BCom Notes Part I Business Establishing A Business

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Establishing A Business

Sole Proprietorship It is the form of business organization in which an individual introduce his own capital, uses his own skill and intelligence in the management of its affairs and is solely responsible for the results of its operations. He may run the business alone or may obtain the assistance of employees. It is the easiest to form and is also the simplest in organization. The sole proprietor may borrow or sue other people’s money in financing his business.

“The individual proprietor is the supreme judge of all matters pertaining to his business, subject only to the general laws of the land and to such special legislation as may affect his particular business.”

Advantages of Sole Proprietorship

1. Easy to Start

The formation of sole proprietorship is quite easy than partnership and joint stock Company. There are no legal formalities for starting this business, like agreement, memorandum of association or articles of association.

2. Easy to Dissolve

It is easy to dissolve because the sole trader is not required to take permission for dissolution either from shareholders in the general meeting as in the case of joint stock companies or consult all the partners in the case of partnership.

3. Freedom of Action

A sole trader has maximum freedom to take decision at his own end. His decision is final. He may expand his business by adding new products or can discontinue old ones. A sole proprietor can wind up his business or he can change his business place from one place to another.

4. Freedom from Government Control

A sole trader is free from government control a great extent than any other form of organization. A sole trader is not required to send his periodical balance sheet to the government.

5. Owner of All Profits

No other form of organization permits to retain cent percent profit they earn. But in sole proprietorship, the sole trader is the master of his business and is entitled to retain the entire profit of the business.

6. Low Taxes

He has to pay minimum income tax and other taxes than in partnership and Joint Stock Company. In this manner he saves much out of his profit.

7. Secrecy

Secrecy is he base of a business and it should not be disclosed. Success of a business is based on secrecy. A sole trader can maintain secrets of his business but it is not possible to keep secrets in partnership or Joint Stock Company.

8. Low Cost Organization

A sole trader is not required to pay registration fees as paid by Joint Stock Company and legal fees in the formation of partnership.

9. Full Control

Sole trader has got full control over his planning. No body is there to interfere in his business.

10. Immediate Action and Quick Decision

In business, it becomes very essential to take decision at particular times and for that purpose immediate action is required. Sole trader can take quick decision and immediate action but in partnership and joint stock companies action cannot be taken without the persmission of owners and meeting should be called for this purpose. In this way business cannot take the proper advantage of time.

11. Flexibility of Organization

If any change in the business is called for, the sole proprietor has a right to bring about the change. A good number of giant sized concerns fail on account of their inability to change their policies promptly with a change in the situation.

12. Social Desirabilities

From the social point of view:

1. Continuity of individual proprietorships ensures that too much wealth does not get concentrated in few hands.

2. The unlimited liability ensures sufficient responsibility to the society.

3. It brings into full play the qualities of self-confidence, diligence and tact among business people.

4. The growing number of sole proprietorship firms contribute to the commercial development of a country.

13. Personal Incentive

A man in business for himself has everything to lose if his efforts are not successful to earn profits. This fact makes him willing to devote maximum time, thought and energy to the successful prosecution of the activities of business he has organized.

14. Credit Worthiness

A sole proprietor’s liabilities are unlimited as the creditor can even recover his amount from the personal belongings of the trader. Therefore, this fact makes a sole proprietor credit worthy.

Disadvantages of Sole Proprietorship

The sole proprietorship has some disadvantages, which are as follows:

1. Limited finances

the sole proprietor can face financial problems. He can depend only his own resources. It is neither safe nor easy for him to borrow large amounts of money from banks or other financial institutions.

2. Difficulties in Management

Each individual has a particular ability or aptitude in particular respect. Modern businesses full of complications arising specially from the ever-changing nature of market and the various laws that are being enacted. An individual may not be an expert in all matters, therefore, some times his decisions may be unbalanced and would lead to the failure of the business.

