5.3 Limited companies

Home

You will not be expected to understand cumulative and non-cumulative preference shares, rights issues, share premium or capital redemption reserve. However, You should understand the difference between redeemable and non-redeemable preference shares.

Starting point

Having a sole trader or partnership business model is a great way of running business but one of the greatest problems is Unlimited Liability owners and partners may need to sell their own assets to cover business debts or losses. There is no separate legal identity. These types of businesses are called unincorporated businesses.

What to do?

Businesses incorporate as limited companies to avoid the unlimited, personal liability that falls on sole traders and partnerships.

Is it easier to form and run a limited company?

Since it provided protection from unlimited liabilities to its owner, limited companies are subject to more strict legal regulation in terms of formation, preparation, reporting and checking (auditing) of their financial statements.

Lets start from definition:

A business that has a separate legal identity from its shareholders (owners).

Shareholders?

Shareholders are the owners of a limited company. They buy shares, which represent part-ownership of the company.

Share Capital?

Share capital is the money invested in a limited company by shareholders in exchange for shares

Limited Liability?

Shareholders of a limited company are not personally liable for the debts of the business.

Equity of a limited company?

The value of the shares issued by a limited company.

Advantages and Disadvantages of Operating as a Limited Company

Advantages:

Limited Liability: Shareholders are only liable for the amount they invested in the company, protecting personal assets.
Access to Capital: Ability to raise capital through the sale of shares.
Continuity: Business continues to exist even if shareholders change or pass away.
Separate Legal Entity: Business is a separate legal entity from its owners,

Disadvantages:

Regulatory Requirements: More strict regulatory and reporting requirements compared to sole traders and partnerships.
Cost: Higher initial setup costs and ongoing administrative expenses.
Complexity: More complex management and decision-making processes.
Public Disclosure: Financial statements and certain company details are publicly available, reducing privacy.

Capital Structure of a Limited Company

Capital Structure: The composition of a company’s financing through debt and equity. For a limited company, it typically includes:

Preference Share Capital: Share capital that returns a fixed dividend, They have preferential rights over ordinary shares, often in receiving dividends but no voting right.
Ordinary Share Capital: Shares that represent ownership in the company and carry voting rights.
General Reserve: Part of retained profits available for distribution to shareholders .
Retained Earnings: Profits that have been reinvested in the business rather than distributed as dividends.

Issued, Called-up, and Paid-up Share Capital

Authorized share capital the maximum value of share capital a limited company can issue
Issued Share Capital: The total value of shares that the company has issued to shareholders.
Called-up Share Capital: The portion of issued capital that shareholders are called upon to pay.
Paid-up Share Capital: The actual amount paid by shareholders for their shares.

Share Capital vs. Loan Capital

Share Capital: Represents funds raised by issuing shares to shareholders. Includes both preference and ordinary shares.
Loan Capital (Debentures): Long-term borrowing by the company, usually with a fixed interest rate and repayment schedule.

Preference shares vs Ordinary shares:

Preference shares:

Receive a fixed rate of dividend.
The dividend is paid before the ordinary share dividend.
Preference shares do not usually carry voting rights.
Capital is returned before the ordinary share capital in a winding up

Ordinary shares:

They are also known as equity shares.
The dividend is paid after the preference share dividend.
The dividend may vary according to profits.
Ordinary shares usually carry voting rights.
Ordinary shares are the last to be repaid in a winding up

Redeemable preference vs Irredeemable preference

Redeemable preference shares are preference shares which are repayable by the company at a specified future date. On this date the shares are canceled and the shareholders are repaid

Non-current liability: these shares have the characteristics of debt. They are therefore classified as a non-current liability on the statement of financial position.

Dividends paid on redeemable preference shares would be treated as an expense in the statement of profit and loss and other comprehensive income.

Irredeemable preference shares are preference shares which are not redeemable. They remain in existence indefinitely.

Equity: These shares are classified as equity on the statement of financial position.

Dividends paid on irredeemable preference shares would be found in the Appropriation account in the statement of profit and loss and other comprehensive income.

Statement of Changes in equity is a financial statement showing the changes in the value of the shareholders' investment in a company over time