UNIT 2 Forms Of Business Organisation I

2.1 INTRODUCTION

In the previous unit you learnt that any activity carried with profit motive is called business and that such activity may be an industrial activity, a trading activity or a service activity like banking, insurance, transportation, etc. You have also learnt that bringing various resources together to set up a business and putting them to work systematically is termed as business organisation. The person who takes initiative to set up a business, provides the necessary funds and bears the risk involved is called the owner of the business. When the business is organised on small scale, it may be possible for one person to provide the funds and bear the risk. But when it is large, he may need others to join hands. Thus, business may be owned by an individual or a group of persons, when a business is owned and carried on by one person it is called ‘Sole Trader Organisation’. But when it is owned by a group of persons it may be the form of a partnership firm, a company or a cooperative society. In this unit you will study in detail the features, classification, merits and limitations of these different forms of business organisations.

2.2 SOLE TRADER ORGANISATION

The sole trader organisation (also called proprietorship) is the oldest form of organization and the most common form of organisation for small business even today. It is the simplest and easiest to form. What is required is that an individual decides about the type of business to be started and arranges the necessary capital. Required capital may be mobilised from his own savings, or may be borrowed from friends and relatives. The business may be carried either in a portion of his own residence or in a rented building. The person generally manages the business on his own. He may also take the help of his family members or employ some persons, if necessary. He can take the advice from others in running the business, but his own will be the final decision. Thus, the sole trader enjoys full control over the affairs of the firm. He enjoys a11 the profits earned by the business. So in case of loss, naturally, he has to bear the full burnt of it.

Thus, we can now define sole trader organisation as “one man’s business in which an individual produces independently with his own capital, skill and intelligence and is entitled to receive all the profits and assumes all the risks of ownership”. J.L. Hanson defines it as “a type of business unit where one person is solely responsible for providing the capital for bearing the risk of the enterprise and for the management of the business”. Under this form of business organisation, no distinction is made between the business concern and the proprietor. Likewise, the management rests with the same person

.

2.2.1 Main Features

Based on the above discussion, we can list the main features of sole trader organisation as follows.

1.  One man ownership: The ownership lies with one person only. There are no associates or partners. He invests his own money or borrows from the friends and relatives.

2.         No separation of ownership and management: The owner himself manages the business. Therefore, the separation of ownership and management which is quite common in big business is not present in this form of organisation. Since the proprietor himself manages the business, he exercises a high degree of supervision and control in the working of his business.

3.         No separate entity: The business does not have an entity separate from the owner. The proprietor and the business enterprise are one and the same.

4.         All profits to proprietor: Since there are no partners, all the profits are enjoyed by the sole proprietor.

5.         Individual risk: All losses in the business are borne by the proprietor himself.

6.         Unlimited liability: The proprietor has an unlimited liability. This means that in caw of loss even the personal property of the owner can be utilised for clearing the business obligations and debts.

7.         Less 1egal formalities: To set up sole proprietorship, no legal formalities are required. Of course, there are some legal restrictions for the setting up of a particular type of business. For example, an individual cannot start a bank or an insurance company. But one can start a fruit stall or a cycle shop without much legal formalities. However, in some cases a licence may be required. For example, to start a restaurant, you need licence from municipal corporation.

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2.2.2 Merits and Limitations

You have learnt about the main features of the sole trade business. In view of these features this form of organisation has the following merits and limitations.

Merits

1 Easy formation: There are no legal formalities to be observed while starting this form of organisation. Therefore, its formation is very easy and simple. The expenditure involved in the process of formation is also negligible.

2 Direct motivation: As you know, all the profits and gains of the business are solely and exclusively pocketed by The sole proprietor. This motivates the proprietor to work hard and develop the business to get more and more profits. His involvement in the business is, therefore, complete and free.

3 Full control: The proprietor is the monarch of the business he owns. He manages the whole business and takes all decisions himself. In other words, proprietor exercises full control over the functioning and working of the business.

4 Quick decision: The proprietor does not depend on others for decision making. Since there are no partners, he is not required to consult others. This enables the proprietor to take quick decisions on numerous matters concerning his business.

5 Flexibility in operations: Being a small organisation it is easy to bring changes if situation so demands. In a large sized organisation to bring changes is difficult.

6 Secrecy: Since the whole business is handled by the proprietor his business secrets are known to him only. He is not bound to publish his accounts. Therefore, the degree of secrecy is the highest in this form of organisation.

7 Personal touch: When the proprietor handles everything relating to the business himself, it is easy to maintain a personal rapport with the customers. He can easily know their tastes, likes and dislikes and adjust his operations accordingly. Similarly, in this form of organisation, employees, if any, work directly under the proprietor. So, it gives scope for the proprietor to maintain harmonious relations with the employees.

8 Dissolution easy: Since there are no co-owners or partners, there is no scope for the difference of opinion in the case of dissolution of business. The proprietor is free to withdraw from the business or to sell it at any time he wants. Because of ease in formation and withdrawal, proprietorship form is often used to test business ideas.

Limitations

1 Limited resources: The capital and other resources of an individual are always limited.

The sole trader has to mainly rely on his own money and earnings, or he can borrow, if necessary, from relatives and friends. Thus, the proprietor has a limited capacity to raise funds. This makes it difficult to plan any large scale expansion.

2 Limited managerial capability: In the modern business, knowledge and skills in various fields like production, finance, marketing, etc., are required. It is not possible for a single individual to possess expertise in all these areas. So, his decisions may not be balanced.

3 Not suitable for large scale operation: Since the resources of the sole trader are limited, it is suitable only for small business and not for large scale operations.

4 Unlimited liability: You know that the proprietor has an unlimited liability. In case of a loss, even his personal property and belongings can be utilised for clearing business obligations. Therefore, he cannot take much risk and is discouraged from expansion of his business.

5 Less stability: The continuity and stability of the business depends solely on one person. When the man dies, there is a likelihood of c1osure of the business.

6 No check and control: As the sole trader is the monarch of the business, no outsider can

question him on his acts and deals. There are no checks and controls on the sole trader.

7 Less scope for economies of scale: Sole trader usually operates on small scale only. So he can not enjoy the benefits of large scale production or buying or selling.  This may raise the cost of business operations.

2.3 PARTNERSHIP FORM OF ORGANISATION

You have learnt that the sole trader organisations have limited financial resources, limited managerial ability and skills, and unlimited liability. In case of expansion more capital and more managerial skills are required. At the same time, the risk will also increase. A sole proprietor may not be able to fulfill all these requirements. A person who lacks, managerial skills may be having capital. Another person who is a good manager may not be having sufficient capital. This calls for a situation where two or more persons come together, pool their capital and skills, and organise the business. This type of business organisation is called partnership organisation. It grew essentially because of the limitations and failure of the sole proprietorships.

As defined by J.L. Hanson, “a partnership is a form of business organisation in which two or more persons upto a maximum of twenty join together to undertake some form of business activity”.

The Indian Partnership Act, I932 defined partnership as “the relation between persons who have agreed to share the profits of business carried on by all or any of them acting for all”. The Uniform Partnership Act of the USA defines a partnership “as an association of two or more persons to carry on as co-owners a business for profit”.

Based on the above definitions, we can state that partnership is an association of two or more persons who have joined together to share the profits of business carried on by all or any of them acting for all. The persons who own the partnership business are individually called ‘partners’ and collectively known as the firm  or partnership firm. On an agreed basis, partners contribute to capital and share the responsibility of running the business. However, in some cases one partner may provide the whole or major portion of the capital and others contribute technical and managerial skills with or without some capital. All such terms and conditions of partnership are usually mentioned in the partnership agreement.

2.3.1 Main Features

From the above discussion, we can list the main features of partnership form of organization as follows :

1 Plurality of persons; To form a partnership firm, there should be at least two persons. The maximum limit on the number of persons is ten for banking business and twenty for other types of business.

2 Contractual relationship: Partnership is created by an agreement between persons called ‘partners’. In other words, a person can become a partner only on the basis of a contract. This contract could be oral, written or implied.

3 Profit sharing: There must be an agreement among the partners to share the profits and losses of the business of the partnership firm. This is one of the basic elements of partnership. If two or more persons jointly own some property and share its income, it is not regarded as partnership.

4 Existence of business: The purpose of the agreement among the partners is to do some lawful business and share profits. If the purpose is something other than business, it should not be treated as partnership. For example, if the purpose is to carry some charitable work, it will not be treated as partnership.

5 Principal-agent relationship: The business of the firm may be carried on by all or one or more partners acting for all the partners. Every partner is entitled to take part in the operations of the firm. In dealing with other parties, each partner is entitled to represent the firm and other partners in respect of the business of the firm. All partners are bound by his acts done in the ordinary course of business and in firm’s name. In this sense a partner is agent of the firm and the other partners.

6 Unlimited liability: In respect of business debts, each partner has unlimited liability. This means that if the assets of the firms are not sufficient to meet the obligations of the firm, the partners have to pay from their private assets. The creditors can even realise the whole of their dues from one of the partners. Thus, all the partners are jointly and severally liable for all business debts and obligations.

7 Good faith and honesty: A partnership agreement rests on good faith among the partners. The partners must be honest to each other and trust each other. They must disclose every information about the business and present true accounts to one another.

8 Restriction on transfer of share: A partner cannot transfer his share to an outsider without the consent of all the other partners.

2.3.2 Classification of Partners

 You have learnt that different partners play different roles in the operations of the firm. One partner may contribute more capital while another partner may spend more time in managing it. Depending on the role played, we can classify the partners into various categories.

Based on the extent of participation in the functioning of the business, we can classify partners into: a) active partners, and (b) sleeping partners.

a) Active partner: If a partner takes an active part in the management of the business, we call him as active partner. He is also known as a ‘working partner’.

b) Sleeping partner: If the partner is not actively associated with the working of the partnership firm, we call him a sleeping partner. A sleeping business partner simply invests his capital. He does not participate in the functioning of the firm. Such a partner is also known as a ‘dormant partner’.

Based on the sharing of profits, partners may be classified into: (a) nominal partners, and

(b) partner in profits.

a) Nominal partner: A partner who just lends his name to the partnership is known as a nominal partner. He neither invests his capital nor participates in the day-to-day working and management of the firm. Such partners are not entitled to a share of profits, but they are liable to other parties for all the acts of the firm.

b) Partner in profits: A partner who shares the profits of the business without being liable for losses is called a partner in profits. As a rule, he will not take any part in the management of the business. This is applicable to a minor who is admitted to the benefits of the firm.

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Based on the behaviour and conduct exhibited, the partners may be divided into:

(a) partner by estoppel, and (b) partner by holding out.

a) Partner by estoppel: A person who behaves in the public in such a fashion as to give an impression that he is one of the partners in a partnership firm is called a partner by estoppel Such partners are not entitled to profits but are fully liable as regards the firms obligations.

b) Partners by holding out: If a particular partner of a firm represents that another person is also a partner of the firm, and if such a person does not disclaim the partnership relationship even after coming to know about it, such person is called a ‘partner by holding out’. Such partners are not entitled to profits but are liable as regards the obligations of the firm.

You should note the difference between these two types clearly. In the case of a partner by

estoppel, the person’s own behavior and conduct have created a mistaken impression in the third parties mind that he is a partner of the firm. Whereas in the case of a partner by holding out, the other partners have represented the person as a partner, though he is not one, and he does not contradict it. You will learn more about such partners in a separate course.

Based on liabilities also, partners may be classified into two categories: (a) limited partners.

and (b) general partners.

a) Limited partner: The liability of such a partner is limited to the extent of the capital contributed by him. He is not entitled to take part in the management of the business, but he can advise the other general members. His acts do not bind the firm. He has right to inspect the books of the firm for his information. Such partners are also called ‘special partners’.

b) General partner: He is also called ‘unlimited partner’. His liability is unlimited and he is entitled to participate in the management of the business. Every partner who is not a limited partner is treated as a general partner.

As you know in partnership the liability of the partners is unlimited. The limited partners are found only in limited partnership form of organisation which is found only in some European countries and the USA. This is not allowed in India.

2.3.3 Partnership Deed

You know that a partnership is formed by an agreement. Such agreement may be either written or oral. To avoid misunderstanding and unnecessary litigations, it is always desirable to have a written agreement. When the written agreement is duly stamped and registered, it is known as ‘Partnership Deed’. After registration, each partner is given a copy of the partnership deed. A partnership deed generally contains the following particulars.

1 Name of the firm.

2 Nature of the business to be carried out.

3 Name of the partners.

4 The town and place where business will be carried on.

5, The amount of capital to be contributed by each partner.

