establishing a small enterprise

8/8/2019 Establishing a Small Enterprise

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Establishing A Small Enterprise (Steps in setting up a Business

Venture)

STEP1; THE START UP PROCESS -

You are choosing one option out of SERVICE OR SELF EMPLOYMENT

Need is to assess SLEPT features of the country before starting a new venture. The main

components of such environment are as under:

(a) Priorities and policies of the Government with respect to Entrepreneurs

(b) Assistance and facilities offered by various states for starting a business

(c) Incentives for starting industry offered from State or Central Government

Above all Personal capabilities

STEP2: PROJECT IDENTIFICATION

Defined as process of identifying OPPORTUNITIES for new business ventures based on

different marketing models. SWOT, GE Model, Porters 5 forces Model etc.

It requires defining the objectives and characteristics of the selected project.

- Done through Environment Scanning also called as Strategic Planning Process

Every project has three dimensionsinputs, outputs and social costs and benefits. .

a) The input characteristics define what the project will consume in terms of raw materials, energy,

manpower, finance and organisational set up. The nature of these inputs is defined by objectives.

b) The output characteristics of a product define what the project will generate in the form of goods

and services, employment, revenue, etc. The quantity and quality of all these outputs should be

clearly specified.

c) In addition to inputs and outputs, every project has an impact on the society. It is, therefore,

necessary to judge the sacrifice which the society will be required to make and the benefits that will

accrue to the society from a given project.

Zeroing in Process:

It is a process to evaluate ideas to identify the most appropriate idea / opportunity. Following factors

should he considered while selecting the product to be manufactured:

(i) Market potential

(ii) Degree of competition

(iii) Availability of raw material and technology

(iv) Government policies and regulations concerning imports and exports, excise and sales tax,

Factories Act, foreign collaborations, etc.

(v) Licensing and registration requirements


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STEP3: SELECTION OF THE PRODUCT e.g. PAPER MILL

Idea Generation:

In order to select the most promising product, it is necessary to generate a few ideas about the

possible lines of business.

Generation of business ideas or opportunities is also known as opportunity scanning and

identification (OSI).

The business ideas may be generated from internal and external sources.

Internal sources of product ideas:

(a) Analysis of concepts in the light ofexisting problems and their solutions

(b) Brain storming of employees

(c) Personal interests and hobbies of the individuals

(d) Conceiving improvements in existing products

External Sources of product ideas:

(i) List of items reserved by the Government for exclusive production in the small sector (35 nos)

(ii) Items reserved for exclusive purchase form small scale industries under the Central Store

Purchase Programme of the Government

(iii) Professional journals, trade fairs, Trade Directories etc.

(iv) Government agencies like SIDO (Small Industries Development Organization), National Small

industries Corporation (NSIC), Chamber of Commerce etc.

(v) Market surveys or Interviews etc.

(vi) Technical and management consultants, trade associations.

(vii) Government store purchase programmes

STEP4: ASSESSMENT OF PROJECT FEASIBILITY

1. Technical Feasibility:

It implies the availability or otherwise ofplant and machinery and technical know-how required for

production. It consists of the following:

Identifying the technical specifications of the product to be manufactured. Finding out availability of necessary inputs e.g. raw materials, (both quantity and quality),

plant and machinery, technical skills, power and water, transport and communication

facilities, service facilities like machine shop and repair shop, etc.

If the technical knowhow to be obtained from outside (Foreign Countries) Exports,

arrangement is made should be specified in the project report.

Preparing an outline of the manufacturing process including flow process charts,

Testing of the product through:

(a) Standard specifications (ISI, ISO, BIS etc)

(b) In comparison to product models and prototype

(c) Product testing through third party laboratories and field study.


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2. Economic Viability: Involves:

(i) Identifying the market potential in terms of current demand for the product and potential future

demand = Demand & Supply .

Based on competition through both direct (from similar products) and in direct (from

substitutes).

