Methodology of Business Studies

Methodology of Business Studies

Introduction:-
    Before a person starts practicing medicine and surgery, he has to acquire sufficient knowledge about the structure of the body, functions of different organs etc. Likewise, a person can hope to understand and tackle problems of business properly only if he has some knowledge of the business world, business activity and its organisation and the relationship of business with the world around it. As we all know, we are all striving for achievement of a work. Our life is built around work, and the work is an essential part of life. This work activity is divided into two broad segments economic and non-economic. So business is an economic activity.
    Business is viewed as an organized economic activity aiming at the production and sale of goods and services needed by the individuals in a society, so the business system cannot be studied without reference to the economic system in which it has to function.
Economic Systems:-
    An economic system consists of people and institutions through which economic resources   are utilized for satisfying needs of individuals in a society. Every society adopts certain institutions through which it attempts to utilize its resources in the best possible manner for satisfaction of human wants. These institutions together constitute an economic system. So simply it refers to the management or the organization pattern formed by various institutions governing economic activities in a society.
Definition of Economic System:-
    An economic system may be defined as the system of production, distribution   and consumption of goods and services in a country. In other words, it is the set of principles and techniques by which problems of economics are addressed, such as problem of society, poverty, unemployment etc.
Central Problems/Basic questions to be addressed by an Economic System:-
a) What commodities shall be produced and in what quantities?
b) How shall the goods be produced? In other words, by whom and with what resources and by what technology are these to be produced?
c) For whom shall goods be produced?
In other words, whose needs are to be catered to by the production and distribution of goods and services?
    In addition to these, modern economies are facing difficulties in relation to maintaining accelerated rate of growth of the economy and in the optimum utilization of resources.
    These questions are answered differently by various economic systems. Business activity and its organization will naturally depend upon the decision made by the society regarding what goods and services should receive priority, which types of consumers should be addressed for making goods and services available to these consumers. This necessitates the study of different economic systems.
Different Economic Systems:-  The basic economic systems fall under four categories: Capitalism, Socialism, Communism and Mixed Economy.
Capitalism:-
    It is an economic system in which individuals are relatively free to determine how goods and services shall be produced and allocated. Here, Capital is owned and invested by individuals and private-owned institutions to earn profit. The investors ultimately benefit by profit and are having the right to own tangible and intangible private property. The system is marked by little or no interference by the Government in business run by private institutions or individuals. This enables individuals to choose what to produce, in what quantity and in which markets to sell.
Socialism:-
    The basic philosophy of socialism is the provision of certain goods and services to all individuals in the nation. It seeks to create more opportunity for the under privileged classes and to end inequality based on birth. So that society can be rebuilt on the foundation of co-operation instead of competition, incentive or profit. Under this economic system, the Government determines what goods shall be produced, how they shall be produced etc. The ultimate goal of this economy is to replace the private ownership of means of production by social ownership and control.
Communism:-
    This system emerged in the twentieth century in countries like Russia and China. Under communism all control of economic power vests in the State. Means of production are socialized and private property is abolished with the object of ending the exploitation of the poor by the rich. The Government owns all economic resources and decided what to produce, how to produce, how to distribute etc. Individuals in such as economy work not for private gain but for the good of society. Here State is the only employer and private freedom of choice and action is getting eliminated.
Mixed Economy:-
    It is a combination of State ownership and control of business and private enterprise. Here the private enterprise is permitted to function and flourish subject to the control and restrictions   by the Government. It aims at blending together the best of control, socialists or communist economy with the best of free enterprise in a capitalist economy.
Division of Labour:-
    The allocation of different jobs to different people is known as specialization or division of labour. It allows individuals to specialize in the types of work in which they have a comparative advantage. It allows the workers to acquire specialized skills, both through training and by learning from experience on the job.
    F.W. Taylor   through scientific management initiated division of labour. The emergence of scientific management in business and planning in national economic systems made the social system of division of labour the key for attaining faster economic growth and better standard of living for people around the world.
    Division of labour was used as a social system in older days to categorize different jobs, and divide labour force to skilled members of a society. An increasingly complex division of labour is closely associated with the growth of total output and trade, the rise of capitalism and of the complexity of industrialization process. Due to globalization, it reaches its maximum scope through business process out sourcing and so on. The WTO supports it through its policy to expand world trade based on comparative advantage.
    It is widely accepted that the division of labour is to a great extent inevitable, simply because no one can do all tasks at once. Some   time critics of extreme division of labour argue that over specialization is bad for intellectual and emotional development and leads to narrow mindedness and feelings of alienation.
Innovation:-
    The term innovation refers to anew way of doing something. It may refer to incremental, radical and revolutionary changes in thinking, products, processes, or organizations. Innovation refers to the commercial application of invention and is the result of attempts to satisfy some feeling of a ‘gap’ somewhere the person is working at. Innovation now a day determines the fate of an industry and paves the way for new allied industries.
    Innovations are of three types: neutral, labour-saving and capital saving. Labour saving innovation enables production of a given output with less labour relative to capital and capital saving innovation enables production of a given output with less capital relative to labour. All other innovations are called neutral innovations.
    The innovation is simply defined as, “the successful introduction of a new thing or method”. Joseph Schumpeter provided an economic conception which includes:
1. The introduction of new good, which is new to consumers, or of a new quality.
2. The introduction of a new method of production.
3. The opening of a new market.
4. The conquest of a new source of supply of raw materials.
5. The carrying out of the new organization of only industry.
Thus the systematic programs of organizational innovations are most frequently driven by:
1. Improved quality
2. Creation of new markets
3. Extension of the product range
4. Reduced labour costs
5. Improved production processes
6. Reduced materials
7. Reduced environmental damages
8. Replacement of products/services
9. Reduced energy consumption
10. Conformance to regulations
    The causes of failure in innovation of a firm may be external or internal. Common causes of failure with in the innovation process in most organizations can be distilled into 5 types, such as:
1. Poor goal definition
2. Poor alignment of actions to goals
3. Poor participation in teams
4. Poor monitoring of results and
5. Poor communication and access to information
Flow of Goods and Services : Accumulation of wealth    Flow of goods and services simply means trade. In this global economy, the flow of goods and services across borders is a critical factor to the health and growth of a country’s economy.
    The accumulation of capital simply refers to the gathering or amassment of objects of value, the increase in wealth; or the creation of wealth. It refers to net addition to existing wealth, or to a redistribution of wealth. If more wealth is produced than there was before, a society becomes richer, the total stock of wealth increases. But if some   accumulate wealth only at the expense of others, wealth is merely shifted from A to B.
Under Capitalism:-
    Since Capitalism is based on economic individualism, it does not guarantee that each individual will share equally in the benefits arising out of the working of the economy. Individuals commanding more wealth will have the advantage over the less wealthy. Capitalism was based on the assumption that competition would automatically eliminate inefficiency in individuals and institutions.
    The flow of goods and services and the accumulation of wealth and income distributions under capitalism are decided on the basis of prices and cost calculations of privately owned, independent business firms. Members of the capitalist economy are free to save part of their income and accumulate wealth. Savings results in investment, which permits the production of capital goods that, contribute to the growth of the economy.
The main features of capitalism include:-
(1)The upper hand of price mechanism
(2)The consumer’s sovereignty
(3)Absence of a central plan
(4)Freedom of enterprise
(5)Property rights
(6)Competition
Merits of Capitalism:-
1. Economic Freedom
2. Efficient use of resources
3. Economic development and prosperity
4. Rise in standard of living
5. Flexibility
Demerits of capitalism are:-
(1) Class Struggles
(2) Wasteful Competition
(3) Emergence of monopoles and concentration of economic power
(4) Economic instability
(5) Ignoring human rights
Under Socialism:-
    Socialism or Common economy believes in social ownership of property and productive resources, central planning and government control, and social welfare activities. Socialists believe in the abolition of private ownership of the instruments of production. It is an economic and political theory based on public or common ownership and cooperative management of the means of production and allocation of resources.
    Socialist economies are centrally planned. The entire economic life of the people and the country is directed and controlled by the State. So the central planning authority decides the organization of production and distribution of goods and services. Here the profit motive has no role to play.
The merits of Socialism are:-
(1) End of exploitation
(2) Check on trade cycles
(3) Prevention of competitive waste
(4) Class Less society
(5) Better allocation of resources.
Demerits of socialism are:-
(1)Bureaucracy and red tapism
(2) Not successful in business
(3) Lack of   incentives
(4) Loss of   liberty
(5)Absence of price mechanism and mis allocation of resources
Under Communism:-
    Communism is a social structure in which classes are abolished and property is commonly controlled, as well as a political philosophy and social movement that advocates and aims to create such a society. ‘Pure Communism’ refers to a classless, stateless society, one where decisions on what to produce and what policies to pursue are made in the best interest of the collective society with the interests of every member of society given equal weight in the practical decision – making process in both political and economic spheres of life.
Features:-
1. It is the extreme form of Socialism
2. Absence of private property
