Budgeting, capital budgeting

Budgeting is the process of developing budgets, or finan­cial plans that project a firm’s inflows and outflows for a future time period. Often budgeting results in the con­struction of pro forma statements, namely the budgeted INCOME STATEMENT and the budgeted BALANCE SHEET.Pro forma, as a matter of form, statements have generally accepted formats but are based on projections. A budgeted (pro forma) income statement is one that reflects projec­tions rather than being based on prior transactions; thus it represents expectations rather than actual data. Likewise, a budgeted (pro forma) balance sheet is one that is con­structed using projections rather than actual data. Pro-forma statements are important tools used in planning and decision-making. In banking, pro forma statements are commonly used as the basis for making loans of VENTURE CAPITAL and loans to new businesses.

Capital budgeting is the planning for a firm’s fixed ASSETS in particular. How a firm decides to use its capital is the most important of all managerial decisions, and since fixed assets represent the majority of most firms’ assets, capital budgeting is the most crucial of all budget­ing activities.

While there are infinite uses for a firm’s capital, its sources are limited, and capital budgeting determines its best uses. Payback period, net present value (NPV), and internal rate of return (IRR) are three capital-budgeting tools commonly used to determine a firm’s most profitable INVESTMENT opportunities.

Payback period, the first capital budgeting tool to be developed, is the expected number of years required for a firm to recoup its original investment in a fixed asset or project. The decision rule when using payback is that shorter payback periods are preferable over longer ones. For example, suppose Project A requires an investment of $10,000 and will generate cash inflows of $3,000 per year for the next five years. Assuming that these inflows are evenly distributed over the next five years, the payback period for Project A is $10,000/$3,000 = 3.33 years. Sup­pose Project Z costs $10,000 and will generate cash inflows of $2,000 per year for the next 10 years. The pay­back period for Project Z is $10,000/$2,000 = 5 years. If payback is used to rank these two projects, Project A is the preferred investment opportunity because of its shorter payback period.

There are two major shortcomings of payback period as a capital-budgeting tool. Only the inflows required to recoup the original investment are considered; the inflows occurring after the payback period are ignored. For Project A above, returns continue for an additional 1.67 years beyond the payback period, but they aren’t considered. For Project Z, returns continue for another five years beyond the payback period. Payback is particularly flawed when used to evaluate investment opportunities where the returns are slow for the first couple of years, but become significant in later years.

An even more serious flaw is that payback is not a dis­counted cash flow technique; it ignores the time value of money. In Project Z, for example, the $2,000 received in

Year 5 is viewed as just as valuable as the $2000 received in Year 1. Depending on the DISCOUNT RATE (cost of capital for the firm) used to determine the present value of the cash inflows, Project Z may, in reality, be a more profitable invest­ment. This makes payback period a crude tool for evaluat­ing and ranking profitable investment opportunities.

To incorporate the time value of money in capital budg­eting, NPV and IRR were developed. These are discounted cash-flow techniques and are more valid tools for decision making than payback period.

NPV is the present value of a project’s future cash inflows minus the initial cash outflow (original invest­ment) required. The decision rule is to accept the project if its NPV is positive but reject if it is negative. If projects are not mutually exclusive, those with greater NPVs are ranked more preferable than those with lower NPVs. Sup­pose a project’s NPV is +$50,000. The present value of the project’s inflows are $50,000 greater than its initial cost, and this net return accrues to the firm’s owners.

IRR, also a discounted cash-flow technique, is similar to NPV except that, while NPV is expressed in dollars, IRR is expressed in percentages. IRR is the discount rate that equates the present value of a project’s expected inflows and its cost. The decision rule to follow when using IRR is to accept projects where the IRR is greater than the firm’s cost of capital and reject those opportunities where the IRR is less than the firm’s cost of capital. For example, if a project’s IRR is 20 percent for a firm whose cost of capital is also 20 percent, undertaking and investing in the proj­ect will add nothing to the firm’s PROFITs; the project’s return exactly offsets the cost of the investment in the project. Thus the cost of capital is a “threshold” which must be exceeded when using IRR as a capital budgeting tool. If projects are not mutually exclusive, projects with higher IRRs are ranked more preferable than those with lower IRRs, and projects whose IRR is less than the firm’s cost of capital are rejected.

Bureau of Economic Analysis

The Bureau of Economic Analysis (BEA) is an agency within the Department of Commerce that produces U.S. economic statistics. Each month the BEA estimates GROSS DOMESTIC PRODUCT (GDP); gross domestic income; and industry, regional, and international economic statistics. To make important policy, INVESTMENT, and spending deci­sions, government officials, business managers, and indi­viduals use economic estimates produced by the BEA.

GDP and other important measures are usually first announced as press releases and widely quoted in the busi­ness media. GDP estimates are first released as a prelimi­nary estimate followed by a first and second revision as more data become available. Financial markets watch GDP statistics closely, and analysts watch growth (or lack thereof) in the industries in which they are involved. Regional economic statistics provide estimates of personal INCOME, population, and EMPLOYMENT by state. Interna­tional economic statistics include BALANCE OF PAYMENTS fig­ures, U.S. DIRECT INVESTMENT abroad, and foreign direct investment in the United States.

The BEA’s monthly journal, Survey of Current Business, presents detailed estimates, analyses, research, and methodology used by the agency to measure economic activity in the U.S. economy.

Business and the U.S. Constitution

The parameters established by the U.S. Constitution affect business and commerce through federalism, judicial inter­pretation, and politics. Federalism is the relationship (divi­sion) of powers between the national government and state governments and, along with separation of powers and checks and balances, forms the foundation of the Con­stitution. Judicial interpretation resolves conflicting con­stitutional issues between national and state authority over business, namely through the COMMERCE CLAUSE (Article 1, Section 8), which gives Congress the power to regulate commerce among states. The policies of Franklin Delano Roosevelt’s New Deal in the 1930s and of Lyndon B. John­son’s Great Society in the 1960s are examples of extending national authority over business and commerce. Former Presidents Richard M. Nixon (1969–73) and George H. W. Bush (1989–93) supported transferring power from the national government back to state authority through the appointment of Supreme Court justices committed to lim­iting national power.

Although the theories of federalism provide a means of ensuring a federal system of government, politics ulti­mately determine the division of power between the national government and state governments. The two fun­damental models of federalism are dual federalism and cooperative federalism. Dual federalism holds that the powers of the national government are fixed and limited and that all rights not explicitly conferred to the national government are reserved to the states. This model was appropriate for American society (business and com­merce) from 1789 to 1933. The GREAT DEPRESSION, however, required a more cooperative relationship between the states and the national government in dealing with the social and economic deprivation of that era.

Cooperative federalism theory states that there is no discernment between state and national powers; their functions and responsibilities are intermingled. This model relies on the elastic clause of Article 1, Section 8 that gives Congress the power to “make laws which are necessary and proper for carrying into Execution the fore­going powers” and confines the Tenth Amendment to spe­cific limitations not given to the national government. Cooperative efforts between the states and national gov­ernment that influenced business and commerce in the 20th century have now shifted the power back to the states in the 21st century, limiting the national government’s scope.

Since the 1960s the federal government’s use of cate­gorical and block grants has become prevalent as a means of shaping its relationships with state governments. Cate­gorical grants are conditionally given for specific purposes; they increase national government power and reduce state government’s power, because states must relinquish the freedom to set their own standards in order to receive financial assistance. Block grants are given for general pur­poses and allow greater flexibility in state spending, there­fore increasing state powers and reducing national power. Greater discretionary state spending may also increase business enterprise with additional financial assistance available to businesses that work in cooperation with state agencies. Since the late 1960s, presidents have revised cat­egorical and block grants in order to return business and commerce regulation to the states. Furthermore, the courts’ interpretation of policies and society’s social and economic welfare influence the continued shifting of busi­ness regulation and responsibilities.