(ii) Estimate potential sales volumes and profit volumes at different price levels;

3. Financial Feasibility:

It comprises the following aspects:

(a) Assessment of total financial requirements: It included

Nonrecurring expenses or fixed investment

Includes land and buildings, plant and machinery, furniture and fixtures, etc. The amount of

fixed capital will depend on the scale of operations, type of technology, tune of investment, etc.

While assessing the fixed capital requirements, the cost of assets, engineering and architectural

fees, installation and electrification charges, pre operation expenses of trial runs, etc. should be

taken into consideration.

Working capital or recurring expenses

Include raw materials, stock of finished goods, wages and salaries, etc. It will depend upon level

of operations.

(b) Determining sources and costs of funds. Once the total funds required are estimated, appropriate

sources need to be chosen to raise the required investment. Some sources of funds are:

Equity or Preference shares

Debentures

Term loans

Bank loans

(c) Analysing cash flow: After estimating the amount of funds required and their costs, the

anticipated flows of cash from the project are determined. For this purpose, a cash flow statement is

prepared. (Cash inflows and Cash outflows)

(d) Anticipating Return on Investment:

ROI IS CALCULATED AS=

Average earnings expected from the project over a specific period of time

Investment

4. Managerial Competence: (Matching the skills sets with Technology and Organizational Basic

Requirement s)A proper organisation structure is decided.

Then the skills and talents required to man the structure are determined.


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5. Implementation Scheme: PERT & GANT Chart

A schedule is prepared to ensure timely completion of the project.

Timely completion will help to avoid time and cost overruns.

Delays in project completion may jeopardise the financial viability of the project.

Difference between Gantt Charts & Pert Charts

Charts Project managers commonly use both Gantt and Program Evaluation and Review Technique (PERT), charts to display

tasks required for task scheduling and project completion.

A main difference between Gantt Charts and PERT charts is that Gantt is a bar chart, while PERT is a flow chart. They are

probably the best-known project management charts.

Time and Relationships

Gantt charts emphasize the time it takes to complete tasks, while PERT charts emphasizerelationshipsbetween tasks.

STEP5: MARKET SURVEY

Product selection is followed by market survey.

To anticipate the possible market for the product to measure returns.

Commonly used survey methods for anticipating the potential market for a product are as:

1. Opinion Polling Method-

In this method, the opinions of the ultimate users of the product i.e. the customers is estimated. It is

of two types:(a) Census Survey (Complete Enumeration Survey) - In this survey, all the probable customers

of the product are approached and their probable demand for the product is estimated and

then summed. It obtains the first hand and unbiased information. Not possible to approach a

large number of customers scattered all over the market.

(b) Sample Survey - Under this method, sample is taken out of their total population is

approached and data on their probable demand for the product during the forecast period are

collected and summed. Figures are then spread over the total population. No doubt, survey

method is less costly than the complete enumeration method.

(c) Vicarious Method- Under the vicarious method, the consumers of the product are not

approached directly but indirectly through some dealers who have a feel of their customers.

The dealers opinions about the customers opinions are elicited. Being based an dealers

opinions, the method is bound to suffer from the bias on the part of the dealers. Then, the

results derived are likely to be unrealistic

(d) Sales Representatives Experience Method- Under this method, executives from sales

department were questioned to judge the sales of new product. Based on their views, total

demand for the product is estimated.

2. Life Cycle Segmentation Analysis (PLC): It is well established that every product has its own life

span. in practice, a product sells slowly in the beginning. Backed by sales promotion strategies over

period, its sales pick up. in due course of time, the peak sale is reached. After that point, the sales

begin to decline. After some period, the product dies. This is, in fact, a case of natural death. Thus,

every product has its own life span. That is why firms go for new products one after another to keep

the firm alive.
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The product life span/cycle has been classified into five stages: (1) Introduction, (2) Growth, (3)

Maturity, (4) Saturation, and (5) Decline. The sales of the product varies from stage to stage and

follows S-shaped curve.

STEP6: INVESTMENT/RISK ANALYSIS

The basic objective of every investment is to maximise the profit. So, capital should be invested in

those opportunities which could give the maximum return on capital employed because SSI havelimited capital.

