S.

SASIKALA
ASSISTANT PROFESSOR
PG AND RESEARCH DEPARTMENT OF COMMERCE
SRI SANKARA ARTS AND SCIENCE COLLEGE
ENATHUR KANCHIPURAM.

EDP (UNIT 4)

SOLE PROPRIETORSHIP

A sole proprietorship (also known as individual entrepreneurship, sole trader, or simply

proprietorship) is a type of an unincorporated entity that is owned by one individual only.
It is the simplest legal form of a business entity.

CHARACTERISTICS OF SOLE PROPRIETORSHIP:

1. Single ownership:

A sole proprietorship is wholly owned by one individual. The individual supplies the
total capital from his own wealth or from borrowed funds.

2. One-man control:

The proprietor alone takes all the decisions pertaining to the business. He is not
required to consult anybody. Ownership and management are vested in the same
person. Some persons may be employed to help the owner but ultimate control lies
with him.

3. No legal entity:

A sole proprietorship has no legal identity separate from that of its owner. The law
makes no distinction between the proprietor and his business. The business and the
owner exist together. If the owner dies or becomes insolvent the business is dissolved.
Business and the proprietor are one and the same.
4. Unlimited liability:

The proprietor is personally liable for all the debts of the business. In case the assets
are insufficient to meet its debts, the personal property of the proprietor can be
attached.

5. No profit-sharing:

The sole proprietor alone is entitled to all the profits and losses of business. He bears
the complete risk and there is nobody to share the profits or losses.

6. Small size:

The scale of operations carried on by a sole proprietorship is generally small. A sole

trader can arrange limited funds and managerial ability. Therefore, the area of
operations is limited.

7. No legal formalities:

No legal formalities are required to start, manage and dissolve sole trader business.

Advantages of a Sole Proprietorship

Despite its simplicity, a sole proprietorship offers several advantages, including the
following:

1. Easy and inexpensive process

The establishment of a sole proprietorship is generally an easy and inexpensive process.

Certainly, the process varies depending on the country, state, or province of residence.
However, in all cases, the process requires minimum or no fees, as well as very little
paperwork.
2. Few government regulations

Sole proprietorships adhere to a few regulatory requirements. Unlike corporations, the

entities do not need to spend time and resources on various government requirements
such as financial information reporting to the general public.

3. Tax advantages

Unlike the shareholders of corporations, the owner of a sole proprietorship is taxed only
once. The sole proprietor pays only the personal income tax on the profits earned by the
entity. The entity itself does not have to pay income tax.

Disadvantages of sole proprietorship

Potential disadvantages include the following:

1. Unlimited liability of the owner

Since a sole proprietorship does not create a separate legal entity, the business owner
faces unlimited personal liability for all debts incurred by the entity. In other words, if a
business cannot meet its financial obligations, creditors can seek repayment from the
entity’s owner, who must use his or her personal assets to repay outstanding debts or
other financial obligations.

2. Limitations on capital raising

Unlike partnerships and corporations, sole proprietorships generally enjoy fewer options
to raise capital. For example, the owner cannot sell an equity stake to obtain new funds.
In addition, the ability to obtain loans depends on the owner’s personal credit history.
 PARTNERSHIP

A partnership is a formal arrangement by two or more parties to manage and operate

a business and share its profits.

There are several types of partnership arrangements. In particular, in a partnership

business, all partners share liabilities and profits equally, while in others, partners
may have limited liability.

Merits of Partnership

The partnership form of business organisation enjoys the following advantages:

1. Ease of formation:

Partnership is simple to form, inexpensive to establish and easy to operate. No legal

formalities are involved and no formal documents are to be prepared. Only an
agreement is required. Even the registration of the firm is not compulsory. Similarly, a
partnership can be dissolved easily at any time.

2. Larger financial resources:

It is possible to collect a large amount of capital due to a number of partners. New

partners can be admitted to raise further capital whenever necessary. Credit-
worthiness is also high because every partner is jointly and severally liable for all the
debts of the firm.

3. Combined abilities and judgement:

The skill and experience of all the partners are pooled together. Combined judgement
of several persons helps reduce errors of judgement.

The partners may be assigned duties according to their talent. Therefore, benefits of
specialisation are available. Partners meet frequently and can take prompt decisions.

4. Direct motivation:
Ownership and management of business are vested in the same persons. There is
direct relationship between effort and reward. Every partner is motivated to work hard
and to ensure the success of the firm.

5. Close supervision:

Every partner is expected to take personal interest in the affairs of the business.
Different partners can maintain personal contacts with employees and customers.