Bureau of Land Management

The Bureau of Land Management (BLM), an agency in the Department of Interior, manages over 264 million acres of public land primarily in 12 western states and Alaska. In addition, the BLM manages 300 million acres of below-ground mineral rights throughout the country. (Owner­ship of land is considered ownership of a “bundle of rights” to the land. Often, in areas of the United States where there are mineral deposits [oil, gas, gold, silver, etc.], developers and homeowners purchase surface rights, while other individuals or businesses own the right to extract subsurface minerals, which has led to conflicts.)

The BLM states its mission is “to sustain the health, diversity and productivity of the public lands for the use and enjoyment of present and future generations.” On pub­ lic lands the agency manages a wide variety of resources and their uses, including energy and mineral extraction, timber, forage, wild horse and burro populations, wildlife habitats, and archaeological and historical sites.

The BLM’s roots go back to the Land Ordinance of 1785 and the Northwest Ordinance of 1787, laws that provided for surveys and settlement of land beyond the original 13 colonies. In 1812 Congress established the General Land Office to oversee disposition of federal lands. Homesteading Laws and the Mining Law of 1872 expanded federal efforts to establish settlements in west­ern territories.

By the end of the 19th century, with the creation of the first national parks, forests, and wildlife refuges, Congress withdrew these lands from settlement and also initiated a change in policy goals for public lands toward resource use. Acts in the early 20th century authorized mineral leas­ing, cattle grazing, and timberland management. In 1946 the Grazing Service was merged with the General Land Office to form the BLM, which operated under more than 2,000 laws, often in conflict with each other, until 1976. That year the Federal Land Policy and Management Act (FLPMA) was enacted, and Congress defined the BLM’s role as “management of public lands and their various resource values so that they are utilized in the combination that will best meet the present and future needs of the American people.”

While directed to achieve “multiple use management,” the BLM remains a controversial federal agency. Tradi­tional users of public lands, including grazing, timber, and mining interests, are often in conflict with increasing pub­lic calls for conservation, environmental management, and recreation. Supporters of the BLM point to the many con­servation and environmental management actions taken by the bureau, while critics point to status quo practices subsidizing private development of public resources.

Balance sheet

The balance sheet is a statement of the financial position and net worth of a firm. Built on the accounting equation assets = liabilities + owners’ equity, the balance sheet is a two-columned statement with ASSETS listed on the left side and liabilities and owners’ EQUITY listed on the right side. Because the right side represents the sources of CAPITAL for the firm and the left side represents the uses of that capi­tal, the two sides of the balance sheet must always be in balance.

On the asset side, current assets are listed at the top, fol­lowed by the long-term assets. The bottom of the left side of the balance sheet is called Total Assets.

On the right side of the balance sheet, liabilities—the firm’s debt—are listed at the top, followed by the equity. The bottom of the right side of the balance sheet is called Total Liabilities and Equity. The left and right-side totals will be equal in dollar amount.

There is a physical significance to the arrangement of the right side of the balance sheet, with liabilities being listed above and before the firm’s equity. This signifies and recognizes that the firm’s creditors (represented by liabili­ties) have a priority to be paid in the event that the firm should have to liquidate (due to insolvency or bankruptcy, for example). The equity owners can receive payment from liquidation only after all the creditors have been paid in full. For this reason, the firm’s equity is often referred to as the residual equity.

The idea of residual equity is also evident in the concept of net worth. With a simple transposition of the accounting equation assets - liabilities = owners’ equity, it is evident that the equity is the firm’s net worth. When debts are subtracted from assets, the residual, if any, is the firm’s net worth.

Individuals and households can construct balance sheets, just as firms do. This is most useful if one wishes to determine his or her net worth. It should be noted that net worth can be negative when the liabilities (debts) exceed the assets. If a firm has a negative net worth, it is insolvent or bankrupt. If an individual or household has a negative net worth, the expression “living hand to mouth” describes the situation more aptly.

Business plan

A business plan is a document that describes a company’s overall plans. The phrase is sometimes used to describe a plan for a segment of the company or for a specific initia­tive. It can also describe the document prepared in an effort to raise VENTURE CAPITAL.

A business plan describes the current business environ­ment, the company’s goals, and the progressive milestones for how those goals will be reached. The plan specifically reports the marketing, operational, staffing, and financial steps to be taken to attain each of the goals.

Here is an outline commonly used in business plans:

- Executive Summary. This section summarizes the rest of the document. It should be interesting enough to entice the reader to read the rest of the document.

- Company Profile. This section, which provides a description of the business, includes the company’s MIS­SION STATEMENT.

- Competitive Analysis. This section describes the busi­ness’s competitive environment, specifies what competi­tors are currently in the business, and looks at their likely response to the actions described in the business plans.

- Marketing Strategy. This section describes the market­ing strategy to accomplish the company’s goals and includes discussion of pricing and distribution issues.

- Operational Strategy. This section tells about the oper­ational milestones needed to accomplish the com­pany’s goals. It describes the development of new processes or technology and the progress being made in these areas.

- Staff Qualifications. This section—one of the plan’s most important—describes the team that has been marshaled to carry out the plans. Potential investors are often more interested in the “who” of the plan than the “what.”

- Financial Information. The business plan needs to include any financial information that helps describe

(a) the company’s current financial situation, (b) cost data relative to carrying out the plan, and (c) the firm’s financial condition if the plan is successful.

- Appendices. This section contains any support docu­mentation that makes the business plan more credible. For example, the financial information section may dis­cuss the company’s income growth over the past five years, and thus the appendix could contain the com­pany’s FINANCIAL STATEMENTS.

The sections described above serve only as an example of what often appears in a business plan. The more creative a person is in clearly presenting the plan, the more likely it is that the plan will get the attention of a potential investor.

Baldrige Award

The Baldrige Award—formally known as Malcolm Baldrige National Quality Award—is an annual award designed to recognize quality management. It was created in 1987 and named after former Secretary of Commerce Malcolm Baldrige, who had died in a rodeo accident that year. Dur­ing the 1980s the United States was perceived as not hav­ing products that could compete in world markets. U.S. products, symbolized by U.S. automobiles, were consid­ered to be not “world class.” As Secretary of Commerce, Malcolm Baldrige had led efforts to improve quality and productivity in U.S. industries.

The National Institute of Standards and Technology (NIST), part of the Department of Commerce, manages the Baldrige Award, criteria for which include

leadership STRATEGIC PLANNING

customer and market focus

information and analysis

human resource focus

process management

business results

Companies submit applications for the award and are evaluated by an independent Board of Examiners. Early recipients of the Baldrige Award have included Motorola Inc., Westinghouse Electric, Xerox, and Milliken & Co. Because of the public recognition associated with the Baldrige Award, some companies hire consultants and spend considerable sums attempting to win this symbol of quality. Winners often use the fact that their company won the award as part of their ADVERTISING efforts.

Winners are expected to share their organization’s per­formance strategies and methods. Some state and local organizations have also created Baldrige Award competi­tions. The award is in some ways similar to Japan’s Dem­ing Award, named after American statistician W. Edwards Deming, who led in the development of TOTAL QUALITY MANAGEMENT (TQM) strategies in Japan during the 1950s and 1960s.

Business cycles

Business cycles are the patterns of increase and decreases in GROSS DOMESTIC PRODUCT (GDP) that occur in an econ­omy. Most countries’ economies have tended to grow over time, but within the trend of overall growth there have been periods of expansion, peaks, contractions, and troughs, followed again by expansion. The movement of an economy through periods of expansion and contraction is called a business cycle.

