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Economic Systems

A country's economic system is made up of institutions and decision-making structures that determine economic activity.

Learning Objectives

Differentiate between planned and free market economic systems

Key Takeaways

Key Points

An economic system is the decision-making structure of a nation's economy, characterized by the entities and policies that shape it.

An economic system may involve production, allocation of economic inputs, distribution of economic outputs, firms, and the government to answer the economic problem of resource allocation.

There are two general subtypes of economic systems: free market systems and planned systems.

A country may have some elements of both systems, and this type of economy is known as a mixed economy.

Key Terms

Planned system: A planned economy is an economic system in which decisions regarding production and investment are embodied in a plan formulated by a central authority, usually by a government agency.

Free market system: A free market is an economic system that allows supply and demand to regulate prices, wages, etc, rather than government.

Economic system: An economic system is the combination of the various agencies, entities (or even sectors as described by some authors) that provide the economic structure that defines the social community.

What is an Economic System?

An economic system is the combination of the various agencies and entities that provide the economic structure that defines the social community. These agencies are joined by lines of trade and exchange goods. Many different objectives may be seen as desirable for an economy, like efficiency, growth, liberty, and equality. An economic system may involve production, allocation of economic inputs, distribution of economic outputs, landlords and land availability, households (earnings and expenditure consumption of goods and services in an economy), financial institutions, firms, and the government.

Alternatively, an economic system is the set of principles by which problems of economics are addressed, such as the economic problem of scarcity through allocation of finite productive resources.

The scarcity problem, for example, requires answers to basic questions, such as:

What to produce?

How to produce it?

Who gets what is produced?

Types of Economic Systems

Examples of contemporary economic systems include:

Planned systems

Free market systems

Mixed economies

Today the world largely operates under a global economic system based on the free market mode of production.

Planned Systems

In a planned system, the government exerts control over the allocation and distribution of all or some goods and services. The system with the highest level of government control is communism.

In theory, a communist economy is one in which the government owns all or most enterprises. Central planning by the government dictates which goods or services are produced, how they are produced, and who will receive them. In practice, pure communism is practically nonexistent today, and only a few countries (notably North Korea and Cuba) operate under rigid, centrally planned economic systems.

Under socialism, industries that provide essential services, such as utilities, banking, and health care, may be government owned. Other businesses are owned privately. Central planning allocates the goods and services produced by government-run industries and tries to ensure that the resulting wealth is distributed equally. In contrast, privately owned companies are operated for the purpose of making a profit for their owners. In general, workers in socialist economies work fewer hours, have longer vacations, and receive more health, education, and child-care benefits than do workers in capitalist economies. To offset the high cost of public services, taxes are generally steep. Examples of socialist countries include Sweden and France.

Free Market System

The economic system in which most businesses are owned and operated by individuals is the free market system, also known as " capitalism. "

In a free market, competition dictates how goods and services will be allocated. Business is conducted with only limited government involvement. The economies of the United States and other countries, such as Japan, are based on capitalism.

In a capitalist economic system:

Production is carried out to maximize private profit.

Decisions regarding investment and the use of the means of production are determined by competing business owners in the marketplace.

Production takes place within the process of capital accumulation.

The means of production are owned primarily by private enterprises and decisions regarding production and investment determined by private owners in capital markets.

Capitalist systems range from laissez-faire, with minimal government regulation and state enterprise, to regulated and social market systems, with the stated aim of ensuring social justice and a more equitable distribution of wealth or ameliorating market failures.

Impacts of Supply and Demand on Businesses

The mechanisms of supply and demand in a competitive market determine the price and quantities of products.

Learning Objectives

Outline the economic effect of the laws of supply and demand

Key Takeaways

Key Points

The interactions between buyers and sellers in a market give rise to the mechanisms of supply and demand, and consequently, the market price and quantities.

For a normal good, demand is downward sloping when graphically depicted.

Supply is upward sloping; businesses would like to sell more goods at higher prices since they would earn more revenue.

The market price is found at the intersection of the supply and demand curves. This is where buyers willingness to buy and sellers willingness to sell are at equilibrium.

Things like input costs, product differentiation, branding, substitute goods, consumer tastes, shortages, and surpluses can change the market by shifting the supply or demand curves.

In a hypothetical perfect competition scenario, a business that tries to charge a price higher than the market price would not survive.

Things like input costs, product differentiation, branding, substitute goods, consumer tastes, shortages, and surpluses can change the market by shifting the supply or demand curves.

Key Terms

supply: provisions

equilibrium: The condition of a system in which competing influences are balanced, resulting in no net change.

demand: The desire to purchase goods or services, coupled with the power to do so, at a particular price.

The Basics of Supply and Demand

In a market characterized by perfect competition, price is determined through the mechanisms of supply and demand. Prices are influenced both by the supply of products from sellers and by the demand for products by buyers.

Demand and the Demand Curve

Demand is the quantity of a product that buyers are willing to purchase at various prices.

The quantity of a product that people are willing to buy depends on its price. You're typically willing to buy less of a product when prices rise and more of a product when prices fall. Generally speaking, we find products more attractive at lower prices, and we buy more at lower prices because our income goes further. Using this logic, we can construct a demand curve that shows the quantity of a product that will be demanded at different prices.

The red curve in the diagram represents the daily price and quantity of apples sold by farmers at a local market. Note that as the price of apples goes down, buyers' demand goes up. Thus, if a pound of apples sells for $0.80, buyers will be willing to purchase only 1,500 pounds per day. But if apples cost only $0.60 a pound, buyers will be willing to purchase 2,000 pounds. At $0.40 a pound, buyers will be willing to purchase 2,500 pounds.

Supply and the Supply Curve

Supply is the quantity of a product that sellers are willing to sell at various prices.

The quantity of a product that a business is willing to sell depends on its price. Businesses are more willing to sell a product when the price rises and less willing to sell it when prices fall. This fact makes sense: Businesses are set up to make profits, and there are larger profits to be made when prices are high. Now, we can construct a supply curve that shows the quantity of apples that farmers would be willing to sell at different prices, regardless of demand.

The supply curve goes in the opposite direction from the demand curve: As prices rise, the quantity of apples that farmers are willing to sell also goes up.

The supply curve shows that farmers are willing to sell only a 1,000 pounds of apples when the price is $0.40 a pound, 2,000 pounds when the price is $0.60, and 3,000 pounds when the price is $0.80.

Equilibrium Price

We can now see how the market mechanism works under perfect competition.

We do this by plotting both the supply curve and the demand curve on one graph. The point at which the two curves intersect is the equilibrium price. At this point, buyers' demand for apples and sellers' supply of apples is in equilibrium.

The supply and demand curves intersect at the price of $0.60 and quantity of 2,000 pounds. Thus, $0.60 is the equilibrium price: At this price, the quantity of apples demanded by buyers equals the quantity of apples that farmers are willing to supply.

If a farmer tries to charge more than $0.60 for a pound of apples, he won't sell very many, and his profits will go down. If, on the other hand, a farmer tries to charge less than the equilibrium price of $0.60 a pound, he will sell more apples but his profit per pound will be less than at the equilibrium price.

Lessons Learned

We've learned that without outside influences, markets in an environment of perfect competition will arrive at an equilibrium point at which both buyers and sellers are satisfied.

But we must be aware that this is a very simplistic example. Things are much more complex in the real world. For one thing, markets rarely operate without outside influences. Circumstances also have a habit of changing.

What would happen, for example, if income rose and buyers were willing to pay more for apples? The demand curve would change, resulting in an increase in equilibrium price. This outcome makes intuitive sense: As demand increases, prices will go up. What would happen if apple crops were larger than expected because of favorable weather conditions? Farmers might be willing to sell apples at lower prices. If so, the supply curve would shift, resulting in another change in equilibrium price: The increase in supply would bring down prices.

The model is commonly applied to wages, in the market for labor. The typical roles of supplier and demander are reversed. The suppliers are individuals, who try to sell their labor for the highest price. The demanders of labor are businesses, which try to buy the type of labor they need at the lowest price. The equilibrium price for a certain type of labor is the wage rate.

Growth Economics

Long term trends in economic growth can be measured by tracking changes in a nation's gross domestic product (GDP) over time.

Learning Objectives

Break down the measure of economic growth and the contributing factors behind it

Key Takeaways

Key Points

Economic growth looks at the macroeconomic performance of an economy, most commonly by tracking a measure of total output known as gross domestic product ( GDP ).

An increase in GDP means an economy is producing more goods, so it is growing.

Inflation or deflation can make it difficult to measure economic growth. Because of this, the nominal GDP is adjusted for inflation or deflation.

Long run growth trends come from much deeper changes with long-lasting consequences.

Shocks like political upheavals, speculative bubbles, and other events can cause business cycle fluctuations.

Long run growth trends come from much deeper changes with long-lasting consequences.

Advancements in technology has the possibility of changing the future of production, as we saw in the Industrial Revolution.

Key Terms

nominal gdp: The raw GDP figure, as given by the GDP calculation equation, is called the nominal, historical, or current GDP.

real GDP: Real Gross Domestic Product (real GDP) is a macroeconomic measure of the value of economic output adjusted for price changes (i.e., inflation or deflation). This adjustment transforms the money-value measure, nominal GDP, into an index for quantity of total output.

GDP: Gross Domestic Product (Economics). A measure of the economic production of a particular territory in financial capital terms over a specific time period.

deflation: a decrease in the general price level of goods and services

inflation: An increase in the general level of prices or in the cost of living.

Economic Growth

Economists can measure the performance of an economy by looking at gross domestic product (GDP), a widely used measure of total output. GDP is defined as the market value of all goods and services produced by the economy in a given year. In the United States, it is calculated by the Department of Commerce. GDP includes only those goods and services produced domestically; goods produced outside the country are excluded. GDP also includes only those goods and services that are produced for the final user; intermediate products are excluded. For example, the silicon chip that goes into a computer (an intermediate product) would not count, even though the finished computer would.

By itself, GDP doesn't necessarily tell us much about the state of the economy, but change in GDP does. If GDP (after adjusting for inflation) goes up, the economy is growing; if it goes down, the economy is contracting.

Economic growth is the increase in the amount of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real GDP.

Growth is usually calculated in real terms, i.e. inflation-adjusted terms, in order to net out the effect of inflation on the price of the goods and services produced. In economics, "economic growth" or "economic growth theory" typically refers to growth of potential output, i.e., production at "full employment," which is caused by growth in aggregate demand or observed output.

Measuring economic growth

Economic growth is measured as a percentage change in the GDP or Gross National Product (GNP). These two measures, which are calculated in slightly different ways, total the amounts paid for the goods and services that a country produced.

As an example of measuring economic growth, a country that creates $9,000,000,000 in goods and services in 2010 and then creates $9,090,000,000 in 2011 has a nominal economic growth rate of 1% for 2011.

A single currency may be quoted to compare per capita economic growth among several countries. This requires converting the value of currencies of various countries into a selected currency, for example U.S. dollars. One way to do this conversion is to rely on exchange rates among the currencies, for example how many Mexican pesos buy a single U.S. dollar? Another approach is to use the purchasing power parity method. This method is based on how much consumers must pay for the same "basket of goods" in each country.

Inflation and Deflation can make it difficult to measure economic growth

Inflation or deflation can make it difficult to measure economic growth. For example, if GDP goes up in a country by 1% in a year, economists must ask if this was due solely to rising prices (inflation) or if it was because more goods and services were produced and saved.

