Conducting feasibility study and

developing business plan…

 Conducting Feasibility study
Assessing the Feasibility of a New Venture
 As the name implies, a feasibility study is an analysis of the
viability of an idea. It focuses on helping answer the essential
question of “should we proceed with the proposed project idea?”
All activities of the study are directed toward helping answer this
question.
 Entrepreneurs with a business idea should conduct a feasibility
study to determine the viability of their idea before proceeding with
the development of the business. Determining early-on that a
business idea will not work, saves time, money and heartache later.
 Con’t

 A feasible business venture is one where the business will

 generate adequate cash-inflow and profits,
 withstand the risks it will encounter,
 remain viable in the long-term and meet the goals of the founders.
 The venture can be a new start-up business, the purchase of an
existing business, franchise, an expansion of current business
operations or a new enterprise for an existing business.
 Elements in Evaluating New Ventures
 Market Opportunity
 Industry Trends & Regulatory Matters
 Proprietary approach …is the intellectual property stand alone or
platform IP
 Technology impact - what is the nature and outgrowth of the
technology?
 Financials - is the model articulated for how products will be sold,
who will buy them, how much revenue is projected and by
when?...
 Team - does the team have the requisite skills to move all aspects
of the company forward?
 SWOT is a series of steps one has to consider in evaluating a
business opportunity and arriving at a decision on starting a
business or not.
 Guidelines of business feasibility study

I. Description of the Business

II. Market Feasibility: Enterprise description, Enterprise

competitiveness, Market potential, sales projection, Access to
market outlets …

III. Technical Feasibility: Determine facility needs, Suitability of

production technology, Availability and suitability of site, Raw
materials …
 Con’t

IV. Financial Feasibility: Estimate the total capital requirements,

Estimate equity and credit needs and determine sources, Budget
expected costs and returns of various alternatives…

V. Organizational/Managerial Feasibility: legal structure of the

business, Business founders,
VI. Study Conclusions: it contain the information you will use for
deciding whether to proceed or not with creating the business
 DEVELOPING A BUSINESS PLAN

WHAT IS A BUSINESS PLAN

• A business plan is a comprehensive set of guidelines for a new
venture.
• A business plan is also called a feasibility plan that encompasses
the full range of business planning activities, but it seldom requires
the depth of research or detail expected for an establishment
enterprise.
• A business plan would present your basic business idea and all
related operating, marketing, financial and managerial
considerations.
 Con’t

• What ever the name, it should lay out your idea, describe where
you are, point out where you want to go, and how you propose to
go there.
• The business plan may present a proposal for launching an entirely
new business. More commonly, perhaps; it may present a plan for
a major explanation of a firm that has already started operation
 THE PURPOSE OF BUSINESS PLAN

1. It can help the owner/manager crystallize and focus his/her

idea.

2. Although planning is a mental process, it must go beyond the

realm of thought. Thinking about a proposed business becomes
more rigorous as rough ideas must be crystallized and
quantified on paper.

3. It can help the owner/manager set objectives and give him a

yardstick against which to monitor performance.

4. It can also use as a vehicle to attract any external finance

needed by the business. Eg. To get fund…
 Con’t

5.It can convince investors that the owner/manager has identified

high growth opportunities.
6. It entails taking a long-term view of the business and its
environment.
7. It emphasizes the strengths and recognizes the weaknesses of the
proposed venture.
8. The plan can uncover weakness or alert the entrepreneur to
sources of possible danger
 WHEN THE BUSINESS PLANS ARE PRODUCED?
Discuss
• At the start up of a new business: After the concept stage of initial
ideas and feasibility study, a new business startup may go through a
more detailed planning stage of which the main output is the business
plan.
• Business purchase: A detailed plan, which tests the sensitivity of
changes to key business variables, greatly increases the prospective
purchasers understanding of the level of risk they will be accepting,
and likelihood of rewards being available.
• On going: Ongoing review of progress, against the objectives of
either a startup or small business purchase, is important in a dynamic
environment.
• Major decisions: at a time of major change, For example, the need
for major new investment in equipment or funds to open a new outlet.
It may be linked to failure, such as a recovery plan for an ailing (or in
 WHO PRODUCED THE BUSINESS PLAN?

o Managers:, Owners:, Lenders:

WHY THE BUSINESS PLANS ARE PRODUCED?

• Assessing the feasibility and viability of the business/project: it is
in every ones interests to make mistakes on paper, hypothetically
testing for feasibility, before trying the real thing.
• Setting objectives and budgets: having a clear financial vision
with believable budgets is a basic requirement of everyone
involved in a plan.
• Calculating how much money is needed: a detailed cash flow with
assumptions is vital ingredient to precisely quantify earlier the
likely funds required.
 THE FORMAT OF A BUSINESS PLAN

1. Where are we now?

• An analysis of the current situations of the market place, the competitions, the
business concept and the people involved. It will include any historical
background relevant to the positions to date.

2. Where do we intend going?

• Qualitative expression of the objectives, quantifiable targets will clarify and

measure progress towards the intended goals.

