Business Economics and Financial Analysis UNIT-1

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1 Business Economics and Financial Analysis Introduction of the subject: It is a combination of two essential fields which can provide the knowledge of business in economic terms, because every activity in any business aimed at earning or spending money is called economic activity and Financial Analysis which will have huge concepts, Principals and methods for analysis of financial matters in business. The main objective of the subject is to realize about the entrepreneurial and business skills of the students in present business environment. By learning these subject the student able to know about: What is a business, how to form and manage business organization UNIT-1 Business and new economic environment Characteristic features of business; Features and evaluation of sole proprietorship; Partnership; Joint stock company; Public enterprises and their types; Changing business environment in post- liberalization scenario. Business Organisation Meaning Business organisation refers to all necessary arrangements required to conduct a business. It refers to all those steps that need to be undertaken for establishing relationship between men, material, and machinery to carry on business efficiently for earning profits. This may be called the process of organising. The arrangement which follows this process of organising is called a business undertaking or organisation. A business undertaking can be better understood by analysing its characteristics. Characteristics 1. Distinct Ownership : The term ownership refers to the right of an individual or a group of individuals to acquire legal title to assets or properties for the purpose of running the business. A business firm may be owned by one individual or a group of individuals jointly. 2. Lawful Business : Every business enterprise must undertake such business which is lawful, that is, the business must not involve activities which are illegal. 3. Separate Status and Management : Every business undertaking is an independent entity. It has its own assets and liabilities. It has its own way of functioning. The profits earned or losses incurred by one firm cannot be accounted for by any other firm. 4. Dealing in goods and services : Every business undertaking is engaged in the production and/or distribution of goods or services in exchange of money.

2 5. Continuity of business operations : All business enterprise engage in operation on a continuous basis. Any unit having just one single operation or transaction is not a business unit. 6. Risk involvement : Business undertakings are always exposed to risk and uncertainty. Business is influenced by future conditions which are unpredictable and uncertain. This makes business decisions risky, thereby increasing the chances of loss arising out of business. Features of business: 1. Perception: they are able to predict how you will receive their message 2. Precision: they create a "meeting of the minds".when the finish expressing themselves share the same mental picture. 3. Credibility: they are believable. you trust their information 4. Control: They shape your response, they can make you laugh, cry and change your mind and take action. 5. Congeniality: They maintain friendly, pleasure relations with you regardless whether you agree with them or not. Definition of firm: Hansn: The firm may be defined as an independently administered business unit. A firm is a business unit which hires productive resources for the purpose of producing goods and services. The following features of a firm emerge from these definitions: o It is a centre where decisions are taken about, what, where, how and how much to produce. o It is a centre where the means of production are hired or purchased and used for production. o It is a centre, where the success of production is reviewed in its entire context and decisions are taken. o It is a centre, where the means of product From the above features of a firm, it will be clear that a firm has to perform several functions simultaneously i.e. to produce a commodity, to sell and distribute the commodity, to advertise the commodity and to perform all those things which will be required to survive competition. To cap it all, the firm is expected to make as much as possible. Theoretically speaking, a firm is expected to organize all the factors of production in the most profitable manner. If one studies the structure and function of modern firm the above definitions will appear to be too simple, because in modern times the firm is expected to perform so many other functions. Formerly, the entrepreneur was taken to be an independent factor of production. Even today the entrepreneur is no doubt a very important factor of production but he has become so highly that it is very difficult to separate him from the production unit of

3 the firm because ultimately the will to produce is provided by the entrepreneur. The mere presence of all the factors of production and a market does not guarantee production. The will be to produce is very important and it cannot be separated from the entrepreneur. The firm and the Industry: For understanding the difference between a firm and an industry, it would be advisable to understand the nature of a competitive industry. A competitive industry has three basic characteristics: Large number of firms Homogeneous product Freedom of entry and exit In a competitive industry, there are a large number of firms, so that the action of a single firm has no effect on the price and output of the whole industry. Every firm therefore enjoys the freedom to increase or decrease its output substantially by taking the price of the product as given. Secondly, every firm in a purely competitive industry, it must be making a product which is accepted by customers as being identical with that made by all the other producers in the industry. This is known as the condition of homogeneity. This ensures all firms have to charge the same price. The firm and the Plant: A plant is a technical unit of a given capacity of output. For example: we speak of sugar plant. What is it? It is nothing but a assembly of several machines, linked together (not necessary physically but by processes also) capable of producing a given quantity of sugar per day. There is a weighing system which weights the sugarcane, the convey or system what takes the cane for crushing, the crushing machinery, and the machinery for removing impurities and so on, until finally sugar is filled in gunny bags. This whole plant is taken together is capable of producing a given quantity of one product sugar. Same like, cement plant, steel plant, etc. Factors affecting the choice of Form of business Organisation: 1. Easy to start and easy to close: The form of business organization should be such that it should be easy to start and easy to close. There should not be hassles or long procedures in the process of setting up or closing the business. 2. Division of labour: There should be possibility to divide the work among the available owners. The idea is to pool the expertise of all the people in business and run the business most efficiently.

