BCom 1st Year Forms of Business Organisation Notes Study Material

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BCom 1st Year Forms of Business Organisation Notes Study Material

There are many bases for classifying business firms—legal structure, type of product and size. Here our emphasis is on the basic legal forms which businesses might assume. The main forms of private business organisation are three in number:

1. Sole proprietorship, also called individual proprietorship.

2. Partnership.

3. Joint stock company or the Corporation.

The other two types are:

4. Co-operatives, and

5. Public Enterprise.

1. THE SOLE PROPRIETORSHIP

The oldest type of business unit is the sole proprietorship—the “one-man” business, individual enterprise or individual proprietorship. In this form of business, the firm is owned and usually operated by a single individual. He undertakes the risks of production. He probably provides all the capital. He receives all of the profits of the firm and he is personally responsible for all of the firm’s liabilities. It is typically “a one-man show”. He is the owner of the business and shoulders the entire responsibility for its management and operation.

Though the importance of this form of business has declined enormously with the growth of large corporations in the 20th century, it is still prevalent in farming and retail trade. Businesses of this type are generally small.

Advantages

The following are the main advantages of the sole proprietorship business:

(a) Self-respect is a powerful motive making for the success of the one-man business. Its owner receives all profits directly. So he has every incentive to make his business as efficient as possible by minimising wastes.

(b) A sole proprietor is not required to consult any one else when deciding upon a new policy. So he is capable of taking quick decisions and also putting them into effect immediately.

(c) A one-man business is done on a small-scale. So he can manage the whole business and attain a high standard of efficiency.

(d) Since the business is on a small-scale, a sole proprietor can maintain a closer and more personal contact with both his employees and his customers which is not possible in large concerns where the manager has to remain somewhat aloof from the employees.

(e) Individual enterprise is a convenient type of business unit for producing special lines on a limited scale. Where variety is preferred to standardised product, the small firm scores over the large one.

(f) It is easy to establish a one-man business and simple to dissolve it as consultation with others are not needed at any stage.

Disadvantages

This type of business suffers from a number of disadvantages as well:

(a) Expansion of business may suffer due to the smallness of capital which a person can provide.

(b) The success of the business is dependent on the ability of one person alone. After the death of an able person there is no guarantee that his children who succeed him will be equally efficient.

(c) The liability of the sole proprietor is not confined to the capital he has invested in the business. Thus he bears all the risks, he is personall. liable for all the debts and obligation of the firm. He is thus subject to unlimited liability.

(d) In those lines of production where the economies of scale are available sole proprietorship is not suitable. Its competitive capacity is very weak here. It cannot get the potential benefits of specialisation in business management.

2. PARTNERSHIP

The partnership form of business organisation is more or less a natural outgrowth of the one-man business. The main factor behind its development has been an attempt to overcome some of the shortcomings of sole proprietorship.

A partnership is an association of two or more persons who operate a business as co-owners by voluntary legal agreement. In the USA, partnership plays the biggest role in professional services, such as law, medicine, and stock brokage. Taking an overall picture, it is the least common of the three major forms of business organisation.

There are many variations of partnership business:

• In some cases all partners are active in the functioning of the enterprise.
• In some other cases one or more partners may be silent; they contribute their finances but do not actively participate in the management of the firm.
• Some partnership business is a limited partnership. This is a special kind of partnership that is not popular. In such partnership the liability of the limited partner is restricted to the amount of capital he has invested in the firm.
• The ordinary partnership is, however, unlimited. Each partner is liable for the debts of the firm, not only to the extent of his share in the business, but to the full extent of even his other resources.

Advantages

A partnership does possess some special advantages that makes it more suitable than either one-man business or joint-stock companies for certain purposes.

(a) Like the sole proprietorship, it is easy to organise. Partnership is no doubt based on a written agreement, but legal red tape is not great.

(b) A partnership has greater continuity of existence than has the business of a sole proprietor.

(c) Greater specialisation in management is made possible because there are more participants. Managerial functions can be allotted to the martners according to their respective abilities and training. It leads to increased efficiency.

(d) Like sole proprietorship, a partnership has the advantage that all profits go directly to the partners.

(e) By comparison with sole proprietorship, a partnership can more easily attract additional capital and managerial talents by adding new partners. Since a partnership has more access to capital, it is usually somewhat better risk in the eyes of the bankers.

Disadvantages

As against the advantages of partnership, there are some shortcomings from which it suffers:

(a) One disadvantage is the unlimited financial liability of the partners (Partnership with limited liability is rare). In terms of liability, a partner is in a worse position than a sole proprietor. It is so because each partner individually bears the liabilities of the entire partnership. In fact, each partner becomes liable for all business debts incurred, not only as a result of his own management decisions, but also as a consequence of the actions of any other partner. “A wealthy partner risks all his riches on the prudence of his partners.”

(b) Continuity is another serious problem of partnership. It is so because the death or withdrawal of a partner generally means the dissolution and complete reorganisation of the firm. This is likely to disrupt severely the operations of the partnership firm.

