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Lecture 1: Overview
In this first lecture we are going to cover the following topics:
Forms of business organisation
Including:

• The “sole trader” (the single person business)

• The partnership (multi person business)
• The corporation (a business that has a separate legal
existence from its owners)
− The private corporation (a business where the stock is
traded privately)
− The public corporation (a business that is easily able to
raise additional finance and which is publicly tradeable
on an exchange)

Each of these forms of business organisation has its own blend

of advantages and disadvantages in terms of the risks and
rewards for the owners, and in terms of its ability to raise
finance to expand the business.
The Financial Manager and the company
We will look at

• The objective of managers

• Agency conflicts: Separation of ownership and control

Taxation
Next we shall look at the important issue of taxation.

• Flat tax vs progressive tax

• Taxation of individuals (personal tax)
• Taxation of corporations (company tax)
• Taxation of dividend income
• Taxation of capital gains
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We shall also look at the important tax deductible expense

known as depreciation in particular the straight line and
reducing balance methods for calculating depreciation
Then we shall go on to discuss
Measurement of financial condition and profit
via Financial Statements and their analysis.

Most businesses produce annual financial statements which

are used to measure their financial condition (net wealth) and
profitability. We shall look at two of these in detail, the balance
sheet and the income statement, and how these are used to
measure net wealth and profit

We cover using spreadsheets for financial calculations

This is a very important topic in this unit and excel spreadsheet

skills are very useful in both the educational and business
contexts. In finance, there are many calculations required.
Excel is a very useful software package for this purpose.
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Forms of Business Organisation

(Parino Section 1.2)

The owners of the business usually choose the organisation

form that will help management to maximise the value of the
company.
When deciding on the appropriate form of business
organisation consideration is given to:

• the size of the business

• the way that income from the business is taxed
• the legal liability of the owners
• the ability to raise cash to finance the business

Sole Trader (http://www.smallbusiness.wa.gov.au/sole-trader/)

A sole trader is a business owned by one person, typically
consisting of the trader and some employees. It is the simplest
form of business structure and the least regulated. It is also
relatively easy and inexpensive to start and maintain.

Many sole traders choose to trade under their own name - for
example, Karen Smith - while others opt to register a business
name which must be done with Australian Securities and
Investments Commission (ASIC).

As a sole trader you retain complete control of your business.

Sole traders keep all the profits from the business and do not
have to share decision-making authority.
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There is no division between business assets or personal

assets, which includes your share of any assets jointly owned
with another person (such as your house or car).

Your liability is unlimited which means that personal assets can

be used to pay business debts.

Sole traders are taxed as individuals and pay income tax at

personal tax rates on their business income.

This means your business income is declared on your personal

tax return along with any other assessable income (such as
your salary or wages, interest, dividends).

The advantages and disadvantages of a sole trader

Advantages

• Simple set up and operation.

• You retain complete control of your assets and business

decisions.

• Fewer reporting requirements.

• Any losses incurred by your business activities, may be

offset against other income earned (such as your investment
income or wages). Subject to certain conditions.

• You are not considered an employee of your own business

and are free of any obligation to pay payroll tax,
superannuation contributions or workers' compensation on
income your draw from the business.

• Relatively easy to change your legal structure if the business

grows, or if you wish to wind things up.
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Disadvantages

• Unlimited liability which means all your personal assets are

at risk if things go wrong.

• Little opportunity for tax planning - you can't split business

profits or losses made with family members and you are
personally liable to pay tax on all the income derived.

• Access to capital for expanding the business may be limited.