3. Society produces every thing needed by it. It is a stage of abundance.
4. People will work willingly and efficiently without wages.
5. It is based in the principle ‘to each according to need, from each according to ability.’
Merits of Communism:-
1. No scarcity, No classes and No exploitation, so there will be no need for a state.
2. No differences between occupations and towns and villages.
3. Dignity of all citizens.
Demerits:-
1. Not successful in business
2. Lack of incentives
3. Loss of Liberty
4. Absence of price mechanism, Individual freedom etc.
5. In practice, Authoritarian govts with ownership of all means of modes.
Under Mixed Economy:-
    As its name indicates it is a mixture of capitalism and socialism. There is co-existence of private sector and public sector. Govt dissects and control same key areas of the economy and the rest are left to price mechanism. Decisions regarding what to produce, how to produce and how much to invest etc. are taken by govt. At the same time private sector is allowed to operate freely except in same key areas. There are two types of mixed economics. In the first, the means of production are owned by private entrepreneurs, while the govt directly controls and regulates the working of the economy through monetary and   fiscal policies.
    Here the govt. producer only defence equipments and taken care of public utility services like water, gas, electricity & transport. So this system is also called mixed capitalism or controlled capitalism.
    In the second, govt. Plays a vital role in the production of commodities and also directs and controls private enterprises. Here the strategic sectors like mining, metals, steel, oil, defence etc are under the control of state and the rest are owned by private entrepreneurs.
Features:-
1. Co-existence of public & private Sector.
2. Centralized economic planning.
3. Depends on both price mechanism and govt. directives.
4. Blending of profit motive with social interest.
5. Consumer’s sovereignty is protected.
Forms of business organizations:-
    Business is an organized economic activity deals with production and sale of goods and services needed by the society. It includes both industrial and commercial activities aiming at profit.
The major characters of business are:
1. Sale, transfer or exchange of goods and services for the satisfaction of human beings.
2. It deals in goods and services
3. Recurrence of Transactions
4. Profit Motive, and
5. The presence of the element of risk
     Every business needs some resources like men, money, materials etc. If these resources are put together to work systematically, that is referred to as organization. Therefore, a business organization is an economic institution which combines and coordinates all the required resources required for carrying out the production and distribution activity with an objective of earning profit.
    The first question to be addressed in organizing the business is that of the ownership of organization. In a mixed economy there are three broad categories of business organizations. They are:
(1) Private Sector Organizations,
(2) Public Sector Organizations, and
(3) Joint Sector Organizations
    The modern day Business Organizations are also classified in to three broad categories on the basis of their ultimate aim. They include:
1. Business for Profit
2. Business not for Profit, and
3. Business for Non-Profit
I.Private Sector Enterprises:-
    An organisation which is owned, managed and controlled by private individuals are called Private sector enterprise.
Eg: TELCO,TISCO,TATA POWER etc of TATA Century, Birla Yamaha, Grasium Industries etc. of Birla, Reliance Industries, Reliance Capital etc. of Ambanies. The various forms of organisation under private sector includes- Sole proprietorship, partnership, HUF, joint stock companies, MNC’S, and Co-operative Societies.
Features:-
1. Private ownership
2. Private management
3. Profit objective
4. private – accountability
5. Private Financing
    Industrial Policy Act 1956 demarcated the areas for the Public and Private sector in India. However, since the introduction of economic reforms in 1991, the government has sought to transform itself from being a provider of probable services to a purchaser on behalf of user. Thus emerged a new paradigm of public-private-partnership (PPP)
Business for Profit/ Private Sector Enterprises:-
1. Sole Proprietorship:-
     Sole Proprietorship is a form of business organization in which an individual introduces his own capital, uses his own skill and intelligence in the management of its affairs and is solely responsible for the results of its operations. The major features of this form of organization are single ownership, one-man control, undivided risk, unlimited liability, minimum or no government intervention and absence of separate legal entity.
Merits:
1. Ease of formation and dissolution
2. Direct Motivation
3. Facility of Co-ordination
4. Promptness in decision – making
5. Flexibility in management
6. High Secrecy
7. Credit Standing
8. Freedom from Govt. Regulations.
Limitations:
1. Limited Finances
2. Limited Managerial skill
3. Unlimited Liability
4. Lack of Continuity
5. Not suited for large scale business operations.
6. Greater risks.
2. Joint Hindu Family Firm / Hindu Undivided Family Business (HUF):-
     Business organization owned by all the male members of an HUF and managed by the head of the family. The members are called coparceners and the head is called Karta. There is no contractual relationship among coparceners, so it is not a partnership. The liability of Karta is unlimited whereas the liabilities of all other members are limited. HUF is a family consists of all male persons lineally descended from a common ancestor and includes their wives and unmarried daughters. The property of an HUF is inherited by a Hindu from his ancestors.
Under Hindu Law, there are two systems of inheritance:
1. Dayabhaga-
    Under this system, male as well as female members of a family can become coparceners.  This system prevails in West Bengal.
2. Mitakashara:-
    Under this system, only male heirs can become coparceners in the family business. The three successive male generations, ie., sons, grandsons and great – grandsons become joint owners of ancestral property.
    In Kerala, the concept of coparceny was abolished and according to the Kerala Joint Family System (Abolition) Act, 1975, the heirs, both male and female do not acquire property by birth but only hold it as tenants as if a partition has taken place.
Features of HUF business:
1. Membership is by virtue of birth in the family as per Hindu Succession Act, 1956.
2. Managed by eldest male member of family called Karta.
3. Liability of Karta is unlimited.
4. Liabilities of coparceners are limited.
5. Right to the accounts vested with the Karta alone.
6. Continuity of business
7. Implied authority of Karta to enter in to contracts and to pledge the business.
3. Partnership Firm:-
    A partnership is a form of business in which two or more people operate for the common goal which is often making profit. They are individually known by the name partners and collectively by the name firm. The name in which they operate business is the firm name. According to sector 4 of Indian Partnership Act 1932, 'Partnership is the relation between two or more persons who have agreed to share the profits of a business carried on by all or any of them acting for all.'
Feature of Partnership:-
1. Partnership is the result of an agreement called Partnership deed, which may be either oral or written. Written agreement should be duly stamped as per Indian Stamp Act 1889.
2. Minimum number of persons required to form a partnership is 2 as per Indian Partnership Act.
3. Maximum number of members for a banking business is 10 and for a non-banking business is 20 as per Section 11 Indian Companies Act.
4. Funds/Capital for the business is usually contributed by all the partners
5. Control/Management vest with all the partners.
6. Incomeof partnership is taxed under slab system.
 Types of Partners:-
(a)Active Partners –Those who carry on the business on behalf of all other partners.
(b)Sleeping or dormant partners –Those who invest capital, shares profit, shares liability but not participating in management.
(c)Nominal Partners -Those who do not invest, do not share profit, do not participate in management but only lend their name to the firm. They are liable to third parties.
(d)Partner by estoppel –Persons behave in such a fashion that he is mistaken to be a partner by third partner and he will be held liable to those third partner who extend credit to the firm on the reputation of his being a partner.
(e)Partner by holding out –If a person is declared by word or deed to be a partner by another, the person concerned should deny it immediately on coming to know of such a declaration.  If he does not, he will be held liable to third partner. Such partners are known as partner by holding out.
(f)Minor partners –As the partnership is formed by an agreement, a minor cannot enter in to a partnership. But with the consent of all the partners, a minor may be admitted to the benefits of partnership and his liability will be limited to the extent of his share in the firm.
 Types of Partnership:-
    Based on the type of agreement, partnership may be a general partnership and special partnership. General partnership may be partnership at will and particular Partnership. When there is no provision in partnership agreement for the duration of partnership, it is called partnership at will. A particular partnership is formed for a specific purpose or for a particular period. A special partnership may be limited partnership where the liability of one more partners is limited and unlimited partnership.
4. Joint Stock Companies:-
    Company form of business organization emerged due to the limitations of earlier forms of organizations on the one hand, and the highly increased needs of large-scale industry in the era following the industrial revolution on the other.
    According to US Supreme Court Justice John Marshall, a company is an artificial being, invisible, intangible and existing only in contemplation of law.
    Sec.3 (1) of the Companies Act 1956, Company means a company formed and registered under this Act or an existing company. An existing company means a company formed and registered under any of the previous Acts.
Characteristics -
1. Separate legal entity
2. Limited liability of members
3. Perpetual existence
4. Common seal as a substitute for signature.
    The process of company formation may be divided into two stages such as promotion and incorporation.
    Promotion is the process of exploration, investigation, and the organization of necessary resources with the object of initiating business under corporate ownership. The persons who take this kind of an initiative to start a business are known as promoters.
    Incorporation is the legal process through which the separate corporate entity of a company is given recognition by law. To secure incorporation, the promoters prepare and file with Registrar of Joint Stock Companies the documents like. Memorandum of Association-Charter of the company contains, name, location, objectives, capital etc. of company.
    Articles of Association- contains rules and regulations of the company
If the registrar is satisfied with these documents , he will issue a certificate of Incorporation.
Types of Companies –
A. On the basis of Incorporation
1. Chartered Companies
2. Statutory Company
3. Registered Company
(a) Public Limited Companies- Minimum 7 members and no restriction towards maximum number of members. The word limited is used at the end of its name. Free transferability of shares. Invites public to accept shares. Minimum paid up capital 5, 00,000. Minimum number of directors required is 3.
(b) Private Limited Companies- Minimum 2 members is enough. Maximum is restricted up to 50. Minimum paid up capital is 1, 00,000/-cannot issue prospectus. Restricts right to transfer shares. The word 'Private- Limited' is used at the end. Minimum number of directors required is 2.
B. On the basis of Liability:-
1. Company limited by shares
2. Company limited by guarantee
3. Unlimited Companies
C. On the basis of area of functioning:-
1. National Company
2. Multinational or transnational Company

