1. UNIT FOUR
THEORY OF THE FIRM

2. THEORY OF FIRM The original theory of the firm is profit max.
Others are:
a. customer satisfaction
b. market share

3. BUSINESS UNIT
A logical element or segment of a company (such as accounting, production, marketing) representing a specific business function, and a definite place on the organizational chart, under the domain of a manager. Also called department, division, or a functional area.

4. TYPES OF BUSINESS UNIT
NATIONAL INTERNATIONAL

5. NATIONAL & INTERNATIONAL BUSINESS UNIT
National business unit is an entity that conduct economic activities within the boundaries of the domestic economy.
International business unit is an entity that conduct economic activities within and outside the boundaries of the domestic economy.

6. PRIVATE FIRM
Entities own by private individual, groups, other companies or a combinations.
The main types of business organisation in the private sector are - sole traders, partnerships, companies and franchises. The sole trader is the most common form of business ownership and is found in a wide range of activities (e.g. window cleaning, plumbing, electrical work, busking). .

7. PUBLIC SECTOR FIRMS
Entities that are under the control and management of the state.
A government-owned corporation, state-owned company, state-owned enterprise, state-owned entity, state enterprise, publicly owned corporation, government business enterprise, commercial government agency.

8. SOLE TRADER
A sole proprietorship, also known as the sole trader or simply a proprietorship, is a type
of business entity that is owned and run by one individual or one legal person and in which there is no legal distinction between the owner and the business.

9. ADVANTAGES
Control - Sole traders maintain full control of their business. Running it how they please without the interference of others.
Profit retention – Sole traders retain all the profits of their business.
Private data – Information about sole traders is kept private, unlike that of limited companies which is necessarily made public after registration with Companies House.

10. Specialist – Often a small business, sole traders can offer a more personal service with local roots and ties. This can be more appealing to potential customers in the local community.
Personal – Because there is no need to confer with other decision makers, sole traders can make decisions quickly and act on them swiftly, providing for the needs of their customers. .

11. DISADVANTAGES
Liability – sole traders are not seen as a separate entity by the law. Therefore, they are subject to unlimited liability. This means if the business gets into debt, the business owner is liable. In the worst case, this may mean a person risks their home, personal savings and any other assets they have both in and outside of the business.
Finance – sole traders often find it difficult to raise finance to fund their business. They may struggle with expansion in the future.

12. Reverse economies of scale – sole traders will be unable to take advantage of economies of scale in the same way as limited companies and larger corporations, who can afford to buy in bulk. This might mean that they have to charge higher prices for their products or services in order to cover the costs.
Decision making – all decisions must be made by the sole trader. There is no room for help by others. So the success or failure of the business rests on one person.

13. PARTNERSHIP A partnership is a single business
where two or more people share ownership. Each partner contributes to all aspects of the business, including money, property, labor or skill. In return, each partner shares in the profits and losses of the business.

14. ADVANTAGES two heads (or more) are better than one
your business is easy to establish and start-up costs are low
more capital is available for the business
you’ll have greater borrowing capacity
high-calibre employees can be made partners

15. there is opportunity for income splitting, an advantage of particular importance due to resultant tax savings
partners’ business affairs are private
there is limited external regulation
it’s easy to change your legal structure later if circumstances change.

16. DISADVANTAGES
the liability of the partners for the debts of the business is unlimited
each partner is ‘jointly and severally’ liable for the partnership’s debts; that is, each partner is liable for their share of the partnership debts as well as being liable for all the debts
there is a risk of disagreements and friction among partners and management

17. each partner is an agent of the partnership and is liable for actions by other partners
if partners join or leave, you will probably have to value all the partnership assets and this can be costly.

18. GEARING RATIO
A general term describing a financial ratio that compares some form of owner's equity (or capital) to borrowed funds. Gearing is a measure of financial leverage, demonstrating the degree to which a firm's activities are funded by owner's funds versus creditor's funds.

19. The gearing ratio is a measure of the firm’s financial leverage or risk
Financial risk is an additional risk taken on by a firm when it financed apart or all of it total assets using debt.

20. Businesses have the option of buying their assets by going into debt or by using the money from people who have invested in the business {shareholders}. Such method of financing is called equity financing.

21. EXAMPLE OF GEARING RATIO
Times Interest Earned = Earnings Before Interest and Taxes/Interest
= # of times
Times Interest Earned ratio tells you how
many times over the business can pay its
interest payments on debt. The higher the
TIE ratio, the more liquid the firm and the
less debt the firm has.

22. Fixed Charge Coverage = Earnings Before Interest and Taxes + Other Fixed Charges/Interest + Other Fixed Charges 
= # of times
where the fixed charge coverage ratio tells you how many times over the business can pay its interest payments on debt, lease payments, and other fixed charges. The higher the fixed charge coverage ratio, the more liquid the firm and the less debt and fixed charges the firm has.

23. Debt to Equity = Total Debt/Total Shareholder's Equity
= _____%
As the debt to equity ratio increases, gearing
also increases along with the financial risk of
the firm.

24. Long-term Debt to Total Capitalization = Long-term Debt/Long-term Debt + Shareholder's Equity
= ______ %
This ratio shows how much long-term debt, such as mortgages and bonds, finance the firm's total assets. If this ratio is high as compared to industry averages, the firm's gearing is high which is also a measure of financial risk.