3. Limited Span of Supervision

A sole proprietor however qualified and clever will find it hard to supervise the work of his sub-ordinates beyond a certain limit e.g. in case of a large general store owned by single person, it will be difficult for the owner to keep an eye on all the departments and employees and to sure that the customers are treated nicely. The problem will be more acute if the store has its branches in other places.

4. Limitation on Size

Because of limitation of finance, managerial skills and span of supervision, a sole proprietor has to manage the size of the business up to a certain limit. This deprives the firm of the opportunities of reaping the economics of large-scale production.

5. Unlimited Liability

The sole proprietor assumes a great risk. It is true that he receives all the profits of the business but likewise he has to face the entire losses. Not only the assets of the business but also his private assets will be used to pay off the firms debts and losses. Unlimited liability also discourages the expansion of business.

6. Lack of Continuity

Any personal problem or illness, which is affecting the sole proprietor to, has a direct effect on his business. It ends with the retirement, death or bankruptcy o the owner. If the busines is rendering useful services to the society, the closure of such a business will be a social loss. Similarly, with the death of the proprietor, the business may pass on to his successors who may not posses the same degree of self-reliance, ability and intelligence.

7. Ease of Formation

The very ease and cheapness of entering business as a proprietor may be a disadvantage. Many people go into business with too little capital and training and are clashed by the competition of the business. As a result, a number of business failures and proprietorships.

Partnership

It is rare that a person combines in himself all that is essential to make him a successful businessman. Besides, the reap the economics of large-scale operation, a sole proprietor may fail to cope up with the demands of expansion. He may possess adequate capital but he may be handicapped by the lack of experience, skill and managerial, ability. Or it may be other way round. Therefore, a combination of two or more persons, some having capital and others having skill or experience proves to be beneficial.

According to Section 4 of the Indian Partnership Act of 1932, partnership is defined as, “The relation between persons, who having agreed to share profits of a business carried on by all or any one of them acting for all.

The above definitions reveals that:

1.  An agreement between the partners is necessary.
2. The agreement must be in regard to the sharing of the profits of the business.
3. The business must be carried on by all or any one of them acting for all.

Advantages of Partnership

Many of the advantages of a sole trader are also present in the partnership form of organization. Therefore, advantages which render partnership preferable to sole proprietorship are given below:

1. Large Amount of Capital

In sole proprietorship, the amount of capital is limited to the personal fortune and credit of one individual. In partnership, the capital can easily be raised according to the requirements by bringing in additional workers.

2. Combined Judgment and Managerial Skills

In partnership business, there are more than one owners, it is therefore possible to combine the abilities and knowledge of every partner to the best interest of the business. With the combined decision and judgment, business is greatly benefited and more profit is possibly earned.

3. Personal Interest

Since each general partner is responsible not only for his own act but also for the acts of his partners, he shall devote his personal attention and interest to the activities of the firm, and this will enable a firm to attain maximum efficiency.

4. High Credit Standing

A partnership has little difficulty in obtaining credit, especially if the partners have their personal wealth. If there are several partners and one or more have extensive private means, creditors have little reason to doubt that the debts of the partnership will be paid in full.

5. Ease of Formation

A partnership business is easy to start as it is free from all legal formalities, it does not suffer from legal handicaps. The business can be easily increased or reduced to suit the conditions.

6. Retaining of Valuable Persons / Provision of New Blood to the Business

New blood can be infused into the business into the business by admitting new partners. Thus the business can utilize the genius of an enterprising young men.

7. Co-Ordinated Decisions

The decisions, which take place in the partnership, are co-ordinated decisions i.e. the decisions which are jointly taken by all the partners.

8. Lighter Risk

Risk in partnership enterprise is spread over several persons who are its partners. All the partners pool together their abilities and their income.

9. Unlimited Liability

Each partner has an unlimited liability towards the firm’s debts. The creditors can recover debts from the personal property of the partners.

10. Flexibility of Organization

A partnership organization is extremely mobile, flexible and elastic. The partners are at ease to carry on any legal business.

