SMALL BUSINESS - Wellington Secondary Collegemoodle2.wellingtonsc.vic.edu.au/pluginfile.php/14981/mod... · 2014-11-18 · manager is the same person (or people), and which employs

SMALL BUSINESS

CHAPTER 3

KEY TERMS

After completing this chapter, you should be familiar with the following terms:

• small business

• term deposit

• negative gearing

• share

• dividend

• franking credit

• cost price

• sole proprietorship

Where are we headed?After completing this chapter, you should be able to:

• defineasmallbusiness

• listthereasonsforowningasmallbusiness

• identifythealternativestoestablishingasmallbusiness

• identifytheresourcesrequiredtoestablishasmallbusiness

• identifythepersonalqualitiesofasuccessfulsmallbusinessowner

• distinguishbetweenbusinessesbasedonthenatureoftheiroperations

• identifyandexplaintheadvantagesanddisadvantagesofvariousownershipstructures

• identifyandexplaintheadvantagesanddisadvantagesofestablishingasmallbusinessorbuyinganexistingbusinessorafranchise

• explainwhysomesmallbusinessessucceedwhereothersfail

• identifysourcesofassistanceforsmallbusinessowners.

• unlimited liability

• partnership

• proprietary company

• limited liability

• goodwill

• franchise

• franchisee

• franchisor

ISBN 978-1-107-65709-0 Photocopying is restricted under law and this material must not be transferred to another party.

© Anthony SImmons, Richard Hardy 2012 Cambridge University Press

34 C A M B R I D G E V C E A C C O U N T I N G U N I T S 1 & 2

3.1 SMALL BUSINESS

Small businesses can be identified by the following characteristics: • Theyareindependentlyownedandoperated.• Theyarecloselycontrolledbytheowner/managerwhoalsocontributesmost,ifnot

all,oftheoperatingcapital.• Theprincipaldecision-makingismadebytheowner/manager.

A simple definition of a small business is any business in which the owner and manageristhesameperson(orpeople),andwhichemploysfewerthan15people.Thenumber of employees is a useful distinguishing feature to determine a small business fromamediumorlargebusiness.Amediumbusinesswouldemploy15ormorepeoplebutlessthan200,whilealargebusinesswouldemployover200people.

However,withtheexceptionofa‘soleproprietorship’,whichhasoneowner,thesizeofthebusinessshouldnotbetakenasevidenceofitsbusinessstructure.Small,mediumandlargebusinessescanallbesoleproprietorships,partnershipsorcompanies.(Thiswillbecoveredindetaillaterinthischapter).

The small business sector

Politicians and economists frequently cite small businesses as the engine room of the Australianeconomy,butjusthowimportantarethey?InAustraliathereareapproximately2.1millionprivatesectorsmallbusinesses,andthisrepresentsroughly96%ofallprivatesectorbusinesses.

Small businesses play a vital role in the Australian economy as they employ almost 5 million people, which is almost half of all private sector employment. They alsocontributestronglytoAustralia’slevelofeconomicactivityandproduction,andexports,which(mostimportantlyfromthegovernment’sperspective)areamajorsourceoftaxrevenue.

Small businessa business in which the owner and manager is the same person, and which employs fewer than fifteen people



35C H A P T E R 3 S M A L L B U S I N E S S

REVIEWQUESTIONS3.1

1 Define theterm‘smallbusiness’.2 Statethreecharacteristicsthatdistinguishabusinessassmall.3 Explain two reasons why small businesses are important to the Australian

economy.

3.2 BECOMING A SMALL BUSINESS OWNER

Unfortunately,thelistofsuccessfulsmallbusinessownersisdwarfedbythosethatfail(seelaterinthischapter).Thedecisiontobecomeasmallbusinessownershouldthusnotbetakenlightly,butratherbetheproductofacarefulassessmentoftheprospectiveowner’smotivation,strengthsandweaknesses,andthecostsandbenefitsofownershipitself.

Reasons for becoming a small business owner

Thereasonswhypeoplechoosetoowntheirownbusinessareasmanyandvariedasthebusinessestheyoperate.Someofthemorecommonreasonsare:

Profit motive

Rightlyorwrongly,manypeople think thatowninga smallbusiness is agateway tofinancialrichesandseebecominganownerasthebestwaytoimprovetheirincome.Although wealth and security are by no means guaranteed, the profit motive is apowerfulfactorinthedecisiontopurchaseorstartabusiness.

A desire for greater freedom/independence – to be your own boss

Manypeoplebecomefrustratedasemployees,eitherbecausetheythinktheyhaveabetterwayofdoingthings,orbecausetheyfeelthattheireffortsareunder-recognised.Byowningtheirownbusiness,smallbusinessownersgaintheirindependenceaswellasallthefinancialrewardsthattheirhardworkhasgained.Thisextendstobeingabletochoosethehourstheywork,andthewaythatworkisdone.

Identifying a market opportunity

A business opportunity can sometimes present itself in a way that an ambitious or creativepersoncannotignore.Anideaforaneworcheaper/betterqualityproduct,oraservice that is not currently being provided can be a strong incentive to go into business for yourself so that the market demand is satisfied (not to mention the recognition – and hopefullyprofits–thatwilleventuate).

Unemployment

Duetoretrenchmentorotherfactorssomeindividualsmaydiscoverthatself-employmentistheironlyoption.Theoldsayingaboutonedoorclosingandanotheroneopeningis apt for those who are forced into what can turn out to be a highly rewarding small business.

While there are certainly benefits to be gained from owning a small business,therearealsocostsandrisksinvolved.Theindependencethatcomeswithbeingtheownerisaccompaniedbyextraresponsibilities,meaningmanyhoursofhardworkandperiodsofstress.The lossofasecure incomeandotherbenefits (likepaidholidays,sickpayandemployer-fundedsuperannuation)thatgowithsalariedemploymentmustbeconsidered,asmusttheriskownersaretakingbyinvestingtheirownfundsinthebusiness–ifthebusinessfails,thisinvestmentwillbelost.




REVIEWQUESTIONS3.2

1 Listfourreasonswhyanindividualmightwanttoowntheirownsmallbusiness.2 List three costs involved with leaving salaried employment to become a small

businessowner.

