Management > General Management > Forms of Business Organizations > Sole Proprietorship
When starting a business or is interested in expanding an existing one, an important decision relates to the choice of the form of organization. By weighing the advantages and disadvantages of each form of organization, the most appropriate form is determined. The decision of selection also depends on the form which satisfies the need of the entrepreneur. Various forms of business organizations from which one can choose the right one include:
- Sole proprietorship,
- Joint Hindu family business,
- Partnership,
- Cooperative societies, and
- Joint-stock company.
In this article, we shall understand the simplest form of the business organization i.e. Sole Proprietorship.
Sole Proprietorship:
A sole proprietorship is the most popular form of business organization which is the most suitable form for small businesses, particularly in their initial years of operation. It is a form of business organization which is owned, managed and controlled by an individual who is the recipient of all profits and bearer of all risks. This form of business is particularly common in areas of personalized services such as beauty parlours, hair saloons and a retail shop in a locality.
Features of Sole Proprietorship:
- Less Legal Formalities: It has less legal formalities. It is the form of business organization which does not have a separate law to govern it. It does not require incorporation or registration of any kind. In most of the cases, only a license is required to carry out the desired business. In the absence of any legal provision, it is easy to close down also.
- Unlimited Liabilities: There is no separation between the owner and the business, hence the liabilities of the owner are unlimited. If the business fails to meet its own liabilities, the burden of liabilities falls upon the proprietor to pay them through his personal assets.
- Ease of Management: The owner can make all decisions and carry out his plans without any interference from others.
- Sole Risk Bearer and Profit Recipient: As the owner is investing money and responsible for everyday management of the business, he is the only risk bearer (in case of losses) and profit recipient (in case of profit).
- No Separate Identity: As the business and owner are one and the same, there is no separate identity of the sole proprietorship.
- Continuity of Business: As the owner is responsible for all the activities of the business, the death, retirement, bankruptcy, insanity, imprisonment, etc. will have an effect on the sole proprietorship.
- Maintenance of Secrecy: The owner is not bound by law to publish his business accounts. It enables him to keep all the information related to business operations confidential and maintain secrecy.
Merits of Sole Proprietorship:
- Quick Decision Making: As the owner is the sole decision-maker in the business, he will have complete control of the entire business, this will facilitate quick decisions and freedom to do business according to his wishes. He is only one who is the risk bearer and the profit recipient. This provides a maximum incentive to the sole trader to work hard.
- Ease of Formation and a Closure: This form of business has less legal formalities. It is the form of business organization which does not have a separate law to govern it. It does not require incorporation or registration of any kind. In most of the cases, only a license is required to carry out the desired business. In the absence of any legal provision, it is easy to start and close down also.
- Confidentiality of Information: In this form of business organization there is no separate law to govern it. Thus the owner is not bound by law to publish business’s accounts or any such documents to any members of the public. Thus it enables the owner to keep all the information related to business operations confidential and maintain secrecy which is sometimes important in the business.
- Direct Incentive: The owner derives the maximum incentive from the business. The owner directly reaps the benefits of his efforts as he is the sole recipient of all the profit. So the work he puts into the business is completely reciprocated in incentives. This reciprocality provides a maximum incentive to the sole trader to work hard.
- Sense of Accomplishment: Here the owner is his own boss. Hence there is personal satisfaction and sense of achievement involved in working for oneself. He need not answer anybody because he is answerable to himself. The knowledge that one is responsible for the success. It boosts self-worth and self-respect for the owner.
Demerits of Sole Proprietorship:
- Unlimited liability: One of the biggest limitations of a sole proprietorship is that the owner has unlimited liability. If the business fails, the creditors can recover their dues not merely from the business assets, but also from the personal assets of the proprietor. Thus if the business fails it can wipe out the personal wealth of the owner. A wrong decision or in unforeseen unfavorable circumstance can create a serious financial problem for the sole proprietor. Hence a sole proprietor is less inclined to take risks in the form of innovation or expansion.
- Limited Resources: Resources of a sole proprietor are limited to his personal savings and borrowings from friends and relatives. Thus the capital for the business is limited. Less capital is available for diversification and expansion of the business. Lack of resources is one of the major reasons why the size of the business rarely grows much and generally remains small. Banks and financial institutions are reluctant in lending to proprietorship firms.
- Limited Life of a Business: The life cycle of a sole proprietorship firm is undecided and attached to its owner. As the owner is responsible for all the activities of the business, the death, retirement, bankruptcy, insanity, imprisonment, etc. will have an effect on the sole proprietorship and can lead to the closure of the business.
- Limited Managerial Ability: A sole proprietor is taking all the decisions in the business and has to perform the responsibility of varied managerial tasks such as planning, purchasing, selling, financing, etc.. He cannot be an expert in all the fields of the business. Due to limited resources, he cannot hire and retain competent and talented people to help him out. This may lead to the business suffering from mismanagement and poor decisions.
Conclusion:
Though sole proprietorship suffers from various shortcomings, many entrepreneurs opt for this form of organization because of its inherent advantages. It has less legal formalities. Decision making is easy. It requires less amount of capital. It is best suited for businesses which are carried out on a small scale and where customers demand personalized services.
Next Topic: Joint Hindu Family Business (HUF)