Business Whats It All About Purpose of a

Business: What’s It All About?

Purpose of a Business n For profit n Not-for-profit

Purpose of a Business

Simple Model of a Business “The Firm” INPUTS Value added conversion OUTPUTS Acquisition/Payment Process Sales/Collection Process Capital, Financing Property, Plant, Equipment Raw Materials Labour Inventory Goods & Services Product or Service

Nature of Business Operations v Service business n Provides services for consumers. v Merchandising business n Wholesale company--buys goods, adds value, and sells them to other companies. n Retail company--buys goods, adds value, and sells them to customers who consume them.

Nature of Business Operations n Manufacturing n Makes the products it sells n Financial Service n Deal in services related to money

What Do All Business have in Common? n All businesses have the same goal: to add value or provide value to customers/clients. n Typically they have three processes: p Acquiring goods p Conversion p Selling the goods or services

The three processes in common n ACQUISITION/PAYMENT: acquiring goods and services and paying for them. n CONVERSION: the firm then does something to add value by taking inputs and converting them into outputs. n SALES/COLLECTION: selling goods and services and collecting payment for them.

The Process of Starting a Business n Owners investment (Capital) n Obtain additional financing if necessary n Purchase necessary assets n Add Value (Conversion) n Sales (generate revenue) n Collect money n Repay any financing

Business Activities n Business transactions are exchanges. n Who “gets” what and who “gives” what in return are separate transactions. n The exchange occurs between the business entity and usually an outside agent. n The business gives something and then gets something in return.

Resources, Events, and Agents n Every business transaction is made up of three components: n n n Resources are things of economic value exchanged. Events are the actual giving and getting of the resources. Agents are the people who actually make the exchange.

Exhibit 1 -9 Steps and Documents in the Acquisition/Payment Process

Exhibit 1 -10 Steps and Documents in the Sales/Collection Process

Who needs information about transactions? Management B) Regulatory agencies C) Canada Customs and Revenue Agency D) Creditors E) Potential investors F) Vendors (current and potential) G) Customers H) Employees A)

The Accounting Equation Assets = Claims Assets = Liabilities + Owner’s Equity Asset: economic resources owned by the business. n Liability: obligations of the business to creditors. n Equity: owner’s claims to the assets. n

Four Basic Financial Statements n Balance Sheet Assets = Liabilities + Equity n Income Statement Revenues - Expenses = Net income n Statement of Retained Earnings Beginning RE + Net income - Dividends = Ending RE n Cash Flow Statement Cash inflow - Cash outflow = Net cash flow

Traditional Approaches: User-View Orientation n When data-modeling and IS design is too oriented toward the user’s views, problems arise: n n multiple information systems duplication of data restricted user-view leads to poor decision-making inability to support change

Traditional Approaches: Financial Accounting Orientation n Dominance of traditional accounting as the primary information provider leads to problems: n single view of business entity using the accounting/balance sheet model: Assets = Liabilities + Owners’ Equity n n double-entry, debits and credits high level of aggregation ignoring non-financial data inability to serve diverse enterprise-wide needs

The REA Approach to Business Modeling

Resources, Events, and Agents (REA) Model n Developed in the ‘ 70's by Dr. Bill Mc. Carthy of Michigan State University n The definition of events is broad enough to encompass both operational and accounting transactions. n Expands the scope and usefulness of AIS by making it capable of providing both financial and nonfinancial information. n Data for each event is stored in disaggregated form. n Outputs are subsequently produced by assembling the required data from the various records. n Many firms have not adopted the REA model since it is a major change from the traditional double-entry approach. n The REA or events perspective is increasingly seen as necessary to meet changing information needs.

Resources, Events, and Agents (REA) Model … n An approach to database design meant to overcome problems with traditional approaches: n n n n formalized data modeling and design of IS use of centralized database use of relational database structure collects detailed financial and non-financial data supports accounting and non-accounting analysis supports multiple user views supports enterprise-wide planning

Resources, Events, and Agents (REA) Model … n The REA model is an alternative accounting framework for modeling an organization’s n economic resources economic events economic agents, and n their interrelationships n n n A variation of entity-relationship diagramming (ERD) is used to model these relationships.

Resources in the REA Model n Economic resources are the assets of the company. n n n able to generate revenue objects that are scarce and under the control of the organization can be tangible or intangible n Does not include some traditional accounting assets: n n for example, Accounts Receivables artifacts that can be generated from other primary data

Events in the REA Model n Economic events are phenomena that effect changes in resources. n a source of detailed data in the REA approach to databases n Three classes of events: n n n operating events--what happens information events--what is recorded decision/management events--what is done as a result n Only operating events are included in the REA model.