5. Cooperative Organizations:-
    A co-operative society is essentially an association of persons who join together on a voluntary basis for the promoting their common economic interest. It functions on the principle of self help through mutual help. The primary motto of cooperative sector is “ll for each and each for all.'
    According to Sec.4 of Indian Cooperative Societies Act, 1912, a cooperative organisation is a ' Society which has as its objectives the promotion of the interests of its members in accordance with cooperative principles'
Features:-
1. Voluntary association
2. Democratic Control
3. Service motive
4. Distribution of surplus to members
5. Separate legal entity
6. Government control and support
7. Contribution of share capital by members
Types of Cooperative Societies:-
1. Consumer cooperative societies- Retail  stores owned and organized by people of small means to make available to themselves their daily requirements of goods at moderate prices.
2. Producer's Cooperative Societies – Voluntary organisation of producers formed with the object of eliminating the capitalist class from the system of industrial production. Producer's cooperative society may be of two types:
(a) Society will supply the necessary inputs and guidance to members, and the members are only expected to produce individually and sell the same to society.
(b) Cooperatives in which members are rapid wages by the society for the work done by them.
3. Cooperative Credit Societies- Credit societies are set up to pool savings of members and to make them available as loans to those members who need credit at cheaper rates.
4. Marketing Co-operatives- Societies for sitting manufactured and agricultural products, for enabling members to get fair prices for their products. They may be of agricultural marketing cooperatives and industrial marketing cooperatives.
5. Cooperative farming societies- The agricultural cooperatives pool the fragmented land holdings of small land owners and farm on a collective basis.
6. Housing cooperative Societies-Societies formed to provide housing to their members either on an ownership basis or at a fair rent.
II. Public Sector Enterprises:-
    An organisation which is owned, managed and controlled by the central government or any State government or local authority is known as PSU. Various forms of PSU’S are
1. Departmental Undertakings:-
    A PSU is organised, controlled and financed by the government in the same way as any other government department. Railways, Civil Aviation, Post and Telegraph, Public Works etc. are examples.
2. Statutory Cooporations:-
    It is an autonomous organisation that is established and governed by a special act of parliament or assembly. LIC, Air India, ONGC, FCI are examples for the same.
3. Government Company:-
    Any company in which at least 51% of the paid up share capital is held by Central Government, or by any State Government or Governments, or partly by Central Government and partly by one or more State Governments and includes a company which is a subsidiary of a government company. Examples SAIL (Steel Authority of India Limited, Coal India Limited and HMT.)

III. Joint Venture:  Joint Venture is a legal entity formed between two or more parties to undertake an economic activity together.  It is the pooling of resources and expertise by two or more businesses to achieve a particular goal.  The organizations involved may be private, government owned, or foreign, and working on the basis of a Memorandum of Understanding (MOU) signed by all parties.
Merits:
1.Creates a base for growth and innovation
2.Enhances resources and capacity
3.Improves access to technology
4.Lowers cost of production
5.Lowers risk, and
6.Establishes brand name.
Demerits:
1.Slow decision making
2.Lack of full disclosure from partnering companies
3.Level of technology to be adopted in not fully disclosed.
Examples are Maruti – Suzuki, Hero – Honda, Ford – Escort etc.
Business Not for Profit/ Non-Profit Organizations:
A non profit or not for profit organization is an organization that does not distribute its surplus funds to owners or shareholders, but instead uses them to help pursue its goals.  Usually they do not seek profits as a goal.  Examples of NPOs include charitable organizations, trade unions, arts organizations and NGOs.  They fill certain needs of society that are not provided by Government and business.
In India, NPOs are commonly known as Non Governmental Organizations (NGOs) and they can be registered as Trusts, Societies, Section 25 Companies or by Special Licensing.  NGOs in India are governed by Articles 19(1) and 30 of the Constitution of India, Indian Income Tax Act 1961, Societies Registration Act 1860, Section 25 of the Indian Companies Act 1956, Foreign Contribution (Regulation) Act 1976 and by the Public Trusts Acts of various States.  The main sources of receipts for NPOs in India are self generated funds, loans, grants and donations.
Examples are Bill Gates Foundation, Amnesty International, Rotary Internationsl, Red Cross, UNESCO, World Wide Fund for Nature, Scout, Helpage India, Save the Children fund etc.
Problems faced by NPOs
1.Difficult to measure the performance of employees and managers when the goal is providing public service rather than increasing sales and profits.
2.Rely on external funding to maintain their operations and changes in these sources may influence the reliability or predictability with which organizations can hire and retain staff, sustain facilities, create programs or maintain tax-exempt status.
3.Unreliable funding, long hours of work and low pay can lead to employee burnout and high labour turnover.
4.Resource mismanagement is high because the employees are not accountable to anybody.
5.Dynamic founders with strong vision try to retain control over the organization, even as new employees or volunteers want to expand the projects' scope and try new things (Founder's Syndrome)
Multi Nationals – Trans Nationals
A MNC or TNC is also  called Multi National Enterprise (MNE).  It is a corporation or enterprise that manages production or delivers services in more than one country.  It can also be referred to as an international corporation.
An MNC is defined as, a corporation that has its management headquarters in one country, known as home country, and operates in several other countries, known as host countries.
The first modern MNC is generally thought to be the East India Company. MNCs can have a powerful influence in local economies, and even the world economy and also play an important role in international relations.
Public-private-partnership
Public-private-partnership describes a government service or private business venture which is funded and operated through a partnership of government and one or more private sector companies.  These schemes are sometimes referred to as PPP, P3, or P .
PPP involves a contract between a public sector authority and a private party, in which the private party provides a public service or project and assumes substantial financial, technical and operational risk in the project.  In some types, the cost of using the services is borne by the users of the service and in other types capital investment is made by the private sector on the strength of a contract with government to provide agreed services and the cost of providing the service is borne wholly or in part by the government.
Typically, a private sector consortium forms a Special Company called a Special Purpose Vehicle (SPV) to develop, build, maintain and operate the asset for the contracted period.  In cases where the government has invested in the project, it is typically alloted an equity share in SPV.
Example- KGS Aranmula Airport Limited of Pathanamthitta.
Sectors of the Economy:
A nation’s economy can be divided into various sectors to define the proportion of the population engaged in the activity sector. This categorization is seen as a continuum of distance from the natural environment. The continuum starts with the primary sector, which concerns itself with the utilization of raw materials from the earth such as agriculture and mining. From there, the distance from the raw materials of the earth increases.
Primary Sector
The primary sector of the economy extracts or harvests products from the earth. The primary sector includes the production of raw material and basic foods. Activities associated with the primary sector include agriculture (both subsistence and commercial), mining, forestry, farming, grazing, hunting and gathering, fishing, and quarrying. The packaging and processing of the raw material associated with this sector is also considered to be part of this sector.
In developed and developing countries, a decreasing proportion of workers are involved in the primary sector. About 3% of the U.S. labor force is engaged in primary sector activity today, while more than two-thirds of the labor force were primary sector workers in the mid-nineteenth century.
Whereas agriculture dominates the Indian economy to such an extent that about two-thirds of India's workforce is directly engaged in agriculture for their livelihood.
Secondary Sector
The secondary sector of the economy manufactures finished goods. All of manufacturing, processing, and construction lies within the secondary sector. Activities associated with the secondary sector include metal working and smelting, automobile production, textile production, chemical and engineering industries, aerospace manufacturing, energy utilities, engineering, breweries and bottlers, construction, and shipbuilding.
Tertiary Sector
The tertiary sector of the economy is the service industry. This sector provides services to the general population and to businesses. Activities associated with this sector include retail and wholesale sales, transportation and distribution, entertainment (movies, television, radio, music, theater, etc.), restaurants, clerical services, media, tourism, insurance, banking, healthcare, and law.
In most developed and developing countries, a growing proportion of workers are devoted to the tertiary sector. In the U.S., more than 80% of the labor force are tertiary workers.
Quaternary Sector
The quaternary sector of the economy consists of intellectual activities. Activities associated with this sector include government, culture, libraries, scientific research, education, and information technology.
Quinary Sector
Some consider there to be a branch of the quaternary sector called the quinary sector, which includes the highest levels of decision making in a society or economy. This sector would include the top executives or officials in such fields as government, science, universities, nonprofit, healthcare, culture, and the media.