The study is called Economic Feasibility

Investment analysis is inversely proportional to risk analysis.

a) Ratio Analysis

Situation1

A ratio shows the arithmetical relationship between the two relevant figures i.e. 2:4 ratio is 50% or

1:2.

Situation2: Ratio against profits

E.g.: X Co. earned a profit of RS 50,000 and Y Co. earned a profit of RS 40,000, we conclude

that X Co. is more profitable.

Situation3: Ratio against profits in relation to capital employed.

X Co. earned profit of RS 50,000 against RS 500,000 employed as capital; and Y Co. earned RS

40.000 against RS 2,00,000 as capital employed, we can conclude that Y Co. is more profitable

since its net profit to capital employed is 20% as against 10% of X Co.

With the help of ratios, we can reach useful conclusions about the profitability of investments made

in tile enterprise.

Profitability ratios are calculated by relating profits either to sales or to investments. They areusually expressed in percentages.

Types of Profitability Ratios:

a) Return on Proprietors Fund or Net Worth This ratio expresses the ratio of net profit after

tax and interest to proprietors funds or net worth, As mentioned earlier, the major objective

of any business is to earn the maximum profits and this ratio indicates the extent to which

this objective is achieved. This ratio also suggests that whether the investment would be

worth making in terms of returns as compared to the risk involved in the business which

ultimately helps in taking business decisions for the future.

It is calculated as follows:

(Net Profit after Tax and Interest / Proprietors Funds or Net Worth)

b) Return on Capital Employed - This ratio indicates the earning power of the capital employed

in the business and points out to the owner the progress or deterioration in the earning

capacity of the business. It is of great significance to the shareholders or the owners as it

shows the ratio of profit earned on invested capital.

For example, if an enterprise has Rs. 5 lakhs as equity capital and Rs. 3 lakhs as loan, its total

capital employed will be Rs. 8 lakhs (Rs. 5 lakhs + Rs. 3 lakhs). Now, suppose the enterprise

earns a profit of Rs. 80,000 in a year before interest and taxation, then Rate of Return on

Investment i.e. capital employed will be 10%.


(Net Profit before Interest and Tax / Capital Employed) x 100


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Thus, the ratio of capital employed indicates how the management has made use of the funds

supplied by the both-owners and creditors. Obviously higher the ratio, the more efficient use

of the funds the enterprise is making and vice-versa. After comparing the ratios of the similar

business and, industry, the enterprise comes to know the relative operating efficiency of the

business which helps take investment decisions accordingly.

c) Return on Total Investments - It is the ratio of net profit to total investment. This ratio

indicates the overall profitability of the enterprise.


(Net Profit after Interest and Tax / Total Assets) x 100

b) Capital Budgeting

Capital budgeting involves investment decision related tobalancing the sources and uses of funds for

acquiring fixed capital assets like machinery and equipments.

a) Payback or Payout Period: How long the investor has to wait before the invested capital is

recovered. The cash flow starts coming and accumulating. After a certain period of time the

accumulated cash inflows become equal to the original investment made. At that point of

time the payback occurs and the time it has taken for recovery is called the Payback or

Payout Period.

It is seen from the Table that cash inflow started from the second year. At the beginning of

the fifth year, the balance of initial investment to cover was Rs. 50,000 but the total inflow

was Rs. 75,000 during the fifth year. Assuming that the inflow of Rs. 75,000 was uniformly

spread over 12 months, the recovery period for Rs. 50,000 will be: (12 x 50,000) / 75000 = 4

years 8 Months.

This method involves CHOSSING THE PROJECT THAT REPAYS INITIALINVESTMENT in the SHORTEST PERIOD OF TIME.

b) Average Rate of Return: In simple words, average rate of return (ARR) is just the reverse of

the payback method. While payback method is based on cash flow, average rate of return is

based upon the principles of accounting.


(Average Net Income after Tax / Average Investment over the life of the project) x 100

Drawback: Both the methods ignore time value of money. The value of RS 1,000 today may be less

after ten years. But, these methods ignore this fact.