To express real growth rather than changes in prices for the same goods, statistics on economic growth are often adjusted for inflation or deflation. For example, a table may show changes in GDP in the period 1990 to 2000, as expressed in 1990 U.S. dollars. This means that the U.S. dollar with the purchasing power it had in the U.S. in 1990 is the only currency being used for the comparison. The table might mention that the figures are "inflation-adjusted," or real. If no adjustment was made for inflation, the table might make no mention of inflation-adjustment, or might mention that the prices are nominal.

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A country's economic system is made up of institutions and decision-making structures that determine economic activity. Differentiate between planned and free market economic systems Key Points An economic system is the decision-making structure of a nation's economy, characterized by the entities and policies that shape it.

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After reading this chapter, you should be able to answer these questions:

1. What philosophies and concepts shape personal ethical standards?

2. How can organizations encourage ethical business behaviour?

3. What is corporate social responsibility?

4. How do businesses meet their social responsibilities to various stakeholders?

5. What are the trends in ethics and corporate social responsibility?

What philosophies and concepts shape personal ethical standards?
Every day, managers and business owners make business decisions based on what they believe to be right and wrong. Through their actions, they demonstrate to their employees what is and is not acceptable behaviour and shape the moral standard of the organization. As you will see in this chapter, personal and professional ethics are important cornerstones of an organization and shape its ultimate contributions to society in the form of corporate social responsibility. First, let's consider how individual business ethics are formed.

Ethics is a set of moral standards for judging whether something is right or wrong. The first step in understanding business ethics is learning to recognize an ethical issue. An ethical issue is a situation where someone must choose between a set of actions that may be ethical or unethical. For example, Martin Shkreli, former CEO of Turing Pharmaceuticals, raised the price of a drug used for newborns and HIV patients by more than 5000 percent, defending the price increase as a "great business decision."¹Few people would call that ethical behaviour. But consider the actions of the stranded, hungry people in New Orleans who lost everything in the aftermath of Hurricane Katrina. They broke into flooded stores, taking food and bottled water without paying for them. Was this unethical behaviour? Or what about the small Texas plastics manufacturer that employed over 100 people and specialized in the Latin American market? The president was distraught because he knew the firm would be bankrupt by the end of the year if it didn't receive more contracts. He knew that he was losing business because he refused to pay bribes. Bribes were part of the culture in his major markets. Closing the firm would put many people out of work. Should he start paying bribes in order to stay in business? Would this be unethical? Let's look at the next section to obtain some guidance on recognizing unethical situations.

Ethics business ethics and social responsibility video: https://youtu.be/0KhURlAim80

Recognizing Unethical Business Activities

Researchers from Brigham Young University tell us that all unethical business activities will fall into one of the following categories:

1. Taking things that don't belong to you: The unauthorized use of someone else's property or taking property under false pretenses is taking something that does not belong to you. Even the smallest offense, such as using the postage meter at your office for mailing personal letters or exaggerating your travel expenses, belongs in this category of ethical violations.

2. Saying things you know are not true: Often, when trying for a promotion and advancement, fellow employees discredit their coworkers. Falsely assigning blame or inaccurately reporting conversations is lying. Although "This is the way the game is played around here" is a common justification, saying things that are untrue is an ethical violation.

3. Giving or allowing false impressions: The salesperson who permits a potential customer to believe that cardboard boxes will hold the customer's tomatoes for long-distance shipping when the salesperson knows the boxes are not strong enough has given a false impression. A car dealer who fails to disclose that a car has been in an accident is misleading potential customers.

4. Buying influence or engaging in a conflict of interes t: A conflict of interest occurs when the official responsibilities of an employee or government official are influenced by the potential for personal gain. Suppose a company awards a construction contract to a firm owned by the father of the provincial attorney general while the provincial attorney general's office is investigating that company. If this construction award has the potential to shape the outcome of the investigation, a conflict of interest has occurred.

5. Hiding or divulging information: Failing to disclose the results of medical studies that indicate your firm's new drug has significant side effects is the ethical violation of hiding information about the potential harm your product has to purchasers. Taking your firm's product development or trade secrets to a new place of employment constitutes the ethical violation of divulging proprietary information.

6. Taking unfair advantage: Many current consumer protection laws were passed because so many businesses took unfair advantage of people who were not educated or were unable to discern the nuances of complex contracts. Credit disclosure requirements, truth-in-lending provisions, and new regulations on auto leasing all resulted because businesses misled consumers who could not easily follow the jargon of long, complex agreements.

7. Committing improper personal behaviour: Although the ethical aspects of an employee's right to privacy are still debated, it has become increasingly clear that personal conduct outside the job can influence performance and company reputation. Thus, a company driver must abstain from substance abuse because of safety issues. Even the traditional company holiday party and summer picnic have come under scrutiny due to the possibility that employees at and following these events might harm others through alcohol-related accidents.

8. Abusing power and mistreating individuals: Suppose a manager sexually harasses an employee or subjects employees to humiliating corrections or reprimands in the presence of customers. In some cases, laws protect employees. Many situations, however, are simply interpersonal abuse that constitutes an ethical violation.

9. Permitting organizational abuse: Many Canadian firms with operations overseas, such as Apple, Nike, and Levi Strauss, have faced issues of organizational abuse. The unfair treatment of workers in international operations appears in the form of child labour, demeaning wages, and excessive work hours. Although a business cannot change the culture of another country, it can perpetuate-or stop-abuse through its operations there.

10. Violating rules: Many organizations use rules and processes to maintain internal control or respect the authority of managers. Although these rules may seem burdensome to employees trying to serve customers, a violation may be considered an unethical act.

11. Condoning unethical actions: What if you witnessed a fellow employee embezzling company funds by forging her signature on a check? Would you report the violation? A winking tolerance of others' unethical behaviour is itself unethical.²

After recognizing that a situation is unethical, the next question is what do you do? The action that a person takes is partially based upon his or her ethical philosophy. The environment in which we live and work also plays a role in our behaviour.

Justice-The Question of Fairness

Another factor influencing individual business ethics is justice, or what is fair according to prevailing standards of society. We all expect life to be reasonably fair. You expect your exams to be fair, the grading to be fair, and your wages to be fair based on the type of work being done.

Today we take justice to mean an equitable distribution of the burdens and rewards that society has to offer. The distributive process varies from society to society. Those in a democratic society believe in the "equal pay for equal work" doctrine, in which individuals are rewarded based on the value the free market places on their services. Because the market places different values on different occupations, the rewards, such as wages, are not necessarily equal. Nevertheless, many regard the rewards as just. A politician who argued that a supermarket clerk should receive the same pay as a physician, for example, would not receive many votes from the Canadian people. At the other extreme, communist theorists have argued that justice would be served by a society in which burdens and rewards were distributed to individuals according to their abilities and their needs, respectively.
How can organizations encourage ethical busine ss behaviour?
People choose between right and wrong based on their personal code of ethics. They are also influenced by the ethical environment created by their employers. Consider the following headlines:

Investment advisor Bernard Madoff sentenced to 150 years in prison for swindling clients out of more than $65 billion.

Former United Airlines CEO Jeff Smisek leaves the company after a federal investigation into whether United tried to influence officials at the Port Authority of New York.

Renaud Laplanche, the founder of Lending Club, loses his job because of faulty practices and conflicts of interest at the online peer-to-peer lender.

Wells Fargo CEO John Stumpf fired after company employees opened more than 2 million fake accounts to meet aggressive sales targets.³

As these actual stories illustrate, poor business ethics can create a very negative image for a company, can be expensive for the firm and/or the executives involved, and can result in bankruptcy and jail time for the offenders. Organizations can reduce the potential for these types of liability claims by leading through example, through various informal and formal programs, and by educating their employees about ethical standards.

Leading by Example

Employees often follow the examples set by their managers. Leaders and managers establish patterns of behaviour that determine what's acceptable and what's not within the organization. While Ben Cohen was president of Ben & Jerry's ice cream, he followed a policy that no one could earn a salary more than seven times that of the lowest-paid worker. He wanted all employees to feel that they were equal. At the time he resigned, company sales were $140 million, and the lowest-paid worker earned $19,000 per year. Ben Cohen's salary was $133,000, based on the "seven times" rule. A typical top executive of a $140 million company might have earned 10 times Cohen's salary. Ben Cohen's actions helped shape the ethical values of Ben & Jerry's.

Offering Ethics Training Programs

In addition to providing a system to resolve ethical dilemmas, organizations also provide formal training to develop an awareness of questionable business activities and practice appropriate responses. Many companies have some type of ethics training program. The ones that are most effective, like those created by Levi Strauss, American Express, and Campbell Soup Company, begin with techniques for solving ethical dilemmas such as those discussed earlier. Next, employees are presented with a series of situations and asked to come up with the "best" ethical solution. According to a recent survey by the Ethics Resource Center, more than 80 percent of U.S. companies provide some sort of ethics training for employees, which may include online activities, videos, and even games.⁴

Establishing a Formal Code of Ethics

Most large companies and thousands of smaller ones have created, printed, and distributed codes of ethics. In general, a code of ethics provides employees with the knowledge of what their firm expects in terms of responsibilities and behaviour toward fellow employees, customers, and suppliers. Some ethical codes offer a lengthy and detailed set of guidelines for employees. Others are not really codes at all but rather summary statements of goals, policies, and priorities. Some companies have their codes framed and hung on office walls, included as a key component of employee handbooks, and/or posted on their corporate websites.

Examples of company codes of ethics:

Do codes of ethics make employees behave in a more ethical manner? Some people believe that they do. Others think that they are little more than public relations gimmicks. If senior management abides by the code of ethics and regularly emphasizes the code to employees, then it will likely have a positive influence on behaviour.

The "50 Best Corporate Citizens in Canada" as ranked by Corporate Knights magazine are selected based on several categories. The top corporate citizens in 2019 were:

1. The Co-operators

2. Hydro-Québec

3. Algonquin Power & Utilities Corp.

4. Teck Resources Ltd.

5. Bombardier Inc.

6. Cascades Inc.

7. Desjardins Group

8. Transcontinental Inc.

9. Société de transport de Montréal

10. Kruger Products

Whistleblowing

A whistleblower is a person who exposes any kind of information that reveals illegal, unethical, or not correct activities within an organization that is either private or public. Many whistleblowers have stated that they were motivated to take action and put an end to unethical practices after witnessing injustices in their businesses or organizations. In addition to ethics, social and organizational pressures are also motivating forces. A 2012 study found that individuals are more likely to blow the whistle when several others know about the wrongdoing, because they would otherwise fear consequences for keeping silent.

The motivation for whistleblowing isn't always virtuous, and the outcome isn't always positive either. There are cases involving employees who blew the whistle as an act of revenge against their employer or supervisor, for instance. While it's possible for the whistleblower to be viewed as a "hero" for his/her courage and truth telling, it's also possible to be seen as a traitor or tattletale-as just one of the many disgruntled employees who are simply trying to get even for a perceived but imaginary injustice. One of the barriers to whistleblowing is the belief-widespread in the professional world-that individuals are bound to secrecy within their work sector. Accordingly, whistleblowing becomes a moral choice that pits the employee's loyalty to an employer against the employee's responsibility to serve the public interest. As a result, in Canada, whistleblower protection laws and regulations have been enacted to guarantee freedom of speech for workers and contractors in certain situations. Whistleblowers have the right to file complaints that they believe give reasonable evidence of a violation of a law, rule, or regulation; gross mismanagement; gross waste of funds; an abuse of authority; or a substantial and specific danger to public health or safety.