6 The profit and loss sharing ratio of each partner.

7 Loans and advances by partners and the interest payable on them.

8 The amount of drawings by each partner and the rate of interest allowed thereon.

9 The rate of interest on capital. ,

10 Duties, powers, and obligations of partners.

11 Remuneration, if any, payable to the active partner.

12 Maintenance of accounts and arrangements for audit.

13 Settlement in the case of dissolution of partnership.

14 The methods of evaluation of goodwillon admission or death or retirement of a partner.

15 The method of revaluation of assets and liabilities on admission or death or retirement of a partner.

16 The method of retirement of a partner, and the arrangement for the payment of the dues of a retired or deceased partner.

17 Arbitration in case of disputes among partners.

18 Arrangements in case a partner becomes insolvent.

This is not an exhaustive list. Any other clauses, as desired by the partners could be included in the partnership deed. In fact, the Partnership Act defines certain, rights and duties of a partner. But the provisions of the Act come into operation only when there is no agreement amongst the partners.

Registration of the firm: Under the Indian Partnership Act it is not compulsory to register the firm. But there are certain limitations for an unregistered firm. So, it is better to register it. Registration can be done at any time. To register the firm an application with all particulars about the firm and registration fee have to be sent to the Registrar of Firms.

2.3.4 Merits and Limitations

You have learnt about the main features of partnership. This would help you to identify the merits and limitations of this form of organisation which are as follows.

Merits

1 Easy formation: Although the formation of a partnership firm is not as easy as the sole proprietorship but it is much less difficult as compared to a company. The partners agree to do business together and draw up and sign the partnership agreement. After that there are no complex government laws regulating the establishment of the partnership.

2 More capital available: Unlike sole proprietorship, there are two or more partners in partnership firms. So a partnership firm does not have to rely on a single individual as the source or its funds. The added financial strength of the partners increases the

Borrowing capacity of the firm.

3 More diverse-skills and expertise: The partnership involves more people in decision making because there are more owners. An ideal partnership brings together partners who complement each other, not partners who have the same background and experience. One partner might be a specialist in manufacturing, another in marketing, and the third partner might be an accountant Combined judgment of all these partners often leads to better decisions than otherwise.

4 Flexibility: Like sole proprietorship, the partnership business is also owned and run by the partners themselves. They can easily appreciate and quickly respond to the changing conditions.

5 Secrecy: In partnership firms, some secrecy can be maintained because there is no obligation to publish accounts of the firm.

6 Keen interest: Since partners are 1iable to losses and risks of the business, they take keen

interest in the affairs of’ the business.

7 Protection: Due to the rule of unanimity in fundamental matters, the rights of all partners

are fully protected. If a partner is dissatisfied with the working of the firm, he can ask for dissolution of the firm and withdraw from the business.

8 Checks and controls over careless decisions: Since the partnership is run on collective basis and all partners participate in major decisions. There is lesser scope for reckless and hasty decisions.

9 Diffusion of risk: The losses of the firm will be shared by all the partners. Hence, the share of loss in the case of each partner will be less than that sustained in sole proprietorship.

Limitations

1  Limited capital: Since there is a limit of maximum partners (20 in non-banking firms and 10 in banking firms), the capital raising capacity of the partnership firms is limited as compared to a joint stock company.

2 Unlimited liability: The most important drawback of a partnership firm is that the liability of the partners is unlimited.

3 No public confidence: Since the accounts are not published and publicised, the firm may not be able to command confidence of the public.

4 Non-transferability of interest: No partner can transfer his interest in a firm without the consent of other partners.

5 Uncertainty: The sudden death, lunacy or insolvency of a partner leads to the dissolution of partnership. This breeds uncertainty in the continuity of a partnership firm. However, this could be partly avoided if such matters are specified in the partnership agreement.

6 Conflicts among partners: There is scope for misunderstanding and conflicts among the partners. This may cause delays in decision making and may lead even to dissolution of the firm. To some extent, this problem could be avoided if the partnership agreement is clear and detailed.

7 Risk of implied authority: Since each partner acts as an agent of the firm, acts of one partner would bind the firm and all the remaining partners. A dishonest or incompetent partner may lend the firm into difficulties and the other partners may have to pay for it.

2.3.5 Joint Hindu Family Firm

Joint Hindu Family firm is a unique form of business organisation prevailing only in India. This is the firm belonging to Joint Hindu family and governed by the provisions of the Hindu Law.

In Hindu Law there are two schools:

a) Mitakshara: 1t is applicable to the whole of India except Bengal and Assam. According to this school, a Hindu inherits property from his father, grand father, and great grand father. Thus, three successive generations in the male line (son, grandson, and great grandson) inherit the ancestral property. They are called coparceners and the senior most member of the family is called ‘Karta’. The Hindu Succession Act, 1956 has extended the line of coparcenary interest to female relatives of the deceased coparcener or male relatives claiming through such female relatives.

b) Dayabhaga: It is applicable in Bengal and Assam. According to this, the male heirs become members only on the death of the father.

According to Hindu Law, a business is an inheritable asset. After the death of Hindu, the business will be jointly owned by all the coparceners. The elder person among the coparceners becomes the new Karta and manages the business. If any property is inherited from any other relative, or acquired from personal resources, such property is regarded as personal property and treated as distinct from ancestral property. Important features of the Joint Hindu Family Firm are:

1) Business is managed by the senior member of the family called Karta. Other members do not have the right to participate in the management of the firm.

2) Other members cannot question the authority of the Karta. Their only remedy is to get the family dissolved by mutual agreement.

3) Karta has the power to borrow funds for the business. The liability of the Karta is unlimited whereas the other coparceners are liable only to the extent of their share in the business.

4) If the Karta has misappropriated the funds of the business, he has to compensate the other coparceners to the extent of their shares in the joint property.

5) The death of any member of the family does not dissolve the business or the family.

6) Through mutual agreement the joint hindu family firm can be dissolved.

You should note the difference between the joint Hindu family firm and the partnership firm. A joint Hindu family firm is the result of the operation of the Hindu Law; No formal agreement is required to convert a business into a joint Hindu family business. The members of the family automatically become coparceners. Only the Karta can participate in the management. The liability of the Karta is unlimited but the liability of the other coparceners is limited to their shares in the business. The rights, duties and liabilities of coparceners are governed by the provisions of the Hindu Law; Partnership is the result of an agreement between the persons who need not be blood relatives. Each partner has the right to participate in the management of the business. The liability of each partner is unlimited. The duties, rights and liabilities of the partners are governed by the Indian Partnership Act, 1932.

2.4 COMPANY FORM OF ORGANISATION

You have learnt that sole proprietorships and partnerships have the disadvantages of limited resources, unlimited liability, limited managerial skills, etc. The life and stability of these organisations also depend on the life and stability of the proprietors/partners. Hence, they are not considered suitable for large scale business.

For large scale business, you require large investment and specialised managerial skills. The element of risk is also very high. This situation led to the emergence of company form of business organisation. In case of joint stock company, capital is contributed by not one or two persons but by a number of persons called shareholders. Thus, it is possible to raise large amount of capital. A joint stock company is an association of persons registered under Companies Act for carrying on some business. It is called an artificial person as it is created by law, with a distinctive name, a common seal and perpetual succession of members. It can sue and be sued in its own name. The most widely quoted definition of a company (called Corporation in USA) is the one given by Chief Justice Marshal. According to him “a corporation is an artificial being, invisible, intangible and existing only in contemplation of law. Being the mere creature of law, it possesses only those properties which the charter of its creation confers upon it, either expressly or an incidental to its very existence.” Lord Justice Lindley has defined it as “an association of many persons, who contribute money or money’s worth to a common stock and employ it for a common purpose. The common stock so contributed is denoted in money and is the capital of the company. The persons who contribute it or to whom it belong are members. The proportion of capital to which each member is entitled is his share.”

The Indian Companies Act (1956) defines joint stock company as “a company limited by shares having a permanent paid up or nominal share capital of fixed amount divided into shares, also of fixed amount, held and transferable as stock and formed on the principles of having in its members only the holders of those shares or stocks and no other persons.”

2.4.1 Main Features

Based on the above definitions, we can list out the features of the company form of organization as follows :

1 Incorporation: A company is an incorporated association. It comes into existence only after registration under the Companies Act.

2 Artificial person: A company is regarded as an artificial person as it is created by law and can be effaced only by law. It has no body, no soul, no conscience, still it is in a position to exist. Like any other person it can own property, conduct a lawful business, enter into contracts with others, buy, sell and hold property, all under its own name and its own seal.

3 Separate legal entity: A company has a distinct entity separate from its members. A shareholder of a company can enter into contract with the company and can sue the company and be sued by it. You know that in the case of partnership, every partner is an agent of the firm and also that of the other partners. But the shareholder is not the agent of the company or its shareholders. He can not bind them with his acts.

4 Common seal: As the company is not a natural person, it cannot sign the documents. It has a device in the form of common seal on which its name is engraved. This common seal is a substitute of its signatures. It is affixed on all important legal documents and contracts. It is used at the direction of the board of directors and two directors have to sign as witnesses wherever it is affixed on any document.

5 Perpetual succession: A joint stock company has a continuous existence. Its life is not affected by the death, lunacy, insolvency or retirement of its shareholders or directors Members may come and go, but the company continues its operations until it is legally dissolved. Thus, a company has perpetual succession irrespective of its membership. This feature provides stability to this form of organisation.

6 Separation of ownership and management: The shareholders of a company are widely scattered throughout the country. For the conduct of the business and its management, shareholders elect another set of persons known as directors. The right to manage the company affairs is vested in the directors who are elected representatives of the shareholders. Thus, ownership is separated from management.

7 Number of members: In the case of a public limited company: the minimum number is seven and there is no maximum limit. In the case of a private limited company, minimum number is two and the maximum is fifty.

8 Limited liability: The liability of the members of a company is normally limited by guarantee or by the shares. Members liability is limited to the amount of shares held. Members are not personally liable for the debts of the company. So, personal properties of the members are not liable to be attached for the payment of the company’s debts. For example, the face value of the share of a company is Rs. 10 which the member has already paid. At the time of winding up of the company, the member cannot be asked to pay any money. But if the member had paid only Rs.7, he can at the most be asked to pay the balance of Rs. 3 (face value Rs.10 minus money paid Rs. 7), and no more.

9 Transferability of shares: The member of a public limited company enjoys a statutory right to sell his shares to others without the consent of other shareholders. But for transferring the shares he has to follow the procedure laid down in the Companies Act. However, there are restrictions for transferring shares in case of a private limited company.

10 Regidity of objects: The scope of the business of a company is limited. The type of business in which the company would participate is mentioned in the ‘object clause’ of its Memorandum of Association. The company cannot take up any new business without changing the object clause. To change the object clause, the co~npanyh as to

comply with the provisions of Lhe Companies Act,

11 Statutory regulations: A company is governed by the Companies Act and it has to

follow various provisions of the Act. It has to submit a number of returns to the

Gopernment. Accounts of a company must be audited by a Chartered Accountant. Thus,

the company ton-n~fo rganisation has to comply with numerous and varied statutory

requirements.

Having studied the features of a joint stock company you can easily make out: that the

shareholders are the real owners of the company, Their liabilityis limited. They can also

transfer their shares to others. Since the shareholders are very large in number, the company

cannot be managed by all. They elect a board of directors to manage the company. The

destiny of the company is guided and directed by the directors. These directors employ

some people to carry on the day-to-day business of the company.

The company can raise additional funds by issuing debentures (also called bonds). You will

learn more aboul these aspects in Units 5 & 6.

2.4.2 Classification of Companies

We can classify companies on the basis of I) Mode of incorporation, 2) Extent of ltability,

3) Category of shareholders, and 4) Jurisdiction of functioning, Look at Figure 2.3 for the

:lassification of companies.

1 On the basis of the mode of incorporation, we can classify companies into three

categories :

a) Statutory Company: A company established by a special Act of the Parliament or

State Legislature is called ‘Statutory Company’. Such companies are established in

special cases when it is necessary to regulate the working of the company for some

specific purposes. Examples of such corporations are Reserve Bank of India, Life

Insurance Corporation of India, Air India Corporation, Food Corporation of India,

etc. These are mostly publ~cs ector enterprises.