Fears of unlimited liability make the partners cautious and avoid reckless dealings.
Management of partnership is cheaper when expert managers are not employed.

6. Flexibility of operations:

Partnership business is free from legal restrictions and government control. Partners
can make changes in the size of business, capital and managerial structure without any
approval. The activities of partnership business can be adapted easily to changing
conditions in the market.

7. Secrecy:

A partnership firm is not required to publish its annual accounts. Audit of accounts is
not essential and no reports are to be filed with the government authorities. Therefore,
the affairs of a partnership business can easily be kept secret and confidential.

8. Protection of minority interest:

Management of partnership is democratic. Every partner has a right to be consulted

and express his opinion. All important decisions are taken with the mutual consent of
all the patters. In case a partner is dissatisfied with the majority decisions, he can
retire from the firm or give a notice for its dissolution.

9. Cooperation:

Partnership encourages mutual cooperation and trust amongst people. Partners work
in common for the benefit of all and do their level best to make the business
prosperous.
Demerits of Partnership

1. Unlimited liability:

Every partner is jointly and severally liable for the entire debts of the firm. He has to
suffer not only for his own mistakes but also for the lapses and dishonesty of other
partners.

This may curb entrepreneurial spirit as partners may hesitate to venture into new lines
of business for fear of losses. Private property of partners is not safe against the risks
of business.

2. Limited resources:

The amount of financial resources in partnership is limited to the contributions made

by the partners. The number of partners cannot exceed 10 in banking business and 20
in other types of businesses.

Therefore, partnership form of ownership is not suited to undertake business

involving huge investment of capital.

3. Risk of implied agency:

The acts of a partner are binding on the firm as well as on other partners. An
incompetent or dishonest partner may bring disaster for all due to his acts of omission
or commission. That is why the saying is that choosing a business partner is as
important as choosing a life partner.

4. Lack of harmony:

The success of partnership depends upon mutual understanding and co-operation

among the partners. Continued disagreement and bickering among the partners may
paralyze the business or may result in its untimely death. Lack of a central authority
may affect the efficiency of the firm. Decisions may get delayed.

5. Lack of continuity:
 A partnership comes to an end with the retirement, incapacity, insolvency and death
of a partner. The firm may be carried on by the remaining partners by admitting new
partner.

But it is not always possible to replace a partner enjoying trust and confidence of all.
Therefore, the life of a partnership firm is uncertain, though it has a longer life than
sole-proprietorship.

6. Non-transferability of interest No partner can transfer his share in the firm to an

outsider without the unanimous consent of all the partners. This makes investment in
a partnership firm non-liquid and fixed. An individual’s capital is blocked.

7. Public distrust:

A partnership firm lacks the confidence of public because it is not subject to detailed
rules and regulations. Lack of publicity of its affairs undermines public confidence in
the firm.

JOINT STOCK COMPANY

A company or association consisting of individuals organized to conduct a business for

gain and having a joint stock of capital represented by shares owned individually by the
members

CHARACTERISTICS OF JOINT STOCK COMPANY:

1. An artificial person:
A joint stock company is an artificial person which is created by the law. It has no
physical shape as a natural person but has almost all the rights of a natural person.
It can sue others and can be sued.

2. Perpetual existence:
A joint stock company is established by the law and the law brings it to an end. So,
many shareholders may transfer their share and the new person may come in their
place but it does not affect the existence of the company.
3. Limited liability:
The liability of the shareholder is limited to the extent of the value of shares held or
the amount guaranteed by them. If the company is unable to pay to the creditors
then the shareholder won't pay anything more than what is to be paid to the
company.

4. Common seal:
A joint stock company is an artificial person. So, it cannot sign any contract in its
name. Therefore, all the documents and contract papers require the affixing of the
seal. Any documents with the common seal are only taken into consideration.

5. Democratic management:
A joint stock company is a democratic organization. The important decisions are
taken by following the principles of democracy in the annual general meeting and
the board of director meeting.

6. Transferability of shares:
The shares of the joint stock company can be transferable from one person to
another without prior permission of the company management. They are free to
transfer their shares.

7. Capital is divided into shares:

A joint stock company divides its capital into a large number of parts with each
value where each part of capital is called share. These shares are purchased by the
general public as well as the promoters to be the shareholders of the company.

8. Publication of financial statements:

A joint stock company should publish the audited financial statements yearly in a
renowned national newspaper. This statement helps to provide information to the
general public and other stakeholders.

