Chapter 1
Outcome
By the end of this session you should be able to:
Define ‘business organisations’, explain why they are formed, their common
features and how they differ
Identify the different types of business organisation: commercial, not-for-profit,
public sector, non-governmental organisations, co-operatives
Explain the concept of separation between ownership and control
Identify and describe the main types of funding used by businesses: equity,
debt, or working capital
Identify and describe the difference between manufacturing and service
businesses
and answer questions relating to these areas.
Chapter 1
Knowledge, Skills and Behaviours:
K10 The role of accountancy or finance within the organisational business
strategy
87 Develop and maintain effective working relationships with stakeholders
The business organisation
Overview
Reasons for Different types of business
formation organisations
BUSINESS ORGANISATIONS
Separation
Types of funding ownership and
control
Chapter 1
Organisations and reasons for formation
1.1 What is a business organisation?
‘Organisations are social arrangements for the controlled performance
of collective goals.’
Buchanan and Huczynski
) Three key Controlled
Collective goals aspects of this performance
definition
Social
arrangements
Core TYU 1
Notes 2
The business organisation
1.2 Why do we need organisations?
Organisations
enable people
to:
Share skills and - Pool
Specialise
knowledge resources
This results in synergy where organisations can achieve more than the individuals
could on their own.
Notes 2
Chapter 1
Different types of organisations
2.1 Commercial ‘for profit’ organisations (‘profit seeking’)
Different organisations have different goals. We can therefore classify them into
several different categories.
Sole traders
Limited liability
companies
Partnershi Commercial
artnerships S
P organisations Private Public
limited limited
companies companies
‘For-profit’ organisations are businesses whose primary goal is making money
(a profit). Their main objective is often seen as maximising the wealth of their owners.
Core TYU 3
Notes P
10
The business organisation
» Sole traders — owned and run by one person. The owner is not legally separate
from the business itself and is responsible for any business debts.
L\‘IVA
v
(Rule of Law)
» Partnerships — owned and run by two or more individuals. Traditionally,
partnerships do not have a separate legal identity from their owners. However
in recent years many countries have created alternative partnership structures
(LLPs in the UK). Limited liability partnerships (LLPs) are partnerships where
some or all of the partners have limited liabilities similar to shareholders in a
company.
;\‘IVA
AR
(Rule of Law)
> Limited liability companies — a company has a separate legal identity to its
owners (who are known as shareholders). The owner’s liability is limited to the
amount they have invested into the company. This remains the case even if it's
run by just one person, acting as shareholder and director.
L\‘IVA
AR
(Rule of Law)
In the UK, there are two types of limited company:
» Private limited companies — with ‘Iltd’ after their name. Shares cannot be offered
to the general public. They can be owned by individual people, trusts,
associations and/or other companies.
» Public limited companies — with ‘plc’ after their name. Shares can be offered to
the general public.
Notes 2
1
Chapter 1
r ~
Example 1 [E1, E13] —
Rohinder is thinking about setting up her own business, making and selling
her own brand of chocolates (‘the purple truffles’). She is unsure whether to
operate her business as a sole trader or a limited company.
Identify whether each of the following statements about key differences
between operating as a sole trader and operating as a limited company
are TRUE or FALSE.
Statement True v
The owners of a limited company are the shareholders. v
If she were to set up as a limited company, Rohinder would have
limited liability for debts incurred by the business, which means v
Rohinder’s liability for company debts is limited to that money
invested.
If she were to set up as a sole trader, Rohinder would have
unlimited liability which means that she would be personally liable v
for the business’ debts.
Sole traders both own and manage their business, so Rohinder v
would have full control over business decisions.
Limited companies would be managed by the director (Rohinder) v
on behalf of the shareholder (herself).
.
Notes P
12
The business organisation
2.2 Not for profit organisations
Government
departments
not for profit
organisations
Clubs Charities
The objectives of different NFPs vary significantly.
Hospitals to treat patients
v
Councils —may see their mission as caring for their communities
v
Government organisations —
v
A chariti—
v
Notes 2
13
Chapter 1
2.3 Public versus private sector organisations
Controlled by
government
organisations
Provides
basic Public sector
government
services
Public versus private
sector organisations
Run by
private
individuals
Private sector
and groups
Within these will
be both profit-
seeking and not-
for-profit
organisations
Notes 2
14
The business organisation
Ve
Example 2 [E1, E13]
Which of the following organisations is most likely to be classified as
part of the public sector?
A Acharity
B A social club
C Aschool
D A public limited company
The correct answer is C
Public sector organisations will be controlled by the central
government. This is unlikely to be a charity, a company or a social club
— which are typical examples of the private sector.
Note that a privately owned and operated school could be part of the
private sector, but schools are still the most likely from the list to be
public.
\\ J/
2.4 Non-governmental organisations (NGOs)
An NGO is one which does not have profit as its primary goal and is not directly
linked to the national government. NGOs often promote political, social or
environmental change within the countries they operate.
NGOs include: the Red Cross, Greenpeace, Amnesty International
Notes /
15
Chapter 1
2.5 Co-operatives
Organisations that are owned and democratically controlled by their members — the
people who buy their goods and services.
Each member usually gets a single vote on key decisions — unlike companies where
shareholders get one vote for each share that they own.
They are organised solely to meet the needs of the member-owners, who usually
share any profits.
