CHAPTER THREE

FUNDAMENTALS SMALL BUSINESS

1. Meaning And Definition Of Small Business
2. Characteristics Of Small Business
3. Rationale With Small Business
4. Role of Small Business In Economic
Development
5. Reasons Why Many Small Businesses Fail
 Group Discussion
• Define Small Scale Business
• Identify the Characteristics of Small
Business
• List the challenges of Small Businesses
 Small Scale
Business/firms/Enterprises
Overview and Facts of small scale business
• Small Scale Enterprises (SSEs) constitute an important
and crucial segment of the industry sector.

• This sector accounts for 40% of total industrial output

and contributes nearly 35% of the total direct exports.

• Because of unique economic and organizational

characteristics, SSEs play important economic,
social and political roles in employment creation,
resource utilization and income generation.
 Definition of Small Businesses

• A small business is a business that is privately

owned and operated with a small number of
employees and relatively low volume of sales.

• Small businesses are normally privately owned by

corporations, partnerships, or sole
proprietorship .

• However, there is no uniform definition of small

businesses worldwide, rather the definition depends
based on the unique context of each country
 Small Scale Business

•There are two approaches to define small

business. They are:
1. Size criteria
2.Economic/control criteria.
 Small Scale Business
1. Size criteria
• Size refers to the scale of operation.
• Varied Criteria used to measure size
are:
• number of employees,

• volume and value of sales turnover,

• asset size and volume of deposits,

• total capital investment,

• volume/value of production, and

• a combination of the stated factors

 Small Scale Business

II. Economic/Control Criteria

•The economic/control definition covers
• Market share - is not large enough

• Independence- the owner has control of the

business himself.
• Personalized management- the owner actively
participatesin all aspect of management of
business and decision-making process.
 Small business in the Ethiopian
Context
• The actual by the Ministry of Trade and Industry adopted

official definition of Micro and Small enterprises in Ethiopia are

as follow:

• Micro enterprises are business enterprises found in all

sectors of the Ethiopian economy with a paid-up capital (fixed

assets) of not more than Birr 20,000, but excluding high-tech

consultancy firms and other high-tech establishments.

• Small Enterprises are business enterprises with a paid-up

capital of more than Birr 20,000 ($2,500) but not more than

Birr 500,000 but excluding high-tech consultancy firms and

other high-tech establishments.

 Characteristics of Small
Business/firms

• Market influence: the small firm has a small

share of the market. Therefore it is not large

enough to influence the prices or national

quantities of the good or service that it provides.

• Independence: The small firm is independent in

the sense that it does not form part of a larger

enterprise and that the owner-managers are free

from outside control in taking their principle

 Characteristics of Small
Business/firms
• Personal influence: The small firm is managed
in a personalized way and not through the

medium of a formalized management structure.

• Short of cash: They cannot raise capital in the

same way that a large company can.

• Operate in a Single Market or Limited

Range of Markets: Small firms usually offers a
limited range of products and services.
 Cont’d …

• Indigenous resources: Small-scale

industries can be easily located anywhere
subject to availability of raw materials, labor,
finance, etc. Small scale units use local
resources.
• Labor intensive: They are generally more
labor oriented with comparatively smaller
capital investment than the larger units.
 Rational with Small Business

•Developing personal relationships:

– small businesses are well placed to build personal
relationships with customers, employees, and
suppliers.

•Responding flexibly to problems and challenges:

– in a small business there is little hierarchy or chain
of command. Inventiveness and innovation:
– small businesses are well positioned to introduce
and develop new ideas.
 Rational with Small Business

•Low overheads:
– due to the small scale of operation, small
businesses have lower overhead costs (not directly
related to production, but important cost for
operation, eg. Rent).
•Catering for limited or niche markets:
– By contrast, small firms are able to make a profit on
much lower sales figures.
 Role of Small Business In Economic
Development

• Equitable distribution of wealth and decentralization

of economic power: due to wide spread ownership and
decentralized location of small scale enterprises they
bring about greater equality of income distribution.
• More Employment creation capacity: they are less
capital intensive and more labor intensive.
• Removing Regional Imbalance : inducing/reminding
people to set up small firms in rural areas- employment
creation/benefits of industrialization.
 Role of Small Business

• Ancillary Function : supply parts and accessories

to bigger enterprises. involves specialization in
specific areas and results in greater profitability.
• Export Promotion : Small-scale enterprises are
opening up fresh avenues in the export market in
our world.
 Advantages of Going in to Small
Business

•Independence

– Most small business owners enjoy being their own boss;

they like the freedom to do things their own way.