Partnership (http://www.smallbusiness.wa.gov.au/partnership/)
A partnership involves two or more people going into
businesses together in order to make a profit. In most cases a
partnership will need to register a business name with the
Australian Securities and Investments Commission (or other
corporate regulator depending on the jurisdiction) unless it uses
the surnames of all the partners involved.
Partners share all business assets and liabilities. A partnership
is a relationship, not a separate legal entity.
Each partner jointly owns all the business assets and liabilities.
It's vital that each partner knows their rights, responsibilities
and obligations.
To set up a partnership the partners should seek the help of a
qualified professional to prepare a written partnership
agreement. The agreement should also state each partner's
role and level of authority, their expected financial contribution
and a clear procedure for dispute resolution and dissolving the
partnership.
This is important because personal liability is unlimited for each
and every partner in the business. If the business fails and your
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partner can't afford to pay their share of any debts incurred, you
will be held liable for the shortfall.
You are also jointly responsible for any debts your partner
incurs, with or without your knowledge.
The problem of unlimited liability can be avoided in a limited
partnership, which consists of general and limited partners.
Here one or more general partners have unlimited liability and
actively manage the business, while each limited partner is
liable for business obligations only up to the amount of capital
he or she contributed to the partnership. In other words, the
limited partners have limited liability. To qualify for limited
partner status, a partner cannot be actively engaged in
managing the business.

The advantages and disadvantages of a partnership

Advantages

• Simple and inexpensive to set up.

• Minimal reporting requirements.

• Shared management/staffing responsibilities.

• More opportunities for tax planning (such as income splitting

between family members) than that of a sole trader.

• A partner's share of the business's tax losses may be offset

against other personal income, subject to certain conditions.

• Combined skills, experience and knowledge can provide a

better product/service.

• Relatively easy to dissolve or exit and recover your share.

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• More access to capital than sole trader

• Partners are not employees. Superannuation contributions

and workers' compensation insurance are not payable on
partners’ profits or drawings.

• Limited partners in a limited partnership have limited liability.

However limited partners cannot be actively involved in
managing the business.

Disadvantages

• Potential for disputes over profit sharing, administrative

control and business direction.

• Joint and several liability of partners. This means that each

partner is fully responsible for debts and liabilities incurred by
other partners - with or without their knowledge.

• Changes of ownership can be difficult and generally require

a new partnership to be established.

Corporations (Companies)
The corporation is a very important form of business
organisation. A corporation is an independent legal entity which
is separate from its owners (the shareholders). In a legal sense,
it is a “person” distinct from its owners. Companies can enter
into contracts with other parties, issue debt, borrow money and
own assets. Being a creation of the law, it possesses those
properties, rights and obligations which the law and its corporate
charter of creation confer upon it.
The major feature of the corporate form of business that
distinguishes it from the sole trader and the partnership is that
the corporation has a separate legal existence from that of its
owners.
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Most corporations are “limited by shares” so the owner’s liability

for the actions or obligations of the corporation is limited to the
amount unpaid on any shares held.
This means the debts and other obligations of the business are
separate from those of the shareholders and the shareholders
are not exposed to the risk of loss of their personal wealth.
This Limited Liability is a very important advantage of the
corporate form of business over the other forms of business
organisation.
However, directors and employees are personally liable under
the Corporations Act 2001 if found to be committing fraudulent,
negligent or reckless acts.
Definition of Limited Liability (Parrino)
The legal liability of a limited partner or shareholder in a
business, which extends only to the capital contributed or the
amount invested.
Capital (money) can be raised by the corporation without
impacting on the liability of the owners of the corporation or
exposing them to risk of loss of their own capital (apart from
their investment in the company). This is a significant
advantage of the corporate form of business.
Ownership of the firm is evidenced by shares. Each
shareholder owns a share of the company in proportion to the
number of shares they own relative to the total number of
shares outstanding. The shares are easily transferrable from
one owner to another. This is another major advantage of the
corporate form.
These various advantages have led to a situation where the
corporate form of business has grown substantially over the
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past 200 years and most of the world’s largest businesses are
corporations, not sole traders or partnerships. This is partly due
to the large demands for capital that come with an advanced
economy.
The life of the corporation is potentially unlimited as it is
independent of the lives of its owners or of their decisions to
sell their shares.
There is a separation of ownership and control in most
corporations. The business is managed by professional
managers with the skills and expertise required to manage the
business but who may or may not have a share of the
ownership. The owners (shareholders) can benefit from this
arrangement by investing in the firm without having the need to
have the expertise to run the business.
Starting company is more costly than starting a business as a
sole trader or partnership. All companies are registered with
and regulated by the Australian securities and investments
commission (ASIC)

The advantages and disadvantages of the corporate form

Advantages

• Limited liability for the owners of the business

• The firm has an indefinite life, independent of the lives of

the owners or of their decisions to buy / sell shares

• The ownership is easily transferred to another person

(tradeable) and this in fact increases the value of the
business compared with what it would otherwise be
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• It is relatively easier for the corporation to raise new

capital (debt and equity) without impacting on the existing
owners than is the case for the other forms of business
and this can allow the firm to grow without being restricted
by the capital available from the existing owners.

