Small Business Management
Order Description
Please answer 5 questions. Please note the layout of your answers should be in paragraph style.
1. What are the primary points of emphasis in a start-up business plan? How might this plan evolve as it changes from a start-up plan to an ongoing business plan that
will be used by the company?
2. What steps can small companies take to scan the market and the threats it maypresent to avoid becoming obsolete?
3. How can technology-based companies keep up with rapidly changing markets, products, and competitors? Which is more important to success: strategy or resources?
4. What are the ramifications of competing with a larger, more powerful competitor? What opportunities might exist?
5. Discuss the entrepreneurial traits.
6. What role does the company’s public relations efforts play in the company’s success? What steps can the entrepreneurs take to generate PR for their companies?
7. Discuss the benefits and the risks of outsourcing the manufacturing of products to foreign countries.
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CHAPTER 8: BUILDING A POWERFUL
MARKETING PLAN
CHAPTER SYNOPSIS
Creating a solid business plan improves an entrepreneur’s odds of building a
successful company. The business plan captures many of the topics discussed, and in
addition, it includes a concise statement of how an entrepreneur plans to achieve
success in the marketplace. This section focuses on building the marketing plan.
CHAPTER OBJECTIVES
1. Describe the principles of building a guerrilla marketing plan and explain the
benefits of preparing one.
2. Explain how small businesses can pinpoint their target markets.
3. Discuss the role of market research in building a guerrilla marketing plan and
outline the market research process.
4. Describe how a small business can build a competitive edge in the marketplace
using guerrilla marketing strategies: customer focus, quality, convenience,
innovation, service, and speed.
5. Discuss the marketing opportunities the Internet offers entrepreneurs and how to
best take advantage of them.
6. Discuss the “four Ps” of marketing—product, place, price, and promotion—and
their role in building a successful marketing strategy.
ISSUES FOR REVIEW AND DISCUSSION
I. Building a Guerrilla Marketing Plan
Marketing is the process of creating and delivering desired goods and services
to customers and involves all of the activities associated with winning loyal
customers.
Guerilla marketing strategies are unconventional, low-cost, creative
techniques – small companies can get more “bang” from their marketing bucks.
The required marketing investment is scaled to fit the often limited marketing
resources of the organization.
A guerilla marketing plan should accomplish four objectives:
1. It should determine customer needs and wants through market research.
2. It should pinpoint the specific target markets the company will serve.
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3. It should analyze the firm’s competitive advantages and build a marketing
strategy around them.
4. It should help create a marketing mix that meets customer needs and wants.
II. Pinpointing the Target Market
Target markets are the specific groups of customers at whom the company aims
its goods or services.
Pinpointing the target market offers greater marketing efficiency. Mass
marketing techniques of the past are expensive and risky. The marketing
strategy can then be built to reach that specific targeted group that has the
highest propensity to buy and be an ongoing customer.
Target customers must permeate the entire business—merchandise, music,
layout, décor, Web site, and the total experience.
Market research can be invaluable to better understand, segment, and identify
target markets.
III. Determining Customer Needs and Wants Through Market Research
Market research serves as the foundation for the marketing plan. Its objective is
to learn how to improve the level of satisfaction for existing customers and to
find ways to attract new customers. By performing some basic market research,
small business owners can detect key demographic and market trends. Market
research does not have to be time consuming, complex, or expensive to be
useful.
Demographics are the characteristics and trends of a population including age,
income, gender (composition), education, household size, race, and ethnicity.
For example, we can quickly gain information regarding the growth rate of U.S.
populations by many criteria, such as race.
Market research is the vehicle for gathering this information and can avoid
basing your marketing plan on assumptions rather than facts.
Tracking trends can be a valuable and affordable way to get a pulse on markets.
Faith Popcorn, a marketing consultant and author, offers tips to help spot
significant trends:
• Read as many current publications as possible
• Watch the top ten TV shows
• See the top ten movies
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• Talk to at least 150 customers a year about what they’re buying and why
• Talk with the 10 smartest people you know
• Listen to your children—What trends are they tracking?
Market research begins with defining the objective and collecting the data.
This is based on successful one-to-one marketing that:
• Collects information on your existing customers
• Identifies your best customers
• Enhances your products and services
• Welcomes customer complaints
• Offers exceptional quality
• Understands your customers’ buying cycle
• Calculates the long-term value of customers
Conducting market research involves four steps:
Step 1: Define the objective
Step 2: Collect the data
Step 3: Analyze and interpret data
Step 4: Draw conclusions and act
IV. Plotting a Guerrilla Marketing Strategy: How to Build a Competitive Edge
A competitive edge is attained when customers perceive that one organization’s
products or services are superior to those of its competitors. Successful
entrepreneurs often use the special advantages that flow from their companies’
small size to build a competitive advantage over their larger rivals.
One way these companies can do this is through relationship marketing, or
customer relationship management, referred to as CRM.
Relationship marketing involves the following five steps:
1. Collect meaningful customer information and compile it as a database
2. Mine the database to identify “best” customers
3. Use the information to develop lasing relationships with “best” customers
4. Attract more customers who fit the “best” customer profile
5. Stay in contact with customers between sales
There are four levels of customer sensitivity, beginning at the base of the
“steps” in the illustration:
• Level 1: Customer Awareness
• Level 2: Customer Sensitivity
• Level 3: Customer Alignment
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• Level 4: Customer Partnership
Guerrilla marketing strategies complement this and propose that a company:
1. Find a niche and fill it
2. Don’t just sell, entertain
3. Strive to be unique; create an identity for your business
4. Connect with customers on an emotional level
The unique selling proposition offers a key customer benefit of a product that
sets it apart from its competition. It answers the question: “What’s in it for me?”
The unique selling proposition should be communicated consistently and often!
Guerilla marketing strategies can be instrumental in building a brand for your
business in a number of ways as long as you always focus on the customer.
We can think about this process in five steps and apply guerilla marketing
strategies to each:
1. Focus on the customer
2. Devotion to quality
3. Concentration on innovation
4. Dedication to service
5. Emphasis on speed
Focus on the customer allows you to optimize your marketing and profitability
potential.
Every business depends on customer satisfaction. If you can’t take care of your
customers, someone else will.
The Principles of Customer Experience Management (CEM) address the need
to establish:
• An intimate understanding of each customer’s needs, want preferences, and
peculiarities
• A personal, customer-specific message in marketing, sales, service, and
advertising
• A consistent, courteous, and professional treatment by everyone
• A responsive, rapid handing of requests, questions, problems, and
complaints
• Helpful information and advice delivered proactively
• The involvement of caring, well-trained people
• Long-term view of the company/customer relationship with an emphasis on
sustaining an ongoing relationship
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• Frequent and visible demonstrations of commitment to nurturing this
relationship
A focus on the customer can directly correlate to higher customer retention rates
and is based on the response to these four questions:
1. What are we doing right?
2. How can we do that even better?
3. What have we done wrong?
4. What can we do in the future?
Guerrilla marketing strategies help to attain customer focus in a direct and
economical manner.
