Chapter 6(38) Module 5

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Chapter 6(38) Module 5


In the UK businesses are self-employed sole traders, partnerships, or companies. Self-employment increased throughout the 1980s and sole traders are by far the commonest type of business organization, though each sole trader operates on a relatively small scale. Partnerships operate on a larger scale and companies are larger still. The largest companies have sales measured in billions of pounds.

A sole trader is a business owned by a single individual who is fully entitled to the income or revenue of the business and is fully responsible for any losses the business suffers. You might open a health food shop, renting the premises and paying someone to stand at the till. Although you can keep the profits, if the business makes losses that you cannot meet you will have to declare bankruptcy. Your remain­ing assets, including personal assets such as your house, will then be sold and the money shared out between your creditors.

However, your health food shop may prosper. You need money to expand, to buy bigger stocks, better premises, a delivery van, and office furniture. To raise all this money, you may decide to go into partnership with some other people.

A partnership is a business arrangement in which two or more people jointly own a business, sharing the profits and being jointly responsible for any losses. Not all the partners need to be active. Some may have put up some money for a share of the profits but take no active part in running the business. Some large partnerships, such as famous law and account­ing firms, may have over a hundred partners, usually all taking an active interest in the business.

Nevertheless, partnerships still have unlimited liability. In the last resort, the owners' personal assets must be sold to cover losses that cannot otherwise be met. This is one reason why firms where trust is involved - for example, firms of solicitors or accountants - are partnerships. It is a signal to the customers that the people running the business are willing to put their own personal wealth behind the firm's obliga­tions.

Any business needs some financial capital, money to start the business and finance its growth, paying for stocks, machinery, or advertising before the corresponding revenue is earned. Firms of lawyers, accountants, or doctors, businesses that rely primarily on human expertise, need relatively little money for such purposes. The necessary funds can be raised from the partners and, possibly, by a loan from the bank. Businesses that require large initial expenditure on machinery, or are growing very rapidly, may need much larger amounts of initial funds. Because of legal complications, it may not make sense to take on an enormous number of partners. Instead, it makes sense to form a company.

A company is an organization legally allowed to produce and trade. Unlike a partnership, it has a legal existence distinct from that of its owners. Ownership is divided among share­holders. The original shareholders are the people who started the business, but now they have sold shares of the profits to outsiders. By selling these entitlements to share in the profits, the business has been able to raise new funds.

For public companies these shares can be resold on the stock exchange to anyone prepared to pay the going price. Trading on the stock exchange, reported in most daily newspapers, is primarily the sale and resale of existing shares in public companies. However, even the largest company occasionally needs to issue additional new shares to raise money for especially large projects.

To buy into a company, a shareholder must purchase shares on the stock exchange at the equilibrium share price, which just balances buyers and sellers of the company's shares on that particular day. In return for this initial outlay, shareholders earn a return in two ways. First, the company makes regular dividend payments, paying out to shareholders that part of the profits that the firm does not wish to re-invest in the business. Second, the share­holders may make capital gains (or losses). If you buy ICI shares for £600 each and then everyone decides ICI profits and dividends will be unexpectedly high, you may be able to resell the shares for £650, making a capital gain of £50 per share on the transactions.

The shareholders of a company have limited liability. The most they can lose is the money they originally spent buying shares. Unlike sole traders and partners, shareholders cannot be forced to sell their personal possessions when the business cannot pay. At worst, the shares merely become worthless.

Companies are run by boards of directors. The board of directors makes decisions about how the firm is run but must submit an annual report to the shareholders. At the annual meeting the shareholders can vote to sack the directors, each shareholder having as many votes as the number of shares owned.

Companies are the main form of organiza­tion of big businesses.

Key Terms

Sole trader




Limited liability


Capital gains

Retained earnings


Balance sheet

Income statement

Cash flow

Opportunity cost

Total costs

Total revenue

Marginal cost

Marginal revenue


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