Starting a small business can be daunting, exciting, and rewarding. A proprietor must consider which form of business organization is best suited for his or her product or service. There has to be consideration with legal, tax, accounting, and other implications when selecting from the four business types. This paper will explore the advantages and disadvantages of sole proprietorship, corporation, and partnership.
This paper will attempt to discuss account financial statements applicable to various forms of business, consequences associated with each form of business (e.g. legal and tax implications, and accounting implications, such as SOX/FASB). A brief synopsis of a unique small business idea will be discussed along with one’s personal rationale for choosing one form of business in lieu of other forms of business. Forms of Business (Advantages and Disadvantages)
According to Cheeseman (2010), “Sole proprietorship is the simplest form of business organization. The owner of the business, the sole proprietor, is the business. There is no separate legal entity. Sole proprietorships are the most common form of business organization in the United States. Many small businesses—and a few large ones—operate in this way,” (p. 543).
The major advantages to operating a business as a sole proprietorship are fourfold and include the following: (1) forming a sole proprietorship is easy and less costly, (2) the owner has the right to make all management decisions concerning the business, including those involving hiring and firing employees, (3) the sole proprietor owns all of the business and has the right to receive all of the business’s profits, (4) sole proprietorship can be easily transferred or sold if and when the owner desires to do so; no other approval (such as from partners or shareholders) is necessary.
There are important disadvantages to this business form, for example, the sole proprietor’s access to the capital is limited to personal funds plus any loans he or she can obtain, and the sole proprietor is legally responsible for the business’s contracts. Moreover, the sole proprietor is legally responsible for the business’s contracts and the torts he or she or any of his or her employees commit in the course of employment. While sole proprietorships are advantageous, “Partnerships often are formed because one individual does not have enough economic resources to initiate or expand the business. Sometimes partners bring unique skills or resources to the partnership,”
(Kimmel and Weygandt et al., 2009, p. 4). Forming a corporation may foster bureaucracy and red tape involving strict guidelines with accounting and reporting standards imposed by the government (e.g. Sarbanes Oxley Act). While a business (or corporation) is organized as a separate legal entity owned by stockholders, thus alleviating partners from any and all individual liability.
It offers an investor in corporation shares of stock to indicate ownership claim. Nonetheless, buying stock in a corporation is often more attractive than investing in a partnership because shares of stock are easy to sell (transfer ownership). The advantages are coupled by the parties who own the business may sell a proprietorship or partnership interest; where as all responsibility with liquidating assets may rest solely on the shoulders of the sole proprietor. Also, individuals can become stockholders by investing relatively small amounts of money. Therefore, it is easier for corporations to raise funds in comparison to sole proprietors trying to gain capital by securing loans or borrowing money.
The disadvantages of partners and corporations are twofold: (1) you pay higher taxes, (2) all actions, such as dissolving partnerships are regulated and have to conform to strict federal and state guidelines. Tax Implications
Cheeseman (2009) implies: “A sole proprietorship is not a separate legal entity, so it does not pay taxes at the business level. Instead, the earnings and losses from a sole proprietorship are reported on the sole proprietor’s personal income tax filing. A sole proprietorship business earns income and pays expenses during the course of operating the business. A sole proprietor has to file tax returns and pay taxes to state and federal governments. For federal income tax purposes, a sole proprietor must prepare a personal income tax Form 1040 U.S. Individual Income Tax Return and report the income or loss from the sole proprietorship on his or her personal income tax form.
The income or loss from the sole proprietorship is reported on Schedule C (Profit or Loss from Business), which must be attached to the taxpayer’s Form 1040,” (p. 533). When we examine the corporation, we should note a divide of two parts: the C corporation and the S corporation. Cheeseman (2009) suggest: “C corporation is a corporation that does not qualify to or does not elect to be federally taxed as an S corporation. Any corporation with more than 100 shareholders is automatically a C corporation for federal income tax purposes.
A C corporation must pay federal income tax at the corporate level. In addition, if a C corporation distributes its profits to shareholders in the form of dividends, the shareholders must pay personal income tax on the dividends. “This cause’s double taxation: one tax paid at the corporate level and another paid at the shareholder level. A corporation is an entity that is set up through legal documentation within the state of residence. From a tax perspective, the corporation may be beneficial to an investor as most of the capital raised is through ownership of stock or debt-like instruments.
For a corporation, tax filing is dependent on which type of business is incorporated. For a C-corporation, income and loss is taxable directly to the corporation. For an S-corporation, the tax burden can be passed onto the shareholders in the form of dividends and capital loss,” (Cheeseman, 2010, p. 567). Partnerships have to conform to “flow-through taxation: A partnership has to file an information return with the government, telling the government how much income was earned or losses were incurred by the partnership. This way, the government tax authorities can trace whether partners are correctly reporting their income or losses,” (Cheeseman, 2010, p. 535). Accounting Implications
From the perspective of a manager, her or his main interest in any business entity would harbor forecasts of cash needs, projections of capital, and revenue from sales. Therefore, the income statement and balance sheet would quantify rather the organization is meeting its goals with generating capital and meeting demand of justifying cost or pricing schedule of goods and services within the organization.
In an attempt to comply with Sarbanes-Oxley Act (SOX) to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals, any efficient and prudent business would use guidelines outlined by the Financial Accounting Standards Board (or FASB) and SOX. As a result of FASB and SOX, “top management must now certify the accuracy of financial information…penalties for fraudulent financial activity is much more severe,” (Kimmel and Weygandt et al., 2009, p. 4). The income statement has to offer accuracy with revenue minus expenses (or net income) and the balance sheet should define a balance of assets equal to the difference between liabilities and owner’s equity. Small Business Proposal
According the Census Bureau (2010) “With steady growing by five percent every year, there seems to be a demand for a small indulgence in every state and every community for baked goods,” (p. 1). Therefore, I propose starting a gourmet baking distribution and subcontractor baking specialty business. This service is a multi-level business that (a) supplies baked goods to caterers, airlines, hotels, resorts, grocery stores, restaurants, wineries, and private parties (b) showcase custom baked cakes, pastries, cupcakes, cookies, and candy that cater to any theme.
Our business would create a unique touch to any special occasion for our customer. Many customers would value our business because they may not have the time or know how to bake their own specialty baked goods. “Magic Apron Bakery” would create special flavors, words, characters, and designs on cookies, cakes, candy, and baked goods, while providing consultations and a delivery service for those customers who cannot find the time to pick their baked goods up. Our staff would ensure that the consumer’s cookies, cakes, candy, baked goods were delivered in perfect condition and on time.
I choose to form a partnership because I could take advantage of sharing equal responsibility for debt, less difficulty with transferring responsibilities in the event of illness or death, equal control, having the advantage of accessing broader skills, knowledge, and experience to draw from. I may also benefit from having access to a broader range of economic resources that I would not have as an individual or sole proprietor.
References Cheeseman, R. (2010). Business Law: Legal Environment, Online Commerce, Business Ethics, and International Issues (7th ed.). Upper Saddle River, NJ: Prentice Hall. Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2009). Accounting: Tools for Business Decision Making (3rd ed.). Hoboken, NJ: John Wiley & Sons United States Census Bureau. (2010). Small business and industries report by IRS. Retrieved from http://census.gov