Types of ownership of a business

A summary of some of the benefits and drawbacks of each of the more popular types of business ownership

Sole Trader

Advantages

• Quick Decision Making
• Keep all profits
• Total Control of all areas

Disadvantages

• Unlimited Liability (critically important!)
• Lack of fresh ideas
• Owner may need to know about all areas of the business
• Harder to raise finance
• May involve longer hours
• May be harder to take holidays

Partnerships

Advantages

• Specialisation / Expertise – do not need to know about all areas of business – each partner could focus on areas of strength
• Fresh ideas may mean better decisions
• Easier to raise finance than sole trader
• Leave others in charge
• Easier to take holidays

Disadvantages

• Unlimited Liability (critically important!)- responsible for other peoples debts too!! Joint and several liability!
• How to share the profits (although the profits may be larger than a sole trader!)
• Less control over company
• Slower decision making?
• Can they work together?

Private Limited Company (Ltd)

Advantages

• Limited Liability (important)
• Raising Finance is easier (due to reputation?)
• Enhanced reputation with suppliers and banks?
• Economies of scale
•  

Disadvantages

• Loss of control for owners?  1 share = 1 vote (ordinary shares) so control may become diluted
• Decision making may be slower – Meetings to organise
• Sharing profits by paying shareholders dividends
• Legal obligations (increase in paperwork needed)
• Minimum share capital £50,000
• Not on the stock exchange so not as easy to raise finance as Plc.
• Harder to buy/sell shares as need to find buyer who the other shareholders are happy with
• Decision making slower – Annual General Meetings & Emergency General Meetings will/may need organising
• Need to appoint directors

Public Limited Company (PLC)

Advantages

• Raising large amounts of finance is easier
• Company reputation may give economies of scale
• Limited Liability

Disadvantages

• Decision making slower – Annual General Meetings & Emergency General Meetings will/may need organising
• Need to appoint directors
• Need to provide shareholder value (consider dividends and raising the share price) - divorce of ownership means a duty of care

Capital & Revenue Expediture and Capital & Revenue Income

Capital Expenditure is the purchase or improvement of Non Current (Fixed) Assets including delivery and installation costs.  It does not include the repair or maintenance of any non current asset as this is a running cost to be paid each year.  The accruals concept says the total cost should be written off (depreciated) over their expected lifetime.  NCA’s are usually kept for more than 12 months and help to generate profits.

Capital Income could be a long term sponsorship deal (e.g. £50m over 5 years is £10m per year claimed as income.  Emirates sponsorship of Arsenal FC’s stadium could be considered an example.

Worked Example

A driving instructors car cost £11,000 to buy plus £1000 in extra signage and dual controls.  The capital expenditure would be £12000.  It is expected to be used for 3 years and have residual value of £3000

The yearly depreciation is (£12000 - £3000)/3 = £3000 per year

Revenue Expenditure is the running costs which belongs to that year.  This is put as an expense in the years Income Statement (Profit and Loss).  Things like repair to a non current asset (new tyres on the car) or the depreciation of £3000 are revenue expenditure

Revenue Income is income belonging to that year – e.g. Sales and Rent Received.

Liquidity Ratios

Liquidity ratios measure a firms short term cash flow.  This is important as they will have short term obligations to staff (wages) and suppliers amongst others.  Looking at then in isolation is of little value.  They must be compared with last years figures, competitors figures or industry averages (if available) in order to build up a picture.

Trade Payable collection period

Trade Payables                                 x 365 =  X days

Credit Purchases

Explanation: This is your trade payables as a proportion of your credit sales.  A higher figure means you wait x days before settling your bills.  Always round answers up to the next whole day.

Comparison:  higher the figure is better for your businesses liquidity 

Assessment: Paying early may mean you receive discounts – increasing profits. Paying late could also squeeze your suppliers’ cash flow.  Paying early will affect yours!

Note: - It is often useful to take Trade Receivable Days away from your Trade payable Days to show the overall credit cycle – a negative figure means you pay your credit suppliers after receiving money from your credit customers.  Quote the difference!

Trade Receivable Collection period

Trade Receivables           x 365 =  X days

    Credit Sales

Explanation: This is your trade receivables as a proportion of your credit sales.  A higher figure means you wait x day to receive your money.  Always round up to the nearest whole day.

Comparison:  lower the figure is better for your firm’s liquidity.

Assessment: Offering cash discounts to your credit customers can lower this and improve cash flow issues.  This should lower profits though and may also reduce sales.  It may reduce the chances of bad debts as there are fewer monies outstanding.

Note: - It is often useful to take Trade Receivable Days away from your Trade payable Days to show the overall credit cycle – a negative figure means you pay your credit suppliers after receiving money from your credit customers.  Quote the difference!

Net Current Asset ratio

   Current Assets               =  x:1

Current Liabilities

Explanation: This means that for every £1 of short term debt a firm has x pounds to pay the debt

Comparison:  higher the figure is safer for the businesses liquidity but not always better for your efficiency

Assessment: A high figure avoids cash flow problems but may mean your short term assets are not working as hard as they could.  The business could be sat on cash or inventory.  A low figure could mean being very efficient or that there are cash flow problems – particularly if most of the current assets are tied up in Trade Receivables / Inventory.

Liquid asset ratio

Current Assets (excluding inventory) =  x:1

Current Liabilities

Explanation: This means that for every £1 of short term debt a firm has x pounds of liquid assets (inventory can be hard to sell quickly!) to pay their short term debts

Comparison:  higher the figure is safer (Liquidity) but not always better (assets not working as hard as they could be!)

Assess: A high figure avoids cash flow problems but may mean short term assets are not working as hard as they could.  Low figures could mean being efficient or cash flow problems (particularly if most of the liquid assets are Trade Receivables)

NB A company with a high current Ratio but low liquid capital ratio has too much inventory!!  This is not good as it is could be hard to sell or perishable etc.

Inventory turnover

Average Stock   x 365 =  X days

Cost of Sales

Or

Cost of Sales     = X times a year

Average Stock

NB Average stock is opening stock plus closing divided by 2

Explanation: This means that inventory is kept for x days before it is sold (round up to the nearest whole day)

Comparison:  the lower the figure is almost always better in days (higher is better in times per year version)

Assessment: Firms with low days of inventory may be more efficient by reducing wastage or theft.   However they may not have enough inventory to fully meet demand which could lose the company sales if deliveries are late.