Nick Wants to Start His Own Business, Consider a Sole Proprietorship?
Definition of a sole proprietorship
A sole proprietorship is also known as a proprietorship or sole trader. It is an unincorporated business that only has one owner that pays personal income tax on the profits earned from the business. The preceding is thus a disclosure that should be part of the business. Further, a sole proprietorship is the simplest form of a business could establish since it barely has any government regulation. Accordingly, such forms of business are popular among the sole owners of the businesses, consultants, and personal self-contractors. Most of the sole proprietors conduct business under their names since the creation of a separate trade or business under separate names is unnecessary. Hence the name of the trade is a disclosure that should be part of the business.
Understanding a sole proprietorship
A sole proprietorship differs from a corporation, a limited liability partnership or a limited liability company. Accordingly, it is not a separate legal entity. Consequently, the business owner of a sole proprietorship is nor exempted from liabilities that are incurred by the entity. For instance, the debts of the sole proprietorship are considered debts of the owner. Nonetheless, the profits of the sole proprietorship are also considered the owner’s profits. This is because all profits directly flow from the business owner. Hence the profits are not a disclosure that should be part of the business.
Advantages of a sole proprietorship
The main advantages of a sole proprietorship include the pass-through tax advantage, ease of creation, and the reduced creation and maintenance fees. Also, with a sole proprietorship, Nick will not have to fill a huge amount of paper work. Hence registration by the relevant state is not disclosure that should be part of the business. However, aspects like licenses and permit are disclosures that should be part of the business depending on the state and form of business. Nonetheless, the less paperwork permits one to get a business from its budding stages to greater heights.
Further, the process of taxation is simpler since one does not have to obtain an employer identification number (EIN). A partner can obtain and EIN at their will but can also use their own Social Security number to pay SSN taxes as opposed to requiring an EIN. These are thus necessarily disclosures that should be part of the business.
Further, since Nick is not required to register his business with the state, he does not have to pay registration fees. Therefore, fees that are linked with registration or any other processes are not disclosures that should be part of the business. Such will save Nick a lot of money which is important in beginning a business.
Also with a sole proprietorship, Nick will not require a business checking account like other business structures. One can simply conduct all their finances through checking one’s account. Hence the business’ finances will not be part of the disclosure that should be part of the business.
Disadvantages of sole proprietorship
Some of the disadvantages of a sole proprietorship that Nick should beware of include unlimited liability. Such goes beyond the business to the owner. The same applies to the challenge of getting funds through channels like issuing equity, credit lines, and bank loans.
Once a business is registered, it is protected by the state. Since a sole proprietorship is not registered, one is not protected from liability. For instance, a limited liability company is protected from creditors seizing the personal assets of the members of the company. However, such protection is not afforded to a sole proprietorship hence the owner’s assets are a disclosure that should be part of the business.
Moreover, funding could be difficult in sole proprietorship. The majority of the banks prefer working with companies that already have a track record. Being a person that is beginning a small business with a small balance sheet is risky for banks to lend money. When obtaining loans, the balance sheet and current financial state of the sole proprietorship are disclosures that should be part of the business. Further, obtaining equity from huge investors could eb difficult since they prefer startups that are refined.
Therefore, Nick should consider starting his business as a sole proprietor then advance the business to a limited liability entity. Such could include an LLP, LLC, or corporation.
Brief summary of the pros of a sole proprietorship
- Less paperwork.
- The optional term of acquiring an employer identification number (EIN).
- A quick and easy setup compared to other forms of business entities.
- Low costs and fees.
- Passing through the tax advantage.
- Easy banking
Brief summary of the cons
- Unlimited liability that flows from the business to the owner.
- Difficulty in raising capital.
Special considerations
Normally, once a sole proprietor desires to incorporate a business, the owner is compelled to restructure into a limited liability company. For this to work, the owner should first establish the company’s name which is a disclosure that should be part of the business. If the desired name is not similar to another’s entity, the article of organization is filed by the state office. Further, the location of the business forms part of the disclosure that should be part of the business.
After filing the paper work, Nick, being the business owner, ought to create a limited liability company agreement. The agreement outlined the structure of the business and forms part of the disclosure that should be part of the business.
How to start a sole proprietorship
Starting a sole proprietorship only requires starting one’s business. Hence Nick is not required to register the business with the state. It is thus recommended that Nick comes up with a name and then apply for a license and permit which are a disclosure that should be part of the business. If Nick is planning to hire employees, then he will require the employee identification number (EIN) from the IRS which is a disclosure that should be part of the business. Further, if he is going to sell taxable products that will have to be registered with the state, he will have to obtain the EIN.
Accounting for a sole proprietorship
The accounting for a sole proprietorship is distinct from the requirements of other forms of business entities. Hence it does not need a separate set of accounting records thus not a disclosure that should be part of the business. This is because Nick will be considered to be inseparable from his business. However, one ought to maintain the records of business activities to judge whether such operations will generate profit.
The required complexity
Sole proprietorships generate less revenue amounts and incur decreased levels of expenses compared to other complex business entities. Consequently, Nick should begin with the most minimal accounting record keeping that will be founded on cash flows in and out of the bank. Thus, separate cash receipts and cash disbursement journals will be a disclosure that should be part of the business. Such is regarded a single-entry accounting strategy because it can not be utilized to produce a balance sheet rather an income statement only. Hence the balance sheet is not a disclosure that should be part of the business.
Tax reporting for a sole proprietorship
The tax reporting for a sole proprietorship normally flows through the personal tax returns of the owner. This is done with a separate form that is used in itemizing the main classes of expenses and revenues that are incurred by the business entity. Further, there is no separate tax return for the business since there is no separate business entity. Thus, a separate tax return not a disclosure that should be part of the business.
Limitations of a sole proprietorship accounting
The major limitation of the accounting system of sole proprietorships is the insufficient accounting records. Such are not a disclosure that should be part of the business hence have to be translated in auditable sets of financial statements. If Nick, being an owner of the sole proprietorship, desires to obtain funds for his business, some documents may be required. Such include the audited financial statements that are normally not a disclosure that should be part of the business. There will also be a sequence of actions that will be required to upgrade the accounting records and include:
- The form of business entity and name which are a disclosure that should be part of the business.
- An accrual basis of accounting using a double entry bookkeeping system that is a disclosure that should be part of the business.
- Audited financial statements that are a disclosure that should be part of the business.
The preceding is a demonstration of an upgrade in complexity from a basic accounting system that has been outlined for the sole proprietorship.
References
XXX
XXX