In general, the sole proprietorship is a form of business that is owned, managed, and controlled by an individual. He has day-to-day responsibility for running the business. Understanding Sole Proprietorship involves a single individual managing the business, arranging capital, and taking full responsibility for its operations. Consequently, they have the right to all profits. However, at the same time, they must also take full responsibility for any losses. Sole proprietors own all business assets and assume complete responsibility for liabilities or debts. This business structure is the simplest and easiest to establish, as it requires minimal legal formalities.
Merits of Sole Proprietorship
- Easy formation: A sole proprietorship business is easy to form where no legal formality involved in setting up this type of organization. It is not governed by any specific law.
- Sole beneficiary of profits: The sole proprietor is the only person to whom the profits belong. There is a direct relation between effort and reward. This motivates him to work hard and bear the risks of business.
- Inexpensive Management: The sole proprietor does not appoint any specialists for various functions. He personally supervises various activities and can avoid wastage in the business.
- Simple tax calculations: One of the benefits of being a sole proprietor is that the taxes are simpler. When compared to other business structures, the tax requirements for a sole proprietorship are relatively straightforward. Moreover, since sole proprietorships are not considered separate legal entities, the owner is personally responsible for reporting business income or losses on their personal income tax return. As a result, this simplifies tax filing but also means that business profits are taxed at the individual’s tax rate.
- Lower business fees: Starting a new venture with a tight budget is not uncommon. Several individuals plan their ventures with less capital. For such entrepreneurs, the sole proprietorship is the best business structure. Sole proprietorships can help the owners save on registration. Moreover, the legal requirements and associated costs in a sole proprietorship are significantly lower. As a result, this makes it an attractive option for small business owners.
Limitations of Sole Proprietorship
- Limitation of Resources: One major disadvantage of owning a sole proprietorship is the difficulty in raising capital. While the setup costs are much lower, securing financing can still be challenging. This is because banks often prefer to fund established businesses, as they tend to generate higher revenue and build a stronger credit history over time.
- Unlimited liability: The sole proprietor is personally liable for all business obligations. In such cases, if the business assets are insufficient, the owner may need to use personal property to cover business debts. This highlights the financial risk involved in a sole proprietorship.
- Risk in decision-making: One of the significant disadvantages of a sole proprietorship that several people do not consider is the risk of making wrong decisions.
- No economies of scale: Large-scale business organizations enjoy large-scale economies as well. That means they can produce more in lesser overhead costs per product.
Understanding Sole Proprietorship and Its Formation Process
Understanding Sole Proprietorship means recognizing that a single individual forms, manages, and controls the business. Unlike other business structures, a Sole Proprietorship is easier to establish. This is because it does not require a deed or agreement for its formation. This makes it a simple and convenient option for individuals starting a business.
In practice, depending on the nature of the business activity, authorities may require registration under specific enactments. As a result, businesses must comply with the relevant regulations set by the respective State or Central Government. Additionally, in certain cases, they may also need to register under specific enactments, such as:
- Shops and Commercial Establishments Act (State specific)
- Law relating to Professional Tax (State specific)
- Registration under Micro, Small and Medium Enterprises Development Act, 2006.
- Registration as a Small Scale Industry (State specific)
- With the launch of GST, businesses will use only the GSTIN as the Import-Export Code Number.
- Intellectual Property laws.