Agents in the REA Model n Can be individuals or departments n Can participate in events n Can affect resources n have discretionary power to use or dispose of resources n Can be inside or outside the organization n n clerks production workers customers suppliers, vendors departments, teams

Resources, Events, and Agents (REA) Model … n A variation of the entity-relationship diagramming (ERD) is used in REA modeling. n Basic ERD symbols: entity relationship (optional) attribute (optional)

Advantages of the REA Model n Using REA can lead to more efficient operations n helps managers identify non-value added activities that can be eliminated n n n increased productivity via elimination of non-value added activities generates excess capacity storing both financial and nonfinancial data in the same central database reduces multiple data collection, data storage, and maintenance detailed financial and nonfinancial business data supports a wider range of management decisions n increased competitive advantage by providing more relevant, timely, and accurate information to managers

Value Chain Analysis n Competitive advantages from the REA approach can be see via value chain analysis. n n n Value chain analysis distinguishes between primary activities (create value) and support activities (assist performing primary activities). REA provides a model for identifying and differentiating between these activities. Prioritizing Strategy: Focus on primary activities; eliminate or outsource support activities.

Revenue Costs Firm Infrastructure Human resource management Technology development Margin Support Activities Porter’s Value Chain Procurement Inbound Operations Logistics Output Logistics Primary Activities Marketing & Sales Service

Database Applications Phase 1 Flat Files Limitations: Redundant data; Anomalies Phase 2 Event-Driven Database Limitations: Loss of noneconomic information Phase 3 REA-Model Database Limitations: Not widely used; Requires detailed analysis

Database Sales Order Entry/Cash Receipts System

Database Purchases/Cash Disbursement System

Limitations of Transaction-Based Systems n Event: a single business activity within a business process which involves resources and agents n Traditional event-based database systems tend to focus exclusively on economic events. n loss of non-economic/non-financial information n REA is event-oriented versus event-based. n includes non-economic and economic event information

Developing an REA Model: Overview n Before developing the REA model, identify events and classify as: § § § Operating events--activities that produce goods and services Information events--activities associated with recording, maintaining, and reporting information Decision/Management events--activities that lead to decisions being taken n REA model uses only operating events.

REA Example: Horizon Books is a bookstore in downtown Philadelphia. It carries an inventory of approximately 5, 000 books. Customers come in and browse the shelves, select their books, and take them to one of three cashiers positioned in different parts of the store. One of the cashiers is situated at an information desk where customers can discover whether a particular book is in stock, place orders for books not currently available in the bookstore, and collect and pay for books previously ordered. The cashier at the information desk has a book database that is consulted for every query. There are no credit sales. All customers pay for their purchases at the time of purchase.

Developing an REA Model: Step 1 n Identify the operating events that are to be included in the model n These are the events that support the strategic objectives of the organization and about which we need to gather information.

REA Example: Horizon Books … Answer Query Make Sale Receive Payment Step 1: Identify operating events in Horizon Books’ sales model

Developing an REA Model: Step 2 n Organize the operating events identified in sequence of occurrence n Show each event as verb-object n This facilitates arranging them in order of occurrence. n Note that the verb/event is represented from the perspective of the organization, not the customer.

REA Example: Horizon Books … Step 2: Place operating events in sequence

Developing an REA Model: Step 3 n Identify the resources and agents involved in each operating event n This is most easily done by answering who, what, and where questions about each event. n n n Who was involved? What was involved? Where did it take place?

REA Example: Horizon Books … Step 3: Identify resources and agents associated with events

Developing an REA Model: Step 4 n Identify the links between the resources, events, and agents n Start from each event and connect it to the resources and agents that are involved in the event n Draw a line connecting events that are logically related

REA Example: Horizon Books … Step 4: Establish Horizon Books’ sales process relationships.

Developing an REA Model: Step 5 n Assign the record associations or cardinalities of all the entity relationships n Five forms of associations (minimum-maximum cardinalities) are used when constructing the REA model: n n n zero-to-one (0, 1) zero-to-many (0, M) one-to-one (1, 1) one-to-many (1, M) many-to-many (M, M)—rare

REA Example: Horizon Books … Step 5: Completed REA model of sales process with cardinalities.

REA Model v. ERD n The two methods have a lot in common, but there are differences: n n n ERDs are more commonly found with traditional event-based systems. REA-modeling is used with event-oriented systems. ERDs often use diamonds to show events, while REA model always classifies events as a type of entity. REA includes only operating events, while ERDs can capture all three types of event. REA facilitates placement of internal controls. REA is more focused on business needs and, as a result, often simpler.

ERD of Manufacturing

REA Model of Manufacturing, 1

REA Model of Manufacturing, 2

Developing an REA Model: Attributes and User-Views n The final step is to define the attributes associated with the entities in the model. n These are used to populate the database. n Also used to create the various physical user-views needed in daily operations: n reports, documents, computer interfaces

Developing an REA Model: Attributes Using the customer as an example, these data include: Financial Nonfinancial Customer name Customer address Customer telephone number Amount owed by customer Value of total sales to date Terms of trade offered Customer credit rating Damaged goods record On-time payment record Customer volume record EDI access Internet access

Developing an REA Model: User-Views User-View #1 Past Due Accounts Name Amount James $500. 00 Henry $100. 00 … … User-View #2 Sales Report REA Database