3.3 ALTERNATIVES TO SMALL BUSINESS OWNERSHIP

Asstatedabove,thepotentialsmallbusinessowneracceptsalargefinancialriskifheorshecommencestheirownsmallbusiness.Theindividualhastheirsavingsatrisksoitwouldnotbeunreasonableforthatpersontoexplorealternatives.LaterinChapter3,weexploreaprofitabilityindicatorcalledReturn on Owner’s Investment (ROI).ROImeasuresthereturn(profit)generatedfortheowneronthecapitaltheyhaveinvested.Specifically,itshowstheprofitearnedperdollarinvestedbytheowner,soitisusefulinassessinghowprofitablethebusinessisasaninvestment.Thisalsoallowsadirectcomparisonwithotheralternativeinvestments.

Alternative investments

The difficulty is that, given the number of alternatives, it can be difficult to choosean investmentoption.Each investmenthas itsownspecific levelsof risk,achievableratesofreturnfortheowner,andadvantagesanddisadvantages,andallthesefactorsmustbetakenintoaccount.Riskyinvestmentsarelikelytoofferahigherrateofreturn.Investingcarriesnotonlytheriskthatareturnwillnotbeearned,butalsotheriskthattheinitialinvestmentmaybelost.Someinvestorswouldratherplayitsafeandachieveamoderatereturnontheirfunds,whereasotherswanttoachieveagreaterreturnontheirfundsandarewillingtotaketherisksassociatedtoachievethatreturn.

Another factor that an investor must take into account is the term (length) of the investment.Forinvestmentoptionssubjecttobusinesscyclesandotherfluctuations,along-terminvestmentmayberequiredtogenerateanadequatereturn.

Similarly,theinvestoralsohastoconsidertheliquidityoftheinvestment:howeasilyitcanbeconvertedbackintocashiftheindividualneededtheirfundsurgently.

Therearethreemainassetgroupsthatcanbeusedasinvestmentoptions: • cash • property • shares.

Withineachassetgrouping,therearemanydifferentindividualinvestmentoptions,eachwithitsownadvantagesanddisadvantages.Thislistisbynomeansexhaustiveandonlyhighlightsanumberofinvestmentoptionsavailabletoinvestors.

Investment option 1: Cash

Bank accounts

Themostbasicandcommonformofcashinvestmentistoputmoneyinthebankorasimilarinstitutionsuchasabuildingsocietyorcreditunion.Ithastheadvantagethatthe cash is readily accessible and that there is virtually no risk of the business losing its investment as the government guarantees all bank deposits. However, basic on-callbusinessbankaccountspayaverylowreturn,withinterestondepositsearnedatonlyhalfapercenttoone-and-a-halfpercent.(Itishighlypossiblethatwhenaccount-keepingfeesarefactoredin,thereturnonabankaccountcouldactuallybenegative.)




Term deposits

Term deposits are an investment option available from banks that does provide a higher rateofinterestinreturnforagreeingtoinvestforasetterm.Thetermcanvary,rangingfromthreemonthstofiveyears.Iftheinvestorrequiresthefundsbeforetheendoftheterm,theymaybeavailablebutthiswouldbeatthecostofanyinterestthatwouldhavebeenearned,plusadditionalcostsforearlyterminationoftheinvestment.

Investment option 2: Property

Investing in property essentially means buying real estate of some type, which canprovide both a capital gainandanincomestreamintheformofrent.Someinvestorsactually borrow to invest in property in order to earn a capital gain from the increase initsmarketvalue.Inaddition,aslongastherentalincomeislessthanthecostoftheproperty(includingtheinterestpaymentsontheloan),theinvestorwillmakea‘loss’,thusreducingtheirtaxableincome.Thisisknownasnegative gearing.

Risks

Giventhedualreturnsavailablefromproperty,itcanseemlikeaveryattractiveoption.However,therearesomefactorsthatcanmakepropertyariskyinvestment.

The property market

Thegeneralwisdomhas it thatpropertypricesdoubleeverysevenyears,but this isnotguaranteed.Thepropertymarketissubjecttofluctuations,meaningthattimingiscrucial: purchasing at the height of the market (when prices have peaked) may mean thattheinvestorsuffersashort-termloss,orasmallercapitalgain.Also,growthratescanvarydramaticallyaccordingtothelocationoftheproperty,meaningthatinvestorsmustconductcarefulandthoroughresearchbeforemakingtheirinvestments.

Interest rates

Propertypricesaredependentontheabilityofbuyerstopay,whichisinturndependentonthecostofborrowing.Ifinterestratesrise,buyersarelesswillingtopayhighpricesmeaning themarketvalueof thepropertymay fall.Thiswill reduceanycapitalgainthe investormaymake.Further, thecostsassociatedwithpaying loansmaybecomeunmanageable for the investor who may then be forced to sell in unfavourable circumstancesormarketconditions.

Rent

Unfortunatelyrentalincomeisnotguaranteed.Someinvestorscanfinditdifficulttofindatenantfortheirpropertyortoachievetheirdesiredrentalincome.Badtenantscancreatecostsrangingfromalossofrentalincometothecostoffixingdamageorneglect.

Liquidity

Propertymustbeviewedasamediumtolong-terminvestment,becausedisposalisnotonlycostly,butalsotime-consuming.Onceabuyerisfoundandthepropertyissold(whichcantaketime),itcanthentakeupto120daysforsettlement.

Althoughpropertycanprovidegoodreturnsintheformofcapitalgains,thisgaincanonlyberealisedifthepropertyissold,andanyprofitisthensubjecttocapital gains tax.Onitsown,therentalincomefrompropertyisunlikelytomatchthereturnonotherlessriskyinvestments.However,thecombinationofthetwoformsofreturnmakesitagoodinvestmenttool,especiallyasalong-terminvestment.

Term depositan investment option

that requires the investor to agree to invest for a

specified length of time

Capital gaina return generated from

an investment in the form of an increase in the value of an asset that can

therefore be sold for more than its purchase cost

Capital gains taxa form of taxation charged

when a gain is made on the sale of an asset

Negative gearinga strategy used by

investors to reduce their taxable income

by purchasing property which generates rental

income which is less than the costs it incurs




Investment option 3: Shares

When an investor buys sharestheyarebuyingpart-ownershipofabusiness,givingtheshareholdersomesayintherunningofthecompany.Intermsofareturn,itgivestheshareholder access to an income stream in the form of dividends(ashareofthefirm’sprofit). Inaddition, theability to trade shares through the stockexchangegives theshareholderapotentialforcapitalgainsifthemarketvalueofthesharesincreases.