3. How do we get there?

• Implementing of accepted aims is what all the parties to a plan are interested in
as a final result.
I. Analysis of the current situation (where are we now?)
COMPONENTS OF BUSINESS PLAN (OUT LINE OF A BUSINESS PLAN)

1. Identification of the business

a. Introduction
- relevant history and background
- Proposed date for commencement of trading /beginning of a plan
b. Names
-name of the business and trading name
- name of the managers/owners
c. Legal identity
-company/partnership/sole-trade/cooperative
- details of share or capital structure
d. Location
-address-registered and operational
- brief details of premises.
e. Professional advisers, -Accountants, solicitors, bank
 OUT LINE OF A BUSINESS PLAN…

2. The key people

a. Existing management- Outline of background experience
, skills and knowledge.
-Names of the management team
b. Future requirement -gaps in skills and experience and how they will
be filled ,- future recruitment intentions
3.The nature of the business
a. Product(s)or service(s)-Description and applications
-Key suppliers
-Planned developments of product or service
b. Market and customers
–Definition of target market, classification of customers
- Trend in market place
c. Competition- description of competitors; strength and weakness of the
 II. FUTURE DIRECTION (where do we intend going?)

i. Strategic Influence -SWOT Analysis

1. Opportunities and threats in the business environment
• Socio-economic trends,
Technological trends
• Legislation and politics,
Competition
2. Strengths and weaknesses
• In its industry, In the general
environment:
ii. Strategic direction:
1. Objectives- general and specific
2. Policies- guidelines and rules
3.Activities- action plans and timetable of key activities
 III. IMPLEMENTATION OF AIM (how do we get there?)

1. Management of resources
a) Operation:-premises, materials, equipment, insurance,
management information system.
b) People/Human resource/- employment practices, recruitment,
team management, training etc
2. Marketing plan
a)Competitive edge- unique selling point of business (Critical
products or service characteristics or uniqueness in relation to
competitors)
b) Marketing objectives - specific aims for product or service in
the market place
c) Marketing methods- product, pricing, promotion,
distributions=4ps
 Part one: Marketing in Business enterprises

1. The Marketing Perspective

2. Marketing Mix-product, price, place, and promotion,
3 .Marketing segmentation and market research,
4 .Factors affecting the Business Environment
 THE MARKETING PERSPECTIVE

Definition of Market:
• Market is a group of potential customers having needs to satisfy,
ability to buy & willingness to pay in order to satisfy these needs.

OR
• A social & managerial process by which individuals & groups
obtain what they need & want through creating & exchanging
products & value with others.
 Con’t

The main concepts of marketing

• Marketing activities are integrated
• Organizations are market oriented
• Marketing focuses on selected markets
• Customer satisfaction is the core of marketing
 THE MARKETING MIX

 A marketing organization has to concentrate on four important

aspects known as the 4P’s of marketing.
 The marketing manager has to combine these 4 P’s (PRODUCT,
PRICE, PROMOTION and PLACE.) in such a way that the
combination provides satisfaction to the customer and profit to
the manufacturer.
 When these elements (4 P’s) are combined together they are called
as “The Marketing Mix”.
1.The product mix: Includes:
– Product planning and development 3. Place mix (Physical
– Branding Packaging Labeling distribution mix):
• Channels of distribution
2.The price mix: Includes • Transportation
• Price polices • Warehousing
– Skimming pricing (Pricing above the
market) 4. Promotion mix: Includes
– Penetration pricing (Pricing below • Advertising
the market) • Personal selling
– Premium pricing (Pricing with the • Sales promotion
market) • Publicity
• Discounts
– Quantity discount Seasonal
discount
– Trade discount Cash discount
• Credits
 I. THE PRODUCT MIX
• Product: Is any commodity that satisfies the needs & wants of
customer.
• It is a bundle of tangible & intangible attributes, which satisfy the
needs, & wants of customers.
• In today market, a product can be
» A person (soccer players), Organization
(privatized firms),
» Places (leased land), Objects (items),
» Idea (business plans or project proposal),
» Services (medication or barber), or mixes of these
elements.
• So, a product can be defined as anything, which comprises of
benefits in forms of physical, service, and symbolic attributes to
maximize buyers’ want satisfaction.
 Con’t

1.Product planning and development

Product planning includes three major types of decisions:
– Development and introduction of new products
– Modifications of existing products in keeping with the
changing tastes and preferences of the target customers and
– Elimination of unprofitable or obsolete products
 Con’t
2. Branding

• Brand name: the part of a brand, which consists of word, letters and/or numbers,
which can be vocalized. … identification to the product Eg. OMO, Coke

• Brand mark: the part of a brand that can be recognized but is not
utterable/complete. It can appear in the form of symbol, design, distinctive
coloring or lettering.

• Trademark: a brand or part of a brand that has been given legal protection so
that the owner has exclusive rights to its use. After companies identify their
trademark, they entail a term “™” or “®”

• Trade Name: Trade name is the name of the business organization. A trade name
may also be used as a brand name. In such a case it performs a dual function. It
gives identification to the product as well as the manufacturer
 Con’t
 A modern example of a brand is Coca Cola which belongs to the
Coca-Cola Company. The Coca-Cola logo is an example of a
widely-recognized trademark and global brand.
• Examples of global brands include Facebook, Apple, Pepsi,
McDonald's, Mastercard, Gap, Sony, Nike, Adidas and Kangoo
Jumps.
• BRAND refers to names, logos and slogans.
for example COKE, NIKE, CALVIN KLEIN
it is what makes a product or service different from its competitors
 TRADEMARK is something you can do to brands. If you trademark
a brand, then you own the "intellectual property" of that brand and
you are the only person allowed to use that Brand name, slogan etc.
If others want to use that brand, they must ask your permission or
pay some money.
• The logo for this website, Wikipedia®, which is a registered
trademark of Wikimedia Foundation, Inc.
 Con’t
Importance of a brand
• The brand makes it easier for the seller to process orders and track down

problems.

