CH-8-11 Accounting Records and Financial Statements – Small Business Management: Entrepreneurship and Beyond : Book Guide

This Document Contains Chapters 8 to 11 Chapter 8 Accounting Records and Financial Statements Teaching Tips • Use the Chapter Opener to show how small business owners can increase profits and free cash flow through simple analysis of their own accounting records • The Entre-Perspectives, Open-Book Management uses an accounting system to apply open-book management. Employees can actually see where money comes from and where it goes. • Have a CPA speak to class about financial statement analysis and accounting systems for small businesses. • Use 'Trep Connections, Computerized Accounting Packages, to discuss the primary way small businesses keep their books with accounting packages. This box highlights some of the most popular choices. The purpose of accounting systems is to convert raw data into information to make management decisions. This shows what small business owners should know at any given time about their business. • Use the case, What Would You Do? when you are discussing financial ratios to have students make calculations in addition to talking about them. • The chapter closing case features a company that started their business working closely high end restaurants—now they face the decision of going another direction. Have students read the case setup before class and have students make a commitment on what they recommend before you share “The Decision” (it is available at the end of this section). Then you can either begin class discussion with the whole group or break the class into groups of three or four and have them brainstorm strategies before opening discussion to all. After you hear students’ recommended strategies, read “The Decision” to share what really happened. Lecture Outline Opening Vignette: Krispy Kreme What’s the Point? Krispy Kreme is a company recognizable to most students that grew quickly then fell upon hard times. The point of this chapter opener is to illustrate how a small business solved a typical problem— reducing costs and improving cash flow via the bookkeeping and accounting systems it already had in place. Concept Module 8.1 Small Business Accounting LO1 Discuss the importance and uses of financial records in a small business. Accounting is not about making rows and columns of numbers—it is about organizing and communicating what is going on in a business. Numbers are the language of business. (See Figure 8.1, The Accounting Process.) How Important Are Financial Records? A. Many of the mismanagement decisions that spell doom for many small businesses are related to financial and accounting issues. B. Accurate Information for Management A small business owner needs information in order to make informed management decisions. Good records provide much of that information. C. Banking and Tax Requirements The information on financial statements is needed to prepare tax records and bank loan documents. Reality Check: But What About…? This box covers questions that small business owners should be asking their accountants. Concept Check Questions 1. How can financial records allow you to identify problems in your business? Financial records allow a business to compare its performance in one period (week, month, quarter, or year) with another period to measure progress or problems. Financial records are the foundation for calculating financial ratios to compare a business with other businesses in its industry to show if something is out of industry norm. 2. Assets = Liabilities + Owner’s Equity. How would you restate this equation if you wanted to know what your liabilities were? Your owner’s equity? Liabilities = Assets – Owner’s Equity Owner’s Equity = Assets – Liabilities 3. What purpose do GAAP and FASB serve for a small business owner? Generally Accepted Accounting Principles (GAAP) are guidelines and principles to be followed when putting together and maintaining accounting systems for businesses. It is important that all businesses follow these guidelines so financial statements of different businesses can be compared and are uniform. 4. Explain the difference between cash and accrual accounting. Both are accounting systems. The difference between the two refers to when income and expenses are recorded. When using a cash method, income and expenses are recorded at the time they are paid. With an accrual system, income and expenses are recorded when they are incurred. Concept Module 8.2 Small Business Accounting Basics LO2 Itemize the accounting records needed for a small business. A. A small business accounting system needs to be easy to use, accurate, timely, consistent, understandable, dependable, and complete. B. Double- and Single-Entry Systems 1. Double-entry systems are comprised of three elements—assets, liabilities, and owner’s equity. Assets are what the business owns. Liabilities are what the business owes, and owner’s equity is the value of the owner’s investment. The margin definition of double-entry accounting states that every transaction is recorded as an asset account and a liability or owner’s equity account. The author would like to thank Donald Marshall of the Houston, Texas, area for pointing out that saying that every transaction is recorded as a debit and a credit is a more accurate statement. 2. Single-entry systems record the flow of income and expenses in a running log—basically as a checkbook. 'Trep Connections: Small Business Dashboard This box discusses computerized accounting information systems that can save time in entering data and generating information, improve traceability of income and expenses, and improve timeliness and frequency of accounting statements. Quickbooks Pro and Peachtree Complete Accounting are discussed. C. Accounting Equations Assets = Liabilities + Owner’s Equity is the basis of the balance sheet. Profit = Revenue – Expenses represents the activity of the income statement. Cash Flow = Receipts – Disbursements is the basis of the cash flow statement. D. Cash and Accrual Methods of Accounting 1. Under an accrual basis method of accounting, income and expenses are recorded at the time they are incurred, rather than when they are paid. 2. With a cash basis method of accounting, income and expenses are recorded at the time they are paid, rather than when they are incurred. E. What Accounting Records Do You Need? 1. Generally accepted accounting principles (GAAP) are guidelines and standards that create uniform financial statement formats. 2. Journals and Ledgers—where all the transactions of a business are recorded into specific accounts. From these records, financial statements are prepared. 3. Income Statement (or profit and loss statement)—can be basically broken into five sections. (See Figure 8.2, Stereo City Income Statement.) a) Net sales b) Cost of goods sold c) Gross margin d) Expenses e) Net income (or loss) 4. Balance Sheet—a snapshot of the business at any given moment in time. The balance sheet has two main sections—assets of the business and another section of the liabilities and capital. (See Figure 8.3, Stereo City Balance Sheet.) 5. Statement of Cash Flow—As the name implies, the statement of cash flow shows cash coming into and going out of the business. More money flowing out than in is called “negative cash flow.” (See Figure 8.4, Stereo City Cash Flow Statement.) 6. What If You Are Starting a New Business? Concept Check Questions 1. You need to write a business plan for a startup business. How do you come up with the numbers for your pro forma financial statements? Do you just guess and make them up? (Hint: the process starts with a sales forecast.) Once you calculate your sales forecast, this becomes the top line of your income statement. From that top line, you can look at industry averages to subtract common levels of expenses for similar businesses. Industry averages are also beneficial for preparing pro forma balance sheets. Concept Module 8.3 Analyzing Financial Statements LO3 Explain the 11 ratios used to analyze financial statements. A. The ability to make sound financial decisions depends on how well a businessperson can understand, interpret, and use the information found in financial statements—specifically ratio analysis. B. Ratio Analysis Financial ratios are calculations that compare important aspects of a business. Ratios are used by comparisons made with historical data from the same business or with industry averages, such as Robert Morris Associates Annual Statement Summaries. Reality Check: Do You Have a Business or a Hobby? How a sideline business is classified depends on several factors cited in this box. C. Liquidity Ratios These ratios measure the firm’s ability to meet its short-term obligations to creditors as they come due. 1. Current Ratio—measures the number of times a business can cover its current liabilities with its current assets. 2. Quick Ratio—measures the firm’s ability to meet current obligations with the most liquid of its current assets. D. Activity Ratios These ratios measure the speed with which various accounts are converted into sales or cash. 1. Inventory Turnover—measures the liquidity of the firms inventory—how quickly goods are sold and replenished. 2. Average Collection Period—measures how long it takes a firm to convert a credit sale into cash. 3. Fixed Asset Turnover—measures how efficiently the firm is using its assets to generate sales. 4. Total Asset Turnover—measures how efficiently the firm uses all of its assets to generate sales. E. Leverage Ratios These ratios measure the extent to which a firm uses debt as a source of financing and its ability to service that debt. 1. Debt Ratio—measures the proportion of a firm’s total assets that is acquired with borrowed funds. 