explain the advantages and disadvantages of operating as a limited company

Topic 5.3 – Limited Companies

1. Definition & Core Concepts

• Limited company: a business that is a separate legal entity from its owners (the shareholders).
• Limited liability: shareholders are liable only for the amount unpaid on their shares; their personal assets are protected.
• Ownership vs management: shareholders own the company, while directors are appointed to manage it on their behalf.
• Equity capital (share capital) is raised by issuing shares; loan capital (e.g., debentures) is borrowed and must be repaid with interest.

2. Capital‑Structure Terminology (required by the syllabus)

3. Numerical Example – Share Issue & Presentation in the Balance Sheet

Company ABC Ltd issues 10 000 ordinary shares with a nominal value of £1 each.

• Issued share capital = 10 000 × £1 = £10 000
• Directors call up £0.75 per share → called‑up share capital = 10 000 × £0.75 = £7 500
• Shareholders have paid £0.50 per share so far → paid‑up share capital = 10 000 × £0.50 = £5 000
• Unpaid amount = £0.25 per share → £2 500 remains unpaid (the amount for which shareholders have limited liability).

How it appears in the equity section of the balance sheet (simplified):

4. Advantages of Operating as a Limited Company

• Limited liability – shareholders are only liable for the unpaid amount on their shares.
• Separate legal entity – the company can own property, sue and be sued in its own name.
• Continuity of existence – the company continues despite changes in ownership or management.
• Access to capital – can raise finance by issuing ordinary or preference shares, or by borrowing on the company’s credit.
• Enhanced credibility – customers, suppliers and lenders often view a limited company as more stable and trustworthy.
• Tax planning opportunities – profits may be retained and taxed at corporation‑tax rates, which can be lower than personal income‑tax rates.
• Transferability of ownership – shares can be bought and sold without affecting the company’s operations.
• Professional image – the status of “Ltd” can attract investors and improve market perception.

5. Disadvantages of Operating as a Limited Company

• Regulatory requirements – must comply with the Companies Act, file annual accounts, a confirmation statement and maintain statutory registers.
• Higher accounting and filing costs – professional fees for preparation of statutory accounts, audits (if applicable) and filing are greater than for sole traders or partnerships.
• Public disclosure – financial statements and certain company details are available on the public register.
• Restrictions on profit distribution – profits can be distributed only as dividends after corporation tax and must follow legal procedures.
• Complex decision‑making – major decisions often require board approval and/or shareholder meetings, which can slow action.
• Potential double taxation – profits are taxed at corporate level and dividends are taxed again in the hands of shareholders.
• Share dilution – issuing new shares may reduce existing shareholders’ control. Note: share dilution is a required disadvantage to mention in the exam.

6. Summary Table – Advantages & Disadvantages

7. Required Financial Statements for a Limited Company

A limited company must prepare the same three primary statements as a sole trader, but the equity section is presented differently.

1. Income Statement (Profit & Loss Account)
   • Revenue – Cost of sales – Gross profit – Operating expenses – Interest – Tax = Net profit for the year.
2. Statement of Changes in Equity
   • Opening balances: issued, called‑up and paid‑up share capital; general reserve; retained earnings.
   • Add: Net profit for the year.
   • Deduct: Dividends declared (and any share premium, if applicable).
   • Closing balances: total equity (share capital + reserves).
3. Statement of Financial Position (Balance Sheet)
   • Assets (non‑current + current) = Liabilities (non‑current + current) + Equity (share capital + reserves).

8. Year‑End Adjustments – Checklist

All adjustments that are required for a sole trader must also be applied to a limited company.

• Depreciation of plant and equipment.
• Accruals – expenses incurred but not yet paid (e.g., salaries, interest).
• Pre‑payments – expenses paid in advance.
• Irrecoverable debts – write‑off of trade receivables unlikely to be collected.
• Closing inventory – adjust to the actual stock on hand at year‑end.
• Dividends – recognise the liability for dividends declared but not yet paid.

9. What You Do NOT Need to Know (to avoid unnecessary detail)

• Cumulative vs non‑cumulative preference shares.
• Rights issues and the mechanics of share premiums.
• Capital‑redemption reserve.
• Detailed calculations of share‑premium accounts.

These topics are **outside the IGCSE 0452 syllabus** and will not be marked.

10. Suggested Diagram

11. Exam Tips

1. Give a balanced answer – list **at least three** advantages and **at least three** disadvantages.
2. Use the exact syllabus terminology: “limited liability”, “separate legal entity”, “higher accounting and filing costs”, “public disclosure of financial statements”, “share dilution”.
3. Where possible, support a point with a brief numerical example (e.g., share‑issue figures shown in the balance‑sheet equity section).
4. Structure your response: short definition → bullet‑point advantages → bullet‑point disadvantages → concluding sentence weighing the two sides.
5. Remember the required disadvantage: **share dilution**.
6. For the statement of changes in equity, list the four components (opening equity, profit, dividends, closing equity) exactly as shown above.