Forms of Business Organisation
Long Answer Type
Question 1: What do you understand by a sole proprietorship firm? Explain its merits and limitation?
Answer: A form of business which is owned, managed and controlled by an individual who gets all the profit and bears all the losses from the business is called a sole proprietorship firm.
Merits of Sole Proprietorship
- Quick Decision Making: The sole proprietorship has the advantage of quick decision making. Since the proprietor does not have to share profit with others, so it works as a motivator for him to take quick decisions.
- Sense of Accomplishment: A person running a sole proprietorship firm gets a high degree of satisfaction from the success of his business enterprise. It instills a sense of confidence in his self abilities.
- Ease of Formation and Closure: A sole proprietorship is the easiest to form as it requires minimum capital and no legal formalities. Similarly, since the proprietor is not answerable to the public or the government, he can easily shut down a business if the need arises.
Limitations of Sole Proprietorship:
- Limited Resources: Personal savings and assets are the main resources of capital for a sole proprietorship firm. At the most, a proprietor can bank upon some friends and relatives for short term borrowings. Hence, a sole proprietorship faces the problem of limited resources. In most of the cases, a sole proprietorship cannot grow beyond certain size.
- Limited Life of a Business Concern: In the eyes of the law, the owner and business are considered one and the same. In case of death, insolvency or lunacy of the owner; the business faces the risk of closure.
- Unlimited Liability: One of the major disadvantages with sole proprietorship is unlimited liability on the owner. In case the business fails and has to pay its creditors, the proprietor will have to pay all the debt even if it involves selling off the personal assets of the proprietor.
- Limited Managerial Ability: A business activity involves various functions; like purchasing, marketing, financing, etc. A single individual will seldom be capable of handling all these affairs with proper expertise. So, the decision making may not be balanced in all the cases. Moreover, because of limited resources the proprietor may not be able to attract talent for taking key responsibility.
Question 2: Why is partnership considered by some to be a relatively unpopular form of business ownership? Explain the merits and limitations of partnership.
Answer: A partnership firm offers some advantages over sole proprietorship; in terms of larger pool of capital, varied expertise and balanced decision making. However, it suffers the problem of conflict among partners and unlimited liability. Moreover, a partnership firm does not get the confidence of public. Hence, a partnership firm is considered by some to be a relatively unpopular form of business ownership.
Merits of Partnership:
- Ease of formation and closure: A partnership firm can be opened by a written agreement between the prospective partners. There is no need for registration of the firm. Similarly, closure of the firm is an easy task.
- Balanced Decision Making: Since more than one individual are involved in the business it means more expertise comes in the decision making. Involvement of more than one individual also facilitates division of responsibilities.
- More Funds: Involvement of more than one person results in access to a larger pool of capital. Thus, a partnership firm has better access to resources than a sole proprietorship.
- Sharing of Risks: When many partners enter into a partnership, they also agree to share the risk. This helps in reducing anxiety and burden on individuals.
- Secrecy: A partnership firm is not legally bound to publish its accounting reports. Hence, it can maintain the confidentiality of its business.
Limitations of Partnership:
- Unlimited Liability: Each partner has unlimited liability. A partner’s liability is both joint and several. This means that if a partner has greater wealth than other partners, he will have to pay the debt by selling off his property if other partners fail to do so.
- Limited Resources: There is a restriction on the number of partners and hence a partnership firm can have resources limited to the extent which can be contributed by the partners. It is usually seen that a partnership firm is unable to aggregate resources required for large scale business operation. Thus, a partnership firm cannot grow beyond a certain size.
- Possibility of Conflicts: The decision making is shared among the partners and hence there are possibilities of difference of opinions. Further, the decision of one partner is binding on all the other partners. So, in case a partner takes an unwise decision other partners will have to share the losses arising out of that decision. In case a partner decides to leave the partnership, the firm ceases to exist because ownership cannot be transferred in a partnership firm.
- Lack of Continuity: A partnership ceases to exist in case of death, insolvency or lunacy of any partner. However, the remaining partners can make a fresh partnership deed and continue the business.
- Lack of Public Confidence: Since a partnership firm does not need to submit its financial report in the public domain, the public confidence is very low on a partnership firm.
Question 3: Why is it important to choose an appropriate form of organisation? Discuss the factors that determine the choice of form of organisation.