In the United States the longest period of economic expansion began with a trough in the first quarter of 1991 and continued until 2001. Since 1929 there have been 12 RECESSIONs, or periods of economic contraction. During the 1930 election, President Herbert Hoover claimed the country was not in a recession, just a mild depression. Since then a severe and prolonged recession has been called a depression. The longest period of recession in U.S. history, the GREAT DEPRESSION, lasted from 1929 to 1934. One saying suggested the distinction between a recession and a depression was that “in a recession your neighbor is unemployed; in a depression, you are too!”

During the Great Depression, GDP declined by one-third and UNEMPLOYMENT rose to 25 percent. Economists continue to analyze and debate the causes of the Great Depression and the causes of business cycles. Changes from economic expansion to contraction are caused by shifts in aggregate DEMAND, aggregate SUPPLY, or combina­tions of both. Changes in business INVESTMENT, CONSUMP­TION spending, government purchases, fluctuations in EXPORTING, and IMPORTS, and changes in a country’s MONEY SUPPLY all impact overall demand and supply in an econ­omy. Discovery of new resources, wars, political upheavals, technological innovation, immigration, and population growth have all been suggested as factors contributing to business cycles. In the 19th century, sunspot cycles were suggested to have been similar to business cycles.

Economists try to predict business cycles. If businesses can anticipate changes in the economy, they can prepare for expansion and contractions in economic activity. If governments can anticipate changes in the economy, they can intervene with fiscal and MONETARY POLICY changes to reduce the severity of business cycle troughs and to sustain periods of economic expansion.

Economists use leading INDICATORS to predict changes in business cycles. Leading indicators, as the term suggests, shift in advance of changes in the economy. Changes in unemployment claims, stock prices, new plant and equip­ment expenditures, new building permits, and consumer expectations all tend to precede changes in economic out­put. Leading indicators are less than perfect predictors of business cycles, leaving business managers and policy makers uncertain about future changes in the economy.

Balance of payments

Balance of payments is a summary of a country’s economic exchanges with the rest of the world for a given period of time. Typically, countries trade goods, services, and finan­cial ASSETS. The balance of payments shows whether a country is accruing debits or credits in its trade with other countries. For a country, exports of goods and services and investment INCOME from other countries represent credits against foreigners, while IMPORTS and investment income paid to foreigners are debits. Debits result in demand for FOREIGN EXCHANGE; credits generate supply of foreign exchange. Without offsetting activities, net trade balances influence foreign EXCHANGE RATES.

There are also unilateral transfers, gifts, and retirement pensions sent to and from countries for which there is no exchange of goods or services. Many foreign-born workers in the United States send money back to their families in other countries. For the United States there are more uni­lateral transfers out of the country than coming into the country.

Balance of payments, by definition, must balance or be equal, but different components of the balance of payments can have net positive or negative balances. The three most important components of a country’s balance of payments are the merchandise account, current account, and capital account. The merchandise account records all interna­tional transactions involving goods. For decades the United States has run a negative net trade in merchandise. The merchandise account is also called the balance of trade. The current account is the sum of a country’s trade in merchandise, services, investment income, and unilat­eral transfers. While the United States has a negative bal­ance in merchandise trade, it has a positive balance of trade in services, and INVESTMENT income going out of the coun­try is almost equal to investment income coming into the country. The United States has had a current account deficit for many years. In 2000, the U.S. current account was approximately $435 billion.

When a country like the United States has a current-account deficit, three things can occur. First, foreigners can exchange the excess dollars for their own currency. This increases the supply of dollars as well as the DEMAND for other currencies, causing the value of the dollar to fall in world currency markets. A decreasing dollar will make imports more expensive and exports cheaper to foreigners, reducing the current account deficit. Second, foreigners can use the excess dollars to make DIRECT INVESTMENTs in the United States. For example, dur­ing the early 1990s foreign investors bought many visible symbols of Americana, including the Empire State build­ing and the Pebble Beach Resort. In both cases they paid too much for these assets and subsequently sold them at a loss.

Third, foreigners can use the excess dollars to purchase financial assets, stocks, and BONDS in U.S. companies and U.S. TREASURY SECURITIES. These are known as portfolio investments. For decades foreigners have invested heavily in U.S. securities. Foreign investors hold almost 20 percent of U.S. Treasury securities. Alarmists fear this could lead to economic blackmail, where foreigners threaten to pull their funds out of the United States if the federal govern­ment does not follow policies they support. But foreigners, not foreign governments, are buying U.S. securities, and foreigners are buying these securities primarily because of the relative safety of financial investments in the United States. To try to undermine the authority of the U.S. gov­ernment would be counter to their investment objective.

Because foreigners have primarily used excess dollars to purchase U.S. investments and securities, the value of the dollar has remained stable and even increased, and the capital account—net investment in the United States ver­sus outside the country by U.S. investors—has been posi­tive. This means the United States (businesses and the government) is selling more bonds and other financial assets to foreigners than it is purchasing from abroad. The media therefore portrays the United States as a “net debtor” nation. Since 1985 the U.S. net debtor status has grown annually. These financial assets represent claims against future income and output from the United States.

Business Roundtable

The Business Roundtable is an association of CHIEF EXECU­TIVE OFFICERs (CEOs) of major U.S.-based CORPORATIONs. The association’s stated goal is “to promote policies that will lead to sustainable, non-inflationary, long-term growth in the U.S. economy.” The Business Roundtable was formed in 1972 through the merger of three organiza­tions: the March Group (a group of CEOs which had been meeting informally to discuss public issues), the Con­struction Users Anti-Inflation Round Table (a group focus­ing restraining construction costs), and the Labor Law Study Committee (a group of labor relations executives of major companies).

The Business Roundtable uses the power and visibility of major CEOs to influence government policies and regu­lations. At the annual meeting each June in Washington, D.C., Roundtable members discuss position papers devel­oped by Task Forces on topics currently important to the group. In 2000, Roundtable Task Forces included Civil Justice Reform, CORPORATE GOVERNANCE, the Digital Econ­omy, Education, Environment, Technology & the Econ­omy, Fiscal Policy, Health & Retirement, Human Resources, and International Trade and Investment.

Roundtable position papers are often used by members in testimony before Congressional committees, lobbying efforts at Congress and the White House, and in media releases for the general public. The Business Roundtable is an important network for business executives, providing a forum for discussion of interests across industries and among competitors in the marketplace.

Bank of International Settlements

The Bank of International Settlements (BIS) is an interna­tional organization supporting cooperation among central banks and other agencies. The Bank’s mission is to ensure international monetary and financial stability. The BIS functions as:

a forum for international central bankers,
a provider of financial services for central banks,
a center for monetary and economic research,

• an agent or trustee for implementation of international financial agreements.
Recently the BIS coordinated antiterrorism financial monitoring.
One of the major activities of the BIS is operating the Financial Stability Institute (FSI). The FSI, created in 1998, provides seminars and information programs train­ing central bank personnel from around the world. As demonstrated in the CIRCULAR FLOW MODEL of an eco­nomic system, monetary flows are needed to facilitate the flow of resources and goods and services. Monetary authorities must provide the needed amount of funds to facilitate exchanges, savings, and INVESTMENT. Excessive or “tight” monetary policies impair economic perform­ance. Financial stability is necessary for sustained ECO­NOMIC GROWTH. The FSI trains central bank personnel in areas concerning promotion of adequate CAPITAL stan­dards, effective risk management, and transparency (openness) in financial markets. The best-known BIS agreement is the 1988 Basel Capital Accord. (The BIS is headquartered in Basel, Switzerland.) The accord strives for international convergence in the measurement of the adequacy of banks’ capital and to establish minimum capital standards.
The BIS was created in 1930 as part of the Young Plan from the Treaty of Versailles ending World War I. The BIS took over responsibility for reparations payments imposed on Germany and was directed to promote cooperation among central banks. Responsibility for war reparations ended with the financial chaos in Germany during the 1930s, focusing BIS efforts toward central bank coopera­tion. The BIS supported the BRETTON WOODS system, with a gold standard and the dollar as the international reserve currency until the early 1970s, and it managed capital flows during the oil crises in the 1970s. The organization also assisted with the international debt crisis in the 1980s and with financial management associated with GLOBALIZA­TION in the 1990s.

