LIVE Course for free

Rated by 1 million+ students
Get app now
NEET 2023
0 votes
in Business Studies by (57.6k points)

What do you understand by a sole proprietorship firm? Explain its merits and limitations?

1 Answer

+1 vote
by (51.9k points)
selected by
Best answer

Sole proprietorship refers to a form of business organization which is owned, managed and controlled by an individual who is the incipient of all profits and bearer of all risks. The word “sole” implies “only” and “proprietor” refers to “owner”. Hence, a sole proprietor is the only owner of a business. This form of business is particularly common in small scale business and areas of personalized services.

Features of Sole Proprietorship

(i) Formation and Closure Very few legal formalities are required to start a sole proprietary business, except in the fields where a license is required. Closure of the business can also be done easily.

(ii) Unlimited Liability Sole proprietors have unlimited liability. This implies that the owner is personally responsible for payment of debts in case the assets of the business are not sufficient to meet all the debts.

(iii) Sole Risk Bearer and Profit Recipient The sole proprietor bears the risk of failure of business all alone and also receives all the business profits which are a reward for his risk bearing.

(iv) Control and Decision Making The sole proprietor has the absolute right to run the business and make all decisions regarding the business without any interference from others. He is the king in all aspects.

(v) No Separate Entity No distinction is made between the sole proprietor and his business in terms of law as business does not have an identity separate from the owner. The owner is, therefore, held responsible for all the activities of the business.

(vi) Lack of Business Continuity Sole proprietorship lacks continuity as death, insanity, imprisonment, physical ailment or bankruptcy of the sole proprietor. It will have a negative effect on the business and may even cause closure of the business.

Merits of Sole Proprietorship

(i) Prompt Decision making: Making The decision making is prompt under sole proprietorship as there is considerable degree of freedom in making business decisions and there is no need to consult others. This results in timely capitalization of market opportunities.

(ii) Confidentiality All the information related to business operations is kept confidential and secrecy is maintained as the sole decision making authority rests with the proprietor. A sole proprietor is also not bound legally to publish firm’s accounts.

(iii) Direct Incentive The sole proprietor receives all the business profits as a reward for bearing the business risk. He/she is the single owner and does not need to share profit. This provides an incentive to the sole proprietor to work hard.

(iv) Sense of Accomplishment There is a sense of personal satisfaction involved in working for oneself. It instills a sense of accomplishment and confidence in the individual. 

(v) Ease of Formation and Closure An important merit of sole proprietorship is the possibility of entering into business with minimal legal formalities. There is no separate law that governs sole proprietorship. As sole proprietorship is the least regulated form of business, it is easy to start and close the business as per the wish of the owner.

Limitations of Sole Proprietorsltip

(i) Limited Resources Resources of a sole proprietor are limited to his/her personal savings and borrowings from others. Banks and other financial institutions hesitate to provide long term loan to a sole proprietor and hence, the size of the business generally remains small. 

(ii) Limited Life of a Business Concern Death, insolvency or illness of a proprietor has detrimental effects on the business and can lead to its closure.

(iii) Unlimited Liability A major disadvantage of sole proprietorship is the unlimited liability of the owner. In case of failure of business, the creditors can recover their dues not only from the business assets but also from the personal assets of the proprietor. 

(iv) Limited Managerial Ability Ability An individual may not be good in all managerial tasks such as purchasing, selling, financing, etc. Thus, decision making of a sole proprietor may not be effective in all the cases. Though sole proprietorship suffers from certain limitations, many entrepreneurs opt for this form of organization because it requires less amount of capital and is best suited for small businesses and where customers demand personalized services.

Welcome to Sarthaks eConnect: A unique platform where students can interact with teachers/experts/students to get solutions to their queries. Students (upto class 10+2) preparing for All Government Exams, CBSE Board Exam, ICSE Board Exam, State Board Exam, JEE (Mains+Advance) and NEET can ask questions from any subject and get quick answers by subject teachers/ experts/mentors/students.