• The seller’s brand name and trademark provide legal protection of unique

product features.

• Branding gives the seller the opportunity to attract a loyal profitable set of

customers and helps to increase the control and share of the market.

• Branding helps the seller to segment markets and expand the product mix.

• Good brand help to build the corporate image because it advertises the quality

and size of the company.

• Brands make it easy for customers to identify products or services.

 Con’t

Requirements of a good brand

• Be easy to pronounce, recognize and remember

• Be distinctive.

• Suggest something about the product’s benefits or characteristics

• Suggest about the product qualities such as action or use.

• Be large enough to be applicable to new products that may be

added to the product line.

• Have a possibility of registration and legal protection.

 Con’t

3.Packaging
 Packaging is a marketing process concerned with the design and
production of the container or wrapper for a product.
 The container or wrapper or covering is called the package.

Importance of packaging
1. Packaging serves several safety and utilitarian purposes
2. Packaging may implement a company’s marketing program.
3. Well-packaged products may increase profit possibilities in that it
stimulates customers to pay more just to get the special package.
 Con’t

4.Labeling
1. Brand label: simply the brand alone applied to the product or to
the package.
2. Grade label: a label, which identifies the quality with, a letter,
number or word.
3. Descriptive label: it gives objective information about the use,
construction, care, performance or other features of the product.
Sometimes it is called informative label.
Eg. medicines
 II. THE PRICE MIX

WHAT IS PRICE?
• Is the amount of money consumers have to pay to obtain the
product.
• Price has operated as the major determinant of user choice
traditionally.
• Although non-price factors have become more important in
recent decades price still remains one of the most important
element determining market share and profitability.
• Different companies set the price haphazardly/arbitrarily as
based on cost.
 METHODS OF PRICING

1.Cost plus pricing/ Mark Up pricing/…cost+ profit=price

2. Skimming pricing
The following conditions should be satisfied
1. A sufficient number of buyers have a high current demand.
2. The high initial prices do not attract more competition to the
market.
3. The high price communicates the image of a superior
product.
3.Penetration pricing: below market price
4. Premium pricing: with market
4. Which one do you think is better for new start-up business?
 Con’t

The major objectives of pricing are:

– Achievement of target return
– Maximization of profit
– Increase of sales volume
– Maintenance or increase of market share
– Stabilization of prices &
– Meeting competition
 III. PLACE MIX

• Place: Includes company activities that make the product available

to target consumers.
• Physical distribution includes:
• Channels of distribution
• Transportation
• Warehousing/ storing goods/

DEFINITION OF MARKETING CHANNELS

The marketing (or distribution) channels refer to the activities, parties
and channel structure required to transfer a product from its point
of production to its point of consumption by the end customer
 Con’t
Direct channel
1.Door-to-door selling
2.Manufacturers’ sales branches
3.Direct mail
Indirect channel

1. Merchant Middlemen:-
• Whole seller:- Eg. Petram PLC and East Africa Trading are
wholesalers of consumer products.
• Retailer:- Eg. Hadiya supermarket, and several Kiosks are found
closer to sell the items to residential houses.
2. Agent Middlemen
• Commission agent, Brokers, Selling agents,
• Eg. -Sony Glorious, is an agent to Sony Electronics products,
-Equatorial business is agent to Samsung.
Channel levels

Zero-level One-level Two-level Three-

Manufact Manufact Manufact level
Manufact
urer urer urer urer
Agent

Wholesa
Wholesa
ler
ler
Retaile Retaile Retaile
r r r
Consum Consum Consume Consum
er er r er
 IV. PROMOTION MIX

– Is sometimes known as marketing communication.

– Means activities that communicate the merits of the product &
persuade target customers to buy it.
– Promotional objectives:
• Informing the product
• Increasing sales
• Stabilizing sales / profit
• Positioning the product
 Con’t
The promotional mix consists of four major tools
–Advertising: such as informative Ad, Persuasive Ad and
Reminder Ad

–Personal selling – Oral presentation in conversation with

one / more consumers for the purpose of making sale

–Sales promotion – Includes: gifts, games, sampling, coupons,

and window displays.

–Publicity – Any information about the organization, its

personnel or its products that appears in any medium on a
non - paid basis.
 Con’t
MARKET SEGMENTATION
• Market segment is a group of individuals or organizations within a
market that share one or more common characteristics.
• The process of dividing a market in to segments is called market
segmentation. Qn. Why segmentation?
Bases for market segmentation
1.Geographic segmentation:- Region Urban, Suburban, Rural,
Market density, Climate, Terrain (land, topography), City size,
Country size, State size
2.Demographic segmentation:- Age, Gender, Race, Ethnicity, Income,
Education, Occupation, Family size, Family life cycle, Religion,
Social class
3.Psycho graphic segmentation:- Personality, Attributes, Motives,
Lifestyles
4.Behavioral segmentation:- Volume usage, End use, Benefit,
Expectations, Brand loyalty, Price sensitivity
 Con’t