In addition to providing training and a forum for cen­tral bank officials’ discussion, the BIS provides banking services, such as reserve management and gold transac­tions for central banks and international organizations. At various times it has acted as the agent for EXCHANGE RATE agreements among European countries. It also hosts G10 (Group of 10, previously G7) central bank governors meetings. The G10 leaders attempt to coordinate monetary polices to stabilize world ECONOMIC CONDITIONS. The G10 includes Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom, and the United States.

Business valuation

A business valuation is an estimate of the fair MARKET VALUE of a closely held business. There is no distinction between a valuation and an appraisal, but usually the term valuation is applied to estimating the value of a business and an appraisal is used to refer to estimating the value of a spe­cific ASSET, such as real estate, jewelry, antiques, or art. Fair market value, an important term in business valuation, means what a willing buyer and seller would agree upon if neither had a particular compulsion to buy or sell and both had reasonable knowledge of all the facts.

Valuations are done for many reasons. The most obvi­ous is the valuation done to assist in a genuine transac­tion, when, for example, a prospective buyer or seller hires a valuation expert to assist them in the process. But valuations are also done for other reasons. The estate tax levies a certain amount of tax on the value of property transferred to an heir, and so an estate must have a valua­tion of any family business that is inherited by the next generation. Sometimes the valuation of a family business is important in divorces. When the assets are being divided by the spouses, it is a relatively easy matter to establish a value for such things as cars and houses, but the value of the family plumbing business is a different matter. A valuation expert is important to guide the courts in the division of the assets.

In general there are three approaches used in estimating the value of a business: asset approach, INCOME approach, and the market approach. The asset approach is the easiest to understand: The company’s individual are valued, then its debts are subtracted to find an overall fair market value.

The income approach estimates the company’s future income and then uses DISCOUNTING techniques to estimate its current value. The difficulties with this approach include estimating the future income and determining an appropriate DISCOUNT RATE.

The market approach is theoretically very appealing. It compares certain characteristics of the company being val ued to companies that have been sold recently; the person doing the valuation tries to find a comparable company in the same industry, with about the same assets and income size. The difficulty with this method is both in finding a comparable company and understanding the elements of the comparable transaction, which may include other con­siderations besides the company being sold. For example, the CONTRACT to sell a comparable company may include a certain amount of work to be done by the previous owner or some special financing provision. Such things have to be stripped from the comparable transaction before it is used as a basis for valuing the business. Finding a compa­rable company and understanding the transaction makes the market approach most difficult to apply.

The American Society of Appraisers and the AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS have specialty designations or valuation credentials that they confer on members who accomplish certain prescribed training and testing and have pertinent experience.

Benchmarking

Benchmarking is the process of identifying and learning from the best business practices in a company, an indus­try, or the world. As stated by C. Jackson Grayson Jr., chairman of the American Productivity and Quality Cen­ter, the essence of benchmarking is, “Why reinvent the wheel if I can learn from someone else who has already done it?” The goals of benchmarking typically include cost reductions, quality improvement, and new product or process ideas.

Benchmarking involves a variety of considerations, including processing, legal issues, and limitations. Bench­marking is a structured analysis, starting with identification of the business or process to be benchmarked. In addition to comparing products with the “best in the business,” companies also compare processes. For example, Wal-Mart is well known as a leader in inventory management. Many companies, including Amazon (which was sued for hiring away Wal-Mart inventory management executives), bench­mark Wal-Mart as the leading firm in the area of cost control. Similarly, the United States is perceived by many nations as a leader in education. Education management personnel from other countries are often sent to the United States to study and bring back for adoption educational practices used in this country.

Once the product or process to be studied is identified, organizations develop a team to participate in the bench­marking process. Since benchmarking, by definition, is designed to create change, who is involved in the process is an important consideration. Team members must be knowledgeable, be open to new ideas, be able to analyze data, and have influence within the organization.

Once the team is formed, the benchmarking process typically involves data collection. For internal benchmark­ing, where similar operating units within an organization are compared, internal data is usually available. For exam­ple, many national sales organizations are broken down into dozens or hundreds of regional and local offices.

Sales, cost per sales, gross margins, and other performance measures can be compared. For competitive benchmark­ing, where companies compare their performance with direct competitors, data collection can be more difficult. Public data, observation, and surveys are often needed to collect needed information. Quality comparisons are often conducted using reverse engineering, purchasing and dis­mantling competitors’ products in order to assess quality, and production processes.

Using the data collected, the benchmarking team looks for gaps between the company’s processes and PRODUCTs and those of the leading unit, firm, or industry. Once gaps are identified, causes are searched for and hopefully iden­tified. This leads to the final step in the process: taking action to change existing practices to match or exceed those of the benchmarked unit or competitor.

As Dean Elmuti et al. suggest, benchmarking can lead to legal issues. Especially in competitive benchmarking, copy­ing the practices or processes of the leading firm in an industry can generate problems associated with PROPRIETARY INFORMATION and INTELLECTUAL PROPERTY. Groups of firms working together to improve industry standards and prac­tices can violate antitrust and unfair trade practices laws.

Benchmarking peaked as a business management process in the 1990s. While many companies used the process to reduce costs and improve quality, bench­marking has its limitations. First, the focus of bench­marking is data. If the numbers are not accurate or do not allow valid comparisons, the process will fail. Also, focusing on data can distract managers from their need to address the desires of customers and needs of employees. With its emphasis on details, benchmarking can misinterpret the organization’s “big picture,” their reason for existing.

Typical areas of business practices where benchmarking is applied include billing and collection, customer satisfac­tion, distribution and logistics, employee EMPOWERMENT, equipment maintenance, manufacturing flexibility, market­ing, product development, QUALITY CONTROL, supply chain management, and worker training.

Buy American Act and campaigns

The Buy American Act (1933) and traditions favor the pur­chase of goods and services from domestic suppliers. Almost every time the U.S. economy begins to decline, local and national politicians, supported by business lead­ers, develop campaigns promoting the purchase of Ameri­can-made products. The Buy American Act requires the federal government to purchase American products unless

(a) the purchase is for use outside the United States (such as U.S. military bases abroad),

(b) there are insufficient quantities of acceptable quality products available domes­tically, or

(c) it results in unreasonable costs.

As currently applied, the act requires federal agencies to purchase domestic goods unless the domestic bids are more than 6 percent higher than bids from foreign pro­ducers. Bids from U.S. companies must contain 50-percent or more American materials to be considered domestic. These rules apply to civil purchases made by the U.S. gov­ernment but are suspended for purchasing subject to WORLD TRADE ORGANIZATION rules.

The U.S. Department of Defense has its own Buy Amer­ican rules giving preference to domestic suppliers. In addi­tion, under the Small Business Act of 1953, federal agencies set aside 30 percent of their procurement for socially and economically disadvantaged businesses.

Many state and local purchasing requirements also sup­port preferences for American producers. For example, California once had a regulation mandating purchase of American products, and cities in Massachusetts banned purchases from Myanmar (formerly Burma). These laws were declared unconstitutional on the grounds that they encroached on the federal power to conduct foreign affairs. State laws that copy the federal Buy American Act incor­porating public interest and unreasonable cost exceptions have generally withstood legal challenges. Many countries around the world have preferential buy­ing laws similar to those of the United States. American laws can be used to deny procurement contracts to suppli­ers from countries that “maintain . . . a significant and per­sistent pattern of practice or discrimination against U.S. products or services which results in identifiable harm to

U.S. businesses.”