Owningsharescanbringavarietyofbenefits,including:

Greater returns

Various studies have shown that Australian shares have out-performed other formsofinvestment.Manyinvestmentstakenwithalong-termperspectivetendtoprovidehigherandmoreconsistentreturns,andshareshappentotopthislist.

Tax benefits

Manydividendsarepaidtoinvestorsfromprofitsthathavealreadyhadcompanytaxdeductedfromthem,reducingthetaxthatmustbepaidbytheinvestor.Thisisreferredto as a franking credit.Onlyiftheinvestorisinataxbrackethigherthanthecompanytaxrateof30%,willtheyhavetopayanytaxonthedividendincome.Inaddition,iftheshareshavebeenheldformorethan12months,theycanqualifyfora50%reductionincapitalgainstax.(Anysharessoldatacapitallosscanbeusedtooffsetanyothercapitalgains.)

Diversification

Thereareover2200differentcompanies’shareslistedonthestockexchange,allowinganinvestmentinavarietyofmarketsandindustryareasallattheonetime.Thismeansthat if one segment of the market is under-performing, it may be offset by strongperformanceinanother.Similarly,ariskyinvestmentinonecompanythatpromisesahigh return can be offset by a safer investment in a company offering a less lucrative return.

Flexibility

Shares themselves are quite liquid and can be sold quickly to return cash to the investor ifitisrequired.

Risks

Investinginsharescarriesriskssimilartothoseinvolvedwithproperty,withthedividendreturndependentontheprofitabilityofthecompany,andthecapitalgaindependentonthesharemarket.Aninvestorwhoholdssharesinanunprofitablecompanywillseelittleornoreturnintermsofdividends,andisalsolikelytosufferacapital loss as the marketvalueoftheirsharesfallsbelowtheirpurchaseprice.

Fluctuations in themarketvalueofsharesareadailyoccurrence.Speculativeorshort-terminvestorsattempttopredictthesefluctuationsbypurchasingsharesinnewindustriesandbusinessesandthensellingthemwhenthemarketpriceishigh.Investorswhotakethisapproacharemoreinterestedinacapitalgainthandividends.Long-terminvestors on the other hand are more likely to purchase shares in companies that have ahistoryofearninggoodprofits,anddistributingthemasdividends.

Sharea document that verifies part-ownership in a public company

Dividenda share of the profit earned by a company that is distributed to shareholders

Franking creditDividend income received by the investor on which the company has already paid tax

Capital lossthe loss incurred when an asset is sold at a price less than its initial purchase price




REVIEWQUESTIONS3.3

1 Explainthemaindifferencebetweenabankaccountandatermdeposit.2 Listthemainreturnstobegainedfrominvestinginproperty.3 Explainthemainbenefitofnegativegearing.4 Explainthefactorsthatcanmakepropertyariskyinvestment.5 Listthebenefitsofbecomingashareholder.6 Explain the benefits of investing in shares rather than other investment

options.7 Explaintherisksassociatedwithowningshares.8 Explain why an individual should explore alternative investments when

consideringstartingtheirownsmallbusiness.

3.4 RESOURCES REQUIRED TO ESTABLISH A SMALL BUSINESS

Having explored all alternatives an individual may still come to the decision thatcommencingtheirownsmallbusinessistheirbestoption.Theindividualthenneedsto identify the resources required tocommence theirownsmallbusiness.Thesewillconsist of:• personalresources – the qualities and traits the individual can bring to the business• financialresources–howthebusinessistobefinanced.Thiswillbediscussedin

detailinChapter4:SourcesofFinance.• externalsupportresources–howprofessionalssuchasaccountantsandsolicitors,

the Government, and professional organisations provide advice to assist small businessownerstosucceed.

Personal qualities of successful small business owners

Evenamongstthosewhoarepreparedtoaccepttherisks,notallpeoplearesuitedtobeingsmallbusinessowners.Successfulsmallbusinessownerssharecertainpersonalattributes,including:• expertise– a detailed knowledge of their product or service and the market into

which it isbeingsold,aswell asa rangeofothermanagement issues includingmarketing,management,humanresources,finance,thelawandaccounting

• entrepreneurship – the ability to recognise a business idea, accept the risk andtransform it into an actual functioning and successful business

• determination – a willingness to persevere in the face of hardships and setbacks • confidence–theself-belieftomakedecisionsandthenaccepttheconsequences• cordiality and patience – an ability to develop good relationships with customers

and employees and resolve disputes in a pleasant manner • humility – a willingness to recognisetheirownlimitationsandseekexpertassistance

inareasinwhichtheirknowledgeislacking.Thismayseemlikeadauntinglist,andnotallbusinessownerspossessallthese

qualitieswhentheystart.However,awillingnessanddesiretodevelopthesequalitieswillallowtheowner,andthereforetheirbusiness,thebestchanceofsuccess.




External support resources

Asshownlater,oneofthemainreasonsforsmallbusinessfailureisalackofmanagerialexperienceandanunwillingnesstoseekassistance.Itisthoseownerswhocanidentifytheirshortfallsorlackofexpertiseandseekprofessionalassistancewhowillensuretheirsmallbusinesssurvives.Therearemanyprofessionalswhocanprovideassistance tosmallbusinesses,including:

Accountants

Accountants are no longer simply bookkeepers (recorders of financial information); they areexpertsinprovidingadviceanddirectiononownershipstructures,pricingpolicies,taxminimisation,superannuationobligations,taxobligationsregardingPAYGandGST,andstrategiesforimprovingbusinessperformance.

Lawyers

AsmallbusinessownercancontactasolicitorortheLawInstitutetoassisttheminanyformof legalmatter.This could involve theestablishmentofanownership structuresuchasapartnershiporproprietarycompany,representationincivilcases,orassistancewiththelodgingofaregisteredtrademark.

Bank managers

A bank manager can provide specific advice regarding business finance and suggest alternativesintermsoffinancingoptions.

