topic 5 - business organization

PSCI 1500:

Introduction to Economics

Business Organization

OVERVIEW OF BUSINESS ORGANIZATIONS

The economy can be divided into two business sectors:

1. The Public Sector• Made up of central government, local government,

and businesses that are owned by government

2. The Private Sector• Firms that are owned by private individuals:

• Sole Traders/Proprietors• Partnerships• Private Limited Companies (Ltd)• Public Limited Companies (PLC)


Business

• Organization established to produce and sell goods

and services.

• The key differences between businesses are the

Liability and Legal Forms.


Liability

i. Unlimited Liability

Business owner’s personal assets are subject to

use as payment for business debts.

Personal assets can be seized if the business's

assets are insufficient to satisfy claims against it.


Liability

ii. Limited liability

Business owner’s financial liability is limited to the

value of a person's investment in the business.

There is a legal separation between ownership and

liability since a stockholder can lose not more than

what he paid for the shares of ownership,

regardless of the firm's financial obligations.

Legal Forms of Business

SOLE PROPRIETORSHIP

Characteristics

• owned and operated by one person

• that one person bear liability which is legally inseparable

from the business

• the resources for operating business are subject to the

owner’s personal capacity



Advantages of sole proprietorships

• easy start-up

• flexible (can make decisions quickly)

• the profits are owned by the owner

• the owner is the boss

• little formality (but still maintain business records)


Disadvantages of sole proprietorships

• unlimited liability – the owner’s personal and

business assets are subject to liability

• difficult to raise capital - financing from single

owner

• diseconomies of scale (expensive inventory –

high cost)

• limited management experience

• Owner is the employee, also hard time finding

qualified employees to fill in the need of

business

• limited business lifespan


PARTNERSHIP

Organization of a business that is similar to a sole

proprietorship but has two or more owners.

Characteristics

• Involves two or more partners, thus allows for the pooling of

money, experience, and talent.

• Must have at least one general partner who holds unlimited

legal liability for the activities of the business.

• Can attract additional resources through limited partner

contributions.



Forming a Partnership

Legal papers drafted must specify:

• how profits are divided.

• how new partners may join.

• how property is divided if the partnership ends.


Forming a Partnership

There are two types of partners:

i. General Partner

• There must be one general partner (responsible

for operating the business) and have unlimited

liability

• Often the general partner is a corporation

ii. Limited Partners

• Passive investors - Contribute money only to the

business, and share in the profits


Advantages of partnerships

• easy to start and manage

• all partners get the share of the profits

• can attract financial capital easier than sole

proprietorships

• easier to attract qualified employees

• combine the talents and energies of all the

partners

• combine financial resources of the partners

• limited partner only lose original investment


Disadvantages of partnerships:

• responsible for the acts of all the other partners

• conflict between partners may lead to the end of

partnership

• general partner have to pay off debts in case of

bankruptcy

• some formality does exist –through a formal

agreement

• It can be legally challenging to disassociate

ones’ self from and/or dissolve a partnership

arrangement



CORPORATIONS

A form of business organization that is recognized by the

law as having all the legal rights of an individual (own a

name business, functions performed by individuals, have

the right to buy & sell property, enter into legal contracts,

and to sue & be sued)



CORPORATIONS

Characteristics

• Governed by the Board of Directors, managed by

professional managers and owned by shareholders

• Flexible and long term running since it can issue stocks,

bonds and other hybrid securities to raise capital for R&D

and overall corporate growth


How a corporation is formed and run

1) Approval of the government.

2) If approved, a charter will issued.

3) The charter states the name of the company, the

address of the business, how many shares of

stock can be issued, and other specific features

of the business.

4) Co-operatives are owned by their staff, who are

known as ‘members’ of the firm

5) Profits and loss are shared amongst the members


Stock

• Stock – a certificate of ownership in a firm.

• Stockholders/shareholders – investors in a

corporation (they own stock).

