Course Code and Title: ACED 7 – Financial Management

Lesson Number: 4

Topic: Business Organization and Trends

Learning Objectives:
After studying Chapter 4, you should be able to:
1. Explain the basic legal forms of business organizations such as, sole proprietorship,
partnership and corporation.
2. Know the advantages and disadvantages of adopting the sole proprietorship, partnership and
corporation form of business organization.
3. Determine the form of business organization most adaptable to an enterprise.
4. Understand the important business trends such as
 Increased globalization of business
 Improving information technology
 Outsourcing
and how they import a business firm’s business operation.
Pre-assessment:
Write T if the statement is true and F if the statement is false.

_____1. The business firm is an entity decided to organize raw materials, machines with the
goal of producing goods and/or services.
_____2. Sole proprietorships are easy to establish in our country setting than other
organizational forms.
_____3. In a partnership, creditors can run after the partner’s personal assets.
_____4. In a corporation, the stockholders or shareholders will not be prosecuted if there is a
major issue involving the company.
_____5. Various organizations need to adopt to new trends such as eating and dance
challenges.
 CHAPTER 4
BUSINESS ORGANIZATION AND TRENDS
THE ORGANIZATION OF THE BUSINESS FIRM
The business firm is an entity designed to organize raw materials, machines with the goal of
producing goods and/or services. Firms

1. purchase productive resources from households and other firms,

2. transform them into a different commodity, and
3. sell the transformed product or service to consumers
For business firms engaged in retail or trading activities, transforming purchased goods into
a different commodity does not necessarily take place.
Every society, no matter what type of economy it has, relies on business firms to organize
resources and transform them into products. In market economies, most firms choose their own
price, output level, and methods of production. They get the benefits of sales revenues, but they
also must pay the costs of the resources they use.
Business firms can be organized in one of three ways: as a proprietorship, a partnership, or a
corporation. The structure chosen determines how the owners share the risks and liabilities of the
firm and how they participate in making decisions.
LEGAL FORMS OF BUSINESS ORGANIZATION
PROPRIETORSHIP
A sole proprietorship is a business owned by a single person who has complete control
over business decisions. This individual owns all the firm's assets and is responsible for all its
liabilities. More businesses are sole proprietorship than any form of business organization. From
a legal point of view, the owner of a proprietorship is not separable from the business and is
personally liable for all debts of the business. From an accounting prospective, however, the
business is an entity separate from the owner (proprietor). Therefore, the financial statements of
the business present only those assets and liabilities pertaining to the business.
The owner cannot be paid salary or wages from the business. Instead, the owner may
withdraw funds or other property from the business. These withdrawals are treated as reduction
of owner's equity or financial interest of the owner in the business. The business itself does not
pay any income taxes. The income or loss of the business is reported on the owner's personal
income tax return on a supporting schedule.
Among the advantages of a sole proprietorship are:
1. Ease of entry and exit
A sole proprietorship requires no formal charter and is inexpensive to form and dissolve.

2. Full ownership and control

The owner has full control, reaps all profits and bears all losses.

3. Tax savings
The entire income generated by the proprietorship passes directly to the owner. This may
result in a tax advantage if the owner’s tax rate is less than the tax rate of a corporation.
 4. Few government regulations
A sole proprietorship has the greatest freedom as compared with any form of business
organization.
Major disadvantages of the proprietorship form include:
1. Unlimited liability
The owner is personally liable or responsible for any and all business debts. Thus, the
owner's personal assets can be claimed by the creditors if the firm defaults on its
obligations.
2. Limitations in raising capital
Fund-raising ability is limited. Resources may be limited to the assets of the owner and
growth may depend on his or her ability to borrow money.
3. Lack of continuity
Upon death or retirement of the owner, the proprietorship ceases to exist.
Therefore, the proprietorship may be an ideal form of business organization when the following
conditions exist:

 The anticipated risk is minimum and adequately covered by insurance.

