Understanding Business Activity

What is business activity?

Every business exists to satisfy unlimited wants from scarce resources. Because using them one way means giving up another, the best business turns scarce inputs into something worth more than they cost.

Needs, wants and scarcity

A need is essential for survival; a want is merely desired, and wants are effectively unlimited. The resources to satisfy them — land, labour, capital, enterprise — are finite. This scarcity forces every individual, business and government to choose, and every choice carries an opportunity cost: the next-best alternative given up.

The purpose of business activity

Business activity combines scarce resources to produce goods and services that satisfy wants, creating incomes, employment and added value. Specialisation, where firms concentrate on what they do best and trade for the rest, raises both output and quality.

Adding value

Added value is the difference between the price a customer pays and the cost of the bought-in materials. A business raises it by charging more for the same inputs, or by lowering input costs. Worked example: a café buys bread, filling and packaging for $1.20 and sells the sandwich for $3.50, so added value = $3.50 − $1.20 = $2.30 per sandwich. That $2.30 is not profit — wages, rent and energy are still paid from it.

Classifying businesses

Businesses can be sorted in two completely separate ways: by what stage of production they occupy, and by who owns them. Keeping these two systems apart is essential — they answer different questions.

Classification by economic sector

The primary sector extracts natural resources; the secondary sector turns raw materials into finished goods; the tertiary sector provides services for the other sectors and the final consumer. A single loaf of bread passes through all three: wheat is farmed (primary), milled and baked (secondary), then sold in a shop (tertiary). As an economy develops, employment shifts from the primary sector towards manufacturing and then services, which is why the tertiary sector is largest in developed countries.

Classification by ownership

In a mixed economy, some businesses are owned by private individuals (the private sector) and some by the state (the public sector). Private-sector firms are typically driven by profit; public-sector organisations usually aim to provide essential services such as health, education and defence. The two classifications are entirely independent — a tertiary-sector business may be either privately or publicly owned.

Enterprise and the business plan

Someone has to take the risk of bringing scarce resources together and hoping customers will pay. That person is the entrepreneur — and the business plan is the tool that turns their idea into something a lender or investor can judge.

The entrepreneur

An entrepreneur organises the factors of production and carries the financial risk. Successful entrepreneurs tend to be hard-working, risk-taking, creative, self-confident and resilient, and effective at organising people and money. In the exam, each trait only earns full credit when it is tied to why it helps the business survive or grow.

The business plan

A business plan sets out what the business intends to do and how: a description of the product or service; the target market and expected competition; the forecast costs, revenue and cash flow; the sources of finance; and the location and operational details. A clear plan helps the entrepreneur think the idea through, sets measurable targets, and persuades banks and investors that the venture is worth backing.

Government support for start-ups

Because new businesses generate employment, incomes and future tax revenue, governments often support them: grants and loans at favourable rates; training schemes that build management skills; enterprise zones offering reduced rents or taxes; and simplified advice and registration. Such support lowers the cost and risk of starting up, improving a new firm’s chance of surviving its fragile early months.

Measuring, growing and failing

Not every business wants to grow, and not every business that grows survives. Three linked questions: how size is measured, how and why firms grow, and why some fail.

Measuring business size

Three measures are accepted by the syllabus: the number of people employed, the value of output produced, and the capital employed. Each has limitations — a highly automated factory may employ few people yet produce enormous output. Profit is explicitly excluded as a measure of size; it reflects performance, not scale.

Why and how businesses grow

Owners may expand to increase profit, gain market share, benefit from lower average costs, or spread risk across more products and markets. Growth can be internal (organic) — opening new outlets or selling more — or external, by joining with another business. Growth also strains cash flow, dilutes management control and creates communication difficulties, all of which must be managed.

Why some stay small — and some fail

Many businesses remain small by choice or circumstance: the owner values independence, the market is small or local, or capital for expansion is unavailable. Common causes of failure are poor management (especially weak financial control), liquidity problems — running out of cash — and adverse changes in the business environment. New businesses are at greater risk because they lack a customer base, a track record with lenders, experienced managers, and financial reserves.

Types of business organisation

The forms of business organisation differ mainly in the risk they place on their owners. The crucial legal distinction is incorporation.

Sole traders and partnerships

A sole trader is owned and controlled by one person — the most common form worldwide because it is easy and cheap to establish, the owner keeps all the profit, and decisions are quick. Drawbacks: unlimited liability, difficulty raising finance, a heavy workload, and the business often ends if the owner retires or dies. A partnership is owned by two or more people who share the capital, responsibilities and profits, usually under a partnership agreement. More owners means more capital and a wider range of skills, but profits are divided, disagreements can arise, and partners usually also have unlimited liability.

Limited companies

An incorporated business is a separate legal person that can own assets, owe debts and be sued in its own name — the foundation of limited liability. A private limited company (Ltd) is owned by shareholders whose shares cannot be sold to the public. A public limited company (plc) sells shares publicly on a stock exchange to raise large capital. Both give limited liability and a separate legal identity but must publish accounts; a plc raises the most finance but risks loss of control as outsiders buy shares.

Franchises, joint ventures and the public sector

A franchise lets a franchisee trade under an established brand for fees — lower-risk than starting alone, but less independent. A joint venture is two businesses sharing the cost, risk and control of a project, often to enter a new market. A public corporation is a state-owned business run to provide a service such as rail rather than for profit.

Worked example — recommend and justify

JK runs a growing bakery as a sole trader. She needs $80,000 to open three new shops but wants to protect her personal savings. A private limited company offers limited liability, so her savings are protected if the venture fails, and it can raise capital by issuing shares to family or private investors. JK should convert to a private limited company — it meets both needs, at the cost of publishing accounts and some privacy.

Objectives and stakeholders

A business needs objectives to give it direction and a way to measure success. But a business serves many groups at once, and their aims rarely align — managing that conflict is a large part of running a business well.

Business objectives

Objectives give a business clear targets and a benchmark for performance. Common objectives include survival (vital for a new firm), profit, growth and increased market share. Objectives change over time: a business fights to survive when young, then pursues growth and profit once established. Social enterprises add a further aim — social or environmental goals, with most profit reinvested rather than distributed.

Stakeholders and their objectives

Internal stakeholders — owners, managers and employees — are part of the business itself. External stakeholders — customers, suppliers, lenders, government and the local community — sit outside it but are affected by it. Each wants something different: owners want profit, employees want secure and well-paid jobs, customers want quality at low prices, and government wants taxes and employment.

Private versus public sector objectives

Private-sector businesses are driven mainly by profit, growth and market share. Public-sector organisations pursue different aims: providing an essential service reliably, controlling cost to the taxpayer, and serving the whole population rather than only paying customers. The same activity — running a railway — is steered very differently depending on whether it is privately or publicly owned.