Size of Business Unit: Definition, Measures, Factors, Concepts, Optimum Size of Business

Size of BusinessThe size of a business unit means the size of a business firm.

It means the scale or volume of operation turned out by a single firm. The study of the size of a business is important because it significantly affects the efficiency and profitability of the firm.

One of the most important entrepreneurial decisions in organizing a business is realizing its ‘size’ as it affects in company and profitability of business enterprises.

The term ‘size of business’ refers to the scale of organization and operations of a business enterprise. It is essential here to have a clear understanding of the terms ‘size’ of the ‘plant’ size of ‘firm’ and size of industry’.

A ‘plant’ means an establishment of the manufacturing of goods. It represents a production unit where the due provision of all the activities facilitating the production process as made.

A ‘firm’ means as an organization that owns, manages and controls a plant or number of plants and also arranges for the marketing of products, provision of finance and other facilities to run the organization.

The term industry’ implies the aggregate of all firm which manufacture similar types of products.

Measures of Size

Business firms vary in size-small, medium and large. To measure the size of a business unit, the standards of measurement can be grouped into the following two categories.

  1. Measures About Input

This includes capital employed, net worth, total assets, labor employed and raw material and power consumed.

  1. Capital employed

The capital includes owned capital and borrowed capital. The larger the amount of capital employed, the larger the size of the firm.

  1. Net worth

Net worth is the excess of assets over liabilities as shown in the balance sheet of a firm.

However, for all practical purposes, it refers to the amount of paid-up capital plays reserves and surpluses built up during business.

This measure is appropriate for comparing the size of different firms in an industry or to measure the rate of growth for a particular firm.

  1. Total assets

Another measure of size if the size of the total assets of a firm.

The value of total assets is calculated by taking into account the amount invested in fixed (land, building, plant, and machinery), current (cash, short-term securities, stock, debtors, etc.) and intangible assets (goodwill, planet, rights, etc).

  1. Labor employed

The number of laborers employed in a firm is another measure commonly employed to measure the size of the business which is producing similar types of goods and which are in the same stage of development.

  1. Amount of raw materials and power consumed

The quantity or value of raw materials and power used is yet another measure that can be used to adjudge a firm.

  1. Measure About Output

This includes a volume of output, the value of output and value-added.

  1. The volume of Output

The number of goods produced or services rendered may also serve as a good basis for comparison between firms. The greater the number of goods and services produced the larger the size.

  1. Value of Output

The monetary value of goods and services produced by a firm also serves as a basis for measuring the size of a firm.

  1. Value Added

A useful variation or combination of the two output criteria is the measure of net value-added, calculated by deducting the costs of production from the value of production.

It must be mentioned here that no one measure is fully comprehensive and the accuracy, adequacy, and utility of each standard will depend upon three factors – nature of industry and character of its output, the uniformity and accuracy of data available and the purpose for which it is required.

On the whole, the output seems to be the best indicator to measure the size of the firm.

Factors Affecting the Size of the Firm

The main factors that affect the size of the firm are as follows:

  1. Nature of Industry

The nature of the industry has a direct influence on the size of the firm. Manufacturing industries are by and large, bigger compared to trading and service firms.

Manufacturing industries heavy machinery, produce goods on large scale, make higher capital investments and therefore large.

  1. Nature of Products

When the product is less standardized, the size of the firm is often small when the product is standardized, complex and durable; the size of the firm is often big.

  1. Capital employed

When the capital involved is large and the firm can raise it, the size of the firm is large. When the capital involved in small, the size of such a unit will be small.

  1. Size of the market

If the size of the market is large for the product the firm will also be large and vice-versa.

  1. Quality of management

The competence and integrity of management largely determine the size of a business unit. If the management is competent to manage the complex tasks of modern business, the firm can afford to be large.

Factors Determining Size of the Firm

Every business is striving towards attaining the optimum size.

Usually, any business starts as a small entity, and then during its operating period, it expands till it reaches the optimum size.

  1. Capital Investment Factor

The capital employed by shareholders in the form of share capital, reserves, and surplus (net worth) determines the size of the business. It is mainly used to compare two firms or more that are producing similar or differentiated products.

  1. Number of Employees

The number of employees employed by any business determines its size. This is done by comparing the wages paid to employees with other businesses.

This factor is used where firms produce similar goods. If you use it in comparing firms that are producing differentiated products, then you end up with false results.

  1. Power Used

The amount of power used determines the size of the business. Business firms don’t rely on this factor as it is inaccurate because of the amount of power used by any business may be more or less.

  1. Raw Materials Used

The annual consumption of raw materials of any firm determines its size. It used only on those firms that are producing similar products.

  1. The volume of the Output

This factor is used for those firms that are producing homogeneous goods.

  1. The capacity of Plant

It is used by firms that produce similar products.

  1. Total Assets

The total assets of any business determine its size. The value of all assets (current and fixed) is taken as a means of measure. It is used in both similar and differentiated firms.

  1. Value of Output

This is another factor that determines the size of any firm; however, this method is only effective in cases where firms produce a variety of products and where price levels remain constant.

In all these factors, the volume of output is the most effective and reliable factor in measuring the size of any business unit.

The Optimum Size of Business

From an economic point of view, every business organization should expand as long as its average per-unit cost is just equal to that of its marginal cost.

In simple words, when the factors of production-land, labor, capital, and organization can affect maximum returns at their minimum involvement, the economics consider that as the best, and the most desired size of business.

A firm with this-sat and volume of operation may ensure minimum unit cost but a maximum return is known as the optimum firm.

“By the optimum firm,” says E.A.G. Robinson, “we must mean that firm which, in exiting conditions of techniques and organizing ability has the lowest average cost of production per unit, when all those costs which must be covered in the long run are included.”

The implications of this definition are as follows;

  1. The point to be considered is the average cost of production and not-profits. The average cost means the total cost divided by the total output. Total cost includes all costs including depreciation, interest and a reasonable margin of profit.
  2. Optimum size is a moving point and depends upon technological and managerial developments. Thus the optimum size is a relative and dynamic concept and static. That is why the optimum size of firms will vary in different industries where different technical, marketing and financial conditions are encountered.

The concept of the optimum firm is represented in the following graph:

Optimum Size of Business

The size’ is measured along the “X” axis and the average cost per unit along the axis. The cost per unit falls as output increases until at point “p” it begins to rise again. This point represents the optimum size.

The Rationale of the Concept of Optimum Size

A firm of optimum size is brought into existence partly by the conscious decisions of a businessman who are considering how they can invest their resources profitably and partly by the forces of competition which tend to eliminate the inefficient and encourage the efficient.

The optimum size, can, however, be achieved only.

  1. If the size of the market is sufficient to absorb the whole production of at least one firm of such a size and
  2. If product competition prevails in the market so that prices charged by the firms tend to be equalized.

The state of perfect competition is hardly encountered in practice and hence the concept of optimum size is generally considered to be of least practice relevance.

However, it is not without practical utility. It motivates the businessmen to bring down the cost of production to the maximum possible extent through the use of better techniques of production and better management methods.

The concept of an optimum firm represents a simple analysis of the problem of determining an efficient size for a firm and the factors which should be taken into account while deciding upon a desirable scale of operations in the process of growth.