Answer: Every form of organization has its merits and demerits. A particular form of organization may be suitable for one type of business and may not be suitable for another type of business. Hence, it is very important to choose an appropriate form of organization while starting a business. The important factors which determine the choice of a form of organization are as follows:
- Cost and ease in setting up the organization: A sole proprietorship is the most easy to set up and begin the business. Partnership firm too does not need legal paperwork but needs the assent of prospective partners. A cooperative society can be ranked at number three; followed by a joint stock company. So, the choice of a particular type of business organization depends on availability of capital and willingness to comply with legal requirements. Many startup companies began as sole proprietorship and progressed to higher scale as the business grew.
- Liability: We know that sole proprietorship, partnership and HUF have the problem of unlimited liability. This can be a big deterrent for many to form these types of venture. Cooperative society and joint stock company have limited liability and hence many prospective entrepreneurs prefer these types of business firms.
- Continuity: Lack of continuity is a major problem with sole proprietorship and partnership. Even in HUF, the business can continue up to three generations only. If a person wants to start a business just for the sake of earning a livelihood and has no bigger plan to create a long lasting brand, then sole proprietorship or partnership may be preferred forms of organization.
- Management Ability: Except the joint stock company; all other forms of business organization suffer from the problem of failure to attract talented and ambitious people. A sole proprietorship is the worst sufferer because a single individual cannot shoulder all responsibilities with equal ease. So, if the business activity requires to grow beyond a certain size then one needs to look at joint stock company as the best option.
- Capital Considerations: If one wants to grow a business to a large scale then one needs to infuse a large amount of capital in the business. Except the joint stock company (some cooperative societies too); no other form of business can attract a huge amount of capital. Moreover, infusion of a particular amount of capital also depends on the stage a business is in and on future plans and prospects of the business.
- Degree of Control: If person wants direct control on the business then sole proprietorship is the best bet for him. The moment number of stakeholder increases in an organization, control of an individual diminishes accordingly. One has to find a balance between control and profit sharing while choosing a particular type of firm.
- Nature of Business: If the business involves direct contact with and personalized attention to the end user then a sole proprietorship is ideal. But when these are not the factors then other forms of business can be considered.
Question 4: Discuss the characteristics, merits and limitation of cooperative form of organisation. Also describe briefly different types of cooperative societies.
Answer: The characteristics of cooperative society are as follows:
- Voluntary Membership: The membership to a cooperative society is voluntary in nature. A person is free to join a cooperative society as per his will and is free to leave the society as per his convenience. Although a member is required to serve a notice before leaving a cooperative society but there is no compulsion on remaining a member.
- Legal Status: A cooperative society is a registered entity and hence it has a legal existence which is different from the identity of its members. A cooperative society can enter into contracts, hold property in its name and can sue or be sued by others. The legal status of a cooperative society is not affected by entry or exit of any member.
- Limited Liability: The liability to a member is limited to the capital amount contributed by that member. So, the risk on an individual member is limited.
- Control: In a cooperative society, decisions are taken by the managing committee and this committee is elected by the members of the society. Thus, each member gets a say in decision making through representation. So, decision making is controlled through democratic process in a cooperative society.
- Service Motive: A cooperative society is formed with the prime motive of mutual help and welfare of its members. Hence, service motive dominates the working of a cooperative society. If any surplus is generated in the process, it is distributed among the members according to the bylaws of the society.
Merits of Cooperative Society:
- Equality in voting status: Irrespective of the amount of capital contributed, each member has equal voting right.
- Limited Liability: Liability is limited to the amount of capital contributed by a particular member. Hence, his personal assets remain safe.
- Stable Existence: A cooperative society continues its existence even in case of death, insolvency or lunacy of a member. So, business operations of a cooperative society remain unaffected.
- Economy in Operations: The members of a cooperative society usually offer voluntary services to the society. This helps in reducing the cost because the focus is on removing the middlemen. Since customers or producers themselves are the members of the society, so chances of bad debt are minimal.
- Support from Government: The government supports the cooperative society in various ways because it promotes democracy. The government supports the society in form of lower taxes, subsidy and easier loans.
- Ease of Formation: A cooperative society is formed with minimum ten members. The legal requirements and procedures for the formation of a cooperative society are simple. Provisions of the Cooperative Societies Act 1912 govern the formation of a cooperative society.
Limitations of Cooperative Society:
- Limited Resources: Since members have limited means so a cooperative society has limited resources. Poor dividend on investment also acts as a deterrent to garnering resources for a cooperative society.