Sponsored assistance programs

In addition to these traditional sources of assistance, there are many private andgovernment sponsored programs to assist small businesses to survive and thrive,including: • TAFEcourses–courseswhichaddressspecificaspectsofrunningasmallbusiness,

fromfoodhandlingandOccupationalHealthandSafety(OHS),tocashmanagementand budgeting

• Industryassociations–groupswhosemembersoperateinaparticularindustry,andso are well placed to provide advice and assistance specific to that industry; for example,RetailTradersAssociation.

• AusIndustry – an Australian Government agency delivering services and information that supports small business, research and innovation: www.ausindustry.gov.au. ThisagencyprovidesaccesstotheSmallBusinessEntrepreneurshipProgram(SBEP)– a general skills development and mentoring program to help small business owners maximisebusinessperformance.

• Business Victoria – a state government initiative that provides a comprehensive onlineresourcethatisdesignedtohelpprospectiveownerstostart,operateanddevelop their business: www.business.vic.gov.au

• SmallBusinessCounsellingService(SBCS)–anindependent,non-profitorganisation providing experienced volunteer business counsellors, mentors and coaches toVictorianbusinesses:www.sbcs.org.au

• The Australian Business Funding Centre – provides information and support on how to secure grants, loans or financial aid to finance your small business idea: www.australiangovernmentgrants.org

• Greater Victoria Economic Development Commission (GVEDC) also known as Business Victoria – an independent, non-profit organisation that focuses on supportingthesmallbusinesscommunity:www.bizvic.com




REVIEWQUESTIONS3.4

1 Explainthepersonalqualitiessharedbysuccessfulsmallbusinessowners.2 Listfiveareasinwhichasmallbusinessownermusthavedetailedknowledge.3 Explain the importance of seeking additional advice to ensure the successful

runningofasmallbusiness.4 List and describe four sources that small business owners may turn to for

advice.

3.5 PLANNING

One of the most important steps before venturing into a business is to formulate a businessplan.Themoreinformationthatisgatheredbeforethebusinesscommencesoperations,thegreateritschancesofsuccess.(Inparticular,abusinessplanmaymakeiteasiertoconvinceafinancialinstitutiontoprovidefinance.)

A comprehensive business plan should include: • adescriptionofthebusinessandthemostappropriatebusinessstructure (this will

be covered in detail later in this chapter)• adescriptionof theproductor service; that is,exactlywhat thebusinesswillbe

selling or providing as a service to its customers • amarketanalysisthatwouldincludemarketingstrategies.Thiswouldalsoassistin

findingatargetmarketandhelptodeterminethebestbusinesslocation.• ananalysisofthepersonalstrengthsandweaknessesoftheowner that would allow

fortheidentificationofareaswhereassistanceorexperthelpwillberequired• adetailedlistofestablishmentcostsandtheexpectedsourcesoffinance (this will

becoveredinChapter4)• projectedsalesfiguresandestimatedrunningcosts.Thesecostsshouldbefurther

brokendownintofixedandvariablecosts.Thiswouldallowfortheforecastingofthefirm’s cashandprofit/loss todeterminewhen thebusiness can support itselffromitsownoperations.(ThiswillbecoveredinChapter5.)

REVIEWQUESTIONS3.5

Listtheissuesthatmustbeaddressedinacomprehensivebusinessplan.

3.6 NATURE OF BUSINESS OPERATIONS

Themarketandtypeofproductsorservicesofferedbyabusinessdeterminesthenatureofitsoperations.

Retail/trading

Thistypeofbusinesspurchasesfinishedgoodsforthesolepurposeofresale.Stockispurchasedfromwholesalers/manufacturersatacost price,andthensoldtoconsumersthrougharetailoutletatamarked-upsellingprice.Tradingbusinessesselljustabouteverythingincludingclothing,hardware,CDsandhi-fiequipment,groceries,andbooks,andmaybewell-known likecertainsupermarketchainsandclothingstores,or localbusinesses in shopping centres.

Cost pricethe original purchase

price of stock




Service

Thistypeofbusinessperformsaserviceforthecustomersoinfactwhatisbeingsoldisthetime,labourandexpertiseofthebusiness.Thereisnophysicalexchangeofgoods.The service industry is the fastest growing sector and can include services such ascleaning,gardeningandotherhomemaintenance,andservicessuppliedbyplumbers,electricians,carpentersandmechanics.

Manufacturing

Thistypeofbusinessactuallyproducesthegoodsitsells,usingaproductionprocess(whichcouldbeonanassemblyline)totransformrawmaterialsintoafinishedproduct.Thiswouldincludethemakersofgoodssuchascars,biscuits,clothingandtoys.Manyofthesemanufacturerssellpredominantlytotradingbusinesses,butanincreasingnumberoffactoryoutletsselldirecttothepublic.

Mixed businesses

Incertaincases,abusinesswillcombineoneormoretypesofoperation.Forexample,hairdressersnotonlyperformaservice(cuttingyourhair)butalsosellavarietyofhair-careproducts,andcardealershipsnotonlysellcarsbutalsoprovideservicecentres for tune-ups.

Therearealsootherwaysofclassifyingoperations,includingmining,agricultureandhospitality,butforourpurposestheabilitytodistinguishbetweentrading,serviceandmanufacturingfirms,or thosewhichcombinemore thanoneof theseoperations, issufficient.

REVIEWQUESTIONS3.6

1 Explainhowatradingfirmearnsprofit.Statetwoexamplesoftradingfirmsinyourarea.

2 Explainhowaservicefirmearnsprofit.3 Suggest two reasons why manufacturing firms sell predominantly to trading

firmsratherthantothegeneralpublic.4 Suggest one reason why manufacturing firms may open a factory outlet to sell

directtothepublic.

3.7 OWNERSHIP STRUCTURES

Once a potential small business owner has determined the nature of their business venture and is satisfied that they have the personal qualities, there is still more toconsider. One of the most important decisions facing an individual who wishes tocommenceasmallbusinessiswhichownershipstructuretoadopt.Thischoicecanhavean impact on:

• theowner’spersonalaccountabilityforthedebtsofthebusiness• theowner’staxliability• thefirm’sabilitytoraisecapital• the costs of establishing the business and compliance with government

regulations • the ability to shut down the business• controloverdecision-makinginthebusiness.




