Section 2.1.31 Liability and Finance

Question 1

liability and finance

Answer 1

every potential entrepreneur needs to know the financial risks being run when starting up. debts are liabilities that can overwhelm a business owner’s personal as well as business finances

Question 2

unlimited liability

Answer 2

the finances of the business are treated as inseparable from the finances of the business owner(s)

Question 3

if the business loses $1 million than what happens in unlimited liability

Answer 3

the people owed money (the creditors) can get the courts to force the individual owners to pay up through selling their houses, cars, etc. if they have to

Question 4

if the owners can’t pay in unlimited liability then what happens

Answer 4

they can be made personally bankrupt

Question 5

two types of business organisation have unlimited liability:

Answer 5

sole traders and partnerships

Question 6

limited liability

Answer 6

the legal duty to pay debts run up by the business stays with the business itself, not its owner/shareholders

Question 7

if the company has $1 million of debts that it lacks cash to repay then what happens in limited liability

Answer 7

the courts can force the business to sell all its assets (cars, computers, etc.)

Question 8

if the company can’t pay in limited liability then what happens

Answer 8

the company is closed down, but the owner/shareholders have no personal liability for the remaining debts

Question 9

the key implication of limited liability:

Answer 9

gives the owners the confidence to push their business forward to the next level
expansion can be financed by bank loans without threatening the well-being of the owners families

Question 10

without the legal protections of limited liability, what would happen

Answer 10

economies would struggle to grow

Question 11

downside of limited liability:

Answer 11

it gives huge scope for fraud. it is hard to to distinguish between fraud (illegal) and incompetence (legal), which is why it’s hard to be certain that it is fraud

Question 12

if it is limited liability:

Answer 12

• personal protection from business debts
• no stress from this source

Question 13

if it is not limited liability:

Answer 13

• unlimited personal liability for business debts
• adds greatly to stress level

Question 14

what are unlimited liability businesses not and what does this mean

Answer 14

they are not companies. therefore, they have no access to share capital (equity), so a sole trader or a partnership must be financed in one of four ways

Question 15

the four ways a sole trader or partnership must be financed in unlimited liability:

Answer 15

1) owner’s capital
2) bank finance, either loan or overdraft
3) leasing
4) trade credit

Question 16

owner’s capital in unlimited liability

Answer 16

an agreement might be drawn up by basing the proportionate ownership of the business on the amount of capital invested by each partner

Question 17

bank finance in unlimited liability

Answer 17

either loan or overdraft. often easier for an unlimited liability business to obtain this because even if the business fails, the bank can recoup its cash from the personal assets of the individual owners

Question 18

leasing in unlimited liability

Answer 18

signing an agreement to rent a specific asset for a specific period of time, therefore avoiding the cash drain caused by purchase

Question 19

trade credit in unlimited liability

Answer 19

supplier companies would often prefer to deal with a sole trader or partnership, as they know they can recoup any debts from the individual owners if the business fails

Question 20

where does the most important form of capital come from

Answer 20

within the business: from trading profit

Question 21

what do companies have more access to

Answer 21

more types of finance than unlimited liability businesses

Question 22

both private and public limited companies have access to the 5 forms of finance:

Answer 22

1) share capital
2) bank finance
3) angel or venture capital investment, both of which tend to be a combination of share and loan capital
4) peer-to-peer or crowdfunding
5) leasing and trade credit are both open to limited liability companies

Question 23

share capital in limited liability

Answer 23

part of which may be under the control of the founder and part sold on to family and friends (ltd) or more widely to the general public (plc)

Question 24

bank finance in limited liability

Answer 24

typically need to be backed by specific collateral, especially for small companies (banks are wary of limited liability).
overdrafts will also need to be backed by security; for new small companies, it is highly likely that a bank would demand a personal guarantee by the founder shareholder

Question 25

angel or venture capital investment in limited liability

Answer 25

both of which tend to be a combination of share and loan capital
: founder suffers dilution of control over the business and the company will probably find that the loan capital is at a much higher interest rate than an ordinary bank loan

Question 26

peer-to-peer or crowdfunding in limited liability

Answer 26

tend to keep control more effectively in the hands of the founder

Question 27

for limited companies, even giant plcs, where does the biggest source of capital for expansion come from

Answer 27

within the business: from trading profit

Question 28

bankrupt definition:

Answer 28

when an individual is unable to meet personal liabilities, some or all of which can be as a consequence of business activities

Question 29

creditors definition:

Answer 29

those owed money by a business - for example, suppliers and bankers

Question 30

limited liability definition:

Answer 30

owners are not liable for the debts of the business; they can lose no more than the sum they invested

Question 31

sole trader definition:

Answer 31

a one-person business with unlimited liability

Question 32

unlimited liability definition:

Answer 32

owners are liable for any debts incurred by the business, even if it requires them to sell all their assets and possessions and become personally bankrupt

Question 33

why would anybody start a business with unlimited personal liability

Answer 33

don’t know, but the majority of uk business have unlimited liability, as proprietors believe there are tax advantages and dislike the extra fiddle and admin costs of running a company

Question 34

why might it be easier for a partnership to raise finance for expansion than a sole trader

Answer 34

simply because the partnership has more than one owner, i.e. there are more pockets to dip in to

Question 35

why might suppliers refuse to give credit to a new small company

Answer 35

a company, by definition, has limited liability. so suppliers are wary of giving credit when, if the company fails, there is no way to recoup the cash from the business owners

Question 36

why don’t companies by assets outright, surely it is cheaper in the long run than leasing

Answer 36

it is, but many firms are so strapped for cash that they take a long-term hit from leasing to gain improved short-term cash flow

Question 37

why do companies pay dividends when the profit they make is so important for financing growth and avoiding debt

Answer 37

shareholders expect an income from their investment; only early-stage, fast-growers such as snapchat can get away with paying no dividends

Question 38

how expensive is it to run a company instead of a sole trader

Answer 38

not that costly. you can form a company for little more than $100, and the ongoing accounting costs are around $1,200 a year