Three Forms Of Business And Their Financing

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02 Nov 2017

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Sole Proprietorship:-

Form of business which is established, financed, managed and controlled by an individual entrepreneur who has complete freedom of operation, who bears all the task and entitled to all the profits. This is the most common form of business. One person provides the permanent finance and in return has full control of the business and is able to keep all of the profits. Although there is a single owner in the business, it is common for sole trader’s to employee others but the firms is likely to remain very small because of this they are great number. The mostly problem in this business which discourages, from starting this business is the finance for expansion and unlimited liability. Many sole traders remain small because the owner wishes to remain in control of their own business but another reason is the limitation that they have in raising additional capital. In order to remain a sole trader the owner is dependent on own savings, profits made and loan made for the injection of capital.

As Mr Javed clearly mentioned that he don’t want further partner’s in his business project and want this business as his baby so to keep in view his desires I have select that form of business for him. Following are the some of advantages and disadvantages of Sole Proprietorship.

Advantages of Sole Proprietorship:-

There are so many advantages and disadvantage of Sole Proprietorship which are given below:-

Easy to set up and having no legal formalities.

Owner has complete control and he is not answerable to anyone.

Owner keeps all the profits.

He is able to choose time and patterns of working

Able to establish close personal relationship with staff (if any are employed) and customers.

The business can be based on the interests or skills of the owner – rather than working as an employee for a large firm.

Disadvantage of Sole Proprietorship:-

Unlimited liability

All of owner’s assets or profitability is at risk.

Often faces intense competition from bigger firms, for example food retailing.

Owner is unable to specialize in areas of the business that are most interesting – is responsible for all aspects of management.

Difficult to raise additional management.

Long hours often necessary to make business pay.

Lack of continuity – as the business does not have separate legal status, when the owner dies the business ends too.

Partnership:-

A business form which is an agreement between two or more person to carry on business together for the purpose of earning profit.

The agreement to work together does not create a separate legal unit. A partnership is just a grouping of an individual. When planning to go into partnership it is important to choose the business partner carefully because the error and poor decision of anyone partner is consider being responsibility of all of them. The agreement of partnership is created by certain papers which are known as partnership deed. This deed provides an agreement on issues such as voting rights, distribution of profits, the management roll of each partner and who has the authority to sign contracts.

Types of Partners:-

General Partners:-

All the partners of the business are known to be general partners. This is further divided into two types of partners.

Active Partner: - The partner which takes part in the activities in the activities of the business to be conducted is called active partner.

Sleeping Partner: - The partner which does not take part in the activities of the business but only to be included in the profits or losses of the business.

Special Partner:-

Those partner which has a limited liability means that they are just liable to pay the liabilities of the business which is limited to the extent of their capital invested. Partnership is another form of business which is also available for Mr. Javed business but he doesn’t want any hassling relationship and partners that why I didn’t select it. There are some Merits and Demerits of Partnership form of business.

Advantages of Partnership:-

Easy to form, only deed is required.

Partners may satisfy in different area of the business management.

Shared decision making.

Additional capital can be injected by partners.

Business losses are shares between the partners’s.

It has a great privacy and few legal formalities (only partnership deed) then companies.

Disadvantage of Partnership:-

Unlimited Liability in case of general partners. Partners are jointly responsible for all debts of the business even they loose all their personal assets.

Profits are shared.

When death of the partner occurs then partnership will have to be reformed.

All partners are bound by the decision of any one of them.

Not possible to raise capital from selling shares.

Anyone partner is not independent to make decisions.

Corporation:-

A corporation is legal entity that exists apart from its owners (better known as stockholders). Ownership is evidence by possession of shares of stocks. In terms of form of the business, the corporate form is not the greatest in number but it is most important in terms of total sales, assets, profits and contribution natural income. This form of business organization is specifically created by law.

Legal Formalities:-

In order to set up a corporation the following legal steps must be taken to establish:-

Memorandum of Association: - This states the name of the company, address of the head office through which it can be contacted. The maximum share capital for which the company seeks authorization and the declared aim of the business.