2. Times Interest Earned—measures the firm’s ability to meet its interest requirements. It shows how far operating income can decline before the firm will likely have difficulties servicing its debt obligations. F. Profitability Ratios These ratios measure the ability of a company to turn sales into profits and to earn profits on assets committed. They provide some insight into the overall effectiveness of the management team. 1. Net Profit Margin—measures the percentage of each sales dollar that remains as profit after all expenses, including taxes, have been paid. 2. Return on Assets—measures the firm’s effectiveness in generating profits from its available assets. 3. Return on Equity—measures the return the firm earned on its owner’s investment into the business. What Would You Do? 1. Calculate liquidity, activity, leverage, and profitability ratios for OnGoal. Liquidity: current ratio—$40,760/$18,000 = 2.26; Activity: inventory turnover—$21,800/18,200 = 1.2; average collection period—$12,400/$178,000/365 = 25.41; Leverage: debt ratio—$93,000/$132,160 = .70; Profitability: net profit—$11,740/$178,000 = .066; return on equity—$11,740/39,160 = .299 2. Pair off and compare your ratios. Discuss which of the ratios look weak and which look positive. Develop a one-page explanation of the company’s ratios that you can show potential lenders. Students answers will vary. Company Ratio Analysis Overview This overview highlights our financial ratios, showcasing strengths and weaknesses for potential lenders. 1. Liquidity Ratios • Current Ratio: 1.5 Positive: Indicates good short-term financial health (above industry average of 1.2). • Quick Ratio: 1.0 Positive: Meets current obligations with liquid assets, equal to industry average. 2. Activity Ratios • Inventory Turnover: 8.0 Positive: Efficient inventory management, significantly above the industry average of 5.0. • Average Collection Period: 30 days Positive: Faster cash conversion compared to the industry average of 45 days. 3. Leverage Ratios • Debt Ratio: 0.4 Positive: Lower reliance on debt than the industry average of 0.5, indicating less financial risk. • Times Interest Earned: 5.0 Positive: Strong ability to meet interest payments, above the industry average of 3.0. 4. Profitability Ratios • Net Profit Margin: 15% Positive: Strong profitability, higher than the industry average of 10%. • Return on Assets (ROA): 12% Positive: Effective asset utilization, exceeding the industry average of 8%. • Return on Equity (ROE): 18% Positive: High returns for shareholders, above the industry average of 12%. Conclusion Overall, our ratios indicate a robust financial position with no significant weaknesses. This strong performance demonstrates our ability to meet obligations, effectively manage resources, and generate profits, making us an attractive candidate for lenders. G. The Use of Financial Ratios Financial ratios by themselves tell us very little. They must be compared with something to be useful. 1. Cross-Sectional Analysis—comparison of a firm’s financial ratios with standard ratios for industry. RMA Annual Statement Studies, Dun & Bradstreet’s Industry Norms and Key Business Ratios, and Financial Research Associates Financial Studies of the Small Business are good sources. (See Table 8.1, Comparing Company and Industry Ratios.) 2. Time Series Analysis—comparison of a firm’s ratios with the same ratios calculated for the same company at other periods of time. Concept Check Questions 1. Define the term “leverage” as it applies to accounting. Leverage refers to the amount of debt a business uses in order to magnify its financial power. In using leverage, the owner of a business must make the borrowed funds produce more money than has to be paid in interest. 2. How can profitability ratios allow insight into the effectiveness of management? Liquidity ratios? Activity ratios? Leverage ratios? Profitability ratios show how efficiently a business has been managed and how well it has used its assets to generate profits. Liquidity ratios show how well a business can meet its financial obligations to pay its debts. Activity ratios show how well a business converts accounts into sales and how efficiently a business uses its assets. Leverage ratios show the extent to which the business uses borrowed funds to use other people’s money to generate profits. 3. The sales projection for your retail business is $650,000. The industry average for the asset turnover ratio is five. How much inventory should you plan to stock? $650,000/5 times turned = $130,000 of inventory needed Concept Module 8.4 Managing Cash Flow LO4 Illustrate the importance of and procedures for managing cash flow. A. Most business failures occur due to cash flow problems. You could say that starting a small business begins a race to see if the business can survive long enough for it to generate a positive cash flow. B. Cash Flow Defined Cash flow is the difference between the actual amount of cash a company brings in and the actual amount of cash a company disburses in a given time period. The key to good cash management is having cash available when it is needed. C. Cash Flow Specialist A small business owner must become a cash flow specialist. D. Cash Flow Fundamentals 1. Motives for Having Cash a) To make transactions b) To protect against unanticipated problems c) To invest in opportunities as they arise. 2. Cash-to-Cash Cycle—also called the operating cycle, tracks the way cash flows through the business. It identifies how long it takes from the time a firm makes a cash outlay for raw materials or inventory until the cash is collected from the sale of the finished goods. (See Figure 8.5, Cash-to-Cash Cycle.) 3. The Timing of Cash Flows E. Cash Flow Management Tools 1. Cash Budgets—allow a company to plan its short-term cash needs. They typically cover a one-year period that is divided into smaller intervals. Cash budgeting is not easy to do—there are always disruptions to the process. (See Table 8.2, Cash Budget Forma.) Entre-Perspectives: Opening the Books (Jack Stack of Springfield Remanufacturing Company) This company was one of the pioneers in open-book management. This practice shows everyone in the company the numbers that are critical to performance. 2. Aging Schedules—list a firm’s accounts receivables according to the length of time they are outstanding. A macro-aging schedule lists categories of outstanding accounts with the percentage of accounts that falls within each category. A micro-aging schedule shows each customer, the amount they owe, and the amount that they are past due. (See Table 8.3, Macro-Aging Schedule and Table 8.4, Micro-Aging Schedule.) F. Strategies for Cash Flow Management 1. Accounts Receivable—the first place to look for ways of improving cash flow. The key to effective cash flow management is the ability to collect receivables quickly. 2. Inventory—can be a huge drain on cash flow. Inventory represents dollar bills stacked on a shelf. 3. Banks—their services and policies can be used to improve cash flow. 4. Other Areas of Cash Flow Concern. Concept Check Questions 1. If you were setting up open-book management in your business, what would you teach employees to make it work? If an open-book management system is to work, the employees must learn what the various numbers in the company’s financial statements mean. When employees know and understand the numbers, they can measure their contribution to the company’s bottom line and how their performance can make a difference in those numbers. Employees are more motivated to work harder when they can see that they have a direct stake in the company’s ultimate success. 2. Explain the difference between macro-aging and micro-aging accounts receivable schedules. A macro-aging schedule breaks down all the money that is owed to a business and shows how long it has been owed. A micro-aging schedule shows each account receivable, the amount owed, and how long each amount has been owed. 3. Cash flow is described as the lifeblood of a business. How would you explain this description to someone who does not understand business finance? Cash is a critical asset to a business because it is needed to meet all the demands of the business: to purchase inventory, pay employees, pay rent and utilities, advertise, and do everything else needed to operate the business. Without cash, the business cannot survive; it is literally the lifeblood of a business—the way it circulates through the business to keep it healthy. 4. Cash flow is more important than profit for a small business. Why? If your income statement shows a profit at the end of the month, how can anything be more important? Money tied up in inventory or accounts receivable is not available for use by the business or you, the owner. So, while a profit may be shown on paper, if you are out of cash, you are on your way to being out of business. Experience This…bonus student exercis Choose a type of small business that is of interest to you. Go to your library and find industry standard ratios in Robert Morris Associates’s Annual Statement Studies or Dun & Bradstreet’s Industry Norms and Key Business Ratios. What do these standards tell you about the financial needs for this type of business? For example, is inventory turnover high or low in your chosen industry? Are profit margins tight or high? In these examples, a business in an industry with high inventory turnover will need access to operating capital because more inventory will be needed more often. An industry with higher gross margins will allow more latitude in operating expenses. Chapter Closing Case TO TEA OR NOT TO TEA? Questions – 1.What financial risks would Mighty Leaf take by pursuing a supermarket strategy? Increased volume of selling via mainstream grocery stores rather than small volume via restaurants will likely create cash flow problems from vastly increased production needed accompanied by longer payment periods. The markup in grocery stores is very different from restaurants also – grocery business means high volume low margin. 2.How could they moderate cash flow problems? Mighty Leaf needs to continue to create their brand based on health benefits rather than competing on price. Premium grocery stores are interested in holding premium prices and may be a better choice than mainstream stores. For such an aggressive expansion plan, Mighty Leaf may need to pursue venture capital giving up equity for enough cash to remain cash flow positive. 3.What would you recommend Mighty Leaf do? Be sure to justify your recommendation? Students generally favor rapid expansion, but recommendations will vary. Make sure students justify their reasons. The Decision Shinner and Portman heard out Woodruff one more time. He laid out his case against Mighty Leaf's becoming mass market: the move was premature, too costly, and ultimately would put the brand's well-cultivated cachet in jeopardy. But even though he made his case forcefully, Shinner and Portman just as convincingly pushed back. Mighty Leaf, they argued, was firmly established in the upscale sectors of hotels, restaurants, and specialty stores. Supermarkets were the next logical frontier. Shinner and Portman were ready to take the plunge. "There's a constant balance between maintaining your brand's halo and making your product accessible in more locations," says Shinner. "But with the right nurturing, they're not mutually exclusive." Shinner and Portman began talking to investors. In May 2007, confident they would be able to raise funds, they hired their first national sales director, Rich Clark, the first of two salespeople Mighty Leaf wound up poaching from herbal-tea giant Celestial Seasonings. Clark, formerly a Celestial sales manager, would lead the ground game, hitting up supermarket buyers for the chance to make a presentation. Because buyers are responsible for hundreds of products at any given time, just getting an appointment can be a coup, and it's usually a positive signal about the chain's willingness to give a new product a go. Many buyers were already familiar with Mighty Leaf, either through seeing it in restaurants or at trade shows, or through word of mouth. In the fall of 2007, Clark sent some samples to Derby Brackett, then a buyer for Ukrop's, a small Virginia grocery chain based in Richmond. Brackett had been looking to add some more expensive tea brands to the chain's existing specialty selection of Twinings, Bigelow, and Celestial Seasonings, and she liked what she saw in Mighty Leaf, especially the attractive packaging. "The same thing that happened in coffee five years ago is now happening in tea," Brackett says. "We have to go upmarket." Brackett agreed to test Mighty Leaf in an upscale outlet Ukrop's operated in Richmond. If it did well there, she would put it in almost all of the chain's 29 stores. The trial was a success. By November, however, Celestial had already launched its own whole-leaf line, called Saphara. Shinner and Portman decided to accelerate their plans. Instead of trying to reach 6,000 supermarkets within two years, they would do it in one. "You start to worry about the entire category being saturated or other companies taking advantage of this opportunity or blocking space on the shelf," Shinner says. "We felt it better to take advantage of that opportunity rather than waiting till '09." Meanwhile, Woodruff tried to assuage his customers' concerns about Mighty Leaf's going downmarket. "It was a couple of sleepless nights and a lot of worried conversations," he says. He lost some customers but gained new ones. In the end, he didn't lose any business on the whole. The final piece of the puzzle -- financing the expansion -- came in December 2007, when San Francisco private equity firm VMG Partners bought roughly a 20 percent stake in Mighty Leaf for an undisclosed sum. The firm's principals had helped launch Vitaminwater into the mass market in 2003, where it fended off copycats from Dasani and Aquafina. "Just because a big guy comes in, it doesn't mean that the entrepreneur cannot compete and get his fair share," says VMG partner Mike Mauze. Mighty Leaf won its first supermarket account in February 2008, and by October, it had landed in most Kroger, Publix, Safeway, and Stop & Shop stores. Sales were up 25 percent and were expected to hit $20 million for 2008. Within a few years, Shinner says, supermarkets should account for at least 40 percent of revenue. Mighty Leaf's mass-market debut has so far gone smoothly, but the economy's deep funk threatens to throw a wrench into the company's ambitious plans. Consumers are retrenching, hotel vacancies are rising, restaurants are closing, and gourmet grocers are struggling. Will supermarket shoppers still be willing to shell out $8 for a box of Mighty Leaf in the depths of a sharp recession? Shinner and Portman are betting yes. Even in an era of belt tightening, they insist, consumers still want to splurge on the little things. Says Mauze: "It's still 50 cents a serving. It's still a simple luxury that the consumer can afford." SOURCE: www.inc.com/magazine/20090101/mighty-leaf-is-a-darlng-of-upscale-restaurants.html Chapter 9 Small Business Finance Teaching Tips • Use the Chapter Opener to begin discussion on variety of funding for small business. • Invite a commercial loan officer from a local bank to speak to the class about what is needed to get a small business loan. • Use Reality Check, Credit Card Start-up Funding - Really? to discuss the important topic of using credit cards as a facet of funding a small business • Show that it is just as important to develop a long-term relationship with bankers as it is with suppliers, employees, and customers. Some hints to accomplish this are in Manager’s Notes, Banker Talk. • Entre-Perspective on Norm Brodsky provides seasoned financial advice that applies to any and every small business. • Since writing a business plan is a common assignment in a small business class, use the case, What Would You Do? for students to identify the assets they will need for their proposed business (or any business they imagine). • The chapter closing case is an especially gut-wrenching story of a business owner struggling with a bankruptcy decision—and the impact it would have on her partner (and mother). Have students read the case before class. Then you can either begin class discussion with the whole group or break the class into groups of three or four and have them brainstorm strategies before opening discussion to all. After you hear students’ recommended strategies, read “The Decision” and “The Experts Weigh In” to share what really happened. Lecture Outline Opening Vignette: Sarah Dvork and other startup funding stories What’s the Point? The point of this chapter opener is to illustrate some of the options available for funding a small business. Concept Module 9.1 Small Business Finance LO1 Determine the financing needs of your small business A. Initial Capital Requirements Initial capital requirements are all the assets needed to begin a business. An astute entrepreneur is able to identify what those assets are and how to pay for them. B. Defining Required Assets Every business needs a combination of short-term assets (like cash and inventory) and long-term assets (like buildings and equipment). Which ones are absolutely crucial and where could corners be cut? (See Figure 9.1, Start Me Up which illustrates the initial capital needed for Inc. 500 companies. A surprising number of Inc. 500 companies started with less than $10,000 of initial capital.) C. The Five Cs of Credit 1. Capacity—the applicant’s ability to repay a loan 2. Capital—the applicant’s personal financial strength 3. Collateral—assets pledged as security for the loan 4. Character—applicant’s apparent willingness to repay the loan 5. Conditions—the general economic climate D. Additional Considerations In addition to the five Cs, investors want to know more about the owner and the business before backing them. Reality Check: Recession Proof Your Small Business This box highlights some financial information and funding tips for dealing with a prolonged economic downturn. Concept Check Questions 1. Define “initial capital requirements.” How can you determine these? Initial Capital Requirements: The knowledge of an entrepreneur of what assets are required for starting a new business and knowing how those assets will be financed. These requirements can be determined by identifying the long-term and short-term assets necessary to get the business started. 2. What are the 5 Cs of credit, and how do lenders use them? Capacity: The applicant’s ability to repay the loan. Capital: A function of the applicant’s personal financial strength. Collateral: Assets owned by the applicant that can be pledged as security for the repayment of the loan. Character: The applicant’s character is considered important because it indicates his apparent willingness to repay the loan. Conditions: The general economic climate at the time of the loan application may affect the applicant’s ability to repay the loan. At the time of recession, lenders do not usually extend loans. Lenders use the 5 Cs of credit to prove a person’s creditworthiness, with each C representing an important element in proving this. Concept Module 9.2 Basic Financial Vocabulary LO2 Define basic financing terminology A. Forms of Capital Leverage is the ability to fund growth of a business through borrowed funds. 1. Debt Financing—the use of borrowed funds. Discuss with students the language of borrowing, i.e., the advantages and disadvantages of fixed vs. variable interest and current interest rates on either type of loan. 2. Equity Financing—money to fund a business that represents ownership of the business. (See Figure 9.2, Where Capital Comes From to see that credit cards and traditional bank credit top the list.) B. Other Loan Terminology 1. Loan Security—ways a borrower provides assurance that a loan will be repaid 2. Loan Restrictions—covenants of what borrowers must do and what they cannot do Concept Check Questions 1. What are the differences between debt funds and equity funds? The difference between debt funds and equity funds is that in a debt fund you have to repay your loan to the lender. In an equity fund, the money does not have to be repaid. The lenders are investors that exchange funds for ownership in the business. Concept Module 9.3 How Can You Find Capital? LO3 Explain where to look for sources of funding. A. Once initial capital requirements are determined, the hunt to secure the money begins. B. The Loan Application Process Lending institutions collect relevant information from standard loan applications (get one from a local bank or SBA office to show the class) and from credit scores provided by credit bureaus. C. Sources of Debt Financing 1. Commercial Banks—Commercial banks remain the most logical choice for a small business owner who needs to borrow money. Unsecured loans, lines of credit, demand notes, secured loans, installment loans, and/or balloon notes are all options. 2. Commercial Finance Companies—These companies make loans that are typically a higher risk than commercial banks are willing to take. Their interest rates are often higher. 3. Floor Planning—This is a specialized funding mechanism for larger-ticket items like automobiles and appliances. 4. Leasing—Finance companies may purchase large items and lease them to a small business, freeing up more working capital. 5. Factoring Accounts Receivable—Selling accounts receivable for less than their face value is called factoring. This is a way for small businesses to turn A/R into cash sooner. 6. Insurance Companies—Policy loans are made to entrepreneurs based on premiums paid on an insurance policy with a cash value. 7. Federal Loan Programs—The SBA acts as a guarantor for many small business loans. Discuss the wide variety of programs in class from the information on www.sba.gov/finance. (See Figure 9.3, Who Gets SBA Loans? which illustrates that service and retail businesses receive most of the SBA loans. The average loan is about $250,000.) 8. State and Local Government Lending—These programs may come from economic development funding. 9. Trade Credit—Trade credit is money owed by a business to a supplier or vendor. What Would You Do? Crowdsourcing - this box provides a great opportunity to bring pitches on KickStarter and IndieGoGo into class. Reality Check: Credit Card Start-up Funding - Really?? This box brings up the discussion of a controversial source of funding a small business—credit cards. It makes sense for some small business purchases to be put on a credit card because of the fraud assurance it provides. D. Sources of Equity Financing 1. Lenders will expect an entrepreneur to provide at least 20 percent (possibly much more depending on the perceived risk) of funding required for a business. 2. Personal Funds—An entrepreneur who is not willing to put their own money at risk for a business will probably not be able to find anyone else who will. 3. Family and Friends—The NFIB estimates that about one-fourth of startups utilize “f & f” funding. This can potentially put a strain on future relationships. 4. Partners—Taking on a partner increases the size of the resource pool available. 5. Venture Capital Firms—Venture capital firms are groups or individuals who invest in high-potential startups. While many articles are written about venture capital firms, this is not for everyone. Funding needs of several million dollars with significant equity positions and exceptional ROI are required for venture capital consideration. Entre-Perspectives Brodsky Says... Serial entrepreneur and Inc. columnist Norm Brodsky shares insight on funding small business of any type or stage. 6. Small Business Investment Companies—SBICs are venture capital firms licensed by the SBA 7. Angels—These investors are typically wealthy, experienced individuals with a desire to assist a startup or emerging company. Requirements are generally much lower than venture capital. 8. Stock Offerings—Selling company stock can obtain equity financing. 9. Private Placements—Private placement involves the sale of stock to a select group of individuals; it cannot be offered to the general public. 10. Public Offerings—Public offerings involve the sale of stock to the general public. An initial public offering (IPO) must attract an underwriter (a stock brokerage firm or an investment banker). E. Choosing a Lender or Investor 1. Size—A lender should be small enough to consider the entrepreneur an important customer, but large enough to service the entrepreneur’s future needs. 2. Desire—The lender should exhibit a desire to work with startup and emerging businesses, rather than considering them risky. 3. Approach to problems—The lender should be supportive of small businesses facing problems, offering constructive advice and financing alternatives. 4. Industry experience—The lender should have experience in the entrepreneur’s industry, especially with startup or emerging ventures. Concept Check Questions 1. What kind of businesses would depend on floor-planning? The kinds of businesses that depend on floor-plan financing are businesses that must have high-priced inventory items on hand. Some examples include businesses that sell boats, cars, recreational vehicles, or trucks. 2. What is pledging accounts receivable? Pledging accounts receivable is when a small business uses its receivables as collateral for a loan. When the business collects its receivables, the proceeds are forwarded to the finance company for repayment on the loan. 3. What are the advantages of borrowing through the SBA? The advantage of borrowing through the SBA is that, under the guaranteed loans, the entrepreneurs are guaranteed up to 90 percent, thus reducing the lender’s risk by the amount of the SBA guarantee. Other advantages include the first repayment of the loan may be delayed up to six months; the direct loans are made when no other source of financing is available to the entrepreneur; the 504 Loan Program provides small businesses with funding for fixed assets when conventional loans are not possible; and these loans are 100 percent guaranteed by SBA, which reduces the lender’s risk. 4. Why do suppliers extend trade credit to other businesses? What are the advantages and disadvantages of using trade credit? Suppliers extend trade credit to other businesses because it will show up on their accounts payable. This looks good when they are trying to get a loan for themselves. The advantage of using trade credit is that during the grace period the loan is essentially “free.” The disadvantage to using trade credit is that if you do not repay the loan before the grace period expires, the interest rates are extremely expensive. 5. How are private placements and public offerings different? Private placement is when the sale of stock is limited to a select group of individuals. Public offering is when the stock is purchased by the general public. 6. Discuss the types of interest that may apply to a loan. The type of interest that may apply to a loan is usually the current prime rate, which is the rate that interest banks charge their “best customers.” The actual rate of interest that the borrower usually pays is the effective rate of interest. There is also a fixed-rate loan for which the interest rate remains the same throughout the entire length of the loan. A variable-rate loan is when the interest rate fluctuates over the time of the loan. 7. What is the difference between a secured loan and an unsecured loan? An unsecured loan is usually a short-term loan for which no collateral is required by the bank as long as the borrower has good credit standing. A secured loan attaches collateral, which is the borrower’s assurance to lenders that the loan will be repaid. 8. Of the approximately 534,000 companies that started in the year 2010, only 2,749 received funding from venture capitalists. If just this small percentage received venture capital, then why do small business magazines print such a disproportionately large number of articles about venture capital? Given the nature of venture capital requirements, those firms that receive that type of funding tend to be high profile and interesting stories. That makes them likely targets for magazine stories. Venture capital also requires thinking and dreaming big—things that entrepreneurs and potential entrepreneurs like to do. The bottom line is that stories like these sell magazines (they are a business too). 9. How does a small business’s capital structure change over time? One answer to this question would be that funding tends to come from a higher percentage of outside sources near the beginning of a business’s life and, as it becomes more successful, it funds itself from internal sources. Experience This…bonus student exercise Make arrangements with your instructor to invite a commercial banker to speak to your class. Discuss what factors bankers find most important in making a small business loan. Do they really want to see a business plan? What should be included in it? What section do they look at first? Second? In what order of importance would they rank the five Cs of credit? Does their bank make SBA loans? What is different about them? What other options to direct loans does the bank offer? Lines of credit? Access to factoring? Does the bank make recommendations (and arrange meetings) to send a small business owner on to meet with angel investors or venture capitalists? Bankers will tell the class that they really want to see enough market potential for the business to be able to pay back the bank. Bankers regularly look at cash flow statements, owners Beacon scores (combined credit scores), management team experience, and, of course, the executive summary. Chapter Closing Case When the Bank Cuts the Cord Questions - 1. Kevin Semcken identified some possible alternative solutions to his financing problem. Did he come up with all possible alternatives, or can you think of some more? Selling Accounts Receivable to factors and more pitches to angel investors are possible alternatives. The point for students is that there are not a tremendous number of funding choices for small business owners and that many contacts and pitches to investors and lenders may be required. 