MARKET RESEARCH

1.Marketing research is the systematic recording and analysis of

data about problems relating to marketing.
American Marketing Association
2.Marketing research is the application of scientific method to the
solution of marketing problems.
Luck, Wales, Taylor
It is important for any business to conduct it before
established ,ongoing business and futurity….
 FACTORS AFFECTING THE BUSINESS
ENVIRONMENT
1.The macro environment (far environment)
i. Economic forces
A. Rising income
B. Inflation
C. Recession:-A recession is a period of economic activity when
income, production, and employment tend to fall-all of which reduce
demand. Thus businesses are expected to design different strategies
that enable them overcome the problems of inflation and recession.
ii. Legal and political factors
A. Federal and state laws
B. The development of regional markets
C. The creation and expansion of the global market
 Con’t
iii. Social forces
A. Demographic forces
i. Population growth
ii Age distribution

B. Cultural forces
C. The consumer movement:-Is a connection of individuals,
organizations and groups whose objective is to protect the
rights of consumers
iv. Technological forces
 Con’t
2.The microenvironment (The near environment)
• The microenvironment refers the competitive situation of an
industry.
• The competitive environment refers to the number of competitors a
firm must face, the relative size of the competitors, and the degree
of interdependence within the industry.
Competition in an industry arises from
i. The power of buyers
ii. The power of suppliers
iii. The threat of new entrants
iv. The threat of substitutes
v. The intensity of rivalry/competition
• Porter claims that five forces determine competitiveness. These are
shown in figure below:
 Con’t

• Economies of scale (i.e. the average size of business varies from

industry to industry .For example, the average size of chemical
firms is very large, where as the average size of retail firms is
relatively small. The most fundamental reason for these
differences in the extent of economies of scale in an industry. i.e
how the total cost per unit produced changes as more units are
produced.)
 Part Two: Financing and accounting in business

1. Financial requirement
2 . Sources of finance,
3 . control of financial resource
4. financial analysis and accounting
 DEVELOPING FINANCIAL PLAN

• Project implementation requires bringing together the inputs of

land, labor, machinery, staff etc.
• Finance is required to assemble these inputs.
• Proper financing of business is essential for success in both small
and large enterprises.
 Con’t
• Financial planning is the process of formulating policies and
strategies relating to the procurement, investment and administration
of funds for an enterprise.
• While formulating a financial plan, the entrepreneur has to answer
the following questions:
– How much money is needed?

– Where the money comes from?

– When should the money be available?

• These three questions are concerned respectively with the estimation

of financial needs, sources of finance, and the time of raising funds.
SOURCE OF FINANCE
 Con’t

A. Internal sources (Equity capital)

• Owners capital or owners equity represent the personal investment
of the owner or owners in a business, and it is sometimes called
risk capital because these investors assume the primary risk of
losing their funds if the business fails.
• It requires no repayment in the form of debt and much safer for
new ventures than debt financing.

• It also requires sharing the ownership and profits with the funding
sources.
 Source of equity capital:

1. Personal savings
• The first place entrepreneurs should take for start up money is in
their own pockets or on their pool of personal savings.
• It is the least expensive source of funds available.
• As a general rules, entrepreneurs should expect to provide at
least half of the start up funds in the form of equity capital.
• If the entrepreneur is not willing to risk his own money, potential
investors are not likely to risk their money in the business either.
 Con’t

2. Friends and relatives:

• After emptying their own pockets, entrepreneurs should turn to
friends and relatives who might be willing to invest in the business
venture.
• Because of their relationships with the founder, these people are
most likely to invest. But having them invest can lead to controversy
if their participation is not clear to everyone.
• To avoid such problems, and entrepreneur must honestly present the
investment opportunity and the nature of risks involved to avoid
alienating friends and family members if the business fails.
 Con’t
3. Angels (private investors )
• After dipping into their own pockets and convincing friends and
relatives to invest in their business ventures, many entrepreneurs still
find themselves short of the seed capital they need. Frequently, the next
step on the road to business financing is private investors
• These private investors (or angels) are wealthy individuals, often
entrepreneurs themselves, who invest in business start ups in exchange
for equity stakes in the companies.
• Due to the inherent risks in start up companies, may venture capitalists
have shifted their investment portfolios away from startups toward
more established firms.
• Angles will often finance the deals that no venture capitalists will
consider most angles have substantial business and financial experience
and prefer to invest in companies at the start up or infant growth stage
 Con’t

4. Partners:
• Before entering into any partnership arrangement, however, the
owner must consider the impact of giving up some personal control
over operations and of sharing profits with one or more partners.
• Whenever an entrepreneur gives up equity in his/her business
(through what ever mechanisms), he/she runs the risk of losing
control over it.
• As the founder’s ownership is a company becomes increasingly
diluted, the probability of losing control of its future directional and
the entire decision making process increases.
 Con’t
5. Venture capital companies
• venture capital companies are private, for profit organizations
that purchases equity positions in young businesses they believe
have high growth and high profit potential.
• They provide start up (seed money) capital to new
ventures,
• Development funds to businesses in their early
growth stage, and
• Expansion funds to rapidly growing ventures that
have the potential to go public or that need capital
for acquisitions.
• Two factors make a deal attractive to venture capitalists: high
returns and a convenient (and profitable) exit strategy.
 Con’t

6. Public stock sale (going public)

• In some cases, entrepreneurs can go public by selling shares of
stock in their corporation to outside investors.
• This is an effective method of raising large amounts of capital, but
it can be an expensive and time-
consuming process filled with regulatory nightmares
 B. External source (Debt capital)