Sole proprietorship

A sole proprietorshipisownedbyasingleindividual,operatingthebusinessintheirownrightundertheirownname(PeterRomer)oraregisteredbusinessname(Romer’sRoof Repairs). It is the most straightforward and inexpensive way of structuring abusiness.Asoletraderisnotaseparatelegalentity,sotheownerwouldbetaxedasan individual and would have to declare all income earned from the business in his or herpersonaltaxreturnandfacepersonalincometaxrates.Examplesofasoletraderbusinesscouldbeamilkbar,fishandchipshoporaplumber.

Advantages

• Itiseasyandcheaptosetup.Atthetimeofwriting,toregisterabusinessnameinVictoriaforthreeyearscostsonly$83.70.

• Theownerhasfullcontroloverdecision-makingwithinthebusiness.• Theownerreceivesallprofitsandhasfullaccesstothecapitalofthebusiness.• Itissimpletosellorwindup.Thereisnochargetoderegisterabusinessname.

Disadvantages

• Theownerhasunlimited liability and is thus personally responsible for all debts and liabilities incurred by the business. This can also extend to personal assetsjointlyownedwithanotherperson:forexample,thefamilyhome.

• Thebusinesshasa limited life; thecontinuityof thebusiness is indanger if theownershoulddie.

• Thereislimitedaccesstocapital,asallstart-upcapitalmustcomefromoneperson. Thismaylimitthefinanceavailabletothebusinessasithastorelyontheowner’s

financialresourcesandtheircreditratingiftheywishtoborrowfunds.• Sincethereisessentiallyonlyonepersonrunningthebusiness,theseskillsmaybe

limitedandmaynotcovereveryareathatisrequiredtorunasuccessfulbusiness.• Theownermayhavetoendurepersonalhardshipastheyhavetoworkexcessively

longhourstoensurethecontinuedoperationandsuccessofthebusiness.Sincetheyareoperatingonanindividualbasis,findingtimeforaholidayortakingtimeoffmaybedifficultanddetrimentaltothebusiness.

Partnership

Sole proprietorshipa business owned by

a single individual, operating their business in their own right under

their own name or a registered business

name

Unlimited liabilitythe legal status of sole

proprietorships and partnerships is that they

are not recognised as separate legal entities,

so the owner(s) is personally liable for the

debts of the business




A partnership is two or more persons in business together operating under their own names (Sue Dorman and Barry Pratt) or a registered business name (Dorman and PrattConsultancyServices)withaviewtomakingaprofit.Partnershipsaregenerallymadeupof2to20legalpersonsbutcanextendbeyondthisnumberunderspecialcircumstances. (For example, accountancy firms have many partners, at least partlyto spread the liability.) Apartnership is not a separate legal entity and thepartnerswouldbetaxedasindividualsontheprofitfromthebusinessthattheyreceivedintheirpersonaltaxreturnandfacepersonalincometaxrates.Examplesofpartnershipscouldincludedoctors,lawyersandaccountants.Althoughnotlegallynecessary,itisstronglyrecommended that a partnership be set out in writing as a legal document by a solicitor intheformofapartnershipagreement.Theagreementshouldcoverallaspectsoftheoperationofthepartnershipandincludethingssuchastheroleofeachpartner,theproportionofownershipandtheresolutionofdisputes.

Advantages

• Itisrelativelycheaptosetup.ToregisterabusinessnameinVictoriaforthreeyearscostsonly$83.70(atthetimeofwriting)andapartnershipagreementwouldattachasolicitor’sfee.

• Itisrelativelysimpletowindupandreclaimanindividual’sinvestmentinthebusiness.• Thereisgreateraccesstocapitalandskills.Withmorepartnersthereisagreater

source of financial resources to fund the business’s start up costs and futureexpansion.Alsothereisgreateraccesstoexpertiseandknowledgetoensurethesmoothrunningofthebusiness.

• Taxadvantagescanexistwherethepartnersaremarried,astheprofitscanbesplitbetweenthem,effectivelygivingthemtwotax-freethresholds.This reducestheirtaxdebt,butnottheirhouseholdincome.

Disadvantages

• Control over decision-making is shared among the partners. This may lead todisagreementsandpersonalityclashes.

• Theownershaveunlimitedliabilityandarethuspersonallyresponsibleforalldebtsand liabilities incurred by the business. This liability extends to debts incurredbytheotherpartners inthebusiness’sname,meaningeachpartner ispersonallyresponsibleforalldebtsandliabilitiesincurredbytheotherpartners.

• Thepartnershiphasalimitedlife–ifoneofthepartnersshoulddie,bedeclaredinsaneordecidetoleavethebusiness,thepartnershipisdissolved.

• Profitsaresharedamongthepartners.This isnormallysetout inthepartnershipagreementbutifnotcouldbeanotherreasonforadisputebetweenthepartners.

Proprietary company (Pty Ltd)

A proprietary company is a registered legal entity with the right to do business in its ownright.ItcomesintoexistencebyincorporationundertheCorporationsAct2001.Asolicitornormallypreparesthenecessarydocumentsrequiredforincorporation.Itcanbeownedandoperatedbyonepersonbeingbothshareholderanddirector;however,itcanhavenomorethan50non-employeeshareholders.Ithasitsownseparatelegalentityandsocansueandbesued,andissubjecttotaxationinitsownright.ExamplesofproprietarycompaniesareMusicalInspirationPtyLtdandDonSmallgoodsCo.PtyLtd.

Partnershipa business owned by two or more persons in business together with a view to making a profit

Proprietary companyabusinessthatexistsasaseparate legal entity that is entitled to do business in its own right




Advantages

• Limited liability means the owners (shareholders) have no further responsibility for anyliabilitiesincurredbythebusinessunlesstheysignedpersonalguarantees.Alsodirectors have no personal responsibility for any debts unless they caused the debts recklessly,negligentlyorfraudulently.

• Thereisagreaterabilitytoattractcapitaltothebusinessasthereislimitedliability.• Thelifeofthebusinessisongoingduetoitsbeingaseparatelegalentity.Itdoes

notceasetoexistevenifadirector/shareholderdecidestoleaveordies.Itexistsuntilitiswoundup.

• ThefirmcanconductbusinessAustralia-wideusingthecompanynameasthenameisregisteredonanationalbasis.