Disadvantages of Partnership

1. Divided Control / Delay in Decision Making

In partnership, more than one person is involved in every decision reached. If the partners are not active in operation, it may necessary to delay the making of important decisions.

2. Frozen or Blocked Investment

For an individual who to invest some money in business, the partnership form may prove to be a poor investment from the view-point of liquidity and transferability. It is correct to say that it is easy to invest money but is difficult to withdraw it, because it would mean the termination of business.

3. Limitation on Size

Since the maximum number of partners is 20, it might be possible that at some time the capital becomes short. If it happens, the business has to be converted into a Joint Stock Company. Therefore, a big business cannot be started even if they get a chance to expand it, because the capital of 20 persons may not be sufficient.

5. No Legal Entity

Law does not recognize a partnership as an organization having an entity or existence separate from the partners who comprise it.

6. Lack of Secrecy

Secrecy in a business is necessary for its success. It is not possible sometimes in a partnership.

7. Possibility of Disagreement Among Partners

Two or more men may start out together as close friends or as relatives. However, they may develop differences over the years that will make for unpleasantness and inability to work together for the best interest of the firm.

8. Unlimited Liability

The greatest disadvantage is that of unlimited liability of the partners. All general partners and liable personally for the partnership debts. Where there are heavy losses, the partner having much property will have to sustain the entire loss.

Partnership Deed or Partnership Agreement

A partnership deed is a document in which the terms and conditions of partnership agreement are written. Hence, contract is said to be essence of partnership business. Partnership agreement may be oral or written. The written document of partnership is known as partnership deed. Partnership may be formed and conditions of the of the contract put down into black and white. The partnership is to be free from future confusions and misunderstandings. Happy or good relations between partners may not continue for a long time.

I future there may be differences of opinions between the partners on some points. The differences may only be removed if the terms and conditions are in a document to avoid future disputes and misunderstandings between partners. A well drawn up partnership deed, usually contains the following terms.

1. Name of the firm.

2. The nature and object of the business.

3. The duration of the business.

4. The names and addresses of the partners.

5. The amount of capital of the firm and the amount contributed by each partner.

6. The ratio of sharing profits and losses of the firm.

7. The management of the firm. (The name or names of the partners who will take part in the management of the firm).

8. Salaries, if any, paid to any partner.

9. Interest on partners’ capital and partners loan.

10. The rights and duties of the partners.

11. The valuation and treatment of goodwill in case of the dissolution of the firm.

12. Rules and regulations regarding the admission of a new partners and expulsion and retirement of an existing partner.

13. Appointment of an arbitrator to settle disputes if any among the partners.

14. The names of the banks where firm accounts will be opened.

15. The name of the auditors who will inspect the Bank Accounts.

16. The names of partners who will sign the important documents.

17. The procedure of the dissolution of the firm and settlement of accounts.

18. Any other clause or clauses necessary for future safety for the conveniences of the partners.

The partnership deed must be signed by all the partners. They may, if thought necessary, make alternations and additions to the provision of the deed at any time.

Memorandum of Association

The first thing in the formation of a Joint Stock Company is the preparation of the Memorandum of Association. It is a document, which sets out the constitution of the company and as such, is really the foundation on which the structure of the company rests. That is why this document has often been called the charter of the company in its relation to the outside world. The document is prepared by the promoters of the company. The memorandum of Association must contain the following clauses:

1. Name Clause

In this clause the full name of the company is shown and the last word of the name of the company must be limited. The company can adopt any name but there are certain restrictions and the words like ROYAL, IMPERIAL, EMPIRE and ESTATE etc cannot be used without the special permission of the Government.

2. Object Clause

This clause is quite important and must be very carefully drafted as it determines the activities of the company. In the object clause each and every detail of activities of the business to be carried out must be laid down. Once the object clause is completed, it become very difficult to make any amendment. The value of the shares, the allotment money must be given in detail.

