Unit iii

Business concept Page 1
UNIT-III
ELEMENTS OF BUSINESS ACTIVITY
PURCHASING:
A business or organization attempting for acquiring goods or services to accomplish the goals of
the enterprise. Though there are several organizations that attempt to set standards in the
purchasing process, processes can vary greatly between organizations. Purchasing is the process
of acquiring goods, services, and equipment from another organization in a legal and ethical
manner.
Condition for Purchasing Process:
• The five Rules of Purchasing
1. Purchasing the right item or service
2. In the right quantity
3. At the right quality level
4. At the right price
5. At the right time
Choosing Suppliers
A supplier is an important element of every business. A supplier could be a provider of good and
or services which the business in turn resells or adds value to. The quality of suppliers a business
has directly impacts or affects the quality of service delivery. It is important to select your
supplier for the right reasons. While you may have once-off suppliers from time to time, it is
riskier as there is no definite service level guarantee and long term commitment. Such suppliers
are to be avoided as much as possible. In some companies, procurement is only done from a list
of vetted registered suppliers who would have met stringent criteria and scrutiny. It is easy to
find any kind of supplier. When you put considerations and conditions you can easily sift and
select those suppliers who meet the standards and status of your organization. There is a supplier
for every size and class of business. Not every supplier that exists is a genuine partner to rely on
and build your business on. Below are considerations and tips that will help you get the best
suppliers to partner with your business.
1. Supplier Capacity and Reliability - In what way is the organization you are considering as a
supplier capable of meeting your needs. How long have they been in operation? What is their
production capacity and level of pressure they are already under from their existing customers?
Consider the reliability and track record the company may have. You may need to speak to other
customers who have already started using the services of this particular supplier to get a second
or third opinion. Without traceable references you are left to assume that the supplier is reliable.
Also consider the levels of stock that the supplier keeps at any given time. This will indicate to
you whether your order will be fulfilled instantly the next time you order. Some suppliers do not

even keep stock, they only order from their own suppliers once they get an order in which case
delays are experienced which could affect how you offer services to your own clients. It is
important to note that the reliability on lack of it on the part of your suppliers has a direct impact
on the business's reliability. You cannot support your customers fully with unreliable suppliers
whom you are not sure to find in the same place the next time you visit them. Take time to cut
out those who let you down constantly.
2. Corporate value system - The value system of a business tells you what they believe in and
their general work ethic. Always study the value systems and choose suppliers who seem to live
according to their value in real life. Values become the habits and character definition of the
people serving you. However, some suppliers simply hang values on the wall and that is where it
all ends. A company would rather have 3 values which they advocate for and live by than have
ten flowery values which remain imaginary not real. Are the values in any way telling you
anything about the service delivery, the customer focus etc? Find a supplier who matches your
values and beliefs. A supplier who does not cut corners in a bit to make a sale. A supplier who
would rather lose the order than supply imitations purporting to be supplying originals.
3. Quality of products - Most organizations thrive because they offer quality products. You may
have sales people who are very jovial, with a positive attitude, smiling all the time but if the
product range you are dealing with leaves a lot to be desired in terms of quality then your service
mars the business growth totally. No one will ever want to resell products that are not tried and
tested. One thing most customers avoid is having to deal with the comebacks or return as this
impacts on profitability and reputation. I have noticed that each time I have provided good and
services to a customer and there are some concerns and comebacks, I have had to work overtime
to retain that customer than in cases where I have given a product or service of high quality. In
such cases customers have gone out and spoken well of my business and in turn became my
silent sales people.
4. Credit terms - The payment options that supplier provide help them to retain and serve their
customers satisfactorily. Most customers are not keen on partying with cash on the very day they
receive the goods or services. Customers require time to process payment and be able to
strengthen their cash flows through these legal delays in payment. While credit terms are
attractive, some customers tend to abuse such facilities by over extending their credit payments.
If you are selecting a supplier, always agree on reasonable credit line such as 7 to 14 days which
is not too short or too long. It gives a win-win scenario. Realize that you also may have
customers who require the same credit facility. In cases where suppliers refuse to give you such
terms, then you also need to tighten your cash-flow position by ensuring that your customers pay
as you deliver the goods. I have seen companies collapse at the weight of having to finance other
businesses all because they simply wanted orders and debtors. You rather not have the order if
you are not getting terms and your customers are putting pressure for terms. You can only give
away what you have been given.
5. Proximity and Distance - This is an important consideration. You could have suppliers on
other continents outside of your own. Realize that there is a delay in shipment that occurs
between the time of placing an order and getting the order into your own stock room. You may
need to keep contact with suppliers that also close in case you run out and receive urgent orders.

In you manage your imports properly you may be able to get all your material from other
continents. In that scenario distance ceases to be an issue. The advantage however of dealing
with smaller local suppliers is that you have a backup plan and in the event of returns, it is an
easier process to get product back to the supplier without huge transportation costs
6. Competitive Pricing - Businesses desire to be profitable. After all, the reason why businesses
exist is to make a solid consistent profit for the benefit of the investor and all stakeholders. One
way to increase on profits is to ensure that you do not unnecessarily purchase your inputs from
expensive suppliers. Having registered suppliers and also a consistent relationship with existing
suppliers allows the customer to leverage on pricing. They can negotiate for bulk purchase
discounts. In most companies, even after selecting a pool of suppliers to deal with both locally
and abroad, there is a policy for procurement staff to get 3 quotations for the same product from
different suppliers. The $5 difference in price does make a difference in your pricing of the same
product. The goal is to ensure they get the best pricing possible so as to forward the same benefit
to the end user.
7. Warranty Issues - It is one thing to supply a product and it is a totally different ball game to
ensure that there is valid warranty on it. Make it clear as you purchase the product that you want
warranty card or certificate. You can only give warranty to your clients based on the warranty
given to you by the supplier. This is where paying attention to detail is of paramount importance.
You must be able to return the product if it fails to deliver what the manufacturer claims to be the
proper life and performance capacity. The warranty must not be assumed but be in writing. If
you have bought from the local channel, it is easier to process your warranty than in situations
where you go to alternative channels or markets. I had a rude awakening once when I established
a supplier in United States of America while running a business in Zimbabwe. It took 2 weeks
for the huge machine to get to my office. The machine was delivered to the client immediately.
After two weeks the huge machine failed and had to come back to my office. Because I had not
bought the machine through the established channels, I had to ship the machine back to America.
The cost of shipping alone equated to the profit I had received a few weeks earlier. It is not worth
it; rather focus on a channel that honors international warranty.
8. After Sales Support - Depending on the nature of product you intend to be procuring from a
supplier, you need to establish what happens in the event that they have sold you the items and
you now need support and technical assistance. Always assess the capacity to support you after
the sale has been done. Likewise you also need to develop or hire skills to ensure they offer the
first level of support and maintenance of the equipment you are selling.
9. Up to date Product Range - How up to date is the product range that your supplier is giving
you. There are always new products being developed daily if your supplier sticks to the old
range, soon enough your company will be left behind. Technology advancements have ensured
that new releases of better, faster, more efficient and cost effective products come on the market.
The goal is to make more modern products available to the market at competitive pricing. This is
made possible as companies invest in research to ensure they make the same products if not
better at a lower cost all the time. Sometimes it is good to partner with a supplier who has a
broader range of choices than where one range is being marketed. The broader the range the
more the choice you have available to yourself to choose from.