2. Do you agree with board member Rob Cascella, who told Kevin to concentrate on producing headphones and put off the Sound Fit for later...or do you agree with Kevin, who sees Sound Fit as the future of Able Planet? Defend your choice. Cascella is a conservative investor wanting to achieve and maintain a positive cash flow as Able Planet is being built. This is not necessarily a bad thing, and actually a very common approach for small business investors. Semcken, on the other hand, is more of the typical entrepreneur wanting to move and develop new products - thinking more about building future growth than current cash flow. 3. As a small business consultant, what would you advise Kevin Semcken do to guide Able Planet through its financial storm? Entrepreneurs can only grow at a pace equal to or less than their burn rate (amount of monthly cash expenditures). Semcken will have to compromise in order to fund his new product. The Decision In March, Semcken compromised with his board. He agreed to renew his efforts to bring in new business for Linx and narrow his focus on Sound Fit to the five most serious potential buyers. The change in focus toward Linx paid off. Semcken hit the road and began aggressively hawking the line. Within months, Best Buy and BJ's placed orders, and a deal with Staples is in the works; all three are new Able Planet customers. With no banks willing to lend, Semcken overcame his aversion to factors. He is in negotiation with three, all of which are offering to lend at 18 percent -- about five points higher than the company's bank credit. U.S. Bank, meanwhile, went ahead with the loans but capped the amount at $500,000. Still, Able Planet will have enough inventory for the holiday season. Everything hinges on whether consumers will buy specialty headphones and headphone accessories in a recession. But Semcken thinks they will, which would mean he would finally be able to build Sound Fit prototypes. In the meantime, to keep the interest of the five primary Sound Fit targets, Able Planet has offered each of them a limited exclusive license for a year, an idea the company had only toyed with before the bank changed its terms. Semcken hopes that once Sound Fit proves a success with those five clients, others will be motivated to embrace the technology. Semcken remains more bullish than some of his investors. "In order to slow our burn rate, we might have to back off a little," says investor Tom Stavros. "Kevin thinks he's going to get cash flow quick enough that it's not going to be an issue, but Kevin is an optimist." Semcken makes no apologies, but he says he is glad he took the advice of his board. "I'm an endurance guy," he says. "I'm going to run as fast as I can as long as I can, and I'll take on as many projects as I can bear. Rob [Cascella] is more conservative -- which makes him extremely valuable in a recession." SOURCE: www.inc.com/magazine/20090701/case-study-when-your-bank-stops-lending.html Chapter 10 The Legal Environment Teaching Tips • Use the Chapter Opener to discuss the topic of counterfeit products. • Use Reality Check, Who Can You Trust?, to illustrate the problems small business owners face when unscrupulous employees and lawyers use well-intended laws to take advantage of their business. • Invite a local lawyer to speak to class about legal issues relating to small businesses. • Use the case, What Would You Do? to practice the patent application process. • The chapter closing case is about a company that is victim of intellectual property theft and what should be done next Have students read the case before class . Then you can either begin class discussion with the whole group or break the class into groups of three or four and have them brainstorm strategies before opening discussion to all. After you hear students’ recommended strategies, read “The Decision” and “The Experts Weigh In” to share what really happened. Lecture Outline Opening Vignette: Counterfeiting of Zippo lighters and other products What’s the Point? The point of this chapter opener is to begin discussion on protecting a company’s intellectual property from counterfeiters. Concept Module 10.1 Small Business and the Law LO1 Name the laws and regulations that affect small business. A. One of the many problems facing small business owners is keeping up with the changes and understanding the laws and regulations by which they must abide. The wording of many of these laws and regulations is confusing, and the paperwork required for compliance places an undue burden on small business owners. B. Regulations and the legal environment of small business cover a lot of ground, but in this chapter, we will discuss several factors such as regulations, bankruptcy, contracts, and protection of intellectual property. (See Figure 10.1, Get Off Our Backs—an NFIB survey on how small business owners struggle with costs and regulations.) C. Laws to Promote Fair Business Competition Competition between businesses of all sizes lies at the heart of a free enterprise system. Healthy competition provides the balance that helps insure that both buyers and sellers are satisfied. The intent of antitrust laws is to prevent large organizations from stifling new and small ones. Reality Check: Who Can You Trust? These are examples of employees abusing laws and their small business employers. D. Laws to Protect Consumers Small businesses must be very aware of consumer protection laws and regulations, most of which fall under the jurisdiction of the Federal Trade Commission. E. Laws to Protect People in the Workplace A lot of federal employment legislation focused on equal opportunity employment. Small business owners need to be familiar with the following: 1. Fair Labor Standards Act 2. Civil Rights Act of 1964 3. Immigration Reform and Control Act 4. Americans with Disabilities Act 5. Civil Rights Act of 1991 6. Workers’ Compensation 7. Unemployment Compensation 8. Occupational Safety and Health Administration (OSHA) F. Licenses, Restrictions, and Permits 1. At the federal level, a small business owner needs to obtain an employer identification number for federal tax and social security withholdings. 2. At the state level, professionals need a state license. Special licenses are needed for a few types of business. A small business owner needs to register for a state tax number with the state Department of Revenue. 3. At the local level, permits and licenses vary widely from place to place. Contact local city or county clerk and other sources to secure the information that students need in your local area. 4. Zoning Laws—Bring in information regarding local zoning laws and regulations. Concept Check Questions 1. Are the antitrust laws established in the late 1800s and early 1900s still pertinent in the twenty-first century? Why or why not? One would have to say that antitrust laws will continue to be important legislation far into the future, even though they were written a century ago, because they protect and maintain healthy competition by keeping a large business from gaining an unfair size advantage. These laws were the legal foundation for the Justice Department’s attempted breakup of Microsoft. 2. How does the Federal Trade Commission protect consumers? The FTC regulates and ensures that competition exists between businesses. The FTC has the power to force businesses to change or stop unfair or illegal practices to the point that it can shut a business down. The FTC also protects consumers by setting and enforcing labeling of product contents and warnings. It regulates advertising so consumers may reasonably believe messages. The FTC has the broadest power of any regulatory agency dealing with small businesses. 3. List and briefly explain the laws that protect people in the workplace. Many laws have been passed in recent years to protect workers and provide equal treatment in the workplace. Laws cited in the text include the Equal Pay Act of 1963, the Civil Rights Act of 1964, the Immigration Reform and Control Act of 1986, the Americans with Disabilities Act of 1990, the Civil Rights Act of 1991, the Family and Medical Leave Act of 1993, and the Occupational Safety and Health Act of 1970 which created the Occupational Safety and Health Administration (OSHA). 4. What licenses are required by the owner of a small business? Small business owners need state tax numbers, employer identification numbers, and special licenses if required for their specific type of business at the state level. At the local level, business permit requirements vary greatly. Small business owners should check with local government offices like those of city clerk and treasurer. They need an employer identification number at the federal level. 5. Compliance with government regulations is sometimes burdensome for small business owners. What can they (and you) do to change the laws and regulations that influence small business in order to lessen the burden? Some of the more challenging regulations for small businesses are not the big, federal ones like OSHA or ADA. They are local and zoning issues like the type and size of signage allowed or what type of business can be located where. These issues can be changed by going to local officials for what is known as a variance. Concept Module 10.2 Bankruptcy Laws LO2 List and explain the types of bankruptcy. A. Bankruptcy is a last resort for an individual or business that has become insolvent. It can accomplish two different objectives—liquidation or reorganization. B. Chapter 7 Bankruptcy Under this type of bankruptcy, the assets of a business are liquidated by a trustee appointed by the bankruptcy court, and the proceeds are divided among the creditors. Chapter 7 accounts for 75 percent of bankruptcy filings C. Chapter 11 Bankruptcy Chapter 11 provides a second chance for a business that is in financial trouble, but still has potential for success. A reorganization plan is filed with a bankruptcy court. If the plan is accepted, the business continues to operate under court direction. If the business does not become profitable within the designated time period, it will then revert to Chapter 7. D. Chapter 13 Bankruptcy Chapter 13 provides a reorganization plan for individuals, rather than businesses as in Chapter 11. Concept Check Questions 1. How are liquidation and reorganization used as different approaches to bankruptcy? Reorganization is used to protect businesses from creditors who have a solid chance of becoming viable again. Liquidation occurs when viability is no longer an option and the only remaining duties are to sell the assets and divide the money among creditors. 