3. Situation Clause

This act provides that the company must have a registered office so that the registrar may be able to send notice etc. to the Company at the registered office.

4. Liability Clause

A declaration that shares holder’s liability is limited.

5. Capital Clause

This clause must contain a statement as to the amount of capital with which the company proposes to be registered and the division there of into shares at a certain fixed amount.

Articles of Association

This is another important document, which must be prepared and filed with the Registrar of the companies. The Article of Association contains rules and regulations regarding the internal working and management of the company. It defines the powers, rights and duties of Directors, shareholders and the other officers of the company. The purpose of the Article of Association is to carry out the objects set out in the Memorandum. The Memorandum limits the jurisdiction beyond which the Article of Association cannot go. The Article of Association states how the general meetings are to be held, how the voting is to be transferred, and how they are to be forfeited, how the accounts are to be kept etc. If a company does not prepare its Article of Association, it can adopt of Table A of Companies Ordinance.

The articles must be properly drafted, serially numbered and printed and then filed with the Registrar of the Joint Stock Companies. The article must be signed by the subscribers and witnessed as in the case of Memorandum. It is usual to print the Memorandum and the Article in one booklet, as the company is required to provide the copies to members on request. The articles can be altered at any time by special resolution.

Joint Stock Company

In the modern times the business and industry has been developed on a large scale the capital required for such industry and trade is huge which cannot be accumulated either in a sole proprietorship or a partnership organization. As a result of this change, a new form of organization has become quite popular in modern times which are known as Joint Stock Company. It is normally defined as;

“An association of many person who contribute money or money’s worth to common stock or employ it in some trade and business, and who share profit or loss arising from there.”

It means the joint stock company is a voluntary association of individual who contribute their money or profit to a common stock for carrying on a particular business. The money or money’s worth contributed by the member known as ‘share holders’ forms the capital of the company. The capital is divided into numbers of unit called share. Each share carries definite face value and is transferable in the market without any restriction or formalities.

A company as soon as incorporated takes a legal entity distinct from the share holder who composes it. It is managed by a group of persons known as directors. Directors are the representatives of share holders.

Formation of Joint Stock Company

All the joint stock companies whether public or private are governed by the company’s ordinance 1984 and must be formed according to the procedures laid down in that act. For the formulation of Joint Stock Company the following document must be submitted to the registrar, joint stock Company;

1. The list of directors along with their address.

2. the memorandum of association on which at least 7 person, who are promoters should sign in case of public limited company and two in case of private limited company. In addition of this it is also essential for the, to purchase the qualification share.

3. Articles of association duly signed as memorandum of association.

4. The consent of all the directors to act as directors.

5. A formal declaration by the secretary that all the formalities are duly completed.

6. A statement of normal capital.

Along with the above documents, registration fees, which varies with the amount of share capital is paid off to the treasury.

When the registrar of the joint stock companies is satisfied from all the formalities he will enter the name of the company in the register and will issue a certificate of incorporation. Now the company will have its separate existence.

Advantages of a Joint Stock Company

1. Huge Amount of Capital

It is in a position to raise large amounts of capital required for big business. The reasons are the limitations of liability and the ease of transferability of shares. The small value of shares allows a large number of persons to invest. So, due to limited liability and issuance of shares, large capital may be raised by a Joint Stock Company.

2. All People can Invest

In a Joint Stock Company, the shares are of different kinds so they are purchased by persons of different temperaments. The small value of shares allows the poor people also to purchase it. Besides, a company may also raise finance by the issue of debentures and bonds.

3. Limited Liability of Shareholders

The liability of shareholders is limited. It means that the risk is spread over a large number of shareholders and the possibility of hardship on a few is reduced. Secondly, if the business is going to be lost, the shareholders are not liable to loose anything from their private property.

4. Efficient Management

the management of the Joint Stock Company is carried out by Directors who are able, experienced and trustees of shareholders. The management is thus, the hands of a few experts. Secondly, the company can also hire efficient and qualified staff since it can pay their wages.

