Discover more from JJ Tax Blog
Types of Business Organizations
Types of Business Organizations
A business organization is an entity aimed at carrying on commercial enterprise by providing goods or services to meet the needs of its customers.
All business organizations have common features such as:
Aim to achieve objectives,
Use of resources,
Requirement of direction, and
Legal regulations controlling them
Here are the 5 main types of business ownership structures:
What is the best form of business ownership?
While selecting a business organization, you must have an understanding about the different types of business structures, its merits, demerits, public acceptance and image.
You should consider ownership structure, tax compliances and other financial elements before making your decision.
Let’s review the different forms of business and how each could impact you, your partners, earnings and the legacy of your business.
Sole Proprietorship is “A type of business unit where one person is solely responsible for providing the capital, bearing the risk of the enterprise and for management of the business.”
CHARACTERISTICS OF SOLE PROPRIETORSHIP FORM OF BUSINESS ORGANISATION
(a) Single Ownership/One-man Control:
A single-owner starts the business by bringing together all the resources. He runs the business as per his own will.
(b) No Separation of Ownership and Management:
The owner manages the business as per his/her own skills and intelligence.
There is no separation of ownership and management.
(c) Less Legal Formalities: :
The formation and operation do not involve any legal formalities.
Formation is quite easy and simple.
(d) No Separate Entity:
The businessman and the business enterprise are one and the same.
The businessman is responsible for everything that happens in his business unit.
(e) No Sharing of Profit and Loss:
The sole proprietor enjoys the profits alone.
At the same time, entire loss is also borne by him.
MERITS OF SOLE PROPRIETORSHIP FORM OF BUSINESS ORGANISATION
(a) Easy to Form and Wind Up:
It is very easy and simple to form a sole proprietorship. No legal formalities are required to be undertaken.
Similarly, the business can be wound up any time as per the decision of the proprietor.
(b) Quick Decision and Prompt Action:
Nobody interferes in the affairs of the sole proprietary organization.
He/she can take quick decisions on the various business issues and prompt action can be taken.
(c) Direct Motivation:
All the profit arising out of the business goes to the owner’s pocket.
This motivates the proprietor to work hard and run the business efficiently.
(d) Flexibility in Operation:
The expansion or curtailment of business activities does not require many formalities as in the case of other forms of business organization.
(d) Maintenance of Business Secrets:
The business secrets are known only to the proprietor.
He is not required to disclose any information to others unless and until he himself so decides.
He is also not bound to publish his business accounts.
(e) Personal Touch:
Since the proprietor himself handles everything relating to business, it is easy to maintain a good personal contact with the customers and employees.
By knowing the likes, dislikes and tastes of the customers, the proprietor can adjust his operations accordingly.
Similarly, as the employees are few and work directly under the proprietor, it helps in maintaining a harmonious relationship with them, and run the business smoothly.
LIMITATIONS OF SOLE PROPRIETORSHIP FORM OF BUSINESS ORGANISATION
(a) Limited Resources:
The proprietor has a limited capacity to raise funds for his business.
Being a single owner, it is not always possible for him to arrange sufficient funds from his own sources.
(b) Lack of Continuity:
The continuity of the business is linked with the life of the proprietor.
Illness, death or insolvency of the proprietor can lead to closure of the business.
(c) Unlimited Liability:
In the eyes of law, the proprietor and the business are one and the same.
Personal properties of the owner can be used to meet the business obligations and debts.
(d) Not Suitable for Large Scale Operations:
Since the resources and the managerial ability is limited, sole proprietorship form of business organization is not suitable for large-scale business.
(e) Limited Managerial Expertise:
A single person may not be an expert in all fields like, purchasing, selling, financing etc.
Because of limited financial resources, it is also not possible to engage professional expertise.
SUITABILITY OF SOLE PROPRIETORSHIP FORM OF BUSINESS ORGANISATION
It can be stated that the sole proprietorship is suitable:
Where the capital requirement is small and risk involved is limited.
Where the market is limited, localized and the customers give importance to personal attention.
For the production of goods and services which involve manual skill e.g., handicrafts, filigree work, jewelry, tailoring, hair cutting, etc.
