Question

Why is it that small businesses often form initially as sole proprietorships, if the corporate form has so many advantages over the sole proprietorship?

Discuss operating cash flow and contrast it to the total cash flow in the firm.

What are the assumptions of the sustainable growth rate? What does sustainable growth rate mean?

Answer 1

a.Reason behind why small businesses are often initially formed as sole proprietorships despite the advantages offered by corporate form.

Even though the Company form provides many advantages like Limited liability,Perpetual Existence,Separate Legal entity etc. many small businesses are often started as sole proprietorships mainly due to its simplicity of formation.The ease of set up,negligible legal formalities and low costs associated with its initial establishment makes it the least inexpensive form of ownership.While the registration process of corporates are much costly and time-consuming.The Decison making power solely lies with the owner(sole proprietor),so it provides him more flexibilty enabling him to take quick action without consulting any members as in the case of companies.The entire profits from the business is pocketed by the owner without any obligation for distrubuting it to shareholders as in the case of a company.This factor boosts the owner to work more efficiently for attaining higher profits.Since,the day-to-day activities are of a smaller scale when compared to a corporate,the working capital requirements are low and don't create a tension for the owner.There's no need for the owner to disclose(publish) his financial statements or any reports to others as a corporate is obliged to.There's no specific act or provisions for the governance of sole proprietorship that considerably reduces the heavy interventions of regulatory bodies,unlike corporates.Also,the owner pays taxes on income from business as a part of his(her) personal income.Any losses from business can be deducted from the personal income which provides the owner a tax benefit.The sale or transfer of business can be done much quicker at the discretion of sole proprietor.This is why many small businesses often starts as a sole proprietorship.

b.Operating Cash Flow and its contrast with Total Cash flow

Operating Cash flow indicates the amount of cash generated by a firm theough its regular business operations(activities).Inflow and outflow of cash arising out of operating activites in a firm.Direct Method and Indirect method are used to depict the Operating cash Flow in the Cash flow statement.A positive operating cash flow indicates the company has sufficinet funds for growth and expansion.Stakeholders analyze it to understand th efinancial success of a firms operating activities.This is often used as a parameter for comparing with the competitors in the industry.Financial viability and Financial stability of a firm is revealed through its Operating Cash flow.It also indicates when a company should go for debt or external financing for meeting its expenses and obligations.

Contrast(Difference)

Total Cash Flow consisits of all cash inflows and ouflows of business,from all sources.Total Cash flow involes cash from Opearing activites,Investing activities and financing activities.Operating cash flow is only a part of the Total cash flow(1st part of Cash Flow Statement).Operating cash flow does not include investing and financing activites.Total Cash flow takes into consideration the costs associated with the long-term investments in capital items(Assets) and investment in securities,unlike Operating Cash Flow.But Operating Cash flow can provide a clear picture a company's current cash holdings as it adjusts for working capital,depreciation etc.

Operating Cash Flow = Net Income + Non-Cash Expenses +/- Changes in Working Capital

c.Assumptions of Sustainanble Growth Rate and what is Sustainable Growth Rate

Assumptions

1.The Firm(Business) does not change its capital structure.It measn the firm doe not go for further external(debt) financing or equity financing for raising funds.

2.The firm has a constant Dividend Pay-Out policy and a fixed Debt/Equty Ratio

3.The Firms Asset(grows) and Net Income is in constant proportion to its sales.(revenue)

4.Profit Margins won't change.

Sustainable Growth Rate

Sustainable Growth Rate is the maximum amount of growth a firm can sustain without having to finance growth with additional equit or debt financing.Maximising sales without leverage is objective.