5. Stability of Business

The success of business also depends upon the life of the business. The Joint Stock Company is more suited in tis respect, for a company is a legal person having a perpetual succession.

Stock/Security Exchange

A stock exchange is an organized market where secondhand listed industrial and financial securities are bought and sold at auction. The securities are bonds and debentures issued bodies or port trusts.

The securities contracts (Regulation) Act of 1956 defines stock exchange as:

“An Association, organization or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities.”

An organized stock exchange is thus an association of persons that provides facilities where the securities can be traded by its members, who are referred to as owning seats on the exchange in accordance with self-imposed rules and regulations that confirm to public law. The general public is not permitted to handle security purchases and sales on the floors of these exchanges, only members of the exchange.

Role Played by the Stock Exchange in the Economic Development of a Country

A stock exchange has been variously described such as the barometer of adversity and prosperity of a nation and as the mart of the world and as “Fortresses of Finance.” In the modern business world of today, stock exchanges are the important ingredients of the capital markets. They are the prime centers through which investment activities are carried by individual and business concerns.

Importance of Stock Exchange

From the View Point of the Community

1. It helps in the economic development by providing a body of interested investors.
2. It upholds the position of the superior enterprises and assists them in raising funds.
3. It encourages capital formation.
4. It helps the government to raise funds through the sale of securities for economic development.
5. It portrays the prevailing economic situation of a country. All the changing political, economic and industrial conditions of the nation are reflected on the stock exchange.
6. Through correct evaluation in terms of their real worth, the stock exchange helps in the orderly flow of distribution of savings as between different types of competitive investments.

From the View Point of a Company

1. The maintenance of a free market, with prices established at all times by the forces of supply and demand, make listed securities more useful then unlisted stocks and bonds.
2. The Securities can be used as collateral at a bank for a loan or as the security for collateral trust bonds.
3. By providing a channel through which million of individuals invest their savings in long term securities, the stock exchange make possible, indirectly, the growth of hundreds of corporations.
4. A member of the company of a stock exchange enjoys better reputation and credit.
5. It provides one great view of business, the capital. It serves as a pivot of money market and fortress of capital.
6. Due to their purchase and sale on a stock exchange, the market price of the shares of a company is likely to be higher in relation to earnings, dividends and property value. This raises the bargaining power of the company in the event of amalgamation.

From the View Point of Investors

1. It is only an organized securities market, which can provide sufficient marketability and price continuity for shares so necessary for the needs of investors.
2. Easily saleable security becomes a good material security for loans.
3. Strict enforcement of rules safeguards the interest of the investors.
4. The daily report enables him to know the exact worth of his investment.
5. It is only such a market that can provide a reasonable measure of safety and fair dealing in the buying and selling of securities.

Functions Or Services of Stock Exchange

1. Distribution of New Securities

The brokers advise their clients regarding the merits of a new issue and distribute the companies prospectus among their clients, thus playing a vital role in obtaining subscription from their clients.

2. Facility of Transfer of Securities

The title to the shares is transferable. Hence those investors who do not want to block their money in the same stock can sell their shares to those who are interested in buying them through the stock exchange.

3. Mobility of Capital

A stock exchange performs the function of a continuous ready market for immediate conversion of stock into cash and vice versa, thus providing a market for capital without adversely affecting the industry.

4. Function of Evaluating Securities

It performs the evaluating function of shares by publishing the prices at which bargains are made which become price quotations. In the confidence of these quotations, investors are able to take decisions regarding their investments.

5. Function of Economic Barometer

Stock exchange is often called an economic barometer, which indicates the wealth and trends of not only the industries but also of the economy as a whole. Symptoms of any disease in the economy can be easily traced through the stock exchange. The functioning and operations of stock exchange reflect the temperament of the economy.

6. Increase in the Number of Dealings

The stock exchange provides the facility for secondary distribution of new securities after their original sale. Stocks of securities of fared for sale in a stock vary from time to time. It increases the marketability of the securities since they are bought and sold again and again.

