Commercial awareness: what you need to know

Commercial awareness is about understanding how businesses work
Commercial awareness
Improving your commercial awareness

Commercial awareness is a concept most people find difficult to define.

The simple answer is that it's a product of staying up to-to-date on developments in the business world. But it's more than this: to be commercially aware you need to understand why businesses act the way they do.

To give you an a definitive answer, we spoke to Christopher Stoakes, author of Know the city and Commercial Awareness, and consultant to global law firm Hogan Lovells (although this advice is relevant to all industries).

In this article he breaks down the business understanding you need to acquire into three areas: money, strategy, and business.

1. Money

Businesses need money to grow.

This money can be generated by the company's business activities, but make sure you understand the difference between cashflow (having enough money in the till to pay your immediate outgoings) and profit (money you've got left over once costs for the period have been deducted).

Cashflow is crucial to startups. Without it they go bust. Profit is what established businesses are expected to generate, but may not provide the money a business needs to grow.

So businesses also raise money for growth from external sources. The two key types of external funding are equity finance (issuing shares) and debt finance (borrowing money in the form of loans or bonds).

Both methods have their advantages and disadvantages, but debt is more appealing to businesses than it is for individuals because for businesses the interest payable is tax-deductible.

The proportion of a company's equity finance to its debt finance is known as its gearing ratio.

Companies with a high gearing ratio (high levels of debt finance in proportion to equity finance) are exposed to the risk of increasing interest rates because interest payments on debt must be paid out regularly, regardless of economic conditions or business circumstances, whereas dividends on shares need only be paid when a business feels it has sufficient distributable profits to do so.

2. Strategy

A business's strategy is made up of its vision (what we'll look like in five years' time) and its mission (what's special about us that will enable us to achieve it).

You should be aware that there are a number of different ways often used to think about business strategy, which can be useful to draw on as you consider particular businesses during the course of your career. Here are some examples of typical models that help businesses focus on strategy:

"PESTL" stands for political, economic, social, technological and legal, and refers to the big picture issues and changes in the world that affect all businesses and their strategies.

"Porter's Five Forces" helps a business focus on its immediate industry sector, including such factors as the threat of potential entrants to a business's market niche, the threat of substitute products, the bargaining power of its suppliers, the bargaining power of its customers, and the business's position in relation to its competitors.

Using this technique to think about a business's strategy means thinking about the first four forces in turn, which all then feed into a consideration of the fifth, the most important.

"Scenario planning" means thinking about what might happen in the future that could affect a business, and drawing up potential plans to minimise damage and maximise opportunities.

3. Business

It's important that you understand how a business is governed, usually by a board of directors and non-executive directors, who may have specific roles and responsibilities.

You also need to understand how businesses as a whole are structured. There are certain functions that almost every industrial business has - for example, sales, marketing, manufacturing, supply chain management, technology, finance, risk and legal, human resources and facilities management.

It's also important to have some understanding of how businesses are regulated and otherwise affected by government policy - for example, in areas such as directors's duties, tax, the environment and employment.

Many businesses today also have extensive corporate social responsibility policies and it's a good idea to have an awareness of this area too.

For whichever business you are joining (and for the clients it serves) you need to consider the particular business sectors it and its clients are in, who the market leaders are, the up-and-coming competitors, and what the major themes in that sector might be.

Key sectors include: manufacturing, pharmaceuticals, transport and shipping, financial services and insurance, professional services, healthcare, retail and real estate.

Finally, you need to appreciate the things that matter most to businesses day-to-day, namely the risks they face (such as going bust, being taken over, or suffering a loss of reputation), what their competitors are doing, and finding customers and keeping them happy.

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