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Chapter 3
BUSINESS ORGANIZATIONS
Forms of business organization
Section 1
Did You Know?
 In 1997 Dun & Bradstreet reported that
corporation start-ups increased by 2 percent
to reach a new high of 798,917. New
corporations in Florida and New York
represented 25 percent of that total
Key Terms
 sole proprietorship/proprietorship A business owned and
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run by one person
unlimited liability The owner is personally and fully
responsible for all losses and debts of the business
inventory A stock of finished goods and parts in reserve
limited life A firm that legally ceases to exist when the
owner dies, quits, or sells the business
partnership A business jointly owned by two or more
persons
limited partnership The investor’s responsibility for the
debts of the business is limited by the size of his or her
investment in the firm
bankruptcy A court-granted permission to an individual or
business to cease or delay debt payments
Key Terms
 corporation A form of business organization recognized by law as
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a separate legal entity having all the rights of an individual
charter A government document that gives permission to create
a corporation
stock Ownership certificates in a firm
stockholder/shareholder An investor who owns stock
dividend A check representing a portion of the corporate
earnings
bond A written promise to repay a loan at a later date
principal An amount of borrowed money
interest The price paid for the use of another’s money
double taxation The taxing of stockholders’ dividends as
corporate profit and again as personal income
Introduction
 There are three main forms of business
organizations in the economy today–the sole
proprietorship, the partnership, and the
corporation.
 Each offers its owners significant advantages
and disadvantages
Sole Proprietorship
 A sole proprietorship is
a business run by one
person. It is the
smallest type of
business organization
in size, yet the most
numerous and
profitable
Sole Proprietorship
 The advantages to sole proprietorships are:
ease of start-up; ease of management; owner
gets all the profits; business itself pays no
income taxes; taxes only on the owner’s
personal income; psychological satisfaction
of owning one’s business; ease of closing the
business
Sole Proprietorship
 The disadvantages to sole proprietorships
are: the owner has unlimited liability; it is
hard to raise financial capital; owner may not
be able to hire enough personnel or stock
enough inventory to operate efficiently;
owner may have limited managerial
experience; hard to attract qualified
employees; business has limited life and
legally stops existing when the owner dies or
sell the business.
Partnerships
 A partnership is a business jointly owned by
two or more persons. It is the least and has
the second smallest proportion of sales and
net income
 General partnerships are a type of business in
which all partners are involved in the
management and finances. In a limited
partnership, at least one partner is not
involved in management. This partner may
have helped to finance the business
Partnerships
 Articles of the partnership document spell out
how the partners divide up the profits or
losses
 The advantages of partnerships are: the ease
of start-up; ease of management; no special
taxes on a partnership; easier to raise capital
through bank loans or new partner; larger
size aids efficient operations; easier to attract
skilled employees.
Partnerships
 The disadvantages of partnerships are:
partners are responsible for the acts of each
and every partner, except in a limited
partnership where the limits are spelled out;
limited life of partnerships ends if a partner
leaves; potential for partner conflicts
Corporations
 A corporation is a business organization
recognized by law as a separate legal entity with
all the rights of an individual.
 Corporations receive a charter, or government
permission to create a corporation, which
includes details about stock ownership
 Investors who buy common or preferred stock in
a corporation become owners of the firm.
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Preferred Stock – represents nonvoting ownership shares of the corporation
Common Stock – represents basic ownership of the corporation
Corporations
 The advantages of corporations are: ease of
raising capital; professionals may run the firm
instead of the owners (shareholders); owners
have limited liability; business’s life is unlimited;
easy to transfer ownership
 The disadvantages of corporations are; a charter
is expensive; ownership and management are
separated so shareholders have little say in
running the business; corporate income is taxed
twice; subject to government regulation
Corporations
Figure 3.2
Stock Ownership
Corporations
Figure 3.3
Ownership, Control, and Organization of a Typical Corporation
AOL Stocks
Mert
•Has $200
Rachael
•Has $500
Becky
•Becky has $1,000
Share Sales
AOL has an IPO
(initial public
offering)
Bubble bursts and
Rachael sells her
stock to Becky for
for $15
Sells one stock to Mert
for $30
Profit loss of _____
Mert sells his one stock
to Rachael for $80
Mert’s Initial profit is
___
Stock goes up to $80
Final Transaction
Racheal sells her
share to Becky for
$15
How much does
each person have
and what is the net
gain and loss?
If Calculations are
correct the total
money has to
equal the total
money gained and
the total number
of stocks lost
Racheal is now
only down $65
Becky is down $15
but up one share
Share Sells
AOL has $30
(down 1 share and
up $30 from initial
Mert has $250 (up
$50 from initial)
Rachael has $420
(up one share,
down $80 from
initial)
Becky has $1000
Has any money
been created?