9. Separate legal entity:

A joint stock company is an artificial company so it has its own separate legal
entity from its members. It can own assets, property, enter into contracts, sue or
can be sued by anyone in the court by the law. Its shareholders cannot be held
liable for any conduct of the company.
MERITS OF JOINT STOCK COMPANY:

1. Huge capital:
A joint stock company has an association with various persons. It has the merits of
huge capital because different member invests a large amount of capital. When
there is a lack of capital in a joint stock company it can issue the shares to the
public. Hence, huge capital can be collected when shares are issued.

2. Perpetual existence:
A Joint stock company has a separate legal existence. The life of a joint stock
company is not affected by death, lunacy, and insolvency of the members.
Therefore, a joint stock company has a long-term life. Even if there are any
changes in management, the board of directors or some member may come or go,
the function of the company is not affected.

3. Limited Liability:
Limited liability is the significance of a joint stock company. The shareholders
should not pay the excess debt of the company by selling their private/personal
property. Shareholders are liable up to the invested amount. Due to the provision of
limited liability potential investors are attracted by a joint stock company.

4. Transfer of shares:
A joint stock company has the provision of free transfer of shares. No one is
compelled to join and leave the company. Permission or mutual consent is not
needed to transfer the shares of a joint stock company.

5. Democratic management:
A joint stock company has democratic management. It is managed by the majority
of shareholders who elect the board of directors. They are responsible for
managing the activities of a joint stock company. Competent members are elected
from election to manage the company. Thus, democratic management can be seen
in a joint stock company.

6. Public faith:
People have faith in a joint stock company. It has an obligation to disclose the
 financial documents to the Annual General Meeting. The banks and the financial
institutions believe in a joint stock company because of the accounts disclosed.

7. Large-scale operation:
A Joint stock company has an association with different managerial skill because
different members are associated with it. Due to the sufficient capital and
competency of the members (directors)joint-stock company has the possibility of a
large-scale operation. Hence, a joint stock company has a large-scale operation.

8. Social importance:
A joint stock company is also a social creature. So, it invests amount for the
betterment of society. It invests its capital in various sectors such as health,
education, sports and so on. Hence, a joint stock company has a responsibility to
society.

DEMERITS OF JOINT STOCK COMPANY:

1. Difficult legal formalities:

A joint stock company has demerits of difficult legal formalities. It is difficult to
establish and run. It has to follow difficult legal formalities in comparison to sole
trading and partnership firm. It is rigidly observed by rules, regulations or laws of
government because it collects capital from the general public.

2. Lack of secrecy:
A Joint stock company has an obligation to disclose the accounts to insider as well
as an outsider. The planned policies and strategies of the joint stock company are
transparent because they are discussed in the Annual General Meeting. The
company has to publish its statements of financial affairs every year. So, it has
demerits of lack of secrecy.

3. Delay in decision making:

Sometimes a business organization has to take the quick decision but the quick
decision is not possible in a joint stock company. The major decision of the
company must be passed from the Annual General Meeting. So, long time is
required to pass the decision. Thus, business delays grabbing the opportunities of
an external environment.
 4. Speculation of share:
There is the possibility of speculation of share in a joint stock company. Some
shareholders have an inside approach with directors. Those shareholders can take
undue advantage when they misuse the inside approach with directors.

5. Management of oligarchy:
Management oligarchy means the rule of the minority. The shareholders elect few
directors in annual general meeting. Those few directors rule/control over the
activities of a large number of shareholders. This is known as oligarchy.

6. Conflict of interest:
Different parties are involved in a joint stock company. They are shareholders,
creditors/bankers, and employees. Different parties have different interest. If the
interest of one party is addressed, it negatively impacts the interest of others.
Therefore, a joint stock company has demerits of conflict of interest.

7. Neglect the minority:

A joint stock company gives priority to majority shareholders. Minority
shareholders are neglected in Annual General Meeting and election. Only majority
shareholders are given priority to take the decision of the joint stock company.
Minority shareholders are boycotted to run productive business activities.

FACTORS INFLUENCING THE CHOICE OF ORGANISATION:

1. Nature of business activity:

This is an important factor having a direct bearing on the choice of a form of

ownership. In small trading businesses, professions, and personal service trades, sole-
proprietorship is predominant.

2. Scale of operations:
The second factor that affects the form of ownership organisation is the scale of
operations. If the scale of operations of business activities is small, sole proprietorship
is suitable; if this scale of operations is modest — neither too small nor too large —
partnership is preferable; whereas, in case of large scale of operations, the company
form is advantageous.

