Welcome to the World of Businesses!

In this chapter, we are going to explore the different ways businesses operate and how they are owned. Whether it's the small bakery downstairs or a massive tech company, every business has a type and a form of ownership. Understanding this is the "foundation stone" of accounting because the way we record information depends on what the business does and who owns it!

Don't worry if this seems like a lot of theory at first! We will break it down into simple parts with relatable examples. By the end of this, you’ll be able to look at any shop and know exactly what kind of business it is.


1. What Does the Business Do? (Trading vs. Service)

At the most basic level, profit-making businesses do one of two things: they either sell physical goods or they sell their time and skills.

A. Trading Businesses

A trading business buys physical goods (inventory) and sells them at a higher price to make a profit. Think of your local stationery shop or a shoe store.

  • Key Activity: Buying and selling inventory.
  • Key Accounting Item: Cost of Sales (the cost of the goods actually sold).
  • Analogy: Buying a pack of 10 pens for \$5 and selling each pen for \$1. You are "trading" pens for money.

B. Service Businesses

A service business provides a service or expertise instead of physical products. Think of a tuition centre, a hair salon, or a delivery company like Grab.

  • Key Activity: Providing skills, time, or facilities.
  • Key Accounting Item: Service Fee Revenue.
  • Analogy: A tutor teaches you for an hour. They aren't "selling" you a physical object; they are selling their knowledge and time.

Differences in Financial Statements

Because they do different things, their financial reports look slightly different:

  • Statement of Financial Performance: A trading business will show Sales Revenue and Cost of Sales to find Gross Profit. A service business usually just shows Service Fee Revenue.
  • Statement of Financial Position: A trading business will have Inventory listed under current assets. A pure service business usually has little to no inventory for sale.

Quick Review:
Trading = Physical Goods + Inventory + Cost of Sales
Service = Skills/Time + Service Fee Revenue


2. Who Owns the Business? (Forms of Ownership)

Now that we know what they do, let's look at how they are owned. In the 7087 syllabus, we focus on three main forms:

A. Sole Proprietorship

This is a business owned by one person.

  • Liability: Unlimited. This means if the business cannot pay its debts, the owner’s personal assets (like their home or car) can be taken to pay the bills!
  • Capital: Provided by the single owner. This usually means limited funds.
  • Control: The owner has total control and makes all decisions.
  • Lifespan: Not a separate legal entity. If the owner passes away, the business legally ends.

B. Limited Liability Partnership (LLP)

This is a business owned by two or more partners (e.g., a law firm or accounting firm).

  • Liability: Limited. A partner is generally not personally liable for the debts of the LLP. Their risk is limited to what they invested.
  • Capital: More people involved means more access to funds compared to a sole proprietor.
  • Lifespan: It is a separate legal entity from its owners. It continues even if a partner leaves or passes away.

C. Private Limited Company

This is a business owned by shareholders. It usually has "Pte Ltd" at the end of its name.

  • Liability: Limited. Shareholders only lose the money they paid for their shares if the company fails.
  • Capital: Can raise a lot of money by issuing shares to up to 50 shareholders.
  • Transferability: Shares can be transferred, but it requires the approval of other shareholders (unlike a public company).
  • Lifespan: Separate legal entity; it has a perpetual succession (it lives on forever unless closed down).

Memory Trick: "The Liability Rule"
If it has "Limited" in the name (LLP or Pte Ltd), the owners' personal stuff is SAFE. If it's a Sole Proprietorship, the owner's personal stuff is AT RISK.


3. Comparing Financial Statements (SP vs. Pte Ltd)

One common exam question is distinguishing how the equity section looks for a Sole Proprietor (SP) versus a Private Limited Company (Pte Ltd).

Statement of Financial Position (The Equity Section)

For a Sole Proprietor:
We use the term Owner's Equity. It shows:
1. Capital (Owner's investment)
2. Add: Profit for the year
3. Less: Drawings (Money the owner took for personal use)

For a Private Limited Company:
We use the term Shareholders' Equity. It shows:
1. Share Capital (Money from selling shares)
2. Retained Earnings (Accumulated profits kept in the company)

Note: There are no "Drawings" in a company! Instead, companies pay out Dividends to shareholders.


4. Factors to Consider When Choosing a Business Form

If you were starting a business today, how would you choose which form to use? Think of these 6 factors:

  1. Owner's Expertise: Do you have all the skills (Sole Prop) or do you need partners with different skills (LLP)?
  2. Nature of Business: Small-scale shops are usually Sole Props; large-scale manufacturing often requires a Pte Ltd.
  3. Capital Commitment: How much money do you need to start? Companies can raise the most.
  4. Lifespan and Transferability: Do you want the business to continue after you are gone? (Choose LLP or Pte Ltd).
  5. Risk (Liability): Are you okay with "Unlimited Liability"? If not, choose a "Limited" form.
  6. Level of Control: Do you want to be the "Big Boss" (Sole Prop) or are you okay sharing decisions (LLP/Pte Ltd)?

Did you know?
Most doctors or lawyers choose LLPs because it allows them to share the costs of an office while protecting them from being sued for a partner's personal mistake!


Common Mistakes to Avoid

  • Confusing Liability: Many students think "Limited Liability" means the business doesn't have to pay its debts. Incorrect! It means the owners don't have to pay the business's debts with their personal money.
  • Inventory in Service: Remember, a service business might have supplies (like soap in a salon), but they don't have "Inventory" meant for resale in the same way a trading business does.
  • Drawings vs. Dividends: Only use the term "Drawings" for Sole Proprietors. Use "Dividends" for Companies.

Key Takeaway:
The form of business you choose affects how much money you can raise, how much risk you take, and how you report your "Equity" in the Statement of Financial Position.