Article of Association:- This is concerned with the internal working and control of the business for example, the name of directors and the procedure to be followed. When these documents have been completed then individual can start the business with the name of corporation. The individual can start the business with name of private Limited Company.

Private Limited Company:-

The word limited or LTD tells us that the business has legal form. Usually the shares will be owned by the original owner, relatives, friend and employees. New issues of shares cannot be sold in the open market and existing shareholders may only share with the agreement of the shareholder’s.

Public Limited Company:-

It is the most common form of legal organization for really large business and they have an access to very substantial funds for expansion. These companies can be recognized by the use of "Plc" or "Inc". These Companies can have all the advantages of the private company status plus they have the rights to advertise their shares for sales and have them quoted on stock exchange. The existing shareholders of these companies may quickly sale their share if they wish too. This flexibility of shares in the first instance and thus invest in the business. Corporation form of business is also available to Mr. Javed but in that form of business there are a lot of complexities and he doesn’t have any idea of Pakistani Market. So i have not selected Corporation form of business for him. Below are the following advantages and disadvantages of Corporation form of business:-

Advantages of Corporation:-

One of the key reasons for forming a corporation is the limited liability protection provided to its owners. Because a corporation is considered a separate legal entity, the shareholders have limited liability for the corporation's debts. The personal assets of shareholders are not at risk for satisfying corporate debts or liabilities

A business owner who works in his or her own business may become an employee and thus be eligible for reimbursement or deduction of many types of expenses, including health and life insurance.

A corporation continues to exist until the shareholders decide to dissolve it or merge with another business.

Tax free benefits such as insurance, travel, and retirement plan deductions

Change of ownership need not affect management

Easier to raise capital through sale of stocks and bonds

There is a centralized management structure in a corporation. Shareholders elect a board of directors, which then elects the officers who run the business.

Disadvantages of Corporation:-

The proper corporate formalities of organizing and running a corporation must be followed, to receive the benefits of being a corporation.

More expensive to form than proprietorship or partnerships

More legal formality

While incorporation provides significant protection of owners' personal assets from repercussions of business downturns, it also means that a business owner is not allowed to tap into the corporation's account for assistance in meeting personal debts.

You must keep a staggering amount of records and reports. Reports and tax returns must be filed regularly and on time. Business bank accounts and records must be maintained and kept separate from personal accounts and assets, and records must be kept of corporate proceedings

According to the given scenario I have explained all three forms of business and its implications given above. I have selected Sole Proprietorship for Mr. Javed because it suits best for his business as compare to Partnership or Corporation form of business.

M1:-

Javed his sufficient amount but he has no knowledge about the market condition currently operated in Pakistan regarding the business activity.

From this sufficient amount if Mr. Javed starts the business with low level then there are many ways for expansion of business.

The expansion in business means that the business will grow and Mr. Javed will be motivated in order to invest more and more money in his business.

Partnership is the contribution of two or more persons means that more individual will be involved in the business activity while Mr. Javed has no intensions about adding any further partners to his business therefore I have selected sole proprietorship for him.

In Sole Proprietorship the owner has the complete control and authority over the business activity and also Mr. javed his mentioned he want this business to be his baby which means that he don’t want to have any hassling relationship or any type of control and authority of the business may shifted to any other person.

In setting up of Private Limited Company the owner will have to provide in initial investment amount which needs so high amount while Mr. Javed has not that sufficient amount in order to set the Private Company.

In the Private Company the owner can finance the business activities by selling their shares to relation, friend and employees but Mr. javed does not want to have any type of relationship by any individual in his business.

P1 P2 P3:-

The sources of finance for the installation of system C can be classified into:-

Internal sources of Finance

Profit Retained in the Business

Sale of Assets

Reduction in Working Capital

External Source of Finance

Short Term External Finance

Bank Overdraft

Trade Credit

Debt Factoring

Medium Term External Finance

Leasing

Long Term External finance

Long Term Loans from Banks

Sale of Shares – Equity Finance

Internal Source of Finance:-

Profit Retained in the Business:-

If a company is trading profitability, some of these profits will be taken as a tax and some is paid to the shareholders and the rest of the profit if remains in the business are the profit retained in the business. So this profit retain in the business becomes a source of finance for the future activities. A newly formed company are the one trading at a loss will not have access to this source of finance. The information given to me in the scenario is only the cost of the systems and hasn’t provided any statement that can guide me about this source of finance. If the statement of the company shows the profit retained then Biz Training can use this profit retained is a source of finance for the installation of system C.

