Understanding Business Accounting For Dummies, 2nd Edition (86 page)

Talent:
Regardless of capital or time, some partners bring more to the business than others. Whatever it is that they do for the business, they contribute much more to the business's success than their capital or time suggests.

Note:
A partnership needs to maintain a separate capital (or
ownership
) account for each partner. The total profit of the entity is allocated into these capital accounts, as spelled out in the partnership agreement. The agreement also specifies how much money each partner can withdraw from his capital account - for example, partners may be limited to withdrawing no more than 80 per cent of their anticipated share of profit for the coming year, or they may be allowed to withdraw only a certain amount until they've built up their capital accounts.

Sole proprietorships

A
sole proprietorship
or, as it is frequently known,
sole tradership
,
is, basically the business arm of an individual who has decided
not
to carry on his or her business activity as a separate legal entity (as a partnership, or limited liability company) - it's
the default option. An individual may do house repair work for homeowners on a part-time basis, or be a full-time barber who operates on his own. Both are sole proprietorships. Anytime you regularly provide services for a fee, or sell things at a flea market, or engage in any business activity whose primary purpose is to make profit, you are a sole proprietor. If you carry on business activity to make profit or income, HM Revenue and Customs requires that you file a separate schedule summarising your profit or loss from trading with your annual individual income tax return. If your business activities are substantial, the Revenue may ask for both a profit and loss account and a balance sheet, but for most small businesses a few lines of figures showing income, main cost categories, and the resultant profit will be sufficient. As the sole owner (proprietor), you have
unlimited liability
,
meaning that if your business can't pay all its liabilities, the creditors to whom your business owes money can come after your personal assets. Many part-time entrepreneurs may not know this or may put it out of their minds, but this is a big risk to take.

One other piece of advice for sole proprietors: Although you don't have to separate invested capital from retained earnings like companies do, you should still keep these two separate accounts for owners' equity - not only for the purpose of tracking the business but for the benefit of any future buyers of the business as well.

Limited companies (Ltd) and public limited companies (plc)

As the name suggests, in this form of business your liability is limited to the amount you contribute by way of share capital.

A
limited company
has a legal identity of its own, separate from the people who own or run it. This means that, in the event of failure, creditors' claims are restricted to the assets of the company. The shareholders of the business are not liable as individuals for the business debts beyond the paid-up value of their shares. This applies even if the shareholders are working directors, unless of course the company has been trading fraudulently. In practice, the ability to limit liability is restricted these days as most lenders, including the banks, often insist on personal guarantees from the directors. Other advantages include the freedom to raise capital by selling shares.

Disadvantages include the legal requirement for the company's accounts to be audited and filed for public inspection.

A limited company can be formed by two shareholders, one of whom must be a director. A company secretary must also be appointed, who can be a shareholder, director, or an outside person such as an accountant or lawyer.

The company can be bought ‘off the shelf' from a registration agent, then adapted to suit your own purposes. This will involve changing the name, shareholders, and articles of association and takes a couple of weeks to arrange. Alternatively, you can form your own company. But before you can form a company, you need to decide which of the two main structures of company to use.

A limited company (Ltd) is the most common type. This is a private company limited by shares. A limited company can be started with, say, an authorised share capital of £1,000. This is then divided into 1,000 × £1 shares. You can then issue as few or as many of the shares as you want. As long as the shares you have issued are paid for in full, if the company liquidates, the shareholders have no further liabilities. If the shares have not been paid for, the shareholders are liable for the value, i.e. if they have 100 £1 shares, they only are liable for £100.

A
plc company
is a public limited company and may be listed on the Stock Exchange. Before a plc can start to trade it must have at least £50,000 of shares issued and at least 25 per cent of the value must have been paid for. A plc company has a better status due to its larger capital.