• Borrowed capital or debt capital is the external financing that a

small business owner has borrowed and must repay with interest.
• Small enterprises have few choices than large firm for obtaining
debt financing.
• Although borrowed capital allows entrepreneurs to maintain
complete ownership of their business, it must be carried as a
liability on the balance sheet as well as be repaid with interest at
some point in the future or with in the time stipulated in the
contract
 Con’t
1. Commercial banks
In most cases commercial banks give
• Short-term loan (repayable with in one year or less) and
• Medium term loan (maturing in above one year but less than five
years) as a working capital.
• Long term loans (maturing in more than five years) for the
purchase of property or equipment or as a project loan, with the
purchased asset or the project itself serving as collaterals.
 unsecured and secured loans from bank
• Banks provide unsecured and secured loans.
• An unsecured loan is a loan in which collateral is not
requested.
• That is the loan is granted against personal guarantee or
corporate customers of the bank.
• Unsecured loans will have high interest charges but this may
not be necessarily applicable by all banks
• Secured loans are those with security pledged to the bank as
assurance that the loan will be paid. There are many types of
security a bank will consider, such as a guarantor another
credit worthy person or company that agrees to pay the loan
in the event the form of tangible assets pledged as collateral.
 Con’t

• To secure a bank loan, an entrepreneur typically will have to

answer a number of question, together with descriptive
commentaries
• What do you plan to do with the money (credit facility)?
• How much do you need?
• When do they need it?.
• How long will you need it?
• How will you repay the loan?
 Con’t

Bank lending decision

• Due to previous bad loan decisions banks are more cautious in
lending money since they cannot afford to incur more bad loans.
• For this reason the small business owner needs to be aware of
the criteria bankers use in evaluating the credit worthiness of
loan applications.
• Most bankers refer to the five Cs of credit in making lending
decision. The five Cs are:
*capital
*capacity/cash flow
*collateral
*character
*condition
 Con’t
 Capital: a small business must have a stable capital base before a bank
will grant a loan.
 Capacity(cash flow):The bank must be convinced of the firm’s ability to
meet its regular financial obligations and to repay the bank loan.
 Collateral : collateral includes any assets the owner pledges/guarantee to
the bank as security for repayment of the loan.
 Character (owner’s character): honesty, competence, polish determine,
willingness to negotiate with the bank and give a position response for
bank enquiry
 Conditions: Banks consider factors relating to the business operation
such as potential growth in the market, competition, location, of
ownership, and loan purpose.
• The higher a small business scores on these five Cs, the greater its
chance will be of receiving a loan. The wise entrepreneur keeps this
in mind when preparing a business plan and presentation.
 2.Trade credit

• It is credit given by suppliers who sell goods on account.

• This credit is reflected on the entrepreneur’s balance sheet as
account payable and in most cases it must be paid in 30 to 90 or
more days interest free because of its ready availability
• Getting suppliers to extend credit in the form of delayed payments
usually is much easier for a small business than obtaining bank
financing.
3.Equipment suppliers
• Most equipment vendors encourage business owners to purchase
their equipment by offering to finance the purchase
• In some cases, the vendors will repurchase equipment for salvage
value at the end of its useful life and offer the business owner
another credit agreement on new equipment
 Con’t

5. Accounts receivable financing

• Short term financing that involves either the pledge of receivables
as collateral for a loan or the sale of receivables (factoring).
• Account receivable bank loans are made on a discounted value of
the receivables pledged.
6. Credit Unions: non profit organizations but borrow for members
7. Insurance Companies:
8. Bonds
 ACCOUNTING FOR SMALL BUSINESS
• Proper financial and accounting records make it possible for the
owner to exercise effective control of funds and overall
performance of his/her business.
• Such records also make it possible to know whether the firm is
earning profits or loss.
• Accounts also help to know the financial position of the business
at any time and at the end of the fiscal year
 BUSINESS TRANSACTION AND ACCOUNTING EQUATION

• A business transaction is the occurrence of an event or of a

condition that must be recorded.
– The payment of a monthly telephone bill,
– The purchase of merchandise on credit and
– The acquisition of land and a building are examples of
business transactions

• A particular business transaction may lead to an event or a

condition that result in another transaction.
– For example, the purchase of merchandise on credit will
be followed by payment to the creditor, which is another
transaction
 The accounting equation

• Assets are the properties owned by a business enterprise

or any thing of value owned by a business enterprise.
• The rights or claims to the properties are referred to as
equities.
• The sum of assets is equal to that of the sum of equities.
• Equities may be subdivided into two principal types:
» the rights of creditors and
» the rights of owners.
• Rights of creditors represent debts of the business and
are called creditor’s equities or liabilities.
• The rights of owner or owners are called owner’s
equity or owner’s capital
 Con’t

• Expansion of the equation to give recognition to the two basic

types of equities yields the following, which is known as the
accounting equation:
» Assets = equities
» Assets = creditor’s equities + owner’s equity
» Assets = liabilities +capital
• It is customary to place “liabilities“ before “owner’s equity” in the
accounting equation because creditors have preferential rights to
the assets.
 Assets

• Assets: any physical thing (tangible) or right (intangible) that has a

monetary value is an asset. Assets are customarily divided into
two:
• Current assets: are cash and other assets that may reasonably be
expected to be realized incase or sold or used up usually within
one year or less, through the normal operations of the business.

