Sample Notes: Types of Business Entity

AS Level Accounting – Chapter 1.1: Types of Business Entity

1. Definition and Purpose of Business Entities

• A business entity is any organisation created to conduct commercial, industrial, or professional activities.
• Business entities differ in terms of:
  • Legal structure
  • Ownership
  • Liability
  • Sources of finance
  • Control and decision-making
  • Continuity and taxation

2. Sole Trader

2.1 Meaning

• A business owned and operated by one individual.
• Also known as sole proprietorship.
• Not legally separate from the owner.

2.2 Characteristics

• Owner makes all decisions and keeps all profits.
• The owner has unlimited liability (personal assets at risk).
• Business does not have a separate legal identity.
• Easy to set up and minimal legal formalities.

2.3 Advantages

• Full control of business decisions
• Easy to establish and operate
• Owner receives all profits
• Minimal legal compliance
• Privacy – financials are not public

2.4 Disadvantages

• Unlimited liability
• Limited access to finance
• Heavy workload on one person
• Lack of continuity if the owner dies
• Limited expertise

2.5 Suitable Sources of Finance

• Personal savings
• Bank loans (secured or unsecured)
• Bank overdraft
• Trade credit

2.6 Example

• A person running a small grocery shop or a tailoring business independently.

3. Partnership

3.1 Meaning

• A business owned by 2 to 20 people (as per most jurisdictions).
• Partners share profits, losses, and management responsibilities.
• Governed by a Partnership Agreement (oral or written).

3.2 Characteristics

• Shared decision-making and workload.
• Unlimited liability (unless structured as LLP, which is not examinable).
• Profits shared according to agreement.
• Can raise more capital than a sole trader.

3.3 Advantages

• More capital available
• Shared responsibility and expertise
• Easier to raise finance than sole traders
• Relatively easy to form
• Flexibility in operations

3.4 Disadvantages

• Unlimited liability for partners
• Disagreements may arise
• Shared profits
• Business ends on retirement or death of a partner (unless agreement says otherwise)

3.5 Suitable Sources of Finance

• Partner contributions
• Bank loans
• Overdrafts
• Trade credit

3.6 Example

• A law firm or medical practice jointly owned by two or more professionals.

4. Limited Company

4.1 Meaning

• A business entity with legal personality separate from its owners (shareholders).
• Liability is limited to the amount unpaid on shares.

4.2 Types

• Private Limited Company (Ltd):
  • Cannot sell shares to the public
  • Typically smaller, family-owned
• Public Limited Company (plc):
  • Can sell shares to the public on the stock exchange
  • Larger businesses

4.3 Characteristics

• Separate legal identity
• Limited liability for shareholders
• Continuity – not affected by death of shareholders
• Owned by shareholders, run by directors
• Accounts must be audited and made public

4.4 Advantages

• Limited liability
• Easier access to large capital
• Continuity
• Can attract investors
• Can expand operations globally

4.5 Disadvantages

• Complex legal formalities
• Financial accounts must be published
• Profits shared among many shareholders
• Possible conflicts between owners and directors (separation of ownership and control)

4.6 Suitable Sources of Finance

• Share capital (ordinary, preference)
• Debentures
• Retained earnings
• Bank loans
• Overdrafts
• Leasing
• Trade credit
• Government grants

4.7 Example

• Ltd: A family-run software development company.
• plc: Apple Inc., Unilever plc, Shell plc.

5. Comparison Table

6. Sources of Finance by Business Type

Sole Trader

• Bank overdraft
• Secured/unsecured loans
• Personal savings
• Trade credit

Partnership

• Partner contributions
• Overdrafts
• Loans
• Retained profits
• Trade credit

Ltd and plc

• Sale of shares
• Debentures
• Retained profits
• Leasing
• Government grants
• Instalment credit
• Trade credit
• Bank loans (secured)

7. Decision-Making Applications in Exams

• Scenario-based questions often ask:
  • Which type of business entity is most suitable for a given entrepreneur?
  • Evaluate the most appropriate source of finance for a new project.
  • Assess the impact of limited liability on business risk.
  • Compare ownership, control, and risk between two types.

8. Worked Example (Exam Style)

Q: Hamza wants to start a delivery business with two friends. They each want to contribute capital and share profits. What form of business entity is most suitable and why?

A:

• Most suitable: Partnership
• Reasoning:
  • 3 individuals involved (meets partnership structure)
  • Capital can be pooled from all partners
  • Shared risk and workload
  • Simpler setup than a company
  • Unlimited liability must be considered

9. Exam Tip Keywords to Use

• Separate legal identity
• Unlimited vs limited liability
• Continuity
• Share capital
• Ownership vs control
• External vs internal finance
• Advantages vs drawbacks
• Stakeholder impact (owners, creditors, employees)