Figure 2.3

Classificalio~r of Companies

Bascd on category Based on the jurisd~ction

f~~~~o~~~~d~l 1 1 ?~~~h~:'”~”ypc 1 1 of ;harcl~okicr~ 1 1 of functioning , 1

Statutory

Company I I I Unl~mitcd

Co~npany

Company Ltd.

by Guarantee

1 71 Fl Co~npany Ltd. hy Shares Company

b) Registered Company: A coinpany which is incorporated through registration with

the Registrar of Companies underJhe Companies Act, 1956, is called a ‘Registered

Company’. This is also called ‘In’corporated Company’. All companies established

under the private sector belong to this category.

C) Chartered Company: A company which is incorporated under a special Royal

Charter granted by the Monarch is called a ‘Chartered Company’. It is regulated by

the provisions of that charter. Examples are: British East India Company, Bank of

England, Hudson’s Bay Company, etc. In India this type of companies does not exist

now because there is no monarchy. ,

Based on the type of liability, companies may be classified into three categories :

a) Unlimited ~om~aniA~ csom: pany in which the liability of the members is

unlimited, is called ‘Unlimited Company’. At the time of winding up of the company

shareholders have to pay, if necessary, from their personal assets to clear the

company’s debts. From this point of view, it is very much like sole proprietorship

.and partnership. However, such companies are very rare. . .

b) Companies Limited by Guarantee: In the case of some compainies, members give

guarantee for the debts of the company up to a certain limit in addition to the amount

of shares held by them. The additional amount guaranteed by the members is,

Forms of Business

Organisation I

Basic Concepts and Forms of

Business Organlsation

generally, laid down in the Memorandum of Association. Such companies are not

formed for the purposeof profit. They are formed to promote art, culture, religion.

trade, sports, etc. Clubs, Charitable organisations, trade association, etc. come under

this category.

C) Companies Limited by Shares: In this case the liability of the members is limited

to the amount of the shares held by them. A shareholder can be called upon to pay

only the unpaid amount of shares held by him and nothing more. Most of the

companies come under this category.

3 On the basis of the ownership, companies may be classified into three categories :

a) Private Limited Company: A private limited company means a company which by

its article

i) restricts the right to transfer its shares;

ii) limits the number of its members to fifty; and

iii) prohibits any invitation to the public to subscribe for any shares or debentures of

the company.

b) Public Limited Company: A public limited company is one which is not a private

limited company. A company having the following characteristics should be called a

public limited company.

i) The right of the shareholder to transfer his shares is not restricted.

ii) The minimum number of shareholders is 7 but there is no limit to the maximum

number of members.

iii) It can invite public to subscribe for its shares and debentures.

The minimum number of inembers in the case of a private limited cornpany is two and

can be formed more easily as compared to a public company. It is exempted from

various regulations of the Companies Act and thus combines the advantages of limited

liability and the facilities of a partnership organisation. It is considered suitable for a

medium sized business.

C) Government Company: A company in which not less than 5 1 per cent of the paid

up share capital is held by the Central Government, or by any State Government or

jointly by Central and/or State Governments.

4 On the basis of the jurisdiction of the functioning, we can classify companies into two

categories :

a) National Company: When the operations of a company are confined within the

boundaries of the country in which it is registered, such a company is called a

national company.

b) Multinational Company: When the operations of a company are extended beyond

the boundaries of the country in which it is registered, such a company is called a

multinational company. It is also called ‘transnational company’.

2.4.3 Merits and Limitations

The company form of organisation has been popular and successful in almost all the

countries. This form is suitable where large resources are required and the ‘production has to

be carried out on a large scale. The number of joint stock companies has shown a

phenomenal increase in the twentieth century. Let us now discuss the merits and limitations

of the company form of organisation.

Merits

1 Large capital: Since company form of organisations are allowed to have a large

number of shareholders, it is possible to raise capital in large amounts. Whenever new

capital is required, it can issue shares and debentures. For this reason, only the company

form of organisation is best suited.

2 Limited liability: The liability of shareholders, unless and otherwise stated, is limited

to the face value of the shares held by them or guarantee given by them. Their private

property is not attachable to recover the dues of the company. Thus, this form of

organisation is a great attraction to persons who are not willing to take risk as is

inherent in sole proprietorship and partnership.

3 Stability of existence: A company has a separate legal entity with perpetual succession.

The corporation is not affected by lunacy or insolvency of a shareholder, director or

officer. The continuity of the company is desirable in the inte. rest of not only its .

members but.also the society.

4 Economies of scale: As companies operate on a large scale, they can take advantage of

large scale buying, selling, production, etc. As a result of these economies of large scale

operations, companies call provide goods to consumers at a cheaper price.

5 Scope for expansion: As there is no limit to the maximum number of shareholders in a

public limited company, expansion of business is easy by issuing new shares and

debentures. Companies normally keep part of their profits as reserve and use them for

expansion.

6 Public confidence: Companies are subject to Government controls and regulations.

Their accounts are audited by a chartered accountant and are to be published. This

creates confidence in the public about the functioning of the company.

7 Transferability of shares: The shares of the public limited company can be sold at any

time in the stock exchange. Shareholders can sell their shares whenever they want.

There is no need to take the consent of other shareholders. Thus, shareholders can

convert their shares into cash at any time without much difficulty.

8 Professional management: You know that the management of a company is in the

hands of the directors who are elected by shareholders. Normally, experienced perscins

are elected as directors. You also know that day-to-day activities are managed by

salaried managers. These managers are the experts in their respective fields. As

companies have large scale operations and profits, attracting good professional

managers is easy by paying attractive salaries. Thus, company form of organisation gets

the services of professionals on the Board of Directors and in various management

positions.

9 Tax benefits: Companies pay income tax at flat rates. There is no provision for slab

system in the taxation of companies. As a result, companies pay lower taxes on higher

incomes compared to other forms of organisations. Companies also get some tax

concessions if they are established in backward areas.

10 Risk diffused: As the membership is very large, the business risk is divided among the

several members of the company. This is an advantage for small investors.

Limitations I

1 Difficulty in formation: Promotion of a company is not as simple as proprietorships

and partnerships. A number of persons known as promoters should be ready to

associate themselves with it for getting a company incorporated. A lot of legal

formalities are to be performed at the time of registration. Promotion of a company is

expensive as well as complicated.

2 Lack of secrecy : The management of companies is usually in the hands of many

persons. Everything is discussed in the meetings of Board of Directors. Therefore,

compared to sole trader and partnership concerns, maintaining business secrets is

relatively difficult in a company form of organisation.

3 Delay in decision making: In company form of organisation all important decisions

are taken by either the Board of Directors or shareholders in their meetings. Hence.

decision makilig process is time consuming. If a quick decision is needed it will be

difficult to arrange meetings all of a sudden. So, some business opportunities may be

lost because of delay in decision making.

4 Neglect of minority interest: The representatives of the majority group of shareholders

become the members in the Board of Directors. The shareholders who are in minority

never get representation on the Board of Directors. As a consequence, the interests of

the minority members may be neglected and oppressed at the hands of the majority

group.

5 Concentration of,economic power: The company form of organisation gives scope for

concentration of economic power in a few hands. Some persons become directors in a

number of companies and formulate policies to promote their personal interests. The

shares of a number of other companies are purchased to create subsidiary companies.

Establishment of subsidiary companies and interlocking of  directorships have facilitated concentration of economic power in the hands of a few business houses.

Lack of personal interest: In sole proprietorship and partnership firms business is managed by owners themselves. In company form of organization, day-to-day management is vested with the salaried executives who do not have any personal interest in the company.  This may lead to reduced employee motivation and result in inefficiency.

More government restrictions: The company is subject to many restrictions from which the proprietorships and partnerships are exempted.  So, it has to spend considerable time and effort in complying with the various legal requirements.

Fraudulent management: There is a possibility that some unscrupulous promoters may float a bogus company, issue shares and collect money.  Later on, they can get away with the money by putting the company in liquidation.  It is also possible that the directors and professional managers may misuse the company resources for their personal benefit and bring losses to the company.

2.5 COOPERATIVE FORM OF ORGANISATION

Cooperative organizations are generally started by the poor and the economically weak sections to promote their common economic interests through business propositions.  The basic philosophy of cooperative organization is self-help and mutual help.  The primary objective of any cooperative organisation is to render service to its members.  In this respect, it is different from the other three forms of organizations which are primarily meant for making profits.  The important features of the cooperative organisation are service in place of profit, mutual help in place of competition, self-help in place of dependence, and moral solidarity (unity) in place of unethical business practices.

UNIT 3 FORMS OF BUSINESS ORGANISATION II

Contents:

Introduction

Requisites of an Ideal Form of Business Organisation

Comparison of Various Forms of Organisations

Criteria for the Choice of Organisation

Criteria at the Time of Starting a Business

Criteria at the Time of Expansion

Choice of Form of Organisation

Let Us Sum Up

Terminal Questions

INTRODUCTION

You learnt in previous chapter that there are four forms of business organisation, viz (i) sole proprietorship, (ii) partnership, (iii) joint stock company, and (iv) cooperative society. You have also learnt about the main features, merits and limitations of each of these four forms.

Sole proprietorship and partnership have the advantages from the point of view of control, secrecy, motivation, ease of formation, and low cost of organisation. But they suffer from the drawbacks of limited resources, limited managerial abilities with unlimited liability. The company form of organisation, on the other hand, has the advantages of more resources, limited liability and diverse managerial abilities. When you plan to set up a new business, you have to decide which form of organisation is more suitable for the proposed business. For this you have to critically analyse the suitability of each of the four forms of organisations in the light of the nature of the proposed business. This is a very crucial decision because it determines the power and responsibility of the entrepreneur and the division of profits and losses. Once it is chosen, it is very difficult and expensive to change it. In this chapter you will learn about the requisites of a good form of organisation, compare the four forms of organisations, analyse the factors influencing the choice of organisation form, and decide which form is the most suitable in a given situation.

REQUISITES OF AN IDEAL FORM OF BUSINESS ORGANIS ATION

Before we discuss how to select a particular form of business organization in a given situation, we should know the essentials of an ideal form of organisation. This may help you in the evaluation of each form of organisation in the right perspective and take the final decision about the choice of a particular form more judiciously. The requisites of an ideal form of organisation are as follows :

1.   Ease of formation: An important factor for preferring a particular form of organization to another is the ease with which a business can be brought into existence. The comparative ease of difficulty in forming a particular form of organisation mainly depends on three factors: (i) formation expenses by way of registration fee, stamp duty, fees of legal experts, charges involved in the drafting of documents, obtaining licenses, etc., (ii) legal formalities, and (iii) procedural delays, etc. Unless it is very essential, it is better to go for an organisation which is easy to form.

2.   Scope of raising capital: The choice of organisation mainly depends on the amount of capital required which is determined by the nature of business and the scale of operations. For example, if you want to open a retail shop in groceries, the amount of capital needed will not be much. But if you want to set up a sugar factory, you may require a large amount of capitaI. Ideal form of organisation is one which provides scope for raising the amount of capital as and when required.

3.   Extent of liability: You know that the element of risk and uncertainty is prevalent in each business. In view of this, normally, the businessmen prefer limited liability. Obviously, limited liability is considered as an important feature of a good form of organisation. However, a certain amount of risk is also found to be important to provide the needed spur for initiative, drive, and involvement in business. Many times, the absence of such spur leads to weakness, inefficiency and even dishonesty on the part of management personnel.

4.   Flexibility of operations: The form of organisation should be very flexible and adaptable to changing business conditions without much difficulty or complication. For example, if you want to expand your business, diversify or modernise the plant and equipment, the organisation should be able to meet all requirements.

5.   Stability and continuity: Stability and long life of business is desirable from the point of view of owners, employees, and customers. Employees always prefer a stable and continuous employment. If the business is stable, the owner should be able to formulate plans for the future and to make investments paying for a considerable length of time. From the customers’ point of view also, regular supply of goods and services is expected to meet their needs. An ideal form of organisation is one which provides reasonable amount of stability to the business.

6.   Effectiveness of management: As you know that the success of any business enterprise depends on the efficiency of management. Managerial efficiency depends on skills, motivation, flexibility, adaptability, etc. It is difficult for an individual to possess all these qualities.

7.   Extent of government control and regulations: If the governmental control and regulations are too many, the enterprise may have to divert a lot of time, money and energy for complying with legal formalities and instructions. In some cases there may be too much interference by the government officials in the day-to-day business of the firm. No doubt, the investors, creditors, and customers trust the business enterprises whose activities are properly regulated by the government. But too much government interference is not favoured by the entrepreneurs because it mars their initiative and disrupts the working of their business.

8.   Business secrecy: In business, it is important to maintain business secrets without leaking them out to competitors. Therefore, a form of organisation which enables, retention of business secrets is preferred to the one wherein business secrets are difficult to preserve.