4 3. Large amount of resources: Large volume of business requires large volume of resources. Some forms of business organizations do not permit to raise larger resources. Select the one which permits to mobilize the large resources. 4. Liability: The liability of the owners should be limited to the extent of money invested in business. It is better if their personal properties are not brought into business to make up the losses of the business. 5. Secrecy: The form of business organization you select should be such that it should permit to take care of the business secrets. We know that century old business units are still surviving only because they could successfully guard their business secrets. 6. Transfer of ownership: There should be simple procedures to transfer the ownership to the next legal heir. 7. Ownership, management and control: If ownership, management and control are in the hands of one or a small group of persons, communication will be effective and coordination will be easier. Where ownership, management and control are widely distributed, it calls for a high degree of professional skills to monitor the performance of the business. 8. Continuity: The business should continue forever and ever irrespective of the uncertainties in future. 9. Quick decision making: Select such a form of business organization which permits you to take decisions quickly and promptly. Delay in decisions may invalidate the relevance of the decisions. 10. Personal contact with customers: Most of the times, customers give us clues to improve business. So choose such a form which keeps you close to the customers. 11. Flexibility: In times of rough weather, there should be enough flexibility to shift from one business to the other. The lesser the funds committed in a particular business, the better it is. 12. Taxation: More profit means more tax. Choose such a form which permits to pay low tax.

5 Types of business Organizations A business organization is concerned with how production and sale of a commodity are organized. A. Private Sector : In a capitalist economy, the first four types of business organizations are set up in the private sector. The private sector is owned by private individuals, families or groups of individuals. It is characterized by private ownership in the means of production, economic freedoms and profit motive. In addition to the first three types of business organization, there are also Joint Hindu Family Firms in the private sector in India and Business Organizations of the New Millennium. B. Public Sector : The public sector includes public or state enterprises like railways, post sand telegraphs, etc. The public sector is owned and controlled by the State. In India we have also a number of public enterprises like Hindustan Machine Tolls, Life Insurance Corporation, Bharat Heavy Electrical Ltd. ect. They are constituted as companies, public corporations and departmental undertakings. C. Joint Sector : Joint sector organizations or enterprises are jointly owned by the public and private sectors. But day-today management is left to the private sector. The following chart indicates various forms of business organization: Types of Business Organization Private Sector Public Sector Joint Sector 7) State Enterprises 8) Public Private Organizations Capitalist Form Non Capitation Form 1) Proprietary Firms 6) Co-operative Organizations Or Proprietorship 2) Partnership 3) Joint-Stock Company 4) Joint-Hindu Family Firms 5) Business Organizations of New Millennium

6 SOLE PROPRIETORSHIP OR PROPRIETARY FIRMS: 'Sole' means single and 'proprietorship' means ownership. It means only one person or an individual becomes the owner of the business. Thus, the business organisation in which a single person owns, manages and controls all the activities of the business is known as sole proprietorship form of business organisation. The individual who owns Business Studies and runs the sole proprietorship business is called a sole proprietor or sole trader. A sole proprietor pools and organises the resources in a systematic way and controls the activities with the sole objective of earning profit. Is there any such shop near your locality where a single person is the owner? Small shops like vegetable shops, grocery shops, telephone booths, chemist shops, etc. are some of the commonly found sole proprietorship form of business organisation. Apart from trading business, small manufacturing units, fabrication units, garages, beauty parlors, etc., can also be run by a sole proprietor. This form of business is the oldest and most common form of business organisation. A. Definition: Individual or sole proprietorship which is also called sole trader ship or sole single entrepreneurship or proprietary firms is the most common, the simplest and the oldest form of business organization. Definition of Sole Proprietorship: A business enterprise exclusively owned, managed and controlled by a single person with all authority, responsibility and risk. In such a unit, a single man called proprietor organizes a business. It is owned, managed, controlled and directed by him. He fixes the amount of capital to be invested. (his own or borrowed), uses his own labour and that of his family members, hires factors, whenever necessary, organizes production as efficiently as possible and markets the product at the highest possible prices. He assumes full responsibility for all business fails. B. Characteristic features: The definition of sole proprietorship Proprietary Firm gives its characteristics or features which are as follows: (i) Ownership by a Single Person: A single person initiates a business whose ownership lies in his hands. He enjoys full powers to fix the lay-out of his business firm. (ii) Organization and Control: A single person organizes and manages his business according to his experience and efficiency. He has full powers to conduct his business in any manner he likes. He need not consult any one. He is also not required to take approval or agreement from others. (iii) Capital: The owner uses his own capital. He may also borrow capital to invest it in his business and thereby expand it.