Making the Right Decision

In many situations, there may be no simple right or wrong answers. Yet there are several questions you can ask yourself, and a couple of self-tests you can do, to help you make the right ethical decision. First, ask yourself, "Are there any legal restrictions or violations that will result from the action?" If so, take a different course of action. If not, ask yourself, "Does it violate my company's code of ethics?" If so, again find a different path to follow. Third, ask, "Does this meet the guidelines of my own ethical philosophy?" If the answer is "yes," then your decision must still pass two important tests.

The Feelings Test

You must now ask, "How does it make me feel?" This enables you to examine your comfort level with a particular decision. Many people find that, after reaching a decision on an issue, they still experience discomfort that may manifest itself in a loss of sleep or appetite. Those feelings of conscience can serve as a future guide in resolving ethical dilemmas.

The Newspaper or Social Media Test

The final test involves the front page of the newspaper or social media posts. The question to be asked is how an objective reporter would describe your decision in a front-page newspaper story, an online media site, or a social media platform such as Twitter or Facebook. Some managers rephrase the test for their employees: How will the headline read if I make this decision, or what will be the reaction of my social media followers? This test is helpful in spotting and resolving potential conflicts of interest.

What is corporate social responsibility?

Acting in an ethical manner is one of the four components of the pyramid of corporate social responsibility (CSR), which is the concern of businesses for the welfare of society as a whole. It consists of obligations beyond those required by law or union contract. This definition makes two important points. First, CSR is voluntary. Beneficial action required by law, such as cleaning up factories that are polluting air and water, is not voluntary. Second, the obligations of corporate social responsibility are broad. They extend beyond investors in the company to include workers, suppliers, consumers, communities, and society at large.

Exhibit 2.2 portrays economic responsibility as the foundation of the other three responsibilities. While a business pursues profits (economic responsibility), it is expected to obey the law (legal responsibility); to do what is right, just, and fair (ethical responsibility); and to be a good corporate citizen (philanthropic responsibility). These four components are distinct but together constitute the whole. Still, if the company doesn't make a profit, then the other three responsibilities won't matter.

Many companies continue to work hard to make the world a better place to live. Recent data suggests that Fortune 500 companies spend more than $15 billion annually on CSR activities. Consider the following examples:

Starbucks has donated more than one million meals to local communities via its FoodShare program and alliance with Feeding America, giving 100 percent of leftover food from their seven thousand U.S. company-owned stores.

Salesforce encourages its employees to volunteer in community activities and pays them for doing so, up to 56 paid hours every year. For employees who participate in seven days of volunteerism in one year, Salesforce also gives them a $1,000 grant to donate to the employee's nonprofit of choice.

Employees who work for Deloitte, a global audit, consulting, and financial services organization, can get paid for up to 48 hours of volunteer work each year. In a recent year, more than 27,000 Deloitte professionals contributed more than 353,000 volunteer hours to their communities around the world.⁶

Understanding Social Responsibility

Peter Drucker, the late globally respected management expert, said that we should look first at what an organization does to society and second at what it can do for society. This idea suggests that social responsibility has two basic dimensions: legality and responsibility.

Illegal and Irresponsible Behaviour

The idea of corporate social responsibility is so widespread today that it is hard to conceive of a company continually acting in illegal and irresponsible ways. Nevertheless, such actions do sometimes occur, which can create financial ruin for organizations, extreme financial hardships for many former employees, and general struggles for the communities in which they operate in. Unfortunately, top executives still walk away with millions. Some, however, will ultimately pay large fines and spend time in prison for their actions. Federal, provincial, and local laws determine whether an activity is legal or not. The laws that regulate business are discussed later in this module.

Irresponsible but Legal Behaviour

Sometimes companies act irresponsibly, yet their actions are legal. For example, the Minnesota-based company that makes MyPillow was recently fined $1 million by the state of California for making unsubstantiated claims that the "most comfortable pillow you'll ever own" could help alleviate medical conditions such as snoring, fibromyalgia, migraines, and other disorders. The company's CEO countered that the claims were actually made by customers; these testimonials were posted on the company's website but later removed. In addition to the fine, the company faced several class-action lawsuits, and the Better Business Bureau has revoked MyPillow's accreditation.⁷

Legal and Responsible Behaviour

The vast majority of business activities fall into the category of behaviour that is both legal and responsible. Most companies act legally, and most try to be socially responsible. Research shows that consumers, especially those under 30, are likely to buy brands that have excellent ethical track records and community involvement. Outdoor specialty retailer REI, for example, recently announced that it gave back nearly 70 percent of its profits to the outdoor community. A member cooperative, the company invested a record $9.3 million in its nonprofit partners in 2016.⁸

How do businesses meet their social responsibilities to various stakeholders?

What makes a company be admired or perceived as socially responsible? Such a company meets its obligations to its stakeholders. Stakeholders are the individuals or groups to whom a business has a responsibility to. The stakeholders of a business are its employees, its customers, the general public, and its investors.

Responsibility to Employees

An organization's first responsibility is to provide a job to employees. Keeping people employed and letting them have time to enjoy the fruits of their labour is the finest thing business can do for society. Beyond this fundamental responsibility, employers must provide a clean, safe working environment that is free from all forms of discrimination. Companies should also strive to provide job security whenever possible.

Enlightened firms also empower employees to make decisions on their own and suggest solutions to company problems. Empowerment contributes to an employee's self-worth, which, in turn, increases productivity and reduces absenteeism.

Each year, in collaboration with Great Place to Work ®, Fortune conducts an extensive employee survey of the best places to work in the United States. For 2017, the top companies included Google, Wegmans Food Markets, Edward Jones, Genentech, Salesforce, Acuity, and Quicken Loans. Some companies offer unusual benefits to their employees. For example, biotech company Genentech offers employee compensation for taking alternative methods of transportation to work at its South San Francisco campus. Employees can earn $12 per day for walking or biking to work, and those who drive a carpool or vanpool can earn $8 and $16, respectively. In addition, the company offers free commuter bus service for all employees via 27 routes around the Bay Area.⁹

Responsibility to Customers

To be successful in today's business environment, a company must satisfy its customers. A firm must deliver what it promises, as well as be honest and forthright in everyday interactions with customers, suppliers, and others. Recent research suggests that many consumers, particularly millennials, prefer to do business with companies and brands that communicate socially responsible messages, utilize sustainable manufacturing processes, and practice ethical business standards.¹⁰

Responsibility to Society

A business must also be responsible to society. A business provides a community with jobs, goods, and services. It also pays taxes that support schools, hospitals, and better roads. Some companies have taken an additional step to demonstrate their commitment to stakeholders and society as a whole by becoming Certified Benefit Corporations, or B Corps for short. Verified by B Lab, a global nonprofit organization, B Corps meet the highest standards of social and environmental performance, public transparency, legal accountability, and strive to use the power of business to solve social and environmental problems via an impact assessment that rates each company on a possible score of 200 points. To become certified as a Benefit Corporation, companies need to reach a score of at least 80 and must be recertified every two years. There are more than 2,000 companies worldwide that have been certified as B Corps, including Method, W.S. Badger Company, Fishpeople Seafood, LEAP Organics, New Belgium Brewing Company, Ben & Jerry's, Cabot Creamery Co-op, Comet Skateboards, Etsy, Patagonia, Plum Organics, and Warby Parker.¹¹

Environmental Protection

Business is also responsible for protecting and improving the world's fragile environment. The world's forests are being destroyed fast. Every second, an area the size of a football field is laid bare. Plant and animal species are becoming extinct at the rate of 17 species per hour. A continent-size hole is opening up in the earth's protective ozone shield. Each year we throw out 80 percent more refuse than we did in 1960; as a result, more than half of the nation's landfills are filled to capacity.

To slow the erosion of the world's natural resources, many companies have become more environmentally responsible. For example, Toyota now uses renewable energy sources such as solar, wind, geothermal, and water power for electricity to run its facilities. When its new $1 billion North American headquarters opened in Plano, Texas, in May 2017, Toyota said the 2.1 million square-foot campus would eventually be powered by 100% clean energy, helping the auto giant move closer to its goal of eliminating carbon emissions in all of its operations.¹²

Corporate Philanthropy

Companies also display their social responsibility through corporate philanthropy. Corporate philanthropy includes cash contributions, donations of equipment and products, and support for the volunteer efforts of company employees. American Express is a major supporter of the Red Cross. The organization relies almost entirely on charitable gifts to carry out its programs and services, which include disaster relief, armed-forces emergency relief, blood and tissue services, and health and safety services. The funds provided by American Express have enabled the Red Cross to deliver humanitarian relief to victims of numerous disasters around the world.¹ ³When Hurricane Katrina hit the Gulf Coast, Bayer sent 45,000 diabetes blood glucose monitors to the relief effort. Within weeks of the disaster, Abbott, Alcoa, Dell, Disney, Intel, UPS, Walgreens, Walmart, and others contributed more than $550 million for disaster relief.¹⁴

Responsibilities to Investors

Companies' relationships with investors also entail social responsibility. Although a company's economic responsibility to make a profit might seem to be its main obligation to shareholders, some investors are increasingly emphasizing other aspects of social responsibility.

Some investors are limiting their investments to securities (e.g., stocks and bonds) that coincide with their beliefs on ethical and social responsibility. This is called social investing. For example, a social investment fund might eliminate from consideration the securities of all companies that make tobacco products, liquor, weapons, or have a history of being environmentally irresponsible. Not all social investment strategies are alike. Some ethical mutual funds will not invest in government securities because they help to fund the military; others freely buy government securities, with managers noting that federal funds also support the arts and pay for AIDS research. Today, assets invested using socially responsible strategies total more than $7 trillion.¹⁵

Perhaps partly due to the global recession of 2007-2009, over the last several years, companies have tried to meet their responsibilities to investors as well as to their other stakeholders. Recent research suggests that now more than ever, CEOs are being held to higher standards by boards of directors, investors, governments, media, and even employees when it comes to corporate accountability and ethical behaviour. A recent global study by PwC reveals that over the last several years, there has been a large increase in the number of CEOs being forced out due to some sort of ethical lapse in their organizations. Strategies to prevent such missteps should include establishing a culture of integrity to prevent anyone from breaking the rules, making sure company goals and metrics do not create undue pressure on employees to cut corners, and implementing effective processes and controls to minimize the opportunity for unethical behaviour.¹⁶

What are the trends in ethics and corporate social responsibility?

Three important trends related to ethics and corporate social responsibility are strategic changes in corporate philanthropy, a new social contract between employers and employees, and the growth of global ethics and corporate social responsibility.

Changes in Corporate Philanthropy

Historically, corporate philanthropy has typically involved companies seeking out charitable groups and giving them money or donating company products or services. Today, the focus has shifted to strategic giving, which ties philanthropy and corporate social responsibility efforts closely to a company's mission or goals and targets donations to the communities where a company does business. Some of the top businesses recognized for their efforts in giving back to the communities in which they operate include technology giant Salesforce, NuStar Energy, insurance and financial services firm Veterans United, and software leader Intuit.¹⁷

Cause related marketing video: https://youtu.be/C1s65IGuRMM

A Social Contract between Employer and Employee

Another trend in social responsibility is the effort by organizations to redefine their relationship with their employees. Many people have viewed social responsibility as a one-way street that focuses on the obligations of business to society, employees, and others. Now, companies recognize that the social contract between employer and employee is an important aspect of the workplace and that both groups have to be committed to working together in order for the organization to prosper. The social contract can be defined in terms of four important aspects: compensation, management, culture, and learning and development.¹⁸

When it comes to compensation, companies today must recognize that most employees do not stay with one organization for decades. Thus, companies need to change their compensation structure to acknowledge the importance of short-term performance and to update their methods for determining compensation, including benefits and other nontraditional perks such as paid leave and telecommuting options.