10. Lower Lead times - systems efficiency - When choosing suppliers you have to consider
how much longer you normally have to wait for your order or for queries to be responded to.
Some companies grow to levels where they can no longer give individual promises to customers
and stick by them. You are left unsure about whether upon placement of an order you will get it
instantly, after 3 days or 3 weeks. Your own customers usually dictate the lead times they need
from you. In the event that you are experiencing delays in your service, endeavor to
communicate with the customer as much as possible to ensure that lead time issues do not affect
their loyalty to your services. Partner with suppliers who have efficient systems. I usually get
annoyed when I have to wait for 20 minutes as the red tape in a company is laid out. All I want
in most cases is to pay, get a product with my receipt or invoice. If the supplier's internal
processes are that yo
Rabison Shumba is a young African entrepreneur who has interests in Information and
Communication Technology, Agriculture and Mining. He is also a motivational speaker, trainer
and author. His book, The Greatness Manual and various online articles are tools for personal
and professional development. Together with 100 other Career Experts, Rabison co-authored the
101 Great Ways to enhance your Career. Rabison has a personal vision of impacting the lives of
children in marginalized communities by creating platforms for career counsel and guidance,
information empowerment and capacity building through the Greatness Factory Trust, where he
currently holds the position of Chairman of the Board of Trustees and Acting Executive Director.
He is actively involved in the organization of career enhancement and guidance colloquiums to
propel and inspire both young and mature professionals to greatness. His areas of expertise
include strategy, leadership, personal and professional development. Rabison is married to
Jackie, and they have two daughters. They reside in Harare, Zimbabwe.
STOCK CONTROL
Managing stock effectively is important for any business, because without enough stock,
production and sales will grind to a halt. Stock control involves careful planning to ensure that
the business has sufficient stock of the right quality available at the right time.
Stock can mean different things and depends on the industry the firm operates in. It includes:
 Raw materials and components from suppliers
 Work in progress or part finished goods made within the business
 Finished goods ready to dispatch to customers
 Consumables and materials used by service businesses
In order to meet customer orders, product has to be available from stock – although some firms
are able to arrange deliveries Just in Time, see below. If a business does not have the necessary

stock to meet orders, this can lead to a loss of sales and a damaged business reputation. This is
sometimes called a ‘stock-out’. It is important therefore that a business either holds sufficient
stocks to meet actual and anticipated orders, or can get stocks quickly enough to meet those
orders. For a high street retailer, in practice this means having product on the shelves.
However, there are many costs of holding stock, so a business does not wish to hold too much
stock either. The costs of holding stock include:
 The opportunity cost of working capital tied up in stock that could have been used for
another purpose
 Storage costs – the rent, heating, lighting and security costs of a warehouse or additional
factory or office space
 Bank interest , if the stock is financed by an overdraft or a loan
 Risk of damage to stock by fire, flood, theft etc; most businesses would insure against
this, so there is the cost of insurance
 Stock may become obsolete if buyer tastes change in favour of new or better products
 Stock may perish or deteriorate – especially with food products
Stock Control - application and evaluation
When a stock control situation is presented in an examination, it is likely to be in the context of a
business that is facing change – so it is rarely as simple as the diagram in the tutor2u stock
control revision note.
Candidates need to interpret and apply stock control principles to the particular situation, and
make practical suggestions to help address the question.
Examples might include:
 A business that is growing will need to review its re-order and buffer stock levels, and the
frequency and size of orders
 Look out for seasonality in a business; larger or more frequent orders may be needed in
busy times
 If the supplier is having trouble supplying goods on time, the firm might need to re-order
at an earlier point (or seek a new supplier!)
 Does the firm have a back-up supplier in case of delays?
 Could small additional orders be made with a supplier as a stop gap if the firm’s stock
runs out suddenly? Note - these orders would be more expensive because of extra
transport costs and lower discount level

STOCK CONTROL:
Inventory is often referred to as the graveyard of business because over investment in
stock is a frequent cause of business failure.
FACTORS FOR STOCK CONTROL:
Many business costs, such as:
 A storeman’s wages
 Storage costs
 Insurance of the stock
 Interest on borrowed money, are directly related to investment in inventory.
STOCK CONTROL SHEET :
STORAGE OF STOCK:
 How and where stock is stored will depend upon:
– The weight of the goods
– The bulkiness of the goods

– The risk of physical deterioration
– The risk of theft
SETTING OF STOCK CONTROL:
– Maximum level of stock
– Minimum level of stock
– Reorder level for stock
– Reorder quantity
Maximum Stock Level:
 This is the level by which stock should not rise above.
 When setting a Maximum Stock Level the following should be considered:
– The cost of storage
– The rate of usage
– The delivery time of stock from the time the order was placed
– The risk of deterioration
Minimum Stock Level:
 This is the level by which stock should not fall below.
 When setting a Minimum Stock Level the following should be considered:
– The rate of usage
– Delivery time
– The level of safety or “buffer” stocks to be held
Reorder Level of Stock:
 This is the level at which an order for new stock should be made.
 When deciding on the reorder level the following should be considered:
– Rate of stock usage
– Level of buffer stocks
– The cost of storage
Reorder Quantity:
 The reorder quantity is the quantity of materials to be ordered when stocks reach the
reorder level and will depend upon:
– Cost of ordering the stock (taking into account any discounts for bulk buying)
– Cost of storing the stock

Good stock control:
 Saves time
 Saves money
 Makes sure the workplace is more efficient.
You can use paper based and computer based stock control methods to:
 Record the movement of stock items
 Maintain stock lists
 Adjust levels to meet demand.
ADVANTAGES:
Stock control is used to:
 Reduce the costs of running the businesses
 Reduce excess stock and wastage
 Make sure there are enough goods to meet the demand
 Speed up deliveries to customers.
PRODUCTION
The production system is ‘that part of an organisation, which produces products of an
organisation. It is that activity whereby resources, flowing within a defined system, are combined
and transformed in a controlled manner to add value in accordance with the policies
communicated by management’. A simplified production system is shown below:

Fig.1.1 Schematic production system
The production system has the following characteristics:
1. Production is an organised activity, so every production system has an objective.
2. The system transforms the various inputs to useful outputs.
3. It does not operate in isolation from the other organisation system.
4. There exists a feedback about the activities, which is essential to control and improve system
performance.
CLASSIFICATION OF PRODUCTION SYSTEM
Production systems can be classified as Job-shop, Batch, Mass and Continuous production
systems.
Fig. 1.2 Classifications of production systems
1.5.1 Job-Shop Production
Job-shop production are characterised by manufacturing one or few quantity of products
designed and produced as per the specification of customers within prefixed time and cost. The

distinguishing feature of this is low volume and high variety of products. A job-shop comprises
of general-purpose machines arranged into different departments. Each job demands unique
technological requirements, demands processing on machines in a certain sequence.
JOB-SHOP PRODUCTION IS CHARACTERISED BY
1. High variety of products and low volume.
2. Use of general purpose machines and facilities.
3. Highly skilled operators who can take up each job as a challenge because of uniqueness.
4. Large inventory of materials, tools, parts.
5. Detailed planning is essential for sequencing the requirements of each product, capacities for
each work centre and order priorities.
ADVANTAGES
Following are the advantages of Job-shop Production:
1. Because of general purpose machines and facilities variety of products can be produced.
2. Operators will become more skilled and competent, as each job gives them learning
opportunities.
3. Full potential of operators can be utilised.
4. Opportunity exists for Creative methods and innovative ideas. Operations Management
Concepts 5
|LIMITATIONS
Following are the limitations of Job-shop Production:
1. Higher cost due to frequent set up changes.
2. Higher level of inventory at all levels and hence higher inventory cost.
3. Production planning is complicated.
4. Larger space requirements.
BATCH PRODUCTION
American Production and Inventory Control Society (APICS) defines Batch Production as a
form of manufacturing in which the job pass through the functional departments in lots or
batches andeach lot may have a different routing. It is characterised by the manufacture of
limited number of products produced at regular intervals and stocked awaiting sales.
BATCH PRODUCTION IS CHARACTERISED BY
1. Shorter production runs.
2. Plant and machinery are flexible.
3. Plant and machinery set up is used for the production of item in a batch and change of set up is
required for processing the next batch.
4. Manufacturing lead-time and cost are lower as compared to job order production.

ADVANTAGES
Following are the advantages of Batch Production:
1. Better utilisation of plant and machinery.
2. Promotes functional specialisation.
3. Cost per unit is lower as compared to job order production.
4. Lower investment in plant and machinery.
5. Flexibility to accommodate and process number of products.
6. Job satisfaction exists for operators.
LIMITATIONS
Following are the limitations of Batch Production:
1. Material handling is complex because of irregular and longer flows.
2. Production planning and control is complex.
3. Work in process inventory is higher compared to continuous production.
4. Higher set up costs due to frequent changes in set up.
MASS PRODUCTION
Manufacture of discrete parts or assemblies using a continuous process are called Mass
Production. This production system is justified by very large volume of production. The
machines are arranged in a line or product layout. Product and process standardisation exists and
all outputs follow the same path.
6
MASS PRODUCTION IS CHARACTERISED BY
1. Standardization of product and process sequence.
2. Dedicated special purpose machines having higher production capacities and output rates.
3. Large volume of products.
4. Shorter cycle time of production.
5. Lower in process inventory.
6. Perfectly balanced production lines.
7. Flow of materials, components and parts is continuous and without any back tracking.
8. Production planning and control is easy.
9. Material handling can be completely automatic.
ADVANTAGES
Following are the advantages of Mass Production:
1. Higher rate of production with reduced cycle time.
2. Higher capacity utilisation due to line balancing.

3. Less skilled operators are required.
4. Low process inventory.
5. Manufacturing cost per unit is low.
LIMITATIONS
Following are the limitations of Mass Production:
1. Breakdown of one machine will stop an entire production line.
2. Line layout needs major change with the changes in the product design.
3. High investment in production facilities.
4. The cycle time is determined by the slowest operation.
CONTINUOUS PRODUCTION
Production facilities are arranged as per the sequence of production operations from the first
Operations to the finished product. The items are made to flow through the sequence of
operations through material handling devices such as conveyors, transfer devices, etc.
CONTINUOUS PRODUCTION IS CHARACTERISED BY
1. Dedicated plant and equipment with zero flexibility.
2. Material handling is fully automated.
3. Process follows a predetermined sequence of operations.
4. Component materials cannot be readily identified with final product.
5. Planning and scheduling is a routine action.
ADVANTAGES
Following are the advantages of Continuous Production:
1. Standardisation of product and process sequence.
2. Higher rate of production with reduced cycle time.
3. Higher capacity utilisation due to line balancing.
4. Manpower is not required for material handling as it is completely automatic.
5. Person with limited skills can be used on the production line.
6. Unit cost is lower due to high volume of production.
LIMITATIONS
Following are the limitations of Continuous Production:
1. Flexibility to accommodate and process number of products does not exist.
2. Very high investment for setting flow lines.
3. Product differentiation is limited.
1.6

PRODUCTION MANAGEMENT
Production management is ‘a process of planning, organising, directing and controlling the
activities of the production function. It combines and transforms various resources used in the
production subsystem of the organization into value added product in a controlled manner as per
the policies of the organization’. E.S.Buffa defines production management as follows:
‘Production management deals with decision-making related to production processes so that
the resulting goods or services are produced according to specifications, in the amount and by the
schedule demanded and out of minimum cost’.
OBJECTIVES OF PRODUCTION MANAGEMENT
The objective of the production management is ‘to produce goods and services of Right Quality
and Quantity at the Right time and Right manufacturing cost’.
1. Right Quality: The quality of product is established based upon the customers need. The right
quality is not necessarily being the best quality. It is determined by the cost of the product and
the technical characteristics as suited to the specific requirements.
2. Right Quantity: The manufacturing organisation should produce the products in right
number. If they are produced in excess of demand the capital will block up in the form of
inventory and if the quantity is produced in short of demand, leads to shortage of products.
3. Right Time: Timeliness of delivery is one of the important parameter to judge the
effectiveness of production department. So, the production department has to make the optimal
utilization of input resources to achieve its objective.
4. Right Manufacturing Cost: Manufacturing costs are established before the product is
actually manufactured. Hence, all attempts should be made to produce the products at pre
established cost, so as to reduce the variation between actual and the standard (pre-established)
cost.
MARKETING
Primary Research: Original research that a company or organization either completes in-house
or is done by an outside contractor. (See Custom Research.) Primary research: observation;
experimentation; surveys, eg face-to-face, postal, email, telephone; e-marketing research; focus
groups; panels; field trials; piloting; appropriateness of each method eg fitness for purpose, cost,
accuracy, time, validity, response rate.
Secondary research: internal sources eg data records, loyalty schemes, EPOS (electronic point
of sale),website monitoring, e-transactions, accounting records, production information, sales
figures, salespersonnel, Delphi technique; external sources eg internet, Government statistics,
libraries, universities, company reports, specialist agencies eg Mintel, Datastream, Dun &
Bradstreet; trade journals; criteria for selection eg checking of validity; use of ICT applications
eg storing, organising, retrieving and reporting data