“Buy American” campaigns—business/political initia­tives to encourage the purchase of American-made prod-ucts—typically arise during downturns in the domestic economy. In the mid-1980s, Wal-Mart, the largest retail chain in the United States, initiated its “Keeping America Working and Strong” campaign. Led by founder Sam Wal­ton, Wal-Mart directed buyers to seek out U.S.-made prod­ucts and encouraged vendors to do business with U.S. manufacturers.

“Buy American” campaigns generate favorable publicity and are good PUBLIC RELATIONS strategies. The federal govern­ment estimates that each additional $1 million spent on U.S. products results in 23 additional jobs in the country. “Buy American” campaigns are frequently associated with trade deficits and efforts to increase protectionism in the country. Economists have conducted numerous studies showing the huge cost to consumers for each job saved through TARIFFs and other competition-reducing trade legislation.

Studies also show that, while Americans prefer U.S.­made products, they tend to purchase the best price/value products available regardless of where they are made. A frequent problem is determining what is American-made. For example, approximately half of the Japanese-brand cars sold in the United States are produced in this country. Similarly, many American-brand cars are produced else­where. Often consumers have to look on the inside pas­senger door to determine where their car was manufactured. In a controversial Harvard Business Review article entitled “Who Are US?,” former Secretary of Com­merce Robert Reich argued that if the goal is to create and maintain jobs in the United States, Americans should also support the many foreign companies producing products and employing workers in the country regardless of where the company is headquartered.

Brady bonds

Brady bonds are debt instruments issued by governments and private lenders in developing countries as a means of restructuring their debt. Named after Nicholas Brady, sec­retary of the Treasury during the George H. W. Bush admin­istration, these BONDS were first issued by the Mexican government as part of a plan to repackage loans made to Mexico during the 1980s. Many governments in develop­ing countries had borrowed billions of dollars but were not able to pay back the loans. Poor INVESTMENT, management, and corruption led governments into situations where they owed significant amounts to foreign lenders and had few productive ASSETS to use or tax to pay off the loans. Just the interest due on the loans represented a significant portion of most government’s budgets. Known as “debt overhang,” these payments prevented governments from making new investments in education, INFRASTRUCTURE, and resource development needed to generate ECONOMIC DEVELOPMENT.

Under Nicholas Brady, a pool of funds from the United States, WORLD BANK, and INTERNATIONAL MONETARY FUND (IMF) was used to guarantee new bonds issued by the developing country government. The new bonds offered to lenders reduced the amount of debt owed and stretched payments over a longer period of time. This lowered the payments of the debtor country, allowing its government greater financial resources to be used in economic devel­opment plans. An alternative procedure provided no debt reduction but lower INTEREST RATES on the new debt than that paid for the old debt in return for guarantees of pay­ment of the principal with the proceeds from long-term bonds provided by the United States and other developed countries. To lenders who faced DEFAULT by the borrowing country, the new debt plans, backed by the funds coordi­nated by Nicholas Brady, were better than default and more secure than direct loans to the borrowing government.

Brady plan restructurings were used in many deveop­ing countries in the late 1980s and early 1990s. As world ECONOMIC CONDITIONS improved, some countries, particu­larly Mexico, paid off their Brady bonds. On the other hand, in 1999 Ecuador became the first government to default on its bonds.

Once issued, Brady bonds became part of international financial debt instruments. A few MUTUAL FUNDS special­ized in purchasing Brady bonds of various countries at deep discounts, hoping to profit from the eventual payoff of these high-risk bonds. These investors recognize the biggest concern associated with these bonds is political risk. The Brady plan was an outgrowth of an earlier strat­egy proposed by then-Secretary of Treasury James Baker, which emphasized economic reforms as a condition for new lending to developing countries.

buying-center concept

The buying-center concept is the idea that in businesses and organizations, many people with different roles and priori­ties participate in PURCHASING decisions. Unlike consumer buying, where the consumer, alone or with assistance or influence from acknowledged opinion leaders, makes his or her own purchase decisions, in business buying a group often determines which PRODUCTs or SERVICES are purchased.
The typical business buying center will include a vari­ety of participants:

- initiators: people who start the purchase process by defining a need
- decision makers: people who make the final decision
- gatekeepers: people who control the flow of informa­tion and access to individuals in an organization
- influencers: people who have input into the purchase decision
- purchasing agent: the person who actually makes the purchase order
- controller: the person who oversees the budget for the purchase
- users: people who use the product or service

In many situations, people play more than one role in business purchasing decisions. Sometimes, buying centers are formal committees created to make a purchase deci­sion, but more often they are defined by organizational relationships. Depending on an organization’s structure and the importance of the decision being made, there could be many or few layers of management involved in a buying center. Some members of a buying center will par­ticipate throughout the decision-making process, while others will only be involved briefly.

Marketers attempt to define who is involved in buying-center decisions. For example, in the 1990s it was often dif­ficult to determine which people made purchase decisions for business computer systems. In many organizations there was no formal computer-systems department. Often important influencers were individuals within an organiza­tion who had taken the time to learn about and analyze computers, even though it was not part of their job require­ments. Influencers were often also initiators of computer-systems purchases and upgrades but sometimes were thwarted by gatekeepers resisting changes in technology. For a marketer of computer systems, it was important to identify who played which roles in business buying centers.

Marketers have also recognized the importance of “champions”—advocates for a company’s products or serv­ices within an organization. During the latter 1990s and early 21st century, many organizations expanded the use of OUTSOURCING—contracting for specific products or services from outside the organization. The jargon term pilot fish refers to individuals and businesses created by former employees now providing outsourcing services to the com­panies they previously worked for. These pilot fish know the company’s structure and the buying-center process in the organization and depend on their champions to con­tinue to influence and send business to them.

boycotts

Boycotts are organized attempts to influence a company, organization, or government through refusal to patronize a business or other group. Boycotts are frequently used to affect business practices. Sometimes boycotts are organ­ized to challenge labor or environmental issues; other times they are used to sway social practices or policies.

In the United States, possibly the most famous boycott was organized by the United Farm Workers (UFW). Dur­ing the 1960s, 1970s, and 1980s, led by charismatic UFW President Cesar Chavez, the UFW asked American con­sumers to not purchase table grapes, claiming unfair labor practices and poor working conditions by grape farmers. By 1975 an estimated 17 million Americans had stopped buying grapes. In another agricultural boycott, the UFW used a DIRECT MAIL campaign asking consumers to boycott Lucky Supermarkets because they were buying nonunion lettuce. The campaign targeted ethnic neighborhoods, areas with high agricultural EMPLOYMENT, and liberal, mid­dle and high-income groups. After nine months Lucky agreed to stop buying nonunion lettuce but claimed the decision had nothing to do with the boycott.

Peace and environmental groups have often attempted to use boycotts to influence government policy. In 1990 Neighbor to Neighbor initiated a boycott of Folgers coffee, a Proctor and Gamble product, accusing P&G of prolong­ing the El Salvadoran civil war by buying Salvadoran coffee beans. The campaign brought attention to the plight of El Salvadorans but was actively opposed by the Bush Administration. (The war ended when the Clinton Admin­istration withdrew financial support for the El Salvadoran military.) Similarly, American and other activists have long supported a boycott of Burma (now called Myanmar) because of its military rule and abuse of human rights. In 1995 U.S. environmental groups organized a short-lived protest of French products in reaction to France’s nuclear tests in the South Pacific.

Boycotts are also used to influence social and political policies. The Boston Tea Party was one of America’s first boycotts. Similarly, one of the hallmarks of the civil rights era was the 1950s boycott of buses in Montgomery, Alabama. The boycott of South Africa in the 1980s dis­played the power of economic sanctions to influence social policies. As one author states, “Boycott. It’s not blackmail. It’s not censorship. What it is is capitalism. A boycott, after all, is merely a way to vote with our wallets.”

