieved?

Efficiently
• what is the gain that the
business has achieved?
 Chapter 3.2: The business financial
function

Measuring critical success factors (CSFs)

- CSFs differ from one business to another
- CSFs concern not only the resources of the business but
also the competitive environment in which it operates.

Key performance indicators (KPIs)

Key performance indicator (KPI): A measure of the level of
performance in an area where a target level must be
achieved in order for the business to outperform rivals and
achieve competitive advantage.
 Chapter 3.2: The business financial
function
Worked example: CSFs, core competences, KPIs and targets

An internet retailer identifies that its critical success factor (CSF) is

delivering goods to mainland UK consumers within 24 hours of an
order being placed over the internet. One of the core competences
associated with that CSF is having sufficient capacity and reliability
in its IT systems. A key performance indicator (KPI) to be
measured for this is the level of downtime in its IT systems per
month. If the business can achieve its target downtime of only, say,
2% per month then it may be satisfied that it is on the way to
achieving its CSF.
 Chapter 3.2: The business financial
function
Measuring sustainability

• Responding to uncertainty and risk

• Developing existing and new markets
• Innovating processes, products and services that can
provide benefits to society:
• Improving operational efficiency and lowering costs
by way of sustainable operations
• Engaging employees, customers and suppliers in the
drive towards sustainability.
 Chapter 3.2: The business financial
function
Measuring sustainability - The triple bottom line
Issues Examples of areas to be measured
Social Health and safety, workers' rights, pay and benefits,
diversity and equality, impacts of product use, responsible
marketing, data protection and privacy, community
investment, and eradication of bribery, fraud and money
laundering
Environmental Climate change, pollution, emissions levels, waste, use of
natural resources, impacts of product use, compliance
with environmental legislation, air quality

Economic Economic stability and growth, job provision, local

economic development, healthy competition, compliance
with governance structures, transparency, long-term
viability of businesses, investment in innovation/NPD
 Chapter 3.2: The business financial
function
Measuring sustainability
The Global Reporting Initiative (GRI)
Economic Environmental Social
Direct economic value Materials used by Diversity and equal opportunity,
generated and distributed weight or volume occupational health and safety
Financial assistance Reduction of Human rights: total number and
received from government energy percentage of significant
consumption investment agreements and
contracts that include human
rights clauses or that underwent
human rights screening
Ratios of standard entry Total water Anti-corruption in society: total
level wage by gender withdrawal by number and percentage of
compared to source local source operations assessed for risks
minimum wage at related to corruption and the
significant locations of significant risks identified
operation
 Chapter 3.2: The business financial
function
Measuring sustainability
The Global Reporting Initiative (GRI)

Economic Environmental Social

Development and impact of Habitats protected Child and forced or
infrastructure investments or restored compulsory labour
and services supported
Proportion of spending on Direct and indirect Labour practices and
local suppliers at significant greenhouse gas decent work
locations of operation emissions
Ratios of standard entry Total weight of Total number of legal
level wage by gender waste by type and actions for anti-
compared to local minimum disposal method competitive behaviour,
wage at significant anti-trust, and monopoly
locations of operation practices and their
outcomes
 Chapter 3.2: The business financial
function
Using information on performance measurement

• Budgets, targets or standards

• Trends over time

• The results of other parts of the business

• The results of other businesses

 Chapter 3.2: The business financial
function

Limitations of financial measures

• Information problems

• Comparison problems: trends

• Comparison problems: different businesses

 Chapter 3.2: The business financial
function
The balanced scorecard
• The balanced scorecard combines traditional financial
performance measures with measures of other key
areas: operational and staff performance, and customer
satisfaction.

• Balanced scorecard: An integrated set of performance

measures linked to the achievement of strategic
objectives.
 Chapter 3.2: The business financial
function
The balanced scorecard
 Chapter 3.2: The business financial
function
Internal controls

A process, effected by an
entity's board of directors,
management and other
personnel, designed to provide
reasonable assurance
regarding the achievement of
objectives relating to
operations, reporting and
compliance.
 Chapter 3.2: The business financial
function
Internal control elements
 Chapter 3.2: The business financial
function
Control environment
• The integrity and ethical values of the business.
• The ability of the board of directors to carry out its
governance oversight responsibilities.
• The organisational structure and assignment of authority
and responsibility.
• The process for attracting, developing and retaining
competent individuals.
• The rigous of the business's performance measures,
incentives and rewards to drive accountability for
performance.
 Chapter 3.2: The business financial
function
Risk assessment
Must be adequate risk management via assessment,
measurement and control activities to address any risks
that threaten achievement of the business's objectives.
 Chapter 3.2: The business financial
function
Control activities
The actions established through policies and procedures that help
ensure management's directives to mitigate risks to the
achievement of objectives are carried out.

• Approval

• Authorisation

• Verification

• Reconciliation

• Business performance reviews and

• Segregation of duties
 Chapter 3.2: The business financial
function
Information and communication
• Information systems produce reports, including
operational, financial and compliance-related information,
that make it possible to run and control the business.

• Effective communication with external parties, such as

customers, suppliers, regulators and shareholders, is also
important for control.
 Chapter 3.2: The business financial
function
Monitoring activities
• The components of internal control need to be monitored
to assess the quality of the internal control system's
effectiveness over time.

• Corrective action should be taken to ensure continuous

improvement of the system.
 Chapter 3.2: The business financial
function
Risk management and internal control (FRC)

Risk management and internal control system: A

system encompassing the policies, culture, organisation,
behaviours, processes, systems and other aspects of a
company that, taken together.

• Directors and managers

• Risk-based approach
• Embedded, flexible, reporting
 Chapter 3.2: The financial function
Practice question

1. Marcus works in the finance function of Everard Ltd and part

of his role is to determine the precise unit cost of a range of
products. He also prepares reports on variances from the
standard cost per unit that he has calculated. It is clear,
therefore, that Marcus is employed by Everard Ltd in its:
A. financial reporting section
B. management accounting section
C. treasury management section
D. financial transaction recording section
 Chapter 3.2: The financial function
Practice question

2.Hayley is an accountant with Worricker plc. Hayley

has joined a project team examining the cost structure
of Worricker plc compared with its major competitors.
She has been recruited into this project team in order
to exploit her expertise in:
A. financial reporting
B. performance measurement
C. capital budgeting
D. management accounting
 Chapter 3.2: The financial function
Practice question

3.Which section of a company's finance function has

primary responsibility for ensuring the sound stewardship
by managers of the resources entrusted to them?
A. The financial transactions recording section
B. The management accounting section
C. The financial reporting section
D. The treasury management section
 Chapter 3.2: The financial function
Practice question
4.Zuma plc wants to introduce a control activity to address
a problem that has come to light. The problem was that a
manager authorised and paid for a sun-lounger from his
department's petty cash box and then had it delivered to his
home for private use. No one within Zuma plc had been
aware of the transaction. The required control activity would
be:
A. reconciliation
B. review of operating performance
C. security of assets
D. segregation of duties
 Chapter 3.2: The financial function
Practice question

5.The Financial Reporting Council's (FRC's) guidance on risk

management and internal control states that, when
assessing the constituents of a sound system of internal
control, managers should look at the:
A. business's ability to reduce the likelihood and impact on it of
risks that materialise
B. operations of the business
C. organisational structure of the business
D. nature and extent of uncertainty facing the business
 Chapter 3.3
Source of finance
 Chapter 3.3 – Business and Personal
finance
Content
1. Risk v return
2. The banking system
3. The money markets
4. The capital market for business finance
5. Sources of equity finance
6. Sources of debt finance
7. Financing a growing business
8. Financing exports
 Chapter 3.3 – Business and Personal finance
Risk and returns
• Debt holders face lower risk but lower returns:
• They receive interest before equity holders receive any
dividends, and
• Debt is often secured by fixed or floating charges, and
• In the event of company failure, debt holders rank higher
than equity holders to receive their capital back, but
• The 'price' they pay is a lower rate of return on their
capital
• Equity holders face higher risk but can enjoy higher returns:
they suffer the downside of any loss but any profits after go to
the equity holders, not the debt holders
 Chapter 3.3 – Business and Personal finance

Balancing short-term and long-term finance

Every business has immediate, short-term, medium-term and
long-term needs for finance, and each one faces risk in the way it
finances itself.
• Immediate needs: to pay wages and petty expenses
• Short-term needs: to pay for goods/services bought on credit
• Medium-term needs: to pay for an increase in inventory and
receivables as the business grows and to pay tax on profits
earned
• Long-term needs: to pay for non-current assets required in the
long term such as machinery, vehicles and buildings
 Chapter 3.3 – Business and Personal finance

Balancing short-term and long-term finance

Chapter 3.3 – Business and Personal finance

The banking system comprises

primary and secondary banks.

Banks are heavily regulated.

 Chapter 3.3 – Business and Personal finance

Benefits of financial intermediation

• Small amounts deposited by savers can be combined to
provide larger loan packages to businesses
• Short-term savings can be transferred into long-term
loans
• Search costs are reduced as companies seeking loan
finance can approach a bank directly rather than finding
individuals to lend to them
• Risk is reduced as an individual's savings are not tied up
with one individual borrower directly
 Chapter 3.3 – Business and Personal finance
Banks
• Primary banks are those which operate the money
transmission service or clearing system as the
commercial, retail or clearing banks.
• Secondary banks are made up of a wide range of
merchant banks and other banks.
 Chapter 3.3 – Business and Personal finance

Bank
Monetary policy
• The Bank of England is banker to
the banks, lending money to the
banking sector through its financial
market operations at the base rate
set by its Monetary Policy
Committee (MPC).
• Financial stability: the Bank of
England also takes action to
remove or reduce systemic risks.
 Chapter 3.3 – Business and Personal finance
Bank – twin peaks’ regulatory regime
❖ The Prudential Regulation Authority (PRA)
• To promote the safety and soundness of firms, by focusing primarily
on the harm that firms can cause to the stability of the UK financial
system
• To secure, in relation to insurers, an appropriate degree of protection
for policyholders
❖ The Financial Conduct Authority (FCA)
• Promoting effective competition
• Ensuring that relevant markets function well
• Regulating the conduct of all financial services firms, which
includes acting to prevent market abuse and ensuring that
consumers get a fair deal from financial firms
 Chapter 3.3 – Business and Personal finance
The clearing system
• General clearing

• Electronic Funds Transfer (EFT)

• Banks Automated Clearing System (BACS)

• Clearing House Automated Payment System (CHAPS)

• Faster Payments Scheme

• Society for Worldwide Interbank Financial
Telecommunication (SWIFT)
 Chapter 3.3 – Business and Personal finance

The bank/customer contractual relationships

• Receivable/payable relationship

• Bailor/bailee relationship

• Principal/agent relationship

• Mortgagor/mortgagee relationship
 Chapter 3.3 – Business and Personal finance
The bank/customer fiduciary relationship
The bank’s duties to the customer
• No legal reason for not honouring customer cheque if they have
enough money or sufficient overdraft limit to cover the amount of the
cheque

• The bank must credit cash/cheques that are paid in to the customer's
account

• If the customer makes a written request for repayment of money in its

account the bank must repay the amount on demand

• The bank must comply with the customer's instructions given by direct
debit mandate or standing order
 Chapter 3.3 – Business and Personal finance

The bank’s duties to the customer

• The bank must provide a statement showing the transactions on the
account within a reasonable period and provide details of the balance on
the customer's account

• The bank must respect the confidentiality of the customer’s

• The bank must tell the customer if there has been an attempt to forge
the customer's signature on a cheque.

• The bank should use care and skill in its actions

• The bank must provide reasonable notice if it is to close a customer's
account
 Chapter 3.3 – Business and Personal finance

The customer's duties to the bank

• To draw up cheques carefully so that fraud is not
facilitated

• To tell the bank of any known forgeries

 Chapter 3.3 – Business and Personal finance

The rights of the bank

• To charge reasonable bank charges and commissions
over and above interest

• To use the customer's money in any way provided that it

is legal and morally acceptable

• To be repaid overdrawn balances on demand

• To be indemnified against possible losses when acting
on the customer's behalf
 Chapter 3.3 – Business and Personal finance
The money markets

• The money markets is a term that covers a vast array of

markets buying and selling different forms of money or
marketable securities.
• Marketable securities are short-term highly liquid
investments that are readily convertible into cash. Companies
might use them to invest short-term surplus finance.
 Chapter 3.3 – Business and Personal finance

Money market financial instruments

• Treasury bills
• Deposits
• Certificates of deposit (CDs)
• Gilts
• Bonds
• Commercial paper
• Inter-bank market: overnight borrowing
 Chapter 3.3 – Business and Personal finance

The capital market for business finance

Capital market: the national and international market in
which a business may obtain the finance it needs for its
short-term and long-term plans.
 Chapter 3.3 – Business and Personal finance

The capital market for business finance

• National stock markets: Primary and secondary

• The banking system: retail and whosesale

• Bond markers

• Leasing

• Debt factoring

• International markets
 Chapter 3.3 – Business and Personal finance

Sources of equity finance

 Chapter 3.3 – Business and Personal finance

Sources of equity finance

1. Retained earnings
• The profits earned by a business can either be paid out to
owners in the form of dividends or reinvested in the business.
• Shareholders will still expect a return on the funds re-invested
in the business.
 Chapter 3.3 – Business and Personal finance

Sources of equity finance

2. Rights issues of shares
A rights issue is an issue of new shares for cash to existing
shareholders in proportion to their existing holdings.