• Example: cash, accounts receivable, notes receivable, suppli

es, prepaid expenses, stock (inventory), etc
• Plant assets: are tangible assets used in the businesses that are of a
permanent or relatively fixed nature. It is also known as fixed
assets.
• Example: equipment, machinery, building, vehicles and land
 Liabilities:
• Liabilities: are debts owned to outsiders (creditors) . Liabilities are
frequently described on the balance sheet by titles that include the
word “Payable”.
1.Current liabilities: are liabilities that will be due within a short time
(usually one year or less) and that are to be paid out of current
assets.
– Example: notes payable, accounts payable, salaries
payable, interest payable, taxes payable.
2.Long-term liabilities: are liabilities that will be due for a
comparatively long time (usually more than one year) it is also
known as fixed liabilities.
As they come within the one-year range and are to be paid, such
liabilities become current.
Example: Mortgage payable
 Owner equity
• Owner equity: is the residual claim against the assets of the
business after the total liabilities are deducted. For a corporation,
owner’s equity is frequently called stockholders equity,
shareholder’s equity or stockholder’s investment.

 Capital: is the owner’s equity in a sole proprietorship (and

partnership)

 Capital stock: represents the investment of the stockholders.

 Retained earnings: represents the net income retained in the

business.

 Drawings: represents the amount of withdrawals made by the

owner of a sole proprietorship (and partnership)
 Con’t
 Dividends: represents the distribution of earnings to stockholders.

 Revenue: is the amount charged to customers for goods or

services sold to them It is an increase in capital that resulted from
the normal operation of the business. Example: Professional fees,
commissions revenue, fares earned, interest income, etc
 Expense: costs that have been consumed in the process of
producing revenue are expired costs or expenses. It resulted in a
decrease in capital. Example: Wages expense, rent expense,
supplies expense, utilities expense, etc
 Preparation of financial statements
• Financial statements: After the effect of the individual
transactions has been determined, the essential information is
communicated to users. The account statements that communicate
this information are called financial statements.
• The principal financial statements are the income statements
the statement of owner’s equity, the balance sheet and the
statement of cash flow.
• The financial statements prepared for sole proprietorship,
partnership and corporation are almost the same.
• The major difference is in the capital section of the balance sheet.
• The capital section of these enterprises indicates the name of the
owner, the name of the partners and the capital stock (common
stock) and/or the preferred stock in their respective order.
• Income statement: a summary of the revenue and the expenses
of a business entity for a specific period of time, such as a month
or a year.
ABC trading
Income statement
For month ended December 31, 2004
Sales 10,000
Operating expenses:
Wages expense 3,000
Rent expense 2,000
Suppliers expense 2,000
Utilities expense 750
Miscellaneous expense 250
Total operating expense (8,000)
Net income 2,000
• Statement of owner’s equity is a summary of the changes in the
owner’s equity of a business entity that have occurred during a
specific period of time such as a month or a year.
ABC trading

Statement of owner’s equity

For month ended December 31, 2004

Investment during the month 15,000

Net income for the month 2,000

Less withdrawals 500

Increase in owner equity 1,500

Mr. X, Capital, December 31,2004 16,500

• Balance sheet: is a list of the assets, liabilities and owner’s equity
of a business entity as of a specific date, usually at the close of the
last day of a month or year.
• Statement of cash flows
 It is a summary of the cash receipts and cash payments of a
business entity for a specific period of time, such as a month or a
year.

 It is customary to report cash flows (cash receipts and cash

payments) in three sections:
1. Operating activities
2. Investing activities, and
3. Financing activities
 Break even analysis

• One of the most common tools used in evaluating the economic

feasibility of a new enterprise or product is the break-even analysis.
• The break-even point is the point at which revenue is exactly equal
to costs. At this point, no profit is made and no losses are incurred.
• The break-even point can be expressed in terms of unit sales or
dollar sales. That is, the break-even units indicate the level of sales
that are required to cover costs.
• Sales above that number result in profit and sales below that
number result in a loss. The break-even sales indicates the dollars
of gross sales required to break-even.
 Con’t

• Break-even analysis is based on two types of costs: fixed costs and

variable costs.
• Fixed costs are overhead-type expenses that are constant and do not
change as the level of output changes.
• Variable cost are not constant and do change with the level of output.
Because of this, variable expenses are often stated on a per unit basis.
• Once the break-even point is met, assuming no change in selling price,
fixed and variable cost, a profit in the amount of the difference in the
selling price and the variable costs will be recognized.
 Con’t
• One important aspect of break-even analysis is that it is normally not this
simple. In many instances, the selling price, fixed costs or variable costs
will not remain constant resulting in a change in the break-even.
• And these changes will change the break-even. So, a break-even cannot
be calculated only once. It should be calculated on a regular basis to
reflect changes in costs and prices and in order to maintain profitability or
make adjustments in the product line.
• There are three basic pieces of information needed to evaluate a break-
even point:
– Average Per Unit Sales Price

– Average Per Unit Variable Cost

– Average Annual Fixed Costs

 Profit = revenue-cost
Profit=(revenue)-(fixed cost (Cf) + variable cost)

Revenue =(selling price (P))* quantity sold (Q))