7 (iv) No Sharing of Profits and Losses: All the profits of business earned by the owner are enjoyed by him alone. These profits of business are not shared with other persons. On the other hand, if there are losses, he has to bear them alone entirely. (v) Unlimited Liability: His liability is unlimited for all his debts. If he fails to clear his business debts, all his private property can be attached by his creditors. (vi) Easy to Form: It can be easily set up. It is not subject to any special legislation. So no legal formalities are involved in starting such a concern by any person who is of major age, i.e. 18 years and above. (vii) Legal Status: A sole trading concern cannot be legally separated from its owner or proprietor. The owner and organization are the same. The life of such a concern depends upon the life of its proprietor. These types of organization are found in agriculture, retails trade, hotel, printing press, tailoring etc. C. Merits and Demerits: Merits: 1. Easily Started & Winding Up: Such a concern can be easily started without any legal formalities. There is also little government interference. Also it is simple to manage and control and requires a small amount of capital for generally it adopts labour intensive techniques. He can also get finance on personal credit. Just a sole trader can easily start a business, so also he may easily wind up his business at any time. 2. Prompt Action: The proprietor can take quick decisions and prompt action regarding his business, its location, method of production etc. He need not consult others about these problems. 3. Personal interest: He would always take personal interest in the business with a view to finding out causes of loss and waste of resources. He would then take measures to remove them. Thus he would maximize his profits. 4. Requirements of Consumers: He has direct contact with his customers, so he can personally attend to all their requirements. He can produce goods according to their desires, tastes and needs. His attempts to meet their needs will help him to increase his sales and profits. Thus it is suitable for small business. 5. Cordial Relations: He has direct and continuous contact with his employees. So he can establish cordial relations with them. This is because he will be in a continuous touch with them. He can also supervise them directly. Hence any scope for conflict between workers and himself can be avoided. 6. Efficiency, Hard Work and Direct Gain: He will always attempt to work hard, efficiently and continuously. This helps to enjoy maximum profits and avoid any loss for his liability is unlimited.

8 7. Business Secrecy: He can carry on his business in secrecy. He is not required to give publicity to the activities of his concern nor disclose his profits to the public. He can also make use of any new idea for his business. 8. Economy in Expenses: Its overhead expenses are low. Hence it is economical. The number of employees employed by him is low. Hence the working expenses can be minimized. 9. Flexibility and Elasticity: Any change in business can be easily introduced without consulting anybody. So it is flexible and elastic. It can easily and quickly adapt to changes in the market conditions. 10. Transferability: It is easily transferable to heirs. 11. Self-Employment: It promotes self-employment, self-reliance, development of one s personality, self-confidence etc. 12. Lower Tax Burden: It is also subject to lower tax burden than other forms of business organizations. 13. Concentration of Wealth: It helps prevent concentration of wealth and income in the hand of a few persons. Demerits: 1. Limited Capital: The amount of capital which an individual can command is limited. He has to depend mainly on his own savings. So it would be difficult for him to expand his business activities much. It may also be difficult for him to raise additional capital by borrowing from banks. Hence the size of his business is small. 2. Unlimited Liability and Risks: It may be very risky for him to invest in a particular business. This is because if he adopts a wrong policy, he may lost everything and also become insolvent. This is because his liability is unlimited. This implies that if his debts exceed his business assets and if he suffers a loss, he will have to use his private property to clear his debts. So the unlimited liability restricts his business activities. 3. Lack of Skill for Efficient Management: It may not also be possible for him to attend personally to all the activities of his concern such as correspondence, maintaining accounts, advertisements, supervision, arrangement of finance, etc. He cannot undertake all activities alone efficiently. Further his business activities may be spread in different places and he may not possess all the qualities and skills required for an efficient management, supervision and control. The limited managerial ability may make it difficult for a sole proprietor to face competition in his business which is subjected to many changes. 4. No Economics of Scale: A sole trader cannot secure many of the economics of large scale production such as purchase of raw materials at low prices, advantages of specialization etc. and minimize its cost of production or running business.

