In Britain the sole trader, or one person business,is the most common type of business organisation. The sole trader may run any kind of business eg baker, grocer, newsagent, clothier, engineer, electrician, joiner or gardener. He/she is the only owner of the business but is not necessarily the only worker; the sole trader can employ a fairly large work force.


There are many reasons for people going into business on their own rather than being employed. The main reason, of course, is profit as being self-employed is generally more rewarding than being employed. Someone who is out of work may see this as the only way forward. Occasionally someone with much experience, feeling he/she is not making enough progress, branches out on his/her own whilst others enjoy the challenge of management and control as well as the opportunity to give employment to others.


An electrician, having several years’ experience as a tradesman and with money saved, may feel that he wants to ‘start up on his own’ but realises that it must be very carefully considered. What are the considerations?


1. Is there enough money?


It is not always necessary to have a lot of money to start in business. Work may be carried out from home, premises may be rented rather than bought, equipment may already be owned or may be bought second-hand.


Capital This is the term used for money invested by the owner of a business. If these funds are invested in a bank/building society they gain interest. However, the sole trader hopes that, by investing it in a business, he/she will gain a higher rate of return – profit.


If there is likely to be insufficient capital it is possible to obtain funds or
raise finance by other means.
Loan A fixed amount may be borrowed, either privately from family and friends, or from a bank or building society. The bank manager will have to be convinced that the business is a worthwhile and financially safe project before lending. Interest must be paid on a loan, the charge depending on the amount, the current rate of interest and the length of the repayment period.
Grant Local councils have ‘enterprise trusts’ which, as well as offering guidance and advice, give grants to people starting up in business. A grant need not be repaid and carries no interest charge. Other trusts, e.g the Prince’s Trust, also give grants, particularly to young people, where the case seems genuine.


Additional facilities such as the following may be available once a business has started up.
Overdraft The bank manager may give permission for the sole trader to continue to withdraw money in excess of any amount deposited in an account (up to a certain limit). Although interest is charged on this type of borrowing, it allows the business to continue to pay debts.
Credit It may be possible to buy assets and stock on credit i.e. pay for them at a later date or in instalments.




2. Is the required organisational ability available?


As well as being skilled in a particular field (electrics), the electrician will need to maintain book-keeping records, file documents, buy stock, advertise, sell, etc. This may take many hours after the day’s work is finished.


3. How do you set up in business?


Setting up as a sole trader is easy and uncomplicated. Once finance, premises and equipment are organised and the tax (Inland Revenue) authority informed, the business can start. As well as financial assistance, valuable guidance and advice on all aspects of starting in business is available from enterprise trusts.


4. What advantages are there in being self-employed?


The main advantages are:
· he/she will be his/her own boss
· he/she will receive all profits
· he/she will be able to give customers more personal attention.


5. What disadvantages are there?


The main disadvantages are:
· there is nobody to share responsibility and decision-making
· the owner carries all losses
· the sole trader has limited liability – he/she stands to lose everything he/she has in order to pay off debts in the event of bankruptcy
· until he/she can employ experienced staff, there is no relief for illness and holidays.


Summary: Comparison of a sole trader with a partnership






Sole trader Partnership
Setting up
· no legal requirement. · no legal requirement but partnership agreement advisable.
Finance
· capital raised privately · capital raised privately
· loan · loan
· grant. · grant.
Management and control
· independent · shared among partners
· under personal direction · under shared personal direction
· must take full responsibility · can share responsibility for decisions
· responsible only for own mistakes. · must carry losses resulting from other partners’ mistakes.
Risk
· unlimited liability. · unlimited liability
(except for sleeping partner).
Accounts
· no legal requirement and no laid-down procedure. · no legal requirement and no laid-down procedure.




Types of business organisation: partnership




A partnership is a combination of between 2 and 20 persons in business, providing goods or services with a view to making a profit. (Lawyers and accountants may have more than 20 partners.) This is a common type of business organisation and often results from the growth of the business of a sole trader. Some partnerships are such from the start.


Finance


The finance of a partnership is similar to a sole trader’s finance – simple and straightforward. Private finance is invested by the owners (the partners) and can be added to by grants and loans.


Setting up


There is no legal requirement to have any agreement before starting in a partnership. However, it is advisable to draw up a partnership agreement which sets out the terms of the partnership in order to minimise misunderstandings and disagreements. If the partnership is dissolved at any time the agreement will form the basis of the dissolution. If there is no partnership agreement, the procedure set out in the Partnership Act of 1890 must be adopted.


Partnership agreement (or deed of partnership)


This is legally prepared and can contain as much or as little detail as the partners wish. It must contain the name and address of the partnership, date of formation and its aims, and the main accounting points covered are as follows:
· capital to be contributed by each of the partners
· ratio in which partners are to share profits and losses
· details of any partnership salaries to be paid
· whether interest is to be paid on capital and, if so, the rate
· whether interest is to be charged on drawings and, if so, the rate.


