Business Decisions: 1
Costs, Revenue & Profits
About Business Firms
Why start a
10 individual fishermen, each
working alone catch a total of “What if we form a team of
1000 fish per day. fishermen and work
together, specializing: one
Average per fisherman = 100. makes and repairs nets,
At $1 per fish, each fisherman another navigates the boat,
earns $100/day some cast nets, etc.”
10 fishermen working as a An organization that uses
team catch 2000 fish per day. resources to produce goods and
services, which are sold to
consumers, other firms, or the
Average per fisherman = 200.
Productivity doubles. Each
fisherman earns $200/day.
• People working together can produce
more than the sum of what people
working alone can produce
Reason to form a firm The Structure of
• People working together cannot
produce more than the sum of what
a Business Firm
people working alone can produce
No reason to form a firm
Works well for some time. The shirking
team or business firm of
fishermen continues to catch The behavior of a worker who is
2000 fish per day.
putting forth less than the
One fisherman feels lazy one day, agreed-to effort.
comes in late, doesn’t work as
hard. Only 1800 fish caught that
day. Each of the 10 earns an
average of $180 for the day.
Others start to shirk as The team or business
well and only 1600 fish firm designates one of
are caught per day. the fisherman to be a
Then 1400 fish are monitor.
caught. What can be
The person in a business firm • But what if the monitor starts
who coordinates team shirking?
production and reduces shirking.
• Do you get a monitor to monitor
• No – Make the monitor a
residual claimant Types of Business Firms
The person in a business firm •Sole Proprietorships
who coordinates team
production and reduces shirking. •Partnerships
Receives an excess of revenues
(profits) beyond the costs.
sole proprietorship Advantages of Sole
A business that is owned by one
individual who makes all 1. Easy to form and dissolve
business decisions, receives all 2. All decision-making power resides
the profits or incurs all of the with the sole proprietor
losses of the firm, and is legally 3. The profit of the firm is taxed only
responsible for all the debts of once.
Disadvantages of Sole unlimited liability
1. The sole proprietor faces unlimited The legal responsibility of a sole
liability. proprietor of a business or of
2. Sole proprietors have limited ability to partners in a business to pay any
raise funds for business expansion. money owed by the business.
3. Sole proprietorships usually end with The proprietor’s or partner’s
the retirement or death of the personal assets may be used to
proprietor; they have a limited life. pay these debts.
partnership general partner
A business that is owned by two A partner who is responsible for
or more co-owners called the management of the firm and
partners who share any profits who has unlimited liability.
the business earns and are
legally responsible for any debts
incurred by the firm.
limited partner Advantages of Partnerships
A partner who cannot participate • In a partnership, the benefits of
in the management of the firm specialization can be realized.
and who has limited liability. • The profit of a partnership is the
income of the partners, and only
personal income taxes apply to it.
Disadvantages of Partnerships unlimited liability
• The General Partner’s liability is The legal responsibility of a sole
unlimited. proprietor of a business or of
• Decision making in a partnership can partners in a business to pay any
be complicated and frustrating. money owed by the business.
The proprietor’s or partner’s
personal assets may be used to
pay these debts.
A legal entity that can conduct A person who owns shares of
business in its own name in the stock in a corporation. The
same way that an individual stockholders of a corporation
does. Ownership of the are the owners of the
corporation resides with the corporation.
A claim on the assets of a Anything of value to which the
corporation that gives the firm has a legal claim.
purchaser a share of the
ownership of the corporation.
Advantages of Corporations limited liability
1. The owners of the corporation (the
stockholders) are not personally liable for A condition in which an owner of
the debts of the corporation; they have a business firm can lose only the
limited liability. amount he or she has invested in
2. Corporations continue to exist even if one the firm. Stockholders of a
or more of the owners sell their shares or
corporation have limited liability.
3. Corporations are usually able to raise large
sums of money by selling stock.
Disadvantages of Corporations How to Form a Corporation
1. Corporations are subject to double 1. Promoters and the prospectus
taxation. 2. Articles of incorporation
3. Corporate Charter
2. Corporations are difficult to set up.
4. Organizational meeting
A. Board of Directors
C. Corporate structure
• The stockholders as a group are
The Corporate Structure
the most important persons in the
• They own the corporation
• They elect the board of directors
The Board of Directors Top Officers
• Determines corporate policy and goals
• Decides what goods and services the corporation • Responsible for day-to-day operations
will produce and sell
• Hire, manage and fire other corporate
• Decides what percentage of the profits will go to
the stockholders (dividends) employees
• Decides what percentage of profits will be • Report to the board of directors
reinvested in the company
• Chooses the corporations top officers: President,
vice presidents, secretary and treasurer
• Do not handle day-to-day operations
Financing Corporate Activity Corporate Vocabulary
• Raise money through borrowing
• Raise money through issuing
• Raise money through selling
additional shares of stock
dividend board of directors
A share of the profits of a An important decision-making
corporation distributed to body in a corporation. It decides
stockholders. corporate policies and goals,
among other things.
Internal rules of a corporation. A statement of debt issued by a
corporation. The corporation
promises to pay a certain sum of
money at maturity and also to
pay periodic fixed sums until
face value (par value) coupon rate
The dollar amount specified on a A percentage of the face value of
bond. a bond that is paid out regularly
(usually quarterly or annually) to
the holder of the bond.
Other Business Organizations cooperative
• Cooperatives A business that provides
• Franchises services to its members and is
not run for profit. Usually a
cooperative is formed when a
group of persons (the members)
want to pool their resources to
gain some benefit that they, as
individuals could not obtain.
A contract by which a firm The entity that offers a franchise.
(usually a corporation) lets a
person or group use its name
and sell its goods in exchange
for certain payments being made
and certain requirements being
The person or group that buys a