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Revision - Forms of business organizations

Question ONE
(a) Identify three main problems facing the owner of a small business.
Answers
(a)The majority of business failures are small firms. The main problems facing them are:
Lack of capital: most small businesses are started with the owners own savings. In times of
recession or falling sales this is inadequate to continue paying the business fixed costs.
Lack of expertise: small businesses employ only a few people, many of whom are not specialists
in areas such as accounting, marketing, production or personnel. Inadequate control of such areas
as credit can lead to severe cash flow problems.
Lack of planning many small businesses start with a simple idea that is easy to establish and
control such as a retail outlet. They are nearly always started when the economy is buoyant and
demand is high. Unfortunately the owner has rarely planned ahead to take account of
opportunities to expand or for periods of low demand. When these occur the owner is taken
unawares and is forced into a hurried decision, often the wrong one for the circumstances.

Question TWO
(a) What are three advantages and three disadvantages of being a sole trader?
Answers
(a) The main advantages of being a sole trader concern decision-making, profit sharing and
customer relations. The sole trader is the boss and as such makes the decisions on a daily basis
with no waste of time in consultation.
This allows the sole trader to be quick in responding to market changes.
Each good decision should be reflected in a cost saving, an increase in revenue or the
enhancement of the business reputation. The reward for being successful is profit that the sole
trader does not have to share with any other partner. This can provide the owner with a great deal
of satisfaction and motivation as well as an income. The third advantage is the opportunity to
build good customer relations. The sole trader is able to have direct contact with customers and
to provide a more personal service that often helps to build a loyal group of repeat clients thus
ensuring future sales.
The disadvantages concern risk and liability, hours of work and expansion. The sole trader has
unlimited liability. This means the owner is fully responsible for all the debts of the business. The
owner is not only risking the capital invested in the business but also their own personal assets
such as a house. The typical sole trader will work much longer hours than any salaried

employees will. It is also difficult to find cover for the taking of holidays or for illness especially
where the business requires personal service such as with a plumber, a hair stylist or a
photographer. Expansion is also a problem as a sole trader will invariably have only a small
capital base. To enlarge the business may require the owner to take on more risk by arranging a
bank loan or share the profits by taking on a partner. Either way the fundamental basis of the
original operation has to change.
Question THREE
(a) Compare and contrast:
(i) A sole trader and a partnership
(ii) The private sector and the public sector
(b) Explain three advantages and three disadvantages of a firm becoming a public limited
company (Plc).
Answers
(a) (i) A sole trader is an individual who owns and operates a business. They generally have very
limited amounts of capital and are heavily reliant on their own personal commitment for the
success of the business. A partnership, however, can have many part owners who share the
responsibilities of the business and can contribute according to their individual expertise.
Both forms of business have unlimited liability which means that the owners are responsible for
all of the firms debts. In general, partnerships tend to be larger businesses than sole traders and
tend to continue much longer.
(ii) Both the private and public sectors are part of a countrys economy. The public sector is
owned and directed by the government on behalf of the people, whereas the private sector is
owned and managed on behalf of the owners and shareholders. The principal task of the private
sector is to make profits whereas the public sectors main role is to provide public services such
as health care and education. The private sector is answerable to the owners or the shareholders.
In the public sector performance is scrutinized initially by politicians but eventually by the
general public.
(b) One of the principal advantages of becoming a public limited company is the access to new
forms of finance. The business has access to much larger sources of funds as it is allowed to sell
shares to the general public. This enables large amounts to be raised at a much lower cost. The
status of a public limited company (PLC) is another advantage as suppliers are more ready to
extend credit facilities to companies that have passed the stringent financial tests required of
PLCs. In the same way customers are more confident in purchasing items, particularly expensive
consumer durables, from large companies as they have the appearance of greater permanence
and security.
On the negative side PLCs are quite expensive to set up. The costs of issuing a prospectus and
satisfying the demands of the stock exchange can be over 1 million.
On top of this initial cost the company must keep a detailed shareholder register and
communicate annually with its members in the form of a published report. The shareholders will
also expect an annual dividend as their reward for investing in the company. Ownership is
diluted with the issue of shares. Public trading opens the possibility for predator firms to

purchase shares and to mount a takeover bid. The advantages of greater finance have to be
balanced by the greater loss of control and ownership.

Question FIVE
a) A successful sole trader wishes to expand and is considering forming a partnership with a lifelong friend. Outline the advantages and disadvantages for a sole trader in forming a partnership.
b) Explain the advantages and disadvantages of operating a business as a franchise.

Answers
a) Forming a partnership is one method of expanding a business.
The main advantages of a partnership are:

There can be division of labor between the partners so that each can specialize and
benefit from each others expertise.
More capital can be introduced into the business by adding new partners
Decision-making can be shared
Partners can develop interchangeability so that one partner can substitute for another in
times of illness or holiday
In this specific case the sole trader is forming a partnership with a lifelong friend who
should therefore be trustworthy and easy to work with.

