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written by | October 11, 2021

What Is a Sole Proprietorship Business and How Does It Work?

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There are numerous business models to choose from. There are a few government-owned enterprises, a few public enterprises and a few sole proprietorships.

The sole proprietorship has become a popular business structure due to its convenience, simplicity, and perceived low cost. The sole proprietor simply needs to register their business name and secure local business licenses. In any case, the proprietor is personally liable for all business obligations, which is an undeniable annoyance. This means that banks have the authority to sue a lone proprietor if the business becomes insolvent. A business owner should put up personal funds to cover the company's debts in the case of successful legal action.

Did you know?

Almost three-fourths of all businesses are sole proprietorships!

Definition of a Sole Proprietorship

A sole proprietorship is the most straightforward type of business structure to operate. It simply refers to the individual who owns the business and is thus accountable for its obligations. 

For example, let’s consider a business like – Chache da Dhaba. It is an example of a sole proprietorship that operates under a fictitious name or maybe the proprietor's name. It is merely a company trademark.

The business is not a separate legal entity distinct from its owner. Unlike a partnership or corporation, a sole proprietorship does not form an independent legal entity. In other words, the business and its owner are synonymous. As a result, the owner is personally liable for all of the company's debts, regardless of their size.

Due to their simplicity, sole proprietorships are popular among small businesses, freelancers, and other self-employed individuals. If a business expands rapidly and hires a large number of employees, it may convert from a sole proprietor to a more complicated corporate form, such as a corporation.

Also Read: Everything You Need to Understand About an LLP Agreement

How does a sole proprietorship function?

Due to the lack of legal personality for a sole proprietorship, the owner typically signs contracts in their name. The majority of the time, a sole proprietor will have consumers write checks in their name, even if the business is operating under a fictitious name. Sole proprietors can frequently combine their personal and business assets in ways that corporations, whereas limited liability companies and enterprises cannot. Sole proprietors maintain their ledgers regularly for the benefit of the owner. You are exempt from the more complex business structures' regulations, such as voting and meeting attendance, as a sole proprietorship. Claims (and lawsuits) against sole proprietorships may be brought in the proprietor's name of no separate entity. Numerous businesses begin as sole proprietorships and then evolve into more complex business structures as the business grows.

Understanding a Sole Proprietorship

In contrast to a corporation, a limited liability company, or a limited liability partnership, a sole proprietorship does not constitute a separate legal entity. As a result, the proprietor of a sole proprietor is not immune from any liabilities incurred by the business. Sole proprietorships are subject to the same liabilities as their owners. Because all profits accrue directly to the proprietor, a sole proprietorship's profit is also the proprietor's profit.

Should you form an LLC or Sole Proprietorship?

Depending on the nature of your business, a limited liability company (LLC) or a sole proprietorship may be a better fit. Sole proprietorships are advantageous for businesses with average earnings and low risk. The company's focus will be on smaller, more targeted customers than a broad spectrum of people. Most sole proprietorships begin as a hobby and grow into a business. For the full polar opposite of the reasons described above, it would make sense to incorporate an LLC. While there are dangers associated with no separate entity, the firm has the potential to earn a lot of money, has a large client base, and is eligible for tax benefits.

Risks in a sole proprietorship

In a sole proprietorship business, the proprietor is responsible for all of the business's tasks. This gets much more puzzling when the idea of accountability is considered. If a sole proprietor takes out a loan to keep the business running smoothly, it is feasible for the business proprietor to lose its most significant client and be unable to repay the debt. Their entire estate and possessions are at risk for a sole proprietor, as they are solely liable for the debt. In the worst-case scenario, a sole proprietor is involved in a disaster that results in an injury or death; the sole proprietor and their assets, such as cash on hand, retirement savings, and even their home, may be held liable for the dissolution of the business. This indicates that they are taking a significant risk by entering this competition.

If you are interested in this mode of operation, the preceding sections should be carefully studied before adopting a sole proprietor as your business structure. Accidents happen, and business proprietors may fail. One-person firms are typically doomed to fail after such an experience for the sole proprietor. Individuals who own their property and are harmed by another party have the right to sue in their own name. On the other hand, a corporation or limited liability company may be compelled to initiate a lawsuit in its own name if another group commits an offence against it.

What are the advantages and disadvantages of a sole proprietorship?

The benefits of a sole proprietorship include

  •  Sole proprietors can build a firm from the bottom up swiftly, effectively, and with all of their available resources.
  • Owners are free to combine their personal and commercial resources however they like. They maintain complete control over their personal and corporate assets because they are all held by the same individual.
  •  A Sole Proprietor has no obligations or commitments to anyone and is free to operate their business.

Also Read: Primary Aspects of Setting up a Partnership Firm in India

The disadvantages of a sole proprietorship include

  • Debts, disasters, losses, and obligations of the business are solely the responsibility of the business's owners.
  •  Due to the proprietorship being a single entity without shares, proprietors cannot raise funds by selling any interest in the business.
  •  Employees have little time left over for their personal lives due to the tremendous demands of the business sector.
  •  It's a risky strategy to run a business because a sole proprietor is entirely responsible for any losses, which may jeopardise their assets as they are exposed to loans and liabilities, despite the fact that there are no conflicts or compromises.

Conclusion

A sole proprietorship is the most straightforward type of business structure to operate and maintain. It simply refers to the individual who owns the business and is thus accountable for its obligations. Sole proprietorships are popular among small businesses, freelancers, and other self-employed individuals. As a sole proprietor, you are exempt from the more complex business structures and regulations. Claims (and lawsuits) against the business are filled in the proprietor's name. In sole proprietorships, even though there are risks, the owner is the sole recipient when it comes to profit!
Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.

FAQs

Q: What are my options for passing on a sole proprietorship to a family member?

Ans:

A family business might be transmitted to the next generation as a gift, as a sale, or as a partial sale. When it comes to making money, you might assume that a sale would always be the most obvious option.

Q: For a sole proprietorship, what are the financial reports?

Ans:

For a sole owner, the income statement and the balance sheet are the two most important financial statements to be completed. It is not uncommon to create the statement of changes in owner's equity and the statement of cash flows.

Q: Is it possible for a lone proprietor to employ others?

Ans:

Like other small business owners, sole proprietorships have the option of hiring employees.

Q: Is there anything you need to do to become a sole proprietor?

Ans:

In terms of starting a business, sole proprietorships are among the simplest. In contrast to corporations and limited liability companies, you are not required to file any paperwork with the state to form a sole proprietorship. Even if your firm is tax-exempt, you are still responsible for any debts, litigation, or taxes that arise from its operations.

Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.