Disadvantages

• Establishmentcostsarehigh.Toregisteraproprietarycompanycancostanywherefrom$462toabout$1000.

• Theremaybedifficultyattractingadditionalcapitalbecauseaproprietarycompanycannotpubliclyadvertiseforfunds.Thisalsocanmakeitdifficultforshareholderstoselltheirsharesandrecovertheirinvestmentinthecompany,astheremaybelimitationsonwhocanpurchasetheshares.

• Therearehighercompliancecostsasaresultoftheneedtocomplywithtaxlaws.Thiscanincludefeespaidtoexternaltaxadvisers,timespentbypersonnelwithinthebusinessdealingwithtaxmattersandotherrelatedcosts.

• Because it is regulatedby theAustralianSecuritiesand InvestmentsCommission(ASIC)aswellastheAustralianTaxationOffice(ATO)andaseparatetaxreturnisrequiredbyboththesebodieseachyear,thedegreeofregulationismuchhigherthanthatimposedonsoleproprietorshipsorpartnerships.

Proprietarycompanies(PtyLtd)arealsoreferredtoas‘privatecompanies’ (familycompanies).Becausetheirownershiptendstobeofasmallernature,theirownershipismore difficult to transfer and they do not have to make their financial reports available to thepublic.APublicCompany(Ltd)isalargebusinessstructurethatisalsoincorporatedso it also has its own legal existence, but derives the ‘Public’ name because it canpublicly raise funds by advertising and selling shares through the Australian Securities Exchange(ASX).Itisalsoopentothescrutinyofthepublicbybeinglistedonthestockexchangeandhastomakeitsfinancialreportspublic.Itisforthisreasontheregulationsand compliance surrounding a public company are more stringent than those under whichaproprietarycompanyoperates.

REVIEWQUESTIONS3.7

1 Define the following types of ownership structure: • soleproprietorship • partnership • proprietarycompany.2 Listtheadvantagesanddisadvantagesofeachtypeofownershipstructure.3 Distinguishbetweenaprivatecompanyandapubliccompany.4 Distinguishbetweenlimitedandunlimitedliability.5 ReferringtooneAccountingPrinciple,explain the effect of unlimited liability

ontherecordingoftransactionsforasoleproprietorshiporpartnership.

Limited liabilitythe legal status of a

company, which exists as a separate legal entity, so the owners have no

further responsibility for liabilities incurred by the

business




3.8 STARTING VERSUS BUYING

Onceaprospectiveownerdecidestogointobusinessforthemselves,threeoptionsexist:• starting a new business • buyinganexistingbusiness• buyingafranchise.

Starting a new business

Asthetitlesuggests,this involvesstartingabrandnewbusinessfromscratch,andifthereisnobusinessforsale,mayverywellbetheonlyoptionforaprospectivebusinessowner.Itsgreatadvantageisalsoitsmaindisadvantage–therewillbenothinginplace,meaning the owner has to decide on a location and ownership structure, purchaseassets,hirestaffanddevelopbusinesspracticesbeforetradingcanbegin.

Advantages

• Almosttotalfreedomindetermininghowthebusinessoperates.• Freedomtosetcustomerexpectations.• No need to pay for goodwill.• Rewardingfortheownerknowingtheyhavecreatedtheentirebusiness.

Disadvantages

• Notrackrecord,sogreaterriskoffailure.• Nocustomerbase–couldmeanlowcashinflowsinfirstmonthsofoperation.• Largestartupcapitalrequiredthatwillessentiallyhavetobeprovidedbytheowner.• Moredifficulttoobtainfinance.

Buying an existing business

Inorder toovercome theuncertaintiesof startinganewbusiness,anotheroption istobuyabusinessthatalreadyexists.Apotentialbuyerwouldneedtoconductcarefulresearchintothehistoryofthebusiness,itsfuturepotentialandthereasonstheownersareselling.

Advantages

• Aproventrackrecordcanincreasethechancesofsuccess.• Allassets,practices,suppliersandcustomersarealreadyestablished.• Animmediateincomestreamisavailable.• Previous owner(s) and current employees can assist in the change of ownership as

theycanprovidehelpfuladvice.

Disadvantages

• Previous success may have been dependent on the skills of the previous owner(s) andtheirrelationshipwithcustomers.

• Difficulttochangeexistingprocedures,staffandcustomerexpectations.• Mustpayforgoodwill(whichisdifficulttovalueaccurately).• Existingassetsmayrequiremajorrenovation,repairorevenreplacement.

Buying a franchise

Buying a franchiseisanincreasinglypopularwayofenteringtheworldofsmallbusiness,as it offers the support and advice of a large financial corporation that has a vested interestinensuringthesuccessofthefranchisee.Underafranchisearrangement,thesmall business owner (the franchisee) purchases the right to use the name and business systems of a larger business (the franchisor)inreturnforacertainfee.Somepopularandsuccessfulfranchisesoperateinthefastfoodandhomegardeningindustries.

Some of these factors could be an advantage ordisadvantage,depending on your pointofview.

STUDY TIP

Goodwillan intangible asset representing the value of the firm’s reputation, clientele, viability and future growth prospects

Franchisean arrangement under which one party (the franchisor) grants to another party (the franchisee)certainrights,including the use of the franchise name and business practices

Franchiseethe entity that purchases the right to operate under the franchise agreement

Franchisorthe entity that holds (and sells to the franchisee) the rights to operate under the franchise agreement




Likeany smallbusiness venture thepotentialbuyermustdo theirhomework toensurethatthefranchiseoperationissoundandthatthecompanyisreputable.Thefranchise agreement will set out the terms and conditions relating to franchise fees,operatingarrangements,territoryinwhichthefranchiseecanoperate,andthelifeoftheagreement.

Advantages

• Recognisedbrandname/nationaladvertising.• Established(andproven)reputationandbusinesspractices.• Allequipmentnecessarytocommenceoperations.• Bulkbuyingpowerthroughthefranchisegroup.

Disadvantages

• Highpurchaseprice,rangingfrom$15000foralawn-mowingbusinesstoupwardsofamilliondollarsforafast-foodrestaurant.

• Ongoing franchise fees (frequently based on sales) to cover expenses such asadvertisingandadministration.