Qualitative and quantitative research: importance and use of each; triangulation Marketing
strategies and activities: eg strategic, technical, databank, continuous, ad hoc research
THE IMPORTANCE OF MARKET SEGMENTS
Successful companies almost all have a significant market share; it is rare for more than three or
four companies to be truly successful in any segment of the market. It is not unusual for one
company to dominate with every other company trying to catch up.
Consider some examples.
 There are around three really successful supermarkets in the UK, with Tesco dominating
 Software is dominated by Microsoft and Google.
 BMW, Mercedes and Audi dominate the market for executive cars
 For many years. The US car market was dominated by just Ford and General Motors with
American Motors trailing
There are a number of reasons for this:
 A dominant supplier controls the market and sets expectations of price and quality
 He develops a reputation and brand, he is highly visible
 There is a “comfort factor” in buying from a market leader
 Customers come to him first
Marketing becomes very much easier if you are a big player in your market place. It you
are not, you will always struggle to be seen. This is all very well for very large companies. But
unless you are a Microsoft or Ford, you won’t be able to dominate sales to the whole world, you
can only ever end up with an insignificant market share.
SPECIALISE
It is often said that it is better to be a relatively big fish in a small pond than a small fish in a big
pond and the way to achieve this is to shrink your target market. You should specialize on a
particular sort of customer. This is called segmenting the market. When you do this, it is much
easier to become known and develop a reputation. You can concentrate your marketing
activities. Referrals are both easier and more effective. You learn the special needs or desires of
your customers. So, how do you select your segment? To be useful, a segment must be:
1. Different
2. Relevant
3. Significant
4. Accessible
5. Suitable size
DIFFERENCE
Difference is what really defines the segment. There is any number of ways to define a Segment.
Some of the commonest ways are:
 Geographic (e.g. a town, county or region)
 Industry or profession

 Consumer interest (e.g. discotheques, koi carp, classic cars)
The most suitable segment will depend on the type of business of the supplier.
Businesses like shops or restaurants mostly sell to customers within a certain area and
Geographical segments work well for them. Other businesses like manufacturing or design are
often more successful when they sell to a specific industry.
The terms vertical and horizontal markets are often used – a horizontal market refers to a
geographical segment and a vertical market to an industry one. It may help to combine both
geographic and industry, for example supplying builders in Hertfordshire or garages in the
Midlands. The important thing is to define a segment of the right size. There are other ways of
defining segments. Size of company is one. Few small Companies supply companies of all sizes.
Some specialize in selling to very large companies, some to small, some to SMEs, and some to
the public sector. Price brackets are another. Supermarkets aim at customers in different
spending brackets. Waitrose aim at the high end of the market, Tesco for the middle, Aldi and
Somerfield for the low end. Supermarkets take the trouble to attract their target customers and
make them feel comfortable in the stores. Garages sell cars within price ranges, some sell new
cars and second hand ones less than three years old, others sell cars from two to five years old,
others sell cars costing less than £3000.The clothing industry tends to segment customers by
age.It is possible to break an industry or product type into further segments. The car market is a
good example of this, there are several segments in the motor industry, for example:
 Small cars – targeted at young adults and pensioners
 Family cars
 Fleet cars (once dominated by Ford and Vauxhall)
 Executives (BMW, Mercedes)
 Low price sports cars
 Expensive sports cars (Porsche, Ferrari)
 Luxury cars (Jaguar, Rolls Royce)
 Off road and SUVs
There are even very specialist niches occupied by companies like Morgan.
RELEVANCE AND SIGNIFICANCE
There must be something special about the needs or desires of the segment. An entire
industry will clearly have special requirements, but even then they can be broken down
smaller. Almost all farms need tractors. However dairy farms, pig farms, orchards, and
grain farms all have very different specialist equipment. Chinese restaurants need
equipment that is not used by Italian restaurants.
Let us look at the case of a supplier of locks.
 The hotel sector needs pass keys that will open any of a group of rooms
 The domestic sector needs easily fitted locks – DIY
 Corrosion is a problem for the marine sector
 The business sector needs locks that conform to insurance industry demands
Each sector has its own special need that is not shared with the others.

ACCESSIBILITY
It must be possible to identify the members of a community. A good segment will have some sort
of “community”. Perhaps a list of members of the community exists. This could take the form of
a trade directory. If that is the case, you can buy the directory or a mailing list and use direct mail
or cold calling. If there are journals or magazines, these will be suitable for press releases or
advertisements. You could even write articles for the magazines. If events and exhibitions are
organized for that segment, these provide marketing opportunities, as do clubs and on line
forums. Local papers can be used for geographical segments, both for advertisements and press
releases. For small geographic segments, leaflet drops can be used. Members of the best
segments will talk to each other, allowing the best form of marketing: word of mouth.
Geographical segments are good for this. Industries tend to be less good because your customers
can be competitors of each other. Customers like local councils, schools and colleges can be
excellent because they cooperate with each other rather than compete and it is easy to get
referrals.
SIZE
Remember that the purpose of a segment is so you can be one of the major players there. You
should aim for a segment where you will be one of the top three suppliers. This means you need
to supply at least a quarter of the market. The ideal size of the segment should be from around
three to ten times your target turnover. Smaller than that, you won’t have room to grow, larger,
you will be one of the bit players.
CHOOSING A SEGMENT
Start by looking at your present customers. What can you say about them? Who are the
customers? What do they have in common? Are they in the same industry for example.
When you have asked these questions, you should be able to create a list of candidate
segments. Next, ask how relevant they are and how easy it is to reach them. Use the
sections above for this. Finally, consider the size of the segments. If it is too small, then ask how
you could make it more general. If it is too big, repeat the first step to break the candidate
segment down into smaller chunks.
MARKETING MIX
When you are developing your marketing plan, there are many factors that need to be
considered. So many, that it could be easy to miss an important element. And since all these
elements are interlinked, overlooking one factor could mean that the decisions you make about
the others are not fully informed.
So why 7 Ps?
Traditionally, the marketing mix was developed for the fast moving consumer goods sector, and
there were 4 Ps: Product, Price, Promotion, and Place (or distribution). As service sectors have
become more aware of marketing, this marketing mix has been developed to also include:
People, Process and Physical Evidence. Even if you think you only sell a product, so the original
4 Ps will suffice, it can be useful to think how much of a service element there is to your