PPT 8.27
Devotion to quality is another point of differentiation. Quality goods and
services are a prerequisite for survival. Today quality is more than just a slogan.
Businesses buy into operational strategies like total quality management (TQM)
where quality is in the product or service and in every other aspect and
component of the business as well. It is important to understand how customers
(American customers and others) define quality in the products and services
they purchase.
Attention to convenience is an important part of this relationship experience.
Customers want convenience. Studies show that customers rank convenience at
the top of their purchasing criteria. Successful companies must show that it is
easy for customers to do business with them.
Areas of customer convenience include:
• Location
• Hours
• Delivery services
• Payment options
• Transaction efficiency
• Additional “extra” experiences
• Product bundling
• Product adaptation
• Communication efficiency
Concentration on innovation is a key to future success. In order to keep up with
changing markets, small businesses must be innovative. Small businesses are
frequently leaders in innovation even though they may lack resources compared
to larger businesses.
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Dedication to service and to consistent customer satisfaction is one way to
achieve the goal of “customer astonishment.” Dedication to service deals with
these twelve attributes:
• Listening
• Defining a “superior space”
• Setting standards and measurements for performance
• Examining your service cycle
• Hiring the right employees
• Training those employees to deliver superior service—every time!
• Empowering employees
• Treating employees with respect and value
• Using technology to provide improved service
• Rewarding superior service
• Getting top managers’ support
• Viewing developing stellar customer service as an investment, not an
expense
Emphasis on speed enables companies to be competitive and reduce the time it
takes to develop, design, manufacture, and distribute a product, which results in
reduced costs, increased quality, and increased market share.
V. Marketing on the World Wide Web
The Internet is a vast network that links computers around the globe via the
World Wide Web. A small business Web site can enable it to sell its products
around the world. It is a phenomenal commercial opportunity that offers
businesses a worldwide marketing and distribution system. The Internet is the
“Great Equalizer” for entrepreneurs in a world of larger and more powerful
competitors.
Today’s business students and entrepreneurs are on the frontier of an industry
and market that will likely see tremendous growth in the next few years. The
opportunity is now. We will talk more about the power of the Web throughout
the course and how it is continuing to change the face of business.
VI. The Marketing Mix
The “four Ps” of the marketing mix are essential elements in developing a solid
marketing strategy and an executable marketing plan.
1. Product
2. Place—or distribution
3. Price
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4. Promotion
Establishing a sound marketing strategy—that fits the resources and objectives
of the organization—is a critical aspect of the plan and future for the business.
The product life cycle plays an important role in the marketing mix. It is
important to realize that the five stages of the PLC impact marketing strategy.
The five stages of the product life cycle are:
1. Introductory
2. Growth and acceptance
3. Maturity and competition
4. Market saturation
5. Product decline
Channels of distribution for consumer goods, or the “place” aspect of the four
Ps, may be direct—manufacturer to consumer—or through a more complex
channel delivery system that involves wholesalers, distributors, and/or retailers.
Channels of distribution for industrial goods, or the “place” for business-to-business dealings, may be direct or simply through a single wholesaler.
CHAPTER DISCUSSION QUESTIONS
1. Define the marketing plan. What lies at its center?
The marketing plan focuses the company’s attention on the customer and
recognizes that satisfying the customer is the foundation of every business. Its
purpose is to build a strategy for success with a focus on the customer.
2. What objectives should a marketing plan accomplish?
The marketing plan has four objectives:
1) Determining customer needs and wants through market research
2) Pinpointing specific target markets the small company will serve
3) Analyzing the firm’s competitive advantages and building a marketing strategy
around them
4) Helping to create a marketing mix that meets customer needs and wants
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3. How can market research benefit a small business owner? List some possible
sources of market information.
Market research provides the foundation for the marketing plan. By performing
basic market research, small business owners can identify key demographic and
market trends. Possible sources of market information include:
1) Current publications
2) Top ten shows
3) Top ten movies
4) Customers
5) Smart people you know
6) Children
4. Does market research have to be expensive and sophisticated to be valuable?
Explain.
No, market research does not have to be expensive and sophisticated to be
valuable. For example, for most business owners, information is often floating
around. It is a matter of collecting and organizing the data to make it valuable.
5. Describe several market trends and their impact on small business.
Six market trends that affect small business include:
1. Increasing population diversity offers special challenges to business owners.
2. Changing family patterns will force marketers to rethink their strategies.
3. Greater environmental and health concerns have consumers more focused
on the environmental impact of the products and services they buy.
4. Emergence of “premium” and “discount” niches as an increasing number of
lower income households force more buyers to become bargain shoppers.
5. Surge in “baby boomers” and the elderly results in changing needs for those
consumers.
6. Greater emphasis on social responsibility has a growing number of
consumers buying products associated with a cause they care about.
7. Slower growing markets and shorter product life cycles require businesses to
focus on narrow niches, understand customer needs and wants, and give them
value.
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6. Why is it important for small business owners to define their target markets
as part of their marketing strategies?
Small businesses must be more focused on the types of customers they want to
target. Small firms are ideally suited to reach market segments that their larger
rivals overlook or consider too small to be profitable. A clear, concise target
market allows a small business to increase its marketing efficiency and be
profitable.
7. What is a competitive advantage? Why is it important for a small business
owner to create a plan for establishing one?
A competitive advantage is an aggregation of factors that sets a company apart
from its competitors. Developing a strategic plan allows a small business to
differentiate itself from other companies. Developing a strategic plan allows the
small company to meet the customers’ needs of today, while looking one step
ahead to what they will need tomorrow.
8. Describe how a small business owner could use the following sources of a
competitive advantage:
• Focusing on a niche: Target a specific segment of the population that your
business can efficiently serve—senior citizens.
• Entertaining: Offer a service that customers enjoy and actively seek out—
gambling.
• Striving to be unique: The latest look in body piercing and tattoos.
• Creating an identity for the business: A name or a song that everyone
associates with your product.
• Connecting with customers on an emotional level: Environmentally safe
products.
• Focusing on the customer: Specialized exercise equipment for disabled
people.
• Focusing on the customer: Health and beauty aids—hair coloring.
• Devotion to quality: Specialty food products.
• Attention to convenience: Business location.
• Concentration on innovation: Battery powered blenders.
• Dedication to service: Installation and maintenance of product lines.
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9. One manager says, “When a company provides great service, its reputation
benefits from a stronger emotional connection with its customers, as well as
from increased confidence that it will stand behind its products.” Do you
agree? Explain. If so, describe a positive service experience you have had
with a company and your impressions of that business. What are the
implications of a company providing poor customer service? Describe a
negative service experience you have had with a company and your
impressions of that business. How likely are you to do business with that
company again?