• Separation of ownership and control means that the

business can be managed by managers with the required
expertise and skills instead of by the owners. This can be
both an advantage and a disadvantage.

Disadvantages

• It takes more time and administration work to set up a

corporation and there is more paperwork to do to satisfy
the requirements of various regulatory agencies

• Increased financial reporting requirements apply to

corporations that don’t apply to partnerships or sole
traders: e.g. the need for annual financial statements

• The set up costs of setting up the corporation

• The ongoing compliance costs of being in business and

complying with relevant regulation / legislation
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Public vs private corporations

A company can choose to list on a stock exchange, such as the
Australian Securities Exchange (ASX), as a public company.

Private company (From Investopedia)

A privately company is a company with private ownership. It
does not have to meet listing rules for an exchange. Private
companies may issue stock and have shareholders, but their
shares do not trade on public exchanges and are not issued
through an initial public offering(IPO). In general, the shares of
these businesses are less liquid and the values are difficult to
determine.
Though less visible than their publicly traded counterparts,
private companies have a major importance in the world's
economy.
US large private corporations

• Cargill; Koch Industries; Bechtel; Publix; Pilot Corp; one of

the members of the Big Four accounting firms, Deloitte
Touche Tohmatsu; Hearst Corporation; S. C. Johnson and
Mars

EU large private corporations

• KPMG; Ernst & Young; PricewaterhouseCoopers; IKEA;

Trafigura; J C Bamford Excavators (JCB); Lidl; Aldi;
LEGO; Bosch; Rolex; Ferrero and Victorinox
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Public company
(http://www.investopedia.com)
A public company is a company that has issued securities
through an initial public offering (IPO) and is traded on at least
one stock exchange or in the over-the-counter market.
Although a small percentage of shares may be initially "floated"
to the public, the act of becoming a public company allows the
market to determine the value of the entire company through
daily trading.
Public companies have inherent advantages over private
companies, including the ability to sell future equity stakes and
increased access to the debt markets. With these advantages,
however, comes increased regulatory scrutiny and less control
for majority owners and company founders.
Once a company goes public, it has to answer to its
shareholders. For example, certain corporate structure changes
and amendments must be brought up for shareholder vote.
Shareholders can also vote with their dollars by bidding up the
company to a premium valuation or selling it to a level below its
intrinsic value.
Public companies must meet stringent reporting requirements
set out by a regulator such as the Australian Securities and
Investments Commission (ASIC) or in the USA, the Securities
and Exchange Commission (SEC), including the public
disclosure of financial statements discussing the state of the
company.
Each stock exchange also has specific financial and reporting
guidelines that govern whether a stock is allowed to be listed
for trading.
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The Financial Manager and the company

The objective of managers (Parrino 1.4)

• Should be to maximise the current value of the company’s

shares. Maximising share value is an unambiguous
objective.
• Note that profit is hard to define and depends on how the
accounts are prepared. In addition, profit maximization
does not take into account the riskiness or the timing of
cashflows.
Agency conflicts: Separation of ownership and control
(Parrino 1.5)

Ownership and control

• For large companies, the ownership of the firm is spread
over a number of shareholders and the company’s owners
may effectively have little control over management
• Management may make decisions that benefit their self-
interest rather than those of the shareholders
Agency relationships
• An agency relationships arises whenever one party, called
the principal, hires another party, called the agent
• Agents have a fiduciary duty to shareholders to put
shareholders interests above their own
Do managers really want to maximise share price?
• Shareholders own the company, but managers control the
money and have the opportunity to use it for their own benefit
Agency Costs
• The costs of the conflict of interest between the
company’s owners and its management