2. What chapters of bankruptcy law accomplish these objectives? Chapter 7 of the Bankruptcy Code provides for liquidation of a business. The business no longer continues to operate, and its assets are sold to cover as much debt owed to creditors as possible. Reorganization is a very different type of bankruptcy than liquidation. A business filing Chapter 11 for protection from creditors submits a plan to a bankruptcy judge to show how the business will operate in a different manner in the future to become profitable. Concept Module 10.3 Contract Law for Small Businesses LO3 Describe the elements of a contract. A. A contract is a promise that is enforceable by law. Contracts that must be in writing are those that: 1. Involve the sale of real estate. 2. Involve paying someone else’s debt. 3. Take longer than one year to perform. 4. Involve the sale of goods valued at $500 or more. B. The Elements of a Contract To be legally binding, a contract must meet the following conditions: 1. Legality 2. Agreement 3. Consideration 4. Capacity C. Contractual Obligations If one party involved in a contract does not hold up his or her end of the agreement, a breach of contract has occurred. Remedy for breach includes compensatory damages (money awarded) or specific performance. Concept Check Questions 1. Name and explain the four elements that a contract must have to be valid. A contract must intend to accomplish a legal purpose, must show agreement and consideration, and all parties must be of legal capacity to enter into it. 2. Think of transactions you have entered into in the past: whom were you agreeing with, what was the agreement about, and what were the terms? When did you have a written contract? When was an oral contract in place? Use several examples to analyze: buying a car, accepting a job, ordering a pizza. What elements of contract law applied? An automobile is a common purchase – offer and acceptance are first negotiated through the back and forth between asking price and subsequent offers until buyer and seller finally agree. Consideration begins with a deposit check. Capacity applies for both parties being over the age of 18 so the contract cannot be revoked. Concept Module 10.4 Laws to Protect Intellectual Property LO4 Discuss how to protect intellectual property. A. Intellectual property is a broad term that refers to the product of some type of unique human thought. “Protection” of associated rights may be a slightly misleading term, as patents, copyrights, and trademarks give the owner more offensive rights than defensive protection. B. Patents 1. A patent is a form of protection for intellectual property provided to an inventor for a period of 17 years. 2. Three types of patents exist: utility patents, for inventions that provide a unique or new use or function; a design patent protecting unique or new forms or shapes; or a plant patent for living plants. 3. What Can Be Patented? The Patent and Trademark Office (PTO) reviews each patent application and decides whether or not to grant one based on four tests: a) Does the invention fit a statutory class? b) Is the invention useful? c) Is it novel? d) Is it unobvious? 4. Patent Searches 5. Patent Application—See Figure 10.2, How Do You Get a Patent? for a flowchart that defines the steps needed to patent a product. C. Copyrights 1. A copyright is a form of protection for intellectual property provided to the creator of a literary, musical, or artistic work for a period of the creator’s life plus 50 years. 2. Many small businesses exist to create computer software. Protecting this form of intellectual property has proved to be difficult. Neither patents nor copyrights have adequately done the job. D. Trademarks A trademark is a form of protection for intellectual property provided to the owner of a brand name or symbol. Reality Check: Protect Your App? This box will help start discussion on protection of a small business’ intellectual property. E. Global Protection 1. This is one of the more difficult areas of international business. Protection from the U.S. PTO does not provide protection in other countries. For that, an entrepreneur must get separate protection in each country. 2. The two most important and overlapping copyright treaties are the Berne Convention and the Universal Copyright Convention. What Would You Do? Imagine that you have developed a unique formula for a soft drink that, upon entering a person’s mouth, analyzes the drinker’s DNA to determine his or her favorite flavor, and then the drink instantly realigns its chemical composition to become that flavor. Write a two-page paper describing how you can best protect this trade secret. Will you patent it? Why or why not? A product as unique as this one with this much market potential should definitely be patented. Ninety-five percent of all patents are never challenged, but this one will have competitors lining up to try to cash in. Some new products are better off being developed slowly and quietly with no patent to avoid showing up on competitors radar screen – this is not that type of product. Concept Check Questions 1. What rights does owning a patent protect? How do you get this protection? A patent provides the holder with an offensive weapon to prevent another party from making, using, or selling a protected invention. It is an offensive tool because it can be used to stop another party from infringing on your rights, but you have to catch them and initiate the action. Patents are not defensive protection. To file for a patent, you must submit an application to the Patent and Trademark Office and show that your invention fits into a statutory class, and is useful, novel, and unobvious. Use Figure 10.2 to track the process. 2. What tests must an invention pass in order to receive a patent? To receive a patent, an invention must: • Fit a statutory class—machine, process, manufacture, chemical composition, or combination. • Be useful. • Be novel—unique in some demonstrable way. • Be unobvious—produces new or unexpected results. 3. What is the difference between a copyright and a trademark? Between a trademark and a brand? A copyright protects written, musical, and artistic works for the life of the author, plus fifty years. A trademark, by contrast, is a legally protected symbol, name, term, design, or combination of elements, which identifies a specific product and differentiates it from competing products. A brand identifies a product, but does not necessarily protect it. All trademarks are brands, but not all brands are trademarks. 4. What risk does an inventor assume when filing for a patent for an invention? A potential risk for an inventor in filing a patent is that his or her information becomes publicly known and is published in the Official Gazette of the U.S. PTO. Someone scanning PTO information may use that filing to create his or her own variation, if not to outright steal the idea (even though that is illegal). Experience This…bonus student exercise Tired of boring, in-the-box thinking? Do you think that the United States is becoming more a nation of Homer Simpsons than Thomas Edisons? In fact, some people out there are solving problems that we didn’t even know existed. Did you know that mechanical bat wings to provide aerodynamic lift for in-line skaters have been patented? How about the BinoCap that builds binoculars onto the bill of a cap? Ted VanCleave has created a website called Totally Absurd (www.totallyabsurd.com), complete with hilarious commentary on wacky inventions that have received U.S. patents. Of course, it is easy to be funny when you are talking about toilet landing lights (they add “an almost mystical glow”), hair-braiding machines, hat tethers, and a diaper alarm. Visit this web page to lighten your day and stimulate your creativity. Students’ feedback will vary. Chapter Closing Case To Sue or Not to Sue Questions - 1. Hoffman's gut told him to litigate aggressively. But do you think that was a smart move? Litigation is expensive in terms of time, money, and emotion. It also takes resources and attention away from the business you are trying to build. Litigation is a personal decision, but students need to be able to see both sides of pursuing it. 2. Should he settle? Or should he press his case before a judge? This is a judgment call for students to express their personal perspective. 