9 5. Weakness in Bargaining and Competition: On account of the limitations of capital, ability and skill, the proprietor is likely to remain weak in respect of bargaining and competition. He may have to compromise many times regarding the terms and conditions of purchase of materials or borrowing loans from the finance houses or banks. 6. Wrong Decisions: All the decisions about his business are taken by the sole proprietor. Some of his decisions may prove to be wrong. This may involve him in losses and ruin. 7. Closure on Death: Because of uncertainty there is no continuity in the duration of the business. Such a concern may be closed on the death of the proprietor. This is because he may not have heirs to run it or they may not like to continue in his business. Hence the business may not be continued. 2. PARTNERSHIP: It is basically a relation between two or more persons who join hands to form a business organisation with the objective of earning profit. The persons who join hands are individually known as Partner and collectively a Firm. The name under which the business is carried on is called firm name. Sultan Chand & Co, Ram Lal & Co, Gupta & Co are the names of some partnership firms. The partners provide the necessary capital, run the business jointly and share the responsibility. You must be thinking how much capital each partner contributes? Do all the partners jointly manage the business or can any of them manage the business on behalf of others? Who will take the profits? If there is any loss then who will suffer the loss? Yes, these are the few questions that might be coming to your mind. Actually, when you invite your friends to start such a business, it should be the duty of all of you to decide (i) the amount of capital to be contributed by each one of you; (ii) who will manage; (iii) how will the profits and losses be shared. Thus, there must be some agreement between the partners before they actually start the business. This agreement is termed as Partnership Deed, which lays down certain terms and conditions for starting and running the partnership firm. This agreement may be oral or written. Actually, it is always better to insist on a written agreement among partners in order to avoid future controversies. Definition and Meaning: The Indian Partnership Act, 1932, defines the partnership as the relation between two or more persons who have agreed to share profits of a business carried on by all or any one of them acting for all. The English Partnership Act, 1980 defines partnership as the relation which subsists between persons carrying on a business in common with a view to profit.

10 So a partnership refers to an organization owned and managed by two or more persons. They pool their capital and undertake all risks associated with their business. Thus there is joint ownership, management, control and risk taking. The person who own the partnership concern are called partners Collectively, all partners constitute a firm. Characteristics or Features of a Partnership Firm: 1. Two or more Members - You know that the members of the partnership firm are called partners. But do you know how many persons are required to form a partnership firm? At least two members are required to start a partnership business. But the number of members should not exceed 10 in case of banking business and 20 in case of other business. If the number of members exceeds this maximum limit then that business cannot be termed as partnership business. A new form of business will be formed, the details of which you will learn in your next lesson. 2. Agreement: Whenever you think of joining hands with others to start a partnership business, first of all, there must be an agreement between all of you. This agreement contain so The amount of capital contributed by each partner; Profit or loss sharing ratio; Salary or commission payable to the partner, if any; Duration of business, if any ; Name and address of the partners and the firm; Duties and powers of each partner; Nature and place of business; and any other terms and conditions to run the business. 3. Unlimited Liability: The liability of all partners is unlimited. Hence all partners are, jointly and severally, held responsible for the losses or debts of the firm to the full extent of their personal assets. Creditors are entitled to attach assets of any one partner or those of others so as to recover their dues. 4. Contact: It is formed voluntarily by an agreement between two or more persons carrying on a particular business for common benefit. It may also be formed to carry on certain trade, profession or lawful occupation. The partners can continuously be in touch with the customers to monitor their requirements. 5. A Partnership Deed: A partnership is formally based upon a partnership deed or agreement. It indicates the names of partners, the shares of individual partners in the capital, their rights and duties, proportion for sharing profits and losses by each of them etc. 6. Registration: The registration of a partnership firm is voluntary. It may or may not be registered. However, if the partners so desire, it can be registered at any time.

11 7. Joint Liability Ownership: The Partners are joint owners of the property of the firm. Its property must be used only for the business purpose for which the partnership was formed. It cannot be used by any partner for his personal purposes. Management: All the partners enjoy equal rights of management. So every partner can participate in management. But for the sake of convenience, a single partner may be given right to manage the firm. 8. No Remuneration: No remuneration is paid to any partner for services rendered by him to the firm. Each partner is supposed to work in the best possible manner for promoting the interest of the firm. 9. Age Limit: Only persons who have attained the major status can become partners. In other words, minors cannot become partners. 10. Statutory Limit or Number of Partners: It consists of minimum two persons and maximum 20 persons in the case of general business and maximum 10 persons in the case of banking. 11. Mutual Confident and Faith: A partnership is based upon mutual confidence and trust of partners in each other or one another. Every partner must be honest regarding the partnership dealings and should provide all the facts ad information regarding their business to all partners. 12. Non-transferability of Interest: A partner cannot transfer his powers or rights to any third party to do any work of the firm on his behalf. If he cannot do it himself, he has to retire from the partnership firm. However, a partner may admit another person as a new partner if other partners give their consent. 13. Principle of Agency: Every partner carries on business activities on behalf of the firm. So he binds the firm and other partners for every commitment that he makes in conducting business. Likewise he is bound by the business activities of the other partners. Thus every partner becomes a principal at one time and an agent of the firm at another time. Hence a partnership firm can be run by one or more partners acting on behalf of all partners. 14. Dissolution: A partnership firm may not last long. It may be dissolved by any partner after giving a written notice to other partners and a new partnership may be formed by the remaining partners. It may also be dissolved due to the death of a partner or due to an adjudication of a partner as an insolvent. Such partnership firms are found among builders, solicitors, chartered accountants, small factories etc. Advantages: 1. Easy to Form : A partnership firm can be easily formed. Its formation does not involve legal formalities.