2.6 Service vs. manufacturing organisations
» The intangibility of what is provided means that it is difficult to define the
‘service and attribute costs; in the NHS, it is challenging to define what a
‘procedure’ is. Clinical specialties cover a wide range of disparate treatments,
and services include high levels of indirect cost. Consistent methods of cost
attribution are needed, and this is not always straightforward. Direct charging is
not always possible and there are different configurations of cost centres across
providers. This may limit the consistency which can be achieved.
» Inseparability/simultaneity of production and consumption: although the
manufacturer of a tangible good may never see the actual customer, the
customer often must be present during the production of a service, and cannot
take the service home. No service exists until it is actually being
experienced/consumed by the person who has brought it.
» Heterogeneity — The quality and consistency varies, because of an absence of
standards or benchmarks to assess services against.
» Perishability — the unused service capacity from one time period cannot be
stored for future use. Service providers and marketers cannot handle supply-
demand problems through production scheduling and inventory techniques.
» No transfer of ownership — Services do not result in the transfer of property.
The purchase of a service only confers on the customer access to or a right to
use a facility.
Notes 2
16
The business organisation
Separation of ownership and control
3.1 The principal agent problem
> In some, usually small, companies the owners also manage the business.
» However, in larger companies shareholders usually delegate control to
professional managers — the board of directors — to run the company on their
behalf.
» This separation of ownership and control leads to a potential conflict of
interests between directors and shareholders.
» This conflict is an example of the ‘agency problem’. The principals (the
shareholders) have to find ways of ensuring that their agents (the managers)
act in their interests.
3.2 Possible areas of conflict
» ‘Fat cat’ salaries and benefits
» Mergers and acquisitions
» Short-termism
» Attempts to resolve this conflict can take a number of forms:
— Corporate governance (see later)
— Areview of the remuneration and bonus schemes given to directors.
Extension TYU 5
Notes P
17
Example 3 [E1, E13]
Identify whether each of the following statements is TRUE or FALSE.
Statement True v
Private limited companies are owned by individual people, trusts, v
associations and/or other companies
A sole trader business operates as a separate legal entity from its
owners
&
Notes »°
18
The business organisation
Types of funding used by businesses
41 Sources of funding
Public sector organisations will tend to raise money from the central
government.
Private sector organisations, such as companies and co-operatives, will most
likely have to raise funds from their owners.
> Charities are usually funded by donations.
The organisation may need additional funding to allow it to grow and invest in new
projects. It therefore may need to raise finance from external sources. The treasury
and finance function will weigh up which source of finance best suits the
circumstances of the business.
4.2 Short- and long-term finance
The classic rule for financing is that short-term needs should be
financed by short-term funds.
‘Short-term funds’ means working capital (the balance of inventories, payables,
receivables and cash) and overdrafts. Here, better management of working
capital (squeezing trade credit, for example, by shortening credit periods given
and using the full credit periods received) releases the necessary short-term
funding.
Long-term assets should be financed by long-term funds, essentially debt and
equity.
Notes 2
19
Chapter 1
4.3 Equity and debt
There are two main types of external finance.
Equity
4
This involves borrowing cash from
) 4 N
This involves selling a stake in
a third party and promising to the business in order to raise
repay them at a later date. cash.
Normally the company will also
have to pay interest on the Advantages:
amount borrowed.
e
Advantages:
——
\. J
Notes »°
The business organisation
4.4 Working capital
> The money available to organisations to pay for all their day-to-day activities is
known as their working capital.
Current assets are the short-term assets that the firm can use to generate cash,
and they are the main source of working capital. However, the organisation also
has current liabilities and so these have to be taken account of when working
out how much working capital the organisation has at its disposal. The total
value of working capital is the total of current assets less the total of current
liabilities.
Working capital measures how much in liquid assets a company has available
to build its business.
Businesses with a lot of cash sales and few credit sales (e.g. supermarkets)
have minimal trade receivables.
Businesses that exist to trade in completed products will only have finished
goods held in inventory. Compare this with manufacturers who will also have to
maintain stocks of raw materials and work in progress.
Larger companies may be able to use their bargaining strength as customers to
obtain more favourable, extended credit terms from suppliers. By contrast,
smaller companies, particularly those that have recently started trading (and do
not have a track record of creditworthiness) may be required to pay their
suppliers immediately.
Some businesses will receive their monies at certain times of the year, although
they may incur expenses throughout the year at a fairly consistent level. This is
often known as ‘seasonality’ of cash flow.
Notes P
21
Chapter 1
( )
Example 4 [E1, E13] v
Using working capital to finance a project means that the financing will
come from:
A the excess of current assets over current liabilities
B the excess of bank borrowings over current assets
C the excess of long-term liabilities over short-term liabilities
D the excess of fixed assets over current assets
The correct answer is A
Working capital is the capital available for conducting the day-to-day
operations of an organisation. It is the total value of working capital is
the total of current assets less the total of current liabilities.
- J
Notes 2
22
The business organisation
O|
Service vs.
manufacturing
Commercial Partnerships Sole traders
vs. non-profit
Definit
ea|2|di lon Public; vs. Limited liability companies (Public/
purpose private sector private)
BUSINESS ORGANISATIONS
Debt/ Equity/new Working
borrowing capital capital
Chapter 1
Additional tutor resources
<O
We recommend the following additional questions for the topics covered in this
chapter:
Study Text (for teaching throughout the chapter and additional learning)
» Chapter1: TYU7,9,12,13
Practice Questions (for teaching throughout the chapter and additional learning)
» Chapter1: Q1 -4
Exam kit (for revision and additional learning)
» Questions Q1-12, 18-29
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