Today many people consider establishing their businesses with the aim of increasing their income streams. However, it is imperative that prospective entrepreneurs have knowledge on the types of business units prescribed by law. This understanding enables them understand the risks associated with particular business units and the capital requirement involved. After deciding the type of business to invest in, entrepreneurs must consider the sources of finance available to them, and the type of accounting skills necessary for running of the venture. Hence, this report analyzes different forms of business units, types of accounting skills, and sources of finance available to prospective business owners.
Forms of business units
A sole proprietorship is an unincorporated business owned by an individual who enjoys all profits and bears all losses. A sole proprietor has unlimited liability whereby the owner’s personal assets can pay off creditors when business assets are inadequate (Small Business Administration 2014). The benefits of a sole proprietorship include ease of formation and dissolution, low startup costs, limited government regulation, sole decision making and control, and business privacy. Its major drawbacks are unlimited personal liability, difficulty in raising additional capital, limited life and limited managerial skills. Banking institutions are unwilling to advance loans to a sole proprietorship due to the latter’s high risk of failure. In addition, sole proprietorships’ existence depends on the wellbeing of the owner. If the owner dies or falls ill, the business activities are interrupted. Sole owners also lack managerial skills needed in running the business effectively.
Partnerships are unincorporated businesses owned by a minimum of two people to a maximum of twenty. Partners contribute capital and skills, and consequently share profits and losses. Normally, partners sign a partnership deed that outlines how the partnership will run. The U.S. Partnership Act recognizes three types of partnerships: general partnership, limited partnership and joint ventures (The American College n.d.). General partnerships divide profits, liability and managerial duties equally among partners unless stated otherwise in the partnership deed. General partners have unlimited personal liability. In limited partnerships, however, the partners’ liability is limited to their capital contribution in the business. Limited partners contribute capital and managerial duties in unequal proportions to the partnership. Joint ventures are businesses acting as a general partnership to accomplish a specified project within a specified period, after which the venture dissolves.
The benefits of partnerships include easy formation, low startup costs, additional capital from partners, complimentary managerial skills and limited government regulation. The shortcomings of partnerships include joint and individual liability, conflicts, sharing of profits, limited life and restriction of share transferability. In addition to unlimited personal liability, a partner is also liable for the actions and decisions of other partners. A partner must seek the consent of other partners before transferring his or her stake in the business to a third party.
A limited liability company is an entity incorporated under the Company Act. It has an independent existence from that of its owners and can, thus, acquire assets and debts, sign contracts, and sue or be sued. In addition, its members’ liability is limited to the share capital they subscribed to. A limited liability company can have a minimum of seven members to no prescribed maximum. The formation of a limited liability company entails the drafting of several legal documents such as a prospectus. Its benefits include limited liability, specialized management by elected directors, transferable ownership, perpetual existence and availability of large capital through loans and sale of shares (Canada Business Network 2014). The major drawbacks of limited liability companies include lengthy formation process, high startup costs, delayed decision-making and scrutiny by the government and other regulatory bodies.
Financial accounting versus management accounting
Accounting is the process of documenting, analyzing and communicating information on business transactions to users to facilitate informed decision making. The role of accounting is twofold: accountability to others (financial accounting) and business planning and control (management accounting).
Financial accounting involves preparation of financial statements detailing past transactions for use by external stakeholders such as investors, creditors and suppliers (Mott 2005, p. 6). Financial accounts usually describe business performance over a specified period, typically one year. Their several regulatory bodies such as the Generally Accepted Accounting Principles (GAAP) and the stock exchange prescribe the format of financial accounts. Such accounts describe the business as a whole rather than examine individual parts, and give a historic view of the transactions. Most financial information contained in these accounts are quantitative in nature, presented in monetary terms. In addition, their preparation and publication are mandatory. Therefore, a financial accountant’s job description entails recording transactions into books of account and periodic preparation and publication of financial statements such as balance sheets and income statements. In addition, a financial accountant also serves an advisory role on matters such as tax, status and use of resources, market trends, asset quality, liability position and cash flow position (Pirraglia 2014).
Conversely, management accounting involves preparation and provision of internal reports to people inside the organization to facilitate better planning, decision making and control (Drury 2001, p. 5). Internal users include management and employees. Unlike financial accounting, it focuses on current business performance and forecasts future performance. The period for preparation of management accounts varies with necessity and can be daily, weekly or monthly. No regulatory body determines their format, and the information contained in them is detailed and focus on specific areas of the business. In addition, they contain both quantitative and qualitative data. Although their preparation is not legally mandatory, few businesses can survive without them. Thus, a management accountant’s job description includes financial data analysis for strategic decision-making, business planning, budget preparation, and estimation of future costs and revenues (Education Portal 2014).
Despite the differences between financial and management accounting, several similarities emerge in terms of certification, historical view, currency measurement, terminology and techniques. Both professions have the same certification such as an associate business degree, Certified Management Accounting (CMA) and Certified Public Accountant (CPA). Secondly, both accounts use historical data to serve their specific purposes. Thirdly, both accounts contain figures expressed in currency units such as costs, expenses and revenues. Finally, both professions use the same accounting terminology such as credit and debit, and employ the same techniques in preparation of accounts.
Sources of finance
There are numerous sources of finance at the disposal of business owners. These sources can be internal or external. Internal sources exist within the business while external sources exists outside the business. Sources of finance can also be short-term or long-term. Short-term sources are repaid within one year and mostly fund working capital requirements and inventory accumulation. Conversely, long-term sources’ repayment periods last more than a year and mostly fund accumulation of capital assets.