Variable cost = (quantity sold * variable cost per unit (Cv))
In break even point the profit is assumed to be zero
0= (P*Q)-(Cf + (Q*Cv))
(P*Q)-(Q*Cv)=Cf
Q(P-Cv)=Cf
Q=Cf/P-Cv
The basic equation for determining the break-even units is=
Average Annual Fixed Cost
(Average Per Unit Sales Price - Average Per Unit Variable Cost)
 Con’t
Example: A local livestock producer utilizes compost waste to develop
an organic fertilizer product. The fertilizer is prepared for retail sale in
50 pound bags. The retail sales price is $5.00 per bag. The average
variable cost per bag is $2.80 and average annual fixed costs are
$60,000. These three pieces of information are:
• Average Per Unit Sales Price = $5.00 per bag
• Average Per Unit Variable Cost = $2.80 per bag
• Average Annual Fixed Costs = $60,000.00
• The above assumption can be utilized to calculate the number of bags
that must be sold in order to break-even as well as the total dollar of
sales needed to break-even. Using the formulas explained earlier, the
following calculations can be made:
• Break-Even Units: $60,000.00 ÷ ($5.00 - $2.80) = 27,273 bags
• Break-Even Sales: $60,000.00 ÷ 1 - ($2.80 ÷ $5.00) =
$136,365
• Therefore, no profits are made from the sale of this product until more
than 27,273 bags are sold or more than $136,365 in gross sales is
generated.
Part Three:- Introduction to Risk and Insurance of
Business enterprises

Outline
3.1 Definition of Risk,
3.2 The process of Risk management,
3.3 Classifying risks
3.4 Insurance of the Small Business
 The concept of business risk

• Risk exists whenever the future is unknown. Because the

adverse effects of risk have plagued mankind since the
beginning of time, individuals, groups and societies have
developed various methods for managing risk. Since no
one knows the future exactly, everyone is a risk manager
for himself. I.e., not by choice, but by sheer necessity.
• Before we define risk for our purpose it would be advisable to
consider the various definitions given by different scholars and
practitioners to comprehend the basic concept of risk
 Con’t
• The term risk used in different ways. The following definitions
given by different scholars and practitioners in the field:

– Risk is the channel of loss

– Risk is the possibility of loss
– Risk is uncertainty
– Risk is the dispersion of actual from expected result
– Risk is the probability of any outcome different from the
one expected

• Generally, risk is an uncertain event or condition that, if it

occurs, has a positive or a negative effect on a business
objective. A risk has a cause and, if it occurs, a consequence.
But usually it has bad/negative connotation
 CLASSIFYING RISK

Generally, Business risks can be classified into two broad categories:

1.Market risk is the uncertainty associated with an investment decision.
An entrepreneur who invests in a new business hopes for a gain but
realizes that the eventual outcome may be a loss.
2.Pure risk is used to describe a situation where only loss or no loss can
occur-there is no potential gain.
• A pure risk exists when there is a chance of loss but no chance of
gain/profit. Example: Owner of an automobile faces the risk of a
collusion loss. If collusion occurs, he will suffer a financial loss. If
there is no collusion, the owner will not gain
 CLASSIFYING RISK BY TYPE OF ASSET

Risk may be grouped according to the type of asset-Physical or

human-needing protection.
1.Property risks
• Property-oriented risks involve tangible and highly visible assets.
Many property-oriented risks are insurable; they include:
• Fire , Natural disasters, Burglary, Business swindles (or
fraudulent transactions) and, Shoplifting.
2.Personnel risks
• Personnel-oriented losses occur through the actions of employees.
The three primary types of Personnel-oriented risks are:
• Employee dishonesty, Competition from former employees,
Loss of key executives
 Con’t
3.Customer risks
• Customers are the source of profit for small business, but they are also
the source of an ever-increasing amount of business risk. Much of these
risks are: On-premises injuries and Product liability
• On-premises injuries:
• Customers may initiate legal claims as a result of on-premises
injuries.
e.g. When a customer breaks an arm by slipping on icy steps while
entering or leaving a store;
• Inadequate security, which may result in robbery, assault, or other
violent crimes; Customers who are victims often look to the
business to recover their losses.
• Product liability:
• A product liability suit may be filed when a customer becomes ill
or sustains physical or property damage from using a product
made or sold by a firm.
 RISK MANAGEMENT
• The complexity of the business environment calls for or demand for a
special attention to a risk:
What is risk management? Many definitions…
 Risk management is a systematic way of protecting business
resources and income against losses so that the organization’s aims
are reached without interruption, creating stability and contributing to
profit.
OR
 Risk management is the identification, measurement and treatment of
liability, property and personal pure risks that the business
organization is facing in order to reduce and prevent the unfavorable
effects of risk at minimum cost.
OR
 It is the science that deals with the techniques of forecasting future
losses so as to plan, organize, direct and control the adverse effect of
risk. i.e., Risk management is defined on the base of managerial
functions.
 Con’t
Risk management and Insurance management
• What is the difference in b/n?

• Risk management is broader than insurance management in that it

deals with both insurable and uninsurable risks. Insurance
management for most part it is restricted to the area of those risks
that are considered to be insurable.
• Naturally only pure risks are insurable . Speculative or market risks
are not. Even all pure risks are not insurable
• The emphasis in the risk management concept is on reducing the
cost of safeguarding against risk by whatever means.
 Con’t

In general, the basic functions of the risk management in carrying

out of the responsibilities assigned are:
1. To recognize exposure to loss
Is also called as risk identification
Is the 1st step of risk managers’ function.
Is the most vital task

• What types of possible losses are there?