Hospitality Industry
The hospitality industry consists of broad category of fields within the service industry that includes lodging, restaurants, event planning, theme parks, transportation, cruise line, and additional fields within the tourism industry. The hospitality industry is a several billion dollar industry that mostly depends on the availability of leisure time and disposable income. A hospitality unit such as a restaurant, hotel, or even an amusement park consists of multiple groups such as facility maintenance, direct operations (servers, housekeepers, porters, kitchen workers, bartenders, etc.), management, marketing, and human resources.
The hospitality industry covers a wide range of organizations offering food service and accommodation. The hospitality industry is divided into sectors according to the skill-sets required for the work involved. Sectors include accommodation, food and beverage, meeting and events, gaming, entertainment and recreation, tourism services, and visitor information.
Health Care Industry
Health care or healthcare is the treatment and prevention of illness. Health care is delivered by professionals in medicine, dentistry, nursing, pharmacy and allied health. The health-care industry incorporates several sectors that are dedicated to providing health care services and products. According to industry and market classifications, such as the Global Industry Classification Standard and the Industry Classification Benchmark, the health-care industry includes health care equipment and services as well as pharmaceuticals, biotechnology and life sciences. The particular sectors associated with these groups are: biotechnology, diagnostic substances, drug delivery, drug manufacturers, hospitals, medical equipment and instruments, diagnostic laboratories, nursing homes, providers of health care plans and home health care.
According to government industry classifications, which are mostly based on the United Nations system, the International Standard Industrial Classification, health care generally consists of hospital activities, medical and dental practice activities, and other human health activities. The last class consists of all activities for human health not performed by hospitals, physicians or dentists. This involves activities of, or under the supervision of, nurses, midwives, physiotherapists, scientific or diagnostic laboratiories, pathology clinics, home, or other para-medical practitioners in the field of optometry, hydrotherapy, medical massage, music therapy, occupational therapy, speech therapy, chiropody, homeopathy, chiropractics, acupuncture, etc.
Business Process Outsourcing
Business process outsourcing (BPO) is a subset of outsourcing that involves the contracting of the operations and responsibilities of specific business functions (or processes) to a third-party service provider. Originally, this was associated with manufacturing firms, such as Coca Cola that outsourced large segments of its supply chain. In the contemporary context, it is primarily used to refer to the outsourcing of services.
BPO is typically categorized into back office outsourcing - which includes internal business functions such as human resources or finance and accounting, and front office outsourcing - which includes customer-related services such as contact center services.
BPO that is contracted outside a company's country is called offshore outsourcing. BPO that is contracted to a company's neighboring (or nearby) country is called nearshore outsourcing.
Given the proximity of BPO to the information technology industry, it is also categorized as an information technology enabled service or ITES. Knowledge process outsourcing (KPO) and legal process outsourcing (LPO) are some of the sub-segments of business process outsourcing industry.

MARKET AND DEMAND ANALYSIS

MARKET AND DEMAND ANALYSIS

    In most cases, the first step in project analysis is to estimate the potential size of the market for the product proposed to be manufactured and get an idea about the market share that is likely to be captured.  To make an idea about these things an in depth study and assessment of various factors like patterns of consumption growth, income and price elasticity of demand, composition of the market, nature of competition, availability of substitutes, reach of distribution channels and so on is required.  Market and demand analysis should be carried out in an orderly and systematic manner.  The key steps in such analysis are as follows:
Situational analysis and specification of objectives
Collection of secondary information
Conduct of market survey
Charecterisation of the market
Demand forecasting
Market planning

Situational analysis and specification of objectives

    In order to get an idea about the relationship between the product and its market, the project analyst may informally talk to customers, competitors, middlemen, and others in the industry.  Wherever possible, he may look at the experience of the company to learn about the preferences and purchasing power of customers, actions and strategies of competitors, and practices of the middlemen.  If such a situational analysis generates enough data to measure the market and get a reliable handle over projected demand and revenues, a formal study need not be carried out, particularly when cost and time considerations so suggest.  The informal goals that guide situational analysis need to be expanded and articulated with greater clarity. A helpful approach to spell out objectives is to structure them in the form of questions. In doing so, always bear in mind how the information generated will be relevant in forecasting the overall market demand and assessing the share of the market the project will capture.
    The objectives of the market and demand analysis may be to answer the following questions:
Who are the buyers of our product?
What is the current demand?
How is the demand distributed?
What is the break-up of demand?
What the price customers willing to pay?
How can potential customers be convinced about the superiority of our product?
What channels of distribution most suited?

Collection of secondary information
    In order to answer the questions listed while setting the objectives of the market study, information may be obtained from secondary and/or primary sources.  Secondary information is information that has been gathered in some other context and is already available.  Primary information on the other hand, represents information that is collected for the first time to meet the specific purpose on hand.  Secondary information provides the base and starting point of market and demand analysis.  It indicates what is known and often leads for gathering primary information required for further analysis.

General sources of secondary information
    The important sources of secondary information useful for market and demand analysis in India are mentioned below:
a)Census data published every ten years containing information on population, demographic characteristics, household size and composition and maps.
b)National sample survey reports containing data on various economic and social aspects like patterns of consumption, distribution of industries etc.
c)Planning commission reports containing data on plan proposals, physical and financial targets, actual outlays, accomplishments etc.
d)Statistical abstracts published by Central Statistical Organisation which contain data on demographic characteristic, national income estimates, agricultural and industrial statistics.
e)India Year Book published by Ministry of Information and Broadcasting containing wide-range of data on economic and other aspects.
f)UN Statistical Year Book giving world statistical data relating to population, gross domestic production, industrial production, world trade etc.
g)Annual Economic Survey published by Ministry of Finance containing data on wholesale prices, industrial production, exports, agricultural production, national income etc.
h)Central Statistical Organisation’s annual Survey of Industries providing information regarding various aspects of industry.
i)Annual reports published by Commerce and Industry department of Indian Government.
j)Exports and Imports Annual Bulletin of Statistics.
k)Techno economic surveys conducted and published by the National Council of Applied Economic Research.
l)Industrial potential Surveys conducted by All India Financial Institutions under the leadership of IDBI giving data on several backward areas.
m)Stock Exchange Directory containing data on financial performance of various companies classified industry wise.
n)Monthly bulletin of Reserve Bank of India containing data on prices, production indices, exchange rates, balance of payment, etc.
o)Monthly studies of production of selected industries published by Central Statistical Organisation containing data on production, number of units installed, their capacities etc. for selected industries.
p)Publications of advertising agencies containing data on consumer index of markets, test markets etc. which is valuable for understanding Indian markets.

The advantage of secondary sources of data is that it is readily and economically available. But the accuracy, reliability and relevance of such data must be studied carefully.

Conduct of market survey
    Secondary information, though useful, often does not provide a comprehensive basis for market and demand analysis.  It needs to be supplemented with primary information gathered through market survey, specific to the project being appraised.  The market survey may be a census survey or a sample survey.  Census surveys are employed principally for intermediate goods and investment goods when such goods are used by a small number of firms.  In other cases, a census survey is costly and may also be infeasible.  Due to the limitations of census survey, the market survey, in practice is typically a sample survey.  In such a survey a sample of the population is contacted/observed and relevant information is gathered.  On the basis of such information, inferences about the population may be drawn.
The information sought in a market survey may relate to one or more of the following:
Total demand and rate of growth of demand
Demand in different segments of the market
Income and price elasticity of demand
Motives of buying
Purchasing plans and intentions
Satisfaction with existing products
Unsatisfied needs
Attitudes toward various products
Distributive trade practices and preferences
Socio-economic characteristics of buyers

Steps in a sample survey
Typically, a sample survey consists of the following steps:
a.Define the target population In defining the target population the important terms should be carefully and unambiguously defined.  The target population may be divided into various segments which may have differing characteristics.

b.Select the sampling scheme and sample size  There are several sampling schemes: simple random sampling, cluster sampling, stratified sampling, systematic sampling and non-probability sampling.  Each scheme has its advantages and limitations.  The sample size has a bearing on the reliability of the estimates- the larger the sample size, the greater is the reliability.

c.Develop the questionnaire   The questionnaire is the principal instrument for eliciting, information from the sample of respondents.  The effectiveness of the questionnaire depends on its length, the type of questions, the wording of the questions.   Developing the questionnaire requires a thorough understanding of the product and its usage, imagination, insight in to human behavior, the familiarity with the tools of descriptive and inferential statistics to be used later for analysis.  Since the quality of the questionnaire has an important bearing on the results of the market survey, the questionnaire should be tried out in a pilot survey and modified in the light of problems/difficulties noted.

d.Recruit and train the field investigators  Recruiting and training of field investigators must be planned well since it can be time consuming.  Great care must be taken in recruiting the right kind of investigators and imparting the proper kind of training to them.

e.Obtain information as per Questionnaire from the sample of respondents  Respondents may be interviewed personally, telephonically, or by mail for obtaining information.  Personal interviews ensure a high rate of response.  But they are expensive and likely to result in biased responses because of the presence of the interviewer.

f.Scruitinise the information gathered   Information gathered should be thoroughly scrutinized to eliminate data which is internally inconsistent and which is invalid

g.Analyse and interpret the information  Information gathered in the survey needs to be analysed and interpreted with care and imagination.  After tabulating it as per a plan of analysis, suitable statistical investigation may be conducted, if necessary.  For purposes of statistical analysis, a variety of methods are available.  These may be divided into two broad categories: parametric method and non-parametric methods.  Parametric methods assure that the variable or attribute under study conforms to some known distribution.  Non-parametric methods do not presuppose any particular distribution.
Results of the data based on the sample survey will have to be extrapolated to the target population.  For this purpose, appropriate inflationary factors, based on the ratio of the size of the target population to the size of the sample studies, will have to be used.