In 1994 the National Organization of Women organized a boycott against orange juice when the Florida Citrus Commission decided to advertise on conservative Rush Limbaugh’s talk show. Limbaugh supporters countered by increasing their purchases of orange juice. In 1996 Jesse Jackson threatened a boycott of Texaco stores in an effort to pressure Texaco to settle a racial discrimination suit. The next year Southern Baptists attempted to dissuade the Disney corporation from its gay-friendly employment poli­cies by declaring a boycott against the company. In 1999 the NAACP organized a boycott of tourism in South Car­olina because the state continued to fly the Confederate flag over its state capital. The National Collegiate Athletic Association (NCAA) joined the boycott, refusing to bring collegiate athletic events to the state. Removal of the flag from the capital to a place on the capital grounds appeased some groups, but others continue to boycott the state.

Bylaws

Bylaws define the organizational and operational structure of a CORPORATION. In addition to the articles of INCORPORA­TION (sometimes called a charter), which state the rights and responsibilities of the corporation, bylaws provide greater definition regarding the powers of managers, SHAREHOLDERS, and the BOARD OF DIRECTORS. Jane P. Mallor et al. note that a typical set of corporate bylaws cover:

- the authority of directors and officers, specifying what they may or may not do
- the place and time at which the annual shareholders’ meeting will be held
- the procedure for calling special shareholders’ meetings
- the procedures for directors’ and shareholders’ meet­ings, including whether a majority is required for approval of specific actions
- provisions for the creation of special committees of the board of directors, defining their scope and membership
- the procedures for the maintenance of records regarding shareholders
- the mechanisms for transfer of shares of stock
- the standards and procedures for the declaration and payment of DIVIDENDs

Bylaws are the rules guiding the behavior of sharehold­ers, management, and the board of directors. Without them many disputes are likely to arise among owners and managers, and they provide greater transparency in corpo­rate business decision making. Even with well-defined bylaws, corporate disputes and lawsuits frequently arise. In the 1900s, shareholders in many companies proposed changes in bylaws, including “shareholder-rights bylaws,” which would require the company’s board of directors to “pull the pill” when confronted with a hostile acquisi­tion—that is, implementing anti-takeover actions to pre­vent another company from taking control of the company. Known as POISON-PILL STRATEGIES, shareholder-rights bylaws would direct specific action by the board of direc­tors, but many legal scholars question their legality.

Border Environmental Cooperation Commission

The Border Environmental Cooperation Commission (BECC), a binational organization created in 1993 as a side agreement to the NORTH AMERICAN FREE TRADE AGREEMENT (NAFTA), helps states, localities, and the private sector develop and find financing for environment INFRASTRUC­TURE projects along the U.S.-Mexico border. The BECC, which identifies, evaluates, and certifies affordable envi­ronment projects with the goal of improving the quality of life for citizens along the border, is an outgrowth of ideas put forth by UCLA urban planning professor Raul Hinjosa and others. The idea for the BECC was adopted by the Bush Administration in 1992 and superseded the 1983 Agreement on Cooperation for the Protection and Improvement of the Environment on the Border Area (the 1983 La Paz Agreement).

The Commission maintains offices in both El Paso, Texas, and Ciudad Juarez, Mexico, and is directed by a 10­member BOARD OF DIRECTORS, with five board members from each country. The Director of the U.S. Environmen­tal Protection Agency is an ex officio member of the BECC board. Decisions of the board are based on a majority vote, thus requiring support from members representing both countries. A major role of the BECC is certifying projects for financing by the NORTH AMERICAN DEVELOPMENT BANK (NAD Bank). By 1998 the BECC had certified 16 projects, mostly water-treatment and municipal solid-waste proj­ects. Many more projects were yet to be addressed, and financing problems, particularly for Mexican municipali­ties lacking authority to enter into public works financing and taxation agreements, limited the ability of the BECC and NAD Bank to address long-term problems.

Many U.S.-Mexico border problems stem from rapid growth of the MAQUILADORAS in Mexico. After the PESO CRI­SIS (1994–95), the reduced cost of Mexican labor for inter­national firms and NAFTA increased access to the U.S. market and overwhelmed an already weak infrastructure. Although the BECC was created to address problems asso­ciated with border-area growth, it had limited impact in the 1990s.

Buy-grid model

The buy-grid model is a business model depicting rational organizational decision making. Business marketers use the buy-grid model to portray the steps businesses go through in making purchase decisions. The model includes two components: buy phase and buy class.

Buy phase represents the logical eight steps businesses (or consumers involved in extensive problem solving) go through

need recognition

definition of PRODUCT type needed

development of detailed specifications

search for qualified suppliers

acquisition and analysis of proposals

evaluation of proposals and selection of a supplier

selection of an order procedure

evaluation of product performance

Business-to-business marketers recognize that at each step in the buying process, business buyers have different needs, and different groups within the organization may be involved. Business marketers anticipate which step organi­zational buyers are in and attempt to provide the needed information and support for that stage of decision making. Marketers who can become involved early in the decision-making process have a greater chance of being considered in the final selection process. Many organizations, includ­ing government agencies, have formal purchasing proce­dures incorporating the buy-grid model. Set-aside programs targeting small and minority-owned businesses and bid solicitation requirements for government offices follow a similar defined procedure for PURCHASING.

Most business-buying situations do not involve all of the steps in the buy-grip model. The number of steps varies with the buy-class, the type of buying decision. There are three buy-class categories: new buys, straight rebuys, and modified rebuys. While the complete buying process is typically used for new buys (purchases of prod­ucts or services never used before), a majority of business purchasing decisions are either straight rebuys or modi­fied rebuys. In straight rebuy situations, only the need recognition (the company almost out of the product) and reordering steps are used. For business marketers it is critical for their products or services to be listed as approved vendors for straight rebuys. Marketers will use reminder ADVERTISING, relationship-building entertain­ment and hospitality, and PERSONAL SELLING to maintain their status as the preferred provider. In modified rebuy decisions (where a buyer is willing to “shop around”), the buyer may go through some or all of the purchasing steps. For marketers desiring to be considered during modified rebuy situations, comparison advertising and demonstrations are used to influence business buyers. Incumbent firms will use relationships, special offers, and anticipation of or quick response to customer needs to maintain their status when business buyers are con­sidering alternatives.

bill of lading

A bill of lading is a document issued by a shipping com­pany to acknowledge that the seller has delivered particu­lar goods to it. Bills of lading are used in both interstate and international shipments. The Federal Bill of Lading Act (1916, formally called the Pomerene Act) governs the transfer and transferability of bills of lading, of which there are two types: a nonnegotiable or “straight” bill of lading; and negotiable bills of lading, known as “white” and “yel­low” bills because of the colors of paper on which they are printed. Both types usually represent the seller’s CONTRACT with the shipping company, setting the terms and TARIFFs of that contract.

In a nonnegotiable bill of lading, the carrier is obligated to deliver the goods to the designated destination point and is liable for misdelivery of the goods. Nonnegotiable bills of lading are sometimes called “air waybills,” “sea waybills,” and “freight receipts,” depending on the intended method of transportation. Nonnegotiable bills are used when the seller is expecting payment upon delivery, not for payment based on bill-of-lading documentation.

The carrier issues a negotiable bill of lading to a person (consignee) or “order.” This allows the person to endorse the bill of lading to “order” delivery of the goods to oth­ers. Negotiable bills can be endorsed to third parties, buy­ers or creditors, allowing the “holder” of the bill to receive the goods at the destination point. The shipping company is liable to the holder of a negotiable bill of lading for mis­delivery if it delivers the goods to anyone but the holder. In this way the negotiable bill of lading is similar to a title document conferring ownership of the goods. Negotiable bills of lading are used when sellers are being paid at the time goods are shipped. In international business letters of credit are often used, obligating the buyer’s bank to pay the amount of the contract once bills of lading are sub­mitted, usually by the seller’s bank to the buyer’s bank. The banks use negotiable bills of lading to control title to the goods in their contracts with buyers and sellers. In the United States, negotiable bills of lading are most often used, but some countries only allow the use of nonnego­tiable bills of lading.

