Partnership, Limited Liability Companies, and Gearing - Assignment Example

Task Discuss the main differences between partnership as organisation and limited liability company, paying particular attention to the following;formation, sources of finance and dissolution. The partnerships can be of two types including general partnership and limited partnership. General partnership is a form of organisation in which two or more people become the co-owners of the business by operation of law and do not sign or file any formal paper, whereas, in limited partnership the written agreements are developed and formal documentation is done with state officials by the partners (Emanuel and Emanuel). A limited liability company or LLC is a form of business allowed by state statute, in which the members of the organisation have limited personal liability similar to corporations and benefit of pass-through taxation similar to partnership (IRS). Following are the differences between partnership and Limited Liability Company based on formation, sources of funds, taxation and dissolution of business Formation: A partnership is created with two or more people and there is no concept of one-person partnership. On the other hand, a Limited Liability Company can be started from one member only and law does not require members to be the resident of the state where the LLC is being formed (Mancuso). A partnership can be inexpensive and easy to create as no filings are required and no fees are associated with it. On the other hand, LLCs are expensive to create and for the protection of the business name, the trade name is registered and a legal fee is paid (JPEC Org). The nature of formation is the primary difference between the two forms of organisations. The formal paperwork is very important in the case of limited liability and the owners are liable to fulfil the filing requirements of the state whereas, a partnership can be formed by just shaking hands. Sources of Fund: The capital required to start a partnership business is shared by the partners of the business. The share of each partner may vary and based on the share of capital, the profit and loss is shared in partnership. On the other hand, in limited liability Company, funds usually come from external sources including both the short term and long term funds. However, the owners of the business also share their capital to start a limited liability company. In short, sources of funds in partnership are only internal sources and very few partnerships get able to take bank loans and other external finances whereas; the sources of funds in a limited liability are both the internal and external sources. Taxation: In partnership as organisation, the income of each partner is subject to taxation. The partnership is not considered separate from its owners when taxes are imposed and each partner pays his share of tax and reports individually on federal tax return. Each partner of the business is responsible to calculate his tax at the end of year and creates four quarterly estimated tax payments (Nolo). On the other hand, in limited liability, the company pays taxes based on its profits whereas, the director are subject to taxations based on what they receive from the company (Complete Formations). Dissolution: In partnership as organisation, each partner is personally liable for the business debts and claims against the organisations for example, if the organisation fails to pay its suppliers, the partner may to mortgage his car, house etc to pay off the debts of suppliers. On the other hand, in Limited Liability Company, the owners of the company are not personally liable for the debts and liabilities of the company. This characteristic of personal legal limited liability protection is similar to that offered in the corporations to shareholders. Therefore, if a company is dissolved, the owners of the limited liability are not personally liable and debts can be paid off by selling the assets of the company whereas, in partnerships, the partners are personally liable to pay off debts (Hunt). In short, the personal assets of the owners are secured in limited liability whereas; they are not secured in the case of partnership. Task 2 Critically analyse the various sources of finance both short and long term for the above entities. Explain Gearing and how different sources of finance can impact on gearing. Sources of Finances in a Limited Liability Company A Limited Liability primary rely on internal sources of finances and the four major internal sources of finances include personal savings, retained profit, working capital and sales of assets. The external sources of finances for a Limited Liability Company can be categorised into two types including ownership capital (ordinary shares and preference shares) and non-ownership capital (such as bank loans, debentures, leasing, lines of credit, venture capital, factoring and invoice discounting etc) (Bized). Although unlike corporations, accessing external sources of finances is not very easy for the Limited Liability Company however, such companies are better able to finance their business from external sources as compared to partnerships. The assets of the company can be liquidated and sold in the case of business failure and owners are not personally liable, therefore, external investors know that they have the share in the assets of the company, in the case of business failure. The long term and short term sources of finances also differ based on the form of organisation. The Limited Liability Company unlike corporations cannot use the long term finances for the purpose of debt whereas; corporations can access both debt and equity (Mapxl). Therefore, in a Limited Liability Company, the shareholders’ equity is the primary sources of long term financing and for short term borrowing, company relies on external sources of debt. Sources of Finances in a Partnership Like a Limited Liability Company, a partnership as organisation also depends on internal sources of funds including personal savings, retained profit, working capital and sale of assets (Bized). A partnership has advantage over the sole trader because taking bank loans is not very easy for a sole trader however, in a partnership, as more investors participate in the business therefore; raising funds from external sources such as bank loans become easier. However, still a partnership has less access to external sources of funds as compared to a Limited Liability Company, because the partnerships are personally liable to pay the debt in the case of business or dissolution of the company, which increases the risks for the external investors. In short term, the partnerships can fulfil their needs through taking bank loans and other short term sources of finances however, since these organisations do not have shareholders therefore, they cannot raise share capital and their sources of long term finances is the capital shared by the partners of the company. Gearing Based on the sources of finances, the capital structure of the organisations is formed. The concept of gearing has been introduced to get an idea about the kind of capital structure which an organisation develops. Gearing is defined as the ways through which a company finances its operations both through shareholders and outside lenders. High gearing is an indicator of more long-term liabilities raised by the company as compared to shareholders’ equity and is an indicator of speculation (Investopedia). On the other hand, low gearing ratio predicts more reliance of the company in shareholders’ equity. Gearing ratio is used by the companies as an indicator of risk. The gearing ratio is calculated as a ratio of fixed interest capital to total capital employed. Moreover, gearing ratio can be also expressed as a ratio of debt to equity (Hargitay and Yu). Hargitay and Yu also highlights the two kinds of gearing ratios which can be calculated including capital gearing ratio and income gearing ratio. The capital gearing ratio is calculated by taking the ratio of debt capital to total capital employed and if the ratio comes higher then it shows the high sensitivity to asset value changes. The income gearing ratio is calculated by taking the ratio of interest payments to gross trading profit. If a comparison is made between the gearing of partnership and limited libaility, the gearing of partnership will be relatively higher because the long term funding provided by internal sources of funds (partners) is greater than long term funds contributed by external sources (lenders). Gearing levels of a company influences the sources of funds for example, if a company has high gearing level then it is assumed to have great financial risk. As a result the shareholders are more likely to react and demand more return on their invested capital. Therefore, gearing level predicts the financial risk to the company, thereby, increasing or decreasing its access to different sources of funds (Anderson). In short, partnership and Limited Liability Company can rely on different sources of finance both in the short term and long term and gearing levels of the companies actually influence the sources and levels of finances. Bibliography Anderson, Malcolm. Gearing. 1 August 2002. 25 October 2010 . Bized. Sources of Finance. 25 October 2010 . Complete Formations. The Difference Between a Partnership and a Limited Company. 24 October 2010 . Emanuel, Steven and Lazar Emanuel. Corporations: Emanuel Law Outlines, Edition 6. Aspen Publishers Online, 2009. Hargitay, Stephen E. and Shi-Ming Yu. Property investment decisions: a quantitative approach. Taylor & Francis, 1993. Hunt, Janet. Difference Between a Partnership and a Limited Company. 24 October 2010 . Investopedia. Gearing. 25 October 2010 . IRS. Limited Liability Company (LLC) . 26 August 2010. 24 October 2010 . JPEC Org. Choosing A Business Organization. October 24 2010 . Mancuso, Anthony. LLC or corporation?: how to choose the right form for your business, Edition 3. Nolo, 2008. Mapxl. Long Term Financing. 25 October 2010 . Nolo. Partnerships FAQs. 24 October 2010 . Read More