Note: If your business operates in an industry where personal liability is more of a risk, you should avoid a sole proprietorship ownership structure.
The Joint Hindu Family (HUF)
The Joint Hindu Family (JHF) business is a form of a business organization run by the Hindu Undivided Family (HUF), where the family members of 3 successive generations own the business jointly. The head of the family known as Karta manages the business. The other members are called co-parceners and all of them have equal ownership right over the properties of the business.
The membership of the JHF is acquired by virtue of birth in the same family. There is no restriction for minors to become members of the business.
CHARACTERISTICS OF Joint Hindu Family (HUF)
From the above discussion, it is clear that the HUF business has certain special characteristics which are as follows:
Formation: In JHF business, there must be at least two members in the family and the family should have some ancestral property. It is not created by an agreement but by operation of law.
Legal Status: The JHF business is a jointly owned business. It is governed by the Hindu Succession Act 1956.
Membership: In JHF business, outsiders are not allowed to become the coparcener. Only the members of an undivided family acquire co-partnership rights by birth.
Profit Sharing: All coparceners have equal share in the profits of the business.
Management: The business is managed by the senior most member of the family known as Karta. Other members do not have the right to participate in the management. The Karta has the authority to manage the business as per his own will and his ways of managing cannot be questioned. If the coparceners are not satisfied, the only remedy is to get the HUF status of the family dissolved by mutual agreement.
Liability: The liability of coparceners is limited to the extent of their share in the business. But the Karta has an unlimited liability. His personal property can also be utilised to meet the business liability.
Continuity: Death of any coparceners does not affect the continuity of business. Even on the death of the Karta, it continues to exist as the eldest of the coparceners takes the position of Karta. However, JHF business can be dissolved either through mutual agreement or by partition suit in the court.
MERITS OF HUF:
Assured Shares in Profits: Every coparcener is assured of an equal share in the profits irrespective of his participation in the running of the business. This safeguards the interest of minor, sick, physically, and mentally challenged coparceners.
The Karta enjoys full freedom in managing the business.
It enables him to take quick decisions without any interference.
Limited Liability of Members:
The liability of the coparceners except the Karta is limited to the extent of his share in the business.
This enables the members to run the business freely just by following the instructions or direction of the Karta.
Unlimited Liability of the Karta:
Because of the unlimited liability of the Karta, his personal properties are at stake in case the business fails to pay the creditors.
This clause of JHF business allows the Karta to manage business most carefully and efficiently.
The death or insolvency of any member does not affect the continuity of the business.
It can continue for a long period of time.
Tax Benefits: HUF is regarded as an independent assessee for tax purposes. The share of coparceners is not to be included in their individual income for tax purposes.
LIMITATION OF HUF:
Limited Resources: JHF business has generally limited financial and managerial resource. Therefore, it is not considered suitable for large business.
Lack of Motivation: The coparceners get equal share in the profits of the business irrespective of their participation.
Scope for Misuse of Power: Since the Karta has absolute freedom to manage the business, there is scope for him to misuse it for his personal gains.
Instability: The continuity of HUF business is always under threat. A small rift within the family may lead to partition.
SUITABILITY OF HUF: It is suitable where the family inherits a running business and the members of the family want to continue that business jointly as a family business. Also, HUF is considered suitable for a business that requires limited financial and managerial resources and having a very limited area of operation. It is found that HUF is usually engaged in trading business, indigenous banking, small industry, and crafts etc.
Partnership is an association of two or more persons who pool their financial and managerial resources, agree to carry on business and share its profit. The persons who form a partnership are individually known as partners and collectively a firm or partnership firm.
CHARACTERISTICS OF PARTNERSHIP:
The various characteristics of partnership form can be summarised as follows:
(a) Two or More Persons:
To form a partnership firm, atleast two persons are required.
The maximum limit on the number of persons is ten for banking business and 20 for other businesses.
If the number exceeds the above limit, the partnership becomes illegal.
(b) Contractual Relationship:
Partnership is created by an agreement among the persons who have agreed to join hands.
Such persons must be competent to contract.
Minors, lunatics and insolvent persons are not eligible to become partners.
A minor can have a share in the profits without any obligation for losses.