Factors to be considerred:

• Issue costs

• Shareholder reactions

• Control

• Unlisted companies
 Chapter 3.3 – Business and Personal finance

3. New issues of shares: Placings

• Benefit: lower transaction costs than public offers

• Drawback: by only offering to a narrow pool of institutional investors,
the spread of shareholders is more limited, which reduces the
efficiency of the market in the shares
 Chapter 3.3 – Business and Personal finance

New issues of shares : Public offers

 Chapter 3.3 – Business and Personal finance

New issues of shares

• Pricing of new issues

• Underwritting the issue

• Using an offer for sale by tender

• Offer for sale by tender

 Chapter 3.3 – Business and Personal finance

New issues of shares

4. Preference shares
Preference shares usually carry no voting rights and have
no right to share in excess profits.
• Benefits: They can be attractive if a company is looking
to raise new capital but wants to avoid additional debt
and does not want to dilute the ordinary shareholders'
influence.
• Drawbacks: While the dividend on ordinary equity shares
will vary from one period to the next
 Chapter 3.3 – Business and Personal finance
New issues of shares - Going public
Advantages of going public
• Gives access to a large source of finance
• Improves the marketability of shares, which should increase the value of the
company
• Improves the standing of the company, as it will be under more scrutiny once listed,
so raising more finance may then be easier
Disadvantages/problems of going public
• Cost: costs run into hundreds of thousands of pounds even for modest issues
• Dilution of control
• Need to have traded for three years
• Having to answer to other investors - often professional institutional investors
• Greater scrutiny of the affairs of the company and the actions of the directors
• Listing might not be successful unless the business is worth at least £50m
• Possibility of being taken over
• Extra costs of control and reporting systems
 Chapter 3.3 – Business and Personal
finance
The process for obtaining a full listing on the Stock Exchange
involves a number of specialist advisors.
Company sells shares Sponsor: Usually an investment Investing public
to raise capital bank, can also be stockbroker,
accountant etc
• Assesses whether fotation is
Corporate broker (can appropriate Solicitors
be same organsisation • Helps draft prospectus • Deal with
as sponsor, in which • Co –ordinates all advisors • Legal aspects
case roles are • Prices and underwrites the
combined) issue
• Advises on market
conditions and likely Registrars
demand • Record
• Generates interest ownership of
Accountant shares
with investors
• Invoved in long – form report
• Helps with issue
(financial control, track
method and pricing
record, financing and
• May organise sub-
forecasting)
underwriting
 Chapter 3.3 – Business and Personal finance

Sources of debt finance

Overdraft

Debt factoring

Term loan

Loan stock

Leasing

Other form of debt

 Chapter 3.3 – Business and Personal finance

Sources of debt finance

A short-term loan of variable

amount up to a limit from a
bank, typically repayable on
demand.
Interest is charged on a day-
to-day basis at a variable rate.
 Chapter 3.3 – Business and Personal finance

Sources of debt finance

Advantages of an overdraft
• Flexibility: an overdraft can be used and repaid as desired, giving the
borrower flexibility
• Cost: overall interest cost can be lower than a term loan, as interest is
only paid when overdrawn
Disadvantages of an overdraft
• Risk: as it is repayable on demand it is not suitable as a long-term
source of capital, since banks can and do demand immediate
repayment
• Cost: if the account is permanently in overdraft, the overall interest
cost is higher than with a term loan as the interest rate is generally
higher
• Control: the bank may require security on assets of the business
 Chapter 3.3 – Business and Personal finance

Sources of debt finance Factoring

• Financing the credit

taken by customers
• Insuring receivables
• Managing the
running of the
receivables ledger
 Chapter 3.3 – Business and Personal finance

Sources of debt finance

Term loans
A term loan is a loan - typically but not always from a bank - where the
repayment date is set at the time of borrowing and, unlike overdrafts, they
are not repayable on demand, unless the borrower defaults on
repayment.
Interest rates on term loans can be fixed or variable
• Arrangement fees are usually payable on term loans, but these are
small compared with issue costs for loan stocks on the London Stock
Exchange
• Security: term loans are usually secured against assets or, in smaller
companies, by directors' personal guarantees
• Flexibility: repayment schedules are flexible and interest 'holidays' of
typically up to two years can be negotiated to allow new ventures to
become established before cash has to be used to repay a loan
 Chapter 3.3 – Business and Personal finance

Sources of debt finance

Loan stock: debt capital in the form of securities issued by
companies, the government and local authorities. These are
also referred to as bonds or debentures

• Coupon (interest) rate

• Redemption value

• Redemption date

• Recipient
 Chapter 3.3 – Business and Personal finance
Sources of debt finance
Leasing
Finance lease Operating lease
This is essentially long-term debt This is essentially the short-term
finance: a purchase of the asset by rental of an asset
the lessee, financed by a loan from
the lessor
One lease exists for the whole or The lease period is less than the
major part of the asset's useful life. asset's useful life.
Either ownership passes to the lessee Ownership remains with the lessor.
at the end of the term, or any
secondary lease period is at a very
low rent.
 Chapter 3.3 – Business and Personal finance
Sources of debt finance
Leasing
Finance lease Operating lease
The lessor does not usually deal The lessor usually carries on a trade
directly in this type of asset eg banks in this type of asset eg building
leasing airliners. contractors leasing equipment to
builders.
The lessee takes on the risks or The lessor is normally responsible for
rewards of ownership eg bears the repairs and maintenance.
risk of downtime.
The lease agreement cannot be The lease can sometimes be
cancelled or early cancellation cancelled at short notice.
charges mean the lessee effectively
has a liability for all payments.
 Chapter 3.3 – Business and Personal finance

Sources of debt finance

Other forms of debt

• Money markets

• Securitisation (Asset-backed borrowing)

• Public sector grants and loans

 Chapter 3.3 – Business and Personal finance

Financing a growing business

• Business angels are experienced individuals who invest
in start-up, early stage or expanding businesses

• Crowdfunding is a means of financing a new business

or a new project for an existing business by raising a
specific sum of money from individuals, usually via the
Internet
 Chapter 3.3 – Business and Personal finance

Venture capital (VC)

 Chapter 3.3 – Business and Personal finance

AIM (Alternative Investment Market)

AIM has less stringent regulations than the Main Market of
the London Stock Exchange

Entry documentation is made as simple as

 Chapter 3.3 – Business and Personal finance

Financing exports

Trading risks
• Physical risk
• Credit risk
• Trade risk
• Liquidity risk
 Chapter 3.3 – Business and Personal finance
Financing exports
Reducing credit risk by credit term
• Bills of exchange
• A bill of exchange is a document that is drawn up by
the exporter and sent to the overseas buyer's bank,
which accepts the obligation to pay the bill by signing
it.
• Letters of credit
• Letters of credit provide a method of payment in
international trade which gives the exporter a risk free
method of obtaining payment. The arrangement must
be made between the exporter, the buyer and
participating banks before the export sale takes place.
 Chapter 3.3 – Business and Personal finance
Financing exports
Reducing credit risk by insurance
Export credit insurance is insurance against the risk of non-payment
by foreign customers for export debts.
Export credit insurance is not essential if exporters are reasonably
confident that all their customers are trustworthy, but it helps cover
some of the special risks involved in exporting,
• Time: If an export customer defaults on payment, the task of
pursuing the case through the courts will be lengthy, and it might be
a long time before payment is eventually obtained.
• Variety: export credit insurance covers non-payment for a variety of
risks not just the buyer's failure to pay on time.
 Chapter 3.3 – Business and Personal finance
Practice question

1. In a typical financial system, the biggest savers are usually:

A. businesses
B. households and individuals
C. the government
D. financial intermediaries
 Chapter 3.3 – Business and Personal finance
Practice question
2. Metrofick Ltd is a small family business that has only
been in existence for a few months. Its managing director
wants to establish a payroll system for the newly recruited
workforce of 25 staff. She wants salary payments to be
made direct to the bank accounts of employees, with a
minimum of paperwork and delay. The managing director
should ask the company's bank to use which of the
following systems regarding the salary payments?
A. BACS
B. Faster Payments
C. CHAPS
D. Payment by cheque
 Chapter 3.3 – Business and Personal finance
Practice question

3. In the banking system, secondary banks are also known as:

A. clearing banks
B. commercial banks
C. retail banks
D. merchant banks
 Chapter 3.3 – Business and Personal finance
Practice question

4.In the UK, the base rate at which the central bank lends
money to the banks is set by:
A. the Chancellor of the Exchequer
B. the Financial Conduct Authority
C. the Monetary Policy Committee (MPC) of the Bank of
England
D. the Financial Reporting Council
 Chapter 3.3 – Business and Personal finance
Practice question

5.In relation to its customer who pays a cheque into their

account, the receiving bank acts as the customer's:
A. creditor
B. agent
C. Bailee
D. mortgagee
 Chapter 3.3 – Business and Personal finance
Practice question

6. The minimum investment that can be made in UK Treasury

bills by members of the public is:
A. £250,000
B. £500,000
C. £1,000,000
D. £2,000,000
 Chapter 3.3 – Business and Personal finance
Practice question

7. Which of the following statements about preference

shares as a source of capital for a company is correct?
A. Preference shares are a form of loan capital which carry
lower risk than ordinary shares
B. Preference shares are a form of equity capital which carry
higher risk than ordinary shares
C. Preference shares are a form of loan capital which carry
higher risk than ordinary shares
D. Preference shares are a form of equity capital which carry
lower risk than ordinary shares
 CHAPTER 4: THE ROLE OF
ACCOUNTANCY PROFESSION
1. The professional accountant
2. The accountancy profession
3. Structure and regulation of the accountancy
profession
 Chapter 4.1: The professional accountant
Content
• Introduction to the accountancy profession
• The importance of the accountancy profession
• Professional responsibility
• Technical competence
• The work of the accountancy profession
• Accounting principles
• Accounting standards
• Roles of the professional accountant
• Limits of the professional accountant's responsibilities
• Technology developments and accountancy profession
 Chapter 4.1: The professional accountant
Accountancy profession - definition
• Assurance: The expression of an opinion or conclusion by a professional
accountant in public practice which is designed to enhance the confidence of
intended users.

• Professional: A person who: accepts a responsibility to operate in the public

interest; 'professes' to have skill resulting from a coherent course of study and
training based on professional values; and continues to develop and enhance
those skills by experience and continuing professional education.

• Accountancy: The profession of accounting which comprises measurement,

preparation, validation, disclosure, auditing of and provision of assurance and
advisory services on financial information.
 Chapter 4.1: The professional accountant
Accountancy profession - definition
• Accountancy profession: The profession concerned with the measurement,
disclosure or provision of assurance about financial information that helps
managers, investors, tax authorities and other decision makers make resource
allocation decisions.

• Financial reporting: The provision of financial information about an entity to

external users that is useful to them in making decisions and for assessing the
stewardship of the entity's management.

• Assurance: The expression of an opinion or conclusion by a professional

accountant in public practice which is designed to enhance the confidence of
intended users
 Chapter 4.1: The professional accountant
Accountancy profession

• The effective working of capital markets, and

• The public interest
 Chapter 4.1: The professional accountant
Accountancy profession
The effective working of capital markets
• If there is inadequate information some or all investors are
at a disadvantage.
• If financial statements demonstrate the qualitative
characteristics, high quality, accurate financial reporting and
assurance that the professional accountant supports the
effective working of capital markets for the benefit of
businesses.
 Chapter 4.1: The professional accountant
Accountancy profession
The public interest
• It is confidence in the profession's expertise and integrity as
demonstrated in high quality financial reporting and assurance

• A key issue is that an accountant's behaviour, in particular

acting well or ethically, serves to protect he public interest

• Accountant to act in the public interest, as well as to satisfy the

needs of individual clients oremployers.

• ICAEW members must report acts of misconduct all members

and states five fundamental professional principles or values
 Chapter 4.1: The professional accountant
Professional responsibility- Definition
• Ethics: A system of behaviour which is deemed acceptable
in the society or context under consideration. Ethics tell us
'how to behave'.
• Ethical behaviour: Acting in a manner which is perceived
to be acceptable in the circumstances — or 'behaving well'.
• Professional ethics: Identifying ethical dilemmas,
understanding the implications and behaving appropriately
in line with a code of behaviour that is accepted among
fellow professionals as being correct.
 Chapter 4.1: The professional accountant

ICAEW Code of Ethics: a conceptual framework

▪ Compliance-based approach (also known as rules-based)

▪ Ethics-based approach (also known as framework-based)

✓ ICAEW follows the ethics-based approach.

✓ Code of Ethics, which is a conceptual network.

✓ The Code identifies potential threats to the principles
and some corresponding safeguards.
 Chapter 4.1: The professional accountant
ICAEW's entry and education requirements
The principal requirements for initial admission to membership of ICAEWare:
• Two passes at A level or the equivalent
• Completion of 450 days' training with an authorised training employer or
authorised training principal
• Completion of a course of theoretical instruction
• Passing ICAEW's professional examinations
• Submission of a certificate of suitability for membership signed by the member
responsible for training
• Payment of the admission and subscriptionfees
By undertaking prescribed training and education the student accountant is:
• Acquiring the knowledge and understanding that underlie what
accountants do
• Developing the skills and abilities necessary to perform the tasks and roles
undertaken by the professional accountant
• Building personal commitment and professi8nalethics
 Chapter 4.1: The professional accountant
ICAEW's entry and education requirements
Professional skepticism Assessing information, estimates and
explanations critically, with a questioning mind, and being alert
to possible misstatements due to error orfraud.
 Chapter 4.1: The professional accountant
Continuing membership of ICAEW
• Obey the Institute's rules and regulations
• Pay the subscription fee annually
• Undertake continuing professional development (CPD)

Members engaged in public practice

• Hold a Practising Certificate

• Implement the ICAEW Code of Ethics

• Be covered by professional indemnity insurance
(PII)
 Chapter 4.1: The professional accountant
Reserved areas of practice

Statutory Investment
Insolvency Probate
audit business
 Chapter 4.1: The professional accountant
The work of the accountancy profession

Maintaining control and safeguarding assets

Financial management

Financial reporting
 Chapter 4.1: The professional accountant
Maintaining control and safeguarding assets

• The recording of transactions is complete, timely and

accurate

• The business's internal controls are sufficient.

• The business's audit committee is properly

• The business has non-executive directors who are
adequately qualified and resourced so that they can fulfil
their role.
 Chapter 4.1: The professional accountant
Financial management
The management of all the processes associated with the
raising and use of financial resources in a business.

• Transactions recording

• Raising new finance

• Using existing funds in ways which support achievement of
the business's objectives

• Planning and control systems

• Treasury management
 Chapter 4.1: The professional accountant
Financial reporting
• Financial reporting involves reporting on the financial
position of the entity at a particular point in time and its
financial performance over a period of time

• In seeking to ensure that there is high quality financial

reporting

• Professional ethics

• Accounting principles
 Chapter 4.1: The professional accountant
Accounting principles
• Accrual basis
• Going concern
• Double entry bookkeeping
• Faithful representation: accuracy and completeness
• Faithful representation: substance over form
• Neutrality
• Prudence
• Materiality
• Timeliness
• Cost versus benefit
• Consistency
• Offsetting
 Chapter 4.1: The professional accountant
Accounting standard
• Accounting standards identify appropriate accounting
practice.
• Financial statements should comply with accounting
standards.
• Listed companies must comply with International
Accounting Standards and International Financial
Reporting Standards.
• Some companies can choose whether to present
financial statements using IFRSs or UK standards.
 Chapter 4.1: The professional accountant
Roles of the professional accountant in public practice
• Accounting
• Auditing and assurance
• Taxation
• Management consulting International standards
• Investment business
• Insolvency
UK standards
• Financial management
• Corporate finance
• Information and communications technology
• Forensic accounting
• Probate
 Chapter 4.1: The professional accountant
Roles of the professional accountant

A professional accountant in business is one who is employed or

engaged, in an executive or non – executive capacity

• Commerce
• Industry
• Service
• The public sector
• Education
• The non-for-profit sector
• Regulatory or professional bodies
 Chapter 4.1: The professional accountant

Limits of the professional accountant's responsibilities

Legal matters

Administrative matters
 Chapter 4.1: The professional accountant
Technology development and accountancy profession
• Automation, machine learning and intelligent system
• More powerful systems
• System innovations and applications
• Digital contracts and transactions
• New types of data, information and risks
• New types of good and services
• Transparency in recording and sharing dât
• Audit analytics and intelligent systems
• Smart contracts
• Data analytics
• Software controls and data sét
• Distributed ledger technology and advanced accounting systems
• Regulation
 Chapter 4.1: The professional accountant

1.Which two of the following are 'reserved areas' of

professional accountancy practice?
A. Mergers and acquisitions
B. Assurance
C. Insolvency
D. Statutory audit
E. Forensic accounting
 Chapter 4.1: The professional accountant

2.To qualify for appointment by a company as its external

(statutory) auditor, a person must comply with which three
requirements?
A. They must be independent
B. They must exercise professional competence and due care
C. They must be registered with the Financial Reporting
Council (FRC)
D. They must be a member of a recognised supervisory body
E. They must hold an appropriate qualification
 Chapter 4.1: The professional accountant

3. The following statements have been made concerning the

impact of technology on accounting.
Statement (1) Automation has impacted on strategic-level
accounting
Statement (2) Accountants need to be prepared to provide
advice on how clients should account for
technological innovations
Identify whether each statement is accurate.
A. Statement (1) accurate; Statement (2) inaccurate
B. Statement (1) inaccurate; Statement (2) inaccurate
C. Statement (1) accurate; Statement (2) accurate
D. Statement (1) inaccurate; Statement (2) accurate
 Chapter 4.1: The professional accountant