It is true in most cases that a great service experience creates a bond, confidence
in the product or service, and the desire to be a repeat customer. Students will
share their positive and negative service experiences and comment on the business
implications of each.
10. Consumer behavior expert and retail consultant Paco Underhill says, “A
[retail] store is a 3-D brand. Everything that’s there has to be there for a
reason.” Do you agree? Explain.
Yes, the most successful retail stores create a complete 3-D retail and
entertainment-like experience. From their merchandise, the store layout, the music,
the atmosphere, their complementary Web site—it all is tailored to communicate a
consistent look, feel, and message that appeals most to their target market.
Ultimately, the total “entertailing” experience catches the attention of customers
and encourages them to shop longer and buy more goods and services. This 3-D
brand approach further differentiates the business, enhances customer loyalty, and
impacts profitability.
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CHAPTER 9: E-COMMERCE AND THE
ENTREPRENEUR
CHAPTER SYNOPSIS
We are fortunate to be witness to the early stages of e-business. It is important for us
to incorporate e-business in order to remain current in the marketplace. E-commerce
has removed the obstacle of size for many small business entrepreneurs, replacing that
with speed, and the Internet has changed the face of business.
CHAPTER OBJECTIVES
1. Describe the benefits of selling on the World Wide Web.
2. Understand the factors an entrepreneur should consider before launching into e-commerce.
3. Explain the twelve myths of e-commerce and how to avoid falling victim to them.
4. Discuss the five basic approaches available to entrepreneurs wanting to launch an
e-commerce effort.
5. Explain the basic strategies entrepreneurs should follow to achieve success in their
e-commerce efforts.
6. Learn the techniques of designing a killer Web site.
7. Explain how companies track the results from their Web sites.
8. Describe how e-businesses ensure the privacy and security of the information they
collect and store from the Web.
9. Learn how to evaluate the effectiveness of a company’s Web site.
ISSUES FOR REVIEW AND DISCUSSION
I. Benefits of Selling on the Web
The Internet has brought new customers and offered an improved competitive
position for many businesses that have an online presence.
Some of the primary benefits of having a market presence on the Internet
include:
• The opportunity to increase revenues
• The ability to expand their reach into global markets
• The ability to remain open 24/7
• The capacity to use the Web’s interactive nature
• The power to educate and inform
• The ability to lower the cost of doing business
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• The ability to spot and capitalize on new business opportunities
• The ability to grow faster
• The power to track sales results
Today, a majority of small businesses—70 percent and growing—have a
presence on the Internet.
II. Factors to Consider before Launching into E-Commerce
As with any proposed change or new venture, business owners must consider
the variables and challenges facing them:
• Is the product or service conducive to e-business?
• Can the business afford not to add e-business to its mix?
• Will customers use the Web to buy?
• How and where to best start a Web site?
• What are the specific goals and objectives of the Web site?
• What effects would a Web site have on customer relations, channels of
distribution, financial condition of the business, and so on?
III. Twelve Myths of E-Commerce
E-commerce already has many stories of success and failure. Make sure that you
do not fall victim to one of the following e-commerce myths:
Myth 1: Setting up a business on the Web is easy and inexpensive.
A Web site can result in additional costs for site redesign, hardware
requirements, and other implication to the infrastructure of the business.
Myth 2: If I launch a site, customers will flock to it.
Promoting the site is important and needs to become an integral part of the
overall promotional strategy.
Myth 3: Making money on the Web is easy.
Web retailers invest 65 percent of revenue in marketing and advertising,
compared to just 4 percent for their off-line counterparts.
Myth 4: Privacy is not an important issue on the Web.
Internet users value their privacy and this concern has a negative impact on
online sales.
Myth 5: The most important part of any e-commerce effort is technology.
Other factors influence online buyer behavior more than technology alone.
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Myth 6: “Strategy? I don’t need a strategy to sell on the Web! Just give me a
Web site, and the rest will take care of itself.”
Having a plan for the role your site will play in your business is critical to
ensure it is a solid investment and that it complements and supports all other
aspects of your business.
Myth 7: On the Web, customer service is not as important as it is in a traditional
retail store. The customer service experience on the Web is vitally important and
directly impacts buyer behavior.
Myth 8: Flash makes a Web site better.
A simple, easy to navigate and intuitive Web site wins every time!
Myth 9: It’s what’s up front that counts.
The site must offer value throughout.
Myth 10: E-commerce will cause brick-and-mortar retail stores to disappear.
A well-designed Web site can provide synergy to the physical retail store.
Myth 11: The greatest opportunities for e-commerce lie in the retail sector.
Internet technology offers tremendous value to many areas of business. The
business-to-business environment is just one other example where the Internet
has had a tremendous influence.
Myth 12: It’s too late to get on the Web.
It is never too late and, as the Internet continues to evolve, additional features
and technologies will make it even more attractive.
Approaches to e-commerce need to consider the short- and long-term goals of a
company along with its target markets, and budgetary constraints help to define
the best approach to an e-business venture. Entrepreneurs have five basic
choices:
1. Online shopping malls
2. Storefront-building services
3. Internet service providers and application service providers
4. Hiring a professional to design a custom site
5. Building a Web site in-house
A well-designed plan for your online presence may benefit from these tactics:
• Consider focusing on a niche in the market.
• Develop a community and potentially leverage Web 2.0 strategies.
• Attract visitors by giving away “freebies.”
• Make creative use of e-mail, but avoid becoming a “spammer.”
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Tracking e-mail read and click-through rates is one method to assess activity on
a day and weekly basis.
In addition, you can increase your online effectiveness when you:
• Make sure your Web site says “credibility.”
• Consider forming strategic alliances.
• Make the most of the Web’s global reach.
• Promote your Web site online and off-line.
Search engine strategies enable your site to be found as visitors use a variety of
search techniques through:
• Natural listings — organic
• Paid listings — sponsored
• Paid inclusions
IV. Designing a Killer Web Site
Web users demand fast and reliable sites, have little patience, and currently buy
from a relatively low number of the e-businesses that they visit. While there are
no guarantees, the following suggestions may increase the chances for online
success.
• Understand your target customer.
• Select a domain name that is consistent with the image you want to create
for your company and register it. Selecting a domain name that is short,
memorable, intuitive with the company name, and easy to spell will help
visitors find it.
• Design your Web site with ease of navigation in mind.
• Give customers what they want.
• Build loyalty by giving online customers a reason to return to your Web site.
• Establish hyperlinks with other businesses, preferably those selling products
or services that complement yours.
• Include an e-mail option and a telephone number in your site.
• Give shoppers the ability to track their orders online.
• Offer Web shoppers a special all their own.
• Assure customers that their online transactions are secure.
• Post shipping and handling charges up front.
• Keep your site updated.
• Consider hiring a professional to design your site.