9.   Tax burden: Business taxes like sales tax, excise duty, and customs duty are charged on certain products and services. Hence, such taxes affect all forms alike and they will not affect the choice. But the income tax liability is different from one form of organisation to the other. Naturally, the form of organisation which attracts the minimum amount of this tax liability is considered as an ideal form. From this point of view company form of organisation is considered to be best because it enjoys a number of tax reliefs which are not available in case of other forms of organisation.  

10.               Ownership prerogatives: Some persons have a very strong desire to control the entire business activities themselves and place a great value upon their right of personal leadership. Some persons are desirous of sharing the responsibilities and risks of a business. Some people may want to own a part of the capital without a strong desire to control the affairs of the business. You can also find some persons who are not ready to bear the business risk. An ideal form of organisation takes care of such prerogatives of the owners.

COMPARISON OF VARIOUS FORMS OF ORGANIS ATIONS

you have learnt that an ideal form of organisation should have the features of easy formation, limited liability, scope to raise enough capital, business secrecy, flexibility, stability in operations, less governmental controls, less tax burden, etc. You know there are four basic forms of organisations viz., (I) sole proprietorship, (2) partnership, (3) company, and (4) cooperative society. In the light of the above features identified for an ideal form of organisation, let us now compare the features of these four forms of organisations. With such comparison, probably, we can identify that form of organisation which fulfils all the ideal features.

If you carefully  analyse the merits and limitations of each form of business organisation you will realise that no single form of organisation is having all the ideal features. You can find each form of organisation having some of these features. Each form is good in some aspects and not good in other respects. For instance, sole proprietorship and partnership forms of organisations are considered good from the point of view of ease of formation, freedom from government regulations, ownership interest, retention of business secrets, etc. But the same features are not prevalent much in company form and cooperative form of organisations. Company form and cooperative form are ideal from the point of view of limited liability, scope of raising capital, professionalised management, continuity of life, etc. So, it is difficult to treat any one form as ideal in all respects and suitable in all situations.

CRITERIA FOR THE CHOICE OF ORGANISATION

By comparing the four forms, we realised that none of them is ideal in all respects. Each form of organisation is good in some respects and not good in other respects. It means that looking for one best form of organization will be like looking for a shirt that fits everybody in the family. Thus, a particular form of organisation which is suitable in one situation may not be suitable in other situations. So, the best form of organisation is one which fulfils the requirements of a particular business in a satisfactory manner. The basic consideration governing the selection is the attainment of the objectives decided upon by the entrepreneur. Since these objectives also vary from one business to the other, no single form of organisation can be considered as the best suited for all kinds of business. Now, let us analyse what considerations help us in making our choice of the form of business organisation. The decision regarding the choice of organisation assumes importance at two stages of a business.

a) At the time of starting a business.

b) At the time of expansion.

Criteria at the Time of Starting a Business

Choice of a suitable form of business organisation assumes great importance at the time of initiating or launching a new business enterprise because it is the form of organisation which ultimately determines the power and responsibility of the entrepreneur. The choice is dependent on the following factors.

1.   Nature of business: Choice of a suitable form of organisation is dependent on the nature of the proposed business. The organisational requirements are different for different types of business. For example, a big cement manufacturing activity and a retail cement shop cannot have the same form of organisation. Similarly, the form of organization suitable for a textile mill is not suitable for a tailoring shop.

2.   Volume of business: The expected volume of business also influences the decision about the suitable form of organisation. If the volume of business is small, you need small amount of capital and run less risk. In that case sole proprietorship may be quite suitable. But if the volume of business is large, you need more capital and run more risk which a single owner may find it difficult to cope with. So, partnership form or a company form would be considered more suitable.

3.   Area of operation: The area of operation of the business also influences the choice of form of organisation. If the area is limited and confined to a particular locality, the suitable form of organisation may be sole proprietorship. In case the area is widespread, the suitable form may be a joint stock company.

4.   Desire for control: The extent of control and supervision will also determine the choice of organisation. If it is desired to have a direct control over the business operations, a sole proprietorship or a partnership form of business should be adopted. In case if you feel that there is no need for direct control, the company form of organization is the best.

5.   Capital requirements: The form of organisation will also depend on the extent of financial requirements of the business. A business which requires a small amount of capital can be organised on sole proprietorship or partnership basis. But if the financial requirements are huge, then the joint stock company form of organisation may be preferred.

6.   Extent of risk and liability: You know business operations involve risk. If the promoters of a business enterprise are deterred by the risk involved, they will start the business on the basis of a limited liability. That means they can go for a company. In case they have capacity to bear the risk involved, it can he organised on sole proprietorship or partnership basis.

7.   Government regulations: As you know the governmental controls and regulations are more in company form and cooperative form of organisations compared to the remaining two forms. If you do not want too much government control and regulation, you should choose either sole proprietorship form or partnership form.

Criteria at the Time of Expansion

Growth is a normal phenomenon in business. When your business is successful, naturally, you may plan to expand it. The expansion programmes may have the following implications.

i)             Need for larger financial resources.

ii)            Need for internal reorganisation and control.

iii)          Need for specialised services like communicalion, accounting, marketing, etc.

iv)      Increase in governmental controls and regulations.

iv)          Increase in tax liability.

v)           Increase in the problem of control and coordination.

In fact the nature of these problems will depend upon the nature of the existing business and type of expansion programme undertaken. To implement your expansion programme, you can either continue with the existing form of organisation or adopt a new form of organisation. Whatever alternative you choose, it must be able to meet all requirements of expansion. If your existing business is organised as a sole proprietor concern, you can think about employing a manager or taking a partner. In case it is a partnership firm, you may have to choose between increasing the number of partners or converting it into a private limited company. Similarly, if your existing business is in the form of a private company, you have the choice of converting it into a public limited company or not.

 

CHOICE OF FORM OF ORGANISATION

On the basis of the above discussion, we can conclude that the small businesses like grocery stores, hair dressers, small restaurants and hotels, small auto workshops, stationery shops, confectionaries, bakeries, dry cleaners, shoe manufacture and suppliers, small electric and electronics repair shops, barbers, tailors, etc., are predominantly sole trade organisations. The reasons for preferring sole proprietorship form of organisation for these types of businesses are abundantly clear. They function on small scale, cater to the needs of a limited market or deal with a restricted number of customers or dealers, and require a very limited capital. Moreover, they require the personalised attention of the owners to deal with a face-to-face situation. The managerial supervision can be tackled easily by the owner himself and the owner generally likes to be his own boss and active manager.

Business on a relatively larger scale is generally organised as partnership firm. Service enterprises like auto workshops, larger restaurants and hotels, large scale retail houses and medium scale industrial organisations are generally organised under partnership form. In these cases the entrepreneurs would like to pool their capital, skills, experience, etc., as partners of a firm. The internal organisation of such undertakings is looked after by the partners who specialise in a particular activity in the enterprise.

In those enterprises where the risk involved is quite significant and scale of operation is medium, the likely choice will be the private company. Transport undertakings, hire purchase units, finance and leasing companies, medium scale manufacturing companies are generally organised as private limited companies. In these undertakings the requirements of

capital are larger as compared to those of a partnership firm. For large scale business operations, the most suitable form of business organisation is the public limited company. The large scale manufacturing plants, large transport undertakings, engineering and electronic companies, departmental stores, multiple shops, etc., are usually organised on the basis of public limited company.

The principal reasons are the necessity of larger capital and the large amount of risk involved.

On the other hand, the cooperative form of organisation is suitable when the interest of a particular segment of society is to be promoted. Thus, the cooperative form of organization is used largely for consumers, producers, farmers, etc.

LET US SUM UP

The features of an ideal form of business organisation are ease of formation, limited liability. scope to raise enough capital, maintenance of business secrecy, flexibility, stability in operations, less governmental controls, less tax burden, higher managerial efficiency, and more ownership interest.

Comparison of the four forms of organisations shows that none of these forms have all the ideal Features. Each form of organisation is good in some respects and not good in other respects. Sole proprietorship and partnership forms are ideal from the point of view of ease of formation, governmental controls, ownership interest, business secrecy, and flexibility.

Company and cooperative forms are ideal from the point of view of limited Liability, scope of raising capital, managerial efficiency, stability, and continuity of operations.

As none of the four forms is ideal in all respects, the entrepreneur has to choose the suitable form of organisation in the light of the objectives of his business. For choosing a suitable form of organisation at the time of launching the new business, the entrepreneur has to consider the nature of business, volume of business, ark of operation, capital requirements, degree of control desired, expected life of business and desired level of governmental regulations. At the time of the expansion, depending on the situation, the entrepreneur can either continue the existing form or adopt a new form or organisation. Raised on the analysis it is concluded that the sole proprietorship is the suitable form for small business. If business is relatively larger, partnership is the proper form of organisation. Private limited company is ideal for medium sized business’ and public company is suitable for large scale business. The cooperative form of organisation is suitable when the interest of a particular segment of the society is to be looked after.

BUSINESS PROMOTION

4.1 Introduction

In the previous tutorials you have learnt about the nature of business activities, the types of business in which individuals and groups of individuals may be engaged, and the different forms in which business activities may be organised. You know in business field a variety of goods and services are dealt with in small shops, large stores, small workshops and large factories. Have you ever enquired how these business activities were started? Who started them and what kind of ideas they had while taking their decision to set up a business?  Certainly, some individuals or groups of individuals must have thought of those businesses to start with.  If your family in running a business, it is possible that your father or grandfather thought about it and then took steps to set it up.  If it is a manufacturing business, a factory building must have been constructed, machinery, supply of raw-materials must have been arranged, workers recruited and availability of power, water, etc., also assured.  For all these purposes, those who started the business must have arranged capital to meet the necessary expenditure.  In other words, every business is the brain child of someone.  That someone is called ‘entrepreneur’, In this unit, you will learn who an entrepreneur is, what are the characteristics and functions of an entrepreneur, the role of an entrepreneur in business promotion, difference between entrepreneur and promoter and various types of promoters. You will also learn how various forms of business organisations are promoted and what steps are taken by promoters to set up the business.

4.2 An Entrepreneur

An entrepreneur is one in whose mind the idea of doing business of a particular type first takes shape. He is on the lookout for business opportunities and is a good judge of which products will sell. He is imaginative and is guided by a strong sense of achievement. He is not afraid of future uncertainties. He is prepared to take risk and face challenges. Above all, an entrepreneur is one who creates something new, something different. He innovates and combines resources in the form of men, materials and money and brings them together to make the business venture profitable.

4.2.1 Entrepreneurship

What the entrepreneurs do may be regarded as ‘Entrepreneurship’. In other words, entrepreneurship is the act of being an entrepreneur. The word entrepreneurship is actually derived from the French term ‘entrepreneur’ which means to undertake, to pursue opportunities, to fulfil needs and wants of people through innovation and starting business. The entrepreneur is the person who does all this. He undertakes a venture, organises it, raises capital to finance it and assumes the whole or major part of the risk of business. Thus, ‘entrepreneurship is the process of giving birth to a new business’.

Innovation and risk bearing are the two basic elements of entrepreneurship. Hence you must know the exact connotation of these terms.

Innovation: If a business activity does not require anything special to be done, it is not entrepreneurship. In fact a person cannot be called an entrepreneur unless he introduces something new, something different, in his venture. This is known as innovation, that is, doing something different from others. The entrepreneurs are constantly on the look out for something unique to fulfill the need or want of people. They may or may not be inventors of new products or new methods of production, but they are able to foresee the possibility of making use of the invention for business. Others who come to know about the same invention are not capable of thinking about its practical usefulness in business. Or, they may not have the ambition or self-confidence to take advantage of it.

In a competitive market, an entrepreneur can succeed in his business only through innovation. An innovation need not necessarily be something big or dramatic. A simple adjustment to something old, or giving a service without extra charge while selling a product, or a colorful packaging, or selling a product in packets of different weights, and such types of steps may be profitable innovations. Of course, if similar things are done by a number of producers and sellers, an entrepreneur has to think of other types of innovations. Thus some innovations may lead to other innovations. No wonder that imagination is sometimes more important than knowledge for innovative thinking. An entrepreneur must have imagination and also the ability to think creatively.

Take the case of fruit juice. Now a days, fruit juice is sold in small cartons instead or bottles so that you can carry it and throw away the container after drinking the juice. This is innovation. Let us take another example. You may have heard of Henry Ford who established the Ford Motor Company in the United States. He did not invent the automobile, but he applied new methods of mass production and turned out passenger cars at low cost so that many people could afford it.