4. The following statements have been made concerning the

impact of technology on auditing.
Statement (1) Audit analytics and intelligent systems allow
100% testing of transactions
Statement (2) Predictive analytics allows better targeting of
risk
Identify whether each statement is accurate.
A. Statement (1) accurate; Statement (2) inaccurate
B. Statement (1) inaccurate; Statement (2) inaccurate
C. Statement (1) accurate; Statement (2) accurate
D. Statement (1) inaccurate; Statement (2) accurate
 Chapter 4.1: The professional accountant

5.Professionals judge each other, and hold each other to

account, for not meeting professional values, such as bringing
the profession into disrepute.
Which common attribute of a profession does this describe?
A. Co-regulation
B. High degree of autonomy
C. Formal regulatory process
D. Self-regulation
Chapter 4.3: Structure and regulation of
the accountancy profession
 Structure and regulation of the accountancy
profession
Content

• The structure of the accountancy profession

• Regulation of professions

• The Financial Reporting Council (FRC)

• Regulation of the accountancy profession in the UK

• Regulation of the financial services industry

• Disciplinary procedures against accountants

 Structure and regulation of the accountancy
profession
The Consultative Committee of Accountancy Bodies (CCAB)
 Structure and regulation of the accountancy
profession

• The aim of IFAC is to protect the public interest

• Providing best practice guidance for professional
accountants employed in business, plus a membership
compliance programme.
 Structure and regulation of the accountancy
profession
Regulation should not

• Protect vested interests from competition

• Be for personal gain or to satisfy prurient interest

• Be disproportionate to the benefit gained

• Distort competition by imposing extra burdens on some,
but not others
 Structure and regulation of the accountancy
profession

Methods of regulation

• By government directly via legislation

• By separate agencies established by government

(delegated legislation)
• By the profession/industry itself (self-regulation — as
follows) or

• By a combination of methods
 Structure and regulation of the accountancy
profession

Self-regulation only works if

• The regime does not seem to act against the public

interest

• Regulatory guidance and its importance are both

understood and enforced

• Members of the profession 'buy in' to the process

• There is no unjustifiable self-protecting regulation

 Structure and regulation of the accountancy
profession
The oversight mechanism
An effective oversight mechanism requires:
• Sufficient independence
• Knowledge of the profession
• Significant, but non-controlling, input from the profession itself
• The ability to take a wide view to balance the various stakeholder interests
• Authority
• Good communication
• Sufficient resources to carry out effective examination
• The key participants
• The government
• Regulators
• Members of the profession
• Members of the public
 Structure and regulation of the accountancy
profession

• Setting standards for corporate governance

• Monitoring and reviewing the quality

• Regulating the audit profession

• Overseeing self-regulation in the accountancy, audit and
actuarial professions

• Acting as the ultimate disciplinary body for the accountancy

and actuarial professions
 Structure and regulation of the accountancy
profession
Conduct Committee: professional discipline
• FRC's Conduct Committee operates independent
investigative and disciplinary schemes for accountants
and actuaries in the UK.

• It deals with cases which raise important issues affecting

the public interest.

• Determine whether or not there has

been any misconduct by an accountant or

accountancy firm.
 Structure and regulation of the accountancy
profession

Conduct Committee: corporate reporting review

• Makes enquiries into apparent departures from the
requirements for financial statements

• Can seek voluntary remedial action

• Can apply to the court for an order for remedial action

• The 'remedial action' sought can be:

• Voluntary withdrawal

• Correction of the comparative figures

 Structure and regulation of the accountancy
profession

Audit quality review

Monitors the quality of the audits of listed and other major public
interest entities and the policies and procedures supporting audit
quality.

Codes and Standards Committee: actuarial

Seeks to establish and improve actuarial standards, primarily of a
technical nature, to ensure that they are coherent, consistent and
comprehensive and thereby to help promote high quality actuarial
practice.
 Structure and regulation of the accountancy
profession

Codes and Standards Committee: audit and assurance

• Develops standards for auditing and assurance
services and their effective application

• Develops ethical standards for auditors relating to the

independence, objectivity and integrity of auditors
 Structure and regulation of the accountancy
profession

❖ Codes and Standards Committee: accounting and

reporting policy
The FRC's Corporate Reporting Council makes, amends
and withdraws UK financial reporting standards.
❖ Codes and Standards Committee: corporate
governance
The FRC maintains and updates two codes in relation to
corporate governance: the UK Corporate Governance Code
and the Stewardship Code
 Structure and regulation of the accountancy
profession
Regulation of the accountancy profession in the UK

The regulatory regime for the accountancy profession

involves:

• The government

• Self-regulation by the accountancy profession

• An oversight mechanism by the FRC

 Structure and regulation of the accountancy
profession
Regulation of the accountancy profession in the UK

The role of ICAEW

• Entry and education requirements

• Eligibility to engage in public practice

• Eligibility for the performance of reserved activities under
statutory powers delegated by the government

• Professional conduct requirements

• Dealing with professional misconduct by its members

 Structure and regulation of the accountancy
profession
Regulation of the accountancy profession in the UK

The FRC's oversight mechanism

Non-statutory oversight of the professional accountancy bodies
Statutory oversight of the regulation of statutory auditors
Independent monitoring of the quality of the auditing function
On audit, the FRC has statutory powers in relation to recognised
supervisory bodies (RSBs) and recognised qualification bodies
(RQBs)
• Considering them carefully, and either
• Implementing them within a reasonable period, or
• Giving reasons in writing for not doing so
 Structure and regulation of the accountancy
profession
Effects on the accountancy profession
• The accountancy profession is directly affected by
financial services regulation as follows:
• Regulations on investment business.
• The FCA is the competent authority for listing as it
comprises the UK Listing Authority (UKLA).
• The FCA issues the following sets of rules
• Listing Rules.
• Disclosure and Transparency Rules.
• Prospectus Rules.
 Structure and regulation of the accountancy
profession

Other financial regulators

• The Financial Ombudsman, who settles disputes
between providers of financial services and their
customers

• The Pensions Regulator, who regulates work-based

pensions; personal pensions are currently regulated by
the FCA
 Structure and regulation of the accountancy
profession
Disciplinary procedures against accountants
✓ Complaints are usually that a member or firm have breached
ICAEW's bye-laws by:
• Breaching a regulation
• Departing from guidance
• Bringing discredit on ICAEW, the profession or themselves
✓ Fee disputes are not covered by the procedures, but the
Institute does offer a fee arbitration service on a voluntary
basis.
✓ Anyone can make a complaint: firms, clients, other
accountants, the Department for Business, Innovation and
Skills (BIS), other regulators, members of the public and even
ICAEW itself.
 Structure and regulation of the accountancy
profession
ICAEW complaints and disciplinary procedure
• Conciliation: try to find practical solution, giving an
explanation or providing information to resolve the problem

• Investigation: by Investigation Committee

• Disciplinary proceedings by the Disciplinary Committee
(DC)
 ICAEW complaints and disciplinary procedure

The Disciplinary Committee

hears evidence from the
investigation Committee
and the accountant or their
representative.
Wereceive It reaches a decision if
your misconduct is proved and
complaint the committee disciplines
the accountant if
appropriate
 ICAEW complaints and disciplinary procedure

The committees involved in dealing with complaints

• The Audit Registration Committee (ARC), which may

withdraw a firm's audit registration

• The Investment Business Committee (IBC)

• The Insolvency Licensing Committee (ILC), which may
withdraw an insolvency licence

• The Probate Committee (PC)

 ICAEW complaints and disciplinary procedure
How are complaints investigated
ICAEW's assessor first writes to the person who has made the complaint (the
complainant), then
to the member or firm setting out full details of the complaint and inviting their
comments. It is one of ICAEW's rules that members must:

• answer questions
• provide any information ICAEW asks for
If members do not reply to letters initially, ICAEW can require them to answer
questions and produce books or papers. If members fail to respond to the
request, they will be in breach of a bye-law and can be disciplined for this.
Following the initial investigation, if it appears there is a case to answer it is
reported to a case manager for reporting to the IC.
 ICAEW complaints and disciplinary procedure

How are complaints investigated

If the member or firm agrees the complaint is valid and there is a
case to answer, the IC can impose one of a range of penalties.

It has the power to:

+ issue a reprimand
+ fine the member or their firm
 ICAEW complaints and disciplinary procedure
What happens if the IC finds that there is a case to answer

• Take no further action

• Invite the firm or member to accept an unpublicised
caution

• Invite the firm or member to consent to an order

• Refer the complaint to the Disciplinary Committee (DC)
 ICAEW complaints and disciplinary procedure
What happens at a DC hearing
DC tribunal hearings are held in public unless the tribunal
has agreed to hear the case in private.
• An ICAEW member of staff or barrister presents the case
on behalf of the IC.
• A Legal Assessor gives the DC advice on law and
procedure but is not involved in taking decisions. The
Legal Assessor is an independent solicitor or barrister.
• The member or firm can attend and be represented by a
barrister, solicitor or member of ICAEW.
 ICAEW complaints and disciplinary procedure

What happens at a DC hearing

The DC can impose penalties or sentencing orders

including:

• Reprimands
• Fines
• Taking away a member's practising certificate
• Excluding them from membership of ICAEW
• Ordering them to pay costs
 Chapter 4.3: Structure and regulation of
the accountancy profession
Appeal Committee
The AC consists of five people: three chartered accountants,
one non-accountant member and a chairman who holds a
legal qualification.
+ If an appeal is successful, the AC overturns the DC's
decision and reconsiders any order made. It may ask ICAEW
to pay costs.
+ If an appeal is unsuccessful the AC may order the member
to pay any additional costs ICAEW has incurred as a result of
having to present the case again to the AC.
 Chapter 4.3: Structure and regulation of
the accountancy profession
FRC’s accounting Scheme
Powers of the Executive Counsel

The Executive Counsel can:

• Require the participating accountants’ professional bodies to
provide documents relevant to any particular matter.

• Seek information and documents from accountants and

accountancy firms.

• Require accountants and accountancy firms to give evidence to a

tribunal
 Chapter 4.3: Structure and regulation of
the accountancy profession
FRC’s accounting Scheme

Role of the Disciplinary Tribunal

• When a complaint is upheld the Tribunal can fine the

accountant or firm and order them to pay all or part of the
costs of the investigation and the hearing.
• When a complaint is dismissed the Tribunal can order
the FRC to pay legal costs.

• Accountancy firm can appeal against Tribunal

 Chapter 4.3: Structure and regulation of
the accountancy profession
FRC’s accounting Scheme

Appealing against a finding of the Disciplinary Tribunal

• An accountant or accountancy firm can appeal against

any finding against it to an Appeal Tribunal.
• It is heard by an Appeal Tribunal set up by the FRC in
the same way and subject to the same criteria as the
Disciplinary Tribunal which hear the original complaint
 Structure and regulation of
the accountancy profession
Upholding transfarency, independent and fair

Transparent

Independent

Fair
 Practice question

1.The agency problem underlies the need for sound

corporate governance. In this context, the 'agents' are the
company's:

A. customers

B. shareholders

C. Directors

D. auditors
 Practice question
2. Which of the following pairs of factors are likely to enable
managers to run a company in their own interests?

A. Low levels of management accountability and shareholder

access to the same information as management
B. High levels of management accountability and management
access to better information than the shareholders
C. High levels of management accountability and shareholder
access to the same information as management
D. Low levels of management accountability and management
access to better information than the shareholders
 Practice question
3.The directors of Clamin plc state in the annual report that
they comply with the requirements of the UK Corporate
Governance Code. This is because they believe that the aim
of the company is to maximise the wealth of its
shareholders, provided the business's activities are
conducted legally. The directors of Clamin plc have adopted
the:
A. corporate perspective on corporate governance
B. public policy perspective on corporate governance
C. stewardship perspective on corporate governance
D. stakeholder perspective on corporate governance
 Practice question

4.A German company, Albrecht AG, has a dual board

structure for its board of directors. This means that, in
addition to the supervisory board, the company also
operates a:

A. unitary board

B. management board

C. non-executive board

D. executive board
 Practice question
5.According to the Organisation for Economic Cooperation
and Development (OECD) Principles of Corporate
Governance, companies must protect and facilitate which
two of the following shareholder rights?

A. The right to receive all the company's profits

B. The right to real-time information concerning the company
C.The right to participate in and vote at semi-annual select
meetings
D. The right to have secure methods of ownership registration
E. The right to elect and remove members of the board
 Practice question

6.Which three of the following attributes and behaviours are

identified by the Institute of Business Ethics as being typical
of ethical business leaders?

A. Openness

B. Integrity

C. Ability to listen

D. Courage

E. Accountability
 Practice question
7. The country of Zooland has a bank-based financial
system. Its financial system will be characterised by:

A. comparatively more government regulation than a market-

based system
B. comparatively less close relationships between banks and
businesses than in a market-based system
C. comparatively less integration of banking and non-banking
services than in a market-based system
D. households with greater access to investment in physical
assets than in a market-based system
CHAPTER 5: RISKS, GOVERNANCE,
CORPORATE RESPONSIBILITY AND
ETHICS
5.1. Risks and Risk management
5.2 Governance and Ethics
5.3. Corporate governance
 Introduction to risk management
Content
• Introduction to risk

• Risks for businesses and their investors

• Types of risk

• Cyber risk

• Risk concepts

• The objectives of risk management

• Crisis management

• Business resilience

• Disaster recovery
 Introduction to risk management
What is risk?
• Risk: The possible variation in an outcome from what is
expected to happen
• Variability: events in the future cannot be predicted with
certainty
• Expectation: we expect something to happen, or perhaps
hope that it will not happen
• Outcomes: this is what actually happens compared with what
is intended or expected to happen
• Uncertainty: The inability to predict the outcome from an activity
due to a lack of information.
• Opportunity: The possibility that an event will occur and positively
affect the achievement of objectives.
 Introduction to risk management
Attitudes to risk

Risk appetite: The extent to which a business is prepared

to take on risks in order to achieve its objectives.
 Introduction to risk management
Risk attitudes

A risk averse
attitude

A risk neutral
attitude

A risk seeking
attitude
Introduction to risk management
 Introduction to risk management
Worked example: Expected returns
Jack pic has the opportunity to invest £100,000 in a project. The
project manager has estimated three scenarios for the project's
annual return, and the related returns and probabilities
Probability of Annual return under
scenario occurring the scenario
£
Worst case
0.3 2,000
scenario
Most likely scenario 0.6 5,000
Best case scenario 0.1 10,000
 Introduction to risk management

Business risk

Financial risks
Types of risks
Operational risks

Cyber risk
Introduction to risk management
Business Risk

Strategic Risk

Financial Risk

Operational Risk

Legal Risk

Other Risks
 Introduction to risk management

Financial risks
• Controllable financial risk is financial risk arising from
factors that are within the business's direct control.
• Uncontrollable financial risk is financial risk arising from
factors that operate independently of the business. The
key factor here is market risk, that is the risk of losses
resulting from changes in
 Introduction to risk management
Operational risks
Operational risk: The risk that actual losses, incurred because of inadequate or failed
internal processes, people and systems, or because of external events, differ from expected
losses.
• Process risk
• People risk
• Systems risk
• Event risk
• Disaster risk
• Regulatory risk
• Reputation risk
• Systemic risk
• Physical risks
• Social risks
• Political risks
• Legal risks
• Economic risks
• Technology risks
 Introduction to risk management
Cyber risk
Cyber risk is the risk of financial loss, disruption or damage to the
reputation of an organisation from failure of its information technology
systems due to accidents, breach of security, cyber attacks or poor
systems integrity.
 Introduction to risk management
Cyber risk
•Hacking - including of social media and email passwords
•Phishing - bogus emails asking for security information
and personal details
•Malicious software – including ransomware through
which criminals hijack files and hold them to ransom
•Distributed denial of service (DDOS) attacks against
websites – often accompanied by extortion
 Introduction to risk management
Tackling cyber attached
 Introduction to risk management
Tackling cyber attached
 Introduction to risk management
Tackling cyber attached
Introduction to risk management
 Introduction to risk management
Technical controls for cyber security
 Introduction to risk management
Risks management
• Reducing the probability of risks occurring in the first
place, and then if they do occur

• Limiting the impact they will have on the business

 Introduction to risk management
Risks management process
 Introduction to risk management
Risks management process
 Introduction to risk management
Risk awareness and identification

Risk identification
Identifying the whole range of possible risks and the
likelihood of losses occurring as a result of these risks.