In the current workplace environment, where employees are likely to jump to new jobs every couple years, managers need to take a more active and engaged approach to supervising employees and perhaps change the way they think about loyalty, which may be difficult for managers who are used to supervising the same group of employees for a long period of time. Engaging employees on a regular basis, setting realistic expectations, and identifying specific development paths may help retain key employees.

Thanks to today's tight labour market, some employees feel empowered to demand more from their employer and its overall culture via strategies such as increased flexibility, transparency, and fairness. This increased importance of the employee's role in the company's culture helps workers stay engaged in the mission of the organization and perhaps makes them less likely to look elsewhere for employment.

Finally, rapidly changing technology used in today's workplace continues to shift the learning and development of the employer-employee contract, causing immense challenges to both companies and workers. It may be more difficult to identify the employee skills that will be critical over the next several years, causing employers either to increase training of current workers or to look outside the organization for other individuals who already possess the technical skills needed to get the job done.

Global Ethics and Social Responsibility

When Canadian businesses expand into global markets, they must take their codes of ethics and policies on corporate social responsibility with them. As a citizen of several countries, a multinational corporation has several responsibilities. These include respecting local practices and customs, ensuring that there is harmony between the organization's staff and the host population, providing management leadership, and developing a solid group of local managers who will be a credit to their community. When a multinational firm makes an investment in a foreign country, it should commit to a long-term relationship. That means involving all stakeholders in the host country in decision-making. Finally, a responsible multinational will implement ethical guidelines within the organization in the host country. By fulfilling these responsibilities, the company will foster respect for both local and international laws.

Multinational corporations often must balance conflicting interests of stakeholders when making decisions regarding social responsibilities, especially in the area of human rights. Questions involving child labour, forced labor, minimum wages, and workplace safety can be particularly difficult. Recently Gap, Inc. decided to publish the list of its global factories in an effort to provide transparency about its suppliers and the efforts the company continues to make to improve working conditions around the world. The company has partnered with Verité, a nongovernmental organization focused on ensuring that people work under safe, fair, and legal conditions. By soliciting feedback from factory workers who make its products, Gap is hoping to improve working conditions and help these factories become leaders in their local communities.¹⁹

Sustainability

Sustainability has become such an important concept that it is frequently used interchangeably with CSR. Indeed, for some companies it seems that CSR is sustainability. This is perhaps not surprising, given the growing media attention on issues related to sustainability.

Sustainability is a concept derived from environmentalism; it originally referred to the ability of a society or company to continue to operate without compromising the planet's environmental condition in the future. In other words, a sustainable corporation is one that can sustain its current activities without adding to the world's environmental problems. Sustainability is therefore a very challenging goal, and many environmentalists maintain that no corporation today operates sustainably, since all use energy (leading to the gradual depletion of fossil fuels while emitting greenhouse gases) and all produce waste products like garbage and industrial chemicals. Whether or not true sustainability will be attainable in the near future, the development and promotion of sustainability strategies has become an obsession for most large corporations today, as demonstrated by their websites' inevitable reference to the corporation's sincere commitment to sustainability and responsible environmental practices. No corporation or corporate executive today will be caught saying they do not really care about the environment. However, if we observe their actions rather than their words, we may have cause for doubt.

Corporate social responsibility and sustainability video: https://youtu.be/xoE8X l cDUI8

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Chapter 2: Ethical Decisions and Socially Responsible Business

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Skip to content After reading this chapter, you should be able to answer these questions: What philosophies and concepts shape personal ethical standards? How can organizations encourage ethical business behaviour? What is corporate social responsibility? How do businesses meet their social responsibilities to various stakeholders? What are the trends in ethics and corporate social responsibility?

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How do companies enter the global marketplace?

Companies decide to "go global" for a number of reasons. Perhaps the most urgent reason is to earn additional profits. If a firm has a unique product or technological advantage not available to other international competitors, this advantage should result in major business successes abroad. In other situations, management may have exclusive market information about foreign customers, marketplaces, or market situations. In this case, although exclusivity can provide an initial motivation for going global, managers must realize that competitors will eventually catch up. Finally, saturated domestic markets, excess capacity, and potential for cost savings can also be motivators to expand into international markets. A company can enter global trade in several ways, as this section describes.

Exporting

When a company decides to enter the global market, usually the least complicated and least risky alternative is exporting, or selling domestically produced products to buyers in another country. A company, for example, can sell directly to foreign importers or buyers. Exporting is not limited to huge corporations such as General Motors or Apple. Indeed, small companies typically enter the global marketplace by exporting. China is the world's largest exporter, followed by the United States.

https://www.cia.gov/library/publications/the-world-factbook/rankorder/2078rank.html, accessed June 25, 2017.

Many small businesses claim that they lack the money, time, or knowledge of foreign markets that exporting requires. The U.S. Small Business Administration (SBA) now offers the Export Working Capital Program, which helps small and medium-size firms obtain working capital (money) to complete export sales. The SBA also provides counseling and legal assistance for small businesses that wish to enter the global marketplace. Companies such as American Building Restoration Products of Franklin, Wisconsin, have benefited tremendously from becoming exporters. American Building is now selling its chemical products to building restoration companies in Mexico, Israel, Japan, and Korea. Exports account for more than 5 percent of the firm's total sales.

Plenty of governmental help is available when a company decides to begin exporting. Export Assistance Centers (EAC) provide a one-stop resource for help in exporting. Over 700 EACs are placed strategically around the country. Often the SBA is located in the same building as the EAC. The SBA can guarantee loans of $50,000 to $100,000 to help an exporter grow its business. Online help is also available at http://www.ustr.gov. The site lists international trade events, offers international marketing research, and has practical tools to help with every step of the exporting process. Companies considering exporting for the first time can go to http://www.export.gov and get answers to questions such as: What's in it for me? Am I ready for this? What do I have to do? The site also provides a huge list of resources for the first-time exporter.

Licensing and Franchising

Another effective way for a firm to move into the global arena with relatively little risk is to sell a license to manufacture its product to a firm in a foreign country. Licensing is the legal process whereby a firm (the licensor) agrees to let another firm (the licensee) use a manufacturing process, trademark, patent, trade secret, or other proprietary knowledge. The licensee, in turn, agrees to pay the licensor a royalty or fee agreed on by both parties.

International licensing is a multibillion-dollar-a-year industry. Entertainment and character licensing, such as DVD movies and characters such as Batman, is the largest single category. Trademarks are the second-largest source of licensing revenue. Caterpillar licenses its brand for both shoes and clothing, which is very popular in Europe.

U.S. companies have eagerly embraced the licensing concept. For instance, Labatt Brewing Company has a license to produce Miller High Life in Canada. The Spalding Company receives more than $2 million annually from license agreements on its sporting goods. Fruit of the Loom lends its name through licensing to 45 consumer items in Japan alone, for at least 1 percent of the licensee's gross sales.

The licensor must make sure it can exercise sufficient control over the licensee's activities to ensure proper quality, pricing, distribution, and so on. Licensing may also create a new competitor in the long run if the licensee decides to void the license agreement. International law is often ineffective in stopping such actions. Two common ways that a licensor can maintain effective control over its licensees are by shipping one or more critical components from the United States and by locally registering patents and trademarks in its own name.

Franchising is a form of licensing that has grown rapidly in recent years. Many U.S. franchisors operate thousands of outlets in foreign countries. More than half of the international franchises are for fast-food restaurants and business services. McDonald's, however, decided to sell its Chinese stores to a group of outside investors for $1.8 billion, but retained 20 percent of the equity.

"McDonald's Sells Control of China Business to Citic, Carlyle," Bloomberg News, https://www.bloomberg.com/news/articles/2017-01-09/mcdonald-s-sells-control-of-china-business-to-citic-carlyle, January 9, 2017.

Having a big-name franchise doesn't always guarantee success or mean that the job will be easy. In China, Home Depot closed its stores after opening 12 to serve the large Chinese population. Had they done market research, they would have known that the majority of urban dwellers live in recently built apartments and that DIY (Do It Yourself) is viewed with disdain in Chinese society, where it is seen as a sign of poverty.

"Famous Failures in China," http://www.1421.consulting, February 2, 2016.

When Subway opened its first sandwich shop in China, locals stood outside and watched for a few days. Patrons were so confused that the franchisee had to print signs explaining how to order. Customers didn't believe the tuna salad was made from a fish because they couldn't see the head or tail. And they didn't like the idea of touching their food, so they would hold the sandwich vertically, peel off the paper wrap, and eat it like a banana. Most of all, the Chinese customers didn't want sandwiches.

It's not unusual for Western food chains to adapt their strategies when selling in China. McDonald's, aware that the Chinese consume more chicken than beef, offered a spicy chicken burger. KFC got rid of coleslaw in favor of seasonal dishes such as shredded carrots or bamboo shoots.

Contract Manufacturing

In contract manufacturing, a foreign firm manufactures private-label goods under a domestic firm's brand. Marketing may be handled by either the domestic company or the foreign manufacturer. Levi Strauss, for instance, entered into an agreement with the French fashion house of Cacharel to produce a new Levi's line, Something New, for distribution in Germany.

The advantage of contract manufacturing is that it lets a company test the water in a foreign country. By allowing the foreign firm to produce a certain volume of products to specification and put the domestic firm's brand name on the goods, the domestic firm can broaden its global marketing base without investing in overseas plants and equipment. After establishing a solid base, the domestic firm may switch to a joint venture or direct investment, explained below.

Joint Ventures

Joint ventures are somewhat similar to licensing agreements. In a joint venture, the domestic firm buys part of a foreign company or joins with a foreign company to create a new entity. A joint venture is a quick and relatively inexpensive way to enter the global market. It can also be very risky. Many joint ventures fail. Others fall victim to a takeover, in which one partner buys out the other.

Sometimes countries have required local partners in order to establish a business in their country. China, for example, had this requirement in a number of industries until recently. Thus, a joint venture was the only way to enter the market. Joint ventures help reduce risks by sharing costs and technology. Often joint ventures will bring together different strengths from each member. In the General Motors-Suzuki joint venture in Canada, for example, both parties have contributed and gained. The alliance, CAMI Automotive, was formed to manufacture low-end cars for the U.S. market. The plant, which was run by Suzuki management, produces the Chevrolet Equinox and the Pontiac Torrent, as well as the new Suzuki SUV. Through CAMI, Suzuki has gained access to GM's dealer network and an expanded market for parts and components. GM avoided the cost of developing low-end cars and obtained models it needed to revitalize the lower end of its product line and its average fuel economy rating. After the successful joint venture, General Motors gained full control of the operation in 2011. The CAMI factory may be one of the most productive plants in North America. There GM has learned how Japanese automakers use work teams, run flexible assembly lines, and manage quality control.

General Motors website, http://www.gmcamiassembly.ca/Facilities/public/ca/en/CAMI/about_us.html, accessed July 17, 2017.