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V. Tracking Web Results
Firms using Web sites must closely track the benefits of increased sales against
increased costs. Web analytics are software tools that measure a site’s ability to
attract customers, generate sales, and keep customers coming back. Other
tracking methods include: clustering, collaborative filtering, profiling systems,
and artificial intelligence.
The art and science of quantifying the return on investment from e-commerce
activities continues to develop.
• Recency – length of time between customers’ visits
• Click-through rate (CTR) – proportion of people who click on a company’s
online ad
• Cost per acquisition CPA – the amount it costs to generate a customer
purchase
• Conversion (browse-to-buy) ratio – the proportion of visitors to a site who
make a purchase
VI. Ensuring Web Privacy and Security
The Web’s ability to track the behavior of its customers raises concerns and
issues over the privacy of that information. Companies are encouraged to take
the following steps to ensure that the information they collect is being used in a
legal and ethical manner:
• Take an inventory of the customer data collected.
• Develop a company privacy policy for the information you collect.
• Post your company’s privacy policy prominently on your site and follow it!
Security is another unresolved and developing Web site issue. Hackers, viruses,
credit card fraud, and unauthorized users continue to adversely affect companies,
customers, and the growth of e-commerce. Virus and intrusion detection
software and firewalls may help to ward off attacks from hackers.
CHAPTER DISCUSSION QUESTIONS
1. In what ways have the Internet and e-commerce changed the ways companies
do business?
The Internet and e-commerce continue to revolutionize the business world. Small
businesses now have markets that span the globe that include both customers and
competitor companies who may cooperate as subcontractors.
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2. Explain the benefits a company earns by selling on the Web.
Selling on the Web can provide relatively low-cost access to increased sales and
profits. A Web business can be run from a student’s dorm room or from an
entrepreneur’s home.
3. Discuss the factors entrepreneurs should consider before launching an e-commerce site.
Entrepreneurs should consider the following factors before launching their Web
site:
• How to exploit the Web’s interconnectivity and relationship building
opportunities with customers
• How to develop a plan that fits within the company’s overall strategy
• How to generate the highest percentage of repeat business
• How to create and maintain a meaningful and exciting Web presence
• How to measure success
4. What are the 12 myths of e-commerce? What can an entrepreneur do to
avoid them?
The 12 myths of e-commerce are:
1. Setting up a business on the Web is easy and inexpensive – careful planning,
execution, and follow-up analysis is essential.
2. If I launch a site, customers will flock to it – assuming that the entrepreneur
has a clear and attractive site positioned within the right search engine.
3. Making money on the Web is easy – making money is almost never easy.
4. Privacy is not an important issue on the Web – the worldwide access of the
Web has also created worldwide access to hackers and other unwanted
intruders.
5. The most important part of any e-commerce effort is technology –
technology represents just one of the components required for success.
6. A strategy is not necessary, just develop a site and the rest will take care of
itself – a strategy will result in an action plan that can help a company
achieve its goals.
7. Customer service on the Web is not as important as it is in a traditional
retail store – customer service is a major key to repeat business and referrals.
8. Flash makes a Web site better – only if that flash is part of a well-thought-out
marketing plan.
9. It’s what up front that counts – what is up front counts in part, but the rest of
the system must be solidly in place as well.
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10. E-commerce will cause brick-and-mortar retail stores to disappear –
e-commerce represents just one component of the marketplace and just one
part of a firm’s target market mix.
11. The greatest opportunities lie in the retail sector – manufacturing and
service-based companies will continue to be prominent worldwide players.
12. It’s too late to get on the Web – e-commerce is currently in the early growth
stages of the product life cycle.
5. Explain the five basic approaches available to entrepreneurs for launching an
e-commerce effort. What are the advantages, the disadvantages, and the costs
associated with each one?
The five basic entrepreneurial approaches for launching an e-commerce effort and
the associated advantages, disadvantages, and costs are as follows:
1. Online Shopping Malls (for products)
2. Advantages: Offers the easiest and least expensive entry.
3. Disadvantages: Lack of prominence and control are limitations of this option.
4. Storefront-building Services
5. Advantages: Offers easy and low-cost entry.
6. Disadvantages: It may be difficult to distinguish one company from the next.
7. Internet Service Providers and Application Service Providers
Advantages: Offers a low-cost means to create an online store.
Disadvantages: Fees are often tied to volume that provides a correlation cost
(to volume) structure.
8. Hiring Professionals to Design a Custom Site
Advantages: May provide greatest returns.
Disadvantages: Costs are higher and this may not be a financially feasible
option for a start-up venture.
9. Building a Web Site In-House
Advantages: Provides the owner with complete control.
Disadvantages: Costs are higher with what may be an unpredictable learning
curve.
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6. What strategic advice would you offer an entrepreneur about to start an e-company?
An entrepreneur should use the same approach as starting any business venture—a
business plan. Special emphasis must be placed on both the nonpersonal and
“personal” marketing efforts.
7. What design characteristics make for a successful Web page?
Successful design characteristics are very customer-connected and may include: a
strong connection to the target customer, the proper and desired company image,
be easy to find, be easy to use, provide access to the firm’s staff, provide the
ability to track orders, and offer security, privacy, and reliability.
8. Explain the characteristics of an ideal domain name.
The ideal domain name will clearly depict and communicate the nature of
products and services offered.
9. Describe the techniques that are available to e-companies for tracking results
from their Web sites. What advantages does each offer?
A variety of software exists and is being further developed that allows a company
to count and track inquiries in great detail to monitor customer behavior, analyze
correlations from those behaviors, and calculate the return on investment. These
and other upcoming features will allow a business to quantify and improve on the
effectiveness of e-business ventures.
10. What steps should e-businesses take to ensure the privacy of the information
they collect and store from the Web?
E-businesses should establish, post, and follow a privacy policy in order for it to
be meaningful and effective.
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CHAPTER 10: PRICING STRATEGIES
CHAPTER SYNOPSIS
Setting prices is a business decision that is both an art and a science. The process
requires entrepreneurs to balance a multitude of complex forces to determine the prices
for their goods and services that will draw customers and produce a profit.
CHAPTER OBJECTIVES
1. Discuss the relationships among pricing, image, competition, and value.
2. Describe effective pricing techniques for both introducing new products or services
and for existing ones.
3. Explain the pricing methods and strategies for retailers, manufacturers, and
service firms.
4. Describe the impact of credit on pricing.
ISSUES FOR REVIEW AND DISCUSSION
I. Three Potent Forces: Image, Competition, and Value
Setting prices for products and services is complex and difficult. A number of
factors are important to carefully consider. Price conveys an image that must
match the company’s target markets. It is an art and a science.
Pricing communicates a powerful message about the organization’s image.
The firm must also consider its place among the competition and that does not
mean they have to match or beat competitor’s prices—it is about value.