There must be an agreement among the partners to share the profits and losses of the business of the partnership firm.
(c) Existence of Lawful Business:
The business of which the persons have agreed to share the profit must be lawful.
Any agreement to indulge in smuggling, black marketing etc. cannot be called partnership business in the eyes of law.
(d) Principal-Agent Relationship:
Every partner is the principal as well as the agent of the firm.
When a partner deals with other parties, he acts as an agent of other partners, and at the same time the other partners become the principal.
(e) Voluntary Registration:
The registration of partnership firm is not compulsory.
But an unregistered firm suffers from some limitations which makes it virtually compulsory to be registered.
Following are the limitations of an unregistered firm.
The firm cannot sue outsiders, although the outsiders can sue it.
In case of any dispute among the partners, it is not possible to settle the dispute through court of law.
The firm cannot claim adjustments for amount payable to, or receivable from, any other parties.
MERITS OF PARTNERSHIP FORM OF BUSINESS ORGANISATION
(a) Easy to Form:
A partnership can be formed easily without many legal formalities.
It is not compulsory to get the firm registered. A simple agreement, either in oral or writing is sufficient to create a partnership firm.
(b) Availability of Larger Resources:
Since two or more partners join hands to start a firm, it may be possible to pool more resources as compared to sole proprietorship form of business organisation.
(c) Better Decisions:
Each partner has a right to take part in the management of the business.
Decisions are taken with the consent of all partners. There is less scope for hasty decisions.
The partnership firm is a flexible organisation.
At any time, the partners can decide to change the size or nature of the business or area of its operation after taking the necessary consent of all the partners.
(e) Sharing of Risks/ Keen Interest.
The losses of the firm are shared by all the partners equally or as per the agreed ratio.
Since partners share the profit and bear the losses, they take keen interest in the affairs of the business.
Business secrets of the firm are only known to the partners.
It is not required to disclose any information to the outsiders.
It is also not mandatory to publish the annual accounts of the firm.
(g) Protection of Interest:
The rights of each partner and his/her interests are fully protected.
If a partner is dissatisfied with any decision, he can ask for dissolution of the firm or can withdraw from the partnership
LIMITATIONS OF PARTNERSHIP
A partnership firm also suffers from certain limitations which are as follows:
(a) Unlimited Liability:
The drawback of partnership firm is that the liability of the partners is unlimited.
Their personal property can also be utilised for payment of firm’s liabilities.
The liability of a minor partner is limited to the extent of his profits.
Every partnership firm has an uncertain life.
The death, insolvency, incapacity or the retirement of any partner brings the firm to an end.
(c) Limited Capital:
Since the total number of partners cannot exceed 20, the capacity to raise funds remains limited as compared to a company where there is no limit on the number of shareholders.
(d) Non-transferability of share:
The share of interest of any partner cannot be transferred to other partners or to the outsiders.
The only alternative is dissolution of the firm.
(e) Possibility of Conflicts:
Every partner can place his opinion or viewpoint before the management regarding any matter at any time.
Sometimes difference of opinion may give rise to quarrels and lead to dissolution of the firm.
SUITABILITY OF PARTNERSHIP FORM OF BUSINESS ORGANISATION
Persons having different abilities, skill or expertise can join hands and form a partnership firm to carry on the business.
Business activities like construction, providing legal services, medical services etc. can successfully run under this form of business organisation.
It is also considered suitable where capital requirement is of a medium size.
Thus, business like wholesale trade, professional services, mercantile houses and small manufacturing units can be successfully run by partnership firms.
A company is defined as a voluntary association of persons having separate legal existence, perpetual succession and a common seal. As per the definition, there must be a group of persons who voluntarily agree to form a company.
CHARACTERISTICS OF A COMPANY:
(a) Registered body:
A company comes into existence only after its registration.
Legal formalities have to be completed as prescribed under the Companies Act.
(b) Distinct legal entity:
A company is regarded as a legal entity separate from its members.
A company can carry on business in its own name, enter into contracts, sue, and be sued.
(c) Artificial person:
A company is the creation of law and has a distinct entity. Therefore, regarded as an artificial person.