STEP6: BREAK -EVEN ANALYSIS


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It is stage where income exactly equals expenses.

It is an analysis of production point at which profit starts. This point is where income and expenses

are exactly equal and the point is called break-even point. Thus, break-even analysis is used to find

the break-even point.

Expenses to be incurred refer to cost. Cost is broadly divided into two types viz. (1) Fixed cost, and

(2) Variable cost. What are these costs?

Fixed Cost: Fixed costs are defined as those that do not change with increase or decrease inproduction. No matter what the production is the fixed cost remains the same. Examples of fixed

costs could be the monthly rent paid for the factory, interest on long term loan, administrative

expenses, etc., Even if there is zero production, the fixed cost will remain unchanged.

Variable Cost: defined as expenses that change with the volume of production. It varies

proportionately with changes in production. Thus, if production is zero, variable cost would be zero.

The absolute total variable cost increases or decreases along with increase or decrease in production.

But the variable cost per unit is constant at any level of production.

There are some variable costs that do not vary proportionately with the change in production. In fact,

these vary in varying degrees. As a result such costs are called semi-variable. The popular examples

of such costs could be telephone, electricity and gas charges if they are billed on a usage basis. Insuch cases that proportion of expenses which continue even if production falls are considered as

fixed and expenses which increase or decrease as production increases or decreases are considered as

variable cost.

After knowing sales and total cost in terms of fixed cost and variable cost, now the breakeven point

can be calculated. According to the simplest method, Profit is the excess of sales over cost, i.e.

Sales-Cost = Profit.

The calculation of break-even point involves four- steps. These are:

Segregation of fixed and variable costs

Percentage of variable costs to sales

Calculate the contribution or margin, i.e., the difference between 100 and the percentage of

variable cost to sales as worked out above.

Divide the fixed cost by the percentage of contribution or margin as worked out above.

Thus, the calculated figure will be break-even point.

NOTE: Break-even point can be calculated in terms of units also.

Fixed Cost

Selling Price Per Unit Variable Cost Per Unit

Break Even Chart


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STEP7: SELECTION OF SITE (LOCATION)

Some of factors to be considered while choosing site are given below:

(i) Nearness to the source of raw materials

(ii) Nearness to the market

(iii) Availability of land at cheap rates

(iv) Availability of skilled labour

(v) Cost of labour (Prevailing wage rates) in the area

(vi) Availability of transport and communication facilities

(vii) Availability of power, water, waste disposal and other essential services

(viii) Incentives and concessions available in different States

(ix) General business climate in the region(x) Climate and environmental factors

(xi) Availability of factory sheds in industrial estates.

STEP8: LEGAL CONSIDERATIONS

Setting up of a small scale industrial unit involves some legal formalities. These legal formalities are

discussed below:

Registration With Director of Industries: Registration of a small scale industry is not compulsory.

However, registration with the State Directorate of Industries or District Industries Centre helps in

getting assistance from the Government.

The registration of small scale units is done in two stages viz (a) provisional registration, and (b)

permanent registration.

Normally, a provisional registration is made before the unit is set up and a permanent registration is

given when the unit goes into production

Provisional Registration:

Provisional registration is possible even when one is planning to set up the unit. The issue of a

provisional certificate is automatic and given within a week unless the proposed industry is one

which needs raw materials which Government has declared nonavailable to new units because of

their scarcity.

The provisional registration is valid for one year in the first instance.


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It may be reviewed for a further period of two years in four 6 monthly extensions on submission of

satisfactory proof that the entrepreneur has taken active steps to establish the new unit and needs

more time. Application for extension should be made within time, otherwise registration

automatically lapses.

The application for registration of a small scale unit should he submitted to the General Manager,

District industries Centre located in the district where the unit is to be set up.

Municipal License: The next step is to obtain the municipal license. For example in Delhi it is

necessary to obtain from the Municipal Corporation of Delhi (M.C.D.).

Registration with Central and State Sales Tax Department would also be necessary for which the

concerned department will have to be contacted.

Permanent Registration:

Provisional registration is meant to enable the entrepreneur to take the necessary steps to bring the

unit into existence.

