Business Organizations 1

Chapter 3
Business Organizations

Learning Competencies
The learners should be able to……
1. Differentiate the forms of business organizations.
2. Identify the advantages and disadvantages of each form of business organization.
3. Compare and contrast the types of business according to activities.
4. Identify the advantages, disadvantages, and business requirements of each type of business
organization.

Introduction
A business is an activity where goods or services are exchanged for money. A person who is
engaged in business is called an entrepreneur or businessman. Businesses come in different
forms and types. These are discussed below:

Forms of Business Organizations:

Businesses in the Philippines are organized in one of the following:

1. Sole or single proprietorship - is a business that is owned by only one individual. It is the
most common and simplest form of a business organization. The business owner is called a
“sole proprietor.”
A sole proprietorship is registered with the Department of Trade and Industry (DTI).

2. Partnership – is a business that is owned by two or more individuals who entered into a
contract to carry on the business and divide among themselves the earnings therefrom. The
business owners are called partners.
A partnership is registered with the Securities and Exchange Commission (SEC).

3. Corporation – a corporation is also owned by more than one individual. However, unlike
partnership, a corporation is created by operation of law rather than a contract. Ownership
in a corporation is represented by shares of stocks while the owners are called stockholders
or shareholders.
A corporation is an artificial being or a juridical person, meaning in the eyes of the law, a
corporation is like a person, separate from its owners. Therefore, a corporation can transact in
its own, it can own properties, incur obligations, and it can even sue or be sued.
For example, when you buy goods from a corporate business, you are actually transacting
with the corporation and not its owners. If you get sick from consuming the goods, you will sue
the corporation and not its owners.
A partnership also has a juridical personality. However, unlike for corporations, the
partners are viewed as agents of the partnership. Meaning, the partners transact on behalf of the
partnership.
For example, if you transact with a partner of a business, you are transacting with the
partnership through the partner. While if you transact with a stockholder, this does not
necessarily mean that you are transacting with the corporation.
The incorporators (i.e., founders) of a corporation shall not be less than 5 but not more
than 15 individuals. However, a corporation can have as many stockholders as its authorized
capitalization permits.
A corporation is registered with the Securities and Exchange Commission (SEC).
Business Organizations 2

4. Cooperative – a cooperative is also owned by more than one individual. However, a

cooperative is formed in accordance with the provisions of The Philippine Cooperative
Code of 2008. The owners of a cooperative are called “members.”
From the root word “cooperative,” a cooperative is an association of individuals who
joined to contribute capital and cooperate to achieve certain goals.
For example, a group of farmers form a cooperative to acquire delivery trucks to be used in
transporting their produce to the market. In here, the farmers voluntarily join to achieve a
common goal, which is to address their need to get the produce to the market.
Another concept of a cooperative is that members need to patronize the cooperative’s good
or services. In the example above, the member farmers shall hire delivery trucks from the
cooperative rather than from other businesses. If the cooperative earns profit (net surplus), a
farmer can recover his costs through patronage refunds. Patronage refunds pertains to the
profit that a cooperative return to its owners. It should be noted that the member who has not
patronized any of the services of the cooperative for an unreasonable period of time may be
removed from the cooperative upon the majority vote of the board of directors.
A cooperative also has juridical personality similar to a corporation.
The founding members of a cooperative shall not be less than 15 individuals. However, a
cooperative can have as many members as its by-laws permits.
A cooperative is registered with the Cooperative Development Authority (CDA).

Summary: Forms of Business Organizations

Form of business Ownership Formation/Registration
organization
1. Sole proprietorship  One individual (i.e.,  Registered with DTI.
sole proprietor)
2. Partnership  More than one (i.e.,  Formed by contractual
partners) agreement.
 Registered with the
SEC.
3. Corporation  More than one (i.e.,  Formed by operation
stockholders) of law.
 Registered with the
SEC.
4. Cooperative  More than one (i.e.,  Formed in accordance
members) with the Cooperative
Code.
 Registered with the
CDA.

Advantages and Disadvantages of the Different Forms of Business Organizations

Sole Proprietorship
Advantages Disadvantages
 You are the boss, and you keep all the  You assume all the risk of loss.
profits.

