In the course of business incorporation, prospective business owners have to decide on the type of business structure they are interested in. The choice of business organization is a very important stage of business formation as this affects a myriad of factors that determine the future of the company. Therefore, Deciding on the most applicable form of business can be a challenging process and, therefore, gaining an understanding of the various forms of business structures is significant. After all, a business organization is reflective of the owner’s strategic goals and objectives. The legal categories of business organizations are sole proprietorships, partnerships, corporations, and limited liability companies. The sole proprietorships is the ideal structure for a new business owing to the ease of formation and management, while its most important financial statements are the cash flows statement, balance sheet, and the profit and loss statement.
Legal Categories of Business Organizations
There are four major forms of business structures. These categories are: sole proprietorship; partnership; corporation; and limited liability company (LLC) ( Trivedi & Stokols, 2011) . Before business registration, potential business owners are required by the law to choose one form of business structure. The structure that one chooses helps determine incorporation costs, operational costs, personal liability and tax liability.
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Sole proprietorships are the most common business structures. This type of structure entails only one business owner in charge of the day to day running of the business. Therefore, this structure is ideal for entrepreneurs who prefer working alone. The major tax advantages of a sole proprietorship form of business is that owners are required to only file returns once because both personal and business taxes are not separate. Therefore, operational losses may be used to offset income that a sole proprietor has earned from other sources. However, the key disadvantage proprietorship is that the business owner suffers all the losses suffered by the business. In the process, the owner’s assets can be seized at any time as collateral for business debts, and owners may also be sued. Additionally, the unlimited liability aspect of this types of business means that business owners may be arrested for tax evasion where there discrepancies in their businesses’ tax accounts.
The second business structure category is the partnership. Ideally, partnerships are owned by two or more individuals. Partnerships can either be limited or general. General partners in both categories of partnerships are tasked with the day-to-day management of the business, while also assuming business liability. However, limited partnerships also have limited partners who lack any form of control over the companies, alluding that they are not subject to business liabilities as is the case for general partners ( Ireland, 2010) . The tax advantage that a partnership enjoys is that the business is only expected to report its profit and loss margins. The profits and losses are then passed through to the partners who then go ahead to file individual tax returns based on their profit or loss figures. However, the disadvantage is that the general partners are free to act on behalf of the business, a factor that may complicate the implementation of operational procedures.
For business owners, corporations may prove to be more expensive and complicated to operate in comparison to the other business structures. These types of businesses operate and completely independent legal bodies from their owners, and this factor means that more tax requirements and regulations are involved. Because the owners are separate legal entities from the corporations, their businesses can retain profits with no requirement that the owners should pay taxes on them. This is the key tax advantage of corporations. Nevertheless, one downside is that corporations involve added accounting and tax arrangement procedures than partnerships and sole proprietorships owing the complexity of the rules and regulations that need to be followed. This disadvantage may be cumbersome for inexperienced business owners and the services of certified accountants may be needed. Another shortcoming is the double taxation on corporations by state and national governments. Owners are expected to pay both income and individual tax rates on dividends and other earnings. However, the double taxation factor can be neutralized by paying out salaries to specific shareholders who also double up as company employees. This is because reasonable earnings for shareholder employees of corporations do not have to be taxed since these earnings can be withheld as business expenses.
On the other hand, limited liability companies differ from corporations in that there is no double taxation. However, the owners of LLCs have limited liability. The proprietors are able to receive the profits and losses and, therefore, they file them as personal tax returns. Essentially, LLCs enjoy the tax benefits that corporations possesses. The major tax downside is that business ownership is dictated by individual state laws, meaning that seeking the services of experienced accountants is inevitable. However, the lack of double taxation makes them lucrative forms of business structure for investors.
As an entrepreneur, I prefer opening a sole proprietorship form of business. Sole proprietorships are desirable because they are swift and inexpensive to form, meaning that they do not possess major regulation complexities. Additionally, sole proprietorships are easier to manage, owing to the fact that only a single business owner is required. This factor eliminates the chances of wrangles ensuing and eases the decision-making process. Finally, sole proprietors are only expected to file their tax returns once because there is unlimited liability. Therefore, sole proprietorships are the most ideal business structure for small businesses that require minimal capital investment.
Significant Financial Statements in Sole Proprietorships
According to Van Auken and Carraher (2013, p. 125) , “good financial decisions are predicated on reliable financial information and an ability to understand financial statements, while ineffective decisions can lead to poor financial management and, ultimately, distress/failure.” For a sole proprietor, the most important financial statements are the cash flows statement, balance sheet, and the profit and loss statement. The balance sheet lists the business’ value of assets against value of liabilities. Essentially, the balance sheet is representative of the owner’s assets and liabilities because he or she owns all the assets and owes all the liabilities. Therefore, the balance sheet would enable me to properly manage the working capital while ensuring that the ratio of assets to liabilities is advantageous to my business.
Conversely, profit and loss accounts are indicative of periodic business earnings. For a sole proprietor, the expenditures and revenue figures are indicated in the personal tax forms. Therefore, the profit and loss statement can help me in filing my income tax while also ensuring that excessive expenditures are avoided.
Cash flows statements, on the other hand, are used to describe the sources of cash and where it went during specific periods. These statements are also indicative of cash at hand and cash carried forward. These statements would help me manage my cash effectively, and therefore reducing capital wastage. This would enable me to save money for expansion and other business activities.
In conclusion, choosing the choice of business organization is important because it affects crucial factors that help determine the future of a company. The legal categories of business organizations are sole proprietorships, partnerships, corporations, and limited liability companies. As an investor, the sole proprietorships is the most attractive business structure as they are easy to form and manage. Finally, the maintenance of financial statements can enable me to properly manage working capital, to efficiently file tax returns, and to save money that can be used for other operational activities.
References
Ireland, P. (2010). Limited liability, shareholder rights and the problem of corporate irresponsibility. Cambridge Journal of Economics , 34 (5), 837-856.
Trivedi, C., & Stokols, D. (2011). Social enterprises and corporate enterprises: Fundamental differences and defining features. The Journal of Entrepreneurship , 20 (1), 1-32.
Van Auken, H., & Carraher, S. (2013). Influences on frequency of preparation of financial statements among SMEs. Journal of Innovation Management , 1 (1), 143.
