All businesses must have the right scale comparing with their actual business operations, a proper business size. Companies selling smart phones to millions of middle-class customers globally are bigger in size comparing with companies selling golfing clothes in Ireland or scuba diving equipment in Thailand to the top 1% of the richest people in the country.
Who wants to measure business size and why?
It is common to compare businesses by their size. Many stakeholders of the business organization will want to know how large a particular business is because of several reasons.
- The government wants to measure business size because it may want to give assistance to small start-up businesses or confirm how much TAXes big businesses should pay.
- Investors (shareholders) in a firm want to measure business size because they want to compare the size of the business with close competitors to find out, if the particular business is growing and how fast.
- Customers of the business want to measure business size because they want to purchase goods and services from well-established stable firms rather than buy from small companies that may cease production anytime, hence stop providing after-sale services.
- Employees want to measure business size because they want to know whether their salaries will increase in the near future as the business grows and to check whether the business will offer them opportunities for promotion anytime soon.
- Local community wants to measure business size in order to find out about any job opportunities created by the business in the future.
Methods of measuring business size
We can measure the size of a business in several ways. Here are the most common methods to find out how big or small a company is.
1. SALES REVENUE (or VALUE OF OUTPUT)
The value of company’s sales in a given time period, usually one year (between January 1 and December 31).
Small businesses will have much lower sales revenue because they have less products available for sale and less customers. Large businesses will have much larger earnings from selling products. Also, the larger the market a business serves, the more revenue the business is likely to earn.
The amount of money businesses earn from selling their goods and services is often used to compare the size of businesses in the same industry. Using sales revenue as a business measurement is a good way when comparing two or more businesses involved in conducting the same business activity, for example two car producers such as Nissan and Toyota. It is because they both produce the same kind of output at the same stage of production.
Comparing companies in two different industries (e.g. car producers and bakeries) may not work quite well because they are using different methods of production – car companies use automated production process to produce a much greater output of millions of cars a month, while bakeries use batch production or job production to hand-make several batches of cookies or a few birthday cakes a month only. Also, the market sizes are different for middle-class cars and local pastry.
2. PROFIT
The amount of a company’s profit in a given time period, usually one year (between January 1 and December 31).
Small businesses will have much lower profit, while large businesses will have much larger profit. Profit is the difference between sales revenue and total costs.
3. NUMBER OF EMPLOYEES
The total number of employees who work in the business in a given moment in time.
A small shop run by just a sole trader and his family is considered a small business. A multinational company employing many staff is likely to be a large business. Larger businesses usually employ many more employees than smaller businesses in the same industry, for example a local convenience store and a large national supermarket.
Also, large businesses will also have more departments and managers while small businesses may not even have all basic business functions.
However, two businesses may hire different number of employees, but still produce the same or similar level of output, therefore this classification can be misleading. One business can use more machinery than the other. Usually, the firm with automated production will require far fewer workers than the one that is using traditional methods.
4. MARKET SHARE
The value of company’s sales revenue expressed as a percentage of the industry’s total sales revenue in a given moment in time. This is calculated using the following formula:
Market Share = Total sales of a business / Total sales of the whole industry
The larger the share of the total market, the larger the business is comparing with other businesses in the same market. The smaller the percentage, the smaller the business as it has smaller market share comparing with other businesses in the market.
However, this measure can also be misleading.
Let’s take a look at three different companies that operate in three different industries – Company A, Company B and Company C.
1. Company A has 15% market share, and USD$500,000 in total sales revenue.
2. Company B has 80% market share, and USD$50,000 in total sales revenue.
3. Company C has 5% market share, and USD$100,000 in total sales revenue.
Based on the market share classification, Company B is the largest because it has the largest market share of 80%. In fact, it has extremely high market share and is actually the leader in this industry. However, based on the value of sales revenue, Company B is the smallest among those three companies.
Also, Company B is much larger than Company C because its market share is twenty times bigger. But, the value of Company C’s sales revenue (USD$100,000) is twice as high as Company’s B (USD$50,000). So, Company B is larger than Company C according to market share, but smaller according to the total sales revenue classification.