- Inefficiency of Management: Since cooperative societies usually work on the concept of voluntary services so it fails to attract talented and ambitious people. The members are generally not professionally equipped to handle the various responsibilities of business.
- Lack of Secrecy: A cooperative society has to hold open meetings of its members and has to make certain disclosures as per the Societies Act (7). Hence, secrecy of business operations is compromised in a cooperative society.
- Government Control: As the government provides many support to the cooperative society, so the society has to make certain disclosures; like auditing and submission of accounts. Moreover, the state cooperative departments also put interference in various operations of the society. This sometimes, hampers the smooth functioning of the society.
- Differences of Opinion: A large gathering of members means there is bound to be difference of opinions. This often results in quarrel in the meetings of the society. Sometimes, personal interests of a few members may get priority and main purpose of the society gets lost.
Question 5: Distinguish between a Joint Hindu family business and partnership.
Answer: Following are the key differences between a Joint Hindu Family business and partnership:
- An HUF is comprised of members of the family, while a partnership need not have family members.
- No written agreement is required for Joint Hindu family business, while a partnership deed is required for a partnership firm.
- In case of HUF business, only the karta has unlimited liability but in a partnership each partner has unlimited liability.
- The karta is the main decision maker in HUF, while each partner has equal say in decision making in a proprietorship.
- The HUF can continue for at least three generations, while a partnership firm ceases to exist in case of death, insolvency or lunacy of a partner.
- Membership to HUF business is based on birth, while membership to a partnership is based on willingness of prospective partners.
- A minor can be an active member of HUF business but it is not possible in case of a partnership.
Question 6(a): Despite limitations of size and resources, many people continue to prefer sole proprietorship over other forms of organisation? Why?
Answer: Sole proprietorship offers many advantages over other forms of business firms. A sole proprietorship can be started or closed as per the wish of the proprietor because he is not answerable to anyone. The proprietor can begin the business with whatever capital is available at his end. He is in total control of the business and does not need permission from anyone to take any decision. A proprietorship can be a fleet footed organization when it involves tackling the changes in business environment. Hence, despite limitations of size and resources, many people continue to prefer sole proprietorship over other forms of organization.
Question 6(b): In which form of organisation is a trade agreement made by one owner binding on the others? Give reasons to support your answer.
Answer: A trade agreement made by one owner is binding on the others in a partnership firm. In case of a partnership firm, the decision of any one partner is binding on all the other members because liability for every partner is unlimited.
Question 7: The business assets of an organisation amount to Rs. 50,000 but the debts that remain unpaid are Rs. 80,000. What course of action can the creditors take if
(a) The organisation is a sole proprietorship firm
Answer: If the organization is a sole proprietorship firm, then the remaining amount will be paid by selling the personal asset of the proprietor.
(b) The organisation is a partnership firm with Anthony and Akbar as partners. Which of the two partners can the creditors approach for repayment of debt? Explain giving reasons
Answer: Both the partners have to pay the remaining amount to the creditor. The creditor can approach any of the partners in this regard because each partner is authorized to take decision on behalf of the organization.
Question 8: Kiran is a sole proprietor. Over the past decade, her business has grown from operating a neighbourhood corner shop selling accessories such as artificial jewellery, bags, hair clips and nail art to a retail chain with three branches in the city. Although she looks after the varied functions in all the branches, she is wondering whether she should form a company to better manage the business. She also has plans to open branches countrywide.
(a) Explain two benefits of remaining a sole proprietor
Answer: If Kiran prefers to remain a sole proprietor, she will have full control on the organization. She will also be the sole recipient of all the profits which may come from the business.
(b) Explain two benefits of converting to a joint stock company
Answer: If Kiran opts for a joint stock company, she can manage to get a bigger capital. She can delegate many of the responsibilities to senior management personnel and major responsibilities would be shared by the members of the board of directors. This will help in reducing her workload.
(c) What role will her decision to go nationwide play in her choice of form of the organisation?
Answer: Planning to go nationwide will play a major role in her choice to form a particular type of organization. For spreading throughout the nation, she needs to have a larger amount of capital which can be only possible by opting for a joint stock company.
(d) What legal formalities will she have to undergo to operate business as a company?
Answer: She will have to go through the processes of registration of the company. She will have to form a board of directors. For all this, she will need the services of professionals; like chartered accountants and lawyers.