Sales of Assets:-

Established companies often find that they have assets that are no longer fully employed. These assets could be sold to raise the cash which will finance various activities of the business. The information provided in the scenario regarding the position of the assets of Biz Training Private Limited is not given so I am not sure that how much assets the company has so that it can be sold to raise the cash for the installation of system C.

Reduction in Working Capital:-

When business sells the goods on credit to customer they use a source of finance. When companies reduce these assets by reducing their working capital, capital is released, which acts as a source of finance for other uses. The working capital in this scenario is not mentioned that why that type of source of finance is not applicable.

External Source of Finance:-

Short Term Sources:-

Bank Over Drafts:-

In this source the bank allows the business to overdraw its account by writing cheques to a greater value then the balance in the account. This amount should always be agreed in advance and always has a credit limits beyond which the business should not go. The information in the scenario regarding the Bank account balance of the Biz Training Company has not been provided so that type of source of finance is not applicable.

Trade Credit:-

By delaying the payment of bill for goods or services received, a business is obtaining finance. Its suppliers, or creditors are providing goods and services without receiving immediate payment and this is good as lending money. Biz training Private Limited Company needs £85000 for the installation of system C, so trade credit can be used as a source of finance by the company. The company can purchase this system from the suppliers on the credit and make certain agreements with the suppliers. The company will install the system and can generate the revenues which will be used to pay the credit of the business to suppliers.

Debt Factoring:-

When a business sells good on credit it creates a debtor. The longer the time allowed to this debtor to pay up, the more finance the business has to find to carry on their business activities. So the business can sell these receivable on certain financial institution which will provide immediate cash to the business and that cash can be used by the business as a source of finance. Here in this scenario the positioned of the debtor is not provided so that type of finance is not applicable.

Medium Term Finance:-

Leasing:-

Leasing involve a contract in which a periodic payment is made over the life of the agreement but the business does not have to purchase the assets at the end. This also avoids the cash purchases of the assets. The lease option is not a cheaper one for the company but it can improve the short term cash flow position of the company as compare to purchase of an asset on cash. Based on the scenario information here if the Biz Training Private Limited is planning of the installation of new online learning system so its full of risks that whether the system will be successful in the future or not. So if the company uses these methods that is leasing then they can minimize this risk by using these method as a source of finance.

Long Term Finance:-

Long Term Loan from banks:-

Commercial Banks are the most important source of external finance for many businesses. They provide various packages of long term loans to businesses on different interest rates which are operated in that particular country. The business will have to provide certain security or collateral for the loan when borrowing from banks. The provision of collateral by the businesses is for the purpose that if the business cannot repay the loan then the banks can sell that collateral in order to receive the amount of loan. The Scenario has not full of information that whether the business has certain securities in order to get the loan from the bank. So that type of finance is not available for Biz Training Private Limited Company.

Sale of Shares:-

Private Limited companies can sell further shares to existing shareholders. This has the advantage of not changing the control or ownership of the company. By the willing of existing shareholders the company can also sell their shares to further new shareholders so that to increase the equity position of the company. Biz Training has five shareholders and one local business person is also a shareholder, the company can increase the equity position by increasing the investment position of each shareholder or they can add others shareholders from their friends which will provide them capital. The capital which has provided can be used as a source of finance for the installation of system c by the Biz Training Company.

Implications of the appropriate source of financing for Biz Training Company:-

Following are alternatives ways in order to finance the system C by the Biz Training Company:-

Trade Credit

Lease

Sale of Shares – Equity Finance

Advantages of Trade Credit:-

Reduced capital requirements, this means that if a new business setting up has trade credit, they will obviously require less money in capital to start up the business.