Importantly, when the size of the total market is small, a high market share will not indicate a very large firm. This is the case for Company B. The total value of the whole market where Company B operates is just USD$62,500. While the total value of the whole market where Company C operates is as much as staggering USD$2,000,000.
5. CAPITAL EMPLOYED
The value of the firm’s long-term finance invested (employed) in the business for the business to function. Capital needed for long-term investment is used for a business in order to produce goods and provide services to customers, for example land, premises, machinery, equipment and tools.
Capital Employed = Retained Profit + Share Capital + Long-term Liabilities
Usually, the larger the business, the more capital employed the business will have. A small business will invest less capital in the long-term than a large business in the same industry. Smaller companies simply cannot afford to employ a huge amount of capital in their operations as it is difficult for a small business with less assets to take a huge bank loan, and no investors want to invest in a tiny unpopular business.
A small restaurant selling hamburgers will only need one shop, one pan and one oven to prepare burgers, and small inventory of raw materials like bread bums, beef, chicken and vegetables. A large donut manufacturer will need production lines, industrial mixers, large ovens and a large inventory of raw materials.
An increase in the value of capital employed would suggest that the business is growing – the company is using more money for long-term investment.
This measurement can be confusing as older companies will have many more opportunities (operating for many years) to generate retained profits that are a part of capital employed. The same comes for private limited companies and public limited companies which can generate a part of their capital employed from selling their shares to investors. In the contrary, small sole traders and partnerships can only generate capital employed from rather limited long-term sources of finance or small retained profit.
Therefore, we should use capital employed as a measurement of the business size when we compare the same type of business organization such as comparing a private limited company with another private limited company.
Also, using capital employed to compare the size of businesses in different industries is a problem because some industries, such as aircraft production need a very large capital investment in factories and machinery like robots. Other businesses, such as website design agency, do not (web designers only need one computer, a desk and a chair).
Additionally, two firms employing the same number of workers may have very different capital equipment needs. Such as a one-person hairdressing salon using scissors and a comb versus an optician who needs expensive medical machines to diagnose patients.
6. MARKET CAPITALIZATION
The total value of all company’s shares issued to the general public
This method is used only for public limited companies – businesses that have shares quoted on the stock exchange. This is calculated using the following formula:
Market Capitalization = Current Share Price x Total Number of Shares Issued
However, because share prices tend to change every day, this form of comparison is not a very stable one. Literally, we may need to recalculate market capitalization daily as a temporary but sharp drop in the share price of a company could appear to suddenly make it much ‘smaller’ than yesterday.
7. OTHER METHODS used to measure business size
Other methods of measuring business size are very industry-specific. They could be ‘total floor space’ for supermarkets and retailers, the number of students and classrooms for schools, the number of doctors and operating rooms for hospitals or the number of hotel rooms and guest beds for hotels and guesthouses.
We could also measure the size of soccer clubs by looking at the size of their stadiums in terms of audience seats or the number of players that also play for their respective national teams.
For multinational companies, we could consider the number of products a company has in its product portfolio, the number of countries where the company operates in, spending on promotion or even the number of suppliers.
Limitations of measuring business size
As you see, there are several ways of measuring and comparing the size of businesses. However, all those methods of measuring business size have their limitations. There are three major problems.
1. Although all of the above methods can be used to measure and compare the size of businesses, different measures can produce different results, as some show the results as monetary value and some as a percentage. So, we need to be careful when drawing conclusions about the size of a business. One company may appear to be a large business when judged by market share, but small when profit is considered. Therefore, it is a good idea to use more than one measure of business size at a time.
2. The measurement of business size used can be either an absolute size or comparative size within one industry. We need to establish our needs first about the firms being compared. And then, we should test a firm on at least two of the above criteria (both an absolute size and comparative size) to make comparisons.
3. Currently in the world, there is no internationally agreed definition of what a small, medium or large business is. Different regions or even different countries use different criteria to judge the size of the business. One of the universal ways we could use is to compare the number of employees.
