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    The Nature and Forms of Business Organization

    Business and Business Organizations

    A business is an activity that is part and parcel of human society: it is an entity in which economic resources or inputs, such as materials and labor, are put together and processed to provide goods or services or outputs to customers. Businesses are usually complex enterprises involving major activities like purchasing, manufacturing, marketing advertising, selling, and accounting. The objective of most businesses is to earn a profit (although this is not the only aim as we shall see in the remainder of this worktext). Profit is the difference between the amount earned and the amount spent in buying, operating, or producing something. In this text, we focus on businesses operating to earn a profit, even though many of the same concepts and principles also apply to not-for-profit organizations. The fundamental reason for examining the activities of the business from a moral perspective is that business organizations, in principle, should help in the promotion of the common good and in the protection of persons’ rights and interests.

    Thus, businesses make the goods and services you use each day. That includes the products and services used by other businesses as well as those needed by individual consumers. There are generally three types of business organizations operated for profit: service, merchandising, and manufacturing businesses. Service businesses provide services rather than products to customers. Merchandising businesses sell products they purchase from other businesses to customers. Manufacturing businesses change basic inputs into products that are sold to customers. 

    The Various Forms of Business Organization

    A business organization may take the form of a proprietorship, partnership, or corporation. Each of these forms and their major characteristics are listed on Table 1.

    The three types of businesses we discussed earlier—service, merchandising, and manufacturing—may be organized as proprietorships, partnerships, or corporations. Given the large size and huge amount of resources required to operate a manufacturing business, most manufacturing businesses, such as San Miguel Corporation, are corporations. Most large retailers like SM Supermalls, Robinsons, and Ayala Mails are also corporations.

    1. Sole Proprietorship

    This is a business owned by one person.

    • Advantages of a sole proprietorship: (a) total undivided authority; (b) low organizational cost and license fees; (c) tax savings; and (d) no restrictions on type of business (as long as it is legal).
    • Disadvantages of a sole proprietorship: (a) unlimited liability; (b) limitation on size (and thus on fund-raising power); and (c) limited by management’s ability to be jack-of-all-trades.

    2. Partnership

    This is an association of two or more people as partners; it refers to an arrangement in which the individuals share the profits and liabilities of a business venture. Its chief characteristics are: (a) association of individuals; (b) mutual agency; (c) limited life; (d) unlimited liability; and (e) co-ownership of property.

    The association of individuals in a partnership may be based on as simple an act as a handshake; however, it is preferable to state the agreement in writing.

    • A partnership is a legal entity for certain purposes.
    • A partnership is an accounting entity for financial reporting purposes.
    • Net income of a partnership is not taxed as a separate entity.

    Mutual agency means that an act of any partner is binding on all other partners, so long as the act appears to be appropriate for the partnership. This is true even when partners act beyond the scope of their authority. Partnerships have a limited life. Partnership dissolution occurs whenever a partner withdraws or a new partner is admitted.

    Each partner has unlimited liability. Each partner is personally and individually liable for all partnership liabilities. Creditors’ claims attach first to partnership assets and then to the personal resources of any partner, irrespective of that partner’s capital equity in the company.

    3. Corporation

    It is an entity created by law that is separate and distinct from its owners and its continued existence is dependent upon the corporate statutes of the state in which it is incorporated.

    The characteristics that distinguish a corporation from proprietorships and partnerships are:

    1. The corporation has separate legal.existence from its owners.
    2. The stockholders have limited liability.
    3. Transferable ownership rights (ownership is in shares of stock).
    4. Ability to obtain capital (relative ease).
    5. The corporation can have a continuous life.
    6. The corporation is subject to numerous government regulations.
    7. The corporation must pay an income tax on its earnings, and the stockholders are required to pay taxes on the dividends they receive: the result is double taxation of distributed earnings.
    8. An artificial/juridical “person” endowed with the ability for self-management, that is, the management structure is at the discretion of the board of directors.

    The first step in forming a corporation is to file an application of incorporation with the government (in the Philippines, this is done through the Securities and Exchange Commission or SEC). After the application of incorporation has been approved, the corporation is granted a charter or articles of incorporation. The articles of incorporation formally create the corporation. The corporate management and board of directors then prepare a set of bylaws, which are the rules and procedures for conducting the corporation’s affairs. Costs may be incurred in organizing a corporation. These costs include legal fees, taxes, state incorporation fees, license fees, and promotional costs. Such costs are considered Organizational Expenses (Weygandt, Kieso, and Kimmel, 2012).

    Comparison and Contrast Among the Various Forms of Business Organization

    The owner of a sole proprietorship has complete control over the company’s finances and operations. Sole proprietors are not required to consult with anyone when it comes to making business decisions. All partners of a partnership have input regarding how the company’s resources are used and other important business decisions. In a partnership business, all partners are responsible for making decisions that will impact the business. This may provide multiple viewpoints, which could potentially lead to better business decisions.

    The sole proprietor can maintain complete control over all aspects of the business. There are no shareholders to pacify and no board of directors to appease. If you feel you need to purchase a piece of equipment, you do not have to justify your actions to others. On the other hand, corporations have an advantage when it comes to raising capital for the business—the ability to raise funds through the sale of stock. In addition, corporations file taxes separately from their owners. Owners of a corporation only pay taxes on corporate profits paid to them in the form of salaries, bonuses, and dividends, while any additional profits are awarded a corporate tax rate, which is usually lower than a personal income tax rate. This is as opposed to single proprietorships which often pay income tax twice, first on the business earnings and then on personal income when the owner draws a salary or takes distributions from the company.

    The Role of Each Form of Business Organization in the Economy

    Small businesses owned by sole proprietors are well recognized worldwide as vital and significant contributors to economic development, job creation, and the general health and welfare of economies. Microbusinesses (firms that employ fewer than ten people) form a dynamic, integral part of the market economy, providing goods and services and a gateway by which millions enter the economic and social mainstream of society. In the US, for example, about half of all private-sector workers are employed by microbusiness firms.

    On the other hand, the Industrial Revolution brought with it new forms of machine production that enabled businesses to make massive quantities of goods to ship and sell in national markets. These changes, in turn, required large organizations to manage the enormous armies of people that had to be mobilized to process the output of these machines on long assembly lines in huge factories. The result was the large corporation that came to dominate our economies. These large businesses, in general, offer better jobs than small businesses, in terms of both compensation and stability. Also, corporations provide such benefits as: links with suppliers, increased consumer spending, the transfer of knowledge from one firm to another, and the sharing of pools of workers. However, competitive forces sometimes fail to steer companies in a socially beneficial way and instead, lead them to act in a socially harmful manner. For example, a company might knowingly pollute a neighborhood with substance that is not yet illegal, in order to save the costs of reducing its pollution and thereby be more competitive. This wave of large corporations has brought with it a host of new ethical issues, including the possibilities of exploiting the workers who labor at the new machines, manipulating the new financial markets that finance these large enterprises, and producing massive damage to the environment. 

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