Principles of Business Section 1: Nature of Business Week 2 and 3

Reasons for establishing a business

There are numerous reasons why people establish businesses:

 To help the community and provide employment

 To provide necessary goods and services which don’t exist in the community
 To make a profit
 To achieve financial independence
 To seek to achieve one’s personal goal
 To become one’s own boss

Functions of a business
These include:

 Providing employment for locals which helps to reduce social problems such as crime and
poverty
 Providing necessary goods and services to local
 Making a profit which contributes to the government revenue by way of taxes.

PRIVATE SECTOR AND PUBLIC SECTOR

Private sector refers to that part of the economy that is owned and controlled by private individuals and
firms. The public sector on the other hand, is that sector of the economy that is owned, controlled and
funded by the government. The table below shows the major differences between the public and
private sectors:

THE PUBLIC SECTOR THE PRIVATE SECTOR

Main aim is to provide services to consumers at
the lowest possible price
Sources of funding include taxation revenue,
grants or loans from other countries or financial
institutions,
Emphasis is on catering to the needs of the entire
population
Main aim is to maximize profits
Sources of funding include personal savings
,inheritances and loans from family members
,friends or lending institutions
Emphasis is on catering to the wants of a
targeted audience or market

Examples include sole trader, partnership, Examples include state corporations and
cooperatives, companies, joint venture business, nationalized industries, statutory bodies or
multinationals and franchises agencies, local and municipal authorities,
government department

Sole Trader/Sole Proprietorship

This is one of the most common forms of business organization and larger businesses would have
started off as a sole trader organization. It is a business that is owned, operated and controlled by one
person. The owner and the business are one and the same meaning that legally, the business is not a
separate entity from the owner. Example includes corner shop owners, mechanics, and street vendors.

Advantages of a sole proprietorship

1. All profits go to the owner

2. Decisions can be made quickly since no consultation is needed
3. It is easy to set up since there are little to no legal formalities required
4. The startup costs are low since the business produces on a small scale
Disadvantages of a sole proprietorship

1. The owner has unlimited liability-This means that in the event of the business failing ,the owner
stands the risks of losing whatever funds he would have invested in the business as well as his
personal assets.
2. The business suffers from a lack of continuity meaning it usually dies with the owner.
3. There is limited sources of finance for the business since the business has a lack of assets that it
can use as collateral. Collateral refers to any form of security that can be used in getting a loan
for e.g. Land, property, and shares.
4. The owner must endure long hours of work since the majority of work has to be done by the
owner.

Partnerships
A partnership may be defined as a group or association of 2-20 partners who establish a business with
the common view of maximizing profits. Examples of partnerships businesses include professionals such
as lawyers,doctors or accountants.

The Partnership deed

It is not compulsory that a partnership be formed under the terms of a Partnership deed. However it is
advisable that the partners draw up this legally binding agreement which outlines the terms and
conditions of the partnership including :

 The names of the partners

 The name,nature of location of the business
 The capital contributions of each partner
 The profit sharing ratio
 The voting rights
 Responsibility of each partner
 The procedures for the admission of new partners

N.B When there is no written partnership agreement, then all profits are shared equally,
no interest is paid on capital invested by partners, no salaries are to be paid and decisions are
made based on the principle of majority.

Types of Partners

1. Sleeping partner- is one who mainly contributes capital but is not involved in the day to day
activities of the business
2. Ordinary partner-largely responsible for the day to day running of the business. He has
unlimited liability and is normally the last to receive dividends.
3. Limited liability partner- personal assets are protected by law and cannot be used to pay off the
business debts.
4. Preferred partner –these partners obtains preferential treatment in the sharing of profits since
they receive dividends before other partners are paid and has to be paid whether or not the
business makes a profit.
Advantages of a Partnership

1. Greater access to more funding than a sole trader since there is more owners contributing
capital
2. There is a greater access to expert knowledge so more ideas can be generated and better
decisions can take place
3. There is continuity when one partner dies
4. The workload is more evenly distributed since there are more people involved in the business
operations
5. No corporate tax is placed on the business profits. However the partners are taxed according to
their share of profits
6. Partners can take vacations and periods of sick leave where necessary and production can still
carry on.
7. It is relatively simple to start up

Disadvantages of a Partnership

1. Each partner has to take responsibility for the acts of other partners.
2. Unlike a sole proprietorship, profits will have to be shared amongst partners despite some being
more burdened than some.
3. The decision making process is slow and difficult since more consultation has to take place
4. Conflicts may arise amongst partners
5. If a partner dies or leaves then the entire partnership agreement has to change to reflect the
new partner coming in
6. At least one partner (ordinary partner) has to bear unlimited liability
 Companies
A company is a business entity that has a separate legal entity from that of its owners. This means that
the company can enter into contracts, make legal claims (sue) and face any legal claims that are made
against them.

There are two types of limited companies:

 Private limited companies

 Public limited companies

Private limited companies

 These are businesses consisting of 2-50 members whose aim is to make profits. The membership
is restricted to family and friends. Before these companies are formed, certain documents must
be submitted to the Registrar of Companies.
These include
 Memorandum of Association( private and public)
 Articles of Association (private and public)
 Prospectus (public)

Memorandum of Association

 This governs the external relationship of a company. It includes

i. the company’s name – private limited companies must have the word ‘limited’ in its
name
ii. the address of the company
iii. objectives of the company
iv. the amount of share capital to be issued

Articles of Association

 This governs the internal relationship of the company. This includes:

i. procedures for calling an AGM(annual general meeting)
ii. rights and obligations of the directors
iii. procedures for the payments of dividends(share of profits to shareholders)

Advantages of Private Limited Companies

1. a larger capital base than sole traders because the membership is larger
2. a company has continuity
3. a company can obtain loans easier from financial institutions since they have a larger capital
base
4. Shareholders have limited liability- means that their personal possessions are not at risk in the
event of the business failing.

Disadvantages of Private Limited Companies

1. Capital is limited to 50 members

2. The selling of shares is restricted to family members
3. The legal requirements could be costly and time consuming
 PUBLIC LIMITED COMPANIES
Characteristics of public limited companies

1. There must be at least 7 shareholders and there is no limit on the maximum amount
2. The letters ‘plc’ must be included in its name
3. Shares are sold on the stock market
4. A company must be registered with the registrar of companies

Advantages of public limited companies

1. Shareholders have limited liability

2. There is continuity
3. It is easier to obtain finance because of the number of investors/shareholders that exist in the
business
4. Shares are quoted on the stock exchange and sold to the public.

Disadvantages of public limited companies

1. The accounts of the company has to be made public

2. The legal requirements to start the business may be costly and time consuming
3. There is the risk of another company taking over the business by buying the majority of shares
4. Because of the large size, decision making is time consuming

MULTINATIONALS

 A multinational is a business that has its headquarters in one country but has other branches in
other countries. For example Rubis and shell gas station.

Advantages

1. Foreign currency can be generated

2. They create employment for locals
3. Local firms are forced to improve their quality in order to compete with multinationals
4. They pay significant tax revenue to the government which can be spent for development
5. The total out of the economy can increase

Disadvantages

1. Competition can cause local businesses to fail

2. Profits are often sent back to foreign countries
3. Possible destruction of the environment
4. Employment may not increase as expected
5. Exploitation of local workforce