business. Indeed, the goods-service continuum demonstrates that very few products are purely
goods and very few purely service.
Most of us sell either products with a surrounding service element (for example, a customer care
help-line for a software retailer) or services with a tangible element (the skill of a hair stylist is a
service but tangible products are required to deliver it). So it could be wise, even for product
manufacturers, to consider all 7 Ps in their marketing mix.
Product
As seen in the goods-service continuum, your product can have both tangible and intangible
aspects, and is the thing you offer to satisfy your customers’ wants and needs. Within this
element, you need to consider such things as your product range; its quality and design; its
features and the benefits it offers; sizing and packaging; and any add-on guarantees and customer
service offerings.
Price
Sound pricing decisions are crucial to a successful business and should be considered at both
long-term strategic and short-term tactical levels. Within this element of the mix you should
consider list price and discount price; terms and conditions of payment; and the price sensitivity
of your market. Worth remembering is the connection of price to your position in the marketing
– specifically that only one operator in any market can be the cheapest. Jostling between
competitors for this position is rarely wise.
Promotion
This is the element of the marketing mix that most people mean when they talk about
‘marketing’. But jumping straight into decisions about what promotional tools to use without
considering their relationship to the rest of the mix can be a sure-fire way to waste money. There
are many different promotional techniques, each with their own strengths but essentially they can
be broken down into four broad categories: Advertising; Public Relations; Sales Promotions; and
Direct Selling. These is techniques are used to communicate the specific benefits of your product
to your customers.
Place
Marketers love models that explain the way they work; they love it even more when elements of
each model begin with the same letter – hence the use of the word ‘Place’ to describe distribution
channels. Your choice of such channels is important, as is the variety of channels you use. For
example, a common issue for businesses beginning to trade on-line is how that will affect their
off-line business, for example selling directly through the web could alienate retail outlets that
have been the mainstay of your business in the past.

People
The impact that your people can have on your marketing cannot be underestimated. At its most
obvious, this element covers your front line sales and customer service staff who will have a
direct impact on how your product is perceived. You need to consider the knowledge and skills
of your staff; their motivation and investment in supporting your brand. Any element of the
marketing mix will also have its impact on other elements of your business, but the people
element is one where the importance of regarding marketing as an integral part of the way you
does business is crystal clear.
Process
The process part of the mix is about being ‘easy to do business with’. If you’ve ever become
frustrated at call centres that can’t answer your questions, or annoyed when you can’t buy
something in a shop because the computerised till doesn’t recognize that it exists, even when you
can see it on the shelves, you’ll know how important this element can be. The more ‘high
contact’ your product, and the more intangible, the more important it is to get your processes
right. Remember to look at this from your customers’ point of view. The process problems that
are most annoying to a customer are those that are designed for the provider’s convenience, not
the customer.
Physical Evidence
When you sell tangible goods, you can offer your customer the chance to ‘try before they buy’,
or at least see, touch or smell. With services, unless you offer a free trial, your customer will
often be buying on trust. And to help them do so you need to provide as much evidence of the
quality you will be providing as possible. So physical evidence refers to all the tangible, visible
touch points that your customer will encounter before they buy, from your reception area and
signage, to your staff’s clothing and they images you include in you corporate brochure. Think
about how all the elements of your marketing mix hang together. Does your pricing reflect the
quality of your product? Does your choice of promotional tools reinforce your choice of
distribution channel? Do your people understand how to implement your process?
MASS VERSUS NICHE MARKETING.
Mass marketing was one of the success stories of the 20th century. Starting of with products like
the Model T Ford, we are now surrounded in our every-day lives by mass market firms,
multinationals aim-ing to maximise profits, market share and economies of scale by producing
and selling huge quantities of similar goods and services to as many customers as possible. These
mass market firms provide the bulk of the goods and services that we consume. Companies like
Ford, Totota, Microsoft, Proctor and Gamble (soap powders), Sony, and Cadburys, pro-duce
ranges of products aimed at target-ing as large a proportion of the total mar-ket as possible. They
achieve this market saturation, by using two methods. The first method used is developing
product width. This means selling a range of similar but differentiated prod-ucts. So Proctor and
Gamble will market several brands of soap powder, each tar-geted at a different segment of the
mass market. By doing this they cut costs, though economies of scale, and through the use of
advertising, establish a range of brands each with different values in the mind of the consumer.
The second method of appealing to as much of the market as possible is to add product depth to
each of the products. Adding product depth means making each product available in a range of
sizes, packs etc. So we have 3 sizes of soap powder pack, targeting for exam-ple, singles,
couples and large families. Mars will sell Mars Bars as a single bar, king size bars, 5 packs,
snack size packs etc., again covering a wide as possible market spread with little extra cost.

ADVANTAGES OF MASS MARKETING.
 Maximises income
 If one sector declines this is likely to be com-pensated for by growth in other sectors.
 Allows reduction in average costs through economies of scale. Allows Brands to be used
to their full value
DISADVANTAGES OF MASS MARKETING.
 Heavy advertising costs, to establish brands and keep them in public eye.
 High development costs of products.
 Competition is often fierce.
 Companies must be market orientated — this brings high innovation and market research
costs.
Niche Marketing
Often for smaller businesses mass marketing is not an option, after all appealing to and
developing products for a mass market is an expensive business. There are huge product
development costs, massive expendi-tures on promotion, constant competition etc. Smaller firms
will therefore have to accept that aiming for spe-cific niches may be their only option. With
niche mar-keting a firm will target a single segment or part of the market, ignoring the rest of the
marketplace.
The idea of niche marketing made a strong come-back in the 1990’s and any quick glance at a
baby or women’s magazine, or the classified pages of a na-tional newspaper, will show how

many firms are tar-geting niches that they have recognised as existing within a market. Recent
examples have shown how successful this type of firm can be. Mothercare, mass marketing
children’s clothes announced the closure of many of thier stores, (May 1999), their market has
been lost to specialists and niche market companies such as Baby Gap and Next for Kids. C & A,
mass market-ing, sensible, if slightly down market clothes have found their customers deserting
them for mail order companies like Cotton Traders or shopping for their leisure wear in the new
breed of sports shops, result-ing in the closure of the entire UK operation.
ADVANTAGES OF NICHE MARKETING
 Lower initial cost -especially in relation to ad-vertising.
 Able to concentrate on company strengths – product can be developed from what the
busi-ness is good at, and then a niche targeted.
 Competition may ignore the niche, either be-cause of lack of awareness or because it is
too small for large firms to focus on.
 Firms can gain expert knowledge of the niche giving them a real advantage over potential
com-petitors.
DISADVANTAGES OF NICHE MARKETING
 Market niches can disappear as a result of changes in economic conditions, fashion or
taste – having all your eggs in one basket.
 Mass market firms can target the niche if it grows in value or size – small firms may find
this competition impossible to deal with.
 Niches are not always neat little market sectors, they may be spread geographically or
otherwise, making targeting and promotion difficult or ex-pensive.
The best niche marketing is based on designing goods or services specifically tailored for the
needs of the customer. Therefore there must be a full un-derstanding of the desires and needs of
the niche. This understanding can be gained through market re-search, but is as often as not at
least initially based on more of a gut feeling and an understanding that comes through personal
experience.
FINANCE
Finance is the study of how investors allocate their assets over time under conditions of certainty
and uncertainty. A key point in finance, which affects decisions, is the time value of money,
which states that a unit of currency today is worth more than the same unit of currency
tomorrow. Finance aims to price assets based on their risk level, and expected rate of return.
Finance can be broken into three different sub categories: public finance, corporate finance and
personal finance.