12 2. More or Additional Capital: Under the partnership, more funds can be raised by all partners to start a business on a large scale. Because of the reputation of the partners and heir contacts, it will not be difficult for a partnership concern to borrow from banks on easy terms. 3. Greater Efficiency due to Division of Labour: There is a greater efficiency in the working of partnership concerns because different partners can be assigned those tasks for which they are best suited as per their qualifications, experience, abilities, talents and aptitude. Thus there would be specialization in the task of every partner. 4. Flexibility: It is also quite flexible and capable of adapting itself to changed circumstances of business by means of quick decisions and prompt action by the partners, i.e. it can quickly adapt itself to change in demand for its product, by increasing and decreasing its business operations and by changing its business policy. Thus the organizational structure of a partnership firm is flexible. The decision taking by a partnership firm does not involve any legal procedure. Its operations are not also subject to any restriction by a government. 5. Co-operation & Personal Contact: It may elicit full co-operation from workers by keeping a close touch with them, by understanding and solving their difficulties. More scope to maintain personal contacts with customers & and requirements by sharing responsibility among partners. 6. Expansion of Business: A partnership firm can expand its business by admitting more partners and raising more capital from them and thereby attempt to earn more profits. 7. Quick Decisions and Prompt actions: While there is an agreement and unity among partners, it is enough to implement any decision and initiate prompt actions. 8. Unlimited Liability: Since there is unlimited liability, the business status of a partnership firm is raised. Hence it will be easy for it to get loans from financers. 9. Advantages of Large-scale production: It can secure all the advantages of large scale production such as advantages of division of labour, bulk purchases of raw materials at lower price, best use of machinery etc. 10. Business Risks and Rewards: Business risks are equally shared by all the partners. In case business fails, they would suffer losses. But if it succeeds, they will enjoy profits. Hence they will try to manage it efficiently and make their business profitable by putting the assets of the firm to the best uses so as to avoid waste. 11. Management and Organizational Abilities: In a partnership fir, there is a combination of capital, abilities and skill. Some partners offer capital. Some partners are experts in management and organization. Some of them possess

13 technical skill. As a result of the pooling of the expert services of all partners, it is possible to run a partnership firm efficiently. 12. Dissolution: In case a partner is not happy with the working of his partnership firm, he can legally dissolve it. He can do so by giving a written notice to the other partners indicating his decision to resign from it. 13. Mutual Consent: All the business decisions are taken with mutual consent of all partners. They hold mutual consultations and discussions on important matters. Thus every partner benefits from the advice of other partners. As a result, their wisdom is pooled for the benefit of the firm. Disadvantages: 1. Unlimited Liability and No Risk Business: On account of the principle of unlimited liability, any bad or irresponsible partner may ruin all the partners. This is because his activities will be binding on all other partners. Every partner runs a considerably risk for any one of them is, jointly or severally, held responsible for the debts or losses of the firm. Further due to unlimited liability, the partners may not undertake any risk in business or take any hasty step to expand business. Hence the spirit of enterprise is checked. 2. Limited on Size of Business: it is also difficult in increase the size of business on account of limited amount of capital which the partners can raise or provide from their own sources. A partnership firm cannot also admit more than 20 members for raising additional resources. This limitation on the number of partners restricts the growth of a partnership form. 3. Lack of Harmony: You know that in partnership firm every partner has an equal right to participate in the management. Also every partner can place his or her opinion or viewpoint before the management regarding any matter at any time. Because of this sometimes there is a possibility of friction and quarrel among the partners. 4. Non-Transferability: A share in a partnership form cannot be transferred by any partner without the consent of all the partners. He cannot also transfer his powers or rights to any third party to do any work of the firm on his behalf. 5. Differences of Opinion: The partners may not agree upon certain matters of business policy. There might by differences of opinion, clashes of interest, mistrust, disputes etc. Such differences among partners may result in dissolution of partnership firms. 6. Short-Lived: A partnership can be dissolved by any partner by giving a written notice to other partners. So this type of business is short-lived. Also default, bankruptcy or insanity of any one of the partners leads to dissolution of the firm unless a provision is made in the partnership deed to the contrary.

