Public limited company: Shares are on offer to the general public, these companies tend to be quite large and the largest are listed in the LSE (London stock exchange). The stock exchange is important as it provides shareholders with the possibility of liquidation and is also useful for to companies as it is easier to fund investments. The exchange of second hand shares does not provide the company with any cash, but only the respective traders. The status given to these companies is PLC.
Private limited company: Shares are largely restricted from general public and are generally distributed amongst very few shareholders e.g. a family business. These are provided the status of LTD.
The importance of providing statuses to these companies is to insure that those dealing with LTD’s and PLC’s are that the liability is limited (amongst the shareholders).
Previous profit and loss statements (i.e. those for sole traders) are not taxed on profits, in this scenario the tax is levied on the business and not on the owners.
The senior management level of a company is the board of directors, which could consist of all the shareholders in the case of a small company or elected individuals that act on behalf of shareholder’s best interests. The divorce of the day-to-day operations of the company and the shareholders has led to exploitation by the directors, as there is a conflict of interests. This principal-agent problem will undermine the corporate governance (the way in which companies are directed and controlled). However this has major problems for the economy, expenditure on perks will lead to X-inefficiency and shareholders may be reluctant to invest, The lack of investment in the economy as a whole will pull down both AS and AD. Framework of rules has recently been constructed to avoid this problem, they include: disclosure, accountability and fairness.
Now we have discussed the corporate differences in sole traders and limited companies it is time to move onto the changes in financial statements.
The capital section in the balance sheet is complicated by the presence of share capital (original investment) and reserves (profit and gains). The sum of share capital and reserves is called the equity.
Reserves exist as both capital and revenue. Revenue reserves arise from trading profit or disposal of non-current assets. Capital reserves however arise through issuing shares above their nominal value or revaluing non-current assets. Issuing shares above their nominal value is usually something that occurs when the company is more successful. The reason for doing this is because the shares are valued more than before, issuing shares at the nominal value would disadvantage the original shareholders (however the new shareholders would benefit).
Share capital: If a company estimates it requires $50,000 in order to obtain more assets then it will issue shares that total $50,000. This could be any combination: 5 million of one penny shares or 250,000 $2 shares, the large denominator value on the later tends to make it unwieldy (difficult to trade amongst other shareholders). There exists ordinary shares and preference shares. Preference shares allow shareholders the first part of the shares issued. Any excess is distributed amongst the ordinary shareholders as the risk borne onto these ordinary shareholders is greater they usually vote on issues that most affect the company.
Share premium is best described using an example:
Net assets: 1.5m
Current shares: 1m ordinary shares at $1 each
Wishes to raise 0.6m – therefore it issues new shares at $1.50,
Previously it issued 600,000 shares at $1 each but now it issues 400,000 at $1.50 each. The excess 0.5*400,000 = 200,000 is the share premium.
Here are some definitions:
Authorised share capital – when a company is setting up there is a limit imposed on the nominal value of shares that can be issued.
Called up share capital – When the company does not require the funds all at once, spme can be paid and the rest called upon at another point in time.
The withdrawable part: revenue reserves
The non-withdrawable part: share capital and capital reserves (upward revaluation of assets or share premium)
The reason for this distinction is due to limited liability, if the owner of the business withdraws all the capital from the business the creditors can legally enforce the obligations upon the owner(s). This is not the case with companies where there is a divorce between business and owners – creditors cannot legally enforce the obligation onto each and every separate shareholder.
The larger the non-withdrawable part the easier to attract creditors and suppliers on credit.