The scale of business operations depends upon the size of the market area served,
which, in turn, depends upon the size of demand for goods and services. If the market
area is small, local, sole-proprietorship or partnership is opted. If the demand
originates from a large area, partnership or company may be adopted.

3. Capital requirements:

Capital is one of the most crucial factors affecting the choice of a particular form of
ownership organisation. Requirement of capital is closely related to the type of
business and scale of operations. Enterprises requiring heavy investment (like iron
and steel plants, medicinal plants, etc.) should be organised as joint stock companies.

4. Degree of control and management:

The degree of control and management that an entrepreneur desires to have over
business affects the choice of ownership organisation. In sole proprietorship,
ownership, management, and control are completely fused, and therefore, the
entrepreneur has complete control over business.

5. Degree of risk and liability:

The size of risk and the willingness of owners to bear it is an important consideration
in the selection of a legal form of ownership organisation. The amount of risk
involved in a business depends, among other, on the nature and size of business.
Smaller the size of business, smaller the amount of risk.

6. Stability of business:

Stability of business is yet another factor that governs the choice of an ownership
organisation. A stable business is preferred by the owners insofar as it helps him in
attracting suppliers of capital who look for safety of investment and regular return,
and also helps in getting competent workers and managers who look for security of
service and opportunities of advancement. From this point of view, sole
proprietorships are not stable, although no time limit is placed on them by law.

SOURCES OF PROJECT FINANCE

Project financing is a means of obtaining funds for industrial projects, long-term

infrastructure, and public services. Many businesses use this funding method to take
care of major projects using a non-recourse or limited financial structure. There are
several ways to secure project finance, such as investor, loans, private finance, equity,
funds, grants, etc. The repayment is managed from the cash-flow generated off the
project.

It is a secured form of lending, accepting the project’s rights, assets, and interests as
collateral. Project loans are useful in more than one way. It can help expand the
manufacturing capacity, rent a workstation, upgrade technology, handle unexpected
expenses, experimentation for a new service or a product, create a cash pool, etc.

Below, we have discussed different sources from where one can obtain project
financing.
 Venture Capital

Venture capitalists invest in a project for a non-executive position on the board. They
provide capital in exchange of an equity share or a position at a strategic level. Once
the value of shares increase, they may sell those for a profit.

Loan for Business

Apart from secured lending, a company can choose unsecured business loan that
Comes for a fixed tenure with a repayment plan. The cost of loan is determined by
estimating the returns from the project. The interest payment is tax deductible in some
cases. An agreement is made between the financial institution and the borrower for a
specific loan amount and tenure.

Overdrafts

Overdrafts are ideal for a short-term finance. The period of overdraft facility is for a
year or less. The interest is only charged on the amount spent from the person’s
account. Such financing can be arranged quickly like business loans.

Share Capital

The shareholders get profits from dividend. This share of profit is derived from
ordinary shares (owned by business owners who can share profits of an organization
from dividends) or preference shares (does not belong to company owners but a third-
party). Capital gain is expected from selling the shares in future. It is the company
shareholders who raise the Share Capital.

Debentures

Debenture loans come with a fixed or a floating rate and provided against an
organization’s assets. The debenture holders receive payment of interest before the
shareholders receive their dividend payment. If the business fails, then these holders
are liable as preferential creditors.

A project loan offers a great opportunity to fund-providers and investors to be a part

of the company’s growth process and share its profits. The above-mentioned sources
 for project financing are crucial for new companies. Apart from these sources, a few
others to mention are project grants and government funding.

SOURCES OF LONG TERM FINANCE:

Long term financing means financing by loan or borrowing for a term
of more than one year by way of issuing equity shares, by the form of
debt financing, by long term loans, leases or bonds and it is done for
usually big projects financing and expansion of company and such
long term financing is generally of high amount.
The fundamental principle of long term finances is to finance the strategic capital projects
of the company or to expand the business operations of the company.
These funds are normally used for investing in projects that are going to generate
synergies for the company in the future years.
Eg: – A 10-year mortgage or a 20-year lease.

Equity Capital

It represents the interest-free perpetual capital of the company raised by public or

private routes. Either the company may raise funds from the market via IPO or may
opt for a private investor to take a substantial amount of stake in the company.

In equity financing, there is a dilution in the ownership and the controlling stake rest
with the largest equity holder.
The equity holders have no preferential right in the dividend of the company and carry a
higher risk across all the buckets.
The rate of return expected by the equity shareholders is higher than the debt holders
due to the excessive risk they bear in terms of repayment of their invested capital.