This focus on value will set the “right” price based upon objective value and
perceived value.
Costs impact pricing and it is important that costs are based on communication
and the continued value you offer.
When all is taken into consideration, the factors that small business owners must
consider when determining price for goods and services includes:
• Product/service costs
• Market factors – supply and demand
• Sales volume
• Competitors’ prices
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• The company’s competitive advantage
• Economic conditions
• Business location
• Seasonal fluctuations
• Psychological factors
• Credit terms and purchase discounts
• Customers’ price sensitivity
• Desired image
Customized or dynamic pricing is a technique that sets different prices based on
the customer and their characteristics. For example, Dell Computer uses this
technique as people order systems online and more is learned about who they are
and what they are willing to pay.
II. Pricing Strategies and Tactics
When introducing a new product, the owner should try to satisfy three objectives:
1. Getting the product accepted
2. Maintaining market share as competition grows
3. Earning a profit
When introducing a new product, firms may choose from three basic strategies:
1. Market penetration: set prices below competitors to gain market entry.
2. Skimming: set higher prices for new products and for markets with little or no
competition.
3. Sliding-down-the-demand-curve: set higher prices initially and slide down as
technology improves and/or one step ahead of competitors.
Pricing established goods and services offers the following techniques:
• Odd pricing
• Price lining
• Leader pricing
• Geographical pricing
• Opportunistic pricing
• Discounts
• Multiple unit pricing
• Suggested retail prices
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III. Pricing Strategies and Methods for Retailers
Retailers have changed their pricing strategies to emphasize the value they offer.
This value/price relationship allows for a wide variety of highly creative pricing
and marketing practices.
Four of those value/price relationship practices are:
1. Markup
2. Follow-the-leader pricing
3. Below-market pricing
4. Adjustable or dynamic pricing
IV. Pricing Concepts for Manufacturers
Cost-plus pricing is the most commonly used pricing technique for manufactures.
The breakeven point is calculated on the basis of the variable costs and the
quantity produced as it compares to the total fixed costs.
Direct costing and price formulation is based upon:
Absorption costing: All manufacturing and overhead costs are absorbed into the
finished product’s total cost.
Variable (direct) costing: The costs of the product include only those costs that
vary directly with the quantity produced.
V. Pricing Strategies and Methods for Service Firms
Most service firms set prices based on hourly rates and materials that include a
margin for both overhead and profit.
VI. The Impact of Credit on Pricing
Consumer credit has a dramatic impact on pricing and on the attractiveness of the
business. This includes:
• Credit cards
• Installment credit
• Trade credit
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CHAPTER DISCUSSION QUESTIONS
1. How does pricing affect a small firm’s image?
A company’s pricing policy offers important information about its overall image.
Thus, when developing a marketing approach to pricing, a small business manager
must establish prices that are compatible with what its customers expect and are
willing to pay. Understanding the firm’s target market allows the small business to
set prices properly.
2. What competitive factors must the small firm consider when establishing
prices?
Factors that small business owners must consider when determining final price
include:
• Product/service costs
• Market factors – supply and demand
• Sales volume
• Competitors’ prices
• The company’s competitive advantage
• Economic conditions
• Business location
• Seasonal fluctuations
• Psychological factors
• Credit terms and purchase discounts
• Customers’ price sensitivity
• Desired image
3. Describe the strategies a small business could use in setting the price of a new
product. What objectives should the strategy seek to achieve?
When introducing a new product, the owner should try to satisfy three objectives:
1. Getting the product accepted
2. Maintaining market share as competition grows
3. Earning a profit
Three basic strategies to choose from in establishing the new product’s price include:
1. Penetration: Set prices below competitors to establish a market and achieve
sales volume.
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2. Skimming: Set a higher-than-normal price for a unique market with little or no
competition.
3. Sliding-down-the-demand-curve: Set high prices initially and then lower based
on competitor behavior and/or technological advancement.
4. Define the following pricing techniques:
1. Odd pricing: Establish prices that end in odd numbers with the belief that
merchandise selling with an odd ending number ($12.95) is cheaper than an
item evenly priced ($13.00).
2. Price lining: Manager stocks merchandise in several different price ranges, or
price lines. Each category of merchandise contains items that are similar in
appearance, quality, cost, performance, or other features.
3. Leader pricing: Small retailer marks down the customary price of a popular
item in an attempt to attract more customers.
4. Geographical pricing: Small company sells merchandise at different prices to
customers located in different territories.
5. Discounts: Reduction in the price of stale, outdated, damaged, or slow-moving
merchandise.
5. Why do so many small businesses use the manufacturer’s suggested retail price?
What are the disadvantages of this technique?
Small business owners frequently use suggested retail prices because this eliminates
the need for a pricing decision. Suggested retail prices are easy to use.
6. What is a markup? How is it used to determine individual price?
Markup is the difference between the cost of a good or service and its selling price.
It can also be expressed as a percentage of either cost or selling price.
7. What is a standard markup? A flexible markup?
A standard markup is a technique that is usually used in retail stores. It applies a
standard percentage markup to all merchandise.
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A flexible markup is usually more practical, and involves assigning various markup
percentages to different types of products.
8. What is cost-plus pricing? Why do so many manufacturers use it? What are
the disadvantages of using it?
Cost-plus pricing establishes prices using the costs of the direct materials, direct
labor, factory overhead, selling, and administrative costs required to produce a
product plus a reasonable profit margin. Cost-plus pricing is very popular, primarily
because of its simplicity. In addition, since a profit is added onto the firm’s cost, the
manufacturer is guaranteed a profit. However, cost-plus pricing does not encourage
the manufacturer to focus on efficient use of his resources since a profit is added
onto costs. Also, manufacturers’ cost structures vary significantly and cost-plus
pricing may not be competitive.
9. Explain the difference between full-absorption costing and direct costing. How
does absorption costing help a manufacturer determine a reasonable price?
Full absorption costing is the traditional method of product costing. It “absorbs”
the cost of direct materials, direct labor, plus a portion of fixed and variable factory
overhead into each unit manufactured. It is not very helpful in setting prices because
it confuses the true relationships among price, volume, and costs by including fixed
expenses in unit-cost computations.
Direct costing includes only those costs of production that vary directly with the
volume of production. Fixed overhead expenses are considered expenses of the
period. The result is a clear picture of the price-costs-volume relationship.
10. Explain the technique for a small service firm setting an hourly price.
Most service firms base their fees on the actual numbers of hours required to
perform the service. The first step is to estimate the actual number of hours of
producing the service and the total costs incurred. Then, the owner must compute
the total cost per productive hour. Next, the owner should determine his desired
profit to compute the final price.
