Types of Business: Benefits and Limitations

Business Informative Report

This descriptive report discusses the types of business and their benefits and limitations. It provides examples to clarify the main purpose of accounting for various business types. The information regarding different sources of finance is also provided in this report to explain their characteristics. The two strands of accounting including financial accounting and management are also discussed in this report to indicate their differences. This report is useful for understanding various terms of accounting and finance.

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Forms of a Business Unit

A business is a legal entity made by a single individual or group of individuals to achieve the common goal of making a profit or carrying out non-profit activities (Mancuso & Laurence 2016). Three different forms of business units have their benefits and limitations.

Sole Proprietorship

A sole proprietorship is regarded as the most basic form of business that is owned by an individual. The key characteristic of this form is that there is no legal distribution of decision-making, profit, and operations (Mancuso & Laurence 2016). There is also no need for formal registration of this form of business.

Benefits

  • Easy to form or close down the business.
  • Freedom of business decision-making and complete control over business operations.
  • The legal cost to establish a sole proprietor business is low.
  • Absence of corporate tax payments.
  • There is no need to file an additional return for taxation as it will be included on the personal tax return.
  • The owner receives all earnings from business dealings and transactions (Singh & Gupta 2016).

Limitations

  • There is a limited capital due to a single business owner.
  • There is an unlimited liability, which means that the owner’s personal property can be used to settle business obligations in the case of default.
  • The illness, insolvency, or death of the owner results at the end of the business.
  • The size of the business is limited due to limited capital.
  • Lack of expertise in different aspects of management (Mancuso & Laurence 2016).

Partnership

When two or more individuals join to carry out a business, it is referred to as a partnership (Kelly & Williams 2017). The main feature of this business form is that individuals share profit/loss and management according to the terms and conditions of the partnership agreement.

Benefits

  • Combined skills and judgments.
  • The arrangement of capital is easy due to the involvement of two or more individuals.
  • Splitting the income also reduces taxes.
  • There are few legal requirements including a partnership deed to form a partnership business.
  • Easy to change the business structure, if needed (Singh & Gupta 2016).

Limitations

  • The uncertainty of the partnership duration due to the possibility of conflicts or disagreements between partners.
  • The partnership will be terminated on the death, bankruptcy, or demand of a partner.
  • Partners’ liabilities are unlimited even when they are incurred by any one of them as each partner is the business agent.
  • Lack of harmony due to different individuals, which can disrupt the business.
  • The revaluation of assets at the end of the partnership may be costly for some partners (Mancuso & Laurence 2016).

Limited Company

A limited company is an entity that is considered as a legal “person,” which is separate from its owners. The main characteristic of this form of business is that its liabilities are limited to the amount of investment (CFP Board 2018). The owners of this type of business are not personally liable for the obligations of the company.

Benefits

  • Limited liability as owners is not personally liable for the business loss.
  • It is treated as a separate entity as its operations will not stop in the absence of its owners.
  • Directors are business decision-makers, which reduces the risk of delay.
  • The ownership and control are in common hands of a private limited company.
  • The name of a company is secured after the registration that reduces the threat of the same name adopted by other companies (Singh & Gupta 2016).

Limitations

  • Start-up costs require high capital.
  • Registration in the Companies House is essential.
  • The complexity of business operations due to major accounting and administrative requirements.
  • A professional accountant has to be paid to audit the company’s accounts.
  • Lack of rapid withdrawals by directors from the company’s earnings (Mancuso & Laurence 2016).

Types of Finance

Finance is the lifeblood of a business, and no firm can achieve its objectives without arranging sufficient finance for different business functions (Mayes & Shank 2017). There are three main sources of finance that are categorized according to their period.

Short-term Sources

A short-term source of finance refers to borrowing that is held by a business for less than 12 months. Short-term finance also is known as working capital financing is used for managing the components of current assets including debtors, cash and cash equivalent, prepaid, and inventory. Trade credit, advances from customers, short-term loans from commercial banks, fixed deposits for less than a year, and bill discounting, etc. are all short-term sources (Jain 2016).

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Medium-term Sources

Medium-term sources of finance provide debt for three to five years. The main reason for using these sources of finance is to arrange funds for the deferred revenue that will be realized in three to five years. The issuance of debentures or bonds by a company is an example of this source of finance in which the company borrows the amount from the general public with a promise to pay a certain amount of interest at its maturity (Petty et al. 2015). Companies mainly utilize the option of short-term debt when they do not want to offer ownership of their businesses. Hire purchase is also a commonly used option of medium-term finance in which a company arranges capital for various business purposes. An agreement is required for hire purchase that includes the clause of the interest to be paid for the use of an asset in addition to its price (Kelly 2015). Preference shares, lease finance, and medium-term loans from the government and financial institutions are examples of a medium-term source of finance.