Charecterisation of the market
   
    Based on the information gathered from secondary sources and through market survey, the market for the product or service may be described in terms of the following
Effective demand in the past and present
Breakdown of demand
Price
Methods of distribution and sales promotion
Consumers
Supply and competition
Government policy

Effective demand in the past and present- To gauge the effective demand in the past and present, the starting point typically is apparent consumption which is defined as:
    Production + Imports – Exports – Changes in Stock level
The figure of apparent consumption has to be adjusted for consumption of the product by the producers and the effect of abnormal factors.  The consumption series, after such adjustments, may be obtained for several years.

Breakdown of demand – To get deeper insight into the nature of demand, the aggregate market demand may be broken into demand for different segments of the market.  Market
segments may be defined by (i) nature of product, (ii) consumer group, and (iii) geographical division.

Price - Price statistics must be gathered along with statistics pertaining to physical quantities.  It may be helpful to distinguish the following types of prices: (i) manufacturer’s price quoted as FOB price or CIF price, (ii) landed price for imported goods,(iii) average wholesale price, and (iv) average retail price.

Methods of distribution and sales promotion – The method of distribution may vary with the nature of product, capital goods, Industrial raw materials or intermediates, and consumer products tend to have differing distribution channels.  Further, for a given product, distribution methods may vary.  Likewise, methods used for sales promotion may vary from product to product.

Consumers – Consumers may be characterized along two dimensions viz, demographic and sociological –age, sex, income, profession, residence, social background etc and attitudinal-preferences, intentions, habits, attitudes, responses etc.

Supply and Competition- It is necessary to know the existing sources of supply and whether they are foreign or domestic.  Competition from substitutes and near substitutes should also be specified.

Government policy – The role of government in influencing the demand and market for a product may be significant.  Government plans, policies, legislations etc. have a bearing on the market and demand of the product under examination should be spelt out.

Demand forecasting

    After gathering information about various aspects of the market and demand from primary and secondary sources, an attempt may be made to estimate future demand.  A wide range of forecasting methods is available to the market analyst.  These may be divided into three categories: qualitative methods, time series projection methods and casual methods.

Qualitative methods
    These methods rely essentially on the judgment of experts to translate qualitative information into quantitative estimates.  The important qualitative methods are as follows.
Jury of executive opinion method-  It is very popular in practice. This method calls for the pooling of views of a group of executives on expected future sales and combining them into a sales estimate.  A small number of top executives are requested to register their individual opinions relating to the probable amount of future sales.  A forecast is derived from the average of these figures.  As executives are fully aware of the market conditions, capabilities of the firm etc.,  a forecast under this method gives a better result.

Poll of Sale Force Opinion method -  In this method, sales personnel from different sales territories are asked to provide sales forecasts.  These individual sales forecasts are then combined, modified and refined by the top executives to predict the total or master forecast for the firm.

Delphi method – This method involves converting the views of a group of experts, who do not interact face-to-face, into a forecast through an iterative process.  The steps involved in this method are:
a.A group of experts is sent a questionnaire by mail and asked to express their views.
b.The responses received from the experts are summarized without disclosing the identity of experts, and sent back to the experts,  for reviewing their views in the light of other experts opinion.
c.This process may be continued for one or more rounds till a reasonable agreement emerges in the view of the experts.        

Time series projection methods
    These methods generate forecasts on the basis of an analysis of the historical time series.  The important time series projection methods are as follows:

Trend projection method – The trend projection method involves determining the trend of consumption by analyzing past consumption statistics, and projecting future consumption by extrapolating the past trend onto the future.
When trend projection method is used, the most commonly employed relationship is the linear relationship.
Yt = a + bT
Where Yt = Demand for the year t
    a = Interception of the relationship
    b = Slope of the relationship
    T = Time variable
To estimate the parameters a and b of the linear relationship, the least squares method is used.

Moving average method – According to this method, the forecast for the next period represents a simple arithmetic average or weighted arithmetic average of the last few observations.

Exponential smoothing method – This method is used in case of short range sales forecasts.  It is a type of moving average representing a weighted sum of all past numbers in a time series, with the heaviest weight placed on the most recent data.  This is used to reduce the gap between the actuals and the forecasts. In exponential smoothing, forecasts are modified in the light of observed errors.

Casual methods
    These methods seek to develop forecasts on the basis of cause-effect relationships specified in an explicit, quantitative manner.  The important methods under this category are as follows:

Chain ratio method – In this method the sales of a product may be estimated by applying a series of factors to a measure of aggregate demand.  For example, a firm planning to manufacture stainless steel blades in India can be estimate its potential sales in the following manner.
Adult male population in the country                    : 150 million
Proportion of adult male using shaving blades            : 0.60
Adult male population using shaving blades                : 90 million
Number of times a person uses shaving blades in a year        : 100
Total shaving done per year                        : 9,000 million
Proportion of shaving done with stainless steel blades        : 0.40
Average number of shaving per stainless steel blade            : 4
Number of stainless steel blades used per year            : 900 million
Proportion of stainless steel blade market the firm could capture    : 0.20
Potential sales                                : 180 million

Consumption level method – This method estimates consumption level on the basis of elasticity coefficients, the important ones being the income elasticity of demand and the price elasticity of demand.

End use method – This method is suitable for estimating demand for intermediate products. The end use method, also referred to as the consumption coefficient method, involves the following steps:
1.Identify the possible uses of the product.
2.Define the consumption coefficient of the product for various uses.
3.Project the output levels for the consuming industries.
4.Derive the demand for the product.

Leading indicator method – Leading indicators are variables which change ahead of other variables, the lagging variables.  Hence, observed changes in leading indicators may be used to predict the changes in lagging variables.  For example, the change in the level of urbanization may be used to predict the change in the demand for air conditioners.

Econometric method – An econometric model is a mathematical representation of economic relationship derived from economic theory.  The primary objective of econometric analysis is to forecast the future behavior of the economic variables incorporated in the model.

Market planning
    To enable the product to reach a desired level of market penetration, a suitable marketing plan should be developed. Broadly, it should cover pricing, distribution, promotion and service.  A marketing plan usually has the following components:
Current marketing situation
Opportunity and issue analysis
Objectives
Marketing strategy

Current Marketing Situation
    This part of marketing plan deals with the different dimensions of the current situation.  It examines the market situation, competitive situation, distribution situation, and the macro environment.
    Market situation deals with size, the growth, the consumer aspirations, and buying behaviour in the market under consideration.  Competitive situation exhibits who are major competitors, their objectives, strategies, strengths, etc.  Distribution situation compares the distribution capabilities of the competitors and available distribution systems which are suitable for our product.  Macro-environment describes the effect of social, political, economic, technological, and other external variables on the market.

Opportunity and Issue Analysis
    The management should conduct a SWOT analysis for the product and the core issues before the product be identified.  The strength may be the use of distribution channel already established for the existing products.  The weakness may be its limited resources.  The opportunities might be the favourable consumer preference.  The threat might be the competition from substitutes.
    The core issues may be how to use our strengths to offset probable threats, how can succeed with the product with identified weaknesses, and how to exploit the opportunities available.

Objectives
    Objectives have to be clear-cut, specific, and achievable.  These objectives form the basis for selection of marketing strategies.  Objectives should be expressed unambiguously, preferable quantitatively and with an indication of time span within which the objectives are planned to be achieved.

Marketing Strategy
    The marketing strategy covers target segment, positioning, product line, price, distribution, sales force, sales promotion, and advertising.
    The market segment the firm wants target should be clearly specified.  It needs to be described clearly in terms of the psychographics.
    Positioning is how a product is placed in the mind of the customer.  Having decided the target market, the positioning should be done in appropriate with its characteristics.
    Product line refers number of similar products a firm offering.  So it has to decide whether to introduce the product with varieties or a single variant.
    Price should be in a range existed within the segment.  It should have a bearing on positioning also.
    The various distribution channels may be available to our product.  Then decision has to be taken to use an effective combination of distribution channels
Sales force should be planned in such a manner that to achieve the objectives.  So strategy in this regard specifies their size, probable abilities, and method training which is proposed to be given to them.
Sale promotion strategies should also be formulated. A balance should be made between dealer level sales promotion and consumer level sales promotion. 
Strategy should also be formulated regarding advertisement.  The firm can choose from a large variety of advertisement media. Before selecting an advertisement media the firm should analyse its effectiveness with respect to our product.

COST OF PROJECT AND MEANS OF FINANCING

COST OF PROJECT AND MEANS OF FINANCING

    A project is concerned finance is the basic prerequisite.  Without proper financial arrangement an entrepreneur is finding difficult to go ahead with his project.  Funds requirement should be optimum so as to avoid the problems of both under and over capitalisation.  So the cost project should be accurately estimated.  Once the estimation of cost of project is over, the next step is to find out the sources of financing.  After identifying the various available sources, a finance mix should be finalised.  The selected finance mix should be optimum from the point of view of cost, control and flexibility.

COST OF PROJECT
    The cost of project represents the total of all items of outlay associated with a project which are supported by long-term funds.  The major cost elements of a project are the following:
Land and site development
Buildings and civil works
Plant and machinery
Technical know-how and engineering fees
Expenses on foreign technicians and training for Indian technicians abroad.
Miscellaneous fixed assets
Preliminary and capital issue expenses
Margin money for working capital
Initial cash losses

Land and site development
    This includes basic cost of land, premium payable on lease hold, cost of levelling and development, cost of laying approach roads, cost of gates, cost of tube wells etc.  The cost of land varies considerably from one location to another location.  Similarly the expenditure on site development also varies according to topography of the land.

Buildings and civil works
    This includes buildings for the main plant and equipment, building for auxiliary services like work shops, laboratory etc., godowns, warehouses, quarters for staff etc.  The cost of buildings and civil works depends on the kinds of structures required.  Once the kinds of structures required are specified, cost estimates are based on the plinth area and rates for various types of structures.

Plant and machinery
    The cost of plant and machinery is the most significant component of the project cost.  This includes the cost of imported machinery and its allied cost, cost of indigenous machinery, cost of stores and spares and installation and foundation charges.  The cost of the plant and machinery is based on the latest available quotation adjusted for possible escalation.

Technical know-how and Engineering fees
    Often it is necessary to engage technical consultants or collaborators from India and/or abroad for advice and help in various technical matters like preparation of the project report, choice of technology, selection of the plant and machinery, and so on.  So the amount payable for obtaining the technical know-how and engineering services for setting up the project is an important component of the project cost.

Expenses on foreign technicians and training of Indian technicians abroad
    Services of foreign technicians may be required in India for setting up the project and supervising the trial runs.  Expenses on their travel, boarding, and lodging along with their salaries and allowances must be shown here.  Likewise, expenses on Indian technicians who require training abroad must also be included here.

Miscellaneous fixed assets
    Fixed assets which are not part of the direct manufacturing process may be referred to as miscellaneous fixed assets.  They include items like furniture, office machinery and equipment, tools, vehicles, railway sidings, diesel generating sets, transformers, boilers, piping systems, laboratory equipments etc.  Expenses incurred for the procurement or use of patents, licenses, trade marks, copyrights, etc and deposits made with electricity board may also be included here.

Preliminary and capital issue expenses
    Expenses incurred for identifying the project, conducting market survey, preparing feasibility report, drafting memorandum and articles of association and incorporating the company are referred to as preliminary expenses.
    Expenses borne in connection with the raising of capital from the public are referred to as capital issue expenses.  The major components of capital issue expenses are: underwriting commission, brokerage, fees to managers and registrars, printing and postage expenses, advertising and publicity expenses, listing fees, and stamp duty.

Pre-operative expenses
    Some revenue expenses incurred till the commencement of commercial production are referred to as pre-operative expenses.  This includes establishment expenses, rent, rates and taxes, travelling expenses, interest and commitment charges on borrowings, insurance charges, mortgage expenses, interest on deferred payments, start-up expenses, and miscellaneous expenses.

Provision for contingencies
    A provision for contingencies is made to provide for certain unforeseen expenses and price increases over and above the normal inflation rate which is already incorporated in the cost estimates.

Margin money for working capital
    The principal support for working capital is provided by commercial banks and trade creditors.  However, a certain part of the working capital requirement has to come from long-term sources of finance.  Referred to as the ‘margin money for working capital’, this is an important element of the project cost.

Initial cash losses
    Most of the projects incur cash losses in the initial years.  Yet, promoters typically do not disclose the initial cash losses because they want the project to appear attractive to the financial institutions and investing public.  Failure to make a provision for such cash losses in the project cost generally affects the liquidity position and impairs the operations.

MEANS OF FINANCING
To meet the cost of project the following means of finance are available:
share capital
term loans
debenture capital
deferred credit
incentive sources
miscellaneous sources

Share capital
 There are two types of share capital-equity capital and preference capital.  Equity capital represents the contribution made by the owners of the business, the equity shareholders, who enjoy the rewards and bear risks of ownership.  Equity capital being the risk capital carries no fixed rate of dividend.  Preference capital represents the contribution made by preference shareholders and the dividend paid on it is generally fixed.

Term Loans
Term loans are provided by financial institutions and commercial banks represents secured borrowings which are a very important source for financing new projects as well as expansion, modernization, and renovation schemes of existing firms.  There are two broad types of term loans available in India: rupee term loans and foreign currency term loans.  While the former are given for financing land, building, civil works, indigenous plant and machinery, and so on, the latter are provided for meeting the foreign currency expenditures towards the import of equipment and technical know how.

Debenture capital
Debentures are instruments for raising debt capital.  There are two broad types of debentures: convertible debentures and non convertible debentures.  Convertible debentures as the name implies, are debentures which are convertible, wholly or partly, in to equity shares.  The conversion period and price are announces in advance.

Deferred credit
Many a time the suppliers of plant and machinery offer a deferred credit facility under which payment for the purchase of plant and machinery can be made over a period of time.

Incentive sources
The government and its agencies may provide financial support as inventive to certain types of promoters or for setting up industrial units in certain locations. These incentives may be in the form of seed capital assistance, capital subsidy or tax exemption for a certain period.

Miscellaneous sources: A small portion of project finance may come from miscellaneous sources like unsecured loans, public deposits, and leasing and hire purchase finance.  Unsecured loans are typically provided by the promoters to bridge the gap between the promoter’s contribution and the equity capital the promoters can subscribe to.  Public deposits represent unsecured borrowings from the public at large.  Leasing and hire purchase finance represent a form of borrowing different form the conventional term loans and debenture capital.


Factors affecting selection of means of finance
The selection of means of finance governs the following considerations:
a) Norms of regulatory bodies and financial institutions
b) Key business considerations

Norms of Regulatory bodies and financial institutions
In many countries, including India, the proposed means of financing for a project must be either approved by a regulatory agency or conform to certain norms laid down by the government or financial institutions in this regard.  The primary purpose of such regulation is to impart prudence to project financing decisions and provide a measure protection to investors.

Key business considerations
The key business considerations which are relevant for the project financing decision are: cost, risk, control and flexibility.

Cost In general the cost of debt fund is lower than the cost of equity funds.  The primary reason is that the interest payable on debt capital is a tax-deductible expense whereas the dividend payable on equity capital is not.

Risk The main sources of risk for a firm are: business risk and financial risk.  Business risk refers to the variability of earning before interest and taxes and arises mainly from fluctuations in demand and variability of prices and costs.  Financial risk represents the risk arising from financial leverage.  It must be emphasized that while debt capital is cheap it is also risky because of the fixed financial burden associated with it.

Control From the point of view of promoters of the project, the issue of control is important.  They would ordinarily prefer a scheme of financing which enables them to maximise their control, current as well as potential, over the affairs of the firm, given their commitment of funds to the project.

Flexibility This refers to the ability of a firm to raise further capital from any source it wishes to tap to meet the future financing needs.  In most practical situations, flexibility means that the firm does not exhaust fully its debt capacity.
WORKING CAPITAL
    Working capital is the amount of money required by an enterprise for carrying out its day to day operations.  The money invested in current assets like raw materials, finished products, debtors etc is known as working capital.  The current assets in aggregate refer to gross working capital and the excess of current assets over current liabilities are called net working capital.  The working capital is of two types: permanent working capital and variable working capital.  Usually the permanent working capital is financed by long-term source of finance and variable working capital by short-term sources.  The short-term sources of finance primarily include the following:
1.Loans from banks
2.Public deposits
3.Trade credit
4.Pledging and factoring
5.Bank overdraft
6.Cash credit
7.Bills discounting
8.Advances from customers
9.Accruals

PLANNING CAPITAL STRUCTURE
    Project financing is usually discussed after project selection.  But, in practice project financing is considered from the time of project conception.  Indeed project financing is tangled with project planning, analysis, and selection.  As the project proposal progresses through the stages of planning, analysis, and selection, the outline of project financing become clearer.

    A capital project involves investment in land, plant and machinery, miscellaneous fixed assets, technical know-how, distribution network, and working capital.  Hence capital project may be regarded as a mini firm.  So the issues to be considered in financing a project are identical to those considered in financing a business firm.

Capital Structure
    The two broad sources of finance available to a firm are:  shareholder’s funds and loan funds.  Shareholder’s funds come mainly in the form of equity capital and retained earnings and secondarily in the form of preference capital.  Loan funds come in a variety of ways like debenture capital, term loans, deferred credit, public deposit and working capital advance.
    Ignoring the preference capital the basic differences between shareholder’s funds and loan funds are as follows:
Equity
Debt
Equity shareholders have a residual claim on the income and the wealth of the firm
Creditors have a fixed claim in the form of interest and principal payment
Dividend paid to equity shareholders is not a tax deductible payment
Interest paid to creditors is a tax deductible payment
Equity ordinarily has an indefinite life
Debt has a fixed maturity
Equity investors enjoy the exclusive privilege to control the affairs of the firm
Debt investors play a passive role- of course; they impose certain restrictions on the way the firm is run to protect their interest.