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CHAPTER 11: CREATING A SUCCESSFUL
FINANCIAL PLAN
CHAPTER SYNOPSIS
A well-designed and logical financial plan is one of the most important steps to
launching a new business venture and therefore a critical aspect of a comprehensive
business plan. This chapter focuses on practical tools that will help entrepreneurs
develop a workable financial plan and enable them to plan to be profitable. We will
discuss the techniques involved in preparing projected (pro forma) financial statements,
conducting ratio analysis, and performing breakeven analysis.
CHAPTER OBJECTIVES
1. Understand the importance of preparing a financial plan.
2. Describe how to prepare the basic financial statements and use them to manage a
small business.
3. Create projected (pro forma) financial statements.
4. Understand the basic financial statements through ratio analysis.
5. Explain how to interpret financial ratios.
6. Conduct a breakeven analysis for a small company.
ISSUES FOR REVIEW AND DISCUSSION
I. Basic Financial Statements
There are four common financial challenges facing entrepreneurs:
1. Failing to collect and analyze basic financial data
2. Lack of any kind of financial plan
3. Ongoing analysis of financial statements
4. Financial planning is essential!
Three important financial statements assist entrepreneurs to better understand the
financial status of their business:
1. The balance sheet takes a “snapshot” of a business at a given date, providing
owners with an estimate of its value in terms of assets, liabilities, and equity.
2. The income statement is also called a profit and loss (P&L) statement and
compares expenses against revenues for a certain period of time to indicate
profits or losses.
3. The statement of cash flows shows the actual flow of cash into and out of a
business for a certain time period.
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II. Creating Projected Financial Statements
Entrepreneurs must determine the funds needed for starting and sustaining a
business for the initial growth period. Typically, the entrepreneur relies on data
collection through extensive market and field research and on published statistics
summarizing the performance of similar companies.
By developing pro forma statements, statements projecting future financial
activity, the owner transforms goals into reality by estimating the profitability and
overall financial condition of the business for the initial one- to three-year period.
A general guideline to assist with this process of developing pro forma statements
is to start with the sales forecast and work down.
• The pro forma income statement begins with the sales forecast and estimates
the corresponding expenses required to generate those sales dollars. Banks
typically require two- to three-year projections.
• The pro forma balance sheet starts with the beginning balances of cash,
inventories, assets, and liabilities. Banks typically require a year-one and year-two balance sheet projection.
• The proforma cash flow statement charts cash flow, typically by month, for
the first two years of operation. It is often one of the major criteria for lending
decisions by creditors.
III. Ratio analysis
Ratio Analysis expresses the relationship between two selected accounting
elements and is one technique used in conducting a financial analysis.
The 12 key ratios include:
Liquidity ratios indicate whether the business will be able to meet its short-term
financial obligations as they come due.
1. Current ratio – measures solvency through the relationship between current
assets and current liabilities.
2. Quick ratio – focuses even more on liquidity by removing inventory from
the current ratio calculation.
Leverage ratios measure the relationships between financing supplied by a
firm’s owners and by its creditors.
3. Debt ratio – measures total debt against total assets – the extent or
percentage of total assets owned by creditors
4. Debt-to-net-worth ratio – indicates the degree of leveraging by measuring
capital contributions from creditors against those by the owners (debt to
equity).
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5. Times interest earned ratio – a measure of the firm’s ability to make the
interest payments on its debt.
6. Average inventory-turnover ratio – measures the average number of times
inventory is “turned over” during the year.
7. Average collection period ratio – measures the average number of days it
takes to collect receivables.
8. Average payable period ratio – indicates the average number of days it takes
a company to pay its accounts payable.
9. Net sales to total assets ratio – the measure of a firm’s ability to generate
sales in relation to its assets.
10. Net sales to working capital ratio – measures the sales that a business
generates for every dollar of working capital.
11. Net profit on sales ratio – measures a firm’s profit per dollar of sales.
12. Net profit to equity ratio – measures an owner’s rate of return on investment.
IV. Interpreting Business Ratios
Ratios are useful yardsticks when measuring a small firm’s performance and can
point out potential problems before they develop into a crisis.
Comparison of a firm’s ratios to businesses within the same industry is a useful
tool. A firm can also develop ratios unique to its operation. Several
organizations compile and publish operating statistics including key ratios. This
information may be found in the following sources:
1. Robert Morris Associates
2. Dun & Bradstreet, Inc.
3. Vest Pocket Guide to Financial Ratios
4. Industry Spotlight
5. Bank of America
6. Trade associations
7. Government agencies
V. Breakeven Analysis
The breakeven point is the level of production and sales volume at which a
company’s revenues equal its expenses, resulting in a net income of zero.
First, determine the variable and fixed expenses.
1. Fixed expenses–costs that do not vary with changes in the volume of sales or
production.
2. Variable expenses–costs that vary directly with changes in the volume of
sales or production.
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Next, follow these steps to calculate the breakeven point:
Step 1: Determine the expenses a business can expect to incur.
Step 2: Categorize those expenses as fixed or variable.
Step 3: Calculate the percentage of variable expenses to net sales.
Determine the percentage of contribution margin to sales.
Step 4: Compute the breakeven point.
Include desired net income into the breakeven analysis calculations.
Calculate the breakeven point and desired profit in both units and dollars.
The breakeven chart illustrates the correlation with fixed and variable costs.
CHAPTER DISCUSSION QUESTIONS
1. Why is developing a financial plan so important to an entrepreneur about to
launch a business?
Developing a financial plan is one of the most important steps in launching a new
business venture. Prospective investors will demand such a plan before putting
their money into a start-up company. A financial plan is a tool that helps
entrepreneurs manage their businesses more effectively, steering their way around
the pitfalls that cause failures.
2. How should a small business use the 12 ratios discussed in this chapter?
Ratios help measure a firm’s performance and can point out potential problems
before they become more serious. One way to use ratios is to compare a business
to others in the same industry. It is also helpful for the owner to analyze the firm’s
financial ratios and trends over time.
3. Outline the key points of the 12 ratios discussed in this chapter. What signals
does each give the manager?
1. Current ratio – the firm’s ability to pay current liabilities using current assets.
2. Quick ratio – extent to which firm’s most liquid assets cover its current
liabilities.
3. Debt ratio – measure the financing supplied by business owners and creditors.
4. Debt-to-net-worth ratio – compares what the business owes to what it owns.
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5. Times interest earned – a measure of the firm’s ability to make interest
payments.
6. Average inventory turnover ratio – measures the number of times inventory is
“turned over” per year.
7. Average collection period – the average number of days to collect accounts
receivables.
8. Average payable period – the average number of days it takes to pay accounts
payables.
9. Net sales to total assets ratio – measures a firm’s ability to generate sales in
relation to its assets.
10. Net sales to working capital – measures sales generated for every dollar of
working capital.
11. Net profit on sales ratio – measures a firm’s profit per dollar of sales.
12. Net profit to equity ratio – measures an owner’s rate of return on investment
(ROI).
4. Describe the method for building a projected income statement and a
projected balance sheet for a new business.