•Financial Opportunities

– Owners make more money running their own company

than working for someone else.

•Community Service

– By realizing unavailable goods or service.

 Advantages …
•Job Security

– When one owns a business, job security is ensured ; no

mandatory retirement exists.

•Family Employment

– The opportunity to provide family members with employment

•Learning from Challenge - learn from the past failure or success.

•Introducing Innovation

•Catering for small or niche markets

– sell into much smaller markets that are ignored by larger

organization
 Reasons Why Many Small
Businesses Fail

• Poor operations management – The manager

lacks the ability to operate a small business.
• Lack of experience – Many owners start businesses
in industries in which they have no experience
• Poor financial management – Many owners start
with too little money and with little or no
understanding of financial spread sheet applications.
• Failure to plan – The lack of a strategic plan to
guide the business in the long run
 Reasons Small Business Fail
• Over-investing in fixed assets – Owners who over-invest in
fixed assets may find themselves with no access to funds for
working capital.
• Poor credit practices – Owners often sell on credit to meet or
beat the competition and find that they lack the additional
working capital required or the ability to collect receivables.
• Unplanned and uncontrolled growth – Growth is natural and
healthy, but unplanned growth can be fatal to a business.
• Inappropriate location
 Avoiding failure of SMB

Small business owner can avoid some of the common

pitfalls that lead to business failure by:

– Knowing the business in depth

– Developing a solid business plan

– Managing financial resources

– Learning to manage people effectively

– Poor management

– Weak control systems

– Insufficient capital
 Successful Small Business
Management Are
1. Owners have developed habits and traits that are
Positive, Committed, Patient and Persistent.
2. A living Strategic Business Plan is in place.
3. An Organizational Structure has been developed
that encourages people to be their best and helps
them do so.
4. Operational Support Systems are used that track
performance and relieve senior management of
daily detail yet supply them with critical data to
manage the business.
 Reasons for Success
• Hard work, drive, dedication
• Market demand

• Strong management

To grow small business:

– Get more customers and clients

– Get your customers/clients to buy more frequently

– Get your customers/clients to spend more money per

transaction

– Keep your customers longer

 Challenges of Small Business/firms

• Marketing the Small Business: Finding new

customers is the major challenge for small
business owners.
• Small Business Bankruptcy: When small
business fails, the owner will have bankruptcy.
• Sales Fluctuations- inconsistency of sales

• Competition: The other disadvantage of owning

a small business is the risk of competition.
 Challenges …
• Increased Responsibility: face many
responsibilities when especially an operation
gets larger and larger.
• Financial Losses
• Access to resources, in particular to finance
• Market access
 Forms of Ownership and Legal
Requirements
• The form of business ownership describes how a business

is legally set up.

• In other words, the form of business ownership is the

business' legal structure.

• The most common forms of business ownership are the Sole

Proprietorship, Partnership, and Corporation.

• Don't confuse the form of business ownership with the type

of business, such as retail, wholesale, service, etc.

• Most types of business can have any form of business

ownership.
 Cont’d …
• The form of business ownership you choose is one of

the most important decisions that you will make when

you are starting a business.

• The decision must be made before the submission of a

business plan and request for venture capital

• The form of business ownership you choose will affect

many aspects of your business' operation, from

attracting potential clients through filing taxes,

so it's important to choose wisely.

 Sole Proprietorship - (Cont’d
…)
• It is also referred as ‘single proprietorship’.

• A sole proprietorship is the simplest form of business

and the easiest to register.

• It is owned by an individual who has full

control/authority of his/hers owns all assets as well as

answers all liabilities or losses.

• The fact that it is run by the individual means that it is

highly flexible and the owner retains absolute

control over it.

 Sole Proprietorship (Cont’d …)

• Since they have few legal requirements, sole

proprietorships are easy to form and operate.

• They can also be more affordable since no

legal documents need to be filed in most cases.

• Because of this relationship, a sole

proprietorship is known as a pass-through entity.

