Starting a business can be an exciting, yet overwhelming experience. Before you can launch your business venture, deciding the form of business organization will be one of the first things necessary. Some of these business organizations include; sole proprietors, corporations, and partnerships. With choosing which organization to go with one must consider consequences in lieu of legal issues, taxes, financial statements, and accounting practices. A new business venture will be summarized along with the business organization type and related consequences regarding different business types. Types of legal business entities
Sole Proprietorship This type of organization is one of the most common for small businesses. This type is controlled by one person for all of the company’s needs—management and operations. This business type is unincorporated and one of the easiest and least expensive to start. Other advantages of a sole proprietorship are that all income generated goes directly to the owner to keep or reinvest, and the business is easy to dissolve, if necessary. Some disadvantages are that the owner is responsible for any incurred debt against the business and personal assets are at risk. Also, raising funds is difficult and are often limited to personal funds or consumer loans.
Tax implications. Sole proprietors pay taxes on his or her personal income taxes. The business itself is not taxed separately. The IRS calls this “pass-through” taxation because business profits pass through the business to be taxed on the personal tax return (IRS, n.d.). An individual will be taxed on all profits of the business—total income minus expenses—regardless of how much money is withdrawn from the business.
Legal implications. Sole proprietors are his or her business. They are one in the same. If the business suffers a financial loss, goes out of business and is unable to repay a loan then, assuming money is borrowed, the sole proprietor is legally liable for the amount of the loan which can potentially affect his or her personal assets. This is also the case if there is a business-related accident and someone is killed or injured.
Accounting implications. Sole proprietors accounting efforts may be a little time consuming with owning two different bank accounts—personal and business, and maintaining a record of transactions necessary for filing taxes.
Sole proprietors must also account for paying local, state, and federal income taxes, as well as self-employment taxes. Sole proprietors may only need a simple ledger and cash receipts to record money transactions going in and out of the business. Financial Statements. Sole proprietors can benefit from using a balance sheet which will indicate the amount of assets held, the owner’s liabilities, and the amount of the owner’s capital. Another financial statement that is beneficial is the statement of cash flows. This will let the owner know where the cash came from and where it went during the period. This is essential because good cash management is essential for business survival.
Partnerships Partnerships are a business type owned by two or more persons. Partnerships are often formed because one individual does not have enough economic resources to initiate or expand the business (University of Phoenix, 2011, Week 1 Supplement). In a partnership each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business (IRS, n.d.). Advantages of partnerships include easy establishment, a broader variety of skills among the partners, the ability to raise funds, and profits directly flow through the partners’ personal tax returns. Disadvantages include being individually liable for actions of other partners, sharing profits, and limited life based on circumstances including death and withdrawal of a partner.
Tax implications. Partners in a business are collectively responsible for all debts of the business. In regards to the rate of income tax, the income of the partnership as well as its losses flows through to the partnership’s partners. Each partner has separate tax liabilities and pays taxes on his or her share of the income of the partnership at his or her own personal marginal rates.
Legal implications. Partnerships share responsibilities in the business. A contract is written, signed, and agreed upon. If a contract is not written, the partnership will be stuck with the laws that the state dictates. Partners are personally liable for all business debts and obligations, including court judgments. A creditor can legally come after any partner’s personal possessions. In regards to lawsuits, each individual partner can be sued for, and required to pay the full amount of any business debt.
Accounting implications. Each partner in the partnership has a separate capital account for investments and his or her share of net income or loss, and a separate withdrawal account (Partnership Accounting, n.d.). The partnership agreement should include how the net income or loss will be allocated to the partners.
Financial statements. All three financial statements—income statement, balance sheet, and statement of owner’s equity are affected because the need to allocate net income and its impact on the partners’ capital balances must be recorded. Partners also have a statement of partners’ equity which indicates a starting capital balance at the beginning of the accounting period and reflects additional investments made by partners during the year, net income for the period, and withdrawals (Partnership Accounting, n.d.). The Business Venture
The type of small business Erica is interested in starting is small fast food restaurant called Soups N Salads. This business will offer a full line of ingredients for both soups and salads for customers to choose from. The salads and soups will be freshly prepared by a chain of employees from start to finish in a fast-paced, bar-like style. This upbeat, friendly restaurant makes it easy for customers to come and go with nothing much to do but call out the ingredients they want and watch their order come to life. Soups are made starting with stock bases such as chicken or beef and a choice of ingredients like vegetables, noodles, potatoes, and meats can be added to complete the soup of your liking.
This service is unique in comparison to similar businesses in the area. Salad bars exist in grocery stores, but customers do not have the convenience of having the salads made for them and other fast-food chains like McDonalds and Wendy’s only offer pre-made salads. Erica has chosen to start this business as a partnership with her mother. Erica has several reasons for choosing this type of organization. Erica’s partner has knowledge and skills in running a business and can offer great insight, and she is someone who can be trusted, which is an important factor when assuming responsibility as a partner.
Due to the limited funds Erica has to start the business her partner can help in adding the necessary resources it takes to get there. A partnership also has a better chance at raising capital, unlike the proprietorship. Last but not least, partnerships have tax advantages, such as not paying taxes, and passing directly through to each partner to file income taxes separately. Conclusion
Anyone planning to start a business should have knowledge in what type of organization to become, and consider all the advantages and disadvantages of each to properly ensure you are making the right decision in the long run. Entrepreneurs have to pick the structure that best suits his or her business needs.
References IRS (n.d.) Publication 541 Maint Content. Retrieved November 5, 2011, from http://www.irs.gov/publications/p541/ar02.html#en_US_publink1000104201 Partnership Accounting (n.d.). Retrieved November 5, 2011, from http://www.cliffsnotes.com/study_guide/Partnership-Accounting.topicArticleId-21248,articleId-21186.html Partnership Accounting (n.d.). Retrieved Novemeber 6, 2011, from http://en.wikipedia.org/wiki/Partnership_accounting University of Phoenix. (2011). Week One Supplement: Wiley Plus Vide Tutorial: Read, Study, & Practice Tab, Acct/561—Accounting course website