Business entities evolve either within manufacturing or in providing services. There are profit making organisations, non-profit organisations and charities.
Sole traders
These are applied mostly to small businesses. They are owned and financed by one individual, who receives all the profit made by the business. The sole trader has the responsibilities in all the types of activities the business may be engaging, when to start or cease the business and the way the business is conducted. They also finance the business, taking all risks, make decisions, employ staff and take responsibility for all the debts the business may have.
This type of business is simple and cheap to set up. The business has no separate legal entity set to its owners. The accounting information are kept by sole traders for the day-to-day management of the business and provide account for profit made in the relevant tax period. Sole traders are not required to file formal reports. They must, however, prepare accounts annually and submit to HMRC.
Partnerships
Partnerships are similar to sole traders and the ownership of the business is in hand of two or more people. Formal partnership agreement will set up how much each of the partners puts into the business, who is responsible for what and how the profits are being shared. The partnership agreement conditions are set in the Partnership Act 1890.
Partnership can carry out any legal activities agreed by all the partners and it is not a legal entity separate from its partners. All partners can be involved in the running of the business, share all the profit, are jointly reliable for the debts, have unlimited liability for the debts and each is liable for the action of the other partners.
Accounting records need to keep by partnerships for the day-to-day management and account for profit made within a specific tax year. They do not require to file financial reports but submit tax returns to HMRC.
Limited companies
A limited company is a legal entity separate from its owners which may enter into a contract, own property and take or receive legal action. The owners limit their obligations to the amount of finance they out into the company. The maximum they can claim for is not more then they have paid for their shares, regardless what happen to the company. There is a risk that shareholders may not recover their original investment.
The unlimited liability company does not give the owners the protection of limited liability. If business were to fail, the members would be liable for all the debts of the business.
Limited companies are required to be registered within the Companies Act 2006 as either private limited company or public limited company.
Private limited company
Private limited company are designated as Ltd. It costs the company to set up the business. These formalities involve drafting of Memorandum and Articles of Association, registering the company and its directors and registering the name of the company. The owners provide funding as shared capital and one company secretary must be appointed. They carry out the day-to-day management of the business.
Limited companies must produce annual accounts and general public have access to these information. The accounting must be audited by suitably qualified accountants.
Public limited company
Public limited company are designated as plc. It usually starts its life as Ltd and becomes plc by applying for listing of its shares on the Stock Exchange or the Alternative Investment Market. This can be a very costly exercise for the Ltd business. The shareholders must appoint at least two directors who carry out the day-to-day management of the business and a suitably qualified company secretary to ensure its compliance with the law.
Plcs must regularly produce company accounts and general public must have access to the information. Larger plcs usually provide printed annual accounts which they distribute to their shareholders and other interested parties. Their accounts must be audited by suitably qualified accountant and provide copies of their accounts to HMRC.
The shareholders are the owners of the business and the shares may be freely traded and bought and sold by the generic public.
Financial statement reporting
Limited companies provide financial statements for each accounting period to provide information on how the company has been doing. There are three basic reports:
* Balance Sheet;
* Income Statement;
* Statement of cashflows.
After each year a company prepares annual accounts and reports for their shareholders. The information include any notes to the accounts and other financial and non-financial information, such as company policies, financial indicators, corporate governance compliance, employee numbers, business analysis and segmental analysis. They include the operating and financial review, report of the auditors and the owner's statement.
The auditor's reports state compliance of the accounting standards and that the information are free from misstatement and they they give true and fair review of the business.
Balance sheet - a financial snapshot of a moment in time or the financial position of the company. It does not tell us what happened in that period of time. The balance sheet is the consequence of everything that has happened and it does not explain how company goes into that position.
Income statement - is used to calculate whether or not the company has made a gain or deficit on his operations during the period its performance through selling or producing their product. Net profit is calculated.
Statement of cash flows - the net earnings is not the same as cash flows, since revenues and costs are not accounted for when cash transfer occurs. Sales are accounted for when goods or services are delivered and accepted by the customer but cash may not be received after some time later. The statement of cash flows summarises cash inflow and cash outflows and calculates the net change in the cash position through-out the reporting period.
Who uses the financial reports?
Competitors as part of their industry competitive analysis to look at market share and financial strength.
Customer to determine the ability to provide a regular and reliable supply of goods and services and to assess their dependance.
Employees to assess the potential for providing continuing employment and assess level of remuneration.
General public to assess employment opportunities, social, political and environmental issues and to consider potential for investment.
Government - value added tax and corporate taxation, Government statistics, grands and financial assistance, monopolies and merges.
Investment analyst as investment potential for individuals and institution with regard to past and future performance, strength of management, risk vs reward.
Lenders assess the capacity and ability to service debt and repay capital.
Managers/directors aid to decision making.
Shareholders/investors - a tool of accountability to maintain a check on how effectively the managers/directors are running the business and to assess the financial strength and future developments.
Suppliers to assess a long-term visibility on whether the company is able to meet the obligations and pay suppliers on an ongoing basis.
It is, therefore, very important that the credibility of the financial statement reporting is maintained so that the actual and potential investors are protected as far as possible against inappropriate accounting practices. The auditors, therefore, must have some rules on which to base their true and fair view of the financial position and financial performance.
There are requirements for all companies registered in the UK to have an annual audit (although there are some exemptions). The Companies Act 2006 contains the overall current legal framework.
Bibliography
Davies, T., Crawford, I., 2011. Business Accounting and Finance, Pearson Education.
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