Types of Businesses

Sole proprietor or Sole trader

The business of a sole trader is owned and managed by one person. Any individual, who sets up in business on his/her own, without creating a company, is a sole trader.

Important features of a sole trader business are as follows.

• There is no legal distinction between the proprietor and the business.
• The owner of the business is personally liable for any unpaid debts and other obligations of the business.
• The profits of a sole proprietor business are treated as income of the owner, for the purpose of calculating the amount of tax payable on income.
• The proprietor is wholly liable for the debts of the business, borrowing money in his/her own name.
• When a sole proprietor dies the business ceases to exist (there is no perpetual succession as the business does not exist independently of the owner).
• The profits of the business belong to the sole proprietor.
• The assets of the business belong to the sole proprietor.
• The sole proprietor can extract cash and other assets from the business (known as drawings).
• The business may be financed by a mixture of owner's capital (including retained earnings) and loans.
• A sole proprietor business might employ many people but it is usual for the proprietor to take a very active role in the business exercising a high degree of control.
• A sole proprietorship business can be sold as a going concern by its owner.

Example:
If a business owes a supplier Rs. 1,000 for goods it has purchased, but does not have the money to make the payment, the owner of the business is personally liable to make the payment out of his/her other assets.

Partnership

A business partnership is an entity in which two or more individuals (partners) share the ownership of a business. Each partner contributes funds (‘capital’) to set up the business.
Partnerships in Pakistan are subject to rules set out in The Partnership Act 1932.
Definition: Partnership
The relationship between persons who have agreed to share the profits of a business carried on by all or any of them, acting for all.

Important features of a partnership are as follows:

• There must be an association of two or more persons to carry on a business 
• The owners of the business are personally liable as individuals for the unpaid debts and other obligations of the business.
• The profits of a partnership are shared between the partners in an agreed way, and each partner’s share of the profits is treated as personal income, for the purpose of calculating the amount of tax payable on his or her income.
• When a partner dies the partnership comes to an end (there is no perpetual succession).
• The profits of the business belong to the partners in an agreed ratio.
• The assets of the business belong to the partners in an agreed ratio.
• The partners can extract cash and other assets from the business (known as drawings).
• The business may be financed by a mixture of partners' capital (including retained earnings) and loans.
• A partnership might employ many people but it is usual for the partners to take a very active role in the business exercising a high degree of control.
• A partnership can be sold as a going concern by its owner.

Example:
If a partnership owes a supplier Rs. 1,000 for goods it has purchased, but does not
have the money to make the payment, the partners are personally liable to make
the payment.

Company (limited liability company)

A company is a special form of business entity. Nearly all companies in business are limited liability companies with liability limited by shares.

Ownership of the company is represented by ownership of shares.

• A company might issue any number of shares, depending largely on its size. A large stock market company will have millions of shares in issue.
• If a company has issued 100 shares, ownership of 40 shares would represent 40% of the ownership of the company.
• Large companies usually have a large number of shares in issue, and a large number of shareholders. This means that the owners (the shareholders) do not manage the business. Managers are employed (the executive directors of the company) to run the company on behalf of the shareholders. This is sometimes referred to as the ‘separation of ownership from control’.

Unlike a sole trader or a partnership, a company has the status of a ‘legal person’ in law.

• A company can be the legal owner of business assets, and can sue or be sued in its own right in the law.
• A company is also taxed separately from its owners (the profits of a sole trader and business partners are taxed as personal income of the business owners).
• A company is liable for its own debts. If a company owes a supplier Rs. 1,000 for goods it has purchased, but does not have the money to make the payment, the company alone is liable for the debt. The owners (shareholders) are not personally liable to make the payment. The liability of shareholders is limited to the amount of capital they have invested or agreed to invest in the company.

When the shareholders are not the managers of their company, it becomes essential that information about the position and performance of the company should be reported regularly by the management to the shareholders. This is the main purpose of financial reporting.
However, there might be a risk that the managers of a company would make false reports to shareholders about the financial position and performance of the company. To reduce this risk, the laws on financial reporting and auditing are generally much stricter for companies than for other types of business entity.