14 7. No Trust: The activities of a partnership firm are kept secret from outsiders. It is not required to publish its accounts. It is also not subject to legal restrictions. Hence people may not fully trust a partnership concern. 8. No Government Control: There is no government control or supervision on the activities of a partnership concern. Hence there is lack of public confidence in such concerns. 9. Leakage of Important Information: Some of the partners may leak important information to outsiders. This may happen when three are differences of opinion among the partners. Hence it may be difficult to maintain business secrecy in a partnership firm. 10. Joint Liability and Dishonest Activities of Some Partners: The activities of a partner are binding on the partnership firm. Some partners may not behave properly. Some of them may be dishonest. Hence they may misuse their rights and bring the firm into difficulties and ruin its business. As a result, the honest and efficient partners will have to suffer losses. Kinds of Partners: In a partnership firm you can find different types of partners. Some may actively participate in the business while others prefer not to keep themselves engaged actively in the business activities after contributing the required capital. Also there are certain kinds of partners who neither contribute capital nor actively participate in the day-to-day business operations. Let us learn more about them. a) Active partners - The partners who actively participate in the day-to-day operations of the business are known as active or working partners. They contribute capital and are also entitled to share the profits of the business. They are also liable for the debts of the firm. b) Dormant partners - Those partners who do not participate in the day-to-day activities of the partnership firm are known as dormant or sleeping partners. They only contribute capital and share the profits or bear the losses, if any. c) Nominal partners - These partners only allow the firm to use their name as a partner. They do not have any real interest in the business of the firm. They do not invest any capital, or share profits and also do not take part in the conduct of the business of the firm. However, they remain liable to third parties for the acts of the firm. d) Minor as a partner -You learnt that a minor i.e., a person under 18 years of age is not eligible to become a partner. However in special cases a minor can be admitted as partner with certain conditions. A minor can only share the profit of the business. In case of loss his liability is limited to the extent of his capital contribution for the business. e) Partner by estoppels - If a person falsely represents himself as a partner of any firm or behaves in a way that somebody can have an impression that such person is a partner and on the basis of this impression transacts with that firm then that

15 person is held liable to the third party. The person who falsely represents himself as a partner is known as partner by estoppel. Take an example. Suppose in Ram Hari & Co firm there are two partners. One is Ram, the other is Hari. If Giri- an outsider represents himself as a partner of Ram Hari & Co and transacts with Madhu then Giri will be held liable for any loss arising to Madhu. Here Giri is partner by estoppel. f) Partner by holding out - In the above example, if either Ram or Hari declares that Gopal is a partner of their firm and knowing this declaration Gopal remains silent then Gopal will be liable to those parties who suffer losses by transacting with Ram Hari & Co with a belief that Gopal is a partner of that firm. Here Gopal is liable to those parties who suffer losses and Gopal will be known as partner by holding out. 3. Joint Stock Companies: Meaning of Joint Stock Company In a partnership firm we know that the number of partners cannot exceed 20. So there is a limit to the contribution of capital. Secondly, even if the partners could contribute a large amount of capital, they would hesitate to do so considering the risk involved in business and their unlimited liability. Mainly to take care of these two problems, a company form of business organisation came into existence. A company form of business orgnisation is known as a Joint Stock Company. It is a voluntary association of persons who generally contribute capital to carry on a particular type of business, which is established by law and can be dissolved only by law. Persons who contribute capital become members of the company. This form of business has a legal existence separate from its members, which means even if its members die, the company remains in existence. This form of business organisations generally requires huge capital investment, which is contributed by its members. The total capital of a joint stock company is called share capital and it is divided into a number of units called shares. Thus, every member has some shares in the business depending upon the amount of capital contributed by him. Hence, members are also called shareholders. And the name of the company ends with Limited (Ltd.) to give an indication to the outsider that they are dealing with limited liability The companies in India are governed by the Indian Companies Act, The Act defines a company as an artificial person created by law, having a separate legal entity, with perpetual succession and a common seal. Characteristics of Joint Stock Company You are now familiar with the concept of company as a form of business organisation. Let us now study its characteristics.

16 1. Legal formation No single individual or a group of individuals can start a business and call it a joint stock company. A joint stock company comes into existence only when it has been registered after completion of all formalities required by the Indian Companies Act, Artificial person Just like an individual, who takes birth, grows, enters into relationships and dies, a joint stock company takes birth, grows, enters into relationships and dies. However, it is called an artificial person as its birth, existence and death are regulated by law and it does not possess physical attributes like that of a normal person. 3. Separate legal entity Being an artificial person, a joint stock company has its own separate existence independent of its members. It means that a joint stock company can own property, enter into contracts and conduct any lawful business in its own name. It can sue and can be sued by others in the court of law. The shareholders are not the owners of the property owned by the company. Also, the shareholders cannot be held responsible for the acts of the company 4. Common seal A joint stock company has a seal, which is used while dealing with others or entering into contracts with outsiders. It is called a common seal as it can be used by any officer at any level of the organisation working on behalf of the company. Any document, on which the company's seal is put and is duly signed by any official of the company, become binding on the company. For example, a purchase manager may enter into a contract for buying raw materials from a supplier. Once the contract paper is sealed and signed by the purchase manager, it becomes valid. The purchase manager may leave the company thereafter or may be removed from the job or may have taken a wrong decision, yet for all purposes the contract is valid till a new contract is made or the existing contract expires. 5. Perpetual existence A joint stock company continues to exist as long as it fulfils the requirements of law. It is not affected by the death, lunacy, insolvency or retirement of any of its members. For example, in case of a private limited company having four members, if all of them die in an accident the company will not be closed. It will continue to exist. The shares of the company will be transferred to the legal heirs of the deceased members. 6. Limited liability In a joint stock company, the liability of a member is limited to the extent of the value of shares held by him. While repaying debts, for example, if a person owns 1000 shares of Rs.10 each, then he is liable only upto Rs 10,000 towards payment of debts. That is, even if there is liquidation of the company, the personal property of the shareholder can not be attached and he will lose only his shares worth Rs. 10,000.