The main disadvantages are:

General partners have unlimited liability and therefore are responsible for all debts
The withdrawal or death of a partner may dissolve the firm
Decision-making may be slow as all partners must agree. Shared control means the
possibility of disagreements and delays.

b) A franchise is an agreement where one person (the franchisee) purchases from another (the
franchisor) the right to sell a patented product or service using a well-established framework and
method. The advantages of operating a business as a franchise are:

The product is already proven in the market place and is known to the customer.
The franchisee will receive expert help from the franchisor before, during and after setup.
The franchisor will provide on-going training and advice to overcome the franchisees
lack of experience.

The franchisor will provide a standard procedure for administration, basic bookkeeping,
financial planning, stock control and personnel management.
The franchisor provides the advantages of bulk buying and mass advertising in return for
the franchise fee.

The disadvantages of a franchise are:

The franchisee may feel constrained by the regulations imposed by the franchisor.
The franchisee must pay a percentage of all sales to the franchisor.
The franchisee is restricted to the franchisor for all of the main purchases.

Question SIX
A small, successful partnership wants to expand to become a significantly larger enterprise.
Identify the advantages and disadvantages to the partnership of becoming a private limited
company (Ltd).
Answers
There are numerous advantages that a partnership could gain from becoming a private limited
company. One of the main advantages is the ability to raise more capital by issuing shares
privately. Extra finance would be needed to pay for the proposed expansion and to provide
working capital while the company built up its market share. Selling shares will provide long
term permanent capital for the business. A second advantage is limited liability. The firm
becomes a separate legal identity and as such the owners are only liable for the capital invested
in the business. This means that the partners are not putting their private assets at risk. This is of
great advantage when undertaking the risk associated with expansion. A third advantage is
economies of scale. As the business expands it can take advantage of savings associated with size
such as purchasing discounts. The owners might be able to secure longer credit terms with
suppliers or negotiate discounts for buying in bulk.
However, by selling shares to people outside the partnership ownership is diluted and there are
more 'stakeholders' who will expect a share of the profits. A second disadvantage is that the
business must now have its accounts audited and submitted to Companies House. This will incur
extra costs and also means that the general public can have access to the financial status of the
business. The business also must follow legal guidelines about holding an annual general
meeting of shareholders and publishing annual accounts. All of these will add to costs and make
the business more open to scrutiny and investigation. The business must, therefore, weigh the
advantages of increased capital for expansion and limited liability against the dilution of
ownership and greater public scrutiny.
Question SEVEN
Examine the reasons why a franchise is more likely to survive in business than a sole trader.
Answers

One of the main reasons for sole trader failure is the lack of detailed planning and research at the
outset of the business. A good idea or product is not always a guarantee of success. Too often the
sole trader has failed to identify the extent of the customer base. This leads to early saturation of
the market or where success is achieved early on to the emergence of competitors with similar
products. Franchises on the other hand have done extensive research and have a tried and tested
recipe for the promotion of the product.
A second reason is concerned with finance. Sole traders often underestimate how much capital is
required to run a business, especially when sales expand on a credit basis. Each credit sale means
the sole trader having to wait for up to two months for payment. This can result in a growing
overdraft, increased finance service costs and greater risk. A franchisee, however, has the support
of the parent group that will often grant extended credit to match the expansion in sales at rates
more favourable than a bank.
Another reason for sole trader failure is lack of managerial experience. The owner is often a
skilled worker or craftsman who is excellent at producing the product or service. This does not
mean, however, that they are also skilled at bookkeeping, tax requirements, health and safety
issues and marketing. The franchise operator has a team of experts who provide these services or
are willing to train the franchisee in the necessary skills before and during the period of the
franchise. The franchisor has a standard operating procedure to deal with advertising, stock
control, employment, accounts and fi nancial planning. Errors of omission by the sole trader can
lead to costly mistakes and even to the transgression of legal requirements concerned with safety
issues and employment.
The sole trader is reliant on his or her own resources, both physical and financial. The franchise
has the technical support and financial backing of a much larger concern. Through the bulk
buying power of the franchisor, the franchisee can benefit from cost reductions for its raw
materials, transport, advertising and promotion.
The main advantage of the franchise operation is seen not when the economy is doing well but in
times of recession. Falling sales and rising interest costs associated with periods of recession
often signal the end of inadequately financed small businesses. The franchise operator, however,
has a vested interest in helping the franchisees to survive and can offer not only professional help
but also temporary funding to enable the business to survive.

Question EIGHT
Explain the advantages and disadvantages of a firm becoming a public limited company.
Answers

One of the principal advantages of becoming a public limited company is the access to new
forms of finance. The business has access to much larger sources of funds as it is allowed to sell
shares to the general public. This enables much larger amounts to be raised at a much lower cost.
The status of a public limited company (PLC) is another advantage as suppliers are more ready
to extend credit facilities to companies that have passed the stringent financial tests required of
PLCs. In the same way, customers are more confident in purchasing items, particularly expensive
consumer durables, from large companies as they have the appearance of greater permanence
and security.
On the negative side, PLCs are quite expensive to set up. The costs of issuing a prospectus and
satisfying the demands of the stock exchange can be several millions of pounds. On top of this
initial cost, the company must keep a detailed shareholder register and communicate annually
with its members in the form of a published report. The shareholders will also expect an annual
dividend as their reward for investing in the company.
Ownership is diluted with the issue of shares. Public trading opens the possibility for predator
firms to purchase shares and to mount a takeover bid. The advantages of greater finance have to
be balanced by the greater loss of control and ownership.