Question

Long Answer Questions :
What do you understand by a sole proprietorship firm? Explain its merits and limitations.

Answer 1

The sole proprietorship is a form of business that is owned and managed by a single individual. That single individual has to supply capital owned or borrowed to the business.

As ownership belongs to one individual, it is both the prerogative and the responsibility of that individual to manage the affairs of business. He has to take decisions managerial, technical, financial, others to ensure efficient, effective, and profitable conduct of his business.

This form is also known as the proprietorship, single proprietorship, individual proprietorship, sole ownership, individual enterprise, and sole trader.

Characteristics of sole proprietorship:

1. Individual ownership and control.

2. Undivided responsibility of business obligations.

3. No (or minimal) government regulation.

4. Complete fusion of ownership and control.

Merits/Advantages of Sole Proprietorship:

1. Ease of formation and dissolution:

The sole proprietorship is the simplest form of business ownership. There is hardly any formality involved in setting up this type of organization. This ownership organization is not governed by any special Act.

However, general laws like Law of Contracts, Sale of Goods Act, etc., are applicable. Dissolution, or sale of business, is equally convenient in most cases. Satisfaction of creditors’ claims is usually the only restriction in winding up the business.

2. Simplicity of operation and flexible management:

A sole trader need not consult anyone, refer to others, discuss with anybody, or take the opinion of any person, before he decides the affairs of his organization. In addition to this, the owner is not required to submit the results of the business to the prescribed authorities. Quick decision and prompt action enable him to take advantage of business opportunities.

3. Sole claim on profits:

The sole trader is the only person to whom the profits belong. This always acts as a stimulant to personal incentive.

4. Favourable credit standing:

Since the owner is personally liable for all debts of the proprietorship, this form often enjoys a favorable rating among creditors. When creditors know that a proprietor has valuable personal assets, they can anticipate satisfaction from these sources if the business fails or debts remain unpaid.

5. Preferential treatment by Government:

Not only that it is free from government regulations, it also gets subsidies, concessions, and a host of facilities from the government being socially useful, it gets loans on concessional rates, liberal repayment schedule, etc.

6. Social usefulness:

The sole proprietorship is often organised as a small business. Thus, it affords opportunities of the widest possible dispersal of ownership, more opportunities for employment — self and public, wider distribution of the giants of industrial development, prevention/reduction in the formation of monopolies, etc.

7. Tax advantage:

A sole proprietor pays income tax the same as any individual, and the business is not taxed. Under the Income Tax Act, 1961, an individual assessed does not pay any tax if his or her income does not exceed a particular limit (called tax exemption limit), and beyond this the tax is levied on the basis of income slabs. As such, the burden of tax on smaller amount of profit is less in sole proprietorship as compared to other forms of ownership organization.

Because of these advantages found in a small business, William Basset once remarked, “The one-man control is the best in the world, if that man is big enough to manage everything.”

Limitations of Sole Proprietorship:

1. Limitations of management:

The proprietor has certain limitations, for example, he/she must rely upon his/her own skills and judgement in managing the business. Few proprietors have all of the management skills required for financing, marketing, purchasing, supervising personnel, and related functions. Not only does this limit the size of the business, but it also contributes to the relatively high rate of failure among sole proprietorship.

2. Unlimited liability:

Since the owner takes all the profits, he must also accept full personal responsibility for all the losses, even to the extent of his personal possessions. Because in the eyes of law, the firm (sole proprietorship business) and sole proprietor are one and the same and not two different entities, and therefore, the liabilities of the business are the personal liabilities of the proprietor.

3. Lack of continuity:

An enterprise that depends on one man comes to a close if that man becomes seriously ill or dies. Such a situation, arising out of lack of continuity, proves disastrous for employees and all those persons and institutions who had business relations with such a business.

4. Limitations of size:

Since a sole proprietary business is conducted on a small scale, it poses- certain problems, especially in raising sufficient financial resources to support expansion, modernization, and diversification plans of business, and also providing meaningful opportunities and welfare measures to employees.