• The money from the stockholders (investors) is

used to set up the firm. This money is called

financial capital.


Types of Stock

1. Common Stock

Basic form of ownership in a corporation. Each

share is worth one vote for the board of directors,

who run the company, Pays a dividend dependent

on the profit of a firm after all other financial

obligations have been met.


Types of Stock

2. Preferred Stock

Pays a stated dividend to its holder before

dividends are issued to common stockholders, non-

voting shares of stock, but these shareholders

receive profits before common stockholders.


Advantages of Corporations

• easy to raise financial capital:

i. sell stock

ii. issue bonds

• professionals/ experts in its board of directors

• limited liability – shareholders only lose money

invested

• unlimited life – the firm stay alive if shareholder dies

• immortal – issue securities with very long terms to

maturity

• potential to attract great amounts of financing by

expanding the base of shareholders


Disadvantages of Corporation

• difficult to start

• shareholders have little say about how to run the

business

• subject to government regulation.

• formality and structure may slow the decision

making

• corporate taxation – shareholder ’s income

(dividends) are paid after-tax and then are taxed

again on the shareholders


Business Ownership of Business

Merger

• Also called an acquisition.

• Acquiring of one company by another.

Conglomerate Merger

Corporation acquires another corporation that

produces unrelated goods and services.

Vertical Merger


supplies its inputs or distributes its products.

Horizontal Merger


competes in the same market.


Why Merge?

1. Grow faster

2. Become more efficient

3. Acquire or deliver a better product

4. Eliminate a rival

5. Change image

What is the Goals of Business Firms?

Profit maximization or loss minimization

(Profit or loss = Revenue – Cost)Revenue is the money or income that a company receives

from selling its product.


The Role of Government

Direct Role of Government

• government supplies good or service that also

competes with private businesses.

• many government agencies are organized as the

government-owned corporations.


The Role of Government

Indirect Role of Government

• government plays an indirect role when it acts as

an intermediary to make sure the market

economy operates smoothly and efficiently.

• for example, the regulation of public utilities,

investor or state-owned companies that offer

important products to the public, i.e. water or

electricity.


Islamic principles on business organizations

Islam encourages trade and commerce. In

fact, Prophet Mohammad PBUH was himself

engaged in this profession before he became a

prophet. He was a successful businessman. Known

for integrity, he bore the honorific title, the

Trustworthy.

The Quran states:

“God has permitted for you trade .....”

(2:275)


Islam stressed business ethics and Shari’ah’s

limitation as the pre-requisite in forming any business

organization.

1. Business Ethics in Islam

• Trustworthiness

• Generosity and leniency

• Honouring and fulfilling business obligations

• Honesty and truthfulness

• Mutual consent in business transactions

• Mutual respect

• Justice and fairness


2. Shari’ah’s limitation

i. Prohibits from producing, selling and purchasing of

goods, which are prohibited in Islamic law, i.e.

alcohol, drugs

ii. Prohibition any kind of transaction involving

uncertainty, or unspecified quantity, i.e.

acceptance of money for fish in the river or bird in

the air as there is element of uncertainty. However;

if the element of uncertainty is very small, the

transactions are permissible.



iii. Condemn hoarding to make high profit at the cost

of public interest. Islam, however, allows normal

trade - buying and selling of goods again and again

at a reasonable profit.

iv. Prohibits fraud in business dealings. The Prophet

has said: "Sell the good and bad separately. He

who deceives is not of us" .The sin of fraud is

greater if the seller supports it by swearing falsely.

The Prophet has said, "Swearing produces ready

sale but blots out blessing".



iii. Prohibits buying or selling what's legal if we know

that it will be used for illegal use: weapons,

abortion drugs, drugs to be sold to drug addicts and

so on.

iv. Muslims are not allowed to pay or receive interest.

The Quran is explicit about it and says, "God has

permitted for you trade and prohibited interest"

(2 : 275).

topic 5 - business organization

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