4M BG

To defi ne a successful business it is necessary to begin by understanding
what a business is – in essence “a commercial operation that is run
with the aim of making a profi t”. This poses two questions: what is a
commercial operation and what is profi t?
 A commercial operation is an activity that is conducted for the
benefi t of its owners. The signifi cant part is “for the benefi t of its
owners”, which differentiates it from a government organisation
or a charity where the activity is conducted for the benefi t of the
people it serves. Although the difference is about who gains from
success, the route to success for all these activities is to understand
and satisfy customers better than your competitors.
 A profi t is a trading surplus whereby the revenues earned from
a commercial operation exceed its costs. This surplus belongs
to the owners of the business to use as they choose; to take for
themselves, to reinvest in the business or a mixture of the two. For
a government organisation or a not-for-profi t organisation such as
a charity the surplus is reinvested back in the activities to further
benefi t the people it serves.
Business structure
A business can take many forms ranging from a sole trader to a large
multinational company. The principal aim of “making a profi t for its
owners” is still the same. A person starting out and setting up a business
will take all the risk and reward as the venture gets under way. As the
business grows it can be advantageous to share the risk with others and
separate the business activities from those of the owner by establishing
a company.
A company is a legal entity in its own right that is separate from its
owners. An investor is risking only the money paid for buying some
shares in the company. If the company ceases trading, the shareholders
(owners) are not liable to make up any shortfall between the value of the
company’s assets and its liabilities.
There are fi ve broad categories of business:
 Sole trader. Someone who sets up a business alone and takes all
the risk and reward of running it, and who may employ staff.
 Partnership. Two or more people who set up a business together.
The partners have joint ownership and share the risk and reward
of running the business. Like a sole trader they may employ staff.
 Limited liability partnership (llp). A hybrid of a partnership
and company which provides the owners with the limited risk
of a company and the shared ownership and tax status of a
partnership.
 Private company. Usually a small organisation raising its money
from a few private investors. The shares may be diffi cult to trade
as they are not listed on any stockmarket. Investors’ liability in
private and public companies is limited to the amount of their
investment.
 Public company. Typically a large organisation that is usually
listed on a stock exchange. Because of its size it may require
signifi cant investment, and hence it may need to draw investment
from many investors.
In this book the focus will be mainly on companies, though the principles
can be equally well applied to a sole trader, a partnership and
indeed not-for-profi t organisations.
The role of the board
The directors of a company are people hired (and at times fi red) by the
shareholders to be stewards of their investment. However, they need to
balance this with their primary fi duciary duty as a director which is to
act in the best interests of the company. Collectively, a board of directors
has overall responsibility for running a company and setting and implementing
its strategy.
In fulfi lling the strategic aims of the company, the board will be
responsible for making sure not only that the company has the necessary
resources in terms of investment, assets and people, but also that there
are appropriate operating controls and procedures for managing business
risk and making sure that all monies that fl ow through the business are
properly accounted for.
What is a successful business?
The media love to report on successful entrepreneurs and tell of how they
beat the odds as they built their business and became household names.
The media also enjoy revelling in the collapse of mighty organisations
and unpicking the journey to their downfall. So what is it that defi nes
business success or failure?
Many descriptions are used to describe success, including “the business
is profi table”, “revenue is growing” and “share price is rising”. All these
attributes are elements of success though individually they do not embrace
the totality. To be successful in business is to “create a sustainable superior
return on investment”.
The core element of this defi nition is “return on investment” (roi).
The business, having been built from money provided by investors, has
a responsibility to reward those investors for risking their money in the
venture. The roi is a measure of the reward being generated. The concept
is similar to a savings account where an amount of money is placed on
deposit with a bank and the investor earns interest on it. The investment
in a savings account is seen as low risk and consequently the return that
the investor will make is similarly low.
ROI for a savings account 
Interest
%
Investment
Therefore, if a deposit of $1,000 is placed in a bank and the gross
interest earned over a year is $50, the roi can be expressed as being 5%.
For a business to be successful it needs to reward investors by making
them wealthier than they would be by putting their money in a savings
account. Why should they accept the greater risk of investing in a business,
with all the uncertainty it faces, if they are not going to be any better off?
The return that investors would require might be double or more than a
savings account depending on the perceived risk, which will be related to
factors such as the nature and maturity of the business.
The return in a business is derived from the profi t it generates compared
with the money invested to achieve that profi t.
ROI for a business 
Profi t
%
Investment
Therefore, if investors place $1,000 in a business and the operating
profi t over a year is $200, the roi can be expressed as being 20%. Some
examples of the returns achieved by companies in 2006 and stated in their
annual reports are bp (an oil company) 22.0% and Anglo American (an
international mining company) 32.4%. Topping these is Nokia (a Swedish
mobile phone manufacturer) that announced a return of 45.8%.
Generating a “superior” return is to achieve an roi that is greaterthan the rate achieved by businesses running similar activities in similar
markets, and so to be successful is to generate a return that is at least
as good as that achieved by your competitors, but ideally better than
them.
A “sustainable” superior return is perhaps the most diffi cult objective
to achieve. It means generating a superior rate of return year in, year
out. A business may be fl ying high when its products or services are
in fashion. But the fall can be swift when its products or services are
no longer in vogue and the business has gone from producing superior
returns to producing inferior ones. To be sustainable is to continuously
develop the business proposition in a way that keeps customers buying
the company’s products or services in preference to those of its competitors.
Innovation, technology and cost reduction are all activities that can
help maintain a sustainable return.
For example, the returns generated by Nokia result from a pre-eminence
in a growing market coupled with an ability to continue to introduce new
technology and ignite passion for the company’s latest products. If Nokia
fails to offer leading technology and its cost base rises, the superior returns
of today will be not be sustained.
On creating a superior roi the directors of a company have two
choices. They can either distribute the wealth to the investors or retain
it in the business. The second option depends on whether the directors
can identify further investment opportunities that will create even more
wealth in the future. In practice profi ts are retained in a company while
investment opportunities are identifi ed. However, this is only in the short
term as investors (particularly in public companies) will demand the cash
be “earning or returning”.
Wealth is created for investors in a business in one of two ways:
 annual income – a distribution of profi t to the investor (by way of
a dividend);
 capital growth – a reinvestment back in the business to increase its
value (share price).
Shareholder value
The phrase “shareholder value” is also used to describe success. Two defi -
nitions of shareholder value are:
 a concept that focuses strategic and operational decision-making
on steadily increasing a company’s value for shareholders;
 maximising shareholder benefi t by focusing on raising company
earnings and the share price.
These defi nitions focus more on increasing the value of a business in
the long term rather than delivering a profi t in the short term. An example
would be Amazon, one of the best-known online retailers, where the
strategy was to invest in building the distribution network and customer
base as the foundation of the business. Once customer numbers grew
the profi ts would emerge. Throughout its early years the company was
creating long-term value while making large losses. During this period
Amazon’s share price was volatile as it refl ected changing views on the
future benefi ts that would arise for investors.
For a mature business, an example would be its investment in research
and development to provide the products and revenue streams of the
future. This investment can create shareholder value because of the
potential it is judged to provide. However, the danger is that success is
built on a future promise, and in a fast-changing world the future is always
uncertain. For example, a company investing in new types of fi lms for
cameras only to fi nd that the world has gone digital would realise the
future less is bright than it had seemed. The same is true of a pharmaceutical
company that has taken years to develop a new drug that fails to
meet Food and Drug Administration (fda) regulatory requirements.
For a company that is quoted on a stockmarket, there is the expectation
to achieve a suffi cient roi every year while also investing to create future
value. Once the business has started to make profi ts, any performance
that is worse than the previous year is likely to meet with an adverse
reaction from analysts and investors, which in many instances leads to
a forced change of management. After many years of staggering losses
Amazon now makes a profi t, and in every year to come profi t expectations
will be greater. It has joined the ranks of other global companies
in a battle to produce the ever more superior results that stockmarket
investors look for.