 Decision making is simple because  You take all responsibility and rely
you have complete control over the mostly on yourself in making
business. decisions.
Business Organizations 3

 Relatively easier and less costly to  It is more difficult to raise capital

form because there are fewer formal because you rely mostly on your
business requirements. personal assets and loans to initially
finance the business.

 Lower extent of government  You are personally liable for the debts
regulation and relatively lower taxes. and obligations of the business.

Partnership
Advantages Disadvantages
 Better business decisions can be made  Making business decisions may give
because “two heads are better than rise to conflict among the partners.
one.”

 You share the business risk and the  You do not keep all the profits because
responsibility of running the business you need to share them with your
with your partner. partners.

 Compared to corporations and  Limited life, in the sense that a

cooperatives, a partnership is easier to partnership can be easily dissolved by
form because only a contractual the withdrawal, retirement, death or
agreement between the partners is insanity of one of the partners.
needed.

 Greater capital compared to a sole  Lesser capital compared to a

proprietorship. corporation.

 Relatively lower extent of government  A partnership (other than a general

regulation compared to corporations. professional partnership) is taxed like
a corporation.

 Unlimited liability. The partners can

be held liable for partnership debts up
to their personal assets.

Corporation
Advantages Disadvantages
 A stockholder who is not a member of  Your “say” on corporate affairs
the corporation’s board of directors is depends on the number of shares you
relieved from managerial own. Those who own more shares are
responsibilities. Only the stockholders the bosses and enjoy a larger share of
that are elected as members of the the corporation’s profits.
board of directors and those they hire
or appoint are tasked with managerial
responsibilities. This can be an
advantage because a regular investor
does not need to work for the
corporation to earn income.
Business Organizations
 Limited liability of the owners because
stockholders are liable for corporate
debts only up to the amount they have
invested.
 Greater capital and ease in raising
additional funds because a corporation
can issue shares to a wider extent of
investors.
 If the corporation is listed, you can
easily transfer your shares to other
investors by selling them in the stock
market. Many investors earn profits
this way – by buying shares at a cheap
price, wait for prices to go up, and
then sell them. This activity is referred
to as stock trading.
 Unlimited life, in the sense that the
withdrawal, retirement, death or
insanity of one of the stockholders
does not dissolve the corporation.
Although a corporation has a legal life
of 50 years, this can be renewed for an
indefinite number of renewals.
Cooperative
Advantages
 Unlike in a corporation, your “say” on
cooperative affairs is not affected by
the number of shares you own. This is
because, in a cooperative, each
member is entitled to one vote
regardless of his or her shareholdings.
However, members with larger
shareholdings are entitled to larger
amount of profit (net surplus).
 A cooperative is generally exempt
from paying taxes. This is the main
advantage of a cooperative and the
most common reason why
cooperatives are organized. Moreover,
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 A corporation is more difficult and
more costly to form because there are
more formal business requirements.
 Greater extent of government
regulation and higher taxes.
 Unlike for a sole proprietorship or a
partnership where business profits are
easily distributed to the owner(s), in a
corporation, you have to wait for the
board of directors to declare dividends
before you get your share in the profits
of the corporation.
Disadvantages
 A cooperative is prone to poor
management. Cooperatives are, often,
managed by members who were
elected as board of directors rather
than by employed professional
managers. Since there is a ‘one-
member, one-vote’ policy in a
cooperative, influential members tend
to dominate the election process. The
result is that those who get elected
may not be the ones who are most
qualified for the task.
 A cooperative is susceptible to
corruption. Due to its management
structure and lack of profit motive, the
elected officers may be inclined to act
on their personal interests.
Business Organizations
a cooperative may receive assistance
from the government.
 Compared to a corporation, a
cooperative is easier and less costly to
form because there are fewer formal
business requirements.
 Limited liability – the members are
liable for cooperative debts only up to
the amount they have invested.
 Unlimited life, in the sense that the
withdrawal, retirement, death or
insanity of one of the stockholders
does not dissolve the cooperative.
Although a corporation has a legal life
of 50 years, this can be renewed for an
indefinite number of renewals.
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 The Cooperative Code places some
restrictions on the distribution of a
cooperative’s profit to its members.
More specifically, the Code requires a
cooperative to appropriate a portion of
its annual profit to some funds. Only
the remaining portion can be
distributed to the members.
Furthermore, when the cooperative is
dissolved, the amount accumulated in
a fund called the “reserve fund” shall
not be returned to the members, but
rather donated to another cooperative
or the community.
 Compared to a corporation, it is more
difficult for a cooperative to sustain
growth. This is in part because of the
lack of profit motive and lack of
management expertise. Moreover, a
cooperative’s success strongly depends
on the members’ cooperation and
members are not always willing to
cooperate. The success of a business
depends on continuing effort. Sadly,
many cooperatives are zealous at the
start but fail to sustain continuing
effort resulting to the waning down of
their activities. This does not mean
though that all cooperatives are small
businesses. There are many multi-
billionaire cooperatives in our country.
Some might be located in your
community.
 Unlike in a corporation where the
stockholder can freely transfer his
shares, in a cooperative, there are
restrictions on the transfer of a
member’s shares. For example, the
approval of the board of directors must
first be obtained before a member can
transfer his or her shares.
Business Organizations 6