Risk Bearing: Risk bearing is another aspect of entrepreneurship that every entrepreneur has to cope with. One who is an entrepreneur must be a risk taker, not a risk-avoider. In fact starting a new business always involves risk because money is invested for profits in future. To try anything new is also risky. A new venture may not bring the expected profits or may fail and run into losses. It may happen because of increasing competition, a change in customer preferences, shortage of raw material supply, or sudden unexpected calamities. But an entrepreneur is bold enough to assume the risks. He is prepared to take risks for the reward. Even if he fails in one venture, he persists, and this helps him to succeed.

4.2.2 Characteristics of an Entrepreneur

If you read business history, you will come across the names of many persons who may be called entrepreneurs. Rockfeller and Henry Ford of the United States, Karl Benz and Gottfried Daimler of Germany, Soichiro Honda of Japan, are well-known names of entrepreneurs, who started industrial organisations and made fortunes, In our country, J.N.Tata, G.D.Birla, Kirloskar and others have set up successful manufacturing industries. Small business firms have often succeeded because of the part played by entrepreneurs. It may be useful to know whether they had anything common as regards their personal characteristics. It has been found that there are certain elements in the character of entrepreneurs which are usually prominent in them.

1.         Independence:         Many entrepreneurs who started their businesses resisted being pigeonholed or Following routine habits. In fact, entrepreneurs become frustrated when they have to follow someone else’s direction. They have to be the boss. They like to be in control. They find it difficult to work under the direction of others.

2.         Hard Work:    Willingness to work-and work hard-is an outstanding trait of entrepreneurs. You can bet that the successful business owner has paid with tedious, sweat-filled hours, emotional stress, and perseverance. Most likely the business verged on failure many times in the beginning, but the owner simply would not let it die. A successful entrepreneur described his early experiences that they worked endless, twelve hour days and sometimes seven days a week. You might say it was his whole life.

3.         Desire-to Achieve Goals:    They have a strong desire to overcome problems and setting up successful business ventures which eventually give adequate profits. They considered profit as a measure of their achievement and performance rather than making money alone.

4.         Foresight and Dynamic Outlook:  Basically, these people have wide knowledge about business environment i.e., market, consumer attitude, technological development, etc. Further, they are dynamic in forecasting business uncertainties and risks, accordingly, they take quick and sound decisions.

5.         Open-mindedness:  They are intelligent in predicting changes in business environment. However, they never resist changes because they know that they cannot stop it. Therefore, they are habituated to open-mindedness even though sometimes they lose crores of rupees due to changes in consumer tastes which ultimately forced them to change their technology, etc.

6.         Optimistic Outlook:   They are generally inclined to believe that present problems are of a temporary nature and conditions will be more favourable in due course. Entrepreneurs are always eager to achieve their goals in the best possible manner, to get outstanding results which they can be proud of.

7.         Working Relationship :       The success of a business mostly depends upon its workers first rind then their links with other business undertakings. Most of the successful business entrepreneurs have had harmonious relationships with others. This builds up their reputation in the market.

8          Good Organisers :    They are good at bringing together different types of resources needed for starling a business and making it operationally efficient. They can convince people about the prospects of business, get their cooperation, raise funds, procure machinery, arrange supply of materials, select right type of employees and coordinate various activities relating to the business.

9.         Innovative Aptitude:            Most of the successful entrepreneurs have innovative aptitude. They spend part of their income on research and innovative activities so that they offer suitable products to meet the demands of consumers. Some of our industrialists like Tata, Birla, Kirloskar, etc. have established their own research centres.

4.2.3 Functions of an Entrepreneur

Having read the preceding pages of this unit, you must have started thinking about the functions of an entrepreneur. Essentially, what the entrepreneur does is to recognise the possibility of starting a business which may be profitable. Then, he prepares a plan of action, and steps to be taken to set up the business, and eventually undertakes the operation of the business. Of course, depending upon the nature of business that is in view, the functions will differ. Let us see functions of an entrepreneur who is looking for Opportunities to engage in production activity.

1.         Develops an idea and explores opportunities:          The idea of forming an business unit is first formed in the creative mind of the entrepreneur. On the basis of the idea he perceives opportunities for profitable investments and explores the prospects of starting a manufacturing enterprise.

2.         Product analysis and market survey:   He collects data on consumer preferences and needs through market research techniques and to find out the salability of the proposed product. Further, he collects consumer preferences in respect of design, colour, size, and shape. In addition, the entrepreneur gathers the total demand and the degree of competition for the proposed product.

3.         Decides form of organisation:    He decides the form of business ownership, i.e. whether it should be a sole proprietorship, a partnership firm, a company or a cooperative society.

4.         Decides location:               He decides location of the factory at a suitable place taking into account the available facilities of transport, power-supply, fuel, water, labour, supply of raw-materials, nearness of market, etc.

5.         Collects necessary capital:         He makes available sufficient amount of capital for the initiation and continuation of the business. He gives personal guarantees to the financiers who contribute capital. Otherwise, he promises to invest capital himself or arrange the necessary amounts from friends and relatives. In case of small enterprises, the promoters can provide funds from their own savings. But in case of large enterprises, funds have to be raised from various sources like general public, commercial banks, financial institutions, etc.

6.         Places orders for machinery: He places orders for machinery, equipments and other requirements. He takes decision about the installation of equipment and machinery in the process of production.

7.         Recruitment of labour:      As an entrepreneur he makes an estimate of skilled and unskilled workers of .different categories required for various departments. Accordingly, the entrepreneur arranges their recruitment.

8.         Designs internal organisation structure:         He designs internal organisation structure for his proposed concern. This involves breaking up of the total work of the enterprise into major functions like production, marketing, finance, personnel, purchase, engineering, etc. and the dividing of each of them into sections. He stipulates the functions of different departments and their inter-relationships.

9.         Fulfils formalities and launches enterprise:    Every type of business has some procedural formalities while starting a new enterprise. The formalities are different for different types of business organisations. Unless you fulfil them you cannot simply launch an enterprise. You will learn about procedural formalities later in this unit.

Thus, the role of an entrepreneur is that of an initiator and promoter. In a sense, the role of an entrepreneur is also that of an expert having knowledge of product, market conditions and of the practical aspects of running a business. He should not be simply an imaginative thinker but also have the ability to judge what kind of business will click. His role is indeed crucial for the eventual success of a business. When an enterprise has been launched and it turns out to be profitable, the entrepreneur may decide to leave it, give up his ownership tights, and hand it over to others to run it. Many entrepreneurs in the past have done so. They have been attracted by new opportunity and more profitable lines of business. But many entrepreneurs have continued to run the business they started taking every opportunity of expanding the original venture, adding new activities, making current operations more efficient, and deriving satisfaction from their achievements.

But you will agree that it is the initial phase which is most important for the success of a venture. It is at this stage that the future of a business is decided. The basic responsibilities of an entrepreneur include the ability to seize an opportunity, to innovate, explore the, prospects of profitable business, and then to complete legal formalities, raise, funds and finally manage the business are the basic responsibilities ‘of the entrepreneur. He has to face many obstacles, many problems and difficulties in the course of promoting business. He has to take decisions which may have long-run implications. An entrepreneur has thus to undertake many things. But the most important of these are: (i) innovation, and (ii) risk-bearing.

4.3 PROMOTION

A business enterprise does not come into existence on its own. It is the result of the efforts of an entrepreneur who conceives the idea based on his knowledge of business opportunities and takes necessary steps to launch the business venture. He is also known as promoter. As a promoter, he assembles the required funds and people, and serves both as a mother and mid-wife to the enterprise. Thus, the promoter is the Kingpin of business as he/she undertakes the risk and gives a concrete shape to business propositions. Promotion may be undertaken for the purpose of setting up a new business, for the expansion of an existing business, or for combing two or more business firms.

4.3.1 Distinction between Entrepreneur and Promoter

Sometimes a distinction is made between ‘entrepreneurs’ and ‘promoters’ of business. Those who are innovators and risk-bearers are strictly known as ‘entrepreneurs’ while those who take steps to set up the business and make it operational are known as ‘promoters’. In actual practice, however, this distinction does not hold good.  Entrepreneurship (act of entrepreneurs) does not remain confined only to recognition of business opportunities and preparedness to do something new. It does not end with the entrepreneur undertaking to bear the risks of business. It includes planning for the business and taking necessary steps to put it into operation. After all, a business becomes a business only when it gets going. Thus, in a wider sense we cannot make a difference between the role of an entrepreneur and the role of promoter.

4.3.2 Types of Promoters

There are various types of promoters. They are classified as professional promoters, financial promoters, entrepreneurial promoters, institutional promoters and government.

1.         Professional promoters: These are specialists in forming new business enterprises. After promoting an enterprise they eventually handover the control and management to the shareholders of the company.

2.         Financial promoters:         These promoters float new enterprises during favorable conditions in securities market. They are people who have financial stability and are looking forward to new opportunities for investment.

3 .        Entrepreneurial promoters:         These promoters conceive the idea of a new business unit, do the necessary preliminary work in setting up the business unit and ultimately control and manage the same. In India most promoters belong to this category.

4.         Institutional promoters: There are some specialised institutions like Industrial Development Bank of India, National Industrial Development Corporation, etc., which are providing technical, managerial and financial assistance for the promotion of new enterprises. These institutions collaborate with other entrepreneurs to launch the enterprises.

5.         Government:           Since independence, Government of India has emerged as a big promoter of enterprises. It has promoted several enterprises in different fields such as ordnance factories, heavy eleclricals, shipping, iron & steel, fertilizers and pesticides, oil and natural gas, etc.

4.4 PROMOTION OF DIFFERENT TYPES OF

ORGANISATIONS

You have already studied the role of an entrepreneur in setting up a business. The promoter decides the product or service which has a market, and then takes necessary steps for launching a business venture. Before launching the business enterprise, the promoter takes decision about the form of business ownership. Will it be under single ownership or joint ownership? If it is to be under joint ownership, will it be a partnership organisation or a joint stock company? The steps that he has to take in launching the business will naturally depend upon the form of organisation. The formalities-particularly the legal formalities necessary to start the business will be different in each case. Let us first see what is required to be done to promote a business venture under single proprietorship and partnership firm.

4.4.1 Proprietary Concern

When a business is decided to be set up under single ownership, there is practically no legal formality involved. Of course, to run certain types of business activities permission has to be obtained from the Government or local authorities. For instance, to open a restaurant, the individual proprietor has to get the permission from the Health Department of the Municipal Corporation. To start a workshop or factory, the proprietor must get the permission of the Director of Industries through the District Industries Centre. A business may also be owned by a Joint Hindu Family. In such a business, the head of the family, known as Karta has full control over the income and expenditure of the business. and controls the business activities just like an individual proprietor. In fact, a joint hindu family business generally comes into existence when the head of the family dies and the members of his family decide to continue the family business through the senior most member of the family. This form of organisation of business also does not require any legal formality.

4.4.2 Partnership Firm

You know that partnership is the relatioiship between two or more persons who have agreed to share the profits of a business. The business may be carried on by all or by any of them acting for all. Collectively those persons are known as ‘a firm’ and individually they are known as ‘partners’. The agreement between the partners may be oral or in writing. A partnership business comes into existence as a result of an agreement between two or more persons. Hence, a partnership firm has no separate existence in the eyes of law. It has no independent legal­­ existence. No legal formality is, thus, required to launch a partnership business and to run it.

However, if the partners desire, a partnership finn can be registered with the Registrar of Firms by filling up a form of application. A fee of Rs. 3 is to be paid for that purpose. Registration of partnership is not compulsory under the law. But it is desirable because an unregistered firm is not permitted to file a law suit or start other legal proceedings against any third party to recover its claims. Moreover, no partner of such a firm can file a suit to enforce his rights against other partners under the partnership agreement, although third parties can, file suits against the firm as well as the partners.

Before starting a partnership business, the partners come to an agreement about their mutual rights and obligations. If it is an oral agreement there is always a possibility of misunderstanding or dispute among the partners as regards their respective rights and liabilities. To avoid any dispute in future, it is advisable that the agreement should be in writing. The written agreement is known as ‘partnership deed’. It should be drawn on a stamped paper and signed by all the partners. The partnership deed should contain the nature and place of business, duration of partnership, capital to be contributed and share of profits of each partner, rights, duties and obligations of partners, salary payable to any partner, and all such clauses as may be agreed upon.