 The owner is either unable or unwilling to maintain the necessary organizational
documents and tax returns of more complicated business entities.
 The business does not require extensive borrowing.
PARTNERSHIP
A partnership is a legal arrangement in which two or more persons agree to contribute
capital or services to the business and divide the profits or losses that may be derived therefrom.
Partnership may operate under varying degrees of formality. For example, a formal partnership
may be established using a written contract known as the partnership agreement which is filed
with the Securities and Exchange Commission.
Partnership may be either general or limited.
A general partnership is one in which, each partner has unlimited liability for the debts
incurred by the business. General partners usually manage the firm and may enter into
contractual obligations on the firm's behalf. Profits and asset ownership may be divided in any
way agreed upon by the partners.
A limited partnership is one containing one or more general partners and more limited
partners. The personal liability of a general partner for the firm's is unlimited while the personal
liability of limited partners is limited to investment. Limited partners cannot be active in
management.
Advantages of a partnership include among others the following:
1. Ease of formation
Forming a partnership may require relatively little effort and low start-UP costs.
2. Additional sources of capital
A partnership has the financial resources of several individuals
 3. Management base
A partnership has a broader management base or expertise than a sole proprietorship.
4. Tax implication
A partnership like a proprietorship does not pay any income taxes. The income or loss of
the business is distributed among the partners in accordance with the partnership and
each partner reports his or her portion whether distributed or not on personal income tax
return.
Disadvantages of partnership are:
1. Unlimited liability
General partners have unlimited liability for the debts and litigations of the business.
2. Lack of continuity
A partnership may dissolve upon the withdrawal or death of a general partner, depending
on the provisions of the partnership.
3. Difficulty of transferring ownership
It is difficult for a partner to liquidate or transfer ownership. It varies with conditions set
forth in the partnership agreement.
4. Limitations in raising capital
A partnership may have problems raising large amounts of capital because many sources
of funds are available only to corporations.
CORPORATION
A corporation is an artificial being created by law and is a legal entity separate and distinct
from its owners. This legal entity may own assets, borrow money and engage in other business
entities without directly involving the owners. In many corporations, owners who are also called
shareholders do not directly manage the firm. Instead they select managers designated as the
Board of Directors to run the firm for them. The Board of Directors is authorized to act in the
corporation's behalf.
The incorporation process is initiated by filing the articles of incorporation other requirements
with the Securities and Exchange Commission (SEC). Articles of incorporation includes among
others the following:
 Incorporators
 Name of the corporation
 Purpose of the corporation
 Capital stock
 Authorized shares
After the corporation is legally formed, it will then issue its capital stock. Ownership of this
stock is evidenced by a stock certificate. The corporate bylaws which are rules that govern the
internal management of the company are established by the board of directors and approved by
the shareholders. These bylaws may be amended or extended from time to time by shareholder.
Advantages of a corporation are:
1. Limited liability
Shareholders are liable only to the extent of their investment in the corporation. Thus,
 shareholders can only lease what they have invested in the firm's shares, not any other
personal assets. However, limited liability is not all-encompassing. Government may pass
through the corporate shield to collect unpaid taxes. Also, it is not uncommon for creditors
to require that major shareholders personally co-sign for credit extended to the
corporation. Thus, upon default by the business, the creditors may sue both the
corporation and shareholders who have co-signed.
2. Unlimited life
Corporations continue to exist even after death of the owners. The maximum legal life of
a corporation is 50 years but may be renewed for the desired additional life not to exceed
50 years.
3. Ease in transferring ownership
Shareholders can easily sell their ownership interest in most corporations by selling their
stock without affecting the legal form of business organizations. The ability to sell stock
provides corporations with a stronger financial base and the capital needed for expansion.
4. Ability to raise capital
Corporations can raise capital through the sale of securities such as bonds to investors
who are lending money to the corporations and equity securities such as common stock
to investors who are the owners.
Disadvantages of a corporation include:
1. Time and cost of formation
Registration of public companies with the SEC may be time-consuming and costly.
2. Regulation
Corporations are subject to greater government regulations than other forms of business
organizations. Shareholders cannot just withdraw assets from the business. They can only
receive corporate assets when dividends are declared and these amounts may be subject
to limits imposed by law.
3. Taxes
Corporations pay taxes on income they have earned. The complexity of the subject of
taxation demands the advice of a qualified tax accountant.
The need of large businesses for outside investors and creditors is such that, the corporate
form will generally be the best for such firms. We focus on corporations in the chapters ahead
because of the importance of the corporate form not only locally but also in world economies.
Also, a few financial management issues, such as dividend policy are unique to corporations.
However, businesses of all types and sizes need financial management, so the majority of the
subjects we discuss bear on any form of business.
IMTORTANT BUSINESS TRENDS
Four important business trends should be noted, namely:

 Increased globalization of business

 Ever improving information technology (IT)
 Corporate governance
 Outsourcing
Globalization of the Firm