Types of Business According to Activities

The following are the major types of business according to the activities they undertake:
1. Service business
2. Merchandising (Trading)
3. Manufacturing

Service business
A service business is one that offers services as its main product rather than physical goods. A
service business may offer professional skills, expertise, advice, lending service, and similar
services.

Examples of service businesses include:

a. Schools
b. Professionals (accounting firm, law firm, electrician, etc.)
c. Hospitals and clinics
d. Banks and other financial institutions
e. Hotels and restaurants
f. Transportation and travel (taxi operator, travel agency, etc.)
g. Entertainment and events planners (wedding planners, concert promoters, etc.)

Merchandising business
A merchandising business (or trading business) is one that buys and sells goods without
changing their physical form.

Examples of merchandising businesses include:

a. General merchandise resellers (grocery stores, department stores, hardware stores,
pharmacies, online stores, sari-sari stores, etc.)
b. Distributors and dealers (rice wholesalers, vegetable dealers, 2nd hand cars dealers, etc.)

Manufacturing business
A manufacturing business is one that buys raw materials and processes them into final
products. Unlike a merchandising business, a manufacturing business changes that physical
form of the goods it has purchased in a production process.
For example, a business that buys and sells eggs is a merchandising business. On the other
hand, a business that buys eggs and uses the eggs as ingredient in producing cakes for sale is a
manufacturing business.

Examples of manufacturing businesses include:

a. Car manufacturers (Toyota, Isuzu, Volkswagen, etc.)
b. Technology companies (Apple, Samsung, Sony, etc.)
c. Food processing companies (San Miguel Pure Foods, Silver Swan, etc.)
d. Factories (clothing factories, animal feeds factories, plastic wares factories, etc.)