All businesses need money. Where the money comes from is known as 'sources of finance'. Now
there are two different types of sources of finance: internal (finance from inside the business) and
external (finance from outside the business).
INTERNAL SOURCES OF FINANCE
Definition These are sources of finance that come from the business' assets or activities.
Retained Profit If the business had a successful trading year and made a profit after paying all
its costs, it could use some of that profit to finance future activities .
This can be a very useful source of long term finance, provided the business
is generating profit (see section on profit & loss accounts).
Sale of Assets The business can finance new activities or pay-off debts by selling its assets
such as property, fixtures & fittings, machinery, vehicles etc.
It is often used as a short term source of finance (e.g. selling a vehicle to pay
debts) but could provide more longer term finance if the assets being sold are
very valuable (e.g. land or buildings)
If a business wants to use its assets, it may consider sale and lease-back
where it may sell its assets and then rent or hire it from the business that now
owns the assets. It may mean paying more money in the long run but it can
provide cash in the short term to avoid a crisis.
Reducing Stocks Stock is a type of asset (see balance sheet work for more on assets) and can
be sold to raise finance. Stock includes the business' holdings of raw
materials (inputs), semi-finished products and also finished products that it
has not yet sold.
Businesses will usually hold some stock. It can be useful if there is an
unexpected increase in demand from customers. Stock levels tend to rise
during economic slowdowns or recessions as goods are not sold and 'pile-up'
instead.
It is not usually a source of large amounts of finance - if a business has very
large stock piles, it might mean that nobody wants to buy the product and
reducing stocks will therefore be hard. It is often considered to be a short
term source.

Trade Credit Unlike you and me, a business does not normally pay for things before it
takes possession of them. Instead, it will usually place an order for supplies /
inputs and will pay after receiving the items. It is good practice to pay
quickly (often within one month) as this will help the business develop a
good relationship with its suppliers.
This source of finance appears on the balance sheet as trade credit. This
method of deferring (delaying) payment to a future date is a form of very
short term borrowing and helps with the problems of the cash cycle
identified in the work on liquidity.
External Sources of Finance
Definition This is finance that comes from outside the business. It involves the business owing
money to outside individuals or institutions
Personal
Savings
This mainly applies to sole traders and partnerships. Owners may use some of their
own money as capital to invest in the business. For instance, a person may be made
redundant by a company that needs to reduce in size. They would receive
redundancy payment that they might use to start their own business.
This is considered an external source as it is assumed that the money lent to the
business will be paid back to the private individual in the future, possibly with an
extra amount to compensate the individual for the help they gave. It can be a short
or long term source of finance, depending upon the amount invested and the
decision of the person using their savings.
Commercial
Banks
We tend to consider two types of finance that banks offer to businesses, overdrafts
and loans.
If a business spends more money than it has in its bank account, we say that it has
become overdrawn. Businesses will often have an arrangement with the bank
whereby the bank will pay the extra money provided the business will pay them
back in a fairly short period of time, with interest. This is a short term source of
finance and is useful for small amounts. It is often used for buying supplies /
inputs.
A bank loan is a long term source of finance and will often be for much larger
sums of money. A loan is useful for a business that is starting up or looking to
grow. Loans are often used to buy fixed assets (see balance sheets) such as
machinery and vehicles. A business will pay the bank back each month in
instalments and will also pay an interest charge.
Interest - Banks are providing a service by lending money in the form of
overdrafts and loans and banks will charge for this service (they want to make a
profit too). When a business takes a loan, it will agree to pay it back over a period

of years but it will also pay an extra charge. This charge, called interest, is a
percentage of the value of the loan.
The interest rate is set by the Bank of England and it varies. The higher the
interest rate, the greater the percentage of the loan that the business must repay. In
other words, if the Bank of England raises interest rates, a business with a loan will
find it has to pay the bank more each month as it pays off its debt. Likewise, a fall
in interest rates will mean that the business will have lower costs (and therefore
more profit). The interest rate is an example of an external constraint - something
outside the business' control that can seriously affect the business' performance.
Building
Societies
A building society is a form of financial that is similar to a bank. It also provides
loans but specialises in providing mortgages.
A mortgage is a special type of loan used to buy property (factories, shops, etc).
Loans and mortgages tend to be paid back over a long period of time, usually
several years, at an interest rate.
In recent years, the differences between banks and building societies have reduced
and both are now very similar. Both can offer mortgages and loans
Factoring
Services
Businesses are often owed money. If you supplied car parts to local garages, you
would often deliver the products to the garages and receive payment within a few
weeks. The garages would be paying by trade credit (see internal sources) and are
in debt to you (they are your debtors - see balance sheet).
A business may have difficulty in collecting its debts from its customers but may
need to get its hands on money very quickly. A special factoring company may
offer to handle the debt collection process for a charge. The factoring company
pays the business most of the value of the debt first and would then collect the
money from the debtor. This is a short term source of finance.
Share Issue An important source of finance for limited companies. A share issue involves a
business selling new shares that entitle the shareholders to share in the control of
the business. Each share gives the shareholder a vote on the direction of the
company. This usually means that the shareholder can elect the board of directors
of the company each year. If the shareholder doesn't like the way the directors are
running the business, they can elect new directors. This is a good incentive to the
directors to run the business well and make a profit which will be paid to the
shareholders in the form of dividends.
The more shares a person holds, the more control they have over a company. If one
company wanted to take another company over, it could arrange to buy over 50%
of that company's shares. This would give it a majority of control and, therefore,
ownership.
Issuing new shares can raise a lot of capital that can be used for expansion (buying
more fixed assets, etc). It is a long term source of finance. If the total number of

shares rises, the votes of existing shareholders will have slightly less significance
and they will have less control. The business will also have to pay dividends on a
larger number of share
Debentures This is a form of long term loan that can be taken out by a public limited company
for a large sum and it will be paid back over several years. It is usually borrowed
from specialist financial institutions.
Venture
capital
Some individuals join together to provide finance for new businesses that are just
starting-up. They look for promising businesses and invest in them, hoping that the
businesses will grow and that they will make a profit. This is similar to issuing
shares.
Leasing and
Hire
Purchase
Leasing involves a business renting equipment that it may use for several years or
months but never own. It will have a contract with a company who may come in to
repair and service the product. The deal may also involve the product being
replaced with a new model every so often. Businesses often lease equipment such
as photocopiers.
Hire purchase involves paying for equipment in instalments. The business will not
own the item until all the payments have been made. It usually works out more
expensive to buy an item on hire purchase than paying all at once but it does mean
that the business doesn't have to spend a large amount of money at once.
THE ADVANTAGES AND DISADVANTAGES OF SOURCES OF FINANCE
INTERNAL SOURCES
1.REINVESTED PROFIT
 Profit can provide a return for investors in which investors plough back
into business to help it grow.
 Does not have associated costs.
 Does not have to be repaid unlike loans.
 No interest charges.
- May be limited which will constrain rate at which business expands.