Direct Foreign Investment

Active ownership of a foreign company or of overseas manufacturing or marketing facilities is direct foreign investment. Direct investors have either a controlling interest or a large minority interest in the firm. Thus, they stand to receive the greatest potential reward but also face the greatest potential risk. A firm may make a direct foreign investment by acquiring an interest in an existing company or by building new facilities. It might do so because it has trouble transferring some resources to a foreign operation or obtaining that resource locally. One important resource is personnel, especially managers. If the local labor market is tight, the firm may buy an entire foreign firm and retain all its employees instead of paying higher salaries than competitors.

Sometimes firms make direct investments because they can find no suitable local partners. Also, direct investments avoid the communication problems and conflicts of interest that can arise with joint ventures. IBM, in the past, insisted on total ownership of its foreign investments because it did not want to share control with local partners.

General Motors has done very well by building a $4,400 (RMB 29,800) minivan in China that gets 43 miles per gallon in city driving. The Wuling Sunshine has a quarter the horsepower of U.S. minivans, weak acceleration, and a top speed of 81 miles per hour. The seats are only a third of the thickness of seats in Western models, but look plush compared to similar Chinese cars. The minivans have made GM the largest automotive seller in China, and have made China a large profit center for GM.

Wuling Sunshine, http://media.gm.com/media/cn/en/wuling/vehicles/sunshine/2010.html, accessed June 27, 2017.

Walmart now has over 6,000 stores located outside the United States. In 2016, international sales were over $116 billion. About one-third of all new Walmart stores are opened in global markets.

"Walmart 2017 Annual Report," http://stock.walmart.com, accessed June 27, 2017.

Not all of Walmart's global investments have been successful. In Germany, Walmart bought the 21-store Wertkauf hypermarket chain and then 74 unprofitable and often decrepit Interspar stores. Problems in integrating and upgrading the stores resulted in at least $200 million in losses. Like all other German stores, Walmart stores were required by law to close at 8 p.m. on weekdays and 4 p.m. on Saturdays, and they could not open at all on Sundays. Costs were astronomical. As a result, Walmart left the German retail market.

Walmart has turned the corner on its international operations. It is pushing operational authority down to country managers in order to respond better to local cultures. Walmart enforces certain core principles such as everyday low prices, but country managers handle their own buying, logistics, building design, and other operational decisions.

Global firms change their strategies as local market conditions evolve. For example, major oil companies like Shell Oil and ExxonMobil had to react to dramatic changes in the price of oil due to technological advances such as more efficient automobiles, fracking, and horizontal drilling.

In 2014, crude oil was $90 a barrel, but increased production due to the shale oil boom and the reluctance of OPEC countries to reduce output led to a price drop to $45-$60 throughout the first quarter of 2015. While this is terrific news for consumers, it does provide challenges to managers at both large and small companies connected to the oil industry. Companies such as Chevron, Royal Dutch Shell, and ExxonMobil saw dramatic reductions in their earnings, which were also reflected in lower stock prices.

The action taken by senior executives at Chevron was to trim their planned capital expenditures by $5 billion in 2016, resulting in the elimination of 1,500 jobs, while ExxonMobil executives Jeff Woodbury and CEO Rex Tillerson (now the former U.S. Secretary of State) were less specific; they planned several belt-tightening strategies and forecast several years of low oil prices. Likewise, Ben van Beurden, the CEO of Royal Dutch Shell, announced plans to eliminate 6,500 jobs and also predicted long-range low prices for oil.

In addition to layoffs, actions that oil company managers can employ include mergers for companies that don't have the ability to become fully efficient themselves. They can merge with other companies that can improve overall efficiencies and operations. Contrary to the cost-cutting plans mentioned earlier, some companies might consider increasing their spending plans. Going against the reduced expenditures trend is Encana, a North American oil producer, which plans to increase its overall spending. Some of the factors that allowed Encana to increase spending was its low debt-to-equity ratio and its growth, which exceeded the industry average.

Growth is an important component of a company's strategy, and reactive short-term strategies can often hurt long-term growth. By implementing performance-improvement programs, companies can address problems and inefficiencies within the company and allow them to focus on innovation. Another strategy that companies can use is to review and alter their supply chain by focusing on costs and efficiency. Companies can expand their supplier base, thus increasing competition and reducing costs. This also requires companies to embrace a lean manufacturing mindset.

New technology can also be used as a cost driver. New technologies such as microseismic sensors used to monitor fracking operations in drilling operations miles under the earth can boost production. Adopting new technology can also lead to changes in the workers that companies employ. New technology usually requires higher-skilled workers, while reducing the number of lower-skilled workers.

The drop in oil prices has produced a survival-of-the-fittest competition among energy companies. The companies that employ multiple strategies to improve efficiency are the ones that will survive and prosper.

Sources: Stanley Reed and Clifford Krauss, "Royal Dutch Shell Profits Continue to Fall, Prompting Layoffs," The New York Times, http://www.nytimes.com, July 30, 2015; John Biers, "More Belt-tightening Ahead as Exxon, Chevron Profits Dive," Yahoo! News, https://www.yahoo.com, July 31, 2015; Aisha Tejani, "How Oil Companies Are Responding to the Oil Price Drop," http://www.castagra.com, accessed June 30, 2017.

Countertrade

International trade does not always involve cash. Today, countertrade is a fast-growing way to conduct international business. In countertrade, part or all of the payment for goods or services is in the form of other goods or services. Countertrade is a form of barter (swapping goods for goods), an age-old practice whose origins have been traced back to cave dwellers. The U.S. Commerce Department says that roughly 30 percent of all international trade involves countertrade. Each year, about 300,000 U.S. firms engage in some form of countertrade. U.S. companies, including General Electric, Pepsi, General Motors, and Boeing, barter billions of goods and services every year. Recently, the Malaysian government bought 20 diesel-powered locomotives from China and paid for them with palm oil.

1. Discuss several ways that a company can enter international trade.

2. Explain the concept of countertrade.

Summary of Learning Outcomes

How do companies enter the global marketplace?

There are a number of ways to enter the global market. The major ones are exporting, licensing, contract manufacturing, joint ventures, and direct investment.

Glossary

contract manufacturing

The practice in which a foreign firm manufactures private-label goods under a domestic firm's brand name.

countertrade

A form of international trade in which part or all of the payment for goods or services is in the form of other goods and services.

direct foreign investment

Active ownership of a foreign company or of manufacturing or marketing facilities in a foreign country.

exporting

The practice of selling domestically produced goods to buyers in another country.

joint venture

An agreement in which a domestic firm buys part of a foreign firm or joins with a foreign firm to create a new entity.

licensing

The legal process whereby a firm agrees to allow another firm to use a manufacturing process, trademark, patent, trade secret, or other proprietary knowledge in exchange for the payment of a royalty.

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How do companies enter the global marketplace? Companies decide to "go global" for a number of reasons. Perhaps the most urgent reason is to earn additional profits. If a firm has a unique product or technological advantage not available to other international competitors, this advantage should result in major business successes abroad.

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The business structure you choose influences everything from day-to-day operations, to taxes and how much of your personal assets are at risk. You should choose a business structure that gives you the right balance of legal protections and benefits.

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Leadership and management are the terms that are often considered synonymous. It is essential to understand that leadership is an essential part of effective management.

As a crucial component of management, remarkable leadership behaviour stresses upon building an environment in which each and every employee develops and excels.

Leadership is defined as the potential to influence and drive the group efforts towards the accomplishment of goals. This influence may originate from formal sources, such as that provided by acquisition of managerial position in an organization.

A manager must have traits of a leader, i.e., he/she must possess leadership qualities. Leaders develop and begin strategies that build and sustain competitive advantage.

Organizations require robust leadership and robust management for optimal organizational efficiency.

Differences between Leadership and Management

Leadership differs from management in a sense that:

1. While managers lay down the structure and delegates authority and responsibility, leaders provides direction by developing the organizational vision and communicating it to the employees and inspiring them to achieve it.

2. While management includes focus on planning, organizing, staffing, directing and controlling; leadership is mainly a part of directing function of management. Leaders focus on listening, building relationships, teamwork, inspiring, motivating and persuading the followers.

3. While a leader gets his authority from his followers, a manager gets his authority by virtue of his position in the organization.

4. While managers follow the organization's policies and procedure, the leaders follow their own instinct.

5. Management is more of science as the managers are exact, planned, standard, logical and more of mind.
Leadership, on the other hand, is an art. In an organization, if the managers are required, then leaders are a must/essential.

6. While management deals with the technical dimension in an organization or the job content; leadership deals with the people aspect in an organization.

7. While management measures/evaluates people by their name, past records, present performance;
Leadership sees and evaluates individuals as having potential for things that can't be measured, i.e., it deals with future and the performance of people if their potential is fully extracted.

8. If management is reactive, leadership is proactive.

9. Management is based more on written communication, while leadership is based more on verbal communication.

The organizations which are over managed and under-led do not perform upto the benchmark.

Leadership accompanied by management sets a new direction and makes efficient use of resources to achieve it.

Both leadership and management are essential for individual as well as organizational success.

Authorship/Referencing - About the Author(s)

The article is Written By "Prachi Juneja" and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.

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relationship between leadership and management

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differences between leadership and management

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Leadership and Management - Relationship & Differences

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Leadership and management are the terms that are often considered synonymous. It is essential to understand that leadership is an essential part of effective management. As a crucial component of management, remarkable leadership behaviour stresses upon building an environment in which each and every employee develops and excels.

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In the Dallas airport the other day I saw many tall, well-dressed, and impressive-looking men wearing large, immaculate Stetson cowboy hats. As I walked by one such hat-wearer, I noticed two middle-aged, sunburned men in faded blue jeans standing nearby. They eyed the same fellow, looked him up and down, and then one said quietly to the other, "Big hat, no cattle."

A version of this article appeared in the September 1981 issue of Harvard Business Review.

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In the Dallas airport the other day I saw many tall, well-dressed, and impressive-looking men wearing large, immaculate Stetson cowboy hats. As I walked by one such hat-wearer, I noticed two middle-aged, sunburned men in faded blue jeans standing nearby. They eyed the same fellow, looked him up and down, and then one said quietly [...]

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This website has links to lots of the best production/operations programs. They are mainly programs at colleges and universities.

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You don't have permission to access "http://www.usnews.com/best-graduate-schools/top-business-schools/production-operations-rankings" on this server.
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The Best Production / Operations Programs, Ranked

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Explore the best business schools for Production / Operations.

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This website talks about making your product affordable, which means it is affordable to a lot more consumers. They are also using good business ethics in their beliefs of no "cutting corners."

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There are many ways to make your product more affordable. It is just finding the ways to cut costs, without cutting corners. So, it means cutting corners a little bit but in a good way. You still want to have a quality product but at the same time you want to make your product more affordable than your competitions.

Making your product affordable can be hard at times. You want to be able to make a good product that will sell plus be able to make a profit. So how do you make a profit off of your product, and make your product affordable all at the same time? The following are some ways to make your product affordable, without cutting into your profits.

First figure out what it costs to make your product. Then figure out what part or parts costs the most to make the product. After that, start researching to see if you can find a wholesaler that will sell you the items that are making your product cost so much. Shop around go to a couple different people before making a choice. Even if you are going through a supplier you might be able to go through a wholesaler and get the products you need for cheaper. Once you have found a couple of different wholesalers try to figure out which one can help you save money and make your product more affordable with out bringing down the quality. Usually when working with wholesalers there is a first time minimum purchase but after that they let you order smaller quantities. Once you have picked a wholesaler you can figure out the new cost for you to make the product. This will help you be able to make it a little more affordable and still make a profit.