The business is run in the name of the company.
Its functions are performed by the elected representatives of members, known as directors.
(d) Perpetual succession:
A company has continuous existence independent of its members.
Death, insolvency, or change of members has no effect on the life of a company.
The life of the company can come to an end only through the prescribed legal procedure.
(e) Common seal:
Every company must have a common seal with its name engraved on it.
Anyone acting on behalf of the company must use the common seal to bind the company.
(f) Transferability of shares:
The capital of a company is divided into parts called shares. The shares of a company are freely transferable by its members.
However, transferability is restricted in the case of private companies.
Merits of Company
The most important advantages of a company are as follows:
(a) Collection of huge financial resources:
A company has the ability to collect large amounts of funds.
A company can raise capital by issuing shares to a large number of persons.
Shares of small value can be subscribed even by people with small savings.
Companies can also raise loans from the public as well as different lending institutions.
Availability of necessary funds makes it possible for a company to undertake business activities on a large scale.
(b) Limited liability:
With the liability of members limited to the value of their shares, the company is able to attract many people to invest in its shares.
A company is in a position to undertake business ventures involving risks.
(c) Free transferability of shares:
A company permits its members to transfer their shares.
Free transferability of shares provides liquidity of the member’s investment.
If a member needs cash he can sell his shares.
(d) Durability and stability:
A company is the only form of organisation which enjoys continuous existence and stability.
Any change in the company’s membership does not affect its life.
A company can undertake projects of long duration and attract people to invest in the business of the company.
(e) Growth and expansion:
With the large resources at its command a company can organize business on a large scale.
Once the business is started on a large scale it gives the company strength to grow and expand.
This is because of high profits, which accrue from the economies of large-scale organisation and production.
(f) Efficient management:
Since a company undertakes large-scale activities, it requires the services of expert professional managers.
Competent managers can be easily hired by a company because it commands large financial resources.
Thus, efficient management is ensured in a company organisation.
(g) Public confidence:
A company enjoys great confidence and trust of the general people.
Companies have to disclose the results of their activities and financial position in the annual reports.
The reports are available to the public.
On the basis of the annual reports and other information, investment is made in companies.
Limitations of a Company
A company suffers from the following limitations:
(a) Lengthy and expensive legal procedure:
The registration of a company is a long-drawn process.
A number of documents are to be prepared and filed.
For preparing documents, professionals are to be hired who charge high fees.
Registration fees have also to be paid to the Registrar of Companies.
(b) Excessive government regulations:
A company is subject to government regulations at every stage of its working.
A company has to file regular returns and statements of its activities with the Registrar.
There is a penalty for non-compliance of the legal requirements.
Filing returns and reports involving considerable time and money is the responsibility of a company.
(c) Lack of incentive:
The company is not managed by shareholders but by directors.
Officials do not have investment in the company and also do not bear the risks. As such, they may not be as motivated to safeguard the interests of the company as the shareholders.
(d) Delay in decision-making and action:
In large companies, decision making and its implementation happen to be a time-consuming process. This is obvious because individual managers are unable to take decisions on their own.
After decisions are taken, they have to be communicated to people working at various levels of the organisation.
It also delays the implementation of already delayed decisions.
(e) Conflict of interest:
A company is generally characterised by a large organization with many groups operating in it.
Sometimes, individual and group interests become difficult to reconcile.
A company organization provides scope for speculation in shares by the directors.
Because directors have knowledge of all information about the functioning of Company, they can use it to their personal advantage.
For example, directors may sell or buy shares knowing that prices will decline or go up because of low or high profits. As a result of this, innocent shareholders may suffer loss.
(g) Growth of monopolistic tendencies:
A company has the tendency to grow into a monopoly so as to eliminate competition.
A company can control the market and charge unreasonable prices to maximise profits.
(h) Influencing government decisions:
Big companies are generally in a position to influence government officials to make decision in their favour.
SUITABILITY OF COMPANY:
It is clear that the company is best suited to those lines of business activity which are to be organised on a large scale, require heavy investment of capital with limited liability of members.
That is why enterprises producing steel, automobiles, computers and high technology products are generally organised as companies.
For Detailed Analysis, watch video on :