Risk identification must be a continuous process

• Potential new risks may arise
• Existing risks may change
 Introduction to risk management
Risk awareness and identification

A bottom-up
approach

A top-down
approach
 Introduction to risk management
Risk assessment and measurement

Risk Risk
Gross risk
assessment measurement

Identifying the
For each risk its
probability The potential loss
nature is
(likelihood) of the associated with the
considered, and
risk occurring, risk, calculated by
the implications it
quantifying the combining the
might have for the
resultant impact impact and the
business achieving
(consequence) probability of the
its objectives; an
and calculating the risk, before taking
initial judgement is
amount of the any control
then made about
potential loss using measures into
the seriousness of
expected values account.
the risk.
for gross risk
 Introduction to risk management
Risk assessment and measurement

Significance can be measured in terms of the potential

loss arising as a result of the risk, that is its gross risk.

Gross risk = Probability x Impact

 Introduction to risk management
Risk assessment and measurement

High
High significance
IMPACT

Low significance

Low

Low High
PROBABILITY
 Introduction to risk management
Risk response and control
High High impact, low probability
High impact, high probability
These risks might be shared using These risks must be controlled,
insurance, and at the same time the using avoidance, reduction
impact might be reduced so that and/or sharing
IMPACT

insurance premiums are lower

Low impact, low probability

Often these risks are just Low impact, high probability
accepted, as the cost of Reduction is the key response
avoiding, reducing or sharing here
Low them exceeds the benefits

Low High

PROBABILITY
 Introduction to risk management
Control

Physical Financial System Management

controls controls controls controls
 Introduction to risk management
Monitoring and reporting risk
Monitoring risk should be a continuous, ongoing process
• Has corrective action now been taken? Has it been
effective?
• Was the risk identified in the first place, and if not why
not?
• If the risk was identified and planned for but the event
still occurred is it because early warning indicators were
not monitored?
• If the response and/or controls were ineffective what
changes or new procedures are necessary?
 Introduction to risk management
Crisis management
Crisis
• An unexpected event that threatens the
wellbeing of a business, or a significant
disruption to the business and its normal
operations which impacts on its customers,
employees, investors and other stakeholders.

Crisis management
• Identifying a crisis, planning a response to the
crisis and confronting and resolving the crisis.
 Introduction to risk management
Types of crisis
• Financial crisis
• Public relations crisis
• Strategic crisis
There are many types of crisis in terms of their cause.
• Natural event
• Industrial accident
• Product or service failure
• Public relations disaster
• Business crisis
• Management crisis
• Legal/regulatory crisis
 Introduction to risk management
Managing a crisis

• Crisis prevention
• Contingency planning

Interactive question: Contingency planning

Consider what you would do if, at a time when your
business has a small overdraft and very little money
expected in shortly, it is faced with a large demand from a
government body which requires settlement in one month.
 Introduction to risk management
Business resilience
• A business's ability to manage and survive against planned or
unplanned shocks and disruptions to its operations.
Axis 1: Processes and Axis 2: More general ('cross-cutting')
functions that protect the characteristics of the organisation that drive
organisation resilience
• Risk management • The level of trust employees have in the
• Business continuity planning organization and it’s management
• Security • The level of trust of customers in the
• IT disaster recovery organization
• Health and safety • The ability of the organisation to innovate
• Crisis management • The extent that organisational values are
• Internal audit understood
• Governance • The extent that organisational values drive
employee behaviour
• The ability of the organisation to operate risk
management
• Employee morale
• Leadership and senior management involvement
 Introduction to risk management
Business resilience
Features of resilient organisations:
• Have diversified resources and assets to facilitate alternative
approaches and adaption to change
• Build strong relationships and networks (both internal and external)
• Have the ability to respond rapidly and decisively to an emerging crisis
• Have the ability to review and adapt based on experience and
changing circumstances
Challenges:
• Lack of expertise
• Lack of input from senior management
• Siloes for delivery
• Limited sharing of risk information
 Introduction to risk management
Business resilience
Four metrics that can be used to measure resilience:
• Compliance - how well the organisation complies with its standards
and policies
• Completeness - the scope of resilience (ie how wide a range of issues
is the organisation prepared for)
• Value – qualitative and quantitative measures of how well the
organisation can meet specific outcomes
• Capability - evidence, collected through exercises and reviews, of the
extent to which the organisation has put resilience processes and
procedures in place
 Introduction to risk management
Business resilience
• Cyber-resilience is the ability of an organisation to ensure that its data
and information are reliable, available, has integrity and is adequately
protected from unauthorised access.
• Cyber security is an important part of an organisation's resilience. It is
a function that helps protect organisations against the risk of cyber-
attack and therefore provides resilience against this type of threat.
• IT disaster recovery provides back-ups of the data and information
held by the organisation that can be used to replace data and
information lost in a cyber-attack.
 Introduction to risk management
Business resilience
Threats to an organisation's cyber-resilience:
• Mobile threats – this is the risk that mobile devices containing information, data
and connections to an organisation's system are lost or stolen
• Networking and cloud considerations - this is the risk that broadband, wi-fi and
other network connections become unavailable and therefore users working
remotely or via the cloud cannot access the organisation's systems or data.
• Access controls in the mobile world - this is the threat that access controls to the
organisation's main system are compromised due to inferior controls being in
place on mobile devices.
• Other threats - attacks on company websites, social media and email. There are
also threats such as fire, hardware failure and burglary that will also prevent
access to company systems.
 Introduction to risk management
Business resilience
Specific cyber-resilience issues to consider.
• Understand where all the information is
• Separate systems with different levels of trust
• User access rights and obligations
• Address specific weaknesses
• Cover all key legal issues
• Address third party relationships
• Conformance assessment and penetration testing
• In-house versus external managed security services
• Define specific responsibilities
• Monitoring and review
 Introduction to risk management
Business resilience
Supply chain
• is a particular issue for companies that adopt a just-in-time approach to
inventory management.
• Organisations receive deliveries almost at the point when the materials
are needed in the production process and very little if any, spare
inventory is held.
 Any disruption to the supply chain (such as late deliveries or the failure
of a supplier) will have a major impact on production.
• The more that companies outsource or work with partners the more they
depend on, and therefore must be able to rely on, their supply chain.
 Introduction to risk management
Disaster recovery
Disaster: The business's operations, or a significant
part of them, break down for some reason, leading to
potential losses of equipment, data or funds.
A long-term disaster recovery plan will typically
provide for.
• Standby procedures so that some operations can be
performed while normal services are disrupted
• Recovery procedures once the cause of the
breakdown has been discovered or corrected
• Personnel management policies to ensure that the
above are implemented properly
 Introduction to risk management
Disaster recovery
Section Comment
Definition of It is important that somebody is designated to take control in a crisis. This
responsibilities individual can then delegate specific tasks or responsibilities to other
designated people.
Priorities Limited resources may be available for processing. Some tasks are
more important than others. These must be established in advance.
Similarly, the recovery plan may indicate that certain areas must be
tackled first.
Backup and These may be with other installations, or with a business that provides
standby such services. Alternatively, other processes may be possible, for
arrangements instance taking cash when credit/debit card processing is interrupted.
Communication The problems of a disaster can be compounded by poor communication
with staff between members of staff.
Public relations If the disaster has a public impact, the recovery team may come under
pressure from the public or from the media
Risk assessment Some way must be found of assessing the particular requirements of
the problem
 Introduction to risk management

Practice question

1. Market risk is:

A.the economic loss suffered due to the default of a customer in

the market
B. the risk of choosing the wrong strategy in a particular market
C.the risk that customers do not buy the company's products in
the expected quantities in the market
D.the exposure to potential loss that would result from changes in
market prices or rates
 Introduction to risk management

Practice question

2.The head of corporate strategy for Mismus plc is assessing the

scale of a particular risk faced by the company. This will depend
on which four of the following concepts?
A. Probability
B. Uncertainty
C. Impact
D. Volatility
E. Appetite
F. Exposure
 Introduction to risk management

Practice question

3.Manator Ltd has developed a new product for use in the

nuclear power industry. Tests on the product have been
successful and the product has been given government approval
for use in the UK. However, a vocal group of lobbyists claim
there is a danger to human health in the long term if the product
leaks into the water supply. The company now has an insurance
policy to cover all the company's liabilities in the event of a legal
claim against the company following a leakage. Manator Ltd is
managing the risk through:
A. risk avoidance
B. risk reduction
C. risk transfer
D. risk acceptance
 Introduction to risk management

Practice question

4.Nantos plc has a standby procedure at one of its coal-

fired power stations. This ensures that some level of
electricity generation will still occur if normal levels of
activity are disrupted. This is part of Nantos plc's:
A. operational planning
B. contingency planning
C. crisis management
D. disaster recovery planning
 Introduction to risk management

Practice question

5.Two aspects of a risk must be taken into account in

calculating the potential gross risk. These factors are the:

A. level of exposure and probability of occurrence

B. potential impact and probability of occurrence
C. potential impact and level of volatility
D. level of exposure and level of volatility
 Introduction to risk management

Practice question

6. Which form of cyber attack risk is described below?

Criminals send bogus emails that ask the user for security
information and personal details.

A. Keylogging
B. Screenshot manager
C. Phishing
D. Adclicker
 Introduction to risk management

Practice question

7.Grange Ltd's computer systems have recently been affected

by hacking with the consequence that its data files have been
stolen by criminals. The criminal gang have offered to return
the files for a payment of £1 million.
Which of the following cyber attacks is Grange Ltd a victim of?

A. Webcam manager
B. Keylogging
C. File hijacking
D. Phishing
Chapter 6.2: Governance, corporate
responsibility, sustainability and
ethics
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Content
1. What is governance?

2. What is corporate governance?

3. Stakeholders' governance needs

4. Symptoms of poor corporate governance

5. What is meant by 'good practice' in corporate governance?

6. The effect of types of financial system on governance

7. Governance structures

8. Ethics, business ethics and an ethical culture

 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics

Governance is the system by which an organisation is

directed and controlled so that its objectives are achieved
in an acceptable and sustainable manner
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Agency problem
The Principal-Agent Relationship
• The Agent is the “person that acts,” whereas the Principal is the
person that receives the benefits from the actions.
• An agency relationship occurs when a principal hires an agent to
perform some duty.
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics

'A set of relationships between a company's management,

its board, its shareholders and other stakeholder that

provides the structure through

which the objectives of the

company are set attained and

monitored'.
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Objectives of corporate governance

The public policy perspective on corporate governance

• The objectives of its shareholders, plus

• The interests of other individuals and groups with a direct

'stake' in the company, plus

• The interests of the public at large

 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Objectives of corporate governance
The stakeholder perspective on corporate governance
• Encourage the efficient use of resources through efficient
investment

• Require accountability from the company's senior

management to shareholders for the way it has managed
and taken care of those resources

• Aim to align the interests of shareholders and companies

with those of other stakeholders
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Objectives of corporate governance
The corporate perspective on corporate governance
• Management should balance the interests of shareholders
with those of other stakeholders in order to achieve long-term
sustained value for shareholders.

The stewardship perspective on corporate governance

• Probably the most narrow view of corporate governance is to
take the approach that the law requires directors to act in the
best interests of the company when acting as 'stewards' of
the company's resources.
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Stakeholders’ governance needs
Conflicts between stakeholders' interests

• Conflict of interests between different stakeholder

groups, with each group wanting different things, in
order to achieve incompatible objectives.
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
What are the symptoms of a serious conflict of interests?

• Financial collapse without warning

• Directors trying to disguise the true financial performance
of the company

• Disputes over directors' remuneration

• Decisions taken by a board of directors to satisfy their
own wish for power and rewards rather than to boost the
interests of shareholders
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Stakeholders' governance needs
• For their interests and expectations to be reflected in the
company's objectives

• For the scope for conflicts to be reduced

• For the company to adhere to good practice in corporate
governance

• For the company to adhere to good business ethics

 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Symptoms of poor corporate governance
• Domination of the board by a single individual or group, with other board
members merely acting as a rubber stamp
• No involvement by the board: meeting irregularly, failing to consider
systematically the organisation's activities and risks, or basing decisions on
inadequate information
• Inadequate control function, for instance no internal audit, or a lack of
adequate technical knowledge in key roles, or a rapid turnover of staff
involved in accounting or control
• Lack of supervision of employees
• Lack of independent scrutiny by external or internal auditors
• Lack of contact with shareholders
• Emphasis on short-term profitability, leading to concealment of problems or
errors, or manipulation of financial statements to achieve desired results
• Misleading financial statements and information
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Good practice in corporate governance
• Risk management and reduction, and good internal controls
• Ethical and sustainable pursuit of the business's strategy in a way
which safeguards against misuse of resources, physical or
intellectual and which aims at ensuring success over the long term
• Openness and transparency; disclosure of information
• Integrity and probity: applying the spirit of the law as well as its
letter, and being honest in all dealings
• Accountability: monitoring and judging directors' performance based
on the returns that the company has achieved under their
stewardship
• Reducing the potential for conflict
• Reconciling the interests of shareholders and directors as far as
possible
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
The Board of Directors
• Executive directors of a very high standard in terms of their decision-
making and of the culture that they create in the company
• Non-executive directors who are independent of the executives yet
who accept that they have collective responsibility with the rest of the
board for corporate governance
• Committees of the board of directors as a whole that are properly
constituted and have the power and resources to make the decisions
delegated to them by the main board.
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Good practice in corporate governance
• Senior management of high quality and able to:
• Put into effect the decisions of the board
• 'Whistle-blow' on the activities of the company should the need
arise
• Shareholders who are proactive at meetings and generally ensure
that the board is acting in their best interests and within the spirit of
good corporate governance
• External auditors working on behalf of the shareholders totally
independently of the directors when reaching a conclusion as to
whether the company's financial statements show a true and fair
view
• Internal auditors who are independent of the directors as far as
possible, reporting to the Audit Committee of the board or to some
other committee dominated by non-executives
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
The effect of types of financial system on governance

There are two broad types of financial system:

Bank-based
systems
Market-based
systems
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Bank-based financial systems
• Households prefer to bear little risk and so allocate more of their financial assets
to cash and cash equivalents
• Households have less access to investments in physical assets such as housing
• Where households do invest in securities, this is primarily done via intermediaries
such as pension and mutual funds, so institutional shareholders are influential
• There is comparatively more government regulation, often as a result of historic
financial catastrophes
• Banks are highly concentrated and integrated in terms of providing both banking
and non-banking services
• Bank lending is the most important source of business finance, after retained
earnings
• Banks and businesses are highly integrated: banks have a long-term relationship
with the businesses they lend to, usually cemented by the bank
• Markets are volatile and speculative because companies are dependent on bank
finance and thus have high gearing
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Market-based financial systems
• Households bear more risk and so hold proportionately more equity and
proportionately fewer deposits with banks
• Households have greater access to investments in physical assets such as
housing
• High levels of indirect investment via intermediaries such as pension and
mutual funds mean that institutional shareholders have a great deal of
influence
• Markets are more important than banks for long-term finance, though
retained earnings remain the most important source of funds
• They are comparatively unregulated
• Banks are more fragmented with less integration of banking and non-
banking services
• Banks have less close relationships with the businesses they lend to, not
holding equity and not being involved in decision-making
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Financial intermediation and the importance of information

The increasing influence of institutional shareholders means that

there is increasing pressure on companies:

• To conduct themselves well

• To respond to the requirements of institutional shareholders

• To provide good financial information via financial reporting

 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Governance structures
There are two basic governance structures:

• Statutes

• Codes of practice

Different countries use different combinations of statutes and

codes of practice, depending in part on whether they have

principles-based or a shareholder led approach to governance

structures.
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Principles - based approach to governance structures
• Promote transparent and efficient financial markets

• Protect and facilitate shareholders' rights, including the following basic rights
• Ensure the equitable treatment of all shareholders, including minority and
foreign shareholders.

