Chapter 2 Finance – Flashcards
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Forms of Business Organizations
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1. Sole proprietorship 2. Partnership 3. Corporation 4. Hybrids (LLP, LLC, Sub S)
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Sole Proprietorship
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Business owned and operated by one person.
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Advantages to the Sole Proprietorship
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1. Easy to form. (no paperwork is involved) 2. Business income is taxed once, at the individual's personal level
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Disadvantages to the Sole Proprietorship
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1. Unlimited Liability 2. Lack of continuity ("unbroken; consistent existence") 3. Limited access to additional funds.
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Small Business Accounting
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Net income is added to the regular salary income and taxed at ordinary tax rates.
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Partnerships
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is a business owned and operated by two or more people.
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A partnership can be formalized by :
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having a lawyer create a partnership agreement
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Partnership Agreement :
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- Establishes how decisions are made, such as how each partner can buy out the other in the event that one wants to dissolve the partnership - Stipulates how the partnership's income is allocated among the partners.
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Advantages to the Partnership Form of Business
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1. Easy to Form 2. Business income is taxed once, at the individual partners' level
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Disadvantages to the Partnership Form of Business
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1. Unlimited liability for general partners 2. Lack of continuity 3. Limited access to additional funds.
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Corporation
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Business organized as a separate legal entity under corporation law, with ownership divided into transferable shares. In tax law, such a business is generally taxed as a C corporation (C corp).
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Corporate Owners have the benefit of limited liability :
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the maximum that owners can lose is their investment.
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A corporation is usually formed by :
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filing articles of incorporation and receiving a certificate of incorporation from the state.
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What does the articles of incorporation indicate ?
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* the most basic information about the company, such as its mailing address, name, line of business, number of shares issued, names and addresses of the officers of the company, and so on.
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What is a critical feature of a corporation?
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It is a distinct legal entity.
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Who are the owners in a corporation?
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the owners are the owners of the ownership interests—that is, the shareholders—who elect members of the board of directors, who in turn hire and monitor the company's management.
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Is the separation of management and ownership an issue for smaller companies? Or large companies?
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For smaller companies, the separation of management and ownership isn't a problem, but for larger companies, it becomes a serious concern. This division is the fundamental problem of the governance structure of large companies
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Advantages to the Corporation Form of Business
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1. Limited Liability 2. Unlimited life 3. Access to capital
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Disadvantages to the Corporation Form of Business
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1. Income taxed at the corporate level and at the owners' level, when distributed. 2. Separation of owners and management.
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Effective tax rate on corporate income
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Tc + [(1-Tc) DPO Ti] where, Tc - represents the corporate tax rate Ti - represents the individual tax rate DPO - represents portion of dividends paid to owners
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Limited Liability Company (LLC) - Hybrid Organization
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- a company that embodies some of the best features of both the partnership and corporate forms of business - business organized as a separate legal entity in which owners have limited liability, but the income is passed through to the owners for tax purposes
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Advantages to the Limited Liability C. Form of Business
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1. Limited liability for the owners 2. Unlimited life 3. Income taxed only at the owners' level
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Disadvantages to the Limited Liability C. Form of Business
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1. Separation of owners and management. 2. Access to capital.
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Limited liability partnership (LLP) or Limited Partnership - Hybrid Organization
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- at least one general partner who manages the business (unlimited liability); - any number of limited partners (limited liability), who are passive investors.
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S corporation (Sub S)
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A corporation that elects to be taxed as a partnership
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C Corporation
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Business taxed as a corporation according to Subsection C of the Internal Revenue Code.
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Characteristics of a Sub S
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Taxation: Pass - through Ownership: Maximum of 75 Shareholders Liability: Limited Liability Life: Perpetual
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Characteristics of a LLC
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Taxation: Pass - through Ownership: No maximum Liability: Limited Liability Life: Limited
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Stakeholders
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is a party that is affected by the decisions and operations of the business entity. SH include not only the owners, but also the creditors, the employees, the suppliers, and the customers.
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What is the goal of a company?
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To maximize the market value of the equity interest or, alternatively, maximize shareholder value.
