Question

Answer the following questions:

1. What are the strengths and weaknesses of a corporation, in comparison with the other two business forms?

2. What is the most important goal of financial management?

Answer 1

Answer 1

Strength of a corporation

a. Separate legal entity

A Corporation is a separate legal entity relating to the owners of the firm. It is a distinct feature of the corporation that may exist forever. It is created through law and it can cease its operation as per the rules of the corporation. Although there is legal obligation that has to be maintained in terms of annual report that has to be filled at the right time with appropriate tax or fee.

In case of partnership business the partnership firm is not considered as separate legal entity so it cannot claim different identity from its partners.

In case of sole proprietorship business the entity of the business and the entity of the owner remain same. When the owner wants to quit he can stop his business.

b.     Limited liability

    The term limited liability refers to the part of ownership held by a stock holder of a particular corporation and it does not mean that if the corporation faces any legal obligations such incident affects the stock holders and they have to face such legal obligations. The term limited means when the corporation will declare dividend the stock holder will obtain the part of the dividend by virtue of holding the part of the stocks of that corporation.

In case of Partnership form of business the partners will have to take the burden to face any legal challenges against the partnership firm. It means the partners are individually liable to take the burden of legal problems if arise against the firm or they jointly and separately face this kind of problem. The partners have to bear unlimited liability.

In case of sole proprietorship business for any legal issue the proprietor of the business solely has to take the responsibility.

c.   Perpetual existence

   In a corporation the stock holders are called the owner of the corporation by virtue of holding the share. In case of death of a stock holder that means owner such death does effect the existence of the corporation. Stock holders may come and they may go but it does not affect the perpetuity of the corporation. It is called continuation of a corporation and no harm will occur in the existence of a corporation for any death of a member, bankruptcy, change in membership in the corporation.

In case of Partnership the death of a partner can affect the existence of a partnership firm and the firm goes to the state of dissolution when a partner dies or retires from the firm. Secondly at any point of suitable time all the partners having mutual consent themselves dissolve the partnership firm

In case of sole proprietorship business when the owner dies automatically the existence of the business stop as the operation gets stuck do to his death.

At any point of time the owner may stop the business also.

d.Source of capital

In case of corporation to avoid the interest expenses the corporation may issue shares to collect its capital where no interest has to pay to the shareholders. They are paid dividends in lieu of interest when the corporation declares dividend to be distributed from the excess profit amount. Declaration of dividend is not mandatory as it is in case of debt borrowing.

When the corporation averse the debt obligation entirely and collect its capital through shares the firm is called unlevered firm and it becomes less risky for its business.

  In case of partnership business there is no concept of issue of shares and collects the money from outside sources. The firm may borrow money through loan or from the partners themselves for which a fixed interest has to pay against such borrowing. It means the risk of interest expense lies in case of partnership firm.

In the sole proprietorship business also the owner has to put his money as a capital or he can avail the loan from outside sources to carry on the business for which he is obliged to pay interest against such borrowing from outside sources.

Disadvantages of a corporation

a) Double taxation

The term double taxation means when a tax is paid twice for indifferent reason. In case of corporation it has to pay corporate tax against earnings and the owner of the corporation the shareholders also have to pay the tax by getting dividend from the earnings of the corporation.

In case of partnership firm there is evidence of double taxation. The income of the entity passes through the partners and they have to pay the tax individually.

In case of sole proprietorship business also the income of the business passes through to the owner and he has to produce the return file and pay the taxes.

b) Independent management

Although the stock holders are called the owners of the corporation but if it is found that there is no clear majority among these share holders, the management of the corporation can create independent management board in operating the business.

In case of partnership firm the partners are liable to the firm in an unlimited manner and there is no presence of separate management in the partnership structure but active partners may be there among the partners who undertake most of the responsibilities of the operations of the partners.

In case of sole proprietorship business if the owner wants to do the business operation through other person he can appoint the other person by way of agreement either by paying salary or commission. But his ownership right cannot be infringed by appointing any other management body without his consent to operate his business.

C) Time consuming

In case of corporation it takes a long time to form such business. Many vital decisions which have to be taken rapidly are not feasible to be executed within a short notice due to complex procedure to be followed for such execution

In case of partnership business since it is made up of lesser number of people called partners the execution of the vital decision can be made quickly without facing any complex decision taking activities. Moreover, the formation of partnership firm is not a time consuming process.

In case of sole proprietorship business the time required to form such business is little. Besides, a sole proprietor can easily execute his decision whenever he wants to do so.

Answer 2

The most important goal of financial management

The most important goal of a firm under financial management is to wealth maximum for its shareholders. It means maximising the net present value of the earnings of the firm which signifies the wealth maximization criteria of the shareholders.

NPV is the present value of the cash inflows minus capital outlay.

Apartment from the aforesaid objective the other functions are also to be taken into consideration:

• Prudent use of capital resources
• Proper allocation of equity capital and debt capital
• Determining proper capital structure to achieve the goal of the firm

computation of debt equity ratio