(c) Though a partnership is in a position to pool larger financial resources than a sole proprietorship, the finances of a partnership are still limited compared to the requirement of the potential growth of the enterprise.

(d) Since each partner is jointly liable with other partners for all debts and obligations of the firm, it would be unwise to enter into partnership with anyone unless convinced of his integrity, judgment and business acumen.

(e) In a partnership firm several people participate in management. The division of authority can lead to inconsistent, divided policies or to inaction when action is required. There is the possibility of partners disagreeing altogether on basic policy. “For all these reasons, management in a partnership may be very unwieldy and cumbersome.”

3. JOINT-STOCK COMPANY

A joint-stock company is the third major form of business organisation. When the need for a greater amount of capital was felt and the sole proprietorship was unable to do so, partnership came into existence. It was precisely this reason for the rise of joint-stock companies and in fact early joint-stock companies were legally nothing more than large partnerships.

At the time of Industrial Revolution, industry existed only on a small-scale and required only limited amount of capital. “Overseas trade, however, required the building of ships, and with the passage of time, these were constructed of ever larger dimensions and as a result became more expensive to build. The pioneer navigators of the fifteenth and sixteenth centuries had to seek the patronage of monarchs to defray the cost of their voyages.”

Joint-stock companies were developed as a substitute for this method financing ventures. The earliest joint-stock companies were therefore trade companies. The British East India Company, founded in 1600, was one of it such earliest companies.

The distinctive features of joint-stock companies (also called corporation are that they are legal entities, distinct and separate from the individuals who own them. They are governmentally created “legal persons”. As such they acquire resources, own assets, produce and sell products, incur debts, extend credit, sue and be sued and carry on all those functions which any other ton of enterprise performs.

In India, the organisation of a joint-stock company needs at least seven persons who draft the Memorandum of Association. It contains the name of the company, the location of the head office, its aims and objects, the amount of share capital, the kind and value of shares and a declaration that the liability is limited.

Articles of Association, containing the rules and regulations of the company, are also drafted. These two documents are submitted to the Registrar of Joint-stock Companies for registration and issue of certificate of incorporation. After the issue of such a certificate the company comes into existence.

(i) The shares of a joint-stock company are of several kinds, such as:

(a) Preference,

(b) Ordinary, and

(c) Deferred.

The preference shareholders have the right to be paid first out of the profits, known as dividend, before anything is paid to the other shareholders. These shareholders are paid dividend at a rate fixed beforehand. Preference shares are either cumulative or non-cumulative.

In the case of cumulative preference shares, the shareholders are entitled to receive the fixed dividend even for the years when no profit was earned. In the other case of non-cumulative preference shares, dividends are paid only for the years when the company earns profits.

Ordinary shareholders are paid after payments are made to the preference shareholders. Payments of dividend to ordinary shareholders are not at fixed rates. Deferred shareholders are last to get the dividend. These shares are generally held by the promoters themselves.

(ii) Another method of raising finance by a joint-stock company is by the sale of debentures or bonds. The debentureholders are not the owners of the company as the shareholders are, but only creditors of the company. Debentura holders must be paid whether the company makes a profit or not.

Thus debentures are debt securities carrying a fixed rate of interest usually issued by a company and secured on its assets.

Bond is a form of fixed interest security issued by central or local governments, companies, banks or other institutions. It is usually a form of long-term security, but may be irredeemable and may be secured or unsecured. In the  USA the term bond includes debentures. Now this term is used generally and more loosely to denote any fixed interest (debt) security.

The shareholders of the company elect a board of directors in the open general meeting of the company annually whose duty is to lay down the general policy and discuss major issues. The day-to-day business is carried on either by the salaried secretary, manager or managing director.

A joint-stock company may take the form of a public limited company in which case the minimum limit to shareholders is seven but there is no maximum limit. A private limited joint-stock company is subject to a maximum limit of shareholders which is 50.

Advantages

The advantages of the joint-stock company form of business enterprise have put this type of firm into a dominant position:

(a) The superiority of the joint-stock company for large-scale business comes from two features, namely, the fact that the company is a legal entity apart from its owners and the fact that owners have limited financial liability.

(i) As a legal entity, the company has a life independent of its owners and ita individual officials. Proprietorship can die a sudden and unpredictable Leath, but legally the company is immortal. The transfer of shares through sale at the stock market does not disrupt this continuity. Thus the company has a certain permanence which the other forms of business organisation do not possess. This permanence is conducive to long-range planning and growth.

(ii) Limited liability confers a distinct advantage to the company. The shareholders who are the owners of the company risk only what they paid for the share purchased. If a company goes bankrupt, shareholders’ personal assets are not at a stake. Creditors of the company have the right to sue the company as a legal person, but not the owners of that company as individuals.

(b) Joint-stock company is the most effective form of business organisation for raising money capital. Through shares, debentures and bonds the company has got new methods of finance. Those who do not like to take risks can purchase debentures and bonds. Those who are not averse to risk can have ordinary shares. Thus the firm is allowed to tap the savings of all types of thousands of households. It has easier access to bank credit too.