Key Factors in Determining the Debt – Equity Ratio
    The key factors in determining the debt-equity ratio for a project are:
a)cost
b)nature if assets
c)business risk
d)norms of lenders
e)control consideration and
f)market conditions

Cost
    Compared to equity shareholders, lenders require lower rate of return.  This advantage gets magnified when the firm pays taxes, because the interest on debt is a tax deductible expense whereas the dividend on equity is not.  Even though the cost of debt is low, it is accompanied by a higher rate of risk.

Nature of assets
    The nature of firm’s assets has an important bearing on its capital structure.  If the assets are primarily tangible, debt finance used is more.  On the other hand, if the assets are primarily intangible debt finance used is less. Usually the lenders are more willing to lend against tangible assets and less inclined to lend against intangible assets.

Business risk
    Business risk refers to the variability of earning power.  Business risk mainly come from demand variability, price variability, variability of input prices and proportion of fixed operating costs.  Generally the affairs of the firm should be managed in such a way that the total risk borne by equity shareholders, which consist of business risk and financial risk, is not unduly high.  This implies that if the firm is exposed to a high degree of business risk, its financial risk should be kept low.

Norms of Lenders
    The norms employed by the lenders have a bearing on the capital structure.  Generally the debt-equity ratio norm allowed by financial institutions is 1:1.  But for highly capital intensive projects they permit a higher debt-equity ratio.

Control considerations
    The extent of equity stake that promoters want to have in a project has an important bearing in its capital structure.  So the promoters make a choice between equity and debt in such a way as to not loose their desired control over the project.

Market conditions
    If the market is attractive and equity shares can be issued at an attractive premium, the project may rely more on equity.  On the other hand, in the equity market is depressed, the project may rely more on debt.
Choice between equity and debt
Use more equity when
Use more debt when
The tax rate applicable is negligible
The tax rate applicable is high
Business risk exposure is high
Business risk exposure is low
Dilution of control is not an important issue
Dilution of control is an issue
The assets of the project are mostly intangible
The assets of the project are mostly tangible
The project has many growth options
The project has few growth options

Project Planning - Project Identification

PROJECT IDENTIFICATION

    Project identification is the first step of a new venture.  A right direction may enable an entrepreneur to scale new heights.  Otherwise, he has to undergo a number of hurdles in his way.  It is therefore, very crucial to entrepreneur to identify projects.
    Theoretically, an entrepreneur has an infinitively wide choice with respect to his project.  The important dimensions of choice are: product/service, market, technology, equipment, scale of production, location, incentives and time phasing.  The task of identifying a feasible and promising project is somewhat difficult.  Moreover it is interrelated with the government policies, infrastructural development and skills of people.

MEANING AND DEFINITION OF PROJECT

    A project or a capital investment involves allocation and consumption of resources in the expected stream of benefits extending far in the future.
The following are the some of the definitions of project.
“An investment project is carried out according to a plan in order to achieve a definite objective within a certain time and which will cease when the objective is achieved” – Dictionary of Management.
“Project is an approval for a capital investment to develop facilities to provide goods and services” – World Bank.
“Any scheme or a part of scheme for investing resources which can be reasonably analysed and evaluated as an independent unit.  It may be any item of investment activity which can separately evaluated” – Little and Mirless
                Thus, a project may be defined as a scientifically evolved work plan devised to achieve a specific objective with a specified period of time.  The three basic attributes are: a course of action, specific objectives and definite time perspective.

CLASSIFICATION OF PROJECTS
    Projects have been classified in various ways by different authorities.  A classification of project helps to highlight its essential characteristics and feasibility evaluation.
1.  Quantifiable project and Non-quantifiable project
    Quantifiable projects are those in which a quantifiable assessment of benefit can be made.  Non-quantifiable projects are those where such an assessment is not possible.  Projects concerned with industrial development, power generation, mineral development fall in the first category while projects involving health, education and defense fall in the second category.

2.  Sectoral Projects
    The planning commission India accepted sectoral base as the criterion for classification of projects.  A project may, under this classification fall in to any one of the following sectors
a)Agriculture and allied sector
b)Irrigation and power sector
c)Industry and mining sector
d)Transport and communication sector
e)Social service sector
f)Miscellaneous
This system of classification has been found useful in resource allocation at macro level

3.  Techno-economic Projects
Projects are sometimes classified on the basis of their techno economic characteristics.  Three main group of classification can be identified here:
a)Factor intensity-oriented classification:  On the basis of this classification, projects may be classified as capital intensive or labour intensive depending upon whether large scale investment in plant and machinery of human resource is involved.
b)Causation – oriented classification: Here projects are classified as demand based or raw materials based projects-depending on the no availability of certain goods or services and consequent demand for such goods and services or the availability of certain raw material, skills or other inputs as the dominant reason for starting the project.
c)Magnitude oriented classification:  In this the size of investment forms the basis of classification.  Projects may thus be classified as large scale. Medium-scale or small scale projects depending upon the total project investment.

4.  Financial Institutions classification
           All India and state financial institutions classify the projects according to the purpose for which the project is being taken up.  They are:
a)New projects
b)Expansion projects
c)Modernization projects
d)Diversification projects
5.  Service projects
           The service oriented projects are classified as under:
a)Welfare projects
b)Service projects
c)R & D projects
d)Educational projects.

IMPORTANCE AND DIFFICULTIES OF CAPITAL INVESTMENT
Importance
    Capital expenditure decisions often represent the most important decisions taken by a firm.  Their importance comes from three inter-related reasons.

Long term effects- The consequences of capital expenditure decisions extend far into the future.  The scope of current manufacturing activities of a firm is governed largely by capital expenditure in the past.  Likewise, current capital expenditure decisions provide the framework for future activities.

Irreversibility- the market for used capital equipment in general is ill-organised.  Further, some type of custom-made equipments, the market may virtually non-existent.  Thus, a wrong capital investment decision often cannot be reversed without incurring a substantial loss.

Substantial outlays- Capital expenditures usually involve substantial outlays.  Capital costs tend to increase with advanced technology.


Difficulties
    While capital expenditure decisions are extremely important, they also pose difficulties which come from three principal sources.
Measurement problems: Identifying and measuring the costs and benefits of a capital expenditure proposal tends to be difficult.  This is more so when a capital expenditure has a bearing on some other activities of the firm or has some intangible consequences.
Uncertainty:  A capital expenditure decision involves costs and benefits that extend far into the future.  It is impossible to predict exactly what will happen in the future.  Hence, there is usually a great deal of uncertainty characterizing the costs and benefits of a capital expenditure decision.
Temporal spread:  The costs and benefits associated with a capital expenditure decision are spread out over a long period of time, usually 10-20 years for industrial projects and 20-50 years for infrastructural projects.  Such a temporal spread creates some problems in estimating discount rates and establishing equivalences.


PROJECT LIFE CYCLE
    A project has to pass through different phases, from beginning to its completion.  Following are the different phases in the life cycle of a project.

1. Conception: In this phase project idea is conceived.  The project ideas come from different sources.  These ideas should be shaped to suit for consideration and comparison.  The ideas have to be examined in the light of objectives and constraints.  The acceptable idea will form the basis of a future project.  Conception is an important phase in the life cycle of a project.

2. Development phase:  In this phase, the idea generated during the conception phase is developed.  This stage comprises of the production of document describing the project in sufficient details covering all the aspects necessary to catch the mind of the customers and/or financial institutions.

3. Planning: Once project proposal is identified, a preliminary analysis should be done.  It helps to know whether the project justify a feasibility study. Planning provides the frame work which shapes, guides and confines the identification of individual project opportunities.

4. Analysis: A detailed analysis of the idea is to be done in this phase.  Marketing, technical, financial, economic and ecological aspects should be analyzed in detail.  The information developed in this analysis will form the basis of designing the cost and benefits associated with the project.

5. Selection: In this phase the worthiness of the project is examined using one or more of the appraisal criteria.  These criteria includes pay back period, accounting rate of return, net present value,  internal rate of return and cost-benefit ratio.  Suitable cutoff values have to be specified to apply the various appraisal criteria.

6. Financing: Once the project is selected the next phase involves making suitable financial arrangements.  Equity and debt are the two major source of finance for a project.  To decide a suitable financial mix, factors like flexibility, risk, income, control and taxes should be considered.

7. Implementation: This is the phase of setting up manufacturing activities.  This includes drawing engineering designs, negotiations and contracting, construction, training and commissioning of plant.  Various techniques of project management like CPM, PERT etc can be applied in this phase.

8. Review: Performance review has to be done periodically to compare the actual performance with projected performance.  The review is useful in the following ways:
(i) It helps to judge how realistic the assumptions underlying the project are.
(ii) It provides the basis of future decision making.
(iii) It helps in taking corrective action.