4.4.3 Joint stock company

You have learnt that a company is an association of persons. So, there must be more than one person to slart a company. A partnership firm also must have more than one person involved in the business. But legally speaking, a partnership firm has no existence apart from its partners. On the other hand, a company after it is formed acquires a separate legal identity. It is regarded in law as a separate entity distinct’from the members who join it. Because of this feature, the promotion of a company requires a number of legal formalities to be completed before it can be established. One or moie promoters can take the responsibility of bringing a company into existence. The Indian Companies Act, 1956 contains provisions regarding the legal formalities for setting up a company. You know that from the point of view of ownership, mainly two types of companies can be formed under the Companies Act-private company and public company. The promoters have to decide which type of company they would prefer to form. For the purpose of running a business, promoters generally want that the liability of members should be limited to the amount of capital that they agree to contribute.

Accordingly, the company decided to be set up may be a private limited company or a public limited company. Whether it is a private limited or a public limited company, it is necessary that the company is duly registered under the Companies Act. The official appointed for the registration of companies is the Registrar of Companies. For each State or group of States in India, there is a Registrar of Companies. For instance, there is a Registrar of Companies for the Union Territory of Delhi and Haryana. His office is in New Delhi. Let us see what the promoters have to do for the registration of a company,

Registration of a company

Registration of a company is also known as incorporation. A company is said to be incorporated when it receives the certificate of incorporation from the Registrar of Companies. The certificate of incorporation is a conclusive proof of the fact that a company bearing a specific name has been lawfully formed. The promoter has to take the following steps for obtaining the Certificate of Incorporation—

1.         Selecting a name for the company

2.         Preparation and printing the documents to be filled

3.         Filing the documents with the Registrar of Companies

Let us now take up these aspects one by one.

1.         Selecting a name: Every company to be registered should have a name by which it will be known for legal and business purposes. The promoters generally select a few names and ascertain from the Registrar’s office whether these names are available. For this purpose an application on a prescribed form is submitted to the Company Law Administration, Government of India, through the Registrar of Companies for approval. The promoter can then adopt any name from the list of approved names. It is also necessary to include the words ‘Limited’ and ‘Private Limited’ in case of public limited company and private limited company respectively.

2.         Preparation and printing of documents: After the name of the company has been approved and adopted, the promoters have to get the following two documents prepared and printed

:

a)         Memorandum of Association

b)         Articles of .Association

Memorandum of Association:    It is the most important document of a company as it lays down the constitution of the company and states the relationship of the company with the outside world. It is a public document and each person who deals with the company is supposed to know the provisions contained in the memorandum. The purpose of memorandum is to enable the shareholder, creditors and those who deal with the company to know what is its permitted range of activities. Although the company is a legal ‘person’ its capacity to do business, unlike that of a real person, is restricted. If a company is engaged in any trade or business which is outside the provisions of the Memorandum of Association, such acts are regarded ultra vires of the company and therefore, void and inoperative.

The Memorandum of Association contains the following particulars under different clauses.

i) Name of the company

ii) Name of the state in which the registered office is to be located.

iii) Objects clause- The nature of business activities which the company will undertake is to be stated in this clause.

iv) A declaration that the liability of’ the members will be limited to the face value of shares subscribed.

v) Capital clause-The total amount of capital with which the company is proposed to be registered and its divisions into different shares of a fixed amount are to be stated under this clause.

vi) A declaration by signatories to the Memorandum that they are desirous of being formed into a company and agree to take the number of shares mentioned against their names.

The Articles of Association:        It contains the rules and regulations relating to the management of its internal affairs. They define the rights, powers and duties of the management, the mode and form in which the business of the company is to be carried on and the manner in which changes in the internal regulations of the company may be made from time to time. Articles lay down the relations between the company and its members and between the members. A public company limited by shares may register its own Articles of Association or adopt Table A containing the model set of 99 articles given in Schedule I of the Companies Act. Other types of companies must prepare and file their own Articles of Association along with the memorandum at the time of incorporation. The Articles of Association must not contain anything contrary to the Companies Act, the public policy, the Memorandum of Association and the general  law of the land.

3.         Filing of documents for registration: After preparing and printing the Memorandum of Association and Articles of Association, the promoters make an application to the Registrar of Companies and file the following documents :

i) A copy of the Memorandum of Association

ii) A copy of the Articles of Association

iii) A-list of persons who have agreed to become director of the company with their names, addresses, age and occupations. In case a separate list of directors is not filed, signatories to the Memorandum of Association will be deemed to be the directors.

iv) Written consent of the directors to act in that capacity, duly signed by each director, along with a written undertaking to take the prescribed qualification shares, if any. A company without share capital and a private company need not file this document.

v) A statutory declaration stating that all the legal requirements with respect to incorporation have been duly complied with, This declaration should be signed by an Advocate of a High Court or of the Supreme Court, or by a practicing chartered accountant or by a person named as director, manager, or secretary of the company.

vi) Notice of the registered office of the company. However, this notice may be filed within 30 days of incorporation.

Along with the above documents, the Memorandum of Association and the Articles of Association must bear stamp duty as per the Indian Stamps Act. The promoters have also arranged payment of registration fees and filing fees at the time of submitting the application. If the Registrar upon scrutiny of the documents finds them to be in order, he issues the certificate of Incorporation in favour of the company. The company becomes a separate entity in law when it gets the Certificate.

Commencement of Business

A private limited company can commence business activities as soon as it is registered. The promoters of such a company raise the amount of capital necessary from their friends and relatives either against shares issued or in the form of loan. The general public cannot be invited to contribute to the capital.

For a public limited company, however, business activities cannot be started immediately after registration. It has to obtain a Certificate of Commencement of Business from the Registrar of Companies for which a number of additional steps have to be taken by the promoters. They are as follows :

1.         Preparation and registration of Prospectus or a Statement in lieu of Prospectus: After the company has been incorporated, it is necessary for the directors to raise necessary capital for the company. Generally, shares of fixed amount are decided to be issued to the public to raise the amount of capital required. The document which is prepared to invite the public to subscribe to the shares of the company is known as Prospectus. In fact, the prospectus includes all such information about the company which may be of interest to the people who are likely to subscribe to the capital. The content of the prospectus have been specified in the Companies Act, so that the promoters may not suppress anything or mislead the public. A copy of the prospectus is required to be filed with the Registrar for registration before it is issued to the public.

A private limited company does not have to issue a prospectus to raise its capital since it is not permitted under law to invite the public to subscribe to its shares. However, it is not compulsory even for a public limited company to issue prospectus unless it decides to approach the public for raising its capital. If the promoters decide not to approach the public for raising the necessary capital but to arrange subscription of capital by their friends or relatives or through underwriters, it is not necessary for them to issue a prospectus. In that case, a Statement in lieu of Prospectus must be filed with the Registrar. The contents of such a statement are virtually the same as those of a Prospectus. The Statement must be signed by all the directors of the company and filed with the Registrar.

2.         Subscription and Allotment of Shares: If public offer for sale of shares and debentures exceeds Rs. 1 crore, the company must obtain the permission of the Controller of Capital Issues, New Delhi.After obtaining such permission and the registration of prospectus with the Registrar, the company can invite public to subscribe to its shares. The companies usually appoint brokers through whom they approach the public for subscription. The brokers issue prospectus and application forms to the prospective investors. The company also appoints some banks who receive the applications from the public along with the application money and credit the amount to company’s account specially opened for the purpose. After the issue is closed, the Board of Directors decide the basis of allotment in consultation with the stock exchange authorities and pass a formal resolution for allotment. On the basis of the resolution the Secretary of the company issues letters of allotment to the subscribers. If the subscription exceeds the amount of capital to be raised, the excess is refunded to the subscribers involved. After the allotment exercise is over, the Secretary submits a Return of Allotment to the Registrar of Companies.

One of the important conditions to be fulfilled by a public limited company before it can apply for the Certificate of Commencement of Business is that it must have received share applications for the minimum subscription as indicated in the prospectus. Minimum subscription is defined as the minimum amount which in the opinion of the directors (or the signatories to the memorandum) must be raised by issue of shares to meet the following expenses :

i) purchase price of any property bought or to be bought which is to be paid out of the

proceeds of the share issue;

ii) preliminary expenses;

iii) repayment of money borrowed in respect of the above matters;

iv) working capital required; and

V) any other payment that may be specified.

If the amount of capital subscribed by the public is less than the minimum subscription or the company could not obtain minimum subscription within 120 days of the issue of prospectus, all money received from the applicants have to be refunded and no allotment can be done.

3.         Declaration of Compliance: When all the formalities in respect of the public issue have been completed, the company will have to file a statement with the following declarations with the Registrar :

i) That the shares payable in cash have been allotted up to the amount of minimum subscription as stated in the prospectus.

ii) That every director has paid in cash the application and allotment money on his shares in the same proportion as others.

iii) That no money is liable to become refundable to the applicants by reason of failure to apply for permission for shares and debentures to be dealt in on any recognized stock exchange.

iv) The statutory declaration by the Secretary or one of the directors that the above requirements have been complied with.

A company which has not issued a prospectus can submit the declaration immediately after the statement in lieu of prospectus has been filed and other conditions have been fulfilled. A private limited company is not required to submit any declaration, as it is permitted to commence business, immediately after incorporation of the company. The Registrar of companies will scrutinise all these documents and if satisfied, he shall issue a ‘Certificate of Commencement of Business’. After this, the company is entitled to commence business and borrow money from the date of issue of the certificate. Look at Figure 4.1. It gives a bird’s eye view of the procedure involved in the formation of private and public limited companies.

4.4.4 Cooperative Society

We have so far discussed the promotion of business organisations of three types: proprietary concerns, partnership firms and companies, There is another form of organisation which is quite common these days, i.e. cooperative society. A cooperative society is a form of organisation wherein persons voluntarily associate together on the basis of equality; They pool their resources and work together. They undertake production or distribution of goods and services with the motive of mutual benefit rather than profit.

You know that at least ten persons are required to form a cooperative society. Every cooperative society must register itself with the Registrar of Cooperative Societies, appointed by the Government under the Cooperative Societies Act. The promoters of a

Cooperative Society have to take the following steps to get it registered :

1.         Make an application to the Registrar of Cooperative Societies stating in it the name of the proposed society, its objects, and particulars about its share capital.

2.         Prepare the Bye-laws ( rules and regulations) of the Society (similar to the Articles of Association of a Company) to be submitted along with the application for registration of the society.

3.         The application and the Bye-laws have to be signed by the promoters. The Registrar scrutinises the objects and bye-laws and, if he is satisfied, issues a ‘Certificate of Registration’. The name of the society is entered in the Register of Cooperatives. Thereafter, the society becomes a separate legal entity just like a company. It can acquire assets in its own name, enroll new members, and engage in its business activities. Thus, the promotion of a cooperative society does not require many legal formalities to be complied with. The promoters can set up a cooperative society with ‘Limited’ liability of its members. But it can be registered only if its object is to serve the economic interest of its members through mutual help. There is no maximum limit fixed as regards the number of members for the cooperative society. Its shares are not transferable. Since, the policy of Government is to encourage development of cooperative organisations, certain concessions are given to cooperative societies, such as exemption from registration fee and stamp duty, income tax, etc.

4.5 LET US SUM UP

Entrepreneur is a person who undertakes the risk of starting and managing a business by bringing together necessary resources. He conceives the idea of starting an enterprise and explores the prospects of starting a new enterprise. He arranges everything required to set up a business unit i.e., funds, land, people, machinery. The entrepreneur retains strong values of independence and is motivated to work harder than the most people. He is not afraid of ‘ future uncertainties. He is always optimistic in outlook and dynamic in taking decisions. He always tries to introduce something different from others in his venture. Innovation and risk bearing are the two basic elements of entrepreneurship.

Promoters can be divided into professional promoters, financial promoters, entrepreneurial promoters, institutional promoters and Government. Entrepreneur decides the form of business ownership and takes necessary steps in launching the enterprise.

The formalities required to start an enterprise are different for different organisations. The promotion of a sole trading concern does not involve many legal formalities. The same thing is true of a partnership firm. The registration of firm is not compulsory but it is considered desirable because otherwise it suffers from certain disabilities. Promotion of a joint-stock company involves a number of legal formalities. It must be registered with the Registrar of Companies. After selecting a name for the proposed company and getting it approved by the Government, the promoter has to arrange the preparation and printing of the Memorandum of Association and Articles of Association for the company. Then he files an application submitting these two documents, a list and the consent of directors and a statutory declaration to the effect that all formalities have complied with. He also pays the registration fee. If everything is in order, the Registrar issues a Certificate of Incorporation. A private limited company can commence business as soon as it receives this certificate. But a public limited company cannot start its business until it gets the Certificate of Commencement of Business. For this again the company has to comply with a number of formalities including issue of prospectus, raising the capital, submitting returns of allotment and a statutory declaration that all conditions have been duly satisfied.