2. Cash Squeezed Out by Day-to-Day Finances
Reduces amount needed to be borrowed (cutting stocks, chasing up customers or delaying
payments to suppliers).
3. Sale of Assets
Sold to raise cash. Makes sense to dispose of underused assets. Finance development without
extra borrowing. They can sale and lease it back.
- Loses assets but has the use of the cash.
EXTERNAL SOURCES
BANK OVERDRAFTS
+ The firm only needs to borrow only when and as much as it needs.
- Very expensive and bank can insist being repaid within 24 hours.
Trade Credit
+ Good way of boosting day-to-day finance.
- Other businesses may be reluctant to trade with the business if they do not get paid in good
time.
Venture Capital
+ Usually wants to contribute to the running of the business - bring in new experience and
knowledge.
- Requires a substantial part of the ownership of the company.
ASSESSING BUSINESS PERFORMANCE
Small adjustments to your business can make all the difference when improving your
profitability. It can also help keep the cash flowing when economic conditions are tough. This
guide has been designed to help you take a step back and understand your business’s finances
better - allowing you to spot problems before they become too serious.
We have divided ‘HELPING YOU ASSESS YOUR BUSINESS PERFORMANCE’ into two
sections.
BUSINESS RATIOS
Section One covers ratios any business should keep a close eye on:
1. Profitability – measuring your income against costs
2. Efficiency – measuring whether your business is using its assets as well as it can
3. Liquidity – how your assets measure up against your liabilities
Ratios relate one number to another, and are usually – but not always – expressed as a
percentage. Each topic in the first section covers a different business area but is laid out in the
same way, step by step:

Step 1: Overview of how the ratio works
Step 2: Shows you how to calculate the ratio
Step 3: Allows you to reflect on your business’s performance
Step 4: If your business figures have changed, this step will help you to identify the reasons
‘why’
Step 5: Covers the benefits of improving particular aspects of your business
Step 6: Balances any benefits against the ease of making changes to your business
Key Success Factors Section Two looks at ‘key success factors’ with top tips to help keep you on
track during Challenging economic conditions. At the back you’ll find an action plan, which you
can fill in using the results from the ratios, put into practice, and see how your business responds.
We’ll start by looking at gross profit margin, describing each of the above steps in detail and
you’ll be able to pick and choose the ratios that are relevant for your business.
PROFITABILITY
• Gross profit margin
• Overheads versus Sales
GROSS PROFIT MARGIN
Although we are only a few lines into the income statement, we can already calculate our
first financial ratio. The gross profit margin is a measurement of a company's manufacturing and
distribution efficiency during the production process. The gross profit tells an investor the
percentage of revenue / sales left after subtracting the cost of goods sold. A company that boasts
a higher gross profit margin than its competitors and industry is more efficient. Investors tend to
pay more for businesses that have higher efficiency ratings than their competitors, as these
businesses should be able to make a decent profit as long as overhead costs are controlled
(overhead refers to rent, utilities, etc.)
To calculate gross profit margin, use this formula: Gross Profit ÷ Total Revenue
Calculating Sample Gross Profit Margin
For illustration purposes, let's calculate the gross profit margin of Greenwich Golf Supply (a
fictional company) using its income statement. You will find the statement at the bottom of this
page in Table GGS-1.
Assume the average golf supply company has a gross margin of 30%. (You can find this sort of
industry-wide information in various financial publications, online finance sites such as
moneycentral.com, or rating agencies such as Standard and Poors).
We can take the numbers from Greenwich Golf Supply's income statement and plug them into
our formula:
$162,084 gross profit ÷ $405,209 total revenue = 0.40

The answer, .40 (or 40%), tells us that Greenwich is much more efficient in the
production and distribution of its product than most of its competitors.
Gross Profit Margin Over Time
The gross margin tends to remain stable over time. Significant fluctuations can be a
potential sign of fraud or accounting irregularities. If you are analyzing the income statement of a
business and gross margin has historically averaged around 3%-4%, and suddenly it shoots
upwards of 25%, you should be seriously concerned. For more information on warning signs of
accounting fraud, I recommend Howard Schilit's Financial Shenanigans: 2nd edition: How to
Detect Accounting Gimmicks and Fraud in Financial Reports.
For more advanced readers who own a business or want to understand how to analyze
gross profit margins for companies in which they wish to buy stock, I wrote an essay called A
Deeper Look at Gross Profit and Gross Profit Margins explaining how it is possible for a company
with low gross profit margins to make more money than a company with high gross profit
margins. It is definitely worth reading.
OVERHEADS VERSUS SALES
All businesses have regular expenses that are not directly related to producing goods or services.
These indirect expenses are termed "overhead" costs. Most businesses calculate overhead cost on
a monthly basis. Typically, overhead cost is expressed as a percentage of sales or of labor cost.
Keeping the proportion of overhead cost low gives a business a competitive advantage, either by
increasing the profit margin or by allowing the business to price its products more competitively.
Step 1 :Draw up a list of your business expenses. Your list should be comprehensive and include
items like rent, utilities, taxes and building maintenance, which are examples of overhead costs.
Other items are inventory, raw materials and production labor, which are not considered
overhead.
Step 2: Categorize each item on your list of expenses according to whether it is the result of
producing a good or service. For example, shop floor labor and the cost of raw materials are
direct costs since they are incurred only when some item is being manufactured. All indirect
costs are overhead. Keep in mind that some items won’t fall easily into one category or the other,
so you must make some judgment calls. For example, most businesses classify legal expenses as
overhead. However, for a law firm, a lawyer's salary is a direct cost, since her work is directly
linked to producing the legal services which are the firm's product. Most business people find it
helpful to follow the accepted conventions used in their particular industry for classifying
expenses as direct or overhead costs.
Step 3: Add all of the overhead costs for the month to calculate the aggregate (total) overhead
cost. You can choose another time period, but most business people find one month to be the
most useful.
Step 4 Calculate the proportion of overhead costs compared to sales. Knowing the percentage of
each dollar that goes to overhead allows you to properly allocate costs when setting prices and
drawing up budgets. Divide your monthly overhead cost by monthly sales and multiply by 100 to
find the percentage of overhead cost. For example, a business with monthly sales of $900,000
and overhead costs totaling $225,000 has ($225,000/$900,000) * 100 = 25 percent overhead.

