Revise Types of business entity for Cambridge 9706 (1.1.1)

A sole trader is the simplest business structure, owned and operated by a single individual. There is no legal distinction between the owner and the business itself. This leads to the most significant feature: unlimited liability. If the business incurs debts it cannot pay, the owner's personal assets, such as their house or car, can be used to settle these debts. Finance is typically sourced from the owner's personal savings (capital), retained profits, and bank loans, which may be difficult to secure without personal guarantees. For accounting purposes, the business entity concept is applied, but legally, the owner is the business. Reporting is minimal; there is no legal requirement to publish accounts, but a Statement of Profit or Loss and Statement of Financial Position are prepared for tax purposes.

A partnership is formed when two or more individuals (typically up to 20) agree to run a business together with the aim of making a profit. Like sole traders, partnerships have no separate legal identity from the owners. Consequently, partners have unlimited liability. This liability is 'joint and several', meaning each partner is individually responsible for all the business's debts, not just their own share. A Partnership Agreement or Deed is crucial to outline profit-sharing ratios, salaries, and interest on capital/drawings. In its absence, the Partnership Act 1890 applies, stipulating equal profit sharing and no salaries or interest. Finance comes from partners' capital contributions and loans. The key financial statement is the Appropriation Account, which shows how profits are distributed among partners.

Partnerships maintain capital accounts for each partner. These can be 'fixed' or 'fluctuating'. With a fixed capital account, the initial capital contribution remains unchanged unless a partner permanently adds or withdraws capital. All other transactions—such as profit shares, salaries, interest on capital, and drawings—are recorded in a separate current account. With a fluctuating capital account, all these items are posted directly to the single capital account, causing its balance to change throughout the year. The Partnership Agreement will specify which system to use.

Limited companies, both private (Ltd) and public (Plc), are distinct legal entities separate from their owners (shareholders). This principle of 'corporate personality' is fundamental. It means the company can own assets, enter contracts, and be sued in its own name. The most significant consequence is limited liability for shareholders. If the company fails and is liquidated, a shareholder's maximum loss is restricted to the amount they have invested in their shares (or any unpaid amount on those shares). Their personal assets are fully protected from the business's creditors. This protection makes investing in a limited company far less risky than being a sole trader or partner, which is a key factor in attracting investment and enabling business growth.

The financing and reporting of limited companies are more complex and regulated. Private limited companies (Ltd) cannot offer shares to the public; they raise capital by selling shares to friends, family, or business associates. Public limited companies (Plc) can raise vast sums by issuing shares to the general public via a stock exchange. Both can also issue debentures (long-term loans). Due to their limited liability status and public accountability, companies are subject to strict reporting requirements under the Companies Act. They must prepare and file a full set of annual financial statements. The Statement of Changes in Equity is unique to companies and details the movement in all equity components during the year. These components include Issued Share Capital (the nominal value of shares sold), Share Premium (amounts received for shares above their nominal value), Revaluation Reserve (surpluses from revaluing non-current assets), and Retained Earnings (accumulated profits after tax and dividends). For Plcs, these accounts must be audited.