Accounting: The Language of Business (Part 3)

Don't ever let your business get ahead of the financial side of your business. Accounting, accounting, accounting. Know your numbers.

Tilman J. Fertitta

Introduction to Accounting and Business

(Part C)

by

Charles Lamson

Value Chain of a Business

Once a business has chosen between low cost, differentiation, or combination strategy (from last post), it must implement the strategy in its value chain. A value chain is the way a business adds value for its customers by processing inputs into a product or service as shown in Exhibit 2.

EXHIBIT 2 The Value Chain

To illustrate, Delta Air Lines' value chain consists of taking inputs, such as people, aircraft, and equipment, and processing these inputs into a service of transporting goods and passengers throughout the world. The extent to which customers value Delta's passenger service is reflected by the airfares Delta is able to charge as well as passenger load factors (percentage of seats occupied). For example, the extent to which Delta can, on average, charge higher fares than discount airlines, such as AirTran, implies that passengers value Delta's services more than AirTran's. These services may include newer, more comfortable aircraft, the ability to earn frequent flyer miles, more convenient passenger schedules, passenger lounges for frequent flyers, and international connections.

A business's value chain can be divided into primary and supporting processes. primary processes are those that are directly involved in creating value for customers. Examples of primary processes include manufacturing, selling, and customer service. supporting processes are those that facilitate the primary processes. Examples of support processes include purchasing and personnel. For Delta Airlines, primary processes would include purchasing and personnel. For Delta Airlines, primary processes would include aircraft maintenance, baggage handling, picketing, and flight operations. Secondary processes for Delta Airlines would include the accounting and finance functions, contracting for fuel deliveries, and investor relations.

Business Stakeholders

A business stakeholder is a person or entity having an interest in the economic performance of the business. These stakeholders normally include the owners, managers, employees, customers, creditors, and the government.

The owners who have invested resources in the business clearly have an interest in how well the business performs. To the extent that the business is profitable, owners will expect to share in the business profits. Since owners may eventually decide to sell their business, they also have an interest in the total economic worth of the business. This economic worth may reflect results of past profits as well as prospects for future profits.

The managers are those individuals who the owners have authorized to operate the business. Managers are primarily evaluated on the economic performance of the business. The managers of poor performing businesses are often fired by the owners. Thus, managers have an incentive to maximize the economic value of the business. Owners may offer managers salary contracts that are tied directly to how well the business performs. For example, a manager might receive a percent of the profits or a percent of the increase in profits. Such contracts are often referred to as profit-sharing plans.

The employees provide services to the business in exchange for a paycheck. The employees have an interest in the economic performance of the business because their jobs depend upon it. During business downturns, it is not unusual for a business to lay off workers for extended periods of time. Whenever a business fails, the employees will lose their jobs permanently. Employee labor unions often use the good economic performance of a business to argue for wage increases. In contrast, businesses often cite poor economic performance as a reason for decreasing wages or denying wage raises.

The customers may also have an interest in the continued success of a business. For example, if Apple Computer were to fail, customers might not be able to get hardware and software for their computers. Likewise customers who purchase advance tickets on Southwest Airlines have an interest in whether Southwest will continue in business. Frequent flyers on Eastern Airlines lost their accumulated frequent flyer points when Eastern went out of business.

Like the owners, the creditors invest resources in the business by extending credit, such as a loan. They, too, have an interest in how well the business performs. In order for the creditors to recover their investment, the business must generate enough cash to pay them back. In addition, creditors view the business as their customer and thus have a stake in the continued success of the business.

Various governments have an interest in the economic performance of businesses. City, county, state, and federal governments collect taxes from businesses within their jurisdictions. The better a business does, the more taxes the government can collect. In addition, workers are taxed on their wages. In contrast, workers who are laid off and are unemployed can file claims for unemployment compensation, which results in a financial burden for the government. City and state governments often provide incentives for businesses to locate in their jurisdictions. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, PP. 6-7*

end