Note


Capital may be added or withdrawn from the partnership provided all the partners agree.


The ratio in which profits and losses are shared may be in proportion to capital contributed or it may reflect the skill, experience or responsibility of each of the partners.


A salary may be paid to a partner who has a special responsibility.


Interest may be paid on capital where the partners’ investment varies but the work undertaken is equal. This will compensate the partner who has made the higher contribution and therefore is taking the greater risk.




The partnership agreement also sets out the conditions under which a new partner may be admitted. This will involve a revaluation of the assets and a corresponding adjustment of the original partners’ capital accounts. The new partner will bring in fresh capital and the profit/loss ratio will be changed to allow for the new partner’s share.
Management and control


Management and control are shared in a partnership, therefore it is essential that the partners agree on their aims and methods. As well as major decisions being made, day-to-day methods must be discussed and agreed upon before starting up. Minor disagreements can very quickly assume great significance, particularly where one of the partners was previously a sole trader and was used to independence.


Additionally, the sharing of this responsibility should lighten the load. As well as being able to discuss problems, the ‘after-hours’ duties will be shared.


Liability


Liability for debts is unlimited and partners may have to sell their personal possessions to pay off the debts of the business. Even if one partner was responsible for making a decision which led to the downfall of the business, all partners share in the resultant loss.


The exception to this is the sleeping partner – a partner who invests money in the partnership but has no say in the actual running of the business. This often happens where a relative can supply necessary capital but does not want to be involved in the work.


Advantages


The main advantages of a partnership are as follows:
· additional capital is available for expansion
· partners bring a variety of skills and experience to the business eg a joiner
combining with a plumber and electrician
· decision-making is shared
· owners have direct control of the business
· all profits belong to the owners.




Disadvantages


The main disadvantages of a partnership are as follows:
· each partner must carry a share of all losses
· liability is unlimited – personal property may be sold to clear debts of business
· disagreements may lead to the break-up of the partnership.




Partnership: capital and current accounts


Capital account


The capital accounts of the partners are fixed, that is they show only the capital contributed when the business started plus any further capital paid in.


Example




D Conn and F Cowan started in partnership on 1 January Year 1 and the following are details of their capital transactions:
D Conn
F Cowan
Year 1 £ £
Jan 1 Paid into bank
10,000
8,000
Year 2
June 1 Paid into bank
5,000
Year 3
Jan 1 Paid into bank
2,000
Bought machine for business
3,000
















The partners’ capital accounts would appear as follows:


Capital account – D Conn
Year 1 Dr Cr Bal
Jan 1 Bank
10,000
10,000
Year 2
June 1 Bank
5,000
15,000
Capital account – F Cowan
Year 1
Jan 1 Bank
8,000
8,000
Year 3
Jan 1 Bank
2,000
10,000
Machine
3,000
13,000




















Current account


A sole trader’s capital account is credited with net profit (or debited with net loss) and debited with drawings. The final balance shows what the business owes the owner.


In a partnership a current account is opened for each partner and records what is due to the partner from the business, over and above the capital.


The account is credited with what is due to the partner:
· partnership salary
· interest on capital
· share of profit.


The account is debited with what reduces any share of profit:
· drawings.


Example


J Duncan and R Davis started business on 1 January with capitals of £12,000 and £9,000 respectively.


At 31 December the following figures were available:
J Duncan
R Davis
£ £
Interest on capital
600
450
Share of profit
3,600
3,600












The current accounts of the partners would appear as follows.


Capital account – J Duncan
Dr Cr Bal
£ £ £
31 December interest on capital
600
600
Share of profit
3,600
4,200
Current account – R Davis
31 December interest on capital
450
450
Share of profit
3,600
4,050


















The current accounts are prepared when the profit and loss account has been completed and the profit shared.


A final credit balance in the current account shows the amount of profit due to the partner.


A final debit balance in the current account shows that share of profit has been overdrawn and the partner is in debt to the partnership.


Partnership: final accounts


At the end of the year when the final accounts are being prepared the trading and profit and loss account is the same as that of a sole trader. However, as the net profit has to be divided among the partners an extra section is required to show this division or appropriation of profit. The extra section is called the profit and loss appropriation section.


Profit and loss appropriation section


This follows immediately on from the profit and loss account.


It starts with the net profit/net loss and shows other items due to the partners such as partnership salary and interest on capital. These are deductions from net profit and are shown as follows.


