CBSE Class 9 Elements of Business Unit III: Steps Involved in Establishing Business

Unit III: Steps involved in Establishing Business

(a) Nature and Forms of Business Organisation
(b) Sole Proprietorship – meaning, features
(c) Partnership – meaning, features and types

(a) Nature & Forms of Business Organisation:

A business enterprise may have different organisational forms and a businessman has to choose a particular form which would suit him. This is a very important decision that one has to take either before starting a business or expanding an existing one. Various forms of organisations available for adoption are:
(a) Sole proprietorship
(b) Joint Hindu family business
(c) Partnerships
(d) Co-operative society
(e) Joint Stock Company

Sole proprietorship is a form of business organisation where business is owned, managed and controlled by a single individual who is the only recipient of all the profits and bears all risks. Sole proprietorship is characterised by ease of formation and closure.

Partnership is an association of two or more persons who agree to carry on a business, share the profits as well as bear the losses collectively. Though ease of formation and closure are advantages of partnership firms, they are offset by unlimited liability of partners.

Joint Hindu family business are owned and carried on by members of Hindu undivided family and is governed by the Hindu law “Karta”. The strong points of this form of business is effective control, stability, limited liability and increased loyalty among family members. But this type of business often suffers from limited resources and hegemonic tendencies.

A Cooperative society is a voluntary association of persons who get together to protect their economic interests. The major advantages of cooperative societies are equality in voting, members’ limited liability, stable existence, scope of expansion and professional management. Its limitations are complexity in formation, numerous regulations, delay in decision making and conflict of interest. Despite the limitations, a cooperative society like Anand Milk Union limited (Amul) has become giant organisation.

A Company on the other hand may be defined as an artificial person existing only in the eyes of law as a separate legal entity distinct from promoters of the business. Major advantages of a company are limited liability of members, transfer of interest, stable existence, access to adequate funds, scope of expansion and professional management. But companies have to work under numerous regulations and there could be damaging conflict of interests.
Companies are of two types, Public Limited and Private Limited. Private Limited companies do not invite public participation while Public Limited Companies can raise funds from public.

(b) Sole proprietorship:

Meaning:

Sole proprietorship is a popular form ofbusiness organisationand is most suitable for small businesses, at least in the formative years. It refers to a form of business organisation which is owned and managed by an individual who is the recipient of all the profits and bearer of all risks. The word “sole” implies only and proprietor refers to “owner”. Hence sole proprietor is the one who is the only owner of a business. This form of business is particularly common in areas of personalised services like beauty parlours and retail shops.

Features:

(i) Formation and closure: There are no separate laws or acts that govern sole proprietorship. Except for a trade license, hardly any other formality is required to start a sole proprietorship business. Closure of business can also be done easily by surrendering the trade license and GST registration.

(ii) Liability: Sole proprietors have unlimited liability as far as debts are concerned. The owner is personally responsible for payment of debts if such debts cannot be recovered from the assets of the business. In such a case, the owner’s personal assets could be used for repaying the debt. Such contingency may arise at the time of closure of the business and if the assets of the concern are not enough to pay off the creditors.

(ii) Sole risk bearer sole entitlement of profit: The risk of failure of the business and consequent losses is borne entirely by the sole proprietor. However, if the business is flourishing the sole proprietor will enjoy all the benefits. His entitlement to profit is reward for his risk taking.

(iv) Control: The sole proprietor has every right to run the business the way he thinks appropriate. He can execute his plans without any outside interference.

(v) Entity: The sole proprietor and his business exist as one and indivisible unit. In the eyes of the law, no distinction is made between the sole proprietor and his business. The owner is therefore responsible for every activity of the business

(vi) Limited Continuity: A sole proprietorship business is vulnerable from the point of view of continuity of business. Its existence may be jeopardised by death of the owner, poor managerial skill or owner migrating to some other profession.

Merits:

1. Quick decision: A sole has the full freedom of taking business decisions and depending on his business skills he takes quick decisions to meet any situation. Thus, he can cash in on market opportunities pretty effectively.

2. Confidentiality: For any business confidentiality of operations is extremely important as it acts as a protective shield against competition. A sole proprietor being the only decision maker can maintain secrecy of the business to keep competition at bay.

3. Profitability: A sole proprietor reaps the benefit of the entire profit of the business. This acts as a huge incentive for an individual prompting him to try and maximise it.

4. Ease of formation and closure: An important merit of sole proprietorship is the opportunity it provides to enter the world of business without much effort and complications. There are no specific laws or restrictions, so the owner can concentrate on the business operations freely.

Limitations:

1. Limited resources: Generally, the source capital of sole proprietorship business comes from personal savings or borrowings from outsiders. Banks and other financial institutions often hesitate to extend long term loans to a proprietorship business. This makes it vulnerable in the face of competition. Lack of resources is also a reason for proprietorship businesses becoming stagnant.

2. Unstable existence: Being owned and controlled by one person has many disadvantages. The business may go haywire in case of death or illness of the proprietor, bankruptcy or noncompliance of tax law.

3. Unlimited Liability: A major disadvantage of sole proprietorship business is that the owner has unlimited liability. So, if the business fails, the creditors can recover their dues not merely from the business assets but also from the personal assets of the proprietor. This can create a serious burden on the proprietor.

4. Lack of Innovation: The huge risk burden on the proprietor acts as a dampener when it comes to expanding the business. It makes the proprietor wary of taking further risk in the form of innovation or expansion.

5. Limited managerial ability: Since sole proprietorship is a one man show the business has to depend on the judgement of the proprietor regarding sales, purchase, finance etc. So, decision making may not be balanced and ambitious employees may take advantage of the situation.