Long-term Sources

Long-term sources of finance refer to external debt arranged for more than five years. These sources are used to finance a new venture of a company that requires high investment. Therefore, companies mainly utilize this option of finance to avail of the opportunities in the target market. Share capital and venture funding are two examples of this source of finance. Share capital refers to the issuance of new shares in the capital market to raise sufficient funds in return for ownership and dividends (Singh & Gupta 2016). Companies can easily generate funds by increasing the number of shares issued provided that it does not exceed the number of authorized shares. They also utilize venture funding to borrow the amount from an investor on agreed terms and conditions. An investor in venture funding may demand interest or sharing of profits generated from the venture provided that it is expressed in terms and conditions of the agreement between parties.

Financial Accounting and Management Accounting

Financial Accounting

Financial accounting refers to the formal process of recordkeeping, summarizing, and reporting of business transactions during a period. The recorded information is summarized in financial statements that are prepared at least once in a year. The financial statements include a statement of income, statement of comprehensive changes in equity, statement of cash flow, and balance sheet (Whittington 2014). These financial statements could be used to analyze the financial performance of a company in the reported period. Furthermore, financial accounting is also important for reviewing the company’s policies and accounting standards for preparing and reporting financial information. The financial information is audited by internal and external auditors to confirm its accuracy.

Management Accounting

Management accounting refers to the process of identifying, measuring, analyzing, and interpreting information that is useful for achieving the performance goals of an organization (Malina 2017). The term is also known as cost accounting, and it may include budget accounting including quantitative expression of the operational plan of a business. Management accounting enables companies to identify and correct variances of actual outcomes from their budgeted outcomes.

Differences

There are many differences between financial accounting and management accounting that are discussed in the following.

Aggregation

Financial accounting reports on the outcomes of business activities (Petty et al. 2015). However, management accounting reports provide details about customers, product lines, and business in different geographic regions, etc.

Reporting Focus

Financial accounting relates to the preparation of financial statements for all stakeholders of the company. On the other hand, management accounting is mainly concerned with operational reports that are distributed within the company (Nilsson & Stockenstrand 2015).

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Efficiency

Financial accounting only represents information regarding assets, liabilities, and equity and profit of the company. On the other hand, management accounting focuses on specific business problems and their solutions (Malina 2017).

Sources of Evidence

Sources of evidence such as sales slips, cheque stubs, and invoices, etc. are required for financial accounting to prove that the information is correct (Nilsson & Stockenstrand 2015). However, management accounting deals with estimates and projections.

Systems

Financial accounting does not consider the overall system to determine the profitability of a company. On the other hand, management accounting focuses on bottleneck operations and their issues (Malina 2017).

Valuation

Financial accounting is concerned with the valuation of assets that also involves revaluation and impairment. However, management accounting only concerns with the productivity of assets.

Timing

Financial accounting requires the issuance of financial statements at the end of the reporting period (Mayes & Shank 2017). However, management accounting can issue reports more frequently to determine the business direction.

Standards

Financial accounting requires the preparation of financial information according to accounting standards (Nilsson & Stockenstrand 2015). On the other hand, management accounting does not require any standards as the information is used for internal purposes.

Conclusion and Recommendation

The report has highlighted differences in management accounting and financial accounting in detail. The three main sources of finances are also presented in detail to provide a clear and concise view of different choices available to clients. The benefits and limitations of different types of business units show that they have distinct characteristics. However, it is recommended that an individual should adopt the sole proprietorship form of business to enjoy full control over business decision making. The partnership is the next best option if more than one individual is starting a new business.

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Reference List

CFP Board 2018, CFP board financial planning competency handbook, John Wiley & Sons, Hoboken, NJ.

Jain, P 2016, Finance for value creation: all true businessmen do it, Notion Press, New York, NY.

Kelly, JE 2015, Bookkeeping and accounting all-in-one for dummies – the UK, John Wiley & Sons, Hoboken, NJ.

Kelly, M & Williams, C 2017, BUSN, Cengage Learning, Mason, OH.

Malina, MA 2017, Advances in management accounting, volume 28, Emerald Group Publishing, London.

Mancuso, A & Laurence, BK 2016, Business buyout agreements: plan now for all types of business transitions, Nolo, New York, NY.

Mayes, TR & Shank, TM 2017, Financial analysis with Microsoft Excel 2016, 8th edn, Cengage Learning, Mason, OH.

Nilsson, F & Stockenstrand, AK 2015, Financial Accounting and management control: the tensions and conflicts between uniformity and uniqueness, Springer, New York, NY.

Petty, JW, Titman, S, Keown, AJ, Martin, P, Martin, JD & Burrow, M 2015, Financial management: principles and applications, Pearson Education, London.

Singh, SK & Gupta, S 2016, Entrepreneurship: e-book, SBPD Publications, New York.

Whittington, OR 2014, Wiley CPA excel exam review 2015 study guide (January): financial accounting and reporting, John Wiley & Sons, Hoboken, NJ.

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