Appropriation section for year ended
£ £
20,000
Net profit
Less partnership salary A
5,000


interest on capital A
2,000
B
2,500
9,500
10,500
share of profit A
5,250
B
5,250
10,500


















When these deductions have been taken into account, the remaining profit, known as the residual profit (£10,500 in the above example) is divided between the partners in the agreed ratio.


It should be remembered that none of these items are cash transactions but figures which show the share of profit to which the partners are entitled.




Example 1


R Peters and K Smith set up in partnership on 1 January with capitals of £12,000 and £10,000. They share profits and losses equally.


Net profit for the year ended 31 December amounted to £20,000.


You are required to prepare the following:
· profit and loss appropriation section for the year ended 31 December
· capital accounts
· current accounts.




Example 2


R Young and V Morrison have contributed £40,000 and £30,000 respectively to their partnership.


The rate of interest on capital is 5% pa.


Profits and losses are shared equally.


Net profit for the year ended 31 December is £28,000.




You are required to prepare the following:
· profit and loss appropriation section for the year ended 31 December
· capital accounts
· current accounts.








Example 3


J Robbins and M West started in partnership on 1 January and contributed capitals of £18,000 and £12,000 respectively. The following conditions are stated in the partnership agreement:
· partnership salary: M West £5,000
· interest on capital: 5% pa
· profits/losses: 3:2 in favour of J Robbins.


Net profit for the year ended 31 December was £15,000.


You are required to prepare the following:
· profit and loss appropriation section for the year ended 30 April
· capital accounts
· current accounts.




Example 4


B Andrews and D Cairns are in partnership on the following terms:
· capital contributed: B Andrews £20,000 D Cairns £30,000
· partnership salary: B Andrews £5,000
· interest on capital: 5% pa
· share of profits: equal.




The following figures have been made available for the year ended 31 December.


£
Net profit:
45,000
Drawings for year: B Andrews
5,000
D Cairns
4,000












You are required to prepare the following:
· profit and loss appropriation section for the year ended 31 December
· capital accounts
· current accounts.








Partnership accounts: exercises


Exercise 1


J Manson and S Morrison are in partnership with capitals of £8,000 and £5,000 respectively. The partnership deed states that:
· interest of 5% per annum is allowed on capital
· remaining profits and losses are to be shared 3:2 in favour of J Manson
· Net profit for the year ended 30 June was £6,000.


You are required to prepare:
· the appropriation section of the Profit and Loss Account for the year ended 30 June
· the capital account of each partner
· the current account of each partner.






Exercise 2


H Wood and M Marr are in partnership with capitals of £12,000 and £8,000 respectively. Their partnership deed states that:
· interest of 6% per annum is allowed on capital
· profits and losses are to be shared equally
· Net profit for the year ended 31 August was £10,500.


You are required to prepare:
· the appropriation section of the Profit and Loss Account for the year ended 31 August
· the capital account of each partner
· the current account of each partner.


Exercise 3


L Andrews and S Edwards formed a partnership on 1 May with capitals of £20,000 and £15,000 respectively. The partnership deed states that:
· L Andrews is to receive a partnership salary of £2,500
· interest of 5% per annum is allowed on capital
· profits and losses are to be shared 2:1 in favour of L Andrews
· Net profit for the year ended 30 April was £17,000.


You are required to prepare:
· the appropriation section of the Profit and Loss Account for the year ended 30 April
· the capital account of each partner
· the current account of each partner.






Exercise 4


D Michael and H Harrison are in partnership and at 1 January the following balances were in their accounts.


D Michael
H Harrison
Capital account
£25,000
£20,000
Current account
£2,000 (Cr)
£3,000 (Cr)


The partnership deed states that:
· interest of 5% per annum is allowed on capital
· partnership salary of £6,000 is payable to H Harrison
· profits and losses are to be shared equally
· Net profit for the year ended 31 December is £18,000.


You are required to prepare:
· the appropriation section of the Profit and Loss Account for the year ended 31 December
· the capital account of each partner
· the current account of each partner.




Exercise 5


Thomson and Steven are in partnership and the following information is available.


Thomson
Steven
Capital account balances at start
£60,000
£40,000
Current account balances at start
£4,200 (Cr)
£3,500 (Cr)
Drawings for the year ended 31 December
£5,000
£3,000


Net profit for the year ended 31 December amounted to £38,000.


The partnership deed states that:
· a salary of £3,800 is payable to Steven
· interest on capital is allowed at 6% per annum
· profits and losses are shared in proportion to capitals.


You are required to prepare:
· the appropriation section of the Profit and Loss Account for the year ended 31 December
· the capital account of each partner
· the current account of each partner.




Exercise 6


The following information relates to the partnership of J Hurst and M Burke.


Net profit for the year ended 30 September is £19,200.


The partnership deed states that:
· interest of 4% per annum is allowed on capital
· a salary of £2,000 is payable to M Burke
· profits and losses are shared 2:1 in favour of J Hurst.