• Recognise the rights of stakeholders established by law or through mutual

agreements

• Ensure that timely and accurate disclosure is made on all material matters,
including the company's.

• Ensure the strategic guidance of the company by the board, the effective
monitoring of management by the board, and the board's accountability.
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Governance structures

• The need for and status of the external audit

• The need for an effective approach to the provision of analysis
or advice by analysts, brokers, rating agencies and others,
that is:

• Relevant to decisions by investors

• Free from material conflicts of interest that might
compromise the integrity of their analysis or advice
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Shareholder - led approach to governance structures
'Institutional shareholders' is a broad term for
organisations which invest money on behalf of other
people.

• Insurance companies

• Pension funds

• Investment trusts
• Investment managers who act as agents of the above
bodies.
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Possible structures for the board of directors
• A unitary board is responsible for both management of the
business and reporting to the shareholders, via the financial
statements and shareholder meetings.
• A dual or supervisory board structure, as is seen in Germany for
instance, with roles split between:

• The management board, with responsibility to manage the

company using similar powers to the unitary board, and

• The supervisory board: an independent separate board

elected by the shareholders and the employees, often
comprising a series of committees with delegated powers.
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
The governance structure of the UK
Rules on corporate governance, especially with regard to:
• The board of directors (a unitary board is required)
• Directors' powers and duties
• The relationship of the company with directors, such as
loans to directors and the interests of directors in
company contracts
• Accountability for stewardship and financial reporting via
the financial statements
• Rules on meetings and resolutions
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Listed companies are regulated by the FCA's UKLA

• Comply with the main principles of the FRC's UK

Corporate Governance Code 2014 contained in the

UKLA Listing Rules , and either

• Comply with the supporting provisions of the Code, or

• Explain why they have not so complied.

 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Ethics, business ethics and an ethical culture
Ethical culture: A business culture where the basic
values and beliefs in a company encourage people
within the company to behave ethical

• Integrity
• Objectivity
• Accountability
• Openness
• Honesty
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Along with the business values listed above are statutory requirements
of all companies:
• Equality for all
• No discrimination on any grounds
• Freedom of information
Values are promoted in the company by the board of directors which
should be committed to:
• Openness and transparency in decisions and use of resources
• Promoting good relationships wherever possible
• High standards in their own personal behaviour, especially preparing
adequately for and attending meetings, and being involved in
decision making
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics

Business ethics: The ways in which a company behaves

in a society which has certain expectations of how a

decent company should behave.

 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Acceptable business ethics may comprise as a
minimum:

• Paying staff decent wages and pensions

• Providing good working conditions for staff

• Paying suppliers in line with agreed terms

• Sourcing supplies carefully

• Using sustainable or renewable resources

• Being open and honest with customers

 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics

How can an ethical culture be promoted?

• Ethical leadership from the board of directors

• Codes of ethics or business conduct

• Policies and procedures to support ethical behaviour

 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Ethical leadership from the board of directors

Attributes Behaviours
Be open minded and willing to learn, and encourage
Openness
others to learn.
Be determined and direct; actively stamp out poor
Courage
behaviour.
Ability to Be aware of what is going on and know that doing the
listen right thing is the right thing to do.
Honesty Be considerate and cautious in managing expectations.
Fair
Be independent and willing to challenge the status quo.
mindedness
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics

A formalisation of principles, values, responsibilities and

obligations
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Codes of ethics or business conduct
• Communication: ethical codes communicate the standard of behaviour
expected of employees.

• Consistency of conduct: with the message effectively communicated, the

behaviour of employees can be standardised or made consistent across all its
operations and locations.

• Risk reduction: standardised behaviour reduces the risk of unethical actions

as employees who are unethical will 'stand out' and can be dealt with.

• Compliance with UK corporate governance rules: the Cadbury Committee

Report on corporate governance in 1992 first recommended that businesses
draw up codes of conduct and publish them internally and externally, so all
employees know what is expected of them
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Codes of ethics or business conduct
A company should have three objectives for a code of ethics
in mind:

• To improve behaviour
• To build the company's reputation and the trust of
stakeholders in the company

• To improve performance and build value

 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics

Employees who make the decision to 'blow the whistle' are

driven to do so by their own moral values and their need to
'do the right thing', but they will normally only do so once
they have tried but failed to get the problems addressed
internally.
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Policies and procedures to support ethical behaviour
• Active leadership by managers
• Consultation and communication procedures so everyone is aware of the code of ethics
• Piloting of the code in draft form so that people have an input to its content
• Review of the code so that it retains its position at the heart of how the company actually
does business
• Training
• Speak-up lines/helplines for internal whistle-blowing
• Performance appraisals incorporating values
• Remuneration policies not cutting across values
• Disciplinary policies enforcing values
• Monitoring of how ethical behaviour is taking place
• Audit and assurance regarding values
• Reporting regularly
• Complaints systems that help employees to draw attention to unethical behaviour
• An explicitly stated duty to report breaches of specific ethical requirements
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
Ethical audit
A process which measures the internal and external consistency of a
company's values base.
• Clarifies the actual values to which the company operates
• Provides a baseline by which to measure future improvement
• Points the way towards meeting any societal expectations which are
not currently being met
• Gives stakeholders the opportunity to clarify their expectations of the
company's behaviour
• Identifies specific problem areas within the company
• Identifies the issues which motivate employees
• Identifies general areas of vulnerability, particularly related to lack of
openness
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
ICAEW members and business ethics

Promoting sustainability and corporate responsibility

• To meet legal compliance requirements

• To build trust and credibility

• To gain external verification and certification

• To gain or restore stakeholder confidence

• To improve management systems through the use of
standards and processes
 Chapter 6.2: Governance, corporate
responsibility, sustainability and ethics
ICAEW members and business ethics

Environmental management systems (EMS) consist of

procedures for compliance with a number of stated
environmental policy objectives and targets, and therefore
they assist the business in promoting sustainability and
corporate responsibility. As well as documenting system
procedures and instructions
 Practice question

1.The agency problem underlies the need for sound

corporate governance. In this context, the 'agents' are the
company's:

A. customers

B. shareholders

C. Directors

D. auditors
 Practice question
2. Which of the following pairs of factors are likely to enable
managers to run a company in their own interests?

A. Low levels of management accountability and shareholder

access to the same information as management
B. High levels of management accountability and management
access to better information than the shareholders
C. High levels of management accountability and shareholder
access to the same information as management
D. Low levels of management accountability and management
access to better information than the shareholders
 Practice question
3.The directors of Clamin plc state in the annual report that
they comply with the requirements of the UK Corporate
Governance Code. This is because they believe that the aim
of the company is to maximise the wealth of its
shareholders, provided the business's activities are
conducted legally. The directors of Clamin plc have adopted
the:
A. corporate perspective on corporate governance
B. public policy perspective on corporate governance
C. stewardship perspective on corporate governance
D. stakeholder perspective on corporate governance
 Practice question

4.A German company, Albrecht AG, has a dual board

structure for its board of directors. This means that, in
addition to the supervisory board, the company also
operates a:

A. unitary board

B. management board

C. non-executive board

D. executive board
 Practice question
5.According to the Organisation for Economic Cooperation
and Development (OECD) Principles of Corporate
Governance, companies must protect and facilitate which
two of the following shareholder rights?

A. The right to receive all the company's profits

B. The right to real-time information concerning the company
C.The right to participate in and vote at semi-annual select
meetings
D. The right to have secure methods of ownership registration
E. The right to elect and remove members of the board
 Practice question

6.Which three of the following attributes and behaviours are

identified by the Institute of Business Ethics as being typical
of ethical business leaders?

A. Openness

B. Integrity

C. Ability to listen

D. Courage

E. Accountability
 Practice question
7. The country of Zooland has a bank-based financial
system. Its financial system will be characterised by:

A. comparatively more government regulation than a market-

based system
B. comparatively less close relationships between banks and
businesses than in a market-based system
C. comparatively less integration of banking and non-banking
services than in a market-based system
D. households with greater access to investment in physical
assets than in a market-based system
Chapter 5.3: Corporate governance
 Chapter 5.3: Corporate governance
Content

• The role of the UK Corporate Governance Code

• Content of the UK Corporate Governance Code

• The role of external audit

• The role of internal audit

 Chapter 5.3: Corporate governance
The role of UK corporate governance

• Maintaining an effective UK Corporate Governance

Code and promoting its widespread application

• Ensuring that related guidance, such as that on internal

control, is current and relevant

• Encouraging shareholder engagement via the

Stewardship Code
 Chapter 5.3: Corporate governance
UK corporate governance code
Compliance with the Code is not a legal
requirement.

FCA Disclosure Rules and Transparency Rules,

implemented by the UKLA, require all
companies listed in the FTSE 350:

• To apply the Code's main Principles, and

• To include in their annual reports:

✓ A statement of compliance with the
supporting principles and provisions of
the Code, or

✓ An explanation of non-compliance
 Chapter 5.3: Corporate governance
UK corporate governance code
The Code are designed to help boards discharge their duties:
• Encouraging all involved in a company to accept their legal
obligations.

• Encouraging the scrutiny of corporate stewardship

• Imposing certain checks and controls on executive directors
but without restricting the commercial enterprise aspect of
business
 Chapter 5.3: Corporate governance
UK corporate governance code 2014

• Companies providing information about the risks which

affect their longer term viability, in particular giving a
clearer and broader view of solvency, liquidity, risk
management and viability
• Boards making sure that executive remuneration is
aligned to the long-term success of the company
 Chapter 5.3: Corporate governance
UK corporate governance code 2014
• While large FTSE 350 listed companies must comply with the main
principles of the Code, departure from compliance with certain
supporting principles and provisions may be justified in particular
circumstances.
• The company must review all provisions of the Code carefully and give
a considered explanation if it departs from any of them. However,
shareholders are encouraged not to consider departures as necessarily
being breaches of the Code

• Smaller listed companies outside the FTSE 350, and externally

managed investment companies which have a different board structure,
can be more flexible about how they apply the Code
 Chapter 5.3: Corporate governance

Disclosure statement: comply or explain

• Reporting on how the company applies the main
principles in the Code, then either

• Confirming that it complies with the Code's supporting

principles and provisions or, where it does not

• Explaining why it does not comply

 Chapter 5.3: Corporate governance
Content of UK corporate governance code

Leadership Effectiveness Accountability Remuneration Relations with

shareholders
 Chapter 5.3: Corporate governance
Content of UK corporate governance code
Leadership: the role of the board (main principle A1)

• Set the company's strategic aims

• Ensure that the necessary financial and human resources are in place
for the company to meet its objectives

• Review management performance

• Set the company's values and standards and ensure that its
obligations to its shareholders and others are understood and met

• All directors - both executives and non-executives - must act in what

they consider to be the best interests of the company, consistent with
their statutory duties
 Chapter 5.3: Corporate governance
Provisions supporting the role of the board
• The board should meet regularly enough to discharge its duties
effectively, with a formal schedule of matters specifically reserved for
its decision

• The annual report should include a statement of how the board

operates, including a high level statement of which types of decision
are taken by the board and which are delegated to management

• The annual report should identify the board's Chairman, the Deputy
Chairman, the Chief Executive, the senior independent (non-
executive) director and the chairmen and members of the board
committees.
 Chapter 5.3: Corporate governance

Leadership: division of responsibilities (main

principle A2)

• Clear division of responsibilities at the head of the

company between the running of the board and the
executive responsibility for the running of the
company's business.

• No one individual should have unfettered powers of

decision
 Chapter 5.3: Corporate governance
Leadership: the Chairman (main principle A3)
• Is responsible for setting the board's agenda and ensuring that
adequate time is available for discussion of all agenda items, in
particular strategic issues

• Should promote a culture of openness and debate by facilitating the

effective contribution of non-executive directors in particular and
ensuring constructive relations between executive and non-
executive directors

• Is responsible for ensuring that the directors receive accurate,

timely and clear information

• Should ensure effective communication with shareholders

 Chapter 5.3: Corporate governance

Leadership: the Chairman (main principle A3)

• The Chairman should, on appointment, meet the
independence criteria.

• A Chief Executive should not go on to be Chairman of the

same company
 Chapter 5.3: Corporate governance
Leadership: non-executive directors (main principle A4)
• Scrutinise the performance of management in meeting agreed goals
and objectives

• Monitor the reporting of performance

• Satisfy themselves on the integrity of financial information and that
financial controls and systems of risk management are robust and
defensible

• Be responsible for determining appropriate levels of remuneration of

executive directors

• Have prime roles in appointing, and where necessary removing,

executive directors, and in succession planning
 Chapter 5.3: Corporate governance
Leadership: non-executive directors (main principle A4)
Non-executive directors to be the senior independent
director:
• To provide a sounding board for the chairman and
• To serve as an intermediary for the other directors when
necessary
• The senior independent director should be available to
shareholders
• The Chairman should hold meetings with the non-
executive directors without the executives present.
• On resignation, a non-executive director should provide
a written statement to the Chairman
 Chapter 5.3: Corporate governance
Effectiveness: the composition of the board (main
principle B1)

• The board should be big enough that the requirements of

the business can be met

• The board should include an appropriate combination of

executive and non-executive directors such that no
individual or small group of individuals

• Committee membership must be refreshed and undue

reliance should not be placed on particular individuals.
 Chapter 5.3: Corporate governance
Provisions supporting the composition of the board
• Have been an employee of the company within the last five years
• Have, or have had within the last three years, a material business relationship
with the company either directly, or as a partner, shareholder, director or senior
employee of a body that has such a relationship with the company
• Have received or receives additional remuneration from the company apart from
the director's fee, participates in the company's share option or a performance-
related pay scheme, or is a member of the company's pension scheme
• Have close family ties with any of the company's advisors, directors or senior
employees
• Hold cross directorships or have significant links with other directors through
involvement in other companies or bodies
• Represent a significant shareholder
• Have served on the board for more than nine years from the date of their first
election
At least 50% of the board, excluding the Chairman, should comprise independent
non-executive directors. A smaller company should have at least two independent
non-executive directors.
 Chapter 5.3: Corporate governance

Effectiveness: appointments to the board (main principle B2)

The search for board candidates and their appointment to the board
should be made:

• On merit and

• Against objective criteria and

• With due regards to the benefits of diversity on the board, including
gender

Essentially this involves a nomination committee making a

recommendation to the board as a whole
 Chapter 5.3: Corporate governance
The nomination committee
• Over 50% of members of the nomination committee should be
independent non-executive directors

• The board Chairman or an independent non-executive director

should chair the nomination

• Non-executive directors should be appointed for specified terms

subject to re-election and to statutory provisions relating to the
removal of a director.

Any term beyond six years for a nonexecutive director should be

subject to particularly rigorous review, and should take into account
the need for progressive refreshing of the board
 Chapter 5.3: Corporate governance
Effectiveness: commitment (main principle B3)
• A Chairman's other significant commitments should be
disclosed to the board

• Non-executive directors should disclose their other

significant commitments to the board

• The board should not agree to a full-time executive

director taking on more than one nonexecutive
directorship in a FTSE 100 company nor the
Chairmanship of such a company
 Chapter 5.3: Corporate governance
Effectiveness: information and support (main principle B4)
• All director should receive induction on joining board and regularly
update & refresh their skills and knowledge

• The board Chairman should ensure directors to continue update

skills

• Director need appropriate knowledge of the company and access to

its operations and staff
 Chapter 5.3: Corporate governance
Effectiveness: information and support (main principle B5)
• The Chairman is responsible for ensuring that the directors receive
accurate, timely and clear information.

• Management has an obligation to provide such information but

directors should seek clarification or amplification where necessary.

• The company secretary's responsibilities include ensuring good

information flows within the board and its committees and between
senior management and nonexecutive directors, as well as
facilitating induction and assisting with professional development
 Chapter 5.3: Corporate governance

Effectiveness: information and support (main principle B5)

• Independent professional advice

• Committees should be provided with sufficient resources to
undertake their duties

• All directors should have access to the advice and services of

the company secretary

• Both the appointment and removal of the company secretary

 Chapter 5.3: Corporate governance
Effectiveness: evaluation (main principle B6)
• The Chairman should act on the results of the performance
evaluation by recognising the strengths and addressing the
weaknesses of the board.

• Evaluation of the board should consider the balance of

skills, experience, independence and knowledge of the
company on the board, its diversity, including gender, how
the board works together as a unit, and other factors
relevant to its effectiveness
 Chapter 5.3: Corporate governance

Effectiveness: re-election (main principle B7)

• All directors of FTSE 350 companies should be subject to
annual election by shareholders.

• Directors should be subject to election by shareholders

at the first AGM after their appointment and re-election
thereafter at intervals of no more than three years.

• Non-executive directors who have served longer than

nine years should be subject to annual re-election.
 Chapter 5.3: Corporate governance
Accountability: financial and business reporting (main
principle C1)

• Interim reports

• Other price-sensitive public reports

• Reports to regulators

• The statutory financial statements

 Chapter 5.3: Corporate governance
Accountability: financial and business reporting (main principle C1)
• The directors should explain in the annual report:
• Their responsibility for preparing the annual report and accounts and
state that they consider the report and accounts, taken as a whole, is
fair, balanced and understandable .
• The basis on which the company generates or preserves value over the
longer term (the business model) and the strategy for delivering the
objectives of the company
• There should be a statement by the auditor about their reporting
responsibilities
• The directors should report in annual and half-yearly financial statements
• Whether the going concern basis of accounting has been adopted in
preparing the financial statements
• Any material uncertainties about the company's ability to continue as a
going concern for at least 12 months from the date of approval of the
financial statements
 Chapter 5.3: Corporate governance
Accountability: risk management and internal control (main principle
C2)
• It acknowledges responsibility for the system of internal control and for
reviewing its effectiveness
• The system is designed to manage rather than eliminate the risk of failure
to meet business objectives
• The system can only provide reasonable, not absolute, assurance
against material misstatement or loss
• An ongoing process is in place for identifying, evaluating and managing
significant risks facing the company
• The process has been in place for the year under review and up to the
date of the annual report and accounts
• The process is regularly reviewed by the board and is in accord with
FRC's guidance on internal control
• There is a process to deal with the internal control aspects of any
significant problems disclosed in the annual report and accounts
 Chapter 5.3: Corporate governance
Accountability: audit committee and auditors (main principle C3)
• The board should establish an audit committee of at least three or, in the case of
smaller companies, two independent non-executive directors.
• At least one member of the audit committee should have recent and relevant
financial experience
• Roles and responsibilities include:
• Monitoring the integrity of the financial statements of the company
• Reviewing the company's internal financial controls
• Monitoring and reviewing the effectiveness of the company's internal audit
function.
• appointment, re-appointment and removal of the external auditor to approve
the remuneration and terms of engagement of the external auditor
• Reviewing and monitoring the external auditor's independence and objectivity
• Developing and implementing policy on the engagement of the external
auditor
• Reporting to the board on how it has discharged its responsibilities
 Chapter 5.3: Corporate governance
Remuneration: level and components of remuneration (main principle D1)
• The company should be able to recover sums paid or withhold the payment of ay
sum in specified circumstances
• Where company releases an executive director to serve ass a non-executive
director elsewhere, the remuneration report should include a statement as to
whether or nor the director will retain such earnings and what the remuneration is
• Remuneration for non-executive directors should:
• Reflect the time commitment and responsibilities of the role
• Not include share options or other performance-related elements, but if such
options are granted, shareholder approval should be sought in advance and
any shares acquired by exercise of the options should be held until at least
one year after the non-executive director leaves the board
• The remuneration committee should carefully consider what compensation
commitments their directors' terms of appointment would entail in the event of
early termination.
• Notice or contract periods should be set at one year or less. If it is necessary to
offer longer notice
 Chapter 5.3: Corporate governance

Remuneration: procedure (main principle D2)

• Consult the Chairman and/or Chief Executive about their
proposals relating to the remuneration of other executive
directors

• Be responsible for appointing any consultants in respect

of executive director remuneration
 Chapter 5.3: Corporate governance
Remuneration: procedure (main principle D2)
• The board should establish a remuneration committee of at least three, or in
the case of smaller companies two, independent non-executive directors
• The board Chairman may be a member of, but not chair, the remuneration
committee if they were considered independent on appointment as
Chairman
• The remuneration committee should have delegated responsibility for setting
remuneration for all executive directors and the Chairman.
• The committee should also recommend and monitor the level and structure
of remuneration for senior management.
• The board itself or, where required by the company's Articles, the
shareholders should determine the remuneration of the non-executive
directors within the limits set in the Articles.
• Shareholders should be invited specifically to approve all new long-term
incentive schemes and significant changes to existing schemes
 Chapter 5.3: Corporate governance
Relations with shareholders: dialogue with shareholders (main
principle E1)

• The board Chairman should ensure that the views of shareholders are
communicated to the board as a whole

• The Chairman should discuss governance and strategy with major

shareholders

• Non-executive directors should be offered the opportunity to attend

scheduled meetings with major shareholders and should expect to
attend meetings if requested by major shareholders

• The senior independent director should attend sufficient meetings with a

range of major shareholders to listen to their views
 Chapter 5.3: Corporate governance
Relations with shareholders: constructive use of the ACM
(main principle E2)

• The chairman should arrange for the chairmen of the audit,

remuneration and nomination committees to be available to
answer questions at the ACM, and for all directors to attend.

• The company should arrange for the Notice of the ACM and
related papers to be sent to shareholders at least 20 working
days before the meeting.
 Chapter 5.3: Corporate governance
The role of external audit
• The directors' remuneration report
• The company's compliance with the UK Corporate
Governance Code
 Chapter 5.3: Corporate governance

Audit opinion
• Directors, who are required by the UK Corporate Governance
Code and the FRC's guidance

• Management who implement and monitor the system of

internal control determined by the directors
 Chapter 5.3: Corporate governance
The role of internal audit
Internal audit: A semi-independent part of the company which monitors the
effective operation of its internal control and risk management systems.
Internal audit is itself a key element of the company's system of internal control.
• Assessing how risks are identified, analysed and managed
• Advising management on embedding risk management processes into
business activities
• Advising management on improving internal controls
• Ensuring that assets are being safeguarded
• Ensuring that operations are conducted effectively, efficiently and
economically in accordance with the company's policies
• Ensuring that laws and regulations are complied with
• Ensuring that records and reports are reliable and accurate
• Helping management to detect or deter fraud
• Helping management to identify savings and opportunities
 Chapter 5.3: Corporate governance
The role of internal audit
The board's audit committee:

• Appointing the head of internal audit

• Ensuring the function has sufficient resources eg staff, access
to management, and a framework of professional standards
 Practice question

1.Portmanteau plc aims to comply with the UK Corporate

Governance Code. There are to be six members of the
company's nomination committee, so the number of
independent non-executive directors on the committee must
be at least:

A. two

B. three

C. Four

D. six
 Practice question

2. Permatan plc has a premium listing on the London Stock

Exchange. The company's chairman is identifying which of
the company's non-executive directors can be classified as
independent. He needs to ascertain this because the board
of directors must identify them as independent or not:
A. at meetings of the nomination, audit and remuneration
committees
B. at the company's annual general meeting
C. in the company's annual report
D. in meetings with the company's external (statutory) auditors
 Practice question
3. Exetrac plc has a premium listing on the London Stock
Exchange. In which of the following do the non-executive
directors have a prime role?

A. Setting the company's strategic aims

B. Ensuring the necessary financial and human resources are in
place for the company to meet its objectives
C. Reviewing management performance in general
D. Determining appropriate levels of remuneration for executive
directors
 Practice question
4. Ryan's performance as the Chair of Interpex plc is due to be
appraised in line with the UK Corporate Governance Code.
This means that his performance will be evaluated by:
A. the non-executive directors, taking into account the views of
executive directors
B. the executive directors, taking into account the views of non-
executive directors
C. the non-executive directors, specifically without any input from
the executive directors
D. the executive directors, specifically without any input from the
non-executive directors
 Practice question
5. The board of Catterick plc, a premium listed company, is
considering the status of Katy, one of the company's
directors. Katy may be determined as not being independent
if which three of the following apply to her?
A. Katy has been an employee of the company within the last
seven years
B. Katy has had a material business relationship with the
company within the last three years
C. Katy receives from the company additional remuneration
above the fee for being a director
D. Katy represents a significant shareholder
E. Katy has served on the board for more than seven years from
the date of her first election
 Practice question

6.Firmin plc is a premium listed company. According to the

UK Corporate Governance Code, what is the longest
Firmin's Chair should remain in post from the date they were
first appointed to the board?

A. 3 years

B. 6 years

C. 9 years

D. 12 years
 Practice question

7. Marchant plc is a premium listed company. Which of the

following statements about its compliance with the UK
Corporate Governance Code is true?

A. It must comply with all the requirements of the Code

B. It may, in particular circumstances, depart from the principles
and provisions of the Code

C. It can be flexible in how it applies the Code

D. It is not affected by the requirements of the Code

 CHAPTER 6: EXTERNAL
ENVIRONMENT
1. The economic environment of business
and finance
2. External regulation of business
 Economic environment
Content

▪ Introduction to the economic environment

▪ The macroeconomic environment

▪ The market mechanism

▪ Demand

▪ Supply

▪ The equilibrium price

▪ Elasticity

▪ Types of market structure

▪ The failure of perfect competition

 Economic environment
Introduction to the economic environment
Two economic environments that affect businesses:
• The macroeconomic environment in which all business
have to operate, which incorporates:

✓ National influences

✓ Global influences

• The microeconomic environment

 Economic environment
The macroeconomic environment
The national economy
To create GDP four factors of production are employed, each of which
enjoys a return

Factor of production Return

Land Rent
Labour Wages
Capital Interest
Entrepreneurship Profit
 Economic environment
The role of the government in the national economy
• It acts as the producer of certain goods and services
instead of privately-owned firms

• It acts as the purchaser of final goods and services and

adds to total consumption expenditure

• It invests by purchasing capital goods, for example

building roads, schools and hospitals

• It makes transfer payments from one section of economy

to another
 Economic environment

The role of the consumer in the national economy

• Changes in disposable income, and the marginal propensity to
consume

• Changes in the distribution of wealth

• Government policy

• The development of major new products

• Interest rates

• Price expectations
 Economic environment

The role of the saver in the national economy

• Income

• Interest rates and the cost of credit

• Long-term savings
 Economic environment
The role of investment by businesses in the national economy
An investment involves the acquisition of more fixed capital volume of
investment in the economy depends on:

• The interest rate on capital

• Expectations about the future and business confidence, including
expectations about future cash flows and profit flows arising from the
investment

• The strength of consumer demand for goods

• The opportunity cost of investment

• The level of new technology to be invested in

 Economic environment
The business/trade cycle
Four main phases of the business cycle can be distinguished.

▪ Recession (A)
▪ Depression (B)
▪ Recovery (C)
▪ Boom (D)
 Economic environment
The business/trade cycle
• Governments generally seek to stabilize the economic
system

• Trying to avoid the distortions of a widely fluctuating

cycle.

• In a recession they will try to boost overall demand

• In a boom they will try to keep dampen overall demand
through raising taxation or interest rates, and by reducing
public expenditure
 Economic environment
Inflation
• Inflation: An increase in price levels generally, and a
decline in the purchasing power of money.

• Deflation: Falling prices generally, which is normally

associated with low rates of growth and recession
• Inflation a problem: Redistribution of income and
wealth
 Economic environment
Types of inflation
• Demand pull inflation: Price rises resulting from a persistent
excess of demand over supply in the economy as a whole. Supply
cannot grow any further once 'full employment' of factors of
production is reached.
• Cost push inflation: Price rises resulting from an increase in the
costs of production of goods and services, eg of imported raw
materials or from wage increases
 Economic environment

Inflation

There are two main causes of demand pull inflation.

• Fiscal – increase government spending or a reduction in
taxes will raise demand

• Credit – Extend level of credit, decrease in interest rate,

expenditure rise.
 Economic environment
Government objectives and policies

▪ Influencing overall demand in the economy via:

o Monetary policy: government policies on the
money supply, the monetary system, interest rates,
exchange rates and the availability of credit.

o Fiscal policy: government policies on taxation,

public borrowing and public spending

▪ Influencing overall supply in the economy via supply-

side policies
 Economic environment
Monetary policy and aggregate demand
• Interest rates - the price of money - are a target of
monetary policy

• The objective of monetary policy has been principally to

reduce the rate of inflation to a sustainable low level
 Economic environment
Monetary policy and aggregate demand
Effects of a rise in interest rates

• The price of borrowing in the economy will rise

• The exchange rate for sterling will be higher than it would
otherwise be

• There will be capital inflows as foreign investors will be

attracted to sterling investments

• The reductions in spending and investment will reduce

aggregate demand in the economy
 Economic environment
Monetary policy and aggregate demand
Fiscal policy: The government's policy on government spending,
taxation and borrowing

• Increased borrowing and spending → expansionary fiscal stance

• Increased taxation but no increase in spending (or decreased
borrowing and decreased spending) → contractionary fiscal
stance

• Increased taxation and spending → broadly neutral fiscal stance

(income diverted from one part of the economy to another)
 Economic environment
Supply-side macroeconomic policies
• More involvement of the private sector in the provision of services

• Reduction in taxes in order to increase incentives to supply

• Increasing flexibility in the labour market by curbing the power of trade
unions

• Improving education and training so the quality of labour and hence the
economy's productive

• Capacity are enhanced

• Increasing competition through deregulation and privatisation of utilities

• Abolition of exchange controls and allowing the free movement of
capital
 Economic environment
The market mechanism
• Market: A situation in which potential buyers and
potential sellers of an item come together for the purpose
of exchange
• Price theory is concerned with how market prices for
goods are arrived at, through the interaction of demand
and supply.
 Economic environment
Demand
• Demand: The quantity of a good that potential
purchasers would buy, or attempt to buy, if the price of
the good were at a certain level.
• The relationship between demand for a good and the
price of the good can be shown graphically as a
demand curve.
• The demand curve is derived by estimating in a demand
schedule how much of a good would be demanded at
various hypothetical market prices
 Economic environment
Demand
Within the control of the business:
• Price
Seven Ps
• Marketing research
✓ Product
• Product research and development
✓ Price
• Advertising
✓ Promotion
• Sales promotion
✓ Place
• Training and organisation of sales force
✓ People
• Effectiveness of distribution
✓ Processes
• After-sales service
✓ Physical evidence
• Granting of credit to customers
Outside the control of the business
• Price of substitute goods
• Price of complementary goods
• Consumers' income
• Fashion and expectations
 Economic environment
Demand

Shifts of the demand curve

 Economic environment
Supply
The quantity of a good that existing suppliers or would-be
suppliers would want to produce for the market at a given price

The supply schedule and the supply curve

A supply schedule and supply curve are constructed in a
similar manner to a demand curve but show the quantity
suppliers are willing to produce at different price levels.