Improve Customer Intent to Purchase

Marketing communications can affect your target market’s intent to purchase. That’s the degree to which a customer intends to buy your product or service or the number of customers who intend to buy. The greater the intent to purchase, the greater the likelihood of sales.

Accounts receivable

Accounts receivable are part of a firm’s ASSETS; they repre-sent monies owed to the firm. (While receivables are assets, payables are liabilities to a firm. Payables are the firm’s debt—that is, monies owed by the firm.) An account receivable is created when a firm sells a good or service to a customer on credit (see DEBIT, CREDIT). Rather than receiving an asset in the form of cash, the firm records an asset called an account receivable. The sum of all the monies owed to the firm by its customers collectively is called accounts receivable.

Because accounts receivable are assets, debit entries will increase accounts receivable, and credit entries will decrease accounts receivable. Because of the dual nature of a transaction (an exchange of equal-valued resources between two parties), for every account receivable in a firm’s ledger, there is an equal-valued account payable in another firm’s ledger.

Every firm that sells on credit will have an INVESTMENT in accounts receivable. The presence of accounts receiv¬able, especially when sizable, creates a cash-flow problem for a firm. A sale was made; the merchandise was sold, but it was not liquidated (cash was not received). Thus, accounts receivable are in reality a pool of idle cash. To off¬set cash-flow problems, the accounts receivable need to be collected on a timely basis. Firms monitor their invest¬ment in accounts receivable by comparing their “days sales outstanding” (DSO) ratio with that of their industry.

A popular way firms attempt to offset cash-flow prob¬lems associated with receivables is to offer sales discounts on the invoices sent to their credit customers. Sales dis¬counts are percentages that can be deducted for the early payment of an invoice. A commonly used sales discount found on invoices is “2/10, net 30.” This means that 2 per¬cent may be deducted from the invoice if payment is made within 10 days of the invoice date; otherwise, the full amount of the invoice is due within 30 days of the invoice date. These sales discounts apply to short periods of time, usually 10 or 15 days, but when expressed as an annual percentage rate, these discounts are considerable and are powerful incentives for credit customers to pay early.

Because it is impossible to predict with accuracy which customers are good credit risks, it is natural and expected that some of the accounts receivable will ultimately prove to be uncollectible, at which time they will be written off as BAD DEBTS. Bad-debt expense can be minimized by a tightening of a firm’s credit policy. However, there is a trade-off: having a tight credit policy means that a firm will sacrifice sales to its marginal credit customers. Periodically a firm may review the status of its accounts receivable using an accounting method known as aging of accounts receivable (see BAD DEBTS, AGING OF ACCOUNTS), where the outstanding balance of each account and its DURATION are determined.

Create a Legal Monopoly

A powerful and well-known brand can even create a perfectly legal perceptual monopoly. There is evidence that the better a brand is known and the better it’s distributed, the more a new competitor must spend just to be noticed, let alone tried. For example, anyone starting a fast food restaurant and trying to compete with McDonald’s or Burger King would have to spend a lot of media dollars just to get its name out there. As a result of decades of consistent investment in marketing communications, McDonald’s has a strong competitive advantage. This is one legal way to minimize the number of serious competitors.

Resist Becoming a Commodity

There is increasing evidence that brands are being driven out of the middle and into two categories: either you are a discount brand competing on price or you are a premium brand competing on quality and brand loyalty. For example, Wal-Mart competes on price, and Neiman Marcus competes on quality. The big losers are the brands that attempt to stay in the middle of the road, neither premium brand nor discount brand. They become a commodity, which means customers will jump if a competitor offers a lower price or a better product. It is a hard place to be. A sure sign is that your salespeople keep requesting lower and lower prices in order to make a sale. Building a brand can help keep you from being a commodity.

Accrual basis, cash basis

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) require accounting on the accrual basis, as opposed to the cash basis for accounting. In cash-basis accounting, rev¬enues are recorded when the monies are received. Expenses are recognized and recorded only when they are paid. In other words, revenues and expenses are recorded only when there is a movement of cash either into or out of the firm, respectively. The use of cash-basis accounting is found in only a few types of businesses, namely restau¬rants, medical offices, and legal firms.

Accrual-basis accounting is based upon GAAP, primarily the revenue and matching principles. The revenue princi¬ple requires that revenues be recognized and recorded when they are earned; this may not be at the same time that the revenues are received. For example, suppose a firm sells a computer on credit in December 1999, and the customer pays for the purchase in January 2000. Using the accrual basis, the sale and revenue is recorded when the transaction occurs—that is, in 1999. When payment from the customer is received in the next year, this is an entirely separate transaction and is recorded with the other transactions of the firm for the year 2000. (If cash-basis accounting were used, the firm would not record the computer sale in 1999, although that is when the sale was made. It would record the computer sale in 2000, because that is when the firm received payment for the computer. Transactions in cash-basis accounting are not recorded unless there is either a receipt or payment of money.)

It is impossible for a firm to generate revenue without incurring some sort of expense. When a good is sold, the expense account—COST OF GOODS SOLD—is debited (increased). If a service is performed, labor and/or supplies expense is debited. The matching principle requires that the expenses incurred in the generation of a firm’s revenue for a particular time period be recorded (included) in the same time period as the revenues to which they are related. For example, suppose a firm receives its telephone bill in January for its telephone expense that month, and the firm pays that bill two months later, in March. Even though the expense is paid in March, it is a January expense, not a March expense. The matching principle requires the expense to be recorded in January.

It is evident from the examples above that an accurate measurement of a firm’s periodic revenues and expenses in only realized with accrual-basis accounting. In the accrual basis, revenues and expenses are recorded when the sale is made and the expense is incurred. Cash-basis accounting ignores the concept of periodicity by recording revenues and expenses only when money changes hands. For this reason, accrual-basis accounting is generally accepted.

Accounts payable, trade credit

Accounts payable are a part of a firm’s current liabilities, debts that must be paid within the short term. The accounts payable are the firm’s trade credit. As the firm does business with its suppliers and other firms on a credit basis, accounts payable accrue. Trade credit is a source of CAPITAL for the firm. Using invoices instead of cash, trade credit facilities purchases from suppliers and others; cumbersome cash transactions aren’t necessary when firms have good trade credit. When the accounts payable are kept current (i.e., paid on a timely basis), trade credit creates a good reputa¬tion for the firm among those with whom it does business.

To encourage the early payment of invoices, most sup-pliers’ invoices contain sales discounts. There are percentages that can be deducted for the early payment of an invoice. A commonly used sales discount found on invoices is “2/10, net 30.” This means that 2 percent may be deducted from the invoice if payment is made within 10 days of the invoice date; otherwise the full amount of the invoice is due within 30 days of the invoice date.

Sales discounts apply to short periods of time, usually 10 or 15 days, but when expressed as an annual percent¬age rate, these discounts are considerable and are powerful incentives for credit customers to pay early. The sales dis¬count of “2/10, net 30” is greater than 36 percent when expressed as an annual percentage rate; “1/15, net 30” is approximately a 24-percent annual percentage rate. Con¬sider a firm with a sizable amount of trade credit, which consistently pays its bills late, not taking advantage of the sales discounts. Such a firm is using its suppliers’ money,

borrowing it at INTEREST RATES more commonly associated with CREDIT CARDs and finance companies.

What About Your Competitors?

We live in an era where customers can instantly find many alternative products and services to meet the same need. Sometimes your copetition can even be your otherwise potential customers. For example, for businesses that sell fast oil changes for cars, one competitor is the do-ityourself oil changer. Sometimes your competition can come from completely different business categories or technologies. To clean my house, do I buy your vacuum cleaner, or do I hire a housekeeper, or do I invest in materials with easy-to-clean surfaces? To get in touch with my friend overseas, do I mail a letter, send an e-mail, call on a cell phone, fax a document, connect face to face via computer, or fly over and meet face to face?