• Rigidguidelinesforoperations.• Competitionfromfellowfranchisees.• Dependenceontheoperationsofthefranchisor.

REVIEWQUESTIONS3.8

1 Listtheadvantagesanddisadvantagesofstartingabusinessfromscratch.2 Definetheterm‘goodwill’.3 Explain how goodwill can bring both benefits and costs for the purchaser of

anexistingsmallbusiness.4 Listtheadvantagesanddisadvantagesofbuyinganestablishedbusiness.5 Definetheterm‘franchise’.6 Suggesttworeasonsforthegrowthinthepopularityoffranchising.7 Listtheadvantagesanddisadvantagesofbuyingafranchise.

3.9 REASONS FOR SUCCESS AND FAILURE

Giventhatsomanysmallbusinessesfail,aprospectivesmallbusinessownermustbeawareofthefactorsonwhichsmallbusinesssuccessarelikelytodepend.Successfulsmall businesses have:• high demand for their product or service • a location that is visible and easily accessible for customers • athoroughbusinessplanthatdetailsallaspectsofthefirm’soperations• sufficient starting capital that can support the business and the owner until it is

functioning in a profitable manner• anownerthatexhibitsthefollowingqualities:

– a strong knowledge of the good or service that they are selling – business acumen – insight or good judgement when it comes to business

dealings and decisions– humility – not being afraid to seek assistance for any areas that they feel they

don’thavetherequiredlevelofexpertise;forexample,legalorfinancialmatters– friendly and fair – when dealing with the public whether employees or customers– resilience – the ability to withstand failures, learn from mistakes and resolve

issuesandmoveon.




Use opposites here – the reasons for success are the opposite of the reasons for failure and viceversa.

STUDY TIP

Unfortunately,approximately80%ofallsmallbusinessesfailwithintheirfirstfiveyearsofoperation,duetofactorssuchas:• competitionfromothersmallandlargebusinesses – some businesses will purposely

cut prices to drive out new competitors because they can afford to endure small marginsorlossesforaperiodoftimewhereasnewbusinessescannot.Itcanalsobedifficult for new businesses to attract customers away from established businesses especiallylargeronesthatcouldofferawiderrangeofgoodsorservices.

• apoorlocation – could be represented by poor visibility or poor access in terms of parking.Itcouldalsobeinthewrongdemographicareaforthecustomersyouaretryingtoreach.Forexample,youwouldnotestablishashopsellingchildren’splayequipmentinademographicareawheretheaverageageofthepopulationis60!

• insufficientstartupcapital tosupportthebusinessortheowner(s)untilsalesareestablished – initial capital not only needs to cover setting up the business in terms of itspremises,fixturesandfittings,signageandstockbut italsoneedstocoverthe operating and ongoing expenses such as electricity, telephone, wages andadvertising.Startingsmallbusinessownersmayalsohaveunrealisticexpectationsoftheirinitialsalesfigures.

• poormarketing, targetingeither thewrongpeople,ornooneatall– in an ever competitivemarket,gettingyourbusinesstobeknownbytherightpeople isallimportant.Thesignificanceofmoderntechnologyhighlightstheneedofawebsiteand being linked to a good search engine, otherwise no one will know of yourbusiness’sexistence.

• poormanagementskillsandalackofwillingnesstoseekprofessionaladvice – there areveryfew,ifany,thatareexpertsinallfieldscoveredbybusiness.However,therearethosethatthinktheycandoitallthemselvesthatsoondiscover,totheirowndetriment,thattheycannot.

• poorcustomerrelations–there isanoldsayinginbusinessthatthe‘customer isalways right’; however, there are small business owners who obviously disagreeandcantreatcustomersinwaysthatcanbeseenasaggressive,unhelpfulorrude.Customerswillnotreturntoabusinessforpoortreatment.

REVIEWQUESTIONS3.9

1 Listthecommoncharacteristicsofsuccessfulsmallbusinesses.2 List the reasons why 80% of small businesses fail in the first five years of

operation.




EXERCISE 3.1 SMALL BUSINESSIn 2012, Travis Sands left his job at a call centre to start his own landscape designbusiness calledEnvironLandscape.Before commencingoperations,Travisdraftedadetailedbusinessplan,andasasoleproprietor,Travishasbeenhandlingthebusinessrecordsandreportssincethebusinessstartedin2012.

Required

a StatetwofeaturesthatwoulddistinguishEnvironLandscapesfromalargebusiness.b Suggest two reasons whyTravis mayhavedecided tobecomea small business

owner.c StatetwopersonalqualitiesTraviswouldneedtobeasuccessfulsmall

businessowner.d ListfourissuesTraviswouldhaveaddressedinhisbusinessplan.

WHERE HAVE WE BEEN?• Smallbusinessesareownedandmanagedbythesameperson,andemployfewer

than15people.• Small businesses represent roughly 96% of all private sector businesses, employ

almost 5 million people and contribute strongly to Australia’s level of economicactivityandproduction,exportsandtaxrevenue.

• Reasons for owning a business include the profit motive, a desire for greaterindependence,theidentificationofamarketopportunityandemployment.

• Investorsmusttakeintoaccountthecorrelationbetweenthelevelofriskandtherateofreturn,theterm,andtheliquidityofanyalternativeinvestment.

• Therearethreemainassetgroupsthatcanbeusedasalternativeinvestmentoptionstostartingasmallbusiness:cash,propertyandshares.

• Most successful business owners are experts in their field, entrepreneurial,determined,confident,cordial,patientandwillingtorecognisetheirownlimitationsandseekassistance.

• Adetailedbusinessplanisessentialbeforeoperationscommence.• Businesscanbeclassifiedbythenatureof theiroperationsas trading,serviceor

manufacturingbusinesses.• Thechoiceofownershipstructurewillhaveconsequencesforawholehostofissues,

includingtheowner’spersonalaccountabilityforthedebtsofthebusiness.• Sole proprietorships and partnerships have unlimited liability; companies have

limitedliability.• Aprospectivebusinessownercanstartanewbusiness,buyanexistingbusinessor

buyafranchise.• Successfulsmallbusinesseshaveahighdemandfortheirproductorservice,agood

location,athoroughbusinessplan,sufficientstartingcapitalandaknowledgeableandresilientowner.