Another way to make your product affordable is to find ways to make your own materials for example say you are going into making decorative signs or clocks, instead of paying someone else to cut out your signs or clocks that you paint, buy the wood at a discounted price and cut the wood yourself. This will help decrease the price of manufacturing your product and will help your product to be more affordable.

If making your own materials is out of the question or is not an option. You could make your products more affordable by finding a wholesale or supplier in your area that will let you pick up supplies yourself or have them delivered. This might save you the money it costs to have your materials shipped to you. This would also make your product more affordable because you won't have to spend that extra money on shipping and in return give the savings to your customers.

You could also make your product more affordable by offering people a deal when they combined shipping. This will not only help you save money having to ship products to a customer if you can ship them in one package instead of two, but it also might get people to but more products from you just to get the discount on the shipping.

You might be able to find better deals for your supplies by buying them off e bay or from another country. Just make sure that you know who you are buying from and you can get feed back or references before buying materials. There are many ways to make your product more affordable you just have to get out there and look for the deals. Where there is a way there is a will. The better deals to can get the better you can make your product affordable.

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There are many ways to make your product more affordable. It is just finding the ways to cut costs, without cutting corners. So, it means cutting corners a little bit but in a good way. You still want to have a quality product but at the same time you want to make your product more affordable than your competitions.

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This website gives good methods and resources for expanding your product distribution. They give you valuable statistics of things such as "89% of the total U.S. population has access to the internet." This tells you that a good place to market your product might be the internet.

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Types of Outlet

Stores

Clothing, Food, Cosmetics, Sports.
Walmart, Costco, Zara.

Drug Stores

Personal hygiene products, Cosmetics, Beauty products, Detergents, Sweets and Drinks.
CVS, Walmart Stores Inc., Rite Aid Corporation, Walgreens Boots Alliance.

Convenient Stores

Open 24/24.
General food, drink, everyday products.
7 Eleven, Turkey Hill, Fresh Start Convenience, Inc.

Speciality Centers (Big Chains)

Gardening, decoration and other items for decorating and fitting out the home
Home Depot, Target, Whole food, Wal Mart.

The Mall

Shopping center with several stores and fast food restaurants.
The Mall of America, King of Prussia Mall, Del Amo Fashion Center, Aventura Mall.

Evolution of the Retail Sector

Growth and Regulation

The U.S. is the undisputed world leader of the retail industry: of the world's ten largest retail companies, five are based in the country. According to the latest report by PwC and the National Retail Federation (NRF) - released on May 2020 - the industry's total GDP impact was $3.9 trillion, accounting for 18.7 percent of US GDP in 2018. The retail industry directly provided 32 million jobs for American workers (accounting for 16.0 percent of the national total), making it the largest private-sector employer in the country. Due to the global Covid-19 pandemic, retail sales in the US could be down by at least 6.5% in 2020, according to new estimates by market research firm Euromonitor. Also according to Euromonitor's analysis, companies that will be less affected by the Coronavirus crisis include food retailers, e-commerce players such as Amazon, third-party delivery platforms and major food brands. Retailers were among the biggest winners of the first complete rewriting of federal tax law in three decades. According to the NRF, the Tax Cuts and Jobs Act has helped revive the economy by eliminating a wide range of tax benefits for businesses and using the money saved to lower rates for all businesses, large and small. The corporate tax rate has been reduced to 21% from 35%, and small business "pass throughs" have received a 20% deduction. The measure also provided relief for middle-class taxpayers. Actually, the retail industry is expected to save $175 billion due to the reduction in the corporate tax rate, according to the NRF. Although it's too early to measure the direct benefits, some retailers have already announced investments in response to the tax cut, like an increase of the minimum salary to $11/hour for their employees.

The U.S. is the ultimate test market for exporters and is open to all kinds of new products and technologies. However, it is very spread out geographically and new products are subject to intense competition. The U.S. market is thus very demanding and requires a considerable amount of preparation, groundwork and long-term consistency. Numerous opportunities for growth exist in the U.S. retail market for retail providers of all sizes, including individual direct marketers or direct sellers, small- to medium-sized franchise unit owners, and large "big-box" store operators.

Market share

The supermarket & Grocery stores industry grew at a rate of 1%, reaching $654.6 billion in 2019. Market segmentation is drawn along various lines, including age group, ethnic group and even social and religious groups, which has forced distributors to adapt their strategies to this situation. One of the most marked consequences of this absence of homogeneity is the emergence in the past few years of "Speciality Stores" (Home Depot, Best Buy, etc.), which currently represent 11% of retail sales. In fact, American consumers stand out for their demanding nature, the importance they attach to price and their product disloyalty. It is thus incumbent upon distributors to continuously adapt themselves to the market and to engage in well-targeted marketing efforts in order to win consumer loyalty. According to the latest figures by USDA, grocery stores, including supermarkets and smaller grocery stores (except convenience stores) accounted for the largest share of store sales (92.2 percent), followed by convenience stores without gasoline (4.5 percent). Specialized food stores, including meat and seafood markets, produce markets, retail bakeries, and candy and nut stores, accounted for the remaining 3.3 percent of the total. According to NRF latest data, the main retailers in US are:

Walmart, with a turnover of $ 387.66 billions in retail sales

Amazon.com ($120.93 billion)

The Kroger Co ($119.70 billion)

Costco ($101.43 billion)

Retail Sector Organisations

National Retail Federation Convenience Distribution Association (CDA)International Council Shopping Centres The Association for Convenience and Fuel Retailing (NACS)

E-commerce

Internet access

The U.S. is among the leading countries in terms of internet technology and penetration. It is estimated that about 89% of the total U.S. population has access to the internet (versus 74% ten years ago). For some demographic groups - such as young adults, college graduates and those from high-income households - internet usage is almost universal (Pew Research Center, 2018). Today, roughly three-quarters of American adults have broadband internet service at home, however the adoption of traditional broadband service has slowed in recent years, also because a growing share of Americans now use smartphones as their primary means of online access at home. In fact, about 95% of Americans now own a device, with the share of those owning smartphones at 77%. Along with smartphones, nearly three quarters of U.S. adults now own desktop or laptop computers, while roughly 50% own tablet computers and around 20% own e-reader devices. The most popular web search engines in the U.S. are led by the market leader Google, which generated 63.4% of all core search queries in 2017, followed by Bing (23.7%) and Oath (formerly known as Yahoo), with a market share of 11.9%.

E-commerce market

Since 2011 the U.S. online retail growth has accelerated and in 2017 the e-commerce represented 13% of total retail sales and 49% of the growth of the retail sector as a whole. Consumers in the US spent US$ 453.4 billion online for retail purchases in 2017, a 16% increase compared with US$ 391 billion in 2016 (data from U.S. Commerce Department). While the top two e-commerce companies - Amazon and eBay - are for the most part online-only retailers, 60% of the biggest e-commerce players are multichannel, with a majority of sales occurring in-store (Walmart, etc.). Other major online stores include Apple, Home Depot, Best Buy and Macy's. Electronics & media is currently the leading product category in America, followed by toys, hobby & DIY. Americans are increasingly using their smartphones to browse and make purchases: it is estimated that mobile shopping represents 40.3% of total e-commerce traffic (Adobe Analytics).

E-commerce sales and customers

There are currently 203.96 million e-commerce users in the U.S., with an additional 26 million users expected to be shopping online by 2021 (eshopworld). Amazon is responsible for an outsized proportion of total online sales, with a turnover forecasted to reach USD 258 billion in 2018 (equal to 49.1% of all e-commerce retail spend in the country, and 5% of all retail sales (e-Marketer). When Amazon's sales are combined with e-commerce sales from eBay and Walmart - the next two companies on the list - they represent almost 5% of total retail sales in the US. It is estimated that 95% of Americans shop online at least once a year, with about 30% shopping online weekly. Online shopping is more common in younger generations, with respectively 67% and 56% of Millennials and Generation X that claim to prefer to search and purchase on e-commerce sites rather than in store (the ratio being 41% for "baby boomers" and 28% for seniors). The top three most influential factors in determining where Americans shop are price (87%), shipping cost and speed (80%) and discount offers (71%). Almost a quarter of online shoppers (23%) are influenced by social media recommendations/reviews. Oddly, one in five Americans have accidentally bought something they didn't want. Credit cards remain the preferred online payment method (56%), while 25% of American shoppers prefer to use PayPal for their transactions. Debit cards and vouchers/promo codes have a lower share (10% and 7% respectively).

Social media

Today around seven-in-ten Americans use social media, compared to 26% in 2008 (Pew Research Center, 2018). While young adults were among the earliest social media adopters, nowadays the share of users aged 50-64 has increased and is estimated to have reached 64%. Facebook is the most-widely used of the major social media platforms across all type of age groups, with 214 million users. Smaller numbers of Americans use social media such as Instagram (77.6 million), Pinterest (75 million), LinkedIn (133 million) and Twitter (67 million). YouTube is also very popular (180 million users), while instant messaging apps like WhatsApp are less common (around 20 million). For many users, social media is part of their daily routine: around 75% of Facebook users - and around 60% of Instagram users - access these platforms at least once a day.

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product distribution in the united states

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Distributing a product in the United States - Distributing a product - Santandertrade.com

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Stores Clothing, Food, Cosmetics, Sports. Walmart, Costco, Zara. Drug Stores Personal hygiene products, Cosmetics, Beauty products, Detergents, Sweets and Drinks. CVS, Walmart Stores Inc., Rite Aid Corporation, Walgreens Boots Alliance. Convenient Stores Open 24/24. General food, drink, everyday products. 7 Eleven, Turkey Hill, Fresh Start Convenience, Inc.

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This is a reputable website that uses great examples to help understand what they are talking about. They have lots of information and supporting details for the numerous subjects on their website.

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By the end of the chapter, you should be able to:

1. Explain the differences between managerial accounting and financial accounting.

2. Identify some of the users of accounting information and explain how they use it.

3. Explain the function of the income statement.

4. Calculate revenue, expenses and net profit.

5. Explain the function of the balance sheet.

6. Calculate assets, liabilities, and shareholders equity.

7. Explain the function of the cash flow statement.

8. Calculate a breakeven point given the necessary information.

9. Evaluate a company’s performance using financial statements and ratio analysis.

Apple Headquarters in Cupertino, California

Apple Inc. is the most valuable company in the world. This statement is based on market value, which in April 2018 was roughly $841 billion. Although markets can fluctuate, sometimes wildly, if you are reading this chapter for a course later in 2018 or in 2019, it is not unlikely that Apple will have retained its leadership position. Its value as of April 2018 was more than $80 billion greater than that of the next largest company, Amazon. Apple has briefly ceded the leadership position to Alphabet, the parent company of Google, on a couple of occasions, but for the most part, it has been the leader for quite some time.[1]

You may wonder what kind of information is used to make these determinations. How does the market know that Apple should be valued more than $120 billion higher than Alphabet?[2] Do investors just make their decisions on instinct? Well, some do, but it’s not a formula for sustained success. In most cases, in deciding how much to pay for a company, investors rely on published accounting and financial information released by publicly-traded companies. This chapter will introduce you to the subject of accounting and financial information so you can begin to get an understanding for how the valuation process works.

