Chapter 1: The Four Types of Firms

• Sole Proprietorship

• Partnership

• Limited Liability Company

• Corporation

• Sole Proprietorship

– Business is owned and run by one person.

– Typically has few, if any, employees.

– Advantages

• Easy to create

– Disadvantages

• No separation between the firm and the owner

• Unlimited personal liability

• Limited life

• Partnership

– Limited Partnership avoids double taxation

– Limited Partnership has two types of owners.

• General Partners

– Have the same rights and liability as partners in a “regular” partnership

– Typically run the firm on a day-to-day basis

• Limited Partners

– Have limited liability and cannot lose more than their initial investment

– Have no management authority and cannot legally be involved in the managerial decision making for the business

• Limited Liability Companies (LLC)

– Avoids double taxation

– All owners have limited liability, but they can also run the business.

– Relatively new business form in the United States.

• Corporation

– Limited liability

– Unlimited life

– Access to capital markets/availability of outside funding

– Tax Implications

• Double Taxation

Sub-chapter “S” corporations and Sub-chapter “C” corporations

• “C” Corporation

– Publicly traded stock

– Unlimited shareholders

– Double taxation

• “S” Corporations

• Avoids double taxation

• Firm’s profits are not subject to corporate income tax, but instead are allocated directly to the shareholders.

Firms’ Disclosure of Financial Information

• Financial Statements

– Firm-issued accounting reports with past performance information

• Balance Sheet

• Income Statement

• Statement of Cash Flows

• Statement of Stockholder’s Equity

– Filed with the SEC

• 10Q – Quarterly

• 10K – Annual

– Must also send an annual report with financial statements to shareholders

Firms’ Disclosure of Financial Information

• Preparation of Financial Statements

– Generally Accepted Accounting Principles (GAAP)

– Auditor

• Neutral third party that checks a firm’s financial statements

• ensures that the annual financial statements are prepared accurately.

• ensures that the annual financial statements are prepared according to GAAP.

• verifys that the information used in preparing the annual financial statements is reliable.