A projected income statement starts with a sales forecast that should be based
primarily on market research about the firm’s competition and customer base. The
sales forecast allows the income statement and balance sheet to be completed.
5. Why are pro forma financial statements important to the financial planning
process?
No entrepreneur should launch a business without first creating a sound financial
plan and attracting the capital to operate it. Pro forma statements are a vital
element in such a plan, as they estimate the firm’s future profitability and overall
financial condition. These statements help the owner determine what funds are
required to launch the business and sustain it through its initial growth period.
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6. How can breakeven analysis help an entrepreneur launch a business?
Break-even analysis first lets an entrepreneur know the sales volume that must be
generated to “break-even.” It also serves as a “reality check” in relation to the
competition, the customer base, and the sales volume that must be generated in
order to earn the desired profit.
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CHAPTER 12: MANAGING CASH FLOW
CHAPTER SYNOPSIS
“Everything is about cash,” says entrepreneur and venture capitalist Guy Kawasaki,
“raising it, conserving it, collecting it.” The phrase “cash is king” is familiar to
entrepreneurs and, once a business is launched, managing cash flow becomes a central
focus.
CHAPTER OBJECTIVES
1. Explain the importance of cash management to a small company’s success.
2. Differentiate between cash and profits.
3. Understand the five steps in creating a cash budget and use them to create a cash
budget.
4. Describe fundamental principles involved in managing the “Big Three” of cash
management: accounts receivable, accounts payable, and inventory.
5. Explain the techniques for avoiding a cash crunch in a small company.
ISSUES FOR REVIEW AND DISCUSSION
I. Cash Management
Cash is the most important yet least productive asset that a small business owns.
Businesses must have enough cash to meet their obligations or run the risk of
declaring bankruptcy. It is entirely possible for a business to earn a profit and still
go out of business by running out of cash. Small and growing companies are like
“sponges,” soaking up every available dollar to fund growth and sales.
The first step in managing cash more effectively is to understand the company’s
cash flow cycle.
Cash flow cycle is the time lag between paying suppliers for merchandise or
materials and receiving payment from customers for the product or service.
Business owners should calculate their cash conversion cycle whenever they
prepare their financial statements. On a daily basis, business owners should
generate reports showing the following: total cash on hand, bank balances,
“summary of day” sales, “summary of the day” cash receipts, and a summary of
accounts receivables collections.
The entrepreneur has five roles they take on to manage cash flow:
1. The role of the cash “Finder”
2. The role of the cash “Planner”
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3. The role of the cash “Distributor”
4. The role of the cash “Collector”
5. The role of the cash “Conserver”
The next step in effective cash management is to shorten the length of the cash
flow cycle. Receiving your cash sooner—rather than later—has a positive impact
on your cash flow.
As an essential business resource, cash is used, or depleted, to purchase goods and
materials and pay for labor to create products for inventory. When these products
are sold, this is turned back into cash or accounting receivables and the inventory
can be replaced as profits are generated.
Profit (or net income) is the difference between a company’s total revenues and
total expenses. It measures how efficiently the business is operating.
Cash flow measures a company’s liquidity and its ability to pay its bill and other
financial obligations on time by tracking the flow of cash into and out of the
business over a period of time. Profitability does not guarantee liquidity. Cash is
the money that flows through a business in a continuous cycle without being tied
up in any other asset.
II. The Cash Budget
The need for a cash budget arises because the uneven flow of cash in a business
cycle creates surpluses and shortages. A cash budget is based on the cash method
of accounting. Credit sales to customers are not recorded until the customer
actually pays, and purchases made on credit are not recorded until the owner pays
them. Depreciation, bad debt expense, and other noncash items that do not involve
cash transfers are omitted entirely from the cash budget. A cash budget is nothing
more than a “cash map.” The cash budget shows the amount and timing of cash
receipts and cash disbursements day by day, week by week, or month by month
and is used to predict the amount of cash the firm will need to operate smoothly
over a specific period of time.
III. Preparing a Cash Budget
Five basic steps to preparing a cash budget include:
1. Determining an adequate minimum cash balance – the most reliable method
is based on past experience. For example, past operating records may indicate
that it is desirable to maintain a cash balance equal to five days’ sales.
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2. Forecasting sales – sales forecasts are the heart of the cash budget and are
based partially on past patterns. Financial analysts suggest creating three
estimates—optimistic, pessimistic, and most likely.
3. Forecasting cash receipts – the budget must account for the delay between
the sale and the actual collection of the proceeds. It is vital to act promptly
once an account becomes past due.
4. Forecasting cash disbursements – many cash payments are fixed amounts
due on specified dates. Others are standard like the purchase of inventory,
salary and wages, overhead, selling expenses, and so on. Financial analysts
suggest that new owners add an additional 10 to 25 percent to estimate
disbursement totals as a cushion.
5. Determining the end-of-month cash balance – the cash balance at the end of
the month becomes the beginning balance for the following month. Anticipate
cash shortages and surpluses; this can reduce lending expenses and time.
Determining a minimum cash balance is also important. A range of cash balances
gives you an insight to know the amount of cash that is acceptable, enough to get
you through time of need, but not too much to have “lazy cash” that is not
effectively working for your business.
Forecasting sales is at the heart of the cash budget and will be an important
predictor for cash flow projections.
Common causes of cash flow problem within small businesses include:
• Difficulty collecting accounts receivables
• Seasonal sales patterns
• Unexpected variations in sales
• Weak sales
Collecting delinquent accounts is critical to keep cash flow moving in a positive
direction and can be a challenging task for the entrepreneur.
Forecasting cash disbursements can become more meaningful through:
• Recording disbursements
• Noting their due dates
• Reviewing the checkbook and expenses
• Adding a cushion to those estimates
• Making a daily list of items that generate and consume cash
Estimating the end-of-the-month balance will give you insight and may help to
avoid a shortage or identify a cash surplus.
The most significant benefits of effective cash management include:
• Increasing the amount of cash and the speed of cash flow into the company
• Reducing the amount of cash flow leaving the company
• Making the most efficient use of available cash
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• Taking advantage of money-saving opportunities such as cash discounts
• Efficiently financing seasonal business needs
• Developing a sound borrowing and repayment program
• Impressing lenders and investors
• Reducing borrowing costs by only doing when needed
• Providing funds for expenses
• Planning for investing surplus cash
IV. The “Big Three” of Cash Management
There are three essential factors for the effective management of cash flow:
1. Accounts receivable – extending credit to customers. A firm should always
try to accelerate the collection of its receivables. If possible, a firm should also
work to reduce or even eliminate credit sales.
2. Accounts payable – suppliers and others extend credit to you. Take advantage
of and never abuse those opportunities.
3. Inventory – is the number one expense for all retail and manufacturing
businesses. Product-based businesses need to monitor, manage, and control
their inventory on a continual basis.