• Smallbusinessescangainassistancefromavarietyofsources.

EXERCISESW B page36




EXERCISE 3.2 NATURE OF OPERATIONSForeachof the followingbusinesses, identify the nature of its operations as one of trading,serviceormanufacturing.a Q-MartClothingEmporiumb KenFarthington,accountantc MacWalterTextilesFactoryd FirstRatePlumbinge TheBookStoref DigbyRecordingStudios.

EXERCISE 3.3 PARTNERSHIPSMaxineSmartistheownerandoperatorofNinetyNights,asmallbusinessthatmakesand sells designer pyjamas.MaxinestartedthebusinessinMarch2015afterleavingherpositionasafashiondesignerwithamajorinternationalclothingretailer.Maxineandherhusband,Nigel,eachcontributed$20000oftheirownfundstostartthebusiness.However,Nigelwasconcernedthatifthefirmwasestablishedasapartnership,itwouldmean thatall theirpersonal assets, including theirhouseandbelongings,wouldbelistedinthefirm’sBalanceSheet.Asaresult,theydecidedthatasoleproprietorship,inMaxine’sname,wasthemostappropriatebusinessstructure.

Required

a StateonereasonwhyMaxinemaybewillingtoacceptlessinprofitthansheearnedasasalaryinherpreviousjob.

b IdentifythenatureofoperationsofNinetyNights.c Referring tooneaccountingprinciple,explain howMaxine andNigel’spersonal

assetswillbetreatedinthefirm’sBalanceSheet.d ExplainonebenefitMaxineandNigelwouldderivebyregisteringtheirbusinessas

apartnershipratherthanasoleproprietorship.e ExplainhowMaxineandNigelcouldensurethatintheeventofbankruptcy,their

personalassetswillnotbeseizedtopaybusinessdebts.

EXERCISE 3.4 PARTNERSHIPSMarco Costa and Vince Carello are cousins who own and operate Ponte VecchioJewellers.Vinceisajewellerbytrade,soMarcolooksaftermostofthemanagementissues.BecauseMarcoandVincearecousins,theyhaveestablishedtheirbusinessasapartnership.Vincesaid,‘Wedon’tneedaformalpartnershipagreement–wearefamily.’Marcoadded,‘Andwhenwedie,ourkidswilltakeover.’

Required

a State two benefits that Marco and Vince derive from operating their business togetherasapartnership.

b State one benefit that Marco and Vince would derive from having a formal partnershipagreement.

c StateonereasonwhyMarco’sstatementisincorrect.d On1May2016,Marcoleftthepartnershiptotakeupanewjob.Vincedecidedto

continuetradingasasoleproprietor.StateonereasonwhyVince’ssmallbusinessmaystillfail.

W B page37

W B page38

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EXERCISE 3.5 COMPANIESLucasGeorgehasdecidedtogointobusinesscreatingandsellinghisownspace-basedcomputergames.HisgirlfriendSkyisverykeentoenterintothebusinesswithhim,andLucasisunsureaboutwhattypeofownershipstructuretoadopt.

Required

a Identifythenatureofoperationsforthisnewbusiness.b StatethreepersonalqualitiesLucaswillrequiretorunhisbusinesssuccessfully.c State one advantage and one disadvantage of establishing the business as a private

companyratherthanapartnership.d Assumingthatthebusinessisstructuredasacompany,explain the effect on the

businessshouldtherelationshipbetweenLucasandSkyend.e State twoarguments tosupportLucas’sdecision tostarthisownbusiness rather

thanbuyanexistingbusiness.

EXERCISE 3.6 SMALL BUSINESS ISSUESPieceofCakesellscakesfromashopinHawthorn.ForthepastthreeyearsithasbeenownedandoperatedasasoleproprietorshipbyElenaStClair,wholeftherjobasananalyst fora largecomputercompany insearchofgreater independence.Elenahasfrequently called on her sister (who is an accountant) for assistance and recently her sisterexpressedadesiretojoinElenaasajointownerofthebusiness.

Required

a State two reasons (other than a desire for independence) why people leave paid employmenttoownasmallbusiness.

b StatetwocoststoElenaofleavingpaidemploymenttostartherownbusiness.c Explain the difference between a sole proprietorship and a proprietary company in

termsoftheirlegalstatus.d Stateonedisadvantageofestablishingthebusinessasaproprietarycompany.e StateonebenefitElenawouldderivefromenteringintoapartnershipwithhersister.f StatetwobenefitsElenaderivedbybuyinganexistingbusinessratherthanstarting

herown.g Explain one reason (other than insufficient professional advice) why this business

maystillfail.h StatetwosourcesfromwhichElenacanseekalternativeprofessionaladvice.

EXERCISE 3.7 SMALL BUSINESS ISSUESUntil2012,JaneBrontewasemployedasajournalistwithalocalbroadsheetnewspaper.Althoughshewasquitehappywithherjob,on1December2012sheleftthispositiontostartherownbookshopcalledBronte’sBooks.Atthetime,afriendhadsuggestedthatitwouldbewisetojoinafranchisegroup.

Required

a ExplainoneriskJanewastakingbybecomingasmallbusinessowner.b Explain why the establishment costs for a new business would be less than the

purchasepriceofanexistingbusiness.c Explainonebenefitofbeingamemberofafranchisegroup.

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d Stateonefinancialandonenon-financialcostofjoiningafranchisegroup.

During December 2015, Jane decided that in addition to selling a range of classicbooks,theshopwouldalsoprovideasmalllibraryservicethatwouldallowcustomersto borrow rare and antique books. The library was due to commence operations inJanuary2016.On1January2016,thebusinesspurchased$500worthofbooksforthelibraryservice.

Required

e ExplainthenatureoftheoperationsofBronte’sBooksinJanuary2016.f Explainwhythebookspurchasedon1January2016shouldbereportedasan

assetofBronte’sBooks.g Explain one circumstance in which the books should be reported as a current

assetasat31January2016.h Explain one circumstance in which the books should be reported as a non-

currentassetasat31January2016.



Documents

SMALL BUSINESS - Wellington Secondary Collegemoodle2.wellingtonsc.vic.edu.au/pluginfile.php/14981/mod... · 2014-11-18 · manager is the same person (or people), and which employs