17 7. Ownership and Management The shareholder is spread over the length and breadth of the company. So, to facilitate administration the shareholders elect some among themselves are the promoters of the company as Directors to a Board, which looks after the management of the business. The board recruits the managers and employees at different levels in the management. Thus, the management is separated from the Owners. 8. Voluntary Association of Persons : The company is association of voluntary association of persons who want carry on business for profit. To carry on business they need capital. So, they invest in the share capital of the company. The total capital is divided into certain no. of units. Each unit is called a share. The price of each share is priced to low, that every investor would like to invest in the company. 9. Winding up: Winding up prefers to the putting an end to the company. Because law creates it, only law can put an end to it in special circumstances such as representatives from the creditors or financial intuitions or share holders against the company that their interests are not safeguarded. And the company is not affected by death or solvency of any of its members. Kinds of Companies: Based on incorporation: 1. Charted Company: It is created by Royal Charter of the state. The charter contains the rights, privileges and covers to be used by the charted company. Ex: British East-India Company formed in England in To trade with India and east. 2. Statutory Corporation: It is created by an Act of the state parliament. The objective, Scope, Powers, responsibilities are clearly defined in the Act. Ex: RBI, IDBI, food Corporation of India, APSRTC, etc. 3. Registered Company: It is which Registered under Indian Companies Act 1956 (1913). The provisions of the Act govern the formation and working of these companies. And the company may be a Public Ltd. Or Private Ltd or Government Company. Based on public interest: 1. Private limited company: According to Sec. 3 of the Indian Companies Act. A private company means a company that has a minimum paid up capital of one lakh rupees or such higher paid up capital as may be prescribed, and its articles a. Restricts the right of transfer its shares, if any b. Limits the number of its members to fifty excluding present and past employees c. Prohibits any invitation to the public to subscribe any shares in or debentures of, the company

18 d. Prohibits any invitation or acceptance of deposits from persons other than its members, directors or their relatives The name of a private company should necessarily end with the words private limited (Pvt. Ltd.). 2. Public Company : This means a company that a. is not a private company b. has a minimum paid up capital of five lakh rupees or such higher paid up capital, as may be prescribed c. is a private company, which is a subsidiary of a company that is not a private company. d. Allows transfer of its shares e. Can have any number of members but minimum, there should be seven members f. Can issue the prospectus to raise the capital The name of the public company ends with the word limited (Ltd.) 3. Government Company: Section 617 of Indian Companies Act, 1956 defines a government company as any company in which not less that 51 percent of the paid-up share capital is held by Central govt., or by any state govt. or governments, or partly by Central Govt. and partly by one or more state governments and includes a company which is a subsidiary of a govt. Company. Ex : National Thermal Power Corporation (NTPC), Bharat Heavy Electricals Ltd. (BHEL), Hindustan Machine Tools ( HMT), Hindustan Port Trust, Steel Authority of India ( SAIL). Based on Controlling interest : Holding and subsidiary companies: A holding company is a company that controls the composition of the board of directors of another company or holds more than half of the nominal value of the equity share capital of another company. The other company that is controlled by the holding company is called subsidiary company. A company (say, X), which is a holding company of another company ( Say, Y), but subsidiary of a third company ( Say, Z) Then that another company (Y) will also be subsidiary of the third company (Z). Based on liability: 1. Unlimited Company: An Unlimited Company is a company in which the liability of every member is unlimited. This implies that the personal property of every member is also liable for the debts of the company. The liability of member is enforceable only at the time of winding up of the company. Unlimited companies are rarely found in practice even through as per Indian Companies Act, unlimited companies can be incorporated. 2. Limited Company: A Company is said to be Limited Liability Company where the liability of its members is limited by the unpaid amount on the shares