7. Forecasting Function

The stock exchange reflects the future business conditions and trends of price. Signals of impending financial and business dooms are indicated by the stock exchange in advance.

8. Imparts A Collateral Value to Securities

The fact that the title of the shares are transferable increases the collateral value of the securities and enables the holder to obtain loan on their basis. The creditor on the other hand, can promptly liquidate these collaterals by selling in time of emergency.

9. Agency of Capital Formation

The liquidity of shares and proper publicity of securities through various means attracts the general public to invest their savings in stock and securities. Greater investment means generation of capital.

10. Clearing House of Business

Companies are required to furnish all the essential financial statements and other reports etc to ensure maximum publicity on corporate operations and working. Thus, stock exchange is an important source of information, which is valuable to the investors, to government bodies and to the company itself.

11. Regulation of Market Prices

Companies are required to furnish all the essential financial statements and other reports etc. to ensure maximum publicity on corporate operations and working. Thus, stock exchange is an important source of information, which is valuable to the investors, to government bodies and to the company itself.

12. Regulation of Market Price

Speculations in the stock exchange promotes equilibrium of demand and supply and prevent large fluctuations in prices. The price movements are made smoother by the activities of speculators.

13. Regulation of Company Management

A company, which wants its securities to be quoted and traded on a stock exchange, has to get itself enrolled according to the laws and rules of the stock exchange. Through these regulations, stock exchange exercise wholesome influence on the management and working of he company in public interest.

Investment Banks

Investment banks perform a major role in the very important function of raising long-term capital for corporations. Such banks are also sometimes called security houses. These specialize in the marketing of new issues of common preferred stocks and bonds of old and new companies. They sell them to the general public or to pension funds, insurance companies or other large investing institutions. These are banks, which provide capital for industry usually for long period purposes of production, in return taking over shares in the borrowing companies. What they actually do is to under-write a corporation’s new security issues. In other words, security houses guarantee the sale of a company’s securities and deliver a check to it for these new securities. They make their profit by changing a commission which may vary from 3% to 10% or more of the proceeds of the sale.

The investment bank would make an investigation of a company prior to making any commitment regarding the proposed bond issue. The final agreement to under-write is usually not signed until a day or two before the securities are put on the market. The price that the investment bank would be willing to pay would depend on the amount that it anticipates can be realized from the sale of securities.

Financing by Leasing

Leasing houses or companies are the institutions that provide business premises, building, plants, machinery, store and office equipment and other fixed assert accessories on rent to business enterprise. They carry on rental business and their source of earning is rental income. Manufacturers and service business owners obtain their fixed asset requirements from leasing companies on rent without buying them up and getting their capital blocked for a longer period. This source is very attractive to those business enterprises that require a relatively large working capital to meet the growing challenge of increasing competition. The facility provided by leasing companies is an indirect finance for fixed capital requirements. Instead of giving loan or providing capital in cash, they offer necessary fixed assets in kinds on monthly rental basis to manufacturers and service business operators. Leasing the cost of typical lease is, as would be expected, higher than the interest on loans.

International Chamber of Commerce

It is a world trade organization founded at Atlantic City, N. J, in 1920 with headquarters in Paris. Its membership, derived from more than 70 countries, consists of Chambers of Commerce, trade and industrial associations, and individual business firms and corporations. Mr. M. A Rangoonwala has been the Vice President of I.C.C for quite some time.

It acts as a clearing house for the exchange of views in international economic policies and problems and to promote world trade. In 1946, it was granted consultative status by the Economic and Social Council of the United Nations. It gives suggestions to GATT and UNCTAD on matters of restrictions on import, shipment problems, customs tariffs etc.

International Chamber of Commerce solves the problems of international arbitration of exchange. in fact, it solves the disputes arising out of payment by a person in one country of a debt payable in another country by means of a Bill of Exchange purchased in a third country.