In-spite of these weaknesses, proprietorship is a highly favoured form of business because of its inherent advantages of simplicity of formation, free and personalised style of operation which can be run with limited financial resources.

(c) Partnership – meaning, features and types:

The Indian partnership Act, 1932 defines partnership as the “relation between persons who have agreed to share the profit of the business carried on by all or any one of them acting for all.” A partnership firm comes into existence through a legal agreement called a Partnership deed. The terms and conditions governing the relationship among partners are mentioned there. Sharing of profits and losses, sharing of functions and responsibilities, exigencies like death or retirement of partner are mentioned there apart from place of business and nature of business.

Features of partnership firms:

(i) Formation: A partnership firm comes into existence through a legal agreement wherein the terms and conditions like sharing of profits and losses among partners, manner of conducting the business are specified.

(ii) Entity: A partnership firm is not a separate or distinct legal entity distinguishable from partners. The partners are jointly and severally liable for its actions and have unlimited liabilities. In other words, liability of the business will be liability of the partners.

(iii) Risk bearing: In a partnershipfirm the partners are jointly and individually liable for payment of debts of the company. The reward comes in the form of profit which are shared in an agreed ratio and losses are shared in the same ratio.

(iv) Management control:The partners share among themselves the responsibility of decision making and responsibility of day-to-day operations. The decisions are generally taken with mutual consent and joint effort is the norm.

(v) Continuity: Most partnership firms are characterized by lack of stability as death, retirement and insolvency of a partner may end the business. A new agreement has to be signed by existing partners if they wish to continue the business.

(vi) Number of partners: The minimum number of partners necessary to start a firm is two and the maximum number is prescribed by Companies rules, 2014. The maximum number of members can be 50.

Merits of Partnership firms:

(i) Ease of formation and closure: A partnership firm can be formed easily by signing an agreement between the prospective partners and selecting a place of business. There is no compulsion with respect to registration of the firm. Closure of firm is also an easy task.

(ii) Joint responsibility: Each partner can be allotted specific responsibility to handle different activities. This can build good teamwork and fewer errors in judgement and management decisions can be more balanced.

(iii) Adequacy of funds: With each partner contributing capital, a partnership concern is generally not faced with fund crisis. Emergency funds can also be arranged quickly.

(iv) Risk sharing: The normal risks of business are shared by partners reducing individual risk which is a distinct advantage compared to proprietorship businesses.

(v) Confidentiality: A partnership firm is not legally required to publish its accounts or submit reports. Thus, it is able to maintain confidentiality of business operations.

Limitations of Partnership firms:

(i) Unlimited liability: One of the main disadvantages of partnership firms is that the partners have unlimited liability as far as paying off creditors are concerned. If the business assets are not sufficient to repay debts the partners will have to meet the debt from their personal sources. The partners are jointly and severally liable to repay company’s debts. Now, if some members do not have sufficient resource those having greater monetary strength will have to bear the responsibility of meeting outstanding liabilities.

(ii) Limited resources: Since there is restriction in the number of persons who can form a partnership the availability of capital is also limited. This is why partnership firms face problems in expansion beyond a certain limit.

(iii) Possibility of conflict: A partnership firm may have several members within stipulated limit. This can be a source of disagreement and conflict of interest. In a partnership, decisions of one partner are binding on others and an unwise decision may ruin the business. One partner’s retirement may result in dissolution of the firm as there are restrictions on transfer of ownership.

(iv) Lack of continuity: Becauseof inherent weaknesses due to death, insolvency or retirement of a partner a partnership firm cannot be sustained for long unless the existing partners enter into a new agreement and start the business afresh. Partnership firms also fail to evoke much confidence in banks or other financial organisations.

Types of Partnerships:

Partnerships can be classified on the basis of two factors, viz., duration and liability.

On the basis of duration, there can be two types of partnerships:
(i) Partnership at will
(ii) Particular partnership

On the basis of liability partnership s can be divided into:
(iii) General Partnership
(iv) Limited Partnership

(i) Partnership at will :
This type of partnership exists at the will of the partners. It can continue as long as the partners want and terminates when a notice of withdrawal from partnership is given to the firm.

(ii) Particular Partnership:
Partnerships formed for the accomplishment of a particular project say construction of a building to be carried on for a specified time period is called “Particular Partnership”. It dissolves automatically when the project is completed or the purpose of the partnership is fulfilled or the time duration expires.

(iii) General Partnership:
In general partnership the liability of partners is unlimited and joint. The partners have the right to participate in the management of the firm and their acts are binding on each other as well as on the firm. Registration is not compulsory. But the existence of the firm is affected by the death, insolvency or retirement of partners.

(iv) Limited Partnership:
In limited partnership liability of at least one partner is unlimited whereas the rest may have limited liability. The mechanism of such a partnership is that partners with limited liability do not enjoy management right and their acts do not bind the firm or other partners. Registration of such partnership is compulsory.
The permission to form partnership firms with limited liability was granted in 1991 in conjunction with New Small Enterprise Policy introduced in the same year. The idea was to enable partnership firms to attract equity capital from friend and relatives of small scale entrepreneurs who were earlier wary of investing because of the unlimited liability factor in partnership firms.

CBSE Class 9 Elements of Business Unit III: Steps involved in Establishing Business – Completed

The following topics have been completed in Unit III: Steps involved in Establishing Business:

(a) Nature and Forms of Business Organisation
(b) Sole Proprietorship – meaning, features
(c) Partnership – meaning, features and types