When the entrepreneur has taken all steps to establish the unit i.e. the factory building is ready,

power connection is obtained, the machinery and pollution control equipments have been installed,and license from municipal corporations and other local authority is obtained, one can apply for

permanent registration.

Cancellation of Registration: Registration of a small scale unit can be cancelled (after a show cause

notice) on the following grounds:

(a) The unit remains closed continuously for more than one year

(b) The unit fails/refuses/avoids to give full and true information required by the registering

authority from time to time;

(c) The unit has misutilized the raw materials allocated to it

Registration With DGS&D/NSIC: A small scale unit can get itself registered with Director Generalof Supplies and Disposal (DGS&D) or National Small Industries Corporation (NSIC) if it wants to

avail of the benefit of purchases made for Government offices.

STEP9: BASIC STARTUP PROBLEMS

(i) Selection of the Industry: Once a person has decided to start his own business, the first major

problem is to select the line of business. This problem can be solved by analysing:

Persons aptitudes,

Propensity to take risk,

Skills and experience, Family background,

Financial position,

Government policy and incentives,

Infrastructural facilities,

Advice of consultants, etc.

(ii) Product Selection: Another start up problem is the choice of the particular product to be

manufactured. This can be decided through a comparative analysis of a few product items with

special reference to:

Size and structure of the market


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Future demand pattern

Competitve position

Life ciycle of the product

Availability of raw materials

Technical aspects of production

Availability of required labour

Government policy and controls

(iii) Choice of Factory Site:

(iv) Form of Organisation:

(v) Problem of Construction: Construction of factory building involves several problems e.g.

Acquisition of land in the chosen locality

Architechtural design of the building

Appointment of engineers and contractors Civil work like obtaining power and water connection

Supervision of construction work.

Acquisition and installation of machinery and equipment.

(vi) Supply of Raw Materials:

Agreement need to be made with the concerned suppliers

(vii) Financing the Unit:

Estimate both fixed capital and working capital.

Identify the sources.

Liason with them.

(viii) Recruitment and Training of Staff:

Identify and design organizational structure.

Iodentify the skills sets needed at each level

Find the quantity of staff.

Recruit and train them.

(ix) Marketing:

Hire consultancies

Conduct proper research.

Identify STP and other related marketing strategies.

Develop a new product.

(x) Gestation Period: Great care and efforts are required to successfullly overcome the problems and

risks during the gestation period (time period before copmany start earning profits).

Effective control over expenses, time and cost overruns, sales pattern, etc. is necessary to ensure that

the unit survives the initial expenses and losses.


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STEP10: PREPARATION OF PROJECT REPORT

A project report or feasibility report is a written document pertaining to any investment

proposal.

A feasibility report enables the entrepreneur to know the inputs required and whether he is

proceeding in the right direction.

Act as readymade document for financial institutions and stake holders.

Other organisations which provide work sheds, raw materials, machinery, etc. also insist on

this report to judge the soundness of the project.

PROJECT REPORT CONSISTS OF:

1. General Information

Industry profile (Past and Present scenario)

Allocation or investment of funds

Choice of technique, etc.

2. Preliminary Analysis of Alternatives

Information related to demand and supply for the outputs which are to be produced,

Production Capacity

Competitors information - capacity and level of production actually attained,

A list of all projects for which LOI / licenses have been issued and a list of proposed

projects.

All options that are TECHNICAL FEASIBILITY should be considered at thispreliminary stage along with their PROFITABILTY.

The rate of return on investment should be calculated and presented in the report.

3. Project Description

Technology / process chosen for the project.

Site selection

Effect on environment i.e., population, water, air, land, flora and fauna, effects arising out

of project pollution, other environmental descriptions, etc.

List of the operational requirements of the plant, requirements of water and power,

requirements of personnel, organisational structure envisaged, transport costs, activity-wise

phasing of construction and factors affecting it.

List of Softwares

4. Marketing Plan

The methods and data used for making estimates of domestic supply and selection of the

market areas should be presented.

Impact of Price on Demand must be presented.