Short-term internal sources include personal savings and sale of personal assets. Investors and financial creditors are normally reluctant to advance loans to startups because they are prone to failure. Hence, a business owner can use personal savings or sell personal assets to generate the funds needed to establish an enterprise. The advantages of such sources include sole decision-making regarding the use of the funds and absence of interest expense associated with loans. The disadvantage, however, is that the owner risks losing the savings if the business fails.
Short-term external sources include friends and family, bank overdraft, trade credit, finance companies and inventory financing (McMillan 2007). Friends and family members are more inclined to lending money than banks, and their repayment terms are flexible and less costly. On the downside, the failure of the business may strain family ties and friendships. Bank overdrafts are agreements between business owners and banks that permit them to overdraw their current accounts up to a specified limit. Their disadvantages, however, include high processing fees, collateral requirement and variable interest rate that makes planning difficult. Trade credit involves obtaining goods from suppliers on credit and repaying them when the goods are sold to customers. This source allows the business to run smoothly during market slumps. Finance companies advance short-term cash to small business owners to solve temporary cash flow problems. However, such cash may come with high fees and interest rates. Inventory financing involves fund advancement against inventory (Fay 2014). The inventory, usually, consists of highly-priced or luxury goods that move slowly in the market. Thus, the lender gets paid as the goods are sold off.
A long-term internal source of finance is the retained earnings. Retained earnings are profits that the business owner ploughs back into the business to generate future revenue. This source is valuable for business in its early stages because it supplements the working capital needs.
Long-term external sources include bank loans, equity, leases, hire purchase, grants and venture capital. Bank loans are money borrowed from banks for a specified period and carry specified interest rates. The repayment of such loans lasts more than a year. Bank loans are suitable for capital expenditures and expansion. The shortcomings of bank loans include collateral requirement, regular interest payments and conditions regarding investment of the funds. Equity involves offering an ownership stake of the business in exchange for cash through sale of shares. Thus, the suppliers of equity become co-owners of the company and receive dividends. The major drawback of equity is the loss of managerial control since more people participate in decision-making. Equity differs from debt on several fronts (Bragg & Burton 2006). Firstly, equity holders are owners of the company who earn dividends while debt lenders are creditors earning regular interest payments. Secondly, equity holders have voting rights and can thus participate in decision making. Conversely, debt holders have no voting rights and cannot participate in decision making. Thirdly, equity requires no collateral while debt requires collateral for funds.
Leases are rental arrangements that enable the business owner obtain the use of equipment without necessarily owning it. The business makes rental payments for the asset over several years, but the lessor retains ownership of the asset. Hire purchase agreements enable a business to acquire an asset by spreading the payment of capital plus interest over an agreed period, after which ownership passes to the buyer. The buyer pays an initial deposit, followed by regular installments. Grants are funds advanced to startups and small businesses through government schemes and do not need repayment. In addition, the government offers expert advice and subsidized consultancy services to the business.
Venture capital are funds given to startups by venture capital firms or angel investors with the aim of receiving returns when the business succeeds (Tedesco 2014). Venture capital firms combine resources from insurance companies and pension schemes. In contrast, angel investors are wealthy individuals who fund novel ideas in their fields of specialization. The benefits of venture capital include additional expertise and no repayment obligations until the business becomes profitable. The drawbacks, however, lie on ownership dilution since venture capitalists require an equity stake in the business.
Firstly, the Swansons should consider forming a general partnership. This recommendation arises from the fact that a sole proprietorship only has one owner yet there are two individuals who want to invest in a biscuit and chocolate business. In addition, the formation of a limited liability company is lengthy and may take longer to begin operations and eventually expand. Thus, a general partnership will provide equal ownership status to the Swansons and enable them run the enterprise together.
Secondly, a business in its infancy needs strong managerial structures to facilitate sound decision making regarding business strategies, resource allocation and set effective controls. Such actions are necessary for the smooth running of the business. Hence, the Swansons should hire a management accountant during the early stage of the startup to provide business structure and maintain books of accounts. However, a financial accountant may be necessary later when the business has taken off, is stable and needs to expand. In this regard, the financial accountant can provide insights regarding possible investment options and their implications.
Thirdly, the choice of finance sources depends on the ease of accessibility to the funds, size of the business, profit stability, growth prospects and the status of business assets (Dauer 1944). During the early stage of a business enterprise, the Swansons should consider short-term sources that are easily accessible such as personal savings, loans from friends and family, retained earnings and trade credit. However, when the scale of operations increases and the business demands growth, they can opt for long-term sources of funds such as banks loans, equity, grants and venture capital that are not easily accessible. In this regard, they will have to tolerate complex application procedures and give up some managerial control. In addition, if the enterprise has a record of profit stability and possesses quality assets, the owners can negotiate for larger loans from banks and investors.
Business ventures provide avenues for entrepreneurs to generate additional income and provide self-employment. In this regard, different forms of business units exist to choose from such as sole proprietorships, partnerships and limited liability companies. In addition, entrepreneurs have different sources of short-term and long-term funds to choose from, depending on the nature and size of operations and profitability. Moreover, enterprises require accountability to both internal and external stakeholders. Thus, entrepreneurs must make decisions on whether to employ a management accountant or a financial accountant.
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