In general, consumers tend to choose from among a small set of products or services and similar brands or suppliers to meet their needs. This is called the considered set. It is very telling which of your competitors your customers lump you in with. You may be very surprised at both how customers categorize their choices and who or what your competitors really are. Needless to say, knowing this can have a large effect on your marketing communications.

Assembly plants

Assembly plants are factories located all over the world that bring together materials and machines to produce PRODUCTs. They are typically located where there is access to large numbers of low-cost workers. MAQUILADORAS, assembly plants located in the northern part of Mexico, take materials and parts produced around the world and produce components and final goods primarily destined for the North American marketplace. The primary manufacturer or a local production management company that agrees to manage PRODUCTION for another firm may own assembly plants.

Textile factories are another typical example of assembly plants. Textile equipment is relatively easily shipped and assembled anywhere in the world. Examination of labels in almost any U.S. clothing store will show that the clothes are made in Mauritius, Mongolia, Mexico, or the Northern Marianas. Entrepreneurs shift assembly-plant textile production based on cheap labor, transportation, and TARIFFs. Changes in international trade laws and regional ECONOMIC CONDITIONS frequently result in new, low-cost centers of assembly-plant production. Often developing countries initially expand their export production based on assembly plants. As market opportunities and workers’ skills improve, they move into higher, valueadded products for global markets.

What Is a Target Market?

While it is tempting to try and sell your product or service to everyone in the world, it is not cost effective. You might convince adult men to buy women’s makeup, but it’s likely that the return on your investment would be negative. You are much better off selling makeup to women or, better still, selling makeup to young adult women who are fashionistas.

To profit from your marketing, you must have a target market—a primary group of people you serve. Your primary market is the group of customers who account for a disproportionate share of your sales and profits. They are the ones you can’t afford to do without. You may also have secondary and tertiary markets, customers who are important, but not as important. For example, in the U.S., women buy most of the men’s underwear, usually for their husbands and sons. Wives and mothers are the primary target market for men’s underwear. But younger single men and divorced men also purchase their own underwear. They are a secondary target market. This is important to understand because they have different motives and beliefs, they need different messages, and they are reached through different media.

One of the most important marketing decisions you will ever make is to decide which group of people is your primary target market. You can’t pursue all markets or even just two markets if they are incompatible. For example, if moms like something, teen boys distrust it; and if amateurs like something, professionals are embarrassed to use it. Sometimes you just have to choose—you can’t please everyone. More about this in later chapters.

Marketing Communications and Your Brand

A brand is perception, and perception is reality for customers. The total of all the customer impressions of your product or service is your brand. Your brand is not the buildings, equipment, boxes, objects, or people you manage. Your brand is a perception that lives in your customers’ minds.

One of the most frustrating experiences for a company is to create a technically superior product that is not perceived as a superior brand by prospective customers. That is one problem that superior marketing communications can help resolve. In fact, any marketing communications on which you spend time or money that doesn’t improve perception is pure non-value-added overhead.

Amortized loan

An amortized loan is one in which the principal and interest are repaid over time via a series of equal payments made over regular intervals of time. Because all the payments are equal in value and are due on the same day of each month over the DURATION of the loan, the stream of payments is considered an ANNUITY. The most common amortized loans are those for car and home purchases.

The payment schedule for an amortized loan typically includes a listing of each payment, indicating how much of each payment goes toward the repayment of principal, how much is interest expense, and the remaining principal. Especially for long-term loans such as 30-year home mortgages, most of each monthly payment for the first couple of years is interest expense, with very little of the payment remaining for the repayment of principal. However, with each successive payment, increasingly less of it is interest expense, leaving more for the repayment of principal. This pattern continues over the life of the loan, and as the end of the loan period approaches, most of each payment goes to the repayment of principal.

The majority of amortized loans are MORTGAGEs (secured loans). Mortgages are backed by collateral, pledge ASSETS, titles, or deeds. With auto loans the lender retains title to the automobile until the last payment of the AMORTIZATION schedule is made. With the purchase of real property, the lender holds the deed to the real estate until the mortgage has been fully amortized (paid off ).

Auditing

Along with bookkeeping, FINANCIAL ACCOUNTING, and MANAGERIAL ACCOUNTING, auditing is one of the branches of accountancy. Auditing—the process of examining the
books and records of a business, agency, or organization to determine the accuracy of the accounts contained therein—verifies that the accounting system accurately represents and reports the transactions that have occurred over the past year.

External auditing is performed by accounting firms or by accountants who are not a part of the organization being audited. Fund-raising organizations, charities, and CORPORATIONs publishing their ANNUAL REPORTs regularly use external audits to provide impartial, objective reviews of their accounting systems.

Internal auditing is performed by accountants who are employees of the firm being audited. Internal audits check for conformance to a firm’s own policies as well as to accounting standards. Because internal audits a e performed by accountants within the firm or organization, such audits are not considered to be as impartial and objective as external audits.

Marketing Communications Multiplies Word-of-Mouth

If your marketing communications claims are supported by word-ofmouth and direct experience, your advertising acts as a multiplier.

It can actually improve the amount of positive word of mouth (how often and how many people say good things about you), and it can even improve and reinforce your customer’s direct experience of your product.

Be Authentic

“Everything you do” includes product development, price, locations, hours, placement and distribution, hiring, listening, promotion, design, contact points, news quotes, mistakes, and word of mouth, as well as classic advertising media communications. In general, direct experience trumps word of mouth, which trumps sales communications.

If your sales communications are making claims that are not supported by word of mouth or, worse, not supported by direct experience, you are better off adjusting your communications downward to fit reality. Otherwise, you are teaching people not to believe your communications. You are teaching them that your brand is a liar. Unless your product or service is a once-in-a-lifetime purchase (such as a presidential election!), it is always better to underpromise and overdeliver, even if your competition is making exaggerated claims.

Most people distrust corporations, sales, salespeople, and marketing communications. One way to stand out from the competition is to always tell the truth.

Increase Sales

Most marketing communications neither dramatically increase nor decrease sales. But there is evidence that the most effective marketing communications help companies outsell the least effective by 600-900 percent! A little-known fact is that the worst marketing communications can even drive sales down by as much as 50 percent every time they run. Part of the purpose of this book is to help you avoid being on the low side of that bell curve and instead move toward that 600 percent elite.

What Is Marketing Communications?

Marketing communications is anything your organization does that affects the behavior or perception of your customers. The marketing communications process is a conversation between you and your customers that is as much about listening to your customers as it is about sending them messages. It is not a one-way street.

It doesn’t matter who your customers are or what you are selling or promoting. Every decision you make and everything you do influences what your customers hear, see, or experience and will affect how they think and feel about your company and your product and/or service. This, in turn, influences what they do. Perception always precedes behavior.

The Importance of Good Marketing Communications

The scarcest resource on the planet is no longer money or diamonds or oil. The scarcest resource is attention. The demand for attention today far exceeds the supply. The resulting scarcity of attention is the greatest problem facing any marketing communicator.

By almost any measure, the noise level or clutter in media has gotten so overwhelming that it is difficult for any one message to stand out and be noticed. Estimates vary depending on the study and the group studied, but the average American is exposed to somewhere between 200 and 5,000 commercial messages a day. We have more demands on our attention in just one day than our great-grandparents had in an entire year. By the time you die, you will have spent years of your life watching commercials and seeing ads.

The vast majority of these messages are ignored, a few are hated, and a tiny percentage are noticed and appreciated. And even if a marketing communication manages to penetrate your consciousness, it must compete with the estimated 45,000 to 50,000 thoughts a day inside your brain.