Week 2 - Business Structures Flashcards
Types of Business Entities
- Most businesses are established to make money (For-Profit) but some businesses are established as Not-For-Profit.
- Manufacturing entities are involved in converting raw materials into finished goods.
- Trading entities buy goods (inventory) at ‘cost’ price and sell for a profit at a higher ‘sales’ price.
- Services entities provided services to people. Services can be equipment based or people based or a mixture.
In what way, do Business Structures differ?
- Owner liability
- Equity structure
- Funding opportunities
- Decision making responsibilities
- Taxation
What are the THREE types of Business Structures?
- Sole Trader
- Partnership
- Company
What is a Sole Trader?
A sole trader is an individual who controls and manages a business and is solely liable for all the business debts.
Features of a Sole Trader
- The business is not a separate legal entity.
- Need to apply for an Australian Business Number (ABN) and GST.
- Usually uses accounting software such as MYOB to prepare financial reports.
Advantages of a Sole Trader
- Quick, inexpensive and easy to establish. Inexpensive to wind down.
- Not subject to company regulation.
- Owner has total autonomy over business decisions.
- Owner claims all the profits of the business and all the after-tax gains if the business is sold.
Disadvantages of a Sole Trader
- Unlimited liability – bears full responsibility for business debts and legal actions such as negligence.
- Limited by skill, time and investment of the owner.
- Restrictive structure due to non-legal status of the entity.
- Business will cease to exist if the owner leaves, retires or dies.
What is a Partnership?
A partnership is an association between two or more persons who carry on a business as partners.
Features of a Partnership
- Enables sharing of ideas, skills and resources.
- Easy and cheap to establish.
- No separate taxation payable but does lodge income tax return with ATO.
- Share profits or losses according to partnership agreement.
- Some partnerships have a written agreement, others don’t.
Advantages of a Partnership
- Relatively easy and simple to set up.
- Informal business structure – not bound by accounting standards.
- Ability to share capital, skills, talents, knowledge and workload between two or more people.
Disadvantages of a Partnership
- Unlimited liability for business debts and obligations by all partners.
- Limited life: if one partner dies or withdraws from the business then the partnership must dissolve.
- Mutual agency: each partner is seen as being an agent for the business and can enter the partnership into contracts.
- Many partnership disputes arise from profit sharing and decision-making issues.
What is a Partnership Agreement?
A Partnership agreement should include details of:
- the name of the partnership
- the contributions of cash and other assets to the partnership made by each partner.
- Methods of sharing profits and losses.
- Procedures for adding or subtracting partners
- If there is no partnership agreement, then the law assumes that all profits or losses will be shared equally between the partners.
What is a Company?
A distinctively separate legal entity from its owners.
- The individual must apply to the Australian Securities and Investments Commission (ASIC) for registration of the company.
- ASIC will allocate a unique Australian Company Number (ACN).
- Companies will also register for an ABN.
Features of a Company
- Owners of a company are known as shareholders.
- Independent legal entity (i.e. separate from the people who own, control and manage it).
- Shareholders have limited liability: for the purchase price of their shares only (not company debts).
- A company has unlimited life: not dissolved when owners die or change.
Advantages of a Company
- Limited liability for shareholders.
- The company taxation rate is 30% (25% for SMEs); considerably lower than the top personal tax rate.
- Business expansion networks are made easier due to legal structure.
- Can raise additional equity (capital) through public share offerings.
Disadvantages of a Company
- More time consuming and costly to set up.
- Must comply with complex company rules and other legal requirements.
- Taxed from the first dollar of profit.
- Limited liability aspect may cause problems:
(banks often prefer to have director’s personal guarantees instead) - Separation of ownership and control
Comparison of Business Structures (Sole Trader)
SOLE TRADER
No. of Owners = 1
Liability = Unlimited
Profit = Belongs to owner
Tax = Owner taxed as individual tax payer (profit treated as income of owner)
Comparison of Business Structures (Partnership)
PARTNERSHIP
No. of Owners = 2-50
Liability = Unlimited
Profit = Distributed to partners as per agreement
Tax = Partners taxed as separate individuals
Comparison of Business Structures (Companies)
COMPANIES
No. of Owners = At least one. Proprietary companies - no more than 50. Public companies - no limit.
Liability = Limited
Profit = Distributed to shareholders in form of dividends, at discretion of board.
Tax = Company taxed on profits. Shareholders taxed on dividends less tax credit for tax paid by company
What is Equity Structure of Sole Traders and Partnerships?
- Capital is raised by the owner/s transferring assets to the business. Each owner’s contribution to capital is recorded separately.
- Owners working in the business are not employees as there is no separation of owners and business in these structures.
- Owners include their respective portion of the business profits on their individual tax return, whether it is distributed from the business or not.
- When the owners take money or assets from the business it is called Drawings. Each owner’s drawings are recorded separately.
What is the Equity Structure of a Company?
- Share Capital is raised by companies through the sale of shares.
- Owners working in the company are employees and paid wages, as the company is a separate legal entity to the owners (shareholders).
- The company pays tax on company profit at a flat rate.
- Distributions of profit are made to Shareholders and are called Dividends, as the company pays tax on the profit. Dividends carry a tax credit.
- Profit not paid as dividends is called Retained Earnings as it is retained by the company.
True or False: Sole Proprietors do not need to keep financial records
False
True or False: A partnership does not pay tax, but does lodge a tax return
True
True or False: A disadvantage of a partnership structure is mutual agency
True