It should contain an analysis of past trends in prices.

5. Operating Requirements and Costs


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Incurred after the commencement of commercial production.

Operating costs relate to the cost of raw materials and intermediates, fuel, utilities,

labour, repair and maintenance, setting expenses and other expenses.

6. Financial Analysis

A Performa Balance Sheet for the project data should be presented

Methods of accounting.

The feasibility report should take into account income-tax rebates for priority industries,

incentives for backward areas, accelerated depreciation, etc.

7. Economic Analysis

Impact of enterprise on employment generation for nation.

The enterprise should try to assess the impact of its operations on foreign trade.

Indirect costs and benefits should also be included in the report. If they cannot be quantified

they should be analysed and their importance emphasised.

Performa for Project Report

Project Profile for Manufacturing Unit...

A. PRODUCT DESCRIPTION

B. PRODUCTION AND GENERAL EVALUATION OF PROSPECTS:

C. MARKET ASPECTS

1. Users:

2. Sales Channels & Methods:

3. Geographical Extent of Market:

4. Competitive Situation:

a) Domestic Market

b) Export Market

5. Market needed for plant described:

D. PRODUCTION REQUIREMENTS

1. Annual Capacity (One / Two / Three shift operation)

2. Capital Requirements

Land & Buildings on rent (Mention value, if owned)

Equipment, furniture and fittings

Working capital

3. Total capital which the entrepreneur would need for the whole project provided he uses

agencies planned by the Government for financial accommodation as discussed in the book

Own

Borrowings

4. Expected net profit per annum

E. CAPITAL REQUIREMENTS


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I. Fixed assets & working capital

(a) Land (...sq. metres) and Building (...sq. meters) on rent at RS..... per annum

(b) Equipments:

Production Equipment

Other Tools & Equipment

Furniture & Fitting

(c) Working Capital

This would be calculated keeping in view the periods in which capital on an average

in various forms, i.e., manufactured goods, semi-manufactured goods, raw materials,

etc., would remain locked up. Often you may calculate it at 3 months requirement

level, unless the situation (line of industry) warrants otherwise]

________

Total ________

II. Raw Material & Allied Supplies (Annual)

Description Qty Rate Annual

(Rs.) Requirements

1.

2.

3.

4.

5. Power, Fuel & Water

6. Maintenance & Allied Supplies

7. Other Supplies __________

TOTAL __________

III. Manpower (Annual)

Description Number Rate Annual

(Rs.) / month Cost (Rs)

1. Manager

2. Foreman

3. Supervisors

4. Skilled Workers

Semi-skilled Workers

Unskilled Workers

5. Office Staff

6. Others

_________

TOTAL

_________


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IV. Other Costs (Annual)

(a) Depreciation on equipment, furniture & fittings @ Annul Cost RS.

(b) Interest on capital (fixed and working) @..... per annum, on average.

(c) Administrative costs

(d) Sales cost (Including Sales Commission, Advertisement, etc)

(f) Training costs_________

TOTAL

_________

F. TOTAL ANNUAL COSTS. SALES REVENUE AND NET PROFITS

(a) Annual Costs

(i) Rent for Land & Buildings

(ii) Raw Materials & Allied Supplies

(iii) Manpower

(iv) Other Costs

_________

TOTAL

_________

(b) Annual Sales Revenue

(c) Expected Annual Net Profit (b-a) say

(d) % Profit on Own Capital

(e) % Profit on Total Annual Sales Turnover

(f) % on Total Investment

ONCE YOU ARE DONE WITH ABOVE STEPS, THEN YOU NEED TO UNDERTAKE

THE ACTIVITIES FOR IMPLMENTATION

The main steps involved in the establishment of a small business venture are as follows:

Selection of the product

Location of the enterprise Choice of form of ownership

Registration with the authorities

Arranging term finance

Licenses and clearances

Acquiring land and building

Arranging Working capital

Recruitment of staff Installation of machinery

Procuring raw materials


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Power connection and water supply

Starting production

Marketing the product

Preparation of the project report

establishing a small enterprise

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