Facets of Project Analysis

    The important facets of project analysis are:
Market analysis
Technical analysis
Financial analysis
Economic analysis
Ecological analysis
Market analysis: Market analysis is primarily concerned with assessment of aggregate demand of proposed product and market share of the proposed project. For this a wide variety of information such as consumption trends, supply position, imports and exports, structure of competition, cost structure, demand elasticity, consumer behavior, distribution channels etc should be required.

Technical analysis: Technical analysis seeks to determine whether the prerequisites for the successful commissioning of the project have been considered and reasonable good choices have been made with respect to location, size, process, etc.

Financial analysis: Financial analysis seeks to ascertain whether the proposed project will be financially viable in the sense that whether it is able service the debt and meet the return expectations of providers of capital.  Cost of project, means of finance, cost of capital, profitability, level of risk, break-even point, etc are the important aspect in this analysis.

Economic analysis: Economic analysis, also known as social cost benefit analysis, is concerned with judging a project from the larger social point of view.  In such an evaluation the focus is on the social costs and benefits of a project.  Here the direct economic benefits and costs of the project measured in terms of shadow prices not in terms of market prices.  It also analyse the impact of proposed project in income distribution, level of savings and investment in the society.

Ecological analysis:  This analysis concerned with environmental impact of the proposed project.  This analysis is very crucial in the case of environment-polluting industries.  The key areas in this analysis are likely environmental damage caused by the project and proposed restoration measures in the project.

GENERATION AND SCREENING OF PROJECT IDEAS
    The search of project ideas is the first step towards establishing a successful venture.  The key to success lies in getting into the right business at the right time. Identification of good business opportunities requires imagination, sensitivity to environmental changes, and realistic assessment of what the firm can do.
    Project identification is concerned with the collection, compilation, and analysis of economic data for eventual purpose of locating possible opportunities for investment and with the development of the characteristics of such opportunities.
    The objective of project identification is to find out investment opportunities which are feasible and promising and which merit further examination and appraisal.
    The following are the different aspects to be considered for the generation and screening of project ideas.

Generation of Ideas
    An entrepreneur or a firm needs to generate a few ideas about the project they can undertake in order to select a most promising one.  The project ideas can be discovered from various sources.  They include:
a)Knowledge about unmet customer needs.
b)A study of existing industries in terms of their profitability and capacity utilization.
c)Examination of inputs and outputs of various industries.
d)Review of imports and exports.
e)Study of plan outlays and Governmental guidelines.
f)Suggestions of financial institutions and developmental agencies.
g)Investigation of local materials and resources.
h)Analysis of economic and social trends.
i)Study of technological developments.
j)Exploring possibility of reviving sick units.
k)Attending trade fairs.
l)Stimulating creativity for generating new project ideas.
Stimulating the flow of ideas
    To stimulate the flow of ideas, the following are helpful:
SWOT Analysis: SWOT analysis represents a conscious, deliberate, and systematic effort by an organization to identify opportunities that can be profitably exploited by it.  Periodic SWOT analysis facilitates the generation of idea.
Clear articulation of objectives: The operations objectives of the firm may be one or more of the following:
Cost reduction
Productivity improvement
Increase in capacity utilization
Improvement in contribution margin
Expansion into promising fields.
A clear articulation and prioritization of objectives helps in channelising the efforts of employees and probes them to think imaginatively.
Fostering a conducive climate: To tap the creativity of people and to harness their entrepreneurial urges, a conducive organizational climate has to be fostered.  Many organizations successfully used suggestion schemes to motivate employees to think more creatively.

Monitoring Environment
    Basically a promising investment idea enables a firm to exploit opportunities in the environment by drawing on its competitive strengths.  Hence, the firm must systematically monitor the environment and assess its competitive abilities.  The important aspects to be studied in monitoring the key sectors of the environment are as follows:
Economic Sector
State of the economy
Overall rate of growth
Growth rate of primary, secondary and tertiary sectors.
Cyclical fluctuations
Linkage with the world economy
Trade surplus/deficits
Balance of payment situation
Governmental Sector
Industrial policy
Government programmes and policies
Tax framework
Subsidies, incentives, and concessions.
Import and export policies.
Financing norms
Lending conditions of FIs and Banks
Technological Sector
Emergence of new technologies
Access to technical know-how
Receptiveness on the part of industry
Socio-demographic Sector
Population trends
Age shifts in population
Income distribution
Educational profile
Employment of women
Attitude toward consumption and investment
Competition sector
Number of firms in the industry and market share of top few.
Degree of homogeneity and differentiation among products
Entry barriers
Comparison with substitutes in terms of quality, price, appeal and functional performance.
Marketing policies and practices
Supplier Sector
Availability and cost of raw materials and sub-assemblies
Availability and cost of energy

Corporate Appraisal
    A realistic appraisal of corporate strengths and weaknesses is essential for identifying investment opportunities which can be profitably exploited.  The broad areas of corporate appraisal and the important aspects to be considered under them are as follows:
Marketing and Distribution
Market image
Product line
Market share
Distribution network
Customer loyalty
Marketing and distributions costs
Production and Operations
Condition and capacity of plant and machinery
Availability of raw material, sub-assemblies, and power
Degree of vertical integration
Locational advantage
Cost structure
Research and Development
Research capabilities of the firm
Track record of new products developments
Laboratories and testing facilities
Coordination between research and operations
Corporate Resources and Personnel
Corporate image
Relation  with governmental and regulatory agencies
Dynamism of top management
Competence and commitment of employees
State of industrial relations
Finance and Accounting
Financial leverage and borrowing capacity
Cost of capital
Tax situation
Relations with shareholders and creditors
Accounting and control system
Cash flows and liquidity.


TOOLS FOR IDENTIFYING INVESTMENT OPPORTUNITIES  
    There are several useful tools or frameworks that are helpful in identifying promising investment opportunities. The most popular one is Porter model, which is discussed below.
Porter Model: Profit Potential for Industries
    Michael Porter has argued that the profit potential of an industry depends on the combined strength of the following five basic competitive forces:

a)Threat of new entrants
b)Rivalry among existing firms
c)Pressure from substitute products
d)Bargaining power of buyers
e)Bargaining power of sellers
Threat of new entrants: New entrants add capacity, inflate costs, push prices down, and reduce profitability.  Hence, if an industry faces the threat of new entrants, its profit potential is limited.  The threat from new entrants is low if the entry barriers confer an advantage on existing firms and deter new entrants.

Rivalry between existing firms: Firms in an industry compete on the basis of price, quality, promotion, service, warranties, and so on.  Generally, a firm’s attempts to improve its competitive position provoke retaliatory action from others.  If the rivalry between the firms in an industry is strong, competitive moves and countermoves dampen the average profitability of the industry.

Pressure from substitute products: All firms in industry face competition from industries producing substitute products.  Performing the same function as the original product, substitute products may limit the profit potential of the industry by imposing a ceiling on the prices that can be charged by the firms in the industry.

Bargaining power of Buyers: Buyers are a competitive force.  They can bargain for price cut, ask for superior quality and better service, and induce rivalry among competitors.  If they are powerful, they can depress profitability of the supplier industry.

Bargaining power of suppliers: suppliers, like buyers, can exert a competitive force in an industry, as they can raise prices, lower quality, and curtail the range of free services that they provide.  Powerful suppliers can hurt the profitability of the buyer industry.

PRELIMINARY SCREENING
    By environment scanning and corporate appraisal it is possible to develop a long list of project ideas.  Before going for detailed analysis some kind of preliminary screening is required to eliminate ideas which are not promising. For this purpose, the following aspects may be looked into:
Compatibility with the promoter
Consistency with governmental priorities
Availability of inputs
Adequacy of market
Reasonableness of cost
Acceptability of risk level

Compatibility with the promoter:  The idea must be compatible with the interest, personality, and resources of the entrepreneur.  A real opportunity has three characteristics (i) it fits the personality of the entrepreneur, (ii) it is accessible to him and (iii) it offers good prospect on the invested capital.

Consistency with governmental priorities: The project idea must be feasible given the national goals and governmental regulatory framework.  There should not be any difficulty in obtaining the license for the project.

Availability of inputs: the resources and inputs required for the project must be reasonably assured.  Capital requirements of the project should be in manageable limit.  It is ensured that there is no difficulty in obtaining technical know-how.  Adequate supply of raw materials and other inputs should also be ensured.

Adequacy of the market: The size of the present market must offer the prospect of adequate sales volume.  Further, there should be a potential for growth and a reasonable return on investment.  To judge the adequacy of the market the factors like market size, competitors and their market share, export market, distribution system, patent protection etc should be considered.

Reasonableness of cost: The cost structure of the proposed project must enable it to realize an acceptable profit with a price.  In this regard the factors such as cost of material inputs, labour costs, factory overheads, administration overheads, selling and distribution costs, service costs, economies of scale etc should be considered.

Acceptability of risk level: The desirability of a project is critically dependent on the risk characterizing it.  In the assessment of risk of a project the factors such as business cycles, technological changes, competition from substitutes and imports and governmental control over price and distribution should be analysed.