Government and Business
Regulation
 Federal and state governments regulate
interest rates and utility rates
 State governments may offer industrial
development bonds to help industries
relocate or tax credits to draw investments
Fortune 500 Companies
Rank
Company
6
Revenues
($ millions)
Profits
($ millions)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
Exxon Mobil
Wal-Mart Stores
Chevron
ConocoPhillips
General Motors
General Electric
Berkshire Hathaway
Fannie Mae
Ford Motor
Hewlett-Packard
AT&T
Valero Energy
Bank of America Corp.
McKesson
Verizon Communications
J.P. Morgan Chase & Co.
Apple
CVS Caremark
452,926.0
446,950.0
245,621.0
237,272.0
150,276.0
147,616.0
143,688.0
137,451.0
136,264.0
127,245.0
126,723.0
125,095.0
115,074.0
112,084.0
110,875.0
110,838.0
108,249.0
107,750.0
41,060.0
15,699.0
26,895.0
12,436.0
9,190.0
14,151.0
10,254.0
-16,855.0
20,213.0
7,074.0
3,944.0
2,090.0
1,446.0
1,202.0
2,404.0
18,976.0
25,922.0
3,461.0
19
International Business Machines
106,916.0
15,855.0
20
21
22
23
24
25
Citigroup
Cardinal Health
UnitedHealth Group
Kroger
Costco Wholesale
Freddie Mac
102,939.0
102,644.2
101,862.0
90,374.0
88,915.0
88,262.0
11,067.0
959.0
5,142.0
602.0
1,462.0
-5,266.0
Profiles in Economics
Kenneth I. Chenault
1951
BUISNESS GROWTH AND EXPANSION
Section 2
Did You Know?
 The federal government’s Bureau of
Economic Analysis reported that, in contrast
to the American public’s suspicions, U.S.based multinational companies do not
establish most of their manufacturing
affiliates in low-wage countries. In 1996, 87
percent of U.S. multinational affiliates’
employment was reported in relatively highwage countries, primarily in Europe
Key Terms
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merger A combination of two or more businesses to form a single firm
income statement A report showing a business’s sales, expenses, and profits for
a certain period
net income Revenues minus expenses and taxes
depreciation A non-cash charge the firm takes for the general wear and tear on
its capital goods
cash flow The sum of net income and non-cash charges such as depreciation
horizontal merger The kind of merger in which two or more firms that produce
the same kind of product join forces
vertical merger The kind of merger in which firms involved in different steps of
manufacturing or marketing join together
conglomerate A firm that has at least four businesses, each making unrelated
products, none of which is responsible for the majority of the firm’s sales
multinational A corporation that has manufacturing or service operations in a
number of different countries
Introduction
 A business can grow in one of two ways.
 First it can grow by reinvesting some of its
profits
 A business can also expand by engaging in a
merger–a combination of two or more
businesses to form a single firm
Growth Through Investment
 Business revenue can be used to invest in
factories, machinery, or new technologies
 Before reinvesting, a business must estimate
its cash flow. The business first records its
total sales and then subtracts all expenses,
taxes, and depreciation. The result is the
business’s net income
Growth Through Investment
 Depreciation is added back to net income to
get cash flow, or the bottom line—the real
measure of business profit
 Business owners then decide whether part of
the cash flow should be reinvested in the
business to generate additional sales and
more profits
Growth Through Investment
Figure 3.4
Growth Through Mergers
 When firms merge, one gives up its separate
legal identity
 A company may merge with another to grow
faster; become more efficient; acquire or deliver
a better product; eliminate a rival; or change its
image
 A horizontal merger is the joining of firms that
make the same product. A vertical merger is the
joining of firms involved in different stages of
manufacturing or marketing
Growth Through Mergers
 A conglomerate is
composed of four or
more businesses, each
making unrelated
products, none of
which is responsible for
a majority of its sales
Growth Through Mergers
 A multinational is a
corporation with
manufacturing and
service operations in
several countries,
which are subjected to
each nation’s business
regulations
OTHER ORGANIZATIONS
Section 3
Did You Know?
 The National Center for Charitable Statistics
reported that nearly 1.5 million organizations
had registered with the federal government
in 1997 as tax-exempt, private nonprofit
organizations. Because some organizations
do not need to register with the Internal
Revenue Service, this number does not
include all types of nonprofit organizations
described in Section 3
Key Terms
 nonprofit organization An organization that operates in a
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businesslike way to promote the collective interests of its
members rather than to seek financial gain for its owners
cooperative/co-op A voluntary association of people formed to
carry on some kind of economic activity that will benefit its
members
credit union A financial organization that accepts deposits from,
and makes loans to, employees from a particular company or
government agency
labor union An organization of workers formed to represent its
members’ interests in various employment matters
collective bargaining Union negotiations with management over
issues such as pay, working hours, health care coverage, and
other job-related matters
Key Terms
 professional association A group of people in a
specialized occupation that works to improve the
working conditions, skill levels, and public
perceptions of the profession
 chamber of commerce An organization that
promotes the welfare of its members and the
community
 Better Business Bureau A nonprofit organization
sponsored by local businesses to provide general
information on companies
 public utility Investor- or municipal-owned company
that offers an important product, such as water or
electricity, to the public
Introduction
 Most businesses use scarce resources to
produce goods and services in hopes of
earning a profit for their owners
 Other organizations operate on a “not-forprofit” basis
 A nonprofit organization operates in a
businesslike way to promote the collective
interests of its members rather than to seek
financial gain for its owners
Cooperatives
 A cooperative is
voluntary association
of people who carry on
an economic activity
that benefits its
members
Figure 3.7
Cooperatives in the United States
Community and Civic
Organizations
 A nonprofit organizations is in business to
promote its members’ collective interests,
not to seek financial gain
 Many nonprofit organizations incorporate to
take advantage of a corporation’s unlimited
life and limited liability
 If the nonprofit organization has money after
its expenses are paid, its board of directors
may apply the surplus to other projects that
further the organization’s mission
Cooperatives
 Consumer cooperatives buy food and other
necessities in bulk. Members donate time to
the co-op, and members pay lower prices for
goods
 Service cooperatives, such as credit unions,
offer services to its members at lower rates
 Producer cooperatives help members, such as
farmers, promote or sell their products
Labor, Professional, and
Business Organizations
 Labor unions represent workers’ interest and
negotiate with management through collective
bargaining
 Professional associations set standards for those
in the profession and influence government
policies on issues concerning members’ interest
 Business associations are industries or trade
associations that represent specific kinds of
businesses. Some business associations, such as
the Better Business Bureau, help protect the
consumer
Government
 Government plays a direct role in the economy
when its agencies produce and distribute goods
and services to consumers such as the Tennessee
Valley Authority (electricity), and the U.S. Postal
Service (stamps and mail delivery).
 Government corporations have boards of
directors, but Congress’s money rather than
investor’s money supports their work
 Government plays an indirect role when it
regulates public utilities or when it grants money
to people in the form of Social Security and
student financial aid
Section 1: Forms of Business
Organization
Sole proprietorships are small, easy-to-manage
enterprises owned by one person. They are
relatively numerous and profitable. Disadvantages
include raising financial capital and attracting
qualified employees
Partnerships are owned by two or more persons.
Their slightly larger size makes it easier to attract
financial capital and qualified workers.
Disadvantages include the unlimited liability of
each general partner for the acts of the other
partners, the limited life of the partnership, and the
potential for conflict among partners
Section 1: Forms of Business
Organization
 Corporations are owned by shareholders who vote
to elect the board of directors. Shareholders have
limited liability and are not liable for the actions or
debts of the corporation. The relatively large size of
the corporation allows for specialized functions and
large-scale manufacturing within the firm.
 Disadvantages of corporations include the cost of
obtaining charters, limited shareholder influence
over corporate policies, and having to deal with
some government regulations
 The corporation is recognized as a separate legal
entity and so must pay a separate corporate income
tax not paid by proprietorships and partnerships
Section 2: Business Growth and
Expansion
 Businesses can grow by reinvesting their cash
flows in plant, equipment, and new technology
 Businesses can also expand through mergers.
Most mergers take place because firms want to
become bigger, more efficient, acquire a new
product, catch up to or eliminate a competitor,
or change its corporate identity
 A horizontal merger takes place when two firms
that produce similar products come together. A
vertical merger is one that involves two or more
firms at different stages of manufacturing or
marketing.
Section 2: Business Growth and
Expansion
 A conglomerate is a large firm that has at
least four different businesses, none of which
is responsible for a majority of sales
 A multinational can be an ordinary
corporation or a conglomerate, but it has
manufacturing or service operations in
several different countries. Multinationals
introduce new technology, generate jobs, and
produce tax revenues for the host countries
Section 3: Other Organizations
 Nonprofit organizations function like a business,
but on a not-for-profit basis to further a cause or for
the welfare of their members
 The cooperative, or co-op, is one of the major
nonprofit organizations. The co-op can be organized
to provide goods and services, or to help producers
• Professional associations work to improve the
working conditions, skill levels, and public
perceptions of their profession. 
• Businesses often form a chamber of commerce or a
Better Business Bureau to promote their collective
interests
Section 3: Other Organizations
 Government plays a direct role in the
economy when it provides goods and services
directly to consumers; it plays an indirect role
when it provides Social Security, veterans’
benefits, unemployment compensation, and
financial aid to college students, or when it
regulates businesses