Most large corporations operate on a global basis and with good reason: investing abroad
has proven to be highly profitable. Decisions to build plants and produce goods abroad are also
motivated by the attraction of low-cost labor and the easy transfer of highly efficient technology
that gives competitive price advantages to foreign operations.
As domestic demand reaches maturity, the search for new markets leads corporation to
invest and sell abroad. The trend to develop a presence abroad is also motivated by a desire to
hedge against risks. Because economic activity differs from one country to the next, diversification
abroad tends to dampen the overall fluctuations of sales and earnings, thus reducing the risk
exposure of a corporation. Fortunately, the advent of ness financial instruments, including
financial derivatives, such as futures and swap agreements, provides managers with new tools
for hedging and minimizing foreign risks.
Competition is intensified with the emergence of foreign industrial power, like Japan, South
Korea and China because of the opportunities for local firms to import lower priced goods for sale
in the domestic market. This not only saves the domestic firm the need to invest in new capacity,
but it also allows to share in the technological advances of that country.
Globalization of the firm will continue to provide highly profitable opportunities to domestic
firms, but this movement requires careful decision making and highly skillful financial
management.
Ever-improving Information Technology (IT)
Improvements in IT are spurring globalization, and they are changing financial
management as it is practiced in North America, Europe, Southeast Asia and elsewhere. Firms
are collecting massive data and using them takes much of the guesswork out of financial
decisions. For example, when Double-Drag011 Corporation is considering a potential site for a
new mall, it can draw historical results from thousands of other stores to predict results at the
proposed site. This lowers the risk of investing in new stores.
Corporate Governance
This trend relates to the way the top managers operate and interface with stakeholders.
At the same time, the Securities and Exchange Commission (SEC) which has jurisdiction over
the shareholders and the information that must be given has made it easier to activist
shareholders to changes the way things are done within firm. Some years ago, the corporation's
chairman of the board of directors was almost always also the chief executive officer, and this
person decides who would be elected to the board and therefore would have complete control of
the firm's operations. That made it impossible for shareholders to replace a poor management
team.
Currently, investors who control huge pools of capital (hedge funds and private equity
groups or venture capitalists) are constantly looking for underperforming firms and they quickly
take control and replace manager.
Most firms today have strong written codes of ethical behavior and companies also
conduct training programs to ensure that employees understand proper behavior in different
situations. When conflicts arise involving profits and ethics, ethical consideration are so obviously
important that they dominate.
Outsourcing
Outsourcing occurs when domestic firms invest and produce goods in foreign countries or
when these firms choose to rely on imports rather than build domestic plans and produce these
goods domestically. Low labor-cost countries, like China, open up new investment opportunities
for corporations from the United States, Europe and Middle-East. Growing competitive pressures
are forcing domestic firms to invest abroad or to import cheap foreign products.
One major factor responsible for outsourcing is the ease with which technology can be
transferred abroad. China, India and other Asian countries including the Philippines can claim
technological parity while enjoying low costs of production. That is why outsourcing is such an
attractive investment option.
When evaluating the merits of outsourcing a corporate manager is to make central decisions.
1. Invest and produce domestically or move a plant overseas.
2. Import cheaper foreign goods to take advantage of low labor and other costs or shift to
more capital-intensive and technologically advanced operations.
3. Invest abroad in order to gain access to new rapidly growing foreign markets.
Outsourcing relieves managers from having to purchase raw materials or to hedge against
the risk that the prices of these raw materials will increase. An outsourcing firm does not have to
incur the high costs of pension plans, health benefits, pollution control, and worker safety. Some
risks such as technological obsolescence and unforeseen changes in demand become less
important with outsourcing. These and other advantages make outsourcing an attractive option.
Learning how to work with probability models will help a manager to evaluate the relative
merits of outsourcing compared to domestic investments. Also, given global cost disparities
among countries, outsourcing will continue to pay an important role in business decision making.
However, when USA President Donald Trump decided to impose higher tariff on goods imported
from other countries such as China, Japan, Canada and others, trade wars are said to have
sparked among these nations.
Activity:
Write T if the statement is true and F if the statement is false.

_____1. A sole proprietorship has complete control over business decisions

_____2. Partnerships may not register with the securities and exchange commission.
_____3. Ownership of a corporation is evidenced by a stack certificate.
_____4. Globalization enables firms to invest abroad to maximize profits.
_____5. Information Technology (IT) can help reduce the manual guesswork in drafting
organizational plans.

Reinforcement:
Choose the letter of the correct answer:
1. The following are forms of business organization in the Philippines, except for one:
a. Cooperation
b. Corporation
c. Sole Proprietorship
d. Partnership
2. The advantages of a sole proprietorship are the following, except:
a. Ease of entry and exit
b. Full ownership and control
c. Tar savings
d. Few government regulations
3. The disadvantages of a sole proprietorship are the following, except:
a. Unlimited Liability
b. Limited capital raising ability
c. Lack of continuity
d. Simpler management approach can be applied.
4. The advantages of a partnership are the following, except:
a. Difficulty in formation
b. Additional sources of capital
c. Management base
d. Tax Implications
5. The disadvantages of a partnership are the following, except:
a. Limited liability
b. Lack of continuity
c. Difficulty of transferring ownership
d. Capital raising limitations
6. The advantages of a corporation are the following, except:
a. Unlimited liability
b. Unlimited life
c. Ease in transferring ownership
d. Ability to raise capital
7. The disadvantages of a corporation are the following, except:
a. Time and cost of formation
b. Regulatory requirements
c. Tax Implications
 d. Limited liability
8. The articles of incorporation include the following, except:
a. Incorporators
b. Name of the corporation
c. Purpose of the corporation
d. Company history
9. The following are the trends in the business environment, except for one:
a. Globalization
b. Social Governance
c. Information Technology (IT) Improvements
d. Outsourcing
10. Statement 1: The shareholders are liable only to the extent of their investment in the
corporation.
Statement 2: Corporations do not require tax accountant advice in their tax implications.
a. Statement 1 is True, Statement 2 is False
b. Statement 1 is False, Statement 2 is True
c. Both statements are True
d. Both statements are False