A cooperative society is also a corporate body and involves certain legal formalities before it is registered by the Registrar of Cooperative Societies. But as compared with a company the procedure for its registration is much simpler.

NATURE AND SCOPE OF BUSINESS

1.1 INTRODUCTION

In our day-to-day life, we use words like business, commerce, trade. industry, etc. quite often. These words have a definite meaning in ‘Business Organisation’. In this introductory unit, you will learn the exact connotation of such terms. You will also learn the distinction between economic and non-economic activities, objectives of business, the classification of business activities, importance of ‘organisation and the role of entrepreneur in business.

1.2 HUMAN ACTIVITIES

All of us participate in various kinds of works from the time we get up from bed in the morning till the time we go to sleep at night. We get up from bed in the morning; brush our teeth, take bath and get breakfast. Then children go to school or college to study, elders go

to office or factory or shop or field to work, and housewives work at home. In the evening all of us come back home, take food and sleep. All the activities in which we, thus, participate from morning till night are called ‘human activities’.

If you closely examine the human activities, you will find that some of these produce economic benefits e.g., working in a factory or in an office or at the farm,. Some other activities like brushing teeth, taking breakfast, going to school, playing, cooking food for the family, etc., do not produce any direct economic benefits. Thus we can classify the human activities into two groups: (1) no-economic activities, and (2) economic activities. .

1 Non-economic activities: These are the activities which are conducted by the human beings due to love and affection, social obligation, religious obligation, physical requirement, patriotism, etc. but not for earning money. The housewife cooking for the family, children going to school and playing games, people going to a temple or a mosque for prayer, a social worker working for the uplift of the poor, etc., are some such examples. Persons who participate in such activities do not get any direct economic benefit.

2.         Economic Activities: These are activities which are undertaken by human beings for earning money or livelihood. These economic activities are concerned with production, exchange and distribution of goods and services. For example, a doctor working in the hospital, a teacher working in a school, an employee going to his office, a farmer working in the field, etc. They are all doing this to earn his or her livelihood or to acquire wealth.

We can further classify these economic activities into three groups: (a) business, (b) profession, and (c) employment.

a) Business: Any activity carried primarily with the object of earning profit can be called a business activity. This objective of earning profit is achieved by production and/or exchange of want satisfying goods and services. Therefore, we can define business as “any activity concerned with the production and/or exchange of want satisfying goods and services carried with a view of earning profit”. Production of soaps, sale of eggs, production of TV sets, transport, etc., are some examples of business. A person who is engaged in business is called a businessman or entrepreneur. Similarly, a firm formed for the purpose of carrying a business activity is called a business enterprise or a business firm. You will learn in detail about business later in this unit.

b) Profession: An activity which involves the rendering of personalised services of a specialised nature, based on professional knowledge, education and training is called a profession. Services rendered by doctors, lawyers, chartered accountants, etc., come under this category. Generally, for each category of profession, there would be a professional body. For example, Bar Council of India is the professional body of lawyers which guides and regulates the law profession in India. The professional body prescribes the nature and type of educational qualifications and training required to practice the concerned profession. A professional should become the member of concerned professional body and follow the code of conduct prescribed by such body. Professionals charge some fee for the professional service they render.

C) Employment: Any activity assigned to a person by the employer under an agreement or rules of service comes under the category of employment. A person who undertakes such activity is called employee. For performing such activity, the employee receives remuneration from the employer in the form of wage or salary, allowance, bonus, etc. The employment is also called ‘service’. Working in a factory, office, hotel, college, etc., are a few examples of employment. Even professionally qualified persons also work as employees in various organisations. For example, doctors employed in government/private hospitals, engineers employed in a factory, etc.

Although business, profession and employment are distinguished from each other, they are also inter-dependent. Business enterprises provide employment to a large number of people in the, country. Similarly, professionals like engineers, chartered accountants, cost accountants, management consultants, legal experts, doctors, etc., work with the business firms for tackling complicated technical problems. Thus, business enterprises provide ’employment opportunities to professionals and general public. At the same time the success of the business is dependent on its employees and professionals working with it.

1.3 BUSINESS

You have learnt that the entire range of economic activities of the human beings could be classified into business, profession and employment. Among these three categories, profession and employment, though important, are outside the scope of this course. We are primarily concerned with business. So, let us discuss about business in more detail.

1.3.1 Essential Features of Business

You have learnt that business refers to the human activities engaged in production and/or exchange of want satisfying goods and services carried with the intention of earning profits. Now let us study the important characteristics of business. We can list the following five broad features of business.

1.         Dealings in goods and services: Business deals with goods and services. The goods may be consumer goods such as sweets, bread, cloth, shoes, etc: They may be producer’s goods such as machinery, equipment, etc., which are used to produce further goods for consumption. Business also deals with services such as transport, warehousing, banking, insurance, etc., which are intangible and invisible goods.

2.         Production and/or exchange: You can call an economic activity a ‘business’ only when there is production or transfer or exchange or sale of goods or services for value. If goods are produced for self-consumption or presentation as gift, such activities shall not be treated as business. In a business activity, there must be two parties i.e., a buyer and a seller. Such activity should concern with the transfer of goods or exchange of goods between a buyer and a seller. The goods may be bartered or exchanged for money.

3.         Continuity and regularity in dealings: A single transaction shall not be treated as business. An activity is treated as business only when it is undertaken continually or at least recurrently. For example, if a person sells his residential house, it is not considered as business. If he repeatedly buys houses and sells to others, such activity comes under business. But how frequently the transaction should occur depends on the nature of the activity. For example, a ship building company takes a long time to manufacture and sell a ship. At the same time, a vegetable vendor purchases vegetables from the market in the morning and sells out to his customers by evening. But both these activities are treated as business.

4.         Profit motive: Earning profit is the primary motive of business. This is not to undermine the importance of the element of service in business activity. In fact a business will flourish only when it is able to serve its customers to their satisfaction. Profits are essential to enable the business to survive, to grow, expand, and to get recognition.

5.         Element of risk: In every business, there is a possibility of incurring loss. This possibility of incurring loss is termed as risk. The element of risk exists due to a variety of factors which are outside the control of the business enterprise. There are two kinds of risks. (1) Risks whose probability can be calculated and can be insured. Losses due to fire, floods, theft, etc., are some examples. (2) Risks whose probability cannot be calculated and which cannot be insured against, e.g., changing technology, fall in demand, changing fashions, short supply of raw materials, etc. These risks are to be completely born by the enterprise.

1.3.2 Objectives of Business

You have learnt that the primary objective of business is to earn profit. Although profit plays an important role as a criterion of success, business may not exist for long with the sole objective of earning profit. As stated by Henry Ford, “business is not mere money chasing ‘ but it also should aim at serving the community”.  According to Urwick, “profit can no more be the objective of a business than eating is the objective of living”. Thus, serving the community is regarded as another important objective of business. In fact, some authors regard ‘service to community’ as the major objective of business and state that this provides the main justification for the existence of business as an important human activity. Therefore, while profit is necessary for the businessman to stay in business, he ought to aim at something more for its survival and growth. ‘The objectives of business could be listed under three broad headings: (1) economic objectives, (2) social objectives, and (3) human objectives.

Basic Concepts and Forms of Economic Objectives: Basically being an economic activity, primary objectives of business are economic. Some of the main economic objectives are :

1. Earning of satisfactory profits.

2. Exploring new markets and creation of more customers.

3. Growth and expansion of business operations of the firm.

4. Making innovations and improvements in goods and services so that customers get improved and more economic goods and services.

Social Objectives: Business, being a part of the society, has obligations towards the society also. Some major social objectives are :

1. Providing more and more employment opportunities to the people in the country.

2. Supply of quality goods to the community.

3. Providing goods at reasonable prices.

4. Ensure fair returns to investors.

5. Avoidance of profiteering and unfair practices.

6. Production of goods in accordance with national interests and priorities.

Human Objectives: Business activity is, generally, carried out through employees who are human beings. In fact, the efficiency and the success of the business enterprise depends on the motivation and ability of its employees. Therefore, business must also have some human objectives to safeguard the interests of its employees. Some of the major human objectives are :

1. Fair deal to employees in terms of wages and incentives.

2. Providing better working conditions and environment to the employees.

3. Provide job satisfaction.

4. Provide the employees more and more promotional/growth opportunities.

1.3.3 Business Distinguished from Profession and Employment

You have learnt about the essential characteristics of business. Keeping in mind these characteristics, let us now analyse how business is different from profession and employment.

Read Table 1.1 carefully. You will find the distinct features of business. profession and employment.

Table 1.1

Characteristics of Business, Profession and Employment

Features	Business	Profession	Employment
1. Establishment	An individual or a group of individuals decides to start business. Legal formalities like registration, etc. are to be fulfilled	Acquire required qualifications, training etc. Become the member of concerned professional body	Enter into service contract with the employer.
2. Qualifications	Specific qualifications are not required	Professional knowledge and training in the specific field is necessary	In some cases specific qualifications required and in some other cases not required.
3. Investment	Capital is required, Actual amount depends on the nature of business.	Some amount of capital required for equipment and establishment of office.	Capital not required.
4. Nature of work	Production and/or exchange of goods and services.	Renders personalized services of a specialized nature to the clients.	Performing the work assigned by the employer under the service contract.
5. Motive	Mainly profit motive	Although fee is charged. Service is the main motive.	No specific motive Mainly to earn livelihood.
6. Reward	Profit	Professional fee	Wage or salary
7. Transferability of ownership interest	By following required legal formalities, business can be transferred to others.	Not possible to transfer	Not possible to transter
Risk	There is risk of loss	Possibility of not getting enough fee to meet the expenditure on establishment	No risk, Employee gets wage or salary regularly so long as the farm continues in operation.

1.3.4 Classification of Business

You just recollect what we have stated about business. We stated that business is concerned with production and/or exchange of goods and services with the intention of earning profit. It states that business is concerned with two aspects i.e, production and exchange. Based on this, we may classify business activities into two categories. In the first category we can group all the business activities relating to production. Similarly, all the activities relating to exchange may be grouped under the second category. The first category is known as ‘industry’, while the second category is called ‘commerce’.

Check Your Progress A

1. What is the main distinction between the economic activity and non-economic activity?

2 What is business?

3 What is profession?

4 What is employment?

5 Classify the following activities into business, profession and employment.

Activity Classification

i) Selling vegetables. …………………………………………..

ii) A person working in a medical shop as salesman ………….

iii) A doctor working in a government hospital. ……………….

iv) A chartered accountant started private practice…………..

V) Manufacture of biscuits. ……………………………..

1.4 INDUSTRY

As you have learnt, industry refers to that part of business activities which is concerned with The production of want satisfying goods through utilisation of available material resources. Industry utilises the natural resources and brings them into the form useful for final consumption or further use. It means that the industrial activity aims at ensuring the supply of goods in that form which suits the objects, needs and convenience of the persons expected to use them. Thus, industry creates form utility to goods. For example, farms, factories, mines, etc:, make available a wide range of goods. These goods cater to the needs and convenience of the people. In a nut shell, the activities of human beings engaged in extraction, production, processing, construction and fabrication of products come under industry. There is another explanation for industry. Under this second explanation, industry means a group of factories usually specialising in a particular product line. For example, all the factories which produce fertilizer are collectively called fertiliser industry. Similarly, all automobile factories together constitute automobile industry. But in the present context, this approach is not relevant. We adopt the first approach.

1.4.1 Classification of Industry

There are various approaches of classifying industries. All these approaches are listed below.

1. On the basis of the nature of activity

a) Extractive industries

b) Genetic industries

c) Manufacturing industries

d) Construction industries

2 On the basis of the nature of goods produced

a) Consumer goods industries

b) Producer goods industries

3 On the basis of the level of investment

a) Heavy industries

b) Light industries

4. On the basis of size of the activity

a) Small scale industries

b) Large scale industries

5 On the basis of area of operations

a) Regional industries

b) National industries

C) Multinational industries

Since the theme of the discussion in this unit is centred around human activity, the classification based on the nature of activity is more appropriate for us. So, let us discuss about the first classification in detail.

a) Extractive Industries: Activities engaged in the discovery and extraction of natural resources like minerals, animals, plants, trees, etc., from the surface or beneath the surface of the earth or air or water come under this category. Extractive industries are also called exhaustive industries because with every attempt there is a depletion of resources and this wealth exhausts. Mining, farming, quarrying, hunting, fishing, etc., come under this category.

b) Genetic Industries: Activities which are concerned with reproducing and multiplying plants and animals with the objective of earning profit from their sale come under this category. Examples are nurseries which multiply and sell plants, poultry farms, cattle breeding farms, fish culture, etc. There is one important difference between an extractive industry and a generic industry.

