TYPES OF BUSINESS ORGANIZATIONS

<< Management Discussion & Analyses (MD&A)

Incorporation of business >>

Financial Statement Analysis-FIN621

Lesson-25

TYPES OF BUSINESS

There are usually three types of Business: service enterprise, merchandise (sale and

purchase) enterprise, and manufacturing enterprises.

TYPES OF BUSINESS ORGANIZATIONS:

Corresponding to three types of business, there are three types of business organizations

viz Sole Proprietorship, Partnership firm and Public Limited Companies or Corporations.

Different combinations of businesses and business organizations can occur. For

example, a sole proprietor can have a manufacturing business or a big corporation can indulge in service

enterprise.

GAAP apply to financial statements of all the three types of business and business

organizations.

Sole Proprietorship:

It is owned by one person (often acting as manager as well). Examples would be small retail stores,

farms, service business and professional practices (law, medicine etc). Accounts of business are

however separate from personal accounts of the owner. Legally, the business and owner are not

separate. It is unincorporated business in which there is personal liability of owner for debts of business.

Creditors look to solvency of owner, rather than financial position of business.

Owner is personally liable for all business obligations. If the organization is sued , the proprietor as an

individual is sued and has unlimited liability, which means that much of his or her personal property, as

well as the assets of the business, may be seized to settle claims. Another problem with a sole

proprietorship is the difficulty in raising capital. Because life and success of the business is so

dependent on a single individual, a sole proprietorship may not be as attractive to lenders as another

form of organization. More over the proprietorship has certain tax disadvantages.. In addition to these

drawbacks the proprietorship form makes the transfer of ownership more difficult than does the

corporate form. No portion of the enterprise can be transferred to members of the family during the

proprietor's lifetime. For these reasons, this form of organization does not afford the flexibility that

other forms do.

Partnership:

It is unincorporated business owned by two or more persons. Owners voluntarily act as partners.

Accounts of firm are separate from personal accounts of owners/partners, which mean there is personal

liability of owners for debts of firm. Partnership dissolves on the death or retirements of any of its

members/partners.

Disadvantages of a Partnership Firm

The Local Law restricts the number of partners in a partnership firm to twenty. If the firm needs more

capital for its business, the partners may not be in a position to invest more money in the business.

Secondly, if the business of the partnership firm is very large and twenty persons can not manage it,

they cannot admit new partners in the business. However, there is one exception. The partnership firm

of professionals can have more than twenty partners.

At this point, need for forming a COMPANY arises.

107

Financial Statement Analysis-FIN621

Public Limited Companies/Corporations:

Ownership of public limited companies vests in individuals, Labour unions, banks, universities and

other organizations like mutual funds etc. Ownership is through shareholding by shareholders or

stockholders.

A corporation is a legal entity having existence separate and distinct from that of its

owners. It is an artificial and legal person which can be sued and be sued.

Assets of the company or corporation belong to the company itself, not to owners.

Creditors of the company thus have a claim against assets of the company, not against the personal

property of stockholders. In other words, there is "limited" liability of shareholders; limited to the extent

of their shareholding. This is because stockholders own the company but not its assets, which belong to

the company itself. It is the corporation which is responsible for its debts, being a legal person.

Advantages Of A Limited Company

A Limited company enjoys the following benefits:

· It can have more than twenty partners, so problem of extra capital is reduced to minimum.

· The liabilities of the members of a company is limited to the extent of capital invested by them

in the company

· There are certain tax benefits to the company, which a partnership firm can not enjoy.

· In Pakistan, affairs of limited companies are controlled by COMPANIES ORDINANCE issued

in 1984.

· The formation of a company and other matters related to companies are governed by

SECURITIES AND EXCHANGE COMMISSION OF PAKISTAN (SECP).

Types of Companies

There are two major types of the companies:

· Private limited companies

· Public limited companies

Private Limited Companies

Following are the main characteristics of private limited companies:

· Number of members in a private limited company ranges from two to fifty.

· Words and parentheses "(Private) Limited" are added at the end of the name of a private limited

company. Example: ABC (Private) Limited.

· Private limited company can not offer its shares to general public at large.

· In case a shareholder decides to sell his shares, his shares are first offered to existing

shareholders. If all existing shareholders decide not to purchase these shares, only then, an

outsider can buy them.

· The shareholders of the private limited company elect two members of the company as

Directors.

· These directors form a board of directors to run the affairs of the company.

· The head of board of directors is called "chief executive".

Public Limited Company

Following are the main characteristics of public limited companies:

· Minimum number of members in a public limited company is seven

108

Financial Statement Analysis-FIN621

There is no restriction on the maximum number of members in a public limited company.

Word "Limited" is added at the end of the name of a public limited company. Example: ABC

Limited.

Public limited company can offer its shares to general public at large.

The shareholders of the public limited company elect seven members of the company as

Directors.

These directors form a board of directors to run the affairs of the company.

The head of board of directors is called "chief executive".

There are two types of public limited company:

· Listed Company

· Non Listed Company

Listed Company

Listed company is that company whose shares are quoted on stock exchange. i.e. whose shares are

traded in stock exchange. It is also called quoted company.

Non Listed Company

Non listed company is that company whose shares are not quoted on stock exchange. i.e. whose shares

are not traded in stock exchange.

109

Table of Contents: