Business Accounting

2.0 Introduction
Define Limited Company
A limited company, also known as a limited liability company (LLC), is a type
of business ownership which determines many aspects of the way the business is run.
A limited company shares some aspects with a privately owned company, some with
a partnership, and some with a corporation. There are both advantages and
disadvantages to making a company a limited company.
A limited company may be formed in the United States by a fairly simple
process. First, the owner or owners of the company, who will be called "members"
when the limited company is formed, must file articles of organization with their
state's Secretary of State. Each state has specific laws about how these articles should
be written.
The members of the company must then pay the required fees to the state.
Each state also has guidelines about other matters that may be required, such as filing
an operating agreement, or making a public notice of the limited company's formation.
Once a limited company is formed, the members gain all the benefits of the limited
company, as well as all the disadvantages.
One of the main benefits of a limited company is that, as the name suggests,
the liability of the members is limited. Members of the company are not responsible
for the debts of the limited company, as it is treated as a separate individual in its own
right. All of the limited company's debts are the responsibility of the company, and
cannot be passed on to its members. In this way, a limited company operates in much
the same manner as a corporation, but with fewer restrictions and requirements of the
members.
Corporations, for example, have the disadvantage of double taxation. The
corporation is taxed on its profits, and the members are taxed on their income. In a
limited company, the company is not taxed on its profits. Each member pays the tax
on his or her own profits. This is known as flow through taxation.
While a limited company has distinct benefits for its members, it also comes
with disadvantages over other types of business. A limited company has much more
paperwork and different rules to follow than a partnership or sole-proprietorship. In
addition, members of a limited company must participate in the running of the
company, or they are considered investors. If your members are investors, then their
share of the company is considered a security. Rules of the Securities and Exchange
Commission (SEC) will apply, requiring more paperwork and regulations, unless the
company qualifies for an exemption.
With many advantages and disadvantages to forming a limited company,
business owners and investors have a lot to consider. A limited company is not the
perfect business type for every business, but many find it both secure and
advantageous.
A limited company also define as a business that is owned by its shareholders,
run by directors and most importantly whose liability is limited.
Limited liability means that the investors can only lose the money they have
invested and no more. This encourages people to finance the company, and/or set up
such a business, knowing that they can only lose what they put in, if the company fails.
For people or businesses who have a claim against the company, “limited
liability” means that they can only recover money from the existing assets of the
business. They cannot claim the personal assets of the shareholders to recover
amounts owed by the company.
To set up as a limited company, a company has to register with Companies
House and is issued with a Certificate of I ncorporation. It also needs to have a
Memorandum of Association which sets out what the company has been formed to
do, and Articles of Association which are internal rules over including what the
directors can do and voting rights of the shareholders.


Private Limited Companies or Public Limited Companies.
The differencesbetween the two are:
Shares in a public limited company (plc) can be traded on the Stock
Exchange and can be bought by members of the general public. Shares in a private
limited company are not available to the general public;
The issued share capital of a plc (the initial value of the shares put on sale)
must be greater than £50,000 in a plc. A private limited company may have a smaller
share capital
The disadvantages of a being a public limited company (plc) are:
 Costly and complicated to set up as a plc – need to employee specialist
bankers and lawyers to help organize the converting to the plc.
 Certain financial information must be made available for everyone,
competitors and customers included (would you want them to know how
much profit you are making?)
 Shareholders in public companies expect a steady stream of income from
dividends, which might mean that the business has to concentrate on short
term objectives of creating a profit, whereas it might be better to work on
longer term objectives, such as growth and investment.
 Threat of takeover, because another company can buy up a large number of
shares because they are traded publicly (can be sold to anyone). If they buy
enough, they can then persuade other shareholders to join with them to vote in
a new management team.
Shareholders own the company. They buy shares because:
Shares normally pay dividends, which is a share of the profits at the end of the
year. Companies on the Stock Exchange usually pay dividends twice each year.
Over time the value of the share may increase and so can be sold for a profit –
this is known as a “capital gain”. Of course, the price of shares can go down as well as
up, so investing in shares can be very risky.
If they have enough shares they can influence the management of the company.
A good example is a “venture capitalist” that will often buy up to 80% of the shares of
a company and insist on choosing some of the directors.
Flotation
A company may float on the stock market. This means selling all or part of the
business to outside investors. This generates additional funds for the business and can
be a major form of fund raising. When shares in a “plc” are first offered for sale to the
general public as the company is given a “listing” on the Stock Exchange.
Divorce of ownership and control
As a business becomes larger, the ownership and control of the business may
become separated. This is because the shareholders may have the money, but not the
time or the management skills to run the company. Therefore, the day-to-day running
of the business is entrusted to the directors, who are employed for their skills, by the
shareholders.
The shareholders are therefore “divorced” from the running the business for
364 days of the year. They will have their say at the Annual General Meeting (AGM)
of the company, where the directors present the accounts and results. Very recently a
couple of businesses have had very strong shareholder unrest leading the company to
tone down a number of their decisions.
In practice directors tend to have at least a modest shareholding in the
company. This provides the director with an incentive to achieve good dividends and
capital growth for the share (an increase in the share price)
Define Sole Trader(Sole Proprietorship)
A sole trader business has many advantages and disadvantages but is easy to
set up and is most favoured by "one man bands" who offer house hold services and
are self employed as the sole owner of the business concerned.
The business is classed as a small business or SME as they only have one employee
who is the owner of the company.
Example sole trader businesses include electricians, gardeners, plumbers,
decorators and plasterers which are all traditional trades and easy for the skilled
tradesman to operate. They will mainly work on word of mouth marketing and work
for domestic households. There are others who set up a limited company but are
regulated under the IR35 legislation. It's also best to seek professional advice before
making a decision for your future
Definition of a Sole Trader
A form of business in which one person owns all the assets of the business, in
contrast to a partnership or a corporation and a sole trader is a type of business entity
that allows one person to be solely responsible for the financial dealings of the
business. The benefits and disadvantages of this responsibility are many and should
be weighed carefully.
A person who does business for himself is engaged in the operation of a sole
proprietorship. Anyone who does business without formally creating a business
organization is a sole proprietor. Many small businesses operate as sole
proprietorships. Professionals, consultants, and other service businesses that require
minimum amounts of capital often operate this way.
A sole proprietorship is not a separate legal entity, like a partnership or a
corporation. No legal formalities are necessary to create a sole proprietorship, other
than appropriate licensing to conduct business and registration of a business name if it
differs from that of the sole proprietor. Because a sole proprietorship is not a separate
legal entity, it is not itself a taxable entity. The sole proprietor must report income and
expenses from the business on Schedule C of her or his personal federal income tax
return.
A major concern for persons organizing a business enterprise is limiting the
extent to which their personal assets, unrelated to the business itself, are subject to
claims of business creditors. A sole proprietorship gives the least protection because
the personal liability of the sole proprietor is generally unlimited. Both the business
assets and the personal assets of the sole proprietor are subject to claims of the sole
proprietorship's creditors. In addition, existing liabilities of the sole proprietor will not
be extinguished upon the dissolution or sale of the sole proprietorship.
Unlike the managers of a corporation or a partnership, a sole proprietor has
total flexibility in managing and controlling the business. The organizational expenses
and level of formality in a sole proprietorship are minimal as compared with those of
other business organizations. However, because a sole proprietorship is not a separate
legal entity, it terminates when the sole proprietor becomes disabled, retires, or dies.
As a result, a sole proprietorship lacks business continuity and does not have a
perpetual existence as does a corporation.
For working capital, a sole proprietorship is generally limited to the individual
funds of the sole proprietor, along with any loans from outsiders willing to provide
extra capital. During her lifetime, a sole proprietor can sell or give away any asset
because the business is not legally separate from the sole proprietor. At the death of
the sole proprietor, the business is usually dissolved. The proprietor's estate, however,
can sell the assets or continue the business.

The main advantages of setting up as a sole trader are:
 Total control of the business by the owner.
 Cheap and easy to start up – few forms to fill in and to start trading the sole
trader does not need to employ any specialist services, other than setting up a
bank account and informing the tax offices.
 Keep all the profit – as the owner, all the profit belongs to the sole trader.
 Business affairs are private – competitors cannot see what you are earning,
so will know less about how the business works and how it succeeds.
The reasons why sole traders are often successful are:
 Can offer specialist services to customers – e.g. appliance repair specialists.
 Can be sensitive to the needs of customers – since they are closer to the
customer and will react more quickly, because they are the decision makers
too.
 Can cater for the needs of local people – a small business in a local area can
build up a following in the community due to trust – if people can see the
owner they feel more comfortable than if the owner is in some far off town,
not able to hear the views of the local community.
The legal requirements of a sole trader are to:
 Keep proper business accounts and records for the Inland Revenue (who
collect the tax on profits) and if necessary VAT accounts
 Comply with legal requirements that concern protection of the customer (e.g.
Sale of Goods Act)

The main disadvantages of being a sole trader are:
 Unlimited liability – see below.
 Can be difficult to raise finance, because they are small, banks will not lend
them large sums and they will not be able to use any other form of long-term
finance unless they change their ownership status.
 Can be difficult to enjoy economies of scale, i.e. lower costs per unit due to
higher levels of production. A sole trader, for instance, may not be able to buy
in bulk and enjoy the same discounts as larger businesses.
 There is a problem of continuity if the sole trader retires or dies – what
happens to the business next?
The reasons for being a sole trader are often a balance between business and
personal costs and benefits. Many will prefer the satisfaction of running a business
with little paper work against the risks, pressure and probably long working hours.
A sole trader is liable for any debts that the business incurs. This means that
any money that the owner has put into the business could be lost, BUT
IMPORTANTLY, if the business continues to incur further costs then the owner has
to pay these as well. In some cases they may have sell some of their own possessions
to pay creditors.
Such a risk often puts potential sole traders off setting up businesses, but also
makes them consider the other forms of business structure.
The Main Advantages of Limited Company
 A Limited Company may appear more credible and substantial although in
reality this is not necessarily the case.
 The liability of its shareholders is limited to the amount of the share capital
issued and so offers protection to the shareholders' personal assets. In the
event of company failure and not being able to pay its creditors, your personal
assets are protected. However, banks, landlords and others will often require
personal guarantees from the shareholders or directors when dealing with
small limited companies.
 A Limited Company may have better borrowing potential than an
unincorporated business as it can use current assets as security by creating a
floating charge over its assets.
 You can use shares to enable different people to hold different proportions of
ownership of the business that they can pass onto the next generation.
 You can have different classes of shares with different rights, such as non-
voting shares for someone who wants to invest some money into the company
but doesn't wish to take part in the management.
 Having a limited company can create significant tax advantages by having
profits taxed at Corporation Tax rates which are a lot lower than the higher
rates of personal tax. However when the funds are extract from the company
extra tax or national insurance charges may arise.

The Main Advantages that Limited Company has over the Sole Trader
A private limited company advantages and disadvantages compared with
retaining sole trader status extends beyond purely tax advantages. There are other
private limited company advantages and also disadvantages particularly in regard to
limited company accounts and administration compared to producing a simple set of
sole trader basic accounts.
A private limited company advantages include:
1. Limitation of Liability
There is no distinction between business money and personal money for
anyone self employed as all business debts are the personal responsibility of the sole
trader. The private limited company advantages are that the company is a separate
corporate body and liability for payment of debts stops with the pvt ltd company, the
owners, shareholders are not personally liable. The directors are only liable if they
continue to trade and incur liabilities after it becomes apparent the ltd company is
insolvent.
2. Lower Taxes
Lower corporation tax offered a private limited company advantages over self
employment in recent years. The £10,000 tax free limit was cancelled several years
ago. Corporation tax rates have increased from 20 per cent to 22 per cent for small ltd
companies over the last three years compared with the basic rate tax for a sole trader
which has reduced from 22 per cent to 20 per cent Incorporation does still offer tax
saving advantages dependent upon the net profit before tax.
The private limited company advantages come from the flexibility of being
able to determine the proportions of salary and dividends taken compared with a sole
trader whose basic accounts are subject to tax at fixed tax rates and thresholds.
A sole trader receives a £6,035 personal allowance and pays basic rate tax of
20 per cent on the next £34,800 of earnings up to the higher threshold limit and 40 per
cent tax thereafter. Class 4 national insurance is 8 per cent of earnings up to the upper
primary threshold and 1 per cent thereafter.
Dividends are taxed at 10 per cent on total income up to the higher threshold
and 32.5 per cent above. The dividend is a distribution of company profit after
corporation tax has been deducted and so the shareholder also receives a dividend tax
credit from the pvt ltd company of 10 per cent.
There are significant private limited company advantages regarding tax
liability compared to a sole trader where net income is below the upper earnings
threshold.
For example assuming the limited company net profit before salary is £35,000.
A sole trader would pay income tax of £5,793 plus national insurance of £2,317.20, a
total of £8,107.20.
If a salary of £6.035 is taken and the rest is taken in dividends a private limited
company would pay £6,372.30 corporation tax, after deducting the salary from net
taxable profit and the sole trader now the shareholder would pay no income tax.
The advantages increase where net taxable profit is above the self employment
upper earnings limit as money can be left in the business and therefore only subject to
the 22 per cent corporation tax rate thereby avoiding the sole trader 40 per cent tax
rate. Another possibility is to distribute the shares among family members to reduce
the risk of 40 per cent tax.
3. Limited Company accounts and Sole Trader basic accounts
Sole trader basic accounts can be quite simple as a formal accounting system
is not required and can be reduced to simple lists of income and expenditure
supported by documentary evidence of sales and purchase invoices, effectively single
entry bookkeeping. Producing a balance sheet is optional. Due to the simplicity then
an accountant may not be required saving a significant cost.
Ltd company accounts have to use double entry bookkeeping to produce the
year end accounts including a balance sheet with statutory notes and statements.
Unless accounting software is employed to produce the company accounts in this
format then accounting knowledge is required and an accountants fee may well be in
the region of £500 to £1,000. An accountant is not essential for a small pvt ltd
company but is the normal approach and offsets some of the tax advantages.
4. Additional financial considerations
Because a director is also officially an employee of the pvt ltd company this
gives rise to a number of considerations in determining the extent of a private limited
company advantages.
Pension contributions of a sole trader are personal and while may be deducted
from the personal income liability do not form part of the basic accounts. The pension
costs including any company contribution to a pension scheme by a private limited
company is a deductible business expense as an employee cost.
Using a car for business purposes may have an impact. The sole trader basic
accounts would include the business proportion of the vehicle running costs or the
mileage allowance. If that vehicle is used by a director then that director is receiving a
taxable benefit potentially resulting in a higher tax burden depending upon the type of
vehicle as taxable benefits vary. An alternative may be to leave the company vehicle
privately owned and the director claim mileage allowances rather than vehicle
running costs.
Potentially small issues but there differences in the accounting treatment of
deductible expenses such as charitable donations, entertaining expenses and use of
home as office. A private limited company advantages consist of being able to claim
such expenses as valid business expenses which would not be claimable in the sole
trader basic accounts as treated as personal not business.
If the director and main shareholder have other associated companies then the
corporation basic tax rate could be affected.
5. Administration, management and business standing
A sole trader basically pleases themselves with regard to the administration and
management of the business. A company director is responsible for adhering to
company administration according to statutory regulations in regard to both the
limited company accounts, statutory books and management as stated in the articles of
association. The duties of a director are more formal than a sole trader.
Forming a private limited company is an indication that a business is both
serious, has a long term objective and is correctly managed. This psychological
perception can increase the business standing of a business. In addition funding
requirements are more likely to be met as the lender to a sole trader has to consider
the absence of a balance sheet statement in the basic accounts and the financial
influences personally affecting the sole trader. A private limited company advantages
concern the published financial statements, protection of the financial position from
personal influences and the option of increasing security by virtue of asking directors
to provide additional personal guarantees.
A private limited company advantages over self employment also extends to
long term finance. Companies tend to retain more funds within the business to meet
future financial commitments which aids year on year growth, a more sustainable
business and medium term profits growth over a sole trader.


Sole Trader versus Limited Company
 A sole trader is an individual in business who is personally responsible for the
debts and liabilities of that business
 A limited company takes on a separate legal existence from the individual
shareholders. The shareholders are only personally responsible for the debts
and liabilities of the company to the extent of their unpaid share capital
 The shareholders’ liability is limited only to the amount of share capital
contributed by them
 The personal assets of directors or shareholders cannot be seized to pay off
company debts
 Unlike a sole trader or partnership, a company has a separate legal existence.
This means that it is the company itself which owns property and that it is the
company which may sue and be sued in respect of the business of the
company
 The registered Business Name of a sole trader is not protected against
duplication, the name of a limited liability company is protected
 A limited company qualifies for a low corporation tax rate of 12.5%
 The company continues to trade irrespective of director or management
changes until the company is wound up and dissolved

6.0 Conclusion
As a rule of thumb you are usually better off, from a Tax and NI point of view,
to set up as a sole trader or partnership - however few partnerships outlast the
business and people who you have known for years, as friends, often turn out to be
terrible business partners.
The new Limited Partnership may be the answer to this when it finally becomes Law.
Limited Liability (in a Limited Company) should be looked at closely when you are
dealing with high incoming costs, such as computer sales or design and print, where
the gain is a lot lower than the risk if a customer should default on payment. However
if you are selling mainly time, or a high profit item, consider the tax advantages of
sole trader or partnership.