Accounts receivable is a critical area for the entrepreneur to address. Establishing
a credit and collection policy and process is essential. This will provide clear and
consistent direction for you, your employees, and your customers.
The steps to establishing a credit and collection policy include:
• Screen customers carefully by developing a detailed credit application. Know
when to walk away from an order—why make the sale if you won’t get paid?
• Establish a written credit policy and let every customer know the company’s
credit terms in advance.
• Send invoices promptly (cycle billing).
• Take immediate actions when an account becomes overdue.
Steps to accelerate the collection of accounts receivable through encouraging the
prompt payment of invoices include:
• Ensure that invoices are clear, accurate, and timely.
• Make sure that invoice prices agree with the quotations on purchase orders or
contracts.
• Highlight the terms of the sale (2/10/net30, net 30).
• Include a telephone number and contact person in your organization in case
the customer has a question or concern.
• Work with company owners or representatives in a positive and collaborative
fashion to reduce and eliminate their overdue accounts.
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• As a last resort, consult with your attorney and/or turn the account over to a
collection attorney.
Few owners use any formal method for managing inventory. Entrepreneurs may
find that they have either too much inventory, or the wrong type of inventory that
has become outdated or obsolete. This inventory ties up cash and is expensive to
the firm. A typical manufacturing company pays 25-30 percent of the value of its
inventory in handling and finance costs; however, retailers that carry too little
inventory experience stockouts and lost sales.
Entrepreneurs can avoid a cash crisis through an effective management of
accounts receivable. Tips to accomplish this include:
• Stretching out payment times without jeopardizing credit
• Verify all invoices before payment
• Take advantage of cash discounts
• Negotiate terms with suppliers
• Communicate with creditors about your status
• Schedule and stagger cash disbursements
• Use credit cards wisely
Inventory management also plays an important role through:
• Monitoring it regularly
• Not buying more than needed
• Scheduling deliveries at the latest possible date
• Negotiating quantity discounts
V. Avoiding the Cash Crunch
Tools that allow small business managers to get the maximum benefit from their
companies’ pool of cash include:
Bartering:
the exchange of goods and services for other goods and services rather than for
cash is an effective way to conserve cash.
Trimming overhead costs:
high overhead expenses can strain a small firm’s cash supply. Ways to trim
overhead costs include:
1. Periodically evaluate expenses
2. When practical, lease instead of buy
3. Avoid nonessential outlays
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4. Negotiate fixed loan payments to coincide with your company’s cash flow
cycle
5. Buy used or reconditioned equipment, especially if it is “behind-the-scenes”
machinery
6. Hire part-time employees and freelance specialists whenever possible
7. Control employee advances and loans
8. Establish an internal security and control system
9. Develop a system to battle check fraud
10. Change your shipping terms
11. Switch to zero-based budgeting
Additional ways to control cash flow include making efforts to:
• Be on the lookout for employee theft.
• Keep your business plan current.
• Invest surplus cash to generate revenue.
CHAPTER DISCUSSION QUESTIONS
1. Why must entrepreneurs concentrate on effective cash management?
Cash is the lifeblood of any business. It is the most important yet least productive
asset a business owns. Proper cash management enables the owner to meet cash
demands, to avoid keeping unnecessary cash balances, and to maximize the profit-generating power of each sales dollar. More businesses fail for lack of cash than for
lack of profit.
2. Explain the difference between cash and profit.
Profit and cash are not the same. Profit is the net increase over a period of time in
capital cycled through the business, indicating how effectively the firm is being
managed. Cash is the money that flows through the business in a continuous cycle.
A business cannot spend profits—only the cash it possesses.
3. Outline the steps involved in developing a cash budget.
There are five basic steps to preparing a cash budget:
1. Determining an appropriate minimum cash balance
2. Forecast sales
3. Forecast cash receipts
4. Forecast cash disbursements
5. Determine end-of-month cash balances and needs
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4. How can an entrepreneur launching a new business forecast sales?
For an established business, a sales forecast can be derived from past experience
and past sales data. The founder of a new business must rely on published statistics,
market surveys, the opinions of outside experts, and his/her own judgment to create
a sales forecast.
5. What are the “big three” of cash management? What effect do they have on a
company’s cash flow?
The “big three” of cash management are:
1. Accounts receivables:
Extending credit to customers. Cash flow is greatly affected due to the time lag
between the sale and the actual collection of cash. It affects cash flow through
the speed in which invoices are paid and cash is received.
2. Accounts payable:
suppliers and others extend credit to you.
This can have a very favorable effect on a firm’s cash flow as inventory may be
purchased using the supplier and/or bank funds. The basic principles of
management revolve around ordering merchandise that will turn over and be
paid for in a timely fashion.
3. Inventory:
the number one expense for all retail and manufacturing businesses. Inventory
affects cash flow because the cash is locked in place until sold. The major
principle of management is maximizing inventory turnover.
6. Outline the basic principles of managing a small firm’s receivables, payables,
and inventory.
The basic principles of managing receivables, payables, and inventory include the
following and are based on the “big three” of cash management:
Accounts receivable:
• Screen customers carefully by establishing a detailed credit application. Know
when to walk away from an order.
• Establish a firm written credit policy and let every customer know the
company’s credit terms in advance.
• Send invoices promptly.
• Take immediate action when an account becomes overdue.
• Ensure that all invoices are clear, accurate, and timely.
Small Business Management – Chapters 3-7 BUS560(2011E)
Page 38
• State clearly a description of the goods or services purchased and an account
number, if possible.
• Make sure that prices on invoices agree with the price quotations on purchase
orders or contracts.
• Highlight the terms of sale (e.g., “net 30”) on all invoices and reinforce them, if
necessary.
• Include a telephone number and a contact person in your organization in case
the customer has a question or a dispute.
Accounts payable:
Managing accounts payable can have a very favorable effect on a firm’s cash flow
as inventory may be purchased using the supplier and/or bank funds. The basic
principles of management revolve around ordering merchandise that will turn over
and be paid for in a timely fashion. For example, extending accounts payable
whenever possible, and without jeopardizing your credit status, can have a very
positive impact on cash flow.
Inventory:
Inventory affects cash flow because the cash is locked in place until sold. The major
principle of management is maximizing inventory turnover.
7. How can bartering improve a company’s cash position?
Bartering is the exchange of goods and services for other goods and services and
can be an effective method of conserving cash. The owner receives goods and
services without having to spend cash. In addition, the owner may be able to
collect uncollectable accounts.
8. What steps can entrepreneurs take to conserve cash within their companies?
Tools that allow small business managers to get maximum benefit from their
companies’ pools of cash include:
1. Bartering
2. Trimming overhead costs
3. Keeping your business plan current
4. Investing surplus cash
9. What should be a small business owner’s primary concern when investing
surplus cash?
The primary concerns for investing surplus cash should be safety and liquidity.
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