 Sole Proprietorship (Cont’d …)

• This means that all income and expenses

pass-through to, and are filed as, part of the
owner's personal return.
• If there is a business loss, the owner will enjoy
a deduction to offset personal (paycheck)
income.
• However, if the business makes a profit, the
owner is responsible for any taxes due
 Sole Proprietorship (Cont’d …)
Generally for Sole Proprietorship:
– Easy and inexpensive to create and operate business.

– Decision-making is entirely in hands of the owner.

– Hard to raise funds. Sources of funds limited to the

owner’s personal funds and the funds that outsiders are

willing to provide.

– You may be co-sole proprietor with a spouse. Co-sole

proprietors can split profits and file separate tax returns.

 Sole Proprietorship (Cont’d …)
Generally for Sole Proprietorship:

– Unlimited personal liability if something bad would happen.

You could lose your car home, etc. if someone sued your

business. Creditors can take personal and business assets

– You have no job security and are completely responsible for

the success for your business.

– You don’t have worker’s compensation or unemployment

insurance.

– The business terminates with the death, disability, or

retirement of the owner.

 Advantage and disadvantage of Sole
Proprietorship
Advantages of sole proprietorship are:

• Easy to form, no sharing of profit to others, not legally

strict to start and close the business, easy to make
decision and no employee compensation.

Disadvantages are:

• Unlimited liability, the business can be terminated

because of the death of the owner, unlimited personal
liability, limited access to capital, limited skills and
abilities and lack of continuity for the business
 Partnership

• A partnership consists of two or more persons

who bind themselves to contribute money or industry

to a common fund, with the intention of dividing the

profits among themselves.

• The most common example of partnerships is

professional partnerships, like in the case of law

firms and accounting firms.

 Partnership - (Cont’d …)

A partnership may be general or limited.

• In a general partnership, the partners have

unlimited liability for the debts and obligation of the

partnership, pretty much like a sole proprietorship.

• In a limited partnership, one or more general

partners have unlimited liability and the limited

partners have liability only up to the amount of their

capital contributions.
 Partnership (Cont’d …)

• In general, the advantages and disadvantages of

partnership are the same as the sole

proprietorship.

• However, the partnership has an additional

drawback. A partner can be held liable for the acts

of the other partners, increasing personal liability.

 Partnership (Cont’d …)

Advantages of Partnership:

• Easy to establish

• Complimentary skills

• Division of profits and losses

• Larger poor of capital and the ability to attract

limited partners

• Little government regulation

• Flexibility and taxation

 Partnership (Cont’d …)

Disadvantages of partnership:
• Unlimited liability of at least one partner

• Difficult to dispose of partnership interest without

dissolving the partnership

• Lack of continuity unless there are correct provisions

in the agreement.

• Potential for personality and authority conflicts

• The law of agency binds partners.

 Corporation

• A corporation is the third most common forms of

business ownership.

• It is a juridical entity established under the

Corporation Code and registered with ministry of

trade in Ethiopia context.

• It must be created by or composed of at least five

natural persons and unlimited maximum

number, technically called ‘incorporators’.

 Corporation (Cont’d …)
• Juridical persons, like other corporations or partnerships,

cannot be incorporators, although they may subsequently

purchase shares and become corporate

shareholders/stockholders.

• The owner of a corporation is known as a shareholder

• Since a corporation is a separate legal entity, the corporation

actually owns and operates the business on behalf of the

shareholder, under the shareholder's total control.

 Corporation (Cont’d …)
• This separation provides a legal distinction between the owner

and the business and provides the following important benefits:

– It allows you, the owner, to hire yourself as an employee

and then participate in company-funded employee
benefit plans.

– Since you and your company are now two separate legal
entities, law suits can be brought against your company
instead of you personally.

– When debt is incurred in the company name, you are not

personally liable and your assets cannot be taken to
settle company obligations.
 Corporation (Cont’d …)
– Transferability of ownership
– The liability of the shareholders of a corporation is
limited to the amount of their capital contribution.
– In other words, personal assets of stockholders
cannot generally be attached to satisfy the
corporation’s liabilities, although the responsible
members may be held personally liable in certain
cases.
 Corporation (Cont’d …)

Disadvantages of Corporation:

• Cost and time involved in the incorporation process

• Double taxation

• Potential for diminished managerial incentives

• Legal requirements and regulatory red tape

• Potential loss of control by the founders.