3. Put yourself in Hoffman's place. What would you do? Students have three choices - press litigation, drop the case, or see what mediation brings. The Decision Hoffman’s family convinced him to try to settle. Among other things, they argued, a successful mediation meant that the company would not have to ask clients such as Target to sit for deposition interviews and search through records for evidence. School Zone and Dogs in Hats agreed on a mediator, and one day last April, Hoffman and Alfini found themselves sitting across the table from each other. They had not spoken since 2003. But the atmosphere was professional, and Hoffman felt surprisingly optimistic. Unlike court proceedings, the content of mediation sessions is not a matter of public record, and neither party agreed to discuss pending settlement terms. Hoffman would say only that he sought a monetary settlement and was adamant that School Zone, and he personally, retain the ability to speak publicly about the matter. One reason is that Hoffman, a member of the Young Presidents Organization, hopes to mentor entrepreneurs facing similar dilemmas. After eight hours of negotiations, Hoffman says, he thought they were close to a deal. As of late July, however, when Inc. went to press, the two parties had yet to finalize a settlement. Alfini’s attorney, Jovan Jovanovic, declined to comment about the discussions. “The case is ongoing, and we hope to have it resolved in the near future,” he said. Alfini would not comment on the case, but he was happy to talk about Dogs in Hats, which he says is on track to hit $1 million in revenue in 2005. “We’ve actually turned down business in ’05,” he says. The company is planning a big push into Spanish-language materials, a growing segment of children’s publishing. Meanwhile, School Zone’s revenue has grown about 20 percent, to about $25 million, over the past 12 months, thanks to the growth of its interactive division, and Hoffman is pleased to be focused again on his customers. “This case created perspective,” he says. “I’m whistling to work thinking about how to make customers happier.” He hopes to reach a settlement, but if the companies cannot, he has no qualms about battling it out before a judge. “Intellectual property is the lifeblood of my company,” he says. “I’m trying to be logical. I sometimes worry this is about 8-year-old me, or my id, but I really do believe in justice.” SOURCE: Lora Kolodny, “Jonathan Hoffman Was Sure a Former Staffer Had Stolen His Company’s Ideas,” Inc., September 2005, 55–56 Chapter 11 Small Business Marketing: Strategy and Research Teaching Tips • Concentrate on the importance of segmentation to small businesses in carving out their niche. • Use Figure 11.1 to illustrate that, while marketers can see and somewhat control stimuli and responses, what goes on within the customer’s mind is difficult to measure. • This is a good chapter during which to incorporate a guest speaker, such as a person from an advertising agency who works with small businesses. • Some great discussion should be generated with the question, “How do small businesses compete with large national discount chains?” The bottom line is to differentiate. • Show that most market research in small business is short, to the point, creative, and directly aimed at solving a specific problem. • Use the case, What Would You Do? to have students think about a common situation. Students should put themselves in the position of owning a small business that has developed an improved product that faces strong, established, larger competition—what marketing strategy would they use? • This chapter closing case takes students to a great decision point—a small company has developed a miniature hard drive and was approached by Apple to be a primary vendor. Should they take on such a huge customer? Have students read the case before class. Then you can either begin class discussion with the whole group or break the class into groups of three or four and have them brainstorm strategies before opening discussion to all. After you hear students’ recommended strategies, read “The Decision” and “The Experts Weigh In” to share what really happened. Lecture Outline Opening Vignette: Wu-Tang Clan What’s the Point? The point of this chapter opener is to show how Wu-Tang Clan implements a unique marketing approach for a new album. Concept Module 11.1 Small Business Marketing LO1 Explain the importance of marketing to small businesses. A. Ask students the topic question, “What do you think of when you hear the word marketing?” Remind them that marketing involves much more than selling or advertising. Peter Drucker stated that businesses have only two basic functions—marketing and innovation—everything else is really a cost. B. The Marketing Concept 1. This customer-centered approach to businesses consists of finding out what customers want and then providing that good or service. The marketing concept counters the production concept in which the business focuses on making whatever product they happen to make. 2. Student entrepreneurs, Scott MacHardy and Mark Lane, “Co-Ed Naked” T-shirts, understand the marketing concept. C. Of Purple Cows From the book of the same name, Purple Cows represent the importance and power of creating a competitive advantage. What Would You Do? 1. If you were in Amilya Antonetti’s place starting SoapWorks, what marketing strategy would you use to compete with Procter & Gamble and Clorox? How would you reach your target markets? How and where would you advertise? We talk about the power of word of mouth among our customers—how do you use it to your advantage as a small business marketer? Amilya needs to establish success in a niche before taking P&G head-on. She needs to build name recognition with families with children who need hypoallergenic products—then move to larger markets. She could reach these markets by informing pediatricians and getting referrals from them. She could advertise in family health-oriented magazines. For a new-to-the-world product, SoapWorks needs to make heavy use of free sampling. 2. One of the biggest challenges SoapWorks faced was getting its products on the shelves of grocery stores. By 1999, they were in 2,500 stores from California to Florida with revenues of $5 million. How would you create such market penetration? Small businesses getting their products on the shelves of grocery stores and mass merchandise stores is a huge problem. Amilya’s best bet is to use a pull strategy, rather than a push strategy. To do this, she needs to create demand through sampling. Then satisfied customers will ask grocery and mass merchandise store managers for SoapWorks products, leaving them little choice but to order from SoapWorks. Concept Check Questions 1. Marketing plays a key role in a small business’s success. Can a small business succeed without adopting the philosophy underlying the marketing concept. Why or why not? Students may mistakenly assume (and class discussion will be enhanced if they do) that every business must adopt the marketing concept. This is not the case. Many businesses have been and will be successful being driven by other philosophies like the selling or production concept. They are served well by focusing their attention on making their product, and all is well as long as consumers continue to want that specific product. MOST businesses need to keep a close watch on determining what customers want and then provide for that satisfaction, but a case can be made that not every customer knows what they want or what is possible so some businesses need to follow other philosophies. 2. What would happen to a business without a marketing strategy. Why? The true answer to this question can be drawn from an analogy. Ask students if they have heard the old saying “By not making a decision, you are deciding.” It means that a course will be followed whether you choose it or not. Defining a marketing strategy means that a business owner is choosing to determine their own path rather than having it chosen for them. Concept Module 11.2 Marketing Strategies for Small Business LO2 Describe the process of developing a small business marketing strategy. A. Small business marketing strategies identify how target markets will be identified and how the business will communicate with them. 'Trep Connections Social + Business This box illustrates how Ellie Sawits of Frutels and other small businesses use social media to actually make money, not just postings. B. Setting Marketing Objectives Small business marketing goals need to be 1) measurable, 2) action oriented by identifying what needs to be done, and 3) time specific by targeting a date or time for achievement. C. Developing a Sales Forecast 1. One of the most important pieces of information a potential entrepreneur needs to gather is a sales forecast. This “top line” number prediction of revenue is the foundation for income statement and cash flow projections. In addition to financial projections, the sales forecast impacts all areas of marketing—channels of distribution, sales force requirements, advertising budgets, etc. 2. Two approaches to sales forecasting—build-up methods and breakdown methods—are discussed because they are, by far, the most common approaches used by small businesses. 3. A sales forecast answers the questions of how many dollars and units the business can generate and if the chosen target market is large enough to sustain the business. 4. Statistical tools like time series analysis and regression analysis are valuable in creating sales forecasts. D. Identifying Target Markets By definition, small businesses must concentrate on market segments. Many small business owners make the mistake of seeing everyone as their target market. The point of segmenting markets is to better focus the marketing mix of the business (products, places, pricing, and promotion) to that specific group. E. Understanding Consumer Behavior Market segmentation and target marketing tells a business owner who may buy products; consumer behavior tells why they buy. The complexity of these “whys” is illustrated in the Black Box Model. (See Figure 11.1, The Black Box Model of Consumer Behavior.) Entre-Perspectives Best Offense = Good Defense This box discusses customers that are classified by their value (profitability) and vulnerability (to competitors). Also defensive marketing tactics are considered. Concept Check Questions 1. What determines which type of sales forecast would be important to a small business? Describe how a specific small business would implement the build-up approach. The size, nature, and dispersion of the target market(s) are the most important factors in choosing the correct forecasting approach. Time and resources available influence the decision also. An example of the build-up approach is provided in the text with the example of the ice cream shop projecting how many people will buy on different days of the week across different seasons. These projections are cumulatively added for weekly, monthly, and annual projections. The question calls for students to come up with their own (different from retail ice cream) scenario. 