It is an upward sloping curve from left to right, because greater

quantities will be supplied at higher prices.
 Economic environment

Factors influence supply:

• The price obtainable for the good

• The price of related goods in 'joint supply'.

• The costs of making the good

• Changes in technology

• Other factors
 Economic environment
The supply schedule and the supply curve
 Economic environment

The effect of time on supply and demand:

• In the case of supply, changes in the quantity of a good
supplied often require the laying off or hiring of new workers,
or the installation of new machinery.

• In the case of demand, it takes time for consumers to adjust

their buying patterns, although demand often responds more
rapidly than supply to changes in price or other demand
conditions
 Economic environment
The equilibrium price
Price signals and incentives
• Market demand conditions influence the price that a supplier will get
for its output.

• Prices act as signals to suppliers, and changes in prices should

stimulate a response from a supplier to change its production
quantities.

• Supply is also influenced by production costs and profits.

• The objective of maximising profits provides the incentive for
suppliers to respond to changes in price or cost by changing their
production quantities.
 Economic environment
Equilibrium price: The price of a good at which the volume demanded
by consumers and the volume businesses are willing to supply are the
same
 Economic environment
The equilibrium price
The forces of supply and demand push a market to its
equilibrium price and quantity.
• If there is no change in the determinant of supply or
demand, the equilibrium price will rule the market and
will remain stable
• If the equilibrium price does not rule, the market is in
disequilibrium, but supply and demand will push prices
towards the equilibrium price
• Shifts in the supply curve or demand curve because of
determinants other than price will change the
equilibrium price and quantity
 Economic environment
Adjustments to equilibrium
(i) Increase in consumer incomes (ii) Product becomes unfastionable

Price
Price

Prediction

• Rise in market price • Fall in market price

• Rise in quantity supplied • Fall in quantity supplied
 Economic environment
The equilibrium price
(iii) Improvement in production technology (iv) Rise in factor costs

Price
Price

Prediction

• Fall in market price • Rise in market price

• Rise in quantity supplied • Fall in quantity supplied
 Economic environment

Price regulation
• To set a maximum price for a good, perhaps as part of
an anti-inflationary economic policy so that suppliers
cannot charge a higher price even if they wanted to, or

• To set a minimum price for a good below which a

supplier is not allowed to fall
 Economic environment

Price regulation
• If this price is higher than the equilibrium price, its
existence will have no effect at all on the operation of
market forces

• But if the maximum price is lower than what the

equilibrium price would be, there will be an excess of
demand over supply.
 Economic environment
Elasticity
Elasticity: The extent of a change in demand and/or supply
given a change in price.

Price elasticity of demand

𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝐶𝐶𝑞𝑞𝑞𝑞𝐶𝐶𝐶𝐶𝑞𝑞𝑖𝑞𝑞𝑞𝑞𝑑𝑑𝐶𝐶𝑑𝑑𝐶𝐶𝐶𝐶𝑑𝑑𝐶𝐶𝑑𝑑,𝐶𝐶𝑎𝑎𝐶𝐶𝑝𝑝𝐶𝐶𝑝𝑝𝑝𝑝𝐶𝐶𝐶𝐶𝑞𝑞𝐶𝐶𝐶𝐶𝐶𝐶𝑜𝑜𝑜𝑜𝑜𝑜𝑝𝑝𝑖𝐶𝐶𝑖𝐶𝐶𝐶𝐶𝑜𝑜𝑑𝑑𝐶𝐶𝑑𝑑𝐶𝐶𝐶𝐶𝑑𝑑
PED =
𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝐶𝐶𝑝𝑝𝑝𝑝𝑖𝑝𝑝𝐶𝐶,𝐶𝐶𝑎𝑎𝐶𝐶𝑝𝑝𝐶𝐶𝑝𝑝𝑝𝑝𝐶𝐶𝐶𝐶𝑞𝑞𝐶𝐶𝐶𝐶𝑜𝑜𝑜𝑜𝑜𝑜𝑝𝑝𝑖𝐶𝐶𝑖𝐶𝐶𝐶𝐶𝑜𝑜𝑝𝑝𝑝𝑝𝑖𝑝𝑝𝐶𝐶
 Economic environment

Price elasticity of demand

𝑃𝑃𝑝𝑝𝑜𝑜𝑝𝑝𝑜𝑜𝑝𝑝𝑞𝑞𝑖𝑜𝑜𝐶𝐶𝐶𝐶𝑜𝑜𝑝𝑝𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝐶𝐶𝑞𝑞𝑞𝑞𝐶𝐶𝐶𝐶𝑞𝑞𝑖𝑞𝑞𝑞𝑞
PED = = 𝑄𝑄𝑄−𝑄𝑄𝑄 ÷
𝑃𝑃𝑄− 𝑃𝑃𝑄
𝑃𝑃𝑝𝑝𝑜𝑜𝑝𝑝𝑜𝑜𝑝𝑝𝑞𝑞𝑖𝑜𝑜𝐶𝐶𝐶𝐶𝑜𝑜𝑝𝑝𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝐶𝐶𝑝𝑝𝑝𝑝𝑖𝑝𝑝𝐶𝐶 𝑄𝑄𝑄 𝑃𝑃𝑄

(Where P1, Q1 are the initial price and quantity; P2, Q2 are the
subsequent price and quantity.)

PED less than 1 = inelastic demand

PED more than 1 = elastic demand
PED = 1 = unit elasticity
 Economic environment
Price elasticity of demand

Worked example: Price elasticity of demand

The price of a good is £1.20 per unit and annual demand
is 800,000 units. Market research indicates that an
increase in price of 10 pence per unit will result in a fall in
annual demand of 70,000 units.

Requirement

Calculate the elasticity of demand when the price is £1.20

Economic environment
 Economic environment
Elastic and inelastic demand
Demand is referred to as:

• Inelastic if the absolute value is less than 1, and

• Elastic if the absolute value is greater than 1

• Where demand is inelastic, the quantity demanded
changes by a smaller percentage than the percentage
change in price

• Where demand is elastic, demand changes by a larger

percentage than the percentage change in price
 Economic environment

Significance of price elasticity of demand

• When demand is elastic, an increase in price will result
in a fall in the quantity demanded such that total
expenditure will fall

• Demand inelasticity above zero means an increase in

price will still result in a fall in quantity demanded, but
total expenditure will rise

• With unit elasticity, expenditure will stay constant given a

change in price
 Economic environment
Factors influencing price elasticity of demand for a good
• Availability of substitutes

• The time horizon

• Competitors' pricing

• Luxuries and necessities

• Percentage of income spent on a good

• Habit-forming goods
 Economic environment
Income elasticity of demand
%𝐼𝐼𝑐𝑒𝑒𝐼𝐼𝑐𝑐𝐼𝐼 𝑒𝑒𝐼𝐼𝑞𝑞𝑞𝑞𝑒𝑒𝐼𝐼𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑑𝑑𝐼𝐼𝐼𝐼𝑒𝑒𝐼𝐼𝑑𝑑𝐼𝐼𝑑𝑑
𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝐼𝐼𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝐼𝐼𝑒𝑒𝑒𝑒𝑒𝑒𝐼𝐼𝑜𝑜𝑑𝑑𝐼𝐼𝐼𝐼𝑒𝑒𝐼𝐼𝑑𝑑 =
% 𝐼𝐼𝑐𝑒𝑒𝐼𝐼𝑐𝑐𝐼𝐼 𝑒𝑒𝐼𝐼 𝑐𝐼𝐼𝑞𝑞𝑒𝑒𝐼𝐼𝑐𝐼𝐼𝑒𝑒𝑑𝑑𝑒𝑒𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝑒𝑒

• Demand for a good is income elastic if income elasticity is greater

than 1
• Demand for a good is income inelastic if income elasticity is
between 0 and 1
• Demand for a good is negatively income elastic where, in response
to an increase in income, demand actually falls. These are inferior
goods. An example could be coach travel, where passengers might
switch to faster, but more expensive, trains as their income rises
 Economic environment
Cross elasticity of demand

Cross elasticity of demand: A measure of the

responsiveness of demand for one good to changes in the
price of another good

%𝐼𝐼𝑐𝑒𝑒𝐼𝐼𝑐𝑐𝐼𝐼𝑒𝑒𝐼𝐼𝑞𝑞𝑞𝑞𝑒𝑒𝐼𝐼𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝐼𝐼𝑜𝑜𝑐𝑐𝐼𝐼𝐼𝐼𝑑𝑑𝐴𝐴𝑑𝑑𝐼𝐼𝐼𝐼𝑒𝑒𝐼𝐼𝑑𝑑𝐼𝐼𝑑𝑑
𝐶𝐶𝐶𝐶𝐼𝐼𝑒𝑒𝑒𝑒𝐼𝐼𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝐼𝐼𝑒𝑒𝑒𝑒𝑒𝑒𝐼𝐼𝑜𝑜𝑑𝑑𝐼𝐼𝐼𝐼𝑒𝑒𝐼𝐼𝑑𝑑=
% 𝐼𝐼𝑐𝑒𝑒𝐼𝐼𝑐𝑐𝐼𝐼𝑒𝑒𝐼𝐼𝑒𝑒𝑐𝐼𝐼𝑝𝑝𝐶𝐶𝑒𝑒𝐼𝐼𝐼𝐼𝐼𝐼𝑜𝑜𝑐𝑐𝐼𝐼𝐼𝐼𝑑𝑑𝐵𝐵
 Economic environment
Price elasticity of supply
Price elasticity of supply: A measure of the responsiveness
of supply to a change in price

%𝐼𝐼𝑐𝑒𝑒𝐼𝐼𝑐𝑐𝐼𝐼𝑒𝑒𝐼𝐼𝑞𝑞𝑞𝑞𝑒𝑒𝐼𝐼𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑞𝑞𝑝𝑝𝑝𝑝𝑒𝑒𝑒𝑒𝐼𝐼𝑑𝑑
𝑃𝑃𝐶𝐶𝑒𝑒𝐼𝐼𝐼𝐼𝐼𝐼𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝐼𝐼𝑒𝑒𝑒𝑒𝑒𝑒𝐼𝐼𝑜𝑜𝑒𝑒𝑞𝑞𝑝𝑝𝑝𝑝𝑒𝑒𝑒𝑒(𝑃𝑃𝑃𝑃𝑃𝑃)=
% 𝐼𝐼𝑐𝑒𝑒𝐼𝐼𝑐𝑐𝐼𝐼𝑒𝑒𝐼𝐼𝑒𝑒𝑐𝐼𝐼𝑝𝑝𝐶𝐶𝑒𝑒𝐼𝐼𝐼𝐼
 Economic environment
Price elasticity of supply
• Where the supply of goods is fixed whatever price is offered, for
example in the case of antiques, vintage wines and land, supply is
perfectly inelastic and the elastic of supply is zero.

• The supply curve is a vertical straight line

• Where the supply of goods varies proportionately with the price,
there is unit elasticity of supply and the supply curve is an upward
slope passing through the origin

• Where the producers will supply any amount at a given price but
none at all at a slightly lower price, elasticity of supply is infinite, or
perfectly elastic. The supply curve is a horizontal straight line
 Economic environment
Elasticity of supply and time
• The market period is so short that supplies of the product
in question are limited to existing inventory. In effect,
supply is fixed
• The short run is a period long enough for supplies of the
product to be altered by increases or decreases in current
output, but not long enough for the long-term plant and
machinery used in production to be altered.
• The long run is a period sufficiently long to allow
suppliers' long-term equipment to be altered.
 Economic environment
Types of market structure
Market structure: A description of the number of buyers and
sellers in a market for a particular good, and their relative
bargaining power
Perfect competition
• Many small (in value) buyers and sellers which, individually,
cannot influence the market price
• No barriers to entry or exit, so businesses are free to enter or
leave the market as they wish
• Perfect information such that production methods and cost
structures are identical
• Homogeneous (identical) products
• No collusion between buyers or sellers
 Economic environment
Perfect competition
Perfect competition is often seen as an ideal state but
very rarely if ever occurs in practice, mainly due to the fact
that:

• There are often barriers to entry

• There is asymmetric information

• Goods are differentiated

• There may be collusion

 Economic environment
Monopoly

• One supplier

• Many buyers

• Barriers to entering the industry

• The fact that businesses can EITHER set the selling
price OR determine the quantity supplied, but the
market will determine the other factors

• Monopolists can earn greater than normal profits

('supernormal profits')
 Economic environment
Reason for monopoly
• A pure monopoly

• An actual monopoly

• A government franchise monopoly

• A natural monopoly
 Economic environment
Monopolistic competition
• Many buyers and sellers (as in perfect competition)
• Some differentiation between products (not
homogeneous as in perfect competition)

• Branding of products to achieve this differentiation

• Some (but not total) customer loyalty

• Few barriers to entry

• Significant advertising in many cases

 Economic environment
Oligopoly
• A few large sellers but many (often small) buyers

• Product differentiation

• A high degree of mutual interdependency

 Economic environment
Oligopoly
• Businesses compete through non-price competition,
particularly advertising and branding

• Price cuts are generally copied by competitors but

• Price increases are not always copied

 Economic environment
Oligopoly
• Two dominant suppliers who between them control
prices

• A temptation for the two suppliers to act in collusion

Consequences include higher prices as competition is
very limited.
 Economic environment
The failure of perfect competition
Is perfect competition the best structure?

• Free markets are efficient

• Free markets are impersonal

• The market forces of supply and demand result in an efficient

allocation of economic resources

There are two types of potential efficiency:

Allocative efficiency is achieved when goods and services that are
wanted by buyers are produced in optimum quantities.

Productive efficiency is achieved when the economy produces its

goods and services at the lowest factor cost.
 Economic environment
The arguments in favour of a free market
• A large number of competing suppliers, each producing a
homogeneous product and each having only a small share of the
market

• Buyers and suppliers having perfect information about markets and

prices

• There is perfect mobility of factors of production, which can be

switched easily from making one type of good into making another

• There is free entry and exit of suppliers into and out of the market
 Economic environment
Market failure
• Market imperfection with one, or a few, suppliers exerting
market power

• Externalities
• The existence of public goods and benefits that are
gained by third parties

• Economies of scale
 Economic environment
Market Imperfection
• If a monopoly supplier controls a market, it might prevent other
suppliers from entering the market
• Monopsony buyers are large individual buyers who dominate
demand in a market. Monopsonists may exert control over the
market, extracting low prices or other favourable conditions from
suppliers
• Consumers may make bad purchasing decisions because they have
incomplete and inaccurate, or asymmetric information about all
goods and services that are available
• It takes time for the price mechanism to work. Firms cannot suddenly
enter a new market or shut down operations. The slow response of
the price mechanism to changes in demand creates some short-
run inefficiency in resource allocation
 Economic environment
Externalities
• Private cost measures the cost to the supplier of the resources it
uses to produce a good

• Private benefit measures the benefit obtained directly by a supplier or

by a buyer

• Social cost measures the cost to society as a whole of the

resources that a supplier uses

• Social benefit measures the total benefit obtained, both directly by a

supplier or a buyer, and indirectly (at no extra cost), by other suppliers
or buyers
 Economic environment
Public goods
Some goods, by their very nature, involve so much
'spillover' of externalities that they are difficult to provide
except as public goods whose production is organised
by the government.
 Economic environment
Economies of scale
The economies of scale attainable from large scale
production may be categorised as:

• Internal economies: economies arising within the

business from the organisation of production, or
• External economies: economies attainable by the
business because of the growth of the industry as a
whole
 Economic environment
Internal economies of scale
• Specialisation of labour.