19 respectively held by them. Generally, the companies incorporated under Indian Companies Act are limited liability companies only. 3. Companies Limited by guarantee: A company is said to be limited guarantee where the liability of the members is limited to such an amount as they agreed upon to contribute to the assets of the company in the event of being wound up. Based on nationality : Based on nationality the companies can be divided into two types : 1. Foreign Company: Foreign Company is a company incorporated outside India but established a place of business within India. Foreign companies come under the purview of the Indian Companies Act, Indian Company: A Company incorporated in India under the Indian Companies Act, How is Capital Raised by a Joint Stock Company? 1. Methods of Raising Capital : A Company raises in two ways, namely, I. Through the sale of shares or stocks and II. Through the sale of bonds or debentures. 2. Types of Share Capital : I. Authorized Capital : Authorized Capital refers to the maximum amount which can be raised by selling shares. This may be, say, Rs. 20 crores. II. Issued Capital: Issued Capital refers to that part of the authorized capital which is issued to the public for subscribed by the public. This may be say, Rs. 14 crores. III. Subscribed Capital: Subscribed Capital refers to that part of the issued capital which is actually subscribed by the public. This may be say, Rs. 14 crores. IV. Paid up Capital: Paid- up Capital refers to that part of the subscribed capital which the public directly pay up to the company, as a part payment of the value of their shares. This may be, say, Rs. 10 crores. The remaining amount of the subscribed capital is paid after further calls from the company. 3. Types of Shares: The capital of a company can be divided into three types of shares: I. Equity or Ordinary Shares: Such shares form the main basis of the finance of a company. The holders of such shares get divided only after the preference shareholders are paid out of its profits. Hence they bear maximum risk. This is because they do not get any divided if the company

20 II. III. does not make any profit. At times when profits high, they get much more than the rate of dividend paid to preference shareholders. Preference Shares: These shareholders enjoy a preferential or prior right over equity shareholders to the profit of a company. They are entitled to a fixed rate of dividend after paying interest on debentures and before any dividend is paid to equity shareholders. Deferred Shares: They are called the Promoters or Management s of Founders shares. The holders of such shares are paid dividend last out of the profits left after meeting the claims of ordinary and preference shareholders and reserve funds. Normally they are issued to promoters of a company but they may also be issued to public. If dividend paid to other classes of shareholders is restricted, the deferred shareholders will enjoy a bigger share of profits. But if there are no profits, they do not get anything. Sale of Bonds or Debentures Debentures: A company may also raise additional finance by borrowing from the public for a specific period of time, say, 15 to 25 years, at a particular rate of interest. This is done by issuing debentures or bonds. A Debenture is an undertaking by a company to repay the borrowed money on or before the specific date at particular interest rate, irrespective of profit or loss made by the company. The capital raised by selling debentures is like taking loans from the public. Hence, a debenture- holder is creditor of a company with no voting right. As such, he can t directly interface with the activities of its management. A company is also free to issue convertible debentures which can be converted into equity share after a period of time, say, 5 to 10 years, at a ratio fixed in advance. Advantages of Joint Stock Company You must be keen to know why we should form a company for carrying out business? Obviously, this is because there are many advantages which the company form of business organization enjoys over other forms of business organization. Let us read about those advantages. The main advantages of Joint Stock Company are - (i) Large financial resources: A joint stock company is able to collect a large amount of capital through small contributions from a large number of people. In public limited company shares can be offered to the general public to raise capital. They can also accept deposits from the public and issue debentures to raise funds. (ii) Limited Liability: In case of a company, the liability of its members is limited to the extent of the value of shares held by them. Private property of members cannot be attached for debts of the company. This advantage attracts many

21 people to invest their savings in the company and it encourages the owners to take more risk. (iii) Professional management: Management of a company is vested in the hands of directors, who are elected democratically by the members or shareholders. These directors as a group known as Board of Directors ( or simply Board) manage the affairs of the company and are accountable to all the members. So members elect capable persons having sound financial, legal and business knowledge to the board so that they can manage the company efficiently. (iv) Large-scale production: Due to the availability of large financial resources and technical expertise it is possible for the companies to have large-scale production. It enables the company to produce more efficiently and at lower cost. (v) Contribution to society: A joint stock company offers employment to a large number of people. It facilitates promotion of various ancillary industries, trade and auxiliaries to trade. Sometimes it also donates money towards education, health and community services. (vi) Research and Development: Only in company form of business it is possible to invest a lot of money on research and development for improved processes of production, new design, better quality products, etc. It also takes care of training and development of its employees. Limitations of Joint Stock Company In spite of many advantages of the company form of business organisation, it also suffers from some limitations. Let us note the limitations of Joint Stock Companies. (i) Difficult to form: The formation or registration of joint stock company involves a complicated procedure. A number of legal documents and formalities have to be completed before a company can start its business. It requires the services of specialists such as Chartered Accountants, Company Secretaries, etc. Therefore, cost of formation of a company is very high. (ii) Excessive government control: Joint stock companies are regulated by government through Companies Act and other economic legislations. Particularly, public limited companies are required to adhere to various legal formalities as provided in the Companies Act and other legislations. Noncompliance with these invites heavy penalty. This affects the smooth functioning of the companies. (iii) Delay in policy decisions: Generally policy decisions are taken at the Board meetings of the company. Further the company has to fulfill certain procedural formalities. These procedures are time consuming and therefore, may delay action on the decisions. (iv) Concentration of economic power and wealth in few hands: A joint stock company is a large-scale business organization having huge resources. This gives