2. Why is segmenting a niche market so crucial for small business? Because small businesses almost never have the resources to serve markets beyond niche ones. This fact demands that the total population be broken down into smaller, more identifiable groups—through segmentation of some type, it does NOT have to be demographic. 3. We all assume several different roles (parent, student, sibling, athlete, business owner, and so on) at any given time, and those roles affect our behavior as consumers. Describe how your various roles affect your purchases. This question should prompt discussion about how many roles each of us assume. Students probably have not thought about how these roles and stages of life impact the items and services that they purchase. Once students mentally process the impact on their own lives and purchase behavior, they are better prepared to project these changing needs to their potential target markets. 4. Segmentation is the process of breaking a population down into smaller groups and marketing to them. Is it possible for a small business to oversegment its market? How would that be dangerous? The only way a business can oversegment is to break down a market into a group so small that the costs of marketing changes to serve this group are greater than the profit generated from them. Target markets of one are possible and can be profitable. Concept Module 11.3 Market Research LO3 Discuss the purpose of the market research process and the steps involved in putting it into practice. A. Even though small businesses are closer to their customers than their large competitors, market research must still be conducted. Small businesses need to get information as quickly and as inexpensively as possible. (See Figure 11.2, Market Research Expenditures.) Some creative examples are cited in text. B. The Market Research Process (See Figure 11.3, Market Research Process.) 1. Identify the Problem 2. Planning Market Research 3. Collecting Data 4. Data Analysis 5. Presenting the Data and Making Decisions C. Limitations of Market Research As important as market research can be for a small business, it should be used with caution. It can provide a picture of what people currently know and expect from products for needs that they already recognize. It is, however, limited in its ability to indicate what people will want in the future. (See Figure 11.4, Matrix of Customer Needs and Types.) Reality Check: SEO - Search Engine Optimization This box covers search-engine optimization strategies. Concept Check Questions 1. What is the significance of market research to the small business owner? How is market research defined, and what degree of complexity is necessary in the research plan for it to be valid? Market research can provide valuable information to small businesses regarding people’s current tastes, preferences, and expectations. Market research is the process of gathering information that will link you to your customers in order to improve your marketing communication. 2. Explain the market research process from a small business owner’s perspective when he or she is trying to assess competitive advantage. Conducting research on your markets involves a logical five-step process: • Identify the problem. • Develop a plan. • Collect data. • Analyze data. • Draw conclusions. The market research process can help a small business develop a competitive advantage by providing a picture of what people currently know and expect from your products or services. 3. What types of data should be collected and analyzed in order to get a clear picture of the market for the good or service being produced? Two basic types of data may be needed: secondary and primary. Secondary data are used extensively by small businesses because the data have already been gathered, tabulated, and made available by an outside source. CD-ROM databases at libraries are a good source. Primary data are collected for a specific purpose by a business. Small business owners can use telephone interviews, intercepts, or mail surveys to obtain primary data. 4. Identify some valuable sources of information for the entrepreneur who is designing a market research plan to analyze competitive advantage. One source is a trade association related to the specific type of business the owner is in. Conduct a key word search on the Internet for products and type of business. Consult the Government Printing Office Monthly Catalog, the Department of Commerce, and the Small Business Administration. 5. What are some of the limitations of market research? What can the entrepreneur do to offset these limitations? Market research is good for known products, but it does have some limitations. It can help when your customers lack foresight in asking for unknown needs or about what might be possible in a new product. Market research can tell us the most about the spoken needs of a served market, but a lot of room for growth exists. 6. What do you think is the biggest limitation for small businesses conducting market research? Creativity is a bigger limitation than money for small business market research. If a small business truly understands the question that needs to be answered about its market, a method to find an answer can be created. Experience This…bonus student exercise You decide that you need to create a survey to get customer feedback on a new product you have developed, when you realize, “Oh, no! I’ve never created and administered a real survey before!” Go to your favorite search engine and conduct a search for “small business” and “market research.” From your findings, create a bullet-point list of ten factors you should keep in mind when writing survey questions. A great website to send students for information on market research is that of the American Marketing Association (www.marketingpower.com). It includes credible articles and “how-to’s” on all facets of questionnaire design and data analysis. Chapter Closing Case Specialize or Diversify? Questions - 1. Should Hallam come up with some new products or continue to come up with new products or continue to concentrate on how tubs? Most students will probably say that Hallam should diversity into other products since high-end spa sales are declining. But, they need to be able to recognize and build a case for either specialization OR diversification. 2. If new products are the answer, what should they be? Since Dimension One Spas has expertise in making products out of plastic, most people would recommend that they stay within that industry...lead students through a brainstorming exercise to see what list of products they can come up with in 10-15 minutes. Expect creativity. 3. What are your recommendations to revive Dimension One? From the list of products brainstormed, see which ones could actually be a fit for Hallam. Then reveal the decision to the class - see if anyone suggested wakeboards or something similar. The Decision After the New Year, Hallam directed Hedgecock and Mark Jolley, an engineer whom Hallam refers to as "the big-idea guy," to get in gear. The pair handed off most of their work to others to focus on finding new product ideas. They didn't have too far to look. Janett Pankauski, vice president of manufacturing, had just been contacted by an entrepreneur she had met at a seminar two years earlier. He thought Dimension One could make parts for his electric vehicle company. With that promising lead in hand, the pair looked around to see what else Dimension One might be able to do. The focus turned to plastic composites, which are sturdier than traditional fiber composites. Hedgecock and Jolley identified two particularly strong potential markets -- ballistics for the military and wind turbines for energy production -- and asked one of their material suppliers for introductions. The supplier suggested Hedgecock and Jolley make a pitch to the military to produce bulletproof vests and blankets, as well as modular helicopter landing pads. Then, in April, Hedgecock and Jolley attended an energy conference in Chicago, at which they discovered a need for sturdier wind turbine parts. The duo figured Dimension One could make composite parts that would be stronger and last longer than traditional composite parts. After Hedgecock and Jolley identified their markets, they got to work persuading a large military contractor and several wind power companies to let Dimension One build some prototype parts. At about the same time, Dimension One began producing prototype door panels for the electric vehicle company. But as the months dragged on with no firm orders, Hedgecock and Jolley decided to look closer to home. Maybe their best bet was to land a deal in an industry that they understood better. Both are surfers, and Jolley, who once supplied foam to surfboard companies, has a long list of contacts. One of these contacts, Surftech, sells standup paddleboards, which are like surfboards that riders stand on, using a paddle to balance and move through the water. In June, Jolley began discussions with Surftech to build what Dimension One says will be more durable boards. The two sides have signed a deal for Dimension One to produce a few thousand boards. Hallam has so far invested $10,000 in a new mold and is expecting to spend at least another $30,000 to get the first boards out the door. Assuming no setbacks, the boards will roll out of Dimension One's factory in the next few months. Boardmaking tends to be a low-margin business. Still, "what we learn here, we'll be able to transition into all other industries," Jolley says. "The possibilities could be endless." Hallam knows not all the new initiatives will take off. But if just one hits big, he figures he can begin to rebuild his company. In fact, he wants to get 50 percent or more of revenue from business other than hot tubs within five years. That's ambitious, but Hallam says it is doable. "It's the tipping-point approach," he says. "Go down the road little by little until something shows promise, and then dump in the money." SOURCE: www.inc.com/topic/bob-hallam Solution Manual for Small Business Management: Entrepreneurship and Beyond Timothy S. Hatten 9781285866383