Chapter three

BUSINESS FORMATION
CHAPTER THREE

Concept of Small Business Development
A business formation deals with the formalization and actual
implementation of business ideas in to practice.
business formation deals with the actual implementation of
business ideas in to practice.
Specifying size and standard to define small business is
necessarily arbitrary, because people adopt different
standards for different purposes.
Based on socio-economic conditions, countries define small
business differently.

But all may use size and economic criteria as a base
to define small business.
There are two approaches to define small business.
They are:
Size Criteria and
Economic/control criteria.

SizeCriteria
Some of the criteria used to measure size are:
number of employees
volume of sales
asset size and volume of deposits
total capital investment
Volume of production
a combination of the stated factors.

The following general criteria for defining a small
business are suggested by Small Business
Administration (SBA).
 Financing of the business is supplied by one
individual or a small group. Only in a rare
case would the business have more than 15 or 20
owners.
 Except for its marketing function, the firm’s
operations are geographically localized.
 Compared to the biggest firms in the industry,
the business is small.
 The number of employees in the business is
usually fewer than 100

Economiccontrol Criteria
 Size does not always reflect the true nature of an enterprise.
In addition, qualitative characteristics may be used to
differentiate small business fromother business.
 The economic/control definition covers:
Market Share
Independence
Technology
Personalized Management
Geographical Area of Operation

Forms of Business
There are three basic legal forms of business formation
with some variations available depending on the
entrepreneurs’ needs.
The three basic legal forms are:-
1) Proprietorship
2) Partnership and
3) Corporation.

9
No Legal Forms of
Business
Description
1 Proprietorship Form of business with
single owner who has
unlimited liability,
controls all decisions, and
receives all profits.
2 Partnership Two or more individuals
having unlimited liability
who have pooled
resources to own a
business.
3 Corporation Separate legal entity that
is run by stockholders
having limited liability.

 These basic legal forms of business formation
are compared with regard to
 Ownership
 Liability of owners
 Costs of starting business
 Business continuity
 Transferability of interest
 Capital requirements
 Management control
 Distribution of profits

Definition of MSEs
Small businesses are playing an important role in the
industrial economy of the world. These are
particularly important in the developing economies.
Small businesses could be entrepreneurial ventures.
Most entrepreneurial ventures start as a small
business.
An entrepreneurial venture is a growth-oriented
innovative company with product or service offerings
that are new to the market.

Importance of MSEs
Some of the contributions are
Large Employment Opportunities
Economical Use of Capital
Balanced Regional Development
Equitable Distribution of Wealth and
Decentralizationof Economic Power
Aiding Large-scale industries
Dispersal over Wide Areas
Higher Standard of Living

Classification of Micro and Small Enterprises
In Case of Manufacturing Enterprise
(Manufacturing, ConstructionandMining)
a) A Micro Enterprise is one in which the
investment in plant and machinery (total
asset) does not exceed birr 100, 000 and
operates with 5 people including the owner.
b) Small Enterprises is one in which the
investment in plant and machinery (a paid up
capital of total asset) of birr 100, 000 and not
more than Birr 1.5 million; and operates
with 6-30 persons.

In Caseof ServiceEnterprise
(Retailing,Transport,Hotel&Tourism,ICTandMaintenance)
a) A micro enterprise is one with the values of
total asset is not exceeding Birr 50,000
and operates with 5 persons including
the owner of the enterprise.
b) Small Enterprises is one in which the total
asset value or a paid up capital of birr 100,
000 and not more than Birr 1.5 million; and
operates with 6-30 persons.

Classification of Micro and Small Enterprises
Summary

Priority Sectors and Sub-Sectors for MSEs in Ethiopia
1) Manufacturing Sector is the one which contains
textile and garment; leather and leather products;
food processing& beverage; metal works and
furniture.
2) Construction Sectors: includes sub-contracting;
building materials; traditional mining works and
cobble stone.
3) Trade Sectors: which contains whole sale of
domestic products; retail sale of domestic products
and raw materials supply.

4. Service Sectors- like: small and rural transport
service; café and restaurants; store service; tourism
service; management service; municipality service;
maintenance service; beauty salon and decoration and
internet café.
5. Agriculture Sector: includes modern livestock
raring; bee production; poultry, modern forest
development; vegetables and fruits; modern irrigation
and animal food processing.

Levels of MSEs in Ethiopia
Start-up: It is a level where an enterprise begins
production and service under a legal entity.
Growth Level: At this level, the enterprise man
power and total asset is larger than at startup
level and use book keeping system.
Maturity Level: when an enterprise able to be
profitable and invest further by fulfilling the
definition given to the sector and using the support
provided.
Growth-Medium Level: An enterprise is said to be
transformed from small to medium level is
called GML

Setting up Small Scale Business
The entrepreneurial process of launching a new
venture can be divided into three key stages of:
Discovery: identify opportunities
Evaluation: analyze and select the opportunities
Implementation: developing the business or
enterprise

Small Business Failure
The causes of business failure are many and complex;
however, the most common causes are inadequate
management and financing.
Other common causes of business failure include
 Neglect occurs whenever an owner does not pay a due
attention to the enterprise.
 Fraud: using business books for personal consumption, the
business might find itself bankrupt before too long.
 Disaster refers to some unforeseen happening like fire

Small Business Success Factors
By understanding why business fail, entrepreneurs can
discover ways to tilt the scales towards success.
These success factors are categorizedas:
Conducive Environment: (Political, economic, technological
and socio-cultural factors)
Adequate Credit Assistance: (Adequate and timely supply
of credit)
 Markets and Marketing Support

Problems of Small Scale Business in Ethiopia
 Lack of adequate finance and credit has always been a
major problem of the Ethiopian small business.
 Small scale enterprises find it difficult to get raw materials
of good quality at reasonable prices in the field of
production.
 Small business’s owner is failures on knowing the business
in depth, developing a solid business plan, managing
financial resources, understanding financial statements and
learning to manage people effectively.

Chapter three

More Related Content

Similar to Chapter three (20)

More from teza bekele (20)

Recently uploaded (20)

Chapter three