Some businesses, called hybrid businesses, engage in more than one type of activity. For
example, a restaurant uses ingredients to cook a meal (manufacturing), sells Coca-Cola drinks
(merchandising), and serves food to consumers (service). Nevertheless, a hybrid business is
classified into one of the major types based on the activity that is most in line with the
business’ purpose. Restaurants are expected to fill-in customer orders and provide dining
services; thus, they are more of a service business.
Business Organizations
Advantages and Disadvantages of the Different Types of Business
Service Business
Advantages
 You do not need to worry about
inventory costs, warehousing, and
distribution costs because you do not
have any inventory. You only have
some minimal supplies necessary in
providing your services.
 You may only need a small capital
because what you are selling is your
skill set and you only need yourself to
render a service. If you are a
manufacturer, you need to buy raw
materials and machinery to produce
your product.
 You are perceived as an expert in your
chosen field. People respect you. You
can also have fans.
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Disadvantages
 You may not have a flexible personal
time because you need to be directly
involved in providing a service to a
customer. You can stock inventory but
not service.
For example, if you are a
manufacturer, you can spend over time
to produce goods, stock them, and then
take break. However, if you are a
doctor, you are on call, and must be
the one to personally examine a
patient.
Until your business is big enough to be
able to hire other professionals to do
the work for you, you will need to
render the services yourself.
 Service businesses normally suffer
first from decline in demand during
times of economic difficulty. This is
because most services are perceived as
luxuries rather than necessities for
survival.
For example, a guy with low funds
would refrain from having a haircut
and uses his funds for food instead. A
smart gal with low funds would cut
back her expenditures on spa and
pedicure.
 Your business’ success depends on
your credibility. Personally, you must
have a good reputation. You need to be
always discreet in the things you say
and the way you act in the society.
 Since a service business is founded on
good reputation, it is more costly to
commit an error in a service business
compared to a merchandising business.
For example, if a merchandising
business erroneously sells damaged
goods, the customer can just return the
Business Organizations
Merchandising Business
Advantages
 Compared to a manufacturing firm,
you may need a much lower start-up
capital because you don’t need to
acquire machineries to produce goods.
 You can take advantage of price
fluctuations. For example, when goods
are on sale, you can acquire them at a
discounted price and resell them at a
much higher price. You can’t do this
in a service business.
 Lower cost of quality. This is because
“what you buy is what you sell.”
In a service or manufacturing business,
you need to continually improve your
products to maintain their salability. In
a merchandising business, if a certain
product is not selling well, you can
just stop buying it and find an
alternative product, another brand
maybe.
 It is much easier to start a
merchandising business because you
don’t need to have an expertise or a
special skill (service business) and you
don’t need to have invented a new
product or have conceptualized an
innovative idea for an existing product
(manufacturing business).
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goods and have them replaced.
However, if you are a barber and
commits an error, you can’t just
replace your customer’s hair!
Disadvantages
 You need to have a retail store to
display your goods and the store must
be in a strategic location for it to
attract more customers.
 Less flexibility in managing costs.
This is because the cost of your goods
is based primarily on their purchase
price, which you do not control.
*In a manufacturing business, you can
cut down costs by redesigning your
product, improving your processes,
acquiring more efficient machines,
employing more skillful personnel,
and so much more.
 Keeping track of inventory is tedious,
most especially when you are selling
numerous and varied items with fast
turnover rate, like for example if your
business is a hardware store or a
grocery store. Also, you can incur
additional costs due to spoilages, theft,
breakages, damages, and obsolescence.
 Self-satisfaction is low because you
did not produce the products you sold.
Business Organizations
Manufacturing Business
Advantages
 You have a high growth potential
because you can tap into a wider
market and can produce in large
quantities.
 You can establish a brand that could
last longer than your lifetime. This is
the ultimate dream of most
entrepreneurs.
 Self-satisfaction is high. Knowing that
consumers are happy and satisfied
with a tangible product you have
produced brings you pride and joy.
 You may not need to have a
strategically located retail store to
display your products because you can
sell directly to wholesalers rather than
to end consumers.
 You can have a better pricing policy
because mass production can decrease
your unit cost (often called ‘economies
of scale’).
For example, you are paying rent of
P100,000 for your factory space. If
you produce only 1 unit of a product,
you unit cost is high because the rent
will be allocated to only 1 unit, i.e.,
P100,000-unit cost (P100,000 / 1 unit).
Therefore, you need to sell this unit for
more than P100,000 to earn profit.
However, if you produce 10,000 units,
your unit cost would be much lower
because the rent will be allocated to
more units, i.e., P10 (P100,000 /
10,000 units). You can now sell each
unit at a much lower price.
 Greater flexibility in managing costs.
(See discussion in disadvantage of a
merchandising business above*)
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Disadvantages
 You need to a high start-up capital to
acquire machineries, to employ people,
and to acquire a big space for your
production.
 Conceptualizing a viable
manufacturing business is difficult.
Therefore, more entrepreneurs would
rather engage in merchandising.
 You need to be continuously
innovative and abreast of changes in
technology. If another company comes
up with a better and cheaper product,
your product will automatically lose
demand.
 Warehousing and logistics costs can be
high.
 You rely on raw materials. You need
to manage them properly to ensure that
they are available when they are
needed. This is because a shortage in a
raw material can disrupt your
operation, and that can be very costly.
For example, when cooking rice, all
the ingredients you need must be
available. You cannot cook the rice
now and just add the water later on.
In a merchandising business, if you
run out of a specific good, you don’t
necessarily need to close your store
because you can still sell other goods.
 Managing a manufacturing business
can be difficult because production
processes are often complicated and
there is always some room for
improvement. Although many skilled
Business Organizations 10

managers may take this positively as a

challenge. Also, more accounting work
is needed. That is why there is a
separate branch of accounting formed
primarily for manufacturing
businesses, i.e., cost accounting.