Accounting is often called “the language of business” because it communicates so much of the information that owners, managers, and investors need to evaluate a company’s financial performance. These people are stakeholders in the business—they’re interested in its activities because they’re affected by them. The financial futures of owners and other investors may depend heavily on strong financial performance from the business, and when performance is poor, managers may be replaced or laid off in a downsizing. In fact, a key purpose of accounting is to help stakeholders make better business decisions by providing them with financial information. You shouldn’t try to run an organization or make investment decisions without accurate and timely financial information, and it is the accountant who prepares this information. More importantly, accountants make sure that stakeholders understand the meaning of financial information, and they work with both individuals and organizations to help them use financial information to deal with business problems. Actually, collecting all the numbers is the easy part. The hard part is analyzing, interpreting, and communicating the information. Of course, you also have to present everything clearly while effectively interacting with people from every business discipline. In any case, we’re now ready to define accounting as the process of measuring and summarizing business activities, interpreting financial information, and communicating the results to management and other decision makers.

Fields of Accounting

Accountants typically work in one of two major fields. Management accountants provide information and analysis to decision makers inside the organization in order to help them run it. Financial accountants furnish information to individuals and groups both inside and outside the organization in order to help them assess its financial performance. Their primary focus, however, is on external parties. In other words, management accounting helps you keep your business running while financial accounting tells the outside world how well you’re running it.

Management Accounting

Management accounting, also known as managerial accounting, plays a key role in helping managers carry out their responsibilities. Because the information that it provides is intended for use by people who perform a wide variety of jobs, the format for reporting information is flexible. Reports are tailored to the needs of individual managers, and the purpose of such reports is to supply relevant, accurate, timely information that will aid managers in making decisions. In preparing, analyzing, and communicating such information, accountants work with individuals from all the functional areas of the organization—human resources, operations, marketing, etc.

Role of Managerial Accounting

Financial Accounting

Financial accounting is responsible for preparing the organization’s financial statements—including the income statement (also called the profit/loss statement), the statement of owner’s equity, the balance sheet, and the statement of cash flows—that summarize a company’s past performance and evaluate its current financial condition. If a company is traded publicly on a stock market such as the TSX (Toronto Stock Exchange), these financial statements must be made public, which is not true of the internal reports produced by management accountants. In preparing financial statements, Canadian financial accountants adhere to a uniform set of rules called international financial reporting standards (IFRS)—the basic principles for financial reporting issued by an independent agency called the Financial Accounting Standards Board (FASB). Users want to be sure that financial statements have been prepared according to IFRS because they want to be sure that the information reported in them is accurate. They also know that when financial statements have been prepared by the same rules, they can be compared from one company to another.

Who Uses Financial Accounting Information?

The users of managerial accounting information are pretty easy to identify—basically, they’re a firm’s managers. We need to look a little more closely, however, at the users of financial accounting information, and we also need to know a little more about what they do with the information that accountants provide them. Publicly Traded companies will provide their financial accounting information to a wider set of stakeholders, including shareholders, potential investors, etc., than compared to a privately held company that will generate a single set of financial statements according to the International Financial Reporting Standards. Publicly Traded companies will also provide their financial accounting information to the general public in order to showcase to potential investors the company’s performance. Therefore, Publicly Traded companies will typically generate two sets of financial statements, one set of detailed statements in accordance with Canadian International Financial Reporting Standards (IFRS) and another set of simplified financial statements that can be more easily consumed by the general public. For example, Tim Hortons provides access to their simplified financial statements through annual reports which can be found at http://www.rbi.com/Annual-Reports

Owners and Managers

In summarizing the outcomes of a company’s financial activities over a specified period of time, financial statements are, in effect, report cards for owners and managers. They show, for example, whether the company did or didn’t make a profit and furnish other information about the firm’s financial condition. They also provide some information that managers and owners can use in order to take corrective action, though reports produced by management accountants offer a much greater level of depth.

Investors and Creditors

Warren Buffet, Presidential Medal of Freedom recipient in 2011

Investors and creditors furnish the money that a company needs to operate, and not surprisingly, they want to know how that business is performing. Because they know that it’s impossible to make smart investment and loan decisions without accurate reports on an organization’s financial health, they study financial statements to assess a company’s performance and to make decisions about continued investment.

According to the world’s most successful investor, Warren Buffett, the best way to prepare yourself to be an investor is to learn all the accounting you can. Buffett, chairman and CEO of Berkshire Hathaway, a company that invests in other companies, turned an original investment of $10,000 into a net worth of $66 billion[3] in four decades, and he did it, in large part, by paying close attention to financial accounting reports.

Government Agencies

Businesses are required to furnish financial information to a number of government agencies. Publicly-owned companies, for example—the ones whose shares are traded on a stock exchange—must provide annual financial reports to their respective provincial Securities Commission. For example, companies located in Ontario would provide financial reports to the Ontario Securities Commission (OSC), a federal agency that regulates stock trades and which is charged with ensuring that companies tell the truth with respect to their financial positions. Companies must also provide financial information to the Canadian Revenue Agency (CRA).

The Role of Financial Accounting

Other Users

A number of other external users have an interest in a company’s financial statements. Suppliers, for example, need to know if the company to which they sell their goods is having trouble paying its bills or may even be at risk of going under. Employees and labour unions are interested because salaries and other forms of compensation are dependent on an employer’s performance.

The previous figures illustrate the main users of management and financial accounting and the types of information produced by accountants in the two areas. In the rest of this chapter, we’ll learn how to prepare a set of financial statements and how to interpret them. We’ll also discuss issues of ethics in the accounting communities and career opportunities in the accounting profession.

We hope that, so far, at least one thing is clear: If you’re in business, you need to understand financial statements. The law no longer allows high-ranking executives to plead ignorance or fall back on delegation of authority when it comes to responsibility for a firm’s financial reporting. In a business environment tainted by episodes of fraudulent financial reporting and other corporate misdeeds, top managers are now being held responsible for the financial statements issued by the people who report to them. Top managers need to know how well the company is performing. Financial information helps managers identify signs of impending trouble before it is too late.

The Function of Financial Statements

Put yourself in the place of Connor, who runs Connor’s Confections out of his home. He loves what he does, and he feels that he’s doing pretty well. In fact, he has an opportunity to take over a nearby store at very reasonable rent, and he can expand by getting a modest bank loan and investing some more of his own money. So it’s decision time for Connor: He knows that the survival rate for start-ups isn’t very good, and before taking the next step, he’d like to get a better idea of whether he’s actually doing well enough to justify the risk. The basic financial statements will give him some answers. Here, three common statement types are introduced.

Income Statement = Shows sales, expenses, and whether or not a profit was made.

Balance Sheet = Show assets and liabilities, the amount invested in the business.

Statement of Cash Flows = Show how much cash is coming in and going out.

Even from this basic overview, match which financial statement answers each of Connor’s questions.

Since this book is for an introductory course, attention is on the income statement, balance sheet, and cash flow statement only, even though other financial statements are mentioned.

Toying with a Business Idea

To bring this concept closer to home, let’s assume that you need to earn money while you’re in college and that you’ve decided to start a small business. Your business will involve selling stuff to other college students, and to keep things simple, we’ll assume that you’re going to operate on a “cash” basis: you’ll pay for everything with cash, and everyone who buys something from you will pay in cash.

You may have at least a little cash on you right now—some currency, or paper money, and coins. In accounting, however, the term cash refers to more than just paper money and coins. It also refers to the money that you have in chequing and savings accounts and includes items that you can deposit in these accounts, such as money orders and different types of cheques.

Your first task is to decide exactly what you’re going to sell. You’ve noticed that with homework, exams, social commitments, and the hectic lifestyle of the average college student, you and most of the people you know always seem to be under a lot of stress. Sometimes you wish you could just lie back between meals and bounce a ball off the wall. And that’s when the idea hits you: Maybe you could make some money by selling a product called the “Stress-Buster Play Pack.” Here’s what you have in mind: you’ll buy small toys and other fun stuff—instant stress relievers—at a local dollar store and pack them in a rainbow-colored plastic treasure chest labeled “Stress-Buster.”

And here’s where you stand: You have enough cash to buy a month’s worth of plastic treasure chests and toys. After that, you’ll use the cash generated from sales of Stress-Buster Play Packs to replenish your supply. Each plastic chest will cost $1.00, and you’ll fill each one with a variety of five simple toys, all of which you can buy for $1.00 each.

You plan to sell each Stress-Buster Play Pack for $10 from a rented table stationed outside a major dining hall. Renting the table will cost you $20 a month. In order to make sure you can complete your school work, you decide to hire fellow students to staff the table at peak traffic periods. They’ll be on duty from noon until 2:00 p.m. each weekday except Fridays, and you’ll pay them a generous $7.50 an hour. Wages, therefore, will cost you $240 a month (2 hours × 4 days × 4 weeks = 32 hours × $7.50). Finally, you’ll run ads in the college newspaper at a monthly cost of $40. Thus your total monthly costs will amount to $300 ($20 + $240 + $40).

The Income Statement

Let’s say that during your first month, you sell one hundred play packs. Not bad, you say to yourself, but did I make a profit? To find out, you prepare an income statement showing revenues, or sales, and expenses—the costs of doing business. You divide your expenses into two categories:

Cost of goods sold: the total cost of the goods that you’ve sold

Operating expenses: the costs of operating your business except for the costs of things that you’ve sold.

Now you need to do some subtracting:

The difference between sales and cost of goods sold is your gross profit, also known as gross margin.

The difference between gross profit and operating expenses is your net income or profit, which is the proverbial “bottom line.” Note we’ve assumed you’re making money, but businesses can also have a net loss.

Below is your income statement for the first month. (Remember that we’ve made things simpler by handling everything in cash.)

Stress-Buster Company

Income Statement

Month Ended April 30, 2018

Sales (100 x $10.00)

$1,000

Less cost of goods sold (100 x $6)

$600

Gross profit (100x ($10 – $6))

$400

Less operating expenses

Salaries

$240

Advertising

$40

Table rental

$20

$300

Net income (Profit) ($400-$300)

$100

Did You Make Any Money?

What does your income statement tell you? It has provided you with four pieces of valuable information:

1. You sold 100 units at $10 each, bringing in revenues or sales of $1,000.

2. Each unit that you sold cost you $6 – $1 for the treasure chest plus 5 toys costing $1 each. So your cost of goods sold is $600 (100 units × $6 per unit).

3. Your gross profit—the amount left after subtracting cost of goods sold from sales—is $400 (100 units × $4 each).

4. After subtracting operating expenses of $300 – the costs of doing business other than the cost of products sold—you generated a positive net income or profit of $100.

The Balance Sheet

A balance sheet reports the following information:

Assets: the resources from which it expects to gain some future benefit

Liabilities: the debts that it owes to outside individuals or organizations

Owner’s equity: the investment in the business

Whereas your income statement tells you how much income you earned over some period of time, your balance sheet tells you what you have at a specific point in time.

Companies prepare financial statements on at least a twelve-month basis—that is, for a fiscal year which ends on December 31 or some other logical date, such as June 30 or September 30. Fiscal years can vary because companies generally pick a fiscal-year end date that coincides with the end of a peak selling period; thus a crabmeat processor might end its fiscal year in October, when the crab supply has dwindled. Most companies also produce financial statements on a quarterly or monthly basis. For Stress-Buster, you’ll want to prepare them monthly to stay on top of how your new business is doing. Let’s prepare a balance sheet at the start and end of your first month in business.

The Accounting Equation

To prepare a balance sheet, one must first understand the fundamental accounting equation:

Assets = Liabilities + Owner’s Equity

This simple but important equation highlights the fact that a company’s assets came from somewhere: either from investments made by the owners (owner’s equity) or from loans (liabilities). This means that the asset section of the balance sheet on the one hand and the liability and owner’s-equity section on the other must be equal, or balance. Thus the term balance sheet.