(c) Since the joint-stock company occupies a strategic position in acquiring nhance, it has the ability to secure more specialised and so more efficient management than sole proprietorship and partnership enterprises can do.

(d) Because of the large access to financial resources, the company can undertake business on a large-scale and reap the advantages of large-scale Production in terms of internal and external economies.

(e) The capital of a shareholder is not permanently sunk in the company. When he needs money he can get it by selling his shares in the stock market as the shares are transferable.

(f) The joint-stock company makes it possible to collect savings from numerous widely scattered persons who are themselves unable or unwilling to make productive use of them. These savings are concentrated in the hands of a relatively few active persons who are prepared to employ them in the conduct of industry.

(g) The joint-stock company offers an honourable and successful career as a salaried official to persons without capital or connection of their own. The company thus mobilizes in the service of industry much business ability wh: might otherwise have remained undiscovered or undeveloped.

Disadvantages

The advantages of a joint-stock company are tremendous and override its disadvantages. Yet we should know the disadvantages as well.

(a) There is some red tape and legal expense in obtaining the certificate of incorporation. In the USA, each state has its own laws of incorporation. Forming a company usually requires the services of a lawyer and entails the payment of fees making it unsuitable for small or temporary business undertakings.

(b) There “is some danger that a company, especially as it advances in an will tend to become less elastic, less adaptable, less strenuous than a private business.”. The defect of all large organisations creeps into it. Things are don with a stereotyped routine which might be better done if they could be left to the unfettered decision of the moment.

(c) The whole-time officials of the joint-stock company appear to administer its affairs with about as much thought and zeal as though they are the sole owners of the enterprise. In doing so, on occasions, they become too ambitious or try to show their self-importance. As a result, they abuse their power to plough back profits and expand the company to an unwieldy size. Sometimes they extend its activities into areas too remote from its original purposes.

(d) From the social point of view, the company lends itself to certain abuses. It is a legal entity and so unscrupulous businesses sometimes can avoid personal responsibility for questionable business activities; they have issued and sold worthless securities.

(e) In the sole proprietorship and partnership forms of business, those who own the real and financial assets of the firm also manage and control those assets. This is as it should be where the risk lies there should lie the control. This is said to be the golden rule of capitalism, according to Robertson. But in larger companies the ownership of shares is widely diffused over thousands and lakhs of shareholders.

This has resulted in a fundamental cleavage between ownership and control. The company is owned, in theory at least, democratically. Each share has one vote in electing the Board of Directors of the firm. But in actual practice the typical shareholder has become lethargic.

Most of them do not exercise their voting rights or when they do they merely sign their rights over by proxy to the company’s present officers. So a democratically owned company becomes oligarchically managed. It is not a serious disadvantage, however, as most of the time the interests of the shareholders and managers of the company coincide.

The advantages of the joint-stock company far outweigh its disadvantages. So it has flourished and no country can do without it now.

4. COOPERATIVES

Cooperatives are a variant of company. They are associations of individual who own and operate a business for their own mutual advantage. As again one share, one vote in a joint-stock company, cooperatives are organised on principle of one man, one vote. They are based on mutual help and self-reliana, “each for all and all for each.” Dealings of a cooperative organisation, confined to members only. It tries to combine the advantages of both capital and socialism and avoids their disadvantages.

Cooperatives are generally of the following types:

(i) Producers’ Cooperatives: Here the workers are their own masters. They are their own employees. The profits, if any, are divided among them. Such cooperatives have had little success. They are known as Workers’ Cooperatives as well. Farmers’ cooperatives have, however, achieved greater success.

(ii) Consumers’ Cooperatives: They are perhaps the most familiar type of cooperative. They are organised for the mutual benefits of their customers. They have been very successful.

(iii) Other Forms of Cooperatives: Other forms of cooperatives are cooperative credit societies, cooperative non-credit societies, cooperative marketing societies, cooperative banks, etc. They serve different purposes.

5. PUBLIC ENTERPRISES

Public or State enterprises are businesses run by the government of Central, State or Local. There are three special features of public enterprises. They are:

(i) Public enterprises are usually such in which overhead costs (indirect costs) bear a high ratio to direct costs. Typical examples are railway track, hydroelectric installation and so forth.

(ii) Public enterprises usually have much monopoly power. Hence managers of each enterprise can decide on their prices by themselves.

(iii) These enterprises are charged with promoting the public interest.

Public enterprises may be organised in several ways, depending on constitutional system, structure of government, political traditions, economic background and social needs. Since these factors vary from country to country, forms of organisation of public sector industries also differ among countries. However, the following are the main types of organisation:

(i) Departmental Undertakings controlled by (a) departmental secretariate or by an (b) interdepartmental committee or board.

(ii) Public Corporation: It is also known as a statutory corporation. It is the most important invention, according to Robson, of the twentieth century in the field of government institutions. A public corporation seeks “a combination of public ownership, public accountability and business management for public ends.”

(iii) Government Company: It is one in which the Government holds majority capital. It can associate private enterprises, national or foreign.