Step 5 Calculate overhead cost as a percentage of labor cost. This measure is useful as an
estimate of how efficiently resources are utilized. The lower the percentage, the more effectively
your business is utilizing its resources. Divide the monthly labor cost into the total overhead cost
for the month and multiply by 100 to express as a percentage.
EFFICIENCY
• Average collection period (debtor days)
• Average credit period (creditor days)
• Stock turnover
AVERAGE COLLECTION PERIOD RATIO:
Definition:
The Debtors/Receivable Turnover ratio when calculated in terms of days is known as
Average Collection Period or Debtors Collection Period Ratio. The average collection period
ratio represents the average number of days for which a firm has to wait before its debtors are
converted into cash.
Formula of Average Collection Period:
Following formula is used to calculate average collection period:
(Trade Debtors × No. of Working Days) / Net Credit Sales
Example:
Credit sales $25,000; Return inwards $1,000; Debtors $3,000; Bills Receivables $1,000.
Calculate average collection period.
Calculation:
Average collection period can be calculated as follows:
Average Collection Period = (Trade Debtors × No. of Working Days) / Net Credit Sales
4,000* × 360** / 24,000
= 60 Days
Creditors / Accounts Payable Turnover Ratio:
Definition and Explanation:
This ratio is similar to the debtors turnover ratio. It compares creditors with the total credit
purchases. It signifies the credit period enjoyed by the firm in paying creditors. Accounts payable
include both sundry creditors and bills payable. Same as debtors turnover ratio, creditors
turnover ratio can be calculated in two forms, creditors turnover ratio and average payment
period.

Formula:
Following formula is used to calculate creditor’s turnover ratio:
Creditors Turnover Ratio = Credit Purchase / Average Trade Creditors
Average Payment Period:
Average payment period ratio gives the average credit period enjoyed from the creditors. It can
be calculated using the following formula:
Average Payment Period = Trade Creditors / Average Daily Credit Purchase
Average Daily Credit Purchase= Credit Purchase / No. of working days in a year
Or
Average Payment Period = (Trade Creditors × No. of Working Days) / Net Credit Purchase
STOCK TURNOVER
Stock turnover helps answer questions such as "have we got too much money tied up in
inventory"? An increasing stock turnover figure or one which is much larger than the "average"
for an industry may indicate poor inventory management.
The stock turnover formula is:
Calculating stock turnover can be illustrated as follows [note: assumes the inventories at year-
end were equivalent to average stock during year] From the data above, the business has
improved its stock turnover, with the ratio rising from 8.6 times to 10.2 times per year. As a
general guide, the quicker a business turns over its stocks, the better. But, it is more important to
do that profitably rather than sell stocks at a low gross profit margin or worse at a loss.
Interpreting the stock turnover ratio needs to be done with some care. For example:
 Some products and industries necessarily have very high levels of stock turnover. Fast-
food outlets turnover their stocks over several times each week, let alone 8-10 times per
year! A distributor of industrial products might aim to turn stocks over 10—20 times per
year

 Some businesses have to hold large quantities and value of stock to meet customer needs.
They may have to stock a wide range of product types, brands, sizes and so on.
 Stock levels can vary during the year, often caused by seasonal demand. Care needs to be
taken in working out what the “average stock held” is – since that directly affects the
stock turnover calculation
A business can take a range of actions to improve its stock turnover:
 Sell-off or dispose of slow-moving or obsolete stocks
 Introduce lean production techniques to reduce stock holdings
 Rationalise the product range made or sold to reduce stock-holding requirements
 Negotiate sale or return arrangements with suppliers – so the stock is only paid for when
a customer buys it
The last point to remember is that stock turnover is an irrelevant ratio for many businesses in the
service sector. Any business that provides personal or professional services, for example, is
unlikely to carry significant stocks.
LIQUIDITY
The next two ratios are useful for many, but not all businesses. Businesses with a relatively low
turnover may want to miss these ratios, and move on to the key success factors.
• Current ratio
• Quick ratio
Definition of 'Current Ratio'
A liquidity ratio that measures a company's ability to pay short-term obligations.
The Current Ratio formula is:
Also known as "liquidity ratio", "cash asset ratio" and "cash ratio".
Investopedia explains 'Current Ratio' The ratio is mainly used to give an idea of the company's
ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash,
inventory, receivables). The higher the current ratio, the more capable the company is of paying
its obligations. A ratio under 1 suggests that the company would be unable to pay off its
obligations if they came due at that point. While this shows the company is not in good financial
health, it does not necessarily mean that it will go bankrupt - as there are many ways to access
financing - but it is definitely not a good sign. The current ratio can give a sense of the efficiency
of a company's operating cycle or its ability to turn its product into cash. Companies that have
trouble getting paid on their receivables or have long inventory turnover can run into liquidity
problems because they are unable to alleviate their obligations. Because business operations
differ in each industry, it is always more useful to compare companies within the same industry.
This ratio is similar to the acid-test ratio except that the acid-test ratio does not include inventory
and prepaids as assets that can be liquidated. The components of current ratio (current assets and
current liabilities) can be used to derive working capital (difference between current assets and

current liabilities). Working capital is frequently used to derive the working capital ratio, which
is working capital as a ratio of sales.
QUICK RATIO
In finance, the Acid-test or quick ratio or liquid ratio measures the ability of a company to use its
near cash or quick assets to extinguish or retire its current liabilities immediately. Quick assets
include those current assets that presumably can be quickly converted to cash at close to their
book values. A company with a Quick Ratio of less than 1 cannot currently pay back its current
liabilities.
Note that Inventory is excluded from the sum of assets in the Quick Ratio, but included in the
Current Ratio. Ratios are tests of viability for business entities but do not give a complete picture
of the business' health. If a business has large amounts in Accounts Receivable which are due for
payment after a long period (say 120 days), and essential business expenses and Accounts
Payable due for immediate payment, the Quick Ratio may look healthy when the business is
actually about to run out of cash. In contrast, if the business has negotiated fast payment or cash
from customers, and long terms from suppliers, it may have a very low Quick Ratio and yet be
very healthy.
Generally, the acid test ratio should be 1:1 or higher; however this varies widely by industry. [1]
In general, the higher the ratio, the greater the company's liquidity (i.e., the better able to meet
current obligations using liquid assets).[2]
Notice that very often Acid test refers instead of Quick ratio to Cash ratio:
There is also another Quick Ratio which is widely used:

Unit iii

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