• Failure to identify exposure to loss ==> the
risk manager will not have any chance of
handling the loss that identify the risk.
 Con’t

2.To estimate the frequency and size of loss, i.e., to estimate the
probability of loss from various sources. It is also called as risk
measurement.
Risk measurement means
i. Determination of the chance of an occurrence or relative
frequency.
ii.Determination of the impact of losses upon financial affairs.
iii.The ability to predict the losses that will actually occur during
the budget year.
 Con’t

3.To decide the best and most economical method of handling the
risk if loss. (risk response development)
i.e. Selection of the proper tool for handling risk
4. Implementing the decision (risk response control)
5.Revaluating the decision
Once the risk manager has identified and measured the risks facing
the firm, the next task is to seek for appropriate tools and decide
how best to handle them. Risk can be handled through the
following tools:
 Tools of Risk Management
1. Avoidance

One way to handle a particular pure risk is to avoid the property, person
or activity with which the risk is associated.
• Two approaches of risk avoidance:

i. Refusing to assume an activity

e.g. For instance, a firm can avoid a flood loss by not building a plant
in a place where flood is frequently affecting. In case of refusing, we
are discontinuing the activity

ii. Abandonment of previously assumed activities:

e.g. A firm that produces a highly toxic product may stop

 Con’t
2. Retention/Acceptance
• Bearing all the risk by that person/organization.
Types of retention
i. Planned/conscious/ active risk retention
– It is characterized by the recognition that the risk exists, and
tacit agreement to assume the losses involved.
– The decision to retain a risk actively is made because there are
no alternatives more attractive.
– Self-insurance is a special case of active retention. Self-
insurance is not insurance, because there is no transfer of the
risk to an outsider.
» E.g. A firm may keep some money to retain the risk.
 Con’t

ii. Unplanned/Unconscious/ Passive Retention

• Passive risk retention takes place when the individual exposed to

the risk does not recognize its existence.

• In this case, the person so exposed retains the financial

consequence of the possible loss without realizing that he does so.
 Con’t
3. Loss Prevention and Reduction Measures
• Prevention is defined as a measure taken before the
misfortune occurs.
• Generally speaking, loss prevention programs intend to
reduce the chance of occurrence.
Example:
• Constricting a building with a fire resistance material /
fireproofing.
• Constructing a building in a place where there is little
danger.
• Regularly inspecting the machine / area
• The existence of automatic loss detection programs.
• Fire alarms
• Warning posters /NO SMOKING!! , DANGER
ZONE!!/
 Con’t
• Loss reduction measures try to minimize the severity of the loss
once the peril happened/ after the event occurs.

For Example:

• Automatic sprinkler
• An immediate first aid
• Medical care and rehabilitation service
• Guards
• Cover
• Fire extinguisher
• Fire alarms
 Con’t

4. Separation /Diversification
• Separation of the firm’s exposures to loss instead of concentrating
them at one location where they might all be involved in the same
loss.
– Separation==>Dispersion/Scattering the exposure in different
places.
– “Don’t put all your eggs in one basket”
• Example: Instead of placing its entire inventory in one warehouse,
the firm may elect to separate this exposure by placing equal parts
of the inventory in ten widely separated warehouses.
•

5. Transfer
– It is also called as shifting method.
– When a business organization cannot afford to cover
the loss by itself, it may look for/transfer institutions.
– Insurance is a means of shifting or transferring risk.
The following matrix can determine which risk
management be used.
 INSURANCE FOR THE SMALL BUSINESS

 Insurance is defined as protection against risks. And there are

many risks associated with starting a business. To protect your
business and yourself, consider the following insurance options.
 Insurers are professional risk takers. They know the probability of
different types of risk happening.
1. Basic principles for a sound insurance program
Basic principles in evaluating an insurance program include:
– Identifying insurable business risks
– Limiting coverage to major potential losses and
– Relating premium costs to probability of loss
 Con’t
2.Requierments for obtaining insurance
1. There must be a sufficiently large number of homogenous exposure
units to make the losses reasonably predictable.
» Insurance is based on the operation of the law of large
numbers.
» There must be a large number of exposures and those
exposures must be homogenous.
» Unless we are able to calculate the probability of loss,
we cannot have a financially sound program.
2. The loss produced by the risk must be definite and measurable.
– The loss must have financial measurement or financial implication.
– The risk must be calculated
– Example: For instance a person may purchase disability insurance.
How do we know that the person is unable to do? Thus, the risk must
be definite and measurable.
 Con’t
3. The loss must be fortuitous or accidental.
– i.e. the loss must be the result of a contingency, i.e., it must be
something that may or may not happen. It must not be something
that is certain to happen.
– Wear and tear or depreciation, which is a certainty, should not be
insured. No protection is given by insurance.
– We should not be certain as to the occurrence of a loss
4. The loss must not be catastrophic
– All or most of the objects in the group should not suffer loss at
the same time because the insurance principle is based on a
notion of sharing losses.
– Example: Damage which results from war, flood, windstorm
and so on would be catastrophic in nature and hence do not
have insurance.
 Con’t
5. The loss must be large loss.
– The risk to be insured against must be capable of producing a large
loss, which the insured could not pay without economic distress.
– Incase the loss occurs, it must be severe that must be transferred to
the insurer. Those recurring and minor types of losses are not
transferred to the insurance company.
6. Reasonable cost of transfer
– i.e: the probability of loss must not be too high because the cost of
transfer tends to be excessive.
– To be insurable, the chance of loss must be small. The more probable
the loss, the more certain it is to occur.
– The more certain it is, the greater the premium will be. But to make
insurance attractive, the premium has to be for less than the face of the
policy. For instance, a life insurance company to issue a birr 1000
policy on a man aged 99. The net premium would be about birr 980.