CHAPTER 2 TUTOTRIAL.docx - CHAPTER 2 FINANCIAL STATEMENTS...

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CHAPTER 2 FINANCIAL STATEMENTS FOR DECISION MAKING 1. Explain the basic differences between a sole trader (or single proprietorship), a partnership and a company. Discuss the factors that need to be considered in selecting an appropriate structure for Cynthia’s beauty services business. The three basic business structures are: Sole traders are where individuals conduct business in their own capacity. They would be contributing their own capital or equity to the business and would be borrowing money in the name of the business in their own name. They would be liable to repay the outstanding debt of the business and, if unable to repay, the bank, would have access to their own personal assets to repay the outstanding debt. This business structure is suitable for small operations with small staff and turnover. The sole trader has sole responsibility and control for the business operations and activities. This structure is suitable for small businesses which require minimal capital to set up and have relatively low running costs and risk. A partnership is two or more persons in business together, operating under a partnership agreement which may or may not be a formally written document. Partnerships have the advantage over sole traders in that they have a larger base for capital contribution and are able to share the risks and responsibilities associated with running a business. The partnership is treated as a separate entity for accounting purposes but is not a separate legal entity. This means that the underlying assets and liabilities of a partnership belong to the individual partners in the proportion agreed upon as part of the partnership agreement. Therefore if the business activities prove to be unsuccessful, creditors have the right to access the personal assets of the individual partners in the event the business is unable to repay any outstanding debt. For this reason, the partnership structure is usually used where there is a low element of risk to the business or where the law dictates that the business entity must be run by the individuals providing the service. For example, work completed by professionals including accountants and lawyers. The company is a separate legal entity with ownership of a company attributed to shares held. The owners of the company are known as shareholders. The advantage of this business structure is that, as a separate legal entity, the assets and liabilities belong to the company. In the event the business is unable to repay its debt, the creditors only have access to company assets for repayment of the debt. The investment in the company by its shareholders is limited only to the shareholders’ capital contribution, i.e. what the shareholder pays for the shares. This business structure is more appropriate for entities requiring larger capital contribution, which have a large number of overheads and employees and has a higher business risk. The disadvantages include higher set up and ongoing
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