J Hurst
M Burke
Capital account balances at start
£25,000
£12,000
Current account balances at start
£1,000 (Cr)
£1,500 (Cr)
Drawings for year ended 30 September
£3,000
£500


You are required to prepare:
· the appropriation section of the Profit and Loss Account for the year ended 30 September
· the capital account of each partner
· the current account of each partner.


Partnership: balance sheet


The first part of the balance sheet of a sole trader shows the total assets of the firm - fixed assets followed by net current assets (current assets - current liabilities). In a partnership this is unchanged.


The second part of the balance sheet shows how this has been financed - the closing capital figure. The sole trader’s closing capital is the opening capital + net profit (- net loss) - drawings.


In a partnership capital accounts are fixed and the adjustments (interest on capital, partnership salary, share of profit and drawings) are shown in the current accounts. The closing balances in the capital and current accounts show the partners’ investment in the business and therefore form the finance section of the balance sheet.


Example 5


T Nicholson and D Laing are in partnership and the partnership deed states the following:
· T Nicholson is to receive a partnership salary of £4,500
· interest on capital is to be allowed at 5% per annum
· profits and losses are to be shared equally.


The following additional information is also available.


Net profit for the year ended 31 December was £20,000.


T Nicholson
D Laing
Capital account balances at 1 January
£35,000
£28,000
Current account balances at 1 January
£5,600 (Cr)
£4,800 (Cr)
Drawings for the year ended 31 December
£2,600
£4,500




You are required to prepare:
· the appropriation section of the Profit and Loss Account for the year ended 31 December
· capital account of each partner
· current account of each partner
· the finance section of the Balance Sheet of the partnership as at 31 December.






Example 6


S Short and B Menzies are in partnership. Their partnership deed states that:
· interest of 4% per annum is allowed on capital
· a salary of £5,000 per annum is to be allowed to Menzies
· remaining profits and losses are to be shared 2:1 in favour of Short.




The following balances were taken from the partnership ledger after the net profit had been found on 30 April.


Dr Cr
£ £
Net profit
28,000
Bank
3,500
Vehicles
54,000
Provision for depreciation of machinery at 30 April
22,000
Machinery
27,000
Provision for depreciation of machinery at 30 April
9,000
Debtors
6,200
Prepayments
800
Creditors
5,700
Accruals
900
Stock
8,600
Capital accounts: S Short
20,000
B Menzies
15,000
Current accounts: S Short
3,600
B Menzies
2,300
Drawings: S Short
3,800
B Menzies
2,600
_______£106,500
_______£106,500




You are required to prepare:
· the appropriation section of the Profit and Loss Account for the year ended 30 April
· capital account of each partner
· updated current of each partner
· the Balance Sheet of the partnership as at 30 April.






Partnership: exercises


Exercise 7


S Desai and K Das are in partnership and their partnership deed states that:
· interest of 6% per annum is allowed on capital
· K Das will have a salary of £4,200
· remaining profit and losses will be shared 2:1 in favour of S Desai.




The following balances were taken from the partnership ledger after the net profit had been found on 30 April.


Dr Cr
£ £
Net profit
21,000
Capital account: Desai
18,000
Das
12,000
Current account: Desai
2,150
Das
1,315


Drawings: Desai
1,560
Das
1,420
Stock
8,200
Bank
1,600
Cash
300
Prepayments
720
Accruals
540
VAT
2,150
Debtors
1,365
Creditors
2,410
Vehicles
45,000
Equipment
19,200
Provision for depreciation of vehicles
16,000
Provision for depreciation of equipment
3,800
______
______
£79,365
£79,365


You are required to prepare the:
· appropriation section of the Profit and Loss Account for the year ended 30 April
· updated Current Accounts for each partner
· Balance Sheet of the partnership as at 30 April.


Exercise 8


S O’Hara and T White are in partnership and their partnership deed states that:
· interest of 4% per annum is allowed on capital
· White will have a salary of £5,350
· remaining profit and losses will be shared equally.


The following balances were taken from the partnership ledger after the net profit had been found on 30 September.


Dr Cr
£ £
Net profit
40,000
Capital account: O’Hara
35,000
White
30,000
Current account: O’Hara
3,420
White
4,370
Drawings: O’Hara
4,000
White
2,800
Stock
12,420
Bank
1,500
Prepayments
825
Accruals
767
VAT
1,340
Debtors
3,452
Creditors
4,600
Buildings
80,000
Machinery
40,000
Provision for depreciation of machinery
22,500
______
_______
143,497
143,497


You are required to prepare the:
· appropriation section of the Profit and Loss Account for the year ended 30 September
· updated Current Accounts for each partner
· Balance Sheet of the partnership as at 30 September.