• Division of labour
• Large undertakings can make use of larger and more specialised
machinery

• Dimensional economies of scale

• Buying economies may be available, reducing the cost of material
purchases through bulk purchase discounts

• Indivisibility of operations

• Holding inventory becomes more efficient

 Economic environment
External economies of scale
• A large skilled labour force is created and educational
services can be geared towards training new entrants

• Specialised ancillary industries develop to provide

components, transport finished goods, trade in by-
products, provide special services and so on - for
instance, law firms may be set up to specialise in the
affairs of the industry
 Practice question

1.The Compura product and the Adesto product are

complements. The cross elasticity of demand between the
two products will, therefore, be:

A. zero

B. positive

C. Negative

D. indeterminate
 Practice question

2. The price of Venturas has fallen by 3% in the last

quarter. In the same period demand for Pectas, where
there has been no price change, has risen by 5.5%.
What is the cross elasticity of demand between
Venturas and Pectas?

A. –1.83

B. –0.55

C. 1.83

D. 0.55
 Practice question

3. The UK government has imposed a maximum price on

Phosphene, a chemical used to produce pharmaceutical
products. Market commentators have noted that this
government action has had no effect whatsoever on the
operation of market forces. This indicates that the price
imposed by the government was:
A. higher than the equilibrium price for Phosphene would be
B. the minimum possible price for Phosphene
C. lower than the equilibrium price for Phosphene would be
D. the equilibrium price of a substitute of Phosphene
 Practice question

4.An economist working for Darwin plc has constructed a

supply curve for one of the company's products, the Xenia.
The curve is a horizontal straight line. This indicates that
the price elasticity of supply for the Xenia is:

A. perfectly inelastic

B. of unitary elasticity

C. perfectly elastic

D. zero
 Practice question

5.The Quantia is an inferior good. The income elasticity

of demand for the Quantia will, therefore, be:

A. less than 0

B. zero

C. greater than 1

D. between 0 and 1
 Practice question
6. The Arduo product has experienced a significant
improvement in its production technology in the past
quarter. It can therefore be expected that there will be:
A. an expansion in supply and a shift to the right of the
demand curve
B. a contraction in supply and a shift to the left of the demand
curve
C. an expansion in demand and a shift to the right of the
supply curve
D. a contraction in demand and a shift to the left of the supply
curve
 Practice question

7.The Braddin is a basic and homogeneous product.

Competitors in its market do not compete through price,
but instead spend a lot on raising consumer awareness
of branding and product availability. Only a small
number of large companies compete in the market. It
would appear that the market for the Braddin product is
characterised by:
A. monopolistic competition
B. oligopoly
C. perfect competition
D. monopoly
Chapter 6.2: External regulation of
business
 Chapter 6.2: External regulation of business
Content
▪ Why is regulation of businesses necessary?

▪ What form does the regulation of businesses take?

▪ Direct regulation of competition in a market

▪ Direct regulation of externalities

▪ Direct regulation of people in business

▪ The effect of international legislation

▪ International trade
 Chapter 6.2: External regulation of business
Why is regulation of businesses necessary?

Any form of state interference

with the operation of the free
market.

This involve regulating demand, supply, price, profit,

quantity, quality, entry, exit, information, technology, or any
other aspect of production and consumption in the market.
 Chapter 6.2: External regulation of business
Addressing market failure
• Market imperfection - where monopoly power is leading to
inefficiency, government will intervene through controls on, say,
prices or profits in order to try to reduce the effects of the monopoly

• Externalities - a possible means of dealing with the problem of

external costs and benefits is via some form of regulation.

• Asymmetric information - regulation is often the best form of

government action whenever informational inadequacies are
undermining the efficient operation of markets

• Equity - the government may resort to regulation to improve social

justice
 Chapter 6.2: External regulation of business
Protecting the public interest

External regulations on businesses of many different

forms are designed to ensure that the needs of the other
stakeholders can be met.

Functions of the regulation of business

Society has increasingly demanded that business

activities should be externally regulated, to restore the
balance of power
 Chapter 6.2: External regulation of business
What form does the regulation of businesses take?
What is regulation?

It is a form of secondary or delegated legislation which is used:

• To implement a primary piece of legislation appropriately

• To take account of particular circumstances or factors emerging
during the gradual implementation of, or during the period, a primary
piece of legislation
 Chapter 6.2: External regulation of business
What form does the regulation of businesses take?
Outcomes of regulation

• Address market failures

• Increase or reduce the social standing of various social groups

• See through the collective desires of a significant section of society

• Enhance opportunities for the formation of diverse preferences and
beliefs in society

• Affect the development of particular preferences across society as a

whole

• Deal with the problem of irreversibility (current activities will result in

outcomes from which future generations may not recover at all)
 Chapter 6.2: External regulation of business
Businesses responses to regulation

• Entrenchment of a particular practice

• Mere compliance, so that the desired regulatory outcome is
met simply by passing on the cost of compliance to clients and
consumers

• Full compliance, so that behaviour is changed and products

and processes are adjusted to comply with regulations

• Innovation: the Porter hypothesis, strict environmental

regulations can induce efficiency and encourage innovations
that help improve commercial competitiveness.
 Chapter 6.2: External regulation of business

Regulatory compliance
• Systems or departments in business which ensure that
people are aware of and take steps to comply with
relevant laws and regulations
 Chapter 6.2: External regulation of business

The role of regulatory bodies

• The Information Commissioner, who is responsible for
enforcing rules brought in by the Data Protection Act 1998 and
the Freedom of Information Act 2000.

• The Competition and Markets Authority (CMA), which replaced

the Office of Fair Trading (OFT) and the Competition
Commission in 2014 following the Enterprise and Regulatory
Reform Act 2013.
 Chapter 6.2: External regulation of business
Direct regulation of competition in a market
Why is regulation of competition important

• Generally monopolies are not in the public interest as they

do not allocate resources efficiently

• Via legislation, government seeks to diminish them so that

market share is not concentrated in the hands of one or
two producers.
 Chapter 6.2: External regulation of business
How is competition regulated in the UK?
• Anti-competitive agreements (Chapter I of the Act, and Article 101 of
TFEU)

• Abuse of a dominant position (Chapter II and Article 102 ofTFEU)

 Chapter 6.2: External regulation of business
Prohibiting anti-competitive agreements
• Fixing purchase or selling prices or other trading conditions
• Agreeing to limit or control production, markets, technical
development or investment

• Sharing markets or supply sources

• Applying different trading conditions to equivalent transactions,
thereby placing some parties at a competitive disadvantage

• Making conclusion of contracts subject to acceptance of

supplementary obligation
 Chapter 6.2: External regulation of business
Prohibiting the abuse of a dominant position
One where the business is able to behave
independently of competitive pressures, such as other
competitors, in that market.

Factors that help to determine whether there is

dominance by a business :

• Its market share

• The number and size of competitors

• The potential for new competitors to enter the
market
 Chapter 6.2: External regulation of business
Prohibiting cartels
An agreement between businesses not to compete with
each other. The agreement is usually verbal and often
informal.

• There are few competitors

• The products have similar characteristics, leaving little
scope for competition on quality, service, or cost.

• Communication channels between competitors are

already established

• The industry is suffering from excess capacity

• There is general economic recession

 Chapter 6.2: External regulation of business
The competition and Market Authority (CMA)
CMA officials can enter premises and demand
relevant documents to establish whether any of the
prohibitions has been infringed.

• The CMA can impose a fine for failure to comply with an interim
measure in respect of a merger of up to 5% of annual revenue

• There will be adverse publicity.

• Competition Disqualification Orders may be made against the
directors
 Chapter 6.2: External regulation of business
Direct regulation of externalities
To intervene in the level of supply in a market where there are
problems of external costs and benefits, the government can
use:
• Price regulations
• Direct or indirect taxation or tariffs
• Subsidies to suppliers, for instance to encourage exports
• Regulation, by means of:
✓ Quotas, that is physical limits on output so that output is
set at the social optimum
✓ Standards that must be complied with
✓ Fines for those businesses that do not meet the
necessary standards
 Chapter 6.2: External regulation of business
Direct regulation of people in business
Insider dealing of a listed company's shares

• People 'in the know' commit a crime under the Criminal Justice Act
1993 if they use knowledge they have as business 'insiders' to
make a profit or avoid a loss when buying or selling shares on the
back of that knowledge and at the expense of open dealings in the
market.
• Significant inside knowledge - of a takeover, an oil strike or a
massive fall in profits - will affect the share price when it becomes
known, so insiders who benefit from dealing in advance of the
knowledge becoming generally known are guilty of market
manipulation.
• The crime of insider dealing extends to getting someone else to
deal, and to disclosing the relevant information at all.
 Chapter 6.2: External regulation of business
Market abuse
The Code of Market Conduct covers:

• Insider dealing including

• Improper disclosure creating an unfair market place

• Misuse of information as an insider

• Manipulating transactions and thus creating a false or misleading
impression about supply, demand, prices and values in the market

• Manipulating devices

• Dissemination Distortion and misleading behaviour

 Chapter 6.2: External regulation of business
Fraudulent trading
• Directors of companies must be very careful of
the danger of continuing to trade when the
company is insolvent - that is, when the
company cannot pay its debts as they fall due.

• If a company that is being liquidated as insolvent is found to have been

carried on with the intent to defraud creditors, or indeed for any
fraudulent purpose, directors and managers who were knowingly party
to this are said to have engaged in fraudulent trading, and can be
personally liable for the company's debts under the Insolvency Act
1986
 Chapter 6.2: External regulation of business

Wrongful trading of an insolvent company

✓ May arise where the director knew, or should have known, that there
was no reasonable prospect of the company avoiding insolvent
liquidation, or where the director took insufficient steps to minimise
the potential loss to creditors.

✓ Professional accountants are more at risk of falling foul of these rules

than anyone else, as their skills, knowledge and experience mean
they are judged by higher standards than those applied to non-
professionals.
 Chapter 6.2: External regulation of business
Disqualification of directors
• Insider dealing
• Fraudulent or wrongful trading
• Violating competition laws
• Being convicted of an offence in connection with the promotion,
formation, management or liquidation of a company or with the
receivership or management of a company's property
• Being the director of an insolvent company
• Being unfit to act as director or manager, such as failing to read the
company's accounts
• Being consistently in default regarding company law requirements,
such as failing to keep proper accounting records
• Being a threat to the public interest
• Making loans from company funds that were unlikely to be repaid
 Chapter 6.2: External regulation of business
Money laundering ✓ There are very extensive regulations on
money laundering that have been made
following the Proceeds of Crime Act 2002,
particularly the Money Laundering
Regulations 2007.

✓ The CCAB issued the Anti Money

Laundering Guidance for the Accountancy
Sector in August 2008, which is approved
by the Treasury as 'relevant guidance'
within the meaning of the Money
Laundering Regulations 2007.
✓ Courts must consider relevant guidance when determining whether an
accountant's conduct gives rise to certain offences under either the Act
or the Regulations.
 Chapter 6.2: External regulation of business
The effect of international legislation

• The US has huge influence over the

globalisation of regulation; the EU has similar
influence.

• International organisations such as the World Trade Organisation

(WTO), International Monetary Fund (IMF) and International
Chamber of Commerce (ICC) also have extensive power to

influence the development of regulations

• US corporations are very effective at enrolling the power of their own
government and international bodies to promote their interests
 Chapter 6.2: External regulation of business

International trade
Advantages of international free trade
• Import substitution: a country aims to produce manufactured
goods which it previously imported. It does this by protecting local
producers

• Export-led growth: relying on cheap labour, businesses ensure

economic growth by exporting.

The success of this particular strategy depends on the

existence of open markets elsewhere

 Chapter 6.2: External regulation of business

Encouraging international free trade has the following

advantages

• Countries specialise
• Some countries have a surplus of raw materials to their needs, and
others have a deficit

• Competition

• Larger markets are created for a business's output

• The development of trading links provides a foundation for closer
political links
 Chapter 6.2: External regulation of business

Barriers to free international trade

• Tariffs or customs duties o Import quotas

• Embargoes (bans on certain imports or exports)

• Hidden subsidies for exporters and domestic producers

• Import restrictions

• Government action to devalue the nation's currency

 Practice question

1.The government legally enforces standards of hygiene in

the food industry. This is an example of business regulation
motivated by the wish to address market failure caused by:

A. asymmetric information

B. economies of scale

C. public goods

D. externalities
 Practice question

2.The government recently conducted a review of the

electricity industry. As a result it introduced a policy of
price regulation. This particular form of business regulation
is a means of addressing market failure by:

A. state ownership

B. creating demand for output

C. influencing supply and demand

D. influencing markets through persuasion

 Practice question

3.The government passed legislation on how companies

safeguard their facilities for the production of chlorine.
Merrivale plc is a major chlorine producer. It responded to
the legislation by appointing a new safety manager
responsible for chlorine production. The manager has
authority to update production procedures, based on
existing technology and environmental standards, in light
of the new legislation. Merrivale plc's response to the new
regulations has been one of:
A. innovation
B. non-response
C. mere compliance
D. full compliance
 Practice question

4. Merit plc and Tumble plc control almost 80% of the market
for a product. They have entered into an informal agreement on
how much of the product they will supply to the market. This
type of collusive behaviour is more likely to occur if the two
companies operate in an industry characterised by which of
the following?
A. Insufficient capacity within the industry to meet existing demand
B. A strong background domestic economy
C. Little communication between the players in the market
D. Little differentiation in either product offering or support services
 Practice question

5.Allerton plc took over its only major UK competitor last

year. The company is now being charged with imposing
unfair selling prices on its products and limiting production
to the detriment of UK consumers. The company will clearly
be charged with breaching:
A. Chapter 1 of the Competition Act 1998
B. Chapter 2 of the Competition Act 1998
C. Chapter 3 of the Competition Act 1998
D. Chapter 4 of the Competition Act 1998
 Practice question

6.Corby plc has been charged with entering into

agreements with its competitors to fix their selling prices
and control their overall production levels. The company
will clearly be charged with breaching:

A. Chapter 1 of the Competition Act 1998

B. Chapter 2 of the Competition Act 1998

C. Chapter 3 of the Competition Act 1998

D. Chapter 4 of the Competition Act 1998

 Practice question

7. The merger of Andover plc with Radice plc is being

investigated by the Competition and Markets Authority.
There have been four areas of concern identified:
competition issues, industry regulation issues, public
interest issues and market issues. Which are the only
issues that the Competition and Markets Authority will look
into?
A. Competition, public interest and regulation issues
B. Competition, regulation and market issues
C. Public interest, regulation and market issues
D. Public interest, competition and market issues