Shawn has a masters of public administration, JD, and a BA in political science.
Meet Liz. She has a great idea for a new product and wants to start a business to produce and sell it. Liz has a good nose for business and knows that planning is a large part of success. The first thing she must figure out is what type of business organization to use, which will be the legal structure of her business.
Liz can choose to operate her business as a sole proprietor or organize a limited liability entity. A sole proprietorship is cheaper and simpler to operate. Liz's business income or loss is reported on her personal tax return. However, a sole proprietorship exposes Liz to personal liability related to her business's contractual obligations, debts and negligence.
Liz can organize a limited liability entity, such as a corporation or limited liability company, which limits an owner's liability arising from the business. These business organizations tend to be more expensive to establish and more complicated to run. A corporation is also subject to double taxation on income since it's considered separate from its owners, but sometimes a corporation can avoid double taxation if it is entitled to an S-corporation status.
Both a limited liability company and a corporation provide Liz limited liability - Liz only risks her investment, not any other personal assets. Since a limited liability company is subject to only one level of taxation and provides Liz protection from personal liability, she opts to structure her business as one.
Liz will also have to figure out how to finance her start-up operations because it's going to take time before her company starts producing products and sales. Liz has some savings but not enough to purchase the plant and equipment necessary to begin operations. She will also need to have funds for payroll and other typical expenses, such as office supplies and insurance.
Aside from her personal wealth, Liz has two basic options. She can raise funds through debt or equity. Raising funds through debt is simply obtaining a loan from a lender. The lender can be a regular bank or private investors who have funds to loan. Raising funds through equity involves offering investors an ownership interest in her company in exchange for capital infusions. If Liz seeks funds through private investors, she needs to make sure she complies with federal and state securities law.
Liz will also have to set up an accounting system. Her business can use either the accrual method or cash method of accounting. If she uses the cash method, she will report income from her business when she receives payment and will deduct expenses when she pays them.
If she uses the accrual method, she will report income when she obtains the right to collect it - even if she has not received it. Liz will deduct expenses when she has an obligation to pay them - even if they haven't been paid in the tax year in question. Since the cash method is easier for her, she opts to use it.
Liz's lenders and investors will want to see her financial statements. She'll need to prepare a balance statement, which will show her business assets and liabilities. Once she starts generating sales, she'll also prepare an income statement, which will show her income and expenses. Finally, she may prepare a cash flow statement, which shows money moving in to and out of her business.
Her accounting issues don't stop there. She'll also have to account for her inventory. Inventory includes the raw materials and components she buys to make her finished product, as well as any finished product that she keeps on hand. Liz will also want to set up a payroll system to manage paying her employees and accounting for payroll tax obligations. Finally, Liz must be sure to account for any sales taxes she collects on the sale of her products.
Liz will also need to develop a marketing program. The 'four Ps of marketing' include product, place, price and promotion. Liz will have to polish her product design to ensure that it meets her customers' preferences as closely as possible. She'll have to decide on the places she will distribute her product.
Liz may decide to sell directly to customers or act as a wholesaler and let retailers sell the product. Liz will also need to set the price of her product and promote it. Promotion involves developing a marketing campaign, using tools such as advertising, public relations and personal selling.
Managing Employees and Operations
Liz must address the management of people and production. She may decide to hire a human resources manager who will be responsible for interviewing, hiring, training and terminating employees. Production management includes such things as scheduling, planning and managing the flow of work, materials and inventories. It also involves managing costs and improving efficiency and quality while trying to minimize waste.
Let's review what we've learned. Operating a small business requires a broad range of knowledge and skills. A business owner must first have a knowledge of the characteristics, advantages and disadvantages of various types of business organizations, including limited liability entities, such as corporations and limited liability companies.
Most small businesses need to obtain financing. A small business can obtain financing by borrowing money or seeking equity investors. Accounting systems must be set up, and financial statements must be prepared and maintained. A small business should also develop a marketing plan, addressing product development, distribution, price and promotion. Finally, a small business owner must effectively manage her employees and the actual operations of her business.
By working your way through this lesson, you should be able to accomplish the following:
- Describe the many aspects that go into running a small business
- Identify the different choices of business organizations
- Summarize two ways for a small business to obtain financing
- Explain the different types of accounting systems
- List the four Ps of marketing, and describe ways a small business can manage employees
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