Trade credit will improve the cash flows and therefore provide smoother operation for the business.

Businesses can buy now and pay later which means even if they don't have the money at first they can purchase items, sell them as a business and then make the payments at the end of the month when the products have been sold and a profit has been made. 

Ease to manage the Finance and the Cash Flow.

Liable for the discount on early payments.

Disadvantages of Trade Credit:-

If repayments are not made by certain deadlines, the business will receive a poor credit history which will be a big blow to any business as they will not trusted in the future if they require any loans, trade credit.

Only companies with a good credit history will get trade credit and these can often be hard to build up, especially for new businesses.

Prices charged for credit sales are usually higher.

Buyer losses cash discounts.

Advantages of Lease:-

It offers fixed rate financing; you pay at the same rate monthly.

Leasing is inflation friendly. As the costs goes up the lease rate will remain the same and will never change.

You do not need to make large cash payments for the purchase of needed equipment.

There is typically an option to buy equipment at end of lease term.

As new equipment becomes available you can upgrade to the latest models each time your lease ends.

Typically, it is easier to obtain lease financing than loans from commercial lenders.

It offers potential tax benefits depending on how the lease is structured.

Disadvantages of Lease:-

You have an obligation to continue making payments. Typically, leases may not be terminated before the original term is completed.

You have no equity until you decide to purchase the equipment at the end of the lease term, at which point the equipment has depreciated significantly.

Although you are not the owner, you are still responsible for maintaining the equipment as specified by the terms of the lease. Failure to do so can prove costly.

Advantages of Sales of Shares – Equity Finance:-

A company is not required to pay-back the equity capital during its life-time and so, it is a permanent source of capital.

Equity shares suppose no fixed burden on the company's resources, because the dividends on these shares are subject to availability of profits and the intention of the board of directors.

Issuance of equity share capital creates no change on the assets of the company. A company can raise further finance on the security of its fixed assets.

Equity capital is said to be the risk capital. A company can trade on equity in bad periods on the risk of equity capital.

Disadvantages of Sale of Shares - Equity Finance:-

Each sale of equity shares dilutes the voting power of the existing equity shareholders and extends the voting or controlling power to the new shareholders. 

It costs more to finance with equity shares than with other securities as the selling costs and underwriting commission are paid at a higher rate on the issue of these shares.

Their prices fluctuate frequently which are not in the interest of the company.

M1:-

I have listed many sources of finance but in my point of view I have selected the above three sources for the installation of System C by the company.

Trade Credit:-

Trade Credit is one of the source of finance that i have select for the company. The Company is operating since ten years and the company can use this source but as this is a new system which is to be installed by the company. Besides operating ten years in the market the company can be in a position to get the trade credit but the risk associated with this source is that the system is the new one and the company cannot forecast about the revenue generated by the system. This risk may leads the company to not repay the trade credit. That why this is not the most appropriate source of finance for Biz Training Company.

Leasing:-

Leasing is one of the sources of finance that i have selected for the company because in this method the payment is to be made in instalments and the company will feel easy in financing that system. But In leasing the ownership of purchasing the System C will remain with the supplier and the failure of the system is responsibility of the company which will be very costly for Biz Training Company. Therefore due to this drawback the leasing is not the most appropriate source of finance.

Sales of Shares – Equity Finance:-

The most appropriate source of finance for Biz Training Company which i have selected as Sales of Shares – Equity Finance. Equity Financing is one of the method that is permanent and this source is no burden over the company resources. In this source the existing shareholders may provide the additional capital by purchasing the additional shares of the company. So the Biz Training Company has five shareholders and if anyone of them provides the additional capital to the business then there will be no burden on the company. The company can easily purchase that system though this additional capital and also it cannot create any additional burden on the company. If the existing shareholders cannot provide the additional capital, then they can also offer the shares of the company to any new share holder which may provide the capital. The only burden of the equity financing is the payment of the dividend to the shareholders but if the company is not profitable then the board of directors may delay the dividend announcement to a next year. As this is new system to be installed by the company so the company cannot forecast about the profit generated from that system.



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