Preference Capital

Preference shareholders are those who carry preferential rights over equity
shareholders in terms of receiving dividends at a fixed rate and getting back invested
capital in the company in case if the same is wound up.
It is a part of the Net Worth of the Company thus increasing the creditworthiness and
improving the leverage as compared to the peers.

Debentures

Is a loan taken from the public by issuing debenture certificates under the common
seal of the company? debentures can be placed via public or private placement. If a
company wants to raise money via NCD from the general public, it takes the debt IPO
route where all the public subscribing to it gets allotted certificates and are creditors
of the company. If a company wants to raise money privately, It may approach the
major debt investors in the market and borrow from them at higher Interest Rates.

• They are entitled to a fixed payment of interest as per the agreed-upon terms
mentioned In the term sheet.
• They do not carry voting rights and are secured against the assets of the company.
• In case of any default in payment of debenture interest, the debenture holders can sell
the assets of the company and recover their dues.
• They can be redeemable, irredeemable, convertible, and non-convertible.

Term Loans

They are given generally by banks or financial institutions for more than one year.
They have mostly secured loans given by banks against strong collaterals provided
by the company in the form of land & bldg, machinery, and other fixed assets.

• They are a flexible Source of finance provided by the banks to meet the long term
capital needs of the organization.
• They carry a fixed rate of interest and gives the borrower the flexibility to structure
the repayment schedule over the tenure of the loan based upon the cash flows of the
company.
• It is faster as compared to the issue of equity or preference shares in the company as
there are fewer regulations to abide and less complexity.

Retained Earnings

These are the profits that are been kept aside by the company over a period of time to
meet the future capital needs of the company.

• These are free reserves of the company which carry nil cost and are available free of
cost without any interest repayment burden.
• It can be safely used for business expansion and growth without taking additional debt
burden and diluting further equity in the business to an outside investor.
• They form part of the net worth and have an impact directly on the equity share
valuation.
SOURCES OF SHORT TERM FINANCE
Trade credit

A firm customarily buys its supplies and materials on credit from other firms,
recording the debt as an account payable. This trade credit, as it is commonly called,
is the largest single category of short-term credit. Credit terms are usually expressed
with a discount for prompt payment. Thus, the seller may state that if payment is
made within 10 days of the invoice date, a 2 percent cash discount will be allowed. If
the cash discount is not taken, payment is due 30 days after the date of invoice. The
cost of not taking cash discounts is the price of the credit.
Commercial bank loans

Commercial bank lending appears on the balance sheet as notes payable and is second
in importance to trade credit as a source of short-term financing. Banks occupy a
pivotal position in the short-term and intermediate-term money markets. As a firm’s
financing needs grow, banks are called upon to provide additional funds. A single
loan obtained from a bank by a business firm is not different in principle from a loan
obtained by an individual. The firm signs a conventional promissory note. Repayment
is made in a lump sum at maturity or in installments throughout the life of the loan.
A line of credit, as distinguished from a single loan, is a formal or informal
understanding between the bank and the borrower as to the maximum loan balance
the bank will allow at any one time.
Commercial paper

Commercial paper, a third source of short-term credit, consists of well-established

firms’ promissory notes sold primarily to other businesses, insurance companies,
pension funds, and banks. Commercial paper is issued for periods varying from two to
six months. The rates on prime commercial paper vary, but they are generally slightly
below the rates paid on prime business loans.

A basic limitation of the commercial-paper market is that its resources are limited to
the excess liquidity that corporations, the main suppliers of funds, may have at any
particular time. Another disadvantage is the impersonality of the dealings; a bank is
much more likely to help a good customer weather a storm than is a commercial-
paper dealer.
Secured loans

Most short-term business loans are unsecured, which means that an established
company’s credit rating qualifies it for a loan. It is ordinarily better to borrow on an
unsecured basis, but frequently a borrower’s credit rating is not strong enough to
justify an unsecured loan. The most common types of collateral used for short-term
credit are accounts receivable and inventories.

Financing through accounts receivable can be done either by pledging the receivables
or by selling them outright, a process called factoring in the United States. When a
receivable is pledged, the borrower retains the risk that the person or firm that owes
the receivable will not pay; this risk is typically passed on to the lender when
factoring is involved.

When loans are secured by inventory, the lender takes title to them. He may or may
not take physical possession of them. Under a field warehousing arrangement, the
inventory is under the physical control of a warehouse company, which releases the
inventory only on order from the lending institution. Canned goods, lumber, steel,
coal, and other standardized products are the types of goods usually covered in field
warehouse arrangements.