January 29, 2022


Accounting + Finance Blog

Sole proprietorship Meaning and key Explanations

Classification of business: Sole proprietorship

During the process of establishing a business, the entrepreneur has to decide the class of business he/she wants to use. Did he want to run the business by himself or herself? Probably, he could ask a friend to join him or look for other business minds interested in the type of business he/she envisaged. Any class of business he ends up with had its good side and bad side. In this article, the focus will be on sole proprietorship.

Different classification of businesses

Below is a list of the various classes of businesses available. We will discuss each of these in a separate article.

1. Sole proprietor (sole trader)
2. Partnership
3. Joint venture
4. Limited Liability Company (LLC)
5. A non-governmental organization (NGO)

Definition of a sole proprietorship

A sole proprietorship is a class of business carried out by a single person.

Here, the business is owned and controlled by one person either a male or female.

Other names for sole proprietorship business are a sole trader and one-man business.

What does it mean?

A sole proprietor enjoys all the profits and cash of the business.

He or she bears whatever risk that comes up from the business.

If there is a litigation, he will have to stand up for his business.

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A sole proprietor may have a management team for his business, however, the final decision making is on him or her.

He/she provides the fund to commence the business and to meet operational activities.

Not all business establishments can apply the sole proprietorship model. Banks and legal firms are not allowed to use the one-man business model.

The Good Side of a sole trader

A sole trader enjoys all the profit and cash flow. He can do whatever he wishes with the returns from the business. He may decide to expand the business or buy a personal property.

No delay in decision making. Since he/she makes all decisions, the delay in decision making caused by a disagreement between a management team is averted.

He/she managed the affairs of the entity. The entrepreneur manages all the affairs of the business. He plans for the future growth of the firm, as well as, supervises and controls its resources.

Simple to establish. The paperwork for establishing a one-man business is simple. The major requirement is a business name that is not illegal and defaming, plus a place where it is located. With that, the entrepreneur can register a business name via the Corporate Affairs Commission (CAC) in Nigeria.

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Capital outlay is small. Although there are exceptions, generally, the fund needed to run a sole proprietor entity is small. The person can use his personal savings, the gift of money from family and friends, and so on to start the business.

The Bad side of one-man business

It is quite risky. If the business turns bankrupt or cannot pay its debts, the sole owner will be required to pay such debt from his personal property.

For example, if a debt of 250,000 Naira cannot be paid from the business’ income, and the sole proprietor owns a car, the car will be sold to settle the debt of 250,000 Naira.

Competition may be scary. A one-man business cannot compete with large businesses like the Limited Liability Company. This is scarier to the sole trader if the large business selling the same products as he is in the same local.

He may choose the wrong alternative decisions. It generally does that there is nothing like the wrong decision, but an optimal decision. However, a decision may become wrong if it doesn’t achieve its purpose.

There is another saying that two good heads are better than one. When a single person chooses from various alternatives, the probability of making the wrong choice is high. This especially can bring down the business. might not be enough. As a result of the small capital outlay, the entrepreneur may not expand more than the area it is located in. Alternatively, he/she may seek loans to expand but most banks may not issue loans to small businesses.

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Aside from this, he/she may end up spending both the revenue generated from the business and the capital for personal gains.

Lack of proper bookkeeping. Most small businesses lack bookkeeping culture. The sole trader may not know the amount of revenue. Even if he knows, he does not know if he makes profit or loss and therefore may eat up the cash available from the business thinking it is the profit.

To conclude, you should remember that sole traders are one-man stuff. This gives him/her to own everything on the business including decision making. However, their risk of bankruptcy that may lead to the disposal of its private properties.