Sole Traders, Partnerships & Limited Companies (Cambridge International AS Accounting)

Sole traders

Spec point — the different types of business entity: – sole trader

the advantages and disadvantages of these types of business entity Candidates are expected to use their understanding of types of business entity to take relevant decisions.

Sole traders

Who is a sole trader?

• A sole trader is someone who owns and controls a business on their own
• This type of business is easier to set up than other types of businesses as there are no legal requirements
• The sole trader may employ others to help them in running the business but the sole trader is the only owner of the business

What are the advantages of operating as a sole trader?

• The sole trader gets to keep all the profits that the business makes
• It is quite easy for the sole trader to make decisions as they do not need to consult with anyone else
• The financial statements prepared by the sole trader are kept private and do not need to be shared with the public
• Book-keeping and accounting functions are much easier to perform

What are the disadvantages of operating as a sole trader?

• The sole trader has to bear all the responsibility for any losses made by the business

• As the sole trader is the only owner, there is no one else to share the workload or **decisions **of the business with

• There are **limits **to the amount of capital the sole trader can invest in the business as they have no one else to contribute to funding the business

• If the owner is on** holiday or becomes sick**, they may not make any money and the business may suffer

• The owner has** unlimited liability**

  • This means the owner’s personal possessions may be used to pay debt if the business becomes bankrupt as the owner and the business are one entity

Exam Hint The advantages and disadvantages may be presented as a multiple choice question on Paper 1. A Paper 2 question may require you to discuss if a sole trader should set up as a limited company or a partnership. Knowledge of the advantages and the disadvantages can be used to present your argument in support or against the decision to be made.

Worked Example Which of the following is not an advantage of operating as a sole trader?

A	Decisions can be made quickly by the sole trader as there is no need to consult with anyone else
B	The sole trader does not have to share any of the profit made
C	The financial statements of a sole trader are published to the public
D	Book-keeping and accounting of the records of a sole trader are simpler

Answer:

Final answer: The correct answer is C. The financial statements of a sole trader do not need to be published to the public. They can be kept private.

Partnerships

Spec point — the different types of business entity: – partnership the advantages and disadvantages of these types of business entity Candidates are expected to use their understanding of types of business entity to take relevant decisions.

Partnerships

What is a partnership?

• **A partnership **is a business in which two or more people operate as owners with the main purpose of making profits
• Normally a partnership consists of** two to twenty partners **
• Sometimes a partnership is formed when a** sole trader** wishes to expand or grow their business
• Two or more sole traders may decide to combine their resources such as money and assets to form a new business

What are the advantages of operating as a partnership?

• Forming a partnership is relatively easy as formal permission is not required to set it up

• Partners have access to additional finance because all partners contribute to raising the capital of the business

• Partners have access to each other's skills and expertise

  • For example, a makeup artist might partner up with a hairstylist

• Partners share the risks of operating the business

• Partners can cover each other for sickness and holidays

What are the disadvantages of operating as a partnership?

• Profits are shared among all partners

  • Unlike a sole trader who keeps all the profits, partners will share it

• Partners may find that they have **disagreements **

• Partners may take** longer to come to decisions** about the operating activities of the business due to them having different opinions

• All partners are responsible for the debts of the business

  • Even if the debt was only created by one of the partners

Exam Hint In the exam on the structured written paper, you may be asked to advise a sole trader whether or not they should form a partnership with another sole trader. You should state two advantages of operating a partnership and two disadvantages of operating as a partnership and then make a recommendation.

Limited companies

Spec point — the different types of business entity: – limited company (including public limited company (plc)) the advantages and disadvantages of these types of business entity Candidates are expected to use their understanding of types of business entity to take relevant decisions. Note: Questions on Limited Liability Partnerships will not be set.

Limited companies

What is a limited company?

• A limited company is a business owned by a group of people

• The ownership of the company is divided into parts known as shares

  • The people who buy the shares are known as the shareholders
  • Each share has a monetary value called nominal, face or par value

• A limited company can be private (Ltd) or public (PLC)

  • Anyone can buy shares in a public limited company
  • Shares in a private limited company are not sold publicly

• Owners of a limited company have limited liability

  • This means the business is a separate entity

  • The owners are only liable for the amount they invest

    • If the company goes bust then they only lose the amount invested

• The reward the shareholder receives for investing their money in the limited company is called a dividend

  • Dividends are paid from the profits the company makes

  • Dividends are paid as a proportion of the face value of the shares owned by the shareholder

    • Dividend paid = number of shares × dividend per share

What are the advantages of operating as a limited company?

• The owners of a limited company can usually generate more capital than sole traders or partnerships
• The owners of a limited company have limited liability whereas sole traders and partnerships have unlimited liability

What are the disadvantages of operating as a limited company?

• Limited companies come with more legal requirements than traders and partnerships such as audits and making financial statements public
• It can cost more to set up a limited company than the costs of setting up a sole trader business or partnership

Trading, service & manufacturing businesses

What is a trading business?

• A trading business buys and sell goods

  • Examples include grocery stores, car dealerships, etc

What is a service business?

• A service business provides a service

• The business does not buy or sell goods

  • Examples include insurance company, accountants, travel agents, hairdresser etc

What is a manufacturing business?

• A manufacturing business produces goods for sale

  • Examples include clothes factory, food factory, etc

Can a business be a combination of these?

• A business can do a mix of trading, service and manufacturing

  • For example, a sandwich shop might create their own sandwiches but buy crisps and snacks for resale

Which businesses can be trading, service and manufacturing businesses?

• Any type of business can be a trading, service or manufacturing business

  • For example, a sole trader can be a manufacturing business and a limited company can be a service business