Let’s prepare the two balance sheets we mentioned: one for the first day you started and one for the end of your first month of business. We’ll assume that when you started Stress-Buster, you borrowed $400 from your parents and put in $200 of your own money. If you look at your first balance sheet below, you’ll see that your business has $600 in cash (your assets): Of this total, you borrowed $400 (your liabilities) and invested $200 of your own money (your owner’s equity). So far, so good: your assets section balances with your liabilities and owner’s equity section as follows:

Stress-Buster Company

Balance Sheet

As of April 1, 2018

Assets

Cash

$600

Liabilities and Owner’s Equity

Liabilities

$400

Owner’s Equity

$200

Total Liabilities and Owner’s Equity

$600

Now let’s see how things have changed by the end of the month. Recall that Stress- Buster earned $100 during the month of September and that you decided to leave these earnings in the business. This $100 profit increases two items on your balance sheet: the assets of the company (its cash) and your investment in it (its owner’s equity). Below shows what your balance sheet will look like on April 30. You now have $700 in cash: $400 that you borrowed plus $300 that you’ve invested in the business (your original $200 investment plus the $100 profit from the first month of operations, which you’ve kept in the business).

Stress-Buster Company

Balance Sheet

As of April 30, 2018

Assets

Cash (original $600 plus $100 earned)

$700

Liabilities and Owner’s Equity

Liabilities

$400

Owner’s Equity ($200 invested by owner plus $100 profits retained)

$300

Total Liabilities and Owner’s Equity

$700

Breakeven Analysis

Let’s take a short detour to see how this information might be put to use. As you look at your first financial statements, you might ask yourself: is there some way to figure out the level of sales you need to avoid losing money—to “break even”? This can be done using breakeven analysis. To break even (have no profit or loss), your total sales revenue must exactly equal all your expenses (both variable and fixed). Variable costs depend on the quantity produced and sold; for example, each Stress-Buster includes the treasure chest and the toys inside. Fixed costs don’t change as the quantity sold changes; for example, you’ll pay for your advertising whether you sell Stress-Busters or not. The balance between revenue and expenses will occur when gross profit equals all other (fixed) costs. To determine the level of sales at which this will occur, you need to do the following (using data from the previous example):

1. Determine your total fixed costs: Fixed costs = $240 salaries + $40 advertising + $20 table = $300

2. Identify your variable costs on a per-unit basis: Variable cost per unit = $6 ($1 for the treasure chest and $5 for the toys)

3. Determine your contribution margin per unit: Selling price per unit – variable cost per unit: Contribution margin = $10 selling price – $6 variable cost per unit = $4

4. Calculate your breakeven point in units: fixed costs: Contribution margin per unit: Breakeven in units = $300 fixed costs ÷ $4 contribution margin per unit = 75 units

Your calculation means that if you sell 75 units, you’ll end up with zero profit (or loss) and will exactly break even. To test your calculation, you can prepare a what-if income statement for 75 units in sales (your breakeven number). The resulting statement is shown in the table below.

Of course you want to do better than just break even, so you could modify this analysis to a targeted level of profit by adding that amount to your fixed costs and repeating the calculation. Breakeven analysis is rather handy. It enables you to determine the level of sales that you must reach to avoid losing money and the level of sales that you have to reach to earn a certain profit. Such information will be vital to planning your business.

Stress-Buster Company

Income Statement

Month Ended April 30, 2018

(at breakeven level of sales = 75 units)

Sales (75 x $10.00)

$750

Less cost of goods sold (75 x $6)

$450

Gross profit ($75 x ($10 – $6))

$300

Less operating expenses

Salaries

$240

Advertising

$40

Table rental

$20

$300

Net income (Profit) ($300 – $300)

$0

The Cash Flow Statement

The Cash Flow Statement provides valuable information about a company’s expenses and receipts and allows insights into its future income needs in order to be able to meet its future obligations (expenses and receipts). The cash flow statement reports cash inflows and outflows, and it will identify the amount of cash the company currently holds, which is also reported in the balance sheet.

Typically the cash flow statement is reported on a month to month basis, however, a statement of cash flow will consolidate month to month cash flow to meet the requirements of the International Financial Reporting Standards.

A statement of cash flow will report cash in three distinct areas of business:

Cash from Operations

Cash from Investing

Cash from Financing

Now let’s prepare the statement of cash flow for Stress-Buster company for the one month period ending April 30, 2018. Stress-Buster would have incurred cash from Operations in the form of Net Income incurred after deducting the month’s expenses from the month’s revenues and would have also incurred cash from Financing from the initial $400 loan taken out to start the business and the additional $200 of personal income. As Stress-Buster did not invest in new equipment, machinery or other assets for the business or use prior cash flows and/or retained earning to earn further investment income, Stress-Buster would not report any cash from investing activities.

Stress-Buster Company

Statement of Cash Flow

Month Ended April 30, 2018

Beginning Cash

$0

Operating Activities

$100

Net Income from Operations

$100

Investing Activities

$0

Financing Activities

$600

Increase in Short Term Debt

$400

Increase in Retained Earnings

$200

Ending Cash Balance

(Net Change)

$700

Now that you know a bit about financial statements, let’s see how they’re used to help owners, managers, investors, and creditors assess a firm’s performance and financial strength. You can glean a wealth of information from financial statements, but first you need to learn a few basic principles for “unlocking” it.

Trend Analysis from the Income Statement

Apple Inc. – Consolidated statements of operations (income statement)

Peruse an abbreviated financial statement for Apple for 2017 taken directly from their website.  You will note that instead of showing only the current year’s results, the company has shown data for the prior year as well.

From this relatively simple exhibit, considerable information about Apple’s performance can be obtained.

For example:

Apple sales grew at 12.7% from 2016 to 2017, not bad for a company with such a large base of sales already, but certainly not the rapid-growth company it once was. When making yearly comparisons this is commonly referred to as performing a horizontal analysis.

Net income as a percent of sales (a ratio also known as return on sales) was 22.7% in 2017 – or in other words, for every $5 in sales, Apple turned more than $1 of it into profit. That is substantial! W hen calculating ratios as a percent of a larger figure (i.e., Net income as a percent of sales, or cash as a percent of Total Assets) this is commonly referred to as performing a vertical analysis.

Many other calculations are possible from Apple’s data, and we will look at a few more as we explore ratio analysis.

Ratio Analysis

How do you compare Apple’s financial results with those of other companies in your industry or with the other companies whose stock is available to investors? And what about your balance sheet? Are there relationships on this statement that also warrant investigation? These issues can be explored by using ratio analysis, a technique for evaluating a company’s financial performance.

Remember that a ratio is just one number divided by another, with the result expressing the relationship between the two numbers. It’s hard to learn much from just one ratio, or even a number of ratios covering the same period. Rather, the deeper value in ratio analysis lies in looking at the trend of ratios over time and in comparing the ratios for several time periods with those of other companies. There are a number of different ways to categorize financial ratios.

Apple Inc. – Consolidated balance sheets

Here’s one set of categories:

Profitability ratios tell you how much profit is made relative to the amount invested (return on investment) or the amount sold (return on sales).

Liquidity ratios tell you how well positioned a company is to pay its bills in the near term. Liquidity refers to how quickly an asset can be turned into cash. For example, share of stock is substantially more liquid than a building or a machine.

Debt ratios look at how much borrowing a company has done in order to finance the operations of the business. The more borrowing, the more risk a company has taken on, and so the less likely it would be for new lenders to approve loan applications.

Efficiency ratios tell you how well your assets are being managed.

We could employ many different ratios, but we’ll focus on a few key examples.

Profitability Ratios

Earlier we looked at the return on sales for Apple. Another profitability ratio on which the financial markets focus is earnings per share, also known as EPS. This ratio divides net income by the number of shares of stock outstanding. According to the earlier exhibit, Apple saw its EPS increase from $3.38 in 2016 to $3.92 in 2017, which indicates a profit of about 15% an excellent return for a company that is already among the world’s largest. Well-paid analysts will spend hours to understand how these results were achieved every time Apple issues new financial statements.

Liquidity Ratios

Liquidity ratios are one element of measuring the financial strength of a company. They assess its ability to pay its current bills. A key liquidity ratio is called the current ratio. It simply examines the relationship between a company’s current assets and its current liabilities. On December 30, 2017 (remember that balance sheets reflect a point in time), Apple had $68.5 billion in current assets and $63.5 billion in current liabilities. Simply, what this means is that Apple has more money on hand than they need to pay their bills. When a company has a current ratio greater than 1, they are in good shape to pay their bills; companies selling to Apple on credit would not need to worry that it is likely to run out of money.

Apple’s current ratio  = $68.5 Billion / $63.5 Billion = 1.08 (greater than >) 1

Now, let’s look quickly at something that is not part of the ratio; look down one line on the balance sheet to long-term marketable securities and see that Apple owns $207.9 billion. While they are long term and so not part of the current ratio, these securities are still easily convertible to cash. So Apple has far more cushion than the current ratio reflects, even though it reflected a healthy financial position already.

Debt Ratios

A key debt ratio, which tells us how the company is financed, is the debt-to-equity ratio, which calculates the relationship between funds acquired from creditors (debt) and funds invested by owners (equity). For this ratio calculation, we use Apple’s total liabilities, not just the line on the balance sheet that says long-term debt, because in effect, Apple is borrowing from those who it owes but has not yet paid. Apple’s total liabilities at the end of 2017 were $266.6 billion versus owner’s equity of $140.2 billion, a ratio of 1.9, which means Apple has borrowed more than it has invested in the business.

Apple’s debt to equity ratio: $266.6 / $140.2 Billion = 1.9

To some investors, that high level of debt might seem alarming. But remember that Apple has $207.9 billion invested in marketable securities. If it wished to do so, Apple could sell some of those securities and pay down its debts, thus improving its ratio. It’s likely that anyone thinking about lending money to Apple and seeing these figures would be confident that Apple has the ability to pay back what they borrow.

Efficiency and Effectiveness Ratios

There are many more ratios which we could apply to Apple to more completely understand its performance. Yet going deeper into ratios would be beyond the scope of an introductory business course. If you continue your study of business, you will get ample exposure to these ratios in your accounting and finance courses. So we’ll leave the rest for another day.

Important terms and concepts

1. Accounting is the process of measuring and summarizing business activities, interpreting financial information, and communicating the results to management and other decision makers.

2. Managerial accounting deals with information produced for internal users, while financial accounting deals with external reporting.

3. The income statement captures sales and expenses over a period of time and shows how much a firm made or lost in that period.

4. The balance sheet reflects the financial position of a firm at a given point in time, including its assets, liabilities, and owner’s equity. It is based on the following equation: assets – liabilities = owner’s equity.

5. Breakeven analysis is a technique used to determine the level of sales needed to break even—to operate at a sales level at which you have neither profit nor loss.

6. Ratio analysis is used to assess a company’s performance and financial condition over time and to compare one company to similar companies or to an overall industry.

7. Categories of ratios include: profitability ratios, liquidity ratios, debt ratios, and efficiency and effectiveness ratios.

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Accounting and Financial Information – Fundamentals of Business: Canadian Edition

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I would say this is one of my favorite things ever to use for financial advice. As long as you are using credible information, there can be really great teachers. I find that the wide variety and not being confined by teacher rules offers benefits teaching.

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