In the case of extractive industry, man cannot add to the wealth which he withdraws from the earth; sea, and air. However, in the case of genetic industry, man not only adds to the growth but also reproduces the nature made goods.

C) Manufacturing Industries: These types of industries are engaged in the conversion or transformation of raw-materials and semi-finished materials into finished products. Generally, the products of extractive industries become raw-materials for manufacturing industries. In other words, manufacturing industries create ‘form utility’ to the products of extractive industries. Cement industry, sugar industry, cotton textile industry, iron and steel industry, fertilizer industry, etc., are some examples for manufacturing industries.

d) Construction Industries: These industries are engaged in the construction activities like the construction of buildings, bridges, dams, roads, canals, railway lines, etc. These industries consume the products of manufacturing industries (e.g., bricks, cement, iron and steel) and extractive industries (e.g., quarries, wood). The products of construction industries are immovable. They are erected, built or fabricated at a fixed site.

1.5 COMMERCE

You have learnt that the business activities are classified into: 1) industry, and 2) commerce. You also learnt that the industrial activities are concerned with the production of want satisfying goods and services. Unless these goods and services are made available to those who need them, they may not fulfill their objectives i.e, satisfying human wants. Therefore, the goods produced by the industries should be made available to the consumers at right place, right time, right quantity, right price and in right manner. Here comes the activity of commerce to fulfill all these requirements. All the activities which establish link between the producers of goods and consumers of these goods, and maintain a smooth and uninterrupted flow of goods between them come under commerce.

A smooth and uninterrupted flow of goods and services from producer to consumer is beset with many barriers and hindrances. For instance, goods produced by one may be consumed by another. In such a case, unless the producer and consumer identify each other, there is no scope for exchange of goods between them. This is the hindrance of person.

Similarly, for buying a product, consumers should have the knowledge about the existence of that product, its features, etc. Therefore, there is a need to provide such information to the

consumers. This is the hindrance of knowledge.

The hindrance of time arises out of the time gap between the time of production and the time of consumption. In many cases goods are produced at one place while they are consumed at another place. So, the goods should be carried from the place of production to the place of consumption. This gives rise for the hindrance of place. Commerce eliminates all these hindrances and facilitates the exchange of goods between producers and consumers. Later, in this section, you will learn in detail how these hindrances are eliminated through various business activities which form Part of commerce.

In a nutshell, commerce is mainly concerned with the purchase and sale of goods, and also embraces all those functions which are essential for maintaining smooth and uninterrupted flow of goods and services between the buyers and sellers. Thus, there are two main aspects in commerce: i) purchase and sale of goods, and ii) activities essential for the smooth and uninterrupted flow of goods. Therefore, we can classify the whole range of commerce activities into two categories :

1 ) Trade-activities of purchase and sale.

2) Aids to Trade- activities which facilitate the smooth and uninterrupted flow of goods.

1.5.1 Trade

You have already learnt that the human activities engaged in buying and selling of goods and services come under trade. Therefore, trade includes sale, transfer or exchange of goods

and services with the intention of earning profit. The objective of trade is to make goods available to those persons who need them and are willing to pay for them. Thus, trade plays

a major role in establishing contact between the producers and the consumers and eliminates the hindrance of person.

A person who is engaged in trade is called ‘trader’ or ‘middleman’. Various traders operate in between producers and consumers and remove the hindrance of person. We can classify

trade into two broad categories: I ) internal trade, and 2) external trade.

1 Internal Trade: When the trade takes place within the boundaries of the country, you can call it ‘internal trade’. It means that both buying and selling should take place within

the country. Payment for the same is generally made in national currency. This internal trade is also termed as inland trade or national trade or home trade or domestic trade. On the basis of the scale of operations, we can classify internal trade into:

a) Wholesale-trade, and b) retail trade.

a) Wholesale Trade: Buying and selling in relatively larger quantities is called wholesale trade. A person who is involved in wholesale trade is called wholesaler.

b) Retail Trade: This refers to buying and selling in relatively smaller quantities. A person engaged in retail trade is called a retailer. Let us now discuss in some detail how these wholesalers and retailers operate and eliminate the hindrance of person. A wholesale trader buys goods in large quantities from the manufacturers and sells in relatively smaller quantities to the retailers. Thus, the wholesale traders constitute a link between the producers on the one hand and the retailers on the other hand. Retailers, who buy goods from the wholesalers, sell them in smaller quantities to the consumers. Thus, retail traders establish link between wholesale traders on the one hand and consumers on the other. Thus, the wholesalers and retailers establish a link between the producers and consumers and eliminate the hindrance of person. However, sometimes producers may take the services of only either wholesalers or retailers, or may establish a direct link with the consumers. The whole chain of traders/middlemen operating in between producer and consumer is referred to as ‘channel of distribution’ about which you will learn in detail in Units 10 and 11 in this course.

2 External Trade: This is also called ‘foreign trade’ or ‘international trade’. When the trade takes place across the boundaries of a country, you can call such trade as external trade. In other words, external trade refers to the trade between nations. This trade could be in the form of exchange of one commodity for another or for money.

We can classify foreign trade into three categories: a) import trade, b) export trade, and c) re-export trade.

a) Import Trade: when a country buys goods from another country, it is called ‘import trade’. For example, India bought machinery from the USA. This is an import trade for India.

b) Export Trade: When a country sells goods to another country, it is called ‘Export Trade’. For example, India sells leather goods to USSR, and tea to USA, for India such selling of goods shall be termed as ‘export trade’.

c) Re-export Trade: This is also called ‘entrepot trade’, When the goods are imported from one country and the same are exported to another country, such trade is called ‘re-export trade’. Re-export is done by those countries which have ports that are conveniently situated to serve as distributing points for neighboring countries. Such countries import large quantities of goods and re-export the same to the neighboring countries.

1.5.2 Aids to Trade

Activities which facilitates the trade are called ‘aids to trade’. Thus, all human activities which eliminate the hindrances and facilitate the flow of goods from producers to consumers come under aids to trade. They are also called ‘auxiliaries to trade’. The whole range of activities coming under aids to trade may be classified into five categories: 1) transportation, 2) warehousing, 3) insurance, 4) advertising, and 5) banking.

1.         Transportation: Generally, all the goods are not consumed at the same place where they are produced. Therefore, goods are to be moved from the place of production to the place where they are demanded. The activity which is concerned with such movement of goods is called ‘transportation’. Thus, transportation eliminates the hindrance of place and creates place utility to goods. Transportation can be of three types:

a) Land transportation – road, rail

b) Air transportation- aero plane

C) Water transportation-boat, ship

2.         Warehousing: Goods may not be consumed immediately after production. Normally there will be time gap between production and consumption. This is the hindrance of time. Therefore, goods once produced should be preserved properly till they are consumed. Particularly, perishable goods like milk, meat, vegetables, flowers, etc., should be preserved very carefully. Otherwise, they get spoiled and become useless. For this reason warehousing is recognised as yet another aid to trade. Warehousing refers to preservation of goods to make them available as and when needed by consumers. Thus, warehousing eliminates the hindrance of time and provides time utility to goods.

3.         Insurance: The goods may be destroyed while in production process, or in transit due to accidents, or in storage due to fire or theft, etc. The businessmen would like to cover these risks. Insurance companies come to their rescue in this regard. They undertake to compensate the loss suffered due to such risks. For this purpose, the business has to take an ‘insurance policy’ and pay a certain amount regularly, called ‘premium’. Thus, insurance eliminates the hindrance of risk.

4.         Advertising: Exchange of goods is possible only when the consumers have the knowledge about the existence of a product. This is the hindrance of knowledge. This hindrance is eliminated through advertising. Through advertisement, producers communicate all information about their goods to the prospective consumers and create in them a strong desire to buy the product. Thus, advertising facilitates the flow of goods between producers and consumers by bringing the knowledge about the products to the consumers. Advertising is done through TV, radio, newspapers, magazines, hoardings,

Wall posters, etc.

5.         Banking: Banking facilitates the flaw of goods by removing the hindrance of finance and credit. Now-a-days we cannot think of business without banks. To start the business or to run it smoothly we require money. Banks supply money. A bank is an organization which accepts deposits of money from the public, withdrawal on demand or otherwise, and lends the same to those who need it. Banks also provide many services required for the business activity.

1.6 ORGANISATION

You have learnt what is a business activity and various types of business activities like industry, trade, transportation, banking; etc. Whatever business activity you may take up, you have to bring together various resources like capital, machinery; raw-materials, labour, technicians, etc. Mere presence or availability of these resources is not enough. Such resources are to be put in action in a systematic way to achieve its objective.

For example, take the case of textile production. First you get some land and construct buildings, buy machinery and install them in the buildings, employ labour and technicians to work on the machinery, buy raw-materials (cotton, dyes, etc.), and process the raw-materials in the factory and produce the cloth. Once cloth is produced it is to be sold to consumers through wholesale and retail dealers. Thus, to produce cloth you have to assemble resources such as factory, cotton, dyes; labour, wholesalers, retailers, etc. But simple presence of these resources may not achieve the purpose. We have to put these resources together in action very systematically and coordinate their activities. Then only it is possible to produce the cloth, distribute it to consumers, and get profits. This is true with any business activity.

A business activity becomes a reality only when efforts are made to bring the required resources together, put them at work systematically, and coordinate their activities properly. This is referred to as business organisation.

In the opinion of J.W. Shulze, “organisation is a combination of necessary beings, materials, tools, equipment, working space apparatus and finance brought together in a systematic and effective correlation to accomplish some desired objective”.

Oliver Sheldon defined it as “the process of combining the work which individuals and groups have to perform with the facilities necessary for its execution so that they provide the best channels for efficient, systematic, positive and coordinated application of the available effort”.

As viewed by F.J. Wright, “organisation is the arranging or combining of resources to achieve an economic aim–either with the resources available to achieve the maximum result or profit, or to achieve a given aim with the least possible expenditure of resources”.

Thus, business organisation means bringing together various components of business such as workforce, raw-materials, machines, capital, energy, etc., putting them on work systematically, and coordinating and controlling their activities effectively to achieve the objective of earning profit.

Forms of Business Organisation: Business may be owned and managed by a single man, or a group of persons forming a partnership firm or as a joint stock company or even as a cooperative society.

Thus, on the basis of ownership and management, we can classify business organisation into four groups.

1 Sole proprietorship

2 Partnership firm

3 Company

4 Cooperative society

The first two categories (sole proprietorship and partnership forms) may be called non-corporate forms of organisations. The remaining two categories (company form and cooperative society) may be called as corporate forms of organisations. About these forms of organisations, you will study in detail in Units 2 and 3.

Entrepreneur: You know that the business is carried with the primary objective of earning profits. You also know that setting up of the business to achieve this objective requires bringing together various resources, coordinating them and controlling all activities. This has to be done by somebody who may conceive the idea of doing a particular type of business, mobilise the resources and bring the organisation into existence. Such a person who does all this is called an entrepreneur. He is the one who also bears the risk of the business. You know that although each enterprise is started with the objective of earning profit but the possibility of loss cannot be ruled out. Thus, the entrepreneur is the person who conceives the business idea, brings the organisation into existence and carry on the business activity, and prepared to bear the risk of loss. You will learn in detail about the entrepreneur in Unit 4.

1.7 LET US SUM UP

The whole range of human activities can be classified into: 1) economic activities, and 2) non-economic activities. Economic activities are further divided into: 1) business, 2) profession, and 3) employment. Business is concerned with production and/or exchange of goods and services carried with the primary objective of earning profits. Activities concerned with the rendering of personalised services of a specialised nature come under profession. Employment refers to the activity assigned to a person by the employer under an agreement or rules of service.

The main features of business activity are: 1) dealings in goods and services, 2) production and/or exchange, 3) regularity in dealings, 4) profit motive, 5) element of risk, and 6)enterprise. Besides earning profit, the business also serves certain economic, social, and human objectives. Business activities are classified into: 1) industry, and 2) commerce. Industrial activities are classified into four categories: 1) extractive industries, 2) genetic industries, 3) manufacturing industries, and 4) construction industries.

Commerce is classified into: 1) Trade, and 2) aids to trade. Activities concerned with buying and selling come under trade. Activities which facilitate buying and selling, and maintain smooth flow of goods and services